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Hutchinson Technology Inc. (NASDAQ:HTCH)

F4Q09 Earnings Call

November 2, 2009; 5:00 pm ET

Executives

Wayne Fortun - Chief Executive Officer

Kathleen Skarvan - President of our Disk Drive Components Division

Rick Penn - President of our BioMeasurement Division

John Ingleman - Chief Financial Officer

Dave Radloff - Corporate Controller

Chuck Ives - Investor Relations

Analysts

Sherri Scribner - Deutsche Bank

Christian Schwab - Craig-Hallum Capital Group

Rich Kugele - Needham & Co.

Tom Lewis - High Road Value Research

Peter Kim - ISI Capital

Operator

Welcome to the Hutchinson Technology’s fourth quarter results conference call. Turning today’s presentation all parties will be in a listen-only mode. Following the presentation the conference will be open for questions. (Operator Instructions)

I’d now like to turn the conference over to Chuck Ives, Investor Relations.

Chuck Ives

Good afternoon everyone. Welcome to our fourth quarter results conference call. On the call with me today are Wayne Fortun, our CEO; Kathleen Skarvan, President of our Disk Drive Components Division; Rick Penn, President of our BioMeasurement Division; John Ingleman, our CFO; and Dave Radloff, our Corporate Controller.

As a reminder, we will be providing forward-looking information on demand for and shipments, of the company’s products, production capabilities, capital spending, worldwide disk drive and suspension assembly demand and shipments; average selling price; product cost, our plans to establish new assembly operation in Thailand, our BioMeasurement Division’s revenue, product commercialization and adoption, the company’s results of operations and operating performance.

These forward-looking statements involve risks and uncertainties as they are based on our current expectations. Our actual results could differ materially as a result of several factors that are described in our periodic reports on file with the SEC. In connection with the adoption of SEC rules governing fair disclosure, the company provides financial information and projections only through means that are designed to provide broad distribution of the information to the public.

The company will not make projections or provide material nonpublic information through any other means. We issued our fourth quarter results announcement just after the market closed this afternoon and it is now posted on our website at www.htch.com.

I’ll turn the call over to Wayne now for his opening remarks.

Wayne Fortun

Thanks Chuck. Good afternoon and thank you for joining us today. The improvement in operating performance and financial position that is evident in our fourth quarter results is the product of actions we have been taking throughout fiscal 2009 to reduce costs and debt. Over the course of the year we have worked aggressively to improve our cash flows, strength in our balance sheet and fundamentally change the cost structure of our business in response to very challenging market and economic conditions.

Due to the substantial cost reductions we achieved, we operated at close to breakeven in the fourth quarter, excluding the gains on debt repurchases and on the sale of our Sioux Falls Building. Our fiscal 2009 fourth quarter operating income increased to $2.1 million compared to a $10.5 million operating loss in last year’s fourth quarter. Our ability to deliver these kinds of results, despite a 31% decline in suspension shipments, illustrates the impact of the actions we took to change the cost structure of the business.

With the respect to our financial position, over the course of year we have repaid $132 million, or 35%, of our convertible debt, reducing the balance from $375 million to $243 million. We had got a lot of hard work to do yet to get back to consistent profitability, but we are pleased to have weathered the period of extraordinary challenges without compromising our ability to innovate and compete.

Now I’ll turn the call over to Kathleen for an update on the Disk Drive Components Division.

Kathleen Skarvan

Thanks Wayne. During our fiscal 2009 fourth quarter we shipped 145 million suspension assemblies, about flat with the 146 million in the preceding quarter. This is down 31% from $209 million in last year’s fourth quarter. The strengthening of demand during the quarter and our ability to respond to that demand enabled us to ship volume that was comparable to the prior quarter, despite a decline in shipments to Seagate Technology that was expected.

In the 1.8inch ATA and enterprise segments, suspension assembly shipments increased slightly quarter-over-quarter, but declined slightly in the 3.5inch ATA and 2.5inch ATA segments. These changes resulted in a product mix that was nearly identical to the preceding quarter and breaks down as follows. Suspension for mobile applications accounted for 44% of our shipments, the same as the preceding quarter.

Suspensions for 3.5inch ATA applications accounted for 37% of our shipments compared to 38% in the preceding quarter and suspensions for enterprise applications accounted for 19% of our shipments compared to 18% in the preceding quarter. Average selling price in the fiscal 2009 fourth quarter was $0.70 down from $0.71 in the preceding quarter and $0.78 in last year’s fourth quarter.

Now moving to TSA+ results for the fourth quarter, our shipments included $18 million TSA+ suspensions, up from $10 million in the preceding quarter. TSA+ suspensions offer our customers superior performance, and as a result they are gaining broader acceptance and being designed in two more disk drive programs. We are also continuing to reduce the cost burden of TSA+ flexure production, which is $7.1 million in fiscal 2009 fourth quarter down from $7.6 million in the preceding quarter and $11 million in last year’s fourth quarter.

Our TSA+ output yields and efficiencies are all improving and we remain on track to eliminate this cost burden in the second half of fiscal 2010. Ultimately we expect that the cost to reduce our additive TSA+ flexures will be lower than the cost to reduce our current subtractive TSA+ flexures. Another technology that is generating interest is dual stage actuation or DSA. This technology was used in the past by one hard drive manufacturer for an enterprise application.

As the sole supplier for that program we produce more than 100 million TSA suspensions. Now the interest is more broad based and we are actively involved with several of our customers on DSA designs in prototype. Our leading-edge designs, proven TSA capability and installed capacity position as well to meet our customers needs for this technology.

Looking ahead to fiscal 2010, we expect our volume will, at minimum keep pace with the worldwide demand for suspension assemblies, resulting in a return to year-over-year volume growth. TSA+ suspensions should account for a steadily increasing percentage of our shipments as the fiscal year progresses and we continue to expand TSA+ adoption. One of our key initiatives this year is establishing an assembly operation in Thailand.

Our goal is to initiate production in the second half of calendar 2010. This operation will further enhance our long term cost position, as well as our ability to serve our customers operations in Asia. Finally, we have initiated an effort to derive additional value from our unique combination of precision manufacturing expertise and capability, coupled with leading edge design, test measurement and engineering services.

These capabilities are valuable in several other industry and we are marketing our metrology, tool design, tool build and component manufacturing to targeted companies. Although we have secured some initial business for these services, this effort is in its very early stages and currently serves primarily as a means to leverage expertise and infrastructure that is already in place.

I’ll turn the call over to Rick now for a review of BioMeasurement Division results.

Rick Penn

Thanks, Kathleen. Net sales for the BioMeasurement Division in the fiscal 2009 fourth quarter totaled $624,000, up from $408,000 in the preceding quarter and $445,000 in the last year’s fourth quarter. The revenue growth resulted primarily from recurring sales to existing customers which more than doubled compared with the preceding quarter and although hospital spending restrictions delayed some initial purchases by prospective new customers, we are encouraged by the growth in recurring sensor sales.

This growth reflects increasing quotation understanding and acceptance of the value of StO2 monitoring resulting from our customer education efforts and the development of protocols that incorporate the use of InSpectra StO2 monitoring. Sales to distributors also increased during the fourth quarter, as we continued to widen the geographic reach of our marketing and sales efforts.

We are now positioned to sell the InSpectra system in 26 countries through a combination of direct sales and distributors. While the division’s fiscal ‘09 sales were short of our initial expectations, we made solid progress in several areas over the course of a year. We nearly doubled the number of customers to 98 and the installed base of monitors nearly tripled to more than 220 at year end.

Throughout fiscal 2009 the body of compelling clinical and economic evidence noting the benefits of InSpectra StO2 monitoring in a broad range of critical care settings continued to grow. During the year, for example, there were more than 60 industry publications and presentations that documented the value of StO2. This body of evidence and momentum built in 2009 provides a firm foundation for our overall marketing and sales efforts.

Our clinician education programs and our focus on establishing InSpectra StO2 monitoring as a standard of care, with our restructuring actions, as Wayne mentioned earlier, we also improved the financial performance of the BioMeasurement Division compared to the preceding quarter, the division’s operating loss declined by about $800,000 to $4.9 million.

Looking ahead, we expect to accelerate BioMeasurement revenue growth through our expanded sales and marketing reach, through our continued focus on clinician education that builds understanding and use and to our ongoing efforts to foster protocols that incorporate StO2 as a standard of care in multiple critical care situations. Our forecasting quarterly sales remains challenging, we currently expect fiscal 2010 revenue for the division to reach $4 million to $6 million, compared to $1.8 million in fiscal ‘09.

I’ll turn the call over to John now for a discussion of our financial results.

John Ingleman

Thanks, Rick. Net sales for the fiscal 2009 fourth quarter totaled $103 million down 3% from the $106 million in the preceding quarter and down 37% from the $164 million in last year’s fourth quarter. The small sequential decline was primarily a result of a decline in the shipments to Seagate Technology that was expected. Revenue percentages for our top customers in the quarter were as follows SAE/TDK 45%; Western Digital, 39%; Seagate, 10%; Hitachi, 5%.

Gross profit totaled $17.5 million or 17% of net sales. That is an increase of $16 million or 15 percentage points from the preceding quarter. It also represents an increase of 6.5 percentage points over last year’s fourth quarter, despite a 31% decline in unit shipments and a $61 million decline in net sales. These gross profit results are strong illustrations of extensive changes that we have made in our cost structure over the course of the year.

As Kathleen mentioned in her remarks, we also reduced the cost burden of TSA+ flexure production by about $500,000 compared with the preceding quarter. This was achieved by reducing out TSA+ cost per part by more than 20% compared with the prior quarter. Even more telling is the fact that our TSA+ cost per part in the last month of the quarter was about 40% lower than our cost per part in the third quarter.

Based on this lower cost as we exit in the fourth quarter and our quarterly TSA+ volume forecast for fiscal 2010, we expect to see a greater incremental reduction of cost burden over the next few quarters. Depreciation and amortization expense was approximately $16 million compared with $17 million in the preceding quarter and $28 million in last year’s fourth quarter.

R&D expenses were $4.7 million down from $5.7 million in the preceding quarter and $9.3 million in last year’s fourth quarter. SG&A expenses totaled $10.6 million, down from $13.3 million in the preceding quarter and $18.7 million in last year’s fourth quarter. The SG&A expenses were reduced during the quarter by $1.9 million gain on the sale of our building in Sioux Falls, South Dakota.

The BioMeasurement Division continued to reduce its operating loss $4.9 million in the fourth quarter down from $5.7 million in the preceding quarter and $6.1 million in last year’s fourth quarter. Interest expense was $2.4 million compared to $2.8 million in the preceding quarter and $2.9 million in last year’s fourth quarter. Interest income was $300,000 compared with $700,000 in the preceding quarter and $1.2 million in fiscal 2008 fourth quarter.

Net income for the quarter totaled $81.3 million or $0.34 per diluted share. As noted in our earnings announcement, our results for the quarter include gains totaling $7.5 million on the repurchase of $47 million of our convertible subordinated notes and previously mentioned gain on the sale of our Sioux Falls building. Excluding these gains, we would have reported a net loss of $1million or $0.04 per share.

Over the course of fiscal 2009, we have strengthened our balance sheet by reducing our debt on favorable terms and we have improved our cash flow. Since beginning the fiscal year, we’ve repaid $132 million, or 35% of our convertible debt, reducing the balance from $375 million to $243 million.

As part of this reduction, the remaining balance of the convertible subordinated notes due in March of 2010 has been reduced to $45.6 million. The remaining balance on the convertible subordinated notes due in January 2026, which are first portable by holders in January of 2013, have been reduced to $197 million.

Our cash and investments at the end of the year totaled $227 million, down $24 million from the preceding quarter. We used $39 million during the quarter for the repayment of the convertible debt, and we received $12 million for the sale of our Sioux Falls building, including capital spending of $2 million, severance payments of $2 million and $6 million reduction in our accounts payable balances.

We generated a free cash flow of $6 million in the fourth quarter. This represents a $16 million improvement year-over-year despite a $61 million decline in revenue. Our share count at the end of the fiscal year was approximately $23.4 million, resulting in a book value per share of $12.44.

Turning now to our outlook, as noted in the earnings release, we expect our suspension assembly volume to at least keep pace with the worldwide demand for suspension assemblies, resulting in a return to year-over-year volume growth. The pricing environment has been aggressive and may continue to be so. However, with HDD unit forecasts to grow roughly 10% to 15% in 2010, we are closely watching variables that may moderate pricing pressure, including the balance of supply and demand, inventory levels, market conditions and behavior of our competitors.

Our fixed portion of cost of goods sold and our operating expenses are expected to remain relatively flat compared with the 2009 fourth quarter. This includes about $10 million in startup expenses for fiscal 2010 for the establishment of our Thailand assembly operation.

Conversely, our fiscal 2010 results will include an additional non-cash interest expense resulting from the adoption of the new accounting pronouncement, which was called out in our earnings announcement. Based on a balance of $197 million for our three and a quarter convertible debt, we estimate that the additional expense will be approximately $8.5 million in 2010.

Our 2010 effective tax rate is expected to remain at about zero. Depreciation and amortization expense for 2010 is expected to be approximately $55 million compared with $77 million in fiscal 2009. We are currently projecting fiscal 2010 capital spending of about $35 million, which includes $15 million to establish our assembly operation in Thailand.

I’ll turn the call over to Wayne, for his closing remarks.

Wayne Fortun

Thanks, John. Needless to say, fiscal 2009 was a very challenging year and we are happy to have it behind us. We are pleased though with how the company responded to the challenges we faced. As a result, the actions we took this past year we start the fiscal 2010 with our financial position substantially strengthened and our cost structure fundamentally reduced.

While we currently expect and are prepared for year-over-year volume growth for our Disk Drive Components Division in 2010, we are also confident that the company is much better positioned to weather market and economic instability should it occur. Looking longer term, our strategy is to achieve consistent profitability, including improving TSA+ production efficiency, expanding TSA+ adoption, initiating assembly operations in Thailand, and growing revenue in our BioMeasurement Division.

That concludes our prepared remarks. Britney, please begin the poling for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Sherri Scribner - Deutsche Bank.

Sherri Scribner - Deutsche Bank

I was just curious if we could get an update on the Seagate business. I think in the past calls you’ve said Seagate would go to less than 10% and they were at 10% this quarter. What is your expectation going forward? Does that fall a little bit more and how does that impact your expectation of growing inline with the industry?

Kathleen Skarvan

I will take that one. I think we’ve talked about 5% to 10% or it wouldn’t be at 5% to 6% and it’s just been a little difficult to get our arms around, but we do believe that we’re going to continue on this generation of enterprise products and there maybe some opportunities for next generation, but it will all depend on the overall market and Seagate’s overall volume needs, but I believe at this time we’re saying it could be anywhere between 5% and 10%.

Sherri Scribner - Deutsche Bank

So is it fair to say that you are just doing enterprise for them going forward, at least at this point?

Kathleen Skarvan

That’s a pretty good assumption.

Sherri Scribner - Deutsche Bank

Just an update on the TSA+, how many customers do you have on that program now? Then maybe if you give us a little bit more color on how those cost are reduced. Is it primarily through volumes or is it the expertise that you’ve gotten? I know you mentioned at the end of the quarter the pricing was lower, but a little more detail if you could help.

Kathleen Skarvan

Right now we’re in volume still with one customer, although we are investigating additional designs with other customers. I’m not going to comment on specifically, but things are going well in that regard and when you look at what’s going on with the operation itself, the volume has been very helpful. So that we can leverage those fixed cost and that investment. We are also though making good gains on our efficiencies and yields quite well on track, so all of that combination has been providing good momentum going forward.

Operator

Your next question comes from Christian Schwab - Craig-Hallum Capital Group.

Christian Schwab - Craig-Hallum Capital Group

John, what is realistic gross margin target in 2011 for your business, given the significant cost restructuring that you guys have done and TSA+ no longer being a drain and also being a lower cost solution to manufacture at the end of the day? Can you give us your internal projections or your goal for that timeframe?

John Ingleman

Christian, I don’t know that I’ll give you exactly 2011, but I think it’s fair to say that we believe that our gross margins can get back into the mid 20s and that would certainly take into consideration all of the things that you mentioned that we would have to see volumes, we would have to see improvement in cost and all of those things.

Christian Schwab - Craig-Hallum Capital Group

Then for 2010 should we be assuming that OpEx stays at Q4 type of levels, give or take or can you give us your expectations for OpEx for next fiscal year?

John Ingleman

Now, OpEx at about the Q4 level is a reasonable way to think about it. You also need to think about above the line. The more fixed portion of the cost of goods sold is probably going to stay pretty close to where we are running or we ran in quarter four.

Operator

Your next question comes from Rich Kugele - Needham & Co.

Rich Kugele - Needham & Co.

A couple of questions, I guess first, when we look at the Thailand facility expense of starting up, where will that appear? Are you going to include that in your gross margin expense to us or are you going to break out?

John Ingleman

I think it’s going to be both above the gross profit line and some of it will be below the gross profit line, Rich. I haven’t even thought about whether we’ll talk about it, but it probably won’t be one of those things that we will just talk about quarter after quarter. I think that it’s fair to say that, we think that the startup costs are about $10 million, and they probably start lower in the year and then rise as we get to the end of the year.

Rich Kugele - Needham & Co.

Then when you look at your share today, if you have a sense on what it is today, and then maybe exiting next fiscal year or even maybe December 2010 tight timeframe, what it might be as you start to see some traction with TSA? Because I would imagine that your TSA+ share is a little different than what it is for the mainstream suspension.

Kathleen Skarvan

I’ll speak to the first part of your question, Rich, and then we’ll probably need a little clarification on that second part of the question, but slight share loss because of the Seagate situation, so we’re estimating we’re in that low 30s, something like that.

Rich Kugele - Needham & Co.

Before I go and clarify that, did you see any prospects over the next 12 months to increase that or do you think you have far your way to stabilizing it?

Kathleen Skarvan

As we said in our earlier remarks, we expect to grow at a minimum with the market. Now, I’m never satisfied with just growing with market, but I don’t think we’re going to make any predictions at this point.

Rich Kugele - Needham & Co.

Then what I was trying to get at was, did the comparable product that’s offered by competitors for TSA+, how much of that is out there in the market today, or what do you expect to be out there 12 months from now? So how should you look at the share for that solution 12 months from now?

Kathleen Skarvan

We’re not viewing that there’ll be a lot of displacement of their share as much as our subtractive will turn over to additive. That’s really how we view it for the most part, Rich.

Operator

Your next question comes from Tom Lewis - High Road Value Research.

Tom Lewis - High Road Value Research

I was looking for a little color on what’s going on there at BioMeasurement? I think we all knew going into it, there it was going to be a long road. I’m just trying to get a sense of what the kind of the gating factor is on your growth?

I would think you would be past the point where it’s about trying to get hospitals to even know about your product or even an actual purchase, and we’ve kind of moved on to the point of it’s about clinical education. It looks like you’ve made, I don’t know was that just an enhancement to your website in August on that subject, or was there a bit of a step up in this effort over the summer?

Rick Penn

Yes, we’ve in a way you could think of our division as an education division. We definitely over the course of this past year really stepped it up. It’s the name of the game. I mean, we’re running a number of sessions where doctors and nurses from a variety of hospitals around the country and in Europe come. We’re also teaching clinicians and giving them the tools to go back and train themselves or others in their institutions.

So it’s a really big deal and I would say the engine, that the education machine is up and running very, very well at this stage of the game. We’ve gotten a lot of that in place through the course of this past fiscal year. We just about doubled our revenues in ‘09 compared to ‘08. We thought we could triple them or better, so we missed our goals, but frankly I would say, most of that miss is because of delays in getting new customer purchasing to move ahead.

I think the economy tanked on us, and that’s a big piece of what I think has caused some delays in winning some new customers, but I think the big deal is that the repeat business VT business is really moving ahead and part of that’s, because of the education that’s going on, which frankly links to more and more of our customers developing more specific protocols for use.

When that happens, we get that expanding use, and so we’ve seen nice growth in business with current customers that are accelerated, even as we’ve kind of come-off at the backend of the year. So I’ll let you ask any other more specific questions, but I’m just trying kind of give you some flavor for how we’re feeling about things as we look ahead, but quite optimistic.

Tom Lewis - High Road Value Research

So it sounded a little bit from your answer here that the gating factor in terms of realizing the potential that was heard about in the past, and I assume is still there, Mike have still be at the point of initial adoption, as opposed to, okay, they’ve got it in-house. Now you got to get a whole bunch of people to change, how they’ve been doing everything their whole working life and Education being the answer to that. Would you consider one to be more of a gating factor than the other to your growth?

Rick Penn

Try me one more time.

Wayne Fortun

I think, if I got you right, the question is really one of, are we still having to really go in and sell a hospital and doctors on the need for StO2 or to explain what it is, versus you have the hospital, the doctors that are perhaps one or two that are championing the use, but it takes the training of a large number of doctors and a large number of nurses to really turn that into the kind of volume that we haven’t had and still anticipated and it’s really is the latter.

We’re not running into places where we have to, like a year ago or a little more than a year ago, explain what StO2 was and to start from scratch. Now, most places know what it is, but what we found, and what Rick was talking about, was we are holding our advanced training, in which we’re bringing several doctors from multiple hospitals together and being taught by other doctors and they’re going back now and we’re getting anybody of users that are large enough now that they are actually and that’s why Rick brought up the protocols.

There’s a large enough body of users at some of these hospitals now that they’re starting to write a protocol saying all of our doctors will use this protocol when treating a patient in a significant way. That I think is the keys that really turning on the volumes where we think they can go.

Rick Penn

What we’re seeing at these education programs that we’re encouraged by if there’ll be an initial team of doctors or nurses they come in these programs, and then they send a following team and another follow-on team that’s a the next programs. I’ve been at several of these and participated and watched what’s going on and talked to the customers.

These teams that are coming that are following on are really there for the purpose of solidifying protocols, at least within parts of their hospitals. Now having said all of that, it is still challenging to keep it moving and expanding within a given hospital. I mean, you may get the trauma area, but you’ve still got to work like crazy to get the ED, that’s lots of work, but I guess the machine that helps make that happen is working pretty well at this point.

Tom Lewis - High Road Value Research

So taking all that with the added data points that you can sell in 26 countries now and looking up into your new business pipeline, would adding 100 or even 200 hospitals over the next year be unrealistic?

Rick Penn

No. You were probably in that neighborhood. I would say, we could certainly double again. We’re sort of fed up to get those early adopters in a variety of regions. Frankly, in a lot of those regions, we are actually getting called, where we’ve got doctors that are hearing about us. They’re at congresses or conferences that are in the U.S. or Europe or wherever, and then they go back to their home region or their home country and we’re getting calls there.

So I think, we’ll expand customers at above that base, double again or something like that. I think we’ll see on a significant part of that $4 million to $6 million in revenue next year coming from current customers actually, that are starting to really grow within their own hospitals.

Tom Lewis - High Road Value Research

Last question then, how do you think about a big customer year ahead? It looks like the average sale per hospital over the last year was a pretty small number, certainly relative to potential numbers I’m hearing, but how are you thinking about your top handful of customers in terms of how much business they do in the year ahead?

Rick Penn

We are trying to move a significant category of customers into the 50 plus sensors per month range and $0.5 million would be a large customer at this stage of the game.

Operator

Your final question comes from Peter Kim - ISI Capital.

Peter Kim - ISI Capital

I just have two quick questions. First, could you give a little bit of an update on what the situation with auction rate securities with Citibank is? Has it been resolved already? Then the second question is about, what are your competitors doing in terms of dual stage actuators? Are you making that model for Seagate at this point?

John Ingleman

I’ll take the first one. With respect to Citi, the auction rate securities at Citi, we’re in arbitration with them and there really isn’t much else that I can tell you about that. We’ve got about nothing has changed. We’ve got about $25 million worth of auction rate securities with Citi.

Kathleen Skarvan

I’ll take the dual stage actuation question. It is our understanding that both of our more key competitors are working on dual stage as we speak and I don’t have a good feel for the volumes that they are at, but they have been working on it also. Your question regarding a specific customer, we typically won’t comment on a specific customer or program. So not going to...

Operator

There are no further questions in the queue at this time. I would like to turn the call back to Mr. Fortun for any closing comments.

Wayne Fortun

Thank you. I really want to thank everyone for joining us today and we look forward to speaking to you next quarter.

Operator

Thank you. Ladies and gentlemen, this concludes the Hutchinson Technology fourth quarter results conference call. You may now disconnect.

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Source: Hutchinson Technology Inc. F4Q09 (Qtr End 27/09/09) Earnings Call Transcript
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