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Edited Transcript of AW.UN.TO earnings conference call or presentation 29-Apr-20 8:00pm GMT

Q1 2020 A and W Revenue Royalties Income Fund Earnings Call

North Vancouver May 3, 2020 (Thomson StreetEvents) -- Edited Transcript of A and W Revenue Royalties Income Fund earnings conference call or presentation Wednesday, April 29, 2020 at 8:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Donald T. Leslie

A&W Revenue Royalties Income Fund - CFO

* Susan D. Senecal

A&W Revenue Royalties Income Fund - President & CEO

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Conference Call Participants

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* John Zamparo

CIBC Capital Markets, Research Division - Associate

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Presentation

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Operator [1]

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Good day, and welcome to the A&W Revenue Royalties Income Fund Q1 2020 Results Conference Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Ms. Susan Senecal. Please go ahead, ma'am.

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Susan D. Senecal, A&W Revenue Royalties Income Fund - President & CEO [2]

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Thanks, Nadia, and good afternoon, everyone. Thanks for taking the time to attend our call today. I'm Susan Senecal, President and CEO of A&W Food Services of Canada and CEO of the A&W Revenue Royalties Income Fund. With me on the call today is Don Leslie, who's the Chief Financial Officer of A&W Food Services and the fund; and Thomas Hughes, the controller of A&W Food Services.

The results that we're presenting today are for the A&W Revenue Royalties Income Fund for the first quarter, which ended on March 22, 2020. A&W same-store sales were down by 4% for the first quarter of 2020 as compared to the first quarter of 2019. Same-store sales growth in January and February 2020 was positive. However, starting March 13, 2020, COVID-19 began to have an immediate effect on A&W restaurant sales.

I will review the impact of COVID-19 pandemic on our restaurant operations and the measures that we're taking to support our restaurants in more detail at the end of our call, but now I'll turn things over to Don, who will review the fund structure and go through the financial results for the quarter. Don?

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Donald T. Leslie, A&W Revenue Royalties Income Fund - CFO [3]

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That's great. Well, thank you, Susan. So before we can tell you much more about our results, I just need to read the following comment on forward-looking information.

Certain statements in this presentation may be forward looking in nature. These include references to liquidity, earnings and anticipated earnings from growth in same-store sales and new restaurant openings. Actual results may differ from those expressed or implied in these forward-looking statements.

The forward-looking statements contained in this presentation are subject to a number of risk factors, including the ability of A&W Food Services of Canada to implement its strategies regarding the marketing of the A&W system and the opening of new A&W restaurants, general economic and business conditions, financial and political instability, and other factors disclosed previously and from time to time in the fund's public filings. So any forward-looking statements in this presentation should be evaluated in light of these important factors.

I'll just also spend a few moments reviewing the fund structure. We often have a few new people on the call. And then I'll go through the financial results for the quarter. After that, as previously mentioned, Susan will discuss the impact of COVID-19 and the actions we are taking to mitigate this impact. We'll be happy to answer your questions at the end of our call.

So for those of you who might not be familiar with the fund structure, I'll just quickly review the highlights. The fund currently owns 76.4% of the -- of A&W Trade Marks, Inc., which, through its interest in A&W Trade Marks Limited Partnership, owns the A&W trademarks used in Canada. These trademarks include some of the best-known names in the Canadian foodservice industry, including A&W Root Beer, The Burger Family and Chubby Chicken. The fund earns income through its ownership interest in A&W Trade Marks, which, through the partnership, licenses the A&W trademarks to A&W Food Services. In return for the use of the trademarks, Food Services pays A&W Trade Marks in royalty equal to 3% of the gross sales reported by A&W restaurants in the Royalty Pool.

Royalties lost due to the permanent closure of restaurants are replaced with royalties from new restaurants at the time of the next expansion of the Royalty Pool. Until then, Food Services continues to pay the Royalty as if the restaurant had not permanently closed.

I want to emphasize that the distributable cash available to make distributions to unitholders is based on the sales of the restaurants in the Royalty Pool with only minimal operating expenses associated with operating the fund. So this is a top line fund and which means it's not subject to variability of earnings or expenses associated with a normal operating business.

An important aspect of the fund is that Food Services owns the equivalent of 23.6% of the units of the fund through its ownership of common shares of A&W Trade Marks, Inc. As a result, the interest of Food Services are closely aligned with the interests of unitholders. Growth in the fund is achieved in 2 ways: first and most importantly, by increasing the same-store sales of the restaurants in the Royalty Pool; and secondly, by adding new restaurants to the pool each year.

On the second point, the Royalty Pool is expanded at the beginning of each year by adding new A&W restaurants opened in the past year plus any restaurants which had permanently closed. On January 5, 2020, the Royalty Pool was increased from 934 to 971 restaurants.

So with that, I'll just now go through our financial results for the first quarter of 2020 as compared to the first quarter of 2019. The news release issued earlier today outlines most of the financial results of the fund, while the interim audited financial statements and MD&A will be released very shortly.

Gross sales reported by restaurants in the Royalty Pool were $308.7 million, which is effectively flat against the sales for the first quarter of 2019. Royalty income for the quarter was $9.3 million, which again was the same as the first quarter of 2019. The negative same-store sales growth in existing restaurants was offset by the gross sales from the new restaurants, which had been added to the Royalty Pool on January 5, 2020. Of significant interest to unitholders is the amount of distributable cash being generated and the payout ratio.

At the end of the quarter, the cumulative surplus of distributable cash on hand decreased from $8.1 million at the beginning of the year to $7.9 million at the end of the first quarter. The payout ratio for the quarter dropped to 104.4%, which is down from 105.3% in the first quarter of 2019. Total distributable cash generated in the quarter was $7.5 million or $0.409 per equivalent unit, which compares to $6.7 million or $0.38 per unit in the same quarter of 2019. The increase in distributable cash was entirely due to the decrease in the income tax provision and a decrease in cash expenses.

Due to the sudden impact of COVID-19, the trustees announced on March 31, 2020, a temporary suspension of monthly distributions on the units, commencing with the distribution that would ordinarily have been declared in April of 2020 and then payable on or about April 30, 2020. Since the start of the COVID-19 pandemic, the trustees of the fund have been in close and regular contact with the management of Food Services. We're carefully monitoring the performance of Food Services and the sales of restaurants in the Royalty Pool to determine an appropriate time for reinstatement of the monthly distributions.

So with that, I'll just turn things back over to Susan.

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Susan D. Senecal, A&W Revenue Royalties Income Fund - President & CEO [4]

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Thanks, Don. The effect of COVID-19 on many businesses, and I'd say particularly restaurants, have been unexpected. They're sudden and unprecedented, and early estimates from industry data indicates that foodservice sales in Canada have fallen since the beginning of the pandemic by over 60%. The future effect of COVID-19 on the economy and on businesses, in general, remains uncertain. The path that governments will follow in easing restrictions on business operations, and in particular restaurants, is yet to be determined, and this could last many months. It is also unclear how quickly consumer demand will resume.

We've taken significant measures in our restaurants and our broader operations to protect the health of our employees and our guests in compliance with social distancing recommendations and mandates of relevant public health authorities. Food Services has closed all dining rooms in A&W restaurants across Canada on a temporary basis. Drive-thru operations, delivery and mobile order for pickup remain open where possible. Approximately 200 A&W restaurants of the 995 total A&W restaurants are presently closed on a temporary basis. Customer traffic in the remaining restaurants is down significantly as guests remain at home and practice social distancing.

Starting May 13 -- sorry, March 13, 2020, sales of restaurants in the Royalty Pool are approximately 42%, down from sales prior to March 13, 2020, including the impact of temporarily closed restaurants. To enable Food Services to continue to support the A&W system through this challenging period, Food Services has taken action to bolster its liquidity, including an equity injection of $10 million by Food Services' shareholders as well as a planned increase in Food Services' credit facility from $6 million to $25 million.

Food Services has delayed the royalty payment of $2.890 million, which was payable to the fund on April 17, 2020, for the last royalty payment period in the first quarter. Food Services also expects to defer payment of royalty payments for the second quarter of 2020. Interest will accrue on unpaid royalties. The trustees have retained independent financial advisers to evaluate Food Services' financial projections, which show that the deferred royalties are expected to be paid in full with interest by December 21, 2021, if not earlier.

Given the extraordinary level of business uncertainty, especially related to the restaurant industry, coupled with the immediate decline in A&W restaurant sales, the trustees have determined that temporarily suspending distributions to unitholders is the most prudent course of action until business conditions and sales trends become less uncertain. They have done so mindful of the long-term interest of the fund, recognizing that it is in the long-term interest of unitholders to have a healthy and stable network of A&W restaurants coming out of the COVID-19 crisis. The trustees will continue to closely monitor the results of operations and the outlook of Food Services and the A&W system with the intention to preserve unitholder value by restarting distributions in a prudent manner based upon A&W restaurant sales that permit distributions to be paid in amounts that are reasonably predictable.

Based on the experience of other restaurant brands in markets outside of Canada, Food Services believes that the foodservice industry, and more particularly the QSR segment of the industry, will recover from the impact of COVID-19. However, the timing and the strength of the recovery cannot now be predicted with any degree of certainty.

Against this backdrop, the success of the A&W brand and individual franchise A&W restaurants is paramount to the long-term success of the overall A&W system and in turn, to the fund. Both Food Services and its franchisees have been working diligently to develop and implement plans and programs to mitigate the effects of the COVID-19 pandemic. Food Services' objective is to ensure that as many as possible of A&W's 995 restaurants are able to operate as permitted during the COVID-19 pandemic and emerge from this period of uncertainty in financial condition that enables them to compete effectively and grow their businesses.

From enhancing the appeal and trust of the A&W brand to ensuring a safe and stable supply chain to developing programs to ensure the safety of our franchisees, customers and employees, Food Services is committed to the long-term health and success of its franchise network and the fund. Food Services believes that its mission to be loved for our natural ingredients, great taste, convenience and for doing what's right will help it to rebound from the impact of COVID-19.

Strategic initiatives, including repositioning and differentiating the A&W brand through the use of better ingredients, continued rapid new restaurant growth and delivering an industry-leading guest experience, have all contributed to A&W's strong appeal and the trust it has built with Canadian consumers over many years. These strengths will be key to delivering strong results and improved market share as the QSR industry and the QSR burger market resume growth.

To update you on our progress in opening new restaurants, 3 new A&W restaurants were opened across the country in the first quarter of 2020. Our pipeline of new restaurants under development remains strong. We currently have 25 new restaurants under construction or in varying stages of permitting, although the opening of these restaurants is expected to be delayed due to the impact of COVID-19.

Looking ahead, A&W's rapid growth of new locations and industry-leading innovation have led to a very strong brand positioning. Our continued focus on consistently delivering great food and a better guest experience, in combination with investments in growth areas such as mobile order and pay and third-party delivery, will all contribute to winning guest visits and building loyalty, enhancing performance over the long term.

Thanks for your attention, and we would now be happy to answer any questions. Thank you.

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Questions and Answers

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Operator [1]

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(Operator Instructions) We're going to take our first question from John Zamparo from CIBC.

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John Zamparo, CIBC Capital Markets, Research Division - Associate [2]

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Can you provide us some data on the business performance since COVID's impact? I was wondering if you could talk about performance specifically subsequent to the quarter. It seems like most restaurant businesses that have reported numbers so far have seen a pretty notable impact in April versus the back half of March, but they're still in fairly material negative territory. Is there anything you can say about April performance so far?

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Susan D. Senecal, A&W Revenue Royalties Income Fund - President & CEO [3]

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I want to say that, certainly, the COVID-19 impact certainly didn't end with the end of the first quarter. We still are facing, in most provinces, restrictions about our ability to operate. People are being guided with some social distancing, and we're very committed to taking action, even voluntary actions such as the closing of our dining rooms, which is not banned, but we didn't feel we were able to respect the proper social distancing. And so therefore, that's had an impact on the ability of restaurants to generate revenue and to serve guests. And of course, people are staying at home correctly because of the guidance that they're receiving from public health authorities. So I think that right now, it's -- our results are kind of similar to what's happening in society, which is that there's less mobility, fewer people out and things like universities and schools are closed. Businesses, to a large degree, have moved away from their offices. In a lot of cases, people are working from home. So certainly, it's had an impact, I'd say, not dissimilar from the impact that we originally saw in -- during Q1.

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Donald T. Leslie, A&W Revenue Royalties Income Fund - CFO [4]

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John, I'm not sure if -- also specific to your question is, in our release, we said that sales are down about 42% since March 13 -- or quarter end actually ended March 22 due to the timing or just the way our quarters end. So really, that 42% is really kind of -- would include all that period from March 13 up until the most recent week or so.

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Susan D. Senecal, A&W Revenue Royalties Income Fund - President & CEO [5]

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Oh, yes. Thanks, Don.

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John Zamparo, CIBC Capital Markets, Research Division - Associate [6]

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Right, right. Okay. That's helpful. And then I was wondering about dayparts performance, in particular, on the breakfast side the past few weeks. How has breakfast performed relative to the other dayparts?

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Susan D. Senecal, A&W Revenue Royalties Income Fund - President & CEO [7]

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It's interesting. I think, to a large degree, the dayparts are sort of blending together as a lot of the people who are visiting our restaurants are essential workers that have not necessarily a 9 to 5 job but different shifts and so on. So I'd say that there's been a bit of a blending of the business, less apparent peaks, if you like, at the different meal -- traditional meal parts and more of a blending of business throughout the day. And I think that's related again to the lack of routine in many people's lives, different from when everything was much more scheduled.

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John Zamparo, CIBC Capital Markets, Research Division - Associate [8]

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Right. Okay. Understood. And then last one for me. You mentioned off-premise season in terms of mobile and delivery. Can you talk about how those have grown? Have they performed fairly similarly these past 6 weeks? And how do you think about digital, whether it's mobile or delivery, in, say, 2021 when we get to a more normalized environment? Do you expect that what consumers are going through now will permanently shift behavior to those channels in the future?

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Susan D. Senecal, A&W Revenue Royalties Income Fund - President & CEO [9]

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I think that a lot of -- anything digital, whether it's Zoom calls or increased use of things like FaceTime to get more personal contact or whether it's third-party delivery, ordering through your phone or mobile order and pay, I think those are technologies that sometimes people, they feel like trying it. They have an intention to try it. They don't necessarily go all the way there. This has been an occasion where I think many, many, many Canadians who never used those types of technologies, and I include there mobile order and pay and third-party delivery, have found themselves deciding to take advantage of those opportunities. And I'd say that those -- to the degree that those are positive experiences for them, I think that, that will certainly continue. Oftentimes, it's a question of kind of breaking through into the habit. And I think that for a lot of people, this has been the prompt that they probably didn't want but ended up having in terms of crossing over to a different kind of experience. And I think people have, generally speaking, seemed to be positive from the ratings on the app, and those types of things are quite good. So yes, I think it'll continue into the future.

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Operator [10]

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(Operator Instructions) We'll next go with [Saurabh Srivastava] from [Ventures Holdings].

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Unidentified Analyst, [11]

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I had a question, and it could be either Susan or Don that wants to answer. But every calendar year, at the end of the year, there is an adjustment done to the number of units that takes into account the realized sales of the new stores. How do you think that's going to be all affected now when you've got 200 stores that are closed temporarily but maybe some of them don't open up all the way? Like is there a chance that -- like how do you calculate that at the end of the year when this could be a calculation that's never been done before?

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Susan D. Senecal, A&W Revenue Royalties Income Fund - President & CEO [12]

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Thanks for the question. Don, I'll let you kick off on the [sales piece].

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Donald T. Leslie, A&W Revenue Royalties Income Fund - CFO [13]

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Well, it's actually a great question, [Saurabh]. It's -- this is unprecedented, and the agreements between the trust and Food Services never anticipated a pandemic. So there's a fairly routine calculation that's done. And it looks at the estimated sales and actual sales and things like that. And I don't think it's fair for either entity to just stick to that rigor of what the actual agreement says because if a restaurant's closed for 2 months, generally is a high-performing restaurant, should Food Services not get the compensation? And similarly is when we look at the next Royalty Pool amendment, the formula is based on a trailing distribution rate, which obviously is going to be impacted by the trustee's decision to suspend distribution. So there's both sides. Both Food Services and the fund would either suffer or benefit from either side. So what we need to do is go back to the principles of really what is the model meant to represent and how do we best to sift through the fog of war or the pandemic and figure out what that actual adjustment should look like.

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Unidentified Analyst, [14]

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Okay. I guess on the plus side, you have the distributions that are not being paid out. So that kind of acts as a buffer. And then on the other hand, you get to see exactly how many stores open up and what your realized sales are at the end of the year, right?

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Donald T. Leslie, A&W Revenue Royalties Income Fund - CFO [15]

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Well, it's fairly technical stuff. So I mean we did an adjustment January of this year, and we put in, it might not be the exact number, 37 net restaurants I think it was. And the way the formula works, it looks at the actual sales for this year and, therefore, does the final determination of the adjustment. Well, if some of those restaurants are closed for half a year, the sales are much lower than you would otherwise anticipate for the next 20 years. And then it's actually the January adjustment next year where it says, well, depending on the new restaurants that have opened, you look at the trailing distributions and if they're half what they normally are, well, then that's not fair the other way. So it's all a bit complicated, but we need to go sort of back to the principles that were established in 2002 that say, well, whether it's meant to have happened and how best can we come to an agreement to make sure that nobody is unfairly treated through this pandemic.

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Unidentified Analyst, [16]

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Okay. And I just have one more question. The cost associated with changing the stores, I mean do you anticipate that's something that just the franchisee handle? And you guys at the fund doesn't have to worry about that, correct?

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Susan D. Senecal, A&W Revenue Royalties Income Fund - President & CEO [17]

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Yes, that's correct. You're talking about changes related to COVID-19, for example, plexiglass shields or those types of things?

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Unidentified Analyst, [18]

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Yes.

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Susan D. Senecal, A&W Revenue Royalties Income Fund - President & CEO [19]

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You're right.

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Unidentified Analyst, [20]

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Okay. And sorry, one last, maybe my final question. Is there something in the tax laws that once this fund was set up in-depth, all of the accumulated distributions that have not been paid out by, say, December 2020, will they have to be paid out? Or can they still stay inside the fund and just get paid out later in 2021?

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Donald T. Leslie, A&W Revenue Royalties Income Fund - CFO [21]

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Good question. Actually, we were one of the first restaurant royalty trusts, and in that era, you actually had to have a corporation underneath the trust. It's called A&W Trade Marks, Inc. Others have limited partnerships, which have the issue that you raised, which is that income has to flow through even if the cash doesn't flow through.

In the case of our structure, the corporation is able to effectively dam up that income and not have to burn the income onto the unitholders. So yes, we can defer the income until such time it's actually paid out as distributions to the unitholders.

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Operator [22]

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There are currently no questions in queue. (Operator Instructions) It appears that there are no questions coming in, in queue. We're going to go ahead and give the floor back to the moderators.

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Susan D. Senecal, A&W Revenue Royalties Income Fund - President & CEO [23]

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Thanks very much, Nadia, and thanks to all of you for attending our call today. We look forward to updating you on our results after our second quarter. And in the meantime, if anyone does have questions which weren't answered on the call today, please do feel free to call either Don or myself at (604) 988-2141. Thanks very much.

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Operator [24]

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This concludes today's call. Thank you for your participation. You may now disconnect.