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PerkinElmer, Inc. (NYSE:PKI)

Q1 2009 Earnings Call

April 30, 2009 5:00 pm ET

Executives

Dave Francisco - VP of IR and Treasurer

Rob Friel - President and CEO

Mike Battles - VP and Interim CFO

Analysts

Ross Muken - Deutsche Bank

Isaac Ro - Leerink Swann

Derik De Bruin - UBS

Justin - Robert W. Baird

Operator

Good day, ladies and gentlemen. Welcome to the Q1 2009 PerkinElmer Earnings Call. At this time all participants are in listen-only mode. We will conduct a question-and-answer session towards the end of this conference. (Operator Instructions). As a reminder, this conference is being recorded for replay purposes.

I would now like to turn the call over to Mr. Dave Francisco, Vice President of Investor Relations and Treasury. Please proceed.

Dave Francisco

Thank you, operator. Good afternoon and welcome to the PerkinElmer first quarter 2009 earnings conference call. I'm Dave Francisco, Vice President of Investor Relations and Treasurer for PerkinElmer. With me on the call today are Rob Friel, President and Chief Executive Officer and Mike Battles, Vice President and Interim Chief Financial Officer.

If you've not received a copy of our earnings press release, you may get one from the Investors section of our website at www.perkinelmer.com or from our toll-free investor hotline at 1-877-PKI-NYSE. Please note this call is being webcast live and will be archived on our website until May 14, 2009.

Before we begin we need to remind everyone of the Safe Harbor statements we have outlined in our earnings press release issued earlier this afternoon and also those in our SEC filings. Any forward-looking statements made today represent our views only as of today. We disclaim any obligation to forward-looking statements in the future even if our estimates change. So you should not rely on any of today's forward-looking statements as representing our views as of any date after today.

During this call, we will be referring to certain non-GAAP financial measures. A reconciliation of the non-GAAP financial measures we plan to use during this call to the most directly comparable GAAP measures is available as an attachment to our earnings press release. To the extent that we use non-GAAP financial measures during this call that are not reconciled to GAAP in that attachment, we will provide reconciliations promptly.

I'm now pleased to introduce the Chairman and Chief Executive Officer of PerkinElmer, Rob Friel.

Rob Friel

Thank you, Dave. Good afternoon and I appreciate you joining us this afternoon for our first quarter 2009 earnings call. We are quite pleased with our financial performance in the first quarter. Despite difficult economic conditions revenue was flat organically and we were able to expand operating margins and generate very good cash flow.

The first quarter of 2009 marked the first quarter that our operating structure was aligned according to human and environmental health. Our increased emphasis on these two attractive end markets coupled with our ability to provide a broad array of service offerings has allowed us to perform relatively well in the first quarter.

In addition, we continue to make good progress on improving operational execution both in the factory and in our front-end organizations. Additionally, we expanded our portfolio of innovative products with significant product launches in the cellular analysis, newborn screening and the analytical sciences area.

We also increased our commitment to advancing drug discovery and life sciences research in Asia with the inauguration of a Center of Excellence in Singapore.

I'm also pleased to announce that we're strengthening our executive management team with the addition of Andy Wilson who will be joining us as our new Chief Financial Officer in mid-May. I'm very pleased that Andy is joining us. Andy is someone I have known since the mid '90s when we worked together at AlliedSignal. He brings some great financial experience starting out at KPMG and having worked at some very good companies like Pepsi, AlliedSignal, and Danaher. In addition he is experienced in business development and operations and most recently served as Corporate Vice President of Investor Relations. So brings a good breadth of experience including a strong knowledge of Wall Street.

I'd also like to take this opportunity to publicly express my appreciation to Mike Battles for serving as Acting CFO over the last couple of quarters and doing a terrific job overseeing the finance organization.

Turning to our market conditions in the first quarter; to summarize, several of our end markets performed a little better than we anticipated while in a few of our markets conditions have continued to deteriorate. Overall, we did not experience any significant surprises relative to our expectations.

Looking at each of the segments, our human health business represented 41% of our revenue in the quarter and grew 3% organically. This business is primarily focused on developing screening and diagnostic tools and applications to fight disease, provide medical insights more accurately and create critical new therapies more quickly.

Within human health, we serve two end markets, Diagnostics and Research, which represented approximately 23% and 18% of our revenue respectively in the first quarter. Revenue from our diagnostics business declined in the low-single digits organically in Q1, with screening growing in the mid-single digit and medical imaging down double digits.

Increased revenue in our genetic screening business was driven by continued [expansion at] screening in both the emerging territories and western European countries and strong double-digit growth from the ViaCord business. This was somewhat offset by continued strict inventory management at the U.S. State Labs.

In our medical imaging business, the decline in revenue over last year was due to the difficult comparisons from the first half of 2008 as we added significant capacity early last year and was able to work off outstanding backlog thereby growing well in excess of market rates.

In addition, the current overall market demand for imaging systems is down in the medical area due to constraints on hospital's capital budgets and lack of financing availability. We continue to see increased penetration in the non-medical markets and are aggressively ramping up new programs in these areas, but they still represent a relatively small portion of the business.

In the research area, we provide a broad suite of products including reagents cellular analysis, lab automation and detection capabilities that are used to improve the drug discovery progress. Our research business grew in the low double digits in the first quarter. Our growth in this area was attributed to demand from recent new product introductions in the reagent area as well as cellular imaging and analysis products with enhanced imaging software.

We are also cycling up against a relatively weak Q1 2008. Within this business, we experienced strong growth in the academic and clinical labs with the pharmaceutical and biotech markets roughly flat. Unlike the overall economy, we believe the research market has stabilized and may potentially provide some upside later in the year as funding from the various government stimulus packages are directed in specific areas of research.

The environmental health business represented 59% of our revenue in the first quarter and contracted 3% organically. In the environmental health area, we provide a number of applications and technologies that improve and protect the surroundings and the environment in which we live. This business includes the environmental safety and security, industrial as well as laboratory services markets.

Our lab services business represented approximately 21% of our revenue and grew low double digits organically in the quarter. This was driven by very strong growth of our multi-vendor OneSource program where we added a number of new customers and continued to gain good momentum in penetrating markets beyond our traditional customer market base. This strong growth from both OneSource and contract revenue more than offset the deferral of maintenance as some customers are prioritizing spending away from repairing instruments.

In addition to seeing good penetration outside our traditional end markets of pharmaceutical and academic labs, we also experienced strong growth in every geographic region of the world as recent increases in our service capabilities outside the U.S. and Europe are paying dividends.

The environmental markets represented approximately 17% of our revenue in the quarter and contracted in the mid-single digits organically. Private testing labs are reducing capital purchases in response to lower demand and tight credit markets, whereas we are seeing increased spending from academic and government-owned labs.

Another area of growth is our products sold in the production and analysis of renewable energy development. However, at this time it is still a relatively small percentage of our business. Safety and security represented 14% of our revenue in the quarter and declined in the mid-single digits organically. Consumer product and food testing grew in the quarter due to increased testing demands for mercury, lead and pesticide testing as well as legislation requiring new testing requirements for consumer product safety applications.

More than offsetting this growth was a decline in our products that serve the pharma QA/QC market as pharmaceutical companies have cut back investing in this area in the short term. In addition, our components in the gas monitoring and intrusion alarms are being negatively impacted due to the overall economic environment.

The industrial market, which represented approximately 8% of our revenue in the quarter, declined approximately 20% organically. These markets that for us, principally include chemical, petrochemical and semiconductor end markets are being severely impacted by economic conditions as these industries are facing both lower demand for their products as well as a need to preserve capital.

I will now turn the call over to Mike to discuss the first quarter financial results in more detail and guidance for the remainder of the year.

Mike Battles

Thank you, Rob. Good afternoon, everyone. I will now provide more details on our Q1 financial performance and guidance for Q2 in 2009 before we open the call for questions.

Before I get into the details, I want to clarify that whenever I talk about a particular measure being up or down, I'm referring to an increase or decrease in that measure during the first quarter of 2009 compared to the first quarter of 2008. To the extent that I use any non-GAAP measures those numbers have been reconciled to a comparable GAAP measure in the financial tables of the press release or posted on our website.

As Rob discussed earlier, Q1 was another solid quarter of financial performance, particularly considering the difficult economic conditions. Revenue was down 6% as compared to the same period last year. The unfavorable impact of foreign exchange net of acquisitions was 6%. Therefore, revenue growth was flat versus the prior year excluding these items. The remaining revenue analysis is presented excluding the favorable impact of foreign exchange and the favorable impact of acquisitions.

By segments, sales grew 3% for human health and declined 3% for environmental health. On a regional basis, the Americas grew low-single digits, Europe declined mid-single digits and Asia grew mid-single digits. Within Asia, we saw strong growth in China, India and Japan offset by continued pressure and key emerging territories where currencies remain weak.

Regions across the globe experienced similar trends within their respective end markets where as Rob mentioned innovative technologies, reagents, consumables and lab services all performed relatively well offset by poor performance in a more capital intensive offerings.

Also contributing to the growth in the quarter was the fact that due to our fiscal calendar every five years we have additional days in our fiscal year, which was the case in the first quarter of 2009. Although it's difficult to determine the precise impact, we believe that these additional days may have added approximately 2% to the overall growth, primarily based on our reagent, consumables and service offerings.

Regarding gross margins, we saw 170 basis points of expansion in the first quarter of 2009 driven primarily by the favorable impact of mix as we experienced relatively good performance from our higher margin product offerings.

Additionally, we generated strong productivity gains from our ongoing cost initiatives and restructuring actions taken early in the quarter related to direct labor in response to anticipated lower demand.

Research and development expenses were $26 million in the first quarter of 2009. Excluding the impact of foreign exchange, R&D expenses were up as compared to the prior year as we continue to invest in our strong pipeline of innovative products, applications and solutions.

Selling, general and administrative expenses decreased by $2.4 million versus the prior year. Excluding the impact of foreign exchange, SG&A expenses increased as a percentage of sales compared to the first quarter of 2008. This increase was attributable to higher selling expense as compared to the prior year primarily related to our continued commitment in investing for growth, particularly in emerging territories.

In addition to the increase in selling expense as mentioned in our January call, our pension expense is higher this year. Offsetting these increases were tight cost controls on G&A expenses.

During the quarter, we recorded $7.8 million pre-tax restructuring charge, primarily related to headcount actions in an effort to resize certain businesses to match decreases in end market demand.

GAAP operating profit was $25.7 million in the first quarter of 2009 versus $33.4 million in Q1 of 2008. On a non-GAAP basis, adjusted operating profit was $48.4 million, which was flat from the prior year as a percentage of sales and represents an additional 70 basis points year-on-year to 11.2%.

Looking at expenses below operating income, interest expense net of interest income for the first quarter was $4.1 million as compared to interest expense of $5 million in the first quarter of 2008. This decrease was primarily led to lower interest rates.

In the quarter, we had an effective tax rate of 28% on a reported basis, which was approximately 170 basis points higher than the prior year. This increase is due to a change in geographic mix of income year-on-year, and we expect this rate to continue throughout the rest of 2009.

GAAP EPS from continuing operations for the first quarter of 2009 was $0.13 compared to $0.18 in the first quarter of 2008. Adjusted EPS from continuing operations, including the effects of stock-based compensation, was $0.26 for the first quarter of 2009, flat from the prior year. This is above the range of our guidance for the quarter of $0.21 to $0.23 and exceeds First Call consensus estimates of $0.20.

Regarding share count, we ended the quarter with 116.5 million shares outstanding. In the first quarter of 2009, we repurchased 1 million of our shares in the open market. We have 8 million shares left in the current repurchase authorization.

Turning to the balance sheet, we continue to maintain a very strong financial position. We finished Q1 with $382 million of net debt, which we define as short- and long-term debt minus cash. We continue to maintain a strong liquidity position with $162 million of cash and approximately $250 million of undrawn availability under our revolving line of credit. We also have no mandatory maturities of debt until 2012.

Looking at the cash flow statement, during the first quarter of 2009 we generate operating cash flows from continuing operations of $18.8 million as compared to $24.9 million in the first quarter of 2008. However, we reduced the drawn amount under our accounts receivable securitization facility by $10 million in the quarter due to the increased costs associated with this asset-backed securitization.

While this is essentially a financing transaction, accounting standards require us to treat the net changes as operating cash flows. Therefore, our adjusted operating cash flows were $28.8 million in the first quarter of 2009 representing an increase of 16% over the same period last year.

Our continued focus on working capital performance has effectively mitigated the impact of external pressures on commercial terms due to the economic conditions. Accounts receivable, exclusive of the reduction in the AR securitization facility, provided approximately $30 million in working capital in the quarter. Working capital turns were relatively flat year-on-year.

In summary, we're pleased with our financial performance in the quarter given the global economic conditions and continued challenges in the credit markets. Let me now provide further detail on our guidance. Although we exceeded our financial targets in the first quarter, we believe that there is continued economic uncertainty in many of our end markets. Therefore, at this time we feel it is prudent to reconfirm our previously issued guidance for the full year of 2009.

For the second quarter of 2009, we don't see a significant change in our end markets, but we are cycling up against more difficult comparisons in a few of our businesses. Therefore, we believe organic revenue growth will be down low to mid-single digits and adjusted earnings for share will be flat sequentially, plus or minus a penny, which is consistent with the current consensus.

In conclusion, we feel good about how we performed in the quarter. We believe that our financial performance was attributed to our ability to execute well, while at the same time deepening our focus and increasing our investments in both human and environmental health. This included launching a strong pipeline of innovative products, applications and services, establishing collaborations and business development activities and launching customer facing activities around the world focused on improving the health and safety of people and their environment.

Before I open the call to questions since Q1 of 2009 is the first quarter in which we are now reporting under the new environmental health and human health business segments. As a convenience to our analysts and investors, we have placed on our website under the Investors section, a historical quarterly segment results for 2008, where we provide the GAAP results as well as the reconciliation to the adjusted results for both human and environmental health.

I would now like to open the call to your questions.

Question-and-Answer Session

Operator

(Operator Instructions). Your first question will come from the line of Ross Muken with Deutsche Bank. Please proceed.

Ross Muken - Deutsche Bank

On the diagnostic assets, could you dig a little deeper on sort of some of the trends you have seen in that business, and if you could talk about what you have seen in sort of the reimbursed assets versus the non-reimbursed? Then in terms of on the cord blood side of things, it seems like that business is held in pretty well. I'm assuming it's sort of performing as you expected and in terms of as we exited the quarter is the same level of kind of demand holding up as we head into Q2 as we sort of saw and then it was sort of just a steady state?

Rob Friel

Let me start off by talking about, I'd say the systems business, which is really sort of a newborn and prenatal screening and I think what we are seeing there is in the U.S., it is sort of flat because as I mentioned there is continued pressure on the U.S. State Labs and their budgets. We think there is maybe another quarter of that.

I think I mentioned in December we were seeing some safety stock reductions and we think that's probably another quarter of that and we start to see growth in the back half, but clearly there is a slowdown in adding tests to the menu. But we continue to see good growth outside the U.S. whether it's in Europe or in the developing areas. So I would say in those cases it is not so much a function of reimburse versus non-reimburse. It's really more of a function of geography. So from that perspective, I think those business will do well in the back half.

With regard to the cord blood, I think there is two things that's going on there. It seems to be fairly recession resilient up to this point and I think it really speaks to the lack of penetration or the fact that it's penetrated probably in the higher sort of economic arenas.

The other thing that is happening is I think we are doing a better job of understanding the fact that we can market cord blood as part of a much larger enterprise. If you look at really the buying factors that people consider when they are going to store blood for let's say 18 or 20 years, one of the major factors they look at is the financial viability of the people they are storing the blood with.

I'd say fortunately when you look at our competitors or you look at other people that are offering cord blood, they've the tendency of being small companies, in most cases private companies and not very well-financially capitalized. I think we have done a nice job recently of pointing that out and taking advantage of the significant financial strength that PerkinElmer has and consequently I believe we are taking share.

Ross Muken - Deutsche Bank

On the service piece, it seems like there's a lot more interest there across the board, as people have been delaying purchases, they're more, I guess, aware of keeping the existing boxes whether your own or not your own kind of working at tip-top shape. Can you characterize the effect of the delayed purchasing versus share gain in terms of the impressive growth in that business?

Rob Friel

I think that's a piece of it. But although I have to say when we don't sell as much instruments, or when we don't sell as much boxes there is a potential negative impact from the service organization because when we sell an instrument we do get some follow-ons revenue in our service organization, whether it's training or validation from that perspective.

So there is a little bit of a negative impact on the service organization when we don't sell instruments. But having said that I think your theory is correct, as people hold on and stretch out purchases of new equipment. They're spending more on service.

I think the other thing that's happening as people come under pressure from a productivity perspective. They really look at service as an opportunity to reduce their costs inside the lab and really focus their expenditures now on things that can help them develop new products.

Ross Muken - Deutsche Bank

Lastly on the guidance. You guys had a really nice quarter here. You kept the guidance. I know the end market environment is still a little bit challenging, but given the fact that the 2Q guidance quarter-over-quarter at least from an EPS perspective looks to be flat. What are you seeing or which specific businesses are you most intently focused on that kind of keep you reserved? Obviously industrial is an obvious one, but aside from industrial to keep you a bit more reserved from being a bit more aggressive on the guidance.

Rob Friel

I'd say we think about our markets and we alluded to that. I think genetic screening is stable, continues to do well. I think bio-discovery is probably stabilizing and may be provides a little bit of an upside depending on the funding of the stimulus packages. I think service continues to do well.

I'd say that one that probably concerns me most of all is medical imaging, and I think we thought that was going to be sort of flattish in the first half, may be a little bit of pickup in the back half, and I think I continue to be concerned about the recovery of that business fundamentally being driven by the lack of financing and also the continued pressure on hospital budgets. So I would say that's the one that I'm sort of most concerned about.

Operator

Your next question comes from the line of Isaac Ro with Leerink Swann. Please proceed.

Isaac Ro - Leerink Swann

On the environmental testing market, could you give us a sense of any new regulations that you're seeing that may be incremental this year or maybe perhaps next year as related to the stimulus package? Just trying to figure out how the regulatory environment is working in your favor.

Rob Friel

There was a new regulation that was passed. I think it was February 10th that increases the testing requirements on consumer products. It was passed in the United States, and so we are seeing some benefit from that.

With regard to the stimulus, I think there are a number of things both in whether it's U.S. I think it is $13 billion going after sort of energy efficiency, some $94 billion on environmental, some $32 billion going into materials and food in addition to the some $120 billion that's going into health care. So I think there are a number of things in the U.S. where we think we can probably see some benefit for.

Then a number of the other areas, China has got a fair amount of money going into health care, energy efficiency, and infrastructure improvements as well as a number of the European countries. So I think there are a number of opportunities there for us. I think the real question is whether it is a 2009 benefit or whether it's a 2010 benefit.

Isaac Ro - Leerink Swann

If it is later this year or early next when you see the first real pickup?

Rob Friel

I think in some areas we will see probably in the fourth quarter, I think probably in our cellular imaging area where we seem to be getting a fair amount of traction at least some of the grants that have been written. So if that funding comes out early fourth quarter, we could see some benefit. I would say we haven't factored any of that in our forecasts or in our guidance. So I think that would be an upside.

Isaac Ro - Leerink Swann

Then just lastly, I think, last couple of quarters, there has been talk about the genetic screening business in the U.S. having some pressure due to state dollars being held up, has that changed at all in the last 90 days? And how does it look going forward?

Rob Friel

I think we are still flat in the first quarter, and as I mentioned previously I think it probably goes another quarter and then I think probably in the back half. We start to see some opportunities to grow again in the U.S., but having said that we continue to see pretty good growth outside in Europe and the developing areas.

Operator

Your next question comes from the line of Derik De Bruin with UBS. Please proceed.

Derik De Bruin - UBS

We've heard a lot about inventory to stocking from some companies and could you just walk us to what exactly you're seeing and what's going on and more importantly do you think the current economic experience that we are seeing right now will prompt a fundamental change in the way the customers manage inventories going forward?

Rob Friel

I would say the area where we saw the destocking was really more in the genetic screening area. Depending on the lab, they would probably keep 60 to 90 day supply of reagents. That's probably the area we saw. We started to see it in 2008. I'd say late third quarter, early fourth quarter of 2008. As I mentioned I think probably come middle to end of second quarter, we'll start to see that bottom out.

Other than that in other areas, we really haven't seen that phenomenon from the standpoint of a stocking problem. Keep in mind some of our reagents on the bio-discovery side are radioactive or radiochemical. The shelf life is not that long. We've got that benefit. So I would say other than in the genetics screening area, we haven't seen a significant impact from destocking.

Derik De Bruin - UBS

What about the second portion of it? It's just a matter of people working for inventories, I'm just wondering if this (inaudible)?

Rob Friel

I think it depends if they can be successful with holding lower safety stock in this environment I think maybe they go up a little bit more but we probably won't return to the levels of safety stock that we were previously. I think if you look at previous recessions in other industries that occurs when people are able to manage their inventory down to a level and they don't lose [phil] rate or they're able to maintain their operations. I don't think we will see go back up, may be a little bit, but I don't think we'll go back to the levels that they had prior to the downturn.

Derik De Bruin - UBS

The gross margin expansion was impressive particularly since you launched a record number of new products with [ViaCord]. Can you just give us a little bit more color into that? I know some of you said it was mixed, but just how sustainable this is going forward?

Rob Friel

Well, I think the new product side of thing is fairly sustainable. I think we're seeing good traction in a number of the new products that are out there and as you mentioned one of the goals with the new products is not only to get new features, but also to improve the gross margin on that. So I think that's repeatable. I think the margin makes it really depend on going forward.

One of the benefits we saw this quarter is the fact that our service and reagent business was very strong and the instruments were down. If you look at our split, service grew, our reagents and consumables grew, and our instruments were down. I think that's driving a lot of the mix. Hopefully going forward that won't always be the case. I mean, hopefully we will get some continued growth on the instrument side.

So I would say I think on the new products it is repeatable. I think on the reagent and instrument mix, I don't know that we will have a growth differentiation going forward as we had this quarter.

Derik De Bruin - UBS

What were the instruments down in terms of organically?

Rob Friel

The instruments were down about 7%.

Derik De Bruin - UBS

And finally, on your discontinued operations is there any update on your plans of it?

Rob Friel

No plans. I mean, the books have been out for another couple weeks now. We have got a fair amount of people interested. We just started discussions about value and due diligence. So I think that continues to go on as planned.

Operator

(Operator Instructions) Your next question comes from the line of Quintin Lai with Robert W. Baird. Please proceed.

Justin - Robert W. Baird

This is actually [Justin] for Quintin. What was the FX in the quarter?

Rob Friel

The FX from a revenue perspective?

Justin - Robert W. Baird

From topline?

Rob Friel

7% FX and 1% helped from acquisitions.

Justin - Robert W. Baird

Is that evenly split between environmental and human health or is it more weighted on one side?

Rob Friel

It is more weighted on the environmental side.

Justin - Robert W. Baird

You said you purchased about a million shares, what was the average repurchase price for that?

Mike Battles

$14 a share.

Justin - Robert W. Baird

One last question, you said that you saw research stabilizing. What are you seeing exactly that made you think that it's stabilizing? Are you looking at stimulus in the back half of the year or are you starting to see cord activity on a more normal basis?

Rob Friel

I would say it is more of the latter. I would say what we are seeing from our customers is a stabilization of order patterns. I think we mentioned this in our last call. I think when you look at the pharmaceutical industry they have been going through a fairly difficult time for some time with whether it is generics or drugs coming off patents. Our belief is they have adjusted their spend rate almost irrespective of what's happened from an economic perspective. So we are actually seeing some stabilization, both on the instrument as well as the reagent side in bio-discovery.

Justin - Robert W. Baird

That's very helpful. Then one last question, you noted that the U.S. was up organically but Europe was down which is kind of counter to lot of what your competitors have said. Can you provide a little more color on that?

Rob Friel

I think part of that's being driven by our medical imaging business, which was down fairly significantly and a lot of that goes into Europe. When we talk about Europe, we include Eastern Europe. Eastern Europe was down quite significantly I think largely because of the FX things that Mike talked about in the emerging territories. Their currency has been devalued quite significantly.

Operator

There are no further questions in queue. I'd now like to turn the call back over to management for any closing remarks.

Rob Friel

Going forward, we will continue to manage the current economic environment through a dedicated focus on cash flow, driving service, consumables and reagents revenue, and containing non-customer related costs, while continuing our investment in high-growth areas, innovations, collaborations and employee development.

As experienced in the first quarter, I believe that this is a balanced approach, which will provide us with a strong foundation to maintain our market leading position now, grow when the economy recovers and become an even greater contributor through improving the health and safety of people in the environment.

This concludes today's call. Thank you for joining us. Have a great day.

Operator

Thank you for your participation in today's conference. This concludes the presentation. You may now disconnect. Good day.

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