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Iridium Communications Inc (NASDAQ:IRDM)

Deutsche Bank's DbAccess 21st Annual Media and Telecom Conference

March 06, 2013 10:10 am ET

Executives

Thomas J. Fitzpatrick - Chief Financial Officer and Executive Vice President

Thomas J. Fitzpatrick

Apologies for being late, everybody.

Unknown Analyst

We'll jump right into it. Thanks for coming back. I think this is the fourth year in a row you've been here, so we appreciate your continued participation at the conference.

Thomas J. Fitzpatrick

Was in snowy [ph] Washington.

Question-and-Answer Session

Unknown Analyst

Yes, which we're heading back to next. I want to talk a little bit of recap from last year and sort of set the stage for what we should expect from Iridium this year. On the conference call, you pointed out that you did come in a little short of where you anticipated on service revenue. You came in at the lower end of the EBITDA guidance, but you do have some visibility here on some improving trends into '13. So I was hoping maybe could just talk a little bit about some of the things that happened last year and why you're feeling reasonably confident that some of your revenue trends are going to accelerate again as we go into the rest of the year.

Thomas J. Fitzpatrick

Right. So if you look at just sort of long-term history, '12 in terms of service revenue growth was a low year. I think we've run over 10% growth in service revenues for some time, and in '12, we posted 4% growth. And the culprit there, what it is not is subscriber growth. Subscriber growth was 17%. In '12, it's going to be 17% -- or it's going to be between 15% and 20% in '13. The culprit in terms of headwind on the service revenue growth is really principally the drawdown of troops out of Iraq and most notably in the U.S. government line of business. What we've seen is our legacy handset business within the U.S. government, I think we peaked at like 30,000 units and their use for morale calling, very high ARPU units, and as the troops have come out, the service revenues declined within that line of business within the U.S. government. And that was the single biggest kind of headwind that we saw occurring. Our other -- our growth lines of business within the U.S. government, namely Netted Iridium, which is our tactical radio used in combat situations, grew notwithstanding the troop withdrawals in Afghanistan as did machine to machine, but they have very high ARPU legacy handset that's used for morale calling declined, and that put pressure on our revenues. We saw the same thing in our commercial line of business most notably in the fourth quarter, and non-U.S. military utilization in Afghanistan essentially dropped precipitously, as those troops did not disconnect or withdraw but rather consolidated in more centralized troop locations and so our usage went down. And so those headwinds are what caused the pressure on 2012 and caused it to be an atypical year for growth versus kind of our 5-year history. We've guided in 2013 that we see service revenues growing between 8% and 10%, up from the 4% that we did in 2012. And the principal kind of shot to the arm that we get in '13 that we didn't have in '12 are in the commercial area, we have implemented about a $5 price increase on our commercial installed base that will benefit us to the tune of about $15 million. We also changed our prepaid policy that we had previously allowed prepaid cardholders to basically perpetually extend their cards, and we've kind of implemented a 3-year limitation on that. The benefit of that will be about $6 million to our service revenue.

Unknown Analyst

Is that because they're going to be priced up when the card expires or...

Thomas J. Fitzpatrick

Just we've made a policy that says you can extend your card, but you can only do it up until 3 years. And once it's 3 years old, it's not extendable anymore because the trouble with it, with an extension is, is you can never recognize the revenue because it's renewable. So those 2 things give us about a $21 million shot in the arm in '13 that we didn't have in '12. And then as we get into '14, we think that the usage pressure abates, one; and two, we're going to redo our contract with the U.S. government in September of 2013, and we think that's going to cause a material increase in our government revenues in '13. So we think we get back on track to kind of historical rates of growth in service revenues in '14.

Unknown Analyst

A couple of follow-up questions. How do we think about the revenue growth rates as we move through the year? So in other words, is it a hockey stick? Are we going to see some traction where you're getting closer to that growth rate that you think you can achieve on average earlier in the year? So I'll start with that just so we have the right expectations for what to expect from you guys as you report.

Thomas J. Fitzpatrick

Sure. Yes. So the key -- there's nothing we can do about the government contract. They can extend it and have done so through September '13. And so what you think -- what you'll see is continued pressure on the U.S. government. Each of the first 3 quarters, they'll be down year-over-year. The government will be down for the full year, but then it'll pop back in the fourth quarter. Similarly, the prepaid policy change benefit, we expect to be largely fourth quarter related.

Unknown Analyst

Some of the price increases otherwise, I assume will start -- will come in right away?

Thomas J. Fitzpatrick

Yes, they're -- will come in -- Yes.

Unknown Analyst

And then you mentioned the renewal on the government contract, and we just hear renewal and you say well, why would renewal improve your growth rate, but you implied that there may be an opportunity to do more business. Can you give us a little more color on that?

Thomas J. Fitzpatrick

Sure. So the history of the U.S. government with Iridium is they were the anchor tenant on the Iridium constellation when the company was -- came out of bankruptcy in the early 2000s. They, back in their early days, they had a sort of $30 million take-or-pay contract for when they had kind of 5,000 or less handsets. So Iridium's strategic importance to the government has -- there's a long legacy of that, and so our expectation is that, that legacy will carry through to our new contract, and we believe that we can offer the government a tremendous amount of additional functionality that can help them in their, frankly, in their for desire for efficiency and their communications needs at a higher price to Iridium. So it's a win-win that'll -- we think we'll see that in the material increase in our service revenues in 2014 from the government.

Unknown Analyst

And you have a very long, as you point out, relationship with the government. How confident are you that they're going to want more from Iridium on the contract renewal? Is this you speculating that you can make that sale? Or are you hearing from your counterparties there that they could buy more from you, they may be interested in buying more from you?

Thomas J. Fitzpatrick

No, I would characterize this as very confident at this point time. And as you know, there are many constituents kind of on the Iridium government, advisory board, et cetera, that have -- basically know how the U.S. military works. There's a decade-long relationship there that were -- that enables us to configure a win-win solution for the government in their current -- I mean, their current circumstance. We're particularly emboldened by our Netted Iridium product, which we think is highly strategic to the U.S. military. Whereas our legacy product was used for -- largely for morale calling outside of tactical sort of circumstances. Netted Iridium is a tactical radio that uniquely provides beyond line-of-sight communication to the warfighter, and so we think that, that is going to have wide deployment in it's kind of as it's currently configured and could actually be deployed into the installed base of communications gear to the -- in combat solutions. So if anything, over the decade that we've had the government as our customer, our strategic importance has only increased, and similarly in the whole machine-to-machine area, we've only scratched the surface there. So the menu of things that we can do for the U.S. government is very, very broad and very deep, and so that's why we're confident that our service revenues are going to go up with them.

Unknown Analyst

This could end up being a weird year for doing business with the federal government though in light of sequestration, with half of those cuts coming out of the Department of Defense. Literally, it started happening 4 days ago, right? So I mean, I don't know that you've seen anything yet, but do you have any sense -- have you gotten any feedback from your counterparties that perhaps the budget line items that they're using to pay their contract with you could potentially be impacted by sequestration?

Thomas J. Fitzpatrick

Well, I mean, I think everything is going to be impacted by sequestration, but as we get to September of 2013, there is no relationship with the government. So the government is -- their desirous of what Iridium provides them is, sequestration or not, we're going to need to have -- forge a new deal. So that's what we're looking at the big picture. Sequestration is kind of cuts on the margin, but this is more fundamental than that. This is we need satellite communications. We don't have an arrangement. We need to get that job done.

Unknown Analyst

So far, I guess you haven't received any communication that to the extent there's any variable spending in your existing agreement that, that could start diminishing next month.

Thomas J. Fitzpatrick

No. I mean, our variable agreement is kind of what we're enduring the effects of today. As troops are being withdrawn from Afghanistan, it's kind of our revenues are going down based on that de-installation so that's just happening, and we've seen that in '12 and don't think sequestration impacts that in any particular way.

Unknown Analyst

Okay. You mentioned earlier some new products. M2M continues to be a good area for you. You have a new product, the smaller transceiver. You just kind of talked in the past as you bring these smaller transceivers to market, it just continues to like exponentially open up the opportunity to generate business. What are you seeing out of the gate with your new product? Is it purely incremental in terms of the revenue opportunities? Is there any cannibalization at all versus existing products?

Thomas J. Fitzpatrick

So you -- are you talking about the 9603?

Unknown Analyst

Yes.

Thomas J. Fitzpatrick

So -- the breakthrough for us in M2M was the transition from the 9601, which was twice the size and twice the price of the 9602, which is kind of our mainstay if you will, and that opened up markets and greatly accelerated our rate of growth in M2M. The 9603 is not lower priced. It's actually priced a bit more, and it finds itself in certain unique applications, but I wouldn't characterize it as cannibalistic. It's really harmonious with the 9602. But the 9602 is finding itself into a broad array of applications, and we're delighted with the performance in that sector.

Unknown Analyst

So what are some of the incremental opportunities you're seeing with the new device?

Thomas J. Fitzpatrick

Where -- in certain military applications where the smaller sized, they're highly desirous of. In certain personal locator applications, it's important. But in this whole machine-to-machine space, not just within the satellite space but within terrestrial wireless, we're just scratching the surface here. I mean, anything I've read says that these are billions of devices that are going to be connected here, and we just think that Iridium is really uniquely positioned there just given, again, the nature of our network.

Unknown Analyst

Great. Can we get a little bit of an update on NEXT? I know you talked about it on the call. It sounds like that's going well in terms of on budget and maybe a little ahead of schedule. What are the next milestones that we're looking for with NEXT?

Thomas J. Fitzpatrick

So yes. We said that we actually moved our first launch up to February of 2015, and our construction project is on budget and on schedule. So we're really kind of delighted with that outcome. There's various milestones that occur throughout 2013 in terms of the critical design review, et cetera. They're going very well.

Unknown Analyst

And what's the period where we're going to see a real significant increase in the deployment of the new satellite? Just remind us of the time frame as kind of having full constellation up and running.

Thomas J. Fitzpatrick

Right. So we will have our first launch in February of 2015, and that will be on Kosmotras. We're going to launch 2 satellites on Kosmotras and then we'll launch 70 satellites, 10 per launch in 7 launches on SpaceX, And the reason we did that is the 2 on Kosmotras kind of gives us an ability to have 2 satellites up in orbit, check them out, make sure everything's going well and before we do the wide deployment on SpaceX, which commences in 2015 and will complete in 2017. So the existing constellation will be fully swapped out in 2017.

Unknown Analyst

And one of the things that you announced this year, which is exciting was the new Aireon venture. Just can you give us a quick recap in sort of what that exactly is, so we can talk a little more about some of the contributions you think you're going to get out of it?

Thomas J. Fitzpatrick

Sure. So what Aireon is, is designed to provide ADS-B functionality for air traffic monitoring over oceans and other undeveloped sections of land. And what ADS-B is, is the successor technology to radar for aircraft monitoring that dates to the second World War. And so that is happening terrestrially, so any aircraft that enters U.S. airspace by, I believe it's 2016 if I have that date right, needs to be equipped with this new technology called ADS-B, which is current generation, and that's all well and good. But it has the same problem that radar has, which is you can't see airplanes as they go out over the oceans. And so when you go off the radar and as you're flying to London, for example, then you need -- the separation between aircraft, because they're off the radar, becomes much wider. I think it's 60 nautical miles it increases to. And so what Aireon is going to do is to provide that same air traffic monitoring capability in ADS-B by equipping Iridium satellites with that technology, with sensors that then transform ADS-B monitoring to a terrestrial base undertaking to a global undertaking with really virtually no incremental infrastructure that it will -- our signals will plug right into the infrastructure that's being built very elegantly. Our last satellite launches in '17. It's right when ADS-B is becoming operational. So with no incremental equipage costs on the airline, you transform terrestrial-based monitoring aircraft to global, and our estimates are that, that fuel savings alone over kind of the 10-year period are somewhere between $6 billion and $8 billion of fuel savings alone before you even start talking about the benefits of passenger safety and air gas or green gas emissions, et cetera. So it's a really kind of a significant undertaking.

Unknown Analyst

And it is set up as a joint venture, correct?

Thomas J. Fitzpatrick

It is. So the Federal Aviation Administration is a air navigation service provider or ANSP. And the world is basically cut into sections where ANSPs from around the world take surveillance responsibility for. And the North Atlantic is shared by the ANSP of Canada, which is called NAV CANADA and the U.K. And so I believe that NAV CANADA is the second biggest ANSP by traffic volume, and they are our -- they are Iridium's partner in Aireon.

Unknown Analyst

And so Aireon's going to be -- first of all, they're going to be a customer of yours. This is the hosted payload that you're doing.

Thomas J. Fitzpatrick

That's right.

Unknown Analyst

What portion of the hosted payload capacity on the NEXT constellation is being consumed by Aireon? Is it sold out now as a result of that venture?

Thomas J. Fitzpatrick

I would say it is not sold out. So we've said that we expect $200 million to $300 million in hosting fees from entities that will take up the payload space. Aireon is $200 million that we have a contract between Iridium and Aireon for $200 million for them to pay a hosting fee essentially to put the Aireon payload on an Iridium satellite.

Unknown Analyst

So it's a onetime fee upfront. I get it now.

Thomas J. Fitzpatrick

That's right. That's right. And then Harris Corporation is building the payload, and as they are well down the road on the design of the payload and have -- there are other payloads that I would call complementary with Aireon that Harris has engineered into the payload because basically, we're beyond the point of new ideas, if you will, for payloads, so we know the possibilities of complementary payloads. And they've been engineered in by Harris at this point. And so I would expect an announcement certainly in 2013 of the complementary payloads.

Unknown Analyst

Got it. So I'm just thinking about the way Aireon creates value for you. You obviously get an upfront payment that goes towards funding essentially the next constellation. You have a stake in Aireon, so you value -- any value creation that they create, you get benefits from, but their model is going to be they're going to be selling information, correct?

Thomas J. Fitzpatrick

That's right.

Unknown Analyst

So on a recurring basis, how does that create benefit for Iridium down the road? And part of the reason I'm asking is that this was not contemplated in the original business case that you had when you put together NEXT. You'd anticipated hosted payloads but not necessarily that they're going to be at the back end of recurring revenue stream off of it, correct?

Thomas J. Fitzpatrick

Well, I would say we considered the ongoing data fee. We did not consider that we would have a retained interested in the enterprise that kind of -- so we thought it would be a one-and-done type of a deal where they paid the fee and they paid us an ongoing data fee but not that we would have an interest in the upside, if you will, of that enterprise.

Unknown Analyst

And because I'm thinking the bigger picture here in terms of what you're trying to do over, say, the next 10 years. You are spending CapEx. You're increasing leverage right now in order to put in place a new constellation, and then the strategy after that is just to generate gobs and gobs of cash, delever the business. Is there going to be an incremental source of cash generation that comes to Iridium through Aireon? In other words, might you accelerate the deleveraging in that long-term business plan above and beyond what you might have anticipated, meaning that you might create cash for your shareholders, you might delever more quickly? That's kind of the genesis of the question.

Thomas J. Fitzpatrick

Sure. Yes. I mean, the retained interest in Aireon could be highly valuable, and so we talk about the cash flow of the business in 2017, and we expressed it in terms of delevering. But if you consider really kind of the Iridium story is, is a company in 2013 that is going to do between $215 million and $225 million in EBITDA and have CapEx over $500 million. That company changes kind of substantially when you consider the exit rate in 2017 where you're going to have a firm that has sub-$50 million in CapEx and in EBITDA, far greater than $225 million. And so the profile of that enterprise changes significantly, and that's central to the kind of the investment consideration in my view. And so we talked about it in terms of delevering, but if you consider that maintenance CapEx level in sort of a sub-$50 million level for a decade, at least, because the network is built, one could argue that allowing firms such as that to delever is not economically what you want to do. I see guys in the audience here will probably be showing us staple financing at that point in time in support of other kind of transactions. So that's how I think you need to think about the prospects of what's going to happen to this enterprise between now and 2017.

Unknown Analyst

And the reason I asked the question, we don't usually harp on the long term so much with companies here, but as you pointed out, there is a meaningful change once you've launched the constellation. It becomes a completely different financial scenario. And in the near term, what we have to deal with is the government's been a little challenging to deal with, and so it's compressed the rate of growth in services revenue. It caused you to come at the tail end, the low end of your EBITDA guidance. You tweaked some of your longer term, your '13 to '15 guidance ranges. You're pretty comfortable with the services revenue midpoint, although it might be a little more levered during this period of time. So I'm just trying to understand what investors hold on for and just to really figure out, are there things that are happening now that are actually likely to make that long-term business case even more compelling than you thought because to your point, you know for a fact that CapEx falls off. And so if there's any residual cash flow above and beyond what you thought, people might start recognizing that now. That's why I was sort of asking those questions on Aireon, just to understand how much might be incremental to what we originally valuated a few years ago.

Thomas J. Fitzpatrick

Right. Yes. And I think we couldn't be more pleased as we've -- value what our circumstance with our -- I would say our increasing kind of relevance in the M2M space in terms of the enterprises that we're talking to for wide-scale deployments. We think that our kind of network superiority lines up so well with that space. It's the fastest-growing segment in the market, and so I think that's an important investment consideration as well.

Unknown Analyst

Another effort you've had to expand your business now is geographically. There have been some big parts of the world that you didn't have formal operations in, but I think you are in Russia now.

Thomas J. Fitzpatrick

We are.

Unknown Analyst

So first of all, can you just help us understand how is it that a global satellite fleet was excluded from certain geographies? What did you actually have to accomplish to get into the market? What are you seeing now that you're formally in it? And then you have a few other big markets you're not in, if we'd some thoughts there.

Thomas J. Fitzpatrick

Right. So our -- the fact that we're not in certain markets, the fact that we weren't in Russia, for example, has more to do with Russia, frankly, than it does with Iridium in certain locale. So we opened for business in South Africa, for example, and that was a matter of paperwork in getting that license. Russia requires that you have a gateway in their country so they can monitor traffic. Well, that has the attendant capital expenditure, et cetera, and so one has to be sure that kind of the economic opportunity given that CapEx that's required and get through all the other regulatory hurdles that need to be done. Russia was top on our list because we just looked at the traffic that we have in Russia, and we have never sold a device in Russia. And there's -- Russia's lit up like a Christmas tree in terms of Iridium, Iridium traffic because it's bought elsewhere and brought -- and then brought into Russia. So our calculus was that there's a significant opportunity in Russia in terms of military, in terms of various commercial applications that have warranted the investment in the gateway. So we are -- we have sold our first subscriber in Russia. We've signed up half a dozen dealers. And we think that Russia's going to give us a shot in the arm. And it was -- the reason that we weren't there is more due to their requirements. Other areas that we're looking at are China and India, which have similar requirements for investment, and I would characterize us as evaluating them and evaluating the political kind of minefield, if you will, in those locales. It's -- is the economic investment warranted.

Unknown Analyst

Do you also have customers in those markets right now or you don't?

Thomas J. Fitzpatrick

Sure. I mean, there's -- you can acquire a phone elsewhere and bring it in, and it's going to work just fine. It's just that we're -- we won't sell -- our dealers can't sell in that geography.

Unknown Analyst

And are there any other products that you have recently put in the market, things that you're anticipating soon that can just be additive to the growth rate here to help you get back to that level of service revenue growth you've been able to sustain in the past?

Thomas J. Fitzpatrick

Yes. I mean, I think if you just -- if you look at Iridium, the company's had a long legacy of product innovation and development. Our -- we're doing so well in machine to machine because we developed our latest-generation modem. What we're most excited about now is the Netted Iridium, which is the government beyond line-of-sight, push-to-talk radio. That will be shortly, and it currently is in kind of in test mode, a global push-to-talk capability, so think of Nextel globally. We are not only going to roll that out within the U.S. government, but we think it's going to have wide deployment commercially. And so that's going to be a source of revenue that is not -- kind of not in our numbers currently. Similarly, we're rolling out global data broadcasts, which is -- uses our paging channel and can penetrate buildings for a blast message to a wide number of recipients for weather messages, pick an applications. So that's going to be rolled out in 2013. Something called -- it's really advanced GPS for tracking. We'll have product developments along there. So we never stop. I mean, we haven't stopped in the 10 years we've been going, and we don't see any end in sight.

Unknown Analyst

Right. So I mean, it does sound like you do have a lot of reasons to be confident to have service revenue growth rate. Maybe not early in the year but as you move through '13 and really position yourself for '14, should recover to that rate of growth that you have been able to achieve for most of your history.

Thomas J. Fitzpatrick

Yes.

Unknown Analyst

Right. And NEXT is on schedule?

Thomas J. Fitzpatrick

Ahead of schedule.

Unknown Analyst

Ahead of schedule and on budget?

Thomas J. Fitzpatrick

On budget.

Unknown Analyst

Aireon's moving as expected?

Thomas J. Fitzpatrick

Yes.

Unknown Analyst

Okay. Do you have any questions? We have a minute or 2 left here. If you have any questions, we can take them. Right down here. If you'd just wait for one moment.

Unknown Analyst

I remember attending a presentation a couple of years ago where you talked about NEXT, and then I recall that the major leap forward was a huge increase in data transfer speeds. Is that still the case? Is that the advantage of putting in the new constellation?

Thomas J. Fitzpatrick

No. I would say that the major advantage of NEXT is that it exactly replicates the current functionality of our current network, which is superior and is our single biggest source of competitive advantage. The reach and functionality of our existing network are superior to the competition, and that's why we're winning. What NEXT does is replace that. So that's the major reason. It's the existing network needs to be replaced. It's going to be 15 years old by the time it gets replaced, and the good news is it retains the existing functionality. However, data speeds will be materially improved. We -- our broadband offering in OpenPort it's our maritime solution. It's 128k. We're expecting that to go between 512 and 1 MB. But we're not going to be the fat pipe. That's -- we're about broadband mobility but not high data speeds. But the improvement will be noticeable and will enable us to avail ourselves of additional markets, but the essential reason is to kind of keep the good things that we like about our current network going for the foreseeable future.

Unknown Analyst

A number of your competitors have launched their own networks, upgraded their networks with Inmarsat, Globalstar, ORBCOMM. I'm struggling to differentiate where each company fits in the overall landscape and who has an advantage where and is there space for all these players.

Thomas J. Fitzpatrick

Right. So we're very confident in our circumstance, and it goes back to the reach and functionality of our network are superior to any player in mobile satellite services. We're a low Earth orbit mesh network, so you mentioned Inmarsat, their satellites are 50x further from the Earth than ours are. So in markets like handheld, which is our principal market, they've made a foray into our market, made substantial reductions in price, and we have seen really no effect of their entry into our market. They thought they'd make a big splash, but the market has kind of spoken. It's if you come in with a product that's inferior in the handheld market, folks like your first responders and others that are desirous of the Iridium experience, just because it's priced, half priced, it doesn't resonate. So that question has been asked and answered as to the biggest section of our marketplace, which is handheld. What we're most excited about is in the machine-to-machine space. So a company like Inmarsat, because they're 50x further from the Earth than we are, you need a really big antenna to get that far. It's just physics. And our machine-to-machine modems are matchbook size. So a very large antenna is not kind of consistent with that market requirement. So that's why we have 30% growth in machine to machine, the fastest-growing segment. Iridium, we think, is going to be the predominant player there. Globalstar is it kind remains to be seen. They kind of have been out of the market, if you will, for a couple of years owing to their network problems, and we'll see kind of the extent to which they come back. But Iridium is as bullish as we've ever been about our prospects, and it all goes back to our network. Answer to the gentleman's question, the replicating existing functionality is what's going to cause us to compete and win against any of the players you named.

Unknown Analyst

How about ORBCOMM? They just completed updating their M2M?

Thomas J. Fitzpatrick

ORBCOMM?

Unknown Analyst

Yes.

Thomas J. Fitzpatrick

Yes. So ORBCOMM -- So Iridium is a mesh network that covers all port -- points of the globe and can provide basically instantaneous surveillance for telemetry asset tracking, et cetera. ORBCOMM's network does not have the coverage by a long shot of what Iridium has, and so what -- the products that ORBCOMM brings to market are for asset tracking, for less than -- let me just say less than instantaneous kind of telemetry and that sort of thing. Their network can do that. But for applications like we provide, which are providing the rate of speed of a vehicle anywhere in the globe at any point in time such as for safety reasons, et cetera, ORBCOMM, as their network is currently configured, can't do that. And so if you look at our ARPUs, we're in the kind of high-teens range, and I believe that ORBCOMM is in the low-single digits. And the kind of the value add of those 2 undertaking is kind of -- are seen loud and clear in the relative ARPUs.

Unknown Analyst

All right. Well, it looks like we have run out of our time. Tom, thanks a lot.

Thomas J. Fitzpatrick

Thank you. Sorry, I was late [ph] [indiscernible] Thank you.

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