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InfoSpace, Inc. (INSP)

Q2 2006 Earnings Conference Call

August 2, 2006 5:00 pm ET

Executives

Stacy Ybarra - Senior Manager, IR

Jim Voelker - CEO, President

Allen Hsieh - Interim CFO

Analysts

Jordan Rohan - RBC Capital Markets

Gordon Hodge - Thomas Weisel Partners

Imran Khan - JP Morgan

Mark May - Needham & Company

Paul Bieber - Piper Jaffray

Scott Sutherland - Wedbush Morgan

Presentation

Operator

Good day, everyone and welcome to the InfoSpace quarter two 2006 earnings release conference call. Today's conference is being recorded. At this time, for opening remarks and introductions, I would like to turn the conference over to Stacy Ybarra, Senior Manager, Investor Relations. Please go ahead.

Stacy Ybarra

Thank you. Good afternoon and welcome to InfoSpace's second quarter 2006 earnings call. I'm Stacy Ybarra, Senior Manager Investor Relations and Communications. With me on the call today is Jim Voelker, Chairman and CEO, and Allen Hsieh, Interim Chief Financial Officer.

Before we get started I want to remind you of two things. First, this is an investor conference call. Accordingly , we will only be taking questions from the investment community.

Second, this conference call contains forward-looking statements relating to the development of the Company's products and services and anticipated future operating results. These statements are subject to certain risks and uncertainties that could cause actual results to differ materially from those projected.

Factors that could affect the Company's actual results of operations include, but are not limited to: the progress and cost related to development of our products and services; the timing of market acceptance of those products and services; our dependence on companies to distribute our products and services; the performance of our systems; the effectiveness of the development and implementation of our strategy; possible changes to that strategy; the ability to retain key contracts and personnel; and the ability to successfully integrate acquired businesses.

A more detailed description of certain factors that the could affect actual results of operations is contained in the Company's most recent Annual Report on Form 10-K and Quarterly Report on Form 10-Q, as filed from time to time with the Securities and Exchange Commission in the sections entitled “Factors Affecting Our Operating Results, Business Prospects and Market Stocks”.

Listeners are cautioned not to rely on these forward-looking statements, which speak to the Company's prospects only as of the date of this conference call. The Company undertakes no obligation to update publicly any forward-looking statements due to new information, events or circumstances after the date of this conference call, or to reflect the occurrence of unanticipated events.

Now I'll turn the call over to Jim. Following his comments, Allen will review the second quarter financial results and third quarter outlook. Then we'll open up the call to your questions.

Jim Voelker

Thank you, Stacy, and welcome to the call today. The second quarter was another solid performance for InfoSpace. We posted our second straight quarter of record revenue behind growth in both of our segments. Revenue was $95.8 million, up 15% year-over-year and 6% sequentially. This was driven by strength in mobile media downloads and in particular an increase in online search monetization.

Mobile revenue was $45.5 million, an increase of 23% year-over-year, and our online segment posted $50.4 million, up 9% year-over-year. Adjusted EBITDA totaled $8.9 million, above our expectations. We added to our balance sheet by $11.5 million to end the quarter with $407 million or more than $13 per share in cash.

We're focused on building a large and diverse mobile and online audience by offering a wide array of personalization, entertainment, information and advertising content to our portals, our applications and our many distribution partners. We believe this audience can be profitably monetized via advertising and the sale of content, and thus far we've been successful at both endeavors.

Our mobile audience is growing rapidly and we estimate that over 35 million unique mobile users accessed our content or utilized our applications in the second quarter, an increase of 40% sequentially. That translates to more than 15% of U.S. subscribers using InfoSpace services.

Online, we have approximately 17 million monthly unique visitors between our owned and operated sites, and those of our 100-plus distribution partners. And our new online local search site, InfoSpaceFindIt.Com attracted over a quarter million users last month without benefit of promotion.

Our strategy for growth and value creation is driven by success in three disciplines: Technology, content, and distribution. Leveraging our capabilities in each, we have three key initiatives this year: Direct-to-consumer mobile, content acquisition, and mobile search. We've gained ground and I'd like to take a moment to share our progress to-date.

I'll begin with our direct-to-consumer offering, Moviso. At the end of the second quarter, we launched Moviso, an online direct to consumer portal that allows users to personalize their cell phones by downloading content from a broad catalogue of ringtones, graphics and games. Initial content partnerships include Warner Music Group, EMI Music, Universal Pictures, Corbis and Getty Images, and we have carrier partnerships with Cingular, Sprint and T-Mobile. We look forward to adding Verizon later this year.

In it's first phase of the product we're collecting information about customer preference and their interaction with the content and features on the site, as well as testing the various delivery and billing systems required to provide a great end-to-end experience. We're feeding those earnings into the next release of Moviso, which will feature more robust content and capabilities, due out in the fourth quarter.

We are growing slowly and we will not significantly ramp up advertising spend in the third quarter. We are using our search engines and online knowledge to drive users to the site during this period.

Now to the content initiative. We're the leading provider and publisher of mobile content in North America. We've licensed and acquired a deep library of music, graphics, games and a variety of other personalization products, and we continue to build our catalogue at a brisk pace. In this quarter, we closed over 50 new licensing deals, including content from Deal Or No Deal and Classic Media, to bring us more than 800 licensing agreements and over 3 million items in our content catalogue. In addition, we created over 1,000 original pieces of content in the form of graphics, ringers and FX tones in the first half of 06.

On the games front, we're partnering with Activision to create mobile versions of top games, including two upcoming Tony Hawk titles, “Project A” and “Downhill Jam”. All of this content is designed to feed a growing market of personalization and entertainment and we're beginning to marry this content with brand new technology. For example, we've developed five theme applications for Sprint utilizing Qualcomm's UI-1 user interface.

This technology integrates rich media with background channel updates so that the phones screen is never really idle; it is constantly being refreshed. Some of the themes include Hubble Space, Alan Iverson and the World Cup.

We believe that the increased deployment of 3G devices and high speed networks and new technologies such as Qualcomm's UI-1 portend good things for our business and products like these are at the leading edge.

Now to our third initiative, mobile search. We continue to be positive about the long-term opportunity here. We view it as the starting point for consumption of mobile media and therefore an important element in driving sales and at a point in the future, advertising.

In our first two implementations, we immediately saw a lift in content sales and we're learning each day about user behavior and query patterns. The product is improving rapidly and we've just launched a second version on Cingular featuring a move of the search box to the top of the page. This will drive more queries and improved content sales.

Our location-based search application, InfoSpaceFindIt is delivering strong product and user reviews yet the process of perfecting deck placement on the carrier is a painstaking task. We're receiving increased support from our carrier partner in this area as well as marketing and are encouraged by the progress.

One of the keys to our success in mobile search has been the extensive knowledge we've developed through our online properties such as Dogpile, Switchboard and InfoSpace.Com. I mentioned the launch of our local site InfoSpaceFindIt.com a little earlier and if you have not visited this site, I urge you to do so. It demonstrates the power of our meta search and directory technologies as well as the opportunity we have to leverage our online assets into the mobile space.

Our location-based mobile application Find It! utilizes the same back end to generate results, and overall, both of these experiences are excellent for users.

We will continue to focus or energies and invest in initiatives that bring our search capabilities to mobile, expand our content portfolio, and enhance our direct-to-consumer offering, Moviso. We believe success in these initiatives allow us to take advantage in the growth and evolution of the mobile market. In addition, we continue to drive profitable growth online and to leverage our assets across a whole new set of users.

We were very pleased with our second quarter and indeed our first half results. We are in exciting growing markets and see significant opportunity in front of us. With that I'll turn the call over to Allen to provide you more details on the financial performance.

Allen Hsieh

Thanks, Jim and welcome to our call today. I will start with the review of our second quarter results and then turn to our third quarter outlook. We are pleased with our revenue growth from a record first quarter. Our revenues for the second quarter were $95.8 million, an increase of $12.6 million from the second quarter of '05 and sequentially up by $5.5 million from the first quarter.

For the second quarter of '06 our adjusted EBITDA was $8.9 million or a 9.3% margin. We continue to invest in significant resources in our three major growth initiatives. As previously discussed, we targeted spend of $6 million or $7 million on those initiatives in the second quarter; however due to the timing of the launch of Moviso and hiring cycles, our spend was approximately $4 million. The timing of our initial spend, combined with the strength in our revenue and gross profit resulted in adjusted EBITDA being ahead of plan.

On a comparative basis, second quarter adjusted EBITDA decreased $10.3 million compared to the second quarter '05 and was sequentially down by $3.8 million from the first quarter, both of which were consistent with our plan.

Net income for the second quarter of '06 was $1 million or $0.03 per share. Please keep in mind when comparing our year-over-year net income results in 2006, we now record stock compensation costs and are also recording full GAAP income taxes. Excluding stock compensation costs of $4.6 million and the related taxes, net income in the second quarter of '06 was $3.5 million compared with second quarter '05 net income of $16.3 million.

Weighted average fully diluted shares were 32.9 million for the second quarter of 06.

Now, let me turn to our segments. Starting with mobile, revenues in the second quarter of ‘06 were $45.5 million, up $8.4 million from the second quarter of '05 and up $1.3 million from a strong first quarter. As a reminder, last year we saw sequential decrease in the second quarter in our mobile revenues; however in the current year, our mobile media revenues increased. We believe that this is partially attributable to the benefits of having search on our carrier partners' portals.

However, our segment gross margin has been impacted by the shift towards more label tone sales, as it has grown to over 80% of our total media sales. This shift in our product mix coupled with the one-off content-related charge of $750,000 and increases in our other content costs resulted in segment gross profit of $17.5 million or a 38% gross profit margin. This is a decrease of $1.8 million compared to the second quarter of ‘05 and a sequential decrease of $1.3 million compared to the first quarter.

Turning to online, in the second quarter of '06, revenues were $50.4 million, up 4.3 million from the second quarter of '05, and up $4.2 million sequentially from the first quarter. We saw a sequential increase in our online search revenues despite the general seasonality in the second quarter. The increases were primarily due to better monetization of our online traffic which is consistent with industry trends and positively impacted both our own sites and our distribution sites.

Segment gross profit was $32.3 million, or 64%. Gross profit increased by $3.2 million from the second quarter of '05, and sequentially gross profit was up by $2.4 million, compared to the first quarter.

In the second quarter of '06, search distribution revenues continued to account for approximately 60% of the portion of our online revenue coming from search. Now, I will touch on a couple of expense items. As we have discussed, starting in 2006, our operating expenses include stock compensation costs amounting to $4.6 million in the second quarter of '06, which was less than expected. In 2005 we did not record stock compensation costs.

Also in 2006, we started to record full GAAP income taxes, which amounted to $900,000 in the second quarter, and is in line with our full year expectation of an effective tax rate of 45%. However, it is important to remember that a majority of our income tax expense is non-cash, because of our significant net operating loss carry forward and for the second quarter of ‘06, our cash taxes were approximately $200,000.

Looking at the balance sheet, we ended the quarter with cash and marketable investments of $407 million, up $11.5 million from the end of the first quarter of '06, and we have zero debt. In May, we renewed our stock repurchase program and are authorized to spend up to $100 million, which is in addition to the $70 million we used to repurchase 2.6 million shares of common stock under the initial program.

Now, let me turn to our third quarter outlook. On the online side, internet usage is typically slower during the summer months, which impacts our online revenues. On a mobile front, we expect sales of our media downloads to moderately increase, consistent with the trends we saw last year. Additionally, we don't expect significant revenues from our recently launched direct-to-consumer site as we continue to apply a measured approach in attracting customers during this phase.

Therefore, we expect revenues in the third quarter to be in line with the second quarter and range between $95 million to $97 million. We expect adjusted EBITDA to be between $3.5 million and $4.5 million in the third quarter. As we have mentioned in the past, this is a very important year for us. The mobile market is a very fast growing and evolving business opportunity and we plan to continue investing significant resources, which will increase our overall operating expenses.

We expect net loss to be between $2.5 million and $3.5 million or a loss of $0.08 to $0.11 per share in the third quarter. This will include approximately $6.5 million in stock compensation expense. This concludes our prepared remarks. I will now turn the call over to the operator and we'll be happy to take your questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). We'll go first to Jordan Rohan - RBC Capital Markets.

Jordan Rohan - RBC Capital Markets

I have a question about the search side of your business. You mentioned on the call an increased monetization. Can you talk about whether there is any volume increase quarter to quarter at all, or should we just assume that the lack of any mention means that it was flat?

Can you talk about the difference between the local-type queries and the national queries? I know you've got a couple different efforts including the assets formerly known as Switchboard? Thanks.

Jim Voelker

Well, with respect to the traffic, the traffic was essentially in line with the first quarter and most of our increase in revenue is due to better monetization off of our search engine partners.

Allen Hsieh

Second question was about between local and that's just not something we break out, Jordan but I would tell you that the traffic trends have been positive on the local stuff overall and pretty positive over the last year or so on the rest of the sites as well.

Jordan Rohan - RBC Capital Markets

Okay, you had mentioned before that you were replacing some of the lost revenues from the SuperPages loss with a different provider. Has that fully been engaged and put on your site and is ramped fully right now?

Allen Hsieh

Well, I think we always feel like we could do better and sell more, but yes, we've actually I think even in the last quarter, by the end of last year had pretty much put things in place and started to see the traffic in the mid first quarter on that. Most of the monetization lift here is coming from higher advertising rates, really.

Jim Voelker

Also remember, Jordan, that Verizon did team up with us as we mentioned on our last call. Just not at the same level as they had been in the past.

Jordan Rohan - RBC Capital Markets

Understood and thank you very much.

Operator

We'll go next to Gordon Hodge - Thomas Weisel Partners.

Gordon Hodge - Thomas Weisel Partners

Hi. Good afternoon. Just a couple questions. You mentioned you were working with Activision and I think that's new. I was wondering if you could just comment on what you're doing with them, if they are developing games and you're distributing them or are they importing them or are you actually developing the games?

Jim Voelker

It is new, Gordon, and we are developing the games and distributing them as well. So it's a matter of taking their intellectual property and some of the game form around it and turning it into games specifically for mobile.

Gordon Hodge - Thomas Weisel Partners

Great. Just on the games topic I was wondering if you could just update us a little bit on how that's progressing with your own titles? Allen, I think you mentioned 80% of media revenues was label tones and if I'm not mistaken I think 80% of your revenue is ring tones, so that would imply -- unless I'm misunderstanding -- that we pretty much made a full conversion to the real or label tones from the polys. Is that fair to say?

Allen Hsieh

I'll take your first question with respect to the games. Games is not performing as we had expected. It is a still relatively small or modest part of our mobile revenues here. We expect that with things like Activision, you need have good titles for those.

In terms of just on the ring tones and more specifically on the label tones, you've got it pretty much right. There's a good size of our label tones, our ring tone sales are label tones, but we still do monetize off of polys and monos, but label tones continue to be a much higher percent and is growing sequentially from the first quarter.

Gordon Hodge - Thomas Weisel Partners

We're getting a really close to a status quo where you aren't expecting additional shifts?

Jim Voelker

Well we think so. As you said, we're at about 80% plus right now, around 83%, I think to be precise, so it doesn't have a great distance to go. But we are still selling poly tones and mono tones, so I suppose over some length of time, you could see those go away completely. My guess is that it reaches a point where they stay in the market a little bit and they are probably at that point or close to it.

Gordon Hodge - Thomas Weisel Partners

Great. A last question on Moviso, just any sense, having been up for a little while now, that you can give us for the economics? I gather the economics to you are going to be better since you're generating the demand?

Jim Voelker

Well they should be and that's all going to be a function obviously of cost per gross add or cost per customer acquisition. At this point our cost per customer acquisition is very low because we're not spending any advertising dollars, so I don't think we really learned anything much on the long-term economics.

In this kind of an environment, it's interesting. You can run a beta site but you're running it basically with your own people banging on it and what we found when we've launched online sites of sites around the online search or what have you such as the new local site, it's just better to put it out there and let people go at it and find out where you have issues that you'd like to improve on.

How do they interact with this site? How do they go back from page to page? Do they give them different landing pages or do they look at does one landing page work better than the other? Those kinds of things and that's the stage we're in now and that we'll continue to be in for most of the third quarter.

Gordon Hodge - Thomas Weisel Partners

Perfect. Sounds good. Thanks.

Jim Voelker

Thank you.

Operator

We'll go next to Imran Khan - JP Morgan.

Imran Khan - JP Morgan

Hi, Jim and Allen, how are you?

Allen Hsieh

Hi, Imran.

Imran Khan - JP Morgan

A couple of questions. First a better understanding of the Q3 guidance, it seems like Q2 numbers were better than what we were expecting and probably the guidance. I was starting to get a sense of , are you planning to invest in any areas in Q3, or do you push out the investment that you were planning in Q2 to Q3?

Secondly, Jim , you have a lot of cash on hand. I know you're buying back shares. Can you give us some sense of what are the other areas of use of cash you're thinking about?

In terms of buying back shares, Allen can you give us an update how many shares you might have bought since May?

Allen Hsieh

I can take the first one about the spend. Imran, we are as we mentioned before, a portion of our spend here is related to hiring folks. We hit certain hiring cycles so those are going to be pushed out into the third quarter as well as some of our promotional costs, so we are going to spend on our initiatives there. That's what's impacting our guidance from an EBITDA standpoint on the third quarter.

On the share buyback, we initiated toward the end of May actually, almost at the end of May, as soon as we walked into our quiet period and as a result we weren't able to repurchase any shares during the second quarter.

Jim Voelker

In terms of the other usage for the cash, obviously there's nothing specific we can talk about here, but we continue to look at opportunities that could grow the business significantly, and that might be geographically or in fact probably geographically or something that would give us a significantly larger audience to sell our content and put search queries through.

Imran Khan - JP Morgan

Great. Thanks.

Allen Hsieh

Thank you.

Operator

We'll go next to Mark May - Needham & Company.

Mark May - Needham & Co.

Hi. Thanks for taking my questions. First on Moviso, I was wondering if you could elaborate a little bit more with what your goals are with Moviso and why you decided to maybe go a little slower in marketing the site?

Secondly, on just more of a financial question, I think guidance for stock comp for the quarter was about $2 million above what it came in at but you're guiding for the third quarter for it to go back up to the $6.5 million range which I think is where you had guided for this quarter. I was just wondering if you could elaborate a little bit why they changed that?

Allen Hsieh

I'll take the stock compensation question. Why the sequential increase from the second quarter to the third quarter, it's really due to the timing of when we granted our stock options. We granted our options in the middle of May and as a result, we didn't have a full quarter of expense in the second quarter. The third quarter reflects a full quarter of the stock compensation charge. Does that help you?

Mark May - Needham & Co.

It's perfect.

Jim Voelker

In terms of Moviso, Mark, this is a long term project for us and so the goals long term are obviously, I guess like anybody else would say, to build a significant brand and an important and trusted brand in the market as a place for people to go and be able to find and purchase mobile content , and mobile content applications.

As such, and again this is something brand new for us, so we were mindful of some of the experiences we've seen and others have in this market where either the quality of the delivery process wasn't up to snuff, or the billing process wasn't up to snuff when first launched and went through a lot of growing pains that way. Or that we weren't addressing a broad enough set of users through handsets, et cetera.

We know we will add that fourth carrier we mentioned here quite soon and so we decided that until we were in that position we wouldn't push the pedal down, if you will, on as much promotion. We want to be able to make sure that promotion gets leveraged across the widest audience possible and taking a quarter of the audience out we didn't think was helpful in that respect.

So we're not in a hurry here. We want to do this right. We want every user we attract to stay. That's a goal we won't achieve, but we certainly don't want to be driving them away with Oh, gee, I can't do this on my phone there or boy, I put this in and I didn't get what I thought I'd get, or I didn't get billed right, or I got billed twice, or things of that nature. So we're putting a lot of water through the pipes here to make sure that we've tested it right.

I think the other advantage we have here is we do have a lot of branded content we can move on that differentiates us quite a bit from others. The second piece is that we have some really interesting applications we can use here. Find It! would be an example. Again, those take a little bit more time to clear through the carriers and make sure that you've got a wide enough audience to be able to promote to.

Mark May - Needham & Co.

It sounds like based on what you know right now, that some time in the fourth quarter is when all of these things align, where you feel more comfortable making a bigger commitment, a bigger investment there?

Jim Voelker

That's certainly the goal. That's certainly the aim.

Operator

We'll go next to Safa Rashtchy - Piper Jaffray.

Paul Bieber - Piper Jaffray

Hi, this is Paul Bieber for Safa. Two quick questions. When you look at where you are in the investment cycle this year, what stage do you think you're in? How long will the current investment cycle last?

Secondly, are there any metrics that you could share with us about how mobile search leads to increased content purchases?

Jim Voelker

Well let me take the second one. We're very confident that that's the case but we're not willing to share any metrics. Perhaps we will at some later time, but in terms of we're doing pretty well in the competitive world right now and we just as soon keep those between our partners and ourselves. In some cases frankly with our partners, we're not free to share all of the metrics but we're very confident that that's the case. I think you can see between the second quarter last year and the second quarter this year the trend has changed. I don't think it's 100% because of that search, but we certainly know that it's somewhat attributable to that.

In the first case in terms of the investment cycle, I guess it depends on what you're talking about. We've made quite a bit of investment to build up human resources here in terms of some of the initiatives, and I think we're near the end of that cycle, if you will. Whether that's three quarters of the way, or two-thirds of the way through, or seven-eighths of the way through, when we're finished we'll be able to tell you what it was today.

In terms of something like Moviso where we are going to have an investment cycle in spending around promotion, we're very early in the cycle. So I think all of these things run on different tracks, if you will.

Paul Bieber - Piper Jaffray

Okay, thank you. That's helpful.

Jim Voelker

Sure, Paul.

Operator

We'll go next to Scott Sutherland - Wedbush Morgan.

Scott Sutherland - Wedbush Morgan

Great. Thank you, and good afternoon. The first question I had is you said that your label sales was 83% -- what was it last quarter again?

Jim Voelker

I'm sorry. I missed that, Scott.

Scott Sutherland - Wedbush Morgan

What was your percentage of label tones of total ring tones last quarter?

Allen Hsieh

Scott, our percentage was right around 80% last quarter.

Scott Sutherland - Wedbush Morgan

Okay. Backing out that $750,000 one-time charge, you still saw some margin compression there in mobile. Do you see any other content costs going up, or as you go forward do you see a stabilization of that gross margin?

Allen Hsieh

Well it's a combination of two things. One is as we bring on more new content, it roughly depends on as we bring that on what the terms are so it could go up or down. I mean, obviously the goal is to get lower cost content and push that through, but you do also have some increase in cost of our other content here.

Scott Sutherland - Wedbush Morgan

On Moviso, I know some other people tackled the revenue side but when you do direct-to-consumer, it obviously allows you to manage the merchandising a lot better. Do you expect a different kind of gross margin profile for Moviso once it ramps up and do you have a range you can share with us?

Jim Voelker

It's really way too early to tell, but we agree with the premise that we should be able to merchandise better and differently. If for no other reason than most of the interactions are on the website as opposed to on a phone which has it's obvious limitations.

We certainly hope that bundling helps us there too to bring along higher content, higher margin content, if you will. Those are all the premises, Scott, and you've got them right. We'll find out how it actually executes.

Scott Sutherland - Wedbush Morgan

Okay and just two more questions. With Moviso, I know you're really spending R&D and we saw that jump, but sales and marketing hasn't jumped. What should we expect in Q4? Does R&D stay where it is, or does that come back as and does sales and marketing jump in the fourth quarter?

You spent about $4 million, you said, last quarter if I remember your remarks. Does that jump to a $5 million or $10 million range? Where should we see the total expenses on Moviso jump to?

Jim Voelker

Well we're giving guidance for the third quarter.

Scott Sutherland - Wedbush Morgan

Can you talk about as it ramps should we see a shift towards sales and marketing incremental spend?

Allen Hsieh

Like Jim said, it's going to be a measured approach on how we do the Moviso launch and how much we invest in it. We mentioned that we are going to look at it from a measured standpoint in the third quarter.

Scott Sutherland - Wedbush Morgan

Last question you had some good monetization on the search side. Is this just from cleaning up the traffic or is there something else that you guys have done to help monetize the traffic?

Allen Hsieh

Actually, as I mentioned earlier, I think someone else had asked a similar question that really it's better monetization off traffic because traffic was relatively stable first quarter to second quarter.

Jim Voelker

I think, Scott, though the driver here is advertising rates. It just seemed to increase.

Scott Sutherland - Wedbush Morgan

Okay, great. Thank you.

Jim Voelker

Thank you.

Operator

(Operator Instructions). There are no other questions remaining.

Stacy Ybarra

Great. Thank you for joining the call.

Operator

Thank you, everyone. That does conclude today's conference. You may now disconnect.

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