Independence Contract Drilling Inc. (NYSE:ICD)
Q4 2016 Earnings Conference Call
February 28, 2017 11:00 ET
Philip Choyce - EVP & CFO
Byron Dunn - President & CEO
Alex George - Evercore ISI
Kurt Hallead - RBC Capital Markets
Rob MacKenzie - IBERIA Capital
Good morning, and welcome to Independence Contract Drilling Fourth Quarter and the Year End 2016 Financial Results Conference Call. All participants will be in listen-only mode. [Operator Instructions] Please also note today's event is being recorded.
I would now like to turn the conference over to Philip Choyce, Executive Vice President and Chief Financial Officer. Please go ahead, sir.
Good morning, everyone, and thank you for joining us today to discuss ICD's fourth quarter and year end 2016 results. With me today is Byron Dunn, our President and Chief Executive Officer.
Before we begin, I would like to remind all participants that our comments today will include forward-looking statements which are subject to certain risks and uncertainties. A number of factors and uncertainties could cause actual results in future periods to differ materially from what we talk about today. For a complete discussion of these risks, we encourage you to read the company's earnings release and our documents on file with the SEC.
In addition, we refer to non-GAAP measures during this call. Please refer to the earnings release and our public filings for our full reconciliation of adjusted net loss, EBITDA and adjusted EBITDA and for definitions of our non-GAAP measures.
With that, I'll turn it over to Byron for opening remarks.
Thank you, Phil. Good morning, everyone and thanks for joining us today. I'll provide some color on ICD's fourth quarter and follow with thoughts and what we expect during the first quarter of 2017 and t overall environment we anticipate during the year. Phil will provide details on our fourth quarter financials and then we'll take questions from call participants.
So the last two years have been brutal on the energy and energy services industries and tough on ICD. As the historic downturn in commodity price and rig count progressed throughout 2016, U.S. field activity levels plummeted in the North America land rig count was decimated to about 400 rigs in all-time industry long. ICD entered 2016 with 11 rigs operating but it dropped down to four by June of last year. However, during the fourth quarter of 2016 we saw stabilization of commodity prices in improved levels and the formation of a bottom in North American rig activity. All in all, we believe that the fourth quarter of 2016 marked the end of the epic energy industry downturn and a beginning of a return to a more balanced supply demand and global oil and gas pricing dynamic.
We believe a significant byproduct of the commodity price collapse we have lived through is the acceleration of technological innovation in drilling, completion, reservoir management and production in logistics across the global E&P industry and in particular, within ICDs target markets. Application of new technologies and the shale serves to rationalize the cost structure of the E&P and service industries and has produced a very efficient and fast responding environment. We believe this has resulted in a permanently lower commodity floor ceiling price structure. To the last three years it's been nothing less than the fall of the old order and the emergence of technological innovations creating new market leaders in both the E&P and energy services industries. ICD intends to be a market leader in this emerging order, not the largest contract drilling company with the best. It's a good time to be an industry innovator.
ICD outperformed the contract drilling industry through the downturn in utilization and we believe in true day rate. Nevertheless, the downturn took a toll on ICDs operational tempo. As the full scale of the energy industry's collapse manifested, our management team took proactive steps to rethink how we define work, how we do work and to restructure and remap rig build, field maintenance and operations processes. This resulted in a much more efficient, current and future ICD structure. Although when we return to growth, revamping of ICD operations will reverse some of these structural cost modifications, the majority of the cost reductions we have implemented are relationally permanent.
Some specific metrics I'd like to comment on include, our SG&A construction overhead. We organized, we restricted our organizational chart, right-sized our senior management team and increased synergies across our rig construction, field and support operations. As a result, we have eliminated approximately $5 million of SG&A and fixed construction overhead costs from our company when compared to our cost structure that was in place in 2015. We streamlined our field operations and focused on eliminating costs such that our fully burdened operating cost per day will run around $12,500 when our rigs reach full utilization. Achieving significant cost efficiencies to the dedication and enrollment of our entire employee base is worth pointing out that ICD employees implemented material, organizational and cost reductions without sacrificing operating performance.
Across our fleet, every one of our rigs operated at less than 2% downtime in 2015 and 2016; even during the second half of 2016 when we more than doubled our operating fleet in less than three months. Today ICD has a more dynamic and seasoned workforce than we ever have. Although utilization through the downturn allowed us to keep our most talented and experienced people and I'm proud to say that even though we were forced to [indiscernible] during the downturn, virtually all have returned to work at ICD. We expanded and solidified our customer base in the geographic reach of our operations, although the Permian remains the focus at most of our fleet, we are now a leading driller in the Haynesville. By the end of March, we will have rigs operating simultaneously in three of our four target market regions with Permian, Eagle Ford and Haynesville.
In the past year we added several new customers, all large, publicly traded or private E&P firms that are well capitalized, have aggressive, complex pad drilling growth plans, paper quality and drill-through cycles. Our expanding backlog of term contracts with these customers illustrates their high regard for ICD's operations, the value we provide from a safety and operational efficiency perspective, and their commitment to partner with us. We continue to set records for our customers in drilling longer and more complex wells from their larger pads. The one Permian customer on a five well pad, every well we drilled was over four miles in total depth. Main takeaway I'd like to leave you with is that from any perspective, ICD exited the downturn a much stronger company than when we entered.
Looking forward by March 2017, we will have more rigs operating than ever before in company history with every available rig in our fleet contracted and we're in discussions with multiple customers regarding the recommencement of our billed program and the resumption of ICDs growth arc. Funding a resumption of our growth strategy is supported by the term structure of our contract fixtures. With recent contract signings and full effective utilization of ICDs fleet, we strategically set up a staggered term contract exploration metrics throughout 2017 and early 2018. This provides ICD a defensive/offensive dynamic. The backlog provides foundational support to fund completion of our final reconversion in the next two 200 series newbuilds under our revolver. Simultaneously, staggering contract explorations across 2017 and early 2018 a lot of this to capture further day rate improvement as contracts roll and re-rate.
I'd like to talk about day rates a little; and first, and to make sure we're talking apples-to-apples, I will always refer to pure rig day rate at the margin, not some number that can flex multiple services at the rig level with day rate or some blend in extend combined result based on historical contract relationships of any other permutation or combination of loosely related rates that contract drilling industry reports as revenue per rig or into some other [indiscernible]. We believe such reporting by the industry is confusing than transparent and obscures the ability of the financial community to understand true rig economics and the temporal path of true rig day rates. In addition, these will take metrics tend to get picked up and discussed as day rate which they are not.
As we have discussed with you on several previous calls in an improving market cycle, increasing contract tender will be observed first which we're seeing followed by day rate improvement. Today real day rates for true pad optimal rigs have in fact begun to move higher driven by what we believe is the full utilization of true pad optimal rigs across the North American industry. Marginal day rates are new fixtures for 1,500 horsepower true pad optimal rigs have moved from the mid-teens to the high teens with continued upward momentum. Assuming commodity pricing remains intact, we would expect to see day rates to continue through the $20,000 per day threshold in 2018. In caveat [ph], I want to make you aware off as we look at four 2017 margin at the rig level, it's a tightening labor market for rig crews as rigs go back to work.
At ICD, we protected our rig level senior leadership and expertise throughout the downturn but are seeing a tightening market for the quality of employee we want as a new or an experienced hire. Many members of the oil service workforce made the decision to exit the industry during the downturn and will never return. As energy industry conditions improve, the North American industry will be required to train a new entry level group. What impacted this will be ICD's carrying a larger number of new employees in training than we have previously. This is a new development and I can't fully quantify for you at this point but it's not going away soon.
I'd also like to comment on rig supply. Recent comments by competitors seem to have established finally that the debate about the superiority of pad optimal omni-directional walking rigs is over and done with and that omni-directional walking systems are superior to all of the moving systems and up with the smallest pads. As a result of this acceptance, there are projects underway to upgrade or refurbish older legacy rigs to some type of walking system. And in response to this, some analysts have raised concern that these projects provide a large supply of pad optimal rigs at a low cost base. We completely disagree and think that this analysis does not hold them to scrutiny in a deeper dive.
If you recall, at ICD we had three 100 Series rigs that featured virtually every attribute of pad optimal systems except they did not walk. We spend hundreds of engineering hours and designed a working Snap-On bolt-on sort of walking shoes which were omni-directional, not just XY. However, we also found significant issues driven by the trade-offs inherent in modifying a highly engineered system to function in a way it was not originally designed for and after further testing and review, we determined that retrofitting equipment, not originally designed to walk was non-competitive and non-economic. We cut the client-on [ph] shoe system up for scrap.
At ICD, all three of our 100 to 200 series conversions features a brand new omni-directional substructure capable of walking over raised well heads and with the BOP handling system. We repopulate that new high-tech sub with a new grasshopper articulated flow line and drilling equipment such as mud-pumps and the ACVFD from the older rig. The end result is a true pad-optimal omni-directional walking rig, no cut corners.
To briefly address the many problems associated with retrofitting aging equipment merely clamping a walking system on a dated rig of any design introduces center of gravity problems, setback problems, flow line and fluids controls issues, electrical and cable tray grasshopper issues, especially at the legacy skidding or non-moving rig becomes after a retrofit of very limited capability walking rig with pad size, setback and surface whole spacing and geometry problems. In addition, since you have four beams or four plate, you cannot walk over anything raised above the surface on a pad. The resulting retrofitted or refurbished legacy unit is not a tad optimal system and we believe it won't be viewed as much such by the empty customer base.
As you all remember, ICD was formed as a growth company. The historic downturn stalled that growth but as we discussed with all of you two years ago at the beginning of the downturn, our omni-directional walking pad optimal rigs would be the last to go down and the first to go back to work during the recovery and that has been the case. Throughout the downturn we focused on making ICD more efficient and making preparations to resume our growth profile. And now, today, we are reengaging ICD in a return to aggressive fleet and company growth.
I'll now hand the call over to Phil to discuss the fourth quarter financial results in detail.
Thank you, Byron. During the fourth quarter, we reported a net loss of $10.4 million or $0.28 per share excluding non-cash charges associated with equipment disposals relating to rig upgrades and write-downs of assets held for sale to an estimated fair value less selling costs. Our adjusted net loss was $5.2 million or $0.14 per share.
Included in this net loss were approximately $930,000 or $0.02 per share of reactivation cost for two rigs mobilized during the quarter. Adjusted EBITDA including the reactivation cost came in at $2.6 million and was $3.5 million excluding those costs. The fleet generated 936 revenue days representing at 21% sequential increase from the prior quarter. This included 92 days earned on a standby with our crew basis. Our marketed rigs achieved 78% utilization during the quarter and we exited 2016 with 92% of our marketed fleet under contract.
Overall, we recognized revenue of approximately $18 million. Pass-through revenues were approximately $900,000 during the quarter. Gross margin per operating day excluding reactivation and rig construction expenses was $7,543; favorable compared to our expectations and guidance. Byron mentioned in his remarks that we expect our operating cost per day to coalesce around $12,500 per day as we approach full effective utilization. We actually did better than that in the fourth quarter.
If you eliminate the positive cost per day impact from standby days, our normalized operating cost per day in the fourth quarter was around $12,000 per day. About half of that delta related to strong performance at our rigs and the other half related to the positive outcomes associated with property tax assessments and workers compensation matters. Reactivation cost for two out-rigs mobilizing during the quarter totaled $930,000. Rig construction costs that were expensed during the second quarter were $200,000 and pass-through costs were $900,000 during the quarter.
SG&A expenses were $4.3 million including $900,000 of non-cash compensation expenses. Cash SG&A expenses of $3.4 million were unfavorable compared to our guidance by approximately $1.2 million or $0.03 per share due to the accrual of the full year of annual incentive compensation expense during the quarter. Non-incentive compensation expense has been accrued in prior quarters as a result of depressed market conditions. Depreciation expense, interest expense, and tax expense; all came in line with our prior guidance.
At December 31, we had net debt excluding capitalized leases of $18.7 million [indiscernible] base under our credit facility was approximately $92 million exceeding the $85 million rough commitment under the facility. Cash outlays for capital expenditures, net of disposal insurance of $3.8 million.
Looking at fiscal 2017, our approved capital budget is approximately $14.1 million, consisting of our final three 7,500 PSI led system upgrades, equipment earmarked for future new bill construction, increases to our capital spare inventories as we reach full effective utilization and maintenance capital expenditures. This excludes the remaining incremental costs associated with completing our last rig conversion and next two new bills for which we are finalizing complete AFE's for our board to consider as market conditions improved.
A vast minority of our CapEx budget we front-loaded in the first half of the year. Our planned asset sales loss costs as we realized proceeds on sales in 2017. As Byron mentioned, subsequent to year-end we have signed six new term contracts with interest bearing between 6 and 15 months which has substantially improved our backlog compared to year-end 2016 levels and staggered our contract explorations throughout 2017 and into 2018.
Our backlog at year end 2016 was approximately $42.5 million and pro forma for these new contracts increased to $75 million. Approximately $62 million of the pro forma backlog is expected to be realized in 2017. The pro forma backlog is a mix of legacy term contracts, contracts signed during the fourth quarter and of course, the recently signed contracts. Part one is a breakdown of our backlog spreads out during 2017. First quarter, 9.6 average rigs of which 4 relates to legacy contracts. Second quarter, 10.7 average rigs of which 2.2 relates to legacy contracts. Third quarter, 8.8 average rigs of which 1.4 relates to legacy contracts. And fourth quarter, 6.9 average rigs of which 1 relates to a legacy contract.
Byron discussed how we have staggered our backlog and faced staggered [ph] rigs roll-off contracts. The following is a breakdown of the number of rigs that currently are scheduled to roll during 2017 for which we do not have signed contracts in place. First quarter, one rig; second quarter, one rig; third quarter, four rigs; fourth quarter, three rigs; first quarter 2018, two rigs; and two of our rigs are contracted beyond this time period.
Some other items relating to our expectations for 2017; we estimated selling, general and administrative expenses will be approximately $13.3 million including non-cash compensation expense of $4 million. Till we front-loaded a little bit with non-cash compensation expense tailing off considerably during the last two quarters and stock based awards relating to our 2014 IPO falloff. We expect rig construction expenses during the year to be approximately $1.4 million. If we restart our rig construction program during 2017, these costs would again be absorbed as part of the rig construction efforts.
We estimate annual depreciation expenses of $25 million and our tax expense should be in line with 2016 amounts. For accounting purposes, we fully reserve deferred tax assets associated with our $88 million NOL and other tax assets and liabilities. So we do not expect to recognize any tax benefits in periods in which we reported net loss.
Looking it at the first quarter of 2017, we expect our rigs will generate between 1,060 and 1,075 revenue days of which 70 to 90 will be standby with our crew days. We estimate our margin per day to range between $5,600 and $6,100 per day. The sequential decrease in margin per day relates to additional rigs activated at the end of 2016 and new term contracts signed early in the fourth quarter of 2016. Known operational repairs to one of our rigs did not result in operating downtime but when impact cost in the quarter by $300 to $400 per day. Costs and idle time associated with transferring one of our rigs between customers and expectations that our operating rigs will incur costs per day of $12,500 range as we increase our investment and new hire strength. Also as I previously discussed, the fourth quarter benefited from favorable outcomes on property taxes and insurance.
With respect to the six new term contracts we signed, all of them included price improvements compared to the contracts they were replacing but very little of that will actually benefit the first quarter as the new rates don't kick-in until late in the quarter when the original contracts expire. This margin guidance excludes reactivation costs. Today we have one rig reactivating during the quarter from standby status and expect to incur a large portion of our reactivation cost during the quarter for our final idle rig that will commence operations during the second quarter. Under these perimeters we estimated reactivation costs during the first quarter to be $750,000 which are additional costs not included in our margin guidance. Some additional reactivation costs for our final rig occurring in the second quarter as well.
We expect rig construction cost expense in the first quarter to be approximately $300,000. These costs also are additional costs, not included in our margin guidance. We expect SG&A for the first quarter to approximately $3.7 million of which approximately $1.2 million will be non-cash stock-based compensation expense. Depreciation expense should approximate $6.2 million and interest expense that approximates $650,000. Similar to the fourth quarter we expect to recognize non-cash disposable charges in connection with decommissioned equipment related to our final 7,500 PSI upgrades.
Tax expense should be flat with the fourth quarter. And with that, I'll turn the call back over to Byron.
Thank you, Phil. So in closing, I'd like to thank all of ICD's employees wherever they may be; they are the people that make this organization what it is. I want to thank our investors and those of you on the line. And with that, we can take questions.
Thank you. We'll now begin the question-and-answer session. [Operator Instructions] Today's first question comes from James West of Evercore ISI. Please, go ahead.
This is Alex for Jim. My first question is regarding the CapEx. How much would CapEx increase by if you do go ahead and finish the three rigs? Or complete the first rig and then dealt to more.
I think we talked about that being about $25 million as we're kind of fine tuning our AFE's, we'll probably need to bring in some more capital spare equipment and things like that. So best estimate now $27.5 million, plus or minus a little bit to get those done.
Okay. Incremental, correct?
Yes. And then that will include the incremental capital spare as we might need to bring in.
Understood. My second question is on day rates. Can give us any qualitative color on the difference between day rates for the 15-month contract and 6-month contract?
I think they're all kind of a blend. I don't think we were going -
There is not a lot of difference. Alex, the new contracts at the margin are all coming in the high teens. There is no - we haven't printed a 20 but they are coming in the high teens.
Okay. And you don't expect the 20 until 18 you said, correct?
There is some 20's out there and the 20's that we have observed in the market relate to two larger equipment of which there is a handful. So 2,000 horsepower, some different characteristics; and there may be more out there but that's where we have run into them. So we haven't seen anything printed at 20 in terms of a pure rig day rate for the type of pad optimal equipment we've put out.
Okay, understood. Thank you, guys.
And our next question comes from Connor [ph] of Morgan Stanley. Please go ahead.
Good morning, guys. I was wondering if you could give us little color; so historically I would have thought of a newbuild not occurring below 20. Can you give us some color on how you're thinking about those newbuild contracts and what's sort of return on capital are you targeting?
So for the first three - because we've spent a substantial amount of money, we're looking at the incremental and those were the numbers Phil gave you. So I think what your question refers to is pure newbuilds?
Yes, exactly. And what's your hurdle in other words than that versus these that are sort of half a CapEx where...
Yes. So the next rigs we build are likely not to look like the rigs that we currently field. We talked about technology and we talked about the market acceleration and it's probable that as we go to mega-pads, we're going to be looking at things that have higher hook load, higher horsepower, some different attributes. So we really haven't - where we're - this is a work in progress to the extent that we had demand for incremental 200 series of rigs and I think that's a probability we've got that nailed to the extent that the market bifurcates yet again because of the development of mega-pads across the customer base. We've got a different type of equipment, it's going to have a little higher incremental cost and it will have different financial dynamics.
So what we look at generally is four to five year payback at the deep cyclical industry and as you know there is a six month lag between when we start and when we get a rig out; so what we'll do is as we've done for as long as you've been in existence which is if we feel comfortable with the market dynamics, we'll build into it. So the current day rate won't be the day rig we're anticipating of course across the term of a contractor fixture. Unless we were confident that day rates weren't going to move into the 20s, we wouldn't pull the trigger. But we also wouldn't be building against economic space on current day rates because of the nature of the cyclicality of the market.
Yes, that's fair. Given your view that this is relatively short cycle industry these days, how do you think about how fast you would build and how large you want to be? And if you had to handicap it, I mean if day rates do move into your 20 per day range, how many newbuilds would you expect to build in 2018?
So, our - I don't know the answer to that but I can tell you that what we've said all along and what we maintain is that our intermediate term goal is to be a 40 rig company, and we'll do that as quickly as we can, prudently.
Understood. Thanks a lot, guys.
[Operator Instructions] Today's next question comes from Kurt Hallead of RBC. Please go ahead.
Good morning. Just real quick, just on - again the pricing dynamic; you've done a lot to kind of explain some of the elements and I guess I'm just trying to connect the dots in the context of my understanding that these pad optimal high expect rigs are effectively sold out and if the company is looking for the most efficient asset and they are not available. I guess I'm a little bit surprised that pricing isn't more firmly in the 20s especially on new contracts. Any…
Yes, sure. Things don't happen in lockstep. Contracts fall-off at varying rates and so it's not a stair-step; it's more of a process but the process is solidly upward.
Okay. Alright, I appreciate that. And so, you guys have been kind of at the leading edge of developments in the land drilling business since you went public; I want to get your perspective on what you think the next leg is? There has been some discussion among one of your peers about the prospect for autonomous drilling and what do you think about that? Do you think it's feasible? And do you think that ICD will be a participant in that segment?
I think it's feasible. I think the E&P industry would like to go that way. I think there are significant trade-offs when you start making those decisions. There is two main drivers for that type of design; one would be to get people out of harm's way, and the second would be to minimize unscheduled downtime maximized efficiency and so on. So I think it is an admirable goal that something we would talk - we talked and thought about and as - if we go to a new rig design, it's something we would if not incorporate immediately, make provisions to incorporate in the future but it's - there is some limitations I think to the equipment that's available today that had the bunch have to be worked out. So in terms of new builds, we wouldn't wait for it but we would be prepared for it and structure around the expectation that this is a way that's coming.
Okay, great. Thanks for that color. I appreciate it.
And our next question comes from Rob MacKenzie of IBERIA Capital. Please go ahead.
Thanks guys, good morning. A couple of follow-ups for you, Byron, and maybe Philip first; Phil, has the formulae for the borrowing base changed here a little bit, let's say the 91.8 or maybe how many rigs was that based on is the better question since so many were reactivated during the quarter.
That was based on 12 rigs. We'll add a rig to the borrowing base in the first quarter. There were some capital spares that were in the borrowing base at the end of the year that won't be in the borrowing base going forward. So it will probably be relatively flat when we report the first quarter borrowing base.
Okay, thanks. And then I think Byron mentioned a lead time of six months to deliver rig once you commit to building it. What does that number look like for - or that timeframe look for rig 101 once you commit to upgrading that to a 200 series rig?
Well, because we've got all the long lead time items; two months, three months, very short period.
Okay. And then I guess, it sounds like you guys are waiting for - actually for contracts before you commit to those. Is that accurate and how soon do you think we could see that playout?
No, we wouldn't wait for contracts before we begin to build but we wouldn't begin to build unless we're in contract negotiations and we're certain about where we were headed. And that would probably be multiple conversations for each rig. If you remember from when we founded the company that's how we grew it and we never had a rig more than half done on the pad before it was contracted but I'm not, I think there may be only be one or two cases where we began building with the contract. So we would - if we were comfortable with the market, we would build into it.
I mean by all accounts Byron, I mean, what you described with the pad-up with rigs sold out and rates rising and hitting rate that hit 20,000; aren't we there yet?
Okay, great. And then coming back to Phil, if I may, on the op-cost side, industry sounds like you underperformed your 12.5 [ph] fully working OpEx this quarter but that baked into your guidance for next quarter. Why shouldn't we expect to see continued outperformance relative to that prior benchmark?
First, fourth quarter we had some positive things as well put on the workers competitive and property things were kind of lumpy for the quarter, so that makes the fourth quarter - and from that perspective a little bit - the good performance was - I don't expect to see that every quarter thereafter. First quarter Byron mentioned, we're going to have some training cost, we're going to bring in some extra people, that's going to flow-through, that's baked into that 12.5 number as we move forward so that's really going to be the delta between the OpEx.
Okay. And have you started to seeing any inflation in wages yet because you mentioned the tightness in getting the kind of quality of people you want to get as new rig counts, is there a replacement in the wages yet?
No, we haven't seen that. From the senior leadership levels, we're well staffed, we have a backlog of people we can bring in and haven't seen any issues there. And on the low end and the inexperienced side, not really a wage issue, it's a training issue. So we have seen no upward pressure on wages across the spectrum to-date.
Okay. And then kind of a bigger picture question for you Bryon; I know one of the things you had to talk about, particularly early on in the life of ICD and from time to time I believe is partnering with a big EMP, perhaps build multiples of rigs. Are you guys still having those kind of conversations and how did you handicap the probability that somebody funds a big newbuild program for you guys?
The answer is yes. And I really can't handicap the conversation speed up and slowdown. Right now they are fairly sped up again, and I - but I really can't - it's - the culmination of those conversations and coming to conclusions is out of my control. We can react much quicker than a larger company can. So I can only handicap our site, our ability to respond and be interested. It's difficult for me to get into the heads of the people we're talking to.
Okay, fair enough. Thank you. I'll turn it back.
Thank you, ladies and gentlemen. This concludes the question-and-answer session. I'd like turn the conference back over to the management team for any closing remarks.
Well, in closing, let me just thank everyone on the call again for their interest and participation and the good questions we got. And I'm looking forward to speaking with all of you again, next quarter.
Thank you, sir. This concludes today's conference. You may now disconnect your lines, and have a wonderful day.
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