Q3 2019 Earnings Call
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Systems.
Quarter 2019 earnings.
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Good evening, ladies and gentlemen, and welcome to Pegasystems Q3, 2019 earnings call.
Before we begin I would like to read our safe Harbor statement.
Certain statements contained in this presentation may be construed as forward looking statements as defined in the private Securities Litigation Reform Act 1995.
The words expects anticipates intends plans believes well could should estimates may targets strategies intends to projects for cash guidance likely and usually we're variations of such words and other similar expressions identify forward looking state.
Which speak only as of the date. The statement was made and are based on current expectations and assumptions because such statements deal with future events. They are subject to various risks and uncertainties.
Actual results for the fiscal year 2019, and beyond could differ materially from the company's current expectations factors that could cause the company results to differ materially from those expressed in forward looking statements are contained in the company's press release announcing its Q3 2019 earnings and in the company's filings with Securities and exchange.
Commission.
Including its annual report on Form 10-K for the year ended December 31st 2018, and other recent filings with the FCC investors are cautioned not to place undue reliance on such forward looking statements and there are no assurances that the matters contained in such statements will be achieved although subsequent events may cause our view to change except as required.
A couple law, we do not undertaken specifically disclaim any obligation to publicly update or revise these forward looking statements whether as a result of new information future events or otherwise and with that I will turn the call over to Alan Trefler founder and CEO Pegasystems.
You can.
Recorded away for the year I'm pleased with the state of the business. We continue to make strong progress makes you'd be growth in our transition to <unk>, we've been executing on our strategy to increase ourselves capacity in response to the large opportunity ahead of us.
The only returns on the effectiveness of sales team as reflected in our pipeline growth.
Kevin will provide more context, our financials a few minutes now.
Now in terms of sort of insights on the market you have your where we're seeing lots of disruption around the world seems like like Brexit and trade towers and our clients are looking at how to plan for any number of changes they make right.
No.
Underlying model driven low code architecture allows for our clients to adapt quickly.
Change.
To really grow their businesses and develop their efficiencies we continue to see enthusiasm for our software now our digital transformation technology helps organizations establish an operational background there could be years equally to either propel topline growth.
And drive bottom on efficiency shutting a necessary technology overhead and also making operations and client engagement more trisha.
I guess intelligent automation solutions optimize operational one employee efficiency as I said, well our decision and capabilities improve the retention and lifetime value applied to gauge what barack ensuring the right actions or offers or provided right toward.
This ensures not just a great client experience at the moment of outreach, but also the ability to drive pre emptive customer service anticipating potential issues. So you can address them when they have a better chance of being mitigated.
No the market's been interesting because we have continued to see a lot of alright.
In the market, including Crazy valuations that don't reflect business fundamentals and the this has been especially true about some of the hot technologies.
What they called robotic process automation <unk>, if I talked about on the last quarters earnings call.
We think there were better ways to go after the market from both technology and marketing and solution perspective, and frankly see a validation of that in some of the recent events.
That's one analyst said in response to the recent in response to the recent layoffs of a major RPH vendor quote.
We are realizing that intelligent automation is a marathon not a spread.
Push the hype around RPK far too aggressive with.
He went on to take well, it's imperative that enterprises invest time and resources evaluating their business processes before taking the plunge buying software that will deliver only one for business cases have been defined.
This is very consistent with Packers approach and our view the ARPU is great, but it should be used as a extension of true intelligent automation and true end to end digital process automation.
I think that bodes very well you know if you know our history. We you know we've been through up and down business and financial cycle, and we know showing both of those environments and I'm like others did appear to have gotten ahead of themselves I don't expect you'll see us having to retrench because of Overhype should the business environment charge.
No driven client trends I know historically, we've focused almost exclusively on the largest most sophisticated clients and projects because we feel we uniquely have the expertise.
Technology to handle them and we're still tackling goes as our clients are continuing to roll out important new major initiatives, but we're also seeing or clients want to start quick quickly with other types of initiatives and then add value rapidly well they weren't and adopt best practices.
You mean being more agile and starting small and fast with the concepts that we can scale with them successfully to deliver what they need as well things get bigger many of these projects center on identifying what we call focused micro journeys.
Sometimes people used to describe as use cases and as I talked about at Pegaworld.
Series of single interactions with the customer the can change their experience in a significant in positive way.
We provide structured design thinking approaches to identify key challenges and to find the right problem to solve as a REIT customer journey Taco first.
And we're working to establish an increasingly repeatable standard way to go after these.
This message is resonating and we continue to see strong new business momentum across our geographies or applications and the industry.
This quarter I'd like to highlight the great progress, we're making in the government market.
Government is full of what we call case management and processes and the need to drive effectiveness and efficiency and I've just returned from our government empowered event, we held in Washington, D.C. I want to say.
Clients and prospects were around the world joined Us to hear all government agencies, working with <unk> to tackle digital transformation and modernize legacy systems.
All while navigating the privacy and policies strikes we had a terrific line of speakers, including she's got count the federal C O <unk>.
That's what was senior representatives from the <unk> U.S. Census Bureau, the department of Veterans Affairs.
In the Air Force Research Laboratory.
Just like our commercial clients, they're looking to digital to drive improved engagement and governments worldwide are increasingly focusing on their constituent experience.
They seek to improve satisfaction, while they're driving better efficiency.
There's a big push to modernization in the government and we're very well suited to handle that.
That trend is working to our advantage and we're making nice strides in the government <unk> market, adding important new business globally.
This quarter for example, we won new business.
One of the largest UK government departments, there's been a longstanding pega case management client, who recently prestigious pega customer service running on Pega cloud to provide a single advisory user interface for their 30000 customer service centers about.
This is a first step towards a wider program to transform customer service with the department.
First of all I'd call was taken usually the pega solution. After just for spreads about eight weeks from project start.
A major department of Defense command is using the Pega GVE crowd in the U.S. to improve commands overall objective of annual audit ready, that's why improving financial management processes and enhancing internal audit controls.
Oh deciding factor in choosing Pega was our digital process automation capabilities, which as I said include end to end automation with robotics, or we should able to command to automate integrate processes with other other critical internal enterprise systems, even if they're quite old and and without a PR.
Yeah.
Do you at Federal Government also selected Packers the intelligent business process management platform for building an end to end grants management solution Pega will serve as a central component of the new system orchestrating all grants lifecycle activities and maintaining key grants management data the unified system.
Replace multiply Douglas multiple legacy systems and establish common business processes.
Across several different graphs programs.
And going overseas for a moment.
The French National authority for help.
Chose pega cloud software to manage a new certification that will create quality rankings used to evaluate all French hospitals.
No. It's not just these sort of direct sales lots of sales actually operate through partners that are or partner relationships is something that's very important you know we have a situation where the largest Medicare surface operation chose pega to transform the way they serve their ever growing beneficiary population, providing seamless and.
So let's start with experiences.
Now in addition to government, we continue to see strength across our other verticals and it's terrific to see new business coming through a range of clients are from one of the largest global CPG leaders to our relatively new consumer groups. So.
If it's actually I think is moving forward very much in a positive way.
In terms of marketing Oh, let's call I mentioned that were in continuing to increase our focus on getting visibility and engaging with their customers and though we had a number of regional events I like the one we just haven't Washington, which we call customer engagement summit scheduled throughout the year and are proving to be valuable venues to reach new audiences and <unk>.
Pretty sharp visibility in a targeted white.
This year long multi city Global Road show complements our annual Pegaworld Conference and this year on the road show, we will be face to face with nearly 10000 additional prospects and clients around the world.
About half of which or net new to pega.
Since we spoke in addition to government of powered in DC Weve up also held events in Detroit, Boston, Melbourne, Munich in Tokyo, and they're driven by amazing clients stories of real work done by Pega and with Pega, which are inspire Reagan include organizations like Celgene Cobble affair.
Think of Australia Delta dental for direct express scripts, the Japan Ministry of economy trade and industry, Siemens Sanofi and Royal Bank of Scotland, We're very honored that our customers are willing to come and talk to others about what they're doing and what they're achieving and we'll be continuing.
The series into 2020 as well.
So in summary.
Please with the progress.
I think what is the way through the year, we think we have strong momentum and we're working hard.
Try to finish the year as strongly as possible, we continue to see a great market opportunity and we're confident we have the right capabilities as a REIT strategies to help clients succeed.
Hi, more color on the financial results, let me turn it over to can still well our CFO .
Thank you Alan.
We've executed well through the first three quarters of 2019, our team delivered solid growth in ACB continuing to increase new recurring license and cloud commitments. We continue to be excited about the huge market opportunity in front of us we're executing on our plan to increase selling capacity it go to markets resources to better.
Penetrate our target accounts and early returns show very healthy pipeline growth as we enter Q4.
As we continue our transition from a company that largely sold at software on a perpetual license basis to a much larger company that sells mostly on a recurring cloud license basis ACB growth continues to be the most important metric that reflects the successful execution of our strategy total waste TV, it's a sum up recurring pega cloud.
And client cloud commitments, representing the annualized spend by our clients for subscriptions term licenses and maintenance.
We ended the third quarter, our total HCV was 634 million.
Up $106 million or 20% consistent with our long term target Pega cloud HCV grew 51% in the same period. Both of these measures are in constant currency.
We continue to transition our business to a recurring model leveraging our market leading cloud choice differentiation.
For the first three quarters of 2019, 57% of our bookings were pega cloud those results are seven percentage points higher than we originally anticipated as I explained at the beginning of the are we plan for pega cloud to be 50% of our new commitments in 2019. This seven point difference in Pega cloud results.
The short term impact of reducing revenue by about $3.7 million for each one percentage point or approximately $20 million for the nine months ended September Thirtyth 2019.
Turning to remaining performance obligation also what we call backlog.
Pega cloud backlog increased by $100 million to 363 million at the end of Q3.
An increase of 38% from one year ago total RPL increased by 86 million from 522 522 million just 609 million.
An increase of about 17% when compared with the balance as of September Thirtyth 2018, a robust backlog is another benefit of our cloud transition historically much of our bookings were taken as revenue in the current period, sometimes causing variability in our quarterly results. These days the largest portion of our book.
Yes, our cloud most of which goes into backlog, creating a more predictable revenue and cash flow stream in the future.
Our deliberate ongoing transformation to a recurring business model continues to track as planned.
As we've discussed in the past a cloud transition typically takes a software company about five years to complete as we began 2020, we expect to be Directionally at the midway point of our cloud transition accomplishing this in somewhere between four and five years in our cloud trends if our cloud transition continues at this pace.
Yes, we expect optics to improve in 2020, and 21 and normalized during 2022, we remain very confident that the long term benefits of a recurring business model, including a more predictable future revenue and cash flow stream far outweigh the skewed short term optics around reported revenue growth and the impact.
Back to near term cash flow and reported EPS.
We're confident that a greater mix of recurring contracts is the correct long term strategic direction for our business and matches the market demand. However in the short term moving away from perfect perpetual bookings replaces large upfront cash in revenue with cash in revenue there will be received and recognized over multiple years.
We expect the lag between the business, we win and its revenue and the ensuing mismatch between revenue and cost to diminish over time.
The impact of our cloud transition can be seen in our reported results revenue for the first three quarters of 2019 totaled $635 million effectively flat when compared to the first three quarters of 2018, well HCV on a constant currency basis increased 20% and cloud backlog grew 38.
8% over the same period.
I want to reiterate that we started the year with an expectation that pega cloud commitments would make up about 50% of new bookings versus the 57%. We saw through the first three quarters of 2019 as a reminder, each 1% ship the pega cloud as the potential to reduce full year revenue by approximately 3.7.
<unk> dollars for the full year 2019.
Cloud deals.
That are reflected in ACB, but it is norte largely not reflected in current period revenue. Therefore, if you adjust for the impact of this transition and the higher cloud mix they the year to date.
Three three quarters in 2019 is approximately $20 million moving next to revenue components Pega cloud revenue grew an amazing 63% to $95 million and maintenance revenue grew by 6% to $207 million for the first three quarters of 2019 versus the same period one year ago.
Our consulting revenue was $167 million a year over year decrease of approximately 15% or $29 million from the first three quarters of 2018, which is consistent with our strategy to shift an increasing proportion of implementation effort to our outside partners. Additionally, we had a very large government can.
Track, where we have significantly enabled the client reducing the necessary involvement for pega, which also we consider strategic notes.
As I mentioned earlier, our pega cloud transition creates a temporary mismatch between reported revenue margin EPS and cash flow.
The fact is further magnified as we continue to invest in increasing go to market resources to accelerate our growth and with demand for pega cloud exceeding even our expectations. We continue to build out our cloud infrastructure to scale is significant growth engine, which also has a near term negative impact as we invest in pega can.
Wow.
For the third quarter 2019 were reporting both GAAP and non-GAAP results a full reconciliation of GAAP to non-GAAP measures is provided in the financial tables in the press release issued earlier today and those are also available on the Investor section of our web site.
So let's turn to a few other details we finished the period with total cash and marketable securities of $113 million in the first three quarters of 2019, we returned about $62 million to shareholders.
Apprised of about $7 million in dividends and approximately 55 million in share buybacks in that settlements of equity as we finished the quarter with just over 5000 employees worldwide, an increase of approximately 13% from one year ago more than half of our employee growth is in the go to Mark.
At organization.
In summary, we continue to be energized by the size and growth of the digital transformation market opportunity in both the front and back office I. Just spent the last few days with Alan speaking directly with numerous government clients and prospects during our government empowered conference in Washington, DC I continue to be impressed by the value we are.
Bringing to these organizations customer demand for digital transformation solutions continues to be strong, especially in the public sector, where pega is a perfect that.
Traditionally the fourth quarter is our largest quarter and we expect this year to be no different in summary, we're very pleased with our year to date execution against our strategy and we're focused on finishing when it's been so far a solid 2019 I look forward to seeing investors over the next several weeks as we get on the road and with that operator, we will open the call to questions.
We will now begin the question answer session to ask a question you mean press Star then one on your Touchtone phone, if you're using a speakerphone. Please pick up your hands up before proceeding the keys to solve any time. Your question has been addressed and deal with bank.
Let's try your question. Please press Star then to at this time, a pause momentarily to assemble our roster.
The first question comes from Steve Koenig with Wedbush. Please go ahead.
Okay, great. Thanks, Hi.
Congrats on solid quarter.
Maybe two questions here for you.
First one can for you.
Spending growth. So are you are you guys still kind of.
As we look at the numbers, though.
Youre kind of targeting mid teens for the year looks like youre substantially above that on in Q3, if I did my numbers right.
Maybe just some color on its just is there some quarterly variability here are you still kind of tracking to the original dolls, and where you know where do you anticipate spending.
So good question, Steve So.
The to the two things that to think about is our our go to market Envestnet is still on pace to be Directionally in line with what we had talked about at the beginning of the year, which is investing in kind of that low 20% range of investment the one area that we've actually had incurred.
Priest investment a year to date that isn't that is in a pega cloud and that really relates to two factors. One is that our pega cloud business is that is higher is growing.
At a faster pace in terms of new bookings than we anticipated and that we need to invest for that faster pace. If you think about pega cloud, we're investing in advance of the booking and booking doesn't even get US revenue. So there is somewhat of a disconnect on the climate cloud gross margin line, because you don't get the revenue, but you do need to invest in the business.
And then secondarily, you'll remember that we got our pega fed ramp certification early in the year with public sector being a very important part of our strategy. We have ensured that we have the right resources to support our public sector clients moving to the cloud.
Accelerated pace.
Okay.
Just just to follow up on that and then I'll ask my question for Alan now as well.
The the kind of what what you're spending that trajectory here on cloud Thats. Your cloud mix is shifting softer in the cloud revenue growing fast is that something we should expect to continue.
As I looked out it looks like you have the street is.
Isn't isn't really growing opex about next year.
So kind of does that does that cloud industry continue and how long does that continue and then I'll I'll just ask my question for Alan now it is.
Bob maybe just an update on project Phoenix kind of where where are we with that and maybe.
Maybe a little color on are we looking to two.
To see more multi tenancy from pega out of some aspects of that.
And could actually be staring up component parts, some kind of ecosystem around that in time.
So I'll I'll answer your for always the first part of your question. Steve You you would see because of the because of the higher growth in Pega cloud and the fact that that won't turn into revenue in the short term, but we need to invest for a larger client base you would expect a little bit of a slower.
Growth in the in our track to our kind of terminal gross margin target. So you would see more investment in pega cloud in 2020, and now and that would be commensurate with us having a bigger book of business. So think about the pega cloud being tied to the backlog.
Just as much as it is tied to the revenue and so thats. The backlog is outpacing the growth that we anticipated and if that continued in 20, we would expect investment to continue in 20 as well and then I'll hit on that Alan for the second part, though the other thing I'll just say about expenses.
We've decided to work to both for example, get our February I'm sort of protection our were shortly going to announce that we have I wrap which is the Australian certification, which we've been approved for and we're doing a variety of these being able to go through those does have some short and intermediate term expense both in terms of going through those processes and you have to set up and demonstrate.
You can do that on ongoing basis, but also getting people with some different skill sets and clearances that might be necessary to be able to work with those clients now will we would eventually expect will slow down.
I see a for the next always six to 12 months I would I would think in terms of Phoenix I'm very very excited when you go when you talk to clients or prospects about what is a major technical change in a lot of white, that's almost contrary to where we were really trying to focus on business improvement bought for <unk>.
Level of enthusiasm since we had our first introduction in detail in June at Pegaworld and did the deep dive with about 150 architects from a from from various customers. The feedback from them and also just a whole variety of obsessions, we keep having about it.
Outpaced my expectations, and there's a huge amount of enthusiasm and the whole notion that we can move at our clients can move to just an absolutely state of the art.
React based front and no J.J.S. environment without having to like rewrite all their applications is exactly the promise of doing things correctly. The model driven way. So there's a lot of enthusiasm or we are building multi tenancy into that capability. So we're expecting to have an effect three levels up some customers and smaller.
Ones with lower risk might choose to operate on a general multitenant environment, which up we would expect frankly, just higher returns on others may want to be multi tenant for a single quiet. So for example, all of a single large customer of ours might be on a single Multitenant system, which provides additional.
One more secure options vis-a-vis encryption and then we still of course will have customers, who will want to operator, we'll merit operating on a soon on a single tenant basis. So we're building it to be able to hit all of those as well of course, continuing the whole vision, which by the way is being endorsed by the market quiet cloud choice, which I think.
Really smart things we do.
Thanks, guys.
Thanks, Steve.
The next question comes from.
Ritchie jewelry out with D.A. Davidson. Please go ahead.
All right. Thanks, Alan can appreciate you taking my question.
Maybe I want to start with gross margin side. It looks like we saw actually negative gross margin from the consulting in training business and cloud gross margins declining a little bit and I understand there's obviously investment in cloud pretty aggressively without necessarily having the revenue yet maybe.
Help me understand both of these PCG in a lot why are we seeing especially offloading more services to partners why are you seeing services gross margins on that negative.
And then maybe whats the path to get from where we are today I believe you've said in the past about 65%.
Gross margin.
So I'll take them I'll take the in the order of that the first is professional services. So we are we are having a lot of success I'm, having partners be more involved in our ecosystem then day trip. They historically worry years ago, and although that is a although that's a great.
Forced multiplier for us to two out to grow the business, we still do quite a lot of implementation work for our clients and even though our revenue is taking a hit as more partners are engaged.
And implementation, there's a lot of precious skill sets that we have it pega and we know that we will need those resources in the future as we scale the business and so there's no.
Knee jerk reaction that we would take do you know changed the sizing up our teams because our resources in our professional services team are the best that are out there and we would think that we would want them or we would want to make sure that they are used to support sometimes our professional services team members go to work for our class.
Yes.
So so the professional services margin is something that will settle overtime as opposed to being something that we would we would try to rightsize quarter to quarter on the gross margin for pega cloud that the the timeless that kind of longer term target.
Margin was to be above 70% actually on the 65% certainly will be somewhere you know it will not be a linear moved to 70, but 65 will be probably a step in that journey. We kinda, we expected our gross margin to be honestly, a few percentage points higher than where it is right now but given the.
Scale growth of cloud the fact that we need to invest in advance as Alan mentioned, we have not only fed ramp we have international cloud environments like I wrap certification et cetera that require us to make sure. We're ahead of the game ops. So some of that investment we had said to kind of pull up a little bit in cloud it doesn't impact our longer term.
Margin targets, it's more the timing of investments coming on the front end of the cloud growth as opposed to a more linear investment.
Got it thanks, that's helpful and then.
Require for Alan.
First just wanted to get a sense of if you're seeing any any changes in buying behavior from customers and any sort of color you can share on on EMEA and especially after like what you told US last quarter and then maybe just wanted to get a sense of where you are in terms of the journey day increase your sales coverage.
Maybe how far we are in that direction of getting to the ideal sales coverage that that you'd want to see thanks.
Sure so.
One of the things that Oh. It was was gratifying is we saw some resurgence in EMEA.
Unpredictable environment.
We're all dealing with here, but certainly there is strengthened a lot of interest both in the UK, but also in some other parts of of Europe , as well relative to the the growing out of the sales team, we're making good progress we've done a lot of work too I think improve our recruitment approach and that.
Both in terms of being more effective it engaging candidates and also I think frankly being really really quite selective what I'm excited about on that front is we're actually finding people who.
Our themselves for example, making quota very large competitors up actually now very open to both talking to us and in many cases, joining us and I think thats because they have competed against us. They see we're becoming more effective and frankly I think we have a lot going for us in terms of the the culture the business.
Commitment to client success on the verge anyway. So I would say that we're going to continue to do that to continue to grow that we didn't do a big push in marketing spend as you know through Q2 in Q3.
We are driving a lot of these conferences in these events, our Europe I'm definitely seeing a return from them. So those are not going to continue to increase.
Got or even a proportional right, but we are going to continue them and sort of the style with way that we're doing them stack as we go into next year.
And one thing to add one thing to add Rishi on the on the on the <unk>. The question about EMEA. If you. If you look at the performance of our sales team with respect to.
Growth in HCV, and you look across the world. The the our performance to kind of our plan has been fairly consistent across the geographies I'm so were.
Using that as one measure.
The only measure.
It looks like there is demand for our solutions in all of our major regions.
That's helpful. Thanks Bonnie.
Next question.
The next question comes from Pat Walravens with JMP Securities.
Please go ahead.
Hi, this month, what Pat Thank you so much for taking my questions.
Hi, this is that in God that federal and I'm. Just wondering could you talk about how does the sales motion deepened there and maybe what's your.
Strategy in that sector.
So can you repeat the sector I'm, sorry that sort of public sector public sector.
Yes.
So obviously, you're dealing with more partners in the public sector in the sales are very much.
Much.
Links to.
Having good partners. So our sales teams are engaging both with the ultimate Department, but also with the partners as well, we're seeing I would say an acceleration in that sector. It's very exciting I would tell you that the growth in the sector has actually been extremely encouraging.
On a year to date basis. So as these guys pursue modernization Oh, we're just a terrific way for them to save money and for them to also get closer to the citizens. So.
And as I think are more in food I do think that you're going to see us.
Having a lot of wins in the next year and.
If you are coming off the government and powered event.
It was just yesterday was.
Also there was extremely invigorating, an exciting and they're even videos that are going to be put up on the website and things or what other people share.
So last year all good from what I see.
Hi, Thanks, and maybe just a quick follow up and it's I'd be a popular topic with.
The customers.
Yeah, I think I think desktop and your process robotics is a popular topic with with absolutely with customers. You know, there's there's really been a lot of attention.
Page two that sector and I think at one point there was a lot of confusion as to whether that was like the cure all miracle Bandaid there was going to render everything obsolete up I think customers are getting a lot smarter and our our understanding better that their initial a lot of these companies was felt.
Five and $10000 deals to enormous companies the frankly I would classify as just experimentation up.
Based on those experiments, we're finding that people have a finer understanding of how if you are going to use robots, you really do need up end to end process automation system to be able to tie them together and that's what you need for intelligent automation, just putting intelligent automation as a buzz word on your website doesn't doesn't do it so I think the.
Increasing sophistication of buyers and that's very much as during the federal government as well is extremely beneficial for us as we continue to compete in the RFP a market as well as the DPN market.
That's great. Thank you.
[noise].
Again, if you have a question. Please press Star then one.
This concludes our question and answer session I would like to turn the conference back over to.
Alan Trefler.
Founder and CEO . Please go ahead.
Thank you and thank you can and thank you all are investors know, we're working hard on your behalf and we're really excited and go to go back to work now so thank you very much all.
The conference has now concluded. Thank you for attending today's presentation you may now disconnect.