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Rex Energy Corp. (NASDAQ:REXX)

Q1 2009 Earnings Conference Call

May 06, 2009 10:30 AM ET

Executives

Benjamin W. Hulburt - President, Chief Executive Officer and Director

William L. Ottaviani - Executive Vice President and Chief Operating Officer

Thomas C. Stabley - Executive Vice President and Chief Financial Officer

Analysts

Mark Lear - Sidoti & Company

Operator

Good morning and welcome to Rex Energy Corporation's First Quarter of 2009 Conference Call. I will be your coordinator for today. At this time, all participants are in a listen-only mode. Statements contained in this conference call that are not historical facts, are forward-looking statements. Such statements are subject to risks and uncertainties, which could cause actual results to differ materially from those in the forward-looking statements.

We will conduct a question-and-answer session towards the end of this conference call. As a reminder, this conference is being recorded for replay purposes.

Now, I would now like to turn the call over to Mr. Benjamin Hulburt, President and Chief Executive Officer of Rex Energy Corporation. Please proceed.

Benjamin W. Hulburt

Thank you. Good morning and welcome to Rex Energy Corporation's conference call, to discuss results from the first quarter of 2009. I encourage you to visit the Rex Energy website for the first quarter earnings announcement issued this morning, which includes information... important information on forward-looking statements, as well as financial statements and non-GAAP reconciliation.

Please note that we routinely post information... important information about the company under the Investor Relations section of our website.

First quarter of 2009 was a solid beginning to the year, and provides a sound foundation to continue our growth through the remainder of the year. Total revenues for the quarter grew to $17.3 million, up 5% from the same period in 2008.

Approximately, $4.6 million of this increase in revenue was attributable to an early redemption of our oil hedging instruments associated with 2011 production.

Production in the first quarter was approximately 232,000 barrels of oil equivalent, which was 78% oil and 22% natural gas.

Our EBITDAX in the quarter grew to $8.7 million, up 19% over the first quarter of 2008. Again, this figure included approximately $4.6 million in hedging redemptions. So, excluding this one-time cash event, our EBITDAX would have been approximately $4.1 million.

We recorded a net loss from continuing operations for the quarter of $1.3 million, which after adjustments for unrealized losses, exploration and impairment expenses, non-cash compensation expenses, loss on disposal of assets, and our income tax benefit, would have been income of approximately $2.5 million.

Perhaps, the most notable achievement for the company this quarter was the completion of the divestment of our properties in the Permian Basin.

The sale was a major milestone for Rex Energy, as it reduced our operational footprint, allowing us to better focus on the Marcellus Shale in the Appalachian Basin, and our secondary and tertiary recovery projects in the Illinois Basin.

As previously announced, we netted approximately $17.3 million in proceeds from the sale. The proceeds were primarily used to pay down debt we had at year end, leaving the company, with only $5 million in debt, and approximately $4 million in cash-on-hand at the end of the first quarter.

In addition to being essentially debt free, the $80 million borrowing base under our credit facility was recently reaffirmed by our bank group, with the next semi-annual redetermination scheduled for October of 2009.

Our hedge position remains secure, with 86% of current production hedged through 2010, and average floor prices of $62.99 per barrel, and $7.32 per Mcf.

Our conservative debt position, coupled with our strong hedged position, enables us to continue to grow during these challenging times.

Lastly, as Bill will elaborate on in a moment, I am pleased to report that we've successfully completed the drilling of our first horizontal Marcellus Shale well in Southwestern Pennsylvania. We plan to fracture, stimulate and complete the well during the month of June.

Our rig has now moved to the second well location and is currently in the process of rigging up. At this point, I'll turn the call over to Bill Ottaviani, our Chief Operating Officer, for a review of the company's operations.

William L. Ottaviani

Thanks Ben. I'll start with the look back at our production results for the first quarter.

In our Appalachian Basin operations, we began preparations for our 2009 Marcellus Shale campaign, by mobilizing a fit-for-purpose drilling rig into the first of our three development areas, targeted for drilling this year.

Drilling of this first well commenced in early April, and continuous drilling is planned for the remainder of year. As a result of last year's Marcellus Shale development program, our first quarter 2009 natural gas production is up 26%, compared to the equivalent period last year.

In the Illinois Basin, we typically do not have any development activity until the risk of spring flooding has passed. As such, first quarter production is usually the lowest for the year, and compared to the equivalent quarter last year, Illinois Basin production volumes were down about 4% in the first quarter of 2009.

Our company wide production however, for the first quarter of 2009, is about 1.5% higher than the first quarter production volumes in 2008.

Total production for the quarter was approximately 232,000 barrels of oil equivalent, representing a production portfolio mix of 78% oil and 22% natural gas.

In terms of lease operating expenses, the news remains positive. During the year-end conference call, I spoke about our efforts to trim operational costs due to the sharp decline in commodity prices. We realized a substantial drop in operating expenses in the fourth quarter of 2008, and that trend continued in the first quarter of 2009.

For the quarter, lease operating expenses were down 15% from the prior quarter, and down 17% relative to the first quarter in 2008. This is a tremendous result, especially, when you take into consideration that we are operating more wells and related infrastructure, than we were at this time last year. It takes every level of our operations team to generate this kind of result. And I want to recognize them for the fantastic job they are doing.

Moving on, I'll now discuss specific project plans in each of our two operating regions. Starting first with the Illinois Basin. At the previous conference call in March, I detailed the status of our Lawrence Field alkali-surfactant-polymer, or ASP pilot project, and outlined the general framework for the direction we are considering with this project.

In summary, we believe the pilot tests confirmed that the ASP process works for our Cypress and Bridgeport reservoirs, by mobilizing incremental oil, not recoverable through conventional primary or secondary recovery techniques like water flooding.

The two pilot tests also provided valuable insight into various reservoir design and performance factors needed for a successful expansion of this project on the field-wide basis.

Using the data collected from the pilot projects, Netherland Sewell and Associates has identified 27 perspective future ASP floods with an estimated 39 million barrels in potential recoverable oil reserves in the Northern and Central portions of the Lawrence Field.

With this information in hand, what we are now doing is fine tuning a development plan for each of our Cypress and Bridgeport reservoirs.

For the Cypress reservoir, we are investigating the use of the conformance gel in our existing pilot project area that will improve sweep efficiency of the ASP chemicals.

Field testing of this conformance gel product is tentatively scheduled to begin in the fourth quarter of this year.

For the Bridgeport reservoir, post pilot development is now in the detailed planning stages. We anticipate commencing a field development of the Bridgeport reservoir during the first half of 2010.

With all of the attention being given to the ASP pilots in the Illinois Basin, I also want to point out that the basin has an attractive inventory of about 175, relatively low cost and low risk proven reserve development locations.

Historically, drilling a select number of these locations has been a means to offset financial decline of our basin fields, and an opportunity to add proved reserves to our portfolio.

So, this year, given our desire to maintain a fairly conservative balance sheet, we are likely to drill only a relatively small number of the more promising opportunities.

Now, I wish to turn attention to where most of our capital expenditures are occurring this year, the Marcellus Shale development and the Appalachian Basin. As I mentioned earlier, we have spud (ph) our first horizontal Marcellus Shale well last month in Western Pennsylvania, and successfully finished the drilling of this well last week.

The initial reservoir diagnostic results of this well look quite favorable, in terms of porosity and estimated total organic content. Completion of the well is planned for June 2009, following analysis of reservoir core samples taken while drilling.

This, and all subsequent Marcellus Shale wells we drill, will be completed via multi-stage hydraulic fracture treatment.

For the year, we reaffirm our plans to drill at least six to eight net wells, across three distinct operational areas in Pennsylvania.

Drilling in our Southwestern operational area is commencing this week, with our second horizontal well for the year, and subsequent drilling across the state will continue through year-end.

In addition to the core taken in the first horizontal well, we have also acquired and processed new seismic data within our development footprint, which has significantly helped in our individual well design plans.

Furthermore, we plan to take several other core samples and collect other diagnostic data in different operating areas, to enhance our general understanding of the reservoir, which will ultimately be used to shape our long-term development plan.

In fact, as our inventory of new well permits continues to grow, preliminary development plans for 2010 and beyond are already taking shape.

We expect overall development costs for the Marcellus Shale to drop sharply, once the diagnostic phase is completed, and improved synergies are realized with increasing well count.

In terms of natural gas infrastructure, our goal is to focus new drilling in those areas where existing marketing facilities allow for the immediate sale of natural gas, while concurrently building the necessary infrastructure for future development.

To that end, work continues on both a gas processing facility in our Western Pennsylvania operating area, and the network of new or expanded pipelines in all operating areas.

Well, that about wraps up the operational and development summary for the quarter. So, I'll turn the call over to Tom Stabley, our Chief Financial Officer.

Thomas C. Stabley

Thanks, Bill. Before I get started, I would like to remind you that this morning's earning release, which has been posted on Rex Energy's website, contains financial statements, supplemental tables and non-GAAP reconciliations, which I encourage you to review if you haven't already.

First quarter of 2009 operating revenues of 17.2 million represented an increase of 5% when compared to the first quarter of 2008.

This increase is primarily attributable to the early redemption of the 2011 oil hedges, for which we received approximately 4.6 million in cash.

These gains were partially offset by lower oil and gas prices during the same quarter. When compared to the first quarter of 2008, our average sales price for oil, excluding the effects of derivatives, decreased approximately 57%. And our average sale price for natural gas, excluding the effects of derivatives, decreased approximately 41%.

Lease operating expenses decreased approximately 17% to 5.2 million in the first quarter of 2009, down from 6.2 million in the first quarter of 2008. These expenses have decreased year-over-year, mainly due to several cost reduction measures implemented during the fourth quarter of 2008, to mitigate discretionary spending and to lower overall operating expenses.

General and administrative expenses increased to approximately 500,000 to 3.8 million for the first quarter of 2009. The increase is predominately due to an increase in wages and benefits, resulting from an increase in the number of employees, when compared to the same period last year. Also contributing to the increase were higher non-cash compensation expenses, which increased roughly 29% when compared to the first quarter of 2008.

We recorded a loss on the sale of assets of approximately $428,000 during the first quarter of 2009, as compared to a gain on the sale of assets of approximately 42,000 during the first quarter of 2008.

The loss during the first quarter of 2009, was impacted by the closing of the sale of our Southwestern Region assets, which as Ben mentioned previously, netted around $17.3 million, and was used to pay down our long-term debt.

DD&A expenses for the first quarter of 2009 increased approximately 1.4 million or 29% from the 4.8 million in the first quarter of 2008. This increase is directly attributable to the downriver vision in our proved reserves at December 31, 2008.

We calculate our depletion on the units of production basis, which accelerated in relation to the reduced projected economic life of our proved reserves, using year-end pricing. Thus resulting in higher DD&A expenses.

We recorded exploration expenses during the first quarter of 2009 of approximately 1.1, as compared to 300,000 in the first quarter of 2008. This increase is predominately attributable to the seismic acquisition and processing costs associated with our Marcellus Shale acreage in the Appalachian Basin.

Interest expense, net of interest income during the first quarter of 2009, was approximately 395,000, which is 8% less than the 436,000 recorded in the first quarter of 2008.

The decrease in interest expense is directly attributable to the average balance on our long-term debt, being reduced by two-thirds over year-over-year.

Unrealized loss on derivatives, a non-cash expense, decreased when compared to the first quarter of 2008 by 10.3 million, to approximately 2.7 million. These expenses reflect the change in fair value of our derivative instruments from the prior period.

Our EBITDAX from continuing operations for the first quarter of 2009 was approximately 8.7 million, as compared to 7.3 million for the first quarter of 2008, representing a 19% increase.

The increase in EBITDAX is attributable to the 5% increase in operating revenues, which included approximately 4.6 million in early redemptions on our 2011 oil hedges, and a 17% decrease in lease operating expenses.

Our management team continues to believe in the value of maintaining a strong hedging position. As Ben mentioned previously, approximately 80% of our current production is hedged through 2010.

Before reviewing our hedging positions with you, it is important to note that all of the estimated hedge production is based on our first quarter actual production, and not our internal projections of our actual future productions.

For the remainder of 2009, our oil production is approximately 86% hedged with an average floor price of $63.35 per barrel, and an average ceiling price of $75.57 per barrel.

In 2010, we have approximately 88% of our current production hedged, with an average floor price of $62.71 per barrel, and an average ceiling price of $79.31 per barrel.

On the natural gas side, approximately 78% of our natural gas production is hedged for the remainder of the year at an average floor price of $7 per Mcf, and an average ceiling of $8.88 per Mcf.

In 2010, our current natural gas production is approximately 87% hedged, with an average floor price of $7.56 per Mcf, and an average ceiling of $10.48 per Mcf. We also have additional natural gas hedge contracts in place to cover 72% of the production in 2011, at an average floor of $8 per Mcf, and a ceiling price of $14.75 per Mcf.

Overall, it was a financially solid first quarter, with many of the trends we had forecasted in 2008 year-end beginning to emerge.

Benjamin W. Hulburt

Thank you, Tom. Operator, at this time we'd like to open the call up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) And your first question comes from the line of Don Chris (ph) with Johnson Rice. Please proceed.

Unidentified Analyst

Good morning, fellows. How are you all?

Benjamin Hulburt

Good morning. Good, how are you?

Unidentified Analyst

As far as your Marcellus program, I know you're going to drill six to eight wells this year, and the first ones is at Butler County. Can you walk us through how many wells are going to be in the other counties as you progress through the year?

Benjamin Hulburt

Well, the current plans would be to do four horizontals in a row in Westmoreland County, PA. And then to finish up the year in Central Pennsylvania.

Unidentified Analyst

Okay. So, maybe one more in Central Pennsylvania, one or two?

Benjamin Hulburt

Yeah. That will all depend on the amount of time we have left in the year. Our plan is to keep the rig running continuously through the year. So, we may actually get more than six spud by the end of year.

Unidentified Analyst

Okay. And as far as the takeaway capacity is concerned, I'm looking at your presentation, and you said that you have taps in place. Are those all... as far as the timing perspective, are those all in place now and ready to go, and you're just waiting on wells to connect to them, or can you elaborate on that some?

Benjamin Hulburt

Sure, in Butler County, Pennsylvania, the tap is in place, but the gas processing plant, because it's a high BTU liquids rich gas there, it's still in the process of being completed. So, that's really what we are waiting for there.

But currently, we show by the time we frac the horizontal well there, the gas plant should be able to take gas.

In Westmoreland County, we already have existing taps in place, and actually we sell gas through them already. That would allow us to put about another 15 million a day into them. And then, we will expand from there in the future into the Equitran line.

In Central Pennsylvania, Columbia 1711 line runs about a bottom mile from our acreage, and that tap is approved by Columbia, but has not yet been installed. And we expect them to install that during the third quarter.

Unidentified Analyst

Okay. And as far as the ASP is concerned, it seems like you don't want spending too much money for the next two quarters and then coming in for the fourth quarter. If gas prices ramp up here, do you see any shift of capital away from your ASP and into your Marcellus areas for now, or do you have that completely allocated to it for the rest of the year?

Benjamin Hulburt

We've already shifted a lot of more capital towards the Marcellus Shale. The activities that we are undertaking in the ASP this year, the largest of which is testing the conformance gels in the Cypress reservoir are extremely important strategically, and the ability to approve the process. But, it's not a terribly capital intensive project.

So, we will be shifting a greater percentage of our planned CapEx towards the Marcellus drilling during the year

Unidentified Analyst

Okay. And as far as guidance, are you in a position now to give us any for the rest of the year?

Benjamin Hulburt

We're really not, because we have yet to frac and complete our first horizontal well. There is just so much uncertainty in a low case and a high case that we're not at a point where we're comfortable doing that yet.

Unidentified Analyst

Okay. What about cost... on the cost side of guidance? Anything on DD&A or LOE going forward, or is it still too early?

Thomas Stabley

Well, I think on the DD&A, at year-end we talked about $29 per BOE. And that number has come down slightly. So, I think, it's about 27 now.

We would... I'm sorry, I think we gave guidance at 27. It's come down about 24. I think that's the vision we would have going forward right in that 24 to $25 range on DD&A.

Unidentified Analyst

Okay.

Thomas Stabley

And I think Bill can comment on the LOEs.

William Ottaviani

In terms of LOE, the costs will be consistent with our activity level. We've lowered our activity level with lower commodity prices, as commodity prices improve, we will see the opportunities, and probably increase our activity consistent with those prices. But, to the extent that commodity prices remain where they are today, I don't see a material change in our LOE going forward.

Unidentified Analyst

Okay. Thanks a lot guys. I will let somebody else jump on.

William Ottaviani

Thank you

Operator

Your next question comes from the line of Christina Pluta (ph) with RBC. Please proceed.

Unidentified Analyst

Good morning, guys. I just wanted to clarify something. It sounds like your Butler County gas price has increasing (ph), you are expecting that to be online by June now, is that correct?

Benjamin Hulburt

Well, Phase I of it will actually be able to... should be actually be able take gas before June.

Unidentified Analyst

Okay.

Benjamin Hulburt

The plant's being built in phases. So, it will be able to take gas probably, before June.

Unidentified Analyst

And what are the volumes on that?

Benjamin Hulburt

We are not sure yet, somewhere between 1 and 5 million a day.

Unidentified Analyst

Okay.

Benjamin Hulburt

The next phase...

Unidentified Analyst

That's down from... it's I think with what you guys were expecting more like 3 to 5.

Benjamin Hulburt

Yes, well the next phase...

Unidentified Analyst

Okay.

Benjamin Hulburt

Would easily get you the 5 million a day. And the plant will actually be done in constructed. But, we are waiting on one air permit from the DEP of the state.

Unidentified Analyst

Okay.

Benjamin Hulburt

So, even though the plant's actually done and constructed, we can't actually turn it on until we get that permit. So, there are some... the question is, to when we will get that. That could come in two weeks or it could come in two months we're just not sure.

Unidentified Analyst

Okay. Yeah with a lot of your control. And then just, maybe if you can give a little more color on your current vertical well production in the Marcellus, trends in terms of what you are looking at for the rest of the year there?

Benjamin Hulburt

Well, the vertical wells that we did last year, currently are flowing about 1.2, 1.3 million a day.

Unidentified Analyst

Okay.

Benjamin Hulburt

At least two of them are fairly severely curtailed in Butler County, because they can't go into the plant. But that's what they're currently flowing. Our...

Unidentified Analyst

Experience (ph) on that processing plant on your... seeing a reintroduction (ph) something like that?

Benjamin Hulburt

Then we'll be able to turn those into plant and run them unrestricted. That's correct.

Unidentified Analyst

Okay, all right. Thank you.

Operator

(Operator Instructions) And your next question comes from the line of Richard Rossi (ph). Please proceed.

Unidentified Analyst

Good morning, everybody. I just have one additional thing to what's been covered. My phone cut out actually. You talked about the first horizontal Marcellus spud in April. And then I missed everything else. Would you mind just, is that complete and when or did you mention, when it would be completing?

Benjamin Hulburt

Sure Rich. The well is Butler County, the drilling is complete. And actually the rig has moved offsite. The frac is not yet complete. The rig is now moved to Westmoreland County and it is rigging up to begin spudding the second horizontal well, which should happen in a matter of very, very short time period, a couple of days.

In Butler County, the frac is scheduled for a mid-May. What we've told the market is that we plan to have the frac completed and tested and flowing and to start connecting to sales line by the end of June.

Unidentified Analyst

Okay, great. That's all I needed. Thank you.

Operator

And your next question comes from the line of Ray Beacon (ph). Please proceed.

Unidentified Analyst

Yeah. Hey Ben. I was just curious. Are you looking at acreage purchases at this point, and can you tell me how I guess, based on any results you could point to, what would you expect for IP rates and EUR's in Westmoreland. The 3.5 piece that some people are throwing out, kind of what you hope to target there?

Benjamin Hulburt

We currently do have land men in the field in very select areas currently. Not... certainly, not a mass leasing program. But, within sight of our operational immediate areas, we are currently leasing. But it's pretty limited.

Unidentified Analyst

Okay.

Benjamin Hulburt

In terms of an IP rate in Westmoreland County, its just not something we are comfortable in giving out yet, because we just haven't done it.

Unidentified Analyst

Got it. Okay. So, there is no reason to think its all that different from Washington County or Greene or Susquehanna where it sounds like other operators are talking 3 to 4.5 b's (ph) somewhere in there I guess?

Benjamin Hulburt

I guess, there is no reason to believe... obviously, its all different in each of those areas. But, no there is no real reason to believe that Westmoreland County is marketably different than some of the other operators' areas.

Unidentified Analyst

Got it. Thanks very much.

Operator

And your next question comes from the line of Mark Lear with Sidoti & Company. Please proceed.

Mark Lear - Sidoti & Company

Good morning. I was wondering, if you could just kind of touch based on the fact you talked about the first quarter being low, the low point for production out of Illinois Basin. What can we look for going forward out of there with the current budget, is it kind of a maintenance capital level from here?

Benjamin Hulburt

Sure. The current budget this year is the maintenance capital level. Absent any capital that that production out there tends to decline between 4 and 6% a year. So, I think we'll do a little better than that. But, if I was building a model, that's the way I would build it.

As far as when the lowest point of production in that basin is, it's usually the first quarter. But, that also somewhat depends on the weather, and when flooding hits, and how severe it is.

As of yet, we've seen very limited flooding there, and it hasn't impacted production. Last year's flooding actually hurt second quarter production more than it hurt first quarter. So, I guess the answer is, so far so good. We haven't seen a lot of flooding yet this year. Obviously, that's something we can't control.

Mark Lear - Sidoti & Company

Understood. And I guess looking back, what was the production just out of your Illinois Basin assets for '08?

Benjamin Hulburt

For the total year?

Mark Lear - Sidoti & Company

Yes.

Benjamin Hulburt

Of the top of my head about three quarters of a million barrels.

Mark Lear - Sidoti & Company

Got you.

Benjamin Hulburt

Yeah, 777,000 barrels.

Mark Lear - Sidoti & Company

Okay. And I guess, helping again on the expense, operating expense side, if you could break that out more on the production tax versus limping (ph) costs?

Benjamin Hulburt

Because we sold our Permian assets in Texas and New Mexico, we have almost no production tax. Pennsylvania has none, and Illinois and Indiana have a very limited at ad valorem tax. So, we are lucky to benefit that we don't operate in states that have much of a production tax.

Mark Lear - Sidoti & Company

Got you. That's helpful. Thank you.

Operator

And your next question comes from the line Brian Eulalie (ph). Please proceed.

Unidentified Analyst

Hi guys. Just going back to the Marcellus for a second. When you kind of look at the work that you've done in say Butler and Westmoreland Counties, are you guys seeing any big difference in terms of reservoir quality or gas properties, other than the overall significant difference of the Marcellus there?

Benjamin Hulburt

Yeah, I do. They are completely different areas. In terms of the debt, the pressures, the porosity, the organic contents, they are completely different project areas that we ultimately think both will work. But, they are completely different, that's true.

Unidentified Analyst

Okay. So, if you kind of think about high grading the areas, then is it safe to assume that your focus would be on the horizontals and Westmoreland as you have already kind of discussed in the call, preferential to the Butler County area.

Benjamin Hulburt

Certainly, this year we'll be spending more capital in Westmoreland County than anywhere else, yes. There has not yet been any horizontal well in the vicinity of our acreage of Butler and Beaver Counties.

So, I think at this point we have to withhold verdict, because we just don't know yet. But, because our vertical wells in Westmoreland County last year were our best wells, that's where most of our drilling and capital will go this year.

Unidentified Analyst

Right. So, I mean, you look at the logs, you can... in the cores and that kind of stuff, you can definitely see porosity differences, organic content differences and that kind of stuff between the two areas?

Benjamin Hulburt

Yes. Depth I think is probably the biggest factor. Westmoreland County is not quite twice as deep, but almost as Butler County. So, just with the increased depth we'd expect increased pressure.

Unidentified Analyst

Sure. And I guess, increased gas rates. Well, thanks for the color.

Benjamin Hulburt

Thank you.

Operator

I show no further questions in the queue. I would now like to turn the call over to Mr. Benjamin Hulburt for any closing remarks.

Benjamin Hulburt

Thank you, everyone, for participating in Rex Energy's first quarter conference call. We have several upcoming events I'd like to make you aware of. Tomorrow, we will be conducting our 2009 Annual Meeting of Stockholders at 1:00 PM in State College of Pennsylvania. Details are available on our website. On May 12th, Rex Energy will be presenting in a Marcellus Shale webinar hosted by the Oil and Gas Investor. On June 1 and 2, we will be presenting at RBC's Global Energy and Power Conference in New York. Thank you, again, to everybody for participating.

Operator

This concludes the presentation. You may all now disconnect. Good day.

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