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Executives

Jon Levenson - Senior Vice President

Ed Noonan - Chairman and CEO

Jeff Consolino - CFO

Analysts

Matthew Heimermann - JPMorgan

Ian Gutterman - Adage Capital

Susan Spivak - Wachovia

Presentation

Validus Holdings Ltd. (VR) Q3 2008 Earnings Call November 7, 2008 11:00 AM ET

Operator

Hello, and welcome to the Validus Holdings Limited Third Quarter 2008 Conference Call. All participants will be in a listen-only mode. (Operator instructions). Please note; this conference is being recorded.

Now, I would like to turn the conference over to Mr. Jon Levenson. Please go ahead sir.

Jon Levenson

Good morning, and welcome to the Validus Holdings Limited conference call for the quarter ended September 30th, 2008. Leading today's call are Ed Noonan, Chairman and Chief Executive Officer, and Jeff Consolino, Executive Vice President and Chief Financial Officer.

After the market closed yesterday, we issued an earnings press release and financial supplement, both of which are available on our website, validusre.bm. Today's call is being webcast, and will be available for replay. That link can also be found on our website.

Certain statements made during this call may be deemed forward-looking within the meaning of U.S. Securities laws. Such statements reflect the company's current view of future events and financial performance, and incorporate our perspective on risks and uncertainties.

More detail on this topic can be found in our most recent Form 10-K annual report and Form 10-Q quarterly report as filed with the US SEC.

Management will also refer to some non-GAAP financial measures, while describing the company’s performance. These items are explained in our earnings release and financial supplement.

With that, I'll turn the call over to Ed Noonan.

Ed Noonan

Hey thanks Jon. And thank you all for taking the time to join us today. So I’ll provide you with the headlines for the quarter, before turning the call over to Jeff Consolino, and Jeff will cover our financials in detail.

Afterwards we would all come back and provide more detail on the hurricane losses and also spend some time talking about forward market conditions, and then of course we’ll take any questions you might have.

There are obviously extraordinary times in the global financial markets, and coupled with the U.S. hurricane loss in the quarter, I think this has been a pretty good test of our strategy, our risk management, and our investment portfolio. We feel like we’ve passed the test with flying colors; and we’re growing increasingly bullish about the forward pricing environment in the short-tailed business.

[Like] as a big loss, we’re pleased that our risk-management approach has worked very smoothly with no surprises. The integration of risk-management between Bermuda and London has functioned exactly as we had planned. And so I think this event is a good validation of our enterprise risk-management program as well.

While reporting the first quarterly loss in our history isn’t a happy event, we’re in the business of taking risk, and I think we’ve been pretty well for the rest that we underwrite. Even after this quarter's event, our returns in each affected class remain quite strong for our three year history.

Most importantly, the conservative investments strategy that you've heard us talked about quarter-after-quarter, has served us very well through the crisis. It's worth repeating. We take risks and make money as underwriters. Our investment strategies predicated on preservation of capital first, liquidity second and yield third.

So while we are not pleased to generate a loss for the quarter; relative to our peers the loss is small and that leaves us very well positioned in the coming market.

Market conditions are building towards a very robust pricing environment in 2009, particularly for short-tail lines, where we enjoy a leading market position. As such, I think we will be uniquely positioned to benefit from the market turmoil to come.

In addition, we continue to opportunistically build our global platform. We've added two very impressive new teams over the last week in the direct aviation and onshore and energy insurance markets. And I will give you more detail on that later on.

At this point, let me turn the call over to Jeff and he could talk about our financial in more detail. Jeff?

Jeff Consolino

Good morning everyone. Thank you for joining us on this busy conference call morning. I am going to provide additional details in the third quarter. Let me start by referring back to our October 8, preannouncement of our Ike and Gustav net loss estimates. That amount is unchanged in a $185 million.

We were significantly affected in the quarter by the same issues that adversely impacted the industry. However, despite hurricanes Ike and Gustav, and the extraordinary volatility in the investment markets, we lead the quarter with a very strong, low risk balance sheet.

Diluted book value per common share at September 30th was $23.58, the growth in diluted book value per share plus accumulative dividends as our preferred measure of growth in financial network for our shareholders due to our $0.20 quarterly dividend which provides a 4.6% cash yield on our shares.

Adjusted for our (inaudible) quarterly dividend, diluted book value per share decreased by 5.3% in the quarter. Growth in diluted book value per share plus accumulated dividends over the last 12 months has been positive at 8.1%.

We’re showing the profits through the first nine months of the year. Net operating income for the nine month period ended September 30, 2008 is $124.1 million; net income for the nine month period is $16.1 million. Our nine month combined ratio is 93.1%, 87.7% for the Validus Re segment, and 92.9% for the Talbot segment.

With that as an overview, I’ll now provide detail on Validus’s third quarter 2008 results. We’ve provided you with a number of documents to follow along with; the Earnings Press Release, our Investor Supplement, and a supplemental 8-K detailing our investment portfolio. All of these documents are posted on our Website.

The third quarter net loss was $126.3 million or $1.71 per diluted share. The net operating loss for the third quarter of 2008 was 53.1 million or $0.73 per diluted share. Net operating income in the quarter declined by a $181.0 million in comparison to the third quarter of 2007.

We reported an adverse effect of $185.9 million in the quarter, related to hurricanes Ike and Gustav. Our press release gives the split by event for each of Validus Re and Talbot segments and by class. This is presented gross and net of $19.7 million in reinstatement premiums.

We benefited from $26.1 million of favorable loss reserve development in the quarter, equal to 7.7 loss ratio points; 3.5 million in favorable development for Validus Re, and 22.6 million for Talbot.

Please note; that as a result of the higher syndicate profit generated by the Talbot prior year adjustments, the Talbot FAL finance expense is correspondingly higher. The consolidated benefit of prior years in the quarter is $18.5 million, net of the incremental FAL expense worth $0.25 per diluted share at the bottom line.

Our combined investment portfolio is $3.26 billion at September 30th, 2008; we continue to follow a very conservative strategy which emphasizes liquidity and preservation of invested assets. We have not investment in equities, hedge funds, transit funds or any other alternative asset class. Our portfolio is all fixed income, and approximately 50% in cash, short term investments, agency paper and sovereign securities.

As we did in the previous two quarters, we furnished via Form 8-K additional disclosure regarding our consolidated investment portfolio. As a company we strive to provide an excellent disclosure package. We often hear that Bermuda has discounted for a lack of transparency. So we have taken further step of providing in Schedule D format a listing of all of our invested assets, leveling the disclosure playing filled with US statutory filers.

In the quarter, we adjusted our leveling of investment and determine we needed to make a transfer of 130 million of certain residential mortgage backed securities to level 3. These have been measured consistent with FASB FAS 157(3), which had the effect of increasing equity by $0.18 per diluted share.

As a final note, the management team that founded this company were granted restricted shares in 2005, which had three year [quick] testing provisions. As these shares are vesting, those executives will become liable for tax on the shares. Shares sold to cover the tax liability will show up as Form 4 filings, commencing on or about November 15th [providing] this information.

With that I would like to return the call to Ed Noonan.

Ed Noonan

Thanks Jeff. So I will spend a few minutes on the catastrophe losses in the quarter first. You will recall that when we pre-announced our estimate for Ike and Gustav on October 8th. We had estimated that the market loss from Ike was $15 billion to $17 billion. This raised some eyebrows at the time, as our view of the industry loss was 50% to 70% higher than that reported by PCS or the catastrophe modeling companies.

Our estimate was based on a very rigorous assessment client by client of the event with no reliance on modeled losses. Over the last month we have observed many of our competitors in the commercial modeling companies ratchet up their view towards our number. Given our substantially higher starting point for the industry loss, we still feel very comfortable with our initial best estimate.

The combined events represented 9% of our June 30 equity, which is in line with our short-tail brethren. Where our performance differs however, is at our overall financial result for the quarter. As Jeff mentioned, we’ve pursued the very non-glamorous strategy of avoiding equities of all types, avoiding alternative asset, limited partnerships, etcetera.

Having a portfolio built on very high quality, short duration, fixed income securities has meant that over the last two years, we’ve sacrificed returns, but we gained a benefit [rather] in this quarter. The storm losses in the aggregate were within 10% to 15% of our expected catastrophe losses for the full year.

Given that Ike is likely to be the third most costly hurricane in U.S. history, we’re really pleased with our overall performance. With no better than normal Cat activity in the fourth quarter, we expect each of our segments to produce solid underwriting results for the full year.

Our Cat losses come from three segments; our U.S. Treaty portfolio, our Gulf of Mexico energy book, and our direct insurance portfolio written through Talbot. We restrict the absolute amount of aggregate limits that we provide, so that we’re never solely reliant on Cat models for risk management.

Given our leadership position in the Gulf of Mexico energy segment, I think it’s worth spending a moment talking about this book. We [write] predominantly treaty portfolio in the Gulf, and we provide most of these single limit coverage at high rates online. As a result, when we look at the returns on this book even in light of Ike, we see attractive results for our three years in the business.

Given the size of the offshore loss, this will be an extremely attractive segment next year, and our market leadership will enable us to capitalize on the opportunity. Retentions, deductibles and prices will all increase sharply in the Gulf next year.

In our US treaty book, our loss in these two events is 35.2% of our catastrophe treaty premium. This compares quite favorably with our peer companies even though we are using a much higher industry loss estimates in some.

From these results, I think it's easier to see that in the absence of any significant events in the fourth quarter, we should generate very good underwriting profits from the Cat portfolio of the year.

We've seen some comparison that match up total losses against property premium. Given the sizable Gulf of Mexico energy portfolio written on our marine book and the direct business we write through Talbot, this is an apples and oranges comparison for Validus.

Our total losses in the two events represent 16.3% of our property and marine premium. I think you can see when matched against the proper premium base, our performance is clearly among the best in the industry.

One final point I'd make is that, in May for the first time we purchased traditional [reposition] for our catastrophe book. Our view at the time was that in the event of losses, there might not be a capital market to draw upon. So we purchased coverage at $150 million attachment level, and while we haven't attached this coverage at [Ike], we continue to sleep better at night knowing that's there.

So let me turn to the (inaudible) rate environment which is looking more favorable by the day, particularly for the short-tail lines. We are in a climate where reinsurance capital will be down materially for next year, as a result of capital depletions being reported. There is no capital market to reload, there are no sidecars, a number of hedge funds are exiting the sector, the collateralized reinsurance have their capital tied up against this year's losses, and the Cat [fund] market is essentially frozen.

At the same time, we are seeing increased demand growing for reinsurance. Direct insurers have also suffered capital depletion, with similarly restricted capital alternatives. In this market, reinsurance becomes one of the few capital surrogates available at a point in time when companies really need to de-risk their operations.

In addition, the vulcanization of the AIG business will have myriad effects. Clients will re-think their counterparty exposure, and both AIG and the companies that take on risk formally written by AIG will have greater re-insurance needs. This presents a scenario that can only lead to increasing prices, particularly for capital-intensive, demand-driven products such as catastrophe and energy risk.

Even in a recessionary environment, the need to protect capital is increasing at a time when the supply of capacity is declining. That’s an environment that I think we should do very well in.

So I also mentioned that we’ve added two new teams to take advantage of the market opportunity. The onshore energy insurance team we’ve assembled are known market leaders globally, with the majority of their business written outside of the United States. This team will operate from our existing offices in London, the U.S., and Asia. The group is deeply experienced, and their collective track record is excellent.

We are already seeing significant price increases in the energy insurance market, and we expect this phenomenon to gain momentum. Given that most of the risk that this team will write is non-US, the business does not proportionately consume U.S. catastrophe capacity, and so it’s also very efficient from a capital utilization perspective for us.

We’ve also been watching the aviation insurance market for the last three years, as the class fits our business model well. We haven’t entered the market, as our view has been that rates have been completely detached from the underlying risk. It’s clear now that aviation rates have reached their bottom, and we see an opportunity building.

To capitalize on the opportunity, we’ve put together a first-class, market-leading aviation team in London to enter this market in 2009. This group also has deep experience as an acknowledged market leader, and an outstanding track record. Both of these teams lead nicely to our revenues in 2009 and beyond. But it's important to note that we wouldn’t have been able to enter either market were it not for last year's acquisition of Talbot underwriters.

In addition to its continued underwriting success, Talbot’s high-quality reputation, as well as its licenses, global network and infrastructure, allow us to pursue opportunities that others cannot during this period dislocation.

So in summary we set out to be a leader in the global short-tail business. Our underwriting, investment, capital management and enterprise risk strategies have all been tested this quarter, and they have all come out looking well up to the task. There are very attractive opportunities available in the market and we are moving very quickly to capture them.

So let me stop there and invite any question that you might have for us.

Question-and-Answer Session

Operator

(Operator Instructions). Now our first question comes from Matthew Heimermann of JPMorgan. Please go ahead.

Matthew Heimermann - JPMorgan

Hi, good morning everybody.

Jon Levenson

Good Morning Matt.

Matthew Heimermann - JPMorgan

Good morning. Two questions; the first question maybe for Ed is; we've all been trying to get our arms around what could happen with pricing particularly on the property side. I guess is there a price increase at which you think you would actually start to see some of the capital markets capacity which is sidelined, because the economics and the model don’t work or other issues actually start to come up the sidelines.

Ed Noonan

I think, one of the nice things that we see in this environment is that the capital is exiting the market that’s sitting on the sidelines isn’t sitting there for lack of opportunity. It's sitting there I think because they are facing capital redemptions and other strains, other capital depletion events in their own firms. And so we don't really envision a scenario where suddenly there is flood of capital back into the market that would dampen the upturn that we see.

Matthew Heimermann - JPMorgan

Okay. It's interesting. I was just talking to some folks there, there's for example a lot of private equity money that's been raised that hasn’t necessarily put to work. So one of things I have heard is that at current prices that capital wouldn’t necessarily be willing to participate as sidecars, but actually if you were to see prices rise dramatically let just say 20%, some of that money might be incentive to come up to sidelines rather than looking at some distrust opportunities in more traditional investment markets.

Ed Noonan

Again, I think that's a scenario that plays to our strength. If you look at the sidecar that we've had for the Gulf of Mexico over the last three years, even we like, the three year track record of that program is outstanding. So if in fact capital wants to come in particularly in sidecars, what it needs is access to distribution, high quality management and underwriting, and the opportunity.

I think we present all three very nicely, as well as technical architecture and infrastructure in the company, it's already got a proven track record in managing capital for third parties.

Matthew Heimermann - JPMorgan

Okay. And have you had any discussion around adding capacity in sidecar form, with any of your historical partners or otherwise at this point.

Ed Noonan

So one of the nice things about Validus is, it seems like we talked to everybody about everything all the time. Having five really high-powered private equity firms as significant investors, we never rush on that one. So we have lots of conversations, there is nothing that I would say at this moment in time that we would feel is so far long that we would report on it or suggest that it's likely to change our strategy going forward.

Matthew Heimermann - JPMorgan

Okay. And then may be for Jeff more or Ed, either one. More specific to just capital; if I look at the disclosure you give around your peak zone, 1 in 100, 1 in 250, it looks like relative to tangible capital that that ratio is up dramatically, relative to the start of the year. And so I certainly understand you’ve got a lot of diversifying businesses that you can grow that don’t actually consume capital. But with respect to the peak zones, are you actually capital-constrained at this point to grow that book outside of rate?

Jeff Consolino

Hey Matt I’m referring to page 33 of our supplement, and if you look at it, our total capital on a GAAP basis started the year at $2.285 billion. Now as of September 30, we’re at $2.221 billion. So that’s effectively the same place, even after spending about $110 million in returning capital to our shareholders and debt holders.

The position we’re in is we’re budgeting for next year; so we’re starting from the stand point that basically is the same capital level in the business for January 1 of '09, that we looked at for January 1 of 2008.

Matthew Heimermann - JPMorgan

So what I was doing was, I was just comparing the disclosure on page 34 with your tangible capital at the end of the quarter, and I think I’m coming up with like 27% if I do the math right. And I thought you had this data threshold of 25%.

Jeff Consolino

We established the beginning of the year Matt our budgets for PML; we established our budgets for zonal aggregate, and we can adjust that during the year. But I think our appetite for writing at January 1, would be largely driven by our December 31 capital base.

Ed Noonan

Yeah Matt, I would observe too that if you’re at 27% then our target is 25%. I think we’re probably, by the time we wrap up our plan, we certainly wouldn’t reach our targets, either for PMLs or equally as important, for zonal aggregate. So, if it’s 2% swing, I think we’re probably both talking about the same range.

Matthew Heimermann - JPMorgan

Okay, fair enough. Thank you guys.

Jeff Consolino

Thank you.

Operator

Our next question comes from Ian Gutterman of Adage Capital. Please go ahead.

Ian Gutterman - Adage Capital

Hi. Good Morning.

Jeff Consolino

Hi Ian.

Ian Gutterman - Adage Capital

Hi. First, can you talk about what the growth [possibly], how does it look like? You said it hit the retro, but you did have your recoverals go up is that at Talbot?

Jeff Consolino

That is at Talbot end.

Ian Gutterman - Adage Capital

Okay. And if I am doing my math right on, it looks like you disclosed about a $140 million in Bermuda and the retro kicks in around 150 I believe. So does that mean the risk for further development is pretty [meudic] as you would have the retro start to kick in?

Jeff Consolino

I would agree with that. If you refer to page 3 of our press release, you can see for Validus, for hurricane Ike we have $157.2 million before reinstatement premium. Of that property is 120, marine is 37, and specialty is de minimus. The retro we bought pertains to onshore, and so the offshore energy loss would not be a covered event under that retro.

Ian Gutterman - Adage Capital

Got it, okay. Again how much reinsurance do you have left on the Talbot side; again if the growth develops up?

Ed Noonan

Actually the Talbot reinsurance recoverable for Ike de minimus.

Ian Gutterman - Adage Capital

It is, okay. Because it looked like your recoverables went up like $30 million - $40 million in the quarter?

Jeff Consolino

That’s just a normal operation…

Ian Gutterman - Adage Capital

That is. Okay, so it's not Cat related.

Jeff Consolino

Not Cat related.

Ed Noonan

The other thing Ian I had mentioned to you is that in the Gulf of Mexico we have separate specific reinsurance even apart from the sidecar. We bough in early summer against the Gulf [loss], and I think we still have roughly $7 million to $10 million in unused capital there or unused limit there. But your broader point about the traditional retro session we bought is exactly right. When we think about this event, it's still early days and if in fact the industry loss worsens. We sleep very well knowing that the money we spend on retro very quickly comes in and starts to dampen any upward movement in our loss.

Ian Gutterman - Adage Capital

Okay, great. And then on market conditions, if I ask the question to a few others about just what your total rate is for writing new businesses especially given Matt's question about how much capacity you have or don't have or etcetera. It's [weighing], the old mid-teen target that you cannot (inaudible) with as a business model, is that good enough these days or given how tight capacity is and how much demand's going to go up.

And frankly my concern that some primaries who have capital issues are going to look at reinsurance as a relatively speaking cheap form a cap or competitor, there are other options and buy up as much as they can. Is mid-teen good enough, or does it needed to be 20% to 25% returns to deploy capital which is precious today, knowing we could have an earthquake any day and obviously don't want to have to see come to the market for that.

Ed Noonan

So Ian you are thinking about the same way we do. First thing I would observe those is that we never had a mid-teens target. We thought we are in a volatile business that over the cycle we needed to be generating returns in the 18% to 20% range.

Ian Gutterman - Adage Capital

Okay.

Ed Noonan

And actually now even including Ike I think we'll look at it and say that we've accomplished that for at least what looks like a brief three year period.

In terms of the return hurdles, if we are heading into hardening market obviously return hurdles go right up with it. In our business you have to generate outside returns in a good year. And it looks like we are heading into a good year. So I don't want to kind of disclose a hard ROE that we are going to embed in our pricing, but you can rest assure that it will be at the high end or above our long term ROE targets.

Ian Gutterman - Adage Capital

Does that need to be higher than it was after Katrina, just given that the ability to access capital markets if another Cat happen is tougher and also the ability of sidecar is probably going to be smaller.

Ed Noonan

Yes, those are all important decisions. As a matter fact in our board meeting this week, we’re adding that conversation in great depth with our Board. One of the things that’s precious to us is our rating, and so we do nothing that would expose our capital to a level that could imperil the rating, that’s a fact of course.

But going back to the post-KRW environment, we were kind of on a day-in-day-out business pricing risk in kind of the mid-20s ROE range, and we were able to write a sizeable portfolio. I can’t predict yet exactly the shape of this turn; the early indications we’re seeing are actually pretty attractive, and some of these kind of spot market deals that we’re binding, we’re seeing really attractive rate increases that would be well beyond the type of ROEs that you and I are discussing now.

Ian Gutterman - Adage Capital

Okay. And then lastly, two other places of possible dislocation, I guess it sounds like some of the hedge funds that were significant in the ILW space are going away. Would you assume that demand comes back to the cap market or is that sort of marginal hedge fund trading and maybe it just disappears?

And then the other one is Florida Cat fund, this debate about whether the FHCF will actually pay if they can’t finance that they won't pay anybody. Do you expect we’ll see primaries buying extra cover even at the FHCF layer, because they consider that the FHCF won’t be able to pay them?

Ed Noonan

Yeah, on the first part of your question regarding the hedge funds and alternative capital providers; first, we are already seeing some people, some U.S. insurance companies who had their programs in the collateralized market, which is largely hedge fund type capital.

Those collateralized markets are either leaving, or because of the losses this year, they’ve had to post their capital as collateral against the outstanding losses, and they don’t have the capacity for next year. And so we’re seeing in one case a very large program come back into the traditional marketplace looking for cover. That's a good thing by the way in terms of its effect on pricing.

As far as the ILW market, I think there were some hedge funds who simply saw it as an attractive risk class and we are treating it. But I think there were some other players who were in it providing capacity that was needed, particularly for reinsures where retro session is not as deeper market, and so a lot of reinsure use ILW so as a surrogate, and so I think that will also have an effect. The diminished ILW capacity will tend to cause reinsurance prices to move up at as well.

Ian Gutterman - Adage Capital

Okay. And then Florida?

Ed Noonan

Yes, Florida. I am kind of politics out at this, (inaudible) in that but compared to presidential election that was a piece of cake then, when you think about trying to predict what will happen in Florida. It's just too political right now with particularly with the change in the administration, with some congress men wanting to have a federal back stop on state insurance funds, and the like. I wouldn’t even venture the prediction. We are not factoring any improvement in Florida into our plan related to the political aspects around the FHCF.

Jeff Consolino

Ian this is Jeff Consolino. I just want to double back to our [adjusting] recoverable question that you asked. There is no recoverable for U.S. property under the metro, but there is also a component to that that's attributable to our offshore energy sidecar structure.

Ian Gutterman - Adage Capital

Got it. Okay. Thank you guys appreciate it.

Operator

Our next question comes from Susan Spivak of Wachovia. Please go ahead.

Susan Spivak - Wachovia

Good morning guys. I was hoping just following up on the whole capacity issue. Could you talk a little about what you've budgeted to pay for the retro next year, and what’s the availability of retro capacity and the type of market environment that you are describing going forward?

Ed Noonan

Susan, I was actually hoping after the call to see if you might be available and interested, a nice opportunity in retro market on a personal level.

Susan Spivak - Wachovia

You know what Ed, I could be.

Jeff Consolino

We really want you to post collateral [does].

Ed Noonan

It's a good question Susan. We are in discussion with a number of different parties; I think the media is in market. I think it's obvious the cost of retro session will be higher next year, will still be in the retro session market as a purchaser I think, and so we will be buying more.

We will probably look at the whole mix of coverage terms conditions, pricing and attachment point. There is only so higher rate on mind that you can pay before you simply say; well that doesn't make any sense to us anymore. We should either look at higher attachment point or cut risk on our peak zone etcetera.

So it's a little bit early but our sense is clearly that retro session market will be more dear next year; even though at this point we haven't hit the traditional cover we purchased.

Susan Spivak - Wachovia

And the renewal date for that is July, which you look to may be renegotiate and place that in January before prices rise as much as they could throughout the year.

Ed Noonan

I refuse to comment on such a strategy Susan. I am always offended when our clients do it us.

Susan Spivak - Wachovia

Okay, great. Well thanks for all the commentary on the call and your answers.

Ed Noonan

Thanks Susan.

Operator

(Operator Instructions). We show no further question at this time. Now, I would like to turn the conference back over to management for any closing remarks.

Ed Noonan

Yes, so thank you all for taking your time. I do realize this is an extremely busy day and you got lots of work to do. But we appreciate your interest in the company and your ongoing support of us. So interesting times, we probably are more bullish than we've been since we started the company on a lot of levels, and we’ll look forward to updating you after the fourth quarter. Thank you.

Operator

The conference has now concluded. Thank you for attending today’s presentation. You may now disconnect your lines.

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