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NIC Inc. (NASDAQ:EGOV)

Q2 2008 Earnings Call

July 30, 2008 4:30 pm ET

Executives

Nancy Beaton - Director of IR and Communications

Harry Herington - Chairman of the Board and CEO

Steve Kovzan - CFO

Analysts

Charlie Anderson - Doherty & Co

Nick Gogerty - Fertilemind Capital

James Cakmak - Sidoti & Co

Chad Bennett - Northland Securities, Inc

Operator

Good afternoon, ladies and gentlemen, and thank you for standing by. Welcome to the NIC second-quarter earnings announcement conference call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions. (Operator Instructions) This conference is being recorded today, Wednesday, July 30, 2008.

I would now like to turn the conference over to Nancy Beaton, Director of Investor Relations and Communications. Please go ahead, ma'am.

Nancy Beaton

Thank you, operator. The press release for NIC's second-quarter earnings announcement was issued 30 minutes ago. For those of you who haven't received the release, the announcement is available on our corporate website at www.nicusa.com. And you may also call our headquarters at 1-877-234-3468, and Chris Davies will fax the information to you.

But before we begin, let's cover our customary Safe Harbor statement. Specifically, the statements in this release regarding continued implementation of NIC's business model and its development of new products and services are forward-looking statements. There are a number of important factors that could cause actual results to differ materially from those suggested or indicated by such forward-looking statements. These include, among others, the success of the company in signing contracts with new states and government agencies, including continued favorable government legislation; NIC's ability to develop new services; existing states and agencies adopting those new services; acceptance of eGovernment services by businesses and citizens; competition and general economic conditions and the other important cautionary statement and risk factors described in NIC's 2007 annual report on Form 10-K filed with the SEC on March 17, 2008 and NIC's Form 10-Q for the quarter ended March 31, 2008 filed with the SEC on May 12, 2008.

I would now like to introduce Harry Herington, Chairman of the Board and Chief Executive Officer of NIC.

Harry Herington

Thank you, Nancy. Good afternoon, and thank you for joining us for NIC's second-quarter earnings call. We truly appreciate your time today as we discuss the events of the quarter and our financial performance.

I will begin with the important topics and metrics for the second quarter, and then Steve Kovzan, our Chief Financial Officer, will provide additional financial details. After that, we will open up the call and take your questions.

First, let's discuss new state opportunities. As you know, we don't normally talk about active opportunities on these calls, as it has been our longstanding belief that the time to talk about new deals is after the contract has been signed. However, as we continue to see our enhanced sales efforts paying off, there has been a lot of discussion around several large opportunities. Thus, I believe it is important to clarify what those opportunities are, the timing, and the next steps around each.

Let's start with New Jersey. The New Jersey RFP issued earlier this summer was a self-funded enterprise portal opportunity, and one we are excited about. The original due date of our response was moved from mid-June to August 8 due to changes within the state's internal timeline. This is very common in government procurements, and does not cause us any concerns.

Next is Georgia. Georgia issued a request for qualified contractors in mid-May, which was used to downselect a small number of providers to which the RFP was issued. NIC was selected as one of three providers for Georgia. BearingPoint and Deloitte are the other two. As usual, we expect this to be a very competitive procurement. We received the Georgia RFP late last week, and as the state has publicly stated, our bid is due September 2.

We are currently in the process of reviewing the RFP and we are under a nondisclosure agreement with the state. Thus, we are unable to make further comments on the contents of the RFP. With both of these opportunities, we believe NIC has the best experience, expertise, and financial models to deliver an outstanding portal, which is the belief that is shared by our 21 state partners.

Now, on to Texas. The state has said its current portal contract will go out for rebid. The last communication from the state is that the RFP will be issued later this year, and an award will be made in the latter half of 2009. California is still working on certain aspects of its bid. The business model addendum originally expected in mid-June is now slated for mid-September, and then the new award date for California is June 2009. Again, delays are very common.

Finally, I have received questions concerning the current New York website redesign. It is important to note that this is not an enterprise-wide portal opportunity. This is strictly a time and materials opportunity with a $500,000 cap on it. This project has numerous and highly complex requirements and a very short delivery timeframe. We do not feel this is a solution we can provide profitably within the time required; thus, we have elected not to bid on it. That being said, we do not believe this decision will impact our ability to obtain a potential enterprise-wide portal opportunity in New York, and we continue to actively pursue that opportunity.

Along with these public opportunities, we are also in active talks with numerous other states. In keeping with our long-established policy, we won't be disclosing the specific states or the status of those discussions until the state should issue a public statement or RFP. All of this activity gives us a high level of confidence in our total sales pipeline.

I'm going to sound like a broken record here, but it is important to remember that we are working with timelines of state government. And while we do everything we can to encourage states to issue RFPs, adhering to stated timelines and the final decision to issue an RFP is outside of our control, and delays are common practice. In addition to pipeline, maintaining our current business is equally as important. We're pleased to announce contract awards and renewals from current partners that took place in second quarter.

Idaho signed a new three-year contract with renewal options through 2015. Arkansas renewed for an additional two years through June 2010. South Carolina renewed for another year through July 2009. And finally, Oklahoma renewed for another year through June 2009. We want to thank these states for their continued partnership, and all of our employees who work hard to make these partnerships possible.

Now onto a topic that doesn't impact the day-to-day business, but has generated a lot of recent attention, the dissolution of the National Information Consortium Voting Trust. It is important to clarify that the voting trust has always been managed independently of NIC by the company's original founders, Jeff Fraser and Ross Hartley. We're not here to speculate why the trust dissolved or what the former members plan to do with their NIC shares.

Rather, we want to provide you a quick update on the status of the shares previously held by the trust, as it appears the anticipation of these shares potentially hitting the market has caused some volatility in our stock price. The trust previously held 21.4 million shares, or roughly 34% of our total shares outstanding. 13.2 million shares are held by officers and directors of NIC, and are subject to SEC Rule 144 trading restriction for as long as an affiliate remains an affiliate.

The other 8.2 million shares are held by non-affiliates. Former voting trust members are currently in the process of converting their voting trust certificates to shares of NIC stock. Upon advice of counsel, NIC submitted a written request for interpretive guidance to the SEC as to whether or not the shares distributed from the voting trust are prohibited from trading for six months after the date of the trust dissolution under Rule 144.

All affiliate and non-affiliate shares distributed from the voting trust will initially be restricted from trading while NIC seeks guidance from the SEC. Currently, we anticipate receiving a response from the SEC in 30 to 60 days. During this time, we are communicating with former voting trust members so that they are aware of NIC's business prospects and the long-term growth strategies so they can make an informed decision when it comes to their holdings.

The final topic before we hit on second-quarter results is the status of the SEC investigation into employee expense reimbursements. NIC received notice from the SEC that a formal order of investigation has been issued with respect to the employee expense reimbursement and related matters that were the subject of an internal investigation completed by NIC's audit committee in February of this year, as disclosed in NIC's Form 8-K filed on February 6, 2008.

As is frequently the case in such situations, the SEC has taken the step of obtaining a formal order of investigation to ensure the thoroughness of its investigation. We believe the investigation conducted by the NIC audit committee was thorough and independent, and we do not anticipate the SEC investigation will reveal any significant additional instances of misreporting of expenses by employees.

Okay, now onto the results for the second quarter. Second quarter was solid. We saw record portal revenues of $24.6 million and earned $0.05 per share. Same-state non-DMV transaction revenues grew 25%, which is in line with our expectations. As you know, non-DMV revenue growth is delivered through the launch of new services, as well as increased usage of existing services across our state portals. In 2007, we lost a total of 368 new revenue-generating applications, or more than one per day. So far this year, we have launched 262 revenue-generating applications, and currently have another 188 in the pipeline.

With that, I will turn the call over to Steve for additional details.

Steve Kovzan

Thanks, Harry. For the second quarter, total revenues were a record $24.6 million, a 19% increase over the same period last year. On a same-state basis, portal revenues grew by 13%. Breaking out the components of this same-state growth, non-DMV transactional revenues grew at 25%, as Harry previously mentioned, while DMV revenues grew at 1%. Both of these metrics were consistent with our results from the first quarter of this year.

Total gross margins for the quarter were 47%. We sometimes get questions about why our margins aren't higher. And the answer that I always give is that we try hard to strike a careful balance between delivering the returns that our shareholders expect and reinvesting in the long-term success of our portal operations, which is what our partners expect. Our gross margins have historically been in the 45% to 50% range. And that is where we expect them to be going forward.

On the expense side, selling and administrative expenses for the quarter were $5.8 million as compared to $5.4 million last year in this same quarter. However, as a percentage of portal revenues, selling and administrative expenses were 24% in the current quarter, down from 26% in the second quarter of 2007.

Operating income was $5.3 million in the second quarter, up 16% over second quarter 2007. As many as you know, we have made growth investments in sales, marketing, and operations to the tune of about $4 million, most of which shows up in the selling and administrative line in the income statement.

We are seeing multiple returns from this investment, with a robust sales pipeline and continued strong organic growth from our existing portal businesses, despite a miserable economy. We expect this investment to result in long-term returns in the form of operating margin expansion, earnings growth, and new state wins.

With that, I will turn the call back over to Harry.

Harry Herington

Thank you, Steve. Operator, we're now open for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Charlie Anderson with Doherty & Co. Go ahead, please.

Charlie Anderson - Doherty & Co

Good afternoon. Thanks for taking my questions. Just a few housekeeping items. First of all, I am wondering on the new state revenue. How much came from new states in the quarter?

Steve Kovzan

Sure, Charlie. Hi. How are you?

Charlie Anderson - Doherty & Co

Good.

Steve Kovzan

In terms of our new state, we are referring to Arizona, which was during the quarter about $1 million, which is right in line with that $4 million a year run rate, and in West Virginia, about $400,000.

Charlie Anderson - Doherty & Co

Great. And then also, I just wanted to understand some the dynamics in the software development and portal management line. It looks like it is kind of down sequentially here, and was also last year. Is there some seasonality in that line I should think about going forward?

Steve Kovzan

You're talking within the portal revenue, the component of the portal revenue that relates to software development and portal management?

Charlie Anderson - Doherty & Co

Yes, you got it.

Steve Kovzan

Yes. We have a couple of onetime larger projects in the first quarter. That can tend to be a little bit lumpy, because it is time and materials. And there were a couple more in the first quarter. So there really is no seasonal aspect to the T&M line.

Charlie Anderson - Doherty & Co

Got you. And then on portal gross margins, you did make a comment on that. I appreciate that. We have seen them down just a little bit year-over-year, both quarters here to start of the year. I just wonder if that is kind of going to be the trend here going forward, or if you guys see any possible leverage in that, in terms of comping against a year ago on the gross margin line?

Steve Kovzan

Yes. When we provided our guidance for the year, we provided guidance of margins between 45% and 47%, and certainly one of the things that contribute a little bit to lower margins is some of the startup margins in our newer portals, most notably in Arizona, as you might recall, we are in the process right now of re-quoting all the applications that the state previously had, and migrating them over to the NIC source code. And so our margins are a little bit lower in Arizona during the first six to nine months of 2008 than they will be going forward. And also, we're seeing a new portal in West Virginia also start to fully ramp.

So those are some of the dynamics at play here. But I don't think that it's indicative of where we expect to see long-term margins in the business. I hope that answers your question.

Charlie Anderson - Doherty & Co

Yes, absolutely. A question here for Harry. Harry, if you could talk a little bit about this SEC investigation as it relates to the headline risk here. I know you guys have kind of had this headline out there already in the past. And you have been in communication with your states, your portal opportunities that are out there. They're going to hear this about this same time we are right here.

I just wonder if you could kind of talk a little bit about the reaction that we could expect. Could this potentially cause some more delays in terms of people wanting to move forward with you, given this headline that is out there?

Harry Herington

I'm not expecting this to have a material impact on our business, internally or externally. We have been very open concerning when it was an SEC inquiry. And now, routinely, they have issued a formal order. I do not expect this to impact our current partners or our sales opportunity. We have been very open.

Charlie Anderson - Doherty & Co

And then, as it relates to the timing on that, I'm not sure if I missed that. Do you know about how long you expect this to go on in terms of this investigation?

Harry Herington

Absolutely not. All we know is that they have issued a formal order.

Charlie Anderson - Doherty & Co

And when did the order come out?

Harry Herington

It came out last month.

Charlie Anderson - Doherty & Co

Okay, got you. That’s it for me. Thanks, guys.

Harry Herington

Thank you, Charlie.

Operator

Thank you. And our next question comes from Nick Gogerty with Fertilemind Capital. Go ahead, please.

Nick Gogerty - Fertilemind Capital

Yes, just wondering if you would comment in regards to some of the things we're seeing in the economy. Is that going to have an impact potentially on margins? Let's say some of the licensing goes up, you take a percentage of that. And then in terms of your cost of delivery and development, is there any potential for impacts?

Harry Herington

This is Harry, Nick.

Nick Gogerty - Fertilemind Capital

Yes.

Harry Herington

Right now, I'm not expecting there to be a negative impact at all.

Nick Gogerty - Fertilemind Capital

Sure.

Harry Herington

What we have noticed and we have ridden through some of these in the past, because we have been at this for quite a while, that when there is an impact in the economy, that impacts state tax dollars, which also impacts the state's ability to hire individuals, to maintain the same level of service that the citizens and businesses are used to getting.

Thus, we are the logical solution. And so they look to us more and more to provide not only the current solutions, but also when you see a downturn, there's new need. There are new issues that come up that state agencies have to deal with. And we are the logical choice again for them to turn to.

So I am actually, and I hate saying this, but this is a good time for us as a company.

Nick Gogerty - Fertilemind Capital

I understand from new opportunities, definitely, there is a push. I was just wondering if states in their drives for new revenues maybe upping some of the tariffs and licenses, and if you actually would get a lift from that in kind of a percentage carry-on along with that?

Harry Herington

Typically, that is not the case. As they raise their rates, we don't typically see that increased with ours.

Nick Gogerty - Fertilemind Capital

Okay.

Harry Herington

I would not expect to see much there.

Nick Gogerty - Fertilemind Capital

Okay. Thank you.

Operator

Thank you. And our next question comes from James Cakmak with Sidoti & Co. Go ahead, please. (Operator Instructions.)

James Cakmak - Sidoti & Co

Hello, good afternoon.

Harry Herington

Good afternoon. Hi, James.

James Cakmak - Sidoti & Co

I know we just touched on the economy, but I specifically wanted to target the DMV line. Do you think we could expect to see any type of weakness on that line from weaknesses in the economy and higher energy cost, like people driving less or seeking less insurance?

Harry Herington

James, I'm going to start, and then I'm going to turn it over to Steve. I would tell you it is too early to tell. DMV is still within where we expect to be, between 1% and 3%. And it is related sometimes to new car sales, used cars sales, and what have you. I would say it is really too early to tell if there will be an impact there. I'm not overly concerned because, again, there will be a larger demand for the non-DMV.

With that, Steve, do you have anything you would like to add?

Steve Kovzan

No, James, we typically talk about, absent any type of price increases. We usually see same-state DMV growth of 1% to 3%. In the first quarter it was flat. In the second quarter here that we are reporting on, it was about 1%. And so while DMV is not wildly exceeding our expectations, who knows where the economy is going to go and we have never found a real close correlation between new car sales, used cars sales, whatever, the economy, and DMV, per se..

So it is too hard to tell. But it certainly has not had a significant negative material impact on our company. It has been kind of a flat performer for us.

Harry Herington

If everybody in the country starts riding bicycles and quits driving their cars, there could be an impact. But we really don't. I'm not trying to be facetious. It's right in line with what we expected.

James Cakmak - Sidoti & Co

Okay. As far as margins go, we did see a slight dip in the portal. But in the software and services, the costs of revenue went up considerably there. Can you shed some color on that?

Steve Kovzan

Sure. Primarily two new states for a full quarter: Arizona, which wasn't in our cost base in the second quarter of 2007; and West Virginia. Those are two primary reasons, in addition to just normal expense growth within the portal.

James Cakmak - Sidoti & Co

Okay. And then finally on the voting trust, once these shares are allocated to their respective non-affiliate beneficiaries, has there been any discussion around possibly repurchasing those shares from those beneficiaries?

Harry Herington

And the company repurchasing the shares? That is not an active board discussion right now. Where we are focused is educating them, making sure that they are quite aware of where we are at. The good news that we have and the growth opportunities that we have and let them make their decisions from there.

James Cakmak - Sidoti & Co

Okay, great. That’s it for me.

Harry Herington

Thank you.

Operator

(Operator Instructions) And our next question comes from Chad Bennett with Northland Securities, Inc. Go ahead, please

Chad Bennett - Northland Securities, Inc

Yeah, thanks. Hi, guys.

Steve Kovzan

Hi, Chad.

Chad Bennett - Northland Securities, Inc

There wasn't anything in the press release, and nothing in your formal remarks on the call. But I am assuming you are comfortable with the '08 guidance that you gave top line and segmentation and everything that you gave last quarter, and at the end of last year?

Steve Kovzan

Yes, our guidance did not change.

Chad Bennett - Northland Securities, Inc

Okay. And then circling back to Arizona, can you just give us a kind of status update? You talked a little bit about doing some recoding work. An update of how that implementation is going? If it's on track? And when we officially will transition the site over? And I don't know if go-live is the right word, but be up and running on your code?

Harry Herington

First off, this is Harry, Chad, and it is right on track. We are very comfortable with where we are at. The partner is very satisfied with our progress. We're looking, and I am with you, going live, because we have already gone live with several of the applications. But October, we are hoping, is going to be the transition timeline.

And if you hear any hesitance in my voice, remember, we're transitioning from someone else. So occasionally, you hit bumps in the road that you are not anticipating. So I will never be just definitive. But yes, we're expecting October.

Chad Bennett - Northland Securities, Inc

Okay. And do we still think, since everything seems to be going pretty good, do we still think there's the opportunity there to up-sell and get incremental business sometime near-term after you're up and running?

Harry Herington

We are already starting to do some of that now.

Chad Bennett - Northland Securities, Inc

Okay.

Harry Herington

We are in transition. We have already started doing some new development there. And once we get through the transition, everybody is going to be more comfortable, and absolutely.

Chad Bennett - Northland Securities, Inc

Okay. And digging into forward-looking stuff and guidance, the non-DMV same-state growth of 25% this quarter was good. I am assuming we still think that is a good hurdle rate going forward, at least looking out the next six months for the non-DMV piece?

Steve Kovzan

Yes, for the year, non-DMV, that is a reasonable estimate for the year, give or take.

Chad Bennett - Northland Securities, Inc

Okay. And I guess one last question. SG&A was actually a little bit better than what I was thinking, better meaning a little bit lower. Is this kind of an ongoing run rate, Steve? Or was there anything that would have benefited SG&A during the quarter that would have been one time?

Steve Kovzan

There were no onetime items that would have, we would have talked about it, but there were no onetime items in SG&A. SG&A isn't a perfectly flat number for us. In the first quarter, it can bounce around a bit when we have professional fees relating to audit services and things of that nature. So there's really nothing that's driving SG&A in an unusual way this quarter.

Chad Bennett - Northland Securities, Inc

Okay. And can you guys just refresh our memory of, I don't want to get into new RFPs or anything like that, but when we do layer on a new state or a couple of states, the upfront investment, the impact early on, maybe the first couple of quarters out of the gate on gross margins, and then the leverage we should see maybe 12 to 18 months out, maybe that's too much to ask. But can we kind of go over that process?

Steve Kovzan

Sure, Chad. We typically see some, I mean, it is a good problem to have, startup dilution in our expense line from new portals. Our rule of thumb is that it typically takes us or costs us anywhere between $0.5 million and $1 million to start up a portal. Now, half of that expense would be capital type expenditures where we are buying servers, and infrastructure things of that nature that get capitalized and that expense gets spread over time.

But the other half is literally just putting a new general manager in place and his or her staff. And it's the employee expense that we incur prior to the time we begin to generate revenues. Typically, the first service we launch is that DMV service. And within that first year that DMV is up and running, we are typically able to earn margins in the 40% range and we are able to grow them from there by adding new services.

So that's kind of the standard way we grow, and the great thing about the business is that we're typically able to pay back that initial investment in no longer than 12 months from a pure cash flow standpoint.

Harry Herington

One thing I would state, I think it would be important. Due to the size of some of the opportunities that are out there, it might take more. But the upside is so much more when we might have to invest more than we typically have in the past. But there is such a tremendous upside it would be worth it.

Chad Bennett - Northland Securities, Inc

I guess maybe a more simple question is, if we added a couple of the smaller states that you talked about in your presentation, maybe it applies to any state, for that matter -- does SG&A necessarily have to increase? Is there additional investment that needs to be had in SG&A to add a couple of those states?

Harry Herington

No.

Chad Bennett - Northland Securities

Okay, that's basically what I was trying to get at in a long way.

Steve Kovzan

Sure, sure.

Chad Bennett - Northland Securities

Okay, good. And just one last quick one, and maybe you can't answer this, but, if we look at your self-funded portal states that you already have onboard, and we look at your blended gross margin there of 47%. Is there a big delta, Steve, between maybe, some of your older states, without naming states in terms of the gross margin on that business versus maybe states you have added within the last two years? Is there any way you can give us a range there? Maybe you can't?

Steve Kovzan

No. We have a very diversified portfolio of portals with margins that range above the 40% and below. And it is not entirely dependent on whether it is new or old.

Chad Bennett - Northland Securities

Okay. Fair enough.

Steve Kovzan

I can't give you any guidance there.

Harry Herington

The older states are not necessarily the ones that are going to have lower margins, if that is where you are headed.

Steve Kovzan

Yes, or higher -- I mean the ones at the higher end -- that is what I am saying.

Harry Herington

We haven't saturated market in any of our states. So I think it's --

Chad Bennett - Northland Securities

Okay, so it doesn't necessarily -- that gives me some info. Okay. Thanks, guys, and good quarter by the way.

Harry Herington

Thank you, Chad.

Operator

Okay. Thank you. (Operator Instructions). And we have a follow up question Charlie Anderson. Go ahead please.

Charlie Anderson - Doherty & Counselor

Sorry guys, just a few quick follow-ups. Steve, I just want to go back to the comment on the service margin line, where you had kind of the impact of those two new states. Is that kind of a run rate going forward, that 35%? Or is there a lot of sort of onetime effect in that?

Steve Kovzan

Charlie, I'm not following you. I think James had asked that the increase in -- what the increase in cost of portal revenues basically related to. Or maybe the margin going from -

Charlie Anderson - Doherty & Counselor

Well, the service margin is, I think what we were looking at.

Steve Kovzan

Oh, so you are looking at your software and services margin?

Charlie Anderson - Doherty & Counselor

Yes, exactly, exactly.

Steve Kovzan

In the other portion of the business.

Charlie Anderson - Doherty & Counselor

Yes, it went from like 51% to 35%.

Steve Kovzan

Oh, I see what you are saying. Yes, again, because it is a time and materials based business, it can bounce around a bit. But I think historically, that business has been a little bit lower than our portals in the 35%, 40% range, and kind of where we expect to see it long-term. There can be some ups and downs among quarters. But long-term, it's probably going to be lower than our portal business.

Charlie Anderson - Doherty & Counselor

Probably, for the year, probably a 35, 40 is a pretty safe place to be in that range.

Steve Kovzan

Sure.

Charlie Anderson - Doherty & Counselor

And then, as it relates to the SEC investigation, again, just real quick on the expense line. I wonder if there is any added legal cost with that that you guys are going to have to incur?

Harry Herington

We may very well incur expense in the future. It is hard to predict what that might be. This quarter, there was not a significant amount of expense from that in this quarter.

Charlie Anderson - Doherty & Counselor

Got you. But, it doesn't sound like its material enough to kind of call it out or anything like that?

Harry Herington

Until we hear more from the SEC, no.

Steve Kovzan

Yes, we are not putting forth a lot of effort, and spending and spending a lot of money on it now. I'm not saying that that couldn't be the case in the future. But I am just saying that in this quarter's numbers, there's nothing of significance in there.

Harry Herington

Or so far, to date.

Charlie Anderson - Doherty & Counselor

Yes, Got you. Okay, thanks.

Operator

(Operator Instructions) And we currently have no more audio questions. I would like to turn the conference back over to management for any closing statements.

Harry Herington

Thank you, operator. I want to thank everybody for joining us this afternoon. I'm very excited about our future opportunities and our current partnerships at NIC. We are not distracted by the SEC or the voting trust issues that are out there. And NIC is as strong as ever. And with that, I look forward to speaking with you next quarter. Thank you, everybody.

Operator

Ladies and gentlemen, this concludes the NIC second-quarter earnings announcement conference call. You may now disconnect. And thank you for using ACT Conferencing.

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