RehabCare Group, Inc. Q1 2008 Earnings Call Transcript

May. 6.08 | About: Rehabcare Group (RHB)

RehabCare Group, Inc. (NYSE:RHB)

Q1 2008 Earnings Call Transcript

April 30, 2008 10:00 am ET

Executives

Gordon McCoun – IR, Financial Dynamics

John Short – President and CEO

Jay Shreiner – SVP and CFO

Analysts

Derrick Dagnan – Avondale Partners

Rob Hawkins – Stifel Nicolaus

Rob Mains – Morgan Keegan

Operator

Good morning, ladies and gentlemen, and welcome to the first quarter earnings conference call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session. Please note that this conference is being recorded. I will now turn the call over to Mr. Gordon McCoun. Mr. McCoun, you may begin.

Gordon McCoun

Thank you and good morning everyone. Welcome again to the conference call to discuss RehabCare's first quarter 2008 earnings. With us today from management are John Short, Chief Executive Officer of RehabCare Group and other members of the senior management team. Before we begin, I'd like to remind you that this conference call contains forward-looking statements that are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Such statements are based on the company's current expectations and could be effected by numerous factors, risks and uncertainties discussed in the company's filings with the Securities and Exchange Commission, including its most recent annual report on Form 10-K, subsequent quarterly reports on Form 10-Q and current reports on Form 8-K.

Do not rely on forward-looking statements as the company cannot predict or control many of the factors that ultimately may affect the company's ability to achieve the results estimated. The company makes no promise to update any forward-looking statements whether as a result of changes in underlying factors, new information, future events or otherwise.

With these introductory comments out of the way, I'd like to turn the call over to Dr. Short. John, please go ahead.

John Short

Thanks, Gordon. Good morning and thank you for joining us today. I'm John Short, President and CEO of the company. With me are Jay Shreiner, Chief Financial Officer and the rest of my executive management team, all of whom will be available to answer your questions at the conclusion of our remarks.

After dedicating 2007 to integrating the significant Symphony acquisition and improving our profitability, we have turned our attention in 2008 back to growing the business. I'm very pleased to report that based on the results of first quarter, we are achieving that goal. We saw sequential operating revenue growth across each of our divisions, with the Contract Therapy division reporting the most significant top line growth of $4.9 million. Sequentially, consolidated operating revenues increased 6%, fueled in part by the long awaited legislative relief we received in our HRS and Hospital divisions and increased patient volumes in our CT division. However, earnings on a sequential basis were hindered by a combination of higher first quarter incentive accruals and a return to more typical levels of self-insurance accruals.

As expected, our Hospital division continued to experience growing pains, impacted by start up and ramp up losses and infrastructure development investments. We remain firm in our commitment to our strategy and are encouraged by the fact that Central Texas Rehab Hospital, our joint venture in Austin, reached breakeven at the end of this quarter, within only four months of receiving its Medicare provider number.

Let me give you some highlights of the quarter as they pertain to our core operating segments. Contract Therapy reported same-store revenue growth of 7.2% as a result of increased patient volume and enhanced therapist efficiency. Strong same-store revenue growth more than offset the net loss of 26 locations in the first quarter. The division opened 25 new locations and signed contracts for 30 new client locations in the first quarter. We remain confident that we can achieve the net increase in locations as we have projected for 2008. We also continue to believe we can obtain operating earnings margins of 4.5% to 5.5% during 2008.

Our Hospital Rehabilitation Services division had its first sequential top line improvement since the second quarter of 2005, marked by a 3.7% increase in operating revenues and a 4% growth in inpatient rehab facilities (NYSE:IRF) or same-store admissions. With the permanent freeze of 75% rule at 60%, our units managed from an average compliance level of 67.8% in the fourth quarter of 2007 to a 62.7% level in the first quarter. Strong development activity coupled with improved client retention led to stabilization in the number of managed inpatient rehabilitation facilities and outpatient units at 107 and 33, respectively. We lost one subacute contract.

In the first quarter, we signed five new IRF clients and opened four new units, which is the largest number of new openings for a quarter in our inpatient segment since 2005. We expect to achieve net additions in IRFs and to deliver operating earnings of 12% to 15% in 2008. In our Hospital division, we saw a healthy sequential operating revenue growth of 13.8% and same-store revenue growth of 9.3%. The division had operating earnings loss of $300,000 in the first quarter. As we had anticipated, operating earnings were unfavorably affected by $300,000 in ramp-up losses at Central Texas Rehabilitation Hospital and an additional $300,000 in start-up losses in conjunction with several other joint venture hospitals.

Earnings also were and continue to be impacted in the short term by investments we're making in resources to support a division that is expected to nearly double its current size, reaching a total of 17 hospitals by the end of 2009. The division managed its rehab hospitals to an average 75% rule compliance level of 59.7% at the end of the quarter. Our five hospitals in operation for less than one year are expected to generate a net EBITDA drag of $4.5 million to $5.5 million during 2008. The impact of this drag on earnings per share will be partially offset by the respective minority partner share of these costs. The eight hospitals that have been in operation for more than one year are expected to achieve 13% to 15% EBITDA margins before corporate overhead in 2008. During the first quarter, we operated at the low end of this range.

Turning to our joint venture development projects, in mid-April, we opened Northland LTAC Hospital, a 35-bed long-term acute care hospital in north Kansas City, Missouri that we developed in partnership with North Kansas City and Liberty Hospitals. The hospital must go through a six-month demonstration period following the receipt of its Medicare provider number, which we anticipate in May, before we will operate the hospital at full-patient capacity. Our joint venture with Floyd Healthcare Resources that we announced in early March, which involves our majority ownership and operation of the specialty hospital and existing 24-bed LTACH in Rome, Georgia is currently expected to receive state Attorney General approval in May with closing scheduled for June.

Our joint venture with Landmark Health Systems, Inc. to purchase a majority interest in and operate the rehabilitation hospital of Rhode Island also is awaiting approval by the state's Attorney General as well the state's Department of Health. If approved, we expect to begin operation in the 41-bed facility during the third quarter of 2008. We also plan to develop a long-term acute care hospital with Landmark, which could open in 2009.

Construction continues on St. Luke's Rehabilitation Hospital in St. Louis, Missouri – our joint venture with St. Luke's Hospital. We are projecting this 35-bed hospital to open in late 2008. Our planned development of an LTACH with our existing rehabilitation hospital partner in Kokomo, Indiana should open in the first quarter of 2009.

In the second quarter of 2009, we expect to open Greater Peoria Specialty Hospital, a 50-bed LTACH we are building in Peoria, Illinois with Memphis Medical Center. Construction has also started on a 60-bed LTACH in Redding, Pennsylvania which we will own and operate in conjunction with our long-term client, the Redding Hospital and Medical Center. We expect to begin operation of the LTACH in the third quarter of 2009.

We believe that the joint venture model provides us greater access to patient volumes which is key to generating stronger revenue and so we continue to evaluate a robust pipeline of joint venture opportunities.

Legislatively, our efforts are concentrated on encouraging Congress to pass a Medicare package by June 30, 2008; failure to react will result in a 10.6% reduction in the Medicare physician fee schedule and elimination of the Part B Therapy Cap auto-exception process.

The Audit Recovery Contract program or RAC has resumed with the demonstration period ending, and the first phase of the 50-state rollout soon to be underway. While CMS has made improvements to the process, we will continue to challenge and appeal all claims that we believe have been inappropriately denied. Full expansion of the program is expected to be completed by January 2010.

Also on April 21, CMS released their 2009 proposed rule for IRFs. While we are continuing to analyze the rule, our initial findings reveal no significant impact for either the HRS or hospital divisions. The final rule is due out sometime in August of this year.

I will now turn the call over to Jay Shreiner who will review our financial results for the quarter.

Jay Shreiner

Thank you, John. Consolidated net revenues for the first quarter of 2008 were $184.1 million compared to $173.6 million in the fourth quarter of 2007, a $10.5 million or 6% increase. Consolidated net earnings were $4.5 million or $0.25 per diluted share in the first quarter of 2008 compared to $5.1 million or $0.29 per share on a fully diluted basis in the previous quarter.

Earnings in the first quarter were impacted by an 11.9% increase in selling, general and administrative expenses, primarily attributed to higher incentive accruals in the first quarter as well as investments in infrastructure to support our growing hospital division. The fourth quarter benefited from a $1.4 million or $0.05 per fully diluted share after tax reduction and net self-insurance accruals.

Net revenues for the Contract Therapy division were $104.3 million, an increase from the fourth quarter of $4.9 million or 4.9%. This increase was driven by a 7.5% increase in revenue per location, and same-store revenue growth of 7.2%, which offset a 2.4% reduction in the average number of locations operated during the quarter.

The division's operating earnings were $3.8 million in the first quarter of 2008 compared to $4 million in the fourth quarter of 2007. This decline was chiefly due to incurring more typical levels of net self insurance accruals compared to the prior quarter and increased corporate SG&A allocations primarily from higher incentive accruals in the first quarter. Excluding favorable self-insurance accrual adjustments in the previous quarter, operating earnings margin improved sequentially from 3.6% to 3.7%.

During the first quarter, 51 programs closed and 25 opened. For the first time in three years, the HRS division achieved sequential operating revenue growth. First quarter HRS revenues were $40.2 million, an increase of $1.4 million or 3.7% on a sequential basis.

Inpatient revenue – inpatient operating revenues improved 3% and IRF same-store admissions increased 4%, a result of increased patient volumes following the 75% rule freeze. Outpatient operating revenues grew 5.6% sequentially due to an increase in same-store revenues of 2.7% and a 2.1% increase in the average number of units operated.

Operating earnings for the division were $4.6 million, a decline of $1.4 million from the $6 million in operating earnings in the fourth quarter due to higher incentive accruals made in the first quarter and the prior quarter's self insurance accrual adjustments. The division ended the quarter with 153 programs, down 1 from the first quarter – excuse me, down 1 from the end of the fourth quarter as a result of four openings and five closures.

IRFs at quarter end were flat at 107. Outpatient units were flat at 33 and subacute units were down 1 at 13. At March 31, 2008, the pipeline of signed but unopened IRF contracts stood at five.

The hospital division reported operating revenues of $29.2 million, a sequential increase of 13.8%. The division incurred an operating loss of $300,000 in the first quarter of 2008 compared to an operating loss of $800,000 in the previous quarter. This improvement resulted from same-store revenue growth of 9.3% and lower start-up losses in the first quarter of 2008.

The division continues to invest in infrastructure to support our growing portfolio of hospitals which is projected to total 13 by year-end 2008 and 17 by the end of 2009. During the first quarter, we generated cash from operations of $4.1 million. We spent $3.2 million for capital expenditures, including $2.6 million in our hospital division, primarily in developing joint ventures. The remaining $600,000 of capital expenditures was principally related to information systems. Days sales outstanding and accounts receivable improved to 69.4 at March 31 from 71.8 at December 31, 2007.

At March 31, we had approximately $15.2 million in cash and cash equivalents, compared to $10.3 million at December 31, 2007. Total debt outstanding at March 31, 2008 was $75.7 million compared to $74.5 million at December 31, 2007.

During 2008, we expect capital expenditures of approximately $32 million, of which $25 million relates to hospitals strategic and maintenance capital and the remaining $7 million relates principally to information systems investments. We are expecting to receive approximately $5 million from our minority joint venture partners to fund their respective shares of each hospital's capital expenditures and working capital requirements.

Now, I'll turn the call back over to John.

John Short

Thanks, Jay. Much of our focus in 2008 is on returning to growth in our CT and HRS divisions. The first quarter is a sign that we are headed in the right direction with strong same-store revenue growth and a healthy pipeline of new business in both divisions. We are also concentrating efforts in converting our revenue growth to profitability and we're confident we'll see improved operating margins in Contract Therapy and HRS. Nearly doubling the size of our hospital divisions in two years is no small task and will require us to make the necessary investments to support our future success, while recognizing the impact these investments will have on the division's bottom line.

Overall, we expect strong growth and consolidated net earnings for the full year. However, quarterly consolidated operating earnings are expected to be uneven with all quarters impacted by hospital startup and ramp-up losses.

In closing, let me thank our stakeholders for their continued support and extend my sincere appreciation to all of our colleagues for their daily commitment to the success of RehabCare into our mission of helping people regain their lives.

With that operator, I would like to open the call for questions.

Question-and-Answer Session

Operator

(Operator instructions) The first question comes from Derrick Dagnan from Avondale Partners. Please go ahead.

Derrick Dagnan – Avondale Partners

Good morning and congratulations on a strong quarter. I want to ask a quick question on the Contract Therapy business. If you could discuss the contract losses that you had in the quarter and maybe any timing impact there, did you lose those contracts mainly at the end of quarter or was it spread evenly over the course of the first quarter?

John Short

It was spread pretty evenly over the course of the quarter.

Derrick Dagnan – Avondale Partners

Okay. And if you look at the same-store growth figure that you have discussed as 7% or so, is that split between kind of patient volumes and pricing growth, or can you give us a breakdown there?

John Short

It was virtually all patient volume.

Derrick Dagnan – Avondale Partners

Okay. And was there anything temporary in the patient volume, was there any event in the quarter that would cause the patient volumes growth to be temporary? I know we have a strong flu season in the hospital business, I don't necessarily think that has a big impact on you, but I was wondering if there was anything else that you guys are pointing to?

John Short

No. The strong same-store growth was a result primarily of increased therapist efficiency which permitted us to treat more patients.

Derrick Dagnan – Avondale Partners

Okay. And I guess one other question and I'll jump back in the queue. On the RAC program as that starts ramping up again, do you feel like you are better prepared this time around? Do you have kind of new procedures in place that should help you out when you deal with claim denials and when you go back to challenge those claims?

John Short

Yes, we've learned a lot over the demonstration period about how to efficiently and effectively deal with the RAC audit issues, so we've automated a lot of that process. We've set up firm criteria in terms of which claims we'll appeal and which claims won't be appealed. We've had a very high success rate over the last 18 months to two years while we've been doing that. So we're fully prepared for the national rollout over the next two and a half years.

Derrick Dagnan – Avondale Partners

Okay. Thank you very much. I'll hop back in the queue.

John Short

Thanks, Derrick.

Operator

Our next question comes from Rob Hawkins from Stifel Nicolaus. Please go ahead.

Rob Hawkins – Stifel Nicolaus

Hey, great quarter, guys. I've got a question first off on the insurance accrual, that's something that kind of gets done during the first quarter, is that correct? Or are we going to see a steady accrual and that the overhead numbers are going to stabilize at this level?

Jay Shreiner

We anticipate that the accrual will be consistent through the four quarters. We also anticipated that though a year ago, and as we got additional information, actuarial updates, we were pleased to report that the performance improved and our claim performance improved, our settlement of those claims improved, and therefore, we were able to take lower costs in the third and fourth quarter. But as it stands today, we anticipate an even accrual in all four quarters.

Rob Hawkins – Stifel Nicolaus

Okay. And in the past, you're bringing in kind of tail-history of other stuff, and they let you bring those accruals down. Is that the way I understand it?

Jay Shreiner

Based upon the performance of older accruals.

Rob Hawkins – Stifel Nicolaus

Right, okay. But there wasn't anything surprising about what they're asking you. We've seen liability claims go down through the cycle. There seems to be a market change there. But is something kind of causing these to jump at all because of, now that you are moving more toward hospitals, or anything like that?

Jay Shreiner

No, we have not seen that.

Rob Hawkins – Stifel Nicolaus

Okay. In the HRS business, you guys were going kind of quickly through this, I think you covered it, but if you don't mind going back through this. You had pretty nice volume growth of 4%, but the margins were down in that business. Now, you said some of that is related to the accrual, but I couldn't understand what the rest of it was because usually you guys have been able to maintain the volumes in that business even – or the margins in that business – even when volumes have been a little softer.

Jay Shreiner

Rob, what I think is the better comparison for this division is against first quarter of '07 because we generally see our first quarter as having lower margins. When you do that you will see a much more comparable result. The fourth quarter does benefit from, as we talked, both the lower self-insurance reserve as well as it generally benefits from lower PDO benefits or higher PDO benefits. So, going from the fourth quarter to the first quarter isn't as much of apples to apples as looking at first quarter to first quarter.

Rob Hawkins – Stifel Nicolaus

Maybe your numbers were restated, but I've got kind of like for last year from a contribution margin standpoint, on the $12 million for what you did last year's first quarter, and you're at $11 million now on that. So I was looking kind of at the first quarter, but could I be looking at that wrong or could the numbers have been restated?

Jay Shreiner

I was looking at it from an EBIT perspective or a margin perspective.

Rob Hawkins – Stifel Nicolaus

Okay. So the overhead is – they're shifting overhead. Is that kind of what's happening there a little bit?

Jay Shreiner

There is a revenue decline from first quarter of last year.

Rob Hawkins – Stifel Nicolaus

True.

Jay Shreiner

But looking at it from –

Rob Hawkins – Stifel Nicolaus

Straight percentage. Okay. Yes.

Jay Shreiner

Margin perspective, it's better to look at year-over-year comparisons.

Rob Hawkins – Stifel Nicolaus

Okay.

Jay Shreiner

For this division.

Rob Hawkins – Stifel Nicolaus

Okay. But there's not a productivity fall off, a change in patient mix. Was the flu impacting this or your LTACHs at all, respiratory, either pulmonary rehab or kind of the respiratory side of the LTACH business, does that explain some of it?

John Short

No. We have very little impact from flu in our HRS division.

Rob Hawkins – Stifel Nicolaus

And any mix changes you guys are seeing in the HRS division or in the rehab hospitals now that you're kind of at the 60% freeze in terms of maybe what you are going after a little more or what the hospitals want to release a little more or want help with a little more on the rehab side, any changes there?

John Short

Clearly, we get to say yes to non-qualifying patients more frequently. But, that's the only real change in both our freestanding IRFs as well as our managed IRFs benefited from that freeze at 60% in the first quarter.

Rob Hawkins – Stifel Nicolaus

Okay. No major changes or strategies I guess other than what you – but the basket's a little bit bigger, I guess.

John Short

That's correct. The market grew by 5 percentage points.

Rob Hawkins – Stifel Nicolaus

Great, thanks. I'll jump back in the queue. Thank you.

John Short

You bet. Thanks.

Operator

Our next question comes from Rob Mains from Morgan Keegan. Please go ahead.

Rob Mains – Morgan Keegan

Good morning, guys. I want to make sure the insurance accruals, (inaudible) correct or add back the third and fourth quarter benefits that you had, the accruals are still at the same rate as they were ex the benefits, is that correct?

Jay Shreiner

Our accruals in the first quarter are similar to what they were in the first and second quarter of last year.

John Short

About the third and fourth quarter.

Jay Shreiner

Well, the third quarter received a benefit of 1 point.

John Short

But I think they are asking you if you take that, are they the same?

Jay Shreiner

Yes.

Rob Mains – Morgan Keegan

Yes, okay. Then could you explain the incentive accruals a little bit since they obviously had an impact on margin, kind of where they come in and whether we're going to see that throughout the year?

Jay Shreiner

Yes. The incentive accruals you see in the first quarter, again, are – we would expect to see those being consistent in the rest of quarters for 2008. We booked to our target for the first quarter. And so they are higher when you compare those to what we booked in the fourth quarter. But if you are looking across the year, we would expect at this point to see consistent accruals.

Rob Mains – Morgan Keegan

You would expect – so the types of levels we saw in Q1 would be, that's kind of what we can take to the bank for rest of the year, assuming business doesn't decline?

Jay Shreiner

Yes.

Rob Mains – Morgan Keegan

Okay. Just kind of a big picture question on the RAC system, obviously the industry has had some issues with it. Do you think, is the issue more – as this rolls out, is it more of a structural problem or is it specific contractors in your opinion?

John Short

I think it's structural. When they announce who the 20 RAC contractors are for the nation, they're going to, they're going to provide those contractors with in effect the same contract that they have to follow, with the same rules and procedures that they have to follow. Some of the abuses that we saw, especially in California, where the one contractor went back five or more years, that's been dealt with. And they're e-mailing us kind of form rejection letters without the benefit of any medical oversight. That's been dealt with. So, we're going to see many fewer, I believe, denials and the denials we see have a much greater foundation clinically. So, that should slow down the volume and of course, we now have had two years of practice with this, so we're getting real good in terms of figuring out where are the RAC auditors correct, where are they incorrect, and what is the most cost effective way of us to respond to each of those denials.

Rob Mains – Morgan Keegan

Are they going to continue to be paid based on the amounts that they ding [ph] you for, or is it going to be based on actual recoveries?

John Short

The consensus here is they're only get paid for what they actually overturn and recoup from us.

Rob Mains – Morgan Keegan

Okay. All right. So it sounds like it might not be as bad as the California experience.

John Short

It should be much better than the California experience.

Rob Mains – Morgan Keegan

Okay. Jay, the HRS added four, loss of five, could you break those down into where they were?

Jay Shreiner

Yes. So we had, in IRFs, there were four additions and four that we lost. So it was breakeven. Of the four that we lost, two of them closed and the other two were self op. And then the fifth one was a subacute unit and that one went in-house.

Rob Mains – Morgan Keegan

As we kind of look forward now that on a 60% world,– take a step back, I think one of the things you talked about possibly happening when we were going to 75% is more operators would be – more hospitals would be looking to outsource to you because of your expertise. Going forward, would you expect that new units would be mostly Greenfield new units as opposed to takeovers and by the same token, does the fact we've got the freeze increase the likelihood of self op?

John Short

Well, our current pipeline, which is much stronger than we've seen in two years, has a pretty even split between takeovers and Greenfield opportunities. So we're not seeing a significant bias one way or another. On the other hand, this is all new world for us. So, it's going to take several quarters before we actually discern a pattern.

Rob Mains – Morgan Keegan

Okay. And during the quarter, you had pretty nice sequential increase in your revenues per average location in Contract Therapy and ARUs. You said the ARU is mostly census driven. What was behind the increase in Contract Therapy, is that the same general drivers of revenues that you mentioned?

John Short

Yes, it was virtually all census driven.

Rob Mains – Morgan Keegan

Okay. So given that there's not– absent any kind of seasonal effects, those are types of levels that you think you would be able to maintain throughout the year or improve upon?

John Short

That's what we believe currently.

Rob Mains – Morgan Keegan

Okay. And then, on the income statement, could you explain the drop sequentially in D&A?

Jay Shreiner

Yes, so the reduction was about $600,000, and it relates principally to IT type of assets, quite a bit of it related to assets that we have set up with the acquisition of Symphony that became fully depreciated at the end of last year when we completely shut down their IT system in the fourth quarter. So all of it relates to IT, but principally the larger portion is Symphony related.

Rob Mains – Morgan Keegan

Okay, so that's a new base level we can work from going forward?

Jay Shreiner

Going forward, keep in mind that we're going to have a couple of new hospitals coming on, so from this base level there'll be some incremental depreciation in subsequent quarters.

Rob Mains – Morgan Keegan

Okay. Similarly, interest expense down because of lower LIBOR rates?

Jay Shreiner

Well, two things, one is lower debt levels in the first quarter versus the average for the fourth quarter and then second was lower interest rates.

Rob Mains – Morgan Keegan

Okay. And then second last one, tax rate in the quarter was over 40%, what should we be using going forward?

Gordon McCoun

Yes, Rob, I saw that in your notes. The tax rate, the 39% if you look, we've moved the placement of minority interests and equity income. So, the 39% we've been quoting should be based on all income sources, net of those minority interests and equity income.

Rob Mains – Morgan Keegan

Got you.

Gordon McCoun

And the reason we did that is all those entities are passed through partnerships.

Rob Mains – Morgan Keegan

Right.

Gordon McCoun

So we're only paying tax on our share of that income or only getting the benefit of our share of those losses.

Rob Mains – Morgan Keegan

Okay. All right then. That's helpful. The last question, April, beginning of the month, we got the cut to inpatient rehab. Obviously, that affects the HRS and the freestanding hospitals division. Is there any kind of ripple effect that we should expect in HRS? Because I know you don't get paid on the CMG, but just kind of what we should be looking for any margin pressure or revenue pressure there.

John Short

I don't believe so at this time. We haven't seen it.

Rob Mains – Morgan Keegan

Okay.

John Short

At this point.

Rob Mains – Morgan Keegan

Great. All right. That's all I had. Thank you.

John Short

Thanks.

Operator

(Operator instructions) At this time, gentlemen, there are no further questions.

Gordon McCoun

Okay then, as a reminder, this conference call is being webcast live on the web site, www.rehabcare.com and will be available for replay beginning at 1:00 pm Eastern Time today. Thanks for joining us and have a good day.

Operator

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. You may disconnect.

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