Pall Corporation F4Q09 (Qtr End 07/31/09) Earnings Call Transcript

Sep.15.09 | About: Pall Corporation (PLL)

Pall Corporation (NYSE:PLL)

Q4 2009 Earnings Call

September 15, 2009 8:30 am ET


Eric Krasnoff - CEO

Lisa McDermott - CFO


Hamzah Mazari – Credit Suisse

Brian Drab – William Blair & Company

Richard Eastman – Robert W. Baird


Welcome to Pall Corporation’s conference call and webcast for the fourth quarter and year-end for fiscal 2009. (Operator Instructions) We’d like to remind you that the company’s fourth quarter and year-end press release is available at

Management’s remarks this morning will include forward-looking statements. Please refer to slide two or request a copy of the specific wording of this qualification of the company’s remarks. Management also uses certain non-GAAP measures to assess the company’s performance. Reconciliations of these measures to their GAAP counterpart are included in slides at the end of this presentation.

At this time, I will turn the call over to Mr. Eric Krasnoff, Pall Corporation’s Chairman and CEO. Please go ahead, sir.

Eric Krasnoff

Good morning to all. We appreciate you joining us here today as we record or fourth quarter and full year fiscal 2009 results. Joining me today are Lisa McDermott, Pall Chief Financial Officer and Frank Moschella, the Corporate Controller and Chief Accounting Officer.

We are pleased to share Pall Corporation’s results with you today. This was a year of remarkable economic challenges. The global financial crisis and subsequent meltdown in GDP across the globe will in retrospect likely be the defining moment for a generation.

The momentum from a strong fiscal year 2008 carried over into Pall’s first quarter of the this past fiscal year but after October everyone fell back to earth. We adjusted quickly and managed through the storm emerging stronger and leaner.

Our fiscal year 2009 results were achieved on the strength of technology, sharp customer focus, and productivity improvement programs that reduced costs. But most importantly they were the results of our people. Professional experience and dedicated, Pall employees deserve tremendous credit and thanks for their tireless efforts under extraordinary conditions.

The scale backs in 2009 have not hampered our longer-term sales, earnings, and cash generation growth initiatives. On the top line this includes our total fluid management strategy, the application of broad and differentiated product portfolios to all of the applications in our customers’ processes.

It also includes the development and sale of differentiated products that make customers more successful and geographic expansion in our pricing excellence program which were launched in fiscal year 2009.

These strategies combined to cushion the impact of a very weak economy. Sales in local currency decreased about 3.5% for the year, with microelectronics and industrial manufacturing markets leading the decline.

Several of our industrial markets showed resilience and life science markets, medical and biopharmaceuticals, still grew for the year. Growth in biopharmaceuticals is being spurred by thriving markets for plasma derivatives including IPIG, and vaccines, with flu one of the biggest drivers.

Entry viral drugs became another driver with the World Health Organization’s assessment last summer that H1N1 had reached pandemic phase. Strong performance for the year in Pall industrial were power generation, municipal water and military aerospace with growth ranging from 11.5% to 18%.

These markets have been resistant to the general industrial weakness in this period. In power generation the market continues to anticipate the longer-term demand for environmentally friendly energy generation.

Europe and even some consideration in the US for nuclear power plants along with their continued growth in Asia are helping and China continues to open what seems like one fossil or nuclear plant per week.

Looking by geography Asia, carving out microelectronics now, grew on top of a double-digit increase from the year before. In Europe the large food and beverage market sales were down almost 9% while in the western hemisphere they grew 17%.

Now almost 67% of Pall sales are outside of the western hemisphere. Our geographic diversity is a competitive advantage and its highly valued by our customers and to build on that strength we’re continuing to expand capabilities in Asia, build them up in Latin America, Eastern Europe and the Middle East.

We’ve most recently established a legal entity in Dubai to expand opportunities in that fast growing region. While we work to preserve the top line and build for the future, we also continue to execute strategies to strengthen our financial performance. A plethora of supply chain initiatives, facilities rationalization, procurement, and [inaudible] manufacturing translated into a modest improvement in gross margin.

This is despite the sales decline in the higher margin microelectronics and industrial manufacturing markets and it was also a big year in our lower margin systems business with over $300 million in sales. We believe these factors somewhat masked the improvements made during the year to our pricing, manufacturing and broad cost control initiatives.

Various infrastructure initiatives including programs you’ve heard about such as [AmeriPall] and [EuroPall] are improving service to customers, increasing efficiency and freeing up capital to reinvest in the business. SG&A which has been trending steadily down over the past several years, from if you recall about 34% in 2002, came up a bit this year on lower sales.

SG&A is down in dollars as we use these programs to carve millions from our operating budgets and build on our evolving continuous improvement culture. It has served us well that these programs were in place years before the economy soured.

But this economy required even greater actions. In response we’ve made further cuts in operating expenses and headcount as customer demand dictates. We continue to invest in the business launching several new initiatives with significant benefits to come. Among them is the establishment of the European management center in Fribourg, Switzerland, which is now officially opened.

We expect the operational improvements and ancillary tax benefits to show beginning in fiscal year 2011. Also new this year is our pricing excellence program which has so far exceeded our early expectations. That the pricing program prospered in the [teeth] of the recession, portends quite well for the future.

We also launched the enterprise risk management, or ERM process, for identifying and managing potential risks. This will enable us to better minimize exposure to loss while also capitalizing opportunities.

So while the conditions were diverse we managed through them while continuing to execute our long-term strategies. We remain confident in the longer-term prospects and in our ongoing strategies to enable sustainable, profitable growth.

We believe Pall is well positioned to outperform as the economy recovers. Now as you know, Pall suspended providing quantified guidance on its expected financial results after the second quarter of last year. The reason was straightforward, the volatility and uncertainty surrounding the financial crisis and its collateral damage to economies globally made accurate projections within meaningful ranges potentially misleading.

Since then, the economic picture or the new normal as some have called it, is slowly coming back into focus. We now plan to resume providing guidance both for the fiscal year and to update our five-year plan objectives. This will take place on December 17th, a few days after our Q1 earnings call.

So with that I’ll turn the call over to our CFO, Lisa McDermott.

Lisa McDermott

Thanks Eric and good morning everyone, now let’s review the earnings and cash flow results for the quarter and the full year. Earnings per share came in at $0.57 in the fourth quarter, up $0.01 from last year. On a pro forma basis, earnings per share as defined on slide 18, were $0.57 per share compared to $0.61 per share a year ago.

Foreign currency translation reduced both measures of earnings per share by $0.05. For the full year diluted earnings per share were $1.64, a decrease of $0.12 compared with $1.76 last year. Earnings per share on a pro forma basis were $1.77 compared to $1.97 a year ago, with foreign currency translation reducing pro forma EPS by $0.05 in the quarter and $0.17 in the year.

To look at the drivers of these results which are displayed on slides 13 and 14, I’ll start with the top of the income statement. Sales decreased about 10% in the quarter and about 9.5% in the year. With the dollar strengthening substantially against the euro, British pound and various Asian currencies compared to a year ago, foreign currency translation also reduced our top line by about 6% in both the quarter and the year.

This equated to about $45 million in the quarter and about $155 million in the year. The remainder of my comments this morning on sales will exclude the impact of foreign currency translation. Excluding this impact sales were down almost 4% in the quarter and about 3.5% for the year.

Pricing increased sales by 1.4% in the quarter and 1.2% for the year, so the volume decreases were about 5% and 4.5% respectively. We ended the year continuing to see life sciences resiliency show through with fourth quarter sales of 5%, 2% from price increases, and the full year up 3%, 1.5% from price increases.

The challenging industrial landscape and particularly the electronics industry continued to be a headwind to Pall industrial results with the fourth quarter sales decrease of 9% following on the prior two quarters of double-digit declines, bringing the full year in with an overall revenue decline of 7.5%.

Pricing increased both Pall industrial’s fourth quarter and full year sales results by about 1%. Sales in both the industrial manufacturing and microelectronics markets were again down double-digits in the quarter. However both saw sequential growth for the first time in the fourth quarter and finished the year down 18% and 30% respectively.

Consumable sales were down 7.5% in the quarter with a 14.5% decrease in Pall industrial and a 3% increase in Pall life sciences. In Pall industrial this reflects market weakness in commercial aerospace and transportation as well as [inaudible] chemical sales, in addition to the electronics and industrial manufacturing challenges mentioned earlier.

In Pall life sciences this reflects mid single-digit growth in pharmaceutical and hospital consumable sales offset by blood filtration sales which were down slightly. System sales increased 19.5% in the quarter with double-digit growth in pharmaceutical and municipal water systems. The mix of systems to total sales in the year was about 17% compared to about 13.5% last year.

For the full year the mix was 13% of total sales versus 12% in the prior year. Looking at sales by geography for the year, sales were down in the low to mid single-digit range in all three geographies with double-digit declines in microelectronics and industrial manufacturing across the board. I’ll now provide some highlights and lowlights relative to each geography beginning with the western hemisphere.

Pall life sciences sales here were down mid single-digits with blood filtration down due to a large contract loss, annualizing at the end of our third quarter, and the challenging environment earlier in the year due to some US drug manufacturers slowing. However the fourth quarter saw good growth in pharmaceuticals again particularly in systems.

And the result in the western hemisphere was overcome by the strong results in Europe and Asia that I’ll review in a moment. Western hemisphere’s municipal water sales represented more than half of the global sales in this market for 2009. These sales grew by 36% last year making this the third consecutive year of double-digit growth.

The US market is largely driven by EPA regulations with stimulus money a potential new growth driver that appears to be just now impacting our quoting activity. Military aerospace sales grew 19% in the western hemisphere primarily driven by CH 47 helicopter product shipments, and increased OEM platform builds while commercial aerospace was down 10.5% due to weakness in aftermarket sales and regional jets later in the year.

And food and beverage saw strong growth in systems investments throughout the year. Turning to Europe pharmaceuticals by far the largest life sciences market in Europe, turned in 7.5% growth reflecting in part strong demand for plasma and vaccines as Eric noted, laboratory sales grew double-digits and blood filter sales were solid.

Food and beverage, the largest Pall industrial market in Europe, had a challenging year with sales down about 8.5%. This has suffered from reduced activity in the high-end wine and bottled water markets, and in particular in eastern European countries afflicted with severe liquidity issues.

Aerospace sales grew double-digits in Europe in both the commercial and military markets. This was partly offset by a double-digit decline in transportation, a market hard hit by the slowdown in construction and capital investment.

Power generation sales grew 34% reflecting continued investment in new and upgraded capacity. And fuels and chemical sales were down mid single-digits. This particularly reflects the slowdown in the automotive and electronic supply chain sectors.

Looking next at Asia our investments in the region are enabling us to capitalize on the growing opportunities there. Life sciences grew by 12% with laboratory and pharmaceuticals performing well. Two new factories that will produce vaccines for the Asian market are doing the final commissioning of equipment signaling production should start soon.

And excluding industrial manufacturing in microelectronics, the latter being in the largest market Pall industrial serves in Asia, industrial sales were almost 7% with power generation, fuels and chemicals and municipal water, all posting double-digit gains.

And while microelectronic sales were still down in Asia in the fourth quarter the rate of deceleration appears to have slowed. The consumer electronics markets appears to be rebounding fueled in part by stimulus programs in China and Taiwan.

For the year gross margins improved 20 basis points to 47.3%. Our pricing and cost reduction initiatives showed through, adding over 3% to margins offset by the reduction in sales volumes, certain inflationary pressures, and the negative mix impact such as the decrease in higher margin microelectronics and industrial manufacturing products.

You can see this in Pall industrial’s gross margins which came in at 44% for the year, compared to 44.4% last year despite volume loss including about $130 million in these two Pall industrial highest margin markets. In the quarter we saw Pall industrial’s gross margins benefit from pricing by about 80 basis points.

However this volume and mix impact as well as the mix impact from the 15.5% growth in system sales continued to pressure margins. Pall life sciences gross margins for the year were 52.1% finishing the year with gross margins in the fourth quarter of 52.2%, a 70 basis point improvement over last year’s fourth quarter.

This was principally driven by cost reductions more then offsetting inflationary pressures and price increases that contributed approximately 1% in margin. Some of the gain was offset by under absorption of overheads, as Pall life sciences is a large supplier to Pall industrial, as well as the shift in product mix in the fourth quarter to a higher percentage of system sales.

SG&A including corporate expenses decreased about 7% compared to fiscal year 2008. Excluding the estimated impact of foreign exchange which reduced SG&A by about $43 million, it decreased 1% for the year, coming in at 30% of sales, it was 90 basis points higher then 2008 despite the cost reductions reflecting the top line reduction and continued investments in the business I’ll discuss in a moment.

And Pall industrial excluding the impact of foreign exchange SG&A decreased 3% while SG&A in life sciences increased 1%. In addition to the longer term cost reduction initiatives we have been executing we also incrementally brought down direct and indirect employment levels this year particularly in industrial as well as other spending globally in response to economic conditions.

And although we continue to look for opportunity to decrease costs, we are still investing in our future. Our ongoing efficiency and cost reduction programs are helping to fund these investments. As we reflect on this for fiscal year 2009, we estimate that price increases and cost reductions, net of inflationary items, added over 2% combined to our operating profit margin.

This was offset principally by the mix and volume factors that I discussed a moment ago. We expect to see some inflationary pressure in 2010 from rising raw material costs as well as medical and pension costs and we will again continue to work to more than offset them.

We held our research and development spending for the year overall which came in at 3.1% of sales compared to 2.8% last year although we did reduce it a bit in the back half of the year. Segment profit margins in the year were 16.6% compared to 17.3% in fiscal year 2008 as an improvement in life sciences operating margin was offset by a decline in industrial.

Consolidated operating margin came in at 14.2% compared to 15.2% last year. Turning to income taxes, the effective tax rate or as reported rate for the fourth quarter was 20.6% compared to 33.8% in the fourth quarter of last year. The effective tax rate for fiscal year 2009 was 27.8% compared to 33.3% last year.

Excluding items that we do not consider to be recurring and therefore did not benefit in the calculations of pro forma earnings per share I referred to earlier, the underlying tax rate for the year was 29.7%. This is below the forecast rate of 31.3% due to a different mix of pre-tax earnings by tax jurisdictions particularly due to lower earnings in higher tax rate countries hard hit like the US and Japan, and higher earnings in lower tax countries.

We do not expect this benefit nor the items excluded from pro forma earnings to be reflected in our tax rate for 2010. We continue to append various tax efficient strategies to our operating strategies and will continue to keep you apprised as we progress.

These strategies are expected to lead to reduced income taxes in addition to operating rigor and efficiencies and we continue to target and effective tax rate of about 25% to 27% by 2013. A significant driver of this anticipated rate reduction is the consolidation of our European management into our new facility in Fribourg, Switzerland, which as Eric mentioned, opened at the start of this fiscal year.

We are also evaluating the operating efficiencies of consolidating our Asian management into Singapore and we have finalized negotiations with local authorities there for various tax incentives.

Turning now to working capital management, cash flows and liquidity, operating cash flow in the quarter was approximately $173 million, compared to $174 million in last year’s fourth quarter. In the year it was about $327 million compared to about $326 million in fiscal year 2008.

And this is after factoring out the $135 million tax payment last year. This is an achievement we are encouraged by as it is showing us the money with operating cash flow of 1.7x earnings versus 1.5x earnings last year.

Efforts to further improve cash flow center on improvements in working capital management which include centralizing our credit and collections functions, renegotiating payment terms with customers, better aligning milestone payments to costs incurred to manufacture systems and other longer-term projects and linking compensation for senior sales and finance personnel to working capital improvement.

We have seen a sequential quarterly improvement in day sales outstanding, from our second quarter to our third quarter and continuing into our fourth quarter. The fourth quarter DSO was the lowest level achieved over the past eight quarters. It also includes renegotiating with suppliers to obtain among other things, shorter lead times and longer payment terms.

We are employing lean principals in our manufacturing processes in our supply chain which will also reduce our investment in finished goods inventory in addition to reducing costs and improving on time delivery to customers. At July 31, 2009 days in inventory were 118 compared to 124 as of July 31, 2008.

Looking at our full cash conversion cycle, it was 129 days in fiscal year 2009 compared to 136 days in fiscal year 2008. We believe there is substantial further opportunities to convert working capital to cash. Improving inn this area continues to be one of our top priorities and we will continue to keep you apprised of our progress.

Significant uses of cash during the year included $133 million in capital spending and this was mainly on production capacity and technological enhancements as well as finishing our facilities rationalization initiative. The closure of our [East Hills] facility and move to our new corporate headquarters in Port Washington, Long Island is imminent.

This move will cut the square footage associated with these facilities almost in half and save approximately $2 million per year starting with 2010. This closure marks the completion of the facilities rationalization program we announced in 2006.

We expect this level of capital spending to continue in 2010 as we invest in our information technology systems, a key enabler to many of our other growth and cost reduction initiatives. Another significant use of cash in the year was stock buybacks of about $96 million.

We bought back 3.3 million shares at an average price of $29.00 per share. This represents the repurchase of over $300 million for the three years ended July 31, 2009, decreasing our shares outstanding by about 9 million. We also paid $65 million in dividends to shareholders reflecting an increase of 11.5% per share attributable to the increase in the quarterly dividend from $0.13 to $0.14.5 per share effective with the dividend declared on January 22, 2009.

We invested in product development, organically and inorganically, $37 million was directed to the acquisition of new technologies for the pharmaceuticals and food and beverage markets last year, in addition to the $71 million spent on R&D and we repaid almost $24 million in outstanding indebtedness.

After accounting for these uses of cash our cash was $414 million at July 31, 2009 and our net debt to net debt plus equities stood at 21.4%, down from 22.1% at July 31, 2008. Our balance sheet and liquidity remain solid and we believe more then adequate to cover our liquidity requirements and to support our refinancing needs.

This includes our 9 billion yen loan which is approximately $95 million US dollars which comes due in June, 2010. I’ll close my remarks by saying that although fiscal 2009 was a challenge, we continued to execute on our strategies and then some. We are well positioned for when the economy rebounds, and our mission is clear, sustainable, profitable growth.

We remain excited and confident in Pall’s prospects and opportunities. I’d like to thank you for your attention this morning, and with that I will hand this back to Eric.

Eric Krasnoff

Thank you Lisa, I appreciate you pulling together all of the many moving parts and certainly share your optimism. So with that we’re now ready for your questions.

Question-and-Answer Session


(Operator Instructions) Your first question comes from the line of Hamzah Mazari – Credit Suisse

Hamzah Mazari – Credit Suisse

Just a couple of questions, could you comment a little bit about how much of your business you personally see as early mid or late cycle and in your forecast for 2010, you talk about a slow recovery in the second half, could you touch on which businesses you’re looking to come back faster then others.

Eric Krasnoff

Sure I think we are likely mid cycle for microelectronics from the capital point of view. I think when everyone used those terms of cycle, we’re looking more at capital spend and how it effects us. But because this downturn over the last 12 to 18 months was so severe and cut into base business, I think we’ll see more of a pick up in earlier base, higher margin business in micro e, in industrial manufacturing as well.

But for the significant capital areas, it would be more mid term. Do you want me to comment on 2010.

Hamzah Mazari – Credit Suisse


Eric Krasnoff

In those markets as well, I think what we’re saying is that our visibility at this point for those industrial markets is really no better nor worse then the industrial pundits and our customers, so, everyone is saying that they believe at least for microelectronics that its bottoming out and beginning to improve, and we have no evidence to argue with them.

Hamzah Mazari – Credit Suisse

And then just to follow-up, how much of a benefit have you already seen in your business from inventory destocking across your segments and what’s your outlook on that.

Lisa McDermott

Well as we mentioned, we did see a sequential improvement the fourth quarter over the third quarter so while for instance industrial manufacturing and microelectronics were down say year over year, we are starting to see a deceleration and we do believe that that relates to a bottoming of destocking and activity starting to pick up and therefore with inventories at bottom, customers resuming some buying.


Your next question comes from the line of Brian Drab – William Blair & Company

Brian Drab – William Blair & Company

A question for Lisa, I just want to understand the details around the tax benefits that you had in the fourth quarter, I know that on your adjusted build up here you use a $0.04 number, I was expecting based on your comments at the end of the third quarter, a tax rate of somewhere in the 31% to 32% range, and with the tax rate at 20.6% in the quarter, that looks like closer to an $0.08 benefit to me then a $0.04 benefit and I’m wondering if you could just break down that benefit and step through that calculation.

Lisa McDermott

Sure, in the quarter we saw about a $0.04 to $0.05 benefit from the items that we, what I’ll say pro [formaed] out. We considered those items to be nonrecurring. They related to certain one-time items from some of our foreign operations.

In addition to that we saw a benefit in the quarter of about $0.02 related to basically the mix of earnings in our various tax jurisdictions.

Eric Krasnoff

So microelectronics for instance is still down in Japan which is the highest tax rate country and we saw better sales in other geographies in other better margin products. So it resulted in a serendipitous but nice lift.

Brian Drab – William Blair & Company

So in general though you wouldn’t expect any of these dynamics that resulted in the $0.08 benefit to continue going forward and you could always have some swing either way given a geographic balance.

Lisa McDermott

That is what my comments reflected and I think that’s a fair assessment.

Eric Krasnoff

And Lisa said that we’d still expect within the five-year plan to get to the 25% to 27% tax rate and everything still looks good for that.

Brian Drab – William Blair & Company

And then you talked about some of the dynamics between systems and consumables, I’m just trying to figure out though, could you give me maybe the top two items that resulted in gross margin actually coming down about 140 basis points sequentially from the third quarter given such a good volume improvement sequentially, that I guess it must have a lot to do with the mix of products and systems.

Lisa McDermott

It had very much to do with the mix of products and systems particularly systems which were up significantly in our fourth quarter as well as some capital goods sales particularly on the Pall industrial side that we reflect as part of our consumable sales but they were also up in the quarter both with margins that are significantly below our corporate average.


Your next question comes from the line of Richard Eastman – Robert W. Baird

Richard Eastman – Robert W. Baird

How did the systems orders in the fourth quarter look relative to sales, book to bill better then one and maybe you could give me that two ways, one with the Philippines order and one without, base business.

Lisa McDermott

The book to bill was approximately, I’d say about 95% on systems.

Richard Eastman – Robert W. Baird

Does that include the large Philippines order.

Eric Krasnoff

The Philippines order is about $17 million and on a systems business of $300 million last year. Its not unusual to get these big orders, so I think you might as well just leave it in.

Richard Eastman – Robert W. Baird

I know you’ll update us maybe on guidance it sounds like in December, but is it, could you just give us a sense at this point in time how you’re thinking about fiscal 2010 from a local currency sales standpoint. Are we—

Eric Krasnoff

I can do that in general, I think that we’re going to see a systems be a lower number this year because we’ve seen some hold off in systems orders due to the promise of stimulus money, so there’s going to be a bit of, I believe, of a hiatus before that picks up again which will be positive on margins and I think we’re going to begin to see a strengthening in base business across most of the sectors as we move through this year.

I’m not going to quantify it at this point, but certainly the fourth quarter if its indicative of what we’re going to see, we’re going to see Pall up with a best cost basis, continuing strong programs for efficiency, improvements in cost reductions, establishment of more centers both for infrastructure rationalization, of back office processes, as well as consolidation of management centers into Europe and Asia.

So I’m very much looking forward to next year.

Richard Eastman – Robert W. Baird

And then just one follow-up there, we talked, in the SG&A section when Lisa was talking she mentioned that there were some investments taking place on the SG&A line, could you highlight those. Where are we investing, is it a regional basis or is it in one of the two product categories.

Eric Krasnoff

We’re definitely investing into our footprint in Latin America into Southeast Asia. We’re investing also in both Eastern Europe and the Middle East which are good growth areas for Pall right now and for the future. And we’re generally strengthening I think our point of contact with customers and we’ve tried not during this downturn to sacrifice our service and our marketing and sales efforts.

Lisa McDermott

And during the year we invested in some outside consulting assistance to facilitate our corporate initiatives particularly on the pricing excellence program and our enterprise risk management program.

Richard Eastman – Robert W. Baird

Is the pricing program expected to yield a point or two of price capture in fiscal 2010 as well, how far into that are we.

Eric Krasnoff

The pricing initiative started at the end of August of 2008, so the beginning of this prior fiscal year and really we start piloting approaches towards the end of winter into the early spring and we’re just seeing now the results of that probably a quarter to a third of our global markets being impacted. So we think we have a lot to go.


There are no additional questions at this time; I would like to turn it back over to management for any additional or closing comments.

Eric Krasnoff

Thank you. I appreciate all of you participating this morning and your interest. We will be presenting at the UBS Healthcare conference in New York City on September 23 and hope to see some of you there. And also please put December 9th for our earnings release for the first quarter and the 10th for our analyst conference call onto your calendars.

And as I mentioned before, save December 17th for our next investor day. Thank you.

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