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Stamps.com (NASDAQ:STMP)

Q3 2011 Earnings Call

October 27, 2011 05:00 pm ET

Executives

Ken McBride – President and Chief Executive Officer

Kyle Huebner – Chief Financial Officer

Jeff Carvari – Senior Director of Finance and Investor Relations

Analysts

[Sarkeesh Kervechian] – B. Riley & Co.

George Sutton – Craig-Hallum Capital Group

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Operator

Good day, ladies and gentlemen, and welcome to the Stamps.com Q3 2011 Financial Results Conference Call. (Operator instructions.) As a reminder this conference is being recorded. I would like to introduce your host for today’s conference, Mr. Jeff Carvari, Senior Director of Finance and Investor Relations. Sir, you may begin.

Jeff Carvari

Thanks very much and good afternoon, everyone. On the call today is Ken McBride, CEO; and Kyle Huebner, CFO. The agenda for today’s call is as follows: we’ll review the results for our Q3 2011, then we’ll discuss finance results and talk about our business outlook, but first the Safe Harbor statements.

The Safe Harbor statement under the Private Securities Litigation Reform Act of 1995: this release contains forward-looking statements such as our expectations and financial guidance and involve risks and uncertainties. Important factors including the company’s ability to complete and ship its products, maintain desirable economics for its products, obtain or maintain (inaudible) may cause actual results to differ materially from those in the forward-looking statements. Our detailed filings with the Securities and Exchange Commission made from time to time are available at www.stamps.com including its annual report on Form 10(k) for the fiscal year ended December 31st, 2010; quarterly reports on Form 10(q) and current reports on Form 8(k). Stamps.com undertakes no obligation to release publically any revisions to any forward-looking statements to reflect events or circumstances after the date hereof or to reflect the occurrence of unanticipated events.

With that let me hand the call over to Ken McBride, our CEO.

Ken McBride

Thank you, Jeff, and thank you for joining us today. Today we announced another great quarter where we saw a record performance in many areas of the business. We achieved a new record high growth rate in the core PC postage revenue at 25% year-over-year growth. We achieved a new record high for paid customers at 374,000. We achieved a new record for RPU at $20.25. We achieved a new record for Q3 total new customer acquisition which was up 29% year-over-year.

We achieved a new record for customer acquisition in our enterprise business with total new enterprise locations added up 199% year-over-year. We achieved a new record for total postage printed by our customer base which was up 52% year-over-year. We achieved a new record for total postage printed in our high-volume shipping area and that was up 101% year-over-year, and the strength across our business lines drove strong earnings growth with a 52% growth rate in our non-GAAP earnings per share.

All of our record highs in our business were particularly significant in light of the fact that Q3 is usually our seasonally slowest quarter each year, and also in light of the continued weak small business economic backdrop that we’re seeing. On the call today we’ll talk in more detail about our key postage metrics and business, our financial results and our business outlook.

Now we’ll begin with a more detailed discussion of the PC postage business. Customer metrics we’re going to discuss on the call are only for the core PC postage business which excludes all enhanced promotion channel activity. For a more detailed definition on how we calculate each of our metrics you may refer to our quarterly investor metrics spreadsheet at www.investor.stamps.com.

Core PC postage revenue was $22.7 million in Q3 which was up 25% versus Q3 2010. Over the past five quarters our core PC postage revenue year-over-year growth rates have accelerated from 8% to 11% to 14% to 23% and now to 25%. This is the highest growth rate we have ever experienced in our core PC postage business since we began tracking this core area separately five years ago. The increase in our core PC postage revenue was attributable to continued strength in our small business area and also helped by our enterprise and high-volume shipping customer segments which are now contributing to our core business revenue growth in a more material way.

We acquired 64,000 gross small business customers in Q3 which was up 29% versus Q3 2010; and our cost per new small business customer acquired, or CPA, was $119 in Q3, and that was down 4% versus Q3 2010. This was our highest quarterly customer acquisition for any Q3 in the history of the company. We were able to increase our customer acquisition spend versus Q3 last year and still achieve the lower CPA, which is a great result and showed that our marketing spend is scaling efficiently. We’ve seen strong results in our core marketing initiatives and continue to ramp our investment in some newer programs which have been doing very well.

Our monthly churn during Q3 was 3.3% and that was down versus 3.6% in Q3 2010. We saw a nice decrease in year-over-year churn again this quarter, and this is our eight straight quarter of year-over-year decreases in our churn metric. Overall we believe churn rates are down due to lower turn rates in our enterprise and high-volume shipping customer segments, new product features which are driving increased usage of our service, and continued success in our ongoing customer retention efforts.

Paid customers in Q3 was 374,000 which is up 12% versus Q3 2010 and up 6000 sequentially versus Q2 2011. The growth in paid customers was the result of strong new customer acquisition and lower churn rates. We typically experience a sequential decline in paid customers during the seasonally slower Q3 so we were encouraged to see sequential growth this quarter.

RPU was $20.25 in Q3, up 12% versus $18.13 in Q3 2010. This is our highest RPU since we began reporting this metric. The increase in RPU was attributable to higher monthly fees from our high-volume shipping and enterprise customer segments, an increase in the average store revenue per paid customer driven by the increased usage of our service, and an increase in insurance purchases driven by our focus on shipping and by new insurance features that we’ve added.

Total postage used by all customers during the quarter was 165 million. That was up 52% versus Q3 2010. This is the second quarter in a row where growth in our total postage usage has exceeded 50%; also the second quarter in a row where growth in our total postage usage in the high-volume shipping segment has been over 100%. For our customers outside of the high-volume shipping segment we also saw a strong 36% year-over-year growth rate in Q3 postage usage. We watch the total postage usage as an indicator of the value customers derive from our service and its growth has been correlated with strength in our other business metrics.

We continue to believe that the economic environment with respect to small business remains challenging relative to pre-recession levels, and the National Federation of Independent Business’ survey of small business showed another decrease in small business optimism during Q3. With the backdrop of the challenging environment we are even more pleased that we have been able to deliver record results across all of our businesses during Q3. We believe that improvements in the small business economic environment from current levels could provide a further lift to our small business efforts.

Now, let’s discuss some detailed initiatives that we’re working on in our PC postage business. Again, the discussion is about the core PC postage business excluding the enhanced promotion channel. In the small business area we’re continuing to scale up our customer acquisition spend. We continue to experience a great return on investment on our marketing spend with an estimated lifetime value that exceeds our current CPA by at least two times.

During Q3 we were able to increase our small business customer acquisition spend investment by 25% versus last year while realizing a decrease in the cost per acquisition CPA by 4%. Based on the improving trends we see in our metrics, we expect that our total 2011 small business customer acquisition spend will increase by 15% to 20% year- over-year. We will continue to utilize our various marketing areas including direct mail, traditional media, online marketing and other areas.

Also in the SOHO area we’re continuing to optimize our business model and our overall customer experience in several ways. We’re continuing to optimize our website, our registration process and our post-registration customer interactions. We’re also continuing to launch new features in our client product that make mailing and shipping easier for our customers. Recently we released version 9.0 of our client software which added several great new features, such as enhancements to our batch interface with new packing slips which can be printed separately from the shipping labels, support for new high-speed printers, better support for new large-batch jobs and other enhancements.

We also added support for customers who sell on [Edsy.com] so that those customers can directly import orders from the [Edsy] marketplace and post back delivery confirmation information easily. [Edsy] is one of the most popular new marketplaces and we are the first PC postage solution to support it. Version 9.0 also added support for new USPS flat-rate legal envelopes and we improved our insurance capabilities as well.

In the enterprise area we’re continuing to scale up our sales and marketing efforts. Customers continue to choose our service as a great alternative to a postage meter based on the dramatically lower cost of our service. Customers also like the visibility available from our centralized reporting tool where they can monitor postage spend across their entire network of users, a feature that is not available with postage meters.

During Q3 we continued to make progress in the enterprise area as we continued to build our customer base. We grew enterprise revenue by 38% year-over-year and in Q3 we also acquired a record number of new enterprise locations, which is up 199% versus the same quarter last year. Churn rates in enterprise continue to be dramatically lower than in our SOHO business. We also get higher monthly service fees from enterprise users driving a higher RPU than we see in our SOHO area. Overall we’re very excited about the continued progress we’re making in enterprise and feel that we are seeing returns on the investment we have been making in this area. We’re expecting to see continued strong growth out of this business line going forward.

In the high-volume shipper area we’re continuing to scale up our efforts in this area. We’re attracting high-volume shippers such as warehouses, fulfillment houses, ecommerce shippers, large retailers and other types of high-volume shippers to our service through our efforts in this area. We’ve always had these types of customers using our platform but we began a more aggressive push into this area starting in 2008. We’ve continued investing in enhancements to the software and new features for the largest high-volume customers such as the aforementioned enhancements to our batch capabilities which we launched in version 9.0; we’re adding new ecommerce integrations for easier data export and import from the tools and platforms the customers like to use; and delivering new software integrations in sophisticated high-volume shipping solutions such as multi-carrier shipping software.

We have also been continuing to ramp and drive our sales efforts using our national sales force. Our business in this area is doing very well as evidenced by the 101% year-over-year growth rate in total postage printed we saw during Q3. Overall, we’re very excited about the progress we’re making in the high-volume shipping area and we think it will be a strong contributor to our overall business. We’re excited and pleased about the progress we’ve made driving our business across all of our three focus areas this year.

Let me now just mention our new corporate headquarters. This week we announced that on October 19th, 2011, we signed an agreement to purchase an 82,000 square foot property to serve as our future corporate headquarters. We paid an aggregate purchase price of $13.35 million and we expect to have to complete some renovations on the building before being able to occupy it. We plan to occupy a portion of the space beginning in mid-2012 when our existing lease for our current corporate headquarters expires, and the remaining portion of the new building will continue to be leased to the existing building tenants. The building purchase and renovations will be funded out of our existing cash and investments. We decided to take this step as owning our corporate headquarters will be a much lower-cost option than continuing to rent.

With that, now let me turn it over to Kyle who will discuss more detailed financial results and our business outlook.

Kyle Huebner

Thanks, Ken. We will now review our Q3 financial results. We will discuss our Q3 financials on a non-GAAP basis which excludes $1 million of stock-based compensation expense. A reconciliation of non-GAAP to GAAP is contained in the earnings release posted on our website.

Total revenue in Q3 was $24.9 million, up 20% compared with Q3 2010. Q3 marked a continuing trend of accelerating growth in total revenue driven by strong results in our core PC postage business. Year-over-year growth and quarterly revenue has accelerated from 2% to 5% to 9% to 15% to 20% over the past five quarters. This is excluding the one-time impact of Photo Stamps’ breakage revenue last quarter.

Core PC postage revenue was $22.7 million in Q3, up 25% compared with Q3 2010. The year-over-year increase in core PC postage revenue was driven by both increase in paid customers and increased RPU as discussed by Ken in the metrics section. In addition to the previously mentioned quarterly acceleration and revenue growth, we’ve also seen a multi-year acceleration in our annual core PC postage growth rates from 5% in 2009 to 10% in 2010, to 20% growth for year-to-date 2011.

Non-core PC postage revenue from the enhanced promotion channel was $787,000 in Q3, down 26% compared with Q3 2010. While we continue to experience year-over-year declines in enhanced promotion revenue we did see Q3 effectively sequentially flat with Q1 and Q2. While it’s too early to conclude that enhanced promotion revenue has stabilized at this level on a long-term basis, we were pleased to see that the year-to-date quarterly revenue has been leveling out.

Photo Stamps’ revenue was $1.4 million in Q3, down 2% compared with Q3 2010. The decline in Photo Stamps’ revenue was primarily attributable to lower marketing spend as we continued to reduce our investment in the Photo Stamps business.

PC postage gross margin was 78.1% in Q3 compared with 77.7% in Q3 2010. Cost of sales includes promotional expenses related to new customer acquisition of $897,000 in Q3 compared with $573,000 in Q3 2010. The increased promotional expense was driven by increased levels of customer acquisition. PC postage gross margins excluding promotional expenses was 81.9% in Q3 compared with 80.7% in Q3 2010. The improvement in gross margins excluding promotional expenses was due to strong revenue growth in the core PC postage business. Photo Stamps’ gross margins were 23.1% in Q3 which was up compared to 21.1% in Q3 2010.

Total sales and marketing spend was $8.1 million in Q3 which was up 20% compared with Q3 2010. PC postage sales and marketing spend increased by 21% compared with Q3 2010 as a result of increased marketing spend in the small business enterprise and shipping segments. Photo Stamps’ sales and marketing spend decreased by 49% compared with Q3 2010.

R&D spend was $2.2 million in Q3 which was up 7% compared with Q3 2010. The increase was primarily related to increased headcount-related expenses to support our expanded product offerings. G&A spend was $3 million in Q3 which was down 5% compared with Q3 2010. The decrease in G&A was primarily attributable to a decrease in legal spend compared to Q3 2010.

Non-GAAP operating income was $5.4 million in Q3 which was up 62% compared with Q3 2010. Non-GAAP operating margin increased from 16.3% in Q3 2010 to 21.8% in Q3 2011. The growth in operating income was primarily attributable to strong revenue growth in our core PC postage revenue. We are also realizing leverage in our operating expense line items which are increasing at rates less than our revenue growth rates.

Non-GAAP net income was $5.5 million or $0.37 per share based on 15.1 million fully diluted shares, compared with $3.5 million or $0.24 per share based on 14.5 million fully diluted shares in Q3 2010 which represented 58% and 52% year-over-year growth in both metrics respectively. The increase in fully diluted shares from 14.5 million in Q2 2011 to 15.1 million in Q3 2011 was partially attributable to higher common stock equivalents as a result of our higher average stock price during the quarter.

Free cash flow, defined as non-GAAP net income plus D&A less CAPEX was positive $5.3 million in Q3. For Q3 D&A was approximately $220,000 and CAPEX was approximately $480,000. Annualized non-GAAP return on equity, calculated as Q3 non-GAAP net income times four quarters divided by the average of Q2 and Q3 ending shareholder equity was 39% for Q3.

During Q3 we repurchased approximately 18,000 shares at a total cost of $300,000 and for the first three quarters of 2011 combined we repurchased approximately 426,000 shares at a total cost of $5.3 million. The company’s current repurchase plan remains in effect through February, 2012, with a remaining authorization of approximately 1 million shares. We've returned more than $257 million in excess cash to our shareholders since 2002 through approximately $107 million in special dividends and $151 million in share repurchases.

NOL shareholder update: As of September 30th, 2011, we had approximately $215 million in federal NOLs and $150 million in state NOLs resulting in a deferred tax asset of approximately $90 million. Our federal NOLs do not begin to expire until 2021, so at our current annual profit levels we would not expect to pay regular cash for federal taxes for the next ten years. We estimate that as of September 30th, 2011, our Section 382 ownership shift was at an approximately 16% level compared with the 50% level that would trigger an impairment of our NOL asset. As part of our ongoing programs that preserve future use of our NOL asset, we request that any shareholder contemplating becoming a 5% shareholder – the equivalent to approximately 700,000 shares or more – contact the company before doing so.

Now, turning to guidance. We expect 2011 revenue to be in a range between $92.5 million to $102.5 million. This compares to previous expectations for 2011 revenue of $90 million to $100 million given in July, and our original expectation of $82.5 million to $92.5 million given in February. We expect 2011 GAAP EPS to be in a range between $1.30 to $1.50 per fully diluted share. GAAP numbers assume an estimated $3.5 million of stock-based compensation expense and an estimated $5 million of non-cash tax benefit.

Excluding the stock-based compensation expense and non-cash tax benefit, we expect 2011 non-GAAP EPS to be in a range between $1.20 to $1.40 per fully diluted share. This compares to our previous expectation for 2011 non-GAAP EPS of $1.10 to $1.30 per share given in July, and our original expectation of $0.85 to $1.05 per share given in February. We expect core PC postage revenue to be up in the approximately 20% range for the full-year 2011. We expect small business PC postage customer acquisition spend to be up 15% to 20% for the full-year 2011. We expect non-core PC postage revenue and marketing spend for the enhanced promotion channel to be down in 2011 compared to 2010, consistent with recent quarterly trends. We expect Photo Stamps’ revenue to be up in the 10% to 20% range for the full year of 2011.

We expect to continue to incur legal expenses related to our patent infringement lawsuits for the remainder of 2011. We note that there’s still a high degree of uncertainty regarding the timing of the Indicia-related litigation expenses as these expenses are typically driven by court-ordered schedules which can change and be hard to predict.

While we don’t provide quarterly financial guidance we did want to note two factors relative to Q4. First, we would expect our fully diluted shares outstanding to increase in Q4 compared to Q3 based on a higher current share price. For example, at the current share price our Q4 fully diluted shares would be approximately 16.3 million. Second, we expect to increase our customer acquisition spend in Q4 compared to Q3 levels, consistent with the seasonally stronger Q4. This has a negative impact on Q4 EPS but results in higher expected revenue in 2012. We expect that in the long term we can continue to grow our core PC postage business at growth rates similar to what we have seen in 2011, and we also expect to see profit margins continue to expand from current levels over the long term.

In summary, our core PC postage business model with recurring revenue and high gross margins is demonstrating accelerating growth and we are starting to realize the benefits of our investments in the enterprise and high-volume shipping segments. We are seeing record-setting performance across many of our financial and key customer metrics. We have a strong balance sheet, attractive return on equity, strong free cash flow generation and a large deferred tax asset of approximately $90 million. We have demonstrated our commitment to enhancing shareholder value including returning over $257 million of excess cash to shareholders via special dividends and our share repurchase program. With that we will open it up for questions.

Question-and-Answer Session

Operator

Thank you. (Operator Instructions.) And our first question comes from [Sarkeesh Kervechian] with B. Riley & Company.

[Sarkeesh Kervechian] – B. Riley & Co.

Hi guys. My first question is centered around the corporate headquarter purchase. Can you talk about the reasons behind the purchase of the new headquarters and why you felt that was the best use for the cash?

Ken McBride

Yeah. I guess in the end we did the analysis – financially it makes a ton of sense in terms of the current position of the company, the stability. We need a corporate space to operate the business; we’re nearing the end of our lease in our existing building which we’ve had as our corporate headquarters for seven years. We took a look at the two alternatives – continuing to rent or purchasing, and it made a ton of financial sense for us to pursue the alternative of purchasing ability.

Kyle Huebner

The other thing I would add is over the long-term, one of the bigger challenges in managing corporate space is expanding to meet your growth and headcount, whereas leases tend to be relatively fixed and long in duration. And the specific property that we’re purchasing has space for us to occupy as well as space for us to expand in the future but there are current tenants in there. So we get the benefit of getting rental income in the current environment but then it also provides a much more flexible expansion path as those tenants roll off, leases roll off in the future. So in addition to the financial benefits it just gives you a much more flexible option to manage future growth than the corporate space needs.

[Sarkeesh Kervechian] – B. Riley & Co.

Okay, understood. And are you willing to share some of the financial benefits currently?

Kyle Huebner

We are just in escrow now. The deal is scheduled to close in January of 2012 so I think on the next call in February we’ll have more of the specifics. At a high level, for the first six months of next year we’re going to be incurring some duplicative costs given that we’ll still be in our current space and we’ll have closed on the other space. Once we’re fully moved into the new building in the second half of the year then we would expect to start realizing cost savings but we’ll have more specifics on the February call.

[Sarkeesh Kervechian] – B. Riley & Co.

Thank you, I appreciate that. And with respect to the partnership with Amazon and USPS Click-and-Ship, can you provide any quantitative or qualitative data on how that’s going so far?

Ken McBride

I think both partnerships are continuing to be very positive. Unfortunately we can’t disclose any information for the contracts and the agreements we have in those partnerships, but I think in both cases we’re happy with how the partnerships have gone. The volumes have been strong, the business is good and everything has gone very well.

[Sarkeesh Kervechian] – B. Riley & Co.

Okay, I appreciate that. Do you anticipate a boost from these partnerships in your operating metrics due to the upcoming holiday season?

Ken McBride

I think both of them are generally focused around shipping, and as you know shipping is really seasonally strong in Q4. So we do expect to see not just in those partnerships but king of generally speaking in our business as well as in the high-volume shipping area strength in Q4 driven by the seasonality of the general nature of shipping.

[Sarkeesh Kervechian] – B. Riley & Co.

Okay, I appreciate that. Moving on to enterprise customers, can you provide us with an update on the number of prospective customers you’re targeting for the enterprise level?

Ken McBride

Yeah, we don’t typically break down the metrics to that level but I can say in general you saw the growth rate in enterprise is up 199% year-over-year – that’s related to all the sales efforts and the marketing efforts we’ve put into the business. And generally speaking we’re very enthusiastic about the opportunities for enterprise going forward. We’ve seen two really strong quarters of new acquisition; we’re continuing to see really strong growth in the overall business and the enterprise business is just very positive.

[Sarkeesh Kervechian] – B. Riley & Co.

Okay, I appreciate that. My final question is related to the high-volume shipping market. Since you’re now aggressively going after that market has Indicia become more aggressive in going after your SOHO base?

Ken McBride

I wouldn’t say that we’ve seen any dramatic change in behavior as a direct result of our foray into shipping. I think we continue to see largely the same product offerings, the same pricing, the same marketing from all the competitors that we’ve seen for the last several years. We really haven’t experienced any big change in the competitive environment, certainly for this year and even for the last several years.

[Sarkeesh Kervechian] – B. Riley & Co.

Okay, thank you.

Operator

Thank you. (Operator Instructions.) And our next question comes from George Sutton of Craig-Hallum.

George Sutton – Craig-Hallum Capital Group

Hi guys, good numbers. So as we look at some of the success you’re seeing and in particular the better customer acquisition cost, I wondered if you could just give us an update in terms of what is working from a marketing perspective outside of just the high-volume channel? You’re still seeing success in other areas, and I think last quarter you referenced some success in the TV and radio in particular but if you could just update us there that’d be helpful.

Ken McBride

I think we’re continuing to see success across all of our traditional areas in our SOHO marketing, and also in some of the new areas; and I think that the direct result of that is the ability to decrease the CPA by 4% while growing the year-over-year spend by 25%. So those two things we look at together as an indication of the scalability and the ability to continue to scale the marketing, so we’re encouraged by our ability to do that especially given that based on all indications the small business environment continues to be as bleak as ever and has if anything decayed. And while it’s decayed we’ve managed to continue to improve our overall marketing efficiency. So strength I think is coming from old as well as some of the newer programs, and I think it’s just also reflective of some of our general effort in improving the product and improving the perception of the product in the world that improves the overall acquisition as well.

George Sutton – Craig-Hallum Capital Group

Ken, you mentioned in your script that the centralized reporting tool was something unique to you when you’re going up against the meters. I haven’t heard you refer to that specifically in the past. Can you give us a sense of when that piece was specifically added and when that part specifically was part of the marketing program?

Ken McBride

Sure. With the postage meter, largely it’s a standalone device that sits off on its own, and the postage gets purchased and run through the meter and not a lot of data is available from any kind of centralized point; whereas with our service it’s all run from a server and all of the data is available real time to the customers. So a corporate controller or a CFO can log into a web-based tool and monitor postage spend across their entire network real time with our solution, so they’re watching 100 offices all across the US; they’re watching print rates and print tendencies. They can drill all the way down to the users so this is something that I think as cost-conscious companies focus on ways to cut costs, looking at monitoring postage spend is a big value proposition that we bring that postage meters just simply don’t have.

We’ve had that for several years so it’s not necessarily a dramatically new thing but we’ve continued to enhance the capabilities over time and the service has gotten better and better so that the centralized reporting tool just has more features, capabilities and is just easier to use. So it’s been a nice selling tool.

George Sutton – Craig-Hallum Capital Group

During the quarter we heard a lot of discussion around the Postal Service and potential changes there. I’m curious if you feel you’re seeing some reaction from customers as a result of that.

Ken McBride

We haven’t seen anything on the customer front certainly related to anything with the Postal Service. Obviously there’s a lot of stuff about the Postal Service in the news and there tends to be kind of about once a year, around this time when their big $5 billion payment is due and a lot of discussion happens it seems like on an annual basis now, but I don’t think we’ve really seen any blowback, if you will, from the customer base or customer reactions to that. So it just seems like it’s more business as usual in the trenches.

George Sutton – Craig-Hallum Capital Group

Perfect, thanks guys.

Operator

Thank you. (Operator Instructions.) And at this time I’m showing no further questions. I’d like to turn the call back over to Mr. Ken McBride for any closing remarks.

Ken McBride

Thanks for joining us today and as always if you have any follow-up questions you can contact us at our investor relations number, which is 310-482-5830 or you can get a hold of us through our website at www.investor.stamps.com.

Operator

Ladies and gentlemen, thank you for your participation in today’s conference. This concludes the program. You may now disconnect. Have a great day.

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