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Central European Media Enterprises (NASDAQ:CETV)

Q2 2013 Earnings Call

July 31, 2013 9:00 am ET

Executives

Mark Kobal - Head of Investor Relations

Adrian Sarbu - Chief Executive Officer, President and Director

David Sach - Chief Financial Officer and Executive Vice President

Anthony Chhoy - Executive Vice President of Strategic Planning and Operations

Daniel Penn - Executive Vice President, Secretary and General Counsel

Analysts

Pavel Ryska - J & T Banka, A.S., Research Division

Vivek Khanna - Deutsche Bank AG, Research Division

Tim Hamby - Janco Partners, Inc., Research Division

Tibor Bokor - WOOD & Company, Research Division

Stanley Martinez - Legal & General Investment Management America Inc.

Ajay Agrawal - Nomura Securities Co. Ltd., Research Division

Operator

Hello, my name is Josh, and I will be your conference operator today. At this time, I would like to welcome everyone to the Central European Media Enterprises Second Quarter 2013 Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded today, July 31, 2013.

It is now my pleasure to turn the floor over to Mark Kobal, Head of Investor Relations at CME, who will be our moderator today. Mr. Kobal, you may begin your conference.

Mark Kobal

Thank you, Josh. Good afternoon and good morning, everyone, and welcome to CME's Second Quarter 2013 Investor Conference Call. We are also broadcasting our earnings call via a video webcast, and you can watch it using the link on our homepage, www.cme.net. There, you can also download the presentation slides, which we will refer to during this call.

The participants of today's call will be CME's President and Chief Executive Officer, Adrian Sarbu;

Adrian Sarbu

Good afternoon, and [Romanian]

Mark Kobal

Chief Financial Officer, David Sach;

David Sach

Good afternoon.

Mark Kobal

Head of Strategic Planning and Operations, Anthony Chhoy;

Anthony Chhoy

Good afternoon.

Mark Kobal

And General Counsel, Daniel Penn.

Daniel Penn

Hello, folks.

Mark Kobal

Before we hear from Adrian, I will highlight a few things.

Our presentation today will contain forward-looking statements. Actual results may vary materially from those expressed or implied due to various factors. Important factors that contribute to such risks include, but are not limited to, those factors set forth under Risk Factors in our SEC filings. This includes the Form 10-Q filed earlier today as well as the following: the effects of the economic downturn and Eurozone instability in our markets and the extent and timing of any recovery, decreases in TV advertising spending and the rate of development in the advertising markets in the countries in which we operate, and our ability to access external sources of capital in light of current significant liquidity constraints. The foregoing review of important factors should not be construed as exhaustive and should be read in conjunction with other cautionary statements that are included in our filings.

Forward-looking statements speak only as of the date, and we undertake no obligation to publicly update or review any forward-looking statements, whether as a result of new information, future developments or otherwise.

During this call, we will refer to certain financial information that is not in U.S. GAAP. Please see the appendix to the presentation and Note 18 to our financial statements in the Form 10-Q for a reconciliation to U.S. GAAP financial measures.

And now, please turn to Page 4 of our presentation, and I will hand you over to Adrian.

Adrian Sarbu

Thank you, Mark, and good afternoon, everyone. There are 2 hot topics for this call: the outcome of our advertising pricing strategy in the Czech Republic, and the new carriage fee agreement in Romania and Bulgaria.

First, advertising. We were successful at increasing advertising prices in our markets as the first step towards reversing the trend of falling spending. On commitments signed today, we secured single-digit price increases in 5 of our countries and double-digit price increases in the Czech Republic. The latest development in the Czech Republic was the majority of our top 20 advertisers committed for 2013 show our new prices are gaining traction. We are also successful in convincing carriers in both Romania and Bulgaria that we should be paid higher fees, reflecting the value of our products. The new carriage fee contract in Romania will start to bring a significant benefit to earnings in the second half of 2013.

These 2 key initiatives rely heavily on our improved product performance. And we did it, especially in the Czech Republic, where our combined prime time audience share increased 5.243%. We have implemented the first phase of the restructuring of our operating model, which will help us to better monetize our product created with lower costs. We also secured additional liquidity through equity offering and improved our capital structure. Looking back, it has taken us longer than expected to get advertisers in the Czech Republic to accept our higher prices. Looking forward, we expect the trend of declining TV advertising spending, especially in the Czech Republic, to reverse in the fall of 2013, building on our pricing initiatives. I will now hand you over to David to discuss our financial results.

David Sach

Thank you, Adrian. Please turn to Slide 5. GDP in our countries is estimated to have stabilized overall in the first half, and we expect it to stay flat for the remainder of 2013. We are seeing improvements in private consumption in many of our markets and expect it to also stabilize in the second half of 2013 but not enough to stimulate TV advertising spending. Consequently, we feel that we have little choice but to stay resolute in our position to increase TV advertising prices.

In this tepid macroeconomic environment, we saw TV advertising spend fall 6% in the second quarter with double-digit decreases in both the Czech Republic and Slovenia. The drop in the Czech Republic was largely attributable to resistance to our pricing initiatives, and the decrease in Slovenia was mainly macroeconomic related where GDP and private consumption fell. Our financial results for the second quarter were greatly impacted by the situation in the Czech Republic where certain advertisers and media agencies withheld commitments from us in an attempt to get us to change our position. We continue to believe the suppression of GRP consumption is unsustainable. Carriage fees and subscription revenues increased by 25% at constant rates compared to the second quarter 2012 due to the increase in carriage fees in Bulgaria.

Moving to Slide 6. The bridge graph shows the decline in revenues is primarily driven by the situation in the Czech Republic that I mentioned earlier. Overall, costs increased by 5% at constant rates mainly driven by restructuring costs but also partly due to investments in additional channels.

We have completed the first phase of our restructuring to streamline our operating model, as explained during the first quarter's earnings call. We believe that our new operating model will help improve product performance with a more efficient cost base. We incurred restructuring costs of $5 million during the period principally relating to employee terminations. Consolidated OIBDA for the second quarter of 2013 was $ 7 million compared to $47 million in the second quarter of 2012, primarily reflecting the decline in revenues in the Czech Republic.

I give you back to Adrian.

Adrian Sarbu

Talking about our product performance. Allow me to remind you that we are undisputed leader with the audience on all our 6 countries. Our pricing strategies are successful because the content we create is the most valuable for our viewers and customers.

In the first half of 2013, we continued to produce television blockbusters: Village Doctors in the Czech Republic, Las Fierbinti in Romania, Taste of Love in Slovakia, Got Talent in Romania and Slovenia, and The Voice in Bulgaria. Our news programs continue to outperform, driving the main general entertainment channel in each of our countries to unchallenged leadership.

With the 3 channels added in the last 12 months, the Czech Republic achieved 43% prime time audience share, 5 percentage points higher than last year. Voyo, our leading subscription video-on-demand service, has been growing its subscriber base. At the end of the second quarter, Voyo exceeded 147,000 subscribers across our 6 markets. Our website traffic grew more than 20%, generating 2.7 million daily unique visitors. David?

David Sach

Thank you, Adrian. My following comments refer to the country's financial performance slides.

As explained previously and shown on Slide 8, our results in the Czech Republic continued to be significantly impacted by resistance to our advertising pricing initiatives. In the seasonally low first quarter, we saw a 25% reduction in GRP consumption compared to 2012.

We anticipated this reaction to our pricing initiatives but did not expect it to continue into the seasonally higher second quarter. Because it took longer than we expected, we saw GRP consumption fall by 22% in the second quarter as certain media agencies and advertisers continued to withhold their marketing budgets for TV or allocate them to competitors. Pleasingly, though, we have seen our competitors start to increase rates, and estimate average prices in the market rose by more than 10% in the quarter. This helped limit the drop in TV advertising spending to 10%.

Recent developments indicate that our pricing strategy is gaining traction. In the last month, we signed agreements with some of the largest advertisers in the Czech Republic for 12- to 18-month commitments. We have now signed or agreed commitments for 70% of expected revenues for 2013.

We will continue negotiations throughout the third quarter to conclude commitments with the remainder of the advertisers that have not yet signed with us.

In our other countries, we have signed commitments for 70% to 85% of expected revenues, which is in line with or better than our progress at this point last year.

In Romania, the increase in net revenues seen in Slide 10 came primarily from our distribution business and an increase in Voyo subscribers. Total cost increased by 7% at

[Audio Gap]

The increasing cost related to our distribution revenue.

In Slovakia, the results, as shown on Slide 12, were impacted by the situation in the Czech Republic as certain advertises withheld commitments from both countries. We expect that the successful implementation of our pricing strategy in the Czech Republic will also result in a higher level of advertising spending in Slovakia.

In Bulgaria, we managed to double our carriage fees in the second quarter of 2013, as seen on Slide 14, following the successful conclusion of the majority or our negotiations with the cable, satellite and IPTV operators. The increasing carriage fees offset the decrease in television advertising and other revenues during the period.

On Slide 16, it shows that Slovenia continued to be impacted by the recent banking sector problems and the ongoing political instability.

In Croatia, we saw a significant increase in market share compared to the second quarter of 2012, as noted on Slide 18, driving revenues higher in a market that fell 3%. The improved revenues came from higher advertising prices.

Please move to Slide 19. As promised, we continue to address our capital structure. During the second quarter, we completed public and private equity offerings, raising net proceeds of $352 million. We used $300 million of the proceeds to repurchase EUR 206 million of our 2016 Notes in private transactions. Following these repurchases, our senior debt decreased over 20% from $1.2 billion at the end of the first quarter to $932 million at the end of the second quarter. This left us with $795 million of net debt.

Our negative free cash flow in the first half of 2013 was $54 million compared to $59 million in the same period in 2012. We were able to offset the decreased OIBDA with improved working capital and lower payments for foreign programming. The improved working capital reflects lower receivable balances as a result of the lower revenues and higher deferred revenues from prepayments of annual commitments.

We ended the period with cash of $145 million.

I now give you back to Adrian for final remarks.

Adrian Sarbu

Thank you, David. And now, about expectations. With the 2 key tasks successfully addressed, we expect to capitalize on these actions during the second half of 2013 and the full year 2014. We expect the anticipated improvement in macroeconomic trends and higher prices will reverse the trend of declining TV advertising spend. We expect an increase in carriage fees in Romania and Bulgaria of 50% for 2013 compared with 2012 and more than double in 2014 compared to 2012. We also expect to sign carriage fee agreements in the Czech and the Slovak republics at a similar cost to subscribers as Romania and Bulgaria. We expect annual cost savings of $20 million following the restructuring once complete. We expect annual -- annualized cash interest savings of $31 million following the repurchase of 2016 Notes. And last but not least, we expect to get the right price for the value delivered to our customers.

The first half of 2013 was a tough and painful experience for everybody. It was a price we had to pay. It has impacted our financial results. Therefore, our obligation is to adjust the guidance we gave you in April. The revised guidance is: 2013 revenues at $700 million to $720 million; 2013 OIBDA of $50 million to $70 million.

The results of our pricing actions, some of them still to be seen in the future, encourage us to persist. We are committed to our priorities for 2013 because we believe the successful execution of our strategy puts the company back on the path to growth in 2014. Thank you. And now back to Mark.

Mark Kobal

Thank you, Adrian. That concludes the formal presentation. We're now going to move to Q&A. So Josh, please open the lines for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And now, I hand you back to Mr. Kobal.

Mark Kobal

Thank you. Our first question is coming from Pavel Ryska from J & T bank.

Pavel Ryska - J & T Banka, A.S., Research Division

I would have several questions today. First one is do you see any possibility of maybe refinancing some your remaining debts? I mean, not paying back the debt but maybe trying to achieve lower interest rates. That's the first question. Second question is, what do you see as the minimum comfortable level of cash at hand that you have or currently have, something on top of $140 million. So maybe if you could give us a level with which you would still be comfortable to conduct your business. And finally, can you give any outlook for free cash flow for the remainder of the year?

Mark Kobal

Okay, thank you, David?

David Sach

Regarding the refinancing question, we're going to wait till the operating improvements that we've mentioned in this call come to fruition. So that could be after the Q3 or Q4 calls before we go in and look at refinancing the remainder of that 2016 debt, which we're keen to do. In terms of the minimum level of cash, we need $50 million of cash in the countries and it's central to the operation. That's a minimum level, but we're looking at more than $100 million by the end of the year. So we should have sufficient liquidity. In regard to free cash flow forecast, no, we're not providing a free cash flow forecast as part of our guidance, Pavel.

Mark Kobal

Okay, thanks you. Our next question comes from Vivek Khanna from Deutsche Bank. Vivek?

Vivek Khanna - Deutsche Bank AG, Research Division

A couple of questions -- 3 questions, if I may. The first one is I think if you could just provide us a little bit more color on carriage fees, so across the markets. So if you could just maybe give us a -- at the group level what you see as the positive year-on-year development with regards to carriage fees for the second half of 2013 and then I guess more importantly, for -- on a full-year basis of 2014. So what's the incremental carriage fees across the group? And just to confirm, that, that will largely flow straight through to EBITDA. Second question, with regards to your signing up of new -- of your customers, you're saying you've got 70% visibility for 2013 in the Czech market. You are also saying that the -- your customers are signing up for 12- to 18-month contract -- 18-month commitments going forward. So I guess my follow-up question is, what level of visibility do you have already into 2014 because it would imply to me that you've at least got 6 to 9 -- 6 or even 9 months of visibility in 2014. I do appreciate that Q4 is a big quarter. And then finally, just on the free cash flow or liquidity level, if I remember correctly, you said that you've got $144 million of cash right now. I appreciate the $50 million minimum liquidity requirement, but I think you're also saying you expect to end the year by a bit -- about $100 million of cash. So is it fair to say that you expect a further $44 million of cash burn in the second half of 2013? Or have I missed something?

Mark Kobal

Okay, thank you. We'll start with Adrian.

Adrian Sarbu

I'll give you an answer about carriage fees. The negotiations are in process in many countries. Part of Romania has agreed. We continue with other carriers in Romania. As our contract expire, they will be renegotiated. So I cannot give you too many details, but I can talk about what we indicated, that we are looking into 2014 to have a revenue double than in 2012. And in 2012, our revenue was $38 million.

Vivek Khanna - Deutsche Bank AG, Research Division

And Adrian, just to clarify, in 2014 then, so the impact would flow straight to the EBITDA also, would they not?

Adrian Sarbu

It's a revenue, which normally goes straight to the EBITDA, obviously.

Mark Kobal

Visibility in 2014, Anthony?

Anthony Chhoy

Vivek, I think both Adrian and David mentioned in their speech earlier that we do have recently concluded agreements with some of the larger advertisers not just for '13 but also '14. At this stage, I mean, I don't want to provide any guidance for '14 yet because we are still working on concluding more of the 2014 contracts. So we'll be able to give you a bit of updates, I think, getting -- the following earnings call on that.

Mark Kobal

Last question, David?

David Sach

Yes, regarding the free cash flow, I did say over $100 million of cash at the end of the year. So yes, you can get some sort of a free cash flow assumption out of that for the second half, Vivek.

Mark Kobal

Thank you. Our next call comes from Tim Hamby, Janco Partners.

Tim Hamby - Janco Partners, Inc., Research Division

A couple of questions around the Czech market. You saw another reduction in consumption of GRPs here in the second quarter. I just want to see if you could give a little bit more color on what is making you a little bit more confident that you can reverse that trend in the second half? I know you have secured some price increases, but I want to know if there's anything in general discussions you've had with advertisers that makes you feel a little bit more confident in kind of a return to normalcy there. And a second question is just on your programming strategy in the Czech Republic. I know you did some investing at the end of last year and earlier in the year, and I wanted to see if you think that's what's kind of driving your audience share there.

Mark Kobal

Okay. Well, we'll start with Anthony.

Anthony Chhoy

Just in terms of the GRP consumption, Tim, we believe that the reduction in the second quarter and also the first half is temporary. I think it's -- we anticipate these advertisers to look to increase the reach and quality of their advertising campaigns in the fall season. The content that we get from that is that we've already concluded 13 out of the top 20 largest advertisers in the Czech Republic, and some of these commitments that's being signed up for the remainder of 2013 and into 2014 gives us great encouragement that the trend will reverse.

Mark Kobal

Okay. And Adrian, you want to add something?

Adrian Sarbu

About programming strategy in Czech Republic, you can find out more tomorrow when our colleagues from Nova will outline the fall schedule. What I can tell you is that exactly what I said in my speech. With a -- Without a strong audience performance, we cannot hope we'll be successful in our pricing initiatives. And as it was proved, we succeed in audience. So the programming strategy is to rely heavily on local content. We are champions. We have a very strong content engine. And also, to maximize the audience output of the new channels, which we launched. Generally, the programming strategy of CME was repeatedly underlined. It's based on the power of our local content. But for more details, you can find out -- you can hear tomorrow from our colleagues. I don't want to preempt what they will say.

Tim Hamby - Janco Partners, Inc., Research Division

All right. Well, I look forward to that release tomorrow then.

Mark Kobal

Thanks, Tim. Our next question comes from Tibor Bokor from Wood.

Tibor Bokor - WOOD & Company, Research Division

It's Tibor Bokor from Wood. Elaborating on Czech Republic a little bit more, can you tell us what are the sell-out ratios of your inventory and perhaps the market sell-out ratios as of the second quarter?

Mark Kobal

Okay. Anthony?

Anthony Chhoy

Tibor, the sell-out rights of our inventory in the second quarter is just over 30%. Obviously, that situation is what we believe to be a temporary situation given the advertising -- pricing action that we are undertaking. I think that's -- hopefully, that answers your question.

Mark Kobal

Okay. Josh, could you please prompt for more questions?

Operator

[Operator Instructions]

Mark Kobal

Thank you. Next question comes from Stanley Martinez from Legal & General. Stanley?

Stanley Martinez - Legal & General Investment Management America Inc.

Just to come back to the sub fees, could you just elaborate on what proportion of the increase that we saw in the second quarter in Romania and Bulgaria was from the sub fee increase? Or at least what portion of the distributors are now paying the higher sub fees just to try and get some visibility into what a normal quarterly run rate ought to be there. And then secondly, with respect to the Czech Republic, it looks like your operating expenses were up in local currency about CZK 200 million, and I wondered whether that was more of an investment in local programming or whether there were some costs related to the new pricing and sales initiatives, and whether you expect that, that would normalized as we got through the second half of the year.

Adrian Sarbu

First of all, all the extra revenues in carriage fees come from price increases, not volume increases. As I said, we cannot disclose too much because we have negotiations in process continuing in Romania and in other countries. And that's all we could give you. [Indiscernible].

Anthony Chhoy

Stanley, on the operating expenses there in the Czech Republic, the increase is largely due to the 3 new channels that we launched in the last 12 months in this market, which has contributed to the prime time audience share of 43%, most of these costs relating to the, I think, existing library resources, the syndication costs. There's hardly any cash costs in those operating expenses.

Stanley Martinez - Legal & General Investment Management America Inc.

Okay. And of course, you do still expect your acquired content costs to go down? So that would provide something of an offset against this run rate for direct programming expense for the thematic channels if you look into the second half or into '14?

Anthony Chhoy

Well, Stanley, I mean, we do have lots of foreign programming studio contracts with the major studios. These are gradually expiring. And as they expire, we negotiate significantly -- we'd highly [ph] negotiate significantly lower price and also volumes. But we intend to use the savings from these to increase the output of our local content because these drive our prime time audience share.

Mark Kobal

Thanks, Stanley. The next question comes from Ajay Agrawal from Nomura. Ajay?

Ajay Agrawal - Nomura Securities Co. Ltd., Research Division

Just one question. You mentioned that you have signed around 25% of commitment in the Czech Republic. I just wanted to know how does that compare with earlier years? I mean, as in by end of June and July 2012, how much was the commitments that you've signed in Czech Republic?

Mark Kobal

Okay. Anthony?

Anthony Chhoy

If you're referring to the April 2013, David mentioned in his speech that we've signed to agree at least 70% of the expected revenues for 2013. That compares to 80%, just over 80% at this time last year. But it's -- in terms of the -- I think that's your question, Ajay?

Ajay Agrawal - Nomura Securities Co. Ltd., Research Division

Yes, yes, that's right.

Anthony Chhoy

Okay.

Mark Kobal

Okay, thank you. We follow-up from Pavel, J&T? Pavel?

Pavel Ryska - J & T Banka, A.S., Research Division

One last question which is about your capital expenditures. Do you expect your CapEx to stay around the same level as it is now? Or -- I mean, in the coming years? Or do you see any bigger change?

Mark Kobal

David?

David Sach

Yes, CapEx is at maintenance levels, Pavel. So we would expect it to stay similar to this level barring some investments in new technology or whatever may come our way. But CapEx at maintenance levels is what you should be foreseeing.

Mark Kobal

Thank you. Another follow-up from Tibor of Wood. Tibor?

Tibor Bokor - WOOD & Company, Research Division

Sorry, I was cut off earlier. I had more questions. First, what -- when you signed the contracts for 12 to 18 months in Czech Republic, what sort of price increases do you anticipate [ph] for the next year? Second question, on costs of programming, my understanding is it's a long-term content programming, especially for the -- foreign content are expiring. Can you comment whether you expect some savings there? And last question, on the revenues in the Czech Republic. I mean, [indiscernible] Year-over-year [indiscernible] if you could just [indiscernible].

Mark Kobal

Sorry, there was a bit of noise and the like. Can you repeat the last one, please?

Tibor Bokor - WOOD & Company, Research Division

Other revenues from Czech Republic?

Mark Kobal

Other revenues, Czech Republic, okay. Let's start with Anthony.

Anthony Chhoy

Tibor, if I hear your correctly, you had 3 questions. The first one is the 12- to 18-month deals that we've signed with the some of the larger advertisers. And we concluded those deals with double-digit price increases in there, Tibor. So that's the first. The question on the long-term programming, I think I've already answered that with the previous caller. We are targeting significantly lower volume and also price for those. And any savings we get from those foreign programmings and contracts, we will use to boost our outputs of local content. The third question is with other revenues, the decline in that -- that's primarily attributed to the theatrical distribution license in Bonton [ph] that we have - we had with some of the major studios, which we did not renew given the, I think, the low margin that was being put on the table.

Mark Kobal

Okay, thank you. Our last question comes from Andre Cabesek [ph] Wood & Company.

Unknown Analyst

I have 2 of them. My first question concerns your GRP sales strategy. You emphasized a decrease in GRP consumption in Czech Republic as something temporary. Yet according to Nova's director, you yourselves are actually driving the decrease by wanting to sell fewer but more exclusive GRPs. So if you could elaborate on what the strategy exactly is? And the second question concerns your restructuring. Under what conditions are you able to redeem the 2016 Notes because the original call options provided you with the option to buy back approximately $283 million in September?

Mark Kobal

Okay, thanks. First one, on GRP consumption, Anthony?

Anthony Chhoy

Andre [ph] can you repeat that GRP consumption question? I didn't quite catch the ...

Unknown Analyst

So in the presentation -- sure. In the presentation, you say -- and you've just mentioned that the decrease in GRP consumption, Czech Republic, is something temporary. But in a recent interview, TV Nova's director said that the decrease is actually driven by you as well -- by you wanting to sell fewer but more exclusive GRPs. So if you could just elaborate on what the strategy exactly is?

Anthony Chhoy

Okay. Just I'll reiterate our advertising sales strategy. It builds around selling our GRPs at the value that reflects the quality of our inventories. So that's -- I think that's really the driver of our price increase in itself. And secondly, the fact that over the last 4 to 5 years, the TV advertising trend has been declining year-on-year. I think it's -- we needed to stop that. And in the first half, we had stopped that. And now, it's just a matter of, I think, getting the GRP consumptions to the same level as historical levels, which we believe will come into fruition starting from the fall this year.

Mark Kobal

Okay. And a question on 2016, David?

David Sach

Yes, we spent $300 million buying back EUR 206 million of those 2016 Notes. So you'll have to take those euros of EUR 206 million, multiply by an exchange rate to get to dollars. You'll have to then multiply by the premium that we needed to pay to redeem those. The premium in September was 105.8. Obviously, it was higher because we took them out early. And then we had some accrued interest of roughly EUR 10 million that we'll use. So that's the calculation to see how we got to EUR 206 million.

Mark Kobal

Thank you, Andre [ph].

There are no more questions in the queue, so I'd like to thank everyone for joining us today. We hope you found our earnings call informative, and we welcome your comments and feedback. We would also like to remind you that you can keep up-to-date and follow our progress between earnings calls on our website, www.cme.net. As always, we're available for any additional comments anytime. Goodbye.

Operator

Thank you. This concludes the Central European Media Enterprises Second Quarter 2013 Earnings Conference Call. Please disconnect your lines at this time, and have a wonderful day.

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