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Global Sources (NASDAQ:GSOL)

Q3 2006 Earnings Call

November 8, 2006 8:00 am ET

Executives:

Moriah Shilton, Investor Relations

Merle Hinrichs, Chairman and Chief Executive Officer

Eddie Heng, Chief Financial Officer

Analysts:

Dick Wei, JP Morgan

Jason Brueschke, Citigroup

Craig Swanson, Devon Capital

John Mow, Roth Capital Partners

Patrick Wren

Ted Pedro, GK Associates

Operator

Welcome to the Global Sources Third Quarter 2006 Earnings Conference Call. At this time, all participants are in a listen-only mode. Following management’s prepared remarks we’ll hold a Q&A session. To ask a question please press * followed by 1 on your touchtone phone. If anyone has difficulty hearing the conference please press * and 0 for operator assistance. As a reminder, this conference is being recorded, Wednesday, November 8, 2006. I would now like to turn the conference over to Ms. Moriah Shilton with of Lippert/Heilshorn & Associates. Please go ahead ma’am.

Moriah Shilton, Investor Relations

Thank you, Nicole, and I’d like to thank everyone again for joining us today for Global Sources Third Quarter 2006 Earnings Conference Call. With us on the call are Merle Hinrichs, Chairman and Chief Executive Officer; and Eddie Heng, Chief Financial Officer. If anyone has not yet received the press release, it is now available at the Company’s web site at www.globalsources.com. If you would like to be added to our distribution list or if you would like additional information about Global Sources, you may call Lippert/Heilshorn & Associates at 415-433-3777. There will be a replay of this call available until November 10th and the dialing instructions are included in the press release. The replay will also be available on the Investor Relations page of the Company’s website for at least 30 days.

Before I turn the call over to management, let me remind you this call will contain forward-looking statements. Investors should be aware that any forward-looking statements are based on assumptions and are subject to risks and uncertainties that could cause actual results to differ materially from those discussed here today. These risk factors are explained in detail in the Company’s filings with the Securities and Exchange Commission. Global Sources does not undertake any obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

I would now like to turn the call over to Mr. Hinrichs. Please go ahead, sir.

Merle Hinrichs, Chairman and Chief Executive Officer

Thank you and welcome everyone to our call today. The third quarter of 2006 was very successful in many respects. Total revenue was $29.39 million and that’s up 16% over the prior year’s period, while there were no China Sourcing Fairs or associated income to this quarter. Compared to last year’s period, online revenue grew 20% and print revenue grew 9%. Both of these revenue sources are benefiting from our cross-selling initiatives whereby a growing number of our customers are using integrated marketing campaigns that utilize our online and our print services along with booths at our highly successful China Sourcing Fairs.

Net income was $4.1 million, that is up 78% over the prior year’s quarter, and earnings per diluted share were $0.11 and that is up $0.83 over the prior year’s quarter. Just over two weeks ago and after the end of the third quarter we completed our three October China Sourcing Fairs at the AsiaWorld-Expo here in Hong Kong. They were very successful with more than 7000 booths in total as compared to approximately 5900 last spring. Gifts and home products were sold out with approximately 4000 booths and was the largest show in our history. Electronics and components had over 2300 booths and that was up approximately 30% compared to the April event. Fashion accessories had over 750 booths and that was up approximately 50% compared to the April show.

Show attendees included truly a who is who of import buying power, to name just a few, and let me share those with you now. In the fashion accessories sector, attendees included Carrefour, GAP, Coles Myer, RTA, Sears, Target, and Tesco. In the electronics and components sector, there were buying representatives from BenQ, BestBuy, Black & Decker, Canon, Carrefour, Philips, Fujitsu, Freescale, KMart, LG Electronics, Samsung, SANYO, Salisbury’s, Target, Staples, Tchibo, NEC, and ThreeSixty Sourcing. And in the gifts and home product sector among buyers who attended were representatives from B&Q International, Sears, OfficeMax, QVC, Staples, Auchan, Coles Myer Asia, Carrefour, El Corte Ingles, ThreeSixty Sourcing, Tesco, Procter & Gamble, Dunlop, L'Oréal, Amway, Sanrio and Next Retail Ltd.

I provide that list just to demonstrate the quality of the attendees at these shows. If we look at the entire year for our China Sourcing Fairs, we will have sold nearly 13,000 booths in our first year at a brand new trade show location. This is a tremendous achievement in the history of the trade show industry. There is also evidence of an outstanding effort by our team members and a clear indication of the reputation and trust that Global Sources brand has achieved in the 35 years we have been serving our buyer and supplier community.

I’ll now turn the call to Eddie Heng, our Chief Financial Officer, for his review of the financials and discussions of the fourth quarter and full year 2006 guidance, after which I will conclude our prepared remarks and then we will welcome your questions. Eddie…

Eddie Heng, Chief Financial Officer

Thank you, Mr. Hinrichs. Now, I’ll review the third quarter of 2006 compared to third quarter of 2005. Revenue was $29.3 million compared to $25.4 million. Online services revenue was $16.7 million compared to $14 million. Print services revenue was $11.9 million compared to $10.9 million. China sales comprised 53% of total revenue and were $15.5 million compared to $12.2 million.

Operating expenses were $25.9 million compared to $23.1 million. The anticipated increase was due mainly to generating the expected higher revenues, investing in trade show infrastructure, and recognizing the increased value of share awards for incentives that have been given to non-employee sales representatives. Net income was $4.1 million compared to $2.3 million in the prior year's quarter. Earnings per diluted share were $0.11 compared to $0.06 in prior year's quarter.

For the nine-month period ended September 30, 2006, compared to the same period in 2005, the results are as follows: revenue was $104.2 million compared to $79.9 million. Revenue from China represented approximately 51% of total revenue compared to 48%. Operating expenses were $93.2 million compared to $17.8 million. Net income was $12.6 million compared to $8.8 million, and earnings per diluted share were $0.33 compared to $0.24.

Now, on to our balance sheet review; cash and securities on September 30, 2006, totaled $145.4 million. Short- and long-term deferred income and customer prepayments, which include online, print, and trade show revenues, which are all collected in cash was $68.7 million at September 30, 2006, compared to $46.9 million at September 30, 2005. The majority of the 46% increase reflects growth in our trade show business. So, deferred income and customer prepayments will be realistically larger at the end of the first and third quarters, just prior to the revenue recognition in subsequent quarters of our large China Sourcing Fairs.

Total assets were $212.1 million compared to $159.5 million a year ago. Also, we do not have any long-term debt or bank debt. Day sales outstanding or DSO were 17 days compared to 20 days at the end of last year’s third quarter, and shareholder’s equity was $116.2 million.

Now, I will review our financial guidance for the fourth quarter and full year 2006. I would like to first remind you of how our trade shows are expected to impact our revenue and profitability, and explain some of our increasing seasonality. Revenue from trade shows is recognized in a month in which the event occurs, which creates greater seasonal revenue fluctuations. Except for our IEEC China Show which is held in a first quarter, all of our largest trade shows are currently held in the second and fourth quarters of this year. For example, in 2006, we expect to derive from exhibitions approximately 12% of our total revenue in the first quarter, 37% in the second quarter, just 1% in the third quarter, and then 41% in the fourth quarter.

In addition, our online and print revenue is seasonal and has to be highest in the fourth quarter of each calendar year. The net result is that the second and fourth quarter revenues are likely to be substantially higher than the first and the third quarter’s revenues.

For the fourth quarter of 2006, we anticipate the following: revenue is expected to be in the range of $50 million to $50.5 million, representing growth of between 55% and 56% as compared to the same quarter last year. Earnings per diluted share are expected to be between $0.18 and $0.20 including an exceptional one-time interest income of $0.05. This range represents growth of between 50% and 67% as compared to $0.12 in the fourth quarter of 2005.

For the full year of 2006, we anticipate the following: revenue is expected to be in the range of $154 million to $164.5 million, more than 37% as compared to $112 million in 2005. Earnings per diluted share are expected to be in the range of $0.51 to $0.53; again including an exceptional one-time interest income of $0.05. This range represent growth of more than 42% as compared to $0.36 in 2005.

And now I’ll turn the call back to Mr. Hinrichs.

Merle Hinrichs, Chairman and Chief Executive Officer

Thank you, Eddie. I’d like to now address several elements of our strategy. In continuation of our growth strategy to expand the number of vertical markets we serve, in October we announced the increased specialization of our broad gifts and home products; one will be gifts and premiums and the other is home products. The online market places for these new verticals are scheduled to go live in January 2007, and the inaugural issues of the monthly magazines are scheduled for publication in February.

As a company, we have intense focus on deeply serving the unique needs of a range of vertical markets. Clearly, one size does not fit all. For example, what our customer is in the house wares industry require in the way of content and services is very different from what our customers in the premiums business require. And the increase specialization from the new verticals is expected to enhance our ability to serve these large or huge industry sectors. We also expect these changes from our buyer and supplier communities and to contribute to revenue growth and profitability.

We also continue to work with HC International, a leading Chinese language B2B media company in China spanning online magazines and research media. As a company, we are committed to aggressively expanding our Chinese language B2B activities. For those who maybe new to Global Sources, we have an approximate 13% investment in HC International with the option to buy an additional 35% approximately by June 2007. We’re still early in the time line and are closely evaluating the potential synergies and opportunities we have identified. We believe a relationship with HC International could facilitate accelerated development of two important objects: first, the expansion of the Chinese language B2B publishing, and second entry basically into the Chinese language search business.

Today, we are closing in on the end of 2006 and have raised our guidance for the fourth quarter and the full year, primarily based on the stellar results from the recent October China Sourcing Fairs. As Eddie mentioned, the annual guidance we have now given works out to a revenue growth of more than 37%, earnings per share growth of more than 42% as compared to 2005.

For 2007, we expect continued revenue growth across all our revenue lines. The dramatic increase of our booth sales capacity in our first year at the new location of the AsiaWorld-Expo enabled our China Sourcing Fairs to provide a major stimulus to revenue in 2006. We expect the second year of our China Sourcing Fairs in Hong Kong to be even better than the first, but with growth on a more moderate scale than what we experienced in 2006 compared to 2005. To give you some perspective, Asia World Expo booth capacity for us is 16,000 booths per year, and in 2006 we sold almost 13,000 booths. We also expect greater contribution from the China Sourcing Fairs to our overall profitability in 2007. And when we look at our trade show business opportunities in 2008 and beyond, we see many potential growth opportunities in China, overseas, and most certainly in new categories.

Globals Sources’ goal is to be the largest B2B media company serving the extended two-way supply chain between China and the world and within China. To achieve this, we strive to deliver superior information based content, services, and solutions that help our customers develop a competitive advantage. In our markets we provide what is by the far the greatest breadth in terms of media formats and the greatest depth of sourcing content. Accordingly, we are uniquely capable of helping companies create and deliver integrated marketing campaigns that address all stages of the buying process, from the awareness and lead generation right through to the placement of the order. This is a powerful differentiator and one we believe will drive long-term growth and success for Global Sources.

I’d now like to turn the call over to the operator for the questions and answer sessions, and thank you.

Question-and-Answer Session

Operator

Ladies and gentlemen, if you wish to register for a question for today’s question and answer session, you will need to press * then the number 1 on your telephone. You will hear a prompt to acknowledge your request. If your question has been answered and you wish you withdraw your polling request, you may do so by pressing the * then the number 2. If you are using a speaker phone please pick up your handset before entering your request. One moment please for the first question. Your first question comes from Dick Wei with JP Morgan.

Dick Wei, JP Morgan

Hi, Merle and Eddie, congratulations on the good numbers. I just have two quick questions. The first one would be, I understand that you plan to launch the two new verticals that came from the gifts and home products vertical. I wonder how much revenue increase from your experience do you expect to see with these two new channels being launched from the whole channel. The second question I have is on Global Sources Direct, if you can give us some color on what is the latest on that front that will be great.

Merle Hinrichs, Chairman and Chief Executive Officer

Thanks Dick and thanks for joining our call. First of all, we will be doing this as we said the early part of the next half. This is strategic in terms of how we hope to be able to better serve the two buying groups. We most certainly do expect an increase in the overall revenue, or the aggregate revenue for the two. We have not provided a number on this as it’s too early in the stage to be certain as to what it would be. But, we’re sure Dick there will be an improvement in the revenue for the combined two titles. With regard to basic of the Global Sources Direct, this as I mentioned in my last call in August, it is an important and very strategic long-term opportunity for us. We are proceeding steadily with it. We’re very pleased with the progress. We are working today on building and developing a management team, certainly attracting more suppliers and getting the hottest possible products. And if you go to the Global Sources website and you click on the Global Sources Direct icon on the right hand side, I’m sure you will be surprised if not pleased with the volume of products and the variety of products on that site now. We will also be providing more detail on this in the next quarter’s webcast when we’ll have a complete year to report, but we will meeting the objectives of the company on this. Thank you Dick.

Dick Wei, JP Morgan

Thanks Merle.

Operator

Your next question comes from Jason Brueschke with Citigroup.

Jason Brueschke, Citigroup

Thank you. Merle and Eddie let me also add my congratulations on the quarter. My question is kind of a followup to the question on Global Sources Direct and one of the things I’ve just been wondering about your business is, and I wonder if you could maybe comment on the opportunities or the difficulties, you have a lot of people producing products and you have a lot of buyers, and at this point you’re not operating as an online store. You’re mostly doing promotions and marketing and you’re making introductions and you’re allowing the transactions to occur whether at your trade show or face to face. Could you just maybe address what the opportunities might be in the future for you to enable people to purchase directly products over the web on your site and maybe some of the challenges of that would be also? That’s the first question.

Merle Hinrichs, Chairman and Chief Executive Officer

Okay. Jason, again, thank for joining our call. As we are all aware, there is an increasing and almost a booming level of activity within the online retail business. The vendors in many markets of course are small enterprises and they need to look for what we call in the business break bulk -- a product that is available to them and less than half a container lot, and typically in products with which are small in queue and high in value, i.e. so that it can be potentially shipped by air -- so we have to work through one product selection on that basis, we have to work through the logistics to support that, and of course any provider of this type of business will have to deal with returns. We have spent the last year in staffing for this. We have spent the last year in working out all of the infrastructure. This we believe, as I said earlier, is really a strategic investment. We want to take it step by step. It is very much a new service. I would not be able to go into specific details with you, but I can say we are quite pleased with the development of the initiatives. So, over time, we feel that we’ll gain in certainly brand recognition, buyer following, supplier engagement, and replenishment of product, and it’s a service which is typically not available elsewhere. This is B2B, this is not B2C. This is trying to provide an additional purchasing opportunity for our buying community as well as another distribution channel for our supply side in the wholesale market. Does that help?

Jason Brueschke, Citigroup

Yeah, absolutely. As a followup to that, I would ask, your answer seems to be more directed, which is with Global Sources directive at the exports aspect of retailing. My followup question is does HC International enable you to maybe take this vision domestically within China as well where you can do B2B transactions within the domestic market in China in B2B as opposed to B2C?

Merle Hinrichs, Chairman and Chief Executive Officer

I would guess that there would be that possibility. Our focus is very much on the export side of it in that this is our area of our specialization. This is the area in which we know the buyer, the buyer needs, the design requirements, the type of categories that they would look for. If you’re doing it in the domestic market, it would be a different type of product range, and it would be a different type of buying group. That is not something that we’re addressing with HC.

Jason Brueschke, Citigroup

Okay, maybe one last question on the trade show business. Phenomenal results for the first year, it’s almost remarkable, I know I was the one who called when you first announced this, and here we are in the first year, and I think you anticipate there’s a possibility of being capacity constrained if not next year then shortly thereafter at AsiaWorld-Expo. Could you maybe comment on what are some of the options that are available to you if you get to 16,000 booths? I know that you’ve got some enormous trade show space that will be coming online probably by ’08 in Macao and I think there have been plans that AWE may actually expand as well, so the investors will know that if you are if you’re not to be capacity constrained, if you can any specifics that will be helpful. Thanks.

Merle Hinrichs, Chairman and Chief Executive Officer

Right, thank you Jason. As you know and we’ve already announced that we are opening a show in Dubai. That is being sold. We think that the AWE…of course this is the first year and buyers have really enjoyed the experience. It is a fabulous venue and there is certainly no resistance on the part of the buy community or the sell community to participate at the venue. And you’re correct the venue will most likely be expanded in due course. Given the size of our contract with AWE, we will working with them to expand our shows. We will be looking at a variety of different venues as we gain momentum in this business, and all of course to compliment what we are doing on online and in print. It’s a very natural relationship and I think that this is probably one of the largest differentiators because we do focus upon the buyer’s needs to meet these suppliers face to face and to gain both in trust and relationship and ultimately in business. So, it has been a great experience.

Jason Brueschke, Citigroup

Great, thank you.

Operator

Your next question comes from Craig Swanson with Devon Capital.

Craig Swanson, Devon Capital

Hi, I just have a question about HC International. How is the relationship coming along and if you guys do proceed with the acquisition once it’s executed, how do you think that will create value for shareholders exactly?

Merle Hinrichs, Chairman and Chief Executive Officer

Thanks Craig. Maybe I should take a few minutes, and I’m sure that there are listeners on the call that do not have a background on this transaction, so let me just back track a little bit. As I mentioned earlier, this is a transaction that was taken earlier this year. We have a 13% holding, we have a 35% option, and then if we do proceed with this it is a strategic investment for us. It’s not an acquisition yet. June is the month a decision will have to be made. The China market of course is a huge market, and it’s a huge market for us to be developing both the export and import side and of course domestically, and we believe that our associated and integrated relationship with HC will give us certainly a head start in that market and give us an opportunity with which if we were to do it on our own would take longer. However, with or without, we definitely plan on pursuing and developing our Chinese language media. And just to remind everybody, we already do a number of Chinese language publications. We do an electronic engineering times publication, we do electronic design publication, electronic supply and manufacturing publication, and then we also do an executive publication called Chief Executive China, which is the largest in the industry. So, the HC relationship will be an extension to our already growing China-based media business. We feel also that it will complement a number of our other verticals and provide us, because there are some 72 verticals combined, opportunities with which we would not otherwise have. So, there are a number of synergies, there are a number of cross-selling opportunities, and we are working through that in a step-by-step basis with HC in identifying exactly how best to leverage the assets and the relationship that we will have. Does that help?

Craig Swanson, Devon Capital

Yeah that’s great, thank you very much.

Operator

Once again ladies and gentlemen, as a reminder, to register for a question please press * and then the number 1 on your telephone. Your next question comes from John Mow with Roth Capital Partners.

John Mow, Roth Capital Partners

Hi, good evening. I have a couple of small questions on a couple of items. One is on your non-employee compensation, even with the change of account principles, and it’s about $1.3 million of employee compensations that is much higher than the regular quarters, is that an indication for the future? The second question is your one-time interest income of $0.05 in the fourth quarter, because you’re currently making about $0.03 a share each quarter from your cash investment, is that $0.05 on top of it, can you give a little bit detail on it?

Merle Hinrichs, Chairman and Chief Executive Officer

John, thank you very much for both questions. I’m going to turn this over to Eddie.

Eddie Heng, Chief Financial Officer

Hi John, thank you for your two questions. In regards to the one-time interest income, that’s one time only and that’s an interest income that we earn from our joint venture partners, so it’s not part of our regular interest income. And regarding your first question on the non-employee, non-cash compensation award, we do not expect it to be a regular cost of this nature. This is one time where every quarter we do our evaluation exercise, and this quarter as you know that compared to last year it will increase our share price. So as a result of the increasing share price we have to do a reevaluation.

Merle Hinrichs, Chairman and Chief Executive Officer

Does that help John?

John Mow, Roth Capital Partners

Sure, I appreciate it. Thanks Eddie.

Operator

Once again, ladies and gentlemen, as a reminder, to register for a question please press * then the number 1 on your telephone. Your next question comes from Dick Wei with JP Morgan.

Dick Wei, JP Morgan

Just a question on advertising with the strong growth in the third quarter, I think in your prepared remarks you mentioned about increased number of cost selling efforts during the quarter. I know you didn’t give an exact number on how many customers you can cross sell, but if you can give us some trend as to how it compares to last year or last quarter, that will be great. And was there any other reason for the growth with advertising?

Merle Hinrichs, Chairman and Chief Executive Officer

First, we have a number of reasons here Dick and one is that we are verticalizing a number of the titles. We will continue to do so to improve of course the value or improve the way that we can serve those particular audiences. For example, as I said earlier, the needs of an electronic component buyer is really quite different than the needs of a baby’s product type of buyer. So, by verticalization we get much closer to the needs of both the supplier and the buyer, and frankly it’s appreciated by both. So, that’s just a matter of being increasingly sensitive and increasingly close to our clients. This is one real primary reason or I think the growth that we are experiencing. And the second of course is the cross selling with the trade shows, because we offer them basically a total solution, a solution that meets their needs, one to get their product in front of the right buyers, and I mentioned to you in my prepared notes the quality of buyers that they can meet at our shows is comparable to none, seriously. These buyers are there, they come back, and the suppliers appreciate it. We have had example after example of suppliers that have traded up, they started with one booth, they’ve traded up to two, they’re up to four. We just a received a letter from one today. He’s traded up to eight booths open space for the next two shows because he is very, very happy with the quality of the buyer that he has been able to meet at the shows, and of course follow through by the advertising, keeping that product, keeping his brand in front of these quality buyers is an important added value, and they appreciate the fact that’s who is using our online services, that’s who is using our publications and will continue to do so. So, it’s a combination of improving the content, improving the distribution, and needless to say improving on the face-to-face opportunities for both the supplier and the buyer. So, I think we’re gaining momentum in these areas Dick, and thank you for the question.

Dick Wei, JP Morgan

Thanks.

Operator

Our next question comes from Patrick Wren.

Patrick Wren

Hi guys, congrats on the quarter. I was just curious just in terms of updating and getting caught up on your travel schedules over the next quarter in terms of your next earnings. Are there any investment conferences or non-deal trade shows that you might be meeting with as far as in North America?

Merle Hinrichs, Chairman and Chief Executive Officer

Just to remind you, this year we’ve done one with JP Morgan, one with Roth Capital and that was in September. I think we’re doing one in Las Vegas in January with Citigroup, and we’re scheduled for another one in March here. But, I think Patrick to your question we are increasing and will continue to increase our investor relations and investor activities both in the United States and of course here in Hong Kong and China. So, there will be more of these kind of events that we will participate in.

Patrick Wren

Great, thank you. So, the Las Vegas one will likely be before or after your year end?

Merle Hinrichs, Chairman and Chief Executive Officer

It will be in the first quarter of January.

Patrick Wren

Okay, so before you actually report December quarter earnings then?

Merle Hinrichs, Chairman and Chief Executive Officer

Yes, and then I’ll also be in New York in March to do another presentation there.

Patrick Wren

Okay, terrific, thank you very much.

Merle Hinrichs, Chairman and Chief Executive Officer

And if you have any other ideas Patrick on events that you think we should be participating in, do let us know.

Patrick Wren

Okay, will do.

Operator

Your next question comes from Ted Pedro with GK Associates.

Ted Pedro, GK Associates

Good morning, great quarter. I have a question. When you guys look at into ’07 and the trade fairs, and so far in building them up you’ve been spending heavily. Based on experience, will those expenses start to decline or will they stay constant and you’ll be expanding the revenue base from the left over capacity of 16,000?

Merle Hinrichs, Chairman and Chief Executive Officer

Ted, thank you for the question and participation. We have had to invest very substantially in 2005 and 2006 to reach the point of having an infrastructure, an operational infrastructure, a sales infrastructure, to meet the needs that we have for filling the venues, and of course in selling 13,000 booths as I said earlier has been an incredible achievement. We’re not going to have to grow at the same extent that we have done so in 2005 and 2006. Having said that, we are going to continue to add and continue to improve both representation in China and elsewhere and we are going to be using that same operation to do other shows; one being of course Dubai and we will be doing others to be announced. So, we believe that the expenses will increase somewhat but we’re looking at improving the revenues a lot more. That’s the focus.

Ted Pedro, GK Associates

Great, thank you.

Operator

That is all the time we have today. Mr. Hinrichs, you may proceed with your presentation or any closing remarks.

Merle Hinrichs, Chairman and Chief Executive Officer

Well, I just want to thank all of you for participating and joining us this evening. We’re delighted with the quarter, and as you can see it looks like we’re going to have a very good fourth quarter and we have now put in place an infrastructure in the trade show area and in the process of verticalizing I think so we can extend our very well established franchise in ways that we would not be previously able to do so. So, again, thank you and thank you for investing in Global Sources. Good night.

Operator

Ladies and gentlemen, that concludes your conference call for today. We thank you for your participation, and I ask that you please disconnect your line.

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