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Edited Transcript of ADN.TO earnings conference call or presentation 14-Feb-19 6:00pm GMT

Q4 2018 Acadian Timber Corp Earnings Call

Vancouver Feb 19, 2019 (Thomson StreetEvents) -- Edited Transcript of Acadian Timber Corp earnings conference call or presentation Thursday, February 14, 2019 at 6:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Mabel Wong

Acadian Timber Corp. - Senior VP & CFO

* Mark M. Bishop

Acadian Timber Corp. - President & CEO

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Conference Call Participants

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* Hamir Patel

CIBC Capital Markets, Research Division - Director of Institutional Equity Research & Paper and Forest Products Analyst

* Paul C. Quinn

RBC Capital Markets, LLC, Research Division - Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to Acadian Timber Corp.'s Q4 2018 Conference Call and Webcast. (Operator Instructions) As a reminder, this conference is being recorded.

I would like to introduce Chief Financial Officer, Mabel Wong. You may begin.

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Mabel Wong, Acadian Timber Corp. - Senior VP & CFO [2]

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Thank you, operator, and good afternoon, everyone. Welcome to Acadian's Fourth Quarter Conference Call.

Before we get started, I would like to remind everyone that in discussing our 2018 financial and operating performance, our outlook for 2019 and responding to questions, we may make forward-looking statements. These statements are subject to known and unknown risks and future results may differ materially. For further information on our known risk factors, I encourage you to review Acadian's annual information form dated March 28, 2018, and the other filings of Acadian, which are available on SEDAR at sedar.com and on our website.

I'll begin with some comments on our financial results for the year ended December 31, 2018. Then our President and CEO, Mark Bishop, will add some further remarks on our business operations, market conditions and our outlook for the new year.

Overall, Acadian performed well operationally, which led to solid results for the 2018 year. During the period, Acadian generated adjusted EBITDA of $22.1 million, which compares to $23.3 million during 2017.

The strong demand and pricing Acadian experienced in the first half of 2018 reflecting the favorable dynamics of the Northeast regional log markets carried through the second half of the year. As a result, log sales from our freehold operations were strong throughout the year, with volumes and pricing up over 2017. However, these benefits were offset by lower ancillary revenues from providing timber services and lower gains on land sales relative to the prior year.

Our net income for 2018 was $26.3 million compared to $30.8 million in the prior year. The variance from the prior year is largely explained by an unrealized foreign exchange loss on the U.S. dollar-denominated long-term debt in 2018 compared to the prior year, which was in an unrealized gain position. The impact of this was partially offset by a favorable fair value revaluation of timber assets at the end of the year.

Acadian's payout ratio was 106% during the year, which is above our long-term target of 95%. We anticipate that over the long term, we will revert to a payout ratio consistent with our target level. However, in the near to medium term, Acadian's strong cash position supports a payout ratio at these levels.

Net sales for the year were $99.8 million. This represents a year-over-year increase of $4.4 million as Acadian benefited from strong demand and favorable operating conditions. And these results had a 3% increase in log sales volumes and a 2% increase in the average log selling price for the company.

Acadian also benefited from a meaningful improvement in biomass revenues due to stronger export markets in the year. Meanwhile, contributions from timber services decreased due to the timing of harvest activities, which we expect will be made up for in the first part of 2019. Additionally, Acadian sold fewer and lower-value properties in Maine in 2018, resulting in a lower level of disposition gain. As a result, adjusted EBITDA margin for 2018 was 22% compared to 24% in the prior year.

Moving on to the results for each of our New Brunswick and Maine operations. Net sales for our New Brunswick Timberlands during 2018 was $74.8 million compared to $71.7 million in 2017. The increase reflects a 4% improvement in log sales volumes due to the strong demand and favorable harvest conditions, as I previously mentioned. The weighted average log selling price of $66 per cubic meter was in line with the prior year. While pricing for all products increased compared to the prior year, this benefit was largely offset by higher relative sales volumes of lower-valued softwood pulpwood.

Contributions from timber services decreased 81% due to the timing of harvest activities, and as I mentioned, we expect this to recover in the first part of 2019. And this was partially offset by a benefit of a 76% increase in contributions from biomass products.

As a result of these factors as well as higher variable log harvest cost per cubic meter, New Brunswick's adjusted EBITDA was $16.6 million in 2018 compared to $18.1 million in the prior year, while adjusted EBITDA margin was 22% for 2018 compared to 25% in 2017.

Moving on to our Maine Timberlands. Net sales during the year totaled $25.1 million compared to $23.7 million during the prior year. The current year results reflect a 6% increase in the weighted average log selling price due to strong log demand compared to the prior year. This benefit was partially offset by a 1% decrease in log sales volumes, as harvest activities for hardwood were adjusted to reflect our commitment to manage Maine Timberlands’ annual harvest volumes to sustainable level.

The weighted average log selling price during 2018 in Canadian dollar terms was $81 per cubic meter, an increase from $76 per cubic meter during the prior year or an improvement of 6% in U.S. dollar terms. This improvement reflects the continued strong demand for softwood sawlogs and hardwood pulpwood. Although net sales were higher and variable log harvest costs were down year-over-year, this was offset by lower sales of higher and better use lands compared to the prior year. As a result, Maine's adjusted EBITDA during 2018 was $6.8 million, in line with 2017, and adjusted EBITDA margin was 27%, marginally lower than the prior year.

And then lastly, a few comments on our overall balance sheet and financial position. Acadian ended the year with a healthy cash balance of approximately $22 million. Acadian has ample cash resources, which is further supported by funds available under our revolving credit facility and a standby equity commitment from Brookfield, overall making up a net liquidity position of $102 million. During the quarter, we declared a dividend of $0.29 per share, which is 3% higher than the prior quarter and 5% higher than the prior year quarter.

That concludes my remarks on this year's financial results, and I'll now turn the call over to Mark.

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Mark M. Bishop, Acadian Timber Corp. - President & CEO [3]

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Thanks, Mabel, and good morning. During the quarter Acadian's operations had 1 recordable safety incident among employees and 1 among contractors. While the incidents resulted in lost time, the injuries were relatively minor in nature. Acadian takes safety in the workplace very seriously, and we strive for continuous improvement in our employee and contractor safety performance.

Acadian's operations benefited from strong demand and favorable operating conditions throughout the year, resulting in log sales volumes of 1.07 million cubic meters, representing a 3% increase from 2017. Log sales volumes in New Brunswick increased 4% year-over-year with continued strong markets for all its products.

Notably, New Brunswick's fourth quarter log sales volumes increased 20% compared to the prior year period.

This increase was driven by timing of harvest activities as New Brunswick benefited from favorable harvest and market conditions, particularly for softwood and hardwood pulpwood during the quarter. However, softwood sales were impacted by an inventory management program with one of the operations' customers that has been in place from time to time historically, but was not in place during the fourth quarter of 2017. In addition, timber services and other sales were impacted by the timing of harvest activity, which, as Mabel noted, we will expect -- we expect to recover in the first part of 2019.

Maine's operations benefited from improved regional sawlog markets, which had been impacted in the prior year by high customer inventories and limited markets for sawmill residuals. As we have discussed on previous conference calls, Maine's prior year hardwood harvest volumes were higher than the average long-run sustainable yield target. As a result, Maine reduced its hardwood volumes during 2019, despite strong market conditions. Notably, for the fourth quarter of 2018, log sales volumes declined 29% compared to the prior year period, almost entirely driven by the reduction in hardwood sales volumes. As we've noted in past calls, Maine's forest management plan and sustainable forestry initiative certification provides sufficient flexibility to respond to market conditions and maximize cash flows over an economic cycle.

As Mabel mentioned, selling prices for our products continue to be solid as the weighted average log selling price per cubic meter increased 2%, driven by strong softwood sawlog and pulpwood markets partially offset by changes in sales mix. In New Brunswick, the weighted average log selling price remained in line with the prior year as a 4% increase in softwood sawlog prices and a 2% increase in hardwood pulpwood prices was offset by higher relative sales of the lower-valued softwood pulpwood. The weighted average log selling price at Maine increased by 6% relative to the prior year, benefiting from a 9% increase in softwood sawlog pricing and a 6% increase in hardwood pulpwood pricing, partially offset by higher relative sales, again, of lower-valued softwood pulpwood.

Acadian's key markets include softwood sawtimber, hardwood sawtimber and hardwood pulpwood. Northeast North American softwood dimension sawmills represent over 1/3 of Acadian's end-use markets and are the primary market for our softwood sawtimber. The case for continued recovery in the U.S. housing starts, over the medium term, remains highly compelling. Demographics for continued solid growth in household formation, home inventories are extremely low. And on average, U.S. housing stock is beyond its prime. However, tight construction labor markets and restrictive building regulations have combined with near-term concerns of rising interest rates and the fallout from U.S. international trade policy to drive what most forecasters believe will be a relatively short-lived slowdown in construction activity. Recent consensus forecasts anticipate average year-over-year growth in U.S. housing starts for 2019 and 2020 of about 1% and 3%, respectively.

Importantly though, most forecasters expect the proportion of single-family starts, the largest lumber-consuming segment of U.S. housing starts, to improve modestly through 2019 and 2020. Additionally, home repair and remodeling, the single largest driver of North American lumber consumption, is also projected to grow modestly over the next 2 years. Therefore, North American sawtimber demand is expected to post modest year-over-year growth, even under more conservative housing start forecasts.

Average fourth quarter benchmark, Eastern Spruce-Pine-Fir and Southern Yellow Pine lumber prices declined 30% and 11%, respectively, from the prior quarter. The continued slide in pricing from the prior quarter was driven by weaker-than-expected home sales and building activities through the quarter.

Despite the U.S. -- strong U.S. economy, buyer apprehension remains high due to risk of Federal Reserve interest rate increase and potential for slowing global economic growth. Forecasters anticipate that extensive market downtime, which has been extended into the first quarter of 2019, principally in the high-cost log regions of -- high log cost region of interior British Columbia, coupled with ongoing steady demand growth, will support continued strong lumber pricing through 2019, albeit below levels achieved in 2018.

The almost 30% recovery in prices -- in lumber prices year-to-date in 2019 is encouraging but not certainly not a surprise. Considering capacity and log supply constraints exhibited in Western Canada during late 2018 and early 2019, we anticipate continued attractive market dynamics to support stable softwood sawtimber pricing in Acadian's regional markets.

Given the current state of U.S. trade relations, there is no expectation of any meaningful discussions toward a softwood lumber agreement in Canada during -- or with Canada during 2019. Further, we anticipate no material change in 2019 to the current duty rates for Canadian lumber producers. Average consensus forecast lumber prices for 2019 would still indicate that a significant proportion of those duties will continue to be passed down to U.S. consumers. We remain steadfast in our view that an eventual negotiated settlement will include an exemption for all Canadian maritime producers, including those in New Brunswick.

Hardwood sawtimber markets, typically oriented to millwork and higher-value specialty markets, remain well balanced with continued positive outlook for the foreseeable future. While there's been modest price erosion in the latest quarter, the outlook for global pulp markets remains positive, particularly in the containerboard and tissue end-use segments. Hardwood pulpwood demand in Acadian's operating region remains stable, with well-balanced supply conditions continuing to support historically very strong pricing. Softwood pulpwood markets, Acadian's smallest product segment by volume and margin, have seen some modest recovery, and the recently announced restart of a pulp mill in Maine during mid-2019 is expected to be a catalyst for further recovery in softwood pulpwood demand and pricing through the second half of 2019.

In New Brunswick, biomass markets continue to be supported by export demand, which is expected to remain strong throughout 2019. While the biomass market in Maine remains weak, efforts to tap into biomass export markets in Maine -- or from Maine continue to progress.

As always, Acadian management remains vigilant in pursuing cost efficiencies across the business. During 2018, the company completed a full review and integration of several activities performed by its Maine and New Brunswick operating divisions, resulting in ongoing administrative and operating efficiencies, particularly across our accounting, cash management and marketing activities.

Marcia McKeague, Vice President of our Maine operations since Acadian's inception retired at the end of 2018. On behalf of the entire management team, I'd like to thank Marcia for her passionate dedication and significant contributions to Acadian and certainly for her support during the integration process.

Acadian was active under our normal course issuer bid during the final quarter of 2018, repurchasing 42,800 shares at an average price of $14.86. We will continue to seek opportunities to continue our activity at the appropriate share valuation.

So to wrap up, I'll highlight that the combination of our strong operating team and encouraging outlook for all our key markets, coupled with our surplus cash balance, supports our view that Arcadian is well positioned to meet its quarterly distributable cash commitments. On behalf of the board and management of Acadian, I'd like to thank all our shareholders for their ongoing support.

That concludes our formal remarks, and we're available to take any questions from participants. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Paul Quinn with RBC Capital Markets.

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Paul C. Quinn, RBC Capital Markets, LLC, Research Division - Analyst [2]

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It seems you've got a fair amount of confidence in raising the dividend up 3%. Maybe you can go through some of the factors because your year-over-year results are down.

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Mark M. Bishop, Acadian Timber Corp. - President & CEO [3]

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Thanks, Paul. I think from our comments and in the press release, I think, you can understand that the key factors of our performance in the year, and my comments in particular about the fourth quarter, we had some timing issues with that management -- inventory management program, which will carry over into 2019. Additionally, our HBU sales in 2017 were very, very strong. 2018, I would say, is more of a normalized indication of what we expect to do going forward. So those obviously were 2 of the key drivers for the difference year-over-year. But listen, we, as you know, unlike most or much of the Western Canadian industry, the Eastern Canadian industry saw no reason to take downtime, continued very strong demand in well-balanced markets. Right now, our customers' log yards or sawmill log yards are very, very low -- seasonally very, very low on log inventory. And we saw virtually no price erosion during that third to fourth quarter period of time, where obviously we saw significant pressure on lumber prices. So to us, the outlook continues to be very strong. And clearly, unless you believe housing starts will drop significantly over the next couple of years, and the fundamentals don't seem to point to that, we think we continue to expect strong markets and good support for a continued modest increase in log pricing over time.

When you think about the dynamic that's been going on in Maine, looking back 2 years, we'd had several shuts and very, very weak softwood pulpwood demand and questions about some of our hardwood pulpwood demand. And we've seen a significant turnaround in both those segments, and we see some solid progress on softwood demand -- softwood pulpwood demand in the second half of 2019. So when we couple what we consider to be a very strong outlook with the fact that we've got a significant surplus cash balance that will contribute to being able to pay that additional dividend over time while we wait and see what the market does, that's really what gives us confidence and continue to support another dividend increase.

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Paul C. Quinn, RBC Capital Markets, LLC, Research Division - Analyst [4]

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Great answer. Maybe you could help me out with just understanding, because you're closer to your sawtimber customers back east. What's the sense of their financial conditions right now? Are they making money right now? Or do they make money through low lumber prices? How competitive are they?

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Mark M. Bishop, Acadian Timber Corp. - President & CEO [5]

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That's a good question, Paul. Certainly, they were under pressure during the fourth quarter. I mean, everybody in North America who produces lumber certainly had a very, very tough quarter. But we certainly didn't see -- we don't have the same log cost differential that the B.C. producers have nor do we have the pressure in some areas on log supply that B.C. interior has. So yes, it was a tough quarter, but they're all -- we didn't see any downtime taken. And many of our customers have continued, in some cases, modest but capital programs to modernize their capacities. So I'm not -- I can't suggest sort of an average conversion cost for east versus west because they're all over the map, but while it was a tough quarter, we saw no downtime and continuing optimism in our customer base.

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Paul C. Quinn, RBC Capital Markets, LLC, Research Division - Analyst [6]

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Great. And then just lastly, just on this payout ratio. I guess, your goal to get down to that 95%, I guess, there's 2 ways to get it. One is to increase the earnings. The other one is to drop the dividend. I guess you don't want to do the latter. So in terms of the levers on increasing the earnings, I mean, there's volume, price and cost. Maybe you could give us an idea as to -- do you have anything on sort of long-term basis in the volume lift from current harvest levels? I guess we'll just leave pricing where it is, but any expectation that your costs will come down over time?

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Mark M. Bishop, Acadian Timber Corp. - President & CEO [7]

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Well, as I noted, we're always looking for opportunities to reduce cost. In this past year, the focus -- the primary focus was G&A, and I think we did well there. And you should see somewhere in the range of $0.5 million to $0.75 million G&A cost at a run rate taken out at the operating level. But it's -- we should see some relief in fuel cost this year over last year as well, but structurally, I wouldn't say if we're going to see significant cost taken out. And I think, as you know, our AIF suggest that we've got some changes in our wood flows coming forward, and we have some mix changes as well, but it will be basically heavier to softwood.

So our perspective is that we are going to continue to see some strength in pricing, and we'll see how that progresses over time. And in the meantime, as we've noted, we've got the cash drawdown. I mean, clearly, we've been active under our normal course, but given our liquidity, we can't deploy an awful lot of that cash. And we continue to look at modest tuck-in opportunities in Maine and New Brunswick, but nothing has really come to surface. So that cash for the foreseeable future is going to be used to support that dividend if we need it.

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Operator [8]

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And our next question comes from Hamir Patel with CIBC Capital Markets.

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Hamir Patel, CIBC Capital Markets, Research Division - Director of Institutional Equity Research & Paper and Forest Products Analyst [9]

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Mark, you referenced inventory management program. How much did that -- how much of that was a drag on EBITDA in the quarter? And will you get all of that back in Q1?

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Mark M. Bishop, Acadian Timber Corp. - President & CEO [10]

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We do think we'll get it all back in Q1, Hamir. Mabel, I think, our view is it's about $600,000, so to speak.

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Mabel Wong, Acadian Timber Corp. - Senior VP & CFO [11]

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That's right. Yes, about $600,000 EBITDA.

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Hamir Patel, CIBC Capital Markets, Research Division - Director of Institutional Equity Research & Paper and Forest Products Analyst [12]

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Okay, great. That's helpful. And Mark, I was just wondering if you could share your thoughts on what you're seeing on the M&A environment out there, if there's any markets that are looking particularly attractive. And did -- any comments you could -- anything you could disclose on how active you might have been on opportunities that came up in the past quarter?

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Mark M. Bishop, Acadian Timber Corp. - President & CEO [13]

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It's good question, Hamir. The 2018 and 2019, so far, other than a large U.S. Southern transaction -- there's been lots of very, very small transactions, both in the Pacific Northwest and the U.S. South, but there's not been very many of scale outside of one large one in the U.S. So 2019 has started off the year very slowly. So I think many of the TIMOs are really searching for opportunities and trying to understand where that next one is going to come from. And I think you're seeing a little bit of activity or interest moving back offshore from the U.S. as a result. I can't specifically talk about what we were active in during the quarter. I will mention that we were active in a small tuck-in within our region, but it went for obviously a value that we couldn't approach. And so we -- no, there has not been as many opportunities across the North American timberland landscape, if you will, of scale or of interest, at least to us, over the past 12 months.

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Hamir Patel, CIBC Capital Markets, Research Division - Director of Institutional Equity Research & Paper and Forest Products Analyst [14]

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And Mark, do you have a sense as to, for some of the recent transactions, what discount rates were being underwritten for properties in the South and the U.S. Pacific Northwest?

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Mark M. Bishop, Acadian Timber Corp. - President & CEO [15]

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Yes, Hamir, I don't think we've seen much of a change in discount rates, and certainly not -- considering interest rate hikes in the U.S., we certainly haven't seen discount rates start to reflect that. So we would still be somewhere in the range. My view is in the 4.5% to 5% real range, and that has to be coupled with -- or take that with a bit of a grain of salt because when we do our underwriting, we obviously have our own view of productivity, inventory and, obviously, pricing. But -- so we worked backwards from our understanding of a transaction to sort of calculate and apply discount rate, but we're certainly still seeing transactions occur below 5%.

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Operator [16]

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At this time, I'm showing no questions in queue. I would like to turn the call back over to Mark Bishop for closing remarks.

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Mark M. Bishop, Acadian Timber Corp. - President & CEO [17]

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Well, again, I just like to thank you all for participating in the call. I know it's always a busy time of the year, and we look forward to talking to you at the end of our next quarter. Have a great day.

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Operator [18]

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