Soft Tyranny?

This note was originally published at 8am on October 24, 2013 for Hedgeye subscribers.

“The will of man is not shattered, but softened, bent, and guided…”

-Alexis de Tocqueville


If we need a French guy to tell us what, precisely, is wrong with an un-elected US Federal Reserve whose Chairman has unlimited power over both the value of your currency and rate of return on your savings, so be it.


“… men are seldom forced by it to act, but they are constantly restrained from acting. Such a power does not destroy, but it prevents existence; it does not tyrannize, but it compresses, enervates, extinguishes, and stupefies people, till each nation is reduced to nothing better than a flock of timid and industrious animals, of which government is the shepherd.”


Isn’t it sad? But which part is the saddest? Is it the cowardice in free-market leadership, or the groupthink grounded in how much people will pander to a man that gets them paid? I don’t know anymore. I read this Tocqueville passage at a picnic table at a rest stop in Maine last night. I lit up a cigar, and I felt like I was going to puke.


Back to the Global Macro Grind


The thought of Gold ripping and #GrowthSlowing because an un-accountable central planner doesn’t allow economic gravity to get marked-to-market makes me sick to my stomach. I run a small business in America. I have a payroll to meet and people to inspire – it gets a lot tougher when the economy slows than when it’s accelerating.


Not that anyone in Washington cares, but I’ll be fine. I started this firm during the thralls of 2008 when Bernanke thought the “shock and awe” rate cuts to 0% were going to save government from itself. So I can take a P&L punch. But if the buck keeps burning and rates keep falling, Bernanke, Obama, and “progressive” Republicans are going to knock some people right out.


I don’t agree with everything he says or thinks, but I think Mark Levin has this part of it right: “The nation has entered an age of post constitutional soft tyranny” (The Liberty Amendments, pg 4). And I’m not talking about politicized social issues or anything outside of my domain of required reading – I’m talking about the economy and markets.


How else would you describe a market that hangs on every breath of what an un-elected body @FederalReserve says and/or hints next? Forget the soft stuff – this is hard core tyranny.


So, after being the US #GrowthAccelerating bulls for the better part of the last year, how do we reposition for?


1.       Down Dollar

2.       Rates Falling

3.       #GrowthSlowing


Whether you like the probability of these things occurring or not, it’s officially rising. But you already know that. You can see the “growth style factors” in your portfolio slowing.


Yesterday’s US stock market correction (from the all-time highs) was led by the Financials (XLF). The only S&P Sectors in our 9 Sector Model that were up on the day were the 2 slowest growth sectors – Utilities (XLU) and Consumer Staples (XLP).


What else has been working this week?

  1. Gold
  2. Bonds
  3. Volatility

Isn’t that just great? Think about that for another few seconds – AT THE ALL-TIME HIGH IN THE US STOCK MARKET, GOLD, BONDS, and VOLATILITY WENT UP! And CNBC’s big government access ratings hit new lows.


This has never happened before…  that’s why it “enervates, extinguishes, and stupefies people.”


Why has it never happened before? That’s easy. We have never been at these all-time highs before – and the Bush/Obama Bernanke legacy now has plenty of “this time is different” economic policy that history will have plenty of time to review.


Is this time really different? Is it still 2008? Or do the people in Washington who are plundering your currency for political gain look like they are living through Bernanke’s said 1936 depression?


Or is it 2013 – the year when de Tocqueville finally nails it on US monetary policy being that soft tyranny that we are all so numb to that we just allow it to exist?


2013 FACT: as US economic growth accelerated (Dollar Up, Rates Up), the bond, currency, and stock markets all had this right. That’s why Gold got tapered. On September 18th, 2013, Ben S. Bernanke restrained market forces from acting as they were.


I don’t think torching the currency, starving savers or a risk free-rate of return, and trying to arrest economic gravity ends well for Americans. That’s why I went to 58% cash yesterday and I still feel like I am going to puke.


Our immediate-term Global Macro Risk Ranges are now as follows:


UST 10yr Yield 2.47-2.60%

SPX 1728-1754

VIX 12.01-14.62

USD 78.99-79.98

Euro 1.36-1.38

Gold 1316-1341


Best of luck out there today,



Keith R. McCullough
Chief Executive Officer


Soft Tyranny? - Chart of the Day


Soft Tyranny? - Virtual Portfolio

RL: We're Concerned

Takeaway: We give the print a C, quality of EPS = D- and cash conversion = F. If you doubt RL is in serious transition, this conf call is your proof.

CONCLUSION: We did not like RL's quarter one bit. Almost every line of the P&L failed to impress us, and the erosion in the cash cycle further impeded RL's ability to convert GAAP profit to cash.  Though CFO Peterson crushed it on the call, Roger Farah was definitely missed. We took our numbers down to be about in-line with RL's guidance. This is the first time in nearly a decade that we don't have confidence that RL will meaningfully beat expectations. We need a sit-down with management to reignite our confidence in the story.


This quarter did nothing to ease our growing concerns about RL. We were upbeat into the print, but despite the beat, we did not like the quarter one bit. Specifically…

  1. RL technically beat the quarter -- with EPS of $2.23 versus the consensus at $2.20. But by our math, it had a $0.09 tax benefit relative to expectations. We call that a miss.
  2. Sales were up only 2.8%, but the company somehow managed to translate that to EBIT down 15%. Yes, there was a business model change with its Chaps business moving from Licensing to Wholesale -- and FX hurt as well. But even excluding those items operating cash flow was down.
  3. Inventories were up 15%, or nearly 6x the rate of sales growth. That amounts to seven more days inventory on hand than a year ago. That would maybe be palatable, but last year's DIH was up a whopping 17 days. In other words they had an easy comp and couldn't comp it.
  4. On the plus side, Receivables were down 4%, which is great. Unfortunately, the DSO decline was entirely offset by weaker payables. In the end, the cash conversion cycle (DSO +DIH less DPO) came crashing in at 137 days -- up 7.7 days vs last year. This marks the worst 2Q cash cycle in 13 years.
  5. One thing we still don't get is how net PP&E came in at $1.28bn -- a 36% sequential increase, or $336 million.  That's the size of RL's entire capex budget this year. And in fact, it spent $148mm this quarter. Perhaps there's a simple answer that we're just unaware of, but it's rare to see PP&E go up 2x the rate of capex. (Chaps closed in 1Q, not 2Q -- so that shouldn't explain it).
  6. Comps at retail stores were down 1%. Bulls will point to the fact they'd have been up 1% excluding FX. But is +1% really anything to be bullish about?
  7. Roger Farah was not on the call. I guess that was inevitable given that he's operating in a diminished role versus the past 10+ years. But for anyone wondering about his level of involvement in the day to day operations of the company, his absence from the call sent a pretty clear signal. It's possible that he chose to abstain in order to give more limelight to Jackie Nemorov, as Roger's presence on the call might have undermined her role to the employee base. But still, it clearly tells the Street that he's handing over the reins.
  8. As for Jackie Nemorov, we'd give her a C+ for how she came across on the call and the confidence that we think she instilled in the investment community. Seriously, did we have to hear about why it's a good idea for us to buy our wives a Ricky bag? Or that the company hosted a fashion show for dogs this quarter?  The answer there is a big No from our perspective.  She should have used her Presidential debut as a venue to highlight her precision on the numbers and focus on a smaller number of key big ideas. The sad thing is that we think that Nemorov is extremely competent, and is a very good leader internally. But it did not come across on the call.
  9. At risk of playing favorites, we think that Chris Peterson was absolutely fantastic on the call. He gets an A+. He was crisp, clear, confident, and answered every question in a way that both gave good insight into the company, but also furthered RL's agenda. It's amazing to thing that he has only been the CFO of a publicly-traded company for a year.  Truth be told, if Peterson was not at RL, we'd be extremely negative on it right now. His presence numbs the blow of Farah stepping back to a huge extent.
  10. Its SIGMA trajectory is horrendous. Last quarter was bad enough when margins turned down by 260bp, but at least inventories were somewhat manageable (-5% relative to sales). But in 2Q14 we saw a 330bp erosion in margins on top of a -12% erosion in the inv/sales ratio.  As a point of reference, it's been 14 quarters since RL's sales/inventory spread has been positive.
  11. The biggest plus is that we're likely to see a 25% acceleration in growth over the next two quarters. Chaps coming online to RL's wholesale division is a big help, and it looks like Europe is finally in a good enough place to start taking more inventory. In addition, Peterson made it clear on the call that the first two months of the quarter were weak, but September was significantly stronger. That's a trend that is impossible to ignore.


RL: We're Concerned - 11 6 2013 3 24 36 PM




RL: ST and LT Calls Are Very Different



CONCLUSION: We have a bifurcated view on RL right now. We like it from both a TRADE and TREND perspective, as expectations are too low headed into Wednesday's print, as RL guided to a msd decline in EPS, but in reality they’re going to post EPS growth of at least 1,000bps higher. Furthermore, the company will begin to show a meaningful acceleration in EPS growth over the next two quarters (near 30%) that should put it in the top decile of earnings growers in retail.


But from a TAIL vantage point, we're far less constructive. As much as we like how the company is executing on its long-term initiatives (international expansion,, and real estate), we're concerned about the recent changes in the C-suite. In the end, our degree of confidence in how the company will be executing three-years out is partially diminished.



So why are we concerned about management? Roger Farah shifting 50% of his time away from the company simply does not sit well with us.  The fact is that Roger has been incredibly effective over the past decade. Ralph might be the CEO, but Roger has basically executed on everything that is outside of the creative side of the organization. Yes, it's a positive that the company still has him given that it was a risk that he'd leave entirely. But we just don't buy the concept of a part-time COO. The way we see it, you're ether in or you're out. It's like being half pregnant.


On the flip side, the promotion of Chris Peterson is a big positive. He's one of the top 5 retail CFOs we've met -- which says a lot. At P&G he was heavily responsible for parts of the organization outside that of a traditional CFO (and his division of P&G was 5x the size of RL).


Similarly, Jackie Nemerov, who was also promoted and reports directly to Ralph Lauren, is far more capable than many on Wall Street likely give her credit for. There's no one at the company (perhaps with the exception of Ralph himself) who has earned more respect and loyalty by her direct and indirect reports. In the end, as incredibly effective as Roger has been over the years, the reality is that some of that was likely Nemerov adding to the size of his halo.


Lastly, we need to consider Ralph Lauren himself. He's one of the more successful CEOs in retail, and has created one of the best brands in apparel. But we can't ignore the fact that he just turned 74. There's not a whole lot of CEO's in the S&P that are over 70. In fact, there are only 14 CEOs in America who are older than 74. Not that there is a set formula for when a person needs to stop working, but it’s worth noting that the average retirement age for CEOs is between 60-65.


We're not questioning Mr. Lauren's competence. How could we? But he's such a powerful force inside the company, and the likelihood of him being the boss in another five years -- at least in his current capacity -- is not too great. We don't have a problem with this at all. But where we're more concerned is that we're not sure the Board has any clear succession plans for Mr. Lauren. That's probably because the Chairman of the Board is also the CEO -- and he has no plans to go anywhere anytime soon.


In the end, there are two things that are certain; 1) The company is executing and has increasing momentum in its business, but 2) The company is undergoing the most significant period of transition in the executive offices that RL has seen since before 2000. 

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Takeaway: Management commentary on October and CY4Q13 comps.


Management Commentary - “Still, given our year-to-date results and more cautious outlook on the fourth quarter, we are revising our full year outlook as Jim will review.”


“Now, turning to our outlook, we are updating our annual expectations based upon the results to-date and the more conservative view regarding the fourth quarter.  Specifically, we although have lowered our range for revenues to between $410 million and $413 million and our comparable sales estimate to between minus 3% and minus 3.5%.”

Commentary on the month of October: “As of last weekend, the BRIO was negative 2.9% and the BRAVO! was slightly better than that.”


HEDGEYE – The Hedgeye Restaurant Dashboard is a flashing red sell signal.  What would you pay for a casual dining company with little to no revenue growth, low returns, and burning cash?




Management Commentary - “Based on the continued sluggish economy and the industry data we are seeing today, we expect the casual dining industry in general to remain challenging for at least the end of this year and most likely into early next year.


However, as I previously mentioned, we have seen our recent comparable restaurant sales trends improve.  To date, through the first three weeks of October, our comparable restaurant sales are down just slightly at minus 0.5% or so.  More importantly, we are seeing this improving trend despite having less menu pricing in October than we have had all year.  Our current menu pricing is a little over 1%.  So, for the first three weeks of October, we are seeing about a 200 bps improvement in our guest traffic, compared to the third quarter.


I do want to remind everyone that this is only for the first three weeks of October and it is always difficult to ascertain a trend in the restaurant business after a few weeks.  Also, our most productive sales time in the fourth quarter starts in December and October tend to be a slower overall period for us.”


HEDGEYE – BJRI reported 3Q13 same-store sales of -2.2%; on a 2-years basis, same-store sales declined 210 bps to +0.1%.  Expectations are for accelerating trends in 4Q13 on more difficult comparisons.  The Hedgeye Restaurant Dashboard remains bearish on BJRI.  While management is bullish on the long term outlook for the company, its growth prospects have diminished significantly over the past two years.  A healthy Chili’s has been taking market share from BJ’s and management has not responded to the increased competitive threat.  We believe the company needs to significantly slow down unit growth in order to fix the profitability of the company. 




Management Commentary - “We exited Q3 with strength which, which continues and expect all four of our concepts to positively contribute to make Q4 our strongest core domestic comp of the year.”


“…this is a choppy environment and we exited Q3 with real strength which has continued through Q4 and we’re very, very pleased and that’s continued across all of our concepts.  As we look at Q4, we feel very good about what we’re seeing and the levers at our disposal.”


“The company is revising its comparable restaurant sales growth expectations for 2013 from at least 2.0% with positive traffic to at least 1.5% with positive traffic.”


HEDGEYE – BLMN reported 3Q13 same-store sales of -0.3%; on a 2-year basis, same-store sales declined 50 bps to +1.7%.  BLMN has set the bar very high for 4Q13, with expectations for +2.0% or better same-store sales.  Given industry conditions, we generally believe the company will have a difficult time delivering next quarter.




Management Commentary - “For the first four weeks of the fourth quarter, same-store sales are trending at 5.3% at company-owned restaurants and 3% at franchise locations.  For comparison purposes, same-store sales trends for the first four weeks in the fourth quarter last year were 3.8% at company-owned restaurants and 5.6% at franchise locations, and for the full fourth quarter of 2012 were 5.8% at company-owned and 7.4% at franchise locations.”


HEDGEYE – BWLD reported 3Q13 same-store sales of +4.8%; on a 2-years basis, same-store sales accelerated 90 bps to +5.5%.  Expectations are for decelerating trends in 4Q13 on easier compares.  We have stayed away from making a call on BWLD for the better part of this year.  BWLD screens favorably on the Hedgeye Restaurant Dashboard.  Lower wing prices are helping margins, while sales trends appear to be holding up better than most.  BWLD has captured a significant opportunity in the “Sports Bar” theme segment of the casual dining space. 




Management Commentary - “As to comparable sales, while the industry is still weak, we are outperforming on a relative basis, and we expect this to continue in 2014.  Economic forecasts continue to show a slow rate of growth.  Nonetheless, we think it’s reasonable to set the high end of our comparable sales range at 2%, which does represent a sequential acceleration from 2013.”


HEDGEYE – CAKE reported 3Q13 same-store sales of +1.7; on a 2-years basis, same-store sales decelerated 40 bps to +1.3%.  Expectations are for accelerating trends in 4Q13 on more difficult compares.  We recently removed CAKE from the Hedgeye Best Ideas list, but continue to feel that CAKE is one of the strongest, best positioned companies in the restaurant space.  The Hedgeye Restaurant Dashboard continues to flash a positive bias, and we will be looking to add the stock back to the Best Ideas list on weakness.




Management Commentary - “What’s the one thing we’ve been able to hang our hat on for a while right now is the consistency of our traffic comps and specifically our same-store sales.  As we finish the last year, in the fourth quarter, we had our best quarter of 2012 which really finished the year in the fourth quarter of 2012 up around 3.1%.  We’ll continue that trend all year luckily, for us and then that’s about – a third of that is customers, the rest is price and we’re seeing that through the one period in the fourth quarter that trend continues.  And, again, we’re up against our best quarter from a year ago though.”


HEDGEYE - CHUY reported 3Q13 same-store sales of +3.1; on a 2-years basis, same-store sales accelerated 30 bps to +2.3%.  Expectations are for accelerating trends in 4Q13 on more difficult compares.  CHUY’s is a strong regional player in the casual dining segment.  The company must continue to grow into a very large multiple.  The Hedgeye Restaurant Dashboard has a positive bias on CHUY.




Management Commentary - “Turning to our outlook, we are fine-tuning some of our full year guidance, which I’ll remind you is a 53-week fiscal period that concludes with a 17-week fourth quarter that began on September 4th.  First, in view of our year-to-date performance, particularly at Sullivan’s, and continued macro uncertainty, we are lowering our expectations for total comparable restaurant sales to positive 1% to 1.5% on a 52-week versus 52-week basis.


This does imply stronger comparable sales growth in the fourth quarter versus earlier in the year, but we remain cautious given the current macro environment.  Despite this caution, we do have several favorable factors within our control in the fourth quarter.  In addition to the blended 1.8% price increase previously mentioned, we do have additional patio seating versus last year that we can better utilize in the cooler fall season as well as some additional private dining seats as we enter the holidays.  Additionally, barring any late season weather concerns, we will have a favorable comparison relative to last year’s Hurricane Sandy impact in the Northeast.”


HEDGEYE – On a consolidated basis, DFRG reported 3Q13 same-store sales of -0.3%; on a 2-years basis, same-store sales accelerated 160 bps to +1.7%.  Expectations are for accelerating trends in 4Q13 on easier compares.  The Hedgeye Restaurant Dashboard is flashing a negative signal on DFRG.  We would stay away. 




Management Commentary - “And finally onto our revised guidance for the year.  Applebee’s domestic system-wide same restaurant sales are expected to range between minus 0.5% and plus 0.5%.  IHOP domestic system-wide same restaurant sales are expected to range between plus 2% and plus 3%, reflecting a continuation of IHOP’s positive momentum.”


“…I think the environment is lumpy and bumpy, and I think it will continue to be lumpy and bumpy.  So I don’t think we were particularly surprised at any time this year.  We said at the beginning of the year it’s going to be lumpy and bumpy.  We focus almost exclusively on what we can do to differentiate both brands, both innovatively, creatively and working with our franchisees.  So that has been our maniacal focus.”


HEDGEYE – DIN is a classic asset light model with little or no growth operating in a casual dining segment in secular decline.  On a system-wide basis, Applebee’s reported 3Q13 same-store sales of -0.4%; on a 2-years basis, same-store sales accelerated 20 bps to +0.8%.  Expectations are for accelerating trends in 4Q13 on easier compares. 




Management Commentary - “This year’s off to a challenging start, as evidenced by our first quarter results.  Consumers continue to navigate the new macroeconomic elements and adjust their allocation of disposable income.  And we see this challenging environment continuing in the near term with industry traffic remaining weak.


Of course, we’re not immune to what’s impacting the industry and there remains significant uncertainty around what the coming year might hold for the consumer.  But based on the current situation, our best projection sees full-year fiscal 2014 Brinker comparable restaurant sales growth between negative 1% and positive 1%...  This sales projection represents an acceleration compared to our first quarter results, but it comes with the background of a second quarter that is off to a good start.”


HEDGEYE – Chili’s reported 1Q14 same-store sales of -1.6%; on a 2-years basis, same-store sales decelerated 20 bps to +0.6%.  Expectations are for accelerating trends in 4Q13 on easier compares.  We continue to believe that EAT is one of the best run companies in the casual dining space and the Hedgeye Restaurant Dashboard is flashing a moderate positive bias. 




Management Commentary - “Our Q4 guidance reflects positive same-store sales of approximately 3%, excluding the impact of remodels, as we continue to build upon the positive traffic trends we saw in Q3.  The 3% comp guidance is based upon quarter-to-date sales trends and what we forecast for the remainder of the quarter.”


HEDGEYE – KONA reported 3Q13 same-store sales of +2.6%; on a 2-years basis, same-store sales decelerated 100 bps to +1.4%.  Expectations are for accelerating trends in 4Q13 on easier compares.  The Hedgeye Restaurant Dashboard suggests that KONA’s trends are stable, but we would not own the stock here.




Management Commentary - On Joe’s Crab Shack: “Positive trend continues into the fourth quarter with positive comparable sales through October in the mid to high single-digits, off to a very good start.”


On Brick House Tavern: “The strong sales trends have continued into the fourth quarter there as well with Brick House comp sales through October also running mid to high single-digits.”


On Macaroni Grill: “Our early fourth quarter results, however, show volatility.  It’s inherent to turn around as comp sales have slowed in October.”


HEDGEYE – IRG is just another small-cap restaurant company that should not be public.  The Hedgeye Restaurant Dashboard is flashing a red sell signal for IRG.




Management Commentary - “With only two months left in the year, we’re obviously confident that we’ll exceed our initial 2013 guidance we issued back in February.  And believe that we have the initiatives in place to outpace our peers in the fourth quarter.  The overall outlook for casual dining, however, is fairly pessimistic in the near term with consumer confidence down and little expected improvement in employment, retail sales or discretionary spending in restaurants.


Based on the 4.2% comparable sales growth for the first three quarters of the year, we expect comparable sales growth for the full year to end somewhere close to 4%, implying about 3.5% growth in the fourth quarter.  We remain concerned about the weak industry trends, the one less weekend and fewer shopping days between Thanksgiving and Christmas compared to last year, and an intensifying competitive environment.  Further, remember we rolled off 90 basis points of price in October, so Q4 will be carrying 140 basis points of price increases.”


“So, I think really fourth quarter for us, we expect to be a little bit of the same, still continued choppiness, we expect competitors and we’ve seen some competitors get even more aggressive, so we’re a little bit nervous about that.  And just with the fewer shopping days and I’m not sure when the political noise will heat back up for the January fight, but that starts hitting into December again.  We are just being pretty cautious on our outlook.”


HEDGEYE – RRGB reported 3Q13 same-store sales of +5.7%; on a 2-year basis, same-store sales accelerated 80 bps to +3.4%.  Expectations are for decelerating trends in 4Q13 on difficult compares.  The company has done an amazing job delivering positive traffic in 3Q13 in light of the challenging environment.  The Hedgeye Restaurant Dashboard is flashing green on RRGB.




Management Commentary - “We anticipate same-restaurant sales to be down high single digits in the second quarter, with sequential improvement in the third and fourth quarter, including positive same-restaurant sales in the fourth quarter, reflecting traction from our new menu offerings and marketing campaign.”


HEDGEYE – RT reported 3Q13 same-store sales of -11.4%; on a 2-years basis, same-store sales decelerated 90 bps to -4.8%.  Expectations are for accelerating trends in 4Q13 on easier compares.  The Hedgeye Restaurant Dashboard is flashing a sell on RT.  This company is in serious trouble and will likely need to close more than one hundred stores as part of a massive restructuring.  




Management Commentary - “Our comparable sales growth trends have slowed modestly in the fourth quarter, in part we believe due to financial uncertainty around the government shut down.  Despite this, we are pleased to note that thus far in the fourth quarter, our comparable sales trends have remained positive in the low-to mid-single-digit range.”


HEDGEYE – RUTH reported 3Q13 company-owned same-store sales of +4.2%; on a 2-years basis, same-store sales decelerated 20 bps to +5.1%.  Expectations are for decelerating trends in 4Q13 on easier compares.  The Hedgeye Restaurant Dashboard is flashing a positive bias on RUTH.    




Management Commentary - “Our top-line momentum has continued with comparable sales growth of 3.4% for the first four weeks of the quarter.”


“…we continue to be very focused on balancing short-term pressures with long-term positioning.  As such, we are likely looking at implementing somewhere around a 1.5% menu price increase in December.”


HEDGEYE – TXRH reported 3Q13 same-store sales of +2.8%; on a 2-years basis, same-store sales decelerated 120 bps to +3.4%.  Expectations are for accelerating trends in 4Q13 on more difficult compares.  The Hedgeye Restaurant Dashboard is flashing a negative bias on TXRH.  A significant increase in capital spending in 3Q13 is raising a red flag.



Source: Company Releases, Unofficial Bloomberg Transcripts



Below, is our Hedgeye Sales Monitor for the casual dining sector.  Same-store sales are color coded green, if above, or red, if below, the sub-sector's mean.  2-year averages are color coded green, if accelerating, or red, if decelerating, on a sequential basis.









Howard Penney

Managing Director


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The total percentage of successful long and short trading signals since the inception of Real-Time Alerts in August of 2008.

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