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Edited Transcript of NBN earnings conference call or presentation 29-Jan-19 3:00pm GMT

Q2 2019 Northeast Bancorp Earnings Call

Lewiston Feb 11, 2019 (Thomson StreetEvents) -- Edited Transcript of Northeast Bancorp earnings conference call or presentation Tuesday, January 29, 2019 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Jean-Pierre L. Lapointe

Northeast Bancorp - CFO & Treasurer

* Richard N. Wayne

Northeast Bancorp - President, CEO & Director

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Conference Call Participants

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* Justin Frank Crowley

Sandler O'Neill + Partners, L.P., Research Division - Associate

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Presentation

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Operator [1]

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Good day, everyone, and welcome to the Northeast Bancorp Fiscal Year 2019 Second Quarter Earnings Results Conference Call.

This call is being recorded. With us today from the company is Rick Wayne, President and Chief Executive Officer; and JP Lapointe, Chief Financial Officer.

Earlier this morning, an investor presentation was uploaded to the company's website, which we will reference in this morning's call. The presentation can be accessed at the Investor Relations section at northeastbank.com under Events and Presentations.

You may find it helpful to download this investor presentation and follow along during the call. Also, this call will be available for rebroadcast on the website for future use. The question-and-answer session for this call will be conducted electronically, following the presentation. Please note that this presentation contains forward-looking statements about Northeast Bancorp. Forward-looking statements are based upon the current expectations of Northeast Bancorp's management and are subject to the risk and uncertainties.

Actual results may differ materially from those discussed in the forward-looking statements. Northeast Bancorp does not undertake any obligation to update any forward-looking statements.

At this time, I would like to turn the call over to Rick Wayne. Please go ahead, sir.

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Richard N. Wayne, Northeast Bancorp - President, CEO & Director [2]

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Good morning, and thank you all for joining us today. I am Rick Wayne, the Chief Executive Officer of Northeast Bancorp, and with me on the call is JP Lapointe, our Chief Financial Officer.

Before we discuss our financial results, I would like to discuss the proposed reorganization announced in our press release issued on January 7. Under the proposed reorganization, Northeast Bancorp would merge into Northeast Bank, with the bank continuing as the surviving entity.

Shares of Northeast Bank's common stock are expected to be owned directly by Northeast Bancorp shareholders in the same proportion as their ownership of Northeast Bancorp immediately before the organization.

The board and the executive officers of Northeast Bancorp will hold the same positions in Northeast Bank following the reorganization. The reorganization requires both regulatory and shareholder approval. If completed, this transaction will improve our efficiency by eliminating redundant corporate infrastructure and activities as well as removing a second level of supervision and oversight that comes with our holding company.

Accordingly, our commitments to the Federal Reserve will no longer be applicable and will be replaced with internal standards to ensure the bank continues to operate in a safe and sound manner, but will allow for more growth of our loan portfolio and more diverse and cost-effective funding sources.

I believe this is a very positive transaction for our company and is in the best interest -- in our best interest to allow us to increase loan production, while decreasing the cost associated with maintaining a certain level of deposits and excess cash.

Now moving on to the financial matters. For the second quarter of fiscal 2019, after the close of the market yesterday, we announced quarterly net income of $5.1 million or $0.56 per diluted common share. Earnings were positively affected by strong loan growth in the LASG portfolio of $58.1 million or 8% over the linked quarter, and transactional income of $2.1 million. This quarterly activity helped us achieve a return on average equity of 13.9%, a return on average assets of 1.7% and an efficiency ratio of 57.6%.

Turning to Slide 3. During the second quarter, bank-wide, we generated $135.1 million of loans, including $113.5 million in our loan acquisition group or LASG. LASG loan production included $64.1 million of originated loans and $49.4 million of purchased loans. Of the $64.1 million of originated loans, 92% were variable rate with a weighted average yield of 7.58% on December 31.

Additionally, we generated $13.8 million of loans in our SBA division, $7.1 million of which were loans secured by hotels, demonstrating the continued build-out of the SBA hotel vertical. We generated a net gain of $942,000 on the sale of $12.8 million of SBA loans.

Net interest margin for the quarter was 5.3%, and our total return on purchased loans for the quarter was 10.3%, which included $2.1 million of transactional income.

Turning to Slide 4. As we have discussed in the past, under a regulatory commitment made in conjunction with the 2010 merger, purchased loans are limited to 40% of total loans. Loan purchasing capacity decreased to $75.7 million as of December 31, as a result of growth in the LASG purchased portfolio during the quarter.

Loan purchasing capacity increases or decreases depending upon the relative amount of purchased and originated loans on our balance sheet at any given point in time. If the reorganization is completed as contemplated, purchased loans could constitute 60% of total loans rather than the current limit of 40%.

Additionally, on Slide 5, under another regulatory commitment, nonowner occupied commercial real estate loans are limited to 300% of total capital. As of December 31, capacity under this condition was $102.8 million. Again, if the reorganization is completed as contemplated, the 300% limit would no longer apply, but rather the bank's real estate concentration risk would be evaluated by bank regulators in the normal course of their examination.

Moving on to Slide 6. Of the $113.5 million invested by LASG for the quarter, $49.4 million were purchased loans and $64.1 million were originated loans. Purchased loans for the quarter have unpaid principal balances of $52.7 million, representing a purchase price of 93.7%.

As frequently mentioned in these calls, loan purchasing is transactional and can vary, and sometime significantly from quarter-to-quarter. Since the merger in 2010, LASG has invested an aggregate of $1.8 billion, consisting of approximately $810 million of purchased loans and approximately $944 million of originated loans.

During the past quarter, we reviewed loans with approximately $600 million of unpaid principal balances and bid on loans with $166.6 million of unpaid principal balances. Subsequently, we purchased loans with unpaid principal balances of $52.7 million at 93.7% or $49.4 million invested. The $49.4 million invested consisted of 128 loans in 10 separate transactions.

As I've said before, we remain disciplined in our selection, underwriting and bidding on loan pools and focused on building a quality portfolio.

Moving on to Slide 7. At the end of the quarter, the discount on purchased loans was $37.7 million as compared to $36.4 million as of September 30. The change is primarily due to $49.4 million of purchases with a related $3.3 million of discount, offset by regularly scheduled accretion as well as purchased loan payoffs and pay downs during the quarter.

Purchased loan payoffs generated $2.1 million of transactional income, approximately 85% of the $37.7 million discount is expected to be realized over the remaining life of the purchased loans through scheduled accretion.

The nonaccretable portion of the discount represents contractual cash flows that in our estimation may not be collectible.

Turning to Slide 8. We provide detail on returns from the LASG portfolio. For the quarter, the purchased portfolio generated a total return of 10.3%, reflecting transactional income of $2.1 million from unscheduled loan payoffs and sales, which was in line with the average of $1.9 million of transactional income for the prior 4 quarters, but below the weighted average return of 11% for the prior 4 quarters.

As we have discussed in the past, transactional income realized on the purchased portfolio as well as the amount of loans purchased may not be consistent from quarter-to-quarter.

The LASG originated portfolio generated a strong return of 7.6% in the quarter.

Turning to Slide 9. We provide statistics on the LASG loan portfolio as of December 31. Of significance, as noted in the chart in the top right, the purchased loan portfolio has a net investment basis of 90%, a slight increase over the linked quarter.

On an invested basis, the average loan size for purchased loans is $400,000 and the average loan size for originated loans is approximately $2 million, with 84% of the purchased and originated portfolio consisting of loans with an investment size of less than $6 million. The loan portfolio has a diverse collateral type, focused on retail and mixed use, industrial hospitality, multifamily and office.

By geography, the largest concentrations are in California and New York, with 18% and 13% of the portfolio, respectively.

Our collateral is geographically diverse with collateral in 42 states.

Turning to Slide 10. One of the benefits of the SBA program is the ability to sell the guaranteed portion of the loan at a premium. For a variety of reasons, SBA loans closed in one quarter are sold in a subsequent quarter.

In the current quarter, we closed $13.8 million of SBA loans, of which $13.1 million was funded. Additionally, the company sold $12.8 million of the guaranteed portion of SBA loans in the secondary market, of which $7.6 million were originated in the current quarter and $5.2 million were originated in prior quarters.

For the quarter ending December 31, the net gain on sale, including capitalized servicing, was $942,000.

On Slide 11, we show the detail of the SBA pipeline as it stands at December 31. The bank holds $289,000 in SBA loans held for sale, which represents the guaranteed portion of SBA loans, which have closed and are fully funded as of quarter-end.

There is also an additional $11.4 million in the guaranteed portion of SBA loans that have closed and will be fully funded in subsequent quarters.

In total, this represents an additional $11.7 million in future SBA guaranteed loan sales before considering any loan production in future quarters.

And now I would like to turn it over to JP, who will discuss in more detail our financial results, after which we will be happy to answer your questions. JP?

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Jean-Pierre L. Lapointe, Northeast Bancorp - CFO & Treasurer [3]

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Thanks, Rick, and good morning, everyone. I'm picking up on Slide 12 to provide more information on our financial results. Net income for the quarter was $5.1 million or $0.56 per diluted common share.

Diluted earnings per share were up $0.07 from the quarter ended September 30, 2018, which I shall refer to as the linked quarter, and up $0.20 from the quarter ended December 31, 2017, which I shall refer to as the comparable prior year quarter.

The increase of $0.07 per diluted common share from the linked quarter was due to higher interest income, which amounted to $20.3 million in the current quarter compared to $18.8 million in the linked quarter as a result of higher transactional income as well as higher average balances in the LASG portfolio. This was offset by higher interest expense of $4.7 million in the current quarter compared to $4.4 million in the linked quarter as a result of higher funding cost and higher average deposit balances required to fund loan originations.

Noninterest expense increased by $548,000 compared to the linked quarter due to higher salary and employee benefit cost, higher professional and data processing fees and higher loan acquisition and collection expenses, offset by lower occupancy and equipment expense. Additionally, the effective tax rate for the quarter was 28.7% compared to 24.8% in the linked quarter. The increase was primarily due to a $178,000 decrease in tax benefits from vested restricted stock awards and stock option exercises as compared to the linked quarter.

The increase from the comparable prior year quarter of $0.20 per diluted common share was due to an increase in interest income of $5.1 million due to an increase in average balances on loans and higher rates earned as well as an increase in transactional income.

Additionally, there was an increase in noninterest income of $317,000, mostly due to increased gains on the sale of SBA loans, offset by lower gains on the sale of residential loans and lower commercial loan servicing fees. These were offset by higher deposit funding cost, which increased by $1.9 million due to increased rates offered in higher average interest-bearing deposit balances, and an increase in noninterest expense of $1.3 million, primarily due to increased salary and employee benefit cost, increased professional fees related to the pending reorganization, increased loan acquisition and collection expenses incurred as a result of the increased SBA purchased loan activity and an increase in other noninterest expense from the quarterly valuation of servicing rights, which had a $110,000 recovery in the comparable prior year quarter compared to a $31,000 impairment charge in the current quarter.

Turning to Slide 13. Over the past year, we have seen net loan portfolio growth, $164.1 million or 21%. The majority of the growth over the last 12 months comes from our LASG portfolio with $444.5 million of purchases and originations. As shown in the chart, in the trailing 12-month period, we have closed $65.5 million of SBA loans and sold $41.8 million of the guaranteed portion of these loans into the secondary market. While bank-wide loan production has been strong over the trailing 12 months, increases have been significantly offset by pay downs and amortization in the purchased and originated portfolios, which amounted to $302.7 million over the trailing 12 months.

These results are further detailed on Slide 14, which shows the composition of the loan portfolio over the most recent 5 quarters. The net loan growth over this time is primarily driven by the strength of the LASG portfolio, which had net loan growth of $176 million or 30% since December 31, 2017. In the current quarter, LASG originated $64.1 million of loans and purchased loans with a recorded investment amounting to $49.4 million.

Turning to Slide 15. In order to fund loan growth, we have had net deposit growth of $137 million or 16% over the trailing 12-month period. Over the past year, time deposits have seen growth, while all other types have been flat or have seen slight decreases. Our nonmaturity accounts, which include money market, savings and demand deposit products as a percent of total deposits has decreased but remains high at 53% as of December 31, 2018, as compared to 63% as of December 31, 2017.

Slide 16 shows trends in the main components of our income. Compared to the linked quarter, base net interest income increased $668,000 due to higher average balances in the LASG and SBA portfolios, along with higher rates earned on our loans as the majority of our LASG originated and SBA portfolios are tied to prime rate. Base interest income increased $946,000, due to the increase in the average balance of the LASG and SBA portfolios and the increase in prime rate, which was then offset by increased funding cost, which increased $278,000 from the linked quarter.

Transactional interest income from the purchased loan portfolio increased by $616,000 compared to linked quarter. The purchased portfolio had a return of 10.3% in the current quarter compared to 9.5% in the linked quarter. The increase in net interest income from the comparable prior year quarter is largely attributable to an increase in base net interest income of $3 million due to higher average balances in the LASG portfolio and higher rates earned on the loans in this portfolio, with an increase of $200,000 in transactional interest income from the purchased portfolio.

The 10.3% return on the purchased portfolio in the current quarter is down from 11% in the comparable prior year quarter due to lower average balances in the comparable prior year quarter with similar transactional interest income amounts. The lower purchased loan yield was more than offset by the higher average balances in the current quarter as compared to the comparable prior year quarter. Compared to the prior year quarter, base interest income increased $4.9 million, while funding costs increased $1.9 million.

Noninterest income decreased by $9,000 over the linked quarter, primarily due to the $152,000 decrease in commercial loan servicing fees as a result of the write off of servicing assets related to SBA loans that paid off and a decrease of $70,000 in the gain on sale of residential loans, offset by a $91,000 increase in the gain on sale of SBA loans and the $90,000 increase in the gain on equity securities compared to the linked quarter.

Noninterest income is up $317,000 from the comparable prior year quarter, primarily due to an increase in the gain on the sales of SBA loans of $601,000 due to more sales volume in the current quarter, offset by a decrease of $135,000 in commercial loan servicing fees as a result of the write off of servicing assets related to SBA loans that paid off and a decrease in the gain on the sale of residential loans of $151,000 due to lower volumes sold in the current quarter.

These results are further detailed on Slide 17, which shows trends in revenue and noninterest expense over the past 5 quarters. Compared to the linked quarter, total revenue has increased by $1.3 million due to the increase in net interest income. Additionally, noninterest expense increased by $548,000 from the linked quarter, primarily due to higher salary and employee benefit cost, higher professional and data processing fees and higher loan acquisition and collection expense, offset by lower occupancy and equipment expense. Total revenue has helped us achieve an annualized return on average equity of 13.9%, the return on average assets of 1.7%, along with an efficiency ratio of 57.6% in the current quarter. Compared to the comparable prior year quarter, total revenue has increased by $3.5 million, while noninterest expense has increased by $1.3 million.

The increase in revenue is primarily due to an increase in base net interest income due to higher average balances and rates earned in the LASG and SBA portfolios. The increase in noninterest expense compared to the comparable prior year quarter is primarily due to a $526,000 increase in compensation expense due to increased base salaries and benefits, stock-based compensation and employee incentive compensation. A $231,000 increase in professional fees, of which $200,000 is due to the increased cost related to the pending reorganization and a $217,000 increase in loan acquisition and collection expenses incurred as a result of the increased SBA and purchased loan activity. A $200,000 increase in data processing fees due to IT improvements and a $292,000 increase in other noninterest expense related to an increase in impairment of other servicing assets, of which a $110,000 recovery in the comparable prior year quarter was recorded compared to a $31,000 impairment charge in the current quarter.

These increases were partially offset by a decrease in occupancy and equipment expense of $192,000.

Slide 18 provides additional information on trends and yields, average balances and our net interest margin, which was 5.33% in the current quarter as compared to 4.93% in both the linked quarter and the comparable prior year quarter.

As previously discussed, the net interest margin, which increased from the linked quarter, is largely driven by an increase in net interest income from higher rates and average balances in the loan portfolio.

The average balance of loans for the current quarter was $910 million as compared to $894 million in the linked quarter and $761 million in the comparable prior year quarter, primarily due to growth in the LASG originated and purchased portfolios.

Slide 19 provides a snapshot of our asset quality metrics. Compared to the linked quarter, nonperforming loans to total loans has increased to 1.32% from 1.3%, and nonperforming assets to total assets has increased to 1.16% from 1.08%. These metrics have also both decreased compared to June 30, 2018 and 2017.

In the top right-hand corner, classified commercial loans were $9.9 million as of December 31, 2018, an increase from $8.9 million in the linked quarter.

Finally, as noted in the chart on the bottom right-hand corner of this slide, annualized net charge-offs to average balance -- average loan balances have remained at very low levels over the past several years and were 4 basis points in the current quarter consistent with the linked quarter. Our allowance coverage appears appropriate to address the risk inherent in our loan portfolio with a slight decrease in the allowance coverage, which is primarily due to a decrease in specific reserves on impaired loans and the change in the composition of the loan portfolio from a decrease in SBA loans as a percent of total loans outstanding.

That concludes our prepared remarks. At this time, we would like to open up the call to Q&A.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Alexander Twerdahl of Sandler O'Neill Partners.

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Justin Frank Crowley, Sandler O'Neill + Partners, L.P., Research Division - Associate [2]

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It's actually Justin Crowley on for Alex this morning. So first off, assuming that the reorganization is completed do you guys expect your pricing thresholds for purchased loans to change at all now that the purchased loan portfolio can be a bigger slice of the overall pie? And then secondly, how quickly do you think that the portfolio could conceivably approach the new 60% of loans level?

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Richard N. Wayne, Northeast Bancorp - President, CEO & Director [3]

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As to the first question, I would expect that we could price more competitively, and hopefully win more purchased loans if we can hold a bigger percentage of those on our balance sheet because even at a lower yield in purchased loans, it's higher than the yield on originated loans. And as you know it, an average of 7.6% on original, even that's a good number. So the answer to your question is, yes. The -- with respect to the second question, it's hard to say. You know we have to look at what the opportunities are. If you think about a spectrum, the world continues as it is now, we buy our fair share in round numbers, over the last 7 years or so, we've kind of bought $100 million, $110 million a year, I think that's a reasonable assumption going forward. If the real estate market changes and the supply-demand ratio changes and there's more opportunities to buy, then we would take a look at that. So it really depends on what's available in the market.

We like our originated business a lot. We, as indicated, get very good pricing on it. It's -- 92% of it's floating. It's building relationships with customers. We have no interest in abandoning that and becoming a total purchase shop, but if there were good purchase opportunities, we would buy more.

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Justin Frank Crowley, Sandler O'Neill + Partners, L.P., Research Division - Associate [4]

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Okay, great. That all makes sense. I appreciate the detail there. And then so my next question was on SBA lending. Were originations here at all impacted by the government shutdown?

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Richard N. Wayne, Northeast Bancorp - President, CEO & Director [5]

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No. the shutdown was mostly in the current quarter. I would use this as an opportunity to point out that the SBA business on the originated, it's very competitive, and the volume we did this quarter at a little bit less than $14 million, we weren't thrilled with. But there are a lot of lenders out there doing SBA lending. And while we see plenty, particularly, a lot in the hotel space, we're not going to put on loans just to do volume. And so as -- that sounds a little bit like I'm getting on a pedestal. Presumably, credible banks think the same way, but it was a tough quarter for originating, but we don't have the shutdown to blame for it.

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Justin Frank Crowley, Sandler O'Neill + Partners, L.P., Research Division - Associate [6]

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Okay, great. That's helpful. And then also, have you guys seen any shift in demand for the LASG originated loan product just as rates have been on the rise?

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Richard N. Wayne, Northeast Bancorp - President, CEO & Director [7]

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No. We have -- we had a strong volume of $64 million of originated at, our pipeline is strong. We have the opportunities to grow that. We have a -- the customers that we have, which is a fair number, based on our in-house and legal lending limits, we have the ability to lend them more. We're out trying to develop new customers with more effort put into marketing and meetings and all the things one would do for business development. There seems to be a lot of interest in this because as you may remember, and I will say it to remind anyone on the call that doesn't know it, the niche that we have found in this area are lending money, particularly, in the nonbank lending space to borrowers that are too small for big banks and the kind of what they're doing is not what most smaller banks would be doing with sometimes collateral in different states or sometimes different regions.

And it's -- we, as a national lender with a lot of experience, and also a lot of experience purchasing loans working by deadlines and a great team to evaluate all this, I think our borrowers recognize that we're a very good fit for a lot of them. And it gives them the ability to leverage their loans to take what might be a -- if they're lending money at a 10, and these are just very rough numbers, and we loan them 70% of their number -- of their loan. They may have the ability on the 30% they keep in between the points and the leverage, to wind up making a '17 or an '18 and there's a lot of interest in that. So I would say, your question in a shift -- I would say that demand is strong and I expect it to get stronger with that. I'm going to remind everybody, we have a forward-looking statement here, the world could change, but that's what we see as of this date.

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Operator [8]

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(Operator Instructions) Now I would like to turn the call back over to Rick Wayne for closing remarks.

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Richard N. Wayne, Northeast Bancorp - President, CEO & Director [9]

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Thank you, and thank you all of you for listening and from time to time giving us your input. We try and make these calls as informative as possible, providing as much transparency as possible into our company so that you can evaluate us and understand what we're doing. And kind of the highlight -- we think this was a very, very strong quarter as JP described in great detail. Again, thank you for your support. We will keep you posted on our reorganization, if we have any news to report as it goes through the process and look forward to talking to you at the end of the -- this quarter we're in now. So thank you all.

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Operator [10]

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Ladies and gentleman, thank you for participating in today's conference. This concludes today's program. You may all disconnect. Everyone, have a great day.