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Ashford Hospitality Trust, Inc. (NYSE:AHT)

Q1 2011 Earnings Call

May 9, 2011 11:00 am ET

Executives

Tripp Sullivan - Corporate Communications

Monty Bennett - CEO

Douglas Kessler - President

David Kimichik - CFO

Analysts

Bryan Maher - Citadel Securities

Ryan Meliker - Morgan Stanley

Dave Loeb - Robert W. Baird

Will Marks - JMP Securities

Operator

Welcome to Ashford Hospitality first quarter 2011 conference call. During the presentation all participants will be in a listen-only mode. Afterwards we will conduct a question-and-answer session. [Operator Instructions]. As a reminder, this conference is being recorded Monday, May 9, 2011.

I would now like to turn the conference over to Tripp Sullivan with Corporate Communications. Please go ahead.

Tripp Sullivan

Good morning. Welcome to this Ashford Hospitality Trust conference call to review the company's results for the first quarter of 2011. On the call today will be Monty Bennett, Chief Executive Officer; Douglas Kessler, President; and David Kimichik, Chief Financial Officer.

The results as well as notice to the accessibility of this conference call on a listen-only basis over the internet were released yesterday evening in a press release that has been covered by the financial media. As we start, let me remind you that certain statements and assumptions in this conference call contain or are based upon forward-looking information, and are being made pursuant to the Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995.

Such forward-looking statements are subject to numerous assumptions, uncertainties and known or unknown risks which could cause actual results to differ materially from those anticipated. These risk factors are more fully discussed in the section entitled risk factors and ask for the registration statement on Form S-3 and other filings with the Securities and Exchange Commission. The forward-looking statements included in this conference call are only made as of the date of this call and the company is not obligated to publicly update or revise them.

In addition, certain terms used in this call are non-GAAP financial measures, reconciliations of which are provided in the company’s earnings release and accompanying tables are scheduled which has been filed on Form 8-K with the SEC on May 8, 2011, it may also be accessed through the company’s website at www.ahtreit.com. Each listener is encouraged to review those reconciliations provided in the earnings release, together with all other information provided in the release.

I will now turn the call over to Monty Bennett. Please go ahead.

Monty Bennett

Thank you and good morning. Continuing the trend of our outperformance through 2010, I am pleased with our execution on all fronts during the first quarter of 2011. We demonstrated once again the benefit of the diversity of our transactional and operational strategies to maximize AFFO and share price. We reported AFFO of $0.41 per share in the quarter, and an 8.8% increase in RevPAR for hotels not under renovation. ADR was up 4.6% and occupancy was 271 basis points.

We exceeded the prior quarter's RevPAR growth performance and have gained momentum in driving ADR growth. Some of our markets that lagged RevPAR acceleration in earlier periods are now showing growth. This is typical in the first phase of a recovery as markets vary in a response time to economic stimulus.

The addition to our platform of the 28 hotels and the $1.3 billion Highland Hospitality portfolio should help us increase our overall average RevPAR and growth due to the exposure to high quality markets, greater concentration and [abrupt scale] hotels and strong brands.

While revenue increases are expected to continue for several quarters to come, we are keenly focused on driving operating results through cost control and flow through. During the downturn we minimized operating margin erosion. Similarly, we expect the same cost controls during the recovery to minimize increases in operating expenses. We believe that because 38% of our EBITDA is managed by our affiliate Remington, we are able to exert greater control over the rise and fall in operating expenses.

For the hotels not under renovation, EBITDA margin increased 280 basis points from a year ago to 30.1%, while for all hotels EBITDA margin increased 219 basis points to 29.2%.

Regarding capital expenditures, we completed $13.9 million of projects in the quarter. Our 2011 CapEx budget is $131 million with approximately $40 million being our share of the total dedicated to the Highland portfolio and the balance to selective upgrades of hotels to improve their competitive position in their markets.

Our capital structure remains a priority and we will continue to seek the right balance for us among equity, debt, interest expense and leverage. We have clearly demonstrated discipline in minimizing equity offerings while still exceeding our peers in asset growth mainly as a result of the Highland Hospitality transaction.

Our focus on opportunistic share repurchases was invigorated with the most recent agreement reached with our Series B-1 shareholder to buyback preferreds that were convertible into common shares. The $81 million Series E preferred offering facilitated this repurchase.

Our overall leverage ticked up during the quarter with the completion of the Highland acquisition. We expect that percentage to come down as virtually all cash flow from that transaction is used to amortize the debt. For 2011, we have $203 million in hard maturities, all of which occurs in December. We have $167 million coming due in May of 2012, in addition to our April 2012 maturity on the credit facility which had $45 million outstanding as of March 31st.

As we noted before, our board declared a dividend of $0.10 per share for the first quarter of 2011 and we provided guidance that we intend to pay at least this amount in subsequent quarters as well. Our solid operating performance combined with the significantly reduced share count has contributed to the dividend strategy. We are pleased to be able to reinstate the dividend to provide additional returns to our shareholders, above and beyond the appreciation in our stock.

The most significant transaction that occurred in the quarter was obviously the Highland Hospitality portfolio acquisition, given that we held a separate call during the quarter to provide specific details on that investment, I'd like to focus here on what we have been doing with this portfolio since the March 10, 2011 acquisition day.

First of all, during the short period of ownership we do not see any material benefits so far in our reported results. Most of our work at this point has been completely transitioned in positioning our asset managers to implement more rigorous revenue and cost management systems in these hotels.

We believe there are clear opportunities to improve cost controls and drive operating margin improvement. As the year progresses, we will be able to provide more definitive assessments on how quickly we can drive improvement and which asset may take longer to bring up to our standards. We believe there is a substantial cash flow opportunity with this portfolio, but I'll remind you that pursuant to the terms of the restructured financing, excess cash flow generated by these assets will go to reduced debt on the properties.

Looking ahead to the rest of the year, our focus remains unchanged: improving our balance sheet and liquidity, controlling costs, budgeting revenue and generating improved operating results while still pursuing selective yet opportunistic capital market investment opportunities. All of these we will execute with our management team's commitment to outpacing our peers through superior shareholder returns.

Lastly, we've announced that we are hosting an analyst and institutional investor conference in New York this Wednesday, May 11th. This will be an opportunity for us to provide some very interesting insights into our investment capital markets and asset management strategies. If you haven’t RSVPed yet, please let us know if you're coming.

I'd now like to turn the call over to David Kimichik to review our financial results.

David Kimichik

Thanks Monty. For the first quarter, we reported net income to common shareholders of $31,278,000, adjusted EBITDA of $58,356,000 million and AFFO of $32,476,000 million or $0.41 per diluted share.

At quarter's end, Ashford had total assets of $3.6 million in continuing operations, and had $4.5 million overall including the Highland portfolio assets which is not consolidated. We had $2.4 million of mortgage debt in continuing operations and $3.2 million overall including Highland.

Our total combined debt has a blended average interest rate of 3.2%, clearly one of the lowest among our peers. Including our interest rate swap, 61% of our debt is now fixed rate debt. The weighted average maturity is 4.6 years.

Since the length of the swap does not match the term of the underlying fixed rate debt for GAAP purposes, the swap is not considered an effective hedge. The result of this is that the changes in the market value of these instruments must do run through our P&L each quarter as unrealized gains or losses on derivative. These are non-cash entries that will affect our net income, it will be added back for the purposes of calculating our AFFO. To the first quarter the unrealized loss was $16.8 million.

At quarter's end our portfolio consists of 97 hotels in continuing operations, containing 20,458 rooms. During the quarter we sold out our discontinued operations, three hotels: the JW Marriott San Francisco, the Hilton Rye New York, and the Hampton Inn Houston for a combined net gain of $2.8 million. Additionally, we acquired 71.74% of the 28 Highland hotels containing 5,800 net rooms in a joint venture. All combined, we clearly own a total of 26,258 net rooms.

As of quarter end, we own in a position in just two mezzanine loans with total book value outstanding of $20.9 million. Subsequent to the end of the quarter we received a slightly discounted payoff of the sales in mezz loan. We realized a gain of $4.2 million since in the previous quarter we took a partial write-down of $7.8 million on this loan as it was coming due with no clear resolution. With the exception of one small loan of $4 million on the Ritz Carlton Key Biscayne, it effectively closed our mezzanine loan portfolio.

Hotel operating profit to the entire portfolio was up by $8.3 million or 15.3% for the quarter. Our quarter end adjusted EBITDA to fixed charge ratio now stands at 1.70 times versus the credit facility that require a minimum of 1.25 times. Our share count currently stands at 76 million, fully diluted shares outstanding, which is comprised of 61 million common shares and 15 million OP units.

I'd now like to turn over the call to Douglas to discuss our capital market strategies.

Douglas Kessler

Good morning. This has been a very active transaction period for us. In addition to the Highland Hospitality investment, we also completed three asset sales, purchased a unique but relatively small hotel asset, negotiated a loan payoff and executed on a value add capital market strategy.

The transaction environment remains extremely competitive. While more properties are coming to the market for sale of significantly greater amount of capital, continues to seek hotel investments. The depth of the buyer market is increasing and includes REITs, investment funds, insurance companies, pension plans, private equity and offshore buyers.

We continue to underwrite potential new investments but have not yet seen opportunities as favorable as the returns we are expecting from the Highland portfolio transaction. We are not pressured to deploy capital and are disciplined in seeking accretive transactions for our shareholders from an EBITDA and FFO per share standpoint.

Subsequent to the end of the quarter, we completed a transaction that resulted in a 5.9 million share reduction in our fully diluted share count to a level of 76 million shares. We accomplished this in two steps. First, we negotiated a stock repurchase agreement with a Series B-1 holder of convertible preferred shares. We then completed our Series E preferred stock offering which with the [green sheet] resulted in the issuance of 3.35 million shares at $25 per share with a 9% yield. We then used $73 million from the $81 million Series E net offering proceeds to complete the repurchase transaction for the recently negotiated agreement. As a result, only 1.4 million shares of the outstanding 7.2 million Series B-1 shares were converted to common from this transaction and the remainder was repurchased.

Since the inception of our buyback program, we reduced our paid share count by almost 50%, and removed Series B-1 convertible preferred. We confidently expect that these share repurchases will provide additional near term and longer term benefits in our reporting metrics and total shareholder returns.

Regarding asset level transactions, in March we acquired 96 units at the 238 unit World Quest Resort located at about a mile from Disney's Magic Kingdom in Orlando for $12 million cash. This is a small but unique opportunity that also includes developable land that would allow us to build additional units.

Remington Lodging, who had been previously managing the asset provide us insight on the Mediterranean style resort containing two and three bedroom suites, and enabled us to us acquire it essentially off market. We expect to derive benefits from the hotel operations, ownership of common areas, as well as the future sale of units.

During the quarter, we completed the sale of the Hilton Rye Town, JW Marriott San Francisco and Hampton Inn Houston Galleria. The Hilton Rye Town traded for $35.5 million and all the proceeds were used to reduce borrowings under the credit facility. The Hampton Inn Houston Galleria generated proceeds of $20.3 million that was used to pay off a $2.7 million mortgage secured by the property, as well as another $2.7 million to our joint venture partner with the balance used to pay down our credit facility.

Combined with the JW Marriott San Francisco sale we discussed on last quarter's call, we produced a $152 million in gross proceeds from dispositions during the first quarter. On a combined basis, these three asset sales traded for a very low trailing 12-month cap rate of 2.5% and also kept us from having to spend future CapEx dollars.

We will continue to think strategically about asset sales given the market demand for high quality hotels in our portfolio. For those assets we may identify for sale, our decisions will be based mainly upon a share price accretion analysis, pricing, CapEx needs, alternative uses of sales proceeds and impact on leverage.

Subsequent to quarter end, we negotiated a $22 million payoff on our $25.7 million mezz loan secured by interest in the Tharaldson portfolio, resulting in an 86% of PAR payoff. We were very pleased with the outcome of this payoff for several reasons. First, the debt yield was 6.9% on our last dollar of investment in the capital stack which can be equated to the cap rate. Second, this loan was secured by mainly midscale hotels, some of which were own leases and secondary and tertiary markets. Lastly, the decline in operating performance due to the economic downturn put in question the recovery in value. As David previously mentioned, the favorable execution relative to our prior write-down will result in a reported gain next quarter.

Just recently we completed the restructuring of debt secured by the Manchester Courtyard, a $5.8 million loan that had matured in January 2011. We were able to secure a new three year term on this loan. As we look to our upcoming debt maturities, the next of which is in December of this year, we are working on restructuring solutions.

In conclusion, all of our acquisition, disposition, financing, capital market and balance sheet decisions have a unilateral focus, namely near term and long term dividend and shareholder price appreciation.

We are very much aware of the qualitative and quantitative aspects of our decision making. Given that insider ownership is approximately 20%, we can assure you that we are closely aligned with our shareholders and focused on continued success in Ashford's overall performance. That concludes our prepared remarks, and we will now open it up for questions.

Question-and-Answer Session

Operator

[Operator Instructions]. The first question comes from the line of Bryan Maher with Citadel Securities. Please proceed.

Bryan Maher - Citadel Securities

A quick question on the Highland portfolio. Have you identified any assets in there that you think you might end up selling?

Monty Bennett

Right now we probably won't be selling too many of the assets, the structure of that debt is such that almost all, if not all of the proceeds will be used to pay down debt, debt that we think has pretty decent pricing on it, and since we generally think that assets will be improving in value over time and those proceeds will be used to pay off relatively inexpensive debt, there's just not much of a motivation to sell any of those right now. Maybe in future years, but not right now.

Bryan Maher - Citadel Securities

And then as it relates to your relationship with Prudential, I am assuming that at some point you do have a right to buy them out, is that correct?

Monty Bennett

Well, we've got traditional mechanisms in there about buy-sell and other disputes and metrics in after a few years, but our long term plan would be to hopefully buy them out if all the conditions are right. And they are operating this in the fund and so at some point they'd be seeking liquidity. So, I'd say that we are the natural buyer for the interest at some point in time. When or where that happens is yet to be determined.

Bryan Maher - Citadel Securities

Thanks. We look forward to hearing more on Wednesday.

Operator

The next question comes from the line of Ryan Meliker with Morgan Stanley. Please proceed.

Ryan Meliker - Morgan Stanley

I just had two quick questions. First one, can you talk a little about SG&A, it looks like it was up materially. I think a lot of that had to do with some litigation costs, so I was wondering if you can give us any color on, if the bulk of that is already through or if we should be expecting those types of costs recurring throughout the year.

David Kimichik

Ryan, this is Kimo. You're right, in the first quarter the G&A had a $5.5 million one-time only cost associated with some legal fees on a contingent settlement of a lawsuit. It's just an accrual and it also will be paid the proceeds of that settlement, but it's a one-time cost if you net that down to about $6.5 million, that’s really our run rate.

Ryan Meliker - Morgan Stanley

That’s helpful. That’s what I figured. I just wasn’t sure if it was going to be recurring or not. And then, the second question I had which is just minor. Your asset management fees from affiliates went up slightly. I am assuming that has to do with the Highland portfolio acquisition. Is that this $338,000 in this quarter, kind of a run rate or should we expect that up materially given only on Highland for a portion of the quarter?

David Kimichik

This is Kimo again. It includes a little bit more for the 20 days that we own the World Quest Resort, that’s included in there as well. I don't think we have a clear handle yet on what the run rate's going to be on that, but it's immaterial I think to the overall, but there's an additional component in there now as the World Quest Resort income.

Ryan Meliker - Morgan Stanley

Okay. But there's no asset management fees on the Highland portfolio?

David Kimichik

It actually is a net credit to our AMG.

Ryan Meliker - Morgan Stanley

Great, that’s helpful. Thanks a lot.

Operator

The next question comes from the line of Dave Loeb with Robert W. Baird. Please proceed.

Dave Loeb - Robert W. Baird

Monty, I wonder if you could just comment a little bit about group bookings and group demand in your market. I am particularly interested. There have been a lot of conversations about Marriott and sales transformation. You're both a franchisee and an owner of managed properties. I am interested in hearing your view on whether there's any difference by brand or between franchised or owned hotels and how that’s going. Is that something you can give us some insights on?

Monty Bennett

Sure. Group bookings overall are good. They are improving. They seem to be continually improving, I don't know if the rates have improved any more this quarter than the past few quarters, so I should rehearse that and say that the rate of improvement is not any greater. They are just picking up. The windows are still short but group bookings are definitely picking up.

Regarding our Marriott sales transformation system, some of our Marriotts didn’t perform as well as we had hoped this past quarter and what we are trying to get a handle on is that underperformance due to just natural variation because you can take a look at all of our 100 and some properties, and every quarter a good portion of them are willing to perform for one reason while some will over-perform, or is that’s because of sales transformation, and that’s really hard for us to get a handle on. So, we went up and visited the folks at Marriott and have got some follow-up meetings in order to determine is the sales transformation specific or is this our portfolio specific, and we just don't have that answer yet, but Marriotts is a sales and marketing machine, and so if it is sales transformation then I measure it will rectify very quickly or even if it just happens to be natural variation and next to come around. But the short answer is that we just don't know yet, but I know that our people in house are working on it fast and furiously as are the Marriott people just understand what the issue is and then to correct it if there is an issue.

Dave Loeb - Robert W. Baird

So looking forward, are you seeing group demand pick up a bit and do you expect that to be stronger as you go through the year?

Monty Bennett

We do. But I think what's more significant is that while group demand is picking up, a big chunk of our business is transient corporate, maybe 25% of our overall businesses grew, but 75% is transient. And then most of that, a good majority of that is business transient, and that business coming back with their high associated rates is what we're very excited about, and what we think should move the needle across the industry going forward.

Dave Loeb - Robert W. Baird

Great, that’s very helpful. Thank you.

Operator

[Operator Instructions]. The next question comes from the line of Will Marks with JMP Securities. Please proceed.

Will Marks - JMP Securities

A question on Highland and the RevPAR growth. Can you talk about how that portfolio maybe did in the quarter and do you expect it to outperform in the rest of your portfolio looking ahead?

Monty Bennett

Sure. We are digging up those steps, so right now as far as there's performance in the first quarter, I believe there's around 5% RevPAR growth. So it's not as good as our core portfolio. I'd say that what you're going to see in that portfolio is some of the cost controls that we put in that place can take place immediately, while some of the revenue generation is going to take some time in order for us to get our feet on the ground and to get those sales efforts focused. Prior ownership was understandably focused on debt maturity and the like and restructuring, and so we think there's some opportunity there, but when we take over a portfolio like this, that’s usually the order events that we see. Cost controls can start to come first and then revenues come a little bit later; and when I say later, maybe a few months later. The number for Highland for the first quarter was 5.4% RevPAR increase.

Will Marks - JMP Securities

And in terms of what that does to the blended to quarter RevPAR to your portfolio. Can you just give us some sense?

David Kimichik

Sure. Let's see if I've got that stat right here. We just have total revenue broken out by the legacy portfolio and the Highland portfolio for the total first quarter, as well as the three previous quarters. So if you go back to the second to last table attached to the earnings release pro forma seasonality table. I think you can get a good handle on the portfolio, revenue-wise and hotel EBITDA and margin-wise.

Will Marks - JMP Securities

Okay, that’s fine on the activity. One other question, you talked in your comments about the mezzanine portfolio kind of going away. I mean is your strategy now looking ahead if you were to make more acquisitions. Is it more on the equity side or you for years had talked about kind of your (inaudible) on when to buy different parts of the structure and capital structure and where are we now?

Monty Bennett

Let me give you a long answer to that question. We launched this, we had hoped to do a good amount of mezzanine investing, but very quickly the markets moved away from us and the pricing on mezz got pretty thin. And so our mezz investing was something like only our mezz platforms, only like 3% of our portfolio. We underwrote those mezz returns in those mezz investments to approximately having 9/11 being the worst case scenario, and then with this great recession, our worst case was about three times as worse, and as a result we got beat up pretty bad in our mezz portfolio.

That being said, if you look at all the income and return of capital, we received from the mezz portfolio compared to how much we put in we were about breakeven, and that doesn’t take into account the benefit from being in a position to take over the Highland transaction, which we think is an extraordinary benefit. So, it was a net (inaudible). Going forward though, we're already starting to see pricing to be pretty thin on the mezz loans. And so it's just tough for us to get too excited about the opportunity to make mezz loans or to buy mezz loans because of the risk reward tradeoff.

Regarding of where we want to be in the capital structure in the time to buy and time to sell, that’s still a very strong focus of our internal thinking. And as you can see right now, we are not buying very many assets outside of the Highland transaction, and that’s because not that it's a bad time to buy for the industry overall, but it’s a bad time to buy for us because of equity, it's too expensive in our view in order to go out and to buy hotels.

So, that’s a very important part of our thinking and over time we'll be selling hotels, but we'll also engage in some other techniques and strategies in order to continue to hedge our positions, and this has included some adopted strategies during the course of our existence such as share buybacks, such as swaps, interest rate swaps such has floor doors and other mechanisms in order to better manage what can be a volatile hotel cycle.

Will Marks - JMP Securities

Okay. Thank you for the response.

Operator

The next question comes from the line of (inaudible) with KeyBanc. Please proceed.

Unidentified Analyst

I just had a couple of quick questions. First, around the current mortgage environment to where you guys were seeing as far as rates and LTVs, and if you could give more specifics on what you are thinking you are going to do with the upcoming maturities in December and spring of next year?

Douglas Kessler

Hi, this is Doug. In terms of what we are seeing in the market, obviously the perception of lodging has improved dramatically in the eyes of lenders and there is increasingly more liquidity for hotel lending. That’s all the good news.

The pricing is continuing to improve and we are seeing that the first mortgages, at least in terms of kind of a CMBS type transaction that part of a stack structure is being priced to about 10.5 debt yield with the ability to layer in some mezz trenches that can take it to 9% and perhaps for higher quality assets maybe just a tad bit below 9% in terms of the debt yield. Some of the LTV comparisons, it's a more stringent market in looking LTVs obviously than what it used to be getting financing into the 70% to 75% range is certainly still achievable today.

The balance sheet lenders are also active. Their underwriting criteria is a little bit more conservative I'd say from the loan-to-value standpoint, but to the extent that you can partner up with a group that might allow some mezz in the capital stack will enable one to achieve slightly higher LTVs.

So the market is definitely improving. Unfortunately, we don't have a significant amount of debt coming due. We have one loan that’s coming due in December of this year. That’s all that we have for our 2011 debt maturities. We are looking at various alternatives. I think our core objective here will actually be to try to restructure with the existing lenders. We are also looking at other prospects but at this point we would say that’s our preferred outcome.

Unidentified Analyst

Okay, great. Thanks.

Operator

The next question comes from the line of Bryan Maher with a follow-up question with Citadel Securities. Please proceed.

Bryan Maher - Citadel Securities

A quick question on the World Quest property. Is that a property that’s rebrandable? I mean can you convert that to like an embassy suites or doubletree guest suites?

Monty Bennett

This is Monty. That would be difficult to do, so probably not. It will probably stay as an independent hotel.

Bryan Maher - Citadel Securities

And is that like a condo hotel where owners own the units and then they rent it out in anyway?

Monty Bennett

It is a condo hotel. And this is an opportunity that we jumped on because we bought about a 100 of the units for $120,000 a key and those are units that sold for about $400,000 during the peak per unit. So, right now kind of on an adjusted basis, after we do some improvements, kind of on an equivalent NOI basis that portfolio is throwing off around $1 million a year. It's equivalent to NOI. And after we sell those hundred units we think it will still be throwing off $1 million a year based upon the revenue splits with the future owners.

So, as long as we can sell those units for what we paid for them which we think is pretty easy to do, then we'll have the income [string] for free, which is great. And so it's got a great dynamics to it, but it's something that we are just dipping our toe in the water on, condo hotels are more complex. We do have a lot of experience with it because Remington has been managing that complex for maybe four years now or so, but we just want to be cautious. But it does have return potentials much higher than just going out and buying straight hotels in this marketplace. You can almost get to a point where you can get the same cash flow from it without having to own it, and those economics, those dynamics are pretty compelling.

Bryan Maher - Citadel Securities

Thanks. That's some pretty good color. What kind of rate and occupancy does the property run?

Monty Bennett

I think all hands if memory serves, it's about 72% occupancy. I don’t have that right here off the hand for you.

Bryan Maher - Citadel Securities

Thank you.

Operator

And Mr. Bennett, I'll turn it back over to you for your closing remarks or continue with the presentation.

Monty Bennett

Thank you for your participation on today's call. We look forward to seeing you the morning of May 11th, that’s this Wednesday in New York for our institutional investor and analyst day, and we also look forward to speaking with you again on our next call.

Operator

Ladies and gentlemen, that does conclude the conference call for today. We thank you for your participation and ask that you disconnect your line.

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