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The Company’s policy to include interest and penalties related to unrecognized tax benefits within the provision for income taxes did not change as a result of adopting FIN 48.
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As of the date of adoption, the Company had accrued $203 million for the gross interest and penalties relating to unrecognized tax benefits.
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As of December 29, 2007, the total amount of gross interest and penalties accrued was $213 million, which is classified as non-current liabilities in the Condensed Consolidated Balance Sheet.
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The Company is subject to taxation and files income tax returns in the U.S. federal jurisdiction and in many state and foreign jurisdictions.
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For U.S. federal income tax purposes, all years prior to 2002 are closed.
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The years 2002-2003 have been examined by the Internal Revenue Service (“IRS”) and disputed issues will be taken to administrative appeals.
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The IRS is currently examining the 2004-2006 years.
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In major state jurisdictions and major foreign jurisdictions, the years subsequent to 1988 and 2000, respectively, generally remain open and could be subject to examination by the taxing authorities.
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Management believes that adequate provision has been made for any adjustments that may result from tax examinations.
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However, the outcome of tax audits cannot be predicted with certainty.
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Should any issues addressed in the Company’s tax audits be resolved in a manner not consistent with management’s expectations, the Company could be required to adjust its provision for income tax in the period such resolution occurs.
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Although timing of the resolution and/or closure of audits is highly uncertain, the Company does not believe it is reasonably possible that its unrecognized tax benefits would materially change in the next 12 months.
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Note 5 - Shareholders’ Equity Preferred Stock The Company has five million shares of authorized preferred stock, none of which is issued or outstanding.
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Under the terms of the Company’s Restated Articles of Incorporation, the Board of Directors is authorized to determine or alter the rights, preferences, privileges and restrictions of the Company’s authorized but unissued shares of preferred stock.
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Comprehensive Income Comprehensive income consists of two components, net income and other comprehensive income.
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Other comprehensive income refers to revenue, expenses, gains, and losses that under U.S. generally accepted accounting principles are recorded as an element of shareholders’ equity but are excluded from net income.
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The Company’s other comprehensive income consists of foreign currency translation adjustments from those subsidiaries not using the U.S. dollar as their functional currency, unrealized gains and losses on marketable securities categorized as available-for-sale, and net deferred gains and losses on certain derivative instruments accounted for as cash flow hedges.
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The following table summarizes components of total comprehensive income, net of taxes, during the three-month periods ended December 29, 2007 and December 30, 2006 (in millions): The following table summarizes activity in other comprehensive income related to derivatives, net of taxes, held by the Company during the three-month periods ended December 29, 2007 and December 30, 2006 (in millions): The following table summarizes the components of accumulated other comprehensive income, net of taxes (in millions): Employee Benefit Plans 2003 Employee Stock Plan The 2003 Employee Stock Plan (the “2003 Plan”) is a shareholder approved plan that provides for broad-based grants to employees, including executive officers.
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Based on the terms of individual option grants, options granted under the 2003 Plan generally expire 7 to 10 years after the grant date and generally become exercisable over a period of four years, based on continued employment, with either annual or quarterly vesting.
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The 2003 Plan permits the granting of incentive stock options, nonstatutory stock options, RSUs, stock appreciation rights, stock purchase rights and performance-based awards.
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As of December 29, 2007, approximately 55.6 million shares were reserved for future issuance under the 2003 Plan.
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1997 Employee Stock Option Plan In August 1997, the Company’s Board of Directors approved the 1997 Employee Stock Option Plan (the “1997 Plan”), a non-shareholder approved plan for grants of stock options to employees who are not officers of the Company.
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Based on the terms of individual option grants, options granted under the 1997 Plan generally expire 7 to 10 years after the grant date and generally become exercisable over a period of four years, based on continued employment, with either annual or quarterly vesting.
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In October 2003, the Company terminated the 1997 Plan and no new options can be granted from this plan.
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1997 Director Stock Option Plan In August 1997, the Company’s Board of Directors adopted a Director Stock Option Plan (the “Director Plan”) for non-employee directors of the Company, which was approved by shareholders in 1998.
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Pursuant to the Director Plan, the Company’s non-employee directors are granted an option to acquire 30,000 shares of common stock upon their initial election to the Board (“Initial Options”).
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The Initial Options vest and become exercisable in three equal annual installments on each of the first through third anniversaries of the grant date.
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On the fourth anniversary of a non-employee director’s initial election to the Board and on each subsequent anniversary thereafter, the director will be entitled to receive an option to acquire 10,000 shares of common stock (“Annual Options”).
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Annual Options are fully vested and immediately exercisable on their date of grant.
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As of December 29, 2007, approximately 370,000 shares were reserved for future issuance under the Director Plan.
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Rule 10b5-1 Trading Plans Certain of the Company’s officers, including Mr. Timothy D. Cook, Mr. Daniel Cooperman, Mr. Jonathan Ive, Mr. Peter Oppenheimer, Mr. Philip W. Schiller, and Dr. Bertrand Serlet, have entered into trading plans pursuant to Rule 10b5-1(c)(1) of the Securities Exchange Act of 1934, as amended (“Exchange Act”).
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A trading plan is a written document that pre-establishes the amounts, prices and dates (or formula for determining the amounts, prices and dates) of future purchases or sales of the Company’s stock including the exercise and sale of employee stock options and shares acquired pursuant to the Company’s employee stock purchase plan and upon vesting of RSUs.
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Employee Stock Purchase Plan The Company has a shareholder approved employee stock purchase plan (the “Purchase Plan”), under which substantially all employees may purchase common stock through payroll deductions at a price equal to 85% of the lower of the fair market values as of the beginning and end of six-month offering periods.
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Stock purchases under the Purchase Plan are limited to 10% of an employee’s compensation, up to a maximum of $25,000 in any calendar year.
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The number of shares authorized to be purchased in any calendar year is limited to a total of 3 million shares.
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As of December 29, 2007, approximately 6.6 million shares were reserved for future issuance under the Purchase Plan.
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Restricted Stock Units The Company’s Board of Directors has granted RSUs to members of the Company’s executive management team, excluding its Chief Executive Officer (“CEO”), as well as various employees within the Company.
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These RSUs generally vest over four years either at the end of the four-year service period, in two equal installments on the second and fourth anniversaries of the date of grant, or in equal installments on each of the first through fourth anniversaries of the grant date.
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Upon vesting, the RSUs are generally net share settled to cover the required withholding tax and the remaining amount is converted into an equivalent number of shares of common stock.
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The compensation expense incurred by the Company for RSUs is based on the closing market price of the Company’s common stock on the date of grant and is amortized ratably on a straight-line basis over the requisite service period.
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The RSUs have been reflected in the calculation of diluted earnings per share utilizing the treasury stock method.
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Stock Option Activity A summary of the Company’s stock option activity and related information for the three months ended December 29, 2007 is set forth in the following table (stock option amounts and aggregate intrinsic value are presented in thousands): Aggregate intrinsic value represents the value of the Company’s closing stock price on the last trading day of the fiscal period in excess of the exercise price multiplied by the number of options outstanding or exercisable.
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Total intrinsic value of options at time of exercise was $887 million and $291 million for the three months ended December 29, 2007 and December 30, 2006, respectively.
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The Company recognized $110 million and $46 million of stock-based compensation expense for the three months ended December 29, 2007 and December 30, 2006, respectively.
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Capitalized stock-based compensation costs were $8 million as of December 29, 2007.
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There were no stock-based compensation costs capitalized as of December 30, 2006.
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The income tax benefit related to stock-based compensation expense was $34 million and $14 million for the three months ended December 29, 2007 and December 30, 2006, respectively.
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As of December 29, 2007, the total unrecognized compensation cost related to stock options and RSUs expected to vest was $1.4 billion and is expected to be recognized over a weighted-average period of 3.35 years.
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As of December 29, 2007, the Company had 7 million RSUs outstanding with a total grant-date fair value of $702 million that were excluded from the options outstanding balances in the preceding table.
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The weighted-average grant date fair value of RSUs granted during the three months ended December 29, 2007 and December 30, 2006, was $174.90 per share and $86.67 per share, respectively.
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The aggregate intrinsic value of RSUs was $1.41 billion as of December 29, 2007.
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RSUs that vested during the three months ended December 29, 2007 totaled approximately 228,000 and had a fair value of $43 million as of the vesting date.
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No RSUs vested during the three months ended December 30, 2006.
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Shares of RSUs granted after April 2005 have been deducted from the shares available for grant under the Company’s stock option plans utilizing a factor of two times the number of RSUs granted.
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SFAS No.
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123R requires the use of a valuation model to calculate the fair value of stock-based awards.
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The Company uses the Black-Scholes-Merton (“BSM”) option-pricing model to calculate the fair value of stock-based awards.
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The BSM option-pricing model incorporates various assumptions including expected volatility, expected life, and interest rates.
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The expected volatility is based on the historical volatility of the Company’s common stock over the most recent period commensurate with the estimated expected life of the Company’s stock options and other relevant factors including implied volatility in market traded options on the Company’s common stock.
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The Company bases its expected life assumption on its historical experience and on the terms and conditions of the stock awards it grants to employees.
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Stock-based compensation cost is estimated at the grant date based on the award’s fair-value as calculated by the BSM option-pricing model and is recognized as expense ratably on a straight-line basis over the requisite service period.
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The weighted average assumptions used for the three-months ended December 29, 2007 and December 30, 2006 and the resulting estimates of weighted-average fair value per share of options granted and for stock purchases during those periods are as follows: Note 6 - Commitments and Contingencies Lease Commitments The Company leases various equipment and facilities, including retail space, under noncancelable operating lease arrangements.
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The Company does not currently utilize any other off-balance sheet financing arrangements.
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The major facility leases are for terms of 3 to 15 years and generally provide renewal options for terms of 3 to 7 additional years.
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Leases for retail space are generally for terms of 5 to 20 years, the majority of which are for 10 years, and often contain multi-year renewal options.
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As of September 29, 2007, the Company’s total future minimum lease payments under noncancelable operating leases were $1.4 billion, of which $1.1 billion related to leases for retail space.
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As of December 29, 2007, total future minimum lease payments related to leases for retail space increased $54 million to $1.2 billion.
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Accrued Warranty and Indemnifications The following table reconciles changes in the Company’s accrued warranties and related costs for the three months ended December 29, 2007 and December 30, 2006 (in millions): The Company generally does not indemnify end-users of its operating system and application software against legal claims that the software infringes third-party intellectual property rights.
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Other agreements entered into by the Company sometimes include indemnification provisions under which the Company could be subject to costs and/or damages in the event of an infringement claim against the Company or an indemnified third party.
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However, the Company has not been required to make any significant payments resulting from such an infringement claim asserted against itself or an indemnified third party and, in the opinion of management, does not have a potential liability related to unresolved infringement claims subject to indemnification that would have a material adverse effect on its financial condition or operating results.
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Therefore, the Company did not record a liability for infringement costs as of either December 29, 2007 or September 29, 2007.
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Concentrations in the Available Sources of Supply of Materials and Product Although most components essential to the Company’s business are generally available from multiple sources, certain key components including, but not limited to, microprocessors, enclosures, certain liquid crystal displays (“LCDs”), certain optical drives, and application-specific integrated circuits (“ASICs”) are currently obtained by the Company from single or limited sources, which subjects the Company to supply and pricing risks.
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Many of these and other key components that are available from multiple sources including, but not limited to, NAND flash memory, DRAM memory, and certain LCDs, are at times subject to industry-wide shortages and significant commodity pricing fluctuations.
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In addition, the Company has entered into certain agreements for the supply of critical components at favorable pricing, and there is no guarantee that the Company will be able to extend or renew these agreements when they expire.
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Therefore, the Company remains subject to significant risks of supply shortages and/or price increases that can adversely affect gross margins and operating margins.
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In addition, the Company uses some components that are not common to the rest of the global personal computer, consumer electronics and mobile communication industries, and new products introduced by the Company often utilize custom components obtained from only one source until the Company has evaluated whether there is a need for and subsequently qualifies additional suppliers.
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If the supply of a key single-sourced component to the Company were to be delayed or curtailed, or in the event a key manufacturing vendor delays shipments of completed products to the Company, the Company’s ability to ship related products in desired quantities and in a timely manner could be adversely affected.
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The Company’s business and financial performance could also be adversely affected depending on the time required to obtain sufficient quantities from the original source, or to identify and obtain sufficient quantities from an alternative source.
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Continued availability of these components may be affected if producers were to decide to concentrate on the production of common components instead of components customized to meet the Company’s requirements.
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Finally, significant portions of the Company’s CPUs, iPods, iPhones, logic boards, and other assembled products are now manufactured by outsourcing partners, primarily in various parts of Asia.
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A significant concentration of this outsourced manufacturing is currently performed by only a few of the Company’s outsourcing partners, often in single locations.
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Certain of these outsourcing partners are the sole-sourced supplier of components and manufacturing outsourcing for many of the Company’s key products, including but not limited to, assembly of most of the Company’s portable Mac computers, iPods, and iPhones.
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Although the Company works closely with its outsourcing partners on manufacturing schedules, the Company’s operating results could be adversely affected if its outsourcing partners were unable to meet their production commitments.
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Long-Term Supply Agreements During 2006, the Company entered into long-term supply agreements with Hynix Semiconductor, Inc., Intel Corporation, Micron Technology, Inc., Samsung Electronics Co., Ltd., and Toshiba Corporation to secure supply of NAND flash memory through calendar year 2010.
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As part of these agreements, the Company prepaid $1.25 billion for flash memory components during 2006, which will be applied to certain inventory purchases made over the life of each respective agreement.
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The Company utilized $250 million of the prepayment as of December 29, 2007.
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Contingencies The Company is subject to certain legal proceedings and claims that have arisen in the ordinary course of business and have not been fully adjudicated.
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In the opinion of management, the Company does not have a potential liability related to any current legal proceedings and claims that would individually or in the aggregate have a material adverse effect on its financial condition or operating results.
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However, the results of legal proceedings cannot be predicted with certainty.
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Should the Company fail to prevail in any of these legal matters or should several of these legal matters be resolved against the Company in the same reporting period, the operating results of a particular reporting period could be materially adversely affected.
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Production and marketing of products in certain states and countries may subject the Company to environmental and other regulations including, in some instances, the requirement to provide customers the ability to return product at the end of its useful life, and place responsibility for environmentally safe disposal or recycling with the Company.
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Such laws and regulations have been passed in several jurisdictions in which the Company operates including various countries within Europe and Asia, certain Canadian provinces and certain states within the U.S.
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Although the Company does not anticipate any material adverse effects in the future based on the nature of its operations and the thrust of such laws, there is no assurance that such existing laws or future laws will not have a material adverse effect on the Company’s financial condition or operating results.
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Note 7 - Segment Information and Geographic Data In accordance with Statement of Financial Accounting Standards (“SFAS”) No.
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131, Disclosures about Segments of an Enterprise and Related Information, the Company reports segment information based on the “management” approach.
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The management approach designates the internal reporting used by management for making decisions and assessing performance as the source of the Company’s reportable segments.
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The Company manages its business primarily on a geographic basis.
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Accordingly, the Company determined its operating segments, which are generally based on the nature and location of its customers, to be the Americas, Europe, Japan, Asia-Pacific, Retail, and FileMaker operations.
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The Company’s reportable operating segments are comprised of the Americas, Europe, Japan, and Retail operations.
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Other operating segments include Asia-Pacific, which encompasses Australia and Asia except for Japan, and the Company’s FileMaker, Inc. subsidiary.
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