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Executives

Jan Watson - Secretary, Treasurer

Brad Beecher - President & CEO

Laurie Delano - VP, Finance & CFO

Analysts

Tim Winter - Gabelli & Company

Robert Howard - Prospective Partners

Peter Hark - Zimmer Lucas Partners

Jim von Riesemann - UBS

The Empire District Electric Company (EDE) Q4 2012 Earnings Call February 15, 2013 1:00 PM ET

Operator

Ladies and gentlemen thank you for standing by. Welcome to The Empire District Electric Fourth Quarter 2012 Earnings Conference Call. At this time, all participants are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session and instructions will be provided. (Operator Instructions) I would like to remind everyone that this conference call is being recorded today Friday, February 15, 2013 at 01:00 PM Eastern.

And I would now like to turn the conference over to Jan Watson. Please go ahead.

Jan Watson

Thank you, Luke. Good afternoon everyone and welcome to The Empire District Electric’s earnings call for the quarter and year ending December 31, 2012. A live webcast of this call is available on The Empire website at empiredistrict.com.

With me today are Brad Beecher, President and Chief Executive Officer, and Laurie Delano, Vice President and Chief Financial Officer. Our press release announcing fourth quarter earnings and our earnings guidance for 2013 was issued yesterday afternoon. A replay of the call will be available for two weeks at 800-406-7325, passcode 4593126#.

Before I turn the call over to Brad, I need to remind you that during the course of the call some of the comments we make may contain forward-looking statements as defined by the Securities and Exchange Commission and there are a number of uncertainties inherent in such comments. Although we believe that our expectations and beliefs are based on reasonable assumptions, actual results may differ materially. We direct you to slide two of the investor presentation on our website and our most recent Form 10-K and Form 10-Q filed with the Securities and Exchange Commission for a list of some of the factors that could cause future results to differ materially from our expectations.

Also for further clarification, the earnings per share impact of revenue expense are discussed on an after-tax basis and the estimated earnings per share impact of individual items and the presentation of gross margins are non-GAAP presentations. We believe these to be useful to investors showing the impact of the various components on earnings per share and analyzing changes in performance from one period to the next. These may not be comparable to other companies or more useful than the GAAP presentation included in the income statement and is not intended to be an alternative to GAAP earnings per share as a measure of operating performance or any other measure of financial performance presented in accordance with GAAP.

I will now turn the call over to Brad Beecher.

Brad Beecher

Thank you, Jan. Good afternoon everybody and welcome. Today, we discuss our financial results for the fourth quarter and 12 months ended December 31, 2012, and update you on various company activities.

As we announced on February 7th following the Board of Directors’ meeting, the Board declared a quarterly dividend of $0.25 per share payable March 15, 2013, for shareholders of record as of March 1st. This represents a 4.6% indicated annual yield at yesterday’s closing price of $21.61.

Yesterday, we reported consolidated fourth quarter 2012 earnings of $9.6 million or $0.23 per share. This compares to the same period in 2011 when earnings were $8.7 million or $0.21 per share. Heating Degree Days for the quarter were up about 1.8% over last year, but remain 0.6% lower than the 30 year norm.

For the 12 months period ending December 31, 2012 earnings were $55.7 million or $1.32 per share compared to December 31, 2011, 12 month earnings of $54.9 million or $1.31 per share. Increase in customer accounts during the year were offset by milder weather and changes in customer usage behavior leading us to a 3.4% reduction in electric sales when compared to 2011. Customer accounts grew by more than 1,400 or 0.85% placing us only about 400 customers behind pre-tornado levels. Offsetting this customer growth was primarily the impact of mild weather.

Cooling Degree Days were 2.9% less than 2011, though they were 27% above the 30-year normal. Heating Degree Days [were less thereof] was a dominant weather factor in 2012. We experienced Heating Degree Days 21% lower than both 2011 and a 30-year average. In fact, we recorded the lowest Heating Degree Day total in at least the last 60 years. Our 2012 results were also impacted in a positive manner by decreased depreciation expenses and increased electric rates. These positive results were tampered by increases in operating expenses in our electric business.

I will now turn the call over to Laurie for details of our financials.

Laurie Delano

Thank you, Brad. Good afternoon everybody. As we walk through the details of our financial results, comparing our earnings per share 2011 results of $1.31 to our 2012 results of $1.32 per share, I will be referring to our webcast presentation slides to talk about the various impacts year-over-year.

As usual, I would like to begin by providing non-GAAP basic earnings per share reconciliation for the year on a consolidated basis. For those of you who have our press release in front of you that will be the earnings per share reconciliation I will follow. For those of you looking at our slides, this begins on slide four. And as a reminder, the earnings per share figures throughout the call are provided on an after-tax basis.

Slide four illustrates the reconciliation between the two years result. First, our consolidated gross margin increased an estimated $0.08 per share year-over-year. Consolidated operating and maintenance expense reduced earnings per share by about $0.13. Depreciation and amortization increased earnings per share another $0.05.

Our Allowance for Funds Used During Construction or AFUDC added about $0.02 per share to earnings while the net effective taxes, interest and other income and deductions had no year-over-year impact. The dilutive effect of common stock issued under our 401(k) employee stock purchase and dividend reinvestment plans reduced earnings about a penny per share.

Now I will give you a little more detail on some of the components that impacted earnings per share for the year. The call out box on slide five provides a further breakdown of the earnings per share impact of our consolidated gross margin components which as I mentioned increased earnings around $0.08 per share.

As Brad described, milder winter weather compared to the 2011 period decreased electric revenues an estimated $25.6 million for the electric segment reducing margin approximately $0.26 per share. The unseasonably mild winter weather also had a negative impact on our gas segment. The gas segment gross margin, which is gas revenues less cost of natural gas sold and transported, declined approximately $2.4 million or about $0.04 per share.

When compared to normal weather we estimate the effects of weather for the year which included the mild winter that we have talked about and a hot summer negatively impacted our margin about $0.07 per share for our electric segment and about $0.03 per share for the gas segment.

Offsetting these negative weather impacts was a full year of increased electric customer rates. This increase when compared to 2011 added an estimated $12 million to 2012 revenues or an increase in margin of about $0.22 per share. Improved customer accounts added about $4.2 million approximately $0.04 per share to margin.

In addition to the positive impact from increased rates and customer accounts a change we made in our estimate for unbilled revenue during the third quarter of 2012 added approximately $3 million to revenues increasing margin of about $0.04 per share.

Other non-volume related fuel adjustments positively impacted margin year-over-year. Our derivative mark-to-mark adjustments that do not flow through our fuel recovery mechanism reduced fuel expense $2.9 million. A full year of the amortization expense we received from the Southwest Power Administration in 2008 decreased fuel expense $1.3 million when compared to 2011. These changes combined to increase margin approximately $0.05 per share. Our off-systems sales revenues were lower during 2012 but had little impact on margin as they roll through our fuel adjustment mechanism.

Turning to the other earnings per share impacts, I’ll focus on our operating and maintenance cost which you see broken out on the call out box on slide six. These increased costs decreased earnings about $0.13 per share year-over-year. Our electric segment operating expense saw increased operating cost of about $8.8 million. Pension and healthcare expenses increased approximately $3.8 million. Power operating costs increased of about $2 million. This reflected a full year’s recognition of expense at our Iatan 2 and Plum Point generating stations. And as a reminder, these increased expenses were included in our customer rates that were effective June 2011.

Our electric transmission expenses increased about $1.7 million primarily due to increased transmission incurred to move power to our system. Professional service fees increased approximately $2.1 million, primarily reflecting a one-time reclassification out of 2011 expense pursuant to our 2011 Missouri rate case order.

Moving on to depreciation and amortization, overall changes increased earnings per share about $0.05 during 2012. These costs decreased approximately $3.1 million year-over-year due to the reduction of $6.6 million in regulatory amortization which ended in June 2011 with the implementation of New Missouri Electric rates.

This decrease was offset by increased depreciation from higher levels of plant and service. As you can see from this slide, overall interest expense had no impact on earnings per share as compared to 2011. I'll point out though that we have reduced our long-term debt interest expense by about $2.4 million through the refinancing of debt at more favorable interest rates.

However, this reduction in interest expense was largely offset by reduced deferred carrying charges related to the construction accounting allowed for our Iatan 2 and Plum Point generating stations.

AFUDC increased approximately $1.4 million or $0.02 per share primarily due to the environmental upgrade project underway at our Asbury generating plant.

Moving on to slide seven, I'll briefly go over the fourth quarter after tax earnings per share reconciliation. Again for those of you who don't have the slides, this information is also on our press release. Beginning with the quarter ending December 31, 2011 earnings per share of $0.21, we saw an increase in total gross margin of $0.01 per share during the 2012 quarter. This reflected decreased electric revenues of approximately $3.9 million and a decrease in fuel and purchase power costs of approximately $4.4 million.

As you can see on the call outbox on slide seven, reduced revenues resulting from milder weather during the 2012 quarter as compared to the 2011 quarter was partially offset by our improving customer counts.

Gas segment margin was unchanged quarter-over-quarter. Decreased operating and maintenance expenses added about a $0.01 to earnings per share, higher levels of plant and service resulted in an increase in depreciation during the 2012 quarter reducing earnings about $0.01, reduced interest expense coupled with an increase in AFUDC increased earnings about $0.02 per share that were partially offset by increases in other deductions which lowered earnings about $0.01.

These changes roll up to our 2012 fourth quarter results of $0.23 per share. I'm pleased to report that our retained earnings balance at December 31 stands at $47.1 million compared to around $33.7 million at the end of 2011. As to our liquidity position at the end of the year, we had $24 million outstanding related to short-term debt borrowing out of our $150 million in capacity.

At the close of business today, our outstanding short-term debt balance will be around $17 million. Our capital expenditure projections for the next five years remain unchanged from our last call. As a reminder, our projections by year are as follows: 2013 $163.4 million, for 2014, $165.5 million, for 2015, $178.1 million, for 2016, $107 million; for 2017, $108.2 million.

The 2013 and 2014 amounts reflect our continued expenditures for the Asbury environmental upgrade which Brad will discuss in greater detail. Through December 31, we have spent approximately $29.8 million on the project. We continue to expect costs associated with the conversion of our Riverton Unit 12 to a combined cycle unit to begin in late 2013 with completion in 2016.

We expect internally generated expense to be sufficient to meet about 70% of our construction financing needs through the remainder of this year. As we alluded to on our previous call, we finalized a bond purchase agreement for a private placement of $30 million of 20-year 3.73% series first mortgage bonds and $120 million of 30-year 4.32% series first mortgage bonds. We expect to receive the total proceeds of $115 million in a delayed settlement about May 30, 2013. We will use the proceeds from the sales to redeem all $98 million of our senior notes, our 4.5% series which are due June 15, 2013.

The remaining proceeds will be used for general corporate purposes, including the construction activities I just mentioned. Given our 50-50 debt equity target mix, our addition of internal equity from our dividend reimbursement stock purchase plans and our continued bill of retained earnings, we still do not anticipate the need for any equity financing until the latter half of 2014.

On a regulatory front, we did reach a unanimous agreement with Missouri Public Service Commissions staff in the office of Public Counsel for an increase in our annual revenues for our Missouri water customers of approximately $450,000. The Missouri Public Service Commission issued an order of proving an agreement on October 31, 2012, and our new water rates become effective November 23, 2012.

As we announced yesterday in our press release, we expect our full year 2013 earnings to be within the range of $1.26 to $1.43 per share. In developing our guidance, we assume 30-year average weather and modest overall system energy growth. We also factored in seven months of increased electric customer rates from our pending Missouri Electric rate case which has an operational date of early June 2013.

In addition, we included increased operating cost due to compliance requirements. Of course, actual overall results of our pending rate case that are different from our assumptions could impact our expected earnings per share range. In addition, other factors that may impact earnings include the ongoing recovery and redevelopment in the tornado impacted area of Joplin, variations in customer usage projections and unanticipated or unplanned events that may impact operating and maintenance costs.

That concludes our slide presentation and I will now turn the presentation back to Brad.

Brad Beecher

Thank you much Laurie. We continued work on our Missouri Electric rate case which was filed last July with local public hearings held in Joplin and Reeds Spring the first week of January. In total, we had a couple of dozen customers that attend the hearings with 14 entering testimony in Joplin and two customers testifying in Reeds Spring.

They are common centered on affordability the economy, the perceived low income demographic of the area and the difficulty of those living on fixed incomes. Overall, no service issues were expressed. I am pleased to announce that this morning we’ve reached agreement in principal with attorneys for the parties to our case. We expect the filing early this afternoon asking the Missouri Public Service Commission to delay the hearings which are scheduled to start next week while the parties get final client approval and craft a joint stipulation which will be filed with the Commission in the near future.

Details of this stipulation are confidential until it is filed with the Commission. In Joplin, we see progress in the rebuilding. At the end of the year, we were down about a 1,000 customers from pre-tornado status in Joplin. System wide, we are down only about 400 customers. The five schools lost in the tornado are currently being replaced on three separate campuses. The elementary and middle schools are scheduled to be ready by year end 2013 and the high school and technical school are set to open for the start of classes in August of 2014.

The Master Developer for Joplin is moving ahead with plans. Joplin City Council on February 4 passed a resolution of intent to move forward with the first of the tornado redevelopment projects a combination of library and movie theater. The complex is to be build at (inaudible) and Connecticut in the heart of the devastation area. This coupled with the completion of the schools will drive further development in the area.

Despite the large construction effort in Joplin, we continue to see weather normalized customer usage remain relatively flat. Going forward, we expect annual electric customer growth range of 0.7% to 1.2% over the next several years.

We expect the corresponding weather normalized sales growth to be approximately 1.5% in the near-term as the Joplin area rebuilding activity continues. We then expect sales growth to flatten to a range of 0.4% to 0.9% over the next several years. We define electric sales growth to be growth in kilowatt sales period-over-period excluding the impact of weather.

We continued rate based assets with work at our Asbury and Riverton power plants and our infrastructure additions. At Asbury the project involves their quality control systems with their price tag of $112 million to $130 million; the project includes the circulating dry scrubber to control sulfur dioxide and pulse-jet fabric filter or baghouse to contain particulate matter and powder activated carbon injection system to help produce mercury emissions.

At the Riverton Power Plant, with transition units 7 and 8 to natural gas only operation (inaudible) due to the agents size of this final two coals units of Riverton, it was not cost effective to retrofit them to meet new environmental standards. The units will be retired in 2016 after the completion of a combined cycle addition to Riverton Unit 12.

The first steps in the addition of the combined cycle conversion of Riverton Unit 12 have begun. We issued a request for proposal for this project in January and anticipate receiving proposals by early April 2013; we broke ground underneath Joplin service center in November. The facility will be located at the cross roads industrial part and will efficiently consolidate numerous commercial operational groups, including T&D Engineering mine operation and others which are currently scattered across Joplin. This facility is scheduled for completion mid 2014. Also at this location we will install a new substation to serve the additional load being added in the industrial park. This load includes the new Coca Cola facility and the Blue Buffalo pet food plant. The first phase of implementation and project overhaul are enterprise resource project was successfully completed in 2012. This involved replacing software for human resource support, the financial reporting system and asset management. Our previous systems no longer had vendor support. The new PeopleSoft Financial Reporting System enhances our internal controls and automates many procedures.

In addition, our employees now have the ability to handle compensation and benefit administration online. The new asset management and resource planning systems improve the way we report, transfer and manage information, while providing enhanced capabilities for analysis and financial reporting. With the implementation of the first phase of this project complete, we have transitioned our focus to continuing to improve and enhance the systems implemented to date and to the addition of the budgeting and operational modules planned for Phase 2.

In other regulatory news, Missouri Governor Jay Nixon has appointed former Missouri State Senator Bill Kenney of The Lee's Summit to the Missouri Public Service Commission. Mr. Kenney is a former two term Republican state senator representing portions of Jackson County from 1995 through 2003. At the time of his appointment he served as the Chief of Staff for Lieutenant Governor Peter Kinder. Mr. Kenney and acting Commissioner Stephen Stahl were confirmed by the Senate on January 31, 2013.

In other Missouri Public Service Commission news, Chairman Kevin Gunn announced his resignation from the PSG effective March 1. With his resignation we will be back to four commissioners in Missouri. In summary, I believe we had solid results in 2012. We continue to be focused on delivering service to our customers and value to our shareholders. I will now turn the call back to the operator for your questions.

Question-and-Answer Session

Operator

(Operator Instructions) We have a question on the line from Tim Winter of Gabelli & Company.

Tim Winter - Gabelli & Company

I was wondering if you guys reached a stipulation with Missouri Electric rates going to affect before what you are currently anticipating in your earnings guidance. What are you anticipating in the earnings guidance seven months, right.

Laurie Delano

Yes, in earnings guidance we anticipate around the 1st of June which is the operational law date.

Brad Beecher

And beyond that Tim the terms of our agreement are confidential until we file it with the Commission, so I really can't comment on that.

Tim Winter - Gabelli & Company

And then just a quick housekeeping item, can you repeat the ’13-’14 CapEx numbers, I did not catch those.

Laurie Delano

I certainly can Tim, hang on just a moment. ’13 is $163.4 million, and ’14 is $165.5 million.

Operator

And we have a question on the line from Robert Howard of Prospective Partners. Please go ahead.

Robert Howard - Prospective Partners

Just related to the CapEx, with the extension of bonus depreciation in to 2013, does that have an impact on like you were talking about equity need, not until the end of 2014. How does that kind of play in to things?

Laurie Delano

We estimate, we are going to go ahead and use the bonus depreciation. It was approved in the Tax Act through 2013 and we estimate that that has about $15 million impact to our cash and so that’s been factored in to our projections.

Operator

And we have a question from the line of Peter Hark of Zimmer Partners. Please go ahead.

Peter Hark - Zimmer Lucas Partners

A quick question on Senate Bill 207. Just was wondering if you might be able to gauge the prospects of getting that passed in Missouri?

Brad Beecher

For those of you who don’t know, Senate Bill 207 is a form of electric infrastructure surcharge that we could charge between rate cases. Getting legislation past is always a very difficult prospect. There are 1,000 ways to kill legislation and only one way to get it through. We have several large industrial customers that are fighting the electric utilities within the state. I can tell you we're doing our absolute best. The group of electric utilities, [Amren], Kansas City and Empire to get this thing passed but there is a lot of opposition. I really can’t handicap with a percent other than to tell you we're working as hard as we can to get it passed.

Peter Hark - Zimmer Lucas Partners

Appreciate that Brad but I know the gas companies in the state have it. What are the obstacles for the electric companies to get similar treatment?

Brad Beecher

Mostly it’s an industrial group out of St. Louis that seems to oppose everything that Amren does, but clearly they are trying to protect their customers from paying what they say is increased costs to their customers. From our standpoint we are really trying to mirror the gas (inaudible) and we are only asking to recover costs for equipment that is built in service and serving customers and so we believe what we have a very reasonable request that would help with regulatory lag for electrics in Missouri.

Peter Hark - Zimmer Lucas Partners

Right if it were to be passed, how much of your capital spending would qualify for Is Res treatment?

Brad Beecher

In the version that is currently filed Senate Bill 207, electric plant that would be subject to Is Res is defined as all electric plant except for new generation new electric generation. So environmental retrofits would be subject to it but a new power plant would not.

Peter Hark - Zimmer Lucas Partners

Separately I just wanted to talk about decision point for Plum Point and when we might anticipate some activity around that?

Brad Beecher

As we have announced in our SEC 10-Q document, we currently do not plan on exercising our option for Plum Point. We are still looking at that in our IRP which is still scheduled to be found mid-year, but with lower natural gas prices, lower power prices in general to us right now, it does not appear that exercising the option for Plum Point is the right long term decision for our customers.

Peter Hark - Zimmer Lucas Partners

So what been supplements the resource needs, is it supply that’s being provided by others or is it something that Empire will look to supplement on your own?

Brad Beecher

That is a good question, our purchase power agreement will continue through the initial 25 year term, so we will just continue to buy power under terms of the purchase power agreement, so will now have to look for another resource.

Peter Hark - Zimmer Lucas Partners

Does the prices modify under the new 25 year agreement?

Brad Beecher

It is not.

Peter Hark - Zimmer Lucas Partners

Okay, all right. And then lastly maybe going back to Tim Winters questions to some extent. The range of guidance $0.17 differential between bottom and top end of guidance range, I am sure, it’s partly tied to the (inaudible) what else streams out the top and bottom numbers?

Laurie Delano

Well, as we indicated in our general statements, some of that is related to what customer usage may do, whether we are right or wrong in our estimates of that. We challenged ourselves to keep operating and maintenance cost pretty flat over the coming year and I think that’s the other thing is probably the player in there.

Brad Beecher

And part of that is surplus powerful transmission cost expenses which are schedule 11 charges for really the lines that are being built elsewhere in the pool that get allocated to us. So ultimate regulatory treatment of that will have some impact as well.

Peter Hark - Zimmer Lucas Partners

And those transmissions charges Brad, do you go to (inaudible) for recovery or to Missouri Commission for recovery?

Brad Beecher

We recovered most of those through our state jurisdictions through Missouri and so that's one of the issues in our case.

Peter Hark - Zimmer Lucas Partners

Okay.

Brad Beecher

What level and then of course we ask for a tracker for those in our original filing.

Operator

(Operator Instructions) Your next question comes from the line of Jim von Riesemann at UBS.

Jim von Riesemann - UBS

Following up on Peter’s question and framing the earnings guidance, how should we think about regulatory lag once the rate case is settled or announced?

Laurie Delano

Well, this case you know a lot of the dollars in this case were about compliance costs.

Jim von Riesemann - UBS

Right.

Laurie Delano

So assuming that everything goes as we would like where to most of those costs will be covered and then like I said we challenged ourselves to try to keep those relatively flat over the next coming years. So we are trying to mitigate the lag on the O&M costs, you know, so the big item becomes the plant and service and depreciation as we continue our construction build. I think that's the really the main thing to think about and then whatever unforeseen things can happen with O&M costs.

Jim von Riesemann - UBS

How’s pension these days for you all? Have you changed your discount rates and if so could you share with us the changes in the discount rates, what do you see in terms of the pension expense increases going forward? Do you need to make any contributions to the plan? I think you are a little under funded.

Laurie Delano

Right, we are under funded to the tune of about $88 million right now and we are about 60 from a book basis that's about 65% funded. It hasn't changed, that's about the same that it was last year. We did reduce our discount rates. What we plan to do is continue to fund our actuarial costs which for next year is about $11 million to $12 million, and of course that still part of the recovery that we get through a tracker mechanism in the rate case or in rates and we haven't had any challenge to that and like I said we did reduce our discount rates. Hang on just a second, I can give you that, yeah we are using a discount rate of 4%.

Jim von Riesemann - UBS

The last question I have is I'm sorry I missed this before but could you refresh my memory what weather was in the quarter relative to normal and then for the year relative to normal.

Brad Beecher

18 degree days we are about 0.6% lower than the 30 year norm in the fourth quarter.

Laurie Delano

So not much impact.

Brad Beecher

And then the next question you had was…

Jim von Riesemann - UBS

For the year like on a per share basis how much would the weather impact for the year.

Laurie Delano

This is a number that's sometimes hard to estimate Jim, but what we estimate is about $0.07 negative impact for our electric company, about $0.03 for the gas company, for the gas segment.

Jim von Riesemann - UBS

So $0.10 overall for the year right.

Laurie Delano

Right.

Brad Beecher

And that's the combination of good weather in the summer and really mild weather the rest of the year.

Jim von Riesemann - UBS

So then my question is why is the range skewed towards the downside rather than the upside if it came in for the year at $1.32 with $0.10 of weather. If you are budgeting on a normalize weather basis, that should be called at $1.42, but yet there is only a penny upside based on your 13 range. How should I think about your earnings outlook?

Brad Beecher

I am trying to absorb the full context of your question.

Jim von Riesemann - UBS

So I normalize 2012 for weather. So instead of $1.22, it's a $1.42, right? But yet your guidance for ‘13 is a $1.26 to $1.43. So I am trying to think about the variability since it skewed towards a downside rather than call it a balance, makes between up and down.

Brad Beecher

And also remember we had an unbilled revenue adjustment of about $0.04 before you start. So $1.32 was higher than otherwise would have been with the revenue adjustments.

Laurie Delano

And the other thing to think about Jim, as I mentioned earlier, this rate case was mostly about cost recovery for expected cost that are coming in to play. So we have a full-year of those cost laid in for 2013 but only seven months worth of rate.

Operator

And we have no further questions at this time. Please continue.

Brad Beecher

Well, thank you very much for your confidence in Empire District. I hope you all have a great weekend and we will talk to you soon. Thank you.

Operator

Thank you. Ladies and gentlemen, this does conclude the conference call for today. We thank you for your participation and you may now disconnect your lines.

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