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Executives

Robin S. Yim - Former Vice President of Investor Relations

Richard Hill - Chairman and Chief Executive Officer

Analysts

Stephen Chin - UBS Investment Bank, Research Division

Mehdi Hosseini - Susquehanna Financial Group, LLLP, Research Division

Timothy M. Arcuri - Citigroup Inc, Research Division

Paul Thomas - BofA Merrill Lynch

James Covello - Goldman Sachs Group Inc., Research Division

Christopher J. Muse - Barclays Capital, Research Division

Satya Kumar - Crédit Suisse AG, Research Division

Christopher Blansett - JP Morgan Chase & Co, Research Division

Mahesh Sanganeria - RBC Capital Markets, LLC, Research Division

Edwin Mok - Needham & Company, LLC, Research Division

Patrick J. Ho - Stifel, Nicolaus & Co., Inc., Research Division

Vishal Shah - Deutsche Bank AG, Research Division

Novellus Systems, Inc. (NVLS) Q4 2011 Mid-Quarter Update Conference Call December 5, 2011 4:30 PM ET

Operator

Welcome to the Novellus Fourth Quarter 2011 Mid-Quarter Update Conference Call. As a reminder, this call is being recorded today, Monday, December 5, 2011. I would now like to turn the conference over to Ms. Robin Yim of Novellus Systems. Please go ahead, ma'am.

Robin S. Yim

Thank you, Melanie. Good afternoon, everyone, and thank you for joining the Novellus Systems Fourth Quarter 2011's Mid-Quarter Update Conference Call. With me on the call are Rick Hill, Chairman and Chief Executive Officer; and John Hertz, Chief Financial Officer.

Today's mid-quarter update call contains forward-looking statements about Novellus' business outlook. These forward-looking statements and all other statements made on this call that are not based on historical factors are subject to risks and uncertainties that may materially affect actual results.

Specific forward-looking statements include, but are not limited to, our expectations regarding future demand, industry drivers, semiconductor and electronics capital expenditures and unit growth in PCs, tablets, ultrabooks and smartphones, seasonal utilization levels and our guidance, including projected bookings, shipments, revenue and gross margin, tax rate and earnings per share for the fourth quarter of 2011.

We caution you that forward-looking statements are projections and expectations regarding future events. They involve risks and uncertainties that could cause actual results to differ materially from the results contemplated. Information concerning these risks is contained in our filings with the Securities and Exchange Commission, including our Form 10-K for fiscal 2010, Form 10-Q for the fiscal quarters ended March 26, June 25 and September 24, 2011, and our current reports on Form 8-K. Forward-looking statements are based on information as of December 5, 2011, and we assume no obligation to update any of these statements.

Rick Hill will begin today's call with comments on the business environment, followed by an update of our fourth quarter 2011 financial outlook and guidance, and then he'll open the call for the question-and-answer session.

And now I'll turn the call over to Rick.

Richard Hill

Okay. Thank you, Robin. Let me first apologize for my voice. I just returned from Asia and I think I have a small bit of a bird flu. So if you can't hear me, I do apologize.

I'll start with a review of the current market conditions and then I'll provide an update to our guidance for the fourth quarter. So with that, the overall macroeconomic factors are still volatile, but the recent market performance is helping to build confidence in the U.S. economy, which is a precursor to growth.

Correspondingly, the semiconductor equipment business environment has shown some relative improvement since our last call. There is no surprise that DRAM is still weak and demand for personal computers remain soft in both the U.S. and Europe. However, demand for mobile devices, smartphones, tablets and ultrabooks are stimulating demand in the semiconductor industry, which is a benefit to our foundry and our NAND consumers.

The early report for Black Friday show that the consumer is in the market for electronics, which is another positive sign for the semiconductor industry. As an example, Black Friday sales were up 6% to 9% over 2010, with approximately 40% of the purchases were electronics.

As we mentioned in our last call, the industry is still seeing slightly below seasonal utilization levels in Q4, but they are improving. And despite the relative seasonal weakness, our customers have resumed their investments in the next technology node. And this supports our view that the long-term fundamental drivers remain unchanged for the expansion of network services, the cloud and new applications for NAND Flash, memory and PCs, all of which we expect will continue to evolve and drive the industry.

So with that, I'll provide guidance for the fourth quarter. Due to our relatively higher level of confidence by customers, since our third quarter earnings call, we are tightening our bookings range to up 20% to 30% versus our quarter end forecast of up 10% to 30%. So we do look to finish on the high end in the bookings area.

We are reiterating the same guidance for shipments and revenues, with shipments ranging from $270 million to $300 million and revenues ranging from $260 million to $290 million. Our gross margin guidance also remains unchanged at 46% plus or minus 1%, as a result of decreased factory loading and product mix.

Our EPS guidance also remains the same at $0.42 to $0.46 on a GAAP basis. As I mentioned in our Q3 earnings call, we have a one-time benefit from the sale of real estate, which translates to approximately $0.07 in GAAP EPS -- $0.42 to $0.62, I am sorry. What did I say? $0.42 to $0.62 on a GAAP basis.

And lastly, our Q4 tax rate guidance remains at 14% plus or minus a couple of points. That concludes my prepared remarks and our guidance for the fourth quarter. Now I'll open it up to any questions you might have.

Question-and-Answer Session

Operator

[Operator Instructions] We'll take our first question from Krish Sankar with Bank of America Merrill Lynch.

Paul Thomas - BofA Merrill Lynch

This is Paul Thomas for Krish Sankar. I just wanted to ask on the updated guidance range. You mentioned strength in DRAM or NAND and foundry. Can you talk about whether the strength was more in one versus the other? And did you see any further pushouts from the DRAM side?

Richard Hill

I think the strength generally is more towards the NAND side of the business, but foundry has come back. As you know, we saw foundry sort of dry up very, very quickly, but there's definitely a resurgence in foundry that's pushing us to the high end of that guidance. Thanks, Paul.

Operator

We'll go next to Mahesh Sanganeria with RBC Capital Markets.

Mahesh Sanganeria - RBC Capital Markets, LLC, Research Division

Rick, I know you won't provide the guidance for the March quarter. But qualitatively, can you give us some idea as to as you look out early part of next year, where do you see the strength in which segment in terms of NAND or foundries, the same will continue or if you can give some color on the regions where you're seeing the strength?

Richard Hill

Okay. Mahesh, forecasting the future is probably one of the most difficult things to do. And so I am always trying to look at what our customers' customers are doing in the overall macroeconomic picture. And while every day, we get up and there seems to be surprises in the macroeconomic picture, from my own perspective, the rhetoric that's coming out of various sovereign nations are really starting now to bear down to try to tackle the problems. And I think that's reflected in the strength we are seeing in our own markets, our financial market. And I think because of that, it has a positive feedback loop on the consumer. And so using those variables, it makes me believe that we're on an upward trend. But as you know, I absolutely can't predict the future. But those are the data points I use. So as I'm making planning, my tendency is pretty positive going forward.

Mahesh Sanganeria - RBC Capital Markets, LLC, Research Division

That's very helpful. I'll ask another question on a similar line and I know it's early, but some of your peers have given their outlook for the capital spending for the next year that range from down 10% to down 10% to 20%. Do you have any preliminary view on the next year's capital spending?

Richard Hill

I don't have a specific view on the CapEx for next year. We'll have that by the end of the fourth quarter when we go to our fourth quarter announcement. But my feeling is this, governments all over the world want to stimulate spending. So part of success factor here in pulling out of these problems is not only cutting expenses for basically social services, social support. They have to put people to work, and that means investment in industry. So from that standpoint, I tend to think that we're going to see somewhat strength than I am optimistic that things can be flat next year. Now that's a tall order, but around Christmas time, I prefer to be optimistic.

Operator

We'll go next to Timothy Arcuri with Citi.

Timothy M. Arcuri - Citigroup Inc, Research Division

A couple of things. First of all, I asked you about this last call and then Jim Cramer asked you about it on his show afterwards. But on the buyback, you just put in the $500 million authorization and you've been pretty committed to consistently buying back the stocks. So can you update us maybe how much stocks you bought back this quarter or some sort of milepost there, and then I have a follow up.

Richard Hill

Okay. All right. Tim, I always give you the data at the end of the quarter and I can't change my policy. So I appreciate you asking, but I don't comment on that. What's your next question?

Timothy M. Arcuri - Citigroup Inc, Research Division

All right. So 2 of your peers have in their numbers, they are showing some pretty significant margin pressure relative to maybe 2 or so years ago. One is saying that its 450 related. The other is sort of saying that it's related to a settlement with a big consumer. But it just sort of seems like maybe there's a little bit more margin pressure out there because there is some consolidation in the customer base. And I'm wondering, what your view is on sort of the concentration of the customer base is in 2012 or moving forward. Is it getting more concentrated in fact, as maybe one big Korean company spends lots of money?

Richard Hill

Well, clearly, Tim, the industry has gotten more concentrated. But the force fields within the industry haven't changed. We are an industry that's highly competitive and things ebb and flow. We believe that our portfolio of technology has such differentiation in the technology, we can maintain margins. Now we fight to maintain those margins by driving down our cost and increasing the value we're selling to the customer. And so I'd have to agree with everybody that there is great pressure in the market, but that doesn't mean we can't be successful. And I think we've demonstrated that over the years and that's what we plan to do. It's a tough market, make no mistake. I keep on thinking, I am expecting Mike Spooner [ph] to call me someday and say, why don't we just sort of take off and give everybody a week off. But normally, he never says that. I've never gotten that call. So I appreciate it, Tim.

Operator

We will go next to Chris Blansett with JP Morgan.

Christopher Blansett - JP Morgan Chase & Co, Research Division

In the last earnings call, you indicated, you talked there couldn't be a bit of a rush of equipment to ship out of the door. And some of our checks have indicated it, but you are keeping your revenue levels constant. So was that just baked in or did the rush not materialize as you traditionally expected?

Richard Hill

Well, there is a rush, but in our planning of our P&L, we also planned in some shutdown periods at times and things and so we're holding tight. We're not trying to necessarily ship everything out the door in this quarter, but you never know what's going to go out the door at the end.

Christopher Blansett - JP Morgan Chase & Co, Research Division

And then lastly for me, I mean do you think, was there a certain region, I mean, of the world that was driving this kind of end-of-year push? I mean, maybe you can give us a help to triangulate on that?

Richard Hill

Well, I don't think it's regionally based, but certainly there are tax incentives in the United States that play a factor, okay, this year. But everybody seems to have sort of an annual budget, and as they got the budget left, there's still plenty of people that feel like they need to spend it and they do.

Operator

We'll go next to Jim Covello with Goldman Sachs.

James Covello - Goldman Sachs Group Inc., Research Division

The question really is kind of center around the foundries, and obviously we're seeing some good technology-based buying right now from everybody making technology transitions, and that's pretty consistent with most cyclical periods where you see the foundries and other guys continuing to make the technology transitions. But you've always been pretty consistent telling us over the years that customers have to be doing well in order to have capacity expansion. And a couple of the foundries in particular are really struggling, one cyclically, one secularly. How do you think that -- how do you think about the sustainability of their orders, in particular a couple of the foundries that are struggling right now?

Richard Hill

Well, as you and I have talked and you're right on, relative to the fact that consumers have to be doing well. I think that when I look at the products that are coming out. In fact just this morning, I got my Galaxy Smartphone II, which is just an amazing product. That's got to be the front end of the driver and you've got to have good macroeconomics. Now relative to foundries in particular, you and I have talked that the foundry model is the right model. That model isn't going away. The phenomena you see now, though, is these foundries are lined up with customers. And as more semiconductors become consumer oriented, if you win big, you go big, and if you lose big, you lose big. And so some foundries -- Nokia has sort of really been hit hard and so that whole food chain gets hit hard. While on the other hand, as we all know, Apple has done extremely well and so the foundry chain that supports Apple does well. I don't think that phenomena is going to change. But the world is be very competitive. And so what it is going to do is it's going to support the necessity for duplicate capacity in the foundry business. And I think what you're going to see is more of an ebb and flow, and a given supply chain will prosper and then they have made a wrong bet, they'll adjust themselves or go compete for the other supply chain, and I think that's a dynamic that's setting up. But the overall macro view of a foundry is no one but a foundry can afford the capital investment to be in the business. In other words, individual IDMs can't afford to invest in the technology, so they have to agglomerate demand and that's what foundries do. So I'm really bullish on the foundry model. You are right in what you are saying relative to some of the foundries are doing well, some of the foundries are struggling and you identified it well also from a standpoint of cyclicality, as well as product mixes, if you will. And I don't expect that to change. But if you're going to compete, you've got to compete in technology. And if you're going to compete in technology, you've got to buy the best equipment. So that's why I'm so bullish on the equipment business.

Operator

We'll go next to Stephen Chin with UBS.

Stephen Chin - UBS Investment Bank, Research Division

Just a follow up on the improving utilization rate you are seeing here in the fourth quarter. It does seem like advanced node utilizations are above 90%. But are you starting to see customer utilization rate improve at the more mature nodes also?

Richard Hill

Yes. I think that we are seeing utilization rates come on in multiple areas, even at earlier technology nodes. Because as you see, we're getting a strong pull right now for consumer electronic products, post-Black Friday. And all that -- all of those inventories have to be replenished, and I think that's going to create pull through the channel, which will just ripple right on through to the foundries and certainly in the memory area. And meanwhile, new exciting products are coming out. With the ultrabooks, solid-state drives, continued upgrading of the worldwide net, which is essential as we try to get to 4G and we've got more data going across the net. I think all those positives are leading to continued investment. And as you get continued investment in the leading edge chips, the support chips that go around it have to expand in capacity. And I think they will go together. So that's my best guess, Peter.

Operator

We will go next to Satya Kumar with Credit Suisse.

Satya Kumar - Crédit Suisse AG, Research Division

I guess on the NAND strength that you talked about, is that strength going from multiple customers? And at the moment, we have a 30% shortage in the hard drive market, and the HDD companies are claiming that it's going to take several quarters to get the supply and demand back on track. And anecdotally, we sort of hear some PC OEMs trying to pull some after the adoption, but it's not clear if it's moving the needle enough to change the capacity ads for NAND. I was wondering if you could give some perspective on what you're seeing for SSD and if that's starting to have a role here in terms of capacity discussions for 2012?

Richard Hill

I think the major effect of it, I don't think that anything -- in other words, you couldn't start adding equipment to fill demand for hard disk drives today and get that equipment up in time if there's only a 3-month delay, okay? So that isn't the advantage I see. But the advantage I do see is more people are starting to buy solid-state drive. And as people get to feel the power of a solid-state drive, the fast access time, the lighter weight, the better performance, lower power consumption, that just feeds for more demand from the consumer. I am walking around with so many phones right now, evaluating the various different phones. I was in the meeting earlier and I brought the phones in and everybody wanted to hold my Apple 4, along with my new Galaxy phone. And people were just sort of amazed at the quality of the screen, how light the new product was. And I think the nature of the product and all of the elements when people see that difference in performance and feel, that's what's driving them to want to buy. And so there's sort of trouble with the hard disk drive is getting more people to try solid-state drive, which just sort of feeds on itself. That's how I see this having an impact on NAND flash. But we'll start to see that ramp up in multiple guys I would say by the end of the second quarter.

Satya Kumar - Crédit Suisse AG, Research Division

Okay. And then on the foundries. Right now, you have a big U.S. logic company really pushing aggressively on its technology roadmap, and you have the Korean foundry, which is also starting to be more aggressive. It seems like the gap is widening between these 2 and the traditional foundry guys. Do you see any move at all from the traditional foundries to try and be a bit more aggressive in terms of the leading edge to narrow the gap or is it sort of business as usual?

Richard Hill

On the big risk, I am going to the bleeding edge, as you might say. If you're going to the bleeding edge and you don't have a critical mass of business utilizing that bleeding edge, that can be a tremendous investment sink. So you have to have enough bleeding edge demand. And as everybody knows in the semiconductor industry, now that we're out here in the 2x generation, design tools, everything has to catch up to be able to have designers be able to fully take advantage of the design capability. So I think we're early on that stage. And the ability of people to switch and take advantage of this new technology, there is a smaller and smaller number of people that really know how to design at these advanced nodes. So I think it's a little bit slower process than some people might think.

Operator

We will go next to C.J. Muse with Barclays.

Christopher J. Muse - Barclays Capital, Research Division

I guess first question. In terms of the order upside, lots of questions on that. I just was hoping that -- to I guess clarify. Was it really one large customer that came in that gave you the confidence or would you say it's more broader-based?

Richard Hill

I think it's a little bit broader-based.

Christopher J. Muse - Barclays Capital, Research Division

Okay. And then you talked about accelerated depreciation impacting second half orders. So I guess 2 questions on that. The first part, for it to count tax-wise, does it have to ship by the end of Q4? And then second question, given the accelerated depreciation and the potential pull-in of equipment, does that create poor comps for the first half of 2012?

Richard Hill

Both are very, very good questions. That's way managing what you ship out the door and what you have coming in the door is very important. The answer to the first question is that, yes, you have to ship it this year, okay? So, in some cases, people are highly motivated by that the accelerated depreciation, so we'll want to help them in any way we possibly can to ship it this year. In other cases, people aren't sensitive to that, and they agreed to take it after the first of the year because it's unimportant to them. That allows us to help manage our P&L so we don't have a vacuum in the next quarter. And so you're very astute in trying to understand the fact that we want to make sure that we can keep our factories loaded evenly, such that by keeping the factories loaded evenly, we can be as efficient as we can be, as we see the ramp build. So your question is a very, very good one and it's tough to answer all the details. But as you can imagine, operationally, we're trying to do the best to satisfy every customer.

Christopher J. Muse - Barclays Capital, Research Division

If I could follow up with just one last question. In terms of the NAND market, it feels like we're only seeing limited kind of spending today. And so I am curious if that jives with what you are seeing? And if we do see, as I would expect greater breadth of spend in the first half of '12, whether that gives you increased confidence that this uptick is sustainable?

Richard Hill

Well, as I said earlier in the call, at Christmas, I always like to be bullish. And while the industry prognosticators are forecasting down 10% for the industry, I've mentioned I'd like to see it flattish, and I think that goes a long way to give me confidence that we could see that. But you're absolutely right on what you're watching.

Operator

We'll go next to Vishal Shah with Deutsche Bank.

Vishal Shah - Deutsche Bank AG, Research Division

Just want to follow up on the foundry side. The pickup that you're seeing, is it coming from one large customer, or are you seeing some of the traditional foundry guys also accelerating orders for some of the older generation nodes?

Richard Hill

I think we see it from a couple of areas, but it's not broad-based yet.

Vishal Shah - Deutsche Bank AG, Research Division

Great. And then on the NAND side, I know that you sort of are looking at next year to be flattish. Is it fair to say that NAND is expected of what you sort of think will happen to some of the other segments would still be up quite a bit, and I think the biggest variable right now seems to be the logic guys?

Richard Hill

I think NAND is going to be up next year. I think NAND is due for a good year. The one I worry most about, of course, is DRAM. We need -- I'd love to see a change in the dynamic of DRAM. But as I've highlighted before, I don't see it yet. But clearly with NAND, I'm very, very optimistic with NAND Flash in 2012. I think logic remains very strong when you look at demand on ultrabook and we see a refresh in the PC cycle. I think that bodes extremely well for the logic marketplace, and then that feeds into foundries for everything that support chips, everything else that surround it, and certainly the graphics market which drives the foundry business. So that's just sort of a general overview of what I think the drivers are. Okay?

Operator

We'll go next to Edwin Mok with Needham & Company.

Edwin Mok - Needham & Company, LLC, Research Division

One question I have on the foundries. With some investors felt that a lot of foundry spending is on the leading edge and that there are some risks associated, maybe cut back on the trailing edge spending, which will not result in as much of an uptick as some believe. Do you agree with that thesis or how do you count this credit -- that thesis?

Richard Hill

I haven't thought of that one. There always seem to be a lot more investment on the leading edge because that's where you're really trying to differentiate yourself. But you can't let your factory not have output when there's demand. So I don't see that people are going to take their eye off the ball and not invest in 45 or even if they need additional capacity of 65, they're not going to ignore it. And I do believe that it's going to be a long time before you see a decay in that overall business. You might see a surplus for a while, but you're not going to see a decay. So I haven't had time, but I will take your thesis and think about it between now and at the end of the quarter and try to come back with a better answer for you, Edwin. That's a good question.

Edwin Mok - Needham & Company, LLC, Research Division

Just quickly touch on you mentioned DRAM. I was wondering, any hopes for DRAM? What do you think need to happen for that sector for those guys to come back and spend?

Richard Hill

DRAM is tough. They've become so productive and we don't have, as I've always said, DRAM is an application follower, not an application driver. And so it's got to follow the size of the word and the microprocessor. It's got to follow the gigahertz of the microprocessor. And I don't see a lot of change, movement there. So DRAM, I don't know. Unless there is great improvements in power consumption, packaging differentiation from mobile applications, stacked DRAM, something. But right now, that's the biggest hole we got.

Operator

We'll go next to Mehdi Hosseini with Susquehanna International.

Mehdi Hosseini - Susquehanna Financial Group, LLLP, Research Division

Back to your -- the downward change I see to the mid-quarter update is the booking tightening to the high end of the range. So, and I'm not going to try to even ask you for shipment guidance for Q1. But given this kind of sequential growth in bookings and with no change to your shipment for Q4 or December quarter, the first thing that comes to my mind is, the shipments are going to start to rebound starting in the March quarter. Is that a logical or rational conclusion?

Richard Hill

I think that's about as rational as anybody could possibly be, Mehdi.

Mehdi Hosseini - Susquehanna Financial Group, LLLP, Research Division

Right. And then with shipment rebounding and going back to our previous question, would the answer be a second rational conclusion to assume every shipment rebounding margins would also -- would show some sort of expansion or improvement?

Richard Hill

If you can run your factories with better absorption, you're likely to have better margins.

Mehdi Hosseini - Susquehanna Financial Group, LLLP, Research Division

Okay. Under operating line, right?

Richard Hill

That's right.

Mehdi Hosseini - Susquehanna Financial Group, LLLP, Research Division

Okay. And then if I may ask one more. We've been talking about foundry, NAND and DRAM. But you haven't really said much about larger, especially the big I company not far from you. Any early thoughts just qualitatively as we exit the year?

Richard Hill

Well, I am a big believer in a refresh of the PC cycle and continued investment in infrastructure. And I think that they're probably the most competitive, aggressive, capable company in the semiconductor industry. And I would never put at doubt anything they say relative about what they're going to do. And with, that bodes well for the equipment guys.

Operator

[Operator Instructions] We'll go next to Patrick Ho with Stifel Nicolaus.

Patrick J. Ho - Stifel, Nicolaus & Co., Inc., Research Division

Rick, can you give a little bit of commentary on, I guess, the yields at the foundries leading edge and whether, I guess, one, if you're seeing any improvements on that part, and two, whether that could potentially create a vacuum given that the demand may be big, but its yields are not. That leads you obviously with excess capacity as well.

Richard Hill

Good observation, Patrick. I mean, we've always said that there's 2 ways to increase capacity in the marketplace. One, buy more equipment, two is improve yield. Unfortunately, I don't have any data right at my hands sitting here, so I don't want to quote you numbers that are bad. But my feeling is yields in general at the leading nodes are improving across the board with a lot of different foundries and customers and it's a pretty regimented process and it's become much more predictable. It's not episodic improvements in yield and we're not dealing with problems that your yield is at zero and now you're going to take it to 50%. So I don't think it's going to yield, no pun intended, any surprise. But we'll always be fighting the fact when you start a new node, you start at lower yield, you work it up and there's 2 ways to increase capacity. We're always hoping its buying more equipment, and our customers are always hoping they could just get more yield. And I think that's the dynamic.

Patrick J. Ho - Stifel, Nicolaus & Co., Inc., Research Division

Great. And maybe a final question for me. I know you've given a little bit of commentary on DRAM and the outlook. Do you see anything in that industry in terms of, I guess, where the manufacture or the process techniques are coming to their limits at the really leading edge, say, at the 2x node, where we're just going to finally see, I guess, a resumption of what we traditionally would call new capacity buys to meet these kind of new process techniques. Is there anything you see over the next 12 to 18 months on the DRAM front?

Richard Hill

There will be continued investment and upgrades in the DRAM marketplace as we push down to 1x, 1y, 1z, and there is still a little room to go, but we are getting close to the wall. But it will take a while. We still have a little bit of legs. It's not going to zero.

Operator

That does conclude today's question-and-answer session. At this time, I would like to turn the call back over to Mr. Hill for any additional or closing remarks.

Richard Hill

Thank you very much for joining us today, and I hope you were able to understand me. I look forward to seeing you at year end and hopefully 2012 will be a great year. Thanks very much and have a happy holiday and safe holiday with your families. Thank you. Bye-bye.

Operator

That does conclude today's conference. We thank you for your participation.

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