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Home Depot, Inc. (NYSE:HD)

Goldman Sachs Dotcommerce Conference

June 4, 2014 09:45 AM ET

Executives

Kevin Hofmann - SVO and President - Online

Analysts

Matt Wexler - Goldman Sachs

Matt Wexler - Goldman Sachs

So, good morning, we’re about to kick off our next session. I’m Matt Wexler from Goldman Sachs and have the privilege of covering Home Depot and I'm introducing the company today for our fireside chat.

Home Depot has been a very successful company in many-many ways, over many-many years and certainly over the last five years coming out of the downturn has put up an operating and financial track record that has been exemplary and second almost to none in the retail sector. But what is interesting and the reason we’re having this conversation here today is that this is a fascinating real life case study if you will of a company which given the sector in which it plays, given the logistics, given the merchandizing dynamics, given the real estate, really has had the opportunity to assess the direction which e-commerce is moving and to still act offensively against its opportunities and to really assess the best practices across the sector developed its own and commit this in a very deliberate cost effective way and it’s been transpired with great success and the company has given and most of its investor session has given this area far more revenue than its revenue share would dictate which I found really fascinating, because I thought that it spoke to the role that management thought this business would play over time and what a great way to see this sort of unfold in a very positive and constructive way as opposed to quite frankly the way it’s played out for so many of the other retailers that we cover. So with us here today we have Kevin Hofmann, welcome back.

First of all, Kevin has been at Home Depot for eight years, he joined leading the company’s technology efforts in retail operations, he then led the team's focused on e-commerce, a supply chain transformation and international, part of this role and that role by the way is senior Vice President at the company and President of online, he had been senior Vice President for home services responsible for strategy sales, operations and compliance for the home services business, a very-very different kind of business quite frankly from where you’re focused today. Prior to that one of the good guys that came over from GE, and a terrific pedigree in that regard and like I said Kevin has been a really essential part of the company’s execution and face to the world for the online effort.

Question-and-Answer Session

Matt Wexler - Goldman Sachs

So, as you might imagine I have a bunch of questions and one I’ll start out with. As online evolves and e-commerce grows, can you talk about changes in the kinds of business that are getting executed online, what are customers looking for online versus what they look for in the past.

Kevin Hofmann

Certainly and before we start which is thanks again for the invite Matt and for everybody’s interest here in Home Depot. Probably starts with just an illustration of how we think about our terminology of this is interconnected retail. It’s how you take the bricks and mortar presence and the assets the company has and you blend in the virtual asset that we can bring to bear with the new technology and the new shopping behaviors. That really is from our company’s perspective the center point of our strategy and interconnected retail isn’t kind of a tangential distraction, we are pretty convinced that this is the future and it’s not certainly anything that we all been in denial. When I think about Matt’s question around which categories and which projects we struggle to find a single category or a single project that isn’t heavily influenced by the interconnected nature of way consumers are shopping. So when you kind of peel back the cover of a Home Depot store and you dissect the businesses inside that store, there’s a multibillion dollar flooring business, a multibillion dollar paint business, a big tool rental business, a kitchen business, an appliance business, not a single business isn’t heavily impacted and influenced either by consumers doing research and shopping up front before they hit the physical location or in some cases too they’re actually going to shop and browse and transact online.

So the changes we’re seeing, we have a very-very healthy bath business online, a very-very healthy and big growing flooring business online, of course appliances, patio, power equipment, power tools, those things are kind of the mainstays of the home improvement online business, but also heavy-heavy shopping and browsing of building materials. We’re not transacting a lot and shipping a lot of 60 pound bags of concrete, you know we sell a 60 pound bag of concrete for $3, people aren’t buying that online and having it showing up to their doorstep, but there’s a ton of price checking, inventory look up in making the physical shopping experience more convenient. So we see that change every year and increasingly consumers are shopping and browsing more online and using that to be a preview to their physical shopping event.

Matt Wexler - Goldman Sachs

So listening to your last statement about what they're browsing and not buying, it might be good news that they're not trying to buy 60 pound bags of concrete, but I guess my question is, are there areas of the business that where your view of the economics of a multichannel interconnector transaction, call it what you will, have evolved from challenging or impossible or unlikely to more feasible over time and I keep in mind the (go-through) [ph] panel that we just heard where everyone's struggling with can this ultimately work, where has your view of what's possible evolved?

Kevin Hofmann

So, certainly, the ship-to-home transactions are challenging because you got to solve the last mile delivery issue, and we learned so much over the last few years around what levers we can pull, and what existing assets that we can leverage to improve the economics. So I would point to our existing supply chain that we built out over the last number of years. Over 50 different distribution centers, rapid deployment centers, stocking distribution centers, bulk distribution centers; those distribution centers moving mass quantities of products. Then you have to think about the Home Depot supply chain too its 2,000 beautiful stores that our conveniently located within five minutes of most people’s household, those when you peel the cover of that sort looks like a distribution center with high racking and lots of Ford trucks and lots of people moving around products. The economics in getting the product to the customer challenging for everybody, but one would argue that we are set up to leverage the buying power and the scale in the point of distribution that very-very few people have. So we have about 35% of all of our online orders; for example, get filled out of our store locations, leveraging that core supply chain, leveraging those little working warehouses, that exist today and it’s already an existing investment. So increasingly we’re getting smarter about what levers we pull, about how we leverage all of the assets, the physical assets and the virtual assets to fine tune the economics.

Matt Wexler - Goldman Sachs

So, going deeper into supply chain, so you had this Analyst Day in December in Boston; and one of the most memorable comments, I think it was Frank Blake, and it was “we were not prepared, for what our supply chain had to look like, to fulfill the business that was going to come our way.” And it sounded like you are in the midst of making a number of incremental investments and fulfillment capability including some dedicated, more dedicated [indiscernible]. Can you talk about what you saw, sort of how you, what brought you to this realization and talk about the investment and the build out, kind of what that end game looks like.

Kevin Hofmann

Yes, so I’ve already mentioned our existing companywide supply chain which we leveraged quite extensively, plus our stores that we used as a supply chain as well. And we also had a decent sized direct-to-consumer sort of distribution centers which do more traditional parcel shipping. They are not sending out mass truckloads of product to Home Depot stores, they are sending out parcel shipments to the consumers. And just this the growth of our online business, we grew the online business by over $900 million last year, about 53% growth last year in the first quarter. There was nearly 40% growth on top of that. And just the need to service the parcel shipments across the country, we started to build new more contemporary direct-to-consumer distribution facilities. We just opened our first one, its 1 million square-foot facility in south of Atlanta. We have two more under construction now and really what that will allow me to do is continue to build on to the existing Home Depot supply chain, and any products we chose to stock in those new distribution centers, will be able to service 90% of the country within two days; for anything that needs to be parcel shipped from those facilities.

Matt Wexler - Goldman Sachs

And we think about the same day, and customers demand for same day; your perception of the need for same day, and executive in another sector said to us a long time ago, you know this isn’t plasma we’re selling here. What’s your sense of what your consumers want, and what is feasible for same day for you?

Kevin Hofmann

A couple of different ways to think about; so we believe our 2,000 stores definitely scratch that itch, and every day we’re satisfying the same day need from a customer’s perspective. And that’s a great differentiator in an asset that we have that many don’t. We also have great delivery capabilities out of our store, and I probably shouldn’t call it great because it’s something that we're improving right now and investing significantly in. Later this year we'll offer a much-much more improved capability to have buy online and deliver from the store, won't be same day, but it’ll be pretty accurate and within a couple hour window next day or scheduled delivery to your home. So we believe between our offerings, satisfying the immediate needs which is a high-high use case for our customer with the convenience of our stores, satisfies the same day. Delivery capability out of stores can satisfy the next day, in within one or two days. Our parcel shipment capability can satisfy that two to five day window and then that’s augmented with our other offerings buy online, pick in store buy online, ship to store, we feel like we’ve got a pretty good full buffet of fulfillment options for our customers and that’s what we’re investing in and that’s what we’re building on.

Matt Wexler – Goldman Sachs

Also on delivery there is what is best for you and then there is what the customer wants. Clearly you're moving with the customer and that being said I would imagine that the economics of buy online ship from store, buy online pick in store, ship from central direct (UC) [ph] are different. Can you talk about how the economics differ and we've heard different things from different companies about whether if they can rent their own ticket what it would be just from a pure financial perspective?

Kevin Hofmann

So definitely the economics depends on I think how you evaluate the economics. If you’re a pure item retailer and the customer is in and out looking for one item and you're evaluating on that item economics, it's tough. But if you are thinking about for example Home Depot it’s we’re an item retailer but we’re more so a project retailer. And customers are coming to us to execute their projects, they are coming to us to execute investments in their homes. So for example when a customer does a buy online pick in store transaction hugely-hugely valuable visit that we then get a chance to monetize and understand that customers’ buying occasion, understand what’s going on in their life.

And then what we see is the attachment transactions. So whether it’s buy online pick up in store, buy online return in the store, 90% of all of our online returns actually happen through the convenience of our store. And on a transaction by transaction basis you could look at that and say the labor economics boy that’s going to be tough but if you look over the customers' buying occasions and their journey in the customer profitability you’ve got to have that offering, you’ve got to have that service if you’re going to continue to command a decent share of wallet from that customer. So the kind of moral of that whole story is yes, item economics then you got to think about basket economics then you got to think about the whole buying occasion and then the customers’ journey over the course of a year or two, you’ve got half of those. And we feel like we’re making a ton of progress in understanding that and continuing to improve it.

Matt Wexler – Goldman Sachs

So in our introductory remarks this morning we talked about the biggest challenges for retailers confronting a world of ecommerce for lesser market share and more so the impact of investing in omni-channel and price transparency. So taking those one at a time, you all have not done a lot of complaining about how much this is costing you. There are some companies not direct peers but other retailers who say that perpetual margin pressure associated with this investment and a big bulge in CapEx. Can you talk about the cost associated with your transition to omni-channel will there be a bulge for you here?

Kevin Hofmann

I think it maybe to the timing around we had declared a number of years ago that we’re pretty satisfied with the square footage we have deployed from a retail store perspective. So don’t really see the need to open up a ton of new stores, maybe a few in Canada, maybe a few in Mexico but that for the number last number of years our capital investment has been pretty much at about $1.5 billion level and that’s what we forecasted out. And that pleasant situation where we’re a cash generating machine we have lots of capital we can deploy, but when you dissect that $1.5 billion and given that this interconnected retail strategy, this interconnected retail theme is the center point of our strategy. It’d be pretty tough to look at that $1.5 billion and declare anything in there not an interconnected investment.

Our IT investments of course are all interconnected, our direct to consumer distribution facility I mentioned is an interconnected investment, the upkeep and maintenance of our existing store fleet we see that as an interconnected investment. We don’t really call that out and call that as a special build out because we really see that as a big part of the future of Home Depot. And then also the short answer is no immediate bulge that we see looming like some of the people have called out.

Matt Wexler – Goldman Sachs

Fair enough. What about online and if you go pricing online that is, can you talk about how you price in store versus online do you have a perfect parity at this point in time? And furthermore if you could talk about the impact of price transparency on pricing and also on the in store experience quite frankly?

Kevin Hofmann

So first just the level set typical Home Depot store is about 35,000-40,000 items in it skews in it, online will have about 700,000 skews and of course their share between that. But we have matched our prices in store with those prices online. So if you are with your mobile device and you’re in the isle of the Manhattan store and you’re looking online at a store skew it’s going to be priced the same online as it is in the store and that’s been our practice for a number of years. So we believe the customer should have that same price online as they do in store.

Of course for the extended assortment online it doesn’t really apply that much. We -- from a pricing transparency perspective no doubt about it we’re leaning into that. We know there is a lot less friction for the customer to compare prices. Our strategy as a company is to be an everyday low price winner and to provide great value to the customer, so when we see showrooming happen in the vein if you are going to win some and you are going to lose some, we actually think we are going to win more than our fair share because those people are showrooming in our isles, they are showrooming in everybody else’s isles and when your strategy is to be the customers' advocate for value and to be an everyday low price leader we should win when showrooming happens.

Matt Wexler - Goldman Sachs

I also want to talk about then just going direct, so you have some vendors who have good brand equity in markets like apparel, beauty. We have seen vendors increase their direct connectivity and commerce connectivity with consumers. What are you seeing in this regard? Are your vendors trying to do this at this stage?

Kevin Hofmann

Yes, so we have seen pockets of it in the home improvement space it hasn’t been as big of an issue as we have seen in other industries and our philosophy around this is on a 52 week basis like-for-like last year Home Depot grew $5 billion. And so our message back to the channel and to the manufacturers is we have got a pretty focused and what we feel like is a good online strategy. We've got a great physical presence. We've got a continuing to improve supply chain. We've got a tremendous value proposition to the manufacturers and distributors and shame on us if they don’t see that value proposition and say we're going to win with Home Depot, look at the growth in 2013, look at the growth in 2014, that’s my preferred choice to distribute my products.

Matt Wexler - Goldman Sachs

I also want to talk about online as an in-store tool and I'll corporate I think you’re in the comScore presentation and Johnny showed I guess with the proportion of time perhaps spent on an app and the in-store retailers and you were kind of right there with the pack, most of the in-store retailers had about a third the level of penetration on apps as say Amazon did. So, can you talk about the degree to which you think you are getting traction now and by the way that’s for overall commerce that’s not just in-store but to what degree are you getting traction in controlling the digital environment in your store?

Kevin Hofmann

So just some stats around how our mobile customer's behaving, so for us the mobile web or the mobile browser is more dominant than the app and it’s largely because of the buying occasions and episodes the consumers have with our brand, it’s just not as frequent, on average four, six, maybe eight times a year a consumer is engaging. So, the barrier to get an app downloaded is pretty high. With that said, we've got nearly 7 million app downloads of the Home Depot app and very, very healthy mobile browser traffic, very, very healthy app traffic and we've been in that game for the last three if not closer to four years.

When we talk about mobile activity in the digital environment and the store, couple of things, so 10% of all of our online orders are originating in the store with the customer and the associate engaging each other and looking at the endless isle or the extended isle online. And so it’s for us the mobile behavior is really the vehicle that helps close the chasm between the customer and the product knowledge and the information that exists online, it’s also a confidence building tool and a knowledge tool for our associates. So, significant number of our online orders originating in the store with the customer and the associate. We also see a very, very heavy penetration of mobile usage in the store, all of our stores have WiFi and have had WiFi for years and a couple of other thoughts around the digital environment. All of our associates are trained in how to leverage the digital assets in the isle to help drive conversion as well.

So, we are not so much concerned about the comScore chart of mobile browser usage versus app usage. We think we've got to be there for the customer no matter how they want to engage, no matter how frequently they want to engage. I would say our pro, our contractor that has a much, much higher frequency of usage, they are more willing to go get the app and engage in app. And so that’s what we use our apps for is the higher frequency customer.

Matt Wexler - Goldman Sachs

You’ve spoken and talking about your e-commerce factored about some new online capabilities, you've talked about shop by room, you've have talked about augmented reality have this complete the collection function. Can you talk about which improvements, which enhancements are driving incremental revenue for the business?

Kevin Hofmann

Yes, so, there are some of those features and functions that all of us are in this perpetual arms race of features and functions that others are rolling out that you need to mimic and as the consumers’ expectations are rising around what they expect from a retailer, those that are driving really, really great transactional behavior rather than talk about those and give that knowledge to potential competitors that are in the room around the webcast. I’ll speak to things like augmented reality. Augmented reality is the ability for you to see the Charismas tree or the vanity or the mirror on your wall or in your room or the patio set in your backyard or on your patio. And we don’t really evaluate those based off did it drive a transaction, we evaluate those based of the amount off engagement and how many customers are using it. Eventually, we want to see that turn in to sales but it’s an important point for our online properties still a small percentage of customers are transacting online.

You know, 3.5 million visits a day small percentages actually are going through checkout online, so a big-big part of our enterprise value returning back to the core Home Depot is giving that customer knowledge, giving that customer confidence because still 90 plus percent of customers are transacting in store. So augmented reality see the whole room, some features like that we track their value based off how many customers for example are bookmarking that and returning to that two or three weeks later. That’s an inspirational dimension that’s the core dimension that traditionally people wouldn’t have through off about Home Depot, and that’s a great thing to think about and how we’re exposing our brand and our company to the customer in a different way that was never possible with just our current bricks and mortar stores.

Matt Wexler - Goldman Sachs

I still have a number of questions unasked, but we do have (roving) [ph] mics, so if they can make themselves known, if anyone has any questions, you can start raising your hands and you'll opportunities, I actually have one right back there if you would.

Unidentified Analyst

Hi, Kevin. Two questions, one would be, can you talk about the impact if any you’re seeing so far from Amazon supply offering? That'll be question one and question two; can you maybe characterize your online advertising strategy how that's changed year-over-year and where you’re seeing greater returns in others and any challenges in doing so by channel?

Kevin Hofmann

So first, I mean, we hold Amazon in very high regard as important and tough competitor. We watch them closely. We watch them arguably just as closely, if not more closely than some of our traditional competitors you would think of. Won't make any comments on specific category penetrations and stuff, but just say that we monitor them closely and view them as very-very healthy competitor.

On the advertising side, so we have had a very pretty aggressive pivot over the last few years really led by our Chief Marketing Officer to make sure that we’re balanced appropriately on traditional media and also digital media. So very-very aggressive push into of course SEO and SCM tactics and affiliate marketing and email marketing, and from what I’ve seen of the more traditional retailers one of the most aggressive pushes and recognizing the digital marketing is where it's at, you can get more personal, you can get more targeted, you can get more surgical, and you can understand what the customer is thinking and what their buying occasion is. So very aggressive there in not just in I would say old digital but also new digital when it comes to mobile and very aggressive on mobile marketing as well.

Matt Wexler - Goldman Sachs

We still have opportunity for questions from the audience. I’ll ask the next one though and that is, can you talk Home Depot gets to know its customers so to speak and this relates to the totality of your relationships and enterprise wide and store online et cetera and to what degree that enables targeted marketing?

Kevin Hofmann

So a couple of thoughts here is, this is definitely a continuum of maturity. Look at some of our customers and also we have a very-very broadened and wide reach with our private label credit cards. We tend to know quite a bit about those customers and that’s a real advantage to us. We also have gotten much, much better around our pro or our contractor customers the ones that have many more frequent buying occasions. They’re in our stores 50 or 60 times a year. We have a loyalty program for those pros it’s called pro-extra. We’ve had very, very healthy reception of our pro-app and so on that end of the spectrum much, much, much better but admittedly still in their early innings of our intimate understanding of the customer.

And then I would go in the other end of the continuum the consumer who we may see for six times a year. We are very early innings with being able to offer personalized experiences to that consumer. And honestly we depend a lot upon our stores to understand the local markets that they participate in understand the local likes and dislikes. And I think if you’ve been in a Home Depot store in your neighborhood, we try a lot to make that a more personal and enjoyable experience for you. But that level of personalization and really truly understanding the individual consumer not one of the things that we'd hold up and say, we’re excellent in that. I would say from a marketing perspective we are pretty good, seeing your behavior online for example and then hitting you a day or two later with something that you left in your cart, something that you may be surfing on another web property or doing re-targeting ads, we’re doing re-targeting emails. So once you give us some demand signals, we’re pretty good at reaching out at you and trying to remind you that you’ve got that $1,000 grill in your cart that you didn’t check out with.

Matt Wexler - Goldman Sachs

Is this an area, I mean you’re pretty candid about where you think you stand, is this an area that customer knowledge, personalization where you would expect to get more traction or is it going to be kind of be the way it is for the time being?

Kevin Hofmann

No its definitely an investment area for us, and I would speak specifically around the pro, that’s where a lot of our focus is. With Pro Extra it’s pretty new for us, our pro app is only three or four quarters old, it’s had very good reception 400,000 downloads, pretty heavy usage, Pro Extra has got 1.5 million sign ups to it and when you think about our target audience there, it’s kind of the blue collar contractor of the country, 1.5 million signups for that loyalty program, is a pretty legit number.

Matt Wexler - Goldman Sachs

We have question again here please.

Unidentified Analyst

Is the online taking out and your customer experience online is improving. Do you see that forcing you to make decisions in terms of closing some of the offline stores or scaling back or in terms of the expense and strategies going forward would you heavily tilt towards online rather than building new stores around the country?

Kevin Hofmann

So thank you for the questions. I would say again we’re very happy with our store footprint and don’t see any near term need to adjust that. But maybe double quick on that for a second and I can just give you the example of our Patio business. So we deliberately and purposely leaned in to our Patio set business and we pushed much of that online and its much, much higher penetrating online and we work through all the economics of that. That essentially frees up square footage in the store for more nutritive categories.

And so we’re going isle by isle, class by class and thinking through that. And rather than messing with the square footage in totality it’s like where can we get the most for the shareholder and for the customer with the proper deployment of that square footage. So that’s how we’re thinking about it.

Unidentified Analyst

A bit curious, how are you sort of thinking about in terms of price parity between the store and online. But how are you thinking about sort of price parity online versus some or your other online only competitors. And then I guess also you talked about using affiliate marketing. I’d be curious how you guys sort of think about attribution there for the people are driving traffic to you. These coupon codes, things like that. How do you think about sort of last quick attribution and how that evolves?

Kevin Hofmann

So the first question is around pricing, and pricing if I am getting it correct, more to the new competitors the emerging competitors, absolutely so something we watch daily and like retail for the last number of decades, there are items that we’re going to say, we’re not going to be on, right. And there are items to that will say we’re not going to raise to the bottom and that’s a deliberate discussion and decision for us.

Just an example on that we acquired a company few years ago by the name of BlackLocus, smart group of folks that have helped us get pretty, I wouldn’t call it real time but pretty good and expeditious visibility to online pricing across the broad spectrum of competitors that we want to monitor. And by merchant, by category we’re looking at how we’re priced to traditional competitors, online competitors and trying to make sure that it’s a case by case deliberate decision on where we’re priced. And we run our entire business as a portfolio, we’ll make margin decisions across the portfolio and as you have seen over the last few years our online business has grown substantially and we’ve also been able to improve our gross margins as well.

And then your second question around last quick attribution, I mean we think affiliate marketing is an interesting animal for us. I mean sometimes we use it to try to acquire new customers and get them through the shopping bypass and get them exposed for our offerings, sometimes we’re using it to liquidate and clear stranded inventory. So I would say the affiliate marketing channel for us is a tool we use and it has many, many uses. It would be probably unfair for me to try to summarize one different strategy, or one strategy we use for affiliate.

Matt Wexler - Goldman Sachs

Question over there.

Unidentified Analyst

Making interconnected retail allowing you to make your product assortments more efficient. Does it also allow you to get into new categories, so you did blinds.com acquisition, can you talk about that and if there are any other new categories that you think would work really well and with interconnected retail?

Kevin Hofmann

So absolutely, so our interconnected retail strategy allows us to not only offer a broader deeper assortment in to things you typically would associate Home Depot with, but we venture into categories that are new neighbors and we’re still trying to be true to our brand and true to our heritage and not deviate too far, absolutely dipping into near neighbor categories. I would say the blinds.com acquisition for those that may not be familiar, just a few months ago we announced the acquisition and closed the acquisition of blinds.com, we have a great rate physical blinds business which is wonderful business for us and as a part of our interconnected retail strategy we said we not only want to win in the physical world, we want to win in the virtual world and with the blinds.com team we found not only great experiences we found a great team with the optionality that that team could help us grow into other configurable and difficult to replicate categories online. So we’re opportunistic as a company where we see those opportunities, again we have a wonderful position from a cash perspective, and we’ll be opportunistic with other categories.

Matt Wexler – Goldman Sachs

We have time for I think one last question, right up front.

Unidentified analyst

Do you do any drop ship fulfillment and could that play a role in your supply chain?

Kevin Hofmann

Yes, so we do quite a bit of drop ship fulfillment, so a significant amount of our online sales are drop shipped direct from vendors to the customers’ homes. And we're pretty deliberate around, you know often times we’ll bring in a new vendor, bring in a new supplier and we’ll start drop shipping from them and then we’ll see the economics and see what service levels the customer requires and see what the peak seasonality demand that we’ll have for products and start making decisions around what we need to forward deploy into our distribution centers versus a vendor’s distribution center. I’ll take a one step further and say that doesn’t stop there, then when we see direct to consumer demand coming from our direct to consumer distribution center then we evaluate whether or not we need to forward to deploy it into our stores, and so we have that last leg that we can do as well, but significant amount of our dotcom businesses is drop shipped from the vendors.

Matt Wexler – Goldman Sachs

We could go on, and I wish we had time to do so, but I think in this 40 minutes or so, we’ve got a good sense as to why the company is making the strides that it is, next up in this room we have the online innovation panel with Dollar Shave Club, (Minted and Plated) [ph] and next door we have the Gap, it’s a lot to choose from. Please join me in thanking Kevin for his remarks.

Kevin Hofmann

Thank you.

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