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Executives

Matt Smith – Director, IR

Bob Currey – President and CEO

Steve Childers – SVP and CFO

Analysts

Frank Louthan – Raymond James

Barry Sine – Drexel Hamilton

Jennifer Fritzsche – Wells Fargo

Steve Blinn – Morgan Stanley

Donna Jaegers – DA Davidson

Consolidated Communications Holdings, Inc. (CNSL) Q2 2012 Earnings Call August 2, 2012 11:00 AM ET

Operator

Good day, ladies and gentlemen, and welcome to the Consolidated Communications Second Quarter 2012 Results Conference Call. At this time, all participants are in a listen-only mode. Later we will conduct a question-and-answer session and instructions will follow at that time. (Operator instructions) As a reminder, this conference call is being recorded.

I would now like to turn the conference over to your host, Mr. Matt Smith. You may begin.

Matt Smith

Thank you, Mamie, and good morning everyone. We appreciate you joining us today for our second quarter 2012 earnings call. At the conclusion of the prepared remarks, we will open the call up for questions. Joining me on the call today are Bob Currey, President and Chief Executive Officer; and Steve Childers, Chief Financial Officer. Also available during the question-and-answer session is Bob Udell, our Chief Operating Officer.

Please review the Safe Harbor provisions in our press release in our SEC filings for information about forward-looking statements and related risk factors. This call may contain forward-looking statements within the meaning of the federal securities laws. Such forward-looking statements reflect, among other things, management’s current expectations, plans and strategies, and anticipated financial results, all of which are subject to known and unknown risks, uncertainties, and factors that may cause the actual results to differ materially from those expressed or implied by these forward-looking statements.

In addition today’s discussion will include certain non-GAAP financial measures. Our earnings release for this quarter’s results, which has been posted to the Investor Relations section of our website, contains reconciliations of these measures to their nearest GAAP equivalent. On July 2, we closed on the acquisition of SureWest Communications, and will report complete pro forma results on the third quarter call on early November.

I will now turn the call over to Bob, who will provide an overview of our second quarter results and an update to our integration progress. Steve Childers will then provide a more detailed review of the financials as well as updates to our 2012 guidance. Bob?

Bob Currey

Thank you, Matt and good morning everyone. I appreciate you joining us today. I’m very pleased with our performance this quarter. We remained focused on delivering excellent results while working rapidly to close on the SureWest transition, which happened in less than five months from the announcement.

Financial results were solid with revenue at $93 million, adjusted EBITDA at $44.8 million and the dividend payout ratio was 59.6%. We have continued to make improvements to the top line trends and the SureWest Acquisition provide additional diversification and growth opportunities.

Second quarter revenue on a pro forma basis was $157.8 million, which represented growth of 2.7% over the second quarter of 2011. We continue transitioning away from traditional regulated revenues while maintaining our consisting cash flows. And indicator of this progress is the continued growth in our business and broadband areas, which on a pro form basis including SureWest were 73% of the second quarter revenue. We also had a good solid quarter operationally.

Our broadband net adds were in – what is historically a seasonally soft quarter were solid and what is seasonally a soft quarter for the industry.

We added 2000 net new broadband subscribers with 1500 of those coming from high-speed Internet and 500 from our digital video. This broadband growth surpassed our ILEC access line losses by over 800 subscribers. The ILEC access line performance was also very strong this quarter with the last 12 months losses improving to 3.2%. These results reflect our continued success in our bundling strategy, led with our triple play offer, which continues to prove to be a differentiator in our retention efforts.

In our carrier sales channel data growth continues to drive increased capacity needs, especially from the wireless carriers. We’re well positioned to continue to benefit from this acceleration in wireless data conception both inside and outside our footprint.

In the second quarter, we added just over 400 new circuits to the wireless towers we served, bringing the total wireless backhaul annual revenue under contract to $9.7 million. Our CLEC business in the Pittsburgh area also had another solid quarter. We continue to extend the network off the fiber-ring into select commercial buildings were playbacks are attractive. We’ve had success in commercial customer growth with this strategy and see continuing demand.

And finally before I turn the call over to Steve, let me provide an update on SureWest. We’re very pleased with how things are progressing. We announced the functional organization structure in advance of the closing and retained two key executives in Scott Barber and Ed Butler.

Scott is leading the network and field operations teams for the new combined company and Ed has the responsibility for all of commercial sales. Both have played key roles and helping make the SureWest employee transition goes smoothly and ensure we’re delivering best practices, efficiencies and excellent customer service. The addition of the SureWest employees strengthens our bench and I would like to personally welcome all of the SureWest employees to the team. And I look forward to achieving great things together.

We already have multiple integration projects underway. As an example early in the fourth quarter, we will be combining both the California and Kansas City operations into a single operating platform. This will provide efficiencies with service improvements in many areas including provisioning, billing, sales and marketing. At year end, we will be combining into a single ERP system platform, bringing together company-wide financial reporting, accounts payable, payroll and human resources. All projects are on schedule and on budget. We will provide updates during our currently calls as we progress through the integration process.

From a synergy perspective, we’ve remain committed to achieving the $25 million in annual operating synergies within two years. At close, we obtained $10 million in annualized savings through both head count and non-headcount reductions. We also remain very confident in the $5 million to $10 million of CapEx synergies that we previously guided.

Overall, the performance from both companies and that integration efforts are proceeding exactly as we planned and we are as excited as ever with the benefits of the combined operations.

And with that update, I’ll now turn the call over to Steve for the financial review.

Steve Childers

Thanks Bob. Good morning to everyone. This morning, I will review our quarterly financial performance and provide update into 2012 guidance pro forma financial for SureWest. As Bob demonstrated, we are very pleased with the results for the quarter and very excited about the SureWest transaction.

Operating revenue for the second quarter of 2012 was $93 million which represented an increase of $400,000 over the second quarter of last year. Increases in network access, subsidies, data and Internet and other operations were partially offset by declines in local and long distance revenues.

Total operating expenses, exclusive of depreciation and amortization were $57.1 million, compared to $56 million for the same period last year. The increase is primarily due to transaction cost relating to the SureWest acquisition as well as to the higher video programming expenses from both the 15% growth in year-over-year video subscribers and in annual content price increases.

Net interest expense for the quarter was $16.9 million compared to $12.4 million for the second quarter of 2011. The increase was attributable to the following factors; first, we had $2.7 million for one-month of interest and $300 million of senior notes we issued on May 30th. And second, we had $2.6 million fee in amortization associated with the committed Bridge financing for the SureWest acquisition. These expenses were partially offset by lower overall cost on interest rate hedges.

Other income, net was $6.9 million, compared to $6.3 million for the same period of last year. For the quarter we received $5.9 million in cash distributions from our Verizon wireless partnerships compared to $5.8 million for the second quarter of 2011. Weighting all these factors on a GAAP basis for the second quarter of 2012, net income was $2.8 million and net income per common share was $0.09. This compared to net income of $5.4 million and net income per common share of $0.18 for the second quarter of 2011.

And a detail when your adjusted net income per share schedule in the earnings release after adjusting for the financing and transaction costs related to the acquisition of SureWest. Our adjusted net income and adjusted net income per share in the second quarter of 2012 was $5.4 million and $0.18 respectively.

Adjusted EBITDA was $44.8 million in the quarter compared to $46.4 million for the same period of last year. Capital expenditures for the quarter were $10.9 million. From a liquidity standpoint, we ended the quarter with $102 million in cash excluding $298 million in net bond proceeds. The $102 million in cash $17 million was considered restricted and held by the escrow agent under the terms of senior notes offering.

For the quarter, our total net leverage ratio as calculated in the earnings release was 4.19 times to 1. Our leverage and coverage ratios were well within compliance level at the credit facility. Cash available to pay dividends was $19.5 million resulting on a dividend payout ratio of 59.6%.

Before I move on to guidance, let me summarize the fund flow for the July second closing in SureWest. To fund the transaction we used $298 million proceeds which will be held less growth since our May 30 senior notes offering, and on the day of closing in addition to using some cash offer balance sheet we also drew the $35 million from our $15 million revolver.

We paid SureWest shareholders total cash consideration of a $176.8 million and issued just under 10 million shares of consolidated stock. We also paid off SureWest outstanding debt the amount of $225.6 million and funded transaction and related fee.

Now for our updated guidance which we are providing on pro forma basis for SureWest for full year 2012. Consistent with our existing policy, we will give guidance from CapEx, cash interest and cash taxes. Capital expenditures for the combined company are expected to be in the range of $110 million to $115 million. Pro forma CapEx for 2011 was $115.1 million. Cash interest costs were expected to be in the range of $63 million to $67 million, that’s compared to $59.7 million last year. And finally cash income taxes are expected to be in the range of $5 million to $6 million and compared to combined cash taxes for 2011 were $7.8 million.

With respect to our dividend, our Board of Directors has declared the next quarterly dividend of approximately $0.39 for common share payable on November 1, 2012, to shareholders of record on October 15, 2012.

I’ll now turn the call back over to Bob for closing remarks.

Bob Currey

So in summary, we had another solid quarter and the close of the SureWest transaction as has very excited about our future. We’re combined two solid businesses that provide significant cash flow to continue to invest in the business to support our dividend and to improve the balance sheet. The larger company has greater scale is more diversified and better position competitively in the market we serve. We will continue to deliver on our strategy by in a best service to our customers and delivering results for our shareholders.

And with that, I’d like to open it up for questions. Mamie?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions) Our first question comes from Frank Louthan of Raymond James. Your line is open.

Frank Louthan – Raymond James

Great, thank you. Can you tell us an idea of sort of the your next opportunities as far as growing subscribers and the combined businesses and when we should start to see the operational impacts of the business, of the combined businesses from a subscriber growth perspective?

Bob Currey

This quarter Frank, good morning it’s Bob. Yeah, I mean we have got the new organization in place, the sales and marketing and the capitals deployed and we should see on my prepared remarks, I commented on 2.7% revenue growth quarter-over-quarter from a year ago. And we are predicting that, we will show top line growth immediately with the combined companies.

Frank Louthan – Raymond James

Okay, great. And then just to clarify the nice uptick on that OpEx synergies of – right off the bad, I would assume sort of the next step in that it’s some of the systems conversions you alluded towards the end of the year, early next year is that how we should think about sort of the next update on that?

Bob Currey

Yes, that as planned in fact, we are bit ahead of where we had previously guided, but we expected something a little under 10 and we achieved 10 and we’ve guided Frank that leaving year one, we would be at $20 million and then the last five would come during the year two. And to your point there will be – there won’t be any big cliffs, but as back office integration projects are completed and we get on common systems between the companies, you will see a gradual, the $10 million over the next 12 months and then the final five in the last year.

Frank Louthan – Raymond James

Okay. Great, thank you.

Operator

Our next question comes from Barry Sine of Drexel Hamilton. Your line is open.

Barry Sine – Drexel Hamilton

Good morning gentlemen, congratulations on getting the deals done. A couple of questions if you don’t mind, first of all, you’re now in the California market and California continues to see challenges like municipal bankruptcies. Can you give us an update what you’re seeing in that market and you know, what’s your strategy in a challenging economy to grow both the retail and the consumer and the business segments of that business?

Bob Currey

Yeah well, thank you for the compliment Barry. Your spot on in California I think we’re a little bit different there in Northern California with the legislature being in the sacramental area. On the commercial side, their stressed in that area like others, but you know like I guess most states in Washington where that capital – when you have the seed of government you don’t get quite the pull back as others. Last year, excuse me, a little over 12 months ago, when they transitioned to Microsoft Mediaroom, they really upgraded their competitive offering on the video side and so we’re seeing some improvement there.

The business growth in data as like our other parts of the company is seeing nice growth and of course the focus on Ethernet and bandwidth will – should continue and our efforts to – their efforts were a bit more focused on residential and we’ve been a bit more focused on business and when you combine those two, I think there are some opportunities that will not only availed in South California, but also when we take some of their res focus to the legacy consolidated operations we expect to see some improvements there. We are obviously trying to capture the best processes of both companies and in fact that always started to do already.

Barry Sine – Drexel Hamilton

That actually leads to my next question with the focus on business sales. We can see in the results, the Pittsburgh like operation had a good quarter, and I think given the economy the Kansas City Metro looks like a pretty good opportunity for you in terms of business sales, can you give us a little more color in terms of what you are going to be doing there to realize that synergy in business sales in that market?

Bob Currey

Specific to Kansas City, Barry this is Bob, you don’t.

Barry Sine – Drexel Hamilton

Yeah, well, I mean I think that has a stronger economy in Kansas City and does in California, so I would think that would be a better opportunity for you?

Bob Currey

Yeah, there is no doubt. But I would say that the benefits of combining the two companies that really put us in a good position to leverage our business bundles and metro Ethernet suites across all markets, Kansas is the right market for that. They’ve got a great network. Its IP oriented. So even though they came from some cable TV heritage with the upgrades they’ve done. We’ve got a great opportunity and they’ve been capitalizing on into some degree of extending that network to businesses with the similar product suite that’s been successful for us in Pennsylvania.

Barry Sine – Drexel Hamilton

And my next question just on the Verizon dividend, they’re up modestly from a year ago. And I know there is some cash flow issues with the Verizon upgrading to LTE and the iPhone. In the past you’ve given a little bit of an outlook on how that looks going forward. Could also update us on that. Do we expect to see pretty good growth from the Verizon dividends as we get into 2013?

Steve Childers

Yeah Barry this is Steve and I’ll take that one. As you remember that we have the five partnerships, two there are in MSA markets, three there are in the RSA markets and into your question on the LTE 4G build out. That’s already behind us the metro markets, the RSA markets and the more world markets are currently doing that. So with distributions for the first half of the year, are generally layer than what they are over the last half of the year and again we are guided to where they might be slightly down for a full year 2012, compared to 2011, and past years, as they made up through this CapEx cycle. So again, we would expect the distributions to increase over the last half of 2012 and then wants that CapEx builds for 4G in LTE is behind us, we would expect to get back in the, kind of grow in the same path that (inaudible) in this guided to 10% and 11% earnings going forward.

Barry Sine – Drexel Hamilton

And that’s in the 2013 timeframe?

Bob Currey

Yeah, and again this emphasize we do expect the distributions to be higher, a last half of this year and want they where the first half.

Barry Sine – Drexel Hamilton

My last question obviously you’ve added and restructured some of the debt on the balance sheet. Could you go through a little bit – in a little bit more detail on what is the existing composition to debt or what are the interest rate pieces and what kind of a blended interest rate were likely to see going forward to help us out from a modeling standpoint?

Steve Childers

Well let’s break it down into the term debt, as a result of the transitions the term debt today’s in place we have the $880 million term debt facility put into place, (inaudible) transaction back in 2007, that’s been modified with the amendment extended that we did in June, of 2011. So at that point in time we extended 46% of the debt that moved out from the due date of December 31, 2014 to December 31, 2017. The coupon rate on the non-extended piece was 2.5%.

The coupon on the extended piece was 375, given a fact us to the hedges that we have in place. The weighted cost of debt on the term debt is about 4.9%. And if you remember with that and then extend, we also committed to start doing a 1% amortization, which came effective the first quarter of this year, so we’re basically now paying back $2.2 million a quarter. So that’s the term debt with the SureWest transaction. The bond deal priced a little higher than what we were expecting, so we downsized the original expectations for the bond deal from 350 to 300, that that priced at 10.875%. And then we also to fund the transaction we drove $35 million on the revolver and that is carrying just 3.25 coupon rate and – with the line board factor, it’s basically 3.5%.

Barry Sine – Drexel Hamilton

Okay. I’m glad I’d asked a lot of moving pieces. Thank you very much gentlemen.

Steve Childers

You bet.

Operator

Our next question comes from Jennifer Fritzsche, The Wells Fargo. Your line is open.

Jennifer Fritzsche – Wells Fargo

Thank you. Good quarter. I just – and I apologize if I missed this, your leverage ratio at 4.2. Can you even just talk about where you anticipate this going to toward? And then nice the fact that broadband growth surpassed the CLEC’s line losses was great. Do you expect this trend to continue near-term?

Steve Childers

Jennifer, this is Steve. Thanks very much for the comment. With respect to leverage, we are at 4.2 times for the earnings release. Overtime a couple of things on capital structure with the senior notes that we put into place as a result of the transaction we are really pleased that we are moving the secured leverage ratio down below, 3 times or below. Pro forma for the transaction introducing the senior notes or full turn of junior capital at the top of the capital structure, we think is going to give us more flexibility going forward. So our new target leverage giving effect to the new balance sheet and our optimism for the SureWest transaction is overtime, we would like to be back in our 3.5 times range.

Bob Currey

And Jennifer regarding your question on the access line losses are the broadband net adds being greater than the access line losses. There is absolutely no reason that that trend should not continue. I don’t see and we continue to enhance our bundle and our Triple Play and we should not, we should continue to see improvement and we still see plenty of opportunity for broadband growth in both our DSL and video offerings.

Jennifer Fritzsche – Wells Fargo

Okay, thanks Steve.

Bob Currey

You bet.

Operator

Our next question comes from Steve Blinn of Morgan Stanley. Your line is open.

Steve Blinn – Morgan Stanley

Great, thanks. Most of my questions have been asked. Just one question on the SureWest EBITDA, it looks like it was down year-over-year, just wondering if there were any one time items in the current quarter or the year ago quarter?

Steve Childers

Yeah, Steve, this is Steve Childers. Thanks for the question. The SureWest numbers and again we’ve been on the business until July 2, so it’s not being the numbers, so just trying to be helpful of what we’ve presented there. But their numbers were influenced by probably around $700,000 in an excess dispute that was booked at the end of the quarter – second quarter of 2012 and we did as we collaborating on the closing process, we did encourage SureWest, you know can’t cleanup a couple of things and dispute item was one of the, and I think just generally the trend on some video programming content, the timing of that also kind of impacts the numbers as alone.

Steve Blinn – Morgan Stanley

Okay, great. And then on the revolver side, did you I think you said $35 million in the quarter to help fund some of the closing cost is that something you expect to repay in the near future or is it once you have passed some of the upfront cost with regard to the deal on the integration?

Bob Currey

I think over – we having set a timeline from when we’ll we repay but there is no term loan on that the extension of the credit facility itself, but can you point we do need to move through some integration we do have some additional one-time cost coming up that we will look to pay back as soon as possible.

Steve Blinn – Morgan Stanley

Okay great. And then the final question I had was just you know it has been a lot of impress again with regard to Google now at Kansas City. Has anything changed there and my assumption that there in a different area than your current footprint, has anything changed there, have you seen anything there that we should be aware of?

Bob Currey

No I think your assumptions are still spot on and very accurate. There is no overlap with our serving territory, they are not anywhere near us and frankly at least the public announcements of their offerings it’s a totally different package clearly not a robust video offering. And frankly, our customers there do not demand the kind of bandwidth that they are offering at the price points. So at this point, we don’t – we’ll obviously follow it but we don’t see any impact on our business.

Steve Blinn – Morgan Stanley

Okay, great. Thank you.

Operator

Thank you. (Operator Instructions) We have a follow-up question from Frank Louthan of Raymond James. Your line is open.

Frank Louthan – Raymond James

Yeah, I wanted to touch base on the CapEx guidance. Turning to a little higher than I would have thought, I just want to see is there anything in that that sort of one-time integration kind of CapEx? And is that – that of the CapEx synergies you’re expecting? Or should we see – should we expect to see that trend down a little bit going forward?

Steve Childers

Yeah, Frank it’s – there is very little synergy or integration CapEx in that number. Basically the guided number is the pro forma that both companies have provided in the past. And as we’ve announced, they’ll be $5 million to $10 million of CapEx synergies in 2013 and there’ll be a modest reduction because of the integration.

Frank Louthan – Raymond James

Okay. And what was the CapEx at SureWest in the second quarter?

Steve Childers

We’re scrambling here Frank that the number was 70 – the budget was 70 for the year and – Frank we had on – looking at the press release and we did call that out here, it was 21.5 for the quarter.

Frank Louthan – Raymond James

Yeah.

Steve Childers

It was a little higher than – you know it’s the building season and it was not proportionate over the four quarters, but we’re on target for $70 million as they previously guided.

Frank Louthan – Raymond James

Okay. Thank you.

Operator

Our next question comes from the Donna Jaegers of DA Davidson. Your line is open.

Donna Jaegers – DA Davidson

Hi, sorry if you’ve answered some of these questions, I joined in progress. Did you give any sort of color on the access charge impact for in a carrier competition in the third quarter?

Steve Childers

Donna, this is Steve. We did not give that, no one ask that question – tough we might make it through the call without...

Donna Jaegers – DA Davidson

That’s good.

Steve Childers

That’s for asking. Yeah the impact with the July 1 kind of scheduled step down. I mean there is two things happening as you probably are aware of. We’re (inaudible) wireless goes away as well as we start to step down for jurisdictional parity on the terminating switched access rates. And there is a lot of moving parts to those but we would – on a combined pro forma basis, we would describe – we would estimate our exposure all things considered to be between a $1 million and $1.05 million for the last half of the year. And again we really comfortable I think it is manageable number, again we remind you that based on the last several years, based just degradation and great minutes of use rate deductions and things like that.

We’ll also have access lines we’ve been more than holding our own with loosing considerably more than that – of revenues. So if better things available to us like looking at the ARC and other things when we think it is more than manageable.

Donna Jaegers – DA Davidson

And that $1 million to $1.5 million is that net of the ARC charges that you guys have put in place?

Bob Currey

Yes, yes it is.

Donna Jaegers – DA Davidson

Okay. And on ARC are you prohibit, I know there was a $31 limit on residential if you were above that limit on basic service, you couldn’t charge ARC, do you guys run into that that...

Bob Currey

There is...

Donna Jaegers – DA Davidson

That limited in place?

Bob Currey

Yeah, there is a baseline number, I would like to know on addition or the local rates are, we are not going to be able to do that. But in some of our taxes and PA markets particularly in Texas where are the rates are lower, we’ve got to a little bit; we got more ability to move the rates, still maintain a strong competitive advantage.

Donna Jaegers – DA Davidson

Great, and then I know Texas on the universal service fund, will keep waiting for to see what it comes out the SEC, but I think Texas was looking at their high cost fund as well, have they come any sort of decision there, or is there any timing that you can help us with on that?

Bob Currey

No, on Texas no, I think there has been more absent like with the hike – the large company fund in Texas we are in the small company fund. And there is nothing that will be 2013 or later in 2013 if that all.

Donna Jaegers – DA Davidson

Okay. And then on I had one another question about I looking forward here, oh on SureWest and on the Kansas City effort that Google is making. And talking this year was previously they held out maybe the possibility they have a call center, I guess, base in Kansas City that maybe they could potentially help Google with whatever services Google wanted to offer. Is that a correct understanding, is there actually a call center in Kansas City or just that show us had a call center that they were using for the Kansas City over build out for?

Bob Currey

Yeah, now Don and there is a call center there, but I would tell you that it’s probably a stretch that we would be doing call center work for Google, I’m here to stay. If they were looking for some help and we could make some money added, sure but I don’t see that as a possibility. There is a possibility though if some facility arrangements with them with our nice network that we have deployed over that – depressed that with SureWest had deployed. There is some possibilities for some sharing of some traffic there. But that would be it I don’t see as much of an opportunity with the call center.

Donna Jaegers – DA Davidson

Bob that would be more using the video head on that show was to just put in place already?

Bob Currey

No, it would be more transport facilities, the fiber that we’ve deployed in the Kansas City Area.

Donna Jaegers – DA Davidson

Okay. All right, thanks.

Bob Currey

Thank you.

Operator

Thank you. Our next question comes from (inaudible) of Goldman Sachs. Your line is open.

Unidentified Analyst

Hi, how are you? I was just wondering, if you can tell us what the revolver balance is currently? And then I had a follow-up question on the pension and (inaudible) contribution, I was wondering what that was for the quarter? Thanks.

Steve Childers

The – this is Steve Childers. The revolver balance we had again the original facility, we had capacity of $50 million and down $35 million as part of the closing on transaction in pension.

Bob Currey

In pension.

Unidentified Analyst

That was out of July 2, which you can comments what is currently?

Bob Currey

I think no change.

Steve Childers

Royalty to the pension fund, the question was how much we paid in the second quarter?

Unidentified Analyst

Yes.

Bob Currey

For CNSL 1.9. And then again with the new legislation, it was impacted. We expect to see the combined requirements for the last half of the year kind of reduce by about $4.5 million.

Unidentified Analyst

Okay. Thank you.

Operator

Thank you. I’m showing no further questions in the queue at this time. I will hand the call back to Bob Currey for closing comments.

Bob Currey

Thank you again for joining us today and for your continued interest and support of Consolidated Communications. We hope you will join us again next quarter. Thanks and have a great day.

Operator

Thank you. Ladies and gentlemen, this concludes the conference for today. You may all disconnect. Have a wonderful day.

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