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Executives

Stacy Ybarra - Director of IR

Jim Voelker - Chairman and CEO

David Binder - CFO

Analysts

Kerry Rice - Wedbush Morgan

James Dobson - Stanford Group

Jeffery Shelton - Natixis

Derrick Wood - Pacific Growth Equities

InfoSpace Inc. (INSP) Q4 2007 Earnings Call February 5, 2008 12:00 PM ET

Operator

Good day, everyone, and welcome to today's InfoSpace fourth quarter, 2007 conference call. (Operator Instructions). And at this time for opening remarks and introductions I would like to turn the program over to Ms. Stacy Ybarra. Please go ahead, ma'am.

Stacy Ybarra

Good afternoon and welcome to InfoSpace's fourth quarter 2007, earnings conference call. I'm Stacy Ybarra, Director of IR. With me on the call today is Jim Voelker, Chairman and CEO, and David Binder, Chief Financial Officer. Before we get started I want to remind you that during the course of this call InfoSpace representatives will make certain forward-looking statements. These forward-looking statements, include statements regarding InfoSpace's expectations for our online business, expectations regarding its marketing and strategic initiatives, expectations for its financial performance for the first quarter 2008, and expectations regarding the future for the company's business. Other statements which may be made in response to questions which refer to our belief, plans, expectations or intensions are also forward-looking statements for purposes of the Safe Harbor, provided by the Private Securities Litigation Reform Act. Because these statements pertain to future events and are subject to various risks and uncertainties and actual results could differ materially from InfoSpace's current expectations and believe.

Factors that could cause or contribute to such difference include, but are not limited to the risks discussed in InfoSpace annual report on Form 10-K for the year ended December 31, 2006 and its quarterly report on Form 10-Quarter, which are filed with the Securities and Exchange Commission. InfoSpace undertakes no obligation to update its forward-looking statements.

Now, I'll turn the call over to Jim. Following his comments, David will review the fourth quarter results and first quarter outlook. Then Jim will wrap up with closing remarks and we will open up the call to your questions.

Jim Voelker

Thank you, Stacy and good afternoon everyone. 2007 was an eventful and positive year for InfoSpace shareholders and stakeholders. Two transactions unlocked substantial market value and we distributed that value and more to shareholders, while retaining our online search business and a healthy balance sheet.

A brief review of the events is in order before we move on to fourth quarter results and a discussion of our search business. When the Board appointed a new management team five years ago InfoSpace was a company searching for direction in myriad of legal issues. As we progressed we strived to optimize our assets by divesting non-core businesses, making acquisitions to bolster growing business and driving cash flows. It has been anything, but a straight road, marked by successes and disappointments. On the plus side we have driven over $230 million in cash flow and yielded $440 million in asset sales.

On the other side we entered and exited the mobile content business over a three year period, enjoyed extreme growth and profit and suffered sudden decline. Yet, when viewed as a whole, enterprise value has grown from a $126 million to $826 million and $1 invested five years ago has yielded 650% return. That's a record we are proud of. The latest transactions were completed in the fourth quarter. The sale of our directory assets to IDR for $225 million and the sale of our mobile assets to Motricity for a $135 million, both in cash,. In each case we believe we extracted top value. The directory assets were purchased in 2004 for $108 million. Contributed over $50 million of cash flow in subsequent years and then sold for a multiple of 11 times cash flow. The mobile assets had yet to yield a profit and sold for over two times revenues. In addition we were able to shield virtually all of the gain from these sales by the application of our NOL, saving over a $100 million in cash taxes. This led to a special dividend of $300 million or $9 pre share, following our May dividend of $208 million or $6.30 per share. Overall, the Board and Management have been and remained focused on maximizing our assets and delivering shareholder value and liquidity.

We’re excited to move forward, focused on a single business, online search, with several assets in place, over 4 million unique searches per month, 100 plus distribution partners, strong committed modernization partnerships with Google and Yahoo and many others, and a differentiated award winning product. We also have a proven, highly scaleable business model and a experienced and talented team, focused solely on search. And we’re off to a good start.

Fourth quarter revenues and adjusted EBITDA were well ahead of expectations. Revenues were $39 million up 15% year-over-year and 15% sequentially. It's important to note that our operating results are profoundly impacted by the many events in the fourth quarter. Specifically: the divestitures, dividend, restructuring and tax accounting.

At this point I would like to turn the call over to David Binder our new CFO to walk through details.

As many of you know, David is been with InfoSpace for four years as our Vice-President of Finance. His appointment follows Allen Hsieh's planned departure in connection with the sales of our mobile and directory businesses. I want to thank Allen for his services to InfoSpace over the years. He is been both a good friend and a great colleague and we wish him well on his endeavors.

Now I'll turn the call over to David and after his discussion I'll finish with comments on our priorities and opportunities. David?

David Binder

Thanks Jim, and welcome to our call today. Along with the performance of our search business, our fourth quarter financial results are greatly impacted by the sale of the directory and mobile business, the shareholder dividend and the previously announced reduction in staff.

I will start to review the numbers first for the look at our net income for the fourth quarter and full year, and then turn to the revenue margin and adjusted EBITDA performance of our search business.

Given that there are several important items to call out, we have posted a table on our website to highlight some of the key data. Net income in the fourth quarter is $57.8 million or $1.74 per share, up by $30.2 million from the prior year. This result is comprised of income from discontinued operations of $131.5 million, offset by a loss from continuing operations of $73.7 million. Within the results of our continuing operations, we recognized employee costs associated with the divided and restructuring equaled to $45.6 million, stock based compensation of $16.9 million and a GAAP tax expense of $16.4 million. Within discontinued operations, we recognized a net gain from the sale of our directory and mobile businesses equaled to $139.9 million, partially offset by a loss from discontinued operations of $8.4 million.

For the full year we recorded net income of $16.9 million or $0.52 per share, up by $32 million from 2006. This result is comprised of income from discontinued operations of $114.6 million, offset by a loss from continuing operations of $97.7 million. For the year, continuing operations includes employee related expenses associated with dividend and restructuring, equaled to $65.8 million, stock based compensation of $34.1 million and GAAP tax expenses of $26.7 million. Within discontinued operations for the year, we recognized $139.9 million from the net gain of the sales, partially offset by a loss from discontinued operations of $25.3 million.

Overall in 2007 we booked a GAAP tax expense of $125 million, however by utilizing our NOL carry forwards, the company will pay less than $6 million in cash taxes. In addition the company maintains an NOL balance of $789 million.

Now, I will turn to a closer review of the performance of our continuing operation, the online search business. As Jim mentioned earlier, revenue for the fourth quarter was $39.1 million, which exceeded our expectations by $4 million to $5 million. Gross profit in the fourth quarter was $20.1 million, an increase of $1.5 million from the third quarter and a decrease of $1 million from the fourth quarter of 2006. Gross profit margin in the quarter was 52%, down 3% sequentially from the third quarter.

In the fourth quarter we experienced growth from both our owned and distribution lines of businesses. However, the rate of growth was higher from distribution. In the quarter distribution represented approximately 64% of our total revenue, up from 60% in the third quarter.

Adjusted EBITDA in the fourth quarter was a negative $42.6 million. Included in this amount is the expense of $45.6 million, I previously mentioned, resulting from employee costs associated with the shareholder dividend and restructuring. Excluding these costs, our adjusted EBITDA would be $3 million n the fourth quarter exceeding our guidance by $2 million. The average basic share count in the fourth quarter was $33.3 million. However, it is worth noting that we ended the quarter with $34.3 million outstanding.

For the full year of 2007, revenue was $140.5 million, a decrease of 13.3 million or 9% from 2006. In looking at this trend, our distribution business represented 82% of the sequential annual decline. We saw significant volatility from our partners, most notably in the second quarter of 2007. Since then, we've seen sequential quarterly growth, in both our distribution and total revenue.

For the year gross profit was $78.8 million, down $12.7 million from 2006. Gross profit margins for the full year were 56%, down 3% from the prior year. Adjusted EBITDA for 2007 was a negative $47: 6 million, which includes employee costs associated with both dividends, and restructuring charges of $65.8 million. Excluding these charges, adjusted EBITDA would have been $18.2 million in 2007. Average basic shares for the year were $32.6 million. Again we ended 2007 with 34.3 million outstanding.

Now, turning to the balance sheet, we ended the year with approximately $575 million in cash, short and long-term investments; an increase of $360 million from the third quarter. This total includes the cash received from both directory and mobile transactions and does not reflect the cash dividend we paid on January 8th, of approximately $300 million.

Given the dividend deal related fees, cash taxes and the employee expenses associated with the dividends and restructuring, we expect our cash balance to be between $210 million and $215 million.

Within our investments we hold $37.4 million in Auction Rate Securities. In the fourth quarter we moved this balance from short-term to long-term investments, in recognition that we would be unable to liquidate if we were to choose to do so today. In addition we recorded a loss of $2.2 million in our Statement of Operations, resulting from an impairment to the value of these investments.

Now, turning to our outlook: For the first quarter of 2008, we expect revenue to range between $35 million and $37 million. Adjusted EBITDA to be between $2.5 million and $3.5 million and net income to be between breakeven and $1.4 million or up to $0.4 per share.

Now I'll turn the call back over to Jim to add on.

Jim Voelker

Thanks David. We have a solid set of search assets, the foundation been our metasearch technology, which is becoming more relevant everyday. Over the past five years the web has grown exponentially, now with over a 100 million sites. Naturally, as Web search has emerged as the most important tool for discovery, the investment in technology has grown exponentially as well, with Google, Yahoo, Microsoft and Ask, taking fundamentally different approaches to indexing and organizing information.

In addition, (inaudible) specialized their vertical search engines with focus on a certain topic, such as health or travel, they have added a new dimension for users. All this activity underscores the value of our metasearch technology, which has continued to evolve with the industry at large.

We developed the capacity to understand the strengths of various engines, the intension of users around specific queries and methods to distil the best results set. This is pouring out in our industry leading success rate as track by comScore, and by the J.D. Power Award for highest customer satisfaction two years running. We have an excellent and improving product. And we need to be more aggressive and in increasing exposure to it.

We are focusing our efforts on Dogpile, where the lion share of our users reside, by adding more verticals to our index, launching a new user interface and later in the year innovation is focused on the intersection of social networking and search. Additionally, we will boost direct to consumer marketing to support the Dogpile brand and educate audiences on the unique benefits of Dogpile.

Specifically, we expect to increase the marketing spend by 50% in 2008. To lead these efforts Bruce Allenbaugh was recently hired to the newly created position of Chief Marketing Officer. Bruce is a seasoned marketing executive with a proven record of developing high impact brands such as Pepsi and Safeco.

While our mascot Arfie didn't make a appearance at the Superbowl this weekend, Bruce and his team will be increasing his and Dogpile's visibility.

On the distribution side, we benefit from having more than 100 private label partners, including six new partners signed in the fourth quarter. Among these partners are content sites such as RealNetworks, community sites like MyPoints.com and connectivity sites like Verizon DSL.

And we recently launched two products that significantly broaden our appeal to the connectivity market: Private-Label portal and DNS Assist. In the past year or so there has been movement by ISPs away from internally developed portals to private label or outsourced arrangements. Reasons include, improved access to content and advertising and scale, and the non-linear step to Web2.0 technologies. Our portal product features an Ajax-based user personalized home page, which offers standard contents, such as news, weather, sports and stocks, as well as a broad menu of user configurable content modules for easy access to our assessed speeds, widgets and applications.

The widget catalogue, user defined tabs and drag and drop functionality make it simple to organize a personal homepage. It is built on an extensible platform that allows for co-branding, while also providing a high degree of customization for our distribution partners and their content and services. Importantly the portal includes our metasearch service providing strong monetization, as well as fixed modules for contextual display advertising. We’re pleased with the initial market response and will launch two partners in the first quarter.

Another trend in the ISP market is DNS Assist which resolves user typing errors and replaces the standard 404 error page with helpful suggestions, corrections and related search terms. We developed filtering technology, as well as the landing page designs and integration of text based relevant ads. This is a relatively untapped, high volume market and we’re currently testing with several ISPs with very encouraging results. As our overall goal is to grow quality searches, these products help expand and strengthen relationships with our distribution partners.

Along with the revenue initiatives, we're focused on rebalancing our operating structure and reducing cost in line with the new size of our business. We’ve reduced our staff by approximately 35 positions during the fourth quarter. And expect to realize approximately $7 million to $9 million in annual cost savings.

In summary, InfoSpace is in a dynamic market that has substantial growth ahead of it. We’ve a talented team, a solid direct customer base, growing distribution network, great partners for monetization, leading technology assets, financial strength and a high leverage business model that generates non-cash flows. We’re proud of our record of creating value thus far. And the game is far from over, with that we’ll be pleased to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions). Our first question will comes from [Kerry Rice] with Wedbush Morgan.

Kerry Rice - Wedbush Morgan

Hi, guys, a nice quarter. Couple of questions; one which I assume you're somewhat anticipating, is the impact of Microsoft's potential acquisition of Yahoo and how that consolidation could be positive for InfoSpace? And then I have a couple of follow-up questions.

Jim Voelker

Sure, Gary. Well, this is something that we've been waiting for, I guess, and we might think of it as the reconsolidation of that network. If you go back a few years for us and of course, just to set the stage a little broader here, we by virtue of the structure we run with the metasearch, and we send every query to a variety of engines, we are in pretty interesting position to look at the different monetization levels, in the way they different engines and beyond engines the ad networks work on queries and how they monetize those.

And if we go back a few years, there really wasn't much to choose between - the kind of monetization we saw from the Yahoo network or the Google network - they were fairly similar. And if we go back and look at the time when Microsoft determined they would build their own network and began to take traffic away from the Yahoo network, on a relative basis the gap got wider and Google continued to get stronger. That hasn't necessarily been bad overall for us, but we certainly prefer having much more competition in that space for advertisers. And we believe that that the consolidated network between Microsoft and Yahoo will help their monetization and will help us overall in the long-term. I think in the short-to-medium run, it probably doesn't mean a lot.

Kerry Rice - Wedbush Morgan

I think Microsoft doesn't use a lot of distributors today; do you think Yahoo will pay more, higher rates?

Jim Voelker

No, not, necessarily higher rates, but as you know, these ad networks have a tremendous network affect, right, they draw more advertisers, the more eyeballs you have, the more advertisers you are driving, the higher your keywords get bid etcetera, etcetera. Right?

Kerry Rice - Wedbush Morgan

Right.

Jim Voelker

And so, we would look at that. And it will also help, frankly it will help stabilize, what you have been talking about rev share. I mean, if we looked out a couple of years and we continued on the road that we were on, and we saw greater diversions, by the time our contracts came up in 2011, Google would, again if this trend had continued in a static way, Google would have much more pricing power in terms of revenue share. So, we think this serves two ways. A larger network will monetize better and will also serve to keep everybody honest on rev share.

Kerry Rice - Wedbush Morgan

Okay. And then on operating expenses, obviously you said that you will be spending more on sales and marketing and the restructuring is $79 million in annual costs savings. When should we see the roughly $2 million a quarter kick in or should I think about it in Q1? And then maybe longer term, what other restructuring efforts or maybe cost cutting efforts do you think about, to bring down G&A even further?

David Binder

No, we are looking at the lion share of the effect of the cost savings to be completely in to the income statement in the third quarter and fourth quarter of this year, and to see EBITDA reflected that way.

Jim Voelker

Actually on the second part of it, Kerry, we will take a little bit of wait and see. Well we went from running three businesses here to one. There were certainly some shared services, if you will, that we went to work on here and cut back on. We are pretty comfortable with the size of the business right now. We are pretty comfortable that we could grow revenues fairly substantially here with very minimal ads to hedge. So, we feel really good about the leverage in the model. Could there be a few more positions as time goes on did we learn new things a little bit more efficiently? Yes, but it’s not going to be a substantial amount.

Kerry Rice - Wedbush Morgan

Okay. So, are you still looking for 15% EBITDA margins exiting the year?

David Binder

Yeah, that's a good way to look at it Kerry, exiting the year.

Kerry Rice - Wedbush Morgan

Okay. And then one final question. Now that you've done the $300 million distribution related to the directory proceeds, sale of the directory business, have you thought anymore about doing another kind of special dividend related to the sale of the mobile business?

Jim Voelker

Well first of all I would say that the overall dividend was related to both sales, and it's really a matter of looking at what your cash needs are going forward and the like. At this point remember, we have a few different ways look at this; one is we've a buyback in place, so kind of watch and see how the equity performs here, and if frankly we think this stock stays really cheap that might be a little bit more attractive. So, we look at all the different opportunities we have here.

Kerry Rice - Wedbush Morgan

Okay. Thanks a lot.

Operator

And our next question will come from Clay Moran, Stanford Group.

James Dobson - Stanford Group

Hi, this is James Dobson asking question for Clay. My first question is, can you talk a little bit about the pricing trends you see, has it stabilized or has it been increasing a little? And then second, I know you mentioned you are trying to concentrate on Dogpile, what about your other owned properties, maybe WebCrawler and Excite, if you can give us maybe some trends of what you are seeing there? Thanks.

David Binder

James, I can do the first part and then I'll kick it over to Jim for the second. In terms of pricing I think you are referring to the rates that we're seeing, how we're monetizing our traffic is that right?

James Dobson - Stanford Group

Yes.

David Binder

And we're seeing those continuing to grow, they grew throughout 2007 and the early indications in 2008 seem to be fairly strong.

Jim Voelker

And on the second part of it, if we look at our owned and operated sites as a whole, out of our 4 million users, you know the lion share, some 70% plus, are at Dogpile. So, that gives us kind of, if you will, critical mass, to work off and that's really where most of our efforts will be concentrated. We do use WebCrawler and MetaCrawler and aim them at slightly different audiences. Frankly use them a little bit as a test bed to try different kinds of marketing efforts, to test different kinds of features, things of that nature, but Dogpile is where we are going to concentrate most of our effort.

James Dobson - Stanford Group

Could you give me a reminder again on how big the buyback emplaces?

Jim Voelker

$100 million.

James Dobson - Stanford Group

Great. Thank you.

Operator

And we will take our next question from (inaudible).

Unidentified Analyst

Hi, guys. Just want to make sure the $39 million in revenue - is that all search, correct?

David Binder

That's correct. Yes. Everything within the mobile and directory business is discontinued operation.

Unidentified Analyst

Got you, got you. So I was wondering, I mean, I am actually pleased with guidance for Q1, but I am wondering if you could just explain why we might be seeing a little dip in there? I know seasonal factors are involved.

Jim Voelker

That's really the lion share we typically see first quarter down.

Unidentified Analyst

Okay. And then, I think someone else asked this, but just want to make sure. So, I am assuming that you are still looking for gross margins 55 to 60 and 58% EBITDA margin, basically going out of the '08?

David Binder

On the EBITDA margin, yes, exiting 2008. The gross profit margin is really going to be affected by the mix between distributions and owned site.

Unidentified Analyst

Yeah, because I mean, I see now that 64% of the revenue is coming from distribution. So, I am assuming, might be more likely for the low end of that range.

Jim Voelker

If the mix between owned and distribution continues in that trend, then we would expect the margins to come down, respectively. And I would expect that that mix is going to have some volatility throughout the year. But remember [Ali], our focus is on the absolute dollars that we can drive here to the bottom. And revenue mix is somewhat unimportant to us, right. I mean we prefer, we would like to see, both of them growing real fast, but both of these are profitable businesses. And so, either way it is pretty much fine with us.

Unidentified Analyst

Of course. And of course it helps increase your cash balance. Besides the stock buyback possibly, and potentially, say, dividend distribution, are you looking to make any acquisitions? I mean is that part of the strategy going forward?

David Binder

We really like the business model we have; we said this all along, if we could find really high quality search traffic dead right on top of our business model, we would be very, very interested in it and I would tell you, we haven't found a lot of that out there yet. But we keep searching for things. But in terms of kind of some type of more broad diversification, no, we want to stay. We like the business model we have here. We think it is highly leveragable. We want to stay very focused on it and that's what we are looking to do.

Unidentified Analyst

Got you. All right thanks, guys.

David Binder

Thank you.

Jim Voelker

Thank you.

Operator

Jeff Shelton with Natixis. Your line is open. Please go ahead.

Jeffery Shelton - Natixis

Thanks, Jim. I was hoping you could go into a little bit more detail about the strength on the distribution side on the sequential basis; was most of that growth from, I would say, your core partners or was it related to some of the more gray areas, which cause some variability earlier in the year?

Jim Voelker

I don't know. David do you want to -- I don't know how much more detail we really want to get at that. I will just tell how it wasn’t one or two partners, that it was kind of distributed across the distribution chain here.

David Binder

In the past we’ve talked about the sort of a mix between our organic and SEM partners and I would say that in the fourth quarter the sequential growth was pretty much shared across those two buckets and we didn’t see a significant mix between those types of partners.

Jeffery Shelton - Natixis

And how much of the five or six new contracts that you said you signed on showed up in the fourth quarter?

David Binder

To a very little extent, a little bit of that sequential growth is coming from new partners, most of it is coming from base that had been in there in the third quarter.

Jeffery Shelton - Natixis

And the distribution as a percentage of total was 64% in the fourth quarter. What was it in the fourth quarter of last year?

David Binder

Off the top of my head, it was around 60%.

Jim Voelker

It was a little bit under 60%.

Jeffery Shelton - Natixis

Okay. And so, that would imply that you are fairly flattish on the Dogpile on NOL side from a revenue perspective year-over-year?

David Binder

That’s right.

Jeffery Shelton - Natixis

And so given the initiatives that you are undertaking in terms of driving traffic, we should expect to see some growth there in '08 versus '07?

David Binder

That’s the advantage.

Jim Voelker

That’s the plan.

Jeffery Shelton - Natixis

Okay. Thank you.

Operator

(Operator Instructions) We now go to Derrick Wood, Pacific Growth Equities

Derrick Wood - Pacific Growth Equities

Thanks. You talked about increasing marketing spend by 50%; can you give us a sense of what you spent on Dogpile in ’07?

Jim Voelker

Our overall marketing spending is below $10 million in '07. So, we’re looking to grow 50% off that base.

Derrick Wood - Pacific Growth Equities

Okay. Thanks. And in terms of the ARS that you classified, I am not sure how much cash that was, but let's move to long-term securities. Can you give a little more clarity on that and why you may have not written down more of that?

Jim Voelker

We actually assess the value, the fair value of the option rate security and we'll do so again at the end of the first quarter. The amount that we wrote down was reflective of the difference between the par value of those securities and what the fair value is as of the end of December. The other than temporary piece of that is what we reflected in our income statements, that $2.2 million that I referenced earlier.

Derrick Wood - Pacific Growth Equities

Okay. And in terms of looking at depreciation going forward, we had a pretty good run rate here, it was $1.4 million in the quarter?

David Binder

Yes. And then you'll see in our guidance, one of the factors in our guidance is pretty flat on depreciation.

Derrick Wood - Pacific Growth Equities

Okay. And just to reiterate, so the upside versus your expectations on the top line really came from more upside from distribution partners and it was both organic and SEM?

Jim Voelker

That's correct.

Derrick Wood - Pacific Growth Equities

Okay. Thank you.

Stacy Ybarra

Operator, we have time for one more question.

Operator

Our final question will come from (inaudible).

Unidentified Analyst

Hi, guys. Thanks for taking my call. Jim you talked about an excellent year at 15% EBITDA margin, which is great, but I mean, given the inherent cost structure of the business, is there any reason why, when look at it a couple of years, this couldn't be a 25% plus margin business or are there more investments that you feel like you need to make?

Jim Voelker

No, I think, the thing we love about this business model is kind of, there are a couple of things, right. We've already seen what it looks like at $150 million in revenue, I mean, unfortunately that was a couple of year back. But, so we know that it can, it produces, it takes, if you will, particularly organic traffic that comes to our owned and operated sites and turns that in to bottom line cash flow very, very efficiently. So, that's really the leverage that we are pushing for here.

And as I mentioned earlier I think the kind of size of the company in terms of the cost infrastructure right now, is appropriate for where we are and where we want to go, but it can also carry a lot more revenue. It is again, a very highly leveragable kind of model. So, we this year want to be very aggressive on trying to grow that owned and operated base. And we think we have the products in place and with some new enhancements behind that, and some good communication programs, and smart ad spending here in order to do that.

Unidentified Analyst

All right. Sounds exciting, guys. Thanks.

David Binder

Thank you.

Jim Voelker

Thank you.

Operator

That would conclude our question-and-answer-session. At this time I would like to turn the conference back to our speakers for any additional or closing comments.

Stacy Ybarra

Thanks for joining the call this afternoon.

Operator

Thank you everyone for your participation in today's conference and you may disconnect at this time.

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