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Executives

Jeff Beyersdorfer - SVP, Treasurer, and Director, IR

Jeff Stevens - President & CEO

Gary Dalke - CFO

Mark Smith - President - Refining and Marketing

Analysts

Jeff Dietert - Simmons

Jacques Rousseau - RBC

Ben Hur - Morgan Stanley

Arjun Murti - Goldman Sachs

Paul Sankey - Deutsche Bank

Chi Chow - Macquarie Capital

Sandy Liang - Cobalt Capital

Gary Stromberg - Barclays Capital

Kelly Krenger - Bank of America/Merrill Lynch

Jim Hom - Miller Tabak

Western Refining, Inc (WNR) Q1 2010 Earnings Call May 6, 2010 10:00 AM ET

Operator

Good morning and welcome to the first quarter 2010 Western Refining Earnings Conference Call. After the speakers' opening remarks, there will a question-and-answer period. (Operator Instructions).

I'd now like to turn the call over to Mr. Jeff Beyersdorfer, Treasurer and Director of Investor Relations of Western Refining. Mr. Beyersdorfer, please go ahead.

Jeff Beyersdorfer

Thank you and good morning. I would like to thank you for taking the time to listen in today. We appreciate your continued interest in Western Refining. My name is Jeff Beyersdorfer. I'm the company's Treasurer and Director of Investor Relations.

Joining me for today's call are Jeff Stevens, CEO; Gary Dalke, our CFO; Mark Smith, President, Refining and Marketing and other members of our senior management team. If you need a copy of the earnings release, you may obtain one from the Investor Relations section of our website at wnr.com.

Before we proceed, I need to make the following Safe Harbor statement. Today's presentation will contain forward-looking statements and I incorporate and refer you to the forward-looking statements section of our earnings release and most recent filings with the SEC.

We assume no obligation to update or revise any forward-looking statements to reflect new or changed events or circumstances. In addition to reporting financial results in accordance with Generally Accepted Accounting Principles or GAAP, we report certain non-GAAP financial results. Investors are encouraged to review the reconciliation of these non-GAAP financial measures to the comparable GAAP results which can be found in the press release which is posted on the IR section of our website.

I’ll now turn the call to Jeff Stevens.

Jeff Stevens

Thank you, Jeff. Welcome to everyone on the call. We appreciate your interest in Western Refining. Today, we will discuss our Q1 results and provide some details on how Western’s addressing the current market environment. After I provide commentary on our operations and an update on market conditions, Gary will review our earnings in more detail and provide operating guidance for Q2 2010.

After Gary’s comments, we will open the call for your questions. As stated in our press release, we reported a net loss of $30.7 million or $0.35 per diluted share for the quarter ended March 31st, 2010. This compares to Q1 2009 earnings of $58.9 million or $0.86 per diluted share. Excluding special items, Q1 2009 earnings were $51.79 million or $0.76 per diluted share. The year-over-year decline primarily reflected lower refinery margins as a result of reduced demand for refined products compared to 2009.

Our results were also impacted by the major turnaround work that was performed at El Paso and the planned maintenance at Gallup during the quarter. During the quarter, refinery margins showed significant improvement relative to very low margins that we experienced in Q4 2009. The Gulf Coast 321 benchmark crack in Q1 improved by more than $3 or 75% relative to Q4 2009.

In the East Coast, the 211 crack spread was more than $2 higher or 37% above Q4, 2009. In addition, the light-heavy and sour-crude differentials continued to widen during the first quarter leading to improved gross margins at El Paso and Yorktown. Overall refining gross margins were $6.38, up by more than 30% compared to Q4, 2009. As I mentioned we completed a major maintenance turnaround at El Paso and a catalyst regeneration at Gallup during the quarter.

We are pleased on how these projects were completed and we are very encouraged by the resulting rate and yield improvements at both of these facilities. The El Paso refinery is currently operating at maximum throughputs in achieving excellent yields of high value products. Our wholesale business has been significantly affected by the economy in recent quarters. However, operating income during Q1 was up by more than $5 million compared to Q1, 2009.

The higher operating income was primarily due to the improvements we made in the cost structure of that business. Our retail business was impacted negatively by poor weather in several of our key markets during much of the quarter.

Retail fuel volumes and margins were down compared to Q1 2009, however we believe business will improve as we enter the driving season and rebound longer term as the economy continues to improve. In previous calls we have discussed the cost improvement initiatives that we are implementing. As you can see in our quarterly results we are beginning to see the financial benefit of these decisions.

By consolidating the operations of our Four Corners refineries we have realized more than $6 million in cost saving during the quarter and we believe the full-year saving will meet the original annualized estimate of $25 million.

In additional to cost savings, the key factor in our Four Corners consolidation decision was improved utilization at Gallup facility. I am happy to report that Gallup is running well, enabling us to achieve one of our goals of processing all available cost effect accrued in the area.

Throughputs today are similar to the volumes achieved historically by both Gallup and Bloomfield and will result in approximately $3 per barrel improvement in operating cost going forward. We have also completed a number of previously announced saving initiatives which are reflected in our Q1 cost performance. We are encouraged by our progress to-date and are on track to exceed our estimated 25 million in savings for 2010.

Summing up cost, we are ahead of schedule in realizing our 2010 cost reduction of $50 million and we believe we will capitalize on more opportunities to improve efficiencies as we progress through the year. As a result, we believe our company is well positioned for the future.

Separately at the end of Q1, management made the decision to forego 2009 incentive bonuses which led to a reversal of the bonus accrual in the first quarter. This is a one time cost reduction of $15 million and is not a part of the cost saving initiatives I just discussed.

Turning to the second quarter, refining margins and light-heavy crude differentials have continued upward momentum which began at the end of Q4 2009. Based on what we are seeing, the overall market environment is strengthening as we have seen increase in sales to our industrial and commercial customers based on the improvements in their businesses.

Distillate volumes and margins are beginning to rebound, and as we enter the driving season we anticipate gasoline demand and margins will continue to improve as well. The recent improvement in our refining business is encouraging as it is the first time in several quarters that we’ve seen positive demand and margin trends.

As always, we will continue to focus on what we can control such as running our operations efficiently, safely and reliably. Now Gary will go through our financials and provide an update on operating guidance.

Gary Dalke

Thank you, Jeff. During the quarter, gross margins at our refineries were $6.38 per throughput barrel which compares to $13.53 per throughput barrel in Q1, 2009. As Jeff mentioned this margin decline was a primary driver in our year-over-year reduction and earnings.

Direct operating expenses at our refineries were $4.73 per barrel for the quarter. The bonus accrual reversal and cost savings initiatives helped to offset the $23 million in cost for the major turnaround at El Paso and the $2 million expensed at Gallup for catalyst regeneration.

Total company SG&A costs were $16.5 million for the quarter compared to $35 million in Q1, 2009. Overall, during the quarter direct operating expenses and SG&A were reduced by more than 25% versus Q1, 2009. While some of this variance was driven by the bonus accrual reversal in Q1, 2010 and a one-time cost incurred in Q1, 2009, we are confident that we are driving sustainable improvements in our cost structure.

Adjusted EBITDA for Q1, 2010 was $26.2 million which compares to adjusted EBITDA of $141.9 million for Q1 2009. Moving down the income statement, depreciation and amortization expense for Q1 was $34.3 million, essentially flat as compared to Q1 2009. Interest expense was $36.8 million, a $9.7 million increase compared to Q1 2009, primarily a result of increased debt cost offset by a modestly lower debt levels.

Our effective tax rate for Q1 was 56.5%, which reflects the federal income tax credit available to small business refiners related to production of ultra low sulphur diesel fuel as well as the company’s current estimate of annual taxable income relative to current period results. For the quarter, cash flow from operations was a negative $147.6 million. This is significantly below Q1 2009 and is primarily due to reduced earnings and temporary inventory builds from prepays which were needed during our turnaround work.

Total capital expenditures for the quarter were $18.8 million. As of March 31st, total debt stood at $1.24 billion included a $170 million outstanding under our revolving credit facility. Total liquidity including cash and availability under our revolver was $209.8 million.

As I mentioned, our turnaround activity created the need for inventory builds and prepays which had a short-term impact on end quarterly liquidity level. However, we have reduced inventories since coming out of our turnaround. During the month of April through early May, our liquidity has averaged $250 million to $300 million and we believe that liquidity will continue to improve as we move through Q2.

Turning to the second quarter operating guidance. We expect crude oil throughput at our refineries to be approximately 195,000 to 205,000 barrels per day during the quarter. We expect total refinery throughput to be approximately 215,000 to 225,000 barrels per day and the second quarter, we expect operating costs to be approximately $3.75 per barrel at the El Paso refinery, approximately $6.50 per barrel at the Gallup refinery and approximately $5.25 per barrel at the Yorktown refinery.

We expect total SG&A in the second quarter to be approximately $23 million, interest expense will be about $36.8 million and depreciation and amortization will be approximately $34.4 million for the quarter. Capital expenditures for the full year of 2010 will be approximately $100 million, about 80% of the spending will be for regulatory projects and the remaining for ongoing maintenance expenditures. Thank you again for listening. We will now open up the call for questions.

Operator

Question-and-Answer session

First question comes from the line of Jeff Dietert with Simmons.

Jeff Dietert - Simmons

You gave a nice update on your cost structure improvements in the wholesale and with the Four Corners consolidations, it looked like you had some benefit at cash operating costs at El Paso as well. Can you fill out where the incremental $50 million comes from, knowing that $25 million of that is Four Corners consolidation; where are the other pieces and give an update on how you're progressing there?

Gary Dalke

Yes, what we realized in the first quarter this year relative to the other cost savings excluding the Bloomfield, Gallup refinery consolidation is we saw about $2 million in contractor reductions at our various refinery locations. On top of that, we have personnel reductions of about $2.5 million, we made some changes to our employee benefit plans which resulted in about in $1.7 million savings.

We rationalized some of our retail stores and we closed I believe three stores in the fourth quarter resulting in a $200,000 to $300,000 savings for the quarter. We have a reduction in management salaries of $400,000 in the quarter and other expenses relative to the reduction of the truck fleet and wholesale corporate sponsorships, consulting et cetera amounted to about $1.2 million. You add all of those together, it’s about $8 million savings we realized during the first quarter of this year.

On an annualized basis, we expect that to run in the $28 million to $29 million level. We continue to look for additional cost savings opportunities on top of these we've already identified though.

Operator

Your next question comes from the line of Jacques Rousseau with RBC.

Jacques Rousseau - RBC

Just wanted to check with you, what's your latest thoughts on Yorktown to see the crude differentials you maybe realizing there? I know that's improved recently with the marlim discounts. And then also your thoughts on if the third quarter turnaround is still on schedule there?

Jeff Stevens

You are right we went through a rough fourth quarter at Yorktown because we got hit both on the crack spreads on the east coast and on the crude differentials. We have seen a major improvement on both fronts here starting really at the end of Q4, it started progressing better through Q1 and it continues to improve both on the margin standpoint and on the light-heavy differential.

And so we were optimistic about going forward there on both those fronts. As far as a third quarter turnaround we have moved that to the first quarter of 2011 and actually changed the scope of it to just a coker outage during that time and it's probably going to be about $10 million turnaround for that project.

Jacques Rousseau - RBC

So do you think Yorktown will return to profitability this quarter then?

Jeff Stevens

Well certainly headed in that direction. If you look at the east coast crack spreads today and you look at the differentials and just the heavy-light differentials continue to trend away we think they should, we believe it will be profitable.

Operator

Your next question comes from the line of Ben Hur with Morgan Stanley.

Ben Hur - Morgan Stanley

I was just wondering if I could follow-up on Jacques' question about Yorktown. It seems to me like last quarter on the call you said it was the third quarter turnaround and it was probably $20 million to $30 million and now you're looking to push that back into 1Q and just do a coker turnaround, am I right on that? What are you forgoing?

Mark Smith

We previously had scheduled a accrued and coker outage and we have done a number of strategic shutdowns on that crude unit and we have determined that we really don’t need to do that turnaround so that was about half the cost to that outage. So we see ourselves just doing a coker outage and that cost is around $10 million and that would be scheduled in for the first quarter of next year?

Ben Hur - Morgan Stanley

One more follow-up on your SG&A. It looks like you dramatically improved from last quarter from around $24 million to $16.5 million and I guess you addressed looking like it's probably more SG&A from refining; is that correct?

Gary Dalke

It's across all business segments. We continue to look at all of the areas within the business segments to see where we can cut out cost, where it makes sense to make changes but I think it's across the board.

Ben Hur - Morgan Stanley

Then correct me if I'm wrong; did you say your guidance for the next quarter on SG&A was back to $23 million?

Gary Dalke

Yes we did. One of the things that also impacted first quarter, we talked about the reversal of the 2009 bonuses. About $4.8 million of that impacted our SG&A costs in Q1 downward, so we did $16.5 million if you add back the $4.8 million, it's back $21.3 million. We expect the run rate in the $22 million to $23 million range, but we will continue to assess additional cost savings.

Operator

Your next question comes from the line Arjun Murti with Goldman Sachs.

Arjun Murti - Goldman Sachs

Just a couple of balance sheet related questions, you mentioned the inventory build in the first quarter and it sounds like based on your liquidity you mentioned so far that maybe some portion of that is reversed. How much of that do you think you get back over the remainder of this year in terms of the inventory build in the first quarter?

Jeff Stevens

When you think we get back a large, probably the majority of it because we definitely built inventory in the turnaround and we had some inventory prepaids. During the first quarter of those two, between those two had amounted to about $140 million. So throughout the year we would expect to get the majority of that back.

Arjun Murti - Goldman Sachs

That's great and it sort of feels like that's probably the bulk of the debt build there in the first quarter. I guess even if we take that back, the debt levels are obviously not low. Can you just provide an update in how you're thinking about steps, whether it's asset sales? It sounds like Yorktown, you've become a little more optimistic on in terms of the trends there, maybe retail, wholesale versus issuing equity or quasi equity securities to help reduce the debt levels.

Jeff Stevens

Obviously the debt on the balance sheet is a major priority for us and we continue to look at all of our options. We look at the assets we look at, the capital markets, obviously the best way to get this result is to become profitable again and we believe we are heading in that direction. So we continue to look at all of our options out there and we will make it a priority as far as getting the debt paid down.

Arjun Murti - Goldman Sachs

I think you mentioned that you are going to defer the crew turnaround, Yorktown. When was the last time you did a crude turnaround there?

Mark Smith

It was in 2005.

Arjun Murti - Goldman Sachs

So I guess if you're going to defer it past 2011, I'm obviously not an engineer, but how long can you defer these things?

Mark Smith

There was less whole turnaround. We’ve done a number of shutdowns and gone in and changed out the packing and the back in town, that sort of thing. So, we’ve been in this unit three times in the last three years and we’re pretty confident in where that unit is at.

Operator

Your next question comes from the line of Paul Sankey with Deutsche Bank.

Paul Sankey - Deutsche Bank

Could you just run through again, the cash flow from operations was quite a bit more negative than we thought it would be for the quarter. I'm assuming that was an inventory effect. I think you've referenced it. Could you just walk me back through if possible? Thanks.

Gary Dalke

Yes, I mean we’ll be publishing our 10-Q, we think tomorrow which would have the detail cash flow from operating activities, but let me kind of just run through and give you a high level of review. Our net cash used in the operating activities in the first quarter was a negative $147 million. You start with our net income, our net loss I should say of about $30.7 million depreciation, amortization of $34 million. we had a cash use on deferred income taxes of $41 million, but then our net change in operating assets and liabilities was a negative $117 million, but as I talked about $140 million negative was used on inventories and prepayments of inventories during that quarter and we expect to rein that back in.

Paul Sankey - Deutsche Bank

Was that as a function of you selling inventory last year to kind of shore up the cash position, you just have to rebuild for operational reasons or is there something else?

Jeff Stevens

It had to do with outreach at El Paso, we have certain amount of crude commitments we have to make during the month, so we build some crude inventory but at the same time when we are not manufacturing as much product we had to go out and purchase product to honor our contracts that we had out there. So it's kind of a double hit Paul, it's one time event related to the turnaround work.

Paul Sankey - Deutsche Bank

I understand. One thing that's been perplexing me has been the sweet-sour spread which I guess would really help you particularly at El Paso, has stayed kind of narrow. Can you just talk a bit about why that is, relative to the heavy-light widening and where we could expect that to go going forward? Because you mentioned that you were hopeful on differentials.

Jeff Stevens

Well I think that obviously the Mid-Continent with the low Canadian spreads for the last two or three quarters has been choosing to buy WTS versus Canadian crude and that certainly has impacted that spread. I think as we see the widening of the Canadian and the ability to get the Canadian to market, I think we will see more WTS pushdown and more pressure put on that differential.

But we are also dealing with the contango and the low price of WTI right now relative to the WTS. So yes the spread is narrow but relative to a lot of other crudes out there, it still is relatively cheap. so I agree with you Paul, I think as we see the Canadian spreads widening and then we see Mid-Continent refineries go back to running them a more traditional slate of Canadian crude I think we will see more TS available at a wider discount.

Paul Sankey - Deutsche Bank Securities

Finally from me, I guess one of the potential bull cases for the stock had been the shutdown at Delaware City. I don't know whether you would agree with that. I'm just assuming as an East Coast refinery it would make a difference. And it seems somewhat of a surprise that they are reinvesting, but I guess it also equally seems they'll be out for a while in process. Is there anything that you can add about the general East Coast environment, the shutdowns that we've seen from Sonoco and how much better that's going to be hopefully going forward and whether or not Delaware City not going away is a major negative or one that you think the market can handle?

Jeff Stevens

Thanks Paul. I think we’ll just have to wait and see what the ultimate plans for that facility are. We’ve continued to see good growth and a little uptick on our margins on what we would call our niche markets relative to where your town is located, but really the East Coast is driven by that New York 211 crack and I think it’s going to be demand-driven and how the economy comes back and how the East Coast ultimately margins improves. So we’re cautiously optimistic on what we’ve seen here in the last two to three months especially. And we’ll continue to monitor closely and do the things necessary to run that operation as efficiently as we can.

Operator

Your next question comes from the line of Chi Chow with Macquarie Capital.

Chi Chow - Macquarie Capital

Just a follow-up I guess on Paul's question. Regarding Yorktown, what are your longer-term thoughts strategically on that plant? Do you think you can get enough improved performance that it will give you some comfort that that plant can be viable going forward?

Jeff Stevens

Well I think that Chi, if we can return to the heavy-light differentials that we have seen over the last three to five years I think the plant is the facility that should be a survival on East Coast because of its location and its ability to run unique crudes. But we are just having deal with everything else, everybody is dealing with on the East Coast, is we have had a poor margin environment and our differentials haven’t been the same.

So, we are trying to do the things at that facility to ensure that it is one of the survivors but it's something we have to watch and monitor and see how everything plays out. We are looking month to month at every possibility. For example, this month it makes sense to bring more components and do more blending at that facility and so we are trying to be as creative as we can to keep it at breakeven or profitable at this point. But definitely Chi, we have seen a marked improvement the last 30 to 60 days and I am sure you are aware of.

Chi Chow - Macquarie Capital

What are your thoughts longer-term on the light-heavy differential in the coming years I guess? You mentioned that return to what we saw in the past three to five years will make that plant profitable and I agree but what is your outlook on the light-heavy?

Jeff Stevens

Well, I mean obviously the new production coming on around the world tends to be more sour and tends to be heavier or unique crudes and so I think that as the world economy comes on and more crude comes available, it will be, there will be more of those types of crudes. I think will we get back to the highest levels we saw, probably not.

I think we tend to model a little bit more conservative on that, but it certainly does it makes sense to have some of these sour crudes at $1, $2 or $3 different than sweet crudes because there is no economics in running them. So I think the market will take care of itself, but I do think that we should return back closer to where we were than where we have been type of thing but actually it's about the economy right now and just world demand and what we see going forward as far as that is concerned.

Chi Chow - Macquarie Capital

The Longhorn pipeline, do you have any thoughts on Magellan's announcement from this week on the alternation or the conversion of the line?

Jeff Stevens

Obviously we don’t have any more details than what was put out in that press release. As you know we have competed against that line as the products line through four different owners and continue to compete today and remain very profitable at the El Paso plant. Would it surprise me, if someone was looking at a change in operations for that line and a different use. No, because I don’t think it has been a successful profitable line as the product’s line at this point. so we just continue to do the things at El Paso that make us cost effective and be competitive and we will monitor the situation as more details come out. We will have more information than we can probably comment on more, but it's just another story in a line that’s been, had its ups and downs over the last 10 years.

Operator

Your next question comes from the line of Sandy Liang with Cobalt Capital.

Sandy Liang - Cobalt Capital

Just some balance sheet questions. Actually, in terms of your covenant calculation, is your adjusted EBITDA $26 million in the quarter, is that anything close to what it would be for covenant purposes?

Gary Dalke

Yes it is, covenant EBITDA is a little bit less than that, but effectively it’s about equal to same number.

Sandy Liang - Cobalt Capital

So you get to add back all the maintenance and turnaround then?

Gary Dalke

The maintenance CapEx or turnaround expense, we get to add back up to $25 million.

Sandy Liang - Cobalt Capital

Are you currently speaking to the banks at all in terms of the next few quarters and possible covenant relief?

Gary Dalke

We don’t disclose whether we are having conversations with banks or not.

Sandy Liang - Cobalt Capital

The [$170] million in financing activities, that was a cash inflow in the quarter; where did your revolver end at the end of the quarter and if it wasn't revolver for all that amount, what other inflows from financing activities were there?

Gary Dalke

The revolver at the end of the quarter was $170 million and we used all of that for crude purchases for the most part.

Sandy Liang - Cobalt Capital

So that was basically the $170 million activities from financing, that was revolver then?

Gary Dalke

Yes.

Operator

Your next question comes from the line of Gary Stromberg with Barclays Capital

Gary Stromberg - Barclays Capital

On Yorktown; what is the right light-heavy differential I should look at when looking at that plant?

Jeff Stevens

Well, what we’ve seen is we’ve seen probably over the last 12 months to two years, I mean we’ve seen a differential as low as 250 and a differential as high as $11. So I think that we would view a differential that would be kind of middle of the road, would be in that $6 to $7 range is where we would expect it to be when you are looking out.

Gary Stromberg - Barclays Capital

I guess to be more specific; what crude should I use when calculating that differential?

Jeff Stevens

That’s a tricky question. I wish I could give. There’s not traditionally a posting for this crew, it's a blend of different crew and it's negotiated every month. So I really can't point you exactly to a posting or to a light crude. It doesn’t move with any other crew that I can think of exactly.

Gary Stromberg - Barclays Capital

Is that something you guys post monthly on your website or is that something we get quarterly?

Jeff Stevens

No. it's something that we negotiate with the suppliers and the number that we actually get, we have to keep confidential.

Gary Stromberg - Barclays Capital

The bonus accrual in the first quarter, what would EBITDA have been without that reversal?

Gary Dalke

It would have been about $11.5 million because that reversal was $14.7 million in the first quarter.

Operator

Your next question comes from the line of Kelly Krenger with Banc of America/ Merrill Lynch .

Kelly Krenger - Bank of America/Merrill Lynch

On the bonus accruals, was that all taken out of SG&A in the quarter?

Gary Dalke

$4.8 million of it was taken out of SG&A and $9.9 million taken out of direct operating expenses.

Kelly Krenger - Bank of America/Merrill Lynch

Presumably that would have been a cash savings amount for the most part?

Gary Dalke

Yes because there was a period we didn’t pay it, so it's definitely a cash savings.

Kelly Krenger - Bank of America/Merrill Lynch

Okay. Then with regard to the covenants, I know they step up a little bit in the second quarter. I know you noted that you won't disclose if you're in negotiation with the banks, but given kind of what you're seeing so far in the quarter, do you feel like the second quarter covenant levels are achievable?

Gary Dalke

Absolutely Kelly, what we are looking at right now is what we've done is quarter to date and looking at the forward curve and right now in this market we are comfortable with our covenants and obviously the number one priority is to stay within those covenants. So it's something that we continue to monitor and watch closely, but based on what we have seen so far in the second quarter, we are comfortable that we are going to stay within older covenants.

Operator

Next question comes fro the line of Jim Hom with Miller Tabak.

Jim Hom - Miller Tabak

Liquidity, you mentioned something about 250 to 300, is that your May level?

Gary Dalke

That was the average for the month of April through early May.

Operator

That was your final question. I will now turn the call over to Jeff Stevens for closing remarks.

Jeff Stevens

In closing I would like to thank our employees for their dedication and commitments to improving cost efficiencies while remaining focused on safety and reliability. Again, thank you for your interest in Western Refining and look forward to talking to you next quarter.

Operator

Thank you. That concludes today’s first quarter 2010 Western Refining earnings conference call. You may now disconnect your lines at this time and have a wonderful day.

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