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Arcos Dorados Holdings Inc. (ARCO) Q4 2018 Earnings Conference Call Transcript

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Arcos Dorados Holdings Inc.  (NYSE: ARCO)
Q4 2018 Earnings Conference Call
March 27, 2019, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Good morning, and welcome to the Arcos Dorados' Fourth Quarter 2018 Earnings Call. A slide presentation will accompany today's webcast, which will be available in the Investors section of the Company's website, www.arcosdorados.com/ir. And as a reminder, all participants will be in a listen-only mode. There will be a opportunity for you to ask questions at the end of today's presentation. Today's conference is being recorded.

At this time, I would now like to turn the call over to Patricio Esnaola, Director of Investor Relations. Please go ahead.

Patricio Esnaola -- Director of Investor Relations

Thank you. Good morning everyone and thank you for joining our earnings call. With me on today's call are Sergio Alonso, Chief Executive Officer; Marcelo Rabach, Chief Operating Officer; and Mariano Tannenbaum, Chief Financial Officer.

Please turn to Slide 2. Before we proceed, I'd like to make the following safe harbor statement. Today's call will contain forward-looking statements, and I refer you to the Forward-Looking Statements section of our earnings release and recent filings with the SEC. We assume no obligation to update or revise any forward-looking statements to reflect new or changed events or circumstances.

In addition to reporting financial results in accordance with Generally Accepted Accounting Principles, we report certain non-GAAP financial results. Investors are encouraged to review the reconciliation of these non-GAAP financial results as compared with GAAP results, which can be found in the press release and unaudited financial statements filed today with the SEC on Form 6-K.

Our discussion today excludes the results of the Venezuelan operation both at the consolidated level as well as for the Caribbean division due to the differences in the exchange rate and inflation in the country. For your reference, we include a full income statement excluding Venezuela with our earnings release. Now I'd like to turn the call over to our CEO, Sergio Alonso.

Sergio Alonso -- Chief Executive Officer

Thank you, Inaki. Good day, everyone, and thank you for joining us today. On this call, we want to update you on the significant progress that we have been making in executing our plan, in addition to updating you on Arcos Dorados' financial performance.

Please turn to Slide 3. Around this time last year, we hosted an Investor Day in New York and shared with you our plans to strengthen our Arcos Dorados' dominant leadership position in Latin America. This strategy is focused on our restaurants, our food, and our people. We have the region's largest restaurant chain and can leverage our leading share in a segment of the informal eating out category, but it's growing faster than any other dining out segment. Our growth plan is attracting more customers more often to our restaurants. This strategy is aligned with McDonald's Global Velocity Growth Plan, and involves open new restaurants as well as physically upgrading and adding digital capabilities to existing ones. We'll focus on being better, not just bigger. These restaurants confirm with the Experience of the Future design and offer modern service features such as self-ordering kiosks and other convenience elements. We're emphasizing an enhanced value experience and growing operating efficiencies over simply expanding our footprint.

EOTF is working. Like our grouping (ph) restaurants, EOTF restaurants also feature in many of menus of high quality meals and desserts for great value. It is giving us a competitive edge and increasing revenues as we intended. We have consistently made investments in bringing our guest to most model environment and the best food and hospitality in the QSR segment.

I'm happy to report that we have already delivered 90 basis points of margin expansion resulting from back-to-back margin improvements with a 120-basis point increase in the fourth quarter. Last year this time, we projected that we would deliver adjusted EBITDA margin expansion of 100 basis points to 200 basis points within two years to three years. In these challenging times, we have been able to reinforce our value for money equation given the efficiencies we're achieving at digital level and through our supply chain, and additionally, we continue to deliver G&A leverage. For the year, our adjusted EBITDA grew 18.9% in constant currency terms, which was well above blended inflation, and a nice increase 3.5% in dollars despite the sharp depreciation of the Brazilian Real and the Argentine peso.

Our SLAD results reflected the strength of our geographic diversification. (inaudible) is also included in the SLAD, and that business in the country produced strong results supporting the stability of the division's margin.

On the cost side of our business, we drove the parallel line down 2 percentage points on revenues in the quarter with favorable productivity gains to our employee scheduling system. We also kept food and paper costs under control and our consolidated G&A expense line was down 9.4% in dollar terms year-over-year.

Now, the execution of our strategy will remain long-term focused and we will continue to emphasize pace, quality and service. These are at the heart of our approach to differentiate the McDonald's brand and offering. And as I said last April in New York, we're always investing in our brand, that's why we gained market share again in 2018 and expect to capture even more this year.

The sales have improved and the Brazil economy was slower than we expected. We are closely monitoring the government's announced initiatives. We remain optimistic that once the reforms are in place, the economy will resume growth. In the meantime, as we mentioned last year, we will turn out the promotional side of our marketing calendar to capture early increases in consumption.

In terms of NOLAD, we're particularly pleased with the result within the Mexico, where we recorded our seventh consecutive quarter of sale increases, which were well above inflation. So I've begun my remarks by describing our growth strategy. We accounted for a big part of Arcos Dorados' improved performance during the second half of the year, and what we're seeing so far in 2019.

So with that in mind, I will turn the call over to Marcelo, who will update you on our investments and the great progress we're making in pulling them in place.

Marcelo Rabach -- Chief Operating Officer

Thank you, Sergio. Please turn to Slide 4. Our three pillar approach is focused on first, creating, inviting memorable restaurants with modern service features; second, offering the best and most appealing menu you can find in the QSR industry in Latin America and the Caribbean; and finally, training employees to deliver the highest quality of service. Across several platforms, these qualities are the essence of our brand and are helping us not only to retain existing customers, but to convert casual ones into committed customers. What does this mean? They are visiting our restaurants over and over again. And by offering value across our menu board, we are regaining customers we have lost to lower tier competitors.

I'll first go over update on this front, where we naturally start with the first pillar, our restaurants. Under the accelerated EOTF deployment plan that we presented in April last year, we set a target of approximately 650 EOTF restaurants by the end of 2019. During the year, every opening in Brazil, Argentina and Uruguay, in addition to restaurants that were modernized brought the total EOTF restaurants to 329 at December 31st. Well, we remain on track to reach our target, and most important, we are seeing the mid-single digit sales lift that we planned for. Let me highlight that we are funding all of these investments with available cash and cash that we generate.

Turning to our food pillar. In Brazil, we continue to expand on our successful signature line with the launch of McPicanha and Duplo Picanha premium burgers. We also added to our McFlurry line-up in the dessert category, new flavors with great (inaudible). A very important initiative that brings our customers closer to the brand food quality standards is Puertas Abiertas or Open Doors. It brings them behind the counter and into our kitchens. Last year, over 2 million Brazilian customers participated in this program and across the region over 3.5 million. We are the only QSR restaurant that proactively opens its kitchens to its customers.

In NOLAD, the launch of the Big Tasty campaign contributed to our objective of growing volumes. We continued with the popular Chipotle Ranch burger, which is part of the Signature Line. Here, we also added to the dessert category with the launch of McColoso and McFloat. Happy Meal also performed well with the Animal Jam and Spiderman properties.

In both, Brazil and NOLAD, we launched Black Friday initiatives with promotions based on iconic products. In SLAD, we launched the Big Mac Baco in the core segment and continued the popular Egg & Bacon premium burger in the Signature Line. We are tying in promotions through our App more and more, which helped mitigate the soft consumer environment in Argentina. Nintendo and Animal Jam featured in the Happy Meal, and the new Snacks platform is doing very well.

Across the Caribbean, the third category performed well, as we continued to introduce new flavors to the classic McFlurry. The launch of the Book of Toy campaign also supported Happy Meal sales. We are very proud of the fact that since 2013, as part of our commitment to promote reading among children and young people, Arcos Dorados has distributed more than 14 million books with Happy Meals across Latin America and the Caribbean.

Regarding people, our Cooltura de Servicio program continues to drive improvement in terms of employee commitment, customer satisfaction and our business results. In a recent survey of our employees, close to 90% said they were very satisfied in their role. This partly explains the significant reduction in crew turnover since 2016, as well as our consistent rankings as the best place to work. For example, we were among the top three in Ecuador, Panama and Uruguay in 2018. Besides productivity gains, these initiatives are also elevating our guest dining experience, resulting in significant improvement in our customer service function scores.

We also continue to make progress with our delivery platform. Delivery is contributing incremental sales and profits overall. At the end of 2018, we offer the delivery service in 10 countries and we recently entered our 11th market. We are the most searched for restaurant brand on the leading delivery apps.

Brazil, our largest market, almost 400 of our restaurants now deliver, compared to 300 at the end of the third quarter. We are the most downloaded app in the QSR space in Latin America, increasing our ability to speak directly to our customers. Our app is now available in all 20 of the territories where we operate with downloads growing to over 21 million from 17 million at the end of the third quarter.

As a result of our innovative marketing efforts, we were recognized by the Mobile Marketing Association as Latin America's mobile marketer of the year. The quality of our creative work coupled with how we are optimizing our media channels is also increasing our media return on investment. We know that we are connecting with our core customers families in the way they want to connect with us, as we have increased our share of the family business. In this segment, our market share is 3 times that of our closest competitor.

Before turning the call over to Mariano, I wanted to highlight an area of innovation that we are excited about. We have been piloting a hand-free payment system in our drive-throughs. This initiative is a partnership with Sem Parar, a hands-free payment system for toll-booths throughout Brazil. Through this exclusive three-year relationship, we have already rolled out hands-free payment of approximately 100 restaurants in the state of Sao Paulo. Consistent with other initiatives to provide faster and more convenient service, we plan to extend this system to many more of our restaurants, across the country.

Slide 5 summarizes the progress made on restaurant openings, bringing us to 2,223 restaurants at the end of the year. Here, you can see details on our footprint by store type as well as company and franchise-operated restaurants.

With that, I will turn the call over to Mariano who will discuss the details of our key financial and operating results with you.

Mariano Tannenbaum -- Chief Financial Officer

Thanks, Marcelo. During our Investor Day last April, we had the opportunity to share with you the results of our turnaround plan as well as our goals and expectations for the coming years. I am very pleased with the progress we made thus far. We closed the year with an adjusted EBITDA of $292 million and the margin of 9.7%, the highest since we became a public company in 2011. Our focus on bringing more guests to our restaurants, more often coupled with our efforts to streamline our cost structure drove an adjusted EBITDA margin expansion of 90 basis points year-over-year. Although, 2018 turned out to be more challenging on the macroeconomic front than we and the rest of the market had anticipated back then, we achieved almost half of our margin expansion goal in less than a year. We continue to gain additional G&A leverage, and most importantly, without compromising on quality or limiting our future growth potential.

Now moving to our fourth quarter results on Slide 6. Starting with our top line, total revenues increased 9.1% in constant currency terms, supported by a 7.5% growth in comparable sales, mainly driven by average check growth, as reported revenues continued to be impacted by the sharp depreciation of the Brazilian Real and the Argentine Peso.

Please turn to Slide 7. Moving on to our cost structure, through the implementation of several cost optimization initiatives, we continued to improve productivity at our restaurants. This resulted in significant savings in payroll costs as a percentage of revenues in all our divisions. Despite our increased level of investments, our G&A expenses decreased by $6.2 million in absolute terms or 9.4% year-over-year, mainly due to higher efficiencies. We also benefited from the depreciation of the Argentine Peso and the Brazilian Real.

Please turn to Slide 8. Adjusted EBITDA in dollar terms decreased 2.2% and increased 13.7% in constant currency, with our margin expanding 120 basis points to 11.7%. Adjusted EBITDA in fourth quarter 2017 benefited from higher proceeds from refranchising activity compared to fourth quarter 2018. If we exclude these proceeds from both periods, the adjusted EBITDA margin would have expanded 190 basis points year-over-year.

Moving to the bottom line, we generated $18.9 million of net income during the quarter compared to $63.9 million in the same period last year. This variation was mainly due to the $35.6 million from redevelopment initiatives in 2017.

Looking at full-year 2018 and excluding costs related to the liability management initiatives that we undertook in March, 2017, we achieved a net interest expense reduction of around $6.5 million per year.

Please turn to Slide 9 for more detail on our divisional results. In Brazil, as we indicated on our last call, we focused on rebalancing growth and profitability. We started to see the results of this mainly toward the end of the quarter and more so in the first quarter of 2019, as we continue to successfully execute our growth strategy.

Moving to SLAD, I would like to highlight that we delivered outstanding results in Chile during the quarter. Our geographic diversification strategy helped to mitigate the impact of strong macroeconomic headwinds in Argentina. Top line performance in NOLAD and the Caribbean remained on track, posting comparable sales above blended inflation in the quarter. The momentum continues in Mexico where we posted our seventh consecutive quarter of strong comparable sales growth.

Please turn to Slide 10. In Brazil, adjusted EBITDA decreased 13.6% in dollars and increased 1.6% in constant currency terms. The margin reached 19.1%, down 30 basis points mainly due to higher refranchising proceeds in the previous year's quarter. Excluding refranchising activity, the margin would have expanded 100 basis points, driven by efficiencies in payroll, royalty fees and G&A.

In NOLAD, our adjusted EBITDA margin contracted 130 basis points, mostly due to the challenging macroeconomic conditions in both Panama and Costa Rica.

In SLAD, our adjusted EBITDA margin remained stable at 8.9%. Adjusted EBITDA in the Caribbean was $8.3 million compared to $5.2 million in 2017. Our margin there expanded 290 basis points, mainly on efficiencies in food and paper costs and G&A expenses.

Turning to Slide 11, as always, we remain focused on driving long-term shareholder value. Not only did we accelerate our CapEx program to support faster EOTF deployment, we also made a dividend payment of $21 million to our shareholders and repurchased shares for a total of $46 million in 2018. Moreover, we continue to maintain a strong balance sheet ending the year with a net leverage ratio of 1.5 times adjusted EBITDA. This was well below our target range of 2 times to 2.5 times. As a remainder, our leverage ratios are calculated using consolidated as reported results.

That concludes the review of our financial and operating results. Sergio has some additional remarks before the Q&A portion of this call. Sergio, up to you.

Sergio Alonso -- Chief Executive Officer

Thanks, Mariano. We're gaining share and growing our business in Latin America through a combination of a focused strategy with many initiatives. We believe that this is the right approach to delivering long-term shareholder value, and in the short term, I am pleased to announce that our Board approved a dividend for 2019 of $0.11 per share.

I always like to finish our quarterly earnings calls with an update and our commitment is capable as this is part of our DNA. Today, I would like to focus on youth employment and equality (ph) , which are among the United Nations sustainable development goals to reduce inequality in the world. As we announced earlier this year, Arcos Dorados expects to employ more than 55,000 team members in Latin America and the Caribbean, an 8% increase compared to 2018. Most important, these jobs provide professional development for the many young people who make up the vast majority of our workforce. This includes the training they receive through our Cooltura de Servicio program and career advancement at Arcos Dorados.

Over last three years, approximately 150,000 of the jobs that we generated in Latin America and the Caribbean were for people between the ages of 17 and 25, including those who belong to vulnerable parts of society. For many of these young people, it's their first formal job. Arcos Dorados remains a catalyst for change in this front. We are expanding our interest through public-private partnerships with various foundations dedicated to significantly reducing youth employment. These include Instituto Ayrton Senna in Brazil; Cimientos in Argentina, Colombia and Uruguay; Forge in Chile and Peru; NEO in Colombia and the International Youth Foundation, which operates globally.

We are also extremely proud to recognized by the United Nations for our best practices in employing and providing opportunities for people with disabilities. This is the highest honor we could win in this area as the company has been investing more and more in social inclusion and development. Arcos Dorados has also been leveraging our scale to encourage reading among children and trusted (ph) family bonding. Since 2013, we have distributed 14 million books to families of Latin America and the Caribbean as part of the Happy Meal Reader Book Program.

And with that, thank you very much for your continued support and let's open the call up for questions. So, operator, please proceed.

Questions and Answers:

Operator

Yes, thank you. We will now begin the question-and-answer session. (Operator Instructions) And our first question today comes from Melissa Byun with Bank of America Merrill Lynch. Please go ahead.

Melissa Byun -- Bank of America Merrill Lynch -- Analyst

Thank you. Can you discuss some of the promotional and marketing efforts in Brazil that -- and going into the first quarter and the level of traction that you're seeing in sales? And then should we be prepared for some margin pressure as a result? Or are there efficiencies or other sources of savings that you think can offset investment? Thanks.

Sergio Alonso -- Chief Executive Officer

Okay, good morning, Melissa. This is Sergio. Thank you for your clear question. Let you recall, when we released the third quarter results in November last year, we anticipated that -- what happened to us back then was the market didn't recover that as we expected and would sort of reacted slowly to that new set of conditions. So we actually changed the profile of our monthly calendar toward the end of the year and we mentioned back then that you should expect effectively well about the significant increase in our comp sales performance, which is happening as we're speaking to you. Of course, we will not disclose Q1 numbers, but you'll see it in Q1 release. As a consequence of that, obviously, there are two forces that are working at the some time. One side would try to mitigate the impact of increasing the promotional component because as you said that creates margin pressures. But we have several levers to offset that pressure and that is what we're doing today and also (inaudible) from Mariano telling.

Mariano Tannenbaum -- Chief Financial Officer

Yes, let me add some color on the answer, Sergio. Hi, Melissa. As Sergio mentioned, we are very pleased with the trend that we were seeing in the first couple of months of this year, and comp sales looks like will be well above inflation for this quarter. And as you know, when we are able to do that, typically, we see leverage in several cost lines in the P&L. So that's -- that's happening and that will help us to support some of the investment we are making through food and paper. And at the same time, we are very confident that our marketing plans for the rest of the year will continue to support restaurant traffic because the increase in sales is coming, both from our check, but from additional traffic. So I think that we are in the right path in the right direction in Brazil and very pleased with the signs that we got in the first couple of months.

Melissa Byun -- Bank of America Merrill Lynch -- Analyst

That's good to hear. Thank you.

Sergio Alonso -- Chief Executive Officer

You're welcome.

Operator

And our next question comes from Robert Schweich with RBM Capital. Please go ahead with your question.

Robert Schweich -- RMB Capital Management LLC -- Analyst

Good morning. The big problem in your reported results has to do with currency. And I don't think there is very much you can do about that, but there is something you can consider that might be somewhat offsetting for stockholders. The effect of the share repurchase program in terms of 6 million shares on a 200 million share base is de minimis. The $0.11 cash dividend possibly is too small considering the earning power of the business and I would suggest that you put more emphasis on a higher cash dividend policy and less on the share repurchase program, as I think that could be a partial offset to the disappointment in reported earnings because of the currency. That's a comment I wanted to make to the entire organization. With regard to the looking forward, I'd like to hear more -- much more discussion on Brazil and the impact of the new political party and how you see this unfolding because the latest information that I'm reading is its popularity has diminished somewhat. But I don't know if that is very significant. And I'd like to hear a lot more comment on that and any comments you want to make on the financial comment I made also would be welcome.

Sergio Alonso -- Chief Executive Officer

Yes, good morning. Thank you Bob and by the way thank you for your comment. And my remark on Brazil situation would be, look, there is a heightened level of expectation in the market about the reform that will be approved by the Congress by mid-year. It is expected that the reform will go through the Congress by June 30, that will bring much more certainty to the current market conditions, and that will help us obviously to revisit the marketing calendar we have. If the economy resumes growth on a higher pace, we may shift back to a more -- previous direction that we used to have, in our actions, that means less promotional activities. Having said all that, the reality is that as Marcelo said in the recent question, what we are seeing so far, it's a very nice recovery in our sales levels and that is adding to our optimism, because we believe that if having the degree of uncertainty that we still have in the market, we are being capable to get these kinds of results in terms of sales growth that we see it a signal of what lays ahead once the reform is approved and that piece of uncertainty is sort of banished, if you will. So things that we cannot control sure are FX, but the reality is that even beyond the FX factor we were able to manage our EBITDA last year and maybe grow 3.5% in spite of all the headwinds that we have had that way, not only in Brazil, but also in Argentina.

Mariano Tannenbaum -- Chief Financial Officer

I'm sorry, let me add one thing. Hi Bob, this is Mariano. Regarding the FX, of course, the depreciation of the real and the Argentine peso has an effect on our -- on our results. Regarding Argentina, always keep in mind, that in Argentina, we have a natural hedge because we have our corporate structure based here. So actually the depreciation of the Argentine peso has an effect on our business, but at the same time, it helps us to reduce, as I mentioned during my speech, that has a positive effect on our G&A. And if you look at our bottom line results, I think we did a wonderful -- a very good job regarding how we managed the business and you can see that in our EBITDA margin, but taking into account that Venezuela is impacting in our results by $50 million in our net income and that has a non-cash nature. So actually, you know, it doesn't affect the cash generation of the business. So without those $50 million on the net income coming from Venezuela, I think the results of the business was not that bad and we were able to overcome the depreciation of the real because the Argentine peso has an effect believe it it's as I mentioned before.

Operator

(Operator Instructions) Seeing that there are no further questions, I'd now like to turn the conference back over to Mr. Alonso.

Sergio Alonso -- Chief Executive Officer

Yes, thank you. Actually before we close or let's say Mariano, as you said a minute ago, the reality is that the results that we're releasing today are heavily impacted by a couple of factors that are clearly beyond our control, currency depreciation being the most relevant, and Venezuela whose results are actually a function of the currency volatility that the markets suffered in 2018. But I believe that the real performance of the business is very different from what our EPS is showing. There is a lot going on today in the company. There is a lot going on in the system. We are speeding up the investment process. We are investing in our restaurant base. We are modernizing at a -- we believe at a very good pace on restaurant base and that is paying off. We've seen the reaction of our customers to those investments and that is creating, I would say, a very realistic deal of optimism in the short-term future of Arcos Dorados. We are managing the business for the long run, that's what we always have done, that is what we always do. We have very talent management team. We have a very robust succession plan as well, and believe me, we will see great results in our business in short term and I believe we have one additional question, it looks like.

Operator

We do Mr. Alonso. And last question comes from Thor Solanes with HSBC. Please go ahead.

Thor Solanes -- HSBC -- Analyst

Hi. Good morning, everyone, and thanks for taking my question. I wanted to ask if you can please share more details on the Mac delivery performance? Maybe how our same-store sales performing in the main markets and what is the share of sales in these markets from this source? Thanks.

Sergio Alonso -- Chief Executive Officer

Okay. Delivery is a market space that is growing very, very fast, but it's not only in our region, but worldwide. We obviously being the leader in Latin America, we have to be part of that business, even though this is not something new for us, in fact, we offer delivery in some of our countries for many, many years. But the reality is what happened is there was a major change in the business model will be now with operation of these companies when we call it three deals, which are the logistic operators, if you will, that created a positive treat to the P&L of this segment and that is why we're moving real quick in this segment. We have, as we said before, 400 restaurants already operating in Brazil and we also have Mexico, Colombia, Costa Rica, Peru, Argentina and Chile are some of the markets and hence growing. It is growing at highest pace, though it is not big in terms of relative terms yet.

We believe that delivery has the capacity obviously to grow over time and we see it as an incremental business. We don't see trading off between customers that actually visit our restaurants and customers that will order delivery in their houses or on a work basis. So Marcelo, can you add to that?

Marcelo Rabach -- Chief Operating Officer

I think that you said almost everything, but I want to emphasize that on top of bringing incremental sales, it's a profitable -- it's a very profitable segment for us. So I think that we have the great kind of deals. We've been with many partners we are working with in the region and we are very confident that this will be a very important driver of our increasing sales and profits going forward.

Sergio Alonso -- Chief Executive Officer

It's actually very small when compared to total volume we do, yet, but with a huge capacity to grow. I believe you will listen about this a lot more in the future, surely.

Thor Solanes -- HSBC -- Analyst

Thank you very much.

Sergio Alonso -- Chief Executive Officer

You're welcome.

Operator

And then at this time, there are no further questions, Mr. Alonso, is there anymore concluding remarks?

Sergio Alonso -- Chief Executive Officer

No, no, thank you. And again, thank you all for your questions, for your attention and have a good day.

Operator

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

Duration: 45 minutes

Call participants:

Patricio Esnaola -- Director of Investor Relations

Sergio Alonso -- Chief Executive Officer

Marcelo Rabach -- Chief Operating Officer

Mariano Tannenbaum -- Chief Financial Officer

Melissa Byun -- Bank of America Merrill Lynch -- Analyst

Robert Schweich -- RMB Capital Management LLC -- Analyst

Thor Solanes -- HSBC -- Analyst

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