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Executives

Jeff Lunsford - Chairman and Chief Executive Officer

Doug Lindroth - Chief Financial Officer

Paul Alfieri - Senior Director, Corporate Communications

Analysts

Derek Bingham - Goldman Sachs

Michael Turits - Raymond James

Colby Synesael - Kaufman Brothers, LP

Srinivas Anantha - Oppenheimer & Co.

Kerry Rice - Wedbush Morgan Securities, Inc.

Analyst for Katherine Egbert - Jefferies & Co.

Limelight Networks, Inc. (LLNW) F1Q09 Earnings Call Transcript May 6, 2009 4:30 PM ET

Operator

Ladies and gentlemen, thank you for standing by. Welcome to Limelight Network first quarter 2009 result conference call. At this time, all participants are in listen-only mode. Later we will conduct the question-and-answer session. (Operator's instruction)

I would now like to turn the call over to Paul Alfieri, Senior Director of Corporate Communications. Go ahead, Paul.

Paul Alfieri

Good afternoon and thank you for joining the Limelight Networks’ first quarter 2009 financial results conference call. Speaking today will be Jeff Lunsford, Chairman and Chief Executive Officer, and Doug Lindroth, Chief Financial Officer.

This conference call is being recorded on May 6, 2009, and will be archived on our website for approximately one week. Some portions of this conference call may include forward-looking statements as defined in the Private Securities Litigation Reform Act of 1995.

Forward-looking statements are all statements that are not strictly statements of historical facts, such as statements regarding future events or future financial performance, including, but not limited to, statements related to Limelight Networks’ market opportunity and future business prospects, guidance on financial results, statements concerning anticipated future growth and profitability, as well as management’s plans, goals, strategies, expectations, hopes and beliefs.

These forward-looking statements are subject to risks, uncertainties and other factors that could cause actual results to differ materially from those contained, projected or implied in the forward-looking statements including the inherent risks associated with litigation particularly intellectual property base litigation. Reported results should not be considered an indication of future performance. Factors that could cause actual results to differ are included in the Company’s periodic filings with the Securities and Exchange Commission.

I would now like to introduce Jeff Lunsford.

Jeff Lunsford

Thanks Paul. Thank you all for joining us. Today, Limelight Networks reported $33.2 million in revenue for the first quarter of 2009 representing 10% year-over-year growth over Q1 of 2008. Adjusted EBITDA before stock-based compensation, litigation cost and reversal of the damage accrual was approximately $4.7 million. Bookings were slightly higher than Q4 of 2008. We are pleased with these results and excited about investments we are making in scaling our platform and expanding our suite of cloud-base services.

We are also pleased that the court in Boston recently ruled that we do not infringe Akamai’s patent which allowed us to repurpose approximately $66 million in capital we had set aside at the end of 2007. Even with solid revenue, adjusted EBITDA and other operating highlights, we are still taking a cautious view on near-term results as it is difficult to determine if business conditions have bottomed. You will hear in Doug's comment that we are still managing through some of the short-term factors brought on by tough economy such as higher than usual bad debt and higher than normal DSOs.

When thinking over the long term, however, we have never been more excited about the prospects for this business. Limelight today operates at the intersection of two incredibly powerful and undeniable long term trends. The first is the ongoing migration of consumer and business activity to the online world whether for entertainment, commerce or general purposes and whether through a computer, mobile device, internet-connected television or set up box. The second trend is the steady and deliberate migration of computing activity out of enterprises and into outsourced computing, networking and telecommunications resources commonly referred to in text circles as the cloud.

To capitalize on this first trend, we continue to scale our content-delivery platform and to extend our capabilities with new solutions such as Limelight site and our mobile platform. When combining our existing services with these new services and factoring in our global scale and eight years of operating history as a leading pure play content delivery company, we believe we are distancing ourselves from a shrinking group of competitors.

To capitalize on the second trend, we are investing to extend our standard delivery and storage capabilities into other cloud-based application service areas that are synergistic with our core business such as transcoding and mobile device detection and delivery optimization and we are continuing to scale our platform which has quietly become one of the largest distributed computing platforms and operation.

These two trends provide great wind in our sales as we grow our business and we feel fortunate to be operating in this market.

Regarding our customer base, during the quarter, we added over 35 net new customers, average annualized revenue per customer in Q1 was $97,000 which was roughly flat from $98,000 in the last year's first quarter. At the end of the first quarter, we had approximately 1,365 active customers. In the media and entertainment market segment, we continue to be a platform of choice for leading content and internet brands as we added customers such as HBO, Public Broadcasting and Japan's Gaitame.com. We also partnered with MobiTV to deliver the NCAA men's college basketball tournament. We also continue to build our channels and professional services businesses in the quarter signing a multiyear reseller partnership with Global Crossing and seeing good traction with our ask-based partnership where our platform is an enabling component of their most of the cloud computing offering.

Additionally at the end of the quarter, we introduced our first solution specifically designed for the enterprise, government e-commerce market segments, Limelight Site. Limelight Site formulizes our entry into the whole site and small object delivery markets. Just as we are seeing a fundamental shift of offline, online and the media and entertainment segment, we are also seeing the shift in the enterprise, e-commerce and government segments. These entities are designed to their web presences to drive revenue, lower cost and enhanced visitor experience. Sites are being designed for educating purposes, catch prospects, capturing leads, training partners, selling goods and services and providing more efficient and effective customer services.

Site owners were adding capabilities that allow them to create communities around their brands and engage in dialogues with their customers and constituents. They are incorporating an increasing array of features into their site architectures such as social networking, personalized log ins, contest, dashboards, consumer generated video, on-demand training modules, live events and rich interactive web applications. All of these new capabilities expand complexity which puts more strain on an already burdened IT department which has to support these initiatives with more hardware bandwidth and personnel.

We believe this environment represents an attractive opportunity for our core content delivery business and for Limelight Site. Our platform is network based meaning we operate a global fiber optic backbone that interconnects thousands of servers, CPUs and storage to over 900 last mile networks worldwide. Our architecture looks to an IT manager exactly like the infrastructure he or she would need to build as they scale their business. But instead of incurring the capital on operational expenses to build such a platform, they would have to handle their site at peak load. They can use our platform on-demand and incrementally avail themselves with more resources as they succeed and grow.

Additionally with a routing feature on Limelight Site known as origin direct, our customers can directly connect their servers to our private fiber optical backbone. So, our global network literally becomes an extension of their in-house network. Origin direct helps to bypass those middle mile internet bottlenecks that often slowdown website performance allowing content to travel at CDN speed from its source to the end-users last mile network. This is increasingly important as we get into the enterprise where there is more dynamic content rather than static content.

We beta tested Limelight Site with several customers before announcing it and so today, we currently have 150 customers in enterprise and government space. We are pleased to have added several premier customers this quarter such as Sharp Electronics, Morning Star, Casio Corporation, Fuji Xerox and ING Direct and we plan to continue focusing on acquiring high-quality long term relationships in these important segments.

In the first quarter, we also continued to see our average traffic levels rise and yet again, experienced new records for peak traffic through the network that were set with the presidential inauguration in the United States. This quarter, we are continuing to build out our network capacity and expand our geographic footprint so that we can capture a growing share of the traffic expansion we anticipate.

With that update, I will now turn the call over to Doug who will take you through the financials and other key points.

Doug Lindroth

Thanks, Jeff. During the first quarter, we reported revenue of $33.2 million, up 10% compared to revenue from the same period last year, down 8% from Q4. We reported first quarter adjusted EBITDA before stock-based compensation, litigation costs and the reversal of the damage accrual of $4.7 million, compared to $4.6 million for Q4 and $2.1 million for the first quarter last year. Our adjusted EBITDA increased to 14% of sales from 7% in the same period last year.

Our GAAP net earnings were $55.1 million or $0.64 on a fully diluted basis. Our GAAP net earnings include the reversal of our previously recorded damage accrual of $66 million as a result of the court finding that we do not infringe Akamai's 703 patent.

We also reported first quarter non-GAAP net loss before stock-based compensation, litigation costs and reversal of the damage accrual of $2.1 million or $0.02 cents per basic share compared to a non-GAAP net loss of $2 million and $0.02 per basic share for the same period last quarter. Please refer to the tables included in our press release for a reconciliation of GAAP measures to these non-GAAP measures.

During the first quarter, Limelight’s international operations continued to perform very well and grew to 19% of total revenue, which was two percentage points higher than the previous quarter. Gross profit margin, which includes both depreciation and stock-based compensation, was 35% during Q1, up from 32% in Q1 of 2008. Cash gross margin was 57% for Q1, up from 53% in the same period last year.

In the second quarter of 2009, we anticipate a gross margin compression of approximately 2 to 4 points from Q1. We expect to see gross margins decline in Q2 as the result of the continued expansion of the scale, capacity and performance of our network and private fiber optic backbone and pricing activity within our customer base.

As we discussed on our Q4 earnings call, we expect the margins to rebound in the second half of the year similar to the pattern we experienced in 2008. Although we are operating in a difficult economic environment, we are continuing to effectively manage our expenses and as a result, our operating expenses were $22.5 million in Q1, down $4.4 million from the fourth quarter and compared to $23 million for the same period last year.

First quarter operating costs exclude the reversal of the damage accrual related to the Akamai litigation. Our operating expenses decreased during the quarter due to lower stock-based compensation, decrease in litigation cost, professional fees, the reduction in compensation-related expenses and a decrease in sales and property taxes. Total depreciation and amortization for the first quarter was $7.1 million, down from $7.3 million in the fourth quarter and up from $6.3 million in the same period last year.

Depreciation and amortization in the current quarter includes $6.5 million of network-related deprecation. Stock-based compensation expenses for the quarter were $4.4 million compared to $5.5 million last quarter and $4 million for the same period last year. The sequential decrease in stock-based compensation is primarily related to the departure of our former CFO.

First quarter interest earnings were $400,000 compared to $700,000 for Q4 and $1.9 million for the same quarter last year. The reduced interest income is associated with lower market interest rates and a lower cash balance from both last quarter and the same quarter last year.

Moving on to the balance sheet, our combined cash and marketable securities balance on March 31 was $162 million, down from $175 million in the fourth quarter. The reduction in cash and marketable securities is primarily related to payments for capital expenditures, litigation fees, a large contract pre-payment related to our global fiber optic backbone and an increase in our accounts receivable. Capital expenditures for the fourth quarter were $4.6 million compared to $5.2 million for Q4 and $3.1 million for the same quarter last year.

Days Sales Outstanding for the quarter were 93 days, up from 84 days with previous quarter and up from 66 days in the first quarter last year. The increase in our DSO is related to both our implementation of a new billing system and to businesses generally delaying payments in this environment. We believe that our DSO would decline over the course of the next few quarters as the complete implementation of this new system and as the business environment improves.

Regarding guidance, for second quarter of 2009, we expect to achieve revenues in the range of $32.2 million to $33.2 million. Stock-based compensation expenses for Q2 are expected to be approximately $4.2 million and capital expenditures are expected to be in the range of $7 million to $8 million.

With that I will turn it back to Jeff.

Jeff Lunsford

Thanks Doug. Before we conclude and go to Q&A, I would like to point out a few initiatives that are shifting the delivery of content from close proprietary networks to open IP based networks in support of the first macro trend I mentioned earlier.

First is the BBC's Canvas Project which is a joint venture with other broadcasters whose mission is to define and promote a set of standards for digital television delivered over broadband connections. The service will allow audiences who do not wish to pay for subscription television services to access a range of on-demand and live content services through internet connected televisions and set up boxes. The long-term implications of such initiatives are clear and they are very positive for content delivery providers. We are also seeing similar initiatives around multiplatform open access programming in the US where major internet video sites are being granted increasing access to mainstream content.

In these instances, the consumer is in control and can access the content they want when and where they want it over in open network. We believe Limelight Networks is well positioned to benefit from this shift from close to open networks and towards multiplatform, multi-device accessibility. We believe the world will only need two or three content delivery networks for delivering broadcast quality experiences to the broadcast quantity audiences that will emerge on this open network and Limelight is currently one of two or three market leaders and is better positioned in our smaller competitors to continue growing and capturing market share. We have more experience delivering the largest internet events in history. We have a world class engineering team that has built what we believe is the highest performance content delivery platform in the world. We have global sales and support infrastructure in place. We have scale that provides us with operating advantages and we are very well capitalized to preserve that position through investment and innovation.

Earlier, I mentioned our multiyear view in the two macro trends whose intersection presents attractive growth opportunities for Limelight, more demand for content, commerce and applications online and a consistent shift to outsource usage-based cloud services for infrastructure computing. An analogous situation existed in the package delivery business a few decades ago as international business growth accelerated and the world began to flatten to borrow the term from Thomas Friedman. Today, the world has UPS and FedEx who combined have created substantial shareholder wealth by thinking big and investing for the long term and executing well. We believe we are building a Company that will capture a similar market position and global content delivery to the ones these two companies have captured in the global package delivery business and with only 15% of video content being consumed online in any given day and approximately 10% of commerce transactions around the globe being conducted online, we believe we are in the very early stages of building to this very bright future.

Operator, at this time, we would like to open the line for questions.

Question-and-Answer Session

Operator

(Operator's instruction) Your first question comes from the line of Derek Bingham - Goldman Sachs.

Derek Bingham - Goldman Sachs

I wonder if you could give us some color on the financial profile of some of the small file deals and the whole site deals in terms of their size and even their profit margin versus your historical deal profile has been so we get a sense of how that is going to contribute going forward.

Jeff Lunsford

Derek, I do not think we get into parsing margins by segments. I think we definitely are on the record stating that we believe the enterprise and e-commerce and government sectors offer a margin expansion opportunity for us. There are oftentimes more services that are higher margin services that these customers need in addition to the regular content delivery but I do not think I could actually quantify that for you. They are the deals that we see. They are higher margins.

Derek Bingham - Goldman Sachs

Internationally, it seems like that has been outgrowing the domestic business. What would you choke that up to? I mean is it more on some investments that you are making there? Is it more of the Greenfield opportunity right now or it is the economy in a different stage right now? Can you give us your thoughts on that?

Jeff Lunsford

I would say it is simply because Limelight has more market penetration opportunity or growth opportunity to establish ourselves in the international markets so we have recently expanded, brought in a new international manager out of the UK, expanded the Japan team. So, this is just bringing or beginning to generate revenue from the investments we have made in those markets and we are opening up more offices over in Mainland Europe where today, Limelight has no on-ground presence from our sales and account management standpoints. We definitely have a network presence but not the go-to-market presence.

Operator

Your next question comes from the line of Michael Turits - Raymond James.

Michael Turits - Raymond James

Can you tell me a little bit, we know that, your churn and your gross as well and then what is happening with customers at the lower end that you are seeing? Any follow up in emerging type business customers?

Jeff Lunsford

Michael, the net add number is a little over 30 or approximately 35 is the number we talked about. I would say churn, just as in Q4, churn has been higher than if you look at our five year average and that is simply because yes, many of the smaller companies out there that were in that emerging category were unable to raise their next round of financing or have decided to pull up a web initiative to save cost or whatever. But I cannot really, I would not quantify that other than we just look at the net add number which is solid in Q1.

Michael Turits - Raymond James

And then can you talk about both the traffic growth trends and obviously you said that your traffic went up but we are overly concerned on the second derivative side with the rate of traffic growth. You said that the rate of the traffic growth rate has been about steady or declining or increasing and same on pricing?

Jeff Lunsford

I would say that those two have been over the last three or four quarters, growth and price unit compression which is an ongoing just dynamic of this business. Bandwidth and CDN prices have been going down for 12 years and they will continue to go down as that traffic grows. I would say that they have been generally consistent over the last three or four quarters.

Michael Turits - Raymond James

And then last one is just a clarification; the 2 to 4 points down of gross margin, was that cash gross margin or including depreciation?

Doug Lindroth

It will factor into both so the 2 to 4 will flow through on both the cash and the gross.

Michael Turits - Raymond James

And if you, I think you said that it tends to pick up in the second half, is that on your assumption that you just started scaling up the build or the pricing which is a component to that starts to ease a little bit too?

Doug Lindroth

Yes, I would say it is on the scaling of our build out both on our network, build out our expansion. I mean, the part of what Jeff is talking about on some of our international growth has been our international expansion plus the expansion that we talked about with our internal backbone so as we get that deployed and then start absorbing that with additional revenue then we should start seeing the peak back up in our margin.

Michael Turits - Raymond James

Okay, no assumption to price changes in any way?

Doug Lindroth

Not a different assumption on pricing than we typically factor in to our forecast which is the typical assumption of price declines.

Operator

Your next question comes from the line of Colby Synesael - Kaufman Brothers, LP.

Colby Synesael - Kaufman Brothers, LP

I have two questions. The first has to do with legal costs. I think they are about $4 million this quarter. I know that Akamai has gone and appealed the decision by the courts but I was wondering if you can give some color on what is your expectation after that going forward. Also my second question has to do with the Limelight Site solution. Can you talk about what was required from an R&D standpoint to build that out maybe in terms of cost, maybe in terms of timing, maybe in terms of expertise and I guess what I am getting at is how difficult would that be for other smaller CDNs to replicate that if in fact the market for CDN services is changing and that is somewhere they can go to expand their own growth? Thank you.

Jeff Lunsford

Sure. Well, the litigation expenses we do believe to go down because we are post-trial phase right now and neither one of the cases have formally gone up to appeal yet. However, when they do, we would expect to have a lower run rate of legal expenses. We have not gone out and never forecasted exact legal numbers in a quarter because they are so variable but there will still be substantial amount of the magnitude that we saw there in the very expensive trial phases.

Colby Synesael - Kaufman Brothers, LP

So below the $4 million that we saw this quarter is fair?

Jeff Lunsford

Yes, I mean again we have not ever quantified it because you just never know what is going to happen in the litigation process. But on a blended basis over the next year, we would anticipate that our legal bills will be lower than they have been over the past year. And then on the Limelight Site R&D, Limelight has a unique architecture for a CDN one that we believe is a better architecture and that is a bit a point of religious debate in the industry but we think our customer success speaks for itself, our ability to go out and win the best customers and the biggest customers and that architecture is very high performance for large object, large library traffic and that is where we started.

It also happens to have some very interesting advantages for dynamic content which is important in the enterprise and the origin direct service that I mentioned earlier is very key there as an example in the world of dynamic content, you have more cash misses out on the edge and if there is a cash missed, normal CDN with outdoor and private network backbone would source that content over the internet whereas we source it over our private network and we believe that will prove out over time to be a better architecture.

And there was a lot of R&D going in to just handling more services that these sites need than standard large object delivery. We have been investing and working on this for over a year and a half and we have the service in the market so this is our formal announcement. There are over 150 customers using it today and we believe as I have said in the script, there is a great opportunity here to focus on the sector and build good long term relationships with many very high quality businesses.

Operator

Your next question comes from the line of Srinivas Anantha - Oppenheimer & Co.

Srinivas Anantha - Oppenheimer & Co.

Jeff, maybe if you could just give us some clarification on the ARPU differential between your enterprise and e-commerce sectors versus your traditional media and entertainment customers and secondly on the expenses, with gross margins down 2% to 4% from 1Q, is the run rate from 1Q specially on cash operating expenses a good run rate going forward? Thanks.

Jeff Lunsford

I will let Doug answer the cash OpEx but again on the margin, we are not breaking out margins specifically for the enterprise segment nor do we break out our pick up. There are everything from the largest e-commerce websites on the planet to the smallest ones and so, if you look at that sector, I think if we had the same type of penetration we had there and even gaining, I would think that our peak could potentially be higher because as I said earlier, there are more products and services to sell them but again we are not going to quantity what we think that would be.

Doug Lindroth

On the operating expenses, yes, I think if you use the Q1 operating expense that is good for thinking about the levels we will spend in Q2. So, there was nothing significant in Q1 that will or will not be around in Q2.

Operator

Your next question comes from the line of Kerry Rice - Wedbush Morgan Securities, Inc.

Kerry Rice - Wedbush Morgan Securities, Inc.

Just a couple of quick questions, sorry I had to jump off really quick, but could you talk a little bit about what you are seeing in April for the media and entertainment trends and traffic and pricing? I know you previously had said they have been pretty consistent over the last three or four quarters. So, has that been consistent so far here in April?

Jeff Lunsford

Kerry, I do not think we will get into monthly color but what we are seeing in April, which factored into the guidance that we provided the $32.2 million to $33.2 million in revenue.

Kerry Rice - Wedbush Morgan Securities, Inc.

Okay, is there one area that is maybe outperforming or underperforming and I do not know if you can break it down into software downloads versus videos or streaming or anything like that?

Jeff Lunsford

No, I think we have seen generally consistent trends across all segments. The only segment, the one I mentioned earlier, what we call sort of the emerging business model category where folks have raised capital not yet gotten the profitability. That would be one sector where I would say simply because of the lack of readily available capital, not so much because they did not have great businesses. They do not have great businesses; it is just that it is very difficult to raise growth capital. That might be one segment I would highlight as the most troubled and as we pointed out before, a very small part of our revenue but it is probably a higher number of customers because they are small customers.

Doug Lindroth

The other way I look at it too is on customer mix as you had said video or social media game software, how we typically break it out. If you look at that over the last three quarters, those categories had stayed relatively consistent. You get a move of maybe 1% from one category to another. So, there has not been a significant move in one category versus another.

Kerry Rice - Wedbush Morgan Securities, Inc.

Okay, great and then one final question on international you had mentioned that is about 19% of revenue and there are just a lot of growth opportunities. Are they primarily in, can you break it down geographically as strength in Europe versus Asia for you guys or is it generally just Europe?

Doug Lindroth

No, it is both. It is Europe and Asia and we have a nice presence in Japan. So, I think we are performing well in both of those regions.

Operator

(Operator's instruction) Your next question comes from the line of Katherine Egbert - Jefferies & Co.

Analyst for Katherine Egbert - Jefferies & Co.

This is [Greva Shar] for Katherine. I was wondering if you guys could maybe comment a bit about FaceBook, I do not believe they were customer of yours but they announced the new technology in the quarter called Haystack and it seems like it is a cashing solution which is, and they said explicitly designed to reduce the dependence on CDN and I am wondering if you guys could just comment a bit about this being a trend with, and I think it has been happening for a while already. Some of the larger internet companies building out their own internal CDNs or solutions that reduce the dependence on CDN. Do you guys have any thoughts to add on that, overview?

Jeff Lunsford

Well, we have always believed that the top five or so internet sites in the planet will build out most of their infrastructure but then below that, it does not make sense. It does not make economic sense and we believe FaceBook is an amazing business that maybe one of those and so we think that, there has always been for the eight years Limelight has been around, there is also folks who come along and they had worked with a CDN and then the other side, they think they can build it themselves and then generally what we see is they build it. They kick off a project. They build it. They run it through about two budget cycles and by the end of that second year, they realize it is capital intensive and people intensive and so they end up either keeping that infrastructure in place and then shifting all the growth traffic back over to an outsourced CDN but for the largest, it is not at all unnatural for those folks, especially those that are technology companies and internet companies to want to build a lot of their own infrastructure. We think the great opportunity is for companies whose core is not technology development but who have to reach a broad base of customers around the globe to use CDNs.

Analyst for Katherine Egbert - Jefferies & Co.

Right, okay and if I could just add one question regarding mobile, are you guys seeing or expecting much of an up tick in demand as a result of mobile traffic? There has been a lot of growth in wireless data.

Jeff Lunsford

We are seeing a lot of up tick in activity, understand that the mobile, the amount of data that is delivered to a mobile device is smaller so what we are seeing is, and I mentioned this in my prepared remarks that we are seeing an up tick in complexity as customers have to deliver experiences to all those devices and that is a great business opportunity that we see. The actual volume is not that huge but we are at the very, first of all, we are at the very early beginnings of just internet base cost in consumption. Second of all, we are still in the warm up phase of mobile content but we do believe it will be massive and then, I think that answers your question.

Operator

You have a follow up question from the line of Derek Bingham - Goldman Sachs.

Derek Bingham - Goldman Sachs

Quick follow up, on Limelight Site, you mentioned you have got a lot of customers already signed up. What is more often the case now for in terms of how you are targeting? Are these Greenfield customers more often than not that you have not had before or are they mostly up-sell, cross-sell in terms of a new product or increased functionality to existing customers?

Jeff Lunsford

I am not prepared to quantify how many of the 150 were existing versus new but I would tell you that like the companies we named, those are new relationships and that is one reason we are very excited about that market segment is these are companies that a year or two ago would not have called on and now we can establish a relationship and we are also rest assured going back to the 1300 plus customers that we have and offering these services to them as well.

Operator, I believe there are no further questions.

Operator

There are no further questions.

Jeff Lunsford

Okay, thank you all for joining us today and we appreciate it. Have a good day.

Operator

Thank you for your participation in today's conference. This concludes your presentation. You may now disconnect and have a wonderful day.

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