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Blount International, Inc. (NYSE:BLT)

Q2 2013 Earnings Conference Call

August 7, 2013 13:00 pm ET

Executives

David Dugan - Director, Corporate Communications & IR

Josh Collins - Chairman & CEO

David Willmott - President & COO

Calvin Jenness - SVP & CFO

Analysts

Robert Kosowsky - Sidoti

Steve Barger - KeyBanc Capital Markets

Larry De Maria - William Blair

Presentation

Operator

Good morning or afternoon as the case may be for each of you and welcome to the Blount International, Inc., teleconference with Mr. Josh Collins, Chairman and Chief Executive Officer, Mr. David Willmott, President and Chief Operating Officer, Mr. Calvin Jenness, Senior Vice President and Chief Financial Officer and Mr. David Dugan, Director of Corporate Communications and Investor Relations.

My name is Laura and I will be your facilitator today. The conference will begin with a brief overview of the second quarter 2013 results and the company’s outlook for 2013, followed by a question-and-answer session. All lines have been placed on-mute to prevent any background noise. (Operator Instructions).

At this time I would like to turn the call over to Mr. Dugan. Mr. Dugan, you may begin.

David Dugan

Thank you, Laura and good day everyone. Before we summarize the company’s performance, I would like to remind everyone that the statements made in the course of this conference call regarding the company’s or management’s intentions, hopes, beliefs, guidance ranges or other expectations for the future are forward-looking statements. Those statements involve risks and uncertainties that could cause actual results to differ materially.

Please refer to this cautionary statements detailed in this morning’s press release and our Form 8-K and SEC filings. Additionally, we have supplemented our second quarter results news release with a presentation that can be found along with the news release on our website at www.blount.com.

At this time, Josh and Cal will give us an overview of the second quarter of 2013 along with our outlook for 2013.

Josh Collins

Thanks, David, and thank you all for joining us on today’s call. In the second quarter, we continue to be challenged by global economic conditions…

Operator

Pardon me, this is the operator, please standby. Pardon me, this is the operator, thank you for standing by. We seem to have lost connection with the speaker location. I will place your lines back on hold until we are able to reconnect the speakers. Thank you again, please standby.

Once again thank you for standing by. The Blount International conference will resume shortly. Thank you for standing by.

Thank you for continuing to wait. The speakers have been reconnected to the conference. Please go ahead.

Josh Collins

Okay. This is Josh again. I’m going to start at the beginning since I’m not sure exactly where we lost you. In the second quarter we continued to be challenged by global economic conditions. We experience lower demand in all of our regions. The sales for the second quarter were down 8% compared to the second quarter of 2012. The FLAG segment sales down about 9% and FRAG down about 5.5% compared to second quarter 2012.

We experienced weakness in North America and Asia during the second quarter. The sales down 10% in North America and nearly 12% in Asia compared to the second quarter of 2012. North America was impacted by a late start to the 2013 spring season and Asia was impacted by excess channel inventory.

Demand in Europe and Russia continues to be soft with sales in the region down approximately 2% compared to the second quarter of 2012 due to ongoing economic conditions. Our on order position reflect softer demand. The total on order position of $173 million compared to nearly $200 million at December 31, 2012.

Our FLAG order board of about $156 million represents approximately 90% of the total. The FLAG order board was down about 7% from December 31, 2012 and declined by about 9% compared to the June 30, 2012 position, as we improved our delivery of back ordered items. Excluding back ordered items; FLAG open orders were flat compared to June 30, 2012. FRAG orders in hand are down about $3.5 million from June 30, 2012 mostly due to improved throughput of SpeeCo products in our Kansas City distribution and assembly center.

EBITDA and operating income results were lower than our expectation for the quarter. Our operating income for the quarter decreased by $4.6 million compared to the second quarter 2012. The profit decline was primarily driven by the lower sales volumes in both the FLAG and FRAG businesses and higher FLAG manufacturing cost on lower plant capacity utilization. We held SG&A spending lower in the second quarter 2013, which also partially offset the sales volume impact.

In our news release this morning, we announced that we will consolidate our two saw chain plants in Portland, Oregon. The plant that was purchased with the 2008 acquisition of Carlton Company will be consolidated into our larger Portland-base saw chain manufacturing facility as well as FLAG production facilities in China, Brazil and Canada.

The consolidation will enhance operational efficiencies and reduce costs, while balancing production capacity with near-term market demand. The consolidation of the two facilities will reduce our overall workforce by approximately 200 people or nearly 5%.

Additionally, we believe the consolidation will provide more timely delivery by moving our manufacturing closer to our customers, which is consistent with our long-term regional manufacturing strategy. For more details please reference news release issued today.

I will now turn the call over to Cal to cover some specifics related to the financial performance of the company and details related to the material weakness mentioned in our news release issued this morning. After that I will wrap up with our 2013 outlook.

Calvin Jenness

Thanks Josh. As a reminder, we posted a presentation to our website this morning in addition to our press release that outlines profit and cash flow drivers for the second quarter 2013 compared to the second quarter of 2012 along with other operating metrics.

FLAG sales were down 9% versus a year ago and profit in the FLAG business declined. Sales volumes decreased which was driven by weakness in North America and Asia as well as the continued soft market conditions in Europe. Compared to the second quarter of 2012, North American sales for the segment were down 10% and sales in Asia were down 12%. Segment sales in Europe and Russia were down 2%. Additionally, sales experienced currency exchange rate headwind of about $1.3 million. And finally, average pricing declined mostly as a result of promotions in select markets and channel mix.

From a profit perspective second quarter 2013 FLAG segment contribution to operating income declined by $8.6 million compared to the second quarter of 2012. The benefits of $1.5 million of lower steel cost and $1.4 million of reduced administrative spending were more than offset by lower sales volumes, average pricing, foreign currency fluctuations, product and channel mix shifts and lower capacity utilization rate.

Specifically, lower volume had a $4.4 million unfavorable impact. Lower FLAG plant utilization and higher logistics cost yielded a negative variance of about $6.1 million. FLAG plant utilization for Q2, 2013 was 76% compared to 85% in this year’s first quarter and 91% for Q2, 2012. Foreign exchange negatively impacted year-over-year profit by $200,000 and a heavier mix of sales OEMs resulted in a negative impact of approximately $800,000.

Turning to the FRAG business, second quarter 2013 sales volume decreased versus the year ago period as we experienced reduced sales volumes of agricultural attachments and tractor parts driven by the late spring and late start to the growing season. These results were partially offset by improved average pricing.

FRAG segment backlog declined by $15.1 million from December 31, 2012 on seasonal order patterns and it was down about 17.8% from June 2012 as we improved our delivery performance and improved throughput as SpeeCo products in our Kansas City, Missouri distribution and assembly center as compared to last year.

The FRAG business EBITDA was $6.4 million in the second quarter of 2013 compared to $3.4 million in the second quarter of 2012. FRAG contribution to operating income was $2 million in the second quarter of 2013 after depreciation expense, non-cash amortization of acquired intangible assets and purchase accounting and allocation of shared services expenses. The FRAG profit improvement was driven mostly by improving our logistics cost and reducing asset quality compared to the second quarter of 2012.

Expedited shipping costs in the prior year of $2.2 million along with $2.6 million of prior year expense related to the product quality were not repeated in the second quarter of 2013. Additionally steel costs were down approximately $300,000, while decreased sales volumes reduced by $1.4 million.

As a total company, our adjusted EBITDA for the second quarter of 2013 was $32 million compared to $38.1 million in the year ago period primarily as a result of the lower sales volume.

Our effective income tax rate was about 32% for the second quarter. Net debt was $461 million at the end of the second quarter, a decrease of $6 million from December 31, 2012. Our total leverage ratio of debt to adjusted EBITDA was 3.7 times and the ratio of net debt to adjusted EBITDA was 3.5 times at the end of Q2, 2013 both consistent within 2012.

Net debt decreased in the second quarter as we generate free cash at $15.9 million and currency rates increased cash another $1 million. This compared to a free cash generation of $5.7 million in the second quarter of 2012. Cash from the second quarter of 2013 operations was higher than a year ago quarter by $2.1 million.

Working capital benefited from accounts receivable collection in the second quarter of 2013 compared to 2012 along with controlled inventory growth compared to the same quarter of last year. A reduction in capital spending of $8 million year-over-year was a result of lower spending on the Fuzhou China plant expansion, as the bulk of the project has been completed and other reduced capital spending in response to the soft market conditions.

As we discussed in this morning’s press release, the company will be amending its 2012 Form 10-K as well as the first quarter 2013 Form 10-Q to reflect a conclusion that internal control over financial reporting and disclosure controls and procedures were not effective as of December 31, 2012, and as of March 31, 2013. The company and our independent registered public accounting firm, PricewaterhouseCoopers LLP re-evaluated our financial reporting controls after a routine inspection by the Public Company Accounting Oversight Board of PwC, which included a review by the PCAOB and PwC’s independent audit of our 2012 financial statements.

After re-evaluating our internal controls as of December 31, 2012 management and PwC concluded that material weaknesses existed in the information systems control on our Woods/TISCO subsidiary and internal controls related to our accounting for indefinite-lived intangible assets.

Additionally, the company and PwC determined that reevaluation of the accounting related to the valuation of goodwill and other indefinite-lived intangible assets originally recorded with acquisitions completed during 2010 and 2011 was appropriate.

The company is in the process of remediating the identified deficiencies and financial reporting controls and expect to have the work completed by the end of 2013, although there can be no assurance how we will accomplish that goal. The reevaluation of the accounting conclusion the company reached with respect to the December 31, 2012 valuation of goodwill and other indefinite-lived intangible assets and follows a relatively complex analysis.

We will now file our 10-Q, file our quarterly report and 10-Q for the second quarter 2013 with the Securities and Exchange Commission until the re-evaluation is completed. And we therefore anticipate the filing of our 10-Q will be delayed beyond the required filing date of August 9, 2013. It is also possible that we may conclude that a restatement of our financial statements for the year ended December 31, 2012 is necessary to reflect an impairment to the value goodwill. Any potential restatement is expected to be limited to an adjustment to reduce the December 31, 2012 carrying value of goodwill through a non-cash charge recorded operating income in the fourth quarter of 2012.

There will be no associated impact in the fourth quarter 2012 sales, cash or adjusted EBITDA. Further no impact on the previous reported first quarter 2013 sales, cash, operating income, net income or adjusted EBITDA amounts. Our guidance for the rest of 2013 on those items is anticipated as a result of any potential restatement of our 2012 financial statements.

That covers the specifics related to the second quarter 2013. So, at this time I’d like to turn the call back to Josh.

Josh Collins

Thanks, Cal. I’ll wrap up today’s call by touching on our outlook for 2013 and we’ll then open the line for questions. Our forward order book and order intake rates remain subdued and reflect continuing difficult economic trends. Therefore we have adjusted our outlook for 2013 and what we discussed earlier this year.

We now expect sales to range between $915 million and $945 million and for operating income to range between $66 million and $76 million. Our sales projection assumes a decrease in FLAG segment sales of 1% to 5% and growth in FRAG segment sales of 5% to 8%, both versus 2012 levels.

At these sales levels, overall adjusted EBITDA should fall within the $130 million to $140 million range. We continue to expect free cash flow in 2013 to be between $40 million and $50 million that’s approximately $35 million to $40 million with CapEx, which is a reduced spending rate versus where we entered 2013. Net interest expense is expected to be between $18 million and $19 million in 2013 and the effective income tax rate is expected to be between 35% and 38% in 2013.

With that, we would like to open the line for questions.

Question-and-Answer Session

Operator

At this time we will begin the question-and-answer session. (Operator Instructions). And our first question comes from Robert Kosowsky of Sidoti.

Robert Kosowsky - Sidoti

Hi, good morning guys, how are you doing?

Josh Collins

Yes, good.

Robert Kosowsky - Sidoti

I was wondering on the guidance, does that include any of the restructuring charges from the facility closure?

Josh Collins

No, that’s adding the restructuring charges back that will be significant as we outline.

Robert Kosowsky - Sidoti

Okay. And just one other question could you discuss, so you’re really looking for a big step up in the second half on the FRAG side from a demand standpoint, is that kind of what the guidance implies and what are you seeing so far quarter to-date to confirm that?

Josh Collins

Yes, it does imply a meaningful step up some of that is seasonality. So, on a sequential basis second half versus first half it’s somewhere around $15 million to $20 million up and that’s there is a lot of seasonality in that business so we would expect that. On a year-over-year basis, it also implies something close to $15 million to $20 million, but that shouldn’t be too surprising given the fact that we had that very severe drought last year in addition to the operating issues that we’ve gotten through around SpeeCo. In terms of what we’re seeing quarter to-date it’s good and in line with our expectations in terms of Woods early order program are continuing good operations that SpeeCo some others, who is going to be dependent on the splitter market and other product markets and there is some uncertainty around that, but so far so good.

Robert Kosowsky - Sidoti

Okay. And any thoughts you can give on the margin profile of the margin expansion you might see in the back half of the year on the FLAG side because the margins did come in pretty significantly and assumes that the last time that are at this level sales were quite a bit lower back in 2009. And I’m just curious how we are looking at the margins evolving rest of this year and into 2014?

Josh Collins

Yeah I mean we’re really looking at in absorption issue and versus today versus 2008, 2009 we of course have significantly more capacity. So, while sales were a lot lower back then you got to look at it in terms of capacity utilization. So, you can see the utilization rate was down has been down significantly. We continue to reduce production rates, which is exactly why we determined that it made sense at this point to consolidate (inaudible) facility into the Portland facility and the other facilities around the globe.

So, our utilization rates will go up will be the numbers exactly and I think you can take all the work through, but some around 90% which is help our margins, but we are not going to feel much of the impact to that this year depending on we think it’s going to be somewhere mid-Q4 that’s complete and we will see people change zero to $1 million of cost savings this year margin permit if you will and that sort of $6 million to $8 million on a full year basis. Is that answer your question.

Robert Kosowsky - Sidoti

Yeah it does and then otherwise within the inventory can you maybe discuss how inventories looked sequentially or maybe versus a year ago or fourth quarter within FLAG and within FRAG. And I’m just trying to get a sense as to how much FLAG inventory you have work down given these low production rates recognizing that the end markets are pretty weak too?

Josh Collins

No, we’ve been chasing it down so we are not where we want to be at and we have still, we still basically holding steady in terms of we think we probably have $10 million to $15 million of excess inventory in FLAG. On the FRAG side, we’ve been able to continually work down it’s really going to be a function of the fall selling season. So, there is another call $10 million it was in FRAG and we are down year-to-date about $3 million at FRAG and in FLAG about flat as I said. Is that answer your question.

Robert Kosowsky - Sidoti

Okay. Thank you very much. Yeah it does. Thank you very much.

Operator

And the next question is from Steve Barger of KeyBanc Capital Markets.

Josh Collins

Hey Steve.

Steve Barger - KeyBanc Capital Markets

We’ve been talking about de-stocking for a while on the last few calls. I know there is never an easy answer here, but what are your updated thoughts on inventory levels in the channel especially in Europe and North America?

Josh Collins

In North America it’s a little bit of a mixed bag, but it’s normal to maybe slightly full or over normal. In Europe once again it’s a bit of a mixed bag that we have continue to see decreases in inventory levels at the distributors and at the dealer level we are actually seeing a pickup at that dealer level. If not significant, but we are seeing in the direct dealer business it’s like year-over-year increase. And in our direct end-user business we are seeing an increase as well even more significant.

Steve Barger - KeyBanc Capital Markets

Where the dealers are starting to pick up, are you getting that information from the distributors, who are saying they expect to increase or?

Josh Collins

No, that’s where we sell direct to dealer.

Steve Barger - KeyBanc Capital Markets

I got you.

Josh Collins

Okay. So, we got good information obviously, where we sell direct to end-user through talks, make it a pretty good insight and we’ve seen sustained and pretty broad year-over-year growth in the past several months. And we are now starting to see some of that within Europe, excuse me it’s a direct to dealer business in Europe.

Steve Barger - KeyBanc Capital Markets

Yeah and for North America being normal to slightly full, I know the slow start to the spring, but it’s been a rainy summer, where I’m anyway and I think in a lot of places. Is that driving any optimism at the distributors or dealers that they are going to that the lawn and garden business is going to see acceleration just because people are more active trying to maintain their lawns?

Josh Collins

Yeah. I would say that overall the sentiment in the U.S. is not bad.

Steve Barger - KeyBanc Capital Markets

I’m so sorry I thought there was more coming sorry. So, two more question with respect to market share. I know it’s hard to measure. Are you thinking there is any share shift, are you seeing more competitive cost pressure than normal in either of the chain business or in log splitters?

Josh Collins

Steve, can you hear me.

Steve Barger - KeyBanc Capital Markets

Yeah I can.

Josh Collins

Okay. I was continuing that answer and we don’t log and were to begin. We’ve got some kind of black cloud over. I love the (inaudible) with all the sentiments.

Steve Barger - KeyBanc Capital Markets

Sentiment in the U.S.

Josh Collins

Yeah, yeah, yeah. So, we just wrap it up by saying, but sentiment in the U.S., I would not say it’s negative.

Steve Barger - KeyBanc Capital Markets

Okay.

Josh Collins

Okay and I’m sorry, we have some share question.

Steve Barger - KeyBanc Capital Markets

Yeah. Is there any more competitive cost pressure or price pressure that you are seeing in the chain business that log splitters than might be what you would consider normal?

Josh Collins

No, because it’s normal to see some depending and it often is specific to a country and we’re continuing to see that. So, I mean, Cal mentioned it we’ve some discounting to kind of fight some of that in certain locations and but that sort of normal too. Now we’ve got some pretty fierce competitors and we expect that we’ve to deal that.

Steve Barger - KeyBanc Capital Markets

Right. Looking at FLAG itself volume was down 8% how much of that was directly attributable to the chain business, whether it’s skewed in that direction and can you talk about the margin impact of volume on chain versus the other products in FLAG?

Josh Collins

It is why we skewed toward or away from it I should say chain as we continue to add products in lawn and garden business and in accessories. You know I think if you look like-for-like it’s probably all pretty bad. But in terms of how much of that is the margin impacted it’s a meaningful amount. But I would say also that just within chain alone we’ve got the absorption issue. So, I don’t have those numbers exactly the breakdown is, but I would say it’s not unfair to say it’s got half and half.

Steve Barger - KeyBanc Capital Markets

Okay. And there was a comment in the prepared remarks that you’ve got positive price I think in the FRAG attachments. How are you driving that given the late spring is or how are you able to get the price increases its pretty good?

Josh Collins

The market is fairly conditioned.

Calvin Jenness

Like that earlier too.

Josh Collins

Yeah, we got an early order programs that started to it’s in June.

Steve Barger - KeyBanc Capital Markets

Okay.

Josh Collins

Orders are placed pretty early and the market is pretty condition there.

Steve Barger - KeyBanc Capital Markets

All right. And last one, I’ll get back in line. Sorry if I missed this. Did you say where the CapEx reduction is coming from down to the new level?

Josh Collins

Well, yeah, no I mean, it’s really we don’t need to add capacity there we expect that we need to add. Now there are some areas, where like some of ours, where we’re continuing to invest there and obviously we’ve what we call maintenance CapEx. Then on the FRAG side, we made some heavy investments as well but that the differential being delaying plants around expansion capital.

Steve Barger - KeyBanc Capital Markets

Got you. I guess I do have one more. We know that you are doing the consolidation on the chain side. Is there anything on the FRAG side that we should be thinking about in terms of the potential facility consolidations or do you like the footprint the way it is relative to current demand and where you think it goes in the future?

Josh Collins

We actually like the footprint there. We’re always looking at different things around and how we get product to our customers as efficiently possible, but we currently like the footprint there. And I’d say we’re focused on the supply chain and cleaning up as many hairballs as they say I think we possibly can.

Steve Barger - KeyBanc Capital Markets

Got you. Okay, thanks. I’ll get back in line.

Operator

And the next question is from Larry De Maria of William Blair.

Josh Collins

Hi Larry.

Larry De Maria - William Blair

Hey, how are you doing? Good morning.

Josh Collins

Good morning.

Larry De Maria - William Blair

Guys I have question first in the plant consolidation, you sound like you guys are taking structurally taking capacity out kind of shifting around. So, how many feet comes out, where do would that leave us and if we are at 90% going into the next year, would we expect the industry to be relatively rationale in terms of inventory and you guys would be thinking about price increases in to next year how we think about that?

Josh Collins

Well, to talk on the pricing side I think it’s going to be a function of supply and demand. And it’s too early to tell there. In terms of our capacity levels, we will be taking out the chunk of capacity, but it’s not - it’s kind of half of the capacities that was in the [Milwaukee] facility. So, we will be left with on a where do we measure at 90% that’s kind of round number is 20 million feet of excess capacity.

And that’s based on a per share by the work with some extra working constraint processes over the weekend. So we, between our CI program that continually increasing up capacity and increases units per labor hour and that extra 20 million feet. We’re going to be fine in terms of there is market rebound, which often improves very quickly we can deal with that.

Larry De Maria - William Blair

Okay. As far as in North America I think that’s kind of where there is may be a little bit more weakness than we thought. It sounds like there is some of its timing and weather, but can you just give some more color really what happened in North America if it really just the weather and if it is the weather should we expect a bigger pickup in here in the third quarter, or those will all tend to be seasonal in loss sales at this point?

Josh Collins

Yeah, well it’s a good question. I don’t think there is going to be meaningful pickup on a year-over-year basis. It is late summer, it is possible, and there are people who were within the marketplace who were discussing that it’s a shift. I'm going to have to wait-and-see on that. We haven’t really seen that yet if that’s the case. But we’re not anticipating on a total FLAG basis growth versus last year in the second half in part of basically flat. And it would be a little bit positive in the U.S. versus some of the other regions, but we’re not expecting meaningful year-over-year growth in the U.S.

Larry De Maria - William Blair

Okay. And obviously there is some issues we speak out very general last year. Can you just give us an update there and how that’s standing is to be able to recruit some of the QC may have lost in other businesses if we don’t have transparency into obviously into the distribution channel and how you’re doing there?

Josh Collins

We’re doing well. We’re operating well our customers are pleased with us. And we have at sales levels. We mentioned this in the prepared remarks a couple of times, but that piece of the business SpeeCo operates with essentially no back orders we should. And is operating with essentially no back orders, relatively small backlog than the full order board. We do have some into that the next market we’ve gone out thee but relatively small. And we’re operating it almost no, very efficient level and almost no back orders at all. Our quality is good and we’re spending a lot of time in product development and refreshing for our significant customers that the sales pieces of the product launch.

Larry De Maria - William Blair

Right. Have you been able to recoup some of the loss share or is it your tracking with the market now?

Josh Collins

We feel that we’ve lost a couple of relatively small customers, we’ve been asked to bid for some of that back. We think that we lost some. We probably lost some sales just due to not being able to ship on time and missed part of the season there. But once again all of our big, all of our largest customers there were in good standing there.

Larry De Maria - William Blair

Okay. And then may be just finally I know you talked a bit about Europe, which is obviously been frustrating for you guys for a while with the de-stocking. And I know you’ve talked about some of that in the past in the conferences about some of the signs where things look like they might be turning, but it’s still early. If you just give us maybe a more tangible update in terms of - its only down 2.5% I think in the quarter so if not too bad. But is there a real tangible sign that we can go for de-stocking or restocking or is that postponed indefinitely or how do we think about that now?

Josh Collins

We try to get data from all of our distributors comes in various forms and you got a numerator and a denominator. We’re improving our information flow there. It’s definitely improving. We think the distributor level we probably still have a little ways to go maybe we are ready to go. At the dealer level we’re in good shape.

And as I said, there is not huge growth but it’s possible on a year-over-year basis. At the end user level, where we go direct to end user its broad and strong growth, and that’s all good news. That should be the right order to go end users, and dealers, then distributor. I think we still have a ways to go. We’re not going to call some big growth spurt in Europe, but it does feel like it’s going in the right direction. And that will lead to better things in other parts of the world both way.

Larry De Maria - William Blair

So, then we should we think about the 2014 story or at this point then I guess?

Josh Collins

I don’t know we’re expecting some improvement in the second half there.

Larry De Maria - William Blair

Okay.

Josh Collins

But I think yeah I don’t want to get on this again if you will. I would figure that it’s a three to six month lag between when you see dealer growth which we now have, the week growth and then for de-stocking start to see year-over-year growth in distributor. So, it could be by the end of the quarter. It could be by the end of the year.

Larry De Maria - William Blair

Got it. Okay thanks. Good luck guys.

Josh Collins

Thanks, Larry.

Operator

And this will conclude our question-and-answer session. I would like to turn the conference back over to Josh Collins for any closing remarks.

Josh Collins

Thank you for your time and I’m sure we all will be talking to you soon. Take care.

Operator

The conference is now concluded. Thank you for attending today’s presentation. You may now disconnect.

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