Vectren's (VVC) CEO Carl Chapman on Q4 2016 Results - Earnings Call Transcript

| About: Vectren Corp (VVC)
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Vectren Corp (NYSE:VVC) Q4 2016 Earnings Conference Call February 23, 2017 2:00 PM ET

Executives

Susan Hardwick - EVP & CFO

Dave Parker - Director, IR

Carl Chapman - Chairman, President, & CEO

Analysts

Operator

Welcome to the Vectren 2016 Year-End Earnings Call and Webcast. [Operator Instructions]. Please also note that this event is being recorded. I would now like to turn the conference over to Mr. Dave Parker, Director of Investor Relations. Please go ahead.

Dave Parker

Thank you Andrea and good afternoon and thank you for joining us on today's call. This call is being webcast and shortly following its conclusion, a replay will be available on our website at www.vectren.com under the investor link that's located at the top of the web page. Yesterday, we released our 2016 fourth quarter and year-end results and this morning, we filed our Form 10-K with the SEC.

You can access our earnings release, today's earnings call slide presentation and the 10-K through the investor link on our website. As described on slide 3, many of the statements we will make on this call are forward-looking statements. Actual results may differ materially from those discussed in this presentation.

Carl Chapman, Vectren's Chairman, President and CEO, will provide opening comments on the 2016 financial results, 2017 guidance and updates to our long term growth targets. Susan Hardwick, Executive Vice President and CFO, will provide details for our utility and non-utility outlook and Carl will offer some closing remarks.

Also joining us on the call today is Ron Christian, Executive Vice President and Chief Legal and External Affairs Officer; and Eric Schach, Executive Vice President and Chief Operating Officer. Following our prepared remarks, we'll be glad to answer questions you may have. With that, I'll turn the call over to Carl.

Carl Chapman

Thanks, Dave and thanks for joining us on our call today. And we look forward to providing you the highlights of 2016 as well as our updated financial outlook. Let's turn to slide 5 and 6 for a review of our 2016 highlights. Overall, 2016 was another great year for Vectren. We achieved earnings of $2.55 per share which is up 6.7% from 2015 continuing our trend of consistent earnings growth. 2016 utility earnings per share were $2.10, up 7.7% compared to 2015 results driven primarily by our long term gas infrastructure investments. I'm pleased to highlight that 2016 was the fifth year in a row that our utility subsidiaries earned their overall allowed ROE.

Working with all our stakeholders, our utility team continues to successfully execute our strategies. Then building on this success, it will be extremely important as we move into the next phase of our regulated utility transformation. In December, we filed our integrated resource plan or IRP, for the State of Indiana laying out that our proposed long term plan for diversifying our electric generation portfolio. Today, we filed our seven-year electric infrastructure improvement plan. The IRP and electric infrastructure plans combined with our ongoing gas investments will transform and prepare our utility business for a smart energy future. Susan will provide additional details a bit later. On the nonutility side, while overall results were flat year over year due to continued market challenges at VISCO's transmission business, we're very pleased that VISCO's distribution business and VESCO both achieved record results in 2016. Finally in November, we announced a 5% increase in our dividend which marks the 57th consecutive year Vectren and its predecessor companies have increased the annual dividends paid.

We're extremely proud of our record that puts us in a select group of companies that have achieved this level of long term commitment to shareholders. Moving on to slide 7, as I mentioned, 2016 continued to trend for consistent earnings growth. Over the past five years, we have delivered strong results through the successful execution of our strategies that have led to consolidated earnings growth per share of 8% and is steadily improving ROE.

Also, our dividend growth rate has more than doubled in recent years. Our balance sheet remains strong and our nonutility business risk has been reduced through our exiting of commodity-based businesses. These accomplishments have helped fuel a five-year average total shareholder return of 16%, exceeding our target over that time and achieving a result that is ahead of our peers as well as the broader market. I firmly believe that disciplined utility growth has been and will be the key to Vectren's overall success. As slide 8 highlights, over the past five years, our utility team has demonstrated we can successfully manage significant growth. Utility EPS growth averaged 7% the past five years reflecting increasing utility CapEx needs that have doubled over $0.5 billion per year while earned returns have improved.

We've worked closely with all of our stakeholders to implement legislative and regulatory solutions in both Indiana and Ohio that allow us to recover a high percentage of CapEx investments to real-time recovery mechanisms. As a result and with the added benefit from bonus depreciation, we substantially funded capital investments through cash flow from consolidated operations which has helped us maintain solid credit metrics. In addition, we continue to cultivate a culture of performance management and strategic sourcing that is now embedded in our day-to-day operations. This discipline has limited control but O&M increases to less than 1% per year, another factor helping us to continue to earn our overall allowed return while at the same time limiting future bill impacts.

Throughout our growth over the past five years, we've remained extremely focused on customer bill impacts. This focus will continue as well as our focus on execution, including effective capital deployment and continuous operational improvements that have fueled our successful utility growth. Moving on to slides 9 and 10, meeting and exceeding our financial targets during the past five years has provided hedge investors with proven multi-year track record of doing what we say we will do. We're standing on that record today as we look out over the next 10 years and see even greater opportunity for investment in our utility business. The skills and experience gained from the past five years boost our confidence in the ability to tackle the opportunities and the challenges that lie ahead as we look at significantly expanded investment in opportunities.

With that backdrop, we expect Vectren can achieve higher long term growth than we have previously communicated reflecting increased capital investment needs in our electric utility coupled with our continuing gas infrastructure investments and supplemented by a strong nonutility group outlook. Consolidated earnings per share are now expected to grow at 6% to 8%, up from our current target of 5% to 7%. Increased utility earnings growth is the primary driver where the new target is 5% to 7%, up from 4% to 6%. In addition, we continue to expect dividend growth to match consolidated earnings growth so now 6% to 8%, with a payout ratio range of 16% to 65%. Turning to slide 10, if you look at the bottom you can see our track record, meeting and exceeding our growth targets from 2011 all the way through 2017 guidance midpoint which I will talk about here in a few minutes. Then when you look at our updated long term targets beyond 2017 and the drivers behind them, the key elements of our strategy are the same as we have already proven we can successfully achieve which we believe should result in a very compelling 15-year growth story. On slide 11, one last thing I would like to leave you with regarding our higher growth targets is our updated rate base growth forecast.

As you can see over the last five years, rate base has grown approximately 5% almost totally from gas infrastructure and investments. Over the first five years of our new 10 year plan, we anticipate gas infrastructure investments will continue to lead overall rate base growth of about 6.5% and will be supplemented by additional electric infrastructure investment.

Then starting at about 2021, we expect electric investments in both generation and infrastructure to help boost overall rate base growth to approximately 7.5%. Based upon our current assumptions, including our generation diversification plan that's under review, over the course of our 10-year plan, we expect rate base growth to average 7%, gas at about 8% and electric about 5.5%.

Susan will discuss our financing plan in further detail, but I want to affirm that we will continue to finance our planned investments with the same approach as we have had in the past. That means we will issue a combination of debt and equity in order and maintain our strong balance sheet. We expect long term utility EPS growth of 5% to 7% over the next 10 years which as I mentioned earlier, is 1% higher than our previous target and we believe that is achievable even with the need to issue equity to help finance the investments. Finally, long term nonutility earnings targets are similar to past targets and we've given you an indication of our expectations for each of our two nonutility businesses here on the slide. Before I turn it over to Susan for all the details, let's turn to slides 12 and 13 to review our outlook for 2017. We're initiating 2017 consolidated earnings guidance of $2.55 to $2.65 per share. This guidance reflects continued utility earnings growth from our extensive capital investments and gas infrastructure and continued strong revenue in earnings growth from VISCO's distribution business. In addition, as we think about how 2017 builds by quarter, VISCO transmissions should see a much improved first half of the year compared to 2016 due to a large project that was awarded in late 2016 and is currently underway.

Apart from this large project, we expect this business to continue to face market headwinds and look for the broader infrastructure and structure market to recover beyond 2017, likely in 2018. One additional note about VISCO's earnings in 2017, unlike the fourth quarter of 2016 when VISCO realized substantial earnings from a large project, our guidance for 2017 does not assume a large project in the fourth quarter of this year. Also, as you think about quarters, even though we don't know how weather might affect the rest of the year, we would remind you that our winter has been very warm to date impacting primarily the electric business. Our growth in 2017 reflects a decline in electric earnings related to lower customer margin from our customer SABIC as we have previously discussed which has built an 85 megawatt co-generation plant that came online early in 2017.

Since that likelihood was announced several years ago, we had considered the loss of margin in our long term goals. Among other things, our continued investment in gas infrastructure has helped offset most of that margin loss. In addition, 179D tax benefits related to energy efficiency savings achieved at VESCO expired in 2016. Recovery of electric investments just starting in 2017 under Indiana Senate Bill 560 will not have any significant impact to our 2017 results. Given these items affecting 2017, we do expect modest earnings growth for the year but importantly significant advancements on the regulatory front that should set a great foundation for higher long term growth.

This higher growth expectation is the same when looking at growth for 2017 or from 2011 when we began our strategy focused on infrastructure investment and a desire for consistent earnings growth. With that, I will turn the call over to Susan.

Susan Hardwick

Thanks, Carl. So as Carl highlighted, Vectren has had a great five-year run of strong and consistent earnings growth and overall performance generally. So where exactly do we go from here? Turning to slide 15, we consider the next several years as the time of transformation for our utility. This transformation involves three components. The first component is the continuation of our successful gas infrastructure investment programs to further improve our ability to deliver safe and reliable service to our gas customers in Indiana and Ohio. The second component is a new infrastructure investment program to modernize and upgrade our electric transmission and distribution grid that will improve the reliability of our electric system, reduce the frequency and duration of service outages and enhance the overall customer service.

As Carl mentioned today, we began the regulatory process for this component through the initiation of a proceeding before the Indiana Commission. The third component is the expected diversification of our generation fleet that would improve our overall fuel source flexibility, further reduce emissions and enhance the utility's ability to adapt to new technologies and changing customer needs. Our execution of this third component is tied to the Indiana Commission's resolution of our IRP. Once the review by the Commission is complete, we will then set forth the details of this generation plan in a regulatory filing later in 2017. Collectively, you will hear us refer to this plan as our smart energy future. Switching over to slide 16, let's review what the smart energy future looks like in terms of investment over the next 10 years.

First, it means a $6.5 billion 10-year investment plan for our gas and electric businesses that will result in higher utility EPS growth rate of 5% to 7%. We're providing investors with a 10-year CapEx plan because of the improved visibility we now have into our long term investment plan due to the level of detailed risk-based models we have undertaken over the last several years for both the gas and electric businesses. Our CapEx plan includes continued gas infrastructure investments totaling about $4 billion, roughly $1 billion to modernize the electric grid and approximately $1.2 billion in electric generation investment which include solar and natural gas combined cycle projects. With our goal to diversify our generation portfolio, the electric CapEx would include additional investments in what will be our remaining coal-fired unit to enable compliance with existing environmental regulations.

On slides 17 through 19, we have provided some key aspects of our smart energy future plan. In the gas business, the key takeaway is that the investment cycle remains very long and robust for required investment needs that will help us meet existing or pending federal pipeline safety integrity management requirements. Likewise, our electric transmission and distribution system investment plan will maintain site safe and reliable service for our customers. On July 18, we have laid out the high-level aspects of our seven-year capital investment plan of more than $500 million which as we've said, we filed with the Indiana Commission today. This plan consists of more than 800 projects aimed at modernizing our electric grid including reliability programs that make up 80% of the total investment. These projects include transmission line rebuilds, substation transformer replacements and pole inspections and replacement.

All 800 plus projects have already been engineered which is gives us great confidence in being able to execute on this electric infrastructure plan much like we have done in the gas business. In conjunction with the modernization of our electric grid, we also plan to transform our generation fleet over the next decade as mentioned in our IRP filed last September. As you can see in the graph at the bottom of slide 19, we expect to significantly diversify our generation portfolio over the next 10 years. As a result of this diversification by 2024, carbon emissions will decline 60% from 2005 levels. To accomplish this in the next 10 years, we plan to invest over $1 billion adding 54 megawatts of solar generation by 2019 and about 900 megawatts of generation from a combined cycle gas plant from the year 2024.

In addition, continued customer energy efficiency improvements and increased participation in demand site response initiatives combined with new renewable generation are expected to meet approximately 15% of our total energy needs by the year 2026. The Commission is currently reviewing the IRP and we expect any comments later this spring or early summer. As we think back to November, a big driver for this diversification is the unavoidable compliance with existing environmental regulations related to the EPA's Effluent Limitation Guidelines or ELG and Coal Combustion Residuals rule or CCR. Given the change in administration in Washington DC as we move forward with our proposed plan outlined in the IRP, we will be sure to keep a close eye on potential changes to any existing regulations and assessing any material impact those modifications could have on our plans.

These ELG and CCR regulations are we think, though, unlikely to change. Now on to slide 20 where I will review how we intend to finance this robust 10-year gas and electric investment plan. As many of you know, Vectren has a long history of commitment to a strong investment-grade credit rating. We expect that history to continue. We're also committed to our utility operations funding approximately 85% to 90% of Vectren's dividend and going forward, we continue to target a utility payout ratio of approximately 70%. Playing a big role in our financing plans will be significant cash flow from operations enhanced by regulatory recovery mechanisms that provide timely recovery investment and the availability of nonutility operating cash flow.

Cash flow from operations is expected to provide a large portion of the funding needed for our long term investment plan with the remainder of the capital needed to be funded by an appropriate mix of debt and equity necessary to maintain an adequate regulatory cap structure and appropriate credit metrics. The possible benefit of future tax reform could positively impact our financing plan but likely in the longer term as CapEx spending picks up and more cash would be available from full expensing of CapEx if that will be part of the new tax law. Our financing goals remain unchanged. We expect to maintain a strong balance sheet and capital structure while adding no incremental debt at the utility parent level. Our anticipated mix of equity and debt has been fully factored into our 6% to 8% earnings growth, as Carl mentioned.

Moving on to slide 21, the corporate tax reform, let's take a look at that. And taken as a whole, we don't expect the tax reform proposals to have a material impact on our long term growth outlook. While we wait for more details to emerge, if corporate tax reform is adopted, we would expect utility rates to reset in the relatively near term to reflect any reduction in tax expense. Since Vectren has very little parent company debt, we expect limited recurring exposure to a loss of interest deductibility. Our nonutility operations would be favorably impacted at the implementation of a new tax rate and for some time to come in the future, but we would expect that benefit would likely be reflected in future competitive bidding activity on a go-forward basis.

Now on to slide 22 where we thought it would be helpful to lay out our expected near term regulatory activity. I'm not going to walk through the whole timeline but as you would expect, our primary focus in 2017 will be related to our electric grid modernization and expected generation diversification plan. Also, we anticipate filing base rate cases overtime as required by recovery mechanisms or legislation, such as with our Ohio base rate filing expected in early 2018. In turning to slide 23, I will point out just a few recent regulatory outcomes, both of which have been positive. First, related to our seven-year gas infrastructure plan, our fifth semiannual filing was just approved in January without any issue. Also in February, the Indiana Commission's order approving our investment in NOV-related equipment was upheld by the Indiana Court of Appeals.

And that's the tone I would like to close on as I wrap up the utility outlook. You can turn to slide 24. This is the table we have shown many times. It lays out the very constructive environments where our utilities operate in Indiana and our gas utility in Ohio. Our colleagues who worked very hard for many years to lay the groundwork for what is to come. As we begin this next phase of our significant utility transformation, never have these regulatory and legislative environments been more important.

Now moving on to slide 26 and our nonutility group results where we will start with VISCO. The distribution business saw 2016 performance driven by a record number of deployed resources. The transmission business, while very profitable, did have a down year. The second half of the year saw a significant improvement as more projects got underway, including a large project that continues into the first quarter of 2017. As of December 31, VISCO backlog was $725 million, nearly $100 million more that the end of the last quarter. In 2017, we expect continued distribution business growth and 2017 transmission projects already in the backlog to drive improved 2017 results.

Turning to the sector outlook on slide 27, we believe the number of projects in queue supports an improving long term construction outlook. In light of continued favorable regulatory landscapes in much of VISCO's service territory, utility pipe replacement programs should continue to accelerate distribution construction activity and help fuel the continued strong performance. In the transmission business, tight competition is expected to continue to pressure margins in the near term with recovery anticipated in 2018. Federal regulatory approval of several large proposed pipeline projects will dictate the timing of recovery in the transmission pipeline construction sector.

As you can see in the graph, low transmission construction activity has pressured gross margins beginning in 2015; however, over 12,000 miles of pipeline projects are expected over the next few years. And as transmission activity picks up, we expect to see margins begin to recover as competition eases in the maintenance work that is our primary area of focus. Turning to slide 28, on VESCO where we saw strong results across most markets and geographic regions that drove margins up 24% and record 2016 revenues of $260 million. 179D tax deductions were $5.5 million in 2016 which translates to an earnings per share impact to Vectren after all related expenses of about $0.05 a share. As a reminder, the tax law related to these deductions ended in 2016.

Looking forward to 2017, we expect significant revenue growth to over $300 million but margins are expected to return to more normal levels of about 21%. Slide 29 highlights projects across VESCO's three different sectors, including one of the big wins for us last year in the federal sector. ESG was awarded a $70 million energy savings performance contract with the U.S. Navy to implement a base-wide steam decentralization system at the Coronado Naval Base in San Diego. In addition, we also won the 23-year or over $60 million operations and maintenance contract related to the project which added nicely to VESCO's smaller but growing O&M business.

As I wrap up, you can see Vectren has several great storylines. A long term utility growth plan that now includes both gas and electric growth strategies. A strong infrastructure services segment that includes a very successful distribution construction business complemented by a transmission business that is well positioned as pipeline construction activity rebounds. And a growing energy services business driven by both performance contracting and sustainable infrastructure.

And now with that, let me turn the call back over to Carl for just a few closing remarks.

Carl Chapman

Thanks, Susan. On slide 31, I'd like to reiterate my opening remarks of how proud we're of our 57 consecutive years of dividend increases. Going forward, we expect to continue to grow the dividend at the same pace as earnings per share growth which as I stated earlier, has increased from 6% to 8%. Moving onto slide 32, our proven track record of achieving or exceeding our financial targets has allowed us to deliver to investors attractive returns which reflects among other things our consolidated earnings per share growth of 8% in the past five years, financial flexibility provided by a strong balance sheet and reduced nonutility business risk.

I'm especially pleased that we're able to exceed our 9% to 11% total shareholder return goal by providing 16% average annual returns the past five years. Finally on slide 33, I would like to close our prepared remarks with a recap of our updated long term targets highlighted by increased earnings per share and dividend growth targets of 6% to 8%. Consistently achieving financial targets can only be accomplished by a team that is intently focused on executing its strategies. After hearing our prepared remarks today, I hope you believe as I do that our team is uniquely positioned to take advantage of the increased investment opportunities we have in the next decade.

We believe Vectren has a very compelling long term growth story and we would be happy to take your questions. With that, operator, we're now ready for questions.

Question-and-Answer Session

Operator

[Operator Instructions]. Our first question comes from Patrick Downey of Canon Asset Management. Please go ahead.

Unidentified Analyst

It’s actually Scott [indiscernible]. Just a quick question. The slide number 10, the $73 in 2011 is that inclusive of the ProLiant loss?

Carl Chapman

No, that was excluded.

Unidentified Analyst

Excluded? Okay, got you.

Carl Chapman

No, 2010 no I'm sorry that would include whatever ProLiant was - exclude the year of sale and that would be in later.

Unidentified Analyst

And then prior guidance prior to this call was 5% to 7%. Is that correct? Was that of 2015 base year or 2016 base year?

Carl Chapman

I think it was really 5% to 7% long term is really what it was. We would not have called it off a particular year we would've set we laid that out back in 2011 when we started talking about consistent earnings and the lesser focus on combining businesses so it really was long term growth target.

Unidentified Analyst

Okay. Now you're saying the long term growth target of 6% to 8% off of 2017 which is 260 is that correct?

Carl Chapman

That's correct.

Operator

Our next question comes from [indiscernible] of KeyBanc. Please go ahead.

Unidentified Analyst

When do you think probably the first time you will come to market with equity is based on the current CapEx plan?

Susan Hardwick

We don't have all those plans laid out Paul just yet, but certainly in this next five year period we would expect them to be in the market for both debt and equity.

Operator

Our next question comes from Joe Zhou of Avon Capital Advisors. Please go ahead.

Unidentified Analyst

Its Andy Lee [ph]. I think Scott asked one question so it is 260 off of 68%. So I got that one.

Carl Chapman

Yes its 68 off of 260 but we will also comment that if we already go back to 2011 when we started our growth rate because we over earned from that original target which originally would be 68% all the way back to 2011 as well.

Unidentified Analyst

Okay. Is this growth rate linear or not?

Carl Chapman

We wouldn't call it linear because you always are going to have some ups and downs. Obviously you have got things like maintenance on the generating plants and some things that can occur. But I would say we expected it to be fairly consistent, there could be some minor differences here and there.

Unidentified Analyst

Very good. I will be honest with you I was looking at something else when Paul asked his question on debt financing and equity financing. So can you frame at all either the time frame of the equity financing and also how much equity financing you may need because you did good on the debt side of the security something, equity side for modeling purposes.

Carl Chapman

I will let Susan comment on that the only thing I would remind you of is whatever timing we end up with we're comfortable that we have factored in the 6% to 8% growth rate which I think may be the sum most significant part of it.

Unidentified Analyst

And the stock is at $56 which is very high multiple. So it’s very favorable to issue equity in general.

Susan Hardwick

Again I just want you back to slide 20 what you obviously saw and we do have the details there. But over the next five years what our specific expectations are we don't mention the equity amount per se there I would again just say that we're still evaluating the timing and the amount and the goal of course would be to maintain that appropriate rate structure and the metrics associated with it. Tax report was variable in this that will be relevant and we're continuing to watch that and it will have some impact on these plans as well. I think again you can sort of expect us to maintain the relative position we're in today with cap structures and you can sort of figure out from there what the levels of the various pieces might be.

Unidentified Analyst

So when we look at cap structure should we more focused on the utility cap structure or [indiscernible] when we try to figure that out?

Susan Hardwick

I think it is a good question. I think certainly you can look at the utility cap structure goals and I think when publicly said the utility cap structure is 50% to 60% permanent capital and the consolidated is roughly 45% to 50%. We again we don't do a whole lot of leverage--.

Unidentified Analyst

45% to 60% equity is what you are saying?

Susan Hardwick

Yes, that way at a consolidated level and--

Unidentified Analyst

So just to understand equity ratio at Vectren Corp of 45% to 50% is where you are comfortable and at your utilities you are comfortable with an equity level of 50% to 60%, is that correct?

Susan Hardwick

I think a target of 55% for the utility.

Unidentified Analyst

55% got it, okay, very good. And then the last question you can answer it anyway you want and the only reason I ask this question is because someone on the sales side I think I don't know if they brought it up on a report but definitely in conversation, so with Visco [ph] can you guys talk about obviously you have owned it for quite some time and you have grown the business quite effectively, you have gone through I don't know if the word is trough but a downswing in the industry and then now back in the other direction it seems to be heading. Are you longer term want to hold onto this business, or at the right price or the right opportunity you would be willing to sell the business? Maybe some of it would finance some of this utility growth.

Carl Chapman

I think the answer to that question is the same that we have provided and I think we're very disciplined and demonstrated from what we have done. Really there are two factors that we always look at. First of all we always look at can a business earn the return that we want to earn and for us we have shared many times that that’s a 15% after-tax and total rate of return as we look at it and then beyond that if you even can make that the question is what value can we get for that business in the stock and so that’s really our driver. We like the business, we think it has done well and we think it will continue to do well but the drivers for us is - can it make our return and is the value in the stock price.

Unidentified Analyst

Okay. So is that like a maybe?

Carl Chapman

No, it's neither one of them. I would just simply say that we have no interest in selling the business. We think the business is fine as long as the shareholder values it and today given where the stock price is I would say we feel comfortable that the shareholders' value it.

Unidentified Analyst

I would agree with you 100% on that. And then last question I should have kind of going back based on the fact that we're kind of uncertain on the tax side and I think you have to get some of the regulatory stuff done for this incremental CapEx, is it safe to say that equity is not on the table for this year it's more of an '18 and beyond?

Susan Hardwick

I think that’s probably fair.

Operator

[Operator Instructions]. There appears to be no further questions at this time. I would like to turn the conference back over to Mr. Dave Parker for any closing remarks.

Dave Parker

Thank you very much Andrea. I would like to thank everyone for joining us on our call today and on behalf of the entire Vectren team, we appreciate your continued interest in the company. With that, we will conclude our call. Thanks again for your participation.

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

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