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Tanger Factory Outlet Centers, Inc. (NYSE:SKT)

Q3 2008 Earnings Call

October 29, 2008 10:00 am ET

Executives

Stanley K. Tanger - Chairman and Chief Executive Officer

Steven B. Tanger - President and Chief Operating Officer

Frank C. Marchisello, Jr. - Executive Vice President and Chief Financial Officer

Analysts

Analyst for Michael Bilerman- Citigroup

Analyst for Christine McElroy- Banc of America Securities

[Sloane Bowen] – Goldman Sachs

[Jihan Mamud] – Goldman Sachs

Jeffrey Spector- UBS

Ben Yang - Green Street Advisors

Nathan Isbee – Stifel Nicolaus & Company Inc.

Jeff Randall - Black Creek Advisors

Craig Schmidt - Merrill Lynch

Operator

Good morning and welcome to the Tanger Factory Outlet Centers third quarter 2008 conference call. Please note that during this conference call some of management’s statements will be forward looking statements regarding the company’s property operations, leasing, tenant sales trends, development acquisition, expansion and disposition activities as well as their comments regarding the company’s funds from operations and available for distribution and dividends. These forward looking statements are subject to numerous risks and uncertainties and actual results could differ materially from those projected.

Due to factors including but not limited to changes in economic and real estate conditions, availability and cost of capital, the company’s ongoing ability to lease, develop and acquire properties, as well as potential tenant bankruptcies and competition. We direct you to the company’s filing with the Securities and Exchange Commission for detailed discussion of the risks and uncertainties. This call is being recorded for a rebroadcast for a period of time in the future. As such, it is important to know that management’s comments include time sensitive information that may be accurate only as of today’s date October 29, 2008.

At this time, all participants are in a listen only mode. Following management’s prepared comments, the call will be opened up for your questions. On the call today will be Stanley Tanger, the company’s Chairman and Chief Executive Officer, Steven Tanger, President and Chief Operating Officer and Frank Marchisello, Executive Vice President and Chief Financial Officer. I will now turn the call over to Mr. Tanger. Please go ahead, sir.

Steven B. Tanger

Good morning everyone and thank you for participating in our call today. Frank will take you through our financial results and I will follow with a summary of our operating performance and future developments. Then we will have an opportunity to answer any of your questions. I will now turn the call over to Frank.

Frank C. Marchisello, Jr.

Thanks, Steve and good morning everyone. Obviously there are no easy answers to the turmoil in the financial markets and no clear vision for what lies ahead. Based upon our 27 years of successfully managing this business, we know that a strong balance is a must in turbulent markets like these.

We have worked hard to maintain a conservative financial position and a low leverage ratio since we went public 15 years ago. It certainly looks like we’ve made the right decision. In fact, just last week on October 23rd, we received an upgrade from Standard and Poor’s from BBB minus with a positive outlook to BBB with a stable outlook.

Tanger was the only REIT to receive an upgrade during this latest round of ratings actions by Standard and Poor’s. We are one of only two REITs to be upgraded at any time so far this year. As we mentioned last quarter in June 2008, we closed on a $235 million dollar unsecured three year term loan facility. The facility bears a floating interest rate at a 160 basis point spread over LIBOR. Subsequently on July 9th, we completed a three year swap transaction which converted the floating rate to a fixed rate, a fixed interest rate of 5.21 % on $118 million of the term loan until April 1, 2011.

We then followed that up on September 25, 2008 by entering into an additional interstate swap agreement which converted the floating rate of interest on the remaining $117 million of the unsecured three year term loan facility to a fixed rate of 5.3%. This interest rate swap agreement also expires on April 1, 2011. We have now fixed the rate on the entire $235 million term loan at an average rate of approximately 5.25% through April 1, 2011.

On a consolidated basis our total market capitalization as of September 30, 2008 was approximately $2.5 billion and our debt to total market capitalization at the end of the third quarter was approximately 31.2%. We also maintain a strong interest coverage ratio of 3.92 times for the third quarter of 2008. Approximately 81% of our debt is now at fixed rates. Our wholly owned portfolio properties is 100% unencumbered and we have no debt maturities until 2011. As of September 30, 2008 we had $175.5 million available on our $325 million in unsecured lines of credit at an interest rate of 75 basis points over LIBOR.

As for our results this quarter, funds from operations per share was $0.70 per share representing a solid 9.4% increase compared to last year. Year-over-year increase in FFO continues to be driven by our ability to increase rental rates on renewals and re-lease space as well as incremental revenues from our four expansion projects would open during the fourth quarter of 2007. FFO for the third quarter of 2008 also benefited from $646,000 or $0.02 per share in termination fees compared to $106,000 in termination fees last year this quarter.

During our second quarter conference call, we mentioned that three tenants had announced to close stores during the second half of 2008 and early 2009. The third quarter termination fees were a result of negotiating early termination grievance with these tenants during the quarter.

Our FFO payout ratio for the quarter ended September 30, 2008 was approximately 54% compared to 56% last year. Our FAD payout ratio was 119% for the third quarter as compared to 67% last year.

We are nearing completion of our capital improvement plans for 2008 including a $19 million reconfiguration project currently under way at our center located on Highway 501 located in Myrtle Beach, South Carolina.

Excluding this reconfiguration project which we have spent $13.8 million year to date, our FAD payout ratio would have been 76% for the third quarter and 78% for the first nine months of 2008. We currently believe we can maintain an adjusted FFO payout ratio in the 60% range and an FAD payout range of 100% in 2008.

Excluding the Myrtle Beach reconfiguration project, our FAD payout ratio for 2008 is expected to be in the mid to low 80% range. In addition we will continue our ongoing efforts to increase occupancies in select centers and attract new high volume tenants to the outlet industry.

We have been committed to achieving high quality long term earnings by consistently investing our business. In fact, over the last five years, we have been planning for the future by making over $60 million in capital improvements over 11 properties.

The vast majority of our large capital improvement projects will be completed by year end. We are currently budgeting to spend very little in capital projects in 2009 which will bring our FAD payout rate down substantially, most likely in the mid to low 70% range. At these levels our dividends are very well covered. I will now turn the call over to Steve.

Steven B. Tanger

Thank you, Frank. In spite of the current economic environment, outlet stores remain a very profitable channel of distribution for our tenants. Tanger Outlet Centers represented an attractive defensive property type and the growth opportunity during an economic slowdown.

In good times, people like to bargain on brand name products and in tough times like now, they need a bargain. From an operational standpoint, I am pleased to report that the rent spreads we achieved for the last few years have continued into the third quarter of 2008. As of September 30, we have executed or in process approximately 79% of the square feet associated with leases coming up for renewal throughout our wholly owned portfolio this year compared to 77% last year.

During the first 9 months of 2008, we have achieved an average increase on the executed renewals of 17.6% compared to 13.2% last year. Over 480,000 square feet was re-tenanted during the first 9 months of 2008 producing an increase of average base rent of 43.8% over the average rent that was being paid by the previous tenant prior to their vacating the space compared to an increase of 37.6% last year.

We are continuing to capture the embedded growth in our portfolio as leases entered into 10 to 15 years ago come the end of their term. Our low cost of occupancy which was 7.7% at the end of 2007 and demand for space from our tenants allows us to continue to increase rent while remaining a profitable distribution channel for our tenants. The fundamental matrix of our business remains strong. Same center NOI, which does not include the $646,000 in termination fee income, grew 4.7% for the third quarter as well as year to date compared to 3.9% during the first 9 months of last year.

The occupancy rate of our wholly owned stabilized properties was 96.7% at the end of the third quarter of 2008, up 50 basis points from the second quarter of this year. As you may recall earlier this year, we recaptured 38 stores that were occupied by six tenants representing a gross leasable area of approximately 236,000 square feet or 2.8% of our wholly owned portfolio.

Sales of these tenants only average $165 per square foot with an average base rent of $16. Approximately 51% of this space is now been released at base rent averaging 61% higher than the $16 dollar average rent paid by the previous tenants. Our goal is to have most of the remaining space re-leased by the middle of next year.

As Frank mentioned earlier, during the second quarter conference call we stated that we had three tenants announce plans to close stores throughout our portfolio for various reasons. Within our portfolio, this represents 32 stores containing approximately 93,000 square feet of GLA. Once again, these stores represent some of the least productive stores in our portfolio with average sales of approximately $197 per square foot, an average base rental of approximately $18.

While some stores closed, the majority of these store closings will occur at the end of 2008 and the beginning of 2009, giving us time to work on re-tenanting the space with higher volume tenants. These tenants are certainly the exception to the rule. In fact, the majority of our tenants have in their long term plans to increase the number of outlet stores in their portfolio.

The good news is that we do not have a single store with retailers that have recently announced bankruptcies including Steve and Barry, Linens and Things, [Murdens], Circuit City and Sharper Image. To date only two tenants in our portfolio filed for bankruptcy representing seven stores and 52,800 square feet. Of those stores in bankruptcy, only one was rejected totaling 7,000 square feet and the rest remain open and paying rent.

This year we have executed leases and welcomed to our portfolio 29 new tenants including: Stewart Weismann, True Religion, Neiman Marcus Last Fall, Restoration Hardware, Victoria’s Secret, Anne Taylor Loft, William Sonoma Home, Betsy Johnson, Optical Shops of Aspen, and Wolford.

With respect to tenant productivity, reported tenant comparable sales within our wholly owned portfolio averaged $341 per square foot for the rolling 12 months ending September 30; up slightly from $340 per square foot for the same period last year. Sales during the third quarter were impacted by the general weakness of the U.S. economy as well as the number of hurricane watches and warnings which occurred along the Atlantic and Gulf coasts keeping vacationers away from their holiday destinations.

As most of you know, the majority of our centers are located in areas that attract domestic tourists. We have not benefited materially from the extraordinary sales volume generated by the international tourist taking advantage of the weak dollar. It is important that even though sales are flat, although occupancy cost to tenants remain, still provides us with the opportunity to raise rental rates on the re-leasing and renewal of space.

Percentage rents, which are paid by tenants once their total sales exceeds certain levels only represents 2.3% of our total revenues during the first 9 months. Approximately 92% of our total revenues were derived from contractual base rentals and tenant expense reimbursements.

Turning to our development pipeline; our wholly owned center located in Washington County south of Pittsburgh, PA opened to tremendous crowds when we held a very successful grand opening celebration on August 29, 2008. The first phase totaling 370,000 square feet was approximately 86% leased upon opening.

Last week on October 23, we held our grand opening for our new center in Deer Park in Long Island, NY. Our Deer Park property is owned by a joint venture by which we and two other partners each have a one-third interest. The property opened to huge crowds and the parking lots filled beyond their capacity. The retail space at Deer Park is approximately 77% leased upon opening.

Based upon the tremendous openings at both of these properties, we feel confident tenant interest in the remaining space will be high and additional signed leases will be completed over the next several months at both locations. Upon stabilization, our initial return on cost in Washington County is expected to be approximately 10% to 10.5% and in Deer Park it is expected to be 8.5% to 9.5%.

We currently have signed purchase options for new development sites in Mebane, North Carolina and Irving, Texas. Initial reactions to these sites from our magna tenants have been positive however we are still in the early due-diligent study period on these sites. We also have several target markets in our shadow pipelines.

Our long standing policy of only buying property and starting construction when at least 50% of the first phase’s lease and when we have all non-appealable permits remains in place, we will not and never have, built on speculation. In that regard, we announced in our press release, that we have decided to terminate our purchase options with respect to our prospective sites in Port St. Lucie, Florida and Phoenix, Arizona.

Given current market conditions, we felt it was in our best interest to terminate these options and focus our efforts on the other development sites as well the remaining space within our two newest centers. As a result, we will be taking charge of approximately $1.8 million relating to the predevelopment costs on these projects during the fourth quarter of 2008.

In the past seven years, we have successfully pruned our portfolio by selling 13 of our poorest performing centers with little potential for future growth. In doing so, we generated approximately $84 million in proceeds and have reinvested these in high return, new development assets.

Our goal remains to deliver at least one new center each year over the next 3 year to 5 year period. Though mindful of the current economic environment, we are long term optimists about the future of the United States economy and our company. Our solid balance sheet should allow us to fund our development pipeline and drive growth in our business for years to come.

Based on our internal budgeting process, our view of current market conditions, and the strength and stability of our core portfolio, we are adjusting our estimated diluted net income per share guidance for this year to arrange of $0.63 to $0.69 per share and our FFO guidance for this year to a range of $2.35 to $2.41 per share.

Our guidance range reflects a number of variables such as the one time charge of approximately $1.8 million relating to the write off of the predevelopment costs which represents about $0.05 per share. The expected lead time necessary to release the space vacated by certain tenants during January of this year as well as the overall sales productivity of our tenants in the current economic environment, the uncertainties of our projected fourth quarter results are greater than normal.

The midpoint of this range is adjusted for the one time charge of approximately $1.8 million related to the write off for the predevelopment costs as well as the $8.9 million treasury locked settlement and the $406,000 prepayment penalty recorded in the second quarter represents an increase in FFO over the prior year of approximately 8%.

As we have done in the past, we will provide 2009 guidance at the time of our year end 2008 conference call early next year. While not immune from the effects of the slowing economy or possible recession, Tanger enters this challenging environment with high occupancy, many long term leases ending with below market rents and a strong balance sheet with low leverage and no corporate debt maturing in three years.

In closing, I would like to welcome Bridget Ryan Berman who will be joining our Board as Independent Director effective January 1, 2009. Bridget was formerly the Chief Executive Officer of Giorgio Armani Corporation, a wholly owned US subsidiary of Giorgio Armani S.p.A, one of the leading fashion and luxury goods groups in the world. Previously she was Vice President and Chief Operating Officer of Apple Computer Retail and held various executive positions with Polo Ralph Lauren Corporation, including Group President of Polo Ralph Lauren Global Retail from 1992 to 2004.

Bridget has also served in various capacities at May Department Stores and Federated Department Stores from 1982 to 1992. Bridget was a member of the Board of Directors and served on the audit committee of J Crew. We are pleased to add to our Board of Directors someone with Bridget’s credentials, her extent of experience, and impressive background in the retail industry will add tremendous value and perspective to our Board.

With that, we’ll be happy to answer any questions that you may have.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Michael Bilerman from Citi.

Analyst for Michael Bilerman- Citigroup

It’s Quinton Falelli here. Just the first question, given you’ve had such strong [relation] spreads over this quarter and over the year, what are your expectations for same-store and NOI next year? I’m basically asking how much of it’s locked in and how much comfort you could have.

Steven B. Tanger

I think we’re still comfortable with our previous guidance of 4% NOI growth for 2009.

Analyst for Michael Bilerman- Citigroup

In terms of the styles which were relatively flat, and given your rents are heading up, I’m just wondering what level of comfort you have with your occupancy cost ratio. I mean, what could that increase to in a weaker sales environment?

Steven B. Tanger

Our occupancy costs is amongst the lowest in the retail industry particularly among the retail publicly traded rates. It’s about 7.7% which is a fabulous shock absorber for times like this Tenant sales flat still allow us to reasonably raise rents and remain profitable for our customers, the tenants, and so far those increases in rent are reflected in the 4% NOI guidance.

Analyst for Michael Bilerman- Citigroup

In terms of your percentage rent, it looks like it’s trailing about 25% lower so far this year. In your guidance of the fourth quarter are you being conservative there and what are you assuming in terms of percentage rent?

Steven B. Tanger

We have historically converted percentage rental income to base rental income or variable rent to fixed rent as we renew leases and that continues to be our strategy.

Analyst for Michael Bilerman- Citigroup

And just on the recapturing of price, you previously said that you monitor the performance for your tenants very closely and if anyone falters you’ll look to recapture it. I’m just wondering if any tenants are in that position at the moment and if so, what would your relief expectations be?

Steven B. Tanger

We continue to monitor tenants. We work with tenants that are not performing well to try to help them through marketing to increase their performance. As of this point there are no additional tenants that we’ve decided or have been requested to take space back. This will have to be your last question. We’ve got many, many people on the line that I need to also get their points of view.

Analyst for Michael Bilerman- Citigroup

Just quickly on the development side, I’m just wondering if you have increased your return expectation for any new development for redevelopment?

Steven B. Tanger

We still remain with the target of 10% to 10.5% return on cost from our new developments.

Operator

Your next question comes from Christine McElroy from Banc of America.

Analyst for Christine McElroy- Banc of America Securities

Hi it’s actually [Sameet] here with Christy. With regards to your sales growth in the third quarter, can you break that out between July, August, and September and give us a sense of how it’s trended going into October?

Steven B. Tanger

We historically have not broken out monthly sales trends.

Analyst for Christine McElroy- Banc of America Securities

Okay then on the two projects that you dropped in Florida and Phoenix. Was this as a result of weak initial tenant demand or was it more your own cautiousness over the local economies as you further did some due diligence?

Steven B. Tanger

I think it’s a combination of both. We felt it prudent at this time to terminate those agreements. We will be focusing on number one, protecting and enhancing our existing assets and number two, leasing space in our new development sites in Mebane, North Carolina, and Irving, Texas, and number three, filling the remaining space which can get us the highest and quickest return in our two new centers which opened south of Pittsburgh and in Deer Park.

Analyst for Christine McElroy- Banc of America Securities

You also mentioned that you have several targeted markets in your shadow pipeline. Could you provide maybe some color on what markets you’re targeting and type of opportunities you’re seeing in those markets?

Steven B. Tanger

For competitive reasons I hope you’ll understand that we’re not prepared to announce those until we’ve actually signed and have a property under control.

Analyst for Christine McElroy- Banc of America Securities

You said you had $640,000 of termination fees in the third quarter. Do you have any forecast or guidance for what term fees will be for the remaining stores maybe that are going to be closing in the fourth quarter?

Steven B. Tanger

The termination fees were related to the stores closing in the fourth quarter and as you probably know, termination fees are very difficult to predict in advance. To my knowledge I don’t think we’ve got much in termination fees or recorded for the fourth quarter.

Frank C. Marchisello, Jr.

This is the first quarter where we’ve actually had a termination fee amount greater than $0.01 per share. Typically it’s not a material number.

Operator

Your next question comes from [Sloane Bowen] of Goldman Sachs.

[Sloane Bowen] – Goldman Sachs

I’m on with [Jihan Mamud] as well. Just a question kind of a follow up onto a related question from early. On the Port St. Lucie and the Phoenix development projects, could you guys give us a sense of how much the pre-leasing or how much levels of pre-leasing you had prior to terminating those projects?

Steven B. Tanger

It’s a moot point. It was less than 50% and we decided not to pursue.

[Sloane Bowen] – Goldman Sachs

A quick one with regard to the reconfiguration at Myrtle Beach. I believe before you guys had looked for a $17 million expenditure there and now it’s $19 million? Could you explain what the bump was?

Frank C. Marchisello, Jr.

We just had to make some additional improvements and up the budget along the way, particularly with regard to additional signage and things like that.

[Sloane Bowen] – Goldman Sachs

What has that done to your return expectations?

Frank C. Marchisello, Jr.

The return expectations in Myrtle Beach are it’s a long term play. We’re enhancing the value of the property in hopes that over time it will generate higher rent and higher percentage rent by attracting more customers and generating higher sales volumes for the tenant.

[Sloane Bowen] – Goldman Sachs

Okay great and I think [Jihan] has one question.

[Jihan Mamud] – Goldman Sachs

Hey guys, you mentioned the considerable interest you’re seeing for your sites in North Carolina and Texas. Would you be able to quantify your pre-lease status on each of these projects as of the close of the quarter?

Steven B. Tanger

We don’t quantify pre-leasing until we reach the 50% level and when we do reach the 50% level, we’ll break ground.

[Jihan Mamud] – Goldman Sachs

Just as a follow up to that 50% pre-lease requirement on new developments, could we expect that requirement to perhaps move upward for future projects just given the increasing challenges associated with development right now?

Steven B. Tanger

We have maintained the 50% discipline for 27 years. It seems to have worked. We see no reason to change that now. I just want to point out one thing. If leases are executed to the level at 50%, there usually is substantial additional leases in process that we’re negotiating that are yet unsigned.

Operator

Your next question comes from Jeffrey Spector from UBS.

Jeffrey Spector- UBS

Just a follow up on development. At this point should we be assuming that in ’09 you won’t have many openings, does Mebane get pushed to 10 at this point?

Steven B. Tanger

Right now we’re predicting Mebane toward the end of ’09, November or December opening. If that shifts we will certainly let you know.

Jeffrey Spector- UBS

On sales, have you typically pulled out in the past renovations from your sales statistic?

Steven B. Tanger

We’ve never had a total renovation reconfiguration of a center and this is the first time we’ve done it on two properties so they dramatically impacted traffic and sales volumes and it’s inappropriate to include them.

Jeffrey Spector- UBS

Can you just talk about any recent trends in your meetings with tenants. Are they asking for more concessions, is it taking a little bit longer to negotiate those deals?

Steven B. Tanger

It’s basically in our industry business as usual.

Operator

Your next question comes from Ben Yang of Green Street Advisors.

Ben Yang - Green Street Advisors

I know you guys don’t break out the monthly sales figures but you have provided a quarterly sales number in the past. Can you tell us what that number was for the third quarter?

Frank C. Marchisello, Jr.

Quarterly comp number?

Ben Yang - Green Street Advisors

Yes.

Frank C. Marchisello, Jr.

We were basically flat every quarter this year so the quarter was flat as well.

Ben Yang - Green Street Advisors

That excludes the major renovations that you are undertaking?

Frank C. Marchisello, Jr.

Yes it does.

Ben Yang - Green Street Advisors

And then for the third quarter number as well were there any lingering weather related issues in line with what you saw in the second quarter?

Frank C. Marchisello, Jr.

We had the hurricanes along the east coast and in the Gulf, certainly kept people from traveling to their vacation destination on a number of occasions.

Steven B. Tanger

As you may recall, one of the hurricanes that went through the Gulf created flooding all the way up to Missouri, so yes, we were impacted by weather.

Ben Yang - Green Street Advisors

It looks like you have 17 fewer Jones retail stores in our portfolio but the GLA is a bit higher. Can you help me understand what’s happening with this tenant?

Steven B. Tanger

We don’t know that off the top of our heads. Why don’t we get back to you on that?

Operator

Your next question comes from Nathan Isbee of Stifel Nicolaus.

Nathan Isbee – Stifel Nicolaus & Company Inc.

On the Deer Park, at Q2 if I remember correctly you were 76% leased or committed and opened at 77% three months later. Can you just talk about any additional lease commitments you have in place now and what type of progress you saw [inaudible] radius restrictions during the last 90 days?

Steven B. Tanger

We’re still negotiating with many new tenants. Several of the tenants have did not make the opening like the health club and some of the other designer tenants that expect to open before year end or the first quarter of next year. With the opening, the fabulous sales created by the opening, we have now received substantial interest from the tenant community that was waiting to see if the project would be proven, particularly in this environment.

Operator

Your next question comes from Jeff Randall of Black Creek Advisors.

Jeff Randall - Black Creek Advisors

I’m just trying to better understand the competitive landscape and I guess relative to Simon’s Chelsea outlets, I was wondering what you attribute to Tangers I guess significantly lower average sales per square foot metric. How much of that difference would you attribute to location and how much to tenant mix?

Steven B. Tanger

Keep in mind some of the leases that are included in our low occupancy costs, they don’t exist in this for 10, 15, and in some instances, 20 years. So as we execute new leases, our target is anywhere depending on the project for 10% to 12% cost of occupancy. We have been fortunate in high renewals with existing tenants so that only a very small percentage of our portfolio actually rolls over each year and we’ve been fortunate in that our tenants sales have dramatically increased each year, so it’s really a fight to keep the cost of occupancy where it is and not going down.

Operator

Your next question comes from Craig Schmidt – Merrill Lynch.

Craig Schmidt - Merrill Lynch

Do you have a targeted size for the Irving, Texas project?

Steven B. Tanger

We’re looking at that project right now. We have a land mass that would produce about half a million square feet with some outparcels. But we really haven’t decided on a footprint yet, Craig.

Craig Schmidt - Merrill Lynch

Given the addition that Chelsea is bringing to the Grapevine Mills, are you adjusting your mix in any way to compete against that?

Steven B. Tanger

I think Simon owns the Mills, not Chelsea, although they are sister companies. We have not adjusted our mix yet. As I mentioned to you, we have not decided on a foot print. We have not decided on a tenant mix yet.

Operator

There are no further questions at this time. I would now like to turn the call back over to Mr. Tanger for closing remarks.

Steven B. Tanger

Thank you, Operator. I just want to thank everybody for your continued interest in our company. The call today had a record number of participants and we appreciate that. Stanley Tanger, Frank, and I are always available to answer any of the other questions you may have. We look forward to seeing you at [Neyre]. Thanks again and have a great day.

Operator

Thank you for your participation. This concludes today’s conference call. You may now disconnect.

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