Fidus Investment's (FDUS) CEO Ed Ross on Q2 2014 Results - Earnings Call Transcript

Aug. 8.14 | About: Fidus Investment (FDUS)

Fidus Investment Corp (NASDAQ:FDUS)

Q2 2014 Earnings Conference Call

August 8, 2014 9:00 AM ET


Stephanie Prince - IR, LHA

Ed Ross - President and CEO

Shelby Sherard - CFO and Secretary


Bryce Rowe - Robert W. Baird

Robert Dodd - Raymond James

Chris Kotowski - Oppenheimer

Vernon Plack - BB&T Capital Markets


Good day, ladies and gentlemen. Welcome to the Fidus Investment Corporation's Second Quarter 2014 Earnings Conference Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question-and-answer session and instructions will follow at that time. (Operator Instructions)

As a reminder, this conference is being recorded and I would like to introduce your host for today's conference, Ms. Stephanie Prince of LHA. You may begin.

Stephanie Prince

Thank you, Sam, and good morning everyone. Thank you for joining us for Fidus Investment Corporation's second quarter 2014 earnings conference call. With me this morning are Ed Ross, Fidus Investment Corporation's Chairman and Chief Executive Officer; and Shelby Sherard, Chief Financial Officer.

Fidus Investment Corporation issued a press release yesterday afternoon with details of the company's quarterly financial results. A copy of the press release is available on the Investor Relations page of the company's website at

I'd like to remind everyone that today's call is being recorded. A replay of today's call will be available by using the telephone numbers and conference ID provided in the earnings press release. In addition, an archived webcast replay will be available on the Investor Relations page of the company's website at following the conclusion of this conference call.

I'd also like to call your attention to the customary Safe Harbor disclosure regarding forward-looking information included in the earnings release. The conference call today will contain certain forward-looking statements including statements regarding the goals, strategies, beliefs, future potential, operating results and cash flow of Fidus Investment Corporation. Although management believes these statements are reasonable based on estimates, assumptions and projections as of today, August 8, 2014 these statements are not guarantees of future performance.

Time-sensitive information may no longer be accurate at the time of any telephonic or webcast replay. Actual results may differ materially as a result of risks, uncertainties, and other factors including but not limited to the factors set forth in the company's filings with the SEC. Fidus undertakes no obligation to update or revise any of these forward-looking statements.

I'd now like to turn the call over to Ed Ross. Ed?

Ed Ross

Thank you, Stephanie, and good morning everyone. Welcome to our second quarter 2014 earnings call. Before I begin my comments, I'd like to introduce Shelby Sherard. As many of you know, she joined Fidus in early June. Shelby brings a wealth of relevant experience to Fidus, and has been a valuable addition to our firm. So yet another welcome, Shelby.

Shelby Sherard

Thank you.

Ed Ross

For today's call, I will start by highlighting our results for the second quarter, before discussing current market conditions, investment activity, and the performance of our investment portfolio. I will then turn the call over to Shelby, who will go into more detail about our financial results and liquidity position, before we open up the call for questions.

Turning to second quarter highlights, we generated solid financial results, producing net investment income of $5.5 million or $0.40 per share. Our adjusted net investment income, which we define as net investment income excluding any capital gains incentive fee, attributable to realized and unrealized gains and losses, was $5.1 million or $0.37 per share. As of June 30, 2014, net asset value was $15.09 per share.

Our business fundamentals remains strong. Deal flow has been strong, market activity has increased, and we are well positioned for a more active second half of the year. Furthermore, I am pleased to report that in June, we established our first revolving credit facility, a $30 million line led by ING capital, enabling us to diversify our funding sources for future investment opportunities.

The Board of Directors has declared a regular quarterly dividend for the third quarter of $0.38 per share, which is payable on September 26, 2014 to stockholders of record on September 12, 2014. Furthermore, in light of our available spillover income, the Board previously declared two special dividends, totaling $0.10 per share. The first special dividend of $0.05 per share was paid on July 31, and the second special dividend of $0.05 per share will be paid on August 29, 2014, to stockholders of record on August 25, 2014.

Regarding our dividend distribution, we seek to balance and maintain capital allocation flexibility. Our primary objective is to deliver long term value to our shareholders, in the form of stable and growing dividends, including periodic special dividends. We also have a goal of growing our net asset value on a per share basis over time, Balancing these goals is important to us, and the Board will, as before, consider these objectives when making distribution decisions.

Since the beginning of the year, activity levels have increased for Fidus, and we are expecting a more robust second half of the year. M&A pipelines are reported [indiscernible], and we are starting to see the benefit of these higher levels of activity.

Relative to 2013, deal activity in 2014 has been more M&A driven, involving multiple players versus refinancing. As a result, Fidus has experienced a lengthening of transaction closing cycles. We do expect more investment opportunities to come to fruition in the second half of the year. For example, we invested $10.5 million on July 3rd, and one new portfolio company, and just yesterday, we invested $20 million in another, I will discuss both in further detail, shortly.

We continue to remain patient and disciplined, focused on capital preservation, and performing well over the long term. One result of this approach, is that our senior secured or unit tranche debt portfolio has increased from approximately 11% of our portfolio a year ago, to just over 21% on a cost basis as of June 30. As we have said in the past, the number of new investments we close will vary quarter-by-quarter.

As of June 30, 2014, we had debt and equity investments in 37 portfolio companies, at a total fair value of $310 million, which equates to approximately 96% of costs, and despite the high level of repayment and realization that we have experienced over the last 12 months, we increased our investment portfolio on a cost basis, by approximately $37.8 million or 13% year-over-year.

In May, we completed a $6 million debt investment in Oaktree Medical Centre, which does business as Pain Management Associates. This new portfolio company is an operator of healthcare clinics and toxicology laboratories, focused on the treatment of patients suffering from chronic pain or acute pre and post operative conditions.

In the second quarter, we received proceeds from repayments and realizations of $5.8 million from convergent resources, as payment in full on their subordinated notes. This repayment was driven by the sale of the company.

As I mentioned earlier, we made investments in two new portfolio companies subsequent to quarter end. We invested $10.5 million in subordinated notes and common equity of U.S. Green Fiber LLC, a leading manufacturer of residential recycled fiber installation products across the United States. We also invested $20 million in second lien notes in Pinnergy, a leading provider of fluid management and drilling services for oil and gas wells located throughout Texas and Louisiana.

During the second quarter, we wrote down our investment in Avrio to zero, and placed the debt investment on non-accrual, due to a meaningful increase in the risk in this investment. We also put the PIK interest of Paramount Building Solutions on non-accrual status, as we work to better position the company for future growth.

Write-downs and losses are an inevitable part of our business. It is because of this business reality, and the effort to mitigate such losses, that we have an investment strategy that includes maintaining a well-diversified investment portfolio.

We also continue to believe, that creating a high quality equity portfolio and provide not only incremental profit, but also a reasonable margin of safety for Fidus. When evaluating our portfolio as a whole, we remain pleased with the overall quality and construct of the portfolio.

Turning to portfolio performance, we track several quality measures on a quarterly basis, to help us monitor the overall stability, quality, and performance of our investment portfolio, which we are pleased to remain strong and in line with prior periods. First, we track the portfolio's weighted average investment rating, based on our internal system. Under our methodology, a rating of one is outperform, and a rating of five is an expected loss. As of June 30, the weighted average investment rating for the portfolio was 1.9 on a fair value basis, in line with prior periods.

The credit performance of the portfolio remained solid as well, with our portfolio company's combined ratio of total net debt to Fidus' debt investments to total EBITDA of 3.7 times. We believe this is a prudent level of risk for our portfolio.

And finally, we track the combined ratio of our portfolio company's total EBITDA to total cash interest expense, which was 3.3 times in the second quarter. We believe that this level is an indicator that our portfolio companies as a whole, currently have significant cushion to meet their debt service obligations to us. Overall, these metrics reflect our longstanding cautious and deliberate investment approach.

From a debt structuring perspective, we look to maintain significant cushions to our borrower's enterprise value, in support of our capital preservation and income goals.

As we said many times, we seek to selectively invest in high quality, lower middle market companies that our market leaders and their respective niches, that operate in industries we know well, that generate excess free cash flow for debt service and investment, and have positive long term outlooks. And due to the sheer size and fragmentation of the lower middle market, our target market continues to be active and attractive, and generally is less competitive than the broader markets.

This strategy, combined with Fidus' competitive differentiators are relationship-based, industry knowledge, and the ability to offer flexible capital solutions, will, we believe, continue to result in a generation of attractive risk adjusted returns for our shareholders.

Now, I will turn the call over to Shelby to provide some details on our financial and operating results. Shelby?

Shelby Sherard

Thank you, Ed, and good morning everyone. I am pleased to say that I have now been at Fidus for two months, and I am very excited to be here. As I look forward to getting to know everyone, please do not hesitate to give me a call with any questions that you may have. I will now review our second quarter results in more detail, and close with comments on our liquidity position.

Total investment income was $10.6 million for the three months ended June 30, 2014, an increase of $0.1 million over the $10.5 million of total investment income for the three months ended June 30, 2013. Interest income was $9.3 million compared to $9.6 million in the year ago period, a decrease of 3%. Dividend income increased to $513,000, up from $350,000 in last year's second quarter. This was due to an increase in the income generating preferred equity securities in the portfolio.

Fee income, which fluctuates from quarter-to-quarter depending on the level of new investments or prepayment activity was $783,000 for the second quarter of 2014, compared to $465,000 in the last year's second quarter, primarily due to a $552,000 prepayment fee related to the Convergent Resources' repayment.

Total expenses were $5.1 million for the second quarter, a decrease of $2.2 million or 30.6% over the $7.3 million of the total expenses in the same period last year. Interest expense was approximately $1.8 million for the second quarter of 2014, roughly in line with the second quarter of 2013. Interest expense includes the interest paid on Fidus' SBA debentures, as well as the commitment fee on our recently closed line of credit.

As of June 30, 2014, the weighted average fixed interest rate on our SBA debentures was 4.5% before fee. The base management fee was in line with the prior year period. The incentive fee declined b $2.5 million to $853,000. Administrative service expenses, professional fees, and other general and administrative expenses, totaled approximately $1 million for the quarter, 23% higher than the second quarter of 2013, which totaled approximately $831,000. This increase was primarily due to a year-over-year increase in personnel. Included in expenses for the Q2 2014 are some one time items related to corporate legal expenses, and the CFO transition that comes to approximately $100,000.

Net investment income, or NII for the three months ended June 30, 2014, was $5.5 million or $0.40 per share, while adjusted NII was $5.1 million or $0.37 per share. Adjusted NII is defined as net investment income, excluding any capital gains incentive fee expense, or reversal attributable to realized and unrealized gains and losses on investment.

For the three months ended June 30, 2014, Fidus realized $59,000 in capital gains on investments net of taxes related to an escrow payment. We reported a change in unrealized depreciation on investments of $2.1 million attributable to net unrealized depreciation of $4.1 million on debt investments, primarily related to non-accrual, and net unrealized depreciation of $2 million on equity investment. Taken together, these activities resulted in a net increase in net assets resulting from operations for second quarter of 2014 of $3.4 million or $0.25 per share.

Per share income results for the quarter ended June 30th 2014, are based on weighted average shares outstanding of $13.8 million. Our net asset value at June 30, 2014, was $15.09 per share, which reflects payment of the $0.38 per share regular dividend in June.

Turning now to portfolio statistics as of June 30, our total investment portfolio had a fair value of $310.5 million or approximately 96% of costs, and consistent with our debt oriented investment strategy, our portfolio on a cost basis was comprised of approximately 64% subordinated debt, 21% senior secured loans, and 15% equity and warrant securities, which reflect the modest increase in the mix of senior secured debt investment in the FIdus portfolio.

For comparison, at June 30, 2013, our portfolio was comprised of approximately 74% subordinated debt, 11% senior secured loans and 15% equity and warrant securities.

Our average portfolio of company investment on a cost basis was $8.8 million at the end of the second quarter. We have equity investments in approximately 91.9% of our portfolio companies, with an average fully diluted equity ownership of 7.6%. Weighted average effective yield on debt investments was 14% as of June 30. The weighted average yields are computed using the effective interest rates for debt investment and cost, including the accretion of original issue discount, and loan origination fees, but excluding investments on non-accrual. The higher repayment levels over the past 15 months, have also impacted the portfolio yields, and some higher yielding loans have been paid off and replaced with loans priced at current market rates, which are lower than the rates on the more mature loans.

As of June 30, our liquidity and capital resources included cash and equivalents of $40.7 million, and unfunded SBA commitments of $29.5 million. In addition, we have access to an additional $50 million of SBA leverage, and as Ed mentioned, we have broadened our funding during the quarter by closing on a $30 million line of credit.

On a final note, before turning the call back to Ed, on June 30, Fidus received exemptive relief on our second SBA fund, which simply means that the SBA debt outstanding is not considered senior securities for purchases of asset coverage requirements.

Now, I will turn the call back to Ed for concluding comments. Ed?

Ed Ross

Thanks Shelby; as always, I'd like to thank the outstanding team and the Board of Directors are Fidus for their hardwork and their shareholders for their continued support. I will now turn the call over to Sam, for Q&A.

Question-and-Answer Session


(Operator Instructions). And our first question comes from Bryce Rowe with Robert W. Baird. Your line is now open.

Bryce Rowe - Robert W. Baird

Thanks. Good morning.

Ed Ross

Good morning Bryce.

Bryce Rowe - Robert W. Baird

Ed, just wanted to ask a couple of questions. First on the credit facility, with the level of availability, within the SBA debenture programs, and then now the new credit facility, just wondering how we as analysts should think about usage of that credit facility, relative to the SBA over the near term, as you book more investment?

Ed Ross

Sure. Great question Bryce. I think that obviously, what the credit facility does for us, is a few things. It just increases our liquidity right at the -- at both the holding company for investment, and for other purposes. I think as we look at it, and those other purposes would include, non-SBIC deals, right. But I would say, we are going to continue to, obviously invest in cash, I think that's the smartest thing, and then we have the $30 million line of credit for further liquidity. But once we get to that point, if -- the transactions that we are closing or investing in, fit the SBIC, then our intent would be to continue to use the SBIC program to its fullest extent. So that's how we are going to kind of think about it and move forward. Is that helpful?

Bryce Rowe - Robert W. Baird

Yes, that is helpful. Second question, unrelated. You've obviously booked some investments subsequent to quarter, and Shelby noted the spread compression or pricing compression you have experienced over the last 15 months, although somewhat minimal relative to the rest of the industry. Just trying to get a feel for the yields that might have come with the newer investments, and any feel for what kind of spread, compression or pricing compression you'd expect over the near term? Thanks.

Ed Ross

Sure. It’s a great question, and I will give you a little detail. But deals, as you know, have come down over the last 12 to 18 months, and we have tried to do a good job of maintaining our yields. I would say that the investments that we made here in the third quarter, or early on in the third quarter, have been lower than what they were in the first quarter of the year, on a weighted average basis. These companies, both of them are probably what I would say larger, lower middle market companies, and what comes with that is a little bit lower yield. So one of them is in the, call it mid-11s and the other one is in the mid-12s. One is -- the first one I just mentioned is a second lien investment and larger portfolio company.

As we look forward, Bryce, just a couple more comments, I do think yields will continue to come down a little bit. If I look at how we have been investing over the past 12 months or so, yields are at a lower rate, generally speaking, not materially so, but generally speaking, lower rate than what our portfolio yields today. So I would expect it to continue to come down a little bit, but not in big movements.

Bryce Rowe - Robert W. Baird

Okay. Thanks.

Ed Ross

Absolutely. Good talking to you Bryce.


And our next question comes from Robert Dodd with Raymond James. Your line is now open.

Robert Dodd - Raymond James

Hi guys. And actually just to follow-up on a couple of Bryce's right there, on the pricing side as you said in the comments, you've gone from uni-tranche, for example, 11%, you've guided 21 now, obviously that's not the same as straight mezz. How much of the pricing, if you can give us any color, is this kind of like-for-like, versus -- and you mentioned here obviously, the larger companies, the lower priced, uni-tranche is issued --- priced a little bit than straight mezz. How much is mix related versus like-for-like price, and the mix obviously on your choice to move to, little bit larger companies and shift to a little bit more senior secured than straight mezz?

Ed Ross

It’s a very good question Robert, and its kind of hard to give you an exact answer. I don't have that detail in front of me, but I will tell you the uni-tranche investments that we have made, our whole portfolio is actually still yielding quite well, in your mezz portfolio, but the one that we made in the first quarter for instance, was in the mid-11s, I believe. So you definitely are going to have and so that over the last 12 months, definitely has impacted our yields a little bit. And then I would say, from a mezzanine perspective, what we are seeing in the market, and it really depends on the size of the company, is it a $15 million EBITDA business, or is it a $3 million EBITDA business, the pricing range is really in the 11% to 14%, and depending on that size, is where the pricing is going to end up. We have seen people for great investments on the subordinated debt side actually go to 10%, but it was a much larger EBITDA business and very high free cash flow, and what I would consider on a comparative basis, moderate leverage.

But so risk adjusted returns is how we think about the business, but I think both mezz returns and the mix has impacted our overall yields a little bit.

Robert Dodd - Raymond James

Okay, great. Another one on that, the cash liquidity, I mean, I don't know if you have this number handy, but how much of the cash you have on hand, is currently at the holding company versus within an SBIC vehicle, where you can't get [indiscernible] anything, but an SBIC eligible asset?

Ed Ross

Sure, great question. I don't have that in front of that, I don't know that Shelby does, but I will give you a quick answer, and she can correct me. I think largely, our cash -- our first SBIC fund and the holding company, I think it was probably at quarter end about 60-40, but I am estimating --

Shelby Sherard

That's about right.

Ed Ross

In terms of percentage. So the $40 million that we referenced at June 30th, about 60%, and there was a little bit of FMC too, meaning SBIC too. But that 60% of the SBIC and then the other 40% of the holding company.

Robert Dodd - Raymond James

And then one more if I can, I mean, last quarter you talked about that you are seeing a lot of deal flow, but turning down more because the terms basically weren't as -- didn't fit the profile, the [indiscernible] that you were looking for, which is a good angle to take. So I mean now, in early Q3, we have seen a couple of pretty sizable, 10 and 20 -- 30 so far obviously. Some of that may have been pushed back from Q2, you said by lengthening -- closing cycles or not. But is this an indications that you've seen terms normalize kind of deals that obviously you're willing to do, or on the negative side, is it an indication that the terms are shifting, and you've shifted your return perhaps just a little bit?

Ed Ross

It’s a great question Robert, and I think I got to go back to a lot of the statements we have made in the past, which is, our focus is on risk adjusted returns, and quite frankly, capital preservation, and so, when we are reducing our yields, we are doing it in a manner where we are comfortable and happy with the risk adjusted returns. So I think that is really how we drive our decision making.

And I think the other thing I would say, it’s the deal business and it can be erratic, as you well know, and I am sure you have heard many talk about. We've had -- there were seven deals during the second quarter that I thought had a chance at one point in time of actually closing during the quarter, and we ended up closing one. We still have three of those that we are working on. We closed obviously a couple here recently, and a couple have gone away, for a variety of reasons. Diligent reasons, as well as, believe it or not, sellers saying, I don't know what I am going to do with the cash, or why don't I provide the financing.

So there is a variety of, its the deal businesses, what I would say, and it can be erratic. And so we have experienced some of that of-late, or at least during the first six months.

Robert Dodd - Raymond James

Perfect. Thanks a lot.

Ed Ross

Absolutely. Good talking to you.


And our next question comes from Chris Kotowski with Oppenheimer. Your line is now open.

Chris Kotowski - Oppenheimer

Yeah. Good morning. I wonder if you could talk about the credit environment in general, and obviously the markets have been under stress, and we have seen some non-accruals and -- is there a, what you would call deterioration in the markets, or is it just the -- or is it pretty much still business as usual?

Ed Ross

Sure, its obviously a very good question, and I will answer that in a couple of ways, Chris, and I think I will also touch on our portfolio, because I think it makes sense to do so. I think the credit environment continues to be relatively solid. I do think, its not an environment where we want to be the volume leader, in terms of putting dollars out the door, and the reason for that is, again, we are focused on risk adjusted returns, and I think it’s a good environment, I think its an active environment, but we are really focused on quality over quantity. And so I don't think there has been a deterioration in the credit environment, as well know the first quarter, for most companies, was a little slower, and I think part of that had to do with the weather.

The second quarter, GDP is up. Our portfolio would tell you, was in a slow growth mode on both an EBITDA basis, and a revenue basis. So I think it is performing fine, and I think that reflects the current credit, or part of the credit environment if you will.

Just to touch on our portfolio for a minute, because I think that's part of your question. As a whole, we feel very good about the health and the construct of our portfolio, and as I mentioned, I would characterize it as being slow growth. But within the portfolio, we clearly have some companies that are exceeding expectations, and then we have some that are underperforming, to varying degrees. And so company-specific outcomes is really what's driving our portfolio and if you look at it on an individual basis -- and that's what we would expect, and quite frankly, if you have 37 portfolio companies. Its also why we have been building our portfolio from a diversification standpoint. That has been a goal of ours, and its also a goal of ours, as we continue to move forward.

I don't think it makes sense to talk about the performance of the individual portfolio companies, for obvious reasons that I stated before. But just mentioning Avrio obviously, our investments in Avrio have been underperforming for some time, and several events that transpired over the last couple of months, meaningfully increased the risks of our investments in the company, and so the current level of risk is reflected in our valuation of the securities we invested in. And Paramount falls in a different category for sure, but it had a couple events that occurred recently, that increased our risk, and so we are currently working with management to position the company for the future.

Overall, I'd say, we continue to be pleased with the overall quality and construct of our portfolio. And importantly the results of our portfolio that we have generated over the past three years have been very strong. However, as I stated in our prepared remarks, losses and write-downs are inevitable events for our vendor and us, and as many of you know, we have purposely structured our portfolio, focusing on debt, but have coupled those debt investments with meaningful equity investments and a large majority of our portfolio companies. So from our perspective, if we do our job, our equity investments should not only offset our investment losses, but also should provide incremental gains, and to that point, our investment portfolio has generated over $30 million in net realized gains since our IPO, which ha also been coupled with strong NII results.

So as we look forward, we continue to be pleased with the composition and the construction of our portfolio, and we believe we are well positioned to deliver stable and growing dividends, including making special distributions from time to time. And then, we also believe we are well positioned to grow our NAV over time, which is also one of our goals. So hopefully that's helpful, and gives you a little flavor for the overall market and as well as our portfolio.

Chris Kotowski - Oppenheimer

Yes, thank you. That's it for me.

Ed Ross

Okay. Thanks Chris.


And our last question comes from Vernon Plack with BB&T Capital Markets. Your line is now open.

Vernon Plack - BB&T Capital Markets

Thanks. I wanted to follow-up on your comments regarding the investment pipeline. How that has set the stage, for what should be a more robust second half of the year, and speaking of the pipeline, can you tell me does it continue to accelerate today, in other words, is the pipeline growing today, versus say 30 days ago, 60 days ago, and with that, I am just wondering what that ells you about your marketing efforts and your staffing levels, and everything that's associated with that?

Ed Ross

Sure. Interestingly, what I would say is, deal flow for us has been pretty good all year. I do think there is a noticeable increase over the past, and really started a couple months ago, but the M&A environment is -- I think the pipeline has picked up, and so that creates a lot of work, because you are looking at auctions as well as some proprietary deals. But it’s a very good thing I think for everyone. So that is a -- it’s a real positive, and so we would expect for a much more active second half of the year, than we would for the first half of the year.

In terms of -- we are pretty well staffed right now. We hired a principal in December. We just recently hired another analyst. So we are continuing to grow our human capital base if you will, in line with our portfolio. So I think we feel pretty good about the team we have right now, and what they are doing, and so now, we are just trying to kind of execute on the highest quality opportunities that we can find. The challenge, as you know, is what comes with a robust deal environment, means you also are going to have some repayments. And so we do expect repayments to elevate a little bit over the first half of the year, and that's a good thing. We invest in, or we make investments with the idea of getting our capital back in a reasonable timeframe, and typically with the goal of the company being sold at some point in time. We think that will happen with some of our portfolio this year.

It’s a good environment, we are just trying to be cautious and highly selective.

Chris Kotowski - Oppenheimer

Okay. That's helpful. Thank you.

Ed Ross

Sure. Absolutely.


And I am showing that there is no further questions at this time. I would like to turn the call back over to Ed Ross for closing remarks.

Ed Ross

Thank you, Sam, and thank you everyone for joining us this morning. We look forward to speaking with you on our third quarter call in early November. Have a great day and a great summer weekend.


Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program, and you may now disconnect.

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