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Greetings. Welcome to Crane's Second Quarter 2022 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] Please note, this conference is being recorded.
I will now turn the conference over to Jason Feldman, Vice President of Investor Relations. Thank you. You may begin.
Thank you, operator and good day, everyone. Welcome to our second quarter 2022 earnings release conference call. I'm Jason Feldman, Vice President of Investor Relations. On our call this morning, we have Max Mitchell, our President and Chief Executive Officer; and Rich Maue, our Senior Vice President and Chief Financial Officer.
We will start off our call with a few prepared remarks, after which we will respond to questions. Just a reminder that the comments we make on this call may include some forward-looking statements. We refer you to the cautionary language at the bottom of our earnings release and also in our annual report, 10-K and subsequent filings pertaining to forward-looking statements. Also during the call, we will be using some non-GAAP numbers which are reconciled to the comparable GAAP numbers and tables at the end of our press release and accompanying slide presentation, both of which are available on our website at www.craneco.com in the Investor Relations section.
Now, let me turn the call over to Max.
Thank you, Jason and good morning, everyone. Thanks for joining the call today. Another strong quarter with solid results across the board. Second quarter adjusted EPS was $1.90, consistent with our expectations and our guidance commentary and compared to $1.93 in the second quarter of 2021. Remember that the May divestiture of Crane Supply reduced EPS by approximately $0.05, both sequentially and compared to the prior year.
We also delivered core sales growth of 7%, with further strength in demand reflected in core order growth of 14% and core backlog growth of 21% compared to last year, continued solid underlying trends in our primary end markets. Clearly, momentum continues with another quarter of strong results, differentiated execution despite a challenging operational environment as well as further evidence of our success in driving accelerating growth.
Across all of our businesses, our commercial excellence, innovation and investment in technology road maps, support our ability to drive outperformance compared to our peers across the cycle in an environment with continued supply chain constraints. In addition, everything is on track and progressing towards our early 2023 separation which will unlock shareholder value and permit each post-separation company to optimize investment and capital allocation and further accelerate growth.
Starting with the market environment, we continue to see robust demand across our end markets. We are carefully watching for any signs of softening but order rates remain strong across our businesses. The supply chain, including material and component availability remain challenging but still fully consistent with the outlook we provided in January of this year. We've clearly planned appropriately for this environment.
From a cost and inflation perspective, we continue to be assertive with pricing actions across all of our businesses and we continue to fully offset the impact of inflation. Overall, we still believe that we planned appropriately when we entered 2022 and that our current guidance is consistent with the demand conditions and supply chain constraints we are seeing today and we expect similar conditions to persist throughout the year, consistently delivering on our commitments.
The year is playing out as expected. And beyond execution for 2022, we remain intensely focused on all strategic initiatives, advancing technology to position our businesses for the future and preparing for the next step of our journey, the April 2023 separation into Crane Company and Crane NXT. Each segment also continues to execute for growth.
We remain highly confident in our ability to drive a 7% to 9% sales CAGR at Aerospace & Electronics through the end of the decade. Process Flow Technologies continues to drive record levels of product vitality and innovation. And at Crane NXT, we are aligned with secular trends and macro drivers in delivering solutions that enhance productivity and efficiency for our customers with leading technologies.
So in summary, excellent execution and all efforts on track, an exciting set of opportunities for these businesses, both before and after the separation.
At this point, I'll turn it over to Rich for some additional financial commentary.
Thank you, Max and good morning, everyone. We continue to make progress, both operationally and strategically on all fronts and it shows in our results as we continue to find ways to drive profitable growth even through all of the challenges we are facing today. My thanks again to our leadership teams and associates globally for their focus and dedication driving sustainable value creation for all our stakeholders. Moving to segment comments that will compare the second quarter of 2022 to 2021, excluding special items, as outlined in our press release and slide presentation. Starting with Aerospace & Electronics, sales of $162 million increased 3% compared to last year. The segment margins of 17.5% were similar to last year's 17.8% and down from 19.6% last year when we had particularly favorable mix.
In the quarter, orders increased 27% compared to last year but with sales still constrained by material availability. We are seeing improvement. Sales improved sequentially from last quarter by 3% and we expect further sequential improvement in the second half of this year as the supply chain constraints continue to moderate gradually. In the quarter, total aftermarket sales remained strong and were up 7% compared to the prior year. Aftermarket strength was led by commercial, up 15%, driven primarily by spares and repair and overhaul. Defense aftermarket sales declined 6%, based on program timing and some temporary shipping delays. Commercial OE sales increased 13% compared to the prior year, driven by higher build rates.
Defense OE sales declined 9% due to program timing and some transient material availability constraints. As we discussed earlier this year at our Investor Day event, we are very excited about the outlook for this business and continue to have confidence in a 7% to 9% sales CAGR over the next decade. Our confidence in this outlook is based on our differentiated technology, a continued post-COVID commercial aerospace recovery and the numerous major multiyear programs, particularly on the defense side of the business that we have already won. This year specifically, we had solid performance that improved progressively over the last 6 months and we expect modest continued sequential improvement in sales over the remainder of this year. Given the expected timing of specific projects, we expect margins to be strongest in the fourth quarter of this year and we remain on track for full year margins of approximately 18%.
At Process Flow Technologies, sales of $296 million decreased 5%, driven by a 7% impact from the May divestiture of Crane Supply and a 4% impact from unfavorable foreign exchange, partially offset by 6% of core growth. Operating profit decreased by 6% to $46 million but adjusting for the divestiture of Crane Supply, operating profit was approximately flat compared to the prior year. Operating margins were basically flat at 15.6% compared to 15.7% last year. Pricing continues to fully offset material inflation. Sequentially, compared to the first quarter, core FX-neutral backlog increased 5% with core FX-neutral orders up 7%, both adjusted for the Crane Supply divestiture. For reference, backlog at Crane supply in the first quarter was $32 million. Compared to the prior year, core FX-neutral backlog increased 14% and core FX-neutral orders increased 8%, also both adjusted for the Crane Supply divestiture.
Backlog related to Crane supply last year was $25 million. Continued strong leading indicators suggesting that we will see strong continued growth throughout 2022, led by our process business where overall order rates have already recovered to approximately pre-COVID levels. The strength is being led by the chemical, pharmaceutical and general industrial end markets. After adjusting for the Crane Supply divestiture which contributed approximately $45 million of sales in the second quarter, we expect third and fourth quarter sales run rate to be similar to the second quarter. However, we do expect margins to improve sequentially in the third quarter and then again in the fourth quarter.
Moving to Payment & Merchandising Technologies. Sales of $334 million in the quarter increased 2%, driven by a 7% increase in core sales, partially offset by a 5% impact from unfavorable foreign exchange. Segment operating profit increased 4% to $81 million. Operating margins improved 50 basis points to 24.2%, reflecting strong pricing and productivity, partially offset by unfavorable mix. Currency markets are behaving as anticipated and previously communicated, with core sales roughly flat compared to last year in the quarter. Remember, currency hit new records in both U.S. and international sales last year. Full year 2022 will decline modestly and we will then resume growth from an elevated base next year.
At CPI, broad-based strength continues with double-digit core growth. Our gaming business has been very strong. Vending continues to improve and the level of activity in the retail market remains very encouraging. We continue to see a proliferation of different solutions across the retail space but the common theme is the need for productivity in an inflationary environment with labor shortages.
For the segment, we expect sales to be similar sequentially from Q2 to Q3 before picking up further in Q4. From a margin perspective, we do expect margins to moderate in the second half due to anticipated mix, while full year segment margins are on track to reach approximately 23%, exceeding last year's record levels. At Engineered Materials, sales of $73 million increased 23% compared to the prior year. Operating profit increased 40% to $11 million. Operating profit margins increased 180 basis points to 14.8%. Strength was broad-based across end markets and led by RV and building materials. The segment remains on track to achieve previously issued full year guidance of 13.5% margins and 5% core growth.
Free cash flow was $92 million in the quarter and consistent with our normal seasonality and a significant pickup relative to the first quarter. Adjusting for onetime cash outflows related to our portfolio actions, we believe that we are on track to achieve our full year adjusted free cash flow guidance of $350 million to $390 million. However, it will be more back-end loaded than normal, given higher working capital related to the market recovery, most notably some improving inventory and in many cases, we are making very conscious deliberate decisions to add inventory in the near term to best protect our customers.
Our balance sheet is in extremely good shape. By the end of the year, we expect adjusted gross leverage towards the bottom end of the 2 to 3x Moody's gross debt-to-EBITDA target range for our current credit rating. Turning to guidance. We are maintaining our adjusted EPS range of $7.45 to $7.85 for the full year. As a reminder, when we announced the sale of Crane Supply in April, we maintained our then guidance range of $7 to $7.40 despite the loss of 7 months of earnings contribution from that business.
So effectively, it was a 25% operational guidance increase at that time. Shortly thereafter, in May, we updated our guidance once more to reflect adding back the earnings of Engineered Materials after it no longer met the criteria for discontinued operations, resulting in our existing $7.45 and to $7.85 range. There is no change in our operational guidance assumptions in May and we continue to remain confident in that outlook despite incremental foreign exchange headwinds of approximately $0.10.
From a cadence of earnings perspective and timing through the quarters, we expect the third quarter to be similar to the second quarter after adjusting for the approximate $0.10 of earnings contribution from Crane Supply in the quarter, said another way, we expect third quarter EPS to decline sequentially about $0.10 which is the amount Crane supply contributed in the second quarter prior to the May divestiture of that business. We then expect the fourth quarter to be stronger, driven primarily by sequential margin improvement at process flow technologies and both sequential sales and margin improvement at Aerospace & Electronics.
Regarding the separation, our work is progressing very smoothly. We have completed the required carve-out financials and associated audits and we are making good progress preparing the initial Form 10 filing. We have completed the future state design for both post-separation businesses across every corporate function. We have made substantial progress on the staffing of both corporate organizations. All Crane corporate associates now know what company they will be working for as well as the specific role and we are executing against a structured hiring plan to fill the remaining open roles over the next 8 months.
And we continue to further refine the details of the post-separation capital structures, our financing plans and our plans for legacy liabilities and we expect to be able to share those details in early fall of this year. Overall, we are on track to complete the separation in the 12-month period we communicated on March 30. A solid outlook and even more exciting times ahead as we enter 2023 and complete the separation. We are all energized at the progress that has been made to date and the opportunities that we are unlocking and pursuing every day.
Operator, we are now ready to take our first question.
[Operator Instructions] Our first question is from Matt Summerville with D.A. Davidson. Please proceed.
First question maybe on process flow. Could you maybe put a little bit of a finer point around maybe of the 6% organic, how much of that is volume versus price? And then maybe add a little bit more detail around geographic and market color? And then I have a follow-up.
Yes. So for the volume price, we did see a very modest drop in volume. So the substantial majority or all of it was related to price in the quarter. When you look at the order profile; however, you noted some of the commentary and what you saw in the release, we feel really good about the level of demand, the nature of the demand and the backlog that we have to execute against. So pretty positive about where we are today in relation to the second half of the year. From a geographic perspective, I would say that not too much has changed since the last quarter. I would say demand continues to be fairly strong here in the Americas, improving in Europe a bit. China remains a little bit constrained with respect to those end markets and COVID restrictions and so forth. Other than that, I would say it's fairly stable since the first quarter.
The only thing I might mention is less material but our nonresidential U.K. business seeing some early signs of some pushouts, projects being questioned, not unexpected, actually but that's probably the only sign that I would say.
Got it. And then as my follow-up, maybe just talk a little bit more detail around the currency business. Obviously, very tough compared there, no doubt about it. But when I look at kind of the numbers coming out of the BEP and where they're at fiscal year-to-date on their production seemingly below, tracking below the low end of an extremely wide range that they issued with respect to the purchase order. I was wondering if you could comment on what sort of dynamics you might be seeing there? And if you have any early thoughts on fiscal '23, as I know their planning process is well underway right now.
Yes. Thanks, Matt. All positive in that -- the main reason for the below the wide range is the work in progress that needs to be set aside for next series. And as we've mentioned in the past, we're a very close partnership with Crane Currency on the micro optic thread that we will -- we strongly expect added content as NXT series is introduced. So there's a tremendous amount of work and progress being made. There needs to be press time set aside for the trial runs and that's impacting. In addition to BEP, has been hit like many of us with COVID-related challenges, other particular challenges specific that I won't get into. But I think the demand is still strong. I think the desire from the Fed to have an increased shipment level would be ideal. But I think that the BEP is doing a fantastic job trying to manage through that the best they can, while also getting prepared for the future. Hopefully, that gives you some insight that it's all very positive trends for the longer term. And I think in terms of 2023, it bodes well for taking almost the maximum that the BEP can continue to try to get out while also conducting trials.
The only thing I would add on, Matt, is just that we -- I think we planned accordingly for the year as well. So notwithstanding that they're at that lower end of the range, we still feel real good about where we are in the year and what we have left to do. And I would say, just outside of the U.S., we continue to see some nice momentum starting to build again on the international side. You'll recall that last year on the international side, it was a really, really strong year and caused some tough comps for us. But we are seeing some nice pickup in order flow that will benefit us going forward as well in 2023.
Understood. Thank you, guys.
Our next question is from Nathan Jones with Stifel. Please proceed.
Good morning, everyone. I'm going to follow up with some more on price versus volume. Obviously, prices are a big contributor to a lot of companies growth, not just yours at the moment. Any more color you can give us on price versus volume in order rates, in backlog growth, those kinds of things and any color, any detail on the different segments? And just any more details you can give us on price versus volume in each of the businesses.
Yes. What I would say is from a price volume point of view in each of the businesses in process, I would say that we're making similar progress across all. It's not unique to the process end market business or in -- or unique to the commercial side. So we're making progress across all. I would say that the price material cost relationship is generally slightly positive across all. I think we're able to hold our margin profile with the process that we've been executing across that business. So there's not one unique spot, Nathan, that's stronger than another necessarily. It's -- the teams are executing really well across the board price cost.
I think it's generally -- check me, Rich, Jason [ph] but I think it's generally accurate to say that while we've been a little supply constrained managing to the sales and price volume, there is more offsetting in our backlog and order rates, though, we do see a core volume increasing significantly versus just price.
Yes. I mean if you look at the order increases that you see, what we've shared, the percent that's volume versus price is significantly outweighed by volume. There isn't a lot of, I would say -- it's weighted towards volume.
And having said that, we feel very confident about the pricing that we have in the backlog as well, where it's positioned and that means for forward...
The volume increases in orders and backlog is across all of the businesses or are more heavily weighted to one or the other?
I would say it's fairly widespread, right? I mean, fairly widespread.
That's helpful. I just wanted to get one on Engineered Materials. Now the sale didn't go through. Can you talk about the plans for that? I mean, obviously, that business has historically been fairly cyclical and interest rates going up and consumer confidence going down. Are there strategic buyers out there? Does the current environment -- the business is obviously performing really well but does the current environment reduced the outlook for price? And could that lead to you not selling it? Just any thoughts that you have about that.
I appreciate that. Nathan, just a reminder, we -- I hope investors appreciate the significance with which we are addressing the portfolio comprehensively and really positioned well to add significant value with the separation moved on Crane supply, clearly indicated for years that while a great business and a great team. Engineered Materials was not strategic. We finally moved forward with the sales process, very unfortunate, after a very long process with potential buyer that -- the regulatory environment today with just a minor overlap in Building Products.
The sale was effectively blocked. Now unfortunately, the time has not been in our favor. And with everything else that's going on at Crane, what we're focused on, where the market is, not unexpectedly, I think this is -- from a macroeconomic standpoint, I think we all kind of clearly see that minor recession is underway. Consumer discretionary is impacted first. I think we're already seeing some hinting that the back half, although we feel very solid about our guidance, it's not going to impact our performance at all. We're seeing some adjustment in Engineered Materials. So net-net, I think investors should feel that Engineered Materials stays with cranes for the foreseeable future is most likely. And then -- it's a great business, great team, continues to drive nice free cash flow in the U.S. that we'll continue to deploy. And we'll address this again at the right time in the future is how we think about it.
That makes sense. I'll pass it on. Thank you for taking my questions. Thank you.
Our next question is from Damian Karas with UBS. Please proceed.
Hey, good morning guys. Good evening. I want to ask you about PMT. Just -- I didn't hear you mention anything about shipment timing or anything seasonal sort of that nature. So I'm just wondering for the second quarter, is it fair to assume that the underlying demand is just coming in above expectations? And if so, where are you seeing that mostly?
I think I might say in line with expectations, right? I mean we're tracking, I think, pretty well for the growth that we had expected for the year. There had been a little bit of shipment timing we mentioned last quarter which favored 1Q at the expense of 2Q but nothing more to kind of add on that.
Yes. The only thing I would add just in terms of where we're seeing it, I would say the percentages and the growth, it's really in line, frankly, with our guidance and what we would have thought. But we -- as I mentioned to Matt, a few minutes ago, we are seeing some nice momentum on the currency side on the international portion of the business. But if you flip them back to the payment side, continued strength in retail. In terms of percentages and so forth, it's what we expected, strength in gaming continues as well.
That would be worth mentioning -- we haven't talked about this with investors to date. But on a year-over-year basis, I mean, the core strength we're seeing in our end markets of gaming, retail, our systems business. It's been very strong. And on a year-over-year basis, we had a bit of a tailwind, well, just a strong end market dynamic last year with bitcoin kiosks actually. We all have had questions in the past about crypto and the threat of bitcoin. Meanwhile, bitcoin kiosks were a huge driver for us last year, taking cash from individuals and converting it into bitcoin. Now since bitcoin and crypto has crashed, we've seen a dramatic decline in that end market move. So you can imagine the offset in our other markets that just continue to be very, very strong. I just want to overemphasize the strength that we see, the tailwinds, we're still under 2019 revenue. I think we have significant end market trends and movement into 2023 and beyond just all positive indicators. I don't know if you want to frame up.
Yes. No, it's an excellent point. We grew. If you look at Q1 and Q2, in the legacy -- the payment components business, we grew in the double digits, right? On a core basis and that includes really having that business that Max just mentioned bitcoin being right now at 0. So just to put some context around that, the growth in the underlying business beyond that is obviously north of that.
Got it. Got it. Helpful color. And then, Rich, you mentioned that actions at Crane taking the secure inventory for your customers. I was wondering if you could maybe just walk through your assessment of where inventory levels are when you look across the various distribution channels that your business sells into.
Yes. So like, for example, in general industrial here in the U.S. in process, I would say that they're replenishing now. There's not -- there's still quite a bit to -- of just pure underlying demand, I think, in that part of the business where it's the primary distribution arm for us right now. The segment where we sell into. So yes, they don't have a whole heck of a lot of inventory. They're still needed. My comment on that, right, was to secure inventory levels to make sure that we can satisfy demand just given lead times, right? So we're making conscious decisions in certain of our business units to make sure that we have that inventory to be able to deliver to our customers.
But even having said that, I wouldn't say it's unnatural or too unusual, I think it's more surgical. There's a couple of strategic. But some slightly higher inventory levels that we're intentionally trying to bring in but nothing too dramatic.
Okay, got it. Thanks, guys.
Yes. Thanks.
Our next question is from Elizabeth Grenfell with Bank of America. Please proceed.
Hi. Good morning. I was hoping you could give us a little more color on the decline in defense on both OE and the aftermarket side. When you expect that to turn the headwinds that you're seeing sort of the timing around it and any detail you could provide? Thank you.
Yes. So the declines that we're seeing were, I think, largely expected. When we came into the year, we guided down on defense. Just as a reminder, right, we have grown in the 20-plus-percent range for the last couple of years. So we really did enjoy some really, really strong growth over the last couple of years coming into 2022. So some very unfavorable comps. When you think about some of the shortfall, I did make some comments with respect to material availability and some timing. That's on the margin around it, just to give you some context. We would expect that to start to turn around next year, maybe in the latter half or so, is sort of our thinking. But yes, it's -- what I would say just broad strokes is that it wasn't unexpected as we guided into the year with down defense. We participate primarily in ISR. If you think about some of the areas where folks are maybe enjoying a little bit more growth versus us in the current year. So that could -- it's where we play effectively versus others.
Thank you very much.
And our next question is from Kristine Liwag with Morgan Stanley. Please proceed.
Well, good morning, everyone. On the Crane supply side, how are you thinking about using the proceeds? And has there been a change in your capital deployment priorities given the tougher macro environment?
Yes. So there's some strategic things that I think you might be aware that we are working on. We've been, I think, pretty clear about initiatives around defeasing asbestos, for example. That could be a potential use of those proceeds. Certainly, we continue to plan for the separation and setting up the capital structure for both organizations post separation. And this is another area that could benefit us as well as we think about setting those companies out. Even excluding -- if I maybe I'll provide a little bit more color on the capital structure of both those organizations post separation, setting aside Crane supply, it is really, really important to us that we set up both these businesses to be hugely successful from a capital deployment perspective, being able to grow through M&A and frankly, just execute on their respective strategies. What I would share with you right now is when you look at net debt-to-EBITDA level in both those organizations.
Our current thinking right now is that, at Crane company, we would see a sub 1x net debt to EBITDA and both of these numbers, I'll give you are including asbestos, assuming actually, I have asbestos, sub-1x net debt to EBITDA at Crane company. And then at Crane NXT, somewhere around 1.5x net debt to EBITDA. So very, very strong balance sheet positioning for both those organizations post separation, if that helps.
And then between now and the end of the year, we certainly have our plates full with what we're executing on and executing well. It would have to be very strategic for us to entertain an acquisition between now and our separation in April. However, we have significant activity that continues funnels across all organizations and plans to deploy quite -- hopefully, quite soon after separation.
And if I could do a follow-up. I mean, with respect to filling out the management team for Crane NXT, with the rise and fall of crypto plus the macro headwinds that we're seeing today, have any of these items led you to think differently about leadership and strategy for that business? Do you think this is going to be a growth segment? Or is it going to be just a cash-generative segment? How has that evolved as we factor in what's happened in the past few months?
We've always felt that it was a growth opportunity. And the leader we're looking for is going to be clearly capable of continuing to drive that growth as we move forward, not just with core but in adjacencies as well without a doubt.
Great. Thanks, guys.
And we do have a follow-up question from Damian Karas with UBS. Please proceed.
Just a couple of quick follow-ups here. I was wondering if you could help us on the math on PFT, just thinking about the margin improvement in the back half. You kind of need to be at 17% or a little bit better, I think, to hit the full year guide. So Rich, maybe you could just walk us through like how much of that is from Crane supply coming out? And what's the good way to think about kind of the incremental margin for that business now, ex the distribution business?
Yes, it's largely going to -- we did have some unfavorable mix that hit us here, expected in the first half of the year. We do expect to see that improve in the second half of the year. I would say it's -- we would see improvement mainly in our process -- the process side of PFT. So a mix of the types of solutions that we're selling into the different end markets, the different brands that we have, beginning to contribute more meaningfully in the second half. It really is just the mix of products that we're selling relative to where we are here in the first half. We continue to execute on the repositioning savings as well. Where we should see some of that incrementally increase as we move through the balance of the year and then just continued strong price cost management. It's going to be those elements that really get us there. And honestly, I feel pretty confident in that target for us. It's not so much driven by Crane supply. It's really more the underlying fundamentals of what we see happening in that business.
And look, incrementals, I think was the other part of your question, a little tricky given all the moving pieces with inflation and price and whatnot. But I think over the long term, we've -- without supply, we've talked about this staying at 35% to 40% incremental margin business right now. That may be obscured in any given quarter but that's kind of the underlying long-term structure of the business.
And Rich, you kind of set yourself off with this one. I can't resist. So on asbestos, what would you say the probability is that there's some actions related to that before the year -- end of the year?
I'll take it, Damian. It's significant interest. We're continuing to progress and progressing very, very well. Just leave it at that.
All right, sir. No. Thanks again, guys.
We have reached the end of our question-and-answer session. I would like to turn the conference back over to Max Mitchell for closing comments.
Thank you, operator. Another quarter with solid performance and further steps in our path to separation to drive further shareholder value. As the late great actor, James Caan, said as Sonny Corleone in The Godfather when discussing a meeting with Sollozzo. What did he say? He wants us to send Michael to hear the proposition and the promise is the deal is so good that we can't refuse. As fans of the Godfather Series, Rich and I and the Crane team have an offer for investors, you can't refuse: rigorous discipline and differentiated execution, consistent investment for growth where our momentum is building and we are showing accelerating results and a firm commitment to shareholder value creation, including disciplined acquisitions, portfolio shaping through divestitures and now a separation that will position our businesses for further acceleration of growth.
What an exciting story and I look forward to sharing updates with all of you over the next several quarters. Thank you all very, very much and have a great day.
Thank you. This does conclude today's conference. You may disconnect your lines at this time. And thank you for your participation.