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Operator
Good day and thank you for standing by. Welcome to the Universal Electronics Q3 2021 Financial Results Conference call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question and answer session. To ask a question during the session, you will need to press star 1 on your telephone. Please be advised that today's conference is being recorded. If you require... For any further assistance, please press star zero. I would now like to hand the conference over to Kirsten Chapman of LHA Investor Relations. Please go ahead.
Kirsten Chapman
Thank you, Mary, and thank you all for joining us today for the Universal Electronics Third Quarter 2021 Financial Results Conference Call. By now, you should have received a copy of the press release, and if you have not, please contact LHA Investor Relations at 415-433-3777 or visit the Investor Relations section of the website. This call is being broadcast live over the Internet, and a webcast replay will be available for one year at www.uei.com. Any additional updated material, non-public information that may be discussed during this call will be provided on the company's website and will be retained for at least one year. You may also access that information by listening to the webcast replay. During this call, management may make forward-looking statements regarding future events and future financial performance of the company and caution to you that these statements are just projections and actual results or events may differ materially from those projections. These statements include the company's ability to timely develop and deliver new technologies and technology upgrades and related products that will be accepted by our existing customers and attract new customers, including the company's Kwikset family of products and technologies, the Apple TV Remote, Nevo Butler Entertainment and Smart Home Hub, Smart Home Automation, and our voice-enabled, AI-powered, and other advanced technology control products and platforms. The positive traction that management is seeing in the various markets and industries in which it serves coming to fruition as expected by management, including with respect to our HAVC customers. The continued successful collaboration with existing and new customers in developing and introducing new next generation products, operating systems, and technologies, which result in increased sales opportunities for the company. The continued trend of industry moving towards providing consumers with more advanced technologies by offering hybrid platforms, expanded smart home offerings, and interactive services. Management's ability to continue to manage its business via new product development, product mix, and deliveries, increased licensing opportunities, and continued operational and administrative efficiencies to achieve its net sales margins and earnings as guided. Interruptions in the company's supply and logistics chains, including the impact that global shortage of integrated circuits and shipping interruptions and delays could have in causing delays in production and delivery of its products. The impact of the company's financial results that it may experience stemming from issues surrounding its Chinese workforce, And the continued effects that natural disasters and public health crises, including the COVID-19 pandemic, have on our business and management's ability to anticipate and mitigate those effects, including the duration, severity, and scope of the COVID-19 pandemic and its actions and restrictions that may be imposed on the company and its operations by federal, state, local, and international public health and government authorities. The company undertakes no obligation to revise or update these statements to reflect events or circumstances that may arise after today's date and refers you to the press release mentioned at the onset of this call and the documents the company files with the SEC, including this quarter's report on Form 10Q. In management's financial remarks, adjusted non-GAAP metrics will be referenced. Management provides adjusted non-GAAP metrics because it uses them for budget planning purposes and for making operational and financial decisions and believes that providing these non-GAAP financial measures to investors as supplement to the GAAP financial measures help investors evaluate UEI's core operations and financial performance and business trends consistent with how management evaluates such performance and trends. In addition, management believes these measures facilitate comparisons with the core operating and financial results and business trends of competitors and other companies. A full description and reconciliation of the adjusted non-GAAP measures versus GAAP is included in the company's press release today. On the call today are Chairman and Chief Executive Officer Paul Arling, who will deliver an overview, and Chief Financial Officer Brian Hackworth, who will summarize the financials. Then Paul will return to provide closing remarks. It is now my pleasure to introduce Paul Arling. Please go ahead, sir.
Mary
Good afternoon and thanks for joining us. Today, as always, we're delighted to speak with investors. The third quarter 2021 sales improved over those in 2020. However, they were impacted more than anticipated by shipping delays as well as ongoing component shortages. Nonetheless, this quarter we maintained a strong product mix and delivered 30.4% gross margins. which combined with our continued cost controls yielded EPS of $1.03, a third quarter record for UEI. Our mission to create smarter living continues to guide our course of action, focusing on creating products and technologies that help everyday people easily discover and interact with the devices and services in their home. We continue to lead the industry with innovative breakthroughs. Overall, we are pleased with the market acceptance of our product our new product initiatives that we have been working on over the past few years. We are making great progress with our Apple TV 4K Siri voice-enabled search and control device. We designed specifically for multi-channel video program distributors, otherwise referred to as MVPDs. In Europe, already seven operators have launched the product, including major MVPDs such as Deutsche Telekom and Free Telekom, while other operators are set to launch their services with our controller over the course of the next few quarters. Voice-enabled remote controls continue to proliferate as a standard feature within operator platforms. As we have said before, many of these relationships restrict our ability to mention them by name, so we cannot. However, one global operator that we can mention is Astro, Malaysia's leading content and consumer company serving 5.7 million households across TV, radio, digital, and e-commerce platforms. Other customers who are scaling their advanced platform services are Claro in Latin America and Megacable in Mexico, leveraging their newly introduced Android TV deployments. UEI's rich product portfolio in this segment is well positioned, having secured three new Android TV projects in the third quarter with new and existing customers across our global footprint. In the US market, we continue to grow our overall market in voice-enabled remotes by expanding distribution on some of our MVPD customer streaming service platforms. In the TV market, we continue to improve the breadth and depth of our Kwikset deployments across the top three major TV brands globally. The design cycles in this channel are long. As our engineers are currently releasing new software to support 2022 TV models, while designing and developing next generation software features to support 2023 TV models for all our major customers. The new features we are deploying expand our software functionality beyond entertainment control, offering new features and services to also enable discovery management and control of popular smart home devices. As communicated previously, we also began shipping Nevo Butler to our first international telecommunication operator in Europe, where the official product launch is expected to occur around the end of November 2021. The product will serve as a far-field voice controller for their premium video entertainment service. We are extremely excited to see this product come to market and anticipate a very positive consumer reaction. We hope this product introduction will represent an important reference design for other partners to follow. Regarding smart home automation, we see strong evidence that our RF design and development expertise and knowledge of wireless connectivity and control are leverageable assets in this domain. We're excited about our progress to date as we are gaining traction across new and existing customers. In the third quarter, we secured multiple design wins with new HVAC customers as well as new brands in the home appliance segment. Our design wins include smart thermostats, wall controllers, smart home gateways, switches, sensors, and even shade controllers. Typically, these complex and interoperable development projects require longer design and development lead times with related revenues expected in late 2022 and into 2023. The good news is that once introduced these home automation products have extremely long product life cycles that can last up to eight or 10 years. Finally, with the new year just around the corner we're truly excited about CES 2022 at which we will be exhibiting in person in January in Las Vegas consistent with prior years at next year's event. we will introduce a suite of new products and technologies across our home entertainment and connected home categories. In our entertainment space, we will be highlighting our new connectivity products and technologies designed for the next generation of sustainable smart home devices, including a Bluetooth smart chipset that is close to 10 times more energy efficient than currently available platforms. When combined with our energy harvesting solutions, we can deliver an advanced remote control that doesn't need battery replacement. While striving to create more sustainable products that our customers are asking for, we can also enrich the user experience with a range of advanced, power-hungry features such as hands-free voice, network-connected, and ambient-aware backlighting that can run as efficiently as many of today's standard remote controls. We are also extending the capabilities of our standard product platforms to support our latest generation of Kwikset Cloud, allowing for seamless control of both entertainment and smart home devices. Powered by a virtual agent for automated self-help when onboarding or troubleshooting, any of our advanced remote controls, thermostats, and soon, our security sensor lines. In our connected home category, we'll be demonstrating an expanded line of UEI comfort smart thermostats, an extended range of wireless sensors, and the Nevo Butler interacting with smart home devices using Matter, a connectivity standard announced earlier this year and supported by the largest smart home ecosystem providers in the industry. I'll now turn the call over to our CFO, Brian Hackworth, for a review of the financials. Please go ahead, Brian.
Claro
Thank you, Paul. First, I'll review the results for the third quarter of 2021 compared to the third quarter of 2020. Net sales were $155.7 million compared to $153.7 million for the third quarter of 2020. We did grow. However, sales fell below our expectations. We accurately forecasted the impact the chip shortage would have on our production and sales. Although we experienced additional logistical issues in the third quarter, resulted in delayed shipments and missed revenue. While we ultimately expect the situation to improve, issues related to the transportation of goods, such as port congestion, were magnified in the third quarter. We also experienced the indirect effect of certain customers not receiving components or companion products on time, resulting in the push-out of orders originally scheduled for the third quarter. Our gross profit was $47.4 million, or 30.4% of sales. compared to 46.1 million or 30% in the third quarter of 2020. Continuing strength in technology sales, mainly in the form of licensing revenue, more than offset the effects of a weaker dollar and the onset of higher commodity and transportation costs. We expect these inflationary pressures to continue and to have a larger impact on our fourth quarter results. Operating expenses were 30.7 million compared to 29 million for the same period last year. SG&A expenses increased to $23.6 million from $21.6 million in the prior year quarter, with increased freight costs being the largest contributor. R&D expenses were $7.1 million compared to $7.4 million in the prior year quarter. Operating income was $16.7 million or 10.7% of sales compared to $17 million or 11.1% of sales in the third quarter of 2020. Our effective tax rate was 14.8%, compared to 21.4% in the prior year quarter. For the third quarter of 2021, net income was $14.1 million, or a third quarter record of $1.03 per diluted share, compared to $13.1 million, or $0.92 per diluted share, in the same period last year, representing an increase in EPS of 12%. Next I'll review our cash flow and balance sheet. We ended the third quarter with cash and cash equivalents of $58.8 million compared to $57.2 million at December 31, 2020. Cash flow from operations for the three months ended September 30, 2021 was $6.4 million. We repurchased 348,000 shares of our stock at an average price of approximately $50 per share for a total cost of $17.5 million. We continue to believe that the current market price of our stock is significantly below UEI's intrinsic value. Given this and the fact we expect continued strength in free cash flow, on October 20, 2021, our Board of Directors approved a plan to repurchase an additional 300,000 shares, contingent on price, over the next few months. Now turning to our guidance. The current macroeconomic pressures, specifically relating to the shortage of chips and transportation issues throughout the supply chain, have created an uncertain environment. We continue to receive forecasts from our customers, which are discounted because of the supply issues, but we're unable to discern what these forecasts would have been in a normal environment. Once we receive a customer's forecast, we can estimate the effect the chip shortage has on our production and on our sales. However, we're unable to quantify the potential customer pushouts caused by shipping delays for their companion products or part shortages from other suppliers. In addition, logistical issues throughout the supply chain, ranging from trucking, warehousing, and port congestion, have complicated matters, as the situation has grown worse. We've experienced, for example, delays in vessels the past two quarters, which have resulted in missed shipments for the respective quarters. Taking all factors into consideration, for the fourth quarter of 2021, we expect sales to range from $143 to $158 million. compared to $156.4 million in the fourth quarter of 2020. We expect EPS to range from $0.65 to $0.80, compared to $1.14 in the fourth quarter of 2020. We continue to believe in our long-term growth targets of sales between 5% and 10% and EPS of 10% to 20%. I would now like to turn the call back to Paul.
Mary
Thanks, Brian. While it is true that today many industries are facing headwinds due to parts, ports, and even potential inflation, We believe these are temporary conditions. We at UEI have been leading control device technology for over 35 years. We've faced these pressures before, and we are prepared to continue navigating these near-term challenges. What is most important is that we continue to see long-term demand for innovative control solutions in our home entertainment and connected home markets. It is difficult in this environment for any company that relies on semiconductor supply or movement of goods across the world to meet their growth objectives. But we know that these challenges are temporal. Semiconductor companies have already committed more than $100 billion to capacity expansion and are well into the process of building it. While shipping delays have persisted for the past couple quarters, this too should ease as capacity expands to meet demand. Our job remains to continue to build and fulfill long-term demand for our innovative solutions, and we believe we are succeeding and will continue to succeed on that front. We are excited to see that smart home automation control is on the cusp of mass adoption, and we are committed to replicate the successful model that yielded our leadership in home entertainment to achieve the same in connected home automation control. As always, our vision remains focused on our long-term growth potential, and we are confident that we have the technological innovation operational prowess, and financial strength to lead the industry. UEI continues to create smarter living, and we plan to lead our industry for decades to come. As always, stay tuned. Operator, we can now open up the call for questions.
Operator
Thank you. As a reminder, to ask a question, you will need to press star 1 on your telephone. To withdraw your question, press the pound key. please stand by while we compile the Q&A roster. Your first question comes from the line of Jeff Bensinger from V. Riley. Your line is now open.
Jeff Bensinger
Hi, everyone. Wow, that supply chain, huh? A little challenging out there. It is. So can you maybe just is there a way I know it's what this is hard to do. I mean, you got different buckets, your own bucket of, you know, you're getting your own components, then you're looking at, you know, what are the customers, you know, them getting components, but is there a way to give us a sense of how much revenues were impacted by your ability to get your own chips and components in Q3? And, you know, I guess how much you're anticipating in Q4 and, And is it really just kind of the logistics and ports and shipping that have gotten worse, or is it also component availability for manufacturers?
Claro
Yeah, Jeff, I think we were accurate in Q3 with the amount that we embedded in the forecast last quarter. We said 10 million. I think from our perspective, once we get the forecast, we're able to predict with accuracy how much it's going to affect us, because we know what chips we have on hand and And we can make a pretty good estimate as to what we're going to receive in the next coming months. So that was accurate. What makes it difficult is you have customers that are discounting their forecasts, but sometimes they don't discount them enough. So what happened in Q3 is we had more than one situation where customers pushed out orders because they did not receive parts, components, or companion products, such as a set-top box, on time. So they called us and said, listen, we don't have the companion product. We need to push out the orders until the next quarter. So that's happened multiple times now. And the other factor is just not knowing really what, if you take a step back, you say, okay, the forecast we're receiving, how much is that being discounted? Like how much would the forecast have been had there not, you know, if there were not the current situation with chip shortages and port congestion? It's just, there's just a myriad of things going on right now that are complicating things. And it's really difficult to tell what our forecast would have been had we been in a normal environment.
Jeff Bensinger
Okay. And then just sort of putting that aside for a moment, my sense in your prepared comments is that you do not believe that there's any change in the overall long-term demand picture. Is that correct?
Claro
Yeah, that's correct. I think right now what we're doing is I think there could be – compounding effect of people saying, okay, I've been burned. I'm going to take down our forecast. I'm referring to, like I say, our customer forecast to us. And then we're looking at it saying, okay, we've been burned a couple of times now with port congestion and vessels not showing up on time. So I want to perhaps be a little conservative. So it's just I think right now you're having layers of complications, and it's making it very difficult to really predict what the revenue is going to be for a given quarter. That's why I expanded the range a bit. Normally we do a $10 million range. If you notice this quarter, I expanded it to $15 million just because it's definitely a more difficult environment, and I feel it's prudent to expand it by $5 million.
Mary
It's difficult because right now it's just pervasive throughout the system, and you You on this call have all seen it. Even the largest companies in the world, I believe Apple said that their revenue is going to be impacted in Q4. They're the largest company probably in the world, and they are having difficulty getting enough parts to make their product to fully fulfill their demand. Our customers often have multiple products that they institute or deploy into a household And they have to rely on the supply chain of multiple companies. So their planners obviously are having a difficult time because they have to predict the supply chain for each of those vendors. And then as Brian said, they come to the end of a quarter and if they're a few thousand or 500,000 or 50,000 short from one vendor, they probably want to short 50,000 on the other vendor because why have the inventory for one part when you can't deploy the other parts? So it's created this sort of flow through impact. But I think it's important, as I said during the prepared remarks for everybody to remember, we've seen this before, maybe not quite as acutely as now, but we've seen it before. Semiconductor shortages have occurred across my many years here. And what happens is the industry responds. And there are multiple vendors out there spending enormous amounts of money. They're already well into building the capacity. It is going to take a little bit of time. This isn't going to ease in the next three months. It's probably going to take towards the end of next year. We do have specific providers that I can't share with you that have told us that they think that their supply will begin to increase late next year. And then I think, again, the industry gets back to a normalized pattern where these, again, the demand and the supply start to equate. Obviously, they want to supply the chip companies because it's revenue. Right now there's revenue loss in their case because they can't build enough to meet demand. So there will be somebody who wants to build that capacity to fulfill that demand, and it will happen. It's just in semiconductors it takes time. So we're dealing with that. We have redesigned some products. We've switched vendors on a few where we could. We could economically switch to a new vendor who had some supply. That's offset it a little bit. But in today's world, it's short in so many places in the semiconductor industry that there's no way to completely avoid it. And then you couple that with the port slowdowns, which again, we think will clear, but it's taking time. It's taking longer than we would have thought. But once that clears, we'll get back to a more normalized pattern. But for right now, it's difficult, right? It's difficult on supply chain. It's difficult in parts and ports, as I'd like to shorthand it. And we're doing our best. I think the team is doing a good job managing it. But right now, it's just, and again, I don't think we're the only company that is facing this. I think any company, as I said, that is using semiconductors in their products or moving product across the world is experiencing this issue.
Jeff Bensinger
Right. Yeah, it's extremely widespread. And I just wanted to follow up a little bit because I know you made some comments on sort of, you know, cost pressures. Can you maybe just give us a little more color on what you're seeing and anticipating in terms of inflationary cost pressures and I guess how you're thinking about the impact to gross margins going forward there?
Claro
Yeah, I mean, we're seeing cost pressures on a lot of items, chips being one of them. And as Paul noted, eventually you're going to see the supply increase, and I think the laws of economics will kick in and the price will come down. But in the short run right now, you're seeing increases in chips, boards, resin. You've got transistors, resistors. I mean, there's a plethora of component increases, price increases that we've experienced, and And right now, we've been able to stave it off to a large degree. But in Q4, what we're seeing is the old inventory is sold off, and now the current pricing is starting to take effect. So we expect Q4's gross margin to be lower than in Q3. Okay. All righty. Fair enough.
Jeff Bensinger
This, too, shall pass. I appreciate you taking my questions, and I'll let someone else jump in.
Stephen Franco
Thank you.
Operator
Next question comes from the line of Stephen Franco with Collier's. Your line is open.
Stephen Franco
Good afternoon. Paul, not to start with a sore subject, but to revisit the Chinese labor issue, you announced some changes, which is good. Does that leave you here post the big holiday short on workers at that facility or do you have an adequate labor pool now? If you ever got the components you needed to really ramp up production, what's the labor situation like today in your Chinese factory?
Mary
Yeah, the agency that had provided workers from the Xinjiang region, it accounted for about 10% of the labor at that one plant. Uh, we have had to move quickly to move projects, uh, which we've done. And so we can, we can, you know, work with that sort of, it's a, it was disruptive, but you know, it's something that we can move to, uh, uh, to, to, to handle in our supply chain, either through subcontractors or moving to new plants, retooling or moving tools to a new plant, uh, or even within the same plant, uh, with obviously a different set of workers.
Stephen Franco
Brian, what were the customer concentration numbers in the quarter?
Claro
We had two customers that exceeded 10% Comcast and Daikin. Comcast was 14.5% and Daikin was 13.2%.
Stephen Franco
How about, Paul, an update on your HVAC hospitality efforts? Is there a pipeline there that should lead to sales in the next couple of quarters, or do you think that product ramp is a little further out than that?
Mary
Well, yeah, we may start to see some in the next few quarters, but probably more dramatically over time. We have... over the last couple years, maybe not even two years now, began a very concerted effort worldwide. This segment for us, or this business area for us, has typically been centered around Asia, and obviously we've built one of our largest customers in that region, but this is obviously a worldwide business. HVAC is is used everywhere in the world. And we've maintained a specific focus recently on other areas of the world, including here in the United States. And we're making real good headway on that. We'll have more to announce on that as next year progresses. I don't know how early in the year we'll be able to talk about that. We'll obviously have some things to say around CES. We do have a lot of new designs. as I alluded to in the prepared remarks. But, yeah, this is a segment or an area of business for us, the HVAC market, that we're very active in and have been targeting customers across the world and have been making – having design wins in that area in areas other than Asia. So a lot more to talk about on that as the next 12 months unfold.
Stephen Franco
Great. And then back to the supply chain issues, if the situation – any easier with the Android or Apple TV boxes as opposed to the traditional set-top boxes made by folks like Comscope, which is talking all about its supply chain woes on its conference call?
Mary
Yeah, well, I think there are certain of our products, we don't want to get too specific, but there are certain products where obviously the semiconductors involved may not be in as quite a short supply. And it was either due to prior planning that we bought as much as we needed. And even though the lead times are longer today and supply is shorter, we have sufficient parts in some areas. We do have parts in certain areas where we can absorb upward momentum, meaning if the forecast is slightly greater than – I'm sorry, the actual sales are slightly greater than the forecast, we could supply it. Other areas, frankly, even if the demand were up, it would be difficult to supply because the parts are short, and it would be difficult to scratch out an extra 5% or 10% of those parts. But I can't speak on the specific products you're mentioning, but I would say that there are certain products that we have enough supply to be able to absorb a little bit of extra momentum in those areas.
Stephen Franco
Okay, and you talked about some incremental cost pressures that are going to impact Q4, and one assumes at least the early part of next year. Does this prevent you from sustaining a 30% gross margin? You should assume that until those cost pressures ease, it's going to be difficult to get to that level.
Claro
Yeah, no, I mean, it depends. There's so many factors that go into the gross margin. I wouldn't say that it's definitely going to be below 30. I think it could. It's just there's a lot of variables, and right now in Q4, there are some items that could play in the factor from royalties to other factors that could change it by a point, point and a half. So it's difficult to predict. I mean, the one thing I could see coming through is that the higher material costs are coming through. But then there's always the question of how will royalties play out in the fourth quarter. We get subsidies, et cetera, in certain situations. So it really depends. But from a long-term perspective, the answer is definitely no. I don't see any reason why we would not be above 30. In the short run, there's a lot of factors at play. So it could be slightly below 30, but it may not be.
Stephen Franco
Okay, and one more nitpicky question. Your tax rate is often wonky in Q4. What tax rate is factored into your guidance?
Claro
It would be a normalized, I would say, in that 18 to 20 range. Q3, it's lower. We got a tax subsidy, and so it lowered the rate to 14.8, half a million dollars. But in Q4, I expect it to be probably in the normalized 18 to 20 range.
Stephen Franco
Okay, great. Thanks, Brian. Thanks, Paul.
Operator
Your next question comes from the line of Greg Burns from Sidoti & Co. Your line is open.
Greg Burns
Good afternoon. This quarter, Comcast rolled out a new global streaming platform, and they're getting set to launch their own smart TVs. Are you involved in any of those projects?
Mary
We can't confirm involvement in projects until such time as customers would allow us to do that. So we can't comment on that right now.
Greg Burns
Okay. And then the Nevo Butler deployment, is there a pipeline behind that one customer that's getting set to roll out, or do you see that as kind of being like a use case, a proof case for the product that maybe will stimulate demand beyond that?
Mary
Yeah, there are other customers that are looking into it. We don't have any launch projects yet. This will be the first. But as most of these things go, if I look back in time at new developments like this, it typically goes this way. The first party, particularly if it's a relatively large company, and this is, will do this implementation. Others will look with great interest. and as it progresses, those that have been talking to us about these designs already will probably become more favorably disposed to it. We actually saw this on the original voice remotes as well, that there was a lot of development work being done on it, but no firm commitments to projects. And then as soon as the first customer comes out and they see the effect of it, everything takes place after that. So this may be similar to that. That's our hope. And, you know, as they put this out, they have plans to launch. We'll probably at some point be able to talk about it more. And then, you know, we'll take it from there.
Greg Burns
Can you talk about how they're planning on using it? Is it like whole home control or just, you know, a replacement for remotes for AV control? How do they...
Mary
envision, um, it won't necessarily be a replacement. We can't give you all the details yet because again, they haven't launched, but clearly we can tell you that it's a far field product that will, uh, will, will completely do your entertainment control and will have capabilities to do many other things that we're going to let our customer, uh, decide, uh, exact rollout and announcement of all those features. But clearly, it's an extremely capable product, far-field. It can go way beyond home entertainment control. But what we're able to announce right now is a complete home entertainment controller that is far-field.
Greg Burns
Okay, great. Thank you.
Operator
I'm not showing any further questions at this time. I would now like to turn the call back to your speakers for any further remarks.
Mary
Okay, thank you for joining us today and your continued support of UEI. We hope to see you at several upcoming investor events. We plan to present at Imperial Capital's Annual Security Investor Conference in December, Needham's Annual Growth Conference in January. Also, we'll be at CES in person in January and would be delighted to see you. Please contact LHA Investor Relations to arrange a meeting if you happen to be in Vegas January for CES. Thank you and have a great day.
Operator
This concludes today's conference call. Thank you for participating. You may now disconnect.
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