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Edited Transcript of SFE earnings conference call or presentation 27-Apr-17 1:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 Safeguard Scientifics Inc Earnings Call

Wayne May 4, 2017 (Thomson StreetEvents) -- Edited Transcript of Safeguard Scientifics Inc earnings conference call or presentation Thursday, April 27, 2017 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Jeffrey B. McGroarty

Safeguard Scientifics, Inc. - CFO and SVP

* John E. Shave

Safeguard Scientifics, Inc. - SVP of IR and Corporate Communications

* Stephen T. Zarrilli

Safeguard Scientifics, Inc. - CEO, President and Director

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Conference Call Participants

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* Carolina Ibanez-Ventoso

Janney Montgomery Scott - Equity Research Analyst

* James Robert MacDonald

First Analysis Securities Corporation, Research Division - MD

* Kevin Latta

Stonegate Capital - Investment Banking Associate

* Robert Labick

CJS Securities, Inc. - Senior MD of Research

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Presentation

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Operator [1]

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Good morning, and welcome to Safeguard Scientifics First Quarter 2017 Financial Results Conference Call. (Operator Instructions) Thank you, I would now like to turn the conference over to John Shave, Senior Vice President, Investor Relations and Corporate Communications. Please go ahead.

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John E. Shave, Safeguard Scientifics, Inc. - SVP of IR and Corporate Communications [2]

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Good morning, and thank you for joining us for this update on Safeguard Scientifics First Quarter 2017 Financial Results. Joining me on today's conference call and webcast are Steve Zarrilli, Safeguard's President and CEO; and Jeff McGroarty, Safeguard's Senior Vice President and CFO.

During today's call, Steve will review highlights of the quarter as well as other developments at Safeguard and in our partner companies. Then Jeff will discuss Safeguard's financial results and strategies. After that, we will open the lines to take your questions.

As always, today's presentation includes forward-looking statements. Reliance on forward-looking statements involves certain risks and uncertainties, including, but not limited to, the uncertainty of future performance of our partner companies, the risks associated with our acquisition or disposition of interest in partner companies, risks associated with our decisions about the deployment of capital, and the effect of regulatory and economic conditions generally, and other uncertainties that are described in our SEC filings.

During the course of today's call, words such as expect, anticipate, believe and intend will be used in our discussion of goals or events in the future. Management cannot provide any assurance that future results will be as described in our forward-looking statements. We encourage you to read Safeguard's filings with the SEC including our Form 10-K which describe in detail the risks and uncertainties associated with managing our business. The company does not assume any obligation to update any forward-looking statements made today.

Now here is Safeguard's President and CEO, Steve Zarrilli.

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Stephen T. Zarrilli, Safeguard Scientifics, Inc. - CEO, President and Director [3]

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Thanks, John and good morning and thank you all for joining us for this update on Safeguard and our partner companies. With 1 quarter in the books, Safeguard is off to good start in 2017, executing against our strategic and operational objectives to achieve corporate goals that ultimately drive shareholder value.

As a publicly traded holding company, Safeguard is appropriately judged by our success in 3 areas: building a group of promising growth-stage technology-enabled businesses, supporting our partner companies' growth and maturation, and then realizing gains from the sale of our interest in those enterprises. This multifaceted evergreen business model generates the capital that sustains Safeguard. All 3 of these initiatives are essential to Safeguard's success in driving value creation.

But first among those responsibilities at this juncture is our keen focus on monetizing our interest in Safeguard's partner companies.

In 2017, we believe we can execute on a number of exit transactions that should provide the opportunity to generate meaningful returns to the company. Year-to-date, we have closed on one exit transaction. We sold our 38% primary ownership stake in Beyond.com back to the company, which generated $15.5 million in cash in addition to a 3-year $10.5 million note at 9.5% interest per annum. As a result, we expect to realize a cash on cash return of approximately 2x that on the Beyond transaction inclusive of the note and interest payable, which is consistent with the aggregate return multiple that Safeguard targets.

Increasing the pace of portfolio monetizations and/or accretive transactions remains an important corporate goal. A significant number of Safeguard's current roster of 28 partner companies are actively exploring potential exit opportunities or new strategic investment from independent third parties. We are encouraged by the growing interest in Safeguard's stable of companies.

Our largest partner company, MediaMath, draws considerable attention in the marketplace. We have held an ownership stake in MediaMath since mid-2009 and have deployed $25.5 million in capital to support its growth. Today, MediaMath is a global provider of analytical technology that has revolutionized marketing and advertising decision-making. It bears repeating that we are actively engaged with MediaMath's management to find an appropriate exit for Safeguard in whole or in part. Over time, as MediaMath's revenue, profits and market opportunities continue to grow, it will require additional capital to continue to accelerate its growth.

Safeguard targets deployment and follow-on financings up to a total of $25 million per partner company. We have achieved that upper limit with MediaMath. We believe that the most successful exit for Safeguard will be accomplished in coordination with MediaMath's overall capital strategies. We cannot predict the exact timing but we believe opportunities may arise in 2017. As with most of our companies, we do not control MediaMath or its board and must work within a process involving the opinions and objectives of management and a number of other individual and institutional shareholders.

U.S. venture capital is returning to a healthy level of activity in line with historical norms, according to data compiled by PitchBook. [DC] investment totaled $16.5 million -- billion during the first quarter of 2017. If that pace is maintained, roughly $66 billion in aggregate investment is expected this year, the fourth highest total in more than a decade.

Emerging software businesses have attracted more venture capital since 2010 than any other any category, according to PitchBook. Since the beginning of 2016, more than 4,500 investors have backed one or more software as a service companies, with deals totaling nearly $30.4 billion. Approximately 37% have gone to Series B rounds followed by approximately 22% for Series C financings and 15% for initial Series A financings.

The majority of Safeguard's partner companies are SaaS Enterprises. The outlook for solid returns from the SaaS sector is promising. And according to an analysis by PitchBook and K&L Gates, value drivers include continued adoption across the business landscape of the efficiencies offered by cloud computing. In addition, consolidation is ramping up within the fragmented market of emerging SaaS businesses. Cisco's willingness to pay a 50% premium to AppDynamics' projected IPO value validated the importance of enterprise software apps.

We are cautiously optimistic that the climate for M&A will be stronger in 2017 than in prior years under the expectation of a more robust general business climate. Our goal remains to realize value through well-timed exit transactions that deliver aggregate cash on cash returns of at least 2x our original capital.

Over the course of Safeguard's 64-year history, we have always embraced change and innovation. We believe that our focus on deploying early-stage capital in select vertical markets of the technology sector has positioned Safeguard on the threshold of another period of dynamic growth. With that, I'll turn it over to Jeff.

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Jeffrey B. McGroarty, Safeguard Scientifics, Inc. - CFO and SVP [4]

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Thanks, Steve. At March 31, 2017, we had 28 partner companies compared with 29 companies at the end of 2016. The total reflects our sale during the first quarter of our interest in Beyond.com. At the end of the first quarter, the cost of our interest in those same 28 companies was $333.2 million and the carrying value was $156.8 million. It is important to note here that for accounting purposes, we have not recognized the value of the note receivable from Beyond.com. And any gain associated with that $10.5 million note has been deferred.

Average capital deployed in our partner companies at March 31 was $11.9 million. The weighted average length of time that Safeguard has been a shareholder in those companies is 4 years. 17 of the 28 companies have been a Safeguard partner company for 3 years or less.

During the first quarter, we deployed $10.1 million of capital in six existing partner companies. Safeguard's cash, cash equivalents and marketable securities at March 31 totaled $36 million compared to $37.7 million at year-end 2016. The carrying value of outstanding debt was $53 million, our current cash balance reflects the initial proceeds from the sale of Safeguard's interest in Beyond.com back to the company.

During the 3 months ended March 31, 2017, corporate expenses, excluding interest, depreciation and stock-based compensation expense, were $5 million versus $4.3 million in the same quarter of 2016. We expect that corporate expenses for 2017 will range from $16.5 million to $17.5 million.

Aggregate partner company revenues for 2017 is projected to be between $370 million and $390 million, which includes revenue for all partner companies in which Safeguard had an interest at January 1, 2017, except Beyond.com. Aggregate revenue for the same partner companies was $321 million for 2016 and $305 million for 2015.

Aggregate revenue for all years reflects revenue on a net basis. Revenue data for certain partner companies pertain to periods prior to Safeguard's involvement with those companies and are based solely on information provided to Safeguard by those companies.

Safeguard reports the revenue of its equity and cost method partner companies on a 1 quarter lag basis.

Now here's Steve to lead us through the Q&A segment of the call.

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Stephen T. Zarrilli, Safeguard Scientifics, Inc. - CEO, President and Director [5]

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Thanks, Jeff. Operator, let's open the phones for any questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from Bob Labick with CJS Securities.

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Robert Labick, CJS Securities, Inc. - Senior MD of Research [2]

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So obviously, you've -- you are here to discussing exits a fair amount of the call, so I just wanted to expand upon that. We know that as a significant minority owner, you don't dictate the timing of exits. But when you take a step back and look, what have been kind of primary reasons that exits have been slower than maybe you would have anticipated a year or 2 years ago? Has it been the market? Has it been the assets? Has it been the minority owners not wanting to sell? Or can you just walk us through what generally have been the impediments and how can that change over time?

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Stephen T. Zarrilli, Safeguard Scientifics, Inc. - CEO, President and Director [3]

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Well I think anyone of those number of attributes may come into play for any particular company. But from a broader perspective, if I step back and look at 2016 in particular, we found an environment that we thought was really not all that robust from the standpoint of M&A, at least for the types of companies that we have an interest in. We're seeing a different dynamic beginning to appear in 2017 and while you know it's always difficult for us to predict with a degree of accuracy as to when these transactions are going to occur, what we do really feel confident about is: a, we have a robust climate for these types of transactions; we have been building substantial value in these businesses as they have matured. I think as a point of emphasis there, if you look at the anticipated aggregate revenue growth in '17 and its increase over '16 and then compare '16 compared to '15, we saw a substantial increase in the projected revenue attainment as a group of companies well above what we had experienced in '16. And that kind of growth tends to lead to greater interest on the part of strategic participants in this process of ultimately finding a home for our interest or for these companies in the hands of another. But we are feeling more bullish this year, Bob, because of those macro trends. When we look across the spectrum of the companies that we have a current interest in, we're finding that they're beginning to accelerate in their revenue growth. We do not have any pre-revenue companies, as you know, and these companies have begun to mature into other categories as we've defined them with regard to revenue stage and we think that that's a barometer and an indicator, a forward-looking indicator as to where we'll have our success.

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Robert Labick, CJS Securities, Inc. - Senior MD of Research [4]

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Great. That's helpful. I appreciate that color there. And then just I guess a follow up for one other. In terms of the balance sheet, obviously, it sounds like there are lots of good things happening so there should be more exits. But until those happen, will you slow down new investments or investments in existing companies? Or how are you thinking about the cash balance now and going forward until there -- until you reach more exits?

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Stephen T. Zarrilli, Safeguard Scientifics, Inc. - CEO, President and Director [5]

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There's probably a couple of things to keep in mind. One, we have been very deliberate in the pace of our exits -- I mean, in the pace of our deployments into new opportunities. Not necessarily due to cash resources because the average amount that we start with with any one of these companies generally is somewhere between $5 million to $6 million, so there's capital here to deploy. But we have not necessarily been enamored with the valuations of the companies and the opportunities that have been presented to us. And that started in the mid-part of last year and it continued into the first part of this year. It's starting to change. I think that the second half of the year will probably be more balanced from that perspective than the first half of the year. And I think you'll see that, when all is said and done for 2017, you may find that this is one of those years, where the deployments tend to be more back-end loaded than front-end loaded. And it's just I think more of an indicator of the nature of the opportunities we're seeing and how we're trying to work through valuation paradigms that would make more sense for us.

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Operator [6]

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Your next question comes from Jim MacDonald with First Analysis.

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James Robert MacDonald, First Analysis Securities Corporation, Research Division - MD [7]

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Following up on Bob's question, so it seems that since you have a bigger stable of companies, you have sort of a bigger share of their losses. And with the cash that you have on hand, are you thinking about it any differently in terms of putting money into those companies versus bringing in outside investors and things like that? Or is there any change in your strategy there?

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Stephen T. Zarrilli, Safeguard Scientifics, Inc. - CEO, President and Director [8]

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I don't think that there's been a change. There's been a reminder to the teams that we should not be the only capital provider in these companies, which, generally, we're not. That some of these companies, as they are looking for their Series C financing, that those opportunity should be led by some other party as we would've originally architected and for us to be able to follow on and protect our ownership stake, but not necessarily be the lead in that particular round. And I think you're going to see evidence of that as we get through this year as some of the initial revenue stage companies and even the expansion stage companies go out to raise their next round of capital. You won't necessarily see Safeguard being the lead dog as we may have been in earlier rounds, but we will be definitely doing our pro rata in order to ensure that we're not minimizing the ownership stake that we have in these businesses. And there's a fair amount of capital that exists in the market. We benefit from having a strong track record as an organization so we attract others as interested parties to join us in these endeavors. You saw some of that play out last year, with regard to Propeller as an example, where they had a round of capital led by another party. Sonobi had a similar situation. And you're going to see those situations play out also in 2017 and there's a greater number of companies this year that are going to be looking for that next round of capital and we're actively working with other parties to have them join us in the capitalization of those businesses.

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James Robert MacDonald, First Analysis Securities Corporation, Research Division - MD [9]

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And to follow-up to that, there are couple of companies where you're getting close to 50% ownership. Maybe you can talk about some of those companies. And I'm thinking about, CloudMine and Full Measure Education, where would you go over 50% and sort of what are you thinking on those companies?

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Stephen T. Zarrilli, Safeguard Scientifics, Inc. - CEO, President and Director [10]

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Well there's nothing that precludes us from going over 50%. If we do, you'll start to see that we'll have to change the accounting from equity method to consolidation accounting. We would prefer not to. In certain circumstances, I think it makes the story of Safeguard a bit more difficult for investors to easily understand, if you're starting to now take into account portions of a companies' P&L and balance sheet into our own. But if we find that it -- strategically, it makes sense to maintain that very significant control position, we will not hesitate to do so. We haven't though, Jim, over the last, I'm going to call it, 7 to 8 years. We've been pretty disciplined in that fashion. Lumesis is an interesting example of where we have been able to solve for their capital needs in a variety of ways without having to take it over 50%. But we are clearly one of the largest -- if we're the largest shareholder there, we're the largest in CloudMine. There are actually 2 smaller companies that, interestingly enough, in '17, if they achieve some of the business objectives that they have set forth for themselves, should be able to attract actually some other parties into their capital structure, which will probably get us further away from that 50% threshold line that you just referred to. So I don't -- I wouldn't tell you to expect that we're going to go beyond 50% on any of these companies during 2017.

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Operator [11]

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(Operator Instructions) Your next question comes from Kevin Latta of Stonegate.

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Kevin Latta, Stonegate Capital - Investment Banking Associate [12]

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I just had a quick question. Can you talk a little bit about kind of the structure of the payment on the Beyond.com deal and maybe kind of how that came across and why you chose that?

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Jeffrey B. McGroarty, Safeguard Scientifics, Inc. - CFO and SVP [13]

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Sure, Kevin. I can address that. Beyond had the ability to -- we had a value that we had in mind for the company based on what they had achieved over the past almost 10 years that they were with us. They had the ability to pay a portion of it in cash. We were willing to, because we believe in the future of the company to be able to continue to operate with close to breakeven or profitable, which the company has historically been. So we feel very confident in the repayment of that note. And the note is a 3-year note for $10.5 million, it paid interest at a rate of 9.5% payable annually. As I mentioned on the call, for accounting purposes, we have deferred recognition of that. So the significant gain that we would have had on the transaction in Q1 has been deferred. But that was an instance where we were the largest shareholder other than the founder and CEO. We were desiring, having been in for almost 10 years, to have an exit. We were on a different timetable, I believe, than the other shareholder and so we were able to be flexible in structuring a transaction that we thought made a lot of sense for us to be able to recoup capital at ultimately greater than a 2x return and deploy that capital in other companies such as some of the follow on funding we've done in our existing companies this quarter.

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Stephen T. Zarrilli, Safeguard Scientifics, Inc. - CEO, President and Director [14]

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Yes, just to add on to that, Kevin, this was a win-win. The company Beyond and its management team and its significant other shareholder, the founder of the business, now has the ability to take a company, which has been growing and continue to adjust that business model as he sees fit, recognizing that he now has the ability to do it without the encumbrance, if you will, of Safeguard. We're pretty confident that he's going to have a number of opportunities presented to him over the next few years. And the note has been structured so that if he ever wants to repay that before its 3-year maturity, there is no penalty for him to do that. And he may find it attractive to do that at some point in time, especially given the interest rate that's attendant to that particular instrument. So we're confident that he's got the business model that would ultimately allow for the satisfaction of the obligation and it may come earlier if things tend to continue to build well for Beyond as they move forward.

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Operator [15]

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(Operator Instructions) Your next question comes from Paul Knight with Janney Montgomery Scott.

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Carolina Ibanez-Ventoso, Janney Montgomery Scott - Equity Research Analyst [16]

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This is actually Carolina Ibanez on for Paul Knight. Could you talk more on valuations specifically in healthcare? And if investments in [business pays] have also become more attractive for you?

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Stephen T. Zarrilli, Safeguard Scientifics, Inc. - CEO, President and Director [17]

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If I understood the question correctly, just a general observation with regards to valuations within the health care technology sector that we focus on? Is that correct?

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Carolina Ibanez-Ventoso, Janney Montgomery Scott - Equity Research Analyst [18]

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Yes, correct, correct. Yes.

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Stephen T. Zarrilli, Safeguard Scientifics, Inc. - CEO, President and Director [19]

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So we're seeing solid valuation parameters within that sector. It's a good time to be a party in a company where you may be looking for an exit because I think the market actually is strong from that perspective. As I mentioned earlier, I'm a bit more cautious as we put capital to work right now that we don't go in at a level that would be considered a bit higher than what would be ideal. So there -- so what we are finding in order to put capital to work in new opportunities, it takes a bit more time to have these conversations with these businesses and other shareholders to see if we can rationalize the thought processes around perceived valuation of business. But generally speaking, the climate is stable, attractive and we continue to believe that we're going to benefit in 2 ways: one, very importantly, from the standpoint of positioning some of our existing companies for exits that will be attractive from a returns perspective that our shareholders will find value in, and if we continue to be disciplined and operate in the manner that we have, we believe that we'll continue to find ways to enter into new opportunities at valuation levels that make sense and help us to establish an initial threshold that will benefit us when we ultimately go to monetize that investment in the future.

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Operator [20]

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There are no further questions at this time. I'll turn the call back over to Safeguard for closing remarks.

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Stephen T. Zarrilli, Safeguard Scientifics, Inc. - CEO, President and Director [21]

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So thank you, everyone for dialing in today. We will keep you apprised of our progress with regard to the initiatives that we have outlined for 2017. And just to reiterate, we do have a very heavy focus this year on trying to move some of these partner companies to the exit doors, as we say, and to provide those returns that you're looking for. Thank you.

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Operator [22]

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This concludes today's conference call. You may now disconnect.