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The Jean Coutu Group (NYSE:PJC), Inc. (PJC.A)

F1Q09 Earnings Call

July 8, 2008 8:30 am ET

Executives

Michael Murray – Director, Investor Relations

François Coutu - President and Chief Executive Officer

André Belzile - Senior VP Finance and Corporate Affairs

Hélène Bisson - Director of Public Relations

Analysts

Ryan Balgopal – Scotia Capital

Winston Lee – Credit Suisse

Jim Durran – National Bank Financial

Perry Caicco – CIBC World Markets

Irene Nattel – RBC Capital Markets

Operator

(Operator Instructions) Good morning ladies and gentlemen. Welcome to The Jean Coutu Group 2009 First Quarter Results Conference Call. I would now like to turn the meeting over to Mr. Michael Murray.

Michael Murray

Welcome to the Jean Coutu Group First Quarter Fiscal 2009 Conference Call. The Q1 earnings release was put on the wire earlier this morning at 7:00 am ET and then posted on the Jean Coutu Group Corporate website. The quarterly press release is accompanied by additional financial information and we will refer to the quarterly results slide presentation during this call.

The press release and MD&A are being made available on CDAR. Later this morning at 9:30 am ET the company’s annual general meeting of shareholders will be held. You are invited to listen to the webcast available in English and French through our website at www.JeanCoutu.com. Here with me are François Coutu, President and Chief Executive Officer, André Belzile, Senior VP Finance and Corporate Affairs and Hélène Bisson, Director of Public Relations.

Mr. François Coutu will discuss the company’s key operating highlights, Canadian results of operations as well as the Rite Aid investment. André Belzile will then discuss financial details. This will be followed by a question and answer period for analysts only. I would ask you to limit yourself to only one question and any related follow up at a time so as to allow us time to address as many different analysts’ questions as possible. Media are invited to contact Madam Bisson for comment or interview purposes.

We would like to remind listeners that the company’s forward looking statement disclaimer applies to all of our communications. Now François Coutu will begin our presentation.

François Coutu

We’ll go straight to the first quarter fiscal 2009 results. Please note that this quarter’s comparable period is the fourth quarter of fiscal 2007 due to the change in fiscal year end last year. Canadian network sales increased by 5.1% to $828.1 million while distribution center sales were up by 4.9% to $516.7 million on a comparable period basis.

As shown on the first table distribution center pharmacy sales growth at 6.8% was slightly less than network growth of 7.3%. This is due to our pharmacists owners reducing inventories of generic drugs that they bought in advance of changes to the Quebec prescription drug plan earlier this year. Actually distribution center purchasing passers were back to normal in May and June.

Distribution center front-end sales growth at 1.7% was higher than what network growth of 1.4% due to the introduction of new products and increased sales distribution since the start up of our Ontario warehouse. Other revenues increased by 3.4% this quarter resulting in a 4.7% increase in overall franchising revenues.

On slide four you see that first quarter revenues amounted to $574.3 million compared with $3.3 billion in the fourth quarter of 2007. The difference is due to the sales of US operations to Rite Aid at the end of fiscal 2007. Franchising operating income before amortization decreased slightly this quarter for various reasons that André Belzile will explain in more detail later in the presentation.

First quarter 2009 earnings include the share of Rite Aid’s loss which amounted to $53.4 million or $0.21 per PJC share after tax. Earnings before specific items and the share of Rite Aid’s loss increased to $33.2 million or $0.13 per share during the first quarter compared with $25.1 million or $0.10 per share for the comparable fiscal quarter.

The following slide is a graphic summary of quarterly same store sales growth for the PJC network. Network pharmacy same store sales increased 6.6% during the first quarter of 2009 over the comparable quarter while front-end same store sales grew 0.3% year over year. Even though script count growth was robust and increased to over 8% in the first quarter pharmacy sales growth was lower due to generic drug price deflation. Changes in the Quebec prescription drug plan are the principle reason and this will impact our pharmacy sales growth figures over the coming year.

Despite the mild, cough and cold and allergy season OTC sales were positive this quarter but growth decreased by 120 basis points year over year. Sales growth was also effected by inclement weather in our region and a price competitive environment as retailers strive to recover lost winter sales. Sales growth was negative in our photo category which represents about 4% of front-end sales.

The good news is that our other retailers have been heavily discounting these services in an effort to generate traffic and sales but we have responded and maintained our leading market share among all retailers in our market. Overall, network same store sales increased 4.2% during the past quarter. I am pleased to report that in May 2008 the JeanCoutu.com consumer website was ranked among the top 25 D2C websites in our market in a [Secor] survey. In fact, we were the only drug store chain in the select top 25 group.

We are undertaking phase two of our consumer website update and among other features PJC customers will soon be able to order their back to school supplies over the web. We are striving to redefine the convenient drug store retailer through our unique website offers. Our goal is to remain competitive and we continue to adjust our merchandising strategy and offer an evolving retail market to consumers that are most focused on value.

The spring edition of quarterly Guide Passion Beauté was well received with over 2.7 million copies distributed in our market. We hold several customer contests each quarter but our Great Spring Cleaning Contest was the most successful. Store traffic increased and sales of our featured household products were up almost 6% during the contest period. This increase was in the face of heavy discounting by other retailers in our market.

Private label products are a very important component of our value focused merchandising strategy. During the first quarter we launched over 20 private label products at PJC Jean Coutu and sales of these products now represent 9.5% of total front-end sales as compared to 9% six months ago. Pharmacy Jean Coutu is all about health and wellness and family activity sponsorship are an integral part of our brand strategy as you can see on slide eight.

On the next slide, the real estate aspect of our business we added a total of five new drugstores completed three relocations and eight other store renovation and expansion projects during the quarter. On this slide is a photo of a relocated PJC drugstore in northern Quebec. Selling are of this particular store has increased by over 50% and local market response has been excellent. In addition we acquired six independent pharmacies and seven properties. There are another 25 renovation and expansion projects underway.

During the first quarter of 2009 we grew network selling square footage by close to 2% and almost 4% year over year and are well on our way to our target of 9% square footage growth for this year. Slides 10, 11 and 12 give you a glimpse of the very successful store opening sales for our new PJC drugstores and relocations. We also offer store reopening sales when expansion and renovation projects are completed. These events are very popular in our local markets and help to build a stronger drugstore network. As you can see our real estate pipeline is full.

As discussed earlier we consolidated all of our health services under the new PJC Well-Being Services brand. The easy to use brochure describes our entire service offer including the PJC health record and convenient prescription transfer and renewal options to new and existing customers. On this slide you see examples of the in store branding for our Well-Being Services that was rolled out across the network this quarter.

Turning to our Rite Aid investment, we see on the next slide that Rite Aid reported a net loss for the quarter and at May 31, 2008 of $166.6 million US or $0.20 per share compared with net income of $27.6 million or $0.04 per share for the same period last year. During the quarter Rite Aid increased pharmacy sales and improved front-end sales in core Rite Aid stores. Sales strength continues to improve in the acquired Brooks Eckerd stores.

Rite Aid has made considerable progress on the integration of the acquired drugstore network and they expect, that’s a very important issue here, to complete the integration by fall of 2008. Finally Rite Aid reaffirmed its fiscal 2009 guidance for sales EBITDA when they released first quarter results on June 26.

Now let’s move the financial review by our CFO André Belzile.

André Belzile

The table show on slide 16 reconciles operating income before amortization the equivalent of EBITDA to net earnings which is the closest GAAP measures. The company’s first quarter share of loss of Rite Aid amounted to $53.4 million or $0.21 after tax for Jean Coutu Group share. Financing expenses decreased substantially during the first quarter of fiscal 2009 due to the repayment of almost all of our debt at the end of fiscal 2007.

There were two specific items recorded during the fourth quarter of fiscal 2007 related to the closing of the Rite Aid transaction. Income taxes amounted to $14.7 million during the first quarter of fiscal 2009 compared to $10.5 million for the comparable period. Earnings from Canadian operations are subject to a 31% tax rate and there were no material items affecting the effective tax rate this quarter. As discussed during the last conference call we did not record the tax benefit on our share of Rite Aid’s loss during the quarter.

Amortization charges amounted to $5.2 million during the first quarter of fiscal 2009 compared to $4.9 million for the comparable period. First quarter fiscal 2009 OIBA amounted to $54.4 million compared to $119 million for the fourth quarter of fiscal 2007. When OIBA for US operations sold to Rite Aid amounted to $63.4 million. First quarter OIBA as a percentage of revenues for Canadian operations were 9.5% compared to 10.2% for the comparable period.

The following factors negatively impacted the OIBA margin; as we grow pharmacy sales faster than front-end sales our sales mix is queued toward the lower margin pharmacy sales affecting overall margins. Also the reduction of generic drug prices at the end of last quarter impacted first quarter pharmacy sales growth by about 200 basis points.

Based on our annual budget also we increased marketing spending for TV, Radio and other advertising during the quarter. This is only a timing effect obviously since the overall expense for advertising should be comparable year over year on an annual basis. The year over year increase in the wholesaler margins both prescription drug distribution from 5% to 6% did not fully offset these negative factors during the first quarter as we thought would be when the wholesale margin was at 7% earlier last year.

Going forward we expect products to contribute to PJC margins and results as it continues to expand its product offering and grow its sales. Our top priority is to contain our expense growth as we grow sales and revenues.

The next slide shows the impact of specific items on net loss and loss per share for the first quarter of fiscal 2009 compared with the fourth quarter of fiscal 2007. During the current fiscal quarter there were not specific items. As discussed there were several specific items recorded during the fourth quarter of fiscal 2007 principally related to the closing of the Rite Aid traction. As François mentioned excluding the Rite Aid loss earnings before specific items amounted to $0.13 per share in the first quarter fiscal 2009 an increase of $0.03 compared to the fourth quarter fiscal 2007.

You can see a summary of our balance sheet on the following slide and you will note that long term debt including current portion amounted to $219.5 million at the end of fiscal quarter principally due to the repurchase of Class A subordinate voting shares during fiscal 2008. The company’s debt ratios are conservative and it is our intention to maintain and LC financial position going forward. Shareholders equity amounted to $1.5 billion at the end of the fiscal quarter.

Today the company announced its intention to purchase or cancellation up to $12.3 million of Class A subordinate voting shares over 12 month period ending in July 2009. The company has determined that this purchase will allow us to optimize its capital structure and create long term value for shareholders. On May 31, 2008 the company held $35.6 of Canadian third party asset based commercial paper and we have nothing new to report today.

As for our cash flow, cash provided by financing activities before net changes in non-cash operating asset and liability items amounted to $40.5 million during the first quarter fiscal 2009. The increase of $52.2 million in non-cash operating assets and liability items is principally due to the payment of income taxes. The company used $26.1 million of cash in investing activities during the first quarter, $14.3 million was used principally for the construction and acquisition of store related capital assets and $10.8 million was used for the funding of the acquisition of six independent pharmacies by franchisees.

That concludes our presentation on the first quarter fiscal 2009 results. I would now ask the operator to open the question period.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Ryan Balgopal – Scotia Capital.

Ryan Balgopal – Scotia Capital

I was wondering if you could just talk about your new store program. I would have thought that your total retail sales growth would have been higher relative to same store sales growth given the 4% increase in square footage. I wonder if you could just comment on how those stores are going in the market.

François Coutu

They are going well. Mind you that most of the relocations and new stores will be in the coming months as we are an extremely busy fall and they’ll start contributing a few months after they’ve actually been open. The real effects of these relos and renos will certainly take place at the end of this year. That’s what I am looking forward to obviously, sales growth in the later part of this year.

Ryan Balgopal – Scotia Capital

The 4% increase in square footage versus less than a 1% difference between total sales and same store sales suggest that the stores that you have put in the last 12 months are struggling to grow. Did you find any to step up your pace of acquisitions or is that why you need to be more promotional.

François Coutu

No, I think these stores are doing very well. It happened that at times either a competitor or a mass merchandiser came along and obviously reduced the progression of extraordinary progression of these stores but overall we are very satisfied with what they contribute and I believe that it’s a decision that we made, extremely important decision because if we hadn’t done that I think the ones that are the older stores, the ones that not been renovated would probably struggle a lot more. That’s why I’m saying the program is accelerating and with good results, believe me.

Ryan Balgopal – Scotia Capital

On the SG&A you indicated that advertising spending was up substantially and you expect it to be flat on an annual basis. Can you quantify how much it was up in the quarter from last year.

André Belzile

Last year we decided not to make TV advertising for the comparable period. This year actually we did so. This alone is about $1 million and again it’s only a question of timing of the expense. On an annual basis it should be comparable by year end.

Ryan Balgopal – Scotia Capital

My last question is just on Rite Aid; do you have any intentions or plans if they need additional capital to participate in a capital infusion?

André Belzile

If you remember last time we had that question the answer was that we thought that it was a long term strategic investment for us but we thought that we had enough invested at this point in time.

François Coutu

Their financing, their program of renovations and consolidation of the new Brooks Eckerd should be done by this early fall so we’ll see.

Ryan Balgopal – Scotia Capital

You alluded to an optimal capital structure what do you think that is?

André Belzile

Our goal is to keep an LC balance sheet something that would be investment grade by the rating agencies. In our mind that would mean for us to keep the investments below the two times beneficial. We’re far from that level at this point in time and we will as we announce probably over the next few months, the next 12 months buy another 12 million shares roughly speaking. We will also make sure to leave enough liquidity available and cash flow for the growth of the company which is a very important part of our strategy plan going forward.

Operator

Your next question comes from Winston Lee – Credit Suisse.

Winston Lee – Credit Suisse

I just wanted to extend the question about the Rite Aid capital infusion. You said it was a long term strategic decision. At this time you don’t see anything like that but does that preclude the possibility of any type of capital infusion going forward or any sort of financial support in the way of guarantees at Rite Aid should they need it.

André Belzile

Rite Aid completed an offering of convertible debt in which we did not participate as you may have known. They also priced last week additional financing so they have plenty of liquidity available to complete their programs and there’s not going to be additional need. Having said that again it’s a long term strategic investment but we cannot speculate on what would happen 10 years from now. At this point in time we have no intention to inject any additional capital or to provide any additional support in terms of guarantees to the company.

Winston Lee – Credit Suisse

Long term in your mind is 10 years?

André Belzile

We’ll see. What I mean is at this point in time we have no intention to inject more capital and our holding we’ll see. There’s nothing that is definite in life but at this point in time for us it’s a hold, a long term investment but in the future we’ll see.

Winston Lee – Credit Suisse

If I could ask a quick question on your acquisition of Independence, I think you had $10.8 million of financing there or incentives to the franchisees which spiked up from prior quarters and I wondered are you seeing a difference in market conditions that allows for that an acceleration of it. Was it just opportunistic based on prior discussions and it just happened to come into fruition this quarter and going forward?

François Coutu

No, I would say it’s opportunistic. You know the formula, it’s all pharmacies owned by pharmacists and at times pharmacists they come to the decision that they are selling their pharmacy so we want to be active especially in the areas we want to be and at times we get them, at times we don’t. Some banners are matching the offers. That’s something that we want to be still active in the future.

André Belzile

These incentives, so you understand, are contributions to the price of acquisition of a pharmacy inspired franchisee. It’s not a financing we do support that portion and for us actually it’s the best investment we can do because then we find where that franchisee a long term franchising contract which will generate cash flows through royalties and sales forever almost. That’s a really good investment for us and we were very active in the quarter as you mentioned.

Winston Lee – Credit Suisse

How many was that?

André Belzile

Six independent pharmacies.

François Coutu

These investments for the Jean Coutu are in the commercial, the professional is bought by the pharmacy.

Operator

Your next question comes from Jim Durran – National Bank Financial.

Jim Durran – National Bank Financial

On your gross margin, was your front-end gross margin down materially in the quarter or was the total gross margin just a function of mix?

André Belzile

The publicity issues we was effecting G&A for TV advertising but there was also co-op revenues and a bunch of things that are disclosed many different places in the P&L as for GAAP. There’s a portion in the other revenues but there’s a portion also in the gross margin of that. Overall, maybe François can comment, we saw some kind of deflation in the front-end part of the business because of the market environment and also the manufacturers adjusting their prices since the Canadian dollar trend so much as you know.

Jim Durran – National Bank Financial

Was that attributable to price promoting and then separately I understand help beauty aid products, there’s been some manufacture price deflation in that area. Have you now gotten what you think is fair share of that price deflation in terms of manufacture support?

François Coutu

It’s something that we’ll have to experience for this coming year. Prescription wise it was the generic situation, deflation of 16% to 20%. Health and beauty, a lot of price reduction there because the American dollar not being as strong as it used to be compared to the Canadian currency meaning that there’s drop of pricing as a result.

We’re not the utmost retailer; we don’t make the profits at the end. We’re selling items to our franchisees so any drop in the prices of deflation is very rare that you see an industry all of a sudden having a drop in their pricing because of external issues. Government in one case, currency on the other end and that’s why it puts a lot of pressure in maintaining that margin on it.

Jim Durran – National Bank Financial

Were you disappointed with the response you got on your front-end portion of your business with respect to how much you spent to get it?

François Coutu

Mind you I hate to give excuses but that quarter, I don’t know if you’ve been in Quebec that quarter because that’s where most of our stores are and we had very inclement weather. A snow storm in April, we closed a lot of stores on one or two days and this is not helping a lot. That’s where we live, where every year we’ll have maybe a situation like this.

When you compare with the previous year where you didn’t have the same situation that’s where it hurts. Overall I’m very satisfied. The program that we have of renovation definitely will help boosting up our sales and we look forward to the rest of the year that’s for sure.

Jim Durran – National Bank Financial

There’s been some speculation in the market that you’re losing market share in Quebec. Have you got access to independent studies that would refute that?

François Coutu

What we see is that obviously there are strong players are gaining market share at the expense of the weaker players. We think that we’re very strong in this market and you can see our brand is well recognized. Obviously when you have a big competitor moving in right in front of your store it may add pressure. Overall it’s compensated by our aggressiveness in the rest of the market. Whether its front store, whether its pharmacy, we still have gaining market share. I’m not afraid at all of the new competitive environment.

Jim Durran – National Bank Financial

Last question on share buy back versus increasing dividend. Do you have a priority on those two elements normal Coutu bid more important use of capital as opposed to increasing the dividend?

André Belzile

The increase of dividend was not discussed at the Board at this point in time so it’s not something. This is a Board decision so we cannot comment on that. We’ll see in the next few quarters if it is something that is brought to the Board for a decision. They decided as we mentioned yesterday to renew the buy back program and saw that it was a priority obviously since we did not discuss the increase of dividends.

Operator

Your next question comes from Perry Caicco – CIBC World Markets.

Perry Caicco – CIBC World Markets

You referred a few times to the market conditions in Quebec. I wonder if you could describe exactly what makes the current market conditions so challenging. How much of it is square footage growth, how much of it’s pricing, are you seeing consumer weakness and maybe some comment about how that differs by competitive channel?

François Coutu

This quarter was maybe to the numbers that we presented was not necessarily an operational issue. These were things that are out of our control, the reduction in prices, reduction in generic prices and the health and beauty products has an influence on both sales at the retail and sales of the Jean Coutu label. That’s what made it a little more challenging. It’s not necessarily due to additional competitive issues in the market.

Obviously the stronger players are there, they’re there to stay, they want to invest in our market but I don’t think that’s an issue for us. The issue is mainly to have a completion of our program of renovation and we will maintain the growth that everyone is expecting. I believe that you see it in pharmacy and the front store is just a question of I believe some situation where OTC levels you know allergy and cough and cold these have a great influence on our overall sales. I don’t want to put it on competitive issues.

André Belzile

When we talk about market conditions we obviously also want to refer to the overall economic condition. In the present condition consumers are a little bit more careful understanding for some part of our offering which is more discretionary. That’s one of the things also we’re working to.

Perry Caicco – CIBC World Markets

Have you see anything specific in consumer behavior in Quebec that might have you concerned about conditions over the next year?

François Coutu

I think it’s generalized; it’s a world wide situation. The price of gas, everybody’s suffering from it an obviously when you want to be careful on your spending this comes into play. Hopefully this is a short term situation; hopefully consumer confidence will go forward and helping all the retailers. Definitely out there there’s some kind of verosity that hopefully will be short term.

Perry Caicco – CIBC World Markets

There seems to be more incidents of poor cough and cold seasons over the course of time than there are good cough and cold seasons. I’m wondering if there’s some structural problem in the category which causes it to almost always decline in sales.

François Coutu

As a pharmacist I can say that you’re right, last year was not a bad one actually. I hate to say that because I’m just going to say as a pharmacist that we’d like to give help to our customers. Last year was a good one. This was not a great one. You’re right, overall in the last 10 years having said that we had a real good season even though companies and OTC manufacturers are coming with new products trying to help.

There’s a need in that category, there’s a need for new product maybe a prescription item that goes OTC or something of that nature to help boost those sale because we haven’t seen a lot of new things especially since the older pharmacists are doing things contrary. Putting available products on the shelves back behind the counter making much more difficult for consumers to be aware of that situation and lost sales in this case.

Perry Caicco – CIBC World Markets

On a different topic there was relatively sizable acquisition in your market place by McKesson and I wonder if you could tell us how that might affect the Quebec market and any impact or opportunities that might have for your company.

François Coutu

This I don’t think will have any impact because McKesson was already distributing for that banner. Proxim was operating on its own, now it’s just to protect their own market that McKesson did that. I don’t think since McKesson are not really operators. I don’t think this will have any impact. It’s not like the addition of a new competitor.

Perry Caicco – CIBC World Markets

I’m wondering when your focused growth in the beauty category will begin to impact positively your gross margin. Are we still two, three, or four quarters away from that?

François Coutu

Beauty, when you talk cosmetics for example is still very viable in our market. The expansion of our [indiscernible] has done a lot of good things. Where it’s a little more difficult is the rest of these categories you will find in the food store and mass merchandiser. I believe we still have a good offer. There’s plenty of price deflation a lot in these categories that we go around a circle and next year should be better.

André Belzile

In the beauty category we’re looking at the AC Nielsen announcement for the overall pharmacy market and yes we have a slight decline but this was about 300 basis point level less than the overall market. We did pretty well actually.

Operator

Your next question comes from Irene Nattel – RBC Capital Markets.

Irene Nattel – RBC Capital Markets

Just staying with the whole notion that consumer spending being a little bit more cautious and the competitive environment really across channels being more focused on price and value. Could you talk a little bit about some specific programs that you’re trying to focus on what you may be doing with air miles anything that you said you’re going to step up your import program, anything we should be looking to in the fall back to school that sort of thing.

André Belzile

Things like more imports especially in the seasonal aspect of our business. Private label is something also we want to accentuate the growth because as you know it gives additional value to people as well as promoting loyalty to our own pharmacy. That’s something that we will accelerate in the future the growth of these two categories. Obviously the air miles program is something that also is interesting because it doesn’t really drive you into a competitive war on price only. It gives you additional value through a loyalty program that we have now in place for many years and has been very successful.

You’re right, I believe I said something in that last quarter something about this thing that because a lot of retailers did not make good numbers for the Christmas season we were expecting a little bit of a price war in the spring to come and that’s probably what happened.

Irene Nattel – RBC Capital Markets

You mentioned something as part of the re-launch of your consumer website that you are going to able to do back to school online. Could you talk a little bit about that and whether you’ve also broadened out your offering for that category?

François Coutu

For a mom it’s sometimes a very strenuous task to go and shop for every product that you have on the school list. What we want to do is to give the chance to order online from that list everything that you’ll find at Jean Coutu available and they will actually make that order and pick it up at the store. It’s a service we’d like to try this year as we see, we look at our consumers and say they stop the headaches we will take care of this for you and just pick it up at the store with the prices we always been recognized for in that seasonal activity.

We’ll give it a chance. I think the web now is extremely popular way of shopping. Not necessarily we want to go into e-commerce but definitely using it for the service a new kind of approach to our clientele.

Irene Nattel – RBC Capital Markets

On the incremental costs associated with that hand pick will it be the franchisee that will absorb it or are you going to be supporting that?

François Coutu

If I could I would probably give them a hand but it will be the franchisee.

Operator

This concludes today’s question and answer session. I would now like to turn the meeting back over to Michael Murray.

Michael Murray

We thank you for your interest in the Jean Coutu Group and your participation in today’s conference call. At 9:30 am ET the company’s annual general meeting of shareholders will be held. You are invited to listen to the webcast through our internet site. If you have further questions please feel free to call us. Our contact information is contained in the company’s communication. We look forward to reporting on our progress when we report on our second quarter results in late September 2008.

François Coutu

Thank you have a great summer.

Operator

The conference has now ended. Please disconnect your lines at this time. We thank you for your participation.

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