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Briggs & Stratton Corp. (NYSE:BGG)

F1Q09 Earnings Call

October 16, 2008; 10:00 am ET

Executive

John Shiely - Chairman of the Board, Chief Executive Officer

James Brenn - Chief Financial Officer, Senior Vice President

Analyst

Michael Hamilton - RBC

James Bank - Sidoti & Company

Gil Nathan - Restoration Capital

Peter Jacobs - Wells Fargo

Steven Gortler - Concentric

Craig Kennison - Robert W. Baird

Sam Darkatsh - Raymond James

Operator

Welcome to the Briggs & Stratton first quarter earnings release conference call. (Operator Instructions) I would now like to introduce your host for today’s program Jim Brenn.

James Brenn

John Shiely our Chairman and Chief Executive Officer and I will be with you on this morning’s call. Before John starts, I’d like to remind you that this presentation and our answers to your questions contain forward-looking statements. These statements are based on our current assessment of the markets we operate in and other factors that could affect our business.

Actual results could differ materially from any stated or implied projections due to changes in one or more other factors as described in our filings with the SEC including, but not limited to our 2008 annual report to shareholders on Form 10K.

As Johnson indicated, the conference call would be made available on our website two hours after the end of this call and a phone replay will also be available in a few hours of the completion of this call.

Now I’ll turn it over to John to cover the first quarter results and our outlook.

John Shiely

As you see from this mornings earning release, consolidate net sales were $458 million, an increase of $91 million from the revenues in the first quarter of last year. The release also reported a net loss of $2 million, an improvement of $19 million over the net loss experienced [Inaudible] each operating segment contributed to these improvements. I’m going to start with a discussion of each of them.

The engine segment had net sales of $259 million before eliminations, an increase of $15 million or 24% between years. Effectively the entire increase was driven by a 27% increase in engine unit volume. Smaller displacement engines used primarily on equipment were the largest contributor to volume increase. Retail sales of lawn and garden equipment were recently good during the first quarter.

In the former months continuing retail demand resulted in better engine reorders, because retailers and OEMs had again attempted to minimize their inventories after the spring selling season. Consequently they needed to meet demands for reordering production. However, at this time we are not increasing our 2009 engine shipment forecast for this activity, because while we are reasonably confident of our placement with the OEMs and major retailers for the spring in 2009, the current economic conditions indicate the spring lawn and garden season maybe challenging. I will discuss this more fully when we get to our outlook.

First quarter engine shipments also were impacted by the landfall of the number of hurricanes in the United States for the first time in three years. In addition, the heavy demand for snow equipment last winter depleted inventories giving better preseason and early season snow engine orders than we saw last year. The impact of these events was enhanced by improvements in market placement for both our engines and the related products.

Major contributor to the first quarter’s improvement in the engine segment income from operations was the impact of the increased shipment volume. Next largest benefit in the first quarter was the fact that the Rolla Missouri Engine Plant was in the process of being closed down in the first quarter last year; in this year none of those costs existed.

Finally on a smaller scale, slightly increased production levels and some pricing improvement provided some gains in income from operations. All of these favorable factors in the first quarter were partially offset by a mix of product that favored engines to have smaller margins as well as increased manufacturing expenses that reflect higher cost for our major raw materials and other costs such as transportation that are affected by higher oil prices.

Now let me turn to the power product segment. First quarter net sales at $256 million were up $68 million between years. Our net share this morning is the exact opposite of that a year ago when we indicated that the lack of landed hurricane activity had significantly reduced interests in the portable generator category and the lack of activity would be a cycle that would be just forced to wait out.

In the first quarter of this year the majority of the sales increase in this segment was due to increased shipments in portable generators to address demand from landed hurricanes. Our shipments were aided by a continued strong placement of our products at key retailers. These retailers value our domestically based production from both engines and portable generators that allows us to work with them and react in a timely manner to the intense spikes in sales activity that comes from the significant concentration of storm related demand in a very short period of time.

Net sales for this segment also increased $14 million between years because of our acquisition of the Australian manufacturer of lawn and garden equipment, Victa Lawncare. We are pleased with this acquisition because they have a significant presence in the Australian and New Zealand markets that provides us with good access to those markets and gives us counter seasonal sales to our North American lawn and garden business.

Dealer sales were similar between years and their inventories continue at normal levels which leads us to believe they could do well next spring depending on the economy. First quarter income from operations for the power products segment was $3 million or $13 million between years from our first quarter loss last year, up $13 million from our first quarter loss last year. The generated product line drove the majority of the income from operations improvement.

Sales and production volume provided close to half of the increase. The shipped status by the immediate demand created by the hurricanes and had to ramp up our operating facilities to keep up with demand and rebuild storm stacks in the event of follow-on weather activity.

Approximately $2 million of the income from operations improvement can be attributed to lower selling, engineering and administrative expenses and the lack of startup and rearrangement costs associated with new operations that were incurred in the first quarter of last year, but were not in the current. That concludes what I wanted to say about the first quarter results of the segments. Now let me address some projections for fiscal 2009.

We’ve broadened the range of our forecast for the year by increasing the top end of our projected range and lowering the bottom end. The upside reflects the benefit that resulted from the increased portable generators sales caused by the hurricanes. Our original forecast for the year anticipated no hurricane volume.

I now anticipate that we could benefit from improved placement of engines and end products with quantities that are projected to be greater than last year and the positive impact this would have on margins from both the sales and production volume prospective. We also believe our price increases will help offset higher [Inaudible] cost experience over the past year and in fiscal 2009 in both segments. In addition we are encouraged by the phase of our cost reduction initiatives in all segments of our business.

Boring the bottom end of our forecast reflects our concern from the improved generator volume and cost reductions that could be offset by another year of market decline in lawn and garden equipment. Current global financial crisis leaves significant doubt as to what market conditions would be like next spring. Since actions of both consumers and major retailers could drive the market lower than any current market modeling projects, we feel it’s prudent to lower the bottom end of the forecast.

Now we would like to open up the call for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Mike Hamilton from RBC.

Michael Hamilton - RBC

I was wondering Jim if you could comment a little bit on both inventory levels and the thoughts to going forward here and also what we are seeing in raw material costs. It certainly played in what we’ve seen in materials like aluminum very well in here and kind of what you are thinking and where it leaves you for the balance of the year.

James Brenn

Well I will tell you that our inventories are even a little bit less than they were last year from an engine prospective and certainly less than they had been in prior years in both pressure washers and generators; pretty much the demand that we have seen.

If you take a look at what we think is at retail, obviously retailers cut even deeper to the bone this year than last year which caused a lot of reordering and since they were kind of working on product, we tell you the retail challenge is pretty well cleaned out going to next spring and I guess I would tell you that applies pretty much to the OEMs also who had to come back to us for engines.

I would tell you that from an inventory prospective we are in pretty good shape. Commodity costs, I think that there has been some move towards softening. I think that the way to think about ourselves is that we would have locked in some of the commodity costs early in the year and while we see some movement in areas like aluminum, we are not seeing anything yet in steel and steel is a significant piece of the numbers that we are facing, so we still look for our price increases to offset the commodity costs that we’re incurring.

Operator

(Operator Instructions) Your next question comes from James Bank from Sidoti & Company.

James Bank – Sidoti & Company

I was wondering if I could just kind of get an update on where the Chinese competitors are. I think last year if I remember correctly they had about 500,000 units in the marketplace. I was wondering if you might have any idea of what we are looking at this year coming from them.

James Brenn

Yes, the Chinese this year as I mentioned in the letter to shareholders are facing some headwinds. Among those headwinds are the shift in the value, the more recent enforcement of labor loss and overtime and other things that are increasing the labor costs in China.

The Chinese banks are tightening up; they are demanding to be paid. The Chinese government is demanding that the taxes to be paid. They are reducing or eliminating subsidies and the cost of containers or shipments is skyrocketing, so the price gap for our Chinese competitors is shrinking. There has been some issues with the quality of the product and so I suspect that this year we’ll probably pickup a little share from the Chinese.

James Bank – Sidoti & Company

Okay, so I guess in effect if we kind of took out GUSTAV and Ike coming to the lower range of your guidance that was really just done because of the macro environment that I guess what we all can see at this point?

James Brenn

Yes as I just said in my remarks and let me elaborate a little bit on that. We feel very good about our placement. This is the time of the year where things are still falling in place and things you can end up with adds and deletes at this point, but generally we feel pretty confident about our placements. It is good as or better than it was last year and we look at what GUSTAV and Ike did and we said that’s good, that’s a very good year.

Now the question is and nobody can really answer this, is there going to be a decent spring selling season? There is a lot of differed maintenance in lawn and garden equipment out there and there is anecdotal evidence that some people who were hiring lawn services are going back and doing it themselves to save a few bucks, but there is also the prospect that we tried to go that one more year without buying the new lawn mower.

James Bank – Sidoti & Company

And then just on your snow, I don’t think this is anything anyone ever asked before, but Jim if you’re able to tell me what snow products you have on the balance sheet and what’s in retail and then what is sort of a normalized unit number for both those two, just so I can get a sense.

James Brenn

Well on our balance sheet, most of the snow product that we would have had either engine and/or end product has actually been shipped and so it’s basically sitting at retail ahead of the season right now.

Operator

Your next question comes from Gil Nathan from Restoration Capital.

Gil Nathan - Restoration Capital

On the generator side, what’s the inventory look like at your level and at the dealer level. I think last time you said it was around 80,000.

James Brenn

Yes I think that at our level it’s probably half of where it was a year ago.

Gil Nathan - Restoration Capital

So 40,000?

James Brenn

Maybe a little bit less and we are working to rebuild our stock to build forward and I think for the retailers, as of the end of September had probably dropped into the 30,000 35,000 unit range; so both of us are working to restore a credible amount of units ahead of anything else that may happen from our hurricane season and/or the ice season that will follow on in November, December, January.

Gil Nathan - Restoration Capital

Okay and on the tax side why is that you guys have a big add back in taxes in the first quarter and you are at the 71% tax rate I think you said, can you explain some of that?

James Brenn

It was a discrete item that we were negotiating with the federal government on whether it was taxable or not and in effect we won our position and because it was a discrete item, it has to be recognized in the quarter that it’s refunded.

Gil Nathan - Restoration Capital

And do you expect to pay taxes for the rest of the year?

James Brenn

Yes, I would tell you our normal, absence the adjustment we had and I would expect to being in a probably 32% to 34% effective tax rate.

Gil Nathan - Restoration Capital

32% to 34% for the rest of the year?

James Brenn

Yes.

Gil Nathan - Restoration Capital

Okay, and in the second quarter last year, you had a $37 million gain which was one time and as part of EBITDA, are you worried at all about your first quarter covenant. I think its four times, correct me if I’m wrong.

James Brenn

Four times and you are talking about the second quarter covenant and we are not worried about it, no. The other thing that you have to think about that’s offsetting the somewhat of that $37 million one time, there was a $20 million recognition of the snow engine recall last year, that will not be reoccurring this second quarter, so the number that you’re looking at is a dealt of about $70 million pretax.

Gil Nathan - Restoration Capital

Okay, and when was the snow recall; was it also in the second quarter?

James Brenn

It was in the second quarter also, yes.

Operator

Your next question comes from Steven Gortler from Concentric.

Steven Gortler - Concentric

Looking at the guidance range, can you quantify what level of demand reduction is contained in the bottom end of the new range?

James Brenn

I would tell you that what it contemplates is 11% to 12% decrease in the lawn and garden markets and that would be in any markets we serve lawn and garden, so it’s primarily Europe and US.

John Shiely

Let me put that in prospective a little bit; since 2004 Riders have been down about 38% through fiscal ‘08 and Walks were down about 36%, so I mean the numbers Jim’s talking about would be on top of that, represent extraordinary increase in demand and an extraordinary lack of reorders on existing equipment out there.

Steven Gortler - Concentric

Okay and I’m guessing economic conditions have slowed pretty significantly since mid September; is it fair to say that you started contemplating a slower spring around that time or I suppose when did you start thinking things might get slower in the spring?

John Shiely

I think it’s like everything else when we saw the stock markets begin to plunge, the credit crisis and we said things look good for us in terms of the placement but can we really count on the number and I think every consumer goods company is saying “what’s Christmas going to look like? Is it going to snap back when the spring comes and people start looking at their lawns?” it’s really hard to tell so we decided to spread the forecast.

Operator

Your next question comes from Peter Jacobs from Wells Fargo.

Peter Jacobs - Wells Fargo

First a question on the dividend and I apologize if you already addressed this in the prepared comments, I just got on the call, but John again did you have any comments on, your thoughts on the dividend and has there been any change since the comments that you made at the end of the fourth quarter?

John Shiely

No I think actually the recent quarter, having a decent quarter gives us a little bit more confidence. At the low end as you can see we will earn the dividend this year. We think that dividend is important. It’s something that we paid every year for as long as I’ve been around here and we are going to do everything we can to protect it, like every other company around there. If the markets totally tank we’ll have to give that reconsideration, but right now I think our level is pretty good.

Peter Jacobs - Wells Fargo

Okay great. Secondly, a little color around the generator sales that you saw during the quarter. How much of the total sales of Briggs & Stratton generators came straight out of the retail channel or directly from what you have in storage, right out to the parking lots and delivered right into the home depots and the lows?

John Shiely

Well we believe that the number of our units at retail as they went into the storm season, numbered about 80,000 units.

Peter Jacobs - Wells Fargo

Of Briggs & Stratton?

John Shiely

Of Briggs & Stratton type units and we probably had in our own inventory and I’ll call it 50,000 units or so. So basically this storm itself, we probably shipped maybe 120,000 units or something like that and we’ll tell there’s very little left and we are down to this 30,000 unit level or so at retail. All generators are not concentrated at the point of storm so they still have units in their inventory located in other parts of the country. Lots of the units that helped people out in the storms came direct from us; that were direct shipped into the affected areas.

Peter Jacobs - Wells Fargo

Okay great, two more quick ones; one, can you quantify the favorable dynamics just seeing in the terms of placement, in terms of market share. If I think about your lawn and garden market share in the US, maybe be around 65% or 70%, I mean are you now above 70% or below, how would I think about that. Secondly, can you just talk about any kind of capital acquirement you may have over the next year or two?

John Shiely

I would tell you that if you blend riding lawn mowers and walk mowers together, we probably are north of 75% market share in the ’08 season that we just finished. We would tell you that we believe that’s going to be advance by 2% or 3% points as we go forward next year. As John indicated a little bit earlier in the discussion we think that the Chinese engines have some fraction in the US market in the lawn and garden space.

Peter Jacobs - Wells Fargo

They saw refraction?

John Shiely

Yes and they have lost some fraction and we have the ability to potentially help to regain some of those for next year. So I would tell you we are starting to push up towards the 80% market share in the lawn and garden world. We did gain some placement of snow engines this year, because one of the competitors is actually almost exiting the market. So I would tell you that market shares would be better next year in our minds.

Peter Jacobs - Wells Fargo

Okay and then lastly I had the question about any capital needs you may have?

John Shiely

Actually the CapEx number that we projected for fiscal ‘09 is down to $50 million which is probably $15 million to may be $20 million less than it has been in prior years. Because we thought it would be a lower earnings year, we basically have prioritized our capital spending and I would tell you we have all the capacity in place that we need to address the demand that we are seeing, so we still believe we will come in at around the $50 million level.

Peter Jacobs - Wells Fargo

I guess what I was asking was about any needs to tap the capital markets. Do you have any debt coming due or any needs or anything like that that we should be aware of over the next let’s say one or one to two years?

John Shiely

Obviously there is a $500 million revolver That’s out there that’s just wrapping up its first year of a five year term and then the only other thing that’s sitting out there right now is there is a ten year bond due in 2011, I think its May of 2011 that would be coming up and that right now on our books is probably at about the $248 million level. So I would tell you that that’s the most close thing on the horizon for us at this point of time.

Peter Jacobs - Wells Fargo

And the revolver, the only catch there would be in the covenants right. I mean you need to roll that over?

John Shiely

That’s correct.

Operator

Your next question comes from Sam Darkatsh from Raymond James.

Sam Darkatsh - Raymond James

I’m trying to get a sense of the beneficial impact that the generator demand had for you folks in the quarter and for the year. I know you mentioned that you had 120,000 units of generators that you shipped, but there would also be an engine impact with that as well. Do you have a sense of the total sales in dollars in the quarter that the storm contributed; all in both power and engines?

James Brenn

I don’t have that on me Sam.

Sam Darkatsh - Raymond James

Can we sort of guess that? I mean what were your average wholesale prices of a generator?

James Brenn

Probably around $550.

Sam Darkatsh - Raymond James

All right so that’s about 60 some odd million dollars in just the generators and then the average engine that you would sell into perhaps our competitors generate. I’m just trying to get a sense of?

James Brenn

Probably around $200.

Sam Darkatsh - Raymond James

Okay and then your contribution margin on the incremental generators generally speaking?

James Brenn

I don’t want to talk about that on the call.

Sam Darkatsh - Raymond James

Okay we can talk about that offline. Let me may be ask you this way; you took your guidance on the high end higher by $4 million net income, I’m trying to get a sense of what the incremental generator business contributed, because if you’re taking your lawn and garden expectations down, it seems like its pretty meaningful, because you were at flat I believe and now your looking at 11% or 12% decrease. I’m just trying to get a sense of what the impact is of that decrease and expectations versus the beneficial impact of the generators of what you were seeing. I’m just trying to get a sense of it.

James Brenn

I would have told you from an operating income point of view that the generator business probably provided probably about $8 million to $10 million of incremental benefit in the first quarter. I mean it’s pretty much what’s driving your power product segment.

The offset for that is if we do pressure washers is more of a discretionary purchase and sales in the spring and I think our model basically is assuming that pressure washers are going to get softer along with the lawn and garden aspect. So if you take that pretax number of 8 to 10 and after tax affected and then bring it down, I mean that’s what we are getting back to little bit from an engine weakness point of view.

We are thinking engines are going to be a little bit more a little weaker for the year. Essentially Sam if you think about it, we also had some engine gains, all of which we gave up. I mean we basically said we are ahead, we benefited from snow engines from incremental late seasons selling in lawn and garden and the generator stuff and we basically said “look, I’m going to take that out of the equation, because I can’t tell how good or bad the spring is going to be.”

Sam Darkatsh - Raymond James

But I’m trying to get a sense of what that 11% to 12% decline represented. Does that represent what you believe the lawn and garden industry will be down in units this year outside of the generators?

John Shiely

Yes.

Sam Darkatsh - Raymond James

Okay so and then you’re getting still may be 5% or 6% pricing, so you would expect all else equal share to have lawn and garden related sales down mid single digits this year instead of up mid single digits previously? Last time as I recall you were assuming a flat lawn and garden season and then pricing up to 5% or 6 % which would --?

John Shiely

While we were up in units we thought at the last time that the market would be down 2%. So we had market share gains built into our numbers that allowed us to have a unit number that was around 10.3 million units when we gave you the last forecast. Basically sitting back and saying we still believe that 10.3 million unit is a number that we can have, but in effect what we would tell you is that if the market falls a part on us, we are probably going to be back closer to 9.5 to 9.7 at the mines.

John Shiely

So now we are not calling that the markets down 12%, what we are saying is that our consumer confidence thinks if a lot of things turn against consumer economy, it could go down that must. We are not calling it that way and nobody who prepares economic models in this industry that we know of is calling it down that way. However, we have considerable concern about the impact that recent events are going to have on consumer spending and I think those concerns follow on after the Christmas selling season.

Sam Darkatsh - Raymond James

Okay, so if I’m understanding it correctly, the $40 million in net income of your guidance which is the low end, does that assume John the $9.5 million to $9.7 million for the year?

John Shiely

Yes.

Sam Darkatsh - Raymond James

So the $40 million assumes a 9.5 to 9.7 and the $50 million assumes a 10.3?

John Shiely

Yes.

Sam Darkatsh - Raymond James

Okay, now I’m with you and you’re still assuming that the pricing is going to be up 5% or 6% or so for the year?

John Shiely

No I thought more probably a 4% on engines is up higher on and the end product part of the business is probably 6%, 7% up on some of the finished.

Operator

Your next question comes from Craig Kennison from Robert W. Baird.

Craig Kennison - Robert W. Baird

I just wanted to follow-up quickly on your industry outlook. I think in the past your industry outlook was down 2% and now what is your current industry outlook?

John Shiely

Well, I would tell you that as you take a look at the high side of the model, we would tell you that we still believe you’re probably off; I’ll call it the 2% maybe 3%. What John just articulated in the last part of the discussion was, the low end of our forecast could assume that a further decrease of anywhere from 10% to 11% in the lawn and garden markets next spring, although that’s just our own internal biasing of the low end of the forecast, we have not seen anyone come out. The only one that we have seen recently would be our own internal forecast, that our own economist does it around 5%. OPI has not upgraded their model from last August.

Craig Kennison - Robert W. Baird

Okay, I mean you’re guide is relatively unchanged at the net income level, you’ve widened it, but the midpoint is close to the same number, but incremental to last quarter you may have maybe a little bit more pessimistic outlook for the downside, but you also had the incremental benefit of profit from the portable generator market; is that a fair way to look at it?

John Shiely

Exactly.

Craig Kennison - Robert W. Baird

Okay and then I apologize if this question has been asked, but relative to your commodity exposure, how long are you locked in for and when do you see potentially the benefit of lower commodity cost hitting your income statement?

John Shiely

We sign an annual contract for our steel requirements and so the one we are effectively on steel, the contract we have goes from July 1 to June of next year. Aluminum number, it varied. We had locked some stuff in through December and basically we are kind of watching the markets trying to figure out when to go in again. So we’ll kind of layer aluminum if we can get out.

Operator

Your next question is a follow-up question from Mike Hamilton from RBC.

Michael Hamilton - RBC

John I was wondering if you could comment a little bit on how your sense is that the big box players are trying to play the lawn and garden season at this stage and totally one would think that they’d be differing out and that seasonally you would see more swing third quarter into fourth quarter this year, but how are they looking at it from your stand point, how are they talking about expectations on mix?

John Shiely

I think that it’s not unlike the other categories and particularly because this one is seasonal. They are calling it very close on inventory, very tight; at the same time they are used to for instance Stratton and one of the reasons they prefer us is that we do have the ability to ramp up and deliver if demand turns out to be decent. So I think your instincts are right. I think that the things will manage even closer to the selling season.

Michael Hamilton - RBC

And then any comment as to how they are trying to play mix?

John Shiely

No I really don’t think so. In hard times the mix tends to favor the lower price skews, but in terms of our business, given the share that Jim described our business covers the entire water front in terms of the available skews and the pricing of those skews, so our experience will match consumer demand and not be really governed by what the retailers think is going to happen.

It’s all going to come down to what the actual consumer decides to buy and if they stay home instead of traveling, but we have had years where things weren’t so good and we had pretty good selling seasons because people decided to stay home and spend a little bit more time in the backyard and improve the quality of their backyard environment, so it’s the nature of the beast.

Michael Hamilton - RBC

Last one, beyond China is there anything in the competitive landscape that you see worth noting?

John Shiely

Not really. It’s an interesting thing. We’d never thought we’d find ourselves here where our leading domestic competitor would have been liquidated; our leading domestic generator competitor would have filed bankruptcy and now the recent announcement of the closure of our only remaining domestic competitor in snow engines.

Over the years we’ve had a lot of pressure from various constituencies including some of the people on the phone line to move all of our operations to China and we always explain that having not just operations, but having extremely efficient operations here in the United States where we can build an engine on half an hour labor is an enormous competitive advantage.

You cannot deliver into our hurricane from half way around the world; you cannot deliver into late snow season from half way around the world. We do have significant operations in China, but those operations involve products that have a very broad range of mix and models that are better handled in a Chinese operation. They are generally skews that are international type skews more related to chore utility products than to lawn and garden products and we think we’ve got the right mix.

We have this plant over in Austria, in the Czech Republic and now that the Euros is coming down, that plant makes a lot more sense. I said for the last couple of years that when we achieve the majority of our strategic plan in terms of operational footprint that we really would have an outstanding situation to deal with the seasonal demands and currency swings and right now I’m pretty pleased with where we are.

Operator

Your final question is a follow up question from Sam Darkatsh from Raymond James.

Sam Darkatsh - Raymond James

I’m sorry, I was just reviewing my notes and I wanted to make sure I was clear on one saying and getting back to the generators, when you were saying 120,000 units from the storms Jim, was that take away at retail and inventory or was that Briggs and Stratton wholesale sales?

James Brenn

That’s our wholesale sales

Sam Darkatsh - Raymond James

So that was out your door, not necessarily take away at retail?

James Brenn

That’s correct.

Operator

There are no further questions at this time.

James Brenn

Okay, thanks everyone for joining us this morning and we will talk to you again in January. Take care.

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