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Mechel Open Joint Stock Company (NYSE:MTL)

Q4 2010 Earnings Call

April 11, 2011 10:00 am ET

Executives

Yevgeny Mikhel – Chief Executive Officer

Stanislav Ploschenko – Chief Financial Officer

Oleg Korzhov – Vice President, Business Planning and Analysis

Vladislav Zlenko – Director, Investor Relations

Analysts

Dan Jacob (phon) – Citi

Yuriy Vlasov – JP Morgan

Boris Krasnojenov – Renaissance Capital

Nur Puri Purini – Intesa Sanpaolo

Sergei Donskoi – Troika

Vlad Zhukov – Nomura

Nikolay Sosnovsky – Uralsib Capital

Dmitry Smolin – Uralsib Capital

Anna Antonova - Metropol

Albert Kalinin (phon) – (?) Capital Markets

Maxim Semenovykh – Alfa Bank

Marek Gobidov (phon) - UniCredit

Operator

Good afternoon and welcome to Mechel Reports Full Year 2010 Financial Results call. My name is Ymes and I’ll be your coordinator for today’s conference. The duration of the call you’ll be on listen-only; and at the end of the call, you’ll have the opportunity to ask questions. If at any time you need assistance, please press star, zero on your telephone keypad and you will be connected to an operator.

I’ll now hand it over to Vladislav Zlenko, Director of IR to begin. Please go ahead, sir.

Vladislav Zlenko

Thank you and good day everyone. I would welcome you to Mechel’s conference call to discuss our full year 2010 financial results, which were reported today. With us from management today are Mr. Yevgeny Mikhel, Mechel’s CEO; Mr. Stanislav Ploschenko, Mechel’s CFO; and Oleg Korzhov, Vice President for Business Planning and Analysis. After management has made their formal remarks, we will take your questions to the presentation team.

Please note that during this call, management will make forward-looking statements, some of which may have been made in the press release. Some of the information on this conference call may contain projections or other forward-looking statements regarding future events or the future financial performance of Mechel as defined in the Safe Harbor provisions of the U.S. Private Securities Litigation Reform Act of 1995. We wish to caution you that these statements are only predictions and that actual events or results may differ materially. We do not intend to update these statements. We refer you to the documents Mechel files from time to time with the United States Securities and Exchange Commission, which contain and identify important factors that could cause the actual results to differ materially from those contained in our projections or forward-looking statements.

In addition, we will be using non-GAAP financial measures, including EBITDA, in our discussion today. A reconciliation of non-GAAP financial measures to those most directly comparable U.S. GAAP financial measures are contained in the earnings press release which is available on our website at mechel.com.

At this point, I would like to turn the call over to Mr. Yevgeny Mikhel. Mr. Mikhel, please go ahead.

Yevgeny Mikhel

(Russian spoken)

Translator

Good afternoon and good morning ladies and gentlemen. We are pleased to welcome you at the conference call dedicated to the Company’s performance in 2010. I will start today’s presentation by giving you the general outlook of the work that we have done and the current situation, and then I’ll turn the floor to the CFO, Mr. Stanislav Ploschenko, who will brief you on the financial results.

Yevgeny Mikhel

(Russian spoken)

Translator

Looking to the results of the Company performance in 2010, first of all it is necessary to point out that the year became very successful to us despite the volatility of the world markets and controversial events in the global economy. The Company has made significant progress in many areas of its operation, and it is not only our successes in ramping up production in all the four segments of the Mechel Group but also the impressive dynamics of our financial indicators that testifies to that.

The consolidated revenues of the opened (inaudible) Mechel in 2010 made up some $9.8 billion U.S. The EBITDA indicator totaled some 2 billion while the net income amounted to $657 million U.S.

Yevgeny Mikhel

(Russian spoken)

Translator

The year of 2010 became a landmark for us and not only in terms of achieving high operational and financial indicators but also because of the fact that we adopted a number of strategically important steps aimed at optimizing and enhancing the efficiency of the management of the Group’s segments. The entire operational activities of the segments currently have been transferred to the respective management companies, which are the integral part of those segments. The holding company performs only the oversight of the operational and financial performance indicators of the Group’s segments, and it also carries out the strategic management over such areas of operations as our financial policy, CAPEX program, major acquisitions and mergers, and some others. I’m confident that the centralization of the operational management of the kind will allow us in the near term to achieve further improvement of our operating performance indicators in each of the segments.

It’s not an easy task given the fact that the operational indicators in the segments have been growing at quite a high pace in recent times. Suffice it to note that as opposed to the previous year, in 2010 we built up the production of coke and coal concentrate by 52%, steel by 9%, rolled product by 16%, hardware by 35%, ferronickel by 7%, ferrosilicon by 5%, and electric power by 15%.

Yevgeny Mikhel

(Russian spoken)

Translator

We have achieved biggest successes in building up the production in our mining segment. In the background of the global demand rally in coke and coal throughout the year, we managed to maintain a high pace that resulted in all year’s high indicators in the performance of the mining segment. In terms of the production volumes, Mechel exceeded the results of its best pre-crisis years. It had not only a favorable impact on the financial status of the Group in the background of the favorable pricing situation in the coke and coal market, but also it allowed the Company to strengthen its position as one of the world leaders in the industry.

Yevgeny Mikhel

(Russian spoken)

Translator

At the very end of December 2010, however, we faced some problems in the operation of the mining segment of the Group when, as a result of the collapse of three thickeners, we had to put a hold on operations in the workshops of coke and coal washing at the Yakutugol washing plant. At the same time, we took very responsive measures aimed at minimizing the loss from putting workshops operations to hold and the speedy recovery of the plant’s operation. So the production of the coke concentrate at the plant was resumed on February 10 this year. At the same time, we took advantage of that forced downtime of the plant to carry out the entire range of necessary plant repairs and maintenance of the equipment that will enable us not to stop the operation of the (inaudible) of the plant in the rest of the year.

Yevgeny Mikhel

(Russian spoken)

Translator

Let us attend the issue of the growth of production volume rate in 2010. I would like to emphasize the successes achieved by Mechel Bluestone of North America. In 2010, as opposed to the previous year 2009, the production of the coke and coal by the Company has doubled from 2.4 million tons up to 4.7 million tons, and at the same time we reduced the production cost by 6% as opposed to the previous year. In the framework of the investment program aimed at enhancing efficiency of production in Mechel Bluestone, in December 2010 we launched the operation of Keystone 2 washing plant, and throughout 2010 we also made some more steps aimed at optimizing our distribution policy. Having acquired Bluestone Company, the Mechel Group secured direct distribution channels both to the Pacific and the Atlantic markets of coke and coal, and that allowed us to enhance the efficiency of our expert deliveries in 2010 by switching to the complex global agreements with metallurgical companies that hold production assets in various countries.

Yevgeny Mikhel

(Russian spoken)

Translator

The improvement of the products portfolio has become another step for optimizing our distribution policy. In the past year, Mechel began producing metallurgical coal that is used to support the PCI, or Pulverized Coal Injection technology, and it will enable us not only to increase the sales margin for certain types of coal used for PCI but it will also expand the product line of coals that are offered by Mechel to their consumers. In Russia, this technology has just been planned to be introduced into processors; however, the demand in the metallurgical coal for PCI on the part of steel producers in Asia is quite high even today. In 2010, we supplied about 2 million tons of such metallurgical coal, and in the near term the plans are to increase the production of PCI coal with due regard to the growing demand in Asia and also due to the plans made public by Russian steel producers to use similar technologies in their production.

Yevgeny Mikhel

(Russian spoken)

Translator

Significant progress has been made in the implementation of the investment projects and there is no doubt that the key project here is the development of the Elga coal deposit. In 2010, we reallocated to that deposit both mining and auxiliary equipment as well as the required components and construction materials. At the present time at the deposit, there are the fully supporting infrastructure installations and facilities have been built. They are three dormitories, a cafeteria, medical stations, and some others. And in the deposit, the stripping operations are in full swing. The construction of the railway track is being continued and its completion is planned for the end of the year. At the current time, the more than 3,000 personnel and 16 units of railroad construction equipment are being employed there. So in the second half of the year, the plans are to start the production of coal in the deposit with its subsequent shipment to the washing plants of Southern Kuzbass.

Yevgeny Mikhel

(Russian spoken)

Translator

Due to the need to launch the Elga coal deposit into operation and the need to operate the railroad track leading to the deposit in 2010, we set up a new company which is called Mechel Transvastok (phon). The company is designed to support the operation and maintenance of that railroad and it will also manage the rolling stock. In the framework of the preparation for the launch of the Elga coal deposit, we have been greatly implementing the program aimed at building up our own rolling stock. In November and December of 2010 alone, the Mechel Group procured about 400 of gondola or box cars, rail cars, and therefore its own prop fleet which is handled by the logistic segment of the Group currently makes up some 5,500 of rail cars. And in the near term, we will add another 1,700 of rail cars to that fleet.

Yevgeny Mikhel

(Russian spoken)

Translator

Now I’d like to say a couple of words on the performance of our steel segment. In 2010, the rally in demand continued in all the key markets which enabled the Company to load our steel production capacities by 100% and achieve an impressive growth in main commodity items of the steel segment. The successes achieved in production coupled with the positive pricing situation allowed us to receive the operating income amounting to $307 million U.S. as opposed to the loss of $19.8 million in 2009.

Yevgeny Mikhel

(Russian spoken)

Translator

Throughout the past year, we continued the development of the segment in the framework of the strategy aimed at reducing the production cost, increasing the output of products featuring high value and added price, and enhancing the quality of the product. In 2010, we implemented a number of very important investment projects featuring a new complex of metal, steel level treatment and the continuous testing of quality and stainless steel in steel melting workshop no. 6 in Chelyabinsk Metallurgical Plant. This complex enables us to raise the production of continuous cast slabs for making high quality flat product up to 1.5 million tons a year.

Yevgeny Mikhel

(Russian spoken)

Translator

Also in 2010, we launched into operation a new electric smelter in (inaudible) Open Joint Stock Company composed of electric arc furnace and the continuous casting—(inaudible) continuous casting machine. This year alone—in this year, we will fully complete the upgrade of production facilities in Izhstal by introducing into operation of rolling mill 215. In accordance with the plans, we continue implementing in other strategically important projects for Mechel, and that is the introduction of the universal rolling mill. The project will not only enable the Company to significantly enhance the efficiency of the production in Chelyabinsk Metallurgical plant, but also it will give us an opportunity to strengthen our positions in the market of 100 meter rails which are not produced in Russia by any company at all.

Yevgeny Mikhel

(Russian spoken)

Translator

In general in 2010, the steel segment of Mechel showed growth both through the build up of production in existing companies of the Group and also through the acquisition of new assets. We significantly increase our presence in the markets of metal products in the European countries by acquiring both production and distribution assets. In this context, thanks to the acquisition of the Romanian metallurgical plant Laminorul Braila, we launched the production of new types of structural shapes, having added its products to the production line of Mechel Service Global and have opened new distribution markets for us.

Yevgeny Mikhel

(Russian spoken)

Translator

The policy of the company aimed at expanding the network of metal service and distribution branches of the Group also contributes to securing new markets. We have the following priorities here, and they are the increase of our sales of rolled products made of quality steel makes to the end users in Europe through Mechel Service Global subsidiaries. In 2010 alone, the Mechel Service Global opened new representations in the U.K., France, and Hungary. Also, Mechel Service Global acquired WML (inaudible) of the Netherlands, Finmax (phon) of the Czech Republic, Remotex of Turkey. In Germany, HBL Holding, Mechel Service Global subsidiary, opened three new divisions, and the volume of metal products sales through the metal service networks in 2010 grew by 73% in terms of physical volumes as opposed to the previous year, and made up some 3 million tons. It is our intention to continue strengthening our leading positions of the Mechel Service Global that will enable us to guarantee the stability of sales, enhance their efficiency, and ensure reliable feedback with our end users; and also, it will give us an opportunity to better understand prospects of the market trends.

Yevgeny Mikhel

(Russian spoken)

Translator

Speaking of the ferroalloy segment operation, I can point out that in general throughout the year favorable price situation remained in all the groups of products for this segment. And with due regard to the stable demand and effective prices, we ramped up the production, increased revenues, and allowed the ferroalloy segment show the operating income as the results of the year. There were some difficulties related to the stable production of hermite ore which we experienced throughout the year, but in quarter four those difficulties were successfully overcome. That made it possible for the segment in quarter four to show the operating income as opposed to the loss of quarter three. In quarter four, we also started implementing the upgrade project for the Bratsk Ferroalloy Plant that makes ferrosilicon. The upgrade phases will be carried out throughout 2011 – 2012, and as a result all four ferroalloy electric arc furnaces would be respectively replaced. And following the upgrade, the Bratsk Ferroalloy Plant capacity will increase by 30%. At the same time, the power consumption which is the main cost production component for ferrosilicon will drop by 10 to 13%.

Yevgeny Mikhel

(Russian spoken)

Translator

The power segment of the Company throughout 2010 showed stable operational performance. At the same time, thanks to some steps aimed at enhancing the efficiency of production, we managed in the past year continuously quarter over quarter to reduce the power generation costs. In the framework of the strategy aimed at developing the power segment, at the end of 2010 we completed the acquisition of Toplofikatsia Rousse power plant in Bulgaria, the power plant that is the traditional consumer of (inaudible) of Southern Kuzbass, and that fits very well into the synergy chain between mining and power segments of Mechel. The direct access of the Company to the European market of power generation not related to nuclear power generation opens up additional opportunities to us with regards to some cautious attitudes of a number of European countries to the operation of nuclear power plants, given recent events in Japan.

Yevgeny Mikhel

(Russian spoken)

Translator

In conclusion, I would like to point out that as a result of the measures taken by us aimed at optimizing the production reducing costs intensifying our distribution policy in 2010, we achieved very impressive growth of financial and operational indicators and strengthened our leading positions in a number of market segments. At the present time, the favorable situation in the main markets enables us to be optimistic about the future, and at the same time it contributes to further intensification of our efforts aimed at implementing strategic investment projects, which make up the backbone of success of the Company in the future.

Having said that, I would like to turn the floor to the CFO of the Company, Mr. Stanislav Ploschenko, who will brief you on the financial results in all the segments of our business in detail. Thank you for your attention.

Stanislav Ploschenko

Good afternoon and good morning ladies and gentlemen. Today we are reporting the full year results of 2010 which has truly been a year of turnaround in our financial performance. It has been a year that demonstrated a rapid recovery from the crisis and expansion of our sales, with revenue up 69% to three times increasing EBITDA and about 9 times growth of the bottom line.

During 2010, our mining operations returned to the pre-crisis levels of production, benefiting from growing commodity prices, whereas our steel segment has made a huge leap forward in conquering new markets and expanding its sales platform, with its revenue surpassing the 2008 record. The ferroalloy segment also past its record high sales on the back of healthy markets and high capacity utilization.

Next, we will take a look at each segment separately, throwing the light on the fourth quarter results and then moving to the annual picture. The continuing modernization program in the steel segment, expansion of our distribution, and improved flexibility to optimize production and intercompany cooperation resulted in a very good reaction of production and sales to the price strengths in the fourth quarter. With generally positive trends across all the products, we managed to sharply increase sales volumes of carbon and alloyed long steel products, which grew by 35%, at the expense of semi-finished products like billet and wire rod. The sales volumes of the latter fell by 29% quarter-on-quarter.

After the launch of the second flat casting machine in the third quarter of 2010 at Chelyabinsk, we significantly increased the output of flat steel where sales volumes grew by 23% quarter-on-quarter to 114,000 tons. Rebar sales volumes decreased by 19% due to maintenance works at the rolling mill in Chelyabinsk, which we shifted towards the year-end where sales are usually suppressed during the Christmas holidays. The situation of January and the first half of February, which saw more than 10% increase in rebar prices on the domestic market, proved that that was a wise decision.

To demonstrate the qualitative shift in the steel segment’s production range, the year-on-year sales of alloyed long products jumped almost three times to 326,000 tons, engineering steel sales grew 23% to almost 600,000 tons, flat steel products up 29% to 440,000 tons, stampings and forgings up 60% to 160,000 tons. Hardware sales grew by 27% to 820,000 tons. In total, the sales of higher value-added products grew by 38% year-on-year to 2.4 million tons. At the same time, an increasing sales of semi-finished product happened fully on the account of resale operations by Mechel Service Global and Mechel Trading. In 2010, products purchased for resale constituted 63% of our billet sales volume-wise versus only 15% in 2009. Sales of own billet fell by 18% for the same period as more of it was used in inter-Group cooperation and production of high value-added products. That combination of price and volume changes resulted only in the slight third party revenue growth of 2% quarter-on-quarter.

The cash cost per ton of billet and rebar production decreased to 435 and $459 respectively, which is largely attributable to using the coke purchased at lower prices in the third quarter. However, the cost of sales grew by 10% due to two main reasons. First of all, as we continued to increase the sales of related parties’ product through our trading subsidiaries, more purchased goods for resale are reflected in the cost of sales. Secondly, about $50 million of that increase came from reclassification of transportation expenses incurred through inter-group sales from selling expenses into the cost of sales as we believe it to reflect better the nature of this expenditure. Consequently, the cross-profit decreased by 23% to $258 million or 16% of the revenue. The reclassification of inter-group transportation expenses led to a 54% quarterly fall in selling and distribution expenses to 4% of the segment’s revenue versus 12% in the previous quarter.

Another reason for such an abrupt decrease was the fact that beginning with the fourth quarter, we switched all the sales contracts to the foreign customers from Mechel Trading, our general trader, to Mechel Carbon, an exclusive trader for Mechel Mining, and I mean the contracts for coke and coal products. Prior to the switch, these expenses were pulled together with those from steel and ferroalloy contracts and attributed to the segments on a pro rata basis. The transfer of coal contracts to a separate trader resulted in approximately $40 million in selling and distribution expenses taken out from the steel segment and added to the mining one. Along with a $10 million reduction in the bad debt provision due to improved collectability of receivables, that led to a 4% decrease in operating expenses to $151 million or 9% of the segment’s revenue, versus 16% in the previous quarter.

The EBITDA ticked slightly up to $132 million. The EBITDA margin remained virtually flat.

Net interest expenses decreased slightly quarter-on-quarter to $46 million. A FX loss posted $8 million in the fourth quarter versus an $11 million gain in the previous one. The income tax expense increased 1.7 times due to the growth of the taxable base following the general improvement in profitability and less available accumulated tax losses that can be used against the taxable profit for income tax purposes. That all led to a 43% quarter-on-quarter decrease in the segment’s net income to $32 million.

For the full year 2010, the steel business generated almost $5.6 billion in revenue from third parties or 78% more than in 2009. Despite the increasing rate of growth demonstrated by this key input, such as iron ore or scrap, and especially coke and coal, our steel segment managed to maintain its gross margin at the level of 19%, stable in comparison with the previous year. At the same time, the EBITDA rose over four times to $414 million and improved from 3 to 7% of the segment’s top line. For the full year 2010, the steel segment added $91 million to the consolidated net income as opposed to a $263 million loss back in 2009.

The fourth quarter sales price dynamics in the mining segment were moderately positive with coke and coal prices up 8% quarter-on-quarter for all metallurgical grades, thermal coal, iron ore and coke remaining virtually flat. In the circumstances of different price trends and limited resources, we set a goal of targeting primarily the market with the highest margins, which are naturally coking coal and coke. We succeeded in pursuing that goal by increasing sales of coking concentrate by 5% to 2.5 million tons, and coke by 15% to 320,000 tons in the fourth quarter at the expense of less profitable steam coal where sales decreased by 16% in physical volumes. The sales of anthracite and PCI did not change tonnage-wise, whereas sales of iron ore concentrate decreased largely due to seasonal factors as mining is subdued in lower temperatures.

The results of growing sales volumes and prices for coking coal and a decrease in steam coal and iron ore sales in the fourth quarter was a slight increase in sales to third parties to $893 million on a virtually unchanged inter-segmental sales and cost of sales. The cash costs in the fourth quarter are traditionally affected by the seasonal factors as maintenance increased and the works switched to consumption of winter fuel, which is more expensive. Besides, in December due to a switch of faces in Lenina Mine, its output temporarily decreased which also contributed to the cash cost per ton. These factors predictably resulted in a temporary uptick in cash costs to $29 per ton at Yakutugol and $32 a ton at Southern Kuzbass. Starting from the fourth quarter of 2010, we are reporting the consolidated cash cost per company, which is virtually represented in the cash cost of metallurgical coal at Yakutugol as effectively mono-product operations, whereas Southern Kuzbass and Bluestone sell metallurgical coal blends from different mining works, with thermal coal and middlings largely being a by-product, after the consolidation of Toplofikatsia Rousse becoming less relevant for third party sales of this segment.

The cash costs of Bluestone were also influenced by the seasonal factors on the one hand; however, increasing volumes and relatively low maintenance resulting from continuous replacement of the old equipment with the new one, exerted downward pressure on the cost on the other hand. The net result in the fourth quarter was a decrease in cash cost per ton to $86. Consequently, the cross-profit increased by 4% to $627 million or 57% of the revenue versus 56% in the third quarter.

Selling and distribution expenses increased considerably quarter-on-quarter due to a number of factors. First of all, our shipments to Ukraine on the DDU basis increased by 50% in the fourth quarter, which added over $12 million to the item. Another $14 million came from the transfer of export contracts from Mechel Trading to Mechel Carbon described above. Non-income tax expenses grew by $8.6 million as a result of the increase in the property tax coming from a revision of the land tax rate in Southern Kuzbass by regional authorities.

The general improvement in the collectability of receivables resulted in a $17 million decrease in the bad debt provision. General and administrative expenses fell by 40% to 4% of the revenue as a result of the decrease in provisions on advances given as well as decrease in cost retirement benefits attributable to the mining segment as the repair personnel was transferred to Mechel (inaudible) Service, a company consolidated in the steel segment which provides repair services to all the work (inaudible) across the four segments. The combination of these factors pushed SG&A expenses 21% up to $280 million, which resulted in operating income of $347 million. The EBITDA posted $416 million, an 8% reduction quarter-on-quarter. The EBITDA margin stood at 38% of sales versus 41% in third quarter. However, if the technical factor of $40 million transfer in selling and distribution expenses between the steel and mining segments is left aside, the operating income will show a 5% quarter-on-quarter increase, leaving the EBITDA almost unchanged.

Net interest expenses fell by 25% in the fourth quarter to $46 million as a result of improvement in financing terms. The $10 million FX loss in the fourth quarter can be compared to a $55 million gain in the third one. That added to decrease of the segment’s net income to $222 million.

For the full year, this segment generated almost $3.1 billion in third party revenue or 78% in growth to the year 2009. The gross margin improved from 40 to 55% for the same period. The EBITDA grew 224% to $1.5 billion or 38% of the segment’s revenue versus only 21% a year ago. The net income improved 27% to $757 million without taking into account the $494 million non-cash CVR effect in the segment income for the year 2009. In March 2011 following the growth of preferred share quotes, the Group was released of the CVR contingent liability and the guarantee issued by Mechel Mining covering the $1 billion of CVR liability.

The financial performance of the ferroalloy segment improved substantially in the fourth quarter with positive developments in all three major alloys. The sale of carry-over nickel tons from the third quarter increased sales volumes to third parties by 25% in physical volumes, which coincided with a 12% quarter-on-quarter growth in the realized price. The cash cost dynamics were mixed as lower price of processed coke, which was purchased in the third quarter, was compensated by higher energy prices which led to a 5% increase in the cash cost of nickel. The third-party sales volumes of chrome decreased by 19% due to stock accumulation during the Christmas holidays on virtually flat sales prices.

At the same time, the better quality ore coming from the Voskhod Mine, after it was shifted to a new face in October, led to savings both on materials and energy consumption for chrome production, which pushed cash costs down to $2,100 a ton. Better mining conditions also helped to decrease the cash costs of chrome ore concentrate by 12% to $161 a ton, adding to the profitability of chrome business.

The price environment on the ferrosilicon market was better than ever in the fourth quarter as a temporary shutdown of production in China provoked a jump in the market price both on international and domestic markets, and we shifted most of our sales to the home market where we have an advantage of lower transport tariff. Although the sales volumes slightly decreased, the 17% jump in the sales prices more than compensated for it. The cash costs increased only slightly to $734 a ton to reflect higher energy costs.

The combination of these factors led to a 21% quarter-on-quarter increase in revenue from third parties to $125 million, whereas cost of goods sold decreased by 4%, driving gross profit of the segment to $38 million or 22% of the segment’s revenue as compared to only 7% in the third quarter, and is the highest margin this segment has earned in the entire history of this segment’s separate reporting.

Operating expenses grew by 15% following an increase in selling and distribution expenses due to the increase of nickel sales volumes. The EBITDA jumped 3.3 times quarter-on-quarter to $14 million or 23% of the segment’s revenue. Net interest expenses decreased by 53% to $22 million due to lower share of the Group’s interest attributable to the ferroalloy segment resulting from debt refinancing in the third quarter.

Income tax expenses grew to $62 million on the account of one of $60 million write-off to the deferred income tax liability stemming from a change in the Kazakh tax legislation. In December 2008 and November 2009, the Kazakh government announced gradual decrease in the statutory income tax rate from 30% in 2008 to 15% in 2014 and thereafter. In the accounts for 2008, we recalculated a deferred tax liability accordingly and posted a $254 million income to the segment P&L. However, in 2010 new amendments in the tax legislation of Kazakhstan provided for the tax rate to remain at 20% for 2010 and thereafter, which led to a $60 million increase in the deferred tax liability, resulting in a one-time loss in the segment P&L for 2010.

A FX loss of $1 million contributed to the negative net income of $62 million, which barring the one-off income tax write-off and FX effect would demonstrate a four-times improvement over the third quarter.

The full year segment’s results demonstrated a 25% growth in the segment sale of revenue to third parties to $455 million, and a 2.5 times improvement in gross income which rose to 15% of the sales versus 9% a year ago. Full year EBITDA jumped 2.7 times to $94 million or 15% of the segment’s revenue versus only 8% in 2009. The bottom line improved to $186 million loss from a $310 million loss a year before.

For the power segment, the first and the fourth quarter are the high season due to better electricity and heat consumption. Not surprisingly, the revenue from third parties grew by 38% to $186 million quarter-on-quarter as sales volumes of electricity in kilowatt hours grew by the same rate. The cash cost of production at Southern Kuzbass power station remained flat at $24 per megawatt hour. The consolidation of Toplofikatsia Rousse in December did not influence the results of this segment much. The gross income improved by 44% to $80 million or 28% of the segment sales versus 24% in the third quarter. The selling and distribution expenses grew by 36% to $64 million or 22% of segment sales, virtually unchanged from the previous quarter. The increase was largely due to higher power transmission tariffs for Kuzbass Power Sales Company.

Continuing improvement in collectability of receivables resulted in a further decrease in bad debt provision which added over $4 million to the P&L in the fourth quarter. Administrative expenses posted an income of $1 million versus $4 million expense in the previous quarter due to a revision of the pension scheme at Kuzbass Power Sales Company, resulting in lower pension liability. As a consequence, EBITDA grew 75% quarter-on-quarter to $21 million or 7% of the segment’s revenue. Net interest expenses decreased by 4%. The FX effect wasn’t significant. The segment posted over $8 million of net income in the fourth quarter, a 2.5 times increase over the previous one.

For the full year of 2010, the power segment generated $654 million of revenue from third parties and 122% year-on-year growth. The inter-segment sales grew by 21% to $409 million. The gross income increased 30% to almost $300 million or 28% of the segment sales versus 25% in the previous year. The EBITDA posted $60 million, an 11% year-on-year increase. Net income added almost $17 million to the consolidated results versus only $2 million the year before.

If we take a look at the consolidated picture, we will see the revenue for the full year grow almost 70% to the previous financial year and exceed $9.7 billion. The gross margin improved from 31 to 37%. The operating expenses grew only 33% which led to a stunning six times improvement in the operating income and a three times growth of EBITDA, which exceeded $2 billion for the full year. The EBITDA margin almost doubled to 21% of the revenue. The consolidated net interest expenses grew by 13% to $541 million as net debt grew by $1.3 billion, offsetting the improvement in financing terms.

The income tax item also cost at a $277 million expense versus only 19 million as the previous year as the profitability of the business improved considerably, including the one-off tax effect in the ferroalloy segment described above. The FX item, on the contrary, was not as big as in 2009, reducing the bottom line by only $15 million versus 174 million in 2009. The result was $657 million of consolidated net income for Mechel shareholders, almost nine times increase over the previous period.

The fourth quarter saw almost flat cash generation to the previous one. The operating cash flow of $56 million was subdued by seasonal factors and despite the improvement in working capital management. The $312 million growth in inventory was partly attributable to growing trading business but largely was seasonal as we increased the stock of both raw materials, including scrap and finished products, to secure uninterrupted production in sales during and after winter holidays. However, the change in receivables and payables, including settlements with related parties, gave a zero figure in the fourth quarter versus more than half a billion negative for the previous nine months, which constituted a substantial improvement.

Cash outflow from investment activity of $373 million made in the fourth quarter were maximal for the entire year, resulting from the consolidation of our holding Toplofikatsia Rousse and intensification of our investments in property, plant and equipment which amounted to $321 million as our investment program continued to unfurl. Our investments were entirely financed through long-term debt, which increased by $536 million in the fourth quarter.

Overall for the full year 2010, the business invested over $1.1 billion, thereof almost $1 billion in property, plant and equipment. This increase was entirely financed by long-term debt, which rose to $5.2 billion year-on-year and it’s share improved to 72% from 68% in the beginning of the year. The backward look in net debt to EBITDA ratio also improved to below 3.5 from 8.3 as of the end of the year. EBITDA interest coverage in the fourth quarter grew to 5.1 times.

All in all, we had a very successful year which offered us great opportunities to expand our operations and to win new markets, and we are satisfied with the swiftness of our reaction to these opportunities. The incredible growth of our retail trading operations in steel, beginning and partial completion of new CAPEX projects which are going to take our steel segment to a completely new level of competitiveness and profitability, the intensification of the construction at Elga, the uncovering of first coal at the deposit and commissioning of almost 40% of Elga railroad - all that has cemented the platform for strong and successful development of our business in the following years, and we remain fully committed to complete these projects in order to achieve that target.

With that having been said, I would like to thank you, ladies and gentlemen, for your attention, and now we are ready to take your questions.

Vladislav Zlenko

Thank you. We will now take questions. I would ask that participants please state their name and company before asking their question and allow some time after for translation. When questions are answered in Russian, they will be followed by translation, so you may ask your question in Russian also and we will translate for you.

Question and Answer Session

Operator

Thank you. Ladies and gentlemen, if you do wish to ask a question on this call, please press seven on your telephone keypad now. And our first question is coming from the line of Dan Jacob (phon) from Citi. Please go ahead.

Dan Jacob – Citi

Guys, thanks very much for such a informative presentation, and a very lengthy one. I just wanted to ask a few question on the details of the Elga coal deposits, which is think is, as you rightly pointed out, one of the most important projects in your portfolio. What’s the state of the railroad – how many kilometers has already been built? And you suggested that the railroad is going to be fully completed by the end of this year. Can you confirm how many kilometers of the railroad you still have to build? And then the second question really relates to whether—what’s the remaining CAPEX for the railroad and the infrastructure around the deposits, including the beneficiation plant. I understand that the first tonnage that will come out of Elga will be processed at the Southern Kuzbass beneficiation plants. Obviously, this is going to be a very inefficient way of producing coke and coal concentrate. When do you think the beneficiation plant at Elga coal deposit will start to be operational? Thank you.

Translator

(Russian spoken)

Vladislav Zlenko

Thank you. The question will be answered by Mechel’s Vice President for Business Planning and Analysis, Mr. Oleg Korzhov.

Oleg Korzhov

(Russian spoken)

Translator

Good afternoon ladies and gentlemen. The total length of the railroad to the Elga deposit is 215 kilometers. As of to date, 124 kilometers have already been built and the work is in progress to complete the construction. In August this year, the plan is to complete 209 kilometers construction so by the end of the year, the full construction cold be completed.

Responding to the question about the CAPEX for that project, I can say that the total amount of $2.8 billion U.S. and as of to date, 716 million have already been used; so the remaining amount is about 900 million. And as far as the beneficiation plant is concerned, we fully realize that the current scheme is not very much efficient and the plans are to build a seasonal plant and we already announced a tender to that effect so that coal could be—run of the mine coal could be beneficiated in the summer season. And by summer of the next year, that plant may start operating.

At the same time, we are announcing a tender for the construction of the main beneficiation plant that is planned to be completed in 2013.

Vladislav Zlenko

We will take the next question.

Operator

Thank you. The next question is coming from the line of Yuriy Vlasov of JP Morgan. Please go ahead.

Yuri Vlasov – JP Morgan

(Russian spoken)

Translator

Question from Mr. Yuriy Vlasov of JP Morgan. First question concerns the universal rolling mill and its construction in Chelyabinsk. Question is about the volumes of production for the next three years. And the second question is about the breakdown of CAPEX.

Vladislav Zlenko

Thank you. The question will be answered by Mr. Oleg Korzhov.

Oleg Korzhov

(Russian spoken)

Translator

The construction of the universal rolling mill is being carried out according to the schedule, and all contracts and tenders have been concluded. The plan is that it will be launched into operation early next year, and when it reaches its full capacity it’s production will amount of 1,100,000 tons a year.

Vladislav Zlenko

Next question will be answered by Oleg Korzhov as well.

Oleg Korzhov

(Russian spoken)

Translator

Speaking of the investment program breakdown, I can say for 2011 the total amount is 2.3 billion and steel segment will receive 850 million. The mining segment will be invested in the amount of 1.3 billion, including 900 million for the Elga deposit. The ferroalloy segment will receive 900 million and the power segment will be paid 70 million, while the transport segment investment will make up some 60 million.

Vladislav Zlenko

We’ll now take the next question, please.

Operator

Thank you. The next question is coming from the line of Boris Krasnojenov of Renaissance Funds Capital. Please go ahead.

Boris Krasnojenov – Renaissance Capital

(Russian spoken)

Translator

The question comes from Boris Krasnojenov of Renaissance Capital. There are actually three questions. First question is about the prices for its products in quarter two. The price seemingly was at the level of $320 per ton at FOB (inaudible), and what are your expectations for quarter three – will there be any adjustment of the prices? And second question is about the Korshunovsky Mining Plant, whether prices of its products are going up in terms of quarter-on-quarter given the supplies to China. And question three is based on some information reported by probably their writers’ agency about the net debt to the EBITDA ration, which is 3.

Vladislav Zlenko

The first two questions will be answered by Mr. Oleg Korzhov and the third one by our CFO, Stanislav Ploschenko.

Oleg Korzhov

(Russian spoken)

Translator

Responding to your question about the prices for coke, I can say that the information you referred to is valid. It’s true that the prices range 10 to 325 FOB. As for the forecast for Q3, it’s hard to say and the market analysts had different views on the price dynamics. And we hope that the prices will go up or at least remain as they are now.

So responding to your question about the Korshunovsky deposit prices, I can say that mostly we have spot contracts there; and as far as the iron ore concentrate is concerned, in Q1 the prices were 180 to 185 CIF for China.

Stanislav Ploschenko

(Russian spoken)

Translator

Responding to your question about the net debt to EBITDA ratio, it’s 1:3, it’s true and we hope that we will achieve that level by the middle of the year.

Vladislav Zlenko

We will now take the next question, please.

Operator

Thank you. The next question is coming from the line of Nur Puri Purini from Intesa Sanpaolo. Please go ahead.

Nur Puri Purini – Intesa Sanpaolo

Hello, hi. I’d just like to ask the company to elaborate a little bit further on its debt reduction plans for 2011, and if the Mechel Mining IPO is still on the table; and if it is, if they can elaborate a little bit more on the timing.

Translator

(Russian spoken)

Vladislav Zlenko

The questions will be answered by Mechel’s CFO, Stanislav Ploschenko.

Stanislav Ploschenko

As I said in my answer to the previous question, we have a target of reaching the net debt to EBITDA of 3:1 level by the end of June this year. We are going to do that by repaying short-term debt using the operating cash flow of the first half of the year. As far as the plans for IPO of Mechel Mining are concerned, as announced before, we are preparing Mechel Mining for possible IPO; however, for the time being the timing is not defined.

Nur Puri Purini – Intesa Sanpaolo

Thank you.

Translator

(Russian spoken)

Vladislav Zlenko

We will now take the next question, please.

Operator

Thank you. The next question is coming from the line of Sergei Donskoi, Troika. Please go ahead.

Sergei Donskoi – Troika

Good evening, gentlemen. I have two questions. One, could you provide some guidance on cost inflation this year, either in relation to the level achieved in the fourth quarter last year or average level for last year, for your mining divisions? And second, could you provide some guidance for your dividends to pref shares on the back of the announced results?

Translator

(Russian spoken)

Vladislav Zlenko

The questions will be answered by Mr. Stanislav Ploschenko.

Stanislav Ploschenko

(Russian spoken)

Translator

Responding to the first question, I can say that the cash cost increase in our mining segment is not visible, at least all factors impacting the cost are under our control excluding some external factors which are the prices for feedstock or power. And speaking of the dividend policy for preference shares, I can say that according to the charter of the company, 20% of the consolidated net income is used to pay the dividends for the preference shares, and the company is not going to change its policy.

Vladislav Zlenko

We will now take the next question, please.

Operator

Thank you. The next question is coming from the line of Vlad Zhukov of Nomura. Please go ahead.

Vlad Zhukov – Nomura

(Russian spoken)

Translator

The question is from Vladislav Zhukov of Nomura Company. First question is about some information on the average prices for coking coal. You said that it is changing, and could you give us some idea about the dynamics of Q4 versus Q1 this year, and perhaps what will it be like in Q2. You said that overall it’s $320, but probably you can elaborate on that And my second question actually is follow-up of the previous question, and it has to do with the quarter-on-quarter cash cost. You said that in Kuzbass they were high because of some seasonal factors. Go into—do you think that you will see lower prices? And my third question is about the dividends – could you just elaborate on some at least base figure which gives the calculation grounds for those 20% of the consolidated net income that is used for dividends?

Vladislav Zlenko

The first question will be answered by Mr. Oleg Korzhov.

Oleg Korzhov

(Russian spoken)

Translator

Well, responding to the first question, I can say that in Q1 prices were based on the contracts that were concluded last year, and for K9 coals the price was about 320. And in Q1, the contract prices made up 190 to $200 per ton. And speaking of the difference between Q1 and Q4, the point was made that they would be roughly at the same level and variation in the price can make up not more than 5%.

Vladislav Zlenko

The next question will be answered by Stanislav Ploschenko.

Stanislav Ploschenko

(Russian spoken)

Translator

Speaking of seasonal factors in terms of cash cost, I can say that in wintertime due to the utilization of more expensive fuel for the repairs and drying, the cost increases; but both in Q4 and Q1, the cash costs were about the same. Throughout the rest of the year, we can also observe some seasonal trends and it is due to such factors as inflation that may affect the mining segment and the cost of power—electric energy for the production. And speaking of cash costs in Q1, they were high because of the halt of operations at Nerungrinskaya washing plant, and we certainly used that forced downtime to carry out all our repairs and maintenance so that the plant will not have to be stopped for those operations in the rest of the year. But that made anyway the cash cost higher.

Stanislav Ploschenko

(Russian spoken)

Translator

Responding to your third question about the base figure of the net income and that can be used for the dividends, you can see the figure in the consolidated profit and loss account in the item that is dedicated to the net income attributed to shareholders, and the figure is 657,212,000.

Vladislav Zlenko

We will now take the next question, please.

Operator

Thank you. The next question is coming from the line of Nikolay Sosnovsky, Uralsib. Please go ahead.

Nikolay Sosnovsky – Uralsib Capital

(Russian spoken)

Translator

The question comes from Nikolay Sosnovsky of Uralsib Capital. The first question is about a possibility that Mr. Justice’s stake can be placed, and about the placement, if so, what amounts or volumes can be offered and the timeline for that. And the second question has to do with some rumors that Mechel may participate in the auction of the 80% stake of Raspotske (phon) deposit, so Nikolay wonders if there are any plans for that.

Vladislav Zlenko

The questions will be answered by Mr. Stanislav Ploschenko.

Stanislav Ploschenko

(Russian spoken)

Translator

Responding to your first question, I can say that currently the company does not have any plans to offer its stock and shares, and we cannot comment on any plans of our shareholders to that effect. And speaking of your second question, I can say that we—in the mining segment, we are looking into all opportunities for the expansion of our operations in the area of coke and coal throughout the globe; and Raspotske, we consider all those opportunities on the basis of specific criteria. And so far, no decision has been taken concerning Raspotske or any other project. But anyway, all decisions about possible acquisitions are made irrespective of specific—whether it is specific Raspotske project or any other project.

Vladislav Zlenko

We will now take the next question, please.

Operator

Thank you. We have a follow-up question from the line of Dan Jacob from Citi. Please go ahead.

Dan Jacob – Citi

(Russian spoken)

Translator

It’s a follow-up question from the Citibank. It concerns again the preference shares. The understanding is that the Justice family is not in a position to offer its stake at the U.S.-based stock exchanges any longer, so are there any other options – for instance, selling at Russian stock exchanges?

Vladislav Zlenko

The question will be answered by Stanislav Ploschenko.

Stanislav Ploschenko

(Russian spoken)

Translator

It is true that the Justice family has exhausted its capabilities to place and offer preference shares and bought it in depositor receipts, so if they take such a decision they can do only local placement and Russian stock exchanges can be the platform.

Vladislav Zlenko

We’ll take the next question please.

Operator

Thank you. The next question is coming from the line of Dmitry Smolin, Uralsib. Please go ahead.

Dmitry Smolin – Uralsib

(Russian spoken)

Translator

The question is from Dmitry Smolin of Uralsib and it concerns a possible Mechel Mining’s IPO. It is the question that is in the interests of many investors, and if it happens, then how it can impact the amount of dividends?

Vladislav Zlenko

The question will be answered by Mr. Stanislav Ploschenko.

Stanislav Ploschenko

(Russian spoken)

Translator

Currently, as I pointed out earlier, no decision has been taken to that effect and we’d have to see when it could be taken. As for the impact on dividends, I hope and we hope that it will have only a positive effect because if we go ahead with the IPO, it will be used to finance the lucrative projects for us and the projects that will bring us more revenues.

Vladislav Zlenko

Income. And we’ll take the next question, please.

Operator

Thank you. We currently have no further questions coming through, so just a reminder, please press 7 if you would like to ask a question on this call. And we have a question from the line of Anna Antonova from Metropol. Anna, please go ahead.

Anna Antonova – Metropol

Good evening, gentlemen. Thank you very much for your presentation. Just a small question from my side. My first question is could you please comment on the factors that contributed to 43% quarter-on-quarter decline in consolidated net income in the fourth quarter to $195 million. And my second question is could you please comment on the decision of the Board of Directors of Korshunovsky GOK about recommending not paying out dividends for fiscal year 2010. Thank you.

Translator

(Russian spoken)

Vladislav Zlenko

The question will be answered by Mr. Stanislav Ploschenko.

Stanislav Ploschenko

(Russian spoken)

Translator

If I got your question right, it concerned the decrease of the consolidate net income in Q3, and here I can mention a number of factors that can explain that particular situation. Some of them were just one-time factors, and we—because of the deferred tax liabilities, and that showed in Q4. And in Q4, I also referred to some tax policy changes in Kazakhstan; and there were also some factors that had to do with the rise in lease payments for land site in Kuzbass.

Stanislav Ploschenko

(Russian spoken)

Translator

Also I would like to turn your attention to the fact that due to the foreign gain and loss, in Q3 we had a positive $73 million U.S. while in Q4 it was on the negative, it was minus

15.

Stanislav Ploschenko

(Russian spoken)

Translator

Responding to your second question on the decision and by the general shareholders meetings of Korshunovsky mining plant, it is true that the decision was taken not to pay dividends and it was made to improve the consolidated funds for the Mechel Group.

Vladislav Zlenko

We will now take the next question, please.

Operator

Thank you. The next question is coming from the line of Albert Kalinin (phon) from (inaudible) Capital Markets. Please go ahead.

Albert Kalinin – (?) Capital Markets

(Russian spoken)

Translator

The question from Albert Kalinin of Capital Markets. It concerns mostly the CAPEX for the Elga deposit. He said that the total CAPEX to build the railroad amounts to 2.6 billion, and there is also a need to build a seasonal washing beneficiation plant, so I wonder if that amount that is given to this plan to build that seasonal plant is part of that total CAPEX or not. And my second question is concerning the plans to further expand the mining segment. Probably your plan to do so through the expansion of the asset base, and if so, I wonder if your preference is with the already developed assets or developing assets?

Vladislav Zlenko

The question will be answered by Mr. Oleg Korzhov.

Oleg Korzhov

(Russian spoken)

Translator

Well, as I already pointed out, the total CAPEX amount is $2.8 billion. We have already spent 700 million and 900 million are planned to be used this year, so the balance will be 1.2 billion. And next year we are going to use that amount to pay for the completion of the construction of bridges on the railroad and 25 million that is included in the CAPEX amount will be spent to build the seasonal beneficiation plant while 150 to 200 million will be spent to build the main beneficiation plant as well as the settlement for makeshift workers who work at the deposit; and that’s all part of the total CAPEX amount.

Vladislav Zlenko

And the next question will be answered by Mr. Stanislav Ploschenko.

Stanislav Ploschenko

(Russian spoken)

Translator

As was pointed out, currently Mechel is engaged in the development of one of the major projects which requires very sufficient financial and managerial resources. However, we cannot rule out any expansion efforts in any area involving the production of coke or steam coals. However, with the development of the Elga biggest project underway, we would rather invest in efforts that are generating revenues currently rather than in those assets that will require investments, although incur some further liabilities. Although as I pointed out before, we cannot rule out any opportunity.

Vladislav Zlenko

We will now take the next question, please.

Operator

Thank you. The next question is coming from the line of Maxim Semenovykh from Alfa Bank. Please go ahead, Maxim.

Maxim Semenovykh – Alfa Bank

(Russian spoken)

Translator

The question from Alfa Bank. There is only one question. It’s about the production plans for coke and coal in the company so that you can refer to the equivalent of coke and coal concentrates, and what amounts or volumes plan to be sold to Elga?

Vladislav Zlenko

The question will be answered by Mr. Oleg Korzhov.

Oleg Korzhov

(Russian spoken)

Translator

According to the company’s 2011 plans, we are going to produce some 4,400,000 tons. The share of the Southern Kuzbass will be 5,800,000 million while the share of Yakutugol is 5,600,000. And Bluestone’s share is going to be 3 million, and as for Elga then the plans are to have from 200 to 300,000 tons of run of the mine coal.

Vladislav Zlenko

We will now take the next question, please.

Operator

Thank you. We have a follow-up question from the line of Boris Krasnojenov from Renaissance Capital. Please go ahead.

Boris Krasnojenov – Renaissance Capital

(Russian spoken)

Translator

Follow-up question from Renaissance Capital from Boris Krasnojenov, and it concerns the (inaudible) Kuzbass, Southern Kuzbass coal prices, and specifically about the price dynamics in March/April, whether prices increased or they remained on the same level.

Vladislav Zlenko

This question will be answered by Mr. Oleg Korzhov.

Oleg Korzhov

(Russian spoken)

Translator

In April versus March, the coals produced in Southern Kuzbass grew an average by 9 to 10%.

Vladislav Zlenko

We will now take the next question, please.

Operator

We currently have no further questions coming through, so just a final reminder, please press seven if you wish to ask a question on this call. We have a last question coming from the line of Marek Gobidov (phon) from UniCredit. Please go ahead.

Marek Gobidov - UniCredit

(Russian spoken)

Translator

The question comes from Marek Gobidov of UniCredit and there are two questions. First concerns the (inaudible) sales and due to the force majeure circumstances in Q1, probably in Q2 coal will be sold at the prices of the contract of Q1. And the second question is since you are making stand-alone statements for commercial mining anyway, probably you can segregate the operating cash flow for that segment, and also just specify also separately the working capital of that segment in 2010.

Vladislav Zlenko

The first question will be answered by Mr. Oleg Korzhov.

Oleg Korzhov

(Russian spoken)

Translator

As I said earlier, in February we managed to partially re-launch the operation at Nerungrinskaya plant and that enabled us to fulfill contracts concluded in last year. And the remaining volumes that will be transferred to Q2 are not very significant and they amount only to 200,000 tons and they will be fulfilled in April.

Vladislav Zlenko

And the next question will be answered by Mr. Stanislav Ploschenko.

Stanislav Ploschenko

(Russian spoken)

Translator

Currently we are reporting the consolidated statements of the Mechel Group, and Mechel Mining does not have a separate statement reporting on that. And when they complete an IPO, they will really report all those indicators separately. Although speaking of its working capital volumes, we can say that the bulk of it is in the steel segment and it can be explained by the fact that it covers the margin for the mining and ferroalloys, and it is also explained by the growth in some trade transactions and operations by Mechel Service Global, both in Europe and Russia.

Vladislav Zlenko

We will now take the next question, please.

Operator

We have no further questions coming through. I hand you back to your host to wrap up today’s call.

Vladislav Zlenko

Ladies and gentlemen, thank you for taking the time to join Mechel’s full year financial results for 2010. The replay of the call will be available for the next 30 days. If you have any further questions, please contact the IR office. Thank you again from all the team here.

Operator

Thank you for joining today’s conference. You may now replace your handsets.

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