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Canon Inc. (CAJ)

Q3 2007 Earnings Call

October 25, 2007, 8:30 AM ET

Executives

Masahiro Osawa - Managing Director, Group Executive, Finance & Accounting Headquarters

Analysts

Robert Cross - Cross Research

Matthew Troy - Citigroup

Jay Vleeschhouwer - Merrill Lynch

Presentation

Operator

Good morning, good afternoon and good evening to all participants. Welcome to Canon's Fiscal Year 2007 Third Quarter Results Conference Call. For the duration of the presentation, all lines will be on a listen-only mode. I would also like to inform you that today's call is being recorded. If you have any objections you may disconnect at this time.

The presentation from Canon is for 30 minutes and the Q&A session is for another 30 minutes after the presentation. As we already let you know the title of the conference is Canon's fiscal year 2007 third quarter results.

I would now like to turn the call over to your speaker Mr. Masahiro Osawa, Managing Director, Group Executive, Finance & Accounting Headquarters. Thank you sir. You may begin.

Masahiro Osawa – Managing Director, Group Executive, Finance & Accounting Headquarters

Hello everyone and welcome to Canon's conference call. My name is Masahiro Osawa, I am in charge of Finance and Accounting. Today, I will review our third quarter results and revise projections for fiscal 2007. Please note that all financial comparisons made during my presentation would be on a year-on-year basis, unless otherwise stated.

Please refer to slide two. This slide outlines today's agenda. Please come to slide three. I will now discuss our third quarter results. In the third quarter [inaudible] business confidence began to kept shadow as a result of the year's subprime loan problem mainly in September. By making the most of our competitive products, however net sales increased 6.4% reflecting increased sales of Cannon copying machines, inkjet printers and digital cameras.

Currency exchange rate also had a positive effect. Gross profit increased 8.3% and our gross profit ratio improved by nearly one point to 15.3%. This [inaudible] sales of high value added products as well as the positive impact of currency exchange rates. Our full operating profit increase was 0.9% following higher [inaudible] expenses and are contributing next generation based business domain and enhancing our core technology. This also reflects the impact of the change in the depreciation method implemented in the second quarter of this year. Net income decreased 8.9% due to an increase in currency exchange loss on foreign currencies denominated trade receivables of 18 billion and resulting from the [inaudible] at the end of this third quarter related to the second quarter of 2007.

Based on our third quarter results, we revised our full-year projections as shown at the bottom of this slide. Despite a projected increase in expenses aimed at enhancing our corporate structure, we now project net sales and profit to grow around 10%. This also reflects continued strong sales of major products excluding semiconductor production equipment and the benefit from the [inaudible].

Please refer to slide four for your reference.

If we exclude the impact of the change in the depreciation method, which was 21 billion Yen before tax in the third quarter. Operating profit and the net income would have increased 13.1% and 1.7% respectively. For the full year, excluding the impact which we project to be 63 billion yen before tax. Projected operating profit and the net income, they both show an increase of 18.2%. [inaudible] depreciation method [inaudible] gross profit as a percentage of net sales for the third quarter and full year would be 51.5% and 51.1% respectively both record high.

I'd now like to review our third quarter results against our previous projections using the next slide. The overall impact of exchange rate changes on projected net sales and operating profit was negative as was sales volume.

By segments, Office Imaging Products, sales volume of our office use color-copying machine was below our projection [inaudible] weak domestic market and the severe price competition for low-speed machines. However for medium and high-speed copying machine for which we expect to benefit from higher print volume, with demand strong.

Computer Peripherals, sales volume of laser beam printers was slightly below our projection due to such hurdles like the shipping delays and lower than projected growth in the domestic market. The volumes of inkjet printers, particularly low-end models, our orders were below our projection as we chose to focus on profitability, earnings, further increase in price competition.

As for cameras, earnings stronger than projected market growth. We exceeded our projection and maintained our number one worldwide market per share position for both digital SLRs and the compact model [inaudible].

As for optical and other products, our results, sales volume of semiconductor production equipment was basically in line with our projection. Overall volume was below our expectation mainly due to the independent businesses of our manufacturing subsidiary.

As for the other category, the [inaudible] figure and the [inaudible] represents lower than projected impact from price decline. Thanks to our ability to maintain price mainly for digital cameras even in the phase of a severe price competition.

The [inaudible] and the operating profit reflects our efforts to control price decline [inaudible] despite lower than projected cost reduction due to rise in raw material pricing and a slight delay in our outcome.

Please refer to slide six. Next I'll discuss on our devices projections. This slide shows our exchange rate assumption and the projected impact that run and change and that rate it had on fourth quarter that preferred and operating profit.

Please transfer to slide seven. In the fourth quarter, we project 13% of the increase for most of our businesses leading to double-digit growth of net sales, gross profit, and net income. Compared with our previous projections, despite the significant [inaudible] the impact of exchange rate, we have tried to replace our projection for net sales and significantly raised our projection for profit. I would explain this in more detail in the next slide.

Our revised exchange rate assumptions have negative impact on previously projected net sales and operating profit. As for sales volume, we raised our projections for all the core segments taking into account new products franchised under our brand to actively promote sales expansion. Regarding the imaging product through the active promotion of sales expansion of media with high-speed office use color copying machine.

High speed monochrome machines [inaudible] we expect to exceed our previous projection. Our full computer peripherals, we obviously expect to exceed our previous projection for laser beam printers mainly due to consumables for which demand is higher than we originally projected especially for color. Regarding the inkjet printers to do continuously hope to expand sales of midrange products and through the enhancement of our lineup with [inaudible] for oversees market. We aim to expand our installed base in markets and segments we have print volumes higher. This will lead to a further expansion of consumable sales of digital cameras. We expect the digital camera market to remain on during the year-end selling season. And with our competitive lineup we will work to expand sales beyond our previous projections.

I will [inaudible] other product, our current projection is basically inline with our previous forecast. Regarding the other category, [inaudible] the net sales lower than previously protected impact from price decline. Although we expect price competition to continue. We are also confident that we would be able to maintain the strong competitiveness of our products, thereby limiting price decline as we did in the third quarter. The positive figure under operating profit reflect how we hope to control our price decline and it was under expenses.

For the full year, we now project 103 billion yen in the portfolio reduction, 15 billion yen based on our previous projections mainly due to rise in lower material prices and a slight delay on our front in the second quarter. Okay, I will discuss our results and the current projections by product group. Starting with business machines, third quarter net sales of business machines increased 7.2% reflecting the steady increase in sales of color copying machines and inkjet printers. Operating profit increased 9.5% due to the increase in net sales and efforts to cut cost through such major procurement reform and in-house production. Our operating profit ratio was below our projections mainly due to currency exchange impact.

Please turn to slide ten. In the fourth quarter, net sales of business machines are projected to increase 9.4% this reflects growing sales of tandem engine [ph] based on used color copying machines and our image machines designed for the POD market. It also represents expanded in sales of laser beam printers and our plans to increase sales of new inkjet printers during the year-end selling season. Operating profit is projected to increase 15.3% due to such factors of the increase in net sales and cost reduction. In addition based on the continued steady growth of our installed base for these products, we project sales of consumable to increase leading to an improvement in profitability.

Please refer to slide 11. I will now discuss net sales of business machines by product segment. Staring with office imaging products, full color copying machines in the third quarter although market growth was relatively weak in the first we continued to see strong unit sales growth in North America and also saw a significant improvement in Europe. As a result new sales of the color copying machines increased 24%.

Unit sales [inaudible] based office use color copying machines particularly strong as we focused our efforts on driving color page volumes in line with our mid term object to improve profitability. Overall improving strong sales growth of image products, net sales of our color copying machines including consumables increased 28.1% also office use monochrome copying machines will [inaudible] significantly expanding unit sales of high-speed modem in Europe and Asia.

We maintained strong sales of low-end A4 model in emerging market. As a result new sales of office use monochrome copying machines increased 6%. Net sales of others, which includes our solution businesses increased 23.8% mainly due to the consolidation of [inaudible]. As a result, third quarter net sales of office imaging products increased for color-copying machines, we plan to focus on further expanding sales over medium to high-speed tandem engine products. In doing so, we project to significantly seek the high-level of sales we posted in the fourth quarter of last year, thereby realizing unit sales growth of over 20% for the year, including our expectation for continued strong sales of image-based product. Fourth quarter, net sales of the color-copying machine including consumables are projected to increase 21.9%. On the monochrome copying machine through expanded sales of the high-speed model in developed markets, and the low end of A4 model emerge in the market. We project unit sales of the office-use model to increase 8%. Overall net sales of our office-imaging product are projected to increase to [inaudible].

I'll now discuss the computer peripherals starting with laser beam printer. The market for both color and the monochrome laser beam printer continued to expand, reflecting continued demand for equipment offering improved performance at low prices. In third quarter, amidst these market conditions, we maintained our high level of unit sales, reflecting the advantage of our products and the strength of our [inaudible] consumables grow. Overall sales growth was limited to 0.2% to 2%. In other countries, rapid shift to low-end products [inaudible] which resulted from the large number of the new products, we launched up the pack.

In the fourth quarter, we continued market growth [ph]. The strength of our products and [inaudible] increase and further net sales expansion of consumables. We predict a strengthening against the US dollar. Net sales of laser beam printers including consumables is projected to increase 7.3%. Despite the relatively low unit to growth rate, we project to invest [inaudible] based on our current prediction should be over 20% leading to double-digits to growth in net sales.

I'll now discuss inkjet printers within the inkjet printer markets. [inaudible] continued to enjoy steady growth. Overall market remains relatively flat in terms of unit. In the farther quarter, this market condition we increased unit sales 2% leveraging our growth and the competitive alignment. Net sales of inkjet printers increased 12.8%'s due to increased sales of consumables, which benefited from the steady growth and the improvement in installed base of printer in the fourth quarter we plan to actively promote sales expansion of our competitive line up of inkjet printers, which are designed for ease of use and the [inaudible] features are the high-speed and the high image quality printing and quick data. And with our expanded line up of business use model for overseas markets, we expect to drive further growth in consumer groups. Through these measures, we project fourth quarter inkjet printer and its sales including consumer groups to increase 8.2%. Please turn to page 13.

On the next slide we will discuss cameras. Third quarter net total for the cameras increased 14.0% reflecting expanded sales of our competitive digital camera line-up within strong [inaudible] fixed digital camera market. Third quarter operating profit increased 14.0% and our operating book-to-ratio was 28.7%.

We improved our product mix through continued strong sales of our high value-added products such as Digital SLR and interchangeable lenses maintained [inaudible] price premium over other brands due to the breadth of our products and [inaudible] cost reduction.

Our operating profit ratio was below our projections mainly due to currency exchange income. In the fourth quarter net sales of cameras projected to increase 13.5% this reflects the contribution of the new competitive digital camera launches both compact and SLR, and our assumptions that the digital camera market will remain strong throughout the year and during the season and that is interchangeable lenses where demand -- and a full profit by maintaining our price premium through the competitiveness of our products improving our product mix and other measures we project an operating profit increase of 17.5% and operating profit ratio higher than that which we achieved last year. Please turn to page 16. Next I'm going to discuss sales of cameras in more detail mainly focusing on our digital camera segment. Third quarter net sales of the digital cameras increased 16.5% amidst our continued underwriting strength of market expansion this was greater than we previously projected and due to the competitiveness of our line-up of both compact and SLR cameras. In the fourth quarter through the launch of new digital cameras in the second half of this year we have enhanced the competitiveness of all our line-up within compact to digital cameras we incorporated our latest [inaudible] included other features within our SLR line-up experienced higher than expected demand for our trend, new yield OPD which we rented in September. From November, we will also launch our new [inaudible] comprised approximately 21.1 million effective pixel for the highest resolution [inaudible] competitive new products, we project net profits to increase 17.2% and expect to further solidify our number one market share position for both compact [inaudible].

For the full year, we based our [inaudible] sale projection from 24 million yen to 25 million yen, because we are representing 18% growth on a year-on-year basis. Within this projection, sales of [inaudible] to 3.2 million yen.

Please turn to slide 16. Next I will discuss Optical and other products. Third quarter net sales of Optical and other products decreased 14.4% reflecting significant decrease in net sales of semiconductor production equipment due to lower unit sales of the LCD arena. Within this category however we continued to see strong sales of large format printers. On the back of [inaudible] and the competitiveness of our products, despite this operating profit for the segment therefore decreased 83.6%. These differences were 17. In the fourth quarter, we project net to sales of Optical and other products to increase 7.4% despite lower net to sale of semiconductor production equipment resulting from lower unit sales by [inaudible] and due to continued strong sales of products such as large format printers, and the independent businesses of our [inaudible]. Our full operating profit for the segment as a whole. We expect to remain profitable in the fourth quarter, operating profit is projected to decrease 85.6%, reflecting lower net sale of semiconductor production equipment. Please turn to slide 18.

Next slide we will discuss sales of semiconductor production improvement in a little more detail [inaudible] IC stepper in the third quarter, although we have all kinds of market to weaken it. We reported units, which was basically in line with our projection. With regard to LCD now, given the low level of investment by manufacturers, we sold 10 units as projected, which is significant to the lower than the [inaudible]. As a result, net to sales of semiconductor production improvement decreased 31.1% in the fourth quarter, unit sales of IC tripled, projected basically in line with our previous projections. For an up-to-date on the status of the new products, we have already shipped more than one new IC stepper and are now looking to book units of sales by $9 a year. As for the margins, we are planning to ship more than one IC stepper sometime between October and November. [inaudible] in 2008. We are steadily working on the expectations of our customer in terms of quality. As for the LCD arena, our new age generation model that we started shipping in April has begun to have early impact on net sales in the solid quarter. Based on that platform, this model is being evaluated very highly by our customers in areas such as [inaudible] productivity. We feel we are in a strong position, [inaudible] projected strong second half of 2008.

Please refer to slide 19. This slide summarizes our full-year projection for net sales by product group. This year we project net sales to increase around 10%, representing strong sales of digital cameras, laser beam printers, and color-copying machine, which is reflected in the strong double-digit growth, we project for all core segments excluding optical and other products.

Please turn to slide 20. This slide summarizes our projection for full year operating profit by product group. For business machines, we project operating profit to increase and our operating profit to improve. [inaudible] increased unit sales of such core products. Our color copying machine and printer, but for reduction and solid sales growth of consumables.

[inaudible] by further improving our product mix through expanded sales over high value added product such as [inaudible] and interchangeable ranges maintaining our price premium which is funded on the string of our competitive products and focusing on cost reduction. We project further improvement in our already exceptional operating profit position. Our full optical and other products [inaudible] unit sales over LCD arena this year. We project operating profit to decline. [inaudible] for additional growth and projected to increase, we expect to offset this through improvement in the profitability of such core businesses [inaudible]. As a result, we project our full year operating profit book-to-ratio basically in nine ways [ph] last year, which was an all time high. Please refer to slide 21.

This slide summarizes our current projections for the full year. Despite the concern of our business confidence obtained [ph] over the third quarter the up sell situation standing [ph] our business remains unchanged. We are still benefiting from the momentum we generated this year and with the launch of new products and with further acceleration of [inaudible] in the fourth quarter. We project nearly 10% to increase in full year [inaudible] and the profit, which we marked our eight consecutive year of sales and profit growth. Gross profit ratio, despite the severe competition, we project an improvement in our gross profit ratio of 0.6 points to 50.2%. And our operating profit ratio and net income ratio even taking into account [inaudible], we have taken to enhance our corporate structure such as increased R&D spending and the change in the method used to calculate depreciation we expect to obtain the same high-level that we achieved throughout the year. Please turn to slide 22.

I would like to discuss our situation regarding cash on hand and the shareholder returns. Regarding cash on hand, this year we project to invest 440 billion yen in the capital expenditure. Despite this elevated level of investment we still expect to generate 660 billion yen increase which is a record high. With this [inaudible] cash this year we decided to acquire our own shares with the aim of improving capital efficiency and ensuring capital shortages that provides for cut -- future transactions [inaudible] exchanges.

Year-to-date we have spent 450 billion yen towards this purpose, and as a result we predict cash on hand obtained over this year to be around 895 billion yen. And for the shares we have acquired our first priority for now is to utilize this is to actively invest in promising areas so, we are on the growth, which means maintaining our high level of profitability and at the same time expand net sales and profit. I for shareholder returns, which basically means our dividend.

We are giving utmost importance to CPT [ph]. Our current consolidated payout ratio was our stated target of 30%. In the fourth quarter, although we expect the severe competitive environment to continue and we will devote all our energy towards achieving our eighth consecutive year of sales and profit to growth. This ends my presentation. I would now like to use the time to answer any questions you may have. Thank you.

Question and Answer

Operator

Thank you. We will now begin the question-and-answer session. [Operator Instructions]. Our first question comes from Robert Cross with Cross Research. Please go ahead with your question.

Robert Cross - Cross Research

Hello every one. The first question has to do with low-end inkjet. In your prepared remarks you noted that there is a slight underperformance in this segment. And I was wondering whether or not that was due to market share lost or end use market. So, with the market overall we... and also Lexmark recently announced that they would walk away from 30% of their units. Are you happy with the usage rates at those low-end devices and would you consider that an attractive market opportunity?

Masahiro Osawa – Managing Director, Group Executive, Finance & Accounting Headquarters

[Foreign Language]. [inaudible] inkjet business. Overall the market has been trapped and meanwhile we've [inaudible] meaning that though it is not significant, we are showing a gradual increase in our share.

[Foreign Language] We have [inaudible] certain areas in which the prospect for profitability such as bundle etc. And in these areas we are not putting that much effort into carrying out our business. That being the case, as a result, our growth rate is not as strong as... in other words it appears to be slightly weak. That is the reason for that. [Foreign Language]. Now regards to second part of your question regards to Lexmark, and as I have explained and that is our basic mentioned policy and therefore we will be carrying out our business in such a way that we will not be influenced by what is taking place and Lexmark. We are trying to secure our profitability and we will work hard, continuing to grow obviously.

Robert Cross - Cross Research

Great, and second question has to do with your high-end color copier market and particularly the ImagePlus 7000. With the understanding that it is still early, are you happy with the progress of that product right now. Are your sales force people trained on that product, are your channel partners lined up correctly and when can we talk about getting an increase in production for that unit? Thank you.

Masahiro Osawa – Managing Director, Group Executive, Finance & Accounting Headquarters

[Foreign Language]. Well, thanks to your support [inaudible]. It has been well received by the market and that indicates we will project on trying to further strengthen our sales network and we continue to carry out training of our salespeople, and so we will be working on establishing and strengthening our sales. Meanwhile, in regards to your question about production, it is true that we do have backorders, and we will make every effort to try to quickly deliver these products to our customers. We will also therefore continue to work on our production network.

Operator

Thank you. Our next question comes Matthew Troy with Citigroup. Please go ahead with your question.

Matthew Troy - Citigroup

Yes, I was wondering if you could talk about inventory levels in the mid range and high-end in the office copy print. Specifically it looks like they went up, the day's inventory went up. Wondering if you kind of worked that off or if there was a larger change in inventory strategy or just typical build through year-end and I have one follow up?

Masahiro Osawa – Managing Director, Group Executive, Finance & Accounting Headquarters

[Foreign Language]. If you look at the inventory level as of the end of September compared to the end of December of last year, yes it is true that it appears to be that there is an increase. However this is to prepare for our sales in the fourth quarter and then therefore it is in-line with our plan and we understand that this is not an increase per say in inventory, but instead within the scheduled range. And also if you were to compare the [inaudible] last year and the revolving inventory you would see that there is two days left and that indicates we think that we're in a better position, stronger position in regards to inventory compared to last year.

Matthew Troy - Citigroup

Second question, given the robust demand and backlog for the image press 7000, I was wondering, if you could share some thoughts what is the potential to expand that product line, I realize it's early but might we look for additional sister products to the 7000 in 2008, given what the significant market opportunity both here in the States and abroad? Thank you.

Masahiro Osawa – Managing Director, Group Executive, Finance & Accounting Headquarters

[Foreign Language]. This is a new business field and we think that this is a new market for us and the [inaudible] and therefore we are looking into this in various ways and including a possibility into the future as we may be expanding the lineup. However, having said that as of now we do not have any specific plans whatsoever.

Matthew Troy - Citigroup

Okay. Thank you very much.

Operator

Thank you. One moment. [Operator Instructions]. Our next question comes from Jay Vleeschhouwer with Merrill Lynch. You may go ahead with your question.

Jay Vleeschhouwer – Merrill Lynch

Thank you. Good morning. My first question concerns the consumer energy market. At least in the US market, it's increasingly apparent from the market data that the home market for photo printing is no longer the majority of consumer photo printing. Various retail venues have grown including online of course. What is Canon 's strategy for growing your exposure to the more rapidly growing addressed markets for consumer photo printing. And additional question regarding the consumer, it is also apparent from the data that digital cameras are growing more quickly than photo printing and you pointed out yourself that your camera business is doing well. Would you explain this phenomenon as being largely a replacement cycle underway, and if so is it something that can be sustained for several years.

Masahiro Osawa – Managing Director, Group Executive, Finance & Accounting Headquarters

[Foreign Language]. In regards to your question about the [inaudible] it's losing weight Tim. I think it is just about the percentage and not the absolute volume because [inaudible] is increasing in volume including Canon, and that indicates and we believe that within the market we will continue to see a gradual increase. And meanwhile in regards to your question about the replacement in digital camera, we believe that we want to emphasize on the good quality and the real feel that you can enjoy and also reduce the costs on single photo, and by doing so we want to expand print, the photo print and that is [inaudible] position.

[Foreign Language]. And also talking about digital cameras I might think that -- in the past it used to be that one family had one digital camera but these days it one digital camera per person. So, I think that we are going to [inaudible] effectively and once that happens I think -- on the one hand of course where you have the compact digital cameras but people will start to seek for better image quality meaning that there will be a stronger demand for digital SLR and the high-end models.

Jay Vleeschhouwer – Merrill Lynch

Okay. And just a couple of questions if I might on the office and commercial side of the Canon imaging business. Starting a year ago in late 2006 you began to introduce number of new products for the office and commercial markets then of course the 7000. In terms of your outlook for those various new products, has there been any change in the buying behavior of customers to lead you to believe that the effective increases in demand would be only temporary, perhaps just a few quarters rather than the usual two to three years of good demand for product cycles that we might have seen several years ago. And then the last question is just to follow up on an earlier question from one of our colleagues on the 7000. Your initial availability of production is about hundred a month if I recall, through the end of this year, when should we see an expansion beyond that initial production rate and by how much?

Masahiro Osawa – Managing Director, Group Executive, Finance & Accounting Headquarters

[Foreign Language]. We liked your question about the new products that have been launched from the end of last year to the beginning of this year. We have been launching these products [inaudible]. And I believe that we are still in the initial stage and having just recently launched these products. And we're going to continue to sell these same products for the time being. This is our basic thinking to begin with. You guys had a question about the 7000 BPN and the production volume. Well, it is very difficult for us to say at this point in time how much will be increased by when, because this is a smaller production. But step-by-step we're working on expanding, increasing our production so as to do away with the backlogs that we have. So, we are working on this and we've expectations towards the future and yet we're still observing what is happening in the market. We will try to get more certain idea as to what the outlook will be for these products. Since [inaudible] we've been enjoying very strong demand and this is the present situation that we are facing.

Jay Vleeschhouwer – Merrill Lynch

Thank you very much.

Operator

Thank you. Our next question comes from [inaudible]. Please go ahead with your question.

Unidentified Analyst

Just wanted to get some sense as to the rate of share repurchase given your cash flow. I think you made some comments about that earlier, but I see there is a real increase in the rate of share repurchase during this past quarter, and I wonder if that might be representative of the rate of share repurchases we might see in the coming years?

Masahiro Osawa - Group Executive, Finance & Accounting Headquarters

[Foreign Language]. In regards to your question as to our buying back our own shares well, we want to look at the situation case by case and carry out whatever needs to be done effectively. And so, this is going to be our policy and at this point in time we cannot say how much and what time we will be buying back instead we want to take a flexible position and judge what needs to be done when.

Unidentified Analyst

Thanks very much.

Operator

Thank You. If you have further questions, please send them to Canon's email address prj-ircall@list.canon.co.jp. Canon will respond as soon as possible. I would now like to turn the call back over to Mr. Osawa for any closing remarks.

Masahiro Osawa - Group Executive, Finance & Accounting Headquarters

[Foreign Language]. I'd like to thank all the participants of this conference call for your attendance and we will work [inaudible] to achieve the various goals that we have explained to you today. There are two more months left for this year and we will carry out corporate wide effort to try to achieve our goals. Once again we thank you very much for your participation and call upon you for your continued interest and support towards Canon Inc. Thank you.

Operator

Thank you. That concludes today's conference call. All lines may disconnect at this time. Thank you for your participation.

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