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Symmetry Medical Inc. (NYSE:SMA)

Q2 2010 Earnings Conference Call

August 5, 2010 8:00 AM ET

Executives

Carol Ruth – IR, The Ruth Group

Brian Moore – President and CEO

Fred Hite – SVP and CFO

Analysts

Matt Miksic – Piper Jaffray

James Sidoti – Sidoti & Co.

Michael Matson – Wells Fargo Securities

Operator

Good day ladies and gentlemen and welcome to the second quarter 2010 Symmetry Medical Inc earnings conference call. My name is Josh and I will be your coordinator for today. At this time all participants are in listen-only mode. We will be facilitating a question-and-answer session towards the end of this conference. (Operator Instructions)

At this time, I will turn the call over to Carol Ruth from the Ruth Group. Carol, you may proceed.

Carol Ruth

Welcome to the Symmetry Medical second quarter conference call. Joining us on the call are Brian Moore, the President and Chief Executive Officer and Fred Hite, Senior Vice President and Chief Financial Officer.

Statements in this conference call regarding Symmetry Medical business which are not historical facts may be forward-looking statements that involve risks and uncertainties within the Safe Harbor provision of the Private Securities Litigation Reform Act of 1995. Forward-looking statements are predictive in nature and are frequently identified by the use of terms such as may, will, should, expect, believe, anticipate, plan, estimate, intend and similar words indicating possible future expectations, events or actions.

Such predicative statements are not guarantees of future performance and actual results and outcome could differ materially from our current expectations. Factors that could cause or contribute to such differences include, but are not limited to, the loss of one or more customers, the development of new products or product innovation by our competitors, product liability, changes in management, changes in conditions affecting the economy, orthopedic device manufacturers, or the medical device industry in general and changes in government regulation of medical devices and third party reimbursement practices.

We refer you to the risks in the forward-looking statements sections of the company’s most recent Annual Report on Form 10-K, filed with the Securities and Exchange Commission, as well as the company’s other filings with the SEC, which are available on the SEC’s website at www.sec.gov.

Before turning the call over to President and Chief Executive Officer, Brian Moore, I’d like to emphasize Symmetry Medical’s policy of not commenting or discussing individual customers or programs, Brian?

Brian Moore

Thank you, Carol and thank you everyone for joining us on our second quarter 2010 investor conference call. We’re pleased to report another quarter of sequential revenue growth and continued improvements in operational efficiency which has led to solid bottom line results.

During the first half of the year, we have seen a stabilization of the business environment in core orthopedic and medical device markets and we remain optimistic that this will continue to create positive traction for Symmetry in the second half of the year. Particularly following revenues in the first and second quarter exceeding our expectations. Accordingly we are increasing our full-year revenue guidance to a range of $340 million to $350 million, up from a range of $330 million to $340 million.

As Fred will discuss a component a component to this increase is related to and expected benefit from foreign exchange rates during the second half of the year which will have a positive impact on our topline results but will not translate through to the bottom line. As a result we are reaffirming our full-year EPS guidance of a range $0.45 to $0.50.

Now turning to the quarter, total revenue was up 5% over the first quarter of 2010, with sequential growth in instruments, cases, implants up 80% excluding foreign exchange. We also are being making excellent progress with several new areas of business where we are investing resources to drive revenues and expand our diversification.

This includes our recently launched spine division, our new product development efforts and our direct instruments sales through SSI. We’ve improved the financial performance at our Sheffield facility and expanded Malaysian operations. Sheffield continues to improve its profitability and including July it has achieved six consecutive months of profitability.

We are pleased with the ongoing results in Sheffield and we expect this trend to continue as we improve the operational efficiency even further. Internationally, we are focused on the Asian Pacific region where the orthopedic industry is robust and we continue to expand our local marketing presence and manufacturing capabilities aggressively.

We are on track to achieve a significant increase in silos from our Malaysian facility in 2010. During Q2, our Malaysian facility shifted first full production order of a Class III medical implant to a major Japanese OEM customer. Our total solutions program including the development and production of the implant plus associated instruments and cases.

The shipment comprised fully finished sterile packed implants with mark-to-market instrument sets that supported the product launch in Japan. Our Japanese OEM customer recently received regulatory approval to market this product in China and we will continue to supply them with products for both markets. This was a key project for our Malaysian operation and its success demonstrates the full breadth of capabilities our operation can provide.

This relationship marks a new development in the region and underscores Symmetry’s strength in providing a high level of quality and regulatory control and validate the experience and expertise of our operations can offer in regional OEMs. Last quarter we added an experienced and dedicated General Manager to our spine business where we have a presence, that’s a good opportunity to replicate our success in other areas of orthopedics.

Our goal is to occupy current spine industry growth rates through investment in product development, sales, engineering and high precision specialized manufacturing equipment. We are pleased with the results for our spine business during the quarter and remain excited of the long-term potential for spine to become an increasingly important part of our business.

Last quarter we also added a Senior Vice President, Jose Fernandez to lead our new product development activities. While it is still early in the process under his leadership Jose’s team is designing and developing value-added products and technology that will be out to offer as proprietary Symmetry products to all of our customers. This expertise will make a significant contribution to our OEM customers and to the ramp up of our direct instruments sales business in SSI at Nashville.

In the second quarter we achieved another record SSI instrument sales, the recently expanded US direct sales team successfully building to up the SSI brand and driving sales. SSI also benefits from the launch of the new dedicated website during the second quarter, that have already been more than 36,000 product pages reviewed by our customers and the websites have proved to be very effective method to sell SSI products directly to our global customer base.

Revenue is down in our other silos in Q2, largely due to decreased aerospace volume and while the long-term outlook for this business is largely dependent on the worldwide aerospace industry, we are pleased with the positive growth coming from the U.S. side of the business and with the early success of our newer center of excellence for fuel nozzles (ph) in Lansing, Michigan.

At Sheffield we are focused on improving margins as against absolute volume and this has the impact of the reducing silos but with improved margin.

Overall our USA operations have experienced considerable demand in Q2, which has resulted in some operational stress, particularly in our case division, which has experienced unexpectedly high demand. This demand has resulted in a temporary buildup of delivery pass dues which we expect to clear most of in Q3.

One current trend worth commenting on is the increased activity in quality and regulatory by the FDA and constantly our OEM customers, and this is resulting in Symmetry Medical investing very heavily in quality systems and specialty personnel. This impacts costs in the short term but we believe is expected to result in a long-term competitive advantage for our business.

We also completed our case and trade facility rationalization during the second quarter and as a result, we expect to realize $2.2 million in cost savings for 2010 and $3.4 million of annualized cost savings.

Before I hand over to Fred, let me explain how we are reacting to some of the large OEMs reporting a slight slowdown in second quarter growth. In our view inventory level and current movement (ph) activity give us confidence to increase our total revenue guidance and longer term as a result of the current trends in our business, we are adding capacity appropriately and feel well positioned to respond quickly as demand accelerates with the improvement in the overall orthopedic sector.

With that, so I would like to hand the call over to Fred for a more detailed review of our financial performance.

Fred Hite

Thanks, Brian. As mentioned, we are encouraged by our sequential revenue growth driven by the ongoing stabilization of our business. Revenue for the second quarter 2010 was $88.8 million, up 5.1% on a sequential basis from $84.5 million reported in the first quarter of 2010 and compares to $101.0 million reported in the same period of 2009.

Revenues during the first quarter reflected increased customer demand in our core orthopedic and other medical device businesses as compared to the first quarter of 2010. Excluding the impact of foreign exchange, revenue for our instrument, implant and case business grew 8% over the first quarter of 2010. Revenue was lower than the second quarter of 2009 primarily due to lower instrument sales associated with fewer product launches. As we progress through the third quarter of 2010, we remain encouraged by our customer demand for our core orthopedic and medical device businesses as well as the outlook for future product launches.

Second quarter 2010 revenue by business segment was as follows. Instrument revenue was $35.4 million, up 12.0% on a sequential basis and up 12.3% excluding foreign exchange from a $31.6 million in the first quarter of 2010 and compared to $46.9 million in the second quarter of 2009. Instrument revenue in the second quarter of 2010 reflects the decrease in the quantity of our customers’ new product launch activity as compared to the second quarter of 2009.

Implant revenue was $28.5 million, up 1.1% on a sequential basis and up 3.9% excluding foreign exchange from the first quarter of 2010 and compared to $29.9 million in the second quarter of 2009. Second quarter 2010 demonstrated continued growth in procedures with the third consecutive growth per implants following the work down of OEM customer inventories in the second half of 2009.

Case revenue was $19.8 million, up 5.3% on a sequential basis and up 6.9% excluding foreign exchange from the first quarter of 2010 and also up 4.8% compared to the $18.9 million in the year ago period. The year-over-year and sequential increase was driven by increased demand in both the orthopedic space and the other medical markets.

Other revenue was $5.1 million, down 13.6% on a sequential basis or down 10.2% excluding foreign exchange from the $5.9 million in the first quarter of 2010 and compared to the $5.3 million in the same period last year. As Brian mentioned, we have made concerted efforts in our Sheffield aerospace business to focus on higher margin products as opposed to the previous focus on maximizing volume. This decline was partially offset by revenue growth in the U.S. segment of our aerospace.

Second quarter 2010 revenue by geography was as follows. $66.2 million in the United States, down 11.0% from the second quarter 2009; $6.6 million in the UK, down 11.1% from the year-ago period; $8.4 million in Ireland, down 14.1% compared to the second quarter of 2009; and $7.6 million in other foreign countries, down 18.4% compared to the same period last year.

Our top five customers represented 62.7% of our second quarter 2010 revenue, down from 68.3% in the year ago period. Our largest two customers accounted for 31.0% and 11.9% of our second quarter 2010 revenue compared to 41.4% and 8.5% of our second quarter revenue in 2009.

Gross profit for the second quarter 2010 was $20.4 million, up from $17.0 million reported in the first quarter of 2010 and compared to $26.8 million reported in the second quarter of 2009.

Gross margin percentage for the second quarter 2010 was 22.9%, compared to 20.2% reported in the first quarter of 2010 and 26.5% during the same quarter last year. Changing volume or volume leverage continues to be the primary driver behind movement in the gross margin rate.

Selling, general, administrative expenses for the second quarter 2010 were $12.3 million, down slightly compared to $12.6 million in the first quarter of 2010. The sequential decrease was a result of lower sales and marketing expenses due to the timing of AOS and AORN (ph) industry meetings during the first quarter of 2010.

SG&A was down 6.9% from the $13.2 million of expense in the second quarter of 2009 but the year-over-year decrease driven by reduced employee compensation cost including non-cash restricted stock compensation expense as a result of cost control initiatives implemented of that lower volume.

During the second quarter of 2010 we recorded a pre-tax charge of $300,000 related to facility consolidation and severance costs. This compares to $500,000 in the first quarter of 2010 and $100,000 in the second quarter of 2009.

Operating income for the second quarter 2010 was $7.8 million compared to $3.9 million in the first quarter of 2010 and $13.5 million in the second quarter of 2009. Operating margin for the second quarter 2010 was 8.7% compared to 4.6% in the first quarter of 2010 and 13.4% for the second quarter of 2009. Excluding expenses related to the facility consolidation and employee severance costs, operating income for the second quarter 2010 was $8.1 million compared to $4.4 million in the first quarter of 2010, an increase of 84.1%.

As Brian mentioned, we are encouraged with the continued progress at our Sheffield facility which including July has been profitable for the past six months. For the second quarter 2010 Sheffield generated an operating income of $400,000 compared to an operating loss of $100,000 in the first quarter of 2010. We expect to continue to gain efficiencies at Sheffield as we advance throughout the year leading to further improvements in their results.

Second quarter 2010 included a non-cash gain of $500,000 for the mark-to-market of our interest rate derivative compared to a non-cash gain of $200,000 in the second quarter of 2009.

Income tax for the second quarter of 2010 was $2.4 million compared to a tax expense of $3.2 million in the year ago period. Net income for the second quarter 2010 was $4.5 million or $0.13 per diluted share, up from $1.6 million or $0.05 per diluted share for the first quarter of 2010 and compared to a net income of $9.0 million or $0.25 per diluted share for the second quarter of 2009. Excluding the onetime facility consolidation and severance expenses in the second quarter of 2010, net income for the second quarter 2010 was $4.7 million or $0.14 per diluted share compared to $0.06 per diluted share for the first quarter of 2010.

Earnings per share for the second quarter 2010 reflected a weighted average number of $35,806,676 diluted shares outstanding compared to a weighted average of $35,529,311 shares outstanding in the year-ago period.

Turning to our balance sheet, cash at the end of second quarter 2010 remained very strong at $9.8 million and our outstanding debt decreased by $34 million or 27% compared to the year-ago period. During the quarter, the current portion of our short-term debt as shown on the face of the balance sheet increased by $62.9 million, which was shifted from long-term debt on the balance sheet primarily due to the timing of maturity date of our term loan, which is due in June 2011. Our long-term debt is now shown at $1.0 million, down from $67.5 million at the end of the first quarter 2010.

As previously discussed, we will be completing our refinancing of our debt sometime during the second half of 2010.

Based on the impact of soft customer demand in the second half of 2009, we did request and receive a waiver of default for our credit agreement related to the company’s fixed charge average financial covenant and related non-financial covenant for the second and third quarter of 2010. The fixed charge coverage financial covenant set the minimum ratio of EBITDA to fix charges over the last 12 months. We are forecasting a potential miss to the minimum primarily due to our financial results in the second half of 2009.

We feel we could have passed the covenants by restricting capital expenditures in the second quarter. However we made the strategic decision to proceeds with capital investments to support our customers and to drive the growth of the business.

Turning to guidance, we are increasing our full year 2010 revenue guidance to a range of $340 million to $350 million. The increase is based on the strong results of the first half of 2010, our current inventory levels at our customers, expected customer product launch activity in the remainder of the year and the expected positive impact from the foreign exchange rates in the second half of 2010. The foreign exchange benefits represented a large component of the revenue increase and this component will not float through to the bottom line. Importantly we are maintaining our previously stated earnings per share guidance of the range between $0.45 and $0.50 per share. With higher degree of confidence today than we had three months ago.

I will now turn the call over to the operator to answer any of your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Matt Miksic of Piper Jaffray.

Matt Miksic – Piper Jaffray

Wanted to just get a sense of where you are in terms of the cycle of inventory reductions that you are seeing in your OEM customers and instrument or new product launches that you see in pipeline. Are we kind of midway through the cycle OEM that backend of it, are we still in the front end of it, if you could give us some color there that would be helpful, and then I have one follow-up.

Fred Hite

Sure. The inventory at our customers, as we discussed in the past, dropped significantly in the fourth quarter of 2009 after several quarters of significant increases. Since that time, which obviously impacted our revenue in the second half of 2009, since that time the inventory levels have been pretty consistent and we don’t think as a big factor impacting our revenue both in the first half of 2010 or expected to impact the second half of 2010.

As far as new product launches, 2008, in the first half of 2009, we had very robust new product launches which drove revenue. That significantly slowed in the second of 2009. It picked up a little bit here in the first half but we see some increases in that demand in the second half of 2010 based on what we have in our order book right now.

Matt Miksic – Piper Jaffray

Okay, so anything like a return to 2008 or is this, how should we measure this in terms of just trends in your business?

Fred Hite

Yes, it’s not back at the 2008 level yet, but it’s definitely much better than it was in the second half of last year.

Matt Miksic – Piper Jaffray

And then follow-up on the margins, guess you talked about the benefit on the SG&A side of the restructuring that you are doing there. Gross margin, where are we with the progression in gross margin, I guess how should we think about the rest of the year here given the improvements that you have shown sequentially?

Fred Hite

We obviously saw nice improvements, second quarter to first quarter and our guidance right now has not a ton of growth relatively flat sales in the third quarter and the fourth quarter but the profitability, the margins improved in the each of those quarters as we have ramped up to those revenue levels that we were in the second quarter brought on a lot of new people we have hired several hundred people across the organization, gotten them trained and they are now starting to produce better results for us. So as we get into that stable environment, it allows more operation efficiencies. In addition to that, when we have larger launch quantities, it’s more of the same range to the factory which gives us nice efficiencies as opposed to a lot of different smaller jobs, which we saw in the first half of the year.

Matt Miksic – Piper Jaffray

And the investments you are making in quality and regulatory that Brian mentioned, those would impact your gross margin sort of fixed costs there?

Fred Hite

That’s right, we added some quite a few indirect people across the facilities in the quality organization. So that did impact the gross margins a little bit. There is also some SG&A impact from that as we hired quite a few managers in that area as well.

Matt Miksic – Piper Jaffray

And you are done with that or is that continuing?

Fred Hite

We still have some open positions in that area but we made I think great progress in that in the first of the year.

Matt Miksic – Piper Jaffray

Just to clarify on that, on those hires, I mean what kinds of things, because you certainly had to deal with the FDA and with the reviews I guess related to your OEMS before, but what – is it just a volume of demand for those inspections that’s driving this, is it new regs, maybe help us understand?

Brian Moore

It might have been driven by customers, the large OEM and in particular, the scope for changing anything in a facility has now been greatly limited so that we have to get formal permission through the quality system, the quality personnel to change anything. So if we for example, the product approved to run on one machine and that happens to be, literally an identical machine next to it. If we have not got approval to run a product in that machine, we have to go and get approval from that machine, and that’s design facility, design facility with design (inaudible).

So you can imagine, if we as a pretty global business with a lot of capability around the world, we can move products on the face of it to help customers very quickly but unfortunately it’s not as quick as we would like and we have quality people to help our customers help us to help them move the products quickly and that’s the biggest area of concern and that’s where we are investing the time and money.

Operator

(Operator Instructions) Our next question comes from the line of James Sidoti of Sidoti & Co.

James Sidoti – Sidoti & Co.

I know you tend to shy away from quarterly guidance but can you just give us some direction, do you think third quarter will be strongest quarter of the year or do you think it will be the fourth quarter?

Fred Hite

In our high end revenue $350 million, we see maybe a slight increase in the third quarter as compared to the second quarter and then something slightly lower than that in the fourth quarter, but it’s all relatively straight line. The $10 million drop is basically protecting fourth quarter, so in case there is some inventory correction that we see from our customers, we have factored in there $10 million drop in the fourth quarter but the third quarter is obviously sitting here in August pretty much we know where it’s going to be and we see it equal to or maybe slightly above the second quarter revenue numbers and then on the EPS side, it just continues to grow quarter-on-quarter as we continue to gain efficiencies.

James Sidoti – Sidoti & Co.

Okay, alright. And Fred on past calls, you’ve indicated that a pickup in case sales usually procedure pickup on the instruments and implants as well. Do you still feel that way?

Fred Hite

Yes, but probably not as strong as I did. We had a very strong load on the cases and we still don’t fully understand it. We had a blip in the first quarter and our case facility was almost totally overwhelmed and we have left few customers down and we’re now throwing lot of resources of that to catch up. There is a linkage and we still do see some instruments sales coming through. We are seeing some launch activities. But it’s not the strongest that we thought it was going to be probably six months ago and that is because the case uptick was more to do with the case business which just to remind you is 60%, 70% of those medical device sectors.

But the general principal is true but probably not such a strong linkage as we’ve probably would have thought a few months ago.

James Sidoti – Sidoti & Co.

Okay and then my last question is regarding the debt, Fred what’s the interest rate of the debt now?

Fred Hite

So we have an all in interest rate of around 5%, 5.5% between our term loans and some hedges we have in place. So every day we weight it seems like the bank of market opens up more and more and the rates to continue to come down and so earlier in the year, I kind of thought that we maybe see a two percentage unfavorable impact on us.

I’m not thinking it’s going to be less than that and it could be closer to par if things maintain where they’re at today.

James Sidoti – Sidoti & Co.

Okay, do you think you’ll have the debt refinance by the end of this year?

Fred Hite

Absolutely.

James Sidoti – Sidoti & Co.

Okay. All right, great. Thank you very much.

Fred Hite

Thanks.

Operator

And our next question comes from the line of Michael Matson of Wells Fargo Securities. Michael, you may proceed.

Michael Matson – Wells Fargo Securities

All right, thanks. I guess, first of all just on the Malaysian sales. How much of that the business coming through that facility is incremental so new business versus just kind of moving business from other facilities that you have.

Fred Hite

Yes, probably about half of it today is new incremental business for us. and we’re excited about, it’s not just more of the same but it’s as Brian mentioned a complete, total solutions, package, start to finish from the design, helping them design the instruments and cases that go with the implant and turning that into a finished products sterilized out to the back door, has been a huge success and its probably the only facility that’s doing implants, instruments and cases all within the organization. So very encouraged by the incremental revenue there and the future potential for that in that area over there.

Brian Moore

Mike, what was sort of planning forward looking is approximately a third for local customers new to the facility, a third for our existing customers that are in the region and a third to support our other international operations by providing lower cost support. And that seems to be the case and we have had some quite pleasant surprises in terms of local interest and local presence and the Japanese project which has created us a fully sterile packed capability over there. We can now produce fully finished sterile packed Class III implantable devices with instruments and that actually is the only facility in Symmetry that can do that total solution at the moment.

Michael Matson – Wells Fargo Securities

Okay, that’s helpful, and then just curious with the addition of Jose Fernandez and some increased efforts in terms of developing your own proprietary products. is that going to lead to some increased R&D spending and I guess the second part of the question which is the are you ever going to kind of break out your R&D spend separately from your SG&A or you just going to continue to lump it in the SG&A.

Brian Moore

Yes, as we talked at the beginning of this year, we made a conscious decision to invest the couple of million dollars in this area by hiring more resources and ramping up that effort and that’s exactly what we’re doing. Those dollars all show up in the SG&A buckets and right now we’ll probably just keep lumping them in there as total SG&A maybe sometime next year to the extent that they’re become material we’ll maybe break them out for them but right now we will just leave them where they are and let them little fall in the total SG&A.

Michael Matson – Wells Fargo Securities

Okay and then just on the revenue guidance increase, you said most of that was due to currency, I guess I’m a little confused just because it seems like most of my other companies have been having some of them had a lower revenue guidance because of the currency and can you may be just walk me through why the currency, the weaker Euro is helping you, I guess in the second half of the year?

Fred Hite

Yes, it’s more driven by the Pound, which is actually diverting a little bit from the Euro. In the middle of the second quarter, the Pound bounced around between 140 and 145 and today sitting on 160. So what happens is those transactions that are in Pound get converted into a larger sales when it comes back into the US. and so right now the guidance I have is that the Pound continues at that 160 level which is all I can do is use today’s rate to project forward but it seems like the trend is improving on the Pound.

The Euro really it’s been pretty stable as of the last month or two at least and we’ve had current rates factored into our earlier guidance so it doesn’t have a big impact on us.

Michael Matson – Wells Fargo Securities

Okay, that’s all I have. Thank you.

Fred Hite

Thanks.

Operator

And at this time, we’re showing no further questions available. Brian Moore, you may proceed.

Brian Moore

Okay, well thank you very much everybody for listening to us today and we remain confident in our guidance and we’re looking forward to finishing the year. And most importantly getting the company ready for what we think will be a good couple of year’s recovery in 11 and 12. So we’re here, if you need to talk to us, call us. Thank you very much.

Operator

Thank you for your participation in today’s conference. This concludes the presentation. You may now disconnect. Have a great day.

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Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

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