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Edited Transcript of PLAB earnings conference call or presentation 22-May-19 12:30pm GMT

Q2 2019 Photronics Inc Earnings Call

Brookfield May 23, 2019 (Thomson StreetEvents) -- Edited Transcript of Photronics Inc earnings conference call or presentation Wednesday, May 22, 2019 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* John P. Jordan

Photronics, Inc. - Senior VP & CFO

* Peter S. Kirlin

Photronics, Inc. - CEO & Director

* R. Troy Dewar

Photronics, Inc. - Director of IR

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Conference Call Participants

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* Franco Rafael Granda Penaherrera

D.A. Davidson & Co., Research Division - Research Associate

* J. Ho

Stifel, Nicolaus & Company, Incorporated, Research Division - MD of Technology Sector

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the Photronics Second Quarter Fiscal Year 2019 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded, Wednesday, May 22, 2019.

I would now like to turn the conference over to Troy Dewar, Vice President of Investor Relations. Sir, you may begin.

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R. Troy Dewar, Photronics, Inc. - Director of IR [2]

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Thank you, Ashley. Good morning, everyone. Welcome to our review of Photronics' 2019 second quarter financial results. Joining me this morning are Dr. Peter Kirlin, Chief Executive Officer; John Jordan, Senior Vice President, Chief Financial Officer; and Dr. Christopher Progler, Vice President, Chief Technology Officer and Strategic Planning.

The press release we issued earlier this morning, along with the presentation material which accompanies our remarks, are available on the Investor Relations section of our webpage. Comments made by any participant on today's call may include forward-looking statements that include such words as anticipate, believe, estimate, expect, forecast. These forward-looking statements are based upon a number of risks, uncertainties and other factors that are difficult to predict. Actual results may differ materially from those expressed or implied, and we assume no obligation to update any forward-looking information.

During the course of our discussion, we will refer to certain non-GAAP financial metrics. These numbers are useful for analysts, investors and management to evaluate our ongoing performance. A reconciliation of these metrics to GAAP financial results is provided in our presentation materials.

At this time, I will turn the call over to Peter.

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Peter S. Kirlin, Photronics, Inc. - CEO & Director [3]

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Thank you, Troy, and good morning, everyone. We performed well during our second quarter in the face of a semiconductor industry downturn due to our design-driven business model, a diverse product platform, an advanced suite of technology and resilient customer relationships. In the current industry environment, our customers are introducing new designs as they attempt to attract consumer attention and gain market share in an increasingly crowded competitive landscape. These new designs require new photomasks, which is great for Photronics. Our leadership position in the market enables us to provide these customers with high-quality masks, and to grow revenue despite the current industry slowdown.

On top of this, we are investing to improve capability and increase capacity while ramping 2 new facilities in China. We have placed ourselves in a great position as our performance clearly demonstrates.

Second quarter revenue improved 6% sequentially with growth in both IC and FPD. In IC, high-end memory recovered as anticipated with good demand for NAND and foundry DRAM masks in Asia.

FPD growth was once again led by mobile displays, both AMOLED and LTPS LCD. Excluding our new Hefei facility that is currently ramping production, we continue to run at full capacity as panel producers across Asia preferentially turn to Photronics for their high-end FPD mask needs.

Operating margin improved from the previous quarter as we maintained tight control on costs while ramping 2 new facilities. Margins were off last year's levels, primarily as a result of the start-up activity in China. All of this plus an FX gain in other income, resulted in solid earnings of $0.13 per share.

On our balance sheet, we ended the quarter with $167 million in cash and trimmed our debt to $36 million as we repaid our convertible security. This is significant not only because it reduced our long-term debt but we also lowered our diluted share count. With the significant portion of our China investment complete, we have a great balance sheet to continue investing to create shareholder value, whether by organic growth, strategic M&A or returning cash to shareholders.

For the first half of 2019, we performed in line with our initial expectations for the year. We have achieved year-over-year growth in each of the first 2 quarters. In fact, Photronics has grown year-over-year in the last 7 quarters and I believe we can continue to do this for the remainder of 2019. Margins should improve as we make progress ramping our China factories and begin enjoying profits there by the end of the year.

Our free cash flow should increase once our China facilities are ramped, providing additional options to increase shareholder value. Our performance during this challenging time is due to our design-driven business model, which also benefits from node transitions, and our growing exposure to China, which continues to expand capacity and production of semiconductors and flat panel displays.

Our total revenue in China this quarter was the highest ever, representing 20% -- 26% of our total revenue. In addition, FPD revenue in China set a new record, representing 47% of total FPD sales.

Our China IC customers are developing new products and moving along the path to advanced nodes in both logic and memory. This increases diversity of our product mix and decreases customer concentration as we ship masks to dozens of Chinese producers.

When we announced our Xiamen investment agreement in August of 2016. We mentioned that our largest IC customer had signed an agreement with us that will enable us to operate the plant at breakeven profitability.

Recently, we signed a second long-term purchase agreement with another large customer in China. The business resulting from these 2 agreements, combined with that of dozens of smaller accounts should support the sustainability of our China IC operations. Each of these companies will enjoy varying levels of commercial success. As a result, each will have different levels of long-term mask demand. However, just as repositioning the business has increased the breadth and stability of our revenue stream across Photronics, we expect the growing diversity of the customer base in China will ensure its success over time.

The FPD story is similar. We have 2 customers that signed long-term purchase agreements to support our Hefei investment. But they are not the only customers. And while the overall number of FPD manufacturers in China is fewer than IC due to the nature of the industry, our sales team has built a solid foundation of business, reducing our dependency on any one customer, thereby creating a healthier, more sustainable revenue stream.

China has a growing number of AMOLED panel producers, and we supply masks to all of them. Likewise, we plan to sell G10.5+ masks to every panel manufacturer using this substrate size.

Last month, we celebrated the grand opening of our 2 new facilities in China. During these celebrations, I was once again reminded of our customers' enthusiasm to have a local supply of high-quality photomasks.

Government officials also reiterated their support for our contribution to the local supply chain and industry development. We broke ground in Xiamen just over 2 years ago. And in Hefei, we went from a shovel in the dirt to producing our first mask in less than 18 months. I'm extremely proud of what our team of employees, working with our partners and suppliers, has been able to accomplish in such a short period of time. While our accomplishments in China over the last few years have been remarkable, our work there is not complete. We must finish the set-up and fine-tuning of all the tools and qualify many customers in the new facilities. Beyond these near-term goals, I have challenged our employees and customers to fill our current capacity so we can then increase our investment and provide even more masks for the growing China market.

The expected the return of these investments was already significantly above our historical ROIC. And steps taken to continue to develop the business in China further expands the potential financial returns, which in turn should enable us to fund our long-term growth plans.

Throughout the first half of 2019, we are performing well and in line with our expectations. Equally important, our China facilities are transitioning from the build to the ramp stage as we make the last few adjustments to tools and move forward with customer qualifications.

We are ahead of last year's record revenue and I'm optimistic that we will set a new record this year. This will keep us on track to deliver on our 2020 targets of $630 million revenue and $0.80 EPS. I am pleased with what we have done and excited to see what we will be able to achieve.

Before I turn the call over to John, I would like to point out for those of you who do not know it, that this is Photronics 50th year in the mask business, our golden anniversary. We started in a storefront, down the street from National Semiconductor's start-up facility in Danbury, Connecticut.

Today, we are the largest merchant mask manufacturer in the world. We have survived numerous economic downturns and navigated industry consolidation to establish our leadership position. Through it all, we have always focused on being the low-cost producer while providing outstanding customer service. This approach has served us well in the U.S, Europe, Korea and Taiwan. We now carry our banner to China and I am confident that we will realize the same success there. I thank everyone, employees, customers, suppliers, partners for their support and allowing us to reach this milestone. I look forward with much enthusiasm to see what we can accomplish together.

At this time, I will turn the call over to John to provide commentary on our performance and outlook.

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John P. Jordan, Photronics, Inc. - Senior VP & CFO [4]

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Thank you, Peter. Good morning, everyone. Second quarter revenue of $131.6 million was a 6% sequential improvement and 1% better than the same quarter last year.

FPD recorded double-digit growth rates when compared with both previous periods while IC was moderately better than last quarter and moderately lower than last year.

High-end IC was the largest contributor to sequential growth, improving $3.8 million or 11% over the first quarter, thanks to the recovery in memory orders, which we anticipated.

Both logic and memory were off the very strong levels of last year. There are still some sectors where demand remains tepid and resolution to the trade issues between the U.S. and China seem to have been pushed out further into the future.

Both -- but our customer relationships, long-term purchase agreements and China market share provide reason for optimism on the IC outlook.

Overall, we're cautiously optimistic and look for demand to be stable to improving.

FPD performed exceptionally well with displays for mobile applications once again leading the way. High-end FPD, comprised mostly of AMOLED masks today, continues to be strong in both Korea and China and improved 7% quarter-over-quarter and 26% year-over-year.

Our technology for these products is excellent and as AMOLED is used in more smartphones and in new applications, we are well positioned to grow with this sector.

In mainstream, mobile displays are also the driver for growth as LTPS LCD demand improved.

Looking forward, we expect demand for mobile applications to remain robust, and we anticipate shipping more G10.5+ masks as we are able to complete additional qualifications in our new facility in Hefei, China.

Gross margin was 19.8%, reflecting the impact of China start-up activity and unfavorable mix. China start-up also impacted operating profit but lower operating expenses in our other operations and some qualification activity from the first quarter was completed, resulted in operating margin of 7%, somewhat better than the first quarter.

Below the operating line, other income is primarily comprised of foreign exchange gain. Minority interest is our partner's share of the income in Taiwan partially offset by their share of the loss in Xiamen. The bottom line, net income attributable to Photronics, Inc. shareholders is $8.5 million or $0.13 per diluted share.

Operating cash turned positive with lower prepaid VAT for tools delivered into China and without many of the timing issues related to our fiscal year-end payments and collections that affected Q1.

Operating cash was $17 million for the quarter. CapEx in Q2 was $33.5 million, somewhat less than our Q1 commentary suggested due to rescheduling payments and not a change in project schedule. Year-to-date CapEx was $140 million and we still expect full year CapEx to be approximately $210 million.

We repaid $61.2 million of debt in the quarter, primarily for the $57.5 million convertible securities that matured on April 1 and eliminated 5.5 million potentially diluted shares -- dilutive shares. When combined with the previous repayment of convertible debt in April 2016, $10.4 million potentially dilutive shares have been eliminated over the last 3 years.

As we have previously reported, we also repurchased 3.7 million shares beginning in July 2018. In total, 14.1 million shares or 18% of dilutive or potentially dilutive shares have been eliminated since 2016.

As a result of this latest debt repayment, strong operations and additional actions we've taken over the last several years, our balance sheet is solid. Just over 5 years ago, we had debt of $194 million, including $137 million in convertible senior notes and net cash of $22 million.

Since that time, we have eliminated all the converts and we now have $36 million in long-term debt comprised entirely of interest-subsidized local borrowings in Xiamen used to finance that project. Repayment of those loans is expected to be made with operating cash anticipated to be generated in Xiamen.

Before I provide third quarter guidance, I'll reiterate the reminder that our visibility is always limited as our backlog is typically only 1 to 2 weeks and demand for some of our products is inherently uneven and difficult to predict. Additionally, the ASPs for high-end mask sets are high and as this segment of the business grows a relatively low number of high-end orders can have a significant impact on our revenue and earnings for a quarter.

Given those caveats, we expect third quarter revenue to be in the range of [$132 million to $142 million] (corrected by the company after the call). This assumes that our IC markets will be stable to improving and FPD will remain near full capacity.

We also anticipate a larger contribution from the ramp of our China facilities, especially FPD. I will also caution that any development from the ongoing trade discussions between the U.S. and China could potentially have an adverse impact on our industry, and therefore, our results.

Based on this revenue expectation and our current operating model, we estimate earnings for the third quarter to be in the range of [$0.05 to $0.14] (corrected by the company after the call) per diluted share, including approximately $0.03 to $0.06 per diluted share net negative impact from China start-up operations.

Through the first half of 2019, we have been performing in line with our expectations. Revenue is up and bottom line results reflect the headwinds inherent in starting up 2 new facilities.

Our balance sheet is in great shape, and we're well positioned to achieve sequential growth throughout the rest of the year as our demand grows and we ramp production in China.

We expect this will improve cash generation, and enable us to further invest in organic growth, be open to strategic M&A opportunities and potentially return more cash to shareholders.

I will now turn the call over to the operator for your questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from the line of Tom Diffely with D.A. Davidson.

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Franco Rafael Granda Penaherrera, D.A. Davidson & Co., Research Division - Research Associate [2]

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This is actually Franco in for Tom. First from us, could you quantify the headwinds that you've seen from China in terms of like the macro headwinds and just compared to your guide?

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R. Troy Dewar, Photronics, Inc. - Director of IR [3]

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Yes. Franco, I think on the slide we talked about the operating profit impact from China was about $4.1 million. I think when you go down to the bottom line, it's about $0.04 a share.

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Peter S. Kirlin, Photronics, Inc. - CEO & Director [4]

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And as far as the business goes for overall revenue and FPD revenue, China set records in the quarter so I wouldn't describe the market as a headwind, but clearly, the start-up costs affect the bottom line.

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Franco Rafael Granda Penaherrera, D.A. Davidson & Co., Research Division - Research Associate [5]

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Okay. And then from that, I guess you just announced the new long-term purchase agreement in China for your IC fab. After you fulfill this contract, at what percentage of the capacity would you be running at?

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Peter S. Kirlin, Photronics, Inc. - CEO & Director [6]

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Well, I think the way I would answer that question is, this new contract is with another large foundry customer in China. Their right now run rate is actually larger than the run rate with the original customer we signed the first contract with. So although we won't specifically divulge the exact capacity, with that extra contract, we're very confident we can ramp that facility to profitability quickly. So we now have 2 large anchors instead of just 1, just as we have in FPD.

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Franco Rafael Granda Penaherrera, D.A. Davidson & Co., Research Division - Research Associate [7]

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Yes. Okay. Sounds good. And then do you still expect to get full capacity in the FPD fab at the end of the year?

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R. Troy Dewar, Photronics, Inc. - Director of IR [8]

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Do we still expect full capacity in FPD at the end of the year?

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Peter S. Kirlin, Photronics, Inc. - CEO & Director [9]

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Yes. We're still -- we still expect to drive to full loading as we exit the year. As we remarked, we shipped our first G10.5 mask in the current -- or in the prior quarter in Q2 at the -- in the month of April and this quarter's mix will be a mix of our qualifications and commercial business, shifting as we go through the quarter. And the fourth quarter, if we continue to stick to our plans, certainly by the time we hit mid-quarter, we should be through all the qualification work and flat out commercial volume.

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Franco Rafael Granda Penaherrera, D.A. Davidson & Co., Research Division - Research Associate [10]

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Okay. Very helpful. And then final from us, you had previously mentioned that the qualification for the high-end IC was between 9 to 12 months. One, is this still the case? And then two, how does that compare to FPD?

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Peter S. Kirlin, Photronics, Inc. - CEO & Director [11]

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Yes, that's certainly true for high-end IC. As far as FPD is concerned, qualifications usually run about -- they're typically concluded in a quarter. So once we start, it's anywhere from 30 to 90 days to completion. So FPD is much shorter and that's why we can ramp the factory to full volume much quicker.

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Operator [12]

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(Operator Instructions) And our next question comes from the line of Patrick Ho with Stifel.

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J. Ho, Stifel, Nicolaus & Company, Incorporated, Research Division - MD of Technology Sector [13]

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Peter, maybe first off, in terms of the IC qualifications in China, you mentioned that you added on a second customer. Is it fair to say that the bias right now in terms of qualifications with other potential customer is more foundry logic base or is there a good mix between memory and foundry logic?

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Peter S. Kirlin, Photronics, Inc. - CEO & Director [14]

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It's weighted, Patrick, to logic and foundry logic. But there is a growing -- our memory, as you heard in my prepared remarks, that our memory business in China is building, I guess, and it's a mix of very large international companies with facilities in China and domestic China manufacturers. So it's both. But still weighted to foundry logic.

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J. Ho, Stifel, Nicolaus & Company, Incorporated, Research Division - MD of Technology Sector [15]

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Great. That's helpful. And maybe as my follow-up question on the display side of things. From a CapEx perspective this year in 2019, China seems to be a little more weighted towards the Gen 10.5 versus AMOLED. So you obviously did very well in getting good revenues on the AMOLED side of things. As 2019 progresses and even to 2020, how do you see the growth forecast for the Gen 10.5, given that that's where, I guess, the local Chinese vendors are least focused this year?

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Peter S. Kirlin, Photronics, Inc. - CEO & Director [16]

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Yes. So as we sit here today, there are 2 Gen 10.5 factories in volume manufacturing in China. A third one will start -- so the reticle set -- the first reticle set for the third factory will be purchased within the Q3, and the fourth, we expect to see a reticle set purchased, oh, I don't know, by around the end of the calendar year. And then the fifth will clearly be in the first half of next calendar year. So by the end -- a year from now, the overall capacity in China and demand for G10.5 will have doubled. And by the end of next calendar year, it will have gone up by a factor of 2.5. So yes, the market there for G10.5 is really hitting its sweet spot. This is one of the reasons why we drove so hard to get that Hefei factory built and ready to run reticles to hit the sweet spot of the growth curve in the market. As far as AMOLED goes, you can see from our current financial results that we're doing quite well, that almost half of our FPD business is in China and it's heavily weighted to AMOLED.

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J. Ho, Stifel, Nicolaus & Company, Incorporated, Research Division - MD of Technology Sector [17]

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Great. And final question from me, maybe for John in terms of the headwinds from China. I understand the start-up costs and the ramp there. Given that you had a really good quarter on the OpEx side of things, are all the remaining, I guess, headwinds and I guess start-up and ramp costs, is that all going to come out of the cost of goods and that's where we'll see the leverage as 2019 progresses and go into 2020?

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John P. Jordan, Photronics, Inc. - Senior VP & CFO [18]

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We have OpEx in China as well, Patrick. So we see cost of goods and OpEx running at -- OpEx running at a similar level for next quarter, cost of goods obviously varying with the level of business.

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Peter S. Kirlin, Photronics, Inc. - CEO & Director [19]

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But I think you're right, Patrick. Our OpEx expenses should be pretty stable in China. They do go up and down quarter-to-quarter. And most of the swing is driven by R&D expenses so they can move around. But as I mentioned, we have a death grip on the operating expenses to the extent we can control them.

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John P. Jordan, Photronics, Inc. - Senior VP & CFO [20]

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And as the revenue increases and we start actually shipping more, the tools that are there will be depreciated as well. So cost of goods will increase with the depreciation and amortization as well as the cost of the goods that are produced.

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Operator [21]

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And ladies and gentlemen, there are no further questions at this time. I would now like to turn the call over to Peter Kirlin for closing comments.

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Peter S. Kirlin, Photronics, Inc. - CEO & Director [22]

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Thank you for your time this morning. 2019 is shaping up to be a great year for Photronics, and we look forward to updating you as we move forward.

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Operator [23]

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Ladies and gentlemen, that concludes the conference call for today. We thank you for your participation and ask you that you please disconnect your lines.