NetSuite's Management Presents at the Deutsche Bank 2013 Technology Conference (Transcript)

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 |  About: NetSuite Inc. (N)
by: SA Transcripts

Unidentified Analyst

All right. Good afternoon. Thank you for joining. I'm pleased to have Ron Gill, CFO of NetSuite. The format is going to be very similar but I don't think Ron's going to do any presentation. I don't think many people need an introduction from NetSuite, but perhaps a 30-second overview.

Ron Gill

Sure. Yes. Can everybody hear my – okay. Yes, if you don't know what we do, we are an ERP software company really started in 1998 as a cloud ERP company. So long before anybody said cloud, we sold initially an accounting system over the web. Delivered over the Internet were a subscription model. We have only ever done SaaS software, nothing – we've never sold anything on premise.

That was initially a small core accounting system. It's grown up over the years and really become full-fledged ERP with everything you think of as ERP and we've kind of evolved from selling to very small companies to selling really with most of the business in the core of the midmarket, but increasingly moving up market as the product has gotten more sophisticated and kind as the world has gotten a little bit readier for SaaS, increasingly selling at the higher end of the midmarket and even into larger enterprises today.

So SaaS subscription model, we've been growing fairly consistently, performing fairly well. We've accelerated growth kind of every year coming out of the recession. So if we were growing – like in the years, right, we're growing like 16% in 2010; 22% 2011; 31% last year. We grew about 35% year-over-year last quarter, so nice revenue growth and acceleration in the growth over that timeframe.

Question-and-Answer Session

Unidentified Analyst

So that accelerated the links growth. What do you think is driving that? Is it that your product has become richer and more competitive or is pricing becoming more attractive? Are you taking – obviously you're taking share at some point on the traditional ERP vendor, so what are some of the competitor dynamics that are driving your growth?

Ron Gill

Yes. So there's definitely been a recurring theme over that entire timeline which has been the move up market which has meant a larger and larger average deal size every year. And that's just because the product gets more sophisticated every year as we add features and functions and so we can do a slightly larger deal. So that's certainly been a driving factor.

And then obviously we've benefited at the same time from sort of being at the right place in history from a SaaS acceptance point of view. So it's certainly true when we started that nobody was doing anything like SaaS ERP. But clearly with sales forces success, with the success of CRM, HCM, marketing automation managed solutions in the cloud, the cloud performed more acceptable overall. And we've been very lucky to be in the market with a product that's ready for the size of company, that's sort of ready for SaaS ERP.

So we started out with very small businesses when they were willing to adopt SaaS as an ERP architecture probably long before any enterprise would have been willing to adopt SaaS as an ERP architecture. We've moved up market fairly steadily as the sort of psychology of acceptance of SaaS has moved up market as well and I think we benefited from that as well.

Unidentified Analyst

So can you describe maybe the cadence of your average deal size where it was when you first started out and as you move up market?

Ron Gill

Right. That part our CEO likes to say when he started to get our average deal sizes in these several hundred dollars per year. Today, the core of the business is still really midmarket business and average deal size for us on the initial sale is in the, probably in the $60,000 range, something like that. But it's an incredibly wide spectrum. So in any given quarter these days, we will find a deal that is small as $10,000 or $11,000 recurring, annual recurring and as large as well in access of $1 million annual recurring and everything in between. I guess I'd overall average maybe somewhere around 60, but it's a fairly wide spectrum. There's some very, very small sort of mom and pop level businesses that we sold during early years that we don't sell to them anymore.

But for the most part we still really do stay on the spectrum from very small businesses up through what you would think of as true midmarket, maybe companies like this size of us, so we are a $400 million revenue public company this year. That's a core market for us. We sell to a lot of companies like that that are going to run us as their core ERP system and increasingly we sell to some very large companies that aren't going to run us for their core ERP system but they are putting us in a second tier to run subsidiaries or divisions.

Unidentified Analyst

Right. So I was going to ask you about that. At your conference you made an announcement about Williams Sonoma in Australia. How many such deals have you done and clearly the two tier ERP architecture has been technically not proven out by you, but is that going to be a sort of a bridge for you to sort of get into the big leagues with the very large enterprises?

Ron Gill

Right. So Williams Sonoma was at the sort of intersection of two phenomena. One, it was a two tier deal as you said. We weren't replacing the headquarters system for them, we were becoming the systems record for their extension into the Australian market, so a two tier business. The two tier business is a decent sized business now. As of 2011 we started to put a team in place that does nothing but that business. In the early days that business sort of found us more than us really designing for it.

And then we put a team in place to 2011 and '12 that really goes after that business very deliberately now, and so that type of business is very steady and consistent. We've named some fairly large names publicly whether that's Qualcomm or Procter and Gamble, they are using us in that way, using us in subsidiaries. The thing that was unique about Williams Sonoma was that it was a two tier deal but it was also really the first large SuiteCommerce deal that we've announced publicly, so SuiteCommerce is a product that we'd announced about a year before there were really just bringing to market in a general availability way today and Williams Sonoma was one of the early customers for that.

So that's a single platform Ecommerce point of sale and the ERP systems of Williams Sonoma in Australia has now four stores; the Williams Sonoma store, Pottery Barn, Pottery Barn Kids and a West Elm store. All four of those stores run NetSuite as point of sale, so literally on the cash registers in the store they run NetSuite as the website for the Ecommerce website and they run NetSuite in the backend in the Australian side.

Unidentified Analyst

Okay. So more on the competitive side, we had Demandware present this afternoon, and you also partner with them because in many of their customers you are the ERP. So do you see them as a competitor more so than a collaborator partner or is it the other way?

Ron Gill

Yes. I mean certainly you got to see them as a competitor in some ways because there are certainly deals that we are competing for. And it's fairly early days with our SuiteCommerce enterprise solution anyway. But certainly in the deals that we've been in so far, it's fairly common that the company has also looked at Demandware. So in that sense you got to think of them as a competitor. The value proposition that we are trying to bring to this is fairly different, so we're a very – as an ERP company, we're a very transition-oriented company and when we are building websites for customers, those tend to be very transition-oriented websites.

So they're not websites about – just about display or presenting a brand, they're really websites meant to process transitions. And the value proposition we really want to bring here is that single platform value proposition. The way – we have all these separate vendors of standalone Ecommerce systems and we really feel like that's an artifact of the way Ecommerce came about in the '90s where companies had a core business, Ecommerce came along as a thing and they setup a separate division to do that thing, and systems developed for those separate divisions.

And a lot of companies still have that type of structure. They've got a core business system and then separately they've got an Ecommerce system. And that causes a lot of problems, especially as Ecommerce transitions have gotten much more sophisticated. It causes a lot of problems in that all of the information that's in the ERP system isn't exposed to the Ecommerce system and to the extent that you want to get it exposed, you have to do integrations between the two systems and often then manage the same piece of data in two different places.

So what we're really attempting to do is to put it on a single platform really, one customer record which is the customer record whether you're buying on the web, in the store, over a catalogue over the phone, one item record rather than maintaining a list of all the items that we sell in the ERP system and separately in the Ecommerce system really maintain them only in one place and have that serve all of those things. And so we felt we're the only ones offering that single platform solution today and so that's the value that customers are going to chose us or customers that are looking for that value proposition.

Unidentified Analyst

Okay. So we have a question from the audience. You and Oracle made a partnership announcement. Oracle also made a similar announcement with Salesforce.com. How broad will the scope of this partnership be for you and the others? And how close is the relationship between NetSuite and Salesforce getting?

Ron Gill

NetSuite and Salesforce and NetSuite and Oracle?

Unidentified Analyst

Yes.

Ron Gill

Yes. So we did make this announcement and if you're not familiar with the announcement, the announcement was specifically with Oracle HCM that we were pre-building the integration with Oracle HCM that the products would work together and that we would be cooperating with some go-to-market activities. Oracle does have a separate sales force for HCM so they can work together with our sales force.

At the same time we do compete with Oracle for ERP business, especially for example in the software vertical. And I think a lot of people look at that announcement in the context of the other announcements that Oracle made. They recently announcement the partnership of Salesforce, they announced a partnership with Microsoft.

For us I think we look at a little bit more in the context of the other announcements we were making at the time, so we had just come off the SuiteWorld and at SuiteWorld we announced partnerships with half a dozen HCM vendors. So we announced a partnership with Tribe, with Asentus, with SilkRoad and with a number of other vendors really all with the same purpose from our point of view and that is those systems are incumbent systems in a lot of places where we're going to go in and behooves us to go work together with them.

NetSuite as an ERP system of course has an employee master record in it that has a lot of employee data, but if a company's going to choose to have their employee system of record be a different system, we want to make sure that NetSuite can share that data and use that HR data in NetSuite workflow and a NetSuite approvals process and a NetSuite purchasing levels approval process, something like that.

And so for us it's about – since we're not in business of selling performance management or recruiting software, we want to be able to work with all those software. And Oracle was really kind of an extension of that for us. They are a big HCM vendor but big installed base. It behooves us to be able to work together with their solutions as well. So that's really the extent of the relationship.

Unidentified Analyst

Okay. So it doesn't soften your competitiveness on the ERP side by any means?

Ron Gill

I don't think any sales rep in the software vertical is going to be pulling punches because of that relationship, no.

Unidentified Analyst

All right, good. One more question from the audience here on my screen and then I'll take the question from the live audience here. Can you discuss how your infrastructure is built and can you comment on the level of multi-tenancy you use and will be using in the future?

Ron Gill

I can comment on that to the extent that a CFO is to be competent to comment on this. Architecture is built on Oracle data base. The data base is multitenant data base, so you can – on the data base side it's literally multitenant in a way that a single data base instance has multiple customers running in it.

But you can walk over to a machine and put your hand on a warm box and say, in this box has customers 1,345 through 1,392 in it. So there's a data base sitting in a specific box for specific customer. The application is more of a single application resource running in the cloud with sort of on a transition by transaction basis that application resource keeps getting consumed by all customers.

So all the customers that we have are today running on 2013.2. We don't have any customers running on any other version of the software, so it's true multitenant SaaS in that sense. And when we go through an upgrade cycle, there's sort of two points in the year when we upgrade during which we might have people running – some customers running on old versions, some has new as we phase those upgrades. So otherwise everybody's running on the same system and it's literally the same system.

Unidentified Analyst

Yes. So the extension of that question, Oracle just launched 12c with multi-tenancy. Is that a platform evolution for you naturally or is that some point in the future? It's probably a technical question…

Ron Gill

Yes. Let's say I probably shouldn't speculate about the technical market actual direction. I probably wouldn't do a very good job on it.

Unidentified Analyst

Fair enough. All right. So any questions from the audience?

Ron Gill

Anybody with a money-oriented question, anything about money at all?

Unidentified Analyst

I'm just kind of curious. At the mid to large end of the customer base and the degree to which the software needs to be customized and I'm just sort of curious about the impact or from the customer point of view, they always spend less on system integration versus obviously a traditional or whether or not – that's not to say even traditionally?

Ron Gill

So actually both are true. So yes, they spend less on customization but they're not doing any less customization. The process of implementing ERP is always a process of customizing, right, because it's always – you have hundreds of these meetings where the customer says like hey, you're about to migrate the customer record. Everything looks good. We just need this one additional field or we're going to – we're putting our order processing process over into NetSuite now and all was great. There's just this one thing and you have that meeting a 100 times.

And you've got to be able to accommodate those changes. So NetSuite is very customizable and it's very customized. I can say as the CFO of the company in the world that's running NetSuite longer than any other company and thus has a very customized version of NetSuite, I can say you can customize the heck out it, we upgrade twice the impact. We're the first company in the cycle to upgrade each time the system upgrades and we do it with the customization in place.

So the systems kind of architect is specifically to allow that, so the customers can customize and we can upgrade the underlying system without breaking stuff. And it really puts a kind of an onus on us as well that doesn't exists at an on-premise ERP company because we are going to be there present at the upgrade and we'll be a little bit responsible for making sure things don't break.

So we have that architectural responsibility. But the system is very, very customized in almost every implementation. It customizes pretty easily and pretty quickly with less sort of modification to core data base structure and that does make the implementations go quickly because there's so many small tweaks down to a system during implementation.

Unidentified Analyst

Yes, here this gentleman.

Unidentified Analyst

Ron, still going after larger enterprises and you had to work with some integrators, right?

Ron Gill

Yes.

Unidentified Analyst

You had this ramp up to work with them and [indiscernible] how to handle between – how does it work, your own professional service, was it the SI?

Ron Gill

Yes, sure. So we have a model today where about – in any given quarter 30% to 40% of our new business is coming through a channel which is usually an SI of some sort. And I've said this before with this weird kind of intersection where most SAP companies have very little channel, most ERP companies have much more channel that we have and we're sort of in the in-between growing out a channel primarily by migrating or winning over SIs who used to be a channel partner for Microsoft Great Plains or for one of the older on premise ERP products and getting them over to NetSuite.

So today we've got a model where 30% to 40% of new sales come to the channel and fundamentally a model where if we sell it, we implement it. If the partner sells it, the partner implements it. I think it would be great and we are seeing the ecosystem grow and partners build up more implementation resources. I'd love to see partners taking on more implementations so that we eventually evolve to a model where even when we sell it direct, we've got partners that take the implementation instead of us.

But the challenge is the last year our professional services revenue grew 51% -- last quarter, I believe 52% year-over-year. So the ecosystem is growing fast but it's growing just fast enough to keep up right now. Everybody's having to grow PS resources a lot to handle all of the implementations out there.

So we've got kind of the core ecosystem that's traditionally done those and we're very lucky now to start to have with these larger enterprise deals, we've got an Accenture relationship now that's about two years old and it's really not only started to yield some new business but they're really ramping their professional services resources which will be helpful.

And then we have the Deloitte relationship which is about a year old and Capgemini relationship which is fairly recent. And then another global SI or two out there – Wipro is building up implementation resources as well, so plenty of demand out there for implementation resources.

Unidentified Analyst

Great. Any other questions from the audience. All right. One more came on my screen. What does your long-term operating margin looks like timing?

Ron Gill

Yes, two good questions. So we run today – so just a quick walk down the P&L. Our recurring revenue runs at about an 85% gross margin and recurring revenue annuity, it really is recurring revenues. If you do a cohort analysis and look at net churn, so if I just say customers that I had onboard at the end of Q1 2012, how much revenue did I get from that customer cohort in Q2 of 2012, how much revenue did I get from that same cohort of customers Q2 of 2013? It's greater than 100%.

So of course in that set, there are some customers that went out of business, there's some customers that got fired, maybe somebody didn't renew, but you've got up-sell into that base that overwhelms that. So you get a number that's more than 100%. So when we say recurring revenue, its recurring revenue in fact the annuity gross, that's an 85% gross margin. And recurring revenue today is about 80% of the mix. It was 79% last quarter. The nonrecurring revenue professional services revenue associated with implementation, it runs – and by the way, the 85% gross margin it won't get much better than that. That's a very good gross margin on the recurring that's got the cost of support, the cost of data centers in it.

It moves around a little bit with a step function when we add a data center, but for the most part I think that's where it's going to run. Professional services gross margin, we've been working on getting them up a little bit. A couple of years ago we were losing money on professional services. And I think at the time we had the philosophy – I think we still maintain this philosophy a little bit that it's okay to lose money on professional services to some extent because it's the cost of buying that annuity and that annuity is obviously very valuable.

But that said, we decided we didn't want to actually lose on the gross margin basis there anymore, so we spent a couple of years driving that up. Last quarter the gross margin on professional services was about 16%. I think for the year it's probably 13%, 14% something like that. I don't expect that we'll try to drive that a whole lot higher than that. I think it probably levels off there. So from a gross margin point, if we get to an overall blended gross margin 70%, 71% something like that which is very sustainable, in fact it would improve a little bit if the business weren't growing so fast because it's new business driving professional services which is keeping the gross margin a little bit lower.

So where is all the money – with 6% overall operating margin this year, something of that magnitude, so where is all the money going? It's all going to sales and marketing. 45% of the P&L spend in sales and marketing and that's really because especially – it's true of any SaaS model company that especially in one that's growing and even more challenging accelerating growth that spend in sales and marketing is coming well ahead of any result in the P&L of the effect of that even when everything's going extremely well and that spend is yielding very effectively, the spend happens well before the yield.

So especially when you're accelerating growth, that's the big jump of spend. So you got 45% of the P&L spent in sales and marketing, net margin something like 6%. So where does that ultimately go? The first part of that – you never want to really think about is the only way it goes anywhere is for growth to slow down. As long as growth is going as fast as it is and especially if growth is accelerating, you're going to always be doing that spend ahead of the yield and you'll always have the P&L that's looking like this.

If you ever get the opportunity because growth levels often decrease that spend, in fact at any point if you wanted to go and say that's really slow growth down and go to – from a profitability company rather than a growth company, it's not something that we're nearly considering I can tell you. But if you want to do that, almost all of the 45% being spent in sales and marketing is to acquire new customers, to add to the annuity. It may be something in there in the 10% to 15% range that you would need to continue to do up-sell into the installed base just to keep that annuity stream growing a little bit.

If you could easily eliminate 30% of revenue as spend and just maintain the current company what would then be a 36% operating margin, obviously growth would slow dramatically but you could just – then you could just continue with that pace and throw off that profit for a long time. So what's the ultimate operating model? I certainly don't expect it in my tenure to be anything that looks like flat growth, but that's where it could ultimately go to. So the ultimate operating model is somewhere in between.

Unidentified Analyst

And any sense for when you might achieve it, I guess, was part of that question?

Ron Gill

Hopefully, no time soon. Definitely I focus on the growth right now and not – we don't spend a lot of time – it's more about where we can invest to lever up than it is about slowing growth, increasing profitability.

Unidentified Analyst

Right. One more question on my screen. SAP has commented recently on seeing some softness in the FD market. Are you seeing any slower trends or pauses in the market or is this a byproduct of NetSuite taking more share?

Ron Gill

Well, it's probably a no as much as I would love to say yes. It's probably a no to both of those just because of scale. So we're certainly not seeing any weakness. And I became CFO in 2010 and had quarter after quarter of macro crisis immediately following that whether it was a U.S. downgrade or a Spanish debt crisis or some jobs reported what have you.

And through this whole series of macro shocks, we just continued to invest, we continued to see the business performing well even as there were some quarters in certainly the installed base here, peak companies where they saw weakness. So we haven't seen it. We really look at our own metrics internally and we have to, to be guided by those to whether we see any softness.

And so we haven't seen that. I would love to say that SAP is feeling the softness because we're taking share from them, we're certainly taking share from them but to be fair we're a $400 million company. And so even though we're taking share, it can grow our own share and our own revenue dramatically. We're a relatively small part of the overall $25 billion ERP market at this point.

Unidentified Analyst

Yes. So kind of related question that I had prepared is one was seeking a lot of traction, very robust growth here something like 40% of you business. From a competitive perspective, it appears that you might be pulling away from Microsoft Great Plains and SAP's business by design. Who else is out there competing in that segment, sort of the mid to high tier of ERP?

Ron Gill

Right. I wouldn't say that we're seeing sort of less compete from Great Plains, it's still the most common compete that we've seen. In the midmarket that is by far the most common compete. I also wouldn't say that we're seeing less of business by design because we've seen any material amount of business by design in the market. So it's still – in the midmarket of course compete really is still very frequently Microsoft with the Great Plains dynamic price.

And then when it becomes a little bit on the vertical and if it's in a wholesale distribution manufacturing side, SAP is common. And that could be SAP business one, the smaller on-premise suite or the ERP suite. And then if it's software it would be – Oracle would be a common compete. And of course we also see a lot of the smaller legacy installed ERP systems, whether that's a Sage product or something along those lines we still see those as well.

Nothing particularly new in the competitive front I think in terms of who we're seeing. It's still really the same cast of characters and I guess the only difference is as we do a little bit more and a little bit more two tier business and to compete in the two tier business is exclusively SAP and Oracle. And usually SAP and Oracle has been incumbent in the company that we're going into the second tier.

Unidentified Analyst

All right. Okay, well, we have about six minutes left. I'll take a little pause here and see if there are more questions from the audience. All right. Nothing came out on the screen. All right. So SuiteCommerce, I asked you about this earlier. How hard are you pushing this as an up-sell opportunity into your embedded base? And what sort of – let me just stop there.

Ron Gill

Yes. So it's got potential in the installed base and also as a net new and it's kind of interesting because – so you have to understand a little bit of history of SuiteCommerce, the enterprise edition now. So we have an Ecommerce product before, now it's called Site Builder which is the midmarket version of this. And that's the one where even when we announced SuiteCommerce as an initiative, we already had I think at the time that was about 2,800 websites that we were running for our customers on the older technology, on the midmarket technology.

And so we've got that installed base and the challenge was that as the rest of this suite, as the software vertical part of the suite or professional services vertical part of the suite, as those parts had moved up market into the Ecommerce portion of the suite, really we hadn't invested in it, hadn't moved the spot market. And so there was a potential back then for customers to sort of outgrow our functionality in Ecommerce that they got bigger and they wanted more sophisticated customized websites we sometimes didn't have the toolset for that.

And so the SuiteCommerce initiative was really about putting that toolset in place so that a, those customers don't outgrow us and they can really continue to grow with us on the Ecommerce side. What we would often see is as they got really more sophisticated and wanted to do really custom things with the website, we in the past couldn't do those from a site design point of view and so they keep us for ERP and go somewhere else for the website part.

So the whole SuiteCommerce initiative, a big piece of it was about the content management part about the website design, about the design and the shopping experience and making those as customizable as responsive design-oriented as possible so that you can design a website and have it as it were on a mobile device, for example. So those tools are in place, so that we hope and expect now should first of all end the need of customers to migrate elsewhere as they grow up and then – and we certainly have and we have already done a couple to sort of bring back the customers that left us for the lack of that functionality in the past and now come back.

I don't know if that's the biggest part of the opportunity because there's certainly another opportunity we see and we talked about Williams Sonoma. So that's a much – it's probably a much bigger size of yield than those in the installed base would be. And the exciting thing about that is it's really net new. So they end up buying and running an ERP system from us, we would have never been in the bidding for their ERP portion of that business if it was just ERP.

They really went out looking for the Ecommerce solution and we were able to sort of put in the whole package instead of just being a piece of that package. But I'm not sure if they had been – if they had found an Ecommerce system they could get in and have it go in quickly and be productive and integrate smoothly and easily with an ERP system. And they looked just for an ERP system, I'm not sure we would have been in there. We really won that business because we had a single platform solution and they didn't find that somewhere else.

Unidentified Analyst

So is Williams Sonoma the biggest deal in the sort of two tier type arrangement?

Ron Gill

No, it's not by a long stretch the biggest deal in a two tier arrangement, but it's the biggest perhaps deal in a two tier arrangement that is SuiteCommerce. So keep in mind a lot of deals in two tier arrangements are just more like a standard ERP implementation and the subsidiaries of companies that run SAP or Oracle.

Unidentified Analyst

Okay. Any other questions from the audience. We're down to about a minute and a half. Here's one.

Unidentified Analyst

Back to the Williams Sonoma case study, I guess are they at this point referenceable? I don't know why I'm stumbling [ph] just late in the day. And I guess what have you learned I guess through this experience? I guess are they fully live yet and I guess what are the learning points and are able to show that success with other potential clients? Thanks.

Ron Gill

Yes, thank you. So I wouldn't speak about them publicly if there weren't up and live. We generally won't talk about a customer that's not gone live yet. I think that's probably common in any space. So yes, they're live. They got the four stores running in Australia. And as I mentioned the point of sale system in those stores is running NetSuite and the website in Australia is running NetSuite in the backend behind that is running NetSuite. So yes, they're up and live and referenceable. They were a pretty early stage customer for this solution, so we're only now – as I've mentioned, we're only now sort of in the transition from a very controlled release to general availability.

I think that one of the biggest reasons that we did such controlled release, I mean certainly you want success and you want to make sure that somebody sort of beats up the new product in a controlled way so that you can address the issues as they come. But the other thing that was really important for us was to make sure that we had professional services resources in place because – especially the website part of this is new for our professional services team, right?

And so we had bought a small company and on-boarded talents specifically for website design. And then we had done increasingly some other projects that were increasingly sophisticated from a website design point of view. But probably the biggest gating factor for us to get ready for general availability for this was to make sure that we're having professional services resources to implement these sites.

So now I think – now we've got – I mean Williams Sonoma is a nice – it's not the only customer, but it's a nice name to mention and also it's nice because some of the other very large customers that I can think of we got an implementation now, they'll be great SuiteCommerce reference points but they have no physical presence. And the nice thing about Williams Sonoma is about stores – Williams Sonoma has stores and so it's a nice proof point for all three, the ERP and the point of sale and the Ecommerce all working together. We just now sort of start to move into general availability and start to really pick up a real deal volume going forward.

Unidentified Analyst

All right. We're out of time. Thank you all for joining. Thank you, Ron. Thanks everyone.

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