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Executives

Alan Lindstrom

Lip-Bu Tan - Chief Executive Officer, President and Director

Geoffrey G. Ribar - Chief Financial Officer, Principal Accounting Officer and Senior Vice President

Analysts

Thomas Yeh - BofA Merrill Lynch, Research Division

Jay Vleeschhouwer - Griffin Securities, Inc., Research Division

Mahesh Sanganeria - RBC Capital Markets, LLC, Research Division

Sterling P. Auty - JP Morgan Chase & Co, Research Division

Richard Valera - Needham & Company, LLC, Research Division

Thomas Diffely - D.A. Davidson & Co., Research Division

Auguste P. Richard - Piper Jaffray Companies, Research Division

Cadence Design Systems, Inc. (CDNS) Tensilica Acquisition Conference March 11, 2013 5:00 PM ET

Operator

Good afternoon. My name is MJ, and I will be your conference operator today. At this time, I would like to welcome everyone to the Cadence's Tensilica Acquisition Conference Call. [Operator Instructions] I'll now turn the call over to the Group Director of Investor Relations, Mr. Alan Lindstrom. Sir, you may begin your conference.

Alan Lindstrom

Thank you, MJ, and welcome to our conference call to discuss our proposed acquisition of Tensilica. The webcast's call can be accessed through our website, cadence.com, and will be archived for 2 weeks. With us today are Lip-Bu Tan, President and CEO; and Geoff Ribar, Senior Vice President and CFO. Please note that today's discussion will contain forward-looking statements and that our actual results may differ materially from those expectations. For information on the factors that could cause the difference in our results, please refer to our filings with the Securities and Exchange Commission. These include Cadence's most recent reports on Form 10-K and Form 10-Q, including the company's future filings and the cautionary comments regarding forward-looking statements in our press release issued today.

Today, we'll be discussing expectations of financial performance measured in accordance with Generally Accepted Accounting Principles or GAAP, as well as expectations for non-GAAP financial performance. Cadence management believes that in addition to using GAAP results in evaluating our business, it can also be useful to measure results using certain non-GAAP financial measures. Investors and potential investors are encouraged to review the reconciliation of non-GAAP financial measures with their most direct comparable GAAP financial results, which can be found in the Quarterly Earnings section of the Investor Relations portion of our website, cadence.com.

Now I will turn the call over to Lip-Bu.

Lip-Bu Tan

Thank you, everyone, for joining us today. I'm very pleased to announce that we have signed a definitive agreement to acquire Tensilica. Tensilica is a premier IP company with high-quality configurable IP targeted at high-growth markets. Cadence is a leader in verification IP and offers a broad portfolio of advanced design IP. Upon closing, the addition of Tensilica IP portfolio, along with that of Cosmic Circuits, which we plan to acquire upon receipt of regulatory approval in India, will significantly expand the scope of our IP offerings and accelerate delivery of our IP roadmap. Both of these acquisitions are in line with our strategy to invest in and grow the scale of our IP business.

Tensilica provides configurable dataplane processing units that are optimized for embedded data and signal processing, allowing customers to quickly develop SoCs optimized for mobile wireless, network infrastructure, audio infotainment and home applications. More than 200 licensees, including system ODMs and 7 of the top 10 semiconductor companies, have shipped over 2 billion Tensilica IP cores. Tensilica IP cores complement industry-standard processor architectures, with application-optimized subsystems to enable customers to increase differentiations and get SoCs to market faster. The combination of Cadence and Tensilica will accelerate IP subsystem development and integration while providing a more extensive support network covering IP and tools, allowing customers to use Tensilica IP with confidence. This combination will enable deeper integration between Tensilica IP and design tools from Cadence resulting in faster design and improved power, performance and area.

Tensilica has approximately 200 employees, and we expect substantially all of those employees to join Cadence. Upon closing, Tensilica's CEO Jack Guedj which will join Cadence.

Geoff will now provide some of the financial details.

Geoffrey G. Ribar

Thank you, Lip-Bu. Under the terms of the definitive agreement, Cadence will acquire Tensilica for approximately $380 million, financed with our existing sources of liquidity, which include cash on hand and access to our revolving credit facility.

Tensilica had approximately $30 million in cash at year-end 2012. Tensilica's unaudited revenue for the year ended December 2012 was approximately $44 million. Revenue growth over the past 2 years averaged approximately 35%. The company was profitable in 2012. We expect the transaction will be slightly dilutive for fiscal 2013 due to merger accounting and accretive to Cadence's fiscal year 2014 non-GAAP earnings per share. The impact in GAAP's earnings-per-share will be available after the valuation and the completion of purchase accounting. We will provide more color and guidance after the transaction is closed. We expect the transaction to close in the second quarter of 2013. We will update our fiscal year 2013 outlook as necessary upon completion of the transaction. We believe that Tensilica is a significant strategic move for Cadence that will expand the scope and scale of our IP business. The fact that Tensilica is one of only a handful of IP companies today that is able to command royalties for its products is an indicator of their strong execution, differentiation and value-add.

With that, operator, we're now ready to take questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from Krish Sankar.

Thomas Yeh - BofA Merrill Lynch, Research Division

This is Thomas Yeh, on behalf of Krish. I just wanted to get a little bit more color on Tensilica. You have provided us with a trailing 12 months revenue. Can you talk a little bit about the profitability profile of the IP company and how it aligns with your current corporate average?

Geoffrey G. Ribar

Thomas, obviously, I think we'll provide more details when we do our Q1 earnings call after the deal is closed. For right now, we're just saying that they are profitable, that it will be slightly dilutive to 2013 for us and accretive in 2014.

Thomas Yeh - BofA Merrill Lynch, Research Division

Okay, got you. And then, I guess, can you provide us an update on your current onshore versus offshore cash balance and maybe your expectations for the mix of cash versus debt that's going to be used for the acquisition, and how that might impact that?

Geoffrey G. Ribar

Yes, at year end 2012, we had $827 million of cash and short-term investments. About half of that was in the U.S. And we'll use a mix of liquidity from both cash on hand, internally generated cash and the line of credit to pay for this.

Thomas Yeh - BofA Merrill Lynch, Research Division

All right. And then a final one for me. Just in terms of the competitive landscape, can you talk a little bit about that for Tensilica?

Lip-Bu Tan

Sure. I think, first of all, I think the Tensilica, as I mentioned earlier, is a premium IP that we acquire and fit in very well to our strategy. The primary competition basically comes from the alternative implementation using custom design IP and DSP. But meanwhile, I think it's a growing opportunity and their unique programmable subsystem gives more flexibility faster to market, and those are very valuable to us, to our customer.

Operator

Your next question comes from Jay Vleeschhouwer.

Jay Vleeschhouwer - Griffin Securities, Inc., Research Division

Geoff, I'd like to ask first about how you arrived at the valuation for Tensilica? Net of cash, it looks like you're still paying well over 7x revenue, which is above the valuation you paid almost 3 years ago for Denali, which had a 30% or so operating margin at the time. Could you put this acquisition, at least from a strategic or valuation perspective, in the context of what you did with Denali?

Lip-Bu Tan

Jay, this is Lip-Bu. Let me start first, and then Geoff will fill in more detail. So first of all, as I mentioned earlier, this is a premier IP. And only a handful of IP companies that can command royalties for their products. And they have a very nice growth, revenue growth, 35% and are profitable. And their technology is proven. 7 out of 10 semiconductor companies, the top semiconductor companies are using them. 2 billion cores had been shipped and 200 licensees. So that's very valuable. And then the other thing is also they are very unique differentiating on the whole dataplane processing unit. And together with our SoC, that will really expand and broaden our design IP, that can address the very fast-growing market opportunities at wireless, cloud infrastructures and many others. And all in all, we also had a very talented top managerial and technology -- technical talents that we're really looking forward to. And so those are really factors why we want this Tensilica, and it really benefit us. And together with our tools, can provide a faster design and also can really drive performance area and speed to our customers.

Geoffrey G. Ribar

And Jay, like all M&A, we spent a lot of time to make sure it fits and furthers our strategy that it provides our customers with the competitive advantage, and it makes economic sense to our shareholders. Obviously, Lip-Bu described this as a strategic, great technology team, great business with royalties. We think the valuation is reasonable for our shareholders.

Jay Vleeschhouwer - Griffin Securities, Inc., Research Division

All right. A couple of follow-ups. Could you give us a breakdown of their licensing versus royalty revenue, if you have that mix? Also, in terms of their addressable market, according to industry data, they serve about 1/2 a dozen or so discrete categories of IP which, for the trailing 12 months, appears to have had revenues of about $130 million to $140 million. So that gives them about 1/3 share of their addressed markets. But how large do you think their addressed markets can be versus where they are today, based on the figures that you shared?

Geoffrey G. Ribar

Sure. So we are not yet giving breakdown between licensee and the royalties or things. We will provide more detail in our Q1 earnings call after the deal is closed. And I think Lip-Bu will address the market.

Lip-Bu Tan

Sure. I think the market is growing, and clearly, programmable flexibility and the higher speed performance is critical for the design. And that's why I think 7 out of the top 10 are using them, 200 licensees, and we have done homework, and I think that we liked their IP in the portfolio that they have. There's a very nice application, very broad application. Clearly, they have a very strong footprint in the mobile side, and then also in the whole audio, video, infotainment and home applications and also the whole infrastructure opportunities. So I think those are all growing globally, and I think we are very excited about the IP portfolio.

Jay Vleeschhouwer - Griffin Securities, Inc., Research Division

All right. Lastly, do you have any breakdown as to the verticals? You mentioned mobile and automotive and others, do you have those splits available yet?

Geoffrey G. Ribar

Again, we may provide more color on our Q1 earnings call on this. But for right now, we just wanted to talk overall about the strategic significance of the deal and a little bit about the numbers and where they are.

Operator

Your next question comes from Mahesh Sanganeria.

Mahesh Sanganeria - RBC Capital Markets, LLC, Research Division

Yes. Lip-Bu, I know that there is limited information you can provide, but we're trying to see what we can decipher or what we can understand. So as much as you can provide, even if it's qualitative, that would be very helpful. Again, not exact but some trend. So one of the question I have was in terms of semiconductor companies versus system companies, is it fair to say that majority is a semiconductor company or there is a big component of system companies customers here, too?

Lip-Bu Tan

Sure. I think clearly, I think, that's a good question. Couple of things. One, clearly, there are customers not just semi and also subsystem and system companies. And as we mentioned in the past, we see a growing trend from the system company going vertical integrations. And so that they are starting to drive performance from the component IP level, and so this is the growing trend. And that's why we are excited about the Tensilica IP and also their system generator. And they're able to customize performance for specific functions, either it's audio or video, and the programmability, the flexibility of doing that is significant for the system company and also for the leading semiconductor company, and there is really a lot of value for doing that. And that it is a trend, and that we see and we're talking to our customers, we felt that this is a very important IP portfolio that they can enhance our overall IP strategy in terms of the IP, the portfolio that we try to reach into some of the vertical markets that really tie in very well with our strategy.

Mahesh Sanganeria - RBC Capital Markets, LLC, Research Division

Okay. And in terms of the application markets segment, you emphasized audio, video. I'm assuming that the 4G DSP probably is a significant growth area. In that market, who would be the competition? Is that -- would you consider that as one of the growth market, big growth market for this IP?

Lip-Bu Tan

Yes. I think the question is very good, and clearly, they have a very strong position in the mobile wireless, mobile -- and the smartphone area. That market, they had been very successful. We're going to continue to see success in that because this is a very fast-growing area. In terms of competition, again, back to the alternative implementation using custom design IP and a pure DSP. But this is very, very different from that. They're basically able to provide, they call it the dataplane processor unit, and they have a very unique combination of customized processing plus DSP. And that, I mentioned earlier, the programmability, the flexibility, that can customize for some specific functions to optimize the data throughput and also the processing speed. I think that it's very significant for the customer that require that particular capability and that can outperform some of the traditional DSP in power and performance. Those are huge important benefit for the customer of ours.

Mahesh Sanganeria - RBC Capital Markets, LLC, Research Division

And there's one more thing I want to understand. I know it's a very specific processing -- I mean, it's a digital signal processing. I just want to make the -- but you definitely use a processing, the function is processing. How does it differ from ARM processor? Is ARM purely targeted towards application processor and this is more targeted towards fixed functions, like a digital signal processor? If you can give us some idea why it's not in direct competition with ARM or any other IP provider, that would be helpful.

Lip-Bu Tan

Sure. I think that Tensilica IP clearly complement industry standard processor architectures that include ARM. And so it clearly is complementary. And secondly, ARM is supportive of the transaction. And in fact, I intend to expand and broaden and deepen our collaboration with ARM. And so that, I think, is a very important complementary, and ARM is very supportive of that, and then we're going to be in a deeper and broader collaboration with ARM.

Mahesh Sanganeria - RBC Capital Markets, LLC, Research Division

Just to verify, the Tensilica will -- like I say, if I take a mobile phone, you sit side-by-side with ARM processor, it will run the apps very well whereas your Tensilica processor will do audio processing, video processing and also 4G signal processing. Is that a characterization?

Lip-Bu Tan

You're correct. And they complement each other in multiple areas, not just mobile, even in smart meter, clearly some of the customers are using Tensilica core and using ARM core, and they are complementing each other.

Operator

Your next question comes from Sterling Auty.

Sterling P. Auty - JP Morgan Chase & Co, Research Division

So you mentioned royalty revenue a couple of times. I know you're not breaking out specifics but is royalty revenue 100% of the revenue, or what are the different revenue sources for Tensilica?

Geoffrey G. Ribar

So there's 2 major sources of revenue for Tensilica. One is the license fee itself for using the IP and the second is royalties on unit volumes for the Tensilica's customers.

Sterling P. Auty - JP Morgan Chase & Co, Research Division

And do most contracts have both kind of an upfront license fee plus royalty?

Geoffrey G. Ribar

Yes, they do. And I think the royalty here again is very important. There is not a lot of IP out there in the world that gets royalties, that shows the value, the differentiation of their IP.

Sterling P. Auty - JP Morgan Chase & Co, Research Division

Sure, sure. Is the upfront license fees -- do they have a chunk of deferred revenue, and how would the acquisition accounting split out the license fee part of the contract that's in deferred revenue versus the royalty?

Geoffrey G. Ribar

Yes, they do have deferred revenue, and that is one of the major reasons the deal is not accretive for this year. On an economic basis, it would be accretive, but on a GAAP accounting basis -- or non-GAAP accounting basis because of the deferred revenue, it's not accretive. It's just slightly dilutive for the year. And that's 100% related to deferred revenue.

Sterling P. Auty - JP Morgan Chase & Co, Research Division

Got you. Is there any customer concentration? So you mentioned 7 of the 10 largest semi [semiconductor] companies. Is there any 1 or 2 that generate an overabundance of their revenue?

Geoffrey G. Ribar

No. They have a lot of good customers, and again, over 200 customers and over 2 billion cores shipped. As you said, 7 out of that top 10 semiconductor companies and a good mix of system companies in there. There's no customer concentration that we're concerned about.

Sterling P. Auty - JP Morgan Chase & Co, Research Division

Now from their perspective, was this something -- just looking at the timing of it, were they running a process? Was this a competitive bid situation, or was it just something that a few companies got together looking at similar strategic outlooks and consummated the deal?

Geoffrey G. Ribar

Yes, we obviously can't talk about the process, but this was something that, I think, was viewed as strategic for both sides.

Sterling P. Auty - JP Morgan Chase & Co, Research Division

Okay, that makes sense. And Lip-Bu, a question for you. Now you've got Denali and as you closed this, how should we think about the IP portfolio? Is there synergies among the development of the IP when you have both companies in terms of common libraries or how the IP will be packaged and presented to the customer? Or will each one of these areas be run as little IP companies within a broader Cadence umbrella?

Lip-Bu Tan

Yes, I think it's a good question. First of all, I just want to highlight, we are very strong, we are a leader in verification IP. And now we are building up piece by piece, and there are differentiating high-quality, silicon-proven design IP portfolio that can address the market that we're going after mobile, cloud, data center, home entertainment. And so we're going to engage with customer very deeply in terms of what they need, in terms of IP blocks and then how can we -- and also the subsystem customers and then how it's really mapping out the IP requirement and also integrate with our tool so that we can really help them faster time to market and then optimize the performance for specific functions they are looking for. So I think all in all, these really broaden and strengthen and expand our design IP portfolio that we can provide. And then very important, a big trend happening is that a lot of our customers prepared to outsource the IP. If we can provide high-quality, silicon-proven differentiating IP. And clearly, Tensilica, Denali fitting that strategy very well in terms of differentiating, high-performance and programmable flexibility that are able to provide to customer that can help them in the faster time to design to market.

Sterling P. Auty - JP Morgan Chase & Co, Research Division

Got it. And last question, was there something when you looked at this asset that you thought Cadence could actually accelerate the adoption within a broader customer base? Or do you feel that it was an attractive asset and would just kind of continue to grow on the same trajectory inside Cadence as it did on a standalone basis?

Lip-Bu Tan

Answer is both. And clearly, we will accelerate the strategy on the IP side and also engage very deeply with our customer so that the customer can win and can be differentiating their product and time to market quicker. And also, I mean this is very unique in differentiating and we can expand from that. And then from this very talented pool that we bring in from Tensilica, together with our existing team, we can really provide a broader and a differentiating IP to our customers.

Operator

Your next question comes from Rich Valera.

Richard Valera - Needham & Company, LLC, Research Division

With respect to the growth rate, I understand you talked about it in mid-30s over the past couple of years. Could you give any color on the relative growth rates of those over those 2 years? Is it sort of roughly comparable, accelerating, decelerating? Any color there would be helpful.

Geoffrey G. Ribar

Rich, it's roughly comparable.

Richard Valera - Needham & Company, LLC, Research Division

That's very helpful. And then sort of follow-up on some of these prior questions. It's sort of unusual to see quote from someone like ARM in a release. I mean, obviously, I think that shows that their 2 products are complementary, but I'm curious how you would characterize Tensilica's current relationship with ARM and how you think it might change now that you own Tensilica? Is there some kind of synergy you can create either purely on the IP side or by somehow doing something different with your EDA design tools and flow that could make the integration between Tensilica and ARM and now Cadence and ARM tighter?

Lip-Bu Tan

Rich, first of all, ARM is a valued partner for Cadence, a very important partner. We work very closely with them, and we are pleased to have their support. As I mentioned, Tensilica IP core complement industry-standard processor architecture, including ARM. And so clearly, we're going to work closely together and collaborate closely and broaden our collaboration with ARM and that is, I think, the key message.

Richard Valera - Needham & Company, LLC, Research Division

Sure. And again, kind of a follow-up. You have significant internal R&D efforts going on in the IP area. You're kind of retargeting significant chunk of professional services employees towards IP. Just wondering is there something you can do synergistically with your internal development as it relates to Tensilica to somehow change the trajectory of this business or increase the value of it by sort of enhance, adding to it in some way.

Lip-Bu Tan

I think, clearly, the answer is yes. And clearly, there's a very strong synergy, and we are just delighted to have a very talented managerial and technical leaders to join us. And clearly, we're going to explore and enhance the internal developing plans to Tensilica and then we have a couple of very important pieces of IP, and then we can really address vertical end markets. As I mentioned earlier, in the mobile, in the cloud, data center, in the home infrastructure. All those are all very exciting to us, and clearly, our different piece of IP will help in terms of processing, connectivity, enhanced performance and then lower power, and then optimized for the specific applications to markets we are going after. So clearly, this is all going to enhance and expand our portfolio to serve our customers success.

Richard Valera - Needham & Company, LLC, Research Division

Great. And then finally, I think this is probably for you, Geoff. Can you say if there's any type of retention plan you're putting in place to try to keep key employees?

Geoffrey G. Ribar

Of course, the employees are an important part of this deal. Obviously, we're not going through detailed terms and conditions on the deal, but the employees are a very important part of this. I think as Lip-Bu said, very talented technical team built a great business, very technical managerial team. Jack Guedj, who is joining, I think has done a great job, and his whole team has done a great job. So we're just excited to have him. And as always with M&A, you want to keep the people.

Richard Valera - Needham & Company, LLC, Research Division

Yes, that goes without saying. So you can't say even qualitatively if there is some kind of specific retention plan you're putting in place at this point?

Geoffrey G. Ribar

We worked hard to retain the people.

Operator

Your next question comes from Tom Diffely.

Thomas Diffely - D.A. Davidson & Co., Research Division

I guess, first, it looks like there's some pretty strong growth going on at Tensilica. I'm curious if you expect any impact on your CapEx this year. If there's any kind of movements or expansions that would be meaningful for you.

Geoffrey G. Ribar

Yes, tentatively, right now, I'd say we don't expect a material impact on our CapEx spending.

Thomas Diffely - D.A. Davidson & Co., Research Division

Okay. And then just quickly on the royalties, did you say it was a per core shipment type of royalty system where every core that shipped is incremental unit from your point of view or is it...

Geoffrey G. Ribar

Almost every core that shipped has royalty attached to it.

Thomas Diffely - D.A. Davidson & Co., Research Division

All right. And just, I guess, kind of backing up on the technology side, is there such a thing as a standalone DPU or is it always a core embedded inside another piece of silicon?

Lip-Bu Tan

Yes, I think it's core embedded in the silicon. And as I mentioned earlier, the combination of customization processing and the DSP.

Thomas Diffely - D.A. Davidson & Co., Research Division

Okay. And then just finally here, is there any way to quantify recent success or some share gains that have increased the business level quite a bit but have yet to translate into royalties? And talk about given the new markets and new places that the company has entered, that you expect to drive a nice ramp of business over the next few years from a royalty point of view?

Geoffrey G. Ribar

Yes, clearly, what they do is they get a license first from a customer. And then as that customer comes in to develop silicon and start shipping that product, the royalties kick in. Obviously, royalties would likely continue to grow as they grow the license fees over time. So we expect some growth in royalties going forward.

Thomas Diffely - D.A. Davidson & Co., Research Division

So you're seeing a big pick-up in licensing just over the last year or 2 then?

Geoffrey G. Ribar

Yes, we're not going into specifics yet on that at this time.

Operator

The last question comes from Gus Richard.

Auguste P. Richard - Piper Jaffray Companies, Research Division

I jumped on late, so I hope I'm not repeating the questions. I would assume I know Tensilica a little bit. This would almost double your IP revenues. Is that a good order of magnitude, or way to think about it?

Geoffrey G. Ribar

We've never disclosed our IP revenues, so I'll leave you to your own conclusions. But it is material to us and it materially helps expand and grow our IP business.

Auguste P. Richard - Piper Jaffray Companies, Research Division

Okay. And then, in terms of the composition of Tensilica's business, as I recall, they had one very large customer that was roughly 50% of revenues and a lot of the revenue came from audio blocks, and I think they were working their way into DSP and things like small cell and cell phones and that sort of thing. Is that the right way to think about where they're licensing their technology?

Lip-Bu Tan

Yes, I think, let me answer in a more general way. I think, clearly, I mean as I mentioned, they have 7 out of top 10 customer. Those are very important to us as we grow our business. And then secondly, clearly, they have the customization and programmability that is very important IP and performance that we're looking for. And clearly, addressing the whole mobile wireless, the infrastructure and mobile device, that is a very fast-growing area. We're delighted to have that. It's a very important IP to complement what we have. And so I think, overall, it's a very good one for us.

Geoffrey G. Ribar

And again, the customer concentration is much, much lower than, I think, the number you just highlighted.

Auguste P. Richard - Piper Jaffray Companies, Research Division

Okay. And then finally, as I recall, they had a way of customizing their blocks for customers. Is that indeed true? Do they do some customization of their IP for individual customers with relative ease?

Lip-Bu Tan

Yes, that is true. And so you can -- the customer can really go-to-market very quickly, with their off-the-shelf DPU. But they also can customize a DPU using their automated processor generation system that is very unique to them, so that is very programmable, and that can really tailor and customize for specific functions to optimize the data throughput and also the processing speed that is significantly improved.

Geoffrey G. Ribar

And they have some vertical solutions already in place for specific markets where the product is pretty much off the shelf in addition to the customization opportunities.

Auguste P. Richard - Piper Jaffray Companies, Research Division

Well, congratulations. It looks like a great acquisition for you, guys.

Lip-Bu Tan

Thank you.

Operator

And we have no further questions at this time.

Lip-Bu Tan

Okay, so let me summarize. First of all, Cadence follows a disciplined approach to M&A, requiring the acquisition must fit and further our strategy, provide our customers with differentiated technology, bring top managerial and technical talents to Cadence and enhance our shareholder value. We believe the acquisition of Tensilica will represent a major milestone in building out our IP vision and growth strategy.

Thank you, everyone, for joining us this afternoon.

Operator

This concludes today's conference call. You may now disconnect.

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