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MERIDIAN BIOSCIENCE INC - 10-Q - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

August 11, 2014

Refer to "Forward Looking Statements" following the Table of Contents in front of this Form 10-Q. In the discussion that follows, all dollar amounts are in thousands (both tables and text), except per share data. Following is a discussion and analysis of the financial statements and other statistical data that management believes will enhance the understanding of Meridian's financial condition, changes in financial condition and results of operations. This discussion should be read in conjunction with the financial statements and notes thereto beginning on page 1.



Results of Operations

Three Months Ended June 30, 2014

Net earnings for the third quarter of fiscal 2014 decreased 13% to $8,835, or $0.21 per diluted share, from net earnings for the third quarter of fiscal 2013 of $10,159, or $0.24 per diluted share. This decrease reflects the combined effects of slightly increased revenues, decreased gross profit margins and increased operating expenses. Consolidated revenues increased less than 1% to $47,212 for the third quarter of fiscal 2014 compared to the same period of the prior year. Included within the third quarter 2014 results were revenues from our illumigene® molecular platform of products totaling $9,578, representing a 9% increase over the fiscal 2013 third quarter. Also contributing to the consolidated revenue increase were increased revenues in our H. pylori focus product family and our respiratory product family, as well as in our Life Science segment's molecular component product line. Serving to substantially offset these revenue increases were decreased revenues in our largest diagnostic focus product family (C. difficile), our foodborne focus product family and our Life Science segment's immunoassay component product line. Page 12



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Revenues for the Diagnostics segment for the third quarter of fiscal 2014 decreased less than 1% compared to the third quarter of fiscal 2013, reflecting the following for each of our focus product families: 10% decline in our C. difficile products, 9% growth in our H. pylori products, and 5% decline in our foodborne products. In addition, we experienced a 9% increase in revenues from our respiratory products, which include both molecular and immunoassay products, compared to the prior year fiscal third quarter. With 6% growth in its molecular component product sales and a 1% decline in its immunoassay component product sales, revenues from our Life Science segment increased by 2% during the third quarter of fiscal 2014 compared to the third quarter of fiscal 2013.



Nine Months Ended June 30, 2014

For the nine month period ended June 30, 2014, net earnings decreased 8% to $26,561, or $0.63 per diluted share, from net earnings for the comparable fiscal 2013 period of $28,882, or $0.69 per diluted share. This decrease reflects the combined effects of increased revenues, decreased gross profit margins and modestly increased operating expenses, along with a $450 (pre-tax) negative effect from medical device tax that did not exist during the first quarter of fiscal 2013 (see discussion in Medical Device Tax below). Consolidated revenues increased 2% to $142,140 for the first nine months of fiscal 2014 compared to the same period of the prior fiscal year. Included within the nine month year-to-date fiscal 2014 results were revenues from our illumigene molecular platform of products totaling $27,926, representing a 15% increase over the first nine months of fiscal 2013. Also contributing to the consolidated revenue increase were increased revenues in our H. pylori focus product family, as well as in both of our Life Science segment's business lines (i.e., molecular component and immunoassay component). Serving to substantially offset these revenue increases were decreased revenues in our largest diagnostic focus product family (C. difficile) and our respiratory product family. During the first nine months of fiscal 2014, revenues for the Diagnostics segment decreased less than 1% from the comparable fiscal 2013 period, reflecting the following for each of our focus product families: 9% decline in our C. difficile products, 10% growth in our H. pylori products, and 1% decline in our foodborne products. In addition, we experienced an 8% decline in revenues from our respiratory products from the comparable fiscal 2013 period. With 12% growth in its molecular component product sales and 6% growth in its immunoassay component product sales, revenues from our Life Science segment increased by 8% during the nine months ended June 30, 2014 over the comparable fiscal 2013 period.



REVENUE OVERVIEW

Below are analyses of the Company's revenue, provided for each of the following:

- By Reportable Segment & Geographic Region

- By Product Platform/Type

- By Disease Family (Diagnostics only)

Revenue Overview- By Reportable Segment & Geographic Region

Our reportable segments are Diagnostics and Life Science. The Diagnostics segment is headquartered in Cincinnati, Ohio, which also serves as the base of manufacturing operations and research and development. The Diagnostics segment sells diagnostic test kits in the U.S. and Canada ("North America"); Europe, Middle East and Africa ("EMEA"); and other countries outside of North America and EMEA (rest of the world, or "ROW"). The Life Science segment consists of manufacturing operations in Memphis, Tennessee; Boca Raton, Florida; London, England; Luckenwalde, Germany; and Sydney, Australia, and the sale and distribution of bulk antigens, antibodies, PCR/qPCR reagents, nucleotides, competent cells and bioresearch reagents domestically and abroad, including a sales and business development location in Singapore. The Life Science segment also includes the contract development and manufacture of cGMP clinical grade proteins and other biologicals for use by biopharmaceutical and biotechnology companies engaged in research for new drugs and vaccines. Revenues for the Diagnostics segment, in the normal course of business, may be affected from quarter to quarter by buying patterns of major distributors, seasonality and strength of certain diseases, and foreign currency exchange rates. Revenues for the Life Science segment, in the normal course of business, may be affected from quarter to quarter by the timing and nature of arrangements for contract services work, which may have longer production Page 13



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cycles than bioresearch reagents and bulk antigens and antibodies, as well as buying patterns of major customers, and foreign currency exchange rates. We believe that the overall breadth of our product lines serves to reduce the variability in consolidated revenues.

Three Months Ended June 30, Nine Months Ended June 30, 2014 2013 Inc (Dec) 2014 2013 Inc (Dec) Diagnostics- North America $ 28,543$ 28,307 1 % $ 86,438$ 86,003 1 % EMEA 5,464 5,535 (1 )% 16,756 16,622 1 % ROW 1,161 1,463 (21 )% 3,872 4,752 (19 )% Total Diagnostics 35,168 35,305 - % 107,066 107,377 - % Life Science- North America 4,749 4,737 - % 14,078 13,299 6 % EMEA 5,278 5,124 3 % 15,287 13,721 11 % ROW 2,017 1,942 4 % 5,709 5,327 7 % Total Life Science 12,044 11,803 2 % 35,074 32,347 8 % Consolidated $ 47,212$ 47,108 - % $ 142,140$ 139,724 2 % % of total revenues- Diagnostics 74 % 75 % 75 % 77 % Life Science 26 % 25 % 25 % 23 % Total 100 % 100 % 100 % 100 % Ex-North America 29 % 30 % 29 % 29 %



Revenue Overview- By Product Platform/Type

The revenues generated by each of our reportable segments result primarily from the sale of the following segment-specific categories of products:

Diagnostics

1) Molecular tests that operate on our illumigene platform 2) Immunoassay tests Life Science 1) Molecular components 2) Immunoassay components Page 14



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Revenue for each product platform/type, as well as its relative percentage of segment revenue, is shown below.

Three Months Ended June 30, Nine Months Ended June 30, 2014 2013 Inc (Dec) 2014 2013 Inc (Dec) Diagnostics- Molecular $ 9,578$ 8,818 9 % $ 27,926$ 24,245 15 % Immunoassay 25,590 26,487 (3 )% 79,140 83,132 (5 )% Total Diagnostics $ 35,168$ 35,305 - % $ 107,066$ 107,377 - % Life Science- Molecular components $ 5,476$ 5,158 6 % $ 15,369$ 13,723 12 % Immunoassay components 6,568 6,645 (1 )% 19,705 18,624 6 % Total Life Science $ 12,044$ 11,803 2 % $ 35,074$ 32,347 8 % % of Diagnostics revenues- Molecular 27 % 25 % 26 % 23 % Immunoassay 73 % 75 % 74 % 77 % Total Diagnostics 100 % 100 % 100 % 100 % % of Life Science revenues- Molecular components 45 % 44 % 44 % 42 % Immunoassay components 55 % 56 % 56 % 58 % Total Life Science 100 % 100 % 100 % 100 %



Following is a discussion of the revenues generated by each of these product platforms/types:

Diagnostics Products



illumigene Molecular Platform Products

We have 1,265 customer account placements. Of these account placements, approximately 1,130 accounts have completed evaluations and validations and are regularly purchasing product, with the balance of our account placements being in some stage of product evaluation and/or validation. Of our account placements, we have approximately 275 accounts that are regularly purchasing, evaluating and/or validating two or more assays. Upon receiving FDA clearance on March 25, 2014, we launched our Bordetella pertussis molecular diagnostic test in early April - the most recent test available on our illumigenemolecular testing platform. We continue to invest in new product development for our illumigene molecular testing platform, and with the launch of the Bordetella pertussis test, now have five commercialized tests on the platform and three additional tests expected to be available for sale in fiscal 2015: 1. illumigene® C. difficile - commercialized in August 2010



2. illumigene® Group B Streptococcus (Group B Strep or GBS) - commercialized

in December 2011 3. illumigene® Group A Streptococcus (Group A Strep) - commercialized in September 2012



4. illumigene® Mycoplasma (M. pneumonia; walking pneumonia) - commercialized

in June 2013 5. illumigene® Bordetella pertussis (whooping cough) - commercialized in March 2014



6. illumigene® Chlamydia trachomatis - expected fiscal 2015 (launch outside

of U.S.)



7. illumigene® Neisseria gonorrhea - expected fiscal 2015 (launch outside of

U.S.) 8. illumigene® Herpes Simplex Virus I & II - expected fiscal 2015



Additional illumigene tests in early-stage research and development include enteric parasites such as Giardia, foodborne pathogens such as E. coli, and bloodborne pathogens such as malaria.

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We believe that the diagnostic testing market is continuing to move away from culture and immunoassay testing to molecular testing for diseases where there is a favorable cost/benefit position for the total cost of healthcare. While this market is competitive, with molecular companies such as Cepheid and Becton Dickinson and new entrants such as Quidel, Great Basin, Nanosphere, and others, we believe we are well positioned to capitalize on the migration to molecular testing. Our simple, easy-to-use, illumigene platform, with its expanding menu, requires no expensive equipment purchase and little to no maintenance cost. These features, along with its small footprint and the performance of the illumigene assays, make illumigene an attractive molecular platform to any size hospital or physician office laboratory.



Immunoassay Products

Revenues from our Diagnostics segment's immunoassay products decreased 3% in the third quarter of fiscal 2014 and decreased 5% on a nine month, year-to-date basis. As described in the product discussions below, the quarterly decrease results primarily from the decline in revenues from our C. difficile products, partially offset by the revenue growth of our H. pylori and respiratory products; while the year-to-date decrease results primarily from the decline in revenues from our C. difficile and respiratory products, partially offset by the revenue growth of our H. pylori products.



Life Science Products

During the third quarter of fiscal 2014, revenues from our Life Science segment increased 2%, with revenues from molecular component sales increasing 6% over the comparable fiscal 2013 quarter and revenues from immunoassay component sales decreasing 1%. For the first nine months of fiscal 2014, revenues from our Life Science segment increased 8%, with revenues from molecular component sales increasing 12% over the comparable prior year period and revenues from immunoassay component sales increasing 6%. Our molecular component revenues continue to benefit from new product launches and advancements - most notably SensiFAST™ and MyTaq™ PCR components.



Diagnostic Revenue Overview- By Disease Family

Revenues from our focus families (C. difficile, foodborne and H. pylori) comprised 63% of our Diagnostics segment's revenue during the third quarter of fiscal 2014 and 61% during the first nine months of the fiscal year. This compared to 65% and 61% during the fiscal 2013 quarterly and year-to-date periods, respectively. Following is a discussion of the revenues generated by each product family: C. difficile Products Revenues for our C. difficile product family decreased 10% to $8,900 for the fiscal 2014 third quarter, and decreased 9% to $26,800 for the nine month, year-to-date period. Revenues for our illumigene product decreased 5% and 1% during the three and nine month periods ended June 30, 2014, respectively, and revenues for our C. difficile immunoassay products continued to significantly decline as expected. The C. difficile market has become highly competitive, with over 10 suppliers in the United States. Certain of these suppliers choose to compete solely on price. We believe that two factors will help us respond to these challenging market conditions. First, our marketing programs emphasize that we are the only company that can offer a full range of high performing, FDA cleared, C. difficile testing formats, including toxin, GDH and molecular tests. Second, our illumigene molecular platform, with its expanding menu, requires no expensive equipment purchase or maintenance contract, which makes it an attractive and affordable option for any size hospital.



Foodborne Products

Revenues for our foodborne products (Enterohemorrhagic E. coli ("EHEC") and Campylobacter), all of which are immunoassay products, totaled $5,800 during the fiscal 2014 third quarter, a 5% decrease from the fiscal 2013 third quarter. During the nine months ended June 30, 2014, foodborne revenues totaled $16,900, a 1% decrease from the fiscal 2013 year-to-date period. We are once again disappointed in the results for this product family and are continuing to re-emphasize the benefits of increased sensitivity and faster turnaround time versus culture methods in our marketing programs. While historically the primary competition for our foodborne products has been laboratory culture methods, during 2012 one of our competitors cleared through the FDA a shiga toxin test that competes with our EHEC test. We believe that our test offers better workflow, less hands-on time and quicker results, in addition to being fully CDC-compliant. Page 16



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H. pylori Products

During the third quarter of fiscal 2014, revenues from our H. pylori products, all of which are immunoassay products, increased 9% to $7,400; and increased 10% to $21,000 during the first nine months of fiscal 2014. These increases continue to reflect the benefits of our partnerships with managed care companies in promoting the health and economic benefits of a test and treat strategy, and the ongoing effects of such strategy moving physician behavior away from serology-based testing toward direct antigen testing. A significant amount of the H. pylori product revenues are to reference labs, whose buying patterns may not be consistent period to period.



Respiratory Products

Total respiratory revenues from our Diagnostics segment increased 9% to $3,700 during the fiscal 2014 third quarter; and decreased 8% to $13,800 for the nine month year-to-date period. Contributing to the quarterly increase was growth in our illumigene Group A Strep, illumigene Mycoplasma and illumigene Pertussis products. Lower sales of influenza products contributed to the year-to-date decline in revenue. Partially offsetting the impact of lower influenza product revenues was growth in the aforementioned respiratory-related illumigene products.



Foreign Currency

During the third quarter of fiscal 2014, currency exchange rates had a $350 favorable impact on revenue; $200 favorable within the Diagnostics segment and $150 favorable in the Life Science segment. On a nine month year-to-date basis, currency exchange rates had a $700 favorable impact on revenue; $600 favorable within the Diagnostics segment and $100 favorable in the Life Science segment.



Significant Customers

Two U.S. distributors accounted for 36% and 40% of our Diagnostics segment's total revenues for the third quarter of fiscal 2014 and 2013, respectively, and 36% and 43% during the nine months ended June 30, 2014 and 2013, respectively. These customers represented 26% and 30% of consolidated revenues for the fiscal 2014 and 2013 third quarters, respectively, and 27% and 33% for the respective year-to-date nine month periods. Within our Life Science segment, two diagnostic manufacturing customers accounted for 15% and 18% of the segment's total revenues for the third quarter of fiscal 2014 and 2013, respectively, and 16% and 18% during the nine months ended June 30, 2014 and 2013, respectively.



Medical Device Tax

On January 1, 2013, the medical device tax established as part of the U.S. healthcare reform legislation became effective, and as a result, the Company made its first required tax deposit near the end of January 2013. The Company recorded approximately $450 of medical device tax expense during each of the fiscal 2014 and 2013 third quarters, which is reflected as a component of cost of sales in the accompanying Condensed Consolidated Statements of Operations. During the nine month periods ended June 30, 2014 and 2013, medical device tax expense totaling approximately $1,350 and $900, respectively, was recorded. Gross Profit Three Months Ended June 30, Nine Months Ended June 30, 2014 2013 Change 2014 2013 Change Gross Profit $ 29,242$ 30,631 (5 )% $ 88,842$ 90,170 (1 )% Gross Profit Margin 62 % 65 % -3 points 63 % 65 % -2 points Page 17



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The overall gross profit margin decrease for the three and nine months ended June 30, 2014 primarily results from the combined effects of (i) mix of revenues from the Company's segments; (ii) mix of products sold; (iii) declines in pricing on selected products; (iv) manufacturing facility utilization; and for the nine month period only (v) the medical device tax, which did not exist during the first quarter of fiscal 2013 (see discussion in Medical Device Tax above). Our overall operations consist of the sale of diagnostic test kits for various disease states and in alternative test formats, as well as bioresearch reagents, bulk antigens and antibodies, PCR/qPCR reagents, nucleotides, competent cells, proficiency panels, and contract research and development, and contract manufacturing services. Product revenue mix shifts, in the normal course of business, can cause the consolidated gross profit margin to fluctuate by several points. Operating Expenses Three Months Ended June 30, 2014 Research & Selling & General & Total Operating Development Marketing Administrative Expenses 2013 Expenses $ 2,711$ 5,440 $ 6,781 $ 14,932 % of Revenues 6 % 12 % 14 % 32 % Fiscal 2014 Increases (Decreases): Diagnostics 419 446 93 958 Life Science 16 363 (159 ) 220 2014 Expenses $ 3,146$ 6,249 $ 6,715 $ 16,110 % of Revenues 7 % 13 % 14 % 34 % % Increase (Decrease) 16 % 15 % (1 )% 8 % Nine Months Ended June 30, 2014 Research & Selling & General & Total Operating Development Marketing Administrative Expenses 2013 Expenses $ 8,039$ 16,604$ 21,484 $ 46,127 % of Revenues 6 % 12 % 15 % 33 % Fiscal 2014 Increases (Decreases): Diagnostics 1,134 1,329 (370 ) 2,093 Life Science 12 854 (668 ) 198 2014 Expenses $ 9,185$ 18,787$ 20,446 $ 48,418 % of Revenues 6 % 13 % 14 % 34 % % Increase (Decrease) 14 % 13 % (5 )% 5 % Overall, total operating expenses increased during both the third quarter and first nine months of fiscal 2014 relative to the comparable prior fiscal year periods, increasing slightly as a percentage of quarterly and year-to-date consolidated revenues. These levels of operating expenses result in large part from the combined effects of our (i) ongoing efforts to control spending in each of our segments while investing the necessary resources in our strategic areas of growth, including increased investment in Research & Development for our molecular platform products; and (ii) overall decreased incentive compensation expense in light of the decline in corporate-wide operating profits. Page 18



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Operating expenses for the Diagnostics segment increased $958 for the third quarter of fiscal 2014 compared to the fiscal 2013 third quarter, and in the first nine months of fiscal 2014, increased $2,093 over the comparable prior year period. These overall increases result largely from the combined effects of (i) currency exchange rates (increases of $100 and $200 for the quarter and year-to-date, respectively); and (ii) the following:



Research & Development

Overall increase in spending on new product development activities, related primarily to the previously noted products for our illumigene molecular platform, as well as immunoassay products in development.

Selling & Marketing

Addition of field sales force personnel, including the filling of open territorial positions, since the prior year quarter, resulting in an approximate $300 increase in personnel-related expenses on a quarterly basis ($900 on a year-to-date basis), along with increased product sample expense of approximately $100 for the quarter ($250 year-to-date).

General & Administrative

A decrease in bonus expense as a result of the previously noted decline in corporate-wide operating profits, partially offset by an approximate $100 and $700 increase in stock-based compensation during the third quarter and first nine months of fiscal 2014, respectively, and other less significant general operating expense increases. Operating expenses for the Life Science segment increased $220 and $198 for the third quarter and first nine months of fiscal 2014, respectively. This activity reflects in large part the net effects of (i) currency exchange rates (increases of $100 and $50 for the quarter and year-to-date, respectively); (ii) ongoing increased sales and marketing investments; and (iii) decreased bonus expenses resulting from the decline in corporate-wide operating profits.



Operating Income

Operating income decreased 16% to $13,132 for the third quarter of fiscal 2014, and decreased 8% to $40,424 for the first nine months of fiscal 2014, as a result of the factors discussed above.

Income Taxes

The effective rate for income taxes was 31% and 35% for the third quarter of fiscal 2014 and 2013, respectively, and 33% and 35% for the nine month, year-to-date periods ended June 30, 2014 and 2013, respectively. The lower current year rates primarily result from the positive effects of research credits in certain foreign jurisdictions and a net U.S. foreign tax credit resulting from a recent restructuring of our legal entities. For the fiscal year ending September 30, 2014, we expect the effective tax rate to approximate 34%. In September 2013, the Internal Revenue Service issued Treasury Decision 9636, which enacted final tax regulations regarding the capitalization and expensing of amounts paid to acquire, produce, or improve tangible property. The regulations also include guidance regarding the retirement of depreciable property. The regulations are required to be effective in taxable years beginning on or after January 1, 2014, although taxpayers may choose to apply them in taxable years beginning on or after January 1, 2012. Our adoption of these regulations on October 1, 2014 is not expected to have a significant impact on the Company's consolidated results of operations, cash flows or financial position.



Liquidity and Capital Resources

Comparative Cash Flow Analysis

Our cash flow and financing requirements are determined by analyses of operating and capital spending budgets, consideration of acquisition plans, and consideration of common share dividends. We have historically maintained a credit facility to augment working capital requirements and to respond quickly to acquisition opportunities. Our investment portfolio presently consists of overnight repurchase agreements. Page 19



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We have an investment policy that guides the holdings of our investment portfolio. Our objectives in managing the investment portfolio are to (i) preserve capital; (ii) provide sufficient liquidity to meet working capital requirements and fund strategic objectives such as acquisitions; and (iii) capture a market rate of return commensurate with market conditions and our policy's investment eligibility criteria. As we look forward, we will continue to manage the holdings of our investment portfolio with preservation of capital being the primary objective. We do not expect current conditions in the financial markets, or overall economic conditions, to have a significant impact on our liquidity needs, financial condition, or results of operations, although no assurances can be made in this regard. We intend to continue to fund our working capital requirements and dividends from current cash flows from operating activities and cash on hand. If needed, we also have an additional source of liquidity through our $30,000 bank credit facility. Approximately $3,400 of our accounts receivable at June 30, 2014 is due from Italian hospital customers whose funding ultimately comes from the Italian government, which is down from approximately $3,500 due on such accounts at September 30, 2013. Our liquidity needs may change if overall economic conditions change and/or liquidity and credit within the financial markets tightens for an extended period of time, and such conditions impact the collectibility of our customer accounts receivable or impact credit terms with our vendors, or disrupt the supply of raw materials and services. Net cash provided by operating activities decreased 27% for the first nine months of fiscal 2014 to $23,611, reflecting the 8% decrease in net earnings, along with the effects of the payment of incentive bonus payments related to fiscal 2013, the timing of federal income tax payments, inventory purchases, and the timing of payments from and to customers and suppliers, respectively. Net cash flows from operating activities and cash on hand are anticipated to be adequate to fund working capital requirements, capital expenditures and dividends during the next 12 months.



Capital Resources

We have a $30,000 credit facility with a commercial bank that expires on September 15, 2015. As of July 31, 2014, there were no borrowings outstanding on this facility and we had 100% borrowing capacity available to us. We have had no borrowings outstanding under this facility during the first nine months of fiscal 2014 or during the full year of fiscal 2013. Our capital expenditures are estimated to range between approximately $5,000 to $6,000 for fiscal 2014, with the actual amount depending upon actual operating results and the phasing of certain projects. Such expenditures may be funded with cash and equivalents on hand, operating cash flows, and/or availability under the $30,000 credit facility discussed above. This range of capital expenditures includes approximately $4,000 related to an expansion of our molecular diagnostic manufacturing capacity in Cincinnati, Ohio.



We do not utilize any special-purpose financing vehicles or have any undisclosed off-balance sheet arrangements.

Recent Accounting Pronouncements

In May 2014, FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, which supersedes and replaces nearly all currently-existing U.S. GAAP revenue recognition guidance including related disclosure requirements. This guidance will be effective for the Company beginning October 1, 2017. The Company has not yet assessed the impact that adoption of this guidance will have on its financial statements. Page 20



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