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Kulicke & Soffa Industries, Inc. (NASDAQ:KLIC)

F3Q08 Earnings Call

August 6, 2008 9:00 am ET

Executives

Geoffrey Grande – FD Ashton Partners, Primary Investor Relations

Scott Kulicke – Chief Executive Officer and Chairman of the Board

Maurice Carson – Chief Financial Officer

Michael Sheaffer – Director of Investor Relations

Analysts

Bill Ong – American Technology Research

Gary Hsueh – Oppenheimer & Company

Brett Hodess – Merrill Lynch

Chris Shankar – Banc of America Securities

Andy Schopick – Nutmeg Securities

Michael Valle – Sierra Capital Management

Andy Schopick - Nutmet Securities

Operator

Welcome to the Kulicke & Soffa third fiscal quarter results conference call. (Operator Instructions) At this time, I would like to introduce Geoffrey Grande of FD Ashton Partners.

Geoffrey Grande

Thank you. Good morning everyone and welcome to Kulicke & Soffa’s third quarter earnings conference call. An audio recording will be made of the entire conference call this morning. Including any questions or comments that participants may contribute. The audio recording will also be available on the internet for a limited time and maybe accessed from the Kulicke & Soffa website at www.kns.com.

During today’s call, we will make a reference to non-GAAP financial measures. Reconciliation of those measures from most directly comparable GAAP results will be posted on our website after the completion of this call. To view them, go to the Investor Relations portion of our website and click on the GAAP to non-GAAP reconciliation link.

The content of this conference call is owned by Kulicke & Soffa Industries and is protected by US copyright law and international treaties. You may not make any recordings or other copies of this conference call. And you may not reproduce, distribute, adapt, transmit, display, or perform the content of this conference call in whole or in part without the written permission of K&S.

Today’s remarks are governed by the Safe Harbor provisions of the 1995 Private Securities Litigation Reform Act. Actual results may turn out significantly better or worse than indicated by any forward-looking statements that we may make this morning.

For a more complete discussion of the risks associated with the operations of Kulicke & Soffa, please refer our SEC filings especially the 10-K for the year ended September 29, 2007 and our other recent SEC filings.

And now it is my pleasure to introduce the host for today’s call, Scott Kulicke, Chief Executive Officer and Chairman of the Board. Scott?

Scott Kulicke

Thanks, Geoff. Good morning and welcome to this call. The purpose of which is to discuss K&S’s financial results for the June quarter. For those of you who would not have seen this morning’s press release those results are available on the Company’s website at www.kns.com in the Investor Relations section.

Before I offer my commentary on these results, I will ask Maurice Carson, our Chief Financial Officer, to take you through the important points of the quarter. Maurice?

Maurice Carson

Thank you, Scott. Good morning everyone. This is the third earnings release and conference call where we are providing non-GAAP measures as a supplement to our GAAP result. The non-GAAP measures exclude gold metal costs, pension termination expenses, equity-based compensation, and amortization of intangibles in order to provide a better view of our profit ability of the percentage of sales.

My remarks compare the June quarter results to the March quarter and reports of non-GAAP numbers unless otherwise noted. Net revenue was $83 million up slightly from $81 million last quarter.

Equipment and packaging materials both increased slightly over last quarter. The gold metal pass-through component of our GAAP, net revenue was $97 million, slightly below what was the anticipated but up from $95 million last quarter. Our gross profit was $37 million compared to $36 million last quarter.

Our gross margin was 44.2%. Equipment ASPs were lower due to the expected volume shift to subcons in the fiscal third quarter. As we ramp IConn shipments in the fourth quarter, we expect a meaningful contribution to gross margins.

Operating expenses were $37 million compared to $36 million last quarter. Our exposure to foreign currencies, particularly the Swiss franc and Israeli shekel, had a negative $2.6 million impact on net income in comparison to the effect in the second quarter.

We are mitigating the impact on foreign exchange on the P&L through natural hedges and we are evaluating certain hedging opportunities using foreign exchange contracts. Looking at the balance for a moment, we ended the quarter with total cash in equivalent of $183 million compared to $171 million last quarter.

Accounts receivable declined $12 million during the quarter to $146 million and DSO improves significantly to 73 days from 81 days last quarter. Before I wrap up, I want to revisit the transactions that we announced last week. For anybody who was on vacation or not reading the news, we are acquiring Orthodyne Electronics, the semiconductor industry’s leading wedge bonding company.

We are funding the acquisition with $7.1 million shares of common stock plus $80 million in cash. If this transaction does not close by October 31, 2008, the purchase price maybe adjusted to be approximately $19.6 million shares of common stock and no cash. This transaction also includes potential earnout payments of up to $40 million in cash over the next three years based on gross profit performance.

This earnout will only be paid if Orthodyne contributes significant additional growth and profits. Additionally, we are divesting our wire business unit. Heraeus, a leading precious metals company and technology group will purchases this business unit from us for $155 million in cash.

Let me end my discussion with a couple of short comments. The overall takeaway here is that the quarter did not include any significant surprises. Revenues were solid given the environment. Our cash generation and cash levels are both good. Foreign exchange did hurt and we would have been about breakeven without these losses.

Looking into next quarter, we will remain focused on running a tight operation, closing the transactions we have discussed and finishing the year in a better position to capitalize on the market opportunity when the cycle turns. Scott?

Scott Kulicke

Thanks, Maurice. On our last earnings call I posed two questions investors ought to be asking relative to K&S.

First, what is the timing of the next upswing in demand for our products? And second, how well positioned is K&S when that upswing does occur?

With regard, to the first question, the industry is in about the same place it was a quarter ago. Our customer’s factories are busy because current IC run rates are strong, estimated at about $38 billion units in the March quarter and forecasted to grow another 8% to about 41 billion units in the quarter just ended.

The units forecast for next year point to about a 12% unit increase over 2008. Nonetheless, customers are buying less for now, resulting in our guidance for the quarter’s revenue to be at about $160 million of which gold pass-through will be about $94 million. Given the IC unit forecast mentioned above, we do not believe these soft conditions can last for too long. We are planning on a 2009 upturn.

As for the second question, we are better positioned for the next upturn than we were for the last due to several positive steps we have taken recently. In March, we introduced a new power series of wire bonders, the IConn and the ConnX, to replace the Maxum Ultra and the Maxum Elite. We have qualified the IConn with several customers and are starting to ramp production.

We have just started with the ConnX qualifications as well. These machines are demonstrating superior performance and higher throughputs relative to their competitors and are generating ASP increases relevant to their predecessors. Also on the wire bonding front in last week’s announcement of the sale of our wire business notwithstanding, the copper wire transaction is still important for K&S.

Copper is as much about bonders and tools as about wire and K&S is uniquely able to create proper solutions by integrating our knowledge of wire tools and bonders. Copper represents an opportunity to extend the total wire bonding market to our obvious benefit given on number one market share position in both bonders and in tools. As a copper bonding device market continues to evolve, we are committed to delivering solutions that enable customers to overcome manufacturing challenges and realize the advantages of copper.

We currently have about 65 customer engagements around copper wire bonding, several of which are already in volume production. We are also busy on the die bonder front. In July, we shipped an alpha version of our next generation die bonder currently named Discovery. The machine met all of our expectations and we remain on track for formal Discovery product launch this winter.

Lastly, let me also point to the two corporate transactions Maurice mentioned earlier, the acquisition of Othodyne Electronics and the sale of our wire business to Heraeus. Selling the wire business strengthens our balance sheet and allows us to focus on the Company’s historical strength in semiconductor assembly equipment. With Orthodyne, we added profitability and expanded our equipment portfolio into the rapidly growing power management and power hybrid markets.

More broadly, it should be increasingly clear that we are successfully executing our strategy of pursuing profitable growth along the way to becoming the leader in the semiconductor assembly equipment market. With that, LaTanya, we would be happy to take some questions.

Question-and-Answer Session

Operator

Thank you. Ladies and gentlemen, we will now conduct a question-and-answer session. (Operator Instructions). Our first question comes from Bill Ong with American Technology. Please proceed with your question.

Bill Ong – American Technology Research

Good morning gentlemen.

Scott Kulicke

Hi, Bill.

Geoffrey Grande

Hi, Bill.

Bill Ong – American Technology Research

Thanks. I just want to integrate your announced transaction and let us say looking a year or so out when your operations start to stabilize, perhaps you can contrast and compare the three product lines. In the wire bonded, die bonded and wedge bonded type of ASPs, gross margins and market size we can expect and that will help us model the business going forward.

Scott Kulicke

Maurice, do you want to tackle that one?

Maurice Carson

So we estimate, I can talk TAMs and this all comes from publicly available information, but I am focusing I think primarily on VLSI data. So the TAM for wire bonders will be around $650 million of wire bonders.

Scott Kulicke

Ball wire bonders.

Maurice Carson

I am sorry, ball bonders. Let us talk specifically ball bonders. Thank you, $650 million. Die bonders, about the same, maybe $700 million and wedge bonders, $175 million, $150 million to $175 million TAM. The margins will be probably the highest in the wedge bonding group, we have not disclosed the Orthodyne numbers yet. When you get the pro formas, you will see an idea of those…I think we have discussed mid-40s for die bonders and low to mid-40s for ball bonders going forward. Does that answer the question or is there something…?

Bill Ong – American Technology Research

Yes, and then die bonders, over time?

Scott Kulicke

Die bonders, mid-40s, Bill.

Bill Ong – American Technology Research

Okay, great. And maybe just for completeness sake, type of general ASPs? I know it is a wide range among the three.

Maurice Carson

Yes, I think we talked about this. It is very hard to put out an ASP for both die bonders and for wedge bonders because the configurations vary so much. Scott, would you have something you would add on that? I do not know what the real lay-out for that number.

Scott Kulicke

I mean it is hard to give a representative number because the standard deviations from the low specification machines to the high specification machines are so large. I mean, die bonders are a lot more expensive that ball bonders. Wedge bonders are a lot more expensive than ball bonders. So they both will show significant ASP increases.

Bill Ong – American Technology Research

Okay, great. Thank you.

Scott Kulicke

Thank you, Bill.

Operator

Our next question comes from Gary Hsueh with Oppenheimer. Please proceed with your question.

Gary Hsueh – Oppenheimer & Company

Thank you.

Maurice Carson

Hi, Gary.

Gary Hsueh – Oppenheimer & Company

Hi, Maurice, how are you? Scott, I was wondering if you could broaden your comments on the industry. You talked about fundamental…being what they were the last quarter or the two quarters but yet a lot of the subcons and CSMC, the foundry included, have guided to sub-seasonal growth here in Q3. Is this another leg down here in this downturn; is this going to be a more extended downturn in terms of wire bonder unit shipments for you guys more than the six quarters that you normally talk about?

Scott Kulicke

Well, I think that six quarters is your analysis not ours. I think we have gone out of our way to say that every cycle is unique and every one has its own twists. This one certainly is displaying some twists. As recently as two months ago, we were getting very strong forecast from our customers anticipating an early and pronounced upturn. Our customers have clearly backed off from that position and just in the last six weeks, eight weeks. So yes, this downturn has lasted longer than we expected a quarter ago. And I would say in general that because everyone is unique. This one also, as I said earlier, has its own twists; I do not if you can take this traditional chart and use it to project forward. We are all going have to play it out day by day, week by week, month by month.

The good news is that customers’ factories are busy. There was not significant excess capacity as we view it. Run rates are strong and it will not take very big increase in unit volumes to start to push customers into the capacity expansion mode.

Gary Hsueh – Oppenheimer & Company

Okay. If I look at your equipment revenue, you are kind of at a quarterly run rate implied in your September quarter that is not an all time low, but getting pretty close to tough levels, but yet you have got inorganic growth with the die bonder business and the alpha tools shipment here. I mean can you give me a little bit more visibility?

Scott Kulicke

Well, you just made a leap that I would not go to. Yes, you are correct. We are implicitly projecting unit volumes for the ball bonder business that are about trough of cycle.

Gary Hsueh – Oppenheimer & Company

Yes.

Scott Kulicke

Similar to the last couple of cycles in terms of unit volumes, there is no Discovery contribution to revenue in the September quarter. There will not be any contribution to revenue in the December quarter. The first revenue machines for Discovery will come, at the earliest, in the March quarter because we are only to launch it in the March quarter. So I am not sure where you are going but there is no change in die bonder revenue profile until the winter.

Gary Hsueh – Oppenheimer & Company

Yes, that was my question, just a long-winded question asking about the status of the die bonder business.

Scott Kulicke

Okay, the die bonder business, we are really excited about Discovery. We had a great alpha experience with the machine, put it in a Taiwanese subcontractor, ran it for a couple of weeks. We met our expectations with it. There were no ugly surprises. The team is really, well, they are working as hard as anybody in Europe works in August. But they are working as hard as they can on getting that product launched and we are on schedule for December launch.

Gary Hsueh – Oppenheimer & Company

Okay, last question for me, Maurice, you talked about a $2.6 million negative impact from foreign exchange. Was that mostly in the cost of sales or was that spread evenly between SG&A and R&D?

Maurice Carson

No, that was specifically in the SG&A line.

Gary Hsueh – Oppenheimer & Company

Okay, makes perfect sense. Thank you.

Scott Kulicke

You are welcome. I am sorry just to follow up on Gary’s question before we take another one. The $2.6 was in comparison to last quarter impact. The actual amount that flowed into the P&L this quarter was $1.6 million. Go on to the next question.

Operator

Our next question comes from Brett Hodess with Merrill Lynch. Please proceed with the question.

Scott Kulicke

Hi, Brett.

Brett Hodess – Merrill Lynch

Good morning. Scott, I was wondering if you…, one of the things that came out of the conference calls from some of the subcons in the last few days was they were saying that they were going to cut their CapEx in the second half of the year and mainly focus it on flip chip and some of the other more advanced packaging technologies. Their comments basically were that is where they saw the majority of the strength in the more advanced packages right now. Are you seeing any acceleration into the advanced packages at this point or do you think it is just where they have the tightest capacity?

Scott Kulicke

I think the answer there really lies in gross margins and their attempt, at least of couple big; the four big subcontractors are all trying to improve their margin structure because they think the grass is greener in the flip chip area. They have been making significant capital investments to try and get those parts. It is still a relatively small number of parts and given the success in copper wire bonding, with the copper wire transition, I expect it to stay a relatively small number of parts. For the kind of parts that are on the bubble as to whether they could go flip chip or whether they could go a wire bonding.

The gold content at $900 an ounce is depending on the device and the wire count and the wire length and all that stuff, anywhere from 25% to 35% of the total packaging costs. We can take that with copper wire or I do not know, I would say almost to zero. That is a little bit extreme, but we can take it down to a tiny percentage. That is a giant cost to pickup and that is why we have got every major subcontractor, most of the next level of subcontractors, most of the big IDNs all beating us to help them with copper.

That transition is happening surprisingly quickly. We have got customers in volume production on particular parts with copper. I think it is going to be a huge driver or the extension of the wire bond market relative to flip chip. It is the back it will be a big contribution by the back in to the whole Moore’s Law phenomenon extending total unit volumes. We think copper is a big deal and I think that the focus on flip chip is… it does not reflect the mass of devices that are and will stay in wire bonding.

Brett Hodess – Merrill Lynch

As a quick follow-on to that then, Scott, when your customers move to copper, does it require you to upgrade their installed base and is that a revenue opportunity or is it more just the change of the material and maybe the capillaries and what not?

Scott Kulicke

Copper requires relatively small changes to the more recent bonders. There is upgrade kits available for the Maxum generation of bonders. Older bonders, it is not clear yet whether they will have to be replaced or can be upgraded. But I think that it will, in time, generate some replacement cycle business. Also we have copper-specific capillaries that carry an ASP, per small ASP premium as well.

So it is all good for us in terms of the replacement cycles and product differentiations. Anything else, Brett?

Brett Hodess – Merrill Lynch

Yes, one last question. If I could, on the two transactions which is relative to the Orthodyne transaction. Having the two structures of purchase one in cash and some stock and the other all stock if it does not close by October, do you see specific impediment that might not allow it to close by the end of October?

Scott Kulicke

No, no. It has to do with the timing between the Heraeus transaction and the other. That is all.

Brett Hodess – Merrill Lynch

All right. Thank you.

Operator

Our next question comes from Chris Shankar with Banc of America. Please proceed with your question.

Chris Shankar – Banc of America Securities

Thanks for taking my questions. Scott, I had a couple of questions. I understand every cycle is unique. You said, you are preparing for the upcycle in 2009 and last year, one of the things that helped during the upcycle was the underlying DRAM unit shipments as far as earning around 30% to 40%. So next year, when you think of an upcycle, can you give us an estimate of where you think the DRAM units would be from the wire bonder side?

Scott Kulicke

I cannot give you a quantified estimate. DRAM assembly capacity is pretty tight. More DRAM units will clearly call for more DRAM-focused bonders, but I would not dare make a forecast to numbers.

Chris Shankar – Banc of America Securities

Okay. In terms of the copper wire bonder, I understand it is a small percentage of the overall wire bonders today. Can you, where do you think it is going to be like a year from now?

Scott Kulicke

Okay, I said before, I think this transition will happen relatively quickly. It is relatively quickly to a normally glacial shift in materials sets. The industry is very conservative about materials because it has to do with the long-term reliability and I think that will be the case with Capwire. I think it will be fast compared with the normal glacial shift. But I think if the industry could be at 10% in a year it would be a very fast shift.

Chris Shankar – Banc of America Securities

Okay. I have a couple of question from Maurice. Maurice, if I you look at your Orthodyne acquisition, obviously better gross margin proposed than your wire bonder business, but should we assume it going to be neutral impact from an up margin level?

Maurice Carson

No, it has about equal margin percentages, but it has a higher gross profit dollars and we will give you the guidance on the…, all the way down to operating income when we publish the pro formas as we get closer to close. But it is relatively close in margin percentage, but it brings significantly more dollars of gross profit dollars in. And I think, I am afraid we will have to defer the question on the full pro forma until we get closer to close.

Chris Shankar – Banc of America Securities

Okay. Just the last question, I know you guys have a conduit coming up, you are going to retire pretty soon, so should we expect a step function down in sharecount in either the September to December quarter?

Maurice Carson

Well, yes you should expect it in both shares and fully diluted shares. Now this quarter, the converts were anti-dilutive and even not included. But on a profitable quarter, yes, you will see the step function down in those underlying shares. You will also see an increase in 7.1 million shares when we close the Orthodyne transaction.

Chris Shankar – Banc of America Securities

Thank you.

Maurice Carson

You are welcome.

Operator

Our next question comes from Andy Schopick from Nutmeg Securities. Please proceed with the question.

Andy Schopick – Nutmeg Securities

Thank you, good morning.

Scott Kulicke

Hi, Andy.

Andy Schopick – Nutmeg Securities

Well, you have certainly given us a lot to think about and we are going to be basically throwing away our miles after September and looking at a very different company than what has traditionally been the case. Obviously, you have spent a lot of time thinking about how to transition this Company perhaps more profitable growth. I have a couple of questions I could as on these transactions. Is the Heraeus transaction, would that have to close in order to affect the close of the Orthodyne purchase? Is one dependent on the other in terms of the timing of the closings?

Maurice Carson

No, they are not. We would prefer to get them done around the same time just administratively but they are both predicated on different filings.

Andy Schopick – Nutmeg Securities

Okay. And the expectation is that this will occur on or about the close of your fiscal year, September 30?

Maurice Carson

The hope is, but we are dependent upon government filings for antitrust in a couple of foreign countries and that is our best estimate of when we can complete those.

Andy Schopick – Nutmeg Securities

Okay. You have indicated the wedge bonder market to have a total addressable market of about $150 to $175 million which Orthodyne, I guess, holds the significant market share. What is the growth of that market or the expected growth rate over the next few years?

Maurice Carson

There is not a lot of forecasts on the wedge bonder market. It is a relatively unknown market. I think the best data that I could give you on that is to look at the underlying drivers for the two main segments that Orthodyne serves. They serve the power management business, power ICs, things like converters and regulators in stock. That business is forecasted to grow around 10% of the next few years and they also have a big stake in the automotive hybrid business. These are under-the-hood and under-the-dash modules that control cars, especially hybrids, gas/electric hybrids, which use a lot of electronics and that business is currently forecasted at about 13% compound annual growth rate.

Andy Schopick – Nutmeg Securities

Do they have a high percentage of sales to GM and Ford? Orthodyne?

Scott Kulicke

Higher percentage of sales in Europe and Japan.

Andy Schopick – Nutmeg Securities

Again, I was just asking specifically about domestically GM and Ford, whether there is any high percentage of sales to those two domestic auto manufacturers?

Scott Kulicke

No, not directly.

Andy Schopick – Nutmeg Securities

Okay, also I would like to ask if Mike Sheaffer is in the room. Is he there?

Scott Kulicke

Mike is here.

Andy Schopick – Nutmeg Securities

Great. Mike, I know that you will be leaving the Company shortly and I would certainly like to acknowledge and thank you for all of your efforts and the outstanding job you have done in your IR capacity at K&S. All the best to you. I will certainly miss you and I could not have asked for a better contact.

Michael Sheaffer

Thanks, Andy. I appreciate it.

Andy Schopick – Nutmeg Securities

You are welcome.

Scott Kulicke

Anything else, Andy?

Andy Schopick – Nutmeg Securities

No, that will do it for me. Thank you.

Scott Kulicke

Well, Andy. I am glad you recognized the changes that will come to the Company with these two transactions. We believe we have upgraded the balance sheet. We have increased our growth prospects and profitable growth prospects. So we are really excited about what it will mean for the Company.

Operator

Our next question comes from Michael Valle from Sierra Capital Management. Please proceed with the question.

Michael Valle – Sierra Capital Management

Good morning, Scott.

Scott Kulicke

Good morning.

Michael Valle – Sierra Capital Management

I am speaking to you not as an analyst but as a long-term investor in the Company. It has been five or six years since I last asked a question at a conference call. At that time, the stock was trading in the high $12’s down from the low $20’s. During this period of time, Scott, I watched you consistently sell shares in the open market. But I never saw you make a purchase. Many of the board members do not own any shares in the Company. During this period of time, the Company has lost well over half its total market capitalization, trading between $5 and $6 over the last year. In light of this and in the interest of all shareholders, why not explore some strategic initiative and just outright sell the whole company?

Scott Kulicke

Okay.

Michael Valle – Sierra Capital Management

Taking your age into account, not holding onto shares or putting money into or buying shares back at $5, why not just sell the whole company?

Scott Kulicke

Well, first let me… I do not want to quibble about your preamble, but some of your facts were wrong about director’s decisions. Yes, I have been selling shares and I have also had shares coming in through option maturities. So my total share count, I do not know if it is gone up, net up or net down but it is still very substantial, but I will not quibble about that.

As to the question of selling the Company, the Company has regularly gone out and investigated its strategic options in terms of selling the Company, in terms of buying other companies, in terms of merging with similar sized companies. The conclusions are obviously that the shareholders will be best served given the circumstances of the last few years with the path we are on. We think that we have made significant strategic choices here with these two transactions that will prove to be beneficial to the shareholders over the long run. I understand that people could differ on these opinions, but these are the choices made by the Board of Directors.

Michael Valle - Sierra Capital Management

Thank you.

Scott Kulicke

You are welcome. Next question.

Operator

(Operator's instruction) We have a follow up question from Andy Schopick from Nutmet Securities. Please proceed to the question.

Andy Schopick - Nutmet Securities

Thank you again, I assume that one of the major reasons for doing these sales is to preempt a lot of the working capital that has been tied up in the gold situations, Maurice, I am wondering if you can give us any additional color as to the impact when these two transactions close on your future cash flows. I assume that there will be no future gold pass-through cost in connection with running the business once these transactions close.

Maurice Carson

That is correct. The entire $90 some million in working capital that is tied up in gold will go away and there will be no more gold pass-through. The cash flows, I wanted to think between EBITDA and cash flow because the wire business has contributed meaningful EBITDA over the time we have owned it, however most of that EBITDA has gone on to be tied up in working capital. Orthodyne will provide reasonably good EBITDAs also but those will flow directly into cash flow because there will not be the working capital requirements. So, much of these two transactions put together are about cash generation and cash flow and being able to have less investments on the balance sheet.

One more comment here, I think in the last call I mentioned that the net of all these transactions will be about an additional $65 million in cash on the balance sheet.

Andy Schopick - Nutmet Securities

Okay, I think they was a follow-up that I have. I just lost my train of thoughts so let me pass it along.

Maurice Carson

Okay, thank you Andy.

Scott Kulicke

Thanks, Andy.

Operator

There are no further questions in queue at this time. I would like to turn the call back over to Mr. Kulicke for closing remarks.

Scott Kulicke

All right, we want to thank you for your attention this morning and we look forward to our next call.

Maurice Carson

Thanks, everybody.

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