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Cleco Corporation (NYSE:CNL)

Q1 2008 Earnings Call Transcript

May 7, 2008 11:00 am ET

Executives

Ryan Gunter – IR

Mike Madison – President and CEO

Kathleen Nolen – SVP and CFO

Darren Olagues – SVP, Cleco Midstream Resources LLC

Dilek Samil – President and COO, Cleco Power LLC

Analysts

Paul Ridzon – KeyBanc

Gordon Howald – Calyon Securities

Michael Lapides – Goldman Sachs

Bob Chewning – Davenport & Co.

Justin Maurer -- Lord Abbett

Operator

Good morning, ladies and gentlemen, and welcome to the Cleco Corporation first quarter 2008 earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference is being recorded. I will now turn the call over to Mr. Ryan Gunter. Mr. Gunter, you may begin.

Ryan Gunter

Thanks, John. Good morning everyone and welcome to Cleco Corporation's first quarter 2008 earnings conference call. On the call today, I have with me Mike Madison, President and CEO of Cleco Corporation, who will update you on current events and Kathleen Nolen, our Senior Vice President and Chief Financial Officer, who will cover financial results for the quarter. We also have with us today other executives who will be available to answer your questions following the prepared remarks.

Before we begin, please keep in mind that during the call today, we will make some forward-looking statements. These statements are subject to many risks and uncertainties. Actual results may differ materially. Please refer to the risk factors and our notice of disclosure regarding forward-looking statements in various reports filed with the Securities and Exchange Commission including our 2007 annual report on Form 10-K and our first quarter 2008 quarterly report on Form 10-Q. And with that, I will turn over to Mike.

Mike Madison

Thank Ryan and good morning everyone. For those who joined us via the webcast at our Annual Meeting that we had April 25, this discussion will be a repeat. For those that didn't, let me start by saying we've completed the financing plan to recover our storm restoration expenses from hurricanes Katrina and Rita. And as you know, we have been working with the Louisiana Public Service Commission or LPSC for the past two years to securitize our unrecovered storm expenses and create a storm reserve to cover our future storm cost by issuing storm recovery bond. We issued these bonds in March and collected approximately $180 million in cash. $50 million of this amount was set aside to fund our storm reserve. Now by issuing storm recovery bonds, we collected our remaining unrecovered storm expenses in one lump sum and accelerated our cash flow. That cash will help us finance our Rodemacher 3 Project and it will also help us lower our customer's storm charges.

According to our calculation, this special financing will save our customers approximately $106 million in storm reimbursement charges compared to traditional financing. This cost recovery plan marked the first time securitization has been used in Louisiana to pay for storm cost. The plan is also an excellent example of constructive relationship we've built with our regulators. We can achieve fair and balanced regulatory outcomes for both our shareholders and our customers by working together.

We have also reached a milestone in our 2007 long-term request for proposal or RFP process since our last call. This RFP was issued in October of last year, after our integrated resource planning process revealed that we would still be short of capacity even after Rodemacher 3 goes online. Cleco Power requested bids for up to 600 megawatts of intermediate and peaking capacity which would start in 2010. The last month or specifically April 15, Cleco Power developed a shortlist of bidders and we have subsequently notified all bidders of their status. As we said during previous updates, this process is overseen by an independent monitor appointed by the LPSC. Therefore, we are very limited in what we can say regarding the RFP process.

I can tell you this that the bidders are under confidentiality agreement and the winning bids will be announced in August. Now following the announcement of the winning bids, we will then apply for LPSC Certification. As a reminder, Cleco Power submitted several self-bid proposals into the RFP. These proposals, as the process is designed, is to test them against market proposal to find the most economical and reliable supply of power for our customers.

Turning now to our Rodemacher 3 Project, as of the beginning of May, we are 24 months into our 42-month construction schedule, which means the unit is more than halfway complete. We are still on schedule to begin commercial operation in October of 2009. Also, the project is on budget. Through March 31 of this year, we have spent $714 million on the project and if you were able to attend our Analyst Day event in March, you saw firsthand the progress that we are making. Once again, Rodemacher 3 is a 600-megawatt solid fuel unit. It is going to diversify our fuel mix, reduce our dependence on natural gas, and lower our customers' fuel cost. It's also going to double our rate base and that brings me to the next agenda item. As you know, we must file a rate case with the LPSC to recover our Rodemacher 3 construction cost, 12 months before the unit is in the service day. Now to ensure we meet this deadline, Cleco Power plans to file its rate case by the end of the second quarter.

Now we have done a lot of preplanning for the upcoming rate case, including monitoring the rate cases of neighboring utilities. After we file, there will be a discovery period, then settlement discussions and a hearing. Assuming we reach an agreement, the new rates will be implemented to coincide with the commercial operation of Rodemacher 3.

Also, our last rate case was in 1985. In the years since then, as you can imagine, our operating costs have increased. Therefore, not only are we seeking approval to recover our Rodemacher 3 investment, we also will be seeking rates that more accurately reflect our current business expense. We expect the fuel savings from Rodemacher 3 to offset the increase in base rates, which means customers' bills will be low.

Now looking to transmission opportunities, if you will remember, during our last call, we told you about a possible transmission investment. We are still working with our neighbors, the LPSC and the Southwest Power Pool, which is Cleco Power's reliability coordinator, on a proposal to relieve transmission constraints in the southern region of our service territory. Hopefully, we will be able to provide more detail on this during the next call.

The last item on my list is the update on our midstream business. You may recall that we signed a 20-year tolling agreement with Williams for Evangeline's capacity. In November of last year, Bear Stearns purchased Williams Power portfolio which included Evangeline's contract. I am also sure you know that Bear Stearns, the parent company of our tolling agreement partner Bear Energy, encountered severe financial difficulties during the week of March 15. Fortunately, JPMorgan Chase agreed to purchase Bear Stearns and confirmed its guarantee of Bear Stearns' credit obligation. We expect this deal to be closed in June.

Our other wholesale asset, Acadia, has and continues to submit bids into long-term and short-term RFPs. The results of these RFPs should be known over the next couple of months. Midstream also continues to focus on sales and hedging strategies in 2008 and 2009 that will better optimize Acadia's output in the near term. Overall, the fundamental outlook for Acadia and merchant gas-fired generation in the region continues to improve. Combined cycle asset prices continue to trend upward as replacement cost increase and the push for cleaner energy and possible carbon dioxide legislation and other environmental mandates can also add to Acadia's value.

Now before turning it over to Kathleen, I would just like to remind you of our gross strategy. Our core business is Cleco Power and it is through Cleco Power that we will continue to grow our company. Our top priority is to keep our solid fuel generating project Rodemacher 3 within budget and on schedule. Filing our rate case with the LPSC to recover Rodemacher 3 investment is the next priority on our list and working to secure additional generating capacity and building up our transmission infrastructure are the remaining top goals. On the wholesale side of our business, we will work to secure short-term and long-term capacity contract for Acadia's output and continue to efficiently manage the expenses of Evangeline.

Now, Kathleen will discuss our first quarter financial results.

Kathleen Nolen

Thanks, Mike, and good morning everyone. For the first quarter 2008, we recorded net income of $22.1 million, which translates to diluted earnings per share of $0.37. This is up from the first quarter of 2007 when we booked net income of $8.2 million and earnings per share were $0.14. First quarter 2008 results were higher than first quarter 2007, primarily because of higher Cleco Power AFUDC or Allowance for Funds Used During Construction and that ties to the construction progress of our Rodemacher 3 unit. Also, we experienced lower Cleco Power O&M or operating and maintenance expenses.

Starting with Cleco Power, we booked $0.46 per share for the quarter. That's up $0.25 from first quarter 2007. Of that, AFUDC was up $0.18 compared to first quarter 2007 and again that's due to the Rodemacher construction and our increasing investment in that project. Non-fuel O&M expenses were down $0.06 compared to the first quarter of 2007. $0.04 of that difference was due to lower compensation and benefits expense, $0.01 of that decline was due to lower professional fees and the other $0.01 was due to lower generation maintenance cost.

For the quarter, winter weather was relative mild, but it was comparable to weather in the first quarter of 2007. Revenue from kilowatt-hour sales was about equal quarter-over-quarter, given the similarity in weather. We did see a $0.01 increase in revenue and that was driven by higher gas prices which pushed mark-to-market values of natural gas hedges higher.

On the midstream side, midstream posted a loss of $0.08 per share for the quarter and that's equal to the results of first quarter '07. Acadia recorded $0.03 in lower interest expense and that is from the inter-affiliate loan with the holding company because of a lower loan balance. Acadia paid down a portion of that inter-affiliate loan with settlement proceeds from the Calpine settlement last year.

On the other side of the shop, Evangeline posted $0.03 of higher maintenance and that was maintenance associated with a planned outage. So, all in all midstream was flat quarter-over-quarter.

At the holding company, results were down $0.02 per share quarter-over-quarter and that is due to lower interest income on the inter-affiliate loan from Acadia. As Mike mentioned, we did complete the securitization of our storm cost on March 6. We are very pleased with the transaction. We priced $180 million of bonds with a seven-year average life at a rate of 4.86%. We think that's a very attractive rate given the volatility of the markets nowadays. And just a few days later, on March 12, we remarketed the $60 million of tax-exempt solid waste disposal bonds that we had issued into the auction rate market last November. We remarketed the bonds with a term of five years and fixed the rate at 5.25%.

We had originally received $200 million of approval from the State Bond Commission for the issuance of tax-exempt solid waste disposal bond for the Rodemacher Project. To date, we have issued $120 million of bonds and this year, we have applied for an additional volume cap of $32 million. That represents the remaining qualifying solid waste disposal equipment on the project.

We are also planning a debt financing for Cleco Power this quarter, again, to support the Rodemacher Project. We had earlier talked about a $200 million issuance. We are actually thinking that we will likely upside that issuance to $250 million in order to capture index into the eligibility and so that's our thought on debt issuance currently.

In terms of guidance, we are still targeting consolidated earnings in the $60 to $70 per share range, so that means despite of very strong first quarter, we do believe that our target range is still appropriate. I do want to remind you that that guidance does as always normal weather. It assumes that we are spending $265 million this year on the Rodemacher Project, including AFUDC. It assumes that our current rate plan continues and that the Evangeline tolling agreement continues as is. And we're also making assumptions in those numbers about natural gas and power prices associated with Acadia.

And with that, I'll turn the call back over to Ryan and we'll open it up for questions.

Ryan Gunter

Thanks, Kathleen. Do we have any questions at this time?

Operator

Are we ready for the Q&A?

Mike Madison

Yes.

Question-and-Answer Session

Operator

We will now begin with the question-and-answer session. (Operator instructions) Our first question comes from Paul Ridzon from KeyBanc. Please go ahead.

Paul Ridzon – KeyBanc

Good morning. You've got, aside from Cleco Power, how many RFPs has Acadia been into and can you just give a little more detail on the calendar when we should see those results?

Mike Madison

Dear Paul, thanks and good morning.

Darren Olagues

We are actively participating in four long-term RFPs and a number of bilateral discussions with regional counterparties. I think it would be too much information to discuss exactly when we would expect each of those RFPs to be finalized. But I do think that, that probably the next quarterly call, we will have some news and we'll probably be in a position to talk about the results of some of those RFPs.

Mike Madison

I've been very pleased. I think Darren has well, with our new partner Cajun, which is I guess the company that King Street has -- or subsidiary that King Street has identified to be our partner. And they have been extremely aggressive in both the short-term and long-term RFP process. And that's about all I can say other than I'm very pleased with how aggressive they've been.

Paul Ridzon – KeyBanc

You've got some mark-to-market earnings in the quarter. Is there any time when those have to reverse by? What's the data on the contracts? And when should these reverse?

Kathleen Nolen

These contracts are as long as three years out or backing up at long-term fixed price contract with the municipal system. So at least within this year, there is no reason for them specifically to reverse other than market movement.

Paul Ridzon KeyBanc

(inaudible) is that gas price increases are gains on your books?

Kathleen Nolen

Sure. That's right.

Paul Ridzon – KeyBanc

Just give an update on the potential size of a transmission investment.

Mike Madison

That's probably one of the reasons why it's taken us so long. In the discussions we've had with our neighboring utilities, it varies on how much the obligation of each of the utilities would be. I think a range and quite frankly, it's a large range, because of the debate and it can run from anywhere from say, maybe 50 million to over 200 million. And just dividing that up with respect to who gets what benefit, therefore who gets what cost allocation, has been very difficult. I remind everybody, we don't have an RTO in the southeast region. But we do have the Southwest Power Pool which is the Reliability Coordinator. And we've relied on them very heavily to do the energy balances to try to determine what the cost benefit breakdown for all the parties are and that has been, as you might imagine, a very, very long process.

Paul Ridzon – KeyBanc

When did you quit booking a return on the storm balance? Is that March 10 when you got the funds?

Kathleen Nolen

It actually what phased in during our billing cycle. So it was pretty much phased out by the end of the quarter.

Paul Ridzon – KeyBanc

Is it safe to say maybe half of this quarter, you enjoyed that benefit?

Kathleen Nolen

First quarter or second quarter?

Paul Ridzon – KeyBanc

First quarter, sorry.

Kathleen Nolen

More than half, because they began phasing out in mid-March, so we enjoyed the full benefit to mid-March and then began phasing it out in billing cycles at that point.

Paul Ridzon -- KeyBanc

Depreciation was down a little bit in the quarter, is that just lower amortization of the storm costs?

Kathleen Nolen

Exactly.

Paul Ridzon – KeyBanc

Okay. Thank you very much.

Kathleen Nolen

Sure.

Mike Madison

Thanks, Paul.

Operator

Our next question comes from Gordon Howald from Calyon. Please go ahead.

Gordon Howald – Calyon Securities

Hey, good morning everyone.

Mike Madison

Good morning, Gordon.

Gordon Howald – Calyon Securities

From your vantage point, you made this comment during the presentation, what has been the average allowed return in equity structure of your neighboring utilities at this point, as a guide to what could be expected as you go forward?

Dilek Samil

Good morning, Gordon. This is Dilek.

Gordon Howald – Calyon Securities

Hello. How are you?

Dilek Samil

Good. How are you?

Gordon Howald – Calyon Securities

Great, thanks.

Dilek Samil

It looks like the other industrial utilities in the state are in the neighborhood of high-nines to the mid-tens. The most recent data point was right around 10.5%. But I will remind you that historically, Cleco has enjoyed a bit of a premium relative to the other industrials in the state. And I think that's attributable to two things -- one is that our customer satisfaction tends to be the highest in the state and our goal of course is to keep it that way. The other, perhaps more practical reason, is that we are the smallest industrial utility in the state and therefore we would argue that we have more risk than the other IOUs. The third is some data points that we've been looking at.

Gordon Howald – Calyon Securities

That's quite helpful. Thank you. If I could just one more quick question here. Where do you stand on purchasing fuel or locking in fuel prices for Rodemacher and what is the outlook for petcoke at this point?

Dilek Samil

The price of petcoke, just like every other energy commodity, has gone up. When we were first planning this project, the all-in cost of petcoke, including transportation, including the limestone that we plan on using in this boiler, we were looking at in the neighborhood of $1 per MMBTU, just to give you some context. At that time, gas was in the neighborhood of I would say $4 an MMBTU. Today, we're probably looking at petcoke in the neighborhood of $2.50 to $2.75 and frankly going up is what we see. But by comparison, the price of natural gas is -- I haven't looked this morning, but it's in the $10 and $11 range. So the price of petcoke has gone up but, by comparison, it's still the cheapest choice that we've got in terms of fueling the power plant. We are working on contracts to secure petcoke. But the pricing will be indexed.

Gordon Howald – Calyon Securities

Got you. Okay. I appreciate it. Thanks very much.

Operator

Our next question comes from Michael Lapides from Goldman Sachs. Please go ahead.

Michael Lapides – Goldman Sachs

Hey guys. Can you talk a little bit about what -- I know there's limited information you can give about which specific RFPs you're participating in. Can you talk a bit about your fundamental view of the power market for merchant assets like yours and others in the region in terms of what kind of uplift, if any, you are expecting to see, and what kind of transmission bottlenecks exist and how those may get alleviated?

Darren Olagues

Good morning, Michael.

Michael Lapides – Goldman Sachs

Good morning guys.

Darren Olagues

That could be a long answer to that question. But, as I'm sure you know, that there have been a fair amount of recent data points of asset sales to load serving entities that reflect a replacement cost discount, the discount is shrinking and those prices are rising. And it appears that load serving entities are willing to pay up for existing plants that are well-located. That trend hasn't made its way all the way into Entergy CIRC region yet. Although there's enough financial players out there that we talk to that certainly are making a bet of that uplift. That trend will continue for all the plants – all the merchant plants that exist in Entergy CIRC region including the FPP border ecosystem, arguably [ph] would include Acadia.

In the short run, prices are still tough. You can't observe day-ahead or year-ahead pricing in the broker market that somehow reflect the asset sale prices. I think it would be hard to believe that you'd ever see that because before that would happen the load serving entities would likely buy up the combined cycle units in the market.

So, how I think that applies to Acadia is we think Acadia is a well-located plant. As we talked about at the Analysts Day that we think the Acadia in a load packet upgrades that sort of we're on the other side of what Mike and Dilek were referring to, we think that only helps Acadia and strengthened our view that it's a well-located plant, we think naturally fits into load serving entities in the region. And so we're hopeful that we're going to capture that upward trend.

Mike Madison

I would add, Michael, that what I also find very interesting in the market at this point in time and that is, if you look at the high end of the values we're seeing for the existing combined cycle assets, say even in the $600 per KW range and you compare that to against what is [ph] quoted in terms of being cost of new construction that's in the $900 per KW range. The delta between those says very clearly that you can make transmission investment and still be competitive. And that to me is the interesting part of the current dynamics of the market.

Michael Lapides – Goldman Sachs

Interesting. Okay. Thank you guys. Much appreciated.

Operator

Our next question comes from Bob Chewning from Davenport and Co. Please go ahead.

Bob Chewning – Davenport & Co.

Good morning.

Mike Madison

Hi, Bob.

Bob Chewning – Davenport & Co.

You currently have a $0.10 squared against on your guidance. Maybe if you could give us some sense as to the principal variables that you still have out there and their potential impact or maybe alternatively looking at the variance by segment?

Kathleen Nolen

Well, I think there's two significant variables. One is weather. That's going to impact Cleco Power. We are a summer peaking utility. We collect most of our revenue in second and third quarter. So, the weather during the summer will impact Cleco Power's profitability. Weather will also have an impact on Acadia as well as other market factors for a portion of the year. At least, we're going to see Acadia out in the merchant market. And so that market's dynamics as well as Acadia's ability to achieve shorter-term contracts for the year, for the summer will affect results as well.

Bob Chewning – Davenport & Co.

Okay. With the weather impact, you mentioned it was mild during the first quarter but comparable to last year. Do you know what the impact would've been on weather for the quarter?

Kathleen Nolen

Well, there was no weather impact. We were pretty much flat because weather was very comparable.

Bob Chewning – Davenport & Co.

Okay. I was think of those in terms of your guidance which assumes normal.

Kathleen Nolen

It isn't very much from normal, Bob. It was less than $0.01 variance.

Bob Chewning – Davenport & Co.

Okay. And lastly, operating expenses were below last year. I'm just wondering in terms of looking at the full year on operating expenses versus '07.

Kathleen Nolen

Some of that was timing. And that's what I meant when I said despite of the strong quarter, we still believe that that target range is appropriate. We see some expenses later in the year that are getting eaten to little bit of a cushion that we built in the first quarter. So bear that in mind that looking at our year as we forecast, we still believe that that guidance range is appropriate.

Bob Chewning – Davenport & Co.

Okay. That's great. Thank you.

Kathleen Nolen

Okay.

Operator

Next question comes from Justin Maurer from Lord Abbett. Please go ahead.

Justin Maurer -- Lord Abbett

Good morning guys.

Mike Madison

Good morning, Justin.

Justin Maurer -- Lord Abbett

Just following up on the $0.04 still in the compensation, is that -- I assume that comment applies as well that it's a timing issue?

Dilek Samil

Actually, some of that we will benefit from, some of that is a permanent difference. It's a difference in incentive compensation booked year-over-year. We do anticipate some expenses that will be higher than last year in other categories.

Justin Maurer -- Lord Abbett

Okay.

Kathleen Nolen

Later in the year that will offset it. So, although that particular line item will be lower, we think for the year, all in all, O&M will not.

Justin Maurer -- Lord Abbett

Got it. Okay. All right. Just so I'm clear, Mike, on the transmission relay that opportunity, is that primarily related to Acadia and maximizing the value of that asset?

Mike Madison

No, it's a regional issue. Louisiana, just like the rest of the country, has transmission issues and has transmission constraints. We have pockets throughout the state that under different loads, different generation configurations, can cause us problems in getting power from point A to point B. And again, we're not any different -- Louisiana any different than some of the other parts of the country. And it's the same problem that the industry has been working with or struggling with for a long time now and that is that the transmission infrastructure hasn't kept up with the generation that has been built both by load serving entities as well as the merchant market.

Dilek Samil

Justin, I would like to clarify that the investment that we're contemplating is in Cleco Power and so Cleco Power is evaluating that investment in terms of its benefit to the retail customer and in no way is considering Acadia. But, nationally, the investment in the region will impact Acadia.

Justin Maurer -- Lord Abbett

Right. Well, that was to the earlier point though right that it's not a stranded asset per se but it's limited somewhat by the transmission issue that you described.

Mike Madison

I think that's correct.

Justin Maurer -- Lord Abbett

Okay. Can you refresh it too on Acadia, what's the assumption for this? You just mentioned some of the variability in the earnings which I can certainly appreciate it, still kind of based on what contracts you end up for the year for Acadia, but what are you guys thinking in terms of utilization there for the year? I know what the net loss is supposed to be, but --

Dilek Samil

It's not something we've gone into detail on, quite honestly. We're basically looking at the same market curves that you probably are in terms of gas and power, (inaudible) differences.

Justin Maurer -- Lord Abbett

Yes.

Dilek Samil

But our budget was based on continuing merchant sales for the year and our ability to contract will help us achieve that.

Justin Maurer -- Lord Abbett

Got it, okay. Thanks guys. Good luck.

Mike Madison

Thanks.

Operator

Our next question comes from Michael Lapides from Goldman Sachs. Please go ahead.

Michael Lapides – Goldman Sachs

Hey, real quick, just coming back to Acadia. If you're unsuccessful in contracting Acadia in one of the future -- in one of the RFPs that are under way, would that impact your view in terms of the strategic rationale for owning the asset?

Mike Madison

I think the answer to that Michael is yes. We have got other plans and other strategies that we are working on, that Darren is very actively pursuing and if we can't get tolls, if we can't get those type of opportunities, we're looking at, as I think I've mentioned in previous calls, the possibility of joint ventures as well as asset sale.

Michael Lapides – Goldman Sachs

Got it. Okay. Thanks, guys.

Operator

Our next question comes from Paul Ridzon from KeyBanc, please go ahead. Paul, your line is now open.

Paul Ridzon – KeyBanc

Sorry, I was muted. This release has a lot less detail than previous releases. Is that just because the quarter was a lot simpler or is this kind of how you are going do releases going forward?

Kathleen Nolen

Paul, it is pretty simple. We certainly want to give you all the clarity you need, but there wasn't a whole lot to report. We were just trying to give you the important facts.

Paul Ridzon – KeyBanc

Great. The Cleco Power RFP, how should we think the evaluators are going to be thinking about the importance or the value of a more efficient plant, given uncertainty around carbon legislation?

Dilek Samil

Hi, this Dilek again. We have been doing our best to quantify the potential impact of carbon legislation. In fact, we even looked at it in our last RFP, through which we got the Rodemacher 3 Project. That said, there's just so much uncertainty about the legislation. How (inaudible) going to be, what it's going to look like, when it's going to come into play, but it's difficult to quantify it. But we have been incorporating that into the analysis just like we incorporate the liability issues, locational issues, all of that factors into the bottom line of ultimately what makes sense for the customer over the long term.

Mike Madison

We have made it a part of our strategy to look at three things on these investments. Cost of course, reliability of course and environmentally friendly products. I'll remind I think people that when we went through the RFP before that resulted in Rodemacher 3, we also put a carbon penalty in the analysis for that one. And so, we will be factoring in environmental issues on the decisions that we will make.

Paul Ridzon – KeyBanc

Thank you again.

Operator

(Operator instructions) And at this time, I show no questions.

Mike Madison

All right, I'd like to thank everybody once again for participating today. If you have any additional questions, feel free to contact us, 1-800-235-2652. Have a nice day.

Operator

Thank you, ladies and gentlemen. This concludes today's conference. Thanks for participating. You may now disconnect.

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