Fomento Economico Mexicano SAB de CV (FMX) 2011 Q4 法說會逐字稿

Good morning and welcome, everyone, to FEMSA's Fourth Quarter and Full Year 2011 Earnings Results Conference Call. All lines have been placed on mute to prevent any background noise. After the presentation there will be a question and answer session.

During this conference call management may discuss certain forward-looking statements concerning FEMSA's future performance and should be considered as good faith estimates made by the Company. These forward-looking statements reflect management expectations and are based upon currently available data. Actual results are subject to future events and uncertainties, which can materially impact the Company's actual performance.

At this time I will now turn the conference over to Javier Astaburuaga, FEMSA's CFO. Please go ahead, sir.

Thank you. Good morning, everyone, and welcome to FEMSA's fourth quarter and full year 2011 results earnings conference call. Juan Fonseca and Jose Castro are with us today as well.

In terms of the operating results, we will focus on the consolidated figures for FEMSA and on FEMSA's Comercio's results, as many of you probably had the opportunity to participate in Coca-Cola FEMSA's conference call earlier today.

As you have also no doubt read our press release and seen our detailed results, we will use this call to discuss some of the highlights and main trends we're seeing in our businesses.

Let me begin by commenting on some of the highlights of what turned out to be a strong 2011 for our Company. Despite the volatile economic environment, demand for our products remains healthy and we managed to convert that demand into robust financial results by focusing our time, efforts and resources on the extraordinary opportunities for Coca-Cola FEMSA and OXXO.

For Coca-Cola FEMSA this was a historic year. We leveraged our financial and operating flexibility, firmly advanced on our strategy to grow through our credit mergers and acquisitions, for our incursion into the dairy category through our joint acquisition of Grupo Industrial Lacteas in Panama to our mergers with the beverage additions of Grupo Tampico, Grupo CIMSA and Grupo Fomento Queretano in Mexico.

And at FEMSA Comercio our robust top-line growth in 2011 was driven by our continuing store expansion and our comparable same store sales growth of 9.2%, ahead of trend and reinforcing our position as an industry benchmark.

Our progress in mapping and understanding consumer's needs and adjusting our value proposition to better fulfill those needs significantly contributed to our same store sales growth.

We also made great strides in our sustainability efforts from launching joint watershed conservation initiatives with world-class NGOs to making significant progress in our renewable energy programs, particularly our large windfall power project in the State of Oaxaca to ensuring that everyone of our managers now incorporates sustainability objectives in their annual performance metrics.

In particular, today we are happy to note that the financing is in place to build this wind farm, the largest in Latin America, which will generate almost 400 megawatts of clean renewable power and will supply the Mexican operations of FEMSA Heineken for 20 years. We have successfully exited our short-term role as investors and will now remain solely as energy up takers. This project underscores our commitment to derive as much as 85% of our energy needs from renewable sources while making perfect economic sense.

So in many ways 2011 was a very good example of what we believe our business model can achieve, sustainable organic growth across our businesses, leveraging our operations and our skill set complemented with value creating mergers and acquisitions.

As we often do in these calls, let's spend a brief moment on our perception of the environment and the drivers for consumption, particularly in our key Mexican market where we have a slightly improving picture in the last few months.

GDPM manufacturing activity, as measured by the guide, are mid single digits, while the Mexico consumer confidence index has rebounded and seems to be back on upward leg.

Unemployment levels are also showing a favorable trend with indicators well below 5% during the fourth quarter. Having said that, as you have seen our results in Mexico during 2011 exceeded the macro trends driven by our business execution but also helped by external factors such as dry and warm weather, particularly during the first half of the year; we should expect the results this year to track the macro data a bit more closely absent extraordinary factors.

Moving on briefly to the macro environment in other markets where we operate, in 2011 Columbia and Argentina performed better than Venezuela and Brazil. In Columbia low unemployment and low inflation contributed to deliver mid single-digit GDP growth, while in Argentina GDP grew in the high single digits but in the face of low double-digit reported inflation.

For its part Brazil experienced a slowdown with GDP growing only in the low single, while Venezuela showed moderate growth but with very high inflation approaching 30%.

Moving on to discuss our consolidated quarterly numbers, we are again encouraged by the results. Total revenues increased 24.5% and operating income grew 25%. On an organic basis excluding the integration of three months of Grupo Tampico and one month of CIMSA, total revenues increased by a couple of points less.

These results were driven by double-digit growth in total revenues and operating income at both Coca-Cola FEMSA and FEMSA Comercio. As has been the case since the Heineken transaction in 2010, these figures do not include the results of the beer operations.

For the full year including acquisitions, total revenues increased 19.6% and operating income grew 19.4%.

On an organic basis the increase in total revenues was similar at 19%.

For the quarter the line labeled participation in Heineken results represents FEMSA's implied 20% for participation in Heineken's fourth quarter net income. Importantly, for the full year the line represents FEMSA's actual 20% participation in Heineken's net income derived from Heineken's full-year numbers reported approximately two weeks ago.

And before leaving the subject of net income, we see the net income from continuing operations increased 900% in the fourth quarter and 15.2% for the year. As we explained in our press release this increase reflects growth in income from operations and the variation in FEMSA's 20% participation in Heineken's net income, which more than compensated the effect of non-recurring items.

These items include the fact that in the second half of 2010, we registered income from the sale of Mundet and of our flexible packaging business setting up a tough comparison for 2011. It also incorporates the impact from the write off of certain unproductive assets at Coca-Cola FEMSA.

Our effective tax rate was 25.6% for the quarter and 27.1% for the year and going forward we expect our tax rate will look like around similar levels and that is in the mid to high single 20s.

Moving to our cash position, during the fourth quarter we went from having a consolidated net cash of MXN7 billion at the end of September to having a consolidated net debt position of MXN1.1 billion at the end of December, reflecting the assumption of approximately MXN4.8 billion of debt related to the Tampico and CIMSA transactions, outflows related to certain backend loaded CapEx of Coca-Cola FEMSA, as well as our second dividend payment for the year, all of which were partially offset by strong cash generation mainly at Coca-Cola FEMSA.

And staying on the subject of dividends, our Board of Directors agreed yesterday to propose a dividend of MXN6.2 billion to be paid in 2012, subject to approval by our shareholders at our meeting to be held in March. This amount represents an increase of 35% over the amount paid in 2011 and is consistent with our long-term objective of increasing our return of cash to shareholders while retaining our financial and strategic flexibility. In fact, our dividend has increased by a factor of almost 4X since 2009.

Moving on to discuss our operations and beginning with FEMSA Comercio, we should highlight that the rollout of new store openings continues to move forward according to plan. We opened 413 net new stores during the fourth quarter, which means we opened 1,135 stores in the last 12 months, slightly ahead of our objective for 2011.

For 2012 you should expect a similar number of net new store openings, slightly above 1,100.

Revenues increased 17% during the quarter. Same store sales were up a healthy 8% reflecting improvements in average traffic as well as ticket. Our average ticket increased 4% and traffic rose 4.1% continued to reflect progress in our management of category importation occasion mix.

We continued to benefit from price increases taken earlier in the year by several of our suppliers for important categories, such as soft drinks, beer, fast drinks, cigarettes and others, as well as from OXXO's continued fine tuning of its value proposition within the store, as we keep improving the fit between that value proposition and growing range of consumer needs.

For the quarter, gross margin expanded 70 basis points, again driven mainly by a positive mix shift due to the growth of higher margin categories and more effective collaboration and execution with our key supplier partners combined with a more efficient use of promotion related marketing resources. In turn these drivers and trends have allowed gross margin to expand by 60 basis points for the full year.

In terms of operating margin, this quarter FEMSA Comercio posted a 10 basis point margin contraction, reflecting mainly incremental expenses such as the strengthening of FEMSA's Comercio organizational structure, mainly IT related, as well as certain targeted marketing efforts to promote key initiatives toward the end of the year in specific categories.

Also, as is always the case, the rapid pace of store openings put some pressure on the selling expense line, as the new stores generate expenses from day one while revenues take a while to get up to speed.

For the full year, FEMSA Comercio's operating margin expanded 10 basis points, very much in line with our long-term expectation. However, as we have stated before, we will maintain the pace of investment required to strengthen our platform and develop the capabilities as we need to keep Comercio growing into cutting edge retailer.

In other words we will always privilege investing in the long-term fundamentals of the business over managing the margins for the short-term.

And finally Coca-Cola FEMSA revenues for the quarter increased 29% versus a comparable period of 2010 as a result of strong revenue growth mainly in Mexico, Central America, Colombia and Argentina and reflecting the incorporation of three months of the Tampico operations and one month of CIMSA in Mexico.

Operating income increased 25% on the same basis. If we exclude integration of Grupo Tampico and Grupo CIMSA, total revenues grew approximately 24% and if you were unable to participate in Coca-Cola FEMSA's conference call earlier today, you can access a replay of their webcast for additional details on the results.

As we start the New Year, we have our work cut out for us. At Coca-Cola FEMSA, we have to focus on integrating and capturing the potential synergies from our recent acquisitions, while keeping the foot on the gas in our pursuit of organic growth.

As you know, last weekend KOF announced that it has entered into a 12-month and specific agreement with the Coca-Cola Company to evaluate the potential acquisition of the controlling ownership stake in the bottling operations of the Philippines. We believe that KOF's expertise and successful track record operating in fragmented markets and emerging economies can be effectively deployed in this territory and contribute significantly towards expanding the penetration of and consumer preference for the Coca-Cola Company's brand in these markets. We will keep you posted on these developments as appropriate.

At FEMSA Comercio, we have to maintain the rapid pace of store openings while continuing to fine tune our value proposition to keep driving same store sales and while we do all this we must continue to be vigilant in our search for incremental transactions that may enable us to put our financial and strategic flexibility to work. And this must be done against difficult comparison basis and a fairly challenging backdrop.

While we can count on our operators to continue to execute the strategy and to continue to improve our businesses, we cannot count on the weather being as warm and as dry this year as it was last year and we cannot count on such a constructive pricing environment for us and for our suppliers either. Yes, many of our suppliers have already taken moderate price hikes in 2012 but not necessarily of the same magnitude as a year ago.

On the other hand, this will be an election year in many of our territories, including Mexico, and that usually fosters economic activity that in turn supports our growth, but there also significant headwinds in the environment so we have to re-double our efforts.

We also expect 2012 to be a year of significant investment in our operations, largely driven by a rapid pace of growth and the resulting needs for increased capacity.

CapEx for Coca-Cola FEMSA should reach USD710 million including half of the investment needed to build our new plants in Brazil and Colombia, while FEMSA Comercio expects to deploy USD350 million for a total of CapEx of approximately USD1.1 billion for the year.

And on a final housekeeping note, as you know we will begin reporting under IFRS as of the first quarter of this year in accordance with the timetable set by Mexican Securities Regulation. However, in order to make the transition smoother we will be releasing our 2011 quarterly and full-year numbers under IFRS before the end of March.

And our Investor Relations Team will be fully available to walk you through the adjustments we're making to comply with IFRS. That way hopefully you will be completely familiar with the changes ahead of our first quarter 2010 results due out in late April.

And, with that, I would like now to open the call for your questions. Operator, please.

Thank you. (Operator Instructions). We'll take the first question from Lauren Torres with HSBC.

It seems like you are getting a bit more positive with respect to the consumer environment and the macro data compared to what we heard of the last couple quarters. I was just curious how you think that translates into your results this year. You've had great same store sales growth at OXXO. Coming off of maybe a more difficult comparison, do you think you could replicate those types of growth rates and, if you do think so, how do you do that? Is it through ticket sales? Is it more traffic? I'm just trying to get a better sense on the consumer. Thanks.

Sure. Hi, Lauren. Yes I think that in the end 2011 turned out to be a better year than anticipated when we started the year. And I would say that going forward are intention and the main thrust of the whole organization in OXXO is do whatever it takes to keep the pace of same store sales growth.

If you look at what we've been doing is pretty much again fine tuning the value proposition and I would say that the main contributor for growth has been having the traffic. We tend to believe that that will continue going into 2012. The effect of the traffic coming a little bit down has a number of components, basically the mix of the products that people are buying, the composition of the average ticket because of the behavior of the categories, which are important such as air time and the likes. We feel more confident then to grow the same store sales growth through the traffic lever than the ticket lever.

So, all-in-all yes we feel that I would say the macro environment combined with the elections taking place in 2012, coupled with what we have been doing inside the store to bring more people into it, I think we're confident that we will continue, I would say, at the same pace of growth but at least on positive numbers on the same store sales growth indicator, Lauren.

Okay that's helpful and just on the cost side too, at OXXO you were able to improve margins and we saw good cost management there. Is that something that you think is also achievable this year?

Most of the improvement at the gross margin, again, it's coming from a change in mix on -- I mean the high gross margin categories have been growing faster than the lower margin. We think that should continue. Nevertheless, the expansion in 2012 I am just guessing might be maybe smaller than the one we had in 2011, which was huge at 70 basis so -- but all-in-all we think that the work that we're doing in terms of again building a healthy business financially in terms of the gross margin platform we think we're going to be again successful doing that again in 2012.

Okay great. Thank you.

Alan Alanis, JPMorgan.

Quick question, I just want to confirm a number regarding the net cash that you have outside of Coca-Cola FEMSA at the holding level, even post the dividend payment, because I am getting a big number and I'll ask you a follow-up on that.

Sure. Just on the top of my head I think it's about USD600 million, Alan.

Yes I am getting USD650 million.

I am sure our Investor Relations' teams can follow that off line with you later but for everybody on the line I think it's some slightly above USD600 million.

Yes no, no. It's the number that I am getting. I am getting USD650 million so I mean it's a big number. What are the preferred uses of that? How should we see that number evolving going forward and specifically, let me ask you two questions that are related to that? One of them, I am knowing that there's about USD0.5 billion of CapEx that is not related to OXXO and it's not related to Coca-Cola FEMSA so if you could remind us if this is logistics or is it refrigerators or is there something new going on there?

And the last question that I have is if you could give us an update regarding your thinking in terms of OXXO's international expansion. I assume that you're not thinking of taking OXXO in the Philippines right now, no?

No. No, no, no. That was a good one.

That was a good one.

No besides OXXO and Coca-Cola FEMSA actually the remaining CapEx should be less than USD50 million, not USD0.5 billion, so--

Yes pesos, pesos I get that.

It's very small stuff, most of it related with the expansion of FEMSA logistical going into Coca-Cola FEMSA's territories in Latin America, very successfully I have to say so, in Brazil and Columbia and Costa Rica and so that's basically it. A little bit of that also it's towards improving our capacity of our refrigerators as well but that's most of it.

And we have said that, again, we recognize that USD600 million excess cash at the [ExKOF] system is a lot of money. The preferred use for that, again, will be to find opportunities that again leverage what we know to do in terms of small format retail in Latin American environment and I would say that we feel very, very confident. I cannot really be more specific on that color for the time being but we feel very confident that we will find uses for that cash during 2012.

And those uses are related to OXXO or related to retail?

They're related to the businesses in which FEMSA believes, which are Coca-Cola FEMSA and small format retail and that is OXXO today as we know it but, as you know, we have also been looking at some opportunities in small format retail, which are pretty much complementary with the skill set required to operate that [C store].

Got it, no I hear you. Thanks so much for the answer, Javier, all the best.

Robert Ford, Bank of America Merrill Lynch.

Javier, I had a question with respect to occupancy, pre operating expenses and I was curious as to how those are trending. And then, as you build densities in your existing markets I was curious as to whether or not you're finding it easier or more difficult to find locations.

Sure, Bob. I think, as we have discussed this in the past that we have a criteria to measure the quality of our openings, which we call the batting average which is pretty much a measure that reflects on what we estimate the performance of a certain new store would look like on a certain time frame, as opposed to reality and I am pleased to comment that our batting average is pretty much at all time highs with the exception of mainly maybe three or four out of the more than 60 cities in which we operate.

But, all-in-all it is really pretty healthy so this -- I would say that if you look at the amount of stores we're opening on a yearly basis as opposed to the base, we are I would say slightly increasing the number of stores so the pre-operating expenses to pretty much open a store, I would say, are pretty much in line with the historic levels so we don't really have there a change in the dynamics of the business.

And on your last point, to tell you the truth, in certain places and very selective places where we have very, very high penetration, we might have I would say a little bit more work to do in order to secure the best locations for new openings but we are still very far away, even in those cities in which we feel we have a very, very high penetration already to get to a point of saturation. And I am speaking about selective cities in the north, namely Tijuana, Mexicali and Monterey, for example, which have some of the highest ratios of number of stores per population.

We still are finding ways again to open new stores in places in which in the past we were not able to do so, either because the value proposition was not suitable for the environment in which those stores are now being located, as well as now having the ability to operate smaller stores in terms of the selling space and bringing down the fixed costs and therefore bringing down the required sales to meet the point of equilibrium from the store.

So, all-in-all I would say that it's in OXXO the same phenomena that I am sure Hector Travino shared with you on the conference call on Coca-Cola FEMSA, which is even though we have the highest penetration of Coca-Cola brand products and specifically Coca-Cola brand in Mexico, the brand continues to grow and I think that merits a lot and the work that our people do in terms of finding again a better way to satisfy consumer needs for different consumption occasions through packaging, through availability, through promotional activity and of course through selecting the right price points for our products. So I would say that in OXXO we're still experiencing the same phenomena, as I explained, Bob.

That's great. Thank you and then with respect to the occupancy part of the question, are you seeing any changes in terms of occupancy costs? And then you addressed your expansion for this year. You said about 1,100 stores but could you let us know how Columbia is going and what you expect in Columbia?

Sure. No occupancy costs I would say are we're not experiencing in Mexico assessing there or for some other parts of the world a radical change, either upwards and downwards on the cost of the leases that we're having, so I think that that's an element that we have under control so there's not really anything different there from what we've been experiencing in the past.

And Columbia is going I would say well still under the face of, again, finding the right value proposition. We opened less than 10 stores in 2011. We think that we will open more than 10 stores in 2012. Some of those stores that will be opened are now going into places, which we're now going to start testing different things, such as habits of consumption of different segments of consumers, so it's still parts of the phasing, which we are again refining our value proposition so -- but we're pleased with the results that we're achieving.

We are testing again a combination of format, which is a typical C store with a little bit more emphasis on the fast food offering in combination with a lot of retailoring in Columbia, so we're pleased with the progress. Of course, we would like it to be faster so we can start getting into the expansion phase more rapidly but we're -- I would say that we're pleased so far on how things are going, Bob.

Thank you very much.

Jose Yordan, Deutsche Bank.

Javier, going back to the question of use of cash, given that Coca-Cola may be selling assets to you this year, would you also take that as an opportunity to potentially buy some of their Coca-Cola FEMSA shares from them in order to go back to your previous holding percentage, percentage holding in KOF, which has been diluted lately?

Yes I've answered this times -- how are you? I've answered positively yes in the past to that answer and the answer still remains the same. Of course we will be interested in doing so.

Okay great. Thank you.

Lore Serra, Morgan Stanley.

I wanted to ask two questions. Javier, one is just to get your perspective. I guess it's almost two years from the sale of the beer company to Heineken in exchange for the 20% stake and any kind of observations you have for us in terms of how you think about that as part of the portfolio for FEMSA over the medium term?

And then on OXXO I wanted ask a question; maybe there are two parts of it. I mean OXXO has just done a phenomenal job in terms of the expansion over the last few years but it seems to be now the kind of -- they're settling into the sort of 1,100 stores a year, which is phenomenal. I mean, it's three stores a day or something but clearly when you see the opportunity in that space and you've got the access to capital, is there -- you know, is it just sort of physically that's what OXXO is capable of or could you possibly accelerate the expansion?

And, as part of that, when you talk about USD350 million of CapEx, maybe I haven't been thinking about the numbers enough but I was thinking that OXXO normally spends about USD250 million so there seems to be some incremental spending on OXXO and if you could give us any sense of what that incremental spending is dedicated to?

So sorry, I think there are about three questions in there.

Yes there are three questions I see, Lore. How are you?

Thank you, good thanks.

On the first one I think, again, I really do not have anything new to say regarding that. We're -- I mean, as you're saying, we're two years into having this stake of Heineken and still one year more to go until the lock-up expires, so so far I think what I can basically share is that again we have been working very closely with the company in terms of trying to contribute to some of our thinking and sharing some of our experiences in developing our businesses in this part of the world, as well as trying to support them as much as we can.

And again, I just only can reiterate at this point of time that we are again thinking about what's best for the business for the long-term as if we will remain the long-term investors with the business, recognizing that we have flexibility to decide what's most convenient for FEMSA shareholders for the long-term regarding this investment, so sorry but there's really not a new insight or anything new to share so far on that behalf.

And on the OXXO expansion I think you raise a good point. We have again debated a lot about the convenience or not of increasing the pace of growth and you might argue that at least on a moderate way we might have taken that route. But if you look at what we are trying to do at the same time, we still think that this is the right level of opening of stores. Once you look, if you think of OXXO and you look at this number of stores on a yearly basis being opened, numbers come to be mind boggling but the truth of the matter is that the Company works as a system so it takes advantage of having more than 50 organizations doing this kind of work.

So once you split more than 1,000 between those 50 areas, then you find out that each area needs to open a little bit more than 20 stores a year so you cannot think of this large group of people put together in a room trying to open 1,100 stores a year but, again, a very decentralized organization but following very, very structured and precise criteria to do that job. But when you think about the number of other stuff that are taking place in those cities in which we have already close to 10,000 stores, this is the right number that will have come up in terms of again balancing the act of changing the way we do things within the store, creating a new infrastructure outside of the door of the stores, which are supposed to be facilitating and potentially leveraging new capabilities going forward for the stores.

So we have some back again and then we have made exercises and we have thought about and debated a lot about if what's good for us to move to the 1,200 or 1,300 level in stores, in terms of store openings, and we have concluded that this is the right balance of expanding and improving the business as we think of it. So we will remain I think in the 1,100 arena hopefully going close to 1,200 but still within that range.

And finally, the CapEx number I would say that the slowly but surely increase now coming to USD350 million for 2012 I would say it's a combination of again slightly increasing the number of stores, a higher amount of CapEx dedicated to refurbishing and maintenance of the existing store base, which as it continues to grow it will require maintenance CapEx which are accounted in that way, as well as the deployment of our point-of-sales system which is also a big CapEx project from the IT point of view. So, all-in-all I would say that those things are pretty much the reasons behind the amount and if you look at our total CapEx investments as percentage of sales, I think that has basically stayed pretty, pretty stable among time, even going into 2012.

Thanks very much.

[Hillary Brown], LD Asset Management.

I wanted to ask you about the taxes paid in 2011 for this quarter. There was a big increase and I just wanted to know what. Is the increase going to be permanent and exactly how much was paid out in cash?

Hi, Hillary, this is Juan. Actually the what we mentioned or Javier mentioned in his opening remarks, the effective tax rate that you see this quarter is very much in line with what you should expect going forward, which is in the mid to high 20s. Last year we had an abnormally low effective tax rate but that was really more of a one-off situation, so it's really not that you see an increase from normal levels. It's really that we are where we will be going forward.

And on the second part of your question, most of the taxes are paid throughout the year. We have the obligation to make monthly payments on income tax, so even though you see it provisioned within the quarter, I would say there's not a significant difference on what we create as a provision as compared with the payment. There is always a lagging effect on that, which is basically close, the difference between the provision of payment and the definite payments, which takes place every April. So but you shouldn't -- if you're looking at or trying to define that in terms of cash flow what it meant, you shouldn't assume a very different figure for cash flow as the one you're seeing for the P&L.

Okay thank you.

Gustavo Oliveira, UBS.

I have two questions. The first one is just a follow-up from your CapEx plans. You mentioned you are investing in new [RTC] systems in (inaudible). What is actually that investment is and what stage you are of the investment? And the second question is when you think about the use of cash that you have and you mentioned that you are studying the possibility of entering to new formats I imagine in Mexico. How you would think about going; you would go on a Greenfield route or you would prefer so you enter a new retail segment via acquisitions?

Sure, sure. The POS, the point-of-sale system project in OXXO, is a multiyear project, which implies buying of the software off the shelf and then making the adaptations required and now it's in the phase of deploying that into the store base and I would say that's a project, which can be measured on tens of millions of dollars, which should be taken in the bulk in the investment within 2012 and 2013. And so that's basically the first question.

And the second one.

New formats.

It's I would say we think, again, that we would be better off if we can get a foothold through small acquisitions that we can grow from there as opposed to starting from Greenfield but we are not discarding any of the two.

Okay thank you.

Ladies and gentlemen, that is all the time we have for questions today. I will now turn the conference back to Mr. Astaburuaga for posing additional remarks.

Right just to thank you very much for the participation and have a great week, everyone. Bye.

And, ladies and gentlemen, if you wish to replay the webcast for this call, you may do so at FEMSA's Investor Relations' website. This concludes our conference for today. Thank you for your participation and have a nice day. All parties may now disconnect.