Q4 2022 GrafTech International Ltd Earnings Call
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Good morning, ladies and gentlemen, and welcome to the graph Teck's fourth quarter 2022 earnings conference call and webcast.
At this time all lines are in a listen only mode. Following the presentation, we will conduct a question and answer session.
If at any time during this call you need assistance. Please press star zero for the operator.
This call is being recorded on Friday February 3rd 2023, I would now like to turn the conference over to Mike Daley, Vice President Investor Relations and corporate Communications. Please go ahead.
Thank you.
Morning, and welcome to graphic International's fourth quarter 2022 earnings call.
With me today are Marcel Kessler, Chief Executive Officer, Jeremy Halfords, Chief operating Officer, and Tim Flanagan Chief Financial Officer.
Marcel will begin with opening comments, Jeremy will then discuss safety sales and operational matters.
I'll review, our quarterly results and other financial details Marcel will close with comments on our outlook. We will then open the call to questions.
Turning to our next slide.
As a reminder, some of the matters discussed on this call may include forward looking statements regarding among other things performance trends strategies.
These statements are based on current expectations and are subject to risks and uncertainties.
Because that could cause actual results to differ materially from those indicated by forward looking statements are shown here.
We will also discuss certain non-GAAP financial measures and these slides include the relevant non-GAAP reconciliations.
You can find these slides in the Investor Relations section of our website at Www Dot graft X dot com AR.
A replay of the call will also be available on our website.
I'll now turn the call over to Marcel.
Good morning, everyone. Thank.
Thank you for joining graphics fourth quarter earnings call.
When he is ready to with a challenging year.
Geopolitical conflict high levels of inflation supply chain pressures and economic uncertainty impacted global market.
The industry.
Is it negatively impacted in the bank for graphite electrodes and continues to do so.
In addition, the temporary suspension of our operations in Monterrey, Mexico in the fourth quarter it affected our business.
These factors.
Along with a substantial shift in mix from LTA LTE volume will have a significant impact on our 2023.
Sure.
However, with the determination and resolve of our talented <unk> team.
Ramping east challenges head on.
And we remain optimistic regarding the longer term outlook for the business and our ability to deliver shareholder value.
I would like to highlight several points.
First.
Our Monterey facility has restarted and is running well.
<unk> reached that reached an agreement in November that allows for the restart and do you remain confident in our ability to achieve our full resolution of this matter.
The impact of the suspension of our sales volume in the first half of 2023 there'll be significant though.
However, it will be but we will be well positioned to fully meet our customer needs.
At the end there.
It can half of the year.
And we expect to meet all our remaining healthy commitments throughout 2023.
Second we are taking proactive actions.
This includes closely managing our operating costs capital expenditures and working capital levels.
If we execute reducing our production volume to Hawaii and yen currency bag for graphite electrodes.
And making targeted investments to further improve our strategic positioning and support long term growth.
Third as a result of our disciplined capital allocation strategy, yes, a strong balance sheet and ample liquidity to navigate the near term challenge it.
Lastly, electric arc furnace steelmaking and demand for graphite electrodes are expected to be experienced accelerating growth in the medium to longer term.
<unk> sustainable competitive advantages remain intact.
These includes three of the highest capacity electrode manufacturing facilities in the world and our substantial vertical integration into petroleum needle Coke.
As such we are well positioned to capitalize on long term demand growth.
I will now expand on my comments regarding our operations in Monterrey, Mexico.
As previously reported in September of 2020 to inspect their stroke, the environmental authorities for the state of wait only all Mexico.
That facility issued a temporary suspension.
When you meet November yes.
Announced at our expertise to work the resolution resulted in an agreement with York already allow us for the conditional lifting up the suspension.
And the restart of the facility.
The lifting up with essentially no. This was subject to the completion of certain agreed upon activity.
We are on track to accomplish all aspect of the condition.
We expect the full resolution of this matter and we continue to expand our engagement that you operate in some of the statements in April the all and accumulate area.
At the same time, we continue to pursue the risk mitigation activities related to pick stocks that you discussed on the previous earnings call.
These include the full the restart the higher St Marys, Pennsylvania operation.
<unk> other alternatives for the reduction of feedstock.
Bob you are encouraged to be working towards final resolution of the situation the negative impact of the suspension on our operating performance in the first half of 2023, there will be significant.
Although production of electrodes at 10 stocks began immediately upon the lifting of the suspension that require manufacturing time for our products is generally seven rollout.
As such the rebuilding of our paint store can't mentor and will take time.
In addition on the commercial front.
Tightening up the suspension according to the items of.
The critical timeframe to six your customer orders for the first half of 2023.
As a result of uncertainty caused by the suspension.
This contract negotiation lingo, our ability to and great team of customer commitments for the first half of 2023 plus limited.
As a result the <unk>.
<unk> made in our sales volume for the first it takes months of this year will be approximately half of that will be reported in 2022 with the largest negative impact to materialize in the first quarter of this year.
As we move into the second half of FY 'twenty, three with replenish Facebook inventory it will be much better positioned.
We expect our second half sales volumes to recover as we move past the Monterey suspension trip and uncertainty and that we anticipate a gradual improvement in market conditions.
Importantly, we continue to expect to meet all of our remaining LTA commitments throughout 2023.
We will provide a more detail previously we will provide more detailed comments on our outlook during his call, but first I'd also attack the entire grass tech team and in particular all of our employees in Monterrey, but theyre ongoing efforts to address this situation and the continuous focus on moving our business to hit.
And I also welcome thank our customers for their ongoing it's important to understand.
With that let me turn the call over to Jeremy.
Thank you Marcel and good morning, everyone.
I'll start my comments with a brief update on health and safety, which is a core value at drastic as people are our most important asset.
We ended 2022 with a total recordable incident rate debt, while continuing to place us among the top operators in the broader manufacturing industry did not meet our high standards, nor our performance levels of the past two years.
Safety is and must be fundamental to everything we do is getting health and safety rate leads us to doing business right.
For this reason improvement in our safety metrics will be a key point of emphasis with our internal teams in 2023, as we remain steadfast and working toward our ultimate goal zero injuries.
Let me now turn to the next slide for an update on steel industry trends as additional context for our fourth quarter results and our outlook commentary.
During the fourth quarter, we saw further softening of key performance indicators for the steel industry.
Global steel production, excluding China in the fourth quarter of 2022 was approximately 194 million times, representing an 11% decline compared to the same period in the prior year.
Global capacity utilization rates declined to 61% commensurate with the lower production.
While we can continue to see steel industry trends that vary by geographic region. The disparity lessened somewhat during the fourth quarter.
Conditions in Europe remained relatively weak, although we started to see the stabilization of certain trends in the quarter, which is driving European HRC prices higher reaching $822 per ton as of last week.
In the U S utilization rates softened further in the fourth quarter hitting a low near 71% late in the quarter, but have since begun to recover as demand prospects peer firmer due to improved auto production and construction spending among other factors.
U S steel mill utilization rates have trended higher since the end of the year and are currently slightly above 73%.
Turning to our fourth quarter performance.
Our production volume was approximately 29000 metric tons, representing a 36% year over year decline in a 22% sequential decline from the third quarter.
The suspension of our Monterey operations was the primary driver of the declines.
In addition towards the end of the fourth quarter, we began to proactively reduce production at our European manufacturing facilities, most notably our facility located in Pamplona, Spain.
Better match production volume with graphite electrode demand and to manage high energy costs more efficiently.
While the impact on our fourth quarter production levels was modest we expect to reduce our production volumes from our two European facilities to approximately one third of their capacity for the first half of 2023.
Turning to sales our fourth quarter sales volume of approximately 28000 metric tons represented a 37% decline from the same period in the prior year and a 22% sequential decline from the third quarter.
The impact of the Monterey suspension, along with lower demand for electrodes drove the declines.
Fourth quarter shipments included 19000 metric tons sold under our LTA is at a weighted average realized price of $9400 per metric ton.
And 9000 metric tons of non LTA sales at a weighted average realized price of $6100 per metric ton.
This non LTA pricing represented an increase of 22% compared to the fourth quarter of 2021 and was slightly above the average for the third quarter of 2022.
FX had a favorable impact on the sequential price improvement during the quarter, reflecting recent declines of the U S dollar most notably compared to the euro as a portion of our sales are denominated in foreign currencies.
Factoring all of this in net sales for the fourth quarter of 2022 decreased 32% compared to the fourth quarter of 2021.
As we look at the first quarter of 2020 free reflecting the headwinds that we discussed we anticipate our total graphite electrode sales volume will be in the range of 15 to 18000 metric tons for the quarter.
Further as you know the terms of most of our L. T. A's ended in 2022, and our mix shift has shifted more to non LTA business.
Lastly, regarding our top line outlook for the first quarter of 2023, we expect our weighted average non LTA pricing to remain comparable to the 2022 full year average of approximately $6000 per metric ton.
Let me now turn it over to Tim to cover the rest of our financial details.
Thanks, Jeremy net.
Net income totaled $50 million in the fourth quarter for a 20% net income margin and resulting in 20 of earnings per share.
Adjusted EBITDA was $80 million, a decrease from $183 million in the fourth quarter of 2021.
Reflecting the lower sales volume and higher year over year costs.
Adjusted EBIT margin was 32% in the fourth quarter.
Let me expand on costs.
For the fourth quarter, we experienced a year over year increase of 47% and cash Cogs per metric ton, which represented a 20% sequential increase compared to the third quarter of 2022.
This resulted in a cost per metric ton average of nearly $5200 for the fourth quarter of 2022.
With this metric, excluding depreciation and amortization as well as the cost of goods associated with byproduct sales and other noncash factors.
As we've indicated during the fourth quarter, we continued to feel the impact of global inflationary pressures that we experienced throughout the year, most notably for certain raw materials energy and freight.
As we sold higher priced inventory during the quarter.
This inflation accounted for approximately half the 20% year over year, or sorry, 20% quarter over quarter increase.
The balance was due to the accelerated.
Balance of the change was due to the accelerated recognition in the fourth quarter of approximately $11 million of fixed costs related to our Monterey operations.
That otherwise would have been inventory that we are operating at normal production levels.
As we look ahead, we project our cash Cogs per metric ton for the first quarter of 2023 to be flat to up slightly compared to the fourth quarter of 2022.
While we expect those two quarters are represent the peak of our recognized cost curve, we anticipate only a slight moderation in our cost per ton for the balance of 2023.
Therefore, we are projecting a year over year increase in our cost per metric ton in the range of 17% to 20% on a full year basis for 2023, as compared to 2022, which averaged $4300 per ton.
As we look forward. In addition to our ongoing focus on cost management, we expect market pricing for certain key elements of our cost structure to decline in the medium to longer term.
Including but not limited limited to energy in Decant oil.
For these reasons and with sales volume is expected to normalize.
Or to return to more normalized levels beginning in the back half of 2023 and for the full year of 2024, we are optimistic that our cost per metric ton will improve significantly as we move beyond the current year.
Turning now to cash flow and.
In the fourth quarter, we generated $50 million of cash from operations and $23 million of adjusted free cash flow with both measures decreasing compared to the fourth quarter of 2021.
Reflecting lower net income.
Moving now to slide nine.
Our gross.
Debt to adjusted EBITDA ratio was one seven times as of December 31.
Third to one six times at the end of 2021.
On a net debt basis, we ended the year at a ratio of one five times.
During the quarter, our total liquidity increased $27 million to approximately $462 million consistent.
<unk> of $135 million of cash and $327 million available under our revolving credit facility.
As we move into 2023, we continue to manage our working capital levels, we expect to be free cash flow positive for the year and do not anticipate the need to borrow against our revolver.
We remain confident we have ample liquidity between cash on hand, and availability under our existing credit facilities.
Now turning to slide 10.
Maintaining a prudent and disciplined capital allocation strategy remains a long term priority.
With the unintended unanticipated suspension of Monterrey, we elected not to pay down debt or repurchase stock in the back half of 2022.
A significant portion of our cash flow generation in the first half of the year was utilized for those purposes.
In 2022, we reduced our term loan balance by $110 million, bringing our cumulative debt repayments to more than $1 2 billion since the start of 2019.
During 2022.
We also returned $70 million to our stockholders in the form of stock repurchases and dividends.
Additionally, we invested $72 million in our capital assets, while also preserving a significant portion of our cash flow generation in the second half of the year to increase our liquidity.
For 2023, we're focused on maintaining a disciplined capital allocation strategy, including certain targeted investments such as the restart of our St Marys operation as Marcel referenced earlier.
For the full year, we expect our capital expenditures to be in the range of $55 million to $60 million, including investments to support our future growth expectations. Let me now turn it back to Marcel for his perspective on the outlook. Thank.
Thank you Tim.
We remain confident in our ability to overcome near term headwinds and are optimistic about the longer term outlook for our business.
We have been taking actions to best position grass Tech for the future. This includes remaining disciplined with all of our operating costs and capital expenditures as well as our working capital.
As an example, a reduction in temporary staffing and implementation of hiring restrictions resulted in a reduction in our workforce during the fourth quarter of 2022.
As Jeremy pointed out we are proactively reducing production at our European electric manufacturing facilities to approximately one third of their capacity to align our production volume with our near term outlook for graphite electrode demand.
We are making targeted investments to further improve our competitive positioning and to support long term growth.
This includes the full restart the virus Marys, Pennsylvania operations.
With these actions with the actions we are taking we will emerge stronger to benefit from longer term demand growth.
We continue to expect the steel industry's efforts to Decarbonize will drive the continued shift to electric arc furnace steelmaking supporting long term demand growth for graphite electrodes.
Factoring in announcements of planned.
Capacity additions by steel producers and estimated production increases at existing Es plans. This could result in an incremental annual electrode graphite electrode demand outside of China of 200000 metric tons by 2030.
We also anticipate the demand for petroleum needle Coke.
Raw materials are used to produce our graphite electrodes to accelerate driven by its use in lithium ion batteries for the growing electric vehicle market.
In fact based on estimates for growth in EV sales and battery pack sizes.
Could result in global needle Coke demand for using battery applications, increasing at a compound annual growth rate of over 20% through 2030.
The view of the growing demand for needle Coke is another positive long term trends for our business as higher demand should result in elevated pricing.
Our sustainable competitive advantages, including our substantial vertical integration into petroleum needle coke production through our seadrift facility are.
Our critical Differentiators and foundational to our ability to meet our customers.
To that point.
Very encouraged by our recently, having entered into several new multiyear electrode sales agreements.
This reflects our customers' confidence in our ability to reliably deliver high performing product.
In closing.
Our investment thesis remains intact.
<unk> possesses an industry, leading position and distinct type of capabilities and competitive advantages and a talented and dedicated team that is committed to serving our customers for these reasons I remain confident in our ability to deliver shareholder value.
That concludes our prepared remarks, we will now open the call for questions.
Thank you.
Ladies and gentlemen, we will now begin the question and answer session should you have a question. Please press star followed by the one on your Touchtone phone.
You are using speaker phone please lift the handset before pressing any keith.
Thanks.
First question comes from David Glick Cogliano at BMO capital markets. Please go ahead.
Hi, Thanks for taking my question I, just I just wanted to ask a clarification question. So the prepared remarks just now.
There was a comment made.
Did that.
St. Marys is slowly restarting is that what I heard.
Yes, that's correct.
Okay.
Can you talk a little bit about.
The reason why St. Marys is slowly restarting at this point, what the Capex is associated with that restart what the volume at XL.
Expectations on the timing of that.
Ramp up in volumes.
Thanks, Dan.
Sure Yeah, I mean, the logic behind it really comes down to.
The abolition a second complete.
Value stream for the production of pins.
And so with that we can.
That project off immediately after the initial.
Initial suspension in Monterrey, and we've been working.
It's too to restart those assets and to complete the permitting process. All of this is in fact going extremely well for us.
The capex that is going to take will be will be minimal in.
In the.
Nature of that it will it wont be incremental to the Capex that we've we've planned for this year and so it will all be managed within atypical cap.
Capex budget for the year, so it won't be anything extraordinary in that regard.
The timing of it is back to them.
It is permit dependent but the state of Pennsylvania has been incredibly responsive to our request in that regard so far so I would expect that.
We should be able to say that we're producing there by the time, we have our next earnings call.
Sorry, I just want to clarify one thing so all that had previously been communicated.
But I thought when you said or when the comment was fully restart St Marys.
Thought that meant into graphite electrode production again is that not correct that we're still just talking about pins right.
<unk>.
What's different from what we've done historically is that we're actually producing the pin stock in St. Marys. So that that will be the complete value stream is being produced there which could also be used for electrode production.
If economically feasible to do so.
Good day to you or to your point of your question. Our intent is not to bring additional electric capacity to the market right now.
Allowing us to have.
Have the redundancy and pin stock and also eliminate some of the movement of stock from Monterrey to St Marys, which hopefully longer term on a cost basis will be will be beneficial to us.
Okay, great. Thanks for clarifying that part of it.
Bill.
The commentary still leaves me a bit with the impression that there's something else to come I E graphite electrode production.
On the way at some point.
Just along those lines if that decision were to be made in two.
Again ramp up volumes of graphite electrode production.
What's the lead time associated with that incremental staff.
When.
Why do you expect to hear an update on that part of it.
So obviously.
The demand situation will drive that decision.
In the current Capex that we talked about the $55 million to $60 million for 2023, a capacity expansion of electrical production is in off peaks, so that will be beyond 2023 timeframe where.
With regards to the timing it will take that.
Jeremy you want to yes.
Yeah, Brian .
Market demand is much much better here than you expect how long do you think it would take me out we're probably talking 18 to 24 months type of timeframe to to execute an expansion of St Marys to drive incremental volume.
Okay. That's very helpful. Thank you.
Thank you, ladies and gentlemen, as a reminder, should you have any questions. Please press star one.
Next question comes from Arun Viswanathan RBC capital markets. Please go ahead.
Great. Thanks for taking my question good morning.
Good morning.
Sure Brian .
Good morning, a lot of a lot of the guidance items you guys offered so.
First off on the tons that you expect to sell in 'twenty three did you say that.
That's about half.
Of what you sold in 'twenty, two and so I'm getting to about 155000 ton number in 'twenty, two but that would put us around 80 for for 'twenty. Three is that right. Yes. So let me let me clarify that Arun. So the guidance was we would be at roughly 50% of the first half of 'twenty two in the first half of.
23, so we did roughly 85000 tons in the first half of 2022.
Okay perfect. So.
Some of that for the first half and then the second half though.
You'll you'll would be comparable to the second half of 'twenty two is that right.
Yes, so I mean, I think we certainly see.
Our ability via re engagement with our customers and the dialogue, we're having with them that the back half of 'twenty three.
We'll start to recover and what look much more like a normal year for us.
I'm not sure we get all the way to where we were in the back half of 'twenty, one, but we certainly will be over where we were in the back half of 'twenty two.
And then you also noted that is Q1 between 14 and 18000 tons is that right.
Between 15 and 18, that's correct that's what we were.
What we're expecting.
Okay, Great perfect and then in that 15 to 18 then.
A portion of that would be long term in a portion of that would be spot and so we'll use the 27% to 30 to long term.
And then what.
The rest will be made up with with spot is that is that correct. Yes, that's the right way to think about that.
Okay.
And then.
And then on the on the on the pricing side, So I guess needle coke or sorry electrode spot electrodes youre still seeing it around 6000, what can you offer as far as needle Coke I think last time, you said it was $25 600 or are we still in that range.
Would you provide an update on.
Electrode in needle Coke pricing.
Yes, so I would say right now in the market, we're seeing kind of on the high end for the Super premium needle Coke you are in that 2500 $2600 range on the top and obviously, the lower grateful traded a little bit of a discount to that.
I think previously we were probably closer to 2800, so we've seen a little bit of a pullback, but I would probably describe it more as a sideways market right now than anything.
And then thanks for that and then on the demand side. So.
You know last year definitely.
In the middle of the year and second half there was very weak demand in Europe .
It sounded like.
Maybe there's been a little bit of pickup in steel utilization rates at that 73 is that right and so what's your outlook from here I mean, do you expect steel utilization rates globally to improve.
May be driven by.
Some restocking some infrastructure build out and then definitely chime.
China coming back or how should we think about how demand evolves from here.
So one thing I just want to clarify is that 73% was a U S operating rate not a European operating rates. So I just didn't want you to get back to didn't want you to get that confused that is global Sir Thank you.
And so then the.
The other thing that I guess I would say is that.
The first the first month of this year is starting to give us some reasons for optimism and we're particularly seeing that on things like HRC pricing and some of the some of the restarts. Some of the recent increases in operating rates that we've been seeing in multiple different regions and so while a while still.
Meaningfully depressed from where we were a year ago.
We're definitely seeing some things that are giving us the degree of confidence that the markets are coming back.
Okay, and then just lastly, so given that comment.
Do you expect.
Boats needle coke and electrode prices to rise through the year and the reason I ask is because.
You noted that.
The demand environment.
Again, there are some potential green shoots and then you noted the.
17%.
Increase I think in in cost per ton for the year.
And so would that 17 to 22 would that would that.
Be in line with kind of how some of the costs involved with with how the pricing evolves or what kind of informs some of your cost commentary and similarly, if you could just elaborate on your on your thoughts on how pricing for these students for electrodes in needle Coke could play out.
So my thoughts here on pricing, everyone. I think it's quite difficult to really forecast short term pricing both for graphite electrodes and needle coke.
So it's very important that youre aware of that right. That's out there is a strong long term linkage between the right pricing of needle coke and spot prices for graphite electrodes.
And the long term average spread between these two is off the order of 38% to $3900.
So that leaves had actually health.
Very strongly over appropriate year plus period.
If you look at the current spot prices around $6000. The current needle coke pricing at least at the high end of about $2500 VR at a spread of about $3500 between the two so and also not completely out of line between the two but there might be a bit of upward move.
That's possibly you wanted to get back to the the long term average.
Longer term the key the key message here on pricing is really weak.
Expect that pricing for needle Coke to go up as demand for that important raw materials accelerated both for graphite electrodes as well.
Alex for battery applications and as such lease was also expected right for graphite electrodes to go up is that spread holds into the future and I think most importantly from my perspective here given that the only large scale producer of graphite electrodes outside of China that is integrated into that.
Raw material it really gives us an advantage vis vis our competition over time.
Okay. Thanks, I'll turn it over.
Okay.
Thank you next question is a follow up from David Gagliano at BMO capital markets. Please go ahead.
Alright, Thanks for taking my follow up I just had a quick question on the 2020 for LTA and the changes there and the revenues expected the volumes didn't change, but the expected revenues went down can you just talk through what happened there.
Yeah. So.
As we note in there.
The contractual volumes haven't changed and they expect as expected revenue from those contractual values have changed but certainly in that estimate there is always an assumption around certain customer contracts and associated termination penalties or termination revenue as a result from those contracts so without getting into the specifics of each.
Those individuals' our estimate of how much of those termination penalties, we'd collect out in the out years of those contracts has come down. So that's what's driving that kind of a weighted average volume weighted average cost reduction.
And the 2024 timeframe.
Okay.
I don't have the info in front of me right now, but I think when I was backing into it. This morning, it worked out to about a $40 million reduction.
Versus just what was implied last quarter, which is.
We weren't assuming that much of a reduction, but I mean that much of a benefit but.
That's a pretty big drop is that math right in.
And is there a little more information that we can get on why such a big drop.
Yes, I mean, you're definitely in the ballpark youre pretty close to $40 million and really again, it's a driver of as we work with these customers.
The contracts have various provisions that protect our interest in their interest as we continue to reach commercial agreements with our customers going forward, our predictions of how that may play out.
And what the requirements under the accounting rules are and what we showed there should not disclose a change so we've reduced that forward looking expectation.
Going forward, but I will say the underlying.
<unk> kind of revenue per ton is really reflective of.
These are the tail ends of these contracts is most of these were entered into again back in 2017, and 18 and and so we've gotten to the tail end of the blend and extends that I think that we've talked about in the past where we extended the term of these increased volumes over time with maybe a little bit of adjustment in price. So we're seeing the tail.
These contracts work out in the out years.
Okay great.
Last related question on that.
On a go forward basis.
Are there.
More.
Potential revisions coming with these contracts that are left.
And if so could you quantify like sort of the assumptions that are made.
It could change yes.
Yes, no I guess, that's why that's why I added the commentary I think the implied revenue net rate right. Now is really reflective of kind of the contractual what the volume times the price would otherwise look like.
Okay, great. Thanks, So let me just add David so unless you have a situation where our customers.
And the situation of Nonperformance I don't think those change.
Perfect got it thanks.
Thank you. This concludes our question and answer session I will now hand, the call back over to Mr. Kessler for closing comments. Thank.
Thank you operator, I would like to thank every US everyone on this call for your interest in graphics and <unk>.
We look forward to speaking with you next quarter. Thank you.
Ladies and gentlemen, this concludes your conference call for today, we thank you for participating and we ask that you. Please disconnect your lines.