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Executives

Jim Gruskin –VP, Finance and IR

Dave Swanson – Chairman and CEO

Steve Blondy – EVP and CFO

Analysts

Matt Chesler – Deutsche Bank

Michael Meltz – JP Morgan

Peter Salkowski – Goldman Sachs

Aaron Watts – Deutsche Bank

Robert Skrzypczak – Credit Suisse

Ken Silver – RBS

Todd Morgan – Oppenheimer & Company

Andrew Finkelstein – Barclays Capital

R.H. Donnelley Corporation (RHD) Q3 2008 Earnings Call Transcript October 23, 2008 10:00 AM ET

Operator

Good morning ladies and gentlemen. Welcome to the R.H. Donnelley Third Quarter 2008 Results Investor 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 be given at that time. Please note that today's call is being recorded, as well as webcast live over the Company's website at www.rhd.com.

I would now like to turn the call over to Mr. Jim Gruskin. Mr. Gruskin, you may begin.

Jim Gruskin

Thank you and good morning everyone. I am Jim Gruskin, VP of Finance at R.H. Donnelley. Hosting the call today are Dave Swanson, Chairman and Chief Executive Officer of R.H. Donnelley; and Steve Blondy, Executive Vice President and Chief Financial Officer.

Certain statements made today may be forward-looking within the meaning of the Private Securities Litigation Reform Act. We call your attention to our press release for the quarter ended September 30th, 2008, and the Company's Form 8-K furnished to the SEC this morning, both of which discuss third quarter results.

We also encourage you to review the company's other periodic filings with the SEC, which set forth important factors that could cause actual results to differ materially from those contained in or suggested by any forward-looking statements. Copies of R.H. Donnelley's SEC filings may be obtained by contacting R.H. Donnelley, searching its website at rhd.com, or visiting the SEC website at sec.gov.

This transmission is the property of R.H. Donnelley Corporation, and any retransmission or broadcast without the expressed consent of the company is strictly prohibited.

During today's call we will make references to certain adjusted figures such as EBITDA, free cash flow, and net debt. Certain of these figures exclude costs such as restructuring charges, FAS 123 expense, restrictive stock unit expense related to the Business.com acquisition and goodwill impairment charges.

Some of the items we will be discussing are non-GAAP financial measures, and additional information about non-GAAP financial measures as well as reconciliation between these items, and the most comparable GAAP measures can be found in the press release and related 8-K furnished to the SEC this morning.

The press release is available on our website and can be accessed by going to www.rhd.com, and clicking on Press Releases. Please review the risk factors described in the Safe Harbor language.

And with that, I would like to turn the call over to Dave.

Dave Swanson

Thank you, Jim. Good morning everyone. Thanks for joining us today. I think to say that this has been an interesting quarter, would be an understatement. Let me just start with a few headlines on what is happening here specifically at R.H. Donnelley.

First, despite the very challenging economic environment in the quarter, we delivered revenue of $648 million and solid EBITDA once again of $334 million. Second, we maintained focus on delivering the balance sheet and lowered net debt by more than $150 million in the quarter.

Third, published ad sales for the quarter declined 8.3%, as expected and in line with Q2. However, ad sales in recent weeks, that will show up in our Q4 results, have trended worse reflecting the unprecedented economic events and fear surrounding the banking crisis, and as a result we have revised our guidance for full-year 2008 ad sales to the low end of our previous range, down approximately 8%.

Fourth, we recognize that the operating environment is likely to remain challenging through next year and we continue to make meaningful progress on our initiatives to improve efficiency and eliminate unnecessary costs in the business.

And finally, in spite of the pressures we are facing to reduce costs in this environment, we remain committed to our strategy of broadening and constantly improving the platforms we use to deliver our advertisers message to consumers seeking the products and services they provide.

Let me provide some color on what we have been seeing in our markets, and this is probably going to sound familiar given what you have been hearing elsewhere about the economy and other local media companies.

Deteriorating consumer sentiment and a lack of available credit can put enormous pressure on small businesses and it forces many to dramatically cut costs in order to remain profitable or even stay in business.

While the impairment had somewhat stabilized over the last two quarters, the events of recent weeks triggered even more distress and caution among small businesses.

With all of our leading indicators turning modestly lower once again, we have become slightly more embarrassed with our guidance.

According to the most recent National Federation of Independent Businesses Survey, expectations for sales growth among small businesses is at its lowest level in over 28 years, meanwhile in Visa’s Latest Quarterly Small Business Survey, more than 40% of companies cited staying in business as a critical or a major concern.

These survey results are consistent with our observations in the field. We are seeing weakness in all markets across virtually all business categories and among local and national advertisers of all sizes.

Large metro markets continue to perform the worst, but even smaller markets are feeling the effects. Recurring ad sales from existing customers continue to be challenged by higher than normal decreasers and defectors as well as significantly lower increase to existing ad programs.

The majority of our advertiser cancellations are coming from businesses that have fallen too far behind in their monthly payments to be allowed to renew or have gone out of business altogether.

Now, as bad as this may sound, it is important to note that the vast majority of our customers are continuing to advertise. They may not be buying or increasing their programs as much, but they know the value and continue to see us as the go-to solution for driving prospects to their place of business.

As I mentioned earlier, we are actively managing our cost structure to adapt to an environment that may remain challenging for the next several quarters. We are prudently managing down expenses and improving our productivity and efficiency along the way.

Employee-lead teams across the entire company continue to work closely with experienced consultants to improve our processes and systems in every area. Year-to-date, our initiatives have yielded a 13% reduction in head count across the enterprise. This comprehensive project will continue through next year.

And finally, we continue to build the foundation for long-term growth by extending the reach of our advertisers and constantly improving upon and expanding the platforms available for consumers to search our content rich and highly accurate database on local businesses.

This month, we rolled out our exciting new voice search platform, 1-800-CALL-DEX, across the 14-state Qwest region. This service allows consumers to use their phone to search our accurate and comprehensive database of local business information as well as locate businesses near landmarks or other convenient search criteria.

By year-end, we will launch the beta for DexKnows.com 2.0, our next generation local search site. In addition, in the first half of 2009, we will be launching the Dex Search Network and a new DexKnows.com platform for mobile, continuing to increase consumers' ability to access our unique and up to date content over additional convenient platforms.

Also of note, at the most recent Search Engine Strategies Conference in San Jose, a leading international conference for online search, Dex Search marketing won an award for best search engine marketing technology platform for small and medium size businesses.

Our goal is to be the market leader in providing local search solutions for the small and medium size business, and this award is another indication that we are well on our way to achieving that goal in search marketing in addition to our print and Internet yellow page solutions.

It is important to remember that it is increasingly difficult for advertisers to generate the consistent volume of leads they need on their own due to complicated technology and increasing consumer fragmentation, and this service is yet another example of how we can leverage our strong advertiser relationships and track record for delivering results.

In other words, we allow local advertisers to focus on running their business while we manage getting that steady strain of ready-to-buy prospects to their door at an accessible price and an attractive ROI.

With that, I will turn it over to Steve.

Steve Blondy

Thanks Dave, and good morning everyone. Third quarter net revenue of $648 million declined 3.5% from Q3 last year as stable ad sales in the back half of 2007 continued to average into this year’s results. We also benefited from Business.com for the full quarter this year versus only one month last year. Versus Q2, revenue was 2.4% lower.

On the expense side, we continue to take a disciplined approach, aggressively ruling out inefficiency, while continuing to invest to support advertiser value. We are on track to achieve our ’08 cost savings targets and our cost-restructuring program.

Normal operating expenses of $314 million were 1.6% higher than Q3 of last year after absorbing a significant increase in bad debt expense and healthy investment in our digital solutions.

Costs were lower in head count, manufacturing, and advertising versus Q3 of last year. Versus Q2, normalized operating expenses increased $16 million or 6%, again due to bad debt and further digital investment.

Q3 restructure expense of $14 million brings the year-to-date total to $19 million of our announced $40 million plan. The program is designed to benefit both our cost structure and productivity initiatives to support ad sales.

Q3 bad debt expense of $38 million represented 5.9% of revenue compared to $34 million or 5.2% in Q2 and just $21 million or 3.1% in Q3 of last year.

Our DSOs also rose to 39 days in Q3 versus 35 days in Q2, and 30 days in Q3 of last year. These numbers evidence the cyclical impact on our business, and unfortunately we do not see any tangible evidence that it will recover in the near term.

Approximately 40% of our increased write-offs from last year represent advertisers going out of business.

Q3 EBITDA of $334 million declined $28 million from last year and $32 million versus Q2 as a result of the foregoing. Q3 EBITDA margin was 51.5%.

Turning to cash flow, we paid $206 million of cash interest in Q3 including $2 million accelerated into the quarter related to bonds repurchased. GAAP interest expense of $198 million included $18 million of bond discount accretion, $6 million of deferred financing fees, and $4 million of purchase accounting benefit.

At September 30th, our average interest rate was 8.3%. Q3 free cash flow of $108 million also reflects $17 million of CapEx and $3 million of net working capital uses. We reduced net debt by $155 million in the quarter, bringing year-to-date debt reduction to $462 million.

During Q3, we repaid $35 million of bank debt at par and we repurchased $187 million principle value of RHD Corp notes in the open market at an average price of 49% of face. Of this amount, approximately $22 million closed in October, and so is not reflected in our Q3 financials. Our next debt maturities are not till 2010 and at the APCO [ph] level, which benefits both from lower leverage and structural seniority.

Required debt payments through the end of 2009 are only $135 million. In the meantime, our strong cash flow and our full $365 million revolver capacity provides ample liquidity.

Despite the weak economy, we still expect full-year 2008 guidance within our previously announced range, albeit at the low end. We expect ad sales to decline approximately 8%, EBITDA of $1,350 million, and free cash flow of around $475 million.

However, we now expect improved year-end net debt at below $9.5 billion, reflecting the added value we recaptured via the bond repurchases. Expectations for net revenue and share count are unchanged at $2.6 billion and 70 million respectively.

To wrap up, we remain focused on three key financial priorities, discipline in cost management, investing in critical growth initiatives, and reducing debt. That should allow us the weather the economic storm and be well positioned to grow once the market recovers.

That concludes our prepared remarks. Operator, we're now ready for questions.

Question-and-Answer Session

Operator

Thank you, sir. At this time we would like to begin the question and answer session of the conference. (Operator instructions) The first question comes from Mr. Matt Chesler with Deutsche Bank, you may ask your question.

Matt Chesler – Deutsche Bank

Good morning.

Dave Swanson

Hi Matt.

Matt Chesler – Deutsche Bank

I just want to start off with the topline. Could you just let us know, implicit in your guidance that full year has no growth, what is the pro forma 4Q07 ad sales number that fits here, you know, using in the base that would require any scheduled changes or any other adjustments that takes place through normal operations?

Dave Swanson

Well, we do not provide that number on a quarterly basis, Matt, but you can back into a number and it is worse than Q3.

Matt Chesler – Deutsche Bank

Okay, thank you. At this point, as we are getting closer to the end of the year, and just we are quite at this number – when you are probably going to provide more specific guidance as to your 2009 cost savings initiatives, but can you give us a sense so we could start thinking about what the range of likely possible outcome could be or how much cost or time to really get after, and whether that is going to be cost that you intentionally take out as to whether cost to come out through (inaudible) owning of your business?

Steve Blondy

Sure, so one way to think about that, I think, is pretty reliable is to look at this year’s ad sales and assume that that’s what happens to revenue next year in terms of the percent change, and so, we have got to take action in order to protect EBITDA. I cannot tell you that next year’s EBITDA will be the same as this year’s, but that is the way we are going about attacking the problem.

Dave Swanson

As far as the breakup for the breakdown between the variable components, that will be a part of it, but that will be the minority and the actions that we will have to take will have to get off – will have to come from what appear to be fixed costs in this year and in the past.

Matt Chesler – Deutsche Bank

Would it be reasonable to assume that the type of restructuring activity that you are going to pursue is going to be on a larger scale and what – we are seeing this year will not (inaudible) for the full year?

Steve Blondy

Yes.

Matt Chesler – Deutsche Bank

And based on your $40 million plan in restructuring benefits, you have talked about how the ongoing savings from of plan, do you think it is substantially larger than what you take in restructuring charges. Can you be a little bit more specific in what you mean by standpoint?

Steve Blondy

We would prefer to hold off on that until next year. I think you kind of get the picture though. If we are trying to sustain leverage if not bring it down, that will give you some kind of a clue as to what we are looking at in terms of what kind of cost savings are necessary.

Matt Chesler – Deutsche Bank

And finally, is sounds like you are moving full to get ahead with comprehensive and independent in a multi-platform strategy, does the difficulties of the current environment make it take a look more differently about partnering with other local search providers or other print-only or online to distribute your content?

Dave Swanson

Yes, Matt. It is a great question. As you know, we are – we have been very open advocates of findings ways, like to do more partnerships in all manner or form with others in the space while there are some cost synergies to doing such things, you know, they are not massive cost synergies and while we will always keep the dialogs going and we will continue to do as many things as we can, we think that we have got a strategy that works for us regardless of how big or broad those things might be or how narrow they might be.

Matt Chesler – Deutsche Bank

Thank you Dave. Thank you.

Operator

The next question comes from Michael Meltz with JP Morgan, you may ask your question.

Michael Meltz – JP Morgan

Thank you. I just have a few questions. Just following up on Matt’s question on the ad sales for Q4, so you are implied guidance is down about 10% for the fourth quarter, am I reading that right?

Steve Blondy

I think that is the order of magnitude that you get when we back into it, right.

Michael Meltz – JP Morgan

Can you give us any guidance on the free cash flow components? Where are you sitting now in terms of your expectation for interest expense, working capital use, and cash flow, and CapEx for the full year?

Steve Blondy

Yes, and you can actually see that in the schedules in the press release Mike. Cash interests paid, 750, I think previously it was 745. CapEx and working capital actually remain the same, although there is a flip about $10 million between them. The last time we showed 65 of CapEx, that has gone up to 75; and working capital changes were 60 and that is gone down to 50, and that is largely the way that we need to account for some tenant improvement dollars associated with our new office space in Denver.

Michael Meltz – JP Morgan

Okay, and then on the mechanics of the bank debt, can you talk a little bit about how that will work ideally?

Dave Swanson

Well, the mechanics are through a Dutch tender, and I think that there will be – we sort of anticipate it that it will be in a series of increments.

Michael Meltz – JP Morgan

Okay, over what duration?

Steve Blondy

I think we got this waiver for a period of up to 270 days.

Michael Meltz – JP Morgan

From yesterday?

Steve Blondy

Just sometime this week, I am sure of the actual –.

Michael Meltz – JP Morgan

Okay, all right. Thank you.

Operator

The next question comes from Peter Salkowski with Goldman Sachs, you may ask your question.

Peter Salkowski – Goldman Sachs

Thank you. Good morning guys. Dave, you did talk about the head count reduction year-to-date, I believe, it was 13%. I was wondering if you could give a little bit of sense of where that falls in terms of sales versus non-sales staff and then how much of that actually occurred in the third quarter?

Dave Swanson

Okay, well. The third quarter was roughly 200 heads lower in the Q3 than at the end of Q2.

Peter Salkowski – Goldman Sachs

Thank you.

Dave Swanson

And Peter, I do not have the exact breakout of sales versus non-sales, but it is clearly both and the process is we are literally going office by office on the sales side and looking at what our current staffing levels are, evaluating based on very strict productivity standards that we have established with the help of the consultants that we are working with, normalizing that and then ensuring that we have enough people to cover the market and make our value proposition in sales to everybody that we want to, but not have any more people than we need to do that, and so that is the approach we are taking on the sales side.

Peter Salkowski – Goldman Sachs

Got it. And then two final questions, one, could you give us sense on Vegas, I know it sort of turned to be bad last year than we would have expected in the third quarter here again in the last year’s book. I am just wondering, if that market – if you are seeing a bottoming in that market at this point, I know, that is a big book for you. And then also a question on your suppliers, are you seeing any pressure from your printer and distributor, I believe at RR Donnelley, although it could be run equivocal [ph] and give us a sense of if you are seeing anything there from them because they know you are under pressure from your advertisers, from your customers?

Dave Swanson

Yes Peter, On Vegas, I do not want to go into too much detail about any specific market. I will tell you that it is kind of more that I told you last time, it is more of the same. It has not gotten worse, but we have not seen any signs at least in order-leading indicators that are better. I did hear anecdotally some good news about Nevada and California housing market that may be they – they are coming to the end of the $0.30 on the dollar buys out there and that may mark the bottom, but it has not reflected in our numbers yet.

Peter Salkowski – Goldman Sachs

Yes, a lot of surprises. Do you know (inaudible) housing market is going to be a while?

Steve Blondy

It looks that way. In terms of suppliers’ fear, we are hearing nothing from anybody, I mean, as you know, we still have a lot of cash flow here and continue to pay our bills and expect to for a long, long time.

Peter Salkowski – Goldman Sachs

Great, thank you very much.

Operator

The next question comes from Aaron Watts with Deutsche Bank, you may ask your question.

Aaron Watts – Deutsche Bank

Good morning everyone.

Steve Blondy

Good morning Aaron.

Aaron Watts – Deutsche Bank

Just more of a few housekeeping questions as to follow up on the amendment you got with your bank. When are you expecting to sort of kick off the Dutch auction process? I know you are not going to do it all in one clump, but do you anticipate doing that sooner rather than later?

Steve Blondy

Yes, we are really not prepared to telegraph that Aaron.

Aaron Watts – Deutsche Bank

Okay, fair enough. And I know you probably had this one when you filed your “Q,” but can you talk about which bonds you went after specifically in the quarter and maybe your thought process behind that?

Steve Blondy

Yes, we brought RHD Corp bonds in all five series, I think. So, we bought the majority of them with the 13 maturities. We did buy some 16s and 17s just because the price was so attractive, but the large majority was in the 13 maturities.

Aaron Watts – Deutsche Bank

Got it, obviously trying to reduce that maturity hurdle of that year?

Steve Blondy

Well all of the things being equal, right. I mean, at the beginning of the quarter when started doing this, the prices were relative the same for 13s and 16s and 17s, and then as we got further and went into the quarter, the 16s and 17s got considerably cheaper, and so we took advantage of that as well.

Aaron Watts – Deutsche Bank

Okay, and were those purchases all done with cash generated by the business or did you sort of cap into any of your revolvers to make that accretive purchase?

Steve Blondy

No draws on the revolvers.

Aaron Watts – Deutsche Bank

Okay, I appreciate it, thanks guys.

Operator

The next question comes from Robert Skrzypczak with Credit Suisse, you may ask your question. Can you please take your mute button.

Robert Skrzypczak – Credit Suisse

A couple of quick questions here. Is it a safe decision for the bank tender process that there will be no draws in the revolver that you will be using – that the game plan is to use cash flow that is generated from the businesses?

Dave Swanson

I really do not want to limit our alternatives in terms of that – in that regard Robert.

Robert Skrzypczak – Credit Suisse

Okay, and then could you give us – two other questions, number one, could you give us a sense in ad sales if there is any decline – differences in the decline by the various debt issuing entities, meaning Dex East, Dex West, RHD Inc., are you seeing any differences there and if so, can you tell us what they are? And lastly, is there any way you can just give us a sense of what the decrease has been year-over-year in like of the number of listings with the number of actual customers that you have signed up?

Steve Blondy

Robert, a couple of those, you might need to remind me, I mean, in terms of the numbers of customers, the decreases very much are paralleling the revenue numbers, so no real differences there. They are tracking the same to the ad sales number.

Dave Swanson

To the ad sales number.

Steve Blondy

And what was the question before, was –?

Robert Skrzypczak – Credit Suisse

And on the ad sales decline that you are seeing, are you seeing differences between the various – in the degree of decline from the various bond issuing entities mainly? Are you seeing greater declines in RHD Inc., in Dex West or vice versa or anything like that?

Dave Swanson

No. The only way that I would call it, you know, across business lines or those entities, I would say no. It is the major markets – the major metro markets are performing worse than the smaller markets.

Robert Skrzypczak – Credit Suisse

Okay, great thanks.

Operator

The next question comes from Ken Silver with RBS, you may ask your question.

Ken Silver – RBS

Hi, thanks for taking the call. Given the weak environment out there, have you seen – are you starting to see closures of some of your smaller – print competition in certain markets?

Dave Swanson

Ken, there has been some of that that is going on over the course of the last year. Right now, we are pretty focused on our own business. We are not hearing a lot from our customers about competitors at all. The discussions that we are having with advertisers are about the stress that they are feeling in the marketplace and – rather than how are they going to – how they can move advertising to some other lower cost providers, so quite high senses gets pretty darn hard out there for everybody and those that have got left staying are – it looks like it is going to be a difficult environment to be able to hang out in the long term.

Ken Silver – RBS

I mean, do you have any indication that there could be a significant shake out among a lot of the smaller competitors?

Dave Swanson

You know, I am just – I am not going to go there – I do not know.

Ken Silver – RBS

Okay, thank you.

Operator

The next question comes from Todd Morgan with Oppenheimer & Company. You may ask your question.

Todd Morgan – Oppenheimer & Company

Good morning, thank you. Can you talk a little bit more about the sales environment, and I guess sort of two things if you could comment on, when you were talking about customers about renewing, I am assuming that they are kind of lamenting their own situation. What sort of strategies do you have to try and keep them as advertisers, to keep their spending levels up? And I guess secondly, I know local is the vast majority of advertising, but can you talk about any differences in national versus local trends, thanks?

Steve Blondy

Yes, Todd. Not much difference between national and local, and these days they are both performing pretty similarly. You know, in terms of the things that we are doing to try to help these small businesses through these times is we are trying to offer for those that will at least spend the same or increase their spending. We are creating a lot of incentives for them. They are able to buy more advertising at a discount. We are including color in many places.

We are leveraging some of these new platforms that we are rolling out, as an example, 1-800-CALL-DEX out there, we are not charging incremental for that. It is just another part of the Dex advantage that people get from doing business with us and other things with our digital products as well, so we try to help them through a very difficult time as best we can and it is one of the reasons why we are not seeing as much lift on the increase line as we normally do.

Todd Morgan – Oppenheimer & Company

Okay, and it looks like you are doing that essentially with a pretty flat cost structure at this point.

Dave Swanson

Yes, it is a great question, because, you know, what we have been talking about and what we have been doing as we have had to increase our investments in the interactive side as a result of changes in technology, we have been trying to find ways to use technology to decrease costs in other parts of our business, and a great example of that is – these will be rough numbers, but as we increase – in 2008, increase the cost spending on the digital side of our business by some $30 million, we have been able to decreases costs in the legacy side of our business by at least $30 million. So, it is not just all increment.

Todd Morgan – Oppenheimer & Company

Good, that is helpful thanks.

Operator

The next question comes from Andrew Finkelstein with Barclays Capital, you may ask your question.

Andrew Finkelstein – Barclays Capital

Hi guys, good morning. I just wanted to follow up on the expense of – the expense issue. It looks like while you are holding it, it is pretty close to home, it is up over from the second quarter and then applying [ph] roles through the guidance for the fourth quarter, it looks like it is going to be a up a little bit more obviously, you know, what is happening on the topline? We thought that – we kind of expected to see that number going negative. So, I was just wondering if you could talk about fourth quarter expenses in sort of where we are at least in the rollout of this – the current set of expense reduction?

Steve Blondy

Hi Andrews, it is good to hear from you. So, remember in the second quarter, we indicated that there were some timing issues related to expenses that did not hit in Q2, but would be – we will be seeing in the back half of the year, and some of that, you see in the Q3 expenses. So, I – you know, there are some timing issues there. I think the other think that – your question about the implied expenses for Q4, I think that maybe what you are seeing there is some level of conservatism on our part with respect to where EBITDA may come in just because we do not know in particular what is going on with bad debt expense and so if bad debt expense remains around the same as it is now in Q3, then we might do slightly better than the bottom end of the range, but if it deteriorates, we are sort of making some sort of revision for that in our guidance.

Andrew Finkelstein – Barclays Capital

And you could you talk a little bit more about maybe bad debt on what you saw sort of through the quarter over the three months and how much you think that is moving?

Steve Blondy

I am sorry, are you saying what – between what timing issue?

Andrew Finkelstein – Barclays Capital

No, it is just the bad debt comp –?

Steve Blondy

Right, the bad debt number in Q3 was $38 million and it was $34 million in Q2 and our DSOs went from 35 to 39 days. So, we are assuming that we continue to lose a day for a month of DSOs in our fourth quarter.

Andrew Finkelstein – Barclays Capital

Okay, great thanks.

Operator

This concludes today’s conference. Thank you for your participation. You may disconnect at this time.

Steve Blondy

Thank you all for your interest.

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