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Edited Transcript of BCSF.N earnings conference call or presentation 7-Nov-19 1:30pm GMT

Q3 2019 Bain Capital Specialty Finance Inc Earnings Call

Nov 13, 2019 (Thomson StreetEvents) -- Edited Transcript of Bain Capital Specialty Finance Inc earnings conference call or presentation Thursday, November 7, 2019 at 1:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Michael Alexander Ewald

Bain Capital Specialty Finance, Inc. - President, CEO & Director

* Michael John Boyle

Bain Capital Specialty Finance, Inc. - VP & Treasurer

* Sally Dee Fassler Dornaus

Bain Capital Specialty Finance, Inc. - CFO

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Conference Call Participants

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* Finian Patrick O'Shea

Wells Fargo Securities, LLC, Research Division - Associate Analyst

* HyungJun Choe

Crédit Suisse AG, Research Division - Research Analyst

* Ryan Patrick Lynch

Keefe, Bruyette, & Woods, Inc., Research Division - MD

* Sloan Bohlen

SOLEBURY TROUT LLC - MD

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Presentation

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Operator [1]

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Greetings. Welcome to the Bain Capital Specialty Finance Third Quarter 2019 Earnings Conference Call. (Operator Instructions) Please note this conference is being recorded.

I will now turn the conference over to your host, Sloan Bohlen, Investor Relations. You may begin.

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Sloan Bohlen, SOLEBURY TROUT LLC - MD [2]

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Good morning. Last night, we issued our third quarter earnings press release and investor presentation of our quarterly results, a copy of which is available on Bain Capital Specialty Finance's Investor Relations website. Following our remarks today, we will hold a question-and-answer session for analysts and investors. This call is being webcast, and a replay will be available on our website. This call and the webcast are property of Bain Capital Specialty Finance and any unauthorized broadcast in any form is strictly prohibited.

Any forward-looking statements we make today do not guarantee future performance, and actual results may differ materially. These statements are based on current management expectations, which include risks and uncertainties, which are identified in the Risk Factors section of our annual report and Form 10-K that could cause actual results to differ materially from those indicated. Bain Capital Specialty Finance assumes no obligation to update any forward-looking statements at this time unless required to do so by law. Lastly, past performance does not guarantee future results.

And with that, I'd like to turn the call over to our President and Chief Executive Officer, Michael Ewald.

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Michael Alexander Ewald, Bain Capital Specialty Finance, Inc. - President, CEO & Director [3]

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Good morning, and thank you for joining us for our third quarter 2019 earnings call. As Sloan mentioned, my name is Michael Ewald, and I'm joined today by our Vice President and Treasurer, Mike Boyle; and our Chief Financial Officer, Sally Dornaus. I'm going to start with a brief snapshot of the portfolio, and we'll provide some high-level comments on our strategy in the market. Then both Mike and Sally will give some additional detail on the investment book and our results.

At the end of the third quarter, the BCSF portfolio represented $2.5 billion invested across 30 different industries and 126 portfolio companies, with a current weighted average yield of 7.7%. In the quarter, we originated $275 million of new investments and had sales or repayments of $184 million. Excluding the impact of the ABCS balance sheet consolidation in the second quarter, our new originations year-to-date totaled $953 million against sales or repayments of $755 million. As for the makeup of the portfolio, it's relatively unchanged by loan type and industry exposure.

At quarter end, approximately 88% of our portfolio is invested in first dollar risk, and is made up of traditional first lien loans and unitranches. Credit in the portfolio is still very strong, and there remain 0 nonaccruals.

We are again pleased to announce that our Board declared a fourth quarter dividend of $0.41 per share. The quarterly dividend will be payable on January 30, 2020, to stockholders of record on December 31, 2019.

Overall, we remain cautious with regard to credit and believe the portfolio is well positioned for a weakening economy if that eventually occurs. Our portfolio remains overweight in resilient sectors like technology and health care.

Before I discuss what we're seeing in the markets, let me take a moment to speak to our capital structure. As you can see, we ended the quarter with leverage of 1.6x gross debt to equity, but it is 1.5x net of cash. As we continue to operate at the high end of our stated 1 to 1.5x range, we continue to be focused on expanding the core earnings of the company through thoughtful portfolio construction. In short, we continue to believe that the natural rotation of the portfolio into higher spread assets, further expansion of unitranche loans under the ABCS program and access to strategic partnerships and verticals such as our aviation efforts will drive continued earnings growth over the near term. Mike Boyle will expand on this in a bit.

From a market perspective, since the beginning of the year, while we have seen periods of fits and starts, the market has generally remained more subdued versus recent years as evidenced by lower new issue volumes published by various providers. This is particularly evident in the broadly syndicated markets where we have seen the increase in flex pricing, spread widening and general terms and documentation pushback. This is most obvious at the lower end of the credit quality spectrum where there continues to be further bifurcation on who can access the market and at what terms. Such an environment is well suited for an experienced middle-market lender such as ourselves. The ability to remain selective, dictate terms and pricing and work alongside trusted private equity partners who we have seen execute in the past, all the while overlaying our senior secured focus, creates the opportunity to originate high-quality loans.

So without painting an overly rosy picture, this is our way of saying that we continue to find compelling investment opportunities and expect we will be able to continue to execute on our direct lending strategy.

Sally will now provide a more detailed financial review.

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Sally Dee Fassler Dornaus, Bain Capital Specialty Finance, Inc. - CFO [4]

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Thank you, Mike, and good morning, everyone. I'll start the review of our third quarter 2019 results with our income statement. Net investment income for the quarter was $21.2 million or $0.41 per share, which was consistent with the second quarter of 2019. GAAP earnings per share for the 3 months ended September 30, 2019, was $0.35 per share compared to $0.37 per share for the 3 months ended June 30, 2019. The quarter-over-quarter decrease was due to net unrealized depreciation of $3.5 million, offset by net realized gains of $500,000. Total expenses for the quarter, net of waivers, increased sequentially by $2.1 million to approximately $31.5 million in the third quarter compared to $29.4 million in the second quarter. Our expenses increased primarily due to a first full quarter of interest and fee expense associated with our JPMorgan credit facility.

For the 3 months ended September 30, 2019, our management and incentive fees, net of waivers, was $6.3 million and $3.6 million, respectively, compared to a management fee and intended fee net of waivers of $6.4 million and $4.5 million for the 3 months ended June 30, 2019. Similar to last quarter, our adviser voluntarily waived its right to receive a base management fee on the incremental assets associated with the ABCS transaction. In the third quarter, the impact of that voluntary waiver was $1.5 million. In addition, our adviser also voluntarily waived an additional $1.1 million related to management fees. As we have stated in the past and continue to demonstrate, we and our adviser believe that fee waiver aligns with the interest of our shareholders and our commitment to a stable dividend.

Now moving to our balance sheet. As of September 30, our investment portfolio at fair value totaled $2.5 billion. The increase was driven by investments of $275 million, offset by sales and paydowns of $184 million in the quarter. The weighted average portfolio yield was 7.7% compared to 8% in the second quarter. Portfolio yields declined due to the decrease in LIBOR during the quarter. However, overall weighted average portfolio spread increased 8 basis points quarter-over-quarter.

Moving to the right side of the balance sheet, the total net assets were $1 billion as of the end of the third quarter. NAV per share was $19.71 compared to $19.77 in the second quarter due to the net activity losses of $3 million. As of September 30, we had total principal debt outstanding of $1.7 billion, comprised of our Goldman Sachs and JPMorgan credit facilities, along with our 2018-1 and 2019-1 notes. In August, we closed our second middle-market CLO for a total amount of $398.8 million. We priced the AAAs at LIBOR 170 and the total liability stack has a weighted average cost of LIBOR plus 230, maturing in October of 2031. As we've talked about before in relation to our first middle market CLO, this structure works very well through a cycle, given the protection it provides around market volatility.

In conjunction with the 2019-1 issuance, we terminated our $192 million balance drawn on the Citibank facility. This was expected to reset at LIBOR plus 260 in February 2020. Our debt-to-equity ratio was 1.63x in Q3 compared to 1.48x in Q2. Our net leverage ratio, which represents principal debt outstanding less cash, was 1.48x in Q3 compared to 1.35x in Q2.

Finally, we are pleased to announce that our Board declared a fourth quarter dividend of $0.41 per share. The fourth quarter dividend is payable on January 30, 2020, to stockholders of record on December 31, 2019.

Thank you, as always. I will now turn the call over to Mike Boyle, our Vice President and Treasurer, to walk through our investment portfolio and some recent investments in more detail.

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Michael John Boyle, Bain Capital Specialty Finance, Inc. - VP & Treasurer [5]

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Thanks, Sally, and good morning. I'll kick it off with an update on the credit quality of our portfolio and also provide more detail on our originations this quarter. As of September 30, the fair value of our investment portfolio was $2.5 billion diversified across 126 companies operating in 30 industries. 99% of the fair value of these investments is performing in line or ahead of our underwriting case, split between our performance ratings of 1 and 2. We are pleased to report that we have had no nonaccruals since the inception of BCSF in 2016 and have no nonaccruals in the portfolio at the end of the third quarter of 2019.

Our investments are primarily comprised of first lien senior secured loans, which represent 87% of the portfolio. The weighted average yield of investments is 7.7%, median EBITDA is $54 million, with an average leverage level of 5.0x. 87% of our investments contain financial maintenance covenants.

Recently, we have been favoring sectors that should not cycle alongside the macro economy, including high-tech, health care and aerospace and defense. We believe that the sum product of these variables creates a portfolio that is well positioned to withstand any potential market volatility. The defensive nature of our investments is a key consideration in choosing to operate at the high end of our leverage range, which Mike Ewald discussed earlier at 1 to 1.5x.

Shifting to the third quarter origination, we invested $275 million in 10 new portfolio companies over the course of the quarter. The weighted average spread of new investments was LIBOR plus 6% versus exits over the quarter at LIBOR 4.9%. Approximately 20% of our new origination were unitranche loans. One specific example is the unitranche we extended to support the LBO of Ventiv Technology, a provider of risk management software to enterprises and government agencies with the specialization in insurable risk. With strong retention statistics and a clear value proposition, we view this investment as one that will demonstrate resilient performance in a variety of macroeconomic environment. The loan represents a 1% position in the portfolio and is one component of our largest industry exposure, high tech.

Another investment made in Q3 was the first lien loan to Kellstrom, a U.S.-based provider of replacement parts to the airline industry. The company has many of the positive attributes we look for in distributors, operating with a many-to-many model, which includes long-term relationships across multiple stakeholders. On the demand side, they have good forward visibility driven by the size and diversification of the global aircraft fleet. Given our deep understanding of the aviation industry, we were able to lead the financing and provide a value solution.

As Mike mentioned earlier, while the direct lending market is competitive, we continue to believe it is investable and requires a manager with long-term expertise and a proven track record. Looking forward, our pipeline for the fourth quarter has continued to be full and is in line with our demonstrated investment pace that we've shown over the course of 2019.

With that, I'll turn the call back over to Mike for closing remarks.

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Michael Alexander Ewald, Bain Capital Specialty Finance, Inc. - President, CEO & Director [6]

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Thanks, Mike. Before I conclude, I would like to reflect on our first year as a publicly traded business development company as we approach the anniversary of our IPO last November. We have continued to execute on the core middle-market investment strategy we have owned at Bain Capital Credit for over 20 years. On the asset side, we are proud of the portfolio of 126 companies we have built with no nonaccruals inception to date. We are maintaining our cautious view of macroeconomic considerations and are focusing on the senior-most exposure in defensible industries. In addition to our comprehensive diligence work, aided by the greater Bain Capital platform, we spend significant time ensuring we have tight documentation in our transactions and are relevant to driving outcomes by controlling the majority of our tranches.

We continue to look for relevant investment opportunities globally with local teams on the ground. On the liability side, we are looking to match our debt to our assets as best as we can, especially while maintaining competitive pricing and flexibility and ensuring longevity and certainty through moves like issuing middle-market CLOs. Put together, we look to provide an appropriate risk-adjusted return to our shareholders, including ourselves.

As always, I would like to thank our investors for their continued support and all of you for your time today.

Operator, please open the line for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) The first question is from Fin O'Shea of Wells Fargo Securities.

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Finian Patrick O'Shea, Wells Fargo Securities, LLC, Research Division - Associate Analyst [2]

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I have a first one, on your top line yields, you outlined both Mike and Mike, that there -- this has been the plan for some time. You have some lower-yielding assets and plans for expansion into unitranche and specialty or asset-backed finance. Can you talk about sort of in the context of today, with LIBOR down, late cycle concerns, what you think is reasonable or what you intend to push toward near to intermediate term on a top line spread perspective?

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Michael Alexander Ewald, Bain Capital Specialty Finance, Inc. - President, CEO & Director [3]

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Sure. And thanks for the question, Fin. So in the last -- in the third quarter, our originations averaged LIBOR plus 6%, as we were thinking about, just from a coupon perspective. And I think that's a fair characterization of where we're seeing attractive risk return. I think that LIBOR 6% is something that has been in line with our Q4 pipeline, and we are assuming that, that's kind of an average pace for originations going forward when we think about first lien and unitranche loans.

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Michael John Boyle, Bain Capital Specialty Finance, Inc. - VP & Treasurer [4]

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Yes. And Fin, I would just add, you're absolutely right in terms of our thinking about where we are in the economic cycle. So we don't think this is a time to take on unnecessary risks. So while we improved our spend I think it was 8 basis points quarter-over-quarter, I wouldn't expect to see a huge jump there. LIBOR coming down obviously helps from a liability perspective as well.

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Finian Patrick O'Shea, Wells Fargo Securities, LLC, Research Division - Associate Analyst [5]

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Okay. And on the theme you also touched on of pushback in the liquid markets, more demand for documentation, is this impacting, I'd imagine in a positive way. But on any specific front of your strategy would we -- as things are now, is it fair to say you're looking at larger deals? Or is it still -- are you in the camp where those are wobbly for a reason, and you're still going to stick to the core middle market?

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Michael Alexander Ewald, Bain Capital Specialty Finance, Inc. - President, CEO & Director [6]

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Yes. No, our average EBITDA hasn't really changed much. We're at about $54 million for average EBITDA amongst our portfolio of companies. That's pretty consistent. And that's the only segment we like. We've certainly seen some other folks that we -- EBITDA numbers increase. And that's certainly a different strategy, but this is a segment that we've been in for 20-plus years, and it's the segment we like. So I certainly don't see us changing from that perspective.

You're absolutely right, though, we're able to push back a little bit more on things like terms and documentation. So if anything else, we're not as much of an outlier as we have been by demanding covenants and those sorts of things in the vast majority of our deals. So that certainly helps by not having a stake out there as much.

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Operator [7]

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The next question is from Ryan Lynch of KBW.

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Ryan Patrick Lynch, Keefe, Bruyette, & Woods, Inc., Research Division - MD [8]

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Just wanted to comment or get you guys comment on your -- you mentioned a nice pipeline building. You guys had strong portfolio growth in this quarter. You guys are at your leverage target. So can you just talk about how you guys manage that pipeline and growth being at your leverage target? In addition to -- one of the reasons I know that you consolidated the JV under the balance sheet was that you guys are bumping up against your 30% bucket and wanted to continue investing in that fund and having the BDC invest and grow the assets with that relationship. Given that you guys are up against your leverage target, how do you manage that?

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Michael Alexander Ewald, Bain Capital Specialty Finance, Inc. - President, CEO & Director [9]

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Sure. And maybe I'll start, and Mike will jump in. A couple of different questions and answers up in there. Certainly, from a leverage range perspective, we're definitely at the high end of that range. And as we mentioned, it does include some cash. We'd expected some paydowns at the end of the quarter, which had a leaking into Q4. So it was somewhat artificially high from that perspective. As we've said before, we certainly think that the nature of the portfolio being such a senior-focused portfolio does lend itself to, on average, a higher level of leverage than you might see out there. But on the other hand, if you think about our leverage at this point, all of our leverage is actually on the balance sheet. So from a look-through perspective, the number we reported at 1.6% is the number that we have on balance sheet and off balance sheet. So we think overall that, that number is fine.

In terms of the collapsing of the JV, you're absolutely right. We're bumping up against that 30% limit bucket. If you recall, one thing that we do there, we have a pretty active international business as well. And with ABCS, as big as it was, there's about roughly 20% of that 30% bucket. International, therefore, is limited to 10%. So we've seen some pretty interesting opportunities internationally from our teams on the ground in Europe and Australia. And so if you think about our Q3 originations, about 17% of those were international deals that would not have been possible if we've still been limited to a 30% bucket, for example. We think it's a nice way to diversify the risk. And so if we find better opportunities globally, we still utilize this fund structure to take advantage of those.

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Ryan Patrick Lynch, Keefe, Bruyette, & Woods, Inc., Research Division - MD [10]

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Okay. And then you guys waived about $3.3 million in fees this quarter. About $1.5 million was related to you guys kind of the continual waiver from collapsing the JV, but the remainder was just on top of that, I would assume, to support the dividend. You guys have done this in the past. Is your guys own intention to continue waiving fees to the extent necessary in the future in order to support the dividend?

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Michael Alexander Ewald, Bain Capital Specialty Finance, Inc. - President, CEO & Director [11]

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Hard to comment on what we do in the future, but clearly, we have a pretty proven track record of having done that now, certainly, in the last 4 quarters or so that we've been public. So I think it's probably reasonable to assume that, that will be the case going forward as well.

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Operator [12]

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[Operator Instructions) The next question is from Sam Choe of Crédit Suisse.

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HyungJun Choe, Crédit Suisse AG, Research Division - Research Analyst [13]

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I'm on for Doug today. One on credit quality. I know you guys don't have any nonaccrual statuses in the portfolio. But I mean I'm just looking at your investment portfolio rating and the rating 3 bucket had a company enter it. So I'm just wondering if there's any common thread you're seeing with those companies? Or if the concerns are pretty idiosyncratic?

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Michael Alexander Ewald, Bain Capital Specialty Finance, Inc. - President, CEO & Director [14]

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Sure. Thanks for the question. Our -- the risk rating 3s and where we're seeing underperformance had been very idiosyncratic, ranging from a company that overspent on OpEx to another business that was a carve-out that had some customer losses that were unanticipated on the back of the carve out. So as we think about the overall quality of the portfolio, it is still quite strong. And any situation that have been on that performance rating 3 have been idiosyncratic environment at the individual business. I did highlight the average leverage across the whole portfolio is 5.0x. So we're still feeling quite good about average leverage and EBITDA trends across the portfolio.

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HyungJun Choe, Crédit Suisse AG, Research Division - Research Analyst [15]

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Great. And then another one on investment activity. How has that trended in the month of October? If you can comment on that?

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Michael Alexander Ewald, Bain Capital Specialty Finance, Inc. - President, CEO & Director [16]

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Sure. I did comment in my statement that it has been fairly in line with the strong investment activity we've seen over the course of 2019, and I won't give kind of specific guidance there, but it has been a very busy Q4. You will note our Q4 of 2018 was our largest origination quarter since IPO. So we certainly have continued to see a strong pipeline and note that Q4 tends to be a busy quarter in direct lending as many transaction looking to get done before the end of the year.

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Operator [17]

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We have reached the end of the question-and-answer session. I will now turn the call back over to Michael Ewald, President and CEO, for closing remarks.

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Michael Alexander Ewald, Bain Capital Specialty Finance, Inc. - President, CEO & Director [18]

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Great. Thanks a lot, and thanks, everyone, for your time and attention today. We're happy with the performance of the quarter. And again, we're happy to have been public for the past year and look forward to continuing to deliver our news to you in future quarters. Thanks very much.

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Operator [19]

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This concludes today's conference, and you may disconnect your lines at this time. Thank you for your participation.