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HNI Corp (NYSE:HNI)

Q3 2011 Earnings Call

October 20, 2011 11:00 am ET

Executives

Derek Schmidt - Treasurer and VP, Corporate Finance

Stan Askren - Chairman, President and CEO

Kurt Tjaden - VP and CFO

Analysts

Saathoff William - Raymond James

Mark Rupe - Longbow Research

Matt McCall - BB&T Capital Markets

Peter Lisnic - Robert W Baird

Todd Schwartzman - Sidoti & Co.

Operator

Good morning. My name is Sean and I will be your conference operator today. At this time, I would like to welcome everyone to the HNI Corporation Third Quarter Fiscal 2011 Results Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions). As a reminder, today’s conference call is being recorded. Thank you.

I would now like to turn the call over to Mr. Derek Schmidt.

Derek Schmidt

Good morning, and thank you for joining us today for the HNI Corporation conference call to discuss third quarter 2011 results, which were announced yesterday after the market closed. My name is Derek Schmidt, Treasurer and Vice President of Corporate Finance for HNI Corporation. If you have not received a copy of the financial news release, it is available on our website, www.hnicorp.com.

A presentation intended to accompany this call has also been posted to our website under the Investor Information section. We encourage you to review this presentation as it contains details of our financial performance, including the non-GAAP to GAAP reconciliation.

Joining me today on the line for HNI are Kurt Tjaden, Vice President and Chief Financial Officer, and Stan Askren, Chairman, President and CEO. Stan and Kurt will review the results and then open up the call for questions.

Before we begin, please be advised that statements made by the corporation during this call that are not strictly historical facts are forward-looking statements. Forward-looking statements are subject to both known and unknown risks. Actual results could differ materially from expected results. Additional information concerning factors that could affect actual results can be found in the conference call presentation posted to the HNI Corporation website. The corporation assumes no obligation to update any forward-looking statements made during this call.

I now have the pleasure of turning the call over to Stan Askren. Stan?

Stan Askren

Thank you, Derek. Good morning everyone. We will share our assessment of the third quarter of 2011 and then provide some thoughts on our outlook for fourth quarter in 2012. We will then open the call up for your question.

Strong execution across all of our businesses drove outstanding third quarter results. Sales and profit growth exceeded our expectations. We increased sales 10% and net income in earning per share increased almost 60% versus prior year. We aggressively manage working capital and generated over $70 million of free cash flow. Our performance is a reflection of the power of our split and focus business model and strong returns from strategic investments.

Sales in our office furniture contract international businesses remained strong with 15% top line growth. Operating leverage was solid and margins improved. Despite low levels of small business confidence, our supplies-driven business improved 4%, exceeding expectation.

Our market leadership position is strong and we continue to leverage the power of our brands to perform well in this challenging environment.

Our Hearth business continues to deliver outstanding performance. Remodel-retrofit sales increased 22% as strong demand for our alternative fuel products was driven by higher energy prices. The new construction channel was up 4%, the overall business of housing conditions remained weak. Profit more than doubled year-over-year, a strong operational execution in cost containment drove excellent operating leverage.

I will now turn the call over to Kurt to review this specific financial data for the third quarter. Kurt?

Kurt Tjaden

Thank you, Stan. So for the third quarter 2011, consolidated net sales increased 9.9% to $504 million. Sales for the Office Furniture segment increased 8.9% to $422 million, while net sales for the Hearth Products segment increased 15.2% to $82 million.

Consolidated gross margins increased to 35.6% compared to 35.1% in the prior year quarter due to higher volume and improved price realization which was partially offset by increased material cost.

As a percent of net sales, total selling and administrative expenses improved 0.8 percentage point due to higher volume, which was partially offset by increased fuel costs and higher incentive-based compensation.

We ended the quarter with $102 million of cash. Operating activities generated $67 million of cash during the first nine months of 2011, which is up 36% from the same period last year. We recently amended and restated our credit facility with strong support from our lender group.

Borrowing capacity was increased by $100 million to support our future business objectives while also lowering costs and increasing flexibility.

I will now turn the call back to Stan.

Stan Askren

Thank you, Kurt. We entered the fourth quarter with strong momentum and we are on track to deliver profit improvement in sales growth for the full year 2011. Our contract brands continued to compete well in their markets. Year-over-year growth rates within the contract channel are expected to moderate in the fourth quarter against strong prior year comparisons.

Our international business remains a significant growth opportunity particularly in China. We have strong brand recognition and continue to aggressively invest in new products and expand sales distribution in their region and the world. Growth in our supplies channels is expected to improve moderately even though small business confidence remains uncertain. We are executing well and continue to expand our competitive advantage by investing in our brands by development and selling capabilities.

In our Hearth segment, we anticipate sales to be relatively flat to prior year. Top line growth in the new construction channel is expected to be down slightly, the single-family housing starts and permits remain depressed. In the remodel-retrofit business, demand for alternative fuel products is projected to remain strong.

Growth rates will be lower given stronger prior year comparisons which benefited from expiring energy efficiency tax credits. We continued to invest in resources to enhance our customers experience, expanded the new channel and delivering innovative products to the market. Looking to 2012, we are building capabilities to strengthen our market position and deliver profitable growth. The economic outlook for next year remains uncertain but we are well positioned to expand profits under multiple scenarios.

Kurt will now provide our financial outlook for the fourth quarter in 2012. Kurt?

Kurt Tjaden

So the fourth quarter 2011 we anticipate overall sales to be up 2% to 5%. Office furniture sales are expected to be up 3% to 6% with sales in the supplies driven channel expected to be up 2% to 5% and sales for the rest of our office furniture business are expected to increase 4% to 6%.

Our sales are expected to be relatively flat versus prior year. Gross profit margin is expected to be in line with fourth quarter 2010 when it was 35.3% excluding restructuring and transition charges. SG&A as a percentage of sales, excluding restructuring and transition charges, is expected to be in line with fourth quarter 2010 when it was 29.4%.

Net interest expense is projected to be $2.5 million. The effective tax rate is projected to be approximately 37% during the fourth quarter. As a reminder, the tax rate last year in the fourth quarter reflected the full-year benefit of the reinstatement of the R&D tax credit.

Capital expenditures were expected to be approximately $30 million which is primarily focused on new products. We project depreciation and amortization will be $46 million to $48 million over the year. So, for the full year 2011 we now expect non-GAAP earnings per diluted share in the range of a $1.00 to $1.5.

Looking towards 2012, our preliminary estimate of non-GAAP earnings per diluted share is in a range to a $30 to $50. These estimates reflect our best view of next year's market conditions although the economic outlook remains dynamic.

For our office furniture segment, we expect low-to-moderate single-digit growth next given stronger comparables. We are projecting margin improvements driven by continued reductions in our structural cost, mix improvements, pricing theory over from 2011 combined with stable commodity costs and benefits from our growth investments.

Our part business is expected to deliver mid-single sales growth in 2012 driven by continued strength in our alternative fuel products. New construction will be challenged by continued weakness in the housing markets but it is anticipated to steadily recover next year.

This summarizes our outlook for fourth quarter 2011 and in full year 2012. I will now turn the call back to Stan for closing comments.

Stan Askren

We feel good about our results of third quarter 2011. We are positive about our markets and the prospects of our businesses in the future. We are on track to increase sales and profits in 2011 and set to drive profitable growth in 2012.

We continue to invest for long-term growth initiatives, aggressively reduce cost and improve operations and focus on cash generation to create shareholder value. The company is financially strong and our businesses are well positioned for the future. With those comments complete, we will now open it up to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from the line of Budd Bugatch from Raymond James. Your line is now open.

Saathoff William - Raymond James

I just wanted to drive down first, if I could, into the segments that you have put up a very strong 35% incremental margin in the Hearth segment. Office was a little more subdued, I calculated 21% contribution margin and I know you called that volume favorable pricing in both segments offset by higher cost.

So I was wondering if you could give us maybe a little bit more insight into the delta there? Was it maybe (inaudible) better pricing realization or did you have some strategic interments or spend in office, just your thoughts there?

Stan Askren

I will take a shot at your [question] and will let Kurt shove in details that I don’t cover if there is any. I guess, as we look at that, the Hearth business is benefiting from lots of structural moves that we have made over recent years. They are very strong positioned from car structure and they did a very nice job of executing. The challenge with -- and by the way, office furniture, I think did a nice job of leverage, one of the better, I think in the industry this period, very impacted by some different things around and more dynamic pricing and customer mix. So, so it depends, you know, any one quarter as far as what they have for material cost price gap. It depends on large projects versus day-to-day business. It depends on the type of customer, whether it’s a larger higher volume customer, you know, and all those sorts of things.

So our goal still is 30% leverage as we will look forward all else equal, where you will see some different movements in the quarter based on price and material costs etc.

Saathoff William - Raymond James

Okay. And I guess as Kurt gave us some preliminary comments about 2012 and from what I gathered sort of mid-single digit from sales growth on average and a buck 30 to a buck 50 I haven’t had the chance to go through the math, but I guess, what sort -- what type of contribution margin are you implying by the guidance and the initial thoughts on next year?

Kurt Tjaden

Well, I think we are at a higher level as we look out at the outlook. So, again, there is some key assumptions in there around mixed improvements, around price costs basically being closed, benefit of structural costs. So there is not any specific contribution margin target there, other than as Stan said I would reiterate that 30% leverage objective is what we target for both our businesses going forward.

Saathoff William - Raymond James

Okay. And if I could, I guess, maybe completing the contribution margin trifactor thinking a little bit about Q4, could you walk me through some of the buckets in terms of how you see it playing out in things like price, cost, any strategic investment, how are you thinking about those elements in the Q4 guidance?

Kurt Tjaden

Yeah, so there are a couple of things in Q4 to take into account. First of all, you know you have to tax adjust last year for a comparable basis. So, if you look at kind of guidance, we would and take that – to that unique one-time full year benefit out of 2010 or showing predicting earnings improvement. You've got core operating earnings improving as we look at the course of price cost, it’s closed as we have talked earlier in the year.

We've got a few negative prior-year items around some LIFO adjustments, some corporate things and timing that bring that down slightly, but again I think that’s core operating leverage, I would say, modest just kind of in line with expectations.

Operator

Your next question comes from Mark Rupe, Longbow Research. Your line is open.

Mark Rupe - Longbow Research

Hey guys, good quarter. On the 2012, obviously I think if you are commenting on next two years, you obviously have a decent degree or a certain degree of confidence in the range. On some of the items that you cited of that you know you take into account, is there a couple that have a little bit of more weight than the others. I know that the whole steel costs and commodity and the pricing that kind of a mismatch can happen against sway, you know certain periods or certain years one way or another, is that playing a bigger role than some of the other assumptions or is it kind of all equal?

Stan Askren

Let me comment on general market, and what we are trying to do here and then, Kurt can fill in. So what we are -- our strategy, our objective here is to give shareholders the best view looking forward to what we know today, and it’s really the attempt to step up some transparency, and then we are going to adjust just as we go forward. So the core here is we are really assuming sort of all else being equal, things are continuing as they are today, which I would say would be steady but modest demand in both businesses and inflationary environment its under control.

There is no significant price changes incorporated in here and takes into effect our sort of continued, current investment profile we go forward. So anything around sort of an accelerating environment around inflation or, you know, a recovery in the economy or that be the plus and the minus side or in the event there are some extraordinary global, economic political events and there is a lot of that action and we would come back and say based on what we know today going forward, this is the new call. So this is the view as we look forward in 2012 of things kind of continue as they are today.

Mark Rupe - Longbow Research

Okay. Is it fair to say the wider range gives you a little bit of flexibility around some of those uncertain kind of, I guess, items or events.

Kurt Tjaden

That’s correct. That’s the objective, Mark.

Mark Rupe - Longbow Research

And then you comment, I know that you, you know the growth investment has been topic of several common cause over the last year and correct me if I am wrong, is it the 12 to 18 month pay back or is it 18-month pay back?

Stan Askren

Yeah, its 18 to 24-month pay back would be more consistent. The range, you know, all over the place depending on the investment, depending on the operating company, etcetera, more kind of at our current run rate as of right now.

Mark Rupe - Longbow Research

Right. But you decided as one of the, I guess, the positives heading into the next year. So you definitely expect start seeing some of that.

Stan Askren

Yeah, I think we’re seeing in some of that now.

Mark Rupe - Longbow Research

Okay. And then just lastly on the supplies channel it sounds like you are positively surprised there and I know last year’s fourth quarter that piece of the segment actually had a pretty good performance. I know there may have been a little bit pull forward going on but just your obviously positive growth commentary for that in the fourth quarter. Does that suggest that it maybe continuing to be that just picking a positively surprising to you given that maybe there is a little bit harder?

Stan Askren

Yeah, I think Mark, again as we look at this things, the quarters move around a bit as, you know, different project activity even in this segment, different movements by some of the large customers in that segment etcetera. But, overall, we feel it’s not a sensational sort of growth momentum but it’s a very solid, steady modest improvement there and we see that going forward into fourth quarter. We feel like there is some good, solid, steady momentum that we expect to continue into 4Q.

Mark Rupe - Longbow Research

Perfect. I guess there is one last, I am sorry. On the contract in international fees, international, I assume, has been outperforming kind of the domestic stuff. Is that, number one I guess, is that still accurate and number two, any updates on kind of the plans there and the investment there? On the international side?

Stan Askren

Yes, the answer to your question is, in fact, it is still relatively small for our total business but it is outperforming all of our businesses. As far as plans going forward, it’s really to continue to invest where we can drive really solid profitable growth there and so it’s a intense area of focus for the corporation of me and the rest of the team to make sure that we’re continuing to grow that business going forward, position ourselves for long-term shareholder value creation of that part of the world.

Operator

Your next question comes from Matt McCall, BB&T Capital Markets. Your line is open.

Matt McCall - BB&T Capital Markets

I guess I'm going to continue on a couple of previous questions. Stan, you’re talking about the assumption in next year kind of assuming things continue where they are today. Just trying to understand what that means, I mean the -- I think the economic outlook is more tepid than the actual data has been. So I'm trying to understand what is the specific macro backdrop? I will let you pick that your (inaudible) pick your metric and then what would be the assumption, say from a BIFMA perspective next year in your guidance?

Stan Askren

Well, first let’s talk about BIFMA. I think BIFMA is projecting 7.5% shipment or something like that. BIFMA is like any forecast. Global Insight doest the forecast for BIFMA and it’s based on lots of factors and what I'm always sure of. Whatever the forecast is, it’s going to be wrong. Starting wrong, I mean, the upside is starting wrong and the downside. So we used that as a general factor and also remind you BIFMA does not take into account, you know, roughly half of our business which is supplies-driven part of the business.

It’s a pretty good proxy for contract. Even there, there are some variants. So what we’re simply looking at is what’s happened in the small business demand. That’s a major driver of that supply side of the business, number one. Number two, what are we forecast international. I think, international, China is going to be still very strong, may be down a little bit over what it was, and contract is starting to run up to some more steep comparables. I think overall we’re seeing the market may be step down a bit even as it relates to BIFMA and so we’re kind of factoring all that together along with our investment along with our momentum and we’re coming up with our best guess as to what we think the top line growth will be next year.

Matt McCall - BB&T Capital Markets

And on the small business side, it’s interesting to -- can you talk about growth there just given the back drop with all the small business data? Can you kind of -- I assume it’s a share gain story at this point or are you seeing actual market growth there.

Stan Askren

Well, you know it is always hard to say, Matt, and I am reticent to jump on share gains in the short terms. Certainly one can conclude that we are making progress vis-à-vis the market -- in that segment of the market.

Matt McCall - BB&T Capital Markets

Okay and Kurt, I think you gave the answer earlier. Some of the inputs to your gross margin outlook, your profitability outlook for next year, you mentioned mix improvement, you mentioned price cost, and mentioned structural cost, I think you said from plant closures it’s about $11 million and if I understood correctly, just now it sounds like most of that is in the current run rate. If not, please correct me. And then the other part is the price cost. How should we look at that relative to work pressure you faced or will face in total for 2011?

Kurt Tjaden

Okay. So two comments on that, one on price cost. If you look at where it will end this year based on the outlook, if it carried through, we can see somewhere around the $10 million benefit carry through into 2012. So that would be the first one. On the structural cost, Matt, what I think you are referring to is our recent announcement which we really see that the benefit of that in 2012, not in the last quarter here of ‘11 and most of that gets in, I think, as we released that's around $10 million on an annualize basis as well.

Matt McCall - BB&T Capital Markets

Okay, and then just to make sure I understand how to look at that 30% leverage objective, is that inclusive of those structural cost reduction initiatives?

Kurt Tjaden

Yes, I would think about that being inclusive of that.

Matt McCall - BB&T Capital Markets

One final question and I will hop off. End market trends, I think, there is lot of concern about slow down in the government sector. Can you talk about government specifically, and then beyond government any other in market color that you can add specifically in contract?

Kurt Tjaden

Yes. So I will talk about government and certainly government has been a large part of our business, our growth story in recent years. Government is going to slow down. I think, modestly, we are, I would say, flat for the year. We still think, though, there is lots of room for continued growth in that as we look out. I would say we are forecasting 2012 to be modestly down both on state and local for all the reasons of the Federal stimulus money kind of rushing through and just states managing budgets and then we think Federal is going to be down, modestly to flat. That’s a big question yet I think as we sort of forecast 2012.

The government is focused on controlling spending, but likewise they are also working on a leaner government and when you think about their white-collar employment and that’s going to be drive, I think, furniture events that could continue to make that a very positive sort of part of our business as we look forward.

Contract, I feel Congress is still relatively good. There are still a lot of furniture events around real-estate strategies and consolidation and merger and acquisition. I think we are just simply seeing, as we look into 2012 versus 2011 working through a lot of that pent-up demand and we are running up against comparable.

So if you leave all that out as we say we think there is still good solid steady growth at lower levels than it has been here the last 24 months with still good solid growth. Barring sort of economic curve, global political disruptions.

Operator

Your next question comes from Peter Lisnic from Robert W Baird. Your line is open.

Peter Lisnic - Robert W Baird

Good morning, gentlemen. I guess, first question on 2012 courtesy, can you just give us a little help on what free cash flow conversion might look like on that, you know, buck 30 to buck 50 on EPS?

Kurt Tjaden

Yeah, I think, you know, similar to as we look out this year, it was $75 to $85 million kind of free cash flow number for next year.

Peter Lisnic - Robert W Baird

Okay, perfect. And then if I look at the growth that you are forecasting for office next year low to mid-single, is there a way of maybe calling out what piece of that would be international around to small pieces of the overall pie? I was just wondering how significant that is for the growth profile next year?

Kurt Tjaden

Yeah, I mean, again, your international was less than 10%. So it’s not meaningful, it will be a multiple of that. So, we don’t break it up specifically but you can count on it significantly more than the base.

Peter Lisnic - Robert W Baird

All right, fine. And then I was wondering as well, you know, the incremental margin office in the third quarter looked really healthy compared at least to where our [intellect] forecast was. Can you give us a sense, just ignoring the price cost and investments, but what is sort of happening trend wise to the level of price competition or discounting in the industry, maybe you can talk about it on a sequential basis versus the second quarter, just kind of what you’ve seen you know from a price competition standpoint?

Kurt Tjaden

Yeah, I think that the price competition reach equilibrium based on, you know, it all depends on the size of the project and it depends on sort of the level of how it’s competed, I guess, so these large Federal projects are very transparent and it shoot out the okay [carol] as you begin to move down, and there is somewhat better margins as the higher costs deserves sometimes there as well. But overall I think we are at equilibrium based on sort of project-by-project, size-by-size sort of opportunity.

Peter Lisnic - Robert W Baird

Okay. Perfect. And then last question, if I could, on the 2012 picture I would say the macro, and given what you have -- read in the press, maybe the macro is a bit worse than what you might be expecting, what sorts of levers, if any, do you think you have to pull or might you pull next year, if indeed, the forecast turns out to be too optimistic?

Stan Askren

We have this long history of running these multiple scenarios. Its also where our split and focus business model where we have these businesses that are tuned and tailored for each segment of the market and each demand segment run by the really sharp management teams, great groups of members that understand, you know, how to track and monitor the market and how to adjust costs. And so, it’s the same thing that we have done here historically as it’s adjusting, spending. It’s continuing to attack structural costs. It’s continuing to find ways for us to leverage sort of the HNI scale to drive structural costs and so it’s really more of the same that we demonstrated I think over here, the last several years demand is thus.

Peter Lisnic - Robert W Baird

Okay. Perfect. And then I actually -- forgot one, but on the -- I look at free cash flow picture for next year and I look at mere 9.0 sequential decline and that the cap, is there any change or do you want to discuss capital allocation priorities just to give us a sense of where that might head next year with cash flow you are generating?

Kurt Tjaden

I mean our capital allocation plans are basically unchanged over what we've been doing which is (a) we are looking at a strong dividend for shareholders; (b) We are always looking for acquisitions that we think we can understand and create value with; (c) We go from there, if we look at potentially special dividends, our share repurchase is always part of that process, and so it’s really kind of the same I think, priority same sort of process, that we've been following historically.

Operator

Your next question comes from Todd Schwartzman from Sidoti & Co. Your line is open.

Todd Schwartzman - Sidoti & Co.

Hi. Good morning, guys. First of all, in the third quarter, did your – you did your insight, did your visibility into the commercial contract business change at all, and if so, what was the trend there?

Stan Askren

I am not sure I understand the question? Todd. You wouldn’t mind, buy me again?

Todd Schwartzman - Sidoti & Co.

The confidence in future orders is on the commercial side of the contract channel, less confident and more confident about the same as the quarter progressed July to September?

Stan Askren

Well, I think Todd as -- if we sort of look at what to inspired during this whole [nonsense] at Washington around the debt feeling discussion etcetera, I think everybody in the economy sort of hit pause, and then I think we saw as time transpired in the third quarter we started to see business activity come back to what I think what is the normal or the standard equilibrium. And so, certainly it was a little bit moderated down a little bit, and then as I think come back onto as I described earlier in the call, I think a modest but steady sort of moment.

Todd Schwartzman - Sidoti & Co.

Okay. And on the fourth quarter outlook the guidance specifically the SG&A margin and the gross margin as well, is that approximating the year-ago levels, that’s sort of your mid point, if you will, or is that a worst case scenario?

Kurt Tjaden

Todd, I would say that’s kind of our best view of about where we look. So you got to take into account seasonality and where we play between the segments. But, you know, I think in other part if you look at gross margin, we’ve closed that price-cost gap. So that, now assuming that defensive commodities remain relatively stable where you would expect to see that continue from a run rate -- going into 2012. But you know there is nothing unique that would say that’s worth case for SG&A in the fourth quarter.

Todd Schwartzman - Sidoti & Co.

Okay. That helps. My math maybe off a little bit here, maybe you could help me with this based on your previous full-year 2011 earnings guidance, the implied Q4 guidance seem to be around to $0.45 to $0.46 range. Now it’s looking more like $0.36 to $0.41, so essentially down about $0.07 or $0.08. Is this correcting or so? What you are seeing, what you are seeing that’s altering your forecast from three months ago?

Kurt Tjaden

I think Todd, as Stan talked, is choppy quarter-to-quarter this year. So there is adjustments on volume. There is adjustment as we are looking at our mix of business and our margins, and as we dial in our SG&A estimates. So, if quarter-to-quarter there are going to be some of those swings, and you know, we’re updating to give you our best view and outlook for the balance of the year.

Todd Schwartzman - Sidoti & Co.

So the third quarter essentially was a little less choppy then may be you are anticipating?

Kurt Tjaden

No, I would say that choppiness actually, probably, continued given where we came out on the beat. So it’s -- quarter-to-quarter, it’s tough out there.

Todd Schwartzman - Sidoti & Co.

Okay, and on the channel investments, obviously if you had anything to announce that you know new and different we would have heard it today, but as we enter 2012 what are your thoughts on similar investments?

Stan Askren

Well, I think, that we’re continuing our same process, which is I’ve described in the past. Each operating company that plays in their particular segment serves there area of customer base, is challenged to find ways to continue to invest money to growth the business. And so it’s a lot of little things across the Board depending on the op company, depending on the market etcetera and we don’t foresee anything major here. It’s more a continuation of the same sort of process.

Todd Schwartzman - Sidoti & Co.

So nothing really new baked into the dollar, $30, $50?

Stan Askren

No.

Operator

There are no further at this time. I turn the call back to the presenters.

Stanley Askren

Okay, thank you very much for your interest and your time this morning and your time and investment in HNI. And we look forward to talking with you in the future and update you on our progress. Have a great day. Bye, bye.

Operator

This concludes today’s conference. You may now disconnect.

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