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VCA Antech, Inc. (NASDAQ:WOOF)

Q2 2010 Earnings Conference Call

July 22, 2010 4:30 PM ET

Executives

Tom Fuller – CFO and VP

Bob Antin – Chairman, President and CEO

Analysts

Ryan Daniels – William Blair & Company

Mark Arnold – Piper Jaffray

Dawn Brock – Kaufman Brothers

Rob Mains – Morgan Keegan

Maggie (ph) – SunTrust Robinson

Mitra Ramgopal – Sidoti

Operator

Good day, ladies and gentlemen, and welcome to the VCA Antech Second Quarter 2010 Conference Call. Before we commence the discussion, I would like to preface the comments made today with a statement regarding forward-looking information.

The information contained in this presentation includes forward-looking statements that involve risks and uncertainties. Such statements appear in a number of places in this presentation and include statements regarding our intent, our belief or current expectations with respect to our revenues and operating results in future periods, our expansion plans and our business strategy and ability to successfully execute on that strategy.

We caution you not to place undue reliance on such forward-looking statements. Such statements are not guarantees of our future performance, and involve risks and uncertainties. Our actual results may differ materially from those projected in this presentation for the reasons among others discussed in our filings with the Securities and Exchange Commission. The information in this presentation concerning our forecast for future periods represents our outlook only as of today's date, July 22, 2010, and we undertake no obligation to update or revise any forward-looking statements, whether as a result of new developments or otherwise.

Listeners should also be aware that today's discussion includes reference to non-GAAP financial measures, which management believes are useful to an understanding of our business. A reconciliation of these non-GAAP measures to the most comparable GAAP measure will be included with our earnings release and posted on our website at investor.vcaantech.com. Our earnings and guidance releases are available on our website at investor.vcaantech.com. In addition, an audio file of this conference call will be available on our website for a period of three months.

I would now like to turn the conference over to our host for today, Mr. Tom Fuller, CFO.

Tom Fuller

Thank you, Karen, and thank you all for joining us for the second quarter 2010 WOOF earnings call. Today we reported second quarter earnings of $0.44 per diluted share. In the second quarter of 2009 we reported $0.44 per share, but that included a %0.04 charge for writing of something developed software, $5.3 million pretax charge, $0.94 per share on adjusted basis we approved last year, $0.48 per share compared to $0.44 per diluted share in this year's quarter.

Our consolidated revenues for the quarter were up 2.6% to 354 million. Adjusted operating income decreased 9.8% and adjusted operating margins decreased 260 basis points to 18.9%. The adjusted refers to prior numbers only as I mentioned above we had a $5.3 million charge to the software for the share. There are no adjustments in the current year quarter.

The decrease in adjusted operating income and operating margins all came in all three segments. Hospital margins were down 200 basis points, Lab margins down 160 basis points and MedTech down 460 basis points. That's surprising given the state of the economy; we continue to see pressure on our internal growth rates. Hospital sales revenue was down 2% and Laboratory internal growth was down 0.5%. I used declines and revenue put pressure on our consolidated operating income and margins.

Adjusted operating income was down 7.3 million. However this decrease was offset pricely by a $3 million reduction in interest expense and as report it was down $0.4 per share compared to $0.44 in the prior year.

As I mentioned our growth rates relative to prior quarters were down slightly but our characterizing is stable. -0.5% decline internal growth in the lab there be 0.2% increase in the second quarter, so basically flat. Hospitals were down 2% compared to 1.6% so there is a small decline and fairly stable. In the Antech division, total revenues increased 0.2%, $83 million due to an acquisition. Internal growth in Antech was -0.5% and on that operating income was down 2.9% and margins were down 160 basis points to 41%.

In terms of the growth – components of the growth a 2.3% increase in average requisition to $23.22 was offset by a 2.8% decline. The number of requisitions at 3,563,000, this decline is due to the slow up of the economy on our volumes. Total requisitions for the quarter was 3,573,000. In terms of our lab facilities, we added one lab in the quarter so we ended the quarter with 48 laboratories, including four in Canada and 44 domestically.

In Household division revenues increased 2.4% to 267.6 million, all that coming from acquisitions. Our sales revenue was down 2%. Gross cover margins decreased 7.7% and gross profit margins declined 200 basis points, 15.3% and most of that decline came in in our same-store margins which declined 180 basis points down to 18.6%. You'll recall that we held margins really well to the third quarter of 2009 mostly through cutting labor cost. You'll also recall each quarter went by we suggested it'll be more, more difficult to cut labor and cut expenses and hold margin. I think we saw that in the second quarter where we lost 180 basis points on same-store growth with 2%.

Same-store revenue components average revenue increased 2.6% to 158.61, and number of orders was down 4.5% to 1,605,000 to a combined -2% growth. Total orders for the quarter was 1,711,000. As I say, we've seen a trend in our growth rates task up improving from the lower of a -4.9 after quarter of 2009 and then 1.6% decline in the first quarter so we will see if not a continued improvement of this stabilizing -2?%. Household acquisition program, seven acquisitions for the quarter with total revenues of 9.5 million, which takes us year-to-date to 17.9 million of acquired revenue. We fit 18.59% to 102% purchase price which is on normal range of evaluation multiples. We started the quarter with 492 hospitals, we acquired seven. We closed/merged three bringing the quarter with 496 hospitals.

Also point out that on July 1, we were happy to announce that we announce a merger with Pet Doctors which has revenues of $55 million to $60 million paid rough before 2 million. So very, very attractive purchase price so with the 18 million of required revenues for the first half of the year. And Pet Doctors I know is 30 million to 40 million. In the back half of the year needs something in $110 million to $120 million required revenue.

Now that the technologies and revenue increased 42% to 14.6 million, due partially to the Eklin acquisition July 1 of 2009. Gross profit margins increased 23% but gross profit margins were down 450 basis points. Just 29.8% and to the prior quarter due to more Ultrasound sales has carried a lower margin and DR sales, in addition to the Canon product line which has a lower margin than our historical product line sold by Sound Technologies.

Operating margin decreased 460 points and the revenue in Sound last quarter was very, very strong. Profit was very, very strong. Had a great quarter in the first quarter, second quarter is a bit little down in the first quarter we suggested that was not sustainable at the time of the great quarter, and because it is a large dollar value sale, $50,000 to $70,000 per unit. It's quite volatile to trickle in the test market for capital spending so good quarter little bit less in the prior quarter which was a phenomenal quarter. We do see the mix shift to lower margin products and some volatility in the sales. But overall we love the product line, we love the business, it's great strategically going forward and very same for good name so good business.

Balance sheet $194 million of cash end of the quarter of 16 million from 178 million at the end of March. I will point out that we used $30 million for the Pet Doctors acquisition. To the long-term debt, $505 million of the senior debt plus $27 million or other debt for a total of 32 million and that debt is at LIBOR plus 150. Cash flow for the quarter, operating cash flow was down 31% to 40.8 million but year-to-date, operating cash flow is actually at 1% to 111 million. You'll recall last quarter we saw a very dramatic increase in operating cash flow due to working capital changes and timing of tax was turned around in the second quarter. So now year-to-date we're back in line with what our operating has been growing at roughly 1%.

In terms of guidance, we continue to see the impact of the economy on internal growth rates. Our growth rates are volatile. One week they're up, one week they're down. So it's really hard to predict. I think we're probably not alone that we see poor visibility. Well we hope to see it improve in the second quarter the pace of that number recovery slowing didn't come and the declines in internal growth rates, although we've seen the past quarter. It's extremely difficult to predict the future. Our outlook for the remainder of the year's (inaudible) what we've seen in the last couple of quarters. It continuously difficult to cut expenses and hold margin and continue to see weakness in growth rates, we will continue to see pressure on margins. But at short term, quite a bit uncertain of long term, long term we still can't the (inaudible) of the pet health care market.

Accordingly, with the uncertainly, the range for our guidance, we revised the numbers down in the range expanded quite a bit so we're going to 101.39 to 1.42 billion, revenues net income are 125 million to 133 million and diluted earnings per share of $1.43 to $1.53 per share. A plan a small air in the press release, we actually do have the senior sub notes which the senior term notes which are maturing in 2011. We may refinance those in the third quarter. This current quarter will end which should have an impact of less than $0.02 per diluted share in the rest of the year. This impact actually is built in to our guidance.

And now Bob will go to some operating results.

Bob Antin

Thank you, Tom. As tom point out, it was a challenging quarter. We showed some improvement in the first quarter with negative same-store on the hospital side of 1.6. And the outlook was optimistic, enthusiastic because we have seen good months but the quarter was a little volatile and same-store sales on the hospital side were down 2% which present the challenges to the margins. The hospital side actually held pretty well, in spite of the fact that the unpredictability of same-store sales. We see constant change, one week is up one week is down. It's throughout the country, it's throughout all services. The base is still tightly managed. We focus on expenses very, very strongly and the margins were down a little bit but still reflective of very, very tight management control.

On the lab side, as a result of the economy in the pass-through from the hospital business. Lab was relatively flat. Margin just came in just a tiny bit. We saw a little slowing in the requisition. Competition remains strong but still very enthusiastic about our position in the market both in the United Stated and in Canada. I think they did a good job with operating margins of 41%.

On Sound technology, they had an expansion of sales which I think is very positive, which still means that there's a lot of enthusiasm among the communities particularly veterinarians, as it is the most – probably the largest expenditure that veterinarians make. So the veterinarians still see comfort in the industry throughout. But we do see hesitation on the consumer side which is reflective of the unpredictability of the economy.

So all in all it was challenging. We have finished this convention with $194million of cash on the balance sheet, so we're still generating a whole lot of cash. Acquisitions have been strong, we spent a quarter preparing for conversion of Firehouse which we acquired a small of Denver chain, very good hospitals. And also for Pet Doctors which had 23 hospitals in California. So it was an active quarter. There were challenges ahead and as Tom said, the platform is still very healthy and obviously the commitment to healthcare is still very strong.

So I'd like to turn it over to questions now.

Question-and-Answer Session

Operator

(Operator Instructions) And our first question comes from the line of Ryan Daniels of William Blair.

Ryan Daniels – William Blair & Company

Yes, good afternoon guys. I was hoping jus to dig in to the hospital things to a growth a little bit more. I know the quarter sounds like it was off to a pretty good start and then weak and then maybe it's not surprising is the economic, the consumer confidence slowed throughout the quarter as well. I'm curious if you've seen anything else on the competitive or maybe anything that we intake medications and moving to the retail side. Anything else that might have pressured results do you really think it's still is the economic noise?

Bob Antin

It was across the board, Ryan. And you're right, we're off to a pretty good start. And across the board, we feel the same challenges. So you're right, it was up and down. We did get hit a little bit for some of those folks there have gone strictly veterinary distribution to OTC, I am sure it had a small impact on us.

Operator

And our next question comes from the line of Mark Arnold of Piper Jaffray.

Mark Arnold – Piper Jaffray

Good afternoon. I just want to clarify something that was just said on the home delivery launch. Would those revenues actually show up in your animal hospital revenues and would they be attached to their individual facility from which they're being prescribed?

Bob Antin

Yes.

Mark Arnold – Piper Jaffray

Okay. So the answer to the last question, in terms of reporting stand point it really shouldn't have much of an impact other than if it does improve compliance it could be a positive.

Bob Antin

That is correct.

Mark Arnold – Piper Jaffray

Okay great. Maybe I could ask a few about acquisitions, as we think about Per Doctors, the EBITDA margins there I think at the facility level were in the mid-teens so quite a bit lower than you system average. To what extent can you Improve both margins in the short term? And do you have plans to consolidate some of those facilities into your existing hospitals in California?

Bob Antin

We do believe we can get some margin expansion. As with all acquisitions, it's gradual. There's no magic pill overnight. Certainly the overhead is being cut, was cut. The (check) that was graciously left where transitioning the corporate office. We're extending the purchasing contracts in the direction of our historical providers except for one the distributor would continue to use. We should get some benefit from it. It'll take a little time. We anticipate in some areas of merging hospitals with existing hospitals going both ways to close some of theirs and merge client base which will provide some advantage but it'll take a little bit of time.

Mark Arnold – Piper Jaffray

So that's something that maybe into the early part of next year before we see –?

Bob Antin

No, I'm hopeful that we'll start to feel some results by the end of the year.

Mark Arnold – Piper Jaffray

And then the lab revenue that you captured from that deal is somewhere around $2 million a good ballpark estimate to that?

Bob Antin

I think that maybe a little on the high side. I think it's a little on the high side. I think it's probably 25% lower than that.

Mark Arnold – Piper Jaffray

Okay. I guess just one other acquisition related comment. I'm sure that your potential acquisition targets are feeling the same pain that your facilities are, with less financial worry of where it was standing. So if that along with the pretty significant tax increases looming at beginning of next year. Are you seeing more potential acquisition more potential acquisition flight Pet Doctors and Firehouse can on the horizon deploy all the cash that you're sitting on?

Bob Antin

The pipeline is full. We held off in the second quarter a little bit in anticipation of Pet Doctors because it's taking off a lot, and also Firehouse. We see the pipeline and the opportunities are pretty full. But one thing you have to remember, like ours, doesn't bleed cash. So the results might be challenged by the economy, from an owner standpoint it doesn't bleed cash. There is some incentive with the uncertainty of what the administration and Congress is going to do with capital gains. So we do feel some of the acceleration and the desire to close by year end.

Mark Arnold – Piper Jaffray

I have one last question for you, Tom. On the debt refinancing, can you give us anymore update in terms of a range where do you think those terms will shake out, and it's said in the press release, August, but it seemed like you may be back in a little bit away from that, that it could be anytime during Q3? Can you just give us any other commentary to provide –?

Tom Fuller

Yes, I think anytime Q3. August, September makes sense. And somewhere in the 4%, 5% range. All in including obviously is discounts and all that.

Mark Arnold – Piper Jaffray

Great. Thank you.

Operator

And our next question comes from the line of Dawn Brock of Kaufman Brothers.

Dawn Brock – Kaufman Brothers

Good afternoon guys. I got a couple of questions in the Lab and I was hoping I could dig into the testing mix versus kind of pure pricing increases. I think you said the pricing side was relatively healthy, or revenue per acquisition was up. And then secondly, could we talk a little bit really just about what you are seeing from the prospective in your labs the new test introductions, whether this is a good time to introduce new tests. I know you guys have had some success with that in the past.

Tom Fuller

I think on the first question, the 2.3% increase in average for acquisition is pretty consistent with the trend, that we are seeing in the past couple of quarters, we are seeing positive price offset by lower volumes due mostly to the economy if not all. 2.3% is probably, most of that price was probably a little bit of positive mix shift. But definitely we are doing price.

Bob Antin

We are still – we have invested in some additional testing capability which really hasn't hit the market. PCR is really – has been introduced, it's being adopted, but it's not a material – it doesn't have a material impact on the marketplace.

Dawn Brock – Kaufman Brothers

On the mix side, if you look at preventative versus wellness versus maybe some of the more higher (inaudible) stuff, maybe that would give us a little bit of insight into the type of visits you are getting to the animal hospital, is that fair?

Bob Antin

I can answer for the animal hospital side. I think what we are seeing across the board is consumers are holding back on preventative medicine. So the facilities are focusing more on carative and we see it, all we have to do specialty hospitals. So there is a lot more carative and if it's a place that consumers are hold back, it's more on elective and preventative health. So you will see a stepdown in the types of preventative testing that they would otherwise do or wellness packages. So, that's a good question.

Dawn Brock – Kaufman Brothers

If I do just ask one more. On the client side, for lab testing, I remember we were talking a couple of years ago about really getting out this on a marketing perspective. You guys have a phenomenal database of clinical outcomes and what not, kind of getting that literature out there and talking to vets about the fact that you were the preeminent lab provider. Are you seeing any chance of getting new clients and you are feeling it though with the pie not necessarily growing, that's were all the competition is coming in or do you feel that have any lost any traction on clients –

Bob Antin

We definitely – we definitely are certainly marketing very hard. It's a very, very competitive market as you know, since you follow both companies. It is very, very competitive in areas where we have a – historically had a dominant share in the market. The competition has been very strong in their efforts in those areas. So, it is competitive. And both companies to their credit right now are investing quite a bit of money and effort in educating veterinarians which still underlying it all is the consumer, the consumer across the board – because you need the consumer in order to go through the doors of the hospital to generate the testing. That's where we see the slowdown, it's coming from there. While we still have a very, very competitive market. Most of it is coming from the competitive side – excuse me, from the consumer side.

Operator

Thank you. And our next question comes from the line of Rob Mains of Morgan Keegan.

Rob Mains – Morgan Keegan

More number I missed, the same-store, the revenues per acquisition in the quarter, what the dollar number was?

Bob Antin

In the lab was 23.22.

Rob Mains – Morgan Keegan

Okay, and then when I dig a little bit the acquisition question, I understand that things slowed down a little bit this quarter in anticipation of pet DRx and you said there is a pipeline for – and you've got kind of a ticking time bomb of the tax. What I am curious about is it, since you are going to pay, you know a multiple of revenues, are there any veterinarians who were just looking out there are seeing that the business kind of stinks right now, likely to improve and therefore they are pointing on the for sale sign and hopes for a better price when the business picks up.

Bob Antin

You certainly have some of that. But remember the comment of stinks. Not every like ours, not every hospital feels the challenge in the same way. Most hospitals that we visit in the country are challenged. But it's marginal. Our comps are down 2%, which compared to other consumer-based businesses including human side is pretty good. So, there are some, there are some that would rather wait. We haven't run into a whole lot of them. It's more dictated by their place and lives. I think most people recognize the tax. But I don't think a slight fall in their revenue is going to determine whether or not they are selling out. I think the tax has more play and also this (inaudible).

Rob Mains – Morgan Keegan

Okay fair enough. Yes, I guess challenge is probably a better word than stinks.

Tom Fuller

Part of the – as was the case in the last couple of quarters, part of our little bit of slowness in acquisitions have started to build up cash and we can be pretty conservative and advance refinancing, building up cash makes sense. So, we are anxious to when we get that done and we are more comfortable on being a loser (ph) in spending and accelerating if we can.

Rob Mains – Morgan Keegan

Right. That makes sense. And then last question, can you give a brief update on how Canada is rolling out? Is it doing kind of better than the US and how is it doing relative to your plans?

Bob Antin

It's profitable. It's growing, it grew at a little faster pace than the US slightly. But we are still, you know, we are confined on mostly in the Toronto (Ottawa) market. So, it's profitable. It turned the corners, it's making money. And now it's a question of building reputation. And again, we compete with another very good company up there, and it's building a base. So, it turned the corners, it's making money, and we are building a good reputation.

Rob Mains – Morgan Keegan

I just have one more. Do you still have an R&D spend going on in the lab division?

Bob Antin

We do.

Rob Mains – Morgan Keegan

Do that enough to bring down margin meaningfully in the quarter?

Bob Antin

No. It's increasing because we are investing more, but it's just really not a big impact on margins.

Operator

Our next question comes from the line of Jonathan Block of SunTrust Robinson.

Maggie – SunTrust Robinson

Hi, this is Maggie (ph) in for Jon. In terms of trends, I understand it's hard to predict, you said week over week, it can change. But just kind of looking through the quarter, it sounded like I think at least on the last call, April was doing pretty well and then I guess it just must have decelerated meaningfully. If you could just give us an idea of how kind of the trends have been going and maybe how July – is that kind of on par with 2Q.

Bob Antin

I can't comment on July. I can't tell you that you – your sense is correct, it was up and down and that's one of the reasons why the approach to guidance is because it swings so much, not just in our company but in the industry and related, it's going up and down. So it's a wide variance that's occurring.

Maggie – SunTrust Robinson

When you gave guidance last time in April, it was just – seemed like things were improving faster?

Bob Antin

Yes, the answer was our outlook was that the economy, as I suspect (inaudible) as well as that the economy was recovering, there was a little bit more enthusiasm. And while we still remain confident in it, it's a harder one because it's not as consistent, it's very up and down.

Maggie – SunTrust Robinson

And then on the lab side, have you guys given any more thought into potentially taking the lab business internationally just in terms of feeling growth there?

Bob Antin

We are. We are in Canada, we are looking not aggressively outside of it. I think we have our hands full, we have tremendous opportunity right now and we are competing with the environment right now. So I think that's where our main focus is.

Maggie – SunTrust Robinson

Can you try to help us understand the extent of the possible deleverage in the animal hospital business kind of how you think about stress testing that and where margins can go?

Tom Fuller

I think that's a great question. That is reflected in the range of the guidance, which I notice is pretty wider range than you have seen in the past because it's difficult to predict margins when the revenue is falling. What we saw in the second quarter is probably indicative of what I would expect to see going forward to the extent that if revenues – you sell more than the 2% and you would see margins (inaudible) a little bit more than what we saw in the quarter, but it's really hard to predict.

Operator

Our next question comes from the line of Robert Willoughby of Bank of America.

Unidentified Analyst

Hi, this is Ann (inaudible) filling for Robert Willoughby. Just a follow-up to the M&A commentary, just directly speaking, are there any revisions to your projected deal spending for the year and how are you prioritizing labs versus hospitals?

Bob Antin

I think on the hospital we will end up the year somewhere about $110 million in lab acquisition. I think that's what our focus is – on hospital acquisitions, not lab. Our growth is not fueled terribly much by acquisitions on the lab side. So it's primarily on the hospital side. So it would be up from the previous.

Operator

Our next question comes from the line Mitra Ramgopal of Sidoti.

Mitra Ramgopal – Sidoti

Following up on the M&A theme, given the success you are having in Canada, are you more inclined to maybe be a little more aggressive, trying to expand the business there?

Bob Antin

We are looking at it. Canada is – we are on the east coast of Canada, not in Montreal, I mean in Toronto, in Ottawa area and we are still focused on that. We do consider moving to the West Coast sometime in the future.

Mitra Ramgopal – Sidoti

It seems like as you said, the economy was sort of the main factor that sort of weigh down results there. Was there anything you are seeing especially on the lab side in terms of any shifting with regards to maybe more testing being done perhaps in house or anything like that that's probably having an effect?

Bob Antin

Certainly competition exists for us on the reference side. Our own experience as users is that one of the areas that we have fall off is the question that was asked before about wellness exams. Our own hospitals which do use some in house testing, our in house testing volume has gone down as a reflection of people's black (inaudible) this right now to spend on wellness and prevent it. So the in house for us as a user has gone down relative to the reference lab. It's harsh for me to say because we are not in the in hospital testing. So I think there are others that can speak to that more than we can but as a user, ours is down.

Operator

I show no further questions in the queue at this time.

Bob Antin

I would like to thank you. As Tom and I have both said that we have grown the number of hospitals, the platform is growing, we are getting some benefits out of our brand recognition through VCA, we are very encouraged in the market. We all know that there is 62% of the households in the United States have pets and it's not going anywhere and we think a lot of the challenges are from the environment, the economic environment. We think we are well positioned, we are still very enthusiastic, we have great cash flow and I think we will meet the challenges that are there that are not significant but they are a little choppy. So I would like to thank you very much for taking the time.

Operator

Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program. You may now disconnect.

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Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

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