Advanced Battery Technologies (ABAT): Doubting the Validity of SEC Filings and Company Claims

5 05 2011

In this article, I’m going to analyze Advanced Battery Technologies, Inc. and provide evidence that the company is inflating its financial statements.

This article summarizes key points that we have put together in a longer report available here.  An alternative copy for backup purposes is available here.

A video summary of the findings, along with discussions with certain customers, are available at the following links:

Our customer interviews feature recorded conversations with ABAT customers. After visiting one of ABAT’s plants, one customer called the facility “absolutely the biggest joke I’d ever seen”. In another conversation, a customer said the CEO admitted to hiring an accounting firm “to cook his stock price up”.

Some of our arguments have been discussed in prior Seeking Alpha articles by other authors, including here, here, here, and here. For instance, in our report, we discuss how ABAT’s SAIC filings show that the company’s actual revenue and profit are a fraction of what is reported in SEC filings. We also show that ABAT’s $20 million acquisition of a Shenzhen battery company appears to be a sham, and that ABAT paid $20 million in 2010 for an entity that they had previously bought in 2008 for $1 million, but had not disclosed to public investors.

In this article, we’re going to highlight new information that ABAT is falsifying its financial statements, including:

  • A comparison of the profit margins of ABAT to 106 global battery makers as provided by Bloomberg and a list Chinese battery makers as provided by Research and Markets in its “Global and China Rechargeable Lithium Battery Industry Report: 2009-2010” industry report. ABAT shows the highest profit margins out of any global and Chinese battery maker, despite having no technological advantage, limited operating experience, an unrecognized brand name, and production facilities too small to claim economies of scale.
  • Site visits show underutilized facilities lacking in quality control. We hired investigators to visit both the Harbin and Wuxi facilities, and provide photos as well as commentary from our investigators in our report. Our investigators concluded that both facilities produce commodity, low-margin products that are highly unlikely to be generating industry-leading margins or return on capital.
  • Extensive discussions with customers and partners that confirm our beliefs that ABAT is fabricating its financial statements

Impossible Economics

Selling a commodity product into a competitive market with no technological advantage is difficult. It’s especially difficult for a small business without economies of scale, limited customer relationships, and no distinguished brand name.  But ABAT purports to be not just surviving, but thriving with industry-leading margins and an ROIC that warrants explanation.

A company with an EBITDA margin of 45% in 2010 must have some uniquely special competitive advantage. Yet ABAT itself recognizes that it has no special technology for its main products. The following is taken from its annual report:

The technology utilized in producing polymer lithium-ion batteries is widely available throughout the world, and is utilized by many competitors, both great and small.  ZQ Power-Tech’s patents give it some competitive advantage with respect to certain products.  However, the key to competitive success will be ZQ Power Tech’s ability to deliver high quality products in a cost-efficient manner.  This, in turn, will depend on the quality and efficiency of the assembly lines that we have been developing at our plant in Harbin.

In choosing a set of comparable companies for ABAT, we’ll use companies listed by Bloomberg in its “Batteries/Battery Systems” industry classification.

The results are startling. In terms of EBIT margin, ABAT ranked #1 out of 106 global companies, with an EBIT margin of 39%, compared to 23% for the next closest competitor Exide Industries Ltd of India, a $40 billion revenue business.

Out of the 106 companies provided by Bloomberg in the “Batteries/Battery Systems” classification, Bloomberg records the EBIT margins for 79 of them (the remaining companies’ margins are shown as “N.A.”). ABAT reports a 39% EBIT margin. Only three other companies report EBIT margins above 20%, one of which is NEWN, another suspect Chinese reverse merger company. Only 10 companies report EBIT margins above 15%. ABAT, a company with less than $100m of sales and a relatively tiny player in a commodity industry, is an extreme outlier in our analysis. ABAT also comes up top in other profit margin metrics, with the #1 ranking in EBITDA margin and #2 ranking in net income margin.

Is it possible that a company with only about 5 years of operating experience is generating higher margins than a company such as Energizer with its 15% EBIT margins, based on the “quality and efficiency of the assembly lines”?

Perhaps it’s ABAT’s position in China and access to cheap labor that gives it such an amazing edge in the global arena.  We can test this hypothesis by comparing ABAT to a handful of other Chinese battery manufacturers.  The independent third party research organization Research in China publishes an annual report titled “Global and China Rechargeable Lithium Battery Industry Report”.  In the 184 pages of the 2009-2010 edition, no mention is made of ABAT or its subsidiaries.  The report does, however, make mention of China BAK Battery Inc. (BAK), BYD Company (BYD), SCUD Group Ltd, and Tianjin Lishen, which generate respective revenue of $222m, $5,805m, $185m, and $295m.

Other Chinese battery manufacturers which are not active in the lithium polymer market can also be compared to ABAT.  Examples include the Coslight Technology International Group Limited and Tianneng Power International Limited, with $352m and $330m of revenue respectively in 2009.  Gross margins and operating profit margins for all six of these companies, as well as ABAT, have been summarized in the table below for the most recent available fiscal year:

Company Gross Margins Operating Profit Margins
China BAK Battery, Inc. 10.6% -9.7%
BYD Company 17.7% 7.3%
SCUD Group Ltd 18.1% 5.8%
Tianjin Lishen* 5.4%
Coslight Technology 26.6% 9.1%
Tianneng Power 28.5% 14.3%
ABAT 47.3% 39.0%

*This is a subsidiary of CNOOC and financial statements were not readily ascertainable, although it is evident that the Research In China report is using numbers specific to Tianjin Lishen.

ABAT’s operating margin is nearly triple that of its closest competitor and six times that of the median operating margin of our Chinese battery makers.

Obviously, strong operating performance alone would not normally be cause for concern.  But when a company is doing as well as ABAT, investors need to understand why or how.  ABAT clearly states in its annual report that it has limited (if any) technological advantage, and is competing in what is predominantly a commodity market.  We have spoken to a customer who has visited ABAT’s Harbin battery manufacturing plant, and he has stated that there was nothing uniquely special about the Harbin facility. We also hired investigators to visit the Harbin facility and their findings are discussed later in this article.

The founder of ABAT, Zhiguo Fu, established it in 2001 without any prior knowledge, experience, or expertise relating to batteries or manufacturing.  Fu’s background is in real estate.  Furthermore, this company didn’t begin manufacturing until 2006.  ABAT has limited operating experience, an unrecognized brand name, and production facilities too small to claim economies of scale.  Yet it seems like no matter how we compare ABAT to its competitors, ABAT’s financial figures come out ahead despite the numerous causes for concern discussed elsewhere in our report.

Wuxi ZQ and Heilongjiang ZQPT Site Visit

As part of our investment research process, we sent an experienced factory inspector to both the Wuxi electric vehicle facility and the Harbin battery facility.  What we found was not encouraging.

Summary points from the Wuxi visit included:

  • Out of four assembly lines, only three were operational.
  • Staff included 200+ workers, but only 20 are office workers, indicating likely weaknesses in R&D, engineering, QC, and sales.
  • Factory management indicated 20,000 unit sales for 2010, with prices ranging from $450-$920 USD.  This compares to 90,000 units reported to us by ABAT VP of Finance Dan Cheng on a conference call, a number which can also be backed into using data provided in ABAT’s 10-k.
  • The facility does not have a motorcycle manufacturer’s permit issued by the Chinese government.
    • Management claims to use the VIN of a partner, which is illegal.
  • Our investigators’ greatest concern was the lack of quality control (QC).
    • No line inspector or inspection of finished products.
    • No inspection list attached to each bike.
    • No testing center inside the factory.
    • The facility lacked basic equipment to test different parts for new product development.
    • Motor speed and efficiency testing machines were present, but no noise, temperature, or salt-fog testing machines.
    • No incoming parts inspection.

Photographs of the Wuxi facility are available in our report.

As lacking as the facilities were in the Wuxi facility, the Harbin site visit was even more disturbing in light of the world-class margins and the Company’s reliance on this facility to support the bottom line.

Our investigators concluded the following:

It appears that the Harbin plant is in operation, does produce cells, and has sales.  The semi-automated processes… are more advanced than some of the battery companies of China, and far less advanced than battery companies of international standing such as ATL, Lishen, Samsung, LG Chem. It appears that they do some things well, and have some potential great strength, but appear to have limited ability and concepts in the marketing and sales of their product. Selling cells to packagers is a common business model for Asian battery factories, but not one that realizes as much profit. And I note that the CTO acknowledged that the packagers and trading companies were making the entire margin and he was not. Again, normal for Asian cell makers – but not a way to gain success.

A proprietary BMS (Battery Management System) is essential for a successful battery company in the Light Electric Vehicle space. And the lack of such is a major handicap for Harbin.  It appears to me that this company has a tiny business selling Li Ma or LFP (Lithium Iron Phosphate) cells to packagers for use in low priced battery packages sold to the domestic China market. This is the least profitable business they could have.  The LI-Polymer cells are apparently not really in production (the normal issue with Li poly) due to high cost of materials and resulting high cost of the cells making them uninteresting to most applications.  The LFP cells cannot be exported due to patent issues… So the only apparent product for any significant sales would be Lithium Manganese cells, and for that to make money for Harbin they would, probably, need to develop their own BMS, become their own packager, and compete with Phylion, Zhenlong, AEE, MGL, LG Chem, Lishen, HYB, and others.


Conversations with ABAT Customers

Since Advanced Battery’s inception, management has made numerous claims regarding relationships with suppliers, distributors, research partners, and other related parties.  As part of our due diligence process, we attempted to contact most of the relevant parties that ABAT has mentioned having a relationship with.  In many cases, the parties we have contacted have been nonexistent, non-locatable, unwilling to speak, or had something strongly negative to say about ABAT.

In multiple cases, we found customers who either came away from their visits to the Company’s factories unimpressed or confident that the Company was inflating its financial figures. In this section, we provide a recording with one such customer, but have concealed and modified his voice.

Click here for a link to a recorded excerpt from our conversation

This customer had signed a contract to receive scooters from ABAT’s Wuxi facility in 2009. After receiving defective product, the customer demanded to visit the Wuxi facility that had supposedly been manufacturing the scooters. During our conversation, the customer indicated that he had visited numerous other Chinese manufacturing facilities to which Wuxi could be compared, and he described the Wuxi facility as a “joke” multiple times.  The facility was described as “four empty walls”, the inadequacy of which made him suspect Wuxi was some sort of distributor operation rather than a manufacturing facility.  Furthermore, the customer stated that he thought about contacting the SEC to report ABAT for fraudulent claims made in press releases.  He said that “none of the stuff they put out was accurate”.

Other customers we’ve been in touch with have voiced similar opinions of ABAT.  For example, in 2010 ABAT touted an agreement to re-enter the US market, expecting to deliver 200,000 electric scooter units to All-Power America for $1.1 million.  Only half the delivery was taken before serious issues surfaced regarding quality control and licensing.  The following comprises one excerpt from the long conversation we had regarding these issues and more with an All-Power executive:

All-Power: Every step of the way we had some serious QC issues… The licensing is the official word that we gave out to everybody because that was a very tangible problem that the retailer used to return the products.  But licensing was a major part of it, they should have checked for licensing compliance before they sent it.
Prescience: So Wuxi, which is the company that you got the cycles from, they sent you shitty product, am I reading you right? I’m not sure if I follow you?
All-Power: Yeah, and that caused a major loss of confidence with our customer.  Plus we missed a lot of deadlines, and the customer said “you missed a lot of deadlines plus you have licensing issues, we’re going to send you all of them back”. So they put them on trucks and sent them back. Now we’re stuck with the inventory that I don’t know how the hell to move.

Wuxi ZQ mentions additional customers in its February 3, 2010 press release and its 2010 10K. We review our diligence with many of these customers in our report.


Conversations with ABAT Partners

Alongside numerous ruined or strained customer relationships, we have also uncovered a number of failed partner relationships. In our report, we discuss our conversations with ZAP and Altair Nanotechnologies, as well as our attempts to contact numerous other ABAT partners. Our conversations, as well as our inability to locate many of ABAT’s obscure or hard-to-locate partners, reinforced our belief that ABAT’s business is much smaller than its SEC financial statements indicate.


Conclusion

Our longer report elaborates on the evidence discussed in this article. Our evidence that ABAT is falsifying its financial statements includes:

  • SAIC filings show that ABAT is reporting significantly lower revenue and operating losses to the authorities in China. For 2009, SAIC filings showed less than $2 million of revenue, compared to $64 million in SEC filings.
  • ABAT has unreasonably high margins in an established industry with strong competitors.  The Company’s SEC-reported margins and return on capital are virtually impossible. Out of 106 global battery manufacturers as classified by Bloomberg, ABAT has the highest operating profit margin by a wide margin. When compared to six leading Chinese battery makers, ABAT’s operating margin is triple that of its closest competitor and six times that of the median operating margin of the comparable companies.
  • Site visits show underutilized facilities lacking in quality control. We hired investigators to visit both the Harbin and Wuxi facilities, and provide photos as well as commentary from our investigators. Our investigators concluded that both facilities produce commodity, low-margin products that are highly unlikely to be generating industry-leading margins or return on capital.
  • In December 2010, ABAT announced that it was acquiring a Shenzhen battery maker for $20 million. We believe this acquisition is a sham, and that ABAT paid $20 million in 2010 for an entity that they had previously bought in 2008 for $1 million, but had not disclosed to public investors.
  • Confirmation from former customers and partners that the Company is likely a fraud. After visiting one of ABAT’s plants, one customer called the facility “absolutely the biggest joke I’d ever seen”. A recording of the conversation is available here. In another conversation available here and here, a customer said the CEO admitted to hiring an accounting firm “to cook his stock price up”.
  • Low quality auditors and high turnover. The company has had 4 auditors in the past 7 years, with no auditor being ranked in the top global 100 auditors at the time of hire.
  • Unqualified CFOs and high turnover. A CFO or auditor has resigned at least once a year. The Company’s past three CFOs have included: (i) a company insider who has been general manager of the Company’s main operating subsidiary since 2004, and is therefore not remotely independent, (ii) a 29-year-old who was formerly VP Finance at China Natural Gas, another fraud, and (iii) a candidate whose primary experience comprised of being a financial adviser at Smith Barney.
  • Continuous share dilution through secondary offerings, despite having more than adequate cash reserves. Through repeated share issuances, the Company has grown its outstanding shares from 10.0 million following the 2004 reverse merger to 76.4 million today.

Disclosure: As of the publication date of this report, the Prescience Investment Group has a short position in and owns options on the stock of the company covered herein (Advanced Battery Technologies, Inc.).

Disclaimer: Following publication of the report, the authors may transact in the securities of the company covered herein. The authors of this report have obtained all information herein from sources they believe to be accurate and reliable. However, such information is presented “as is”, without warranty of any kind – whether express or implied. The authors of this report make no representation, express or implied, as to the accuracy, timeliness, or completeness of any such information or with regard to the results obtained from its use. All expressions of opinion are subject to change without notice, and the authors do not undertake to update this report or any information contained herein. Please read the full legal disclaimer at the end of the written report for which a link is provided in this post.

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Active Power (ACPW): Likely to be Multiples of the Current Price Over a Multi-Year Horizon

30 12 2010

Active Power is a defensible business that’s likely to trade at a multiple of the current price over the next several years.  It’ll pay to get to know what it’s all about and to understand the changes it’s driving in the space for energy storage.

Description of business and company background

The continual, exponential expansion in the volume of data (e.g. think of the number of email accounts being created, credit card transactions being processed, YouTube videos being uploaded, etc) is driving a secular expansion in the build-out of datacenter facilities, which house and store data. With new datacenter facility build-outs as its #1 end market, not only is Austin-based Active Power well-positioned to capitalize on this trend, it’s also revolutionized how consultant engineers think about continuous power

Datacenter facilities have a zero tolerance for energy blackouts, which can lead to revenue losses, customer defections, etc.  Uninterruptable Power Systems (UPS’s), which protect these facilities against voltage fluctuations and provide ride-through power to bridge the 8-15 second gap between power outage and diesel generator start-up, are necessities in the build out of datacenters: They are essentially insurance on continuous power.  Active Power is a leading manufacturer of flywheel-based Uninterruptable Power Systems (UPS’s) – insurance.

Unlike most of its competitors which utilize lead-acid battery based technology in their UPS’s, ACPW’s products utilize a patented flywheel-based UPS system which stores kinetic energy by spinning a compact steel wheel (“flywheel”) at several thousand RPM while the utility power is running normally.  Then, if the utility power fluctuates or is interrupted, the flywheel’s inertia causes it to continue spinning. The resulting kinetic energy of the spinning flywheel generates “bridging power”.

We have developed a high degree of comfort from numerous conversations with customers, industry experts and competitors that ACPW’s flywheel products provide many competitive advantages over conventional battery-based UPS systems, including a lower total cost of ownership, substantial space savings, higher power densities, “green” energy storage, and higher power efficiencies (and hence, lower total cost of ownership).

This product’s been around for a long time – about a decade – and it takes these engineer-types a really long time to put their necks out in terms of trying something new. And this is the story here.  There is enough data at this point to have proven the flywheel’s benefits over conventional energy storage, and the company has taken enough market share at this point that we believe market adoption to have hit an inflection point and to be on a steep rise.

We have prospected the company’s manufacturing facility in Austin and have been engaged in a frequent and ongoing dialogue with the CEO and CFO since the beginning of 2009.  Jim Clishem was named CEO in 2006 and John Penver CFO in 2005.  Since they took the helm, the company’s made substantial strides in creating a viable business and is currently on the path of growth through the disintermediation of market alternatives… yeah, it’s expanded its sales footprint into new global markets; expanded its direct sales distribution channel (previously distribution was primarily driven by OEM Caterpillar); increased focus on generating recurring, high-margin service revenues; and has facilitated the improved market acceptance of flywheel technology.  To sum this up, we like management.

Market Opportunity

Active Power has traditionally sold into a UPS target market that measures $2.1 billion and that through 2008 was expanding at an annual growth rate of 12-14%.  Over the period 2006-2008, ACPW grew its sales at a compound annual growth rate of 34%, indicative of expansion of share.

The credit crisis and resultant economic uncertainty led many companies to delay their build-outs of new datacenters.   We believe the market was at the time already nearing capacity and that as of 2010 it entered a state of under-capacity in the US, with demand continuing to build.  As such ACPW’s full year 2009 sales came in flat relative to 2008’s at ~$42MM.  This said, 2010 has been a banner year for the company and recent action in the stock price tells the story:  Revenues will exceed $60MM this year and we are expecting significant top-line growth over the years to come.  I view 2009 as the recoiling of a spring, as happened with Intel way back in the day. (Don’t ask me about Intel’s story because I’ve forgotten the year I’m referring to and am not about to waste time researching for it.)

ACPW recently introduced a containerized, all-in-one continuous power solution product (“Powerhouse”) that is being sold alongside Sun Microsystems’ and HP’s modular datacenter solutions.  By integrating ancillary products alongside its UPS’s, this product has expanded ACPW’s addressable market potential by about 4x, to ~$6 billion.

ACPW competes primarily with conventional battery-based UPS manufacturers (i.e. Emerson/Liebert, Eaton/Powerware and APC/MGE) – this is the competitive inferior – and KE-based rotary systems producers (i.e. Pillar, Eurodiesel, and Hitec). The rotary systems producers command almost half of ACPW’s UPS market segment.  Their product is similar to a flywheel type of system, but with key differences in how the wheel is linked to the backup generator.  ACPW competes with these companies based on the decoupling of power storage and backup, as well as modularity.  Rotary companies compete on their strong brands, service and better distribution.

Based on the sum of our due diligence, when it comes to UPS, KE storage technology is indeed superior to that of batteries and we anticipate seeing continued market share gains from lead-acid counterparts. This will be the ‘low hanging fruit’ going forward – continued growth in market acceptance and market entrenchment of battery alternatives.   And, it’s plausible that the well-capitalized battery suppliers eventually make acquisitions to deal with the continual decline in their piece of the pie. Liebert, Eaton, APC  – they will all need to remain competitive in the +100kW energy storage space.  As the rotary providers continue to grow, the flywheel manufacturers are well-positioned as targets — eh emm. By that I mean that ACPW might be well-basted turkey on Thanksgiving.  Happy Holidays.

Economics

ACPW is a relatively early-stage story on the verge of breaking a profit this year.  Most companies don’t appear on many investors’ radars until reaching profitability; we have found that identifying those approaching that inflection point particularly rewarding in the past.

Its break-even point depends on its sales mix.  It has to sell the equivalent of 125 flywheels per quarter at an average unit price of $80k to break even. Alternatively it can hit break-even by selling 100 flywheels and 2 Powerhouse units. (As the Powerhouse business grows, revenue expands while gross margin per flywheel declines, partly offset by an associated rise in high margin consulting and maintenance services.)

Margin drivers:

  • The company IPO’d in August 2000 at $17/share, raising a net $126MM.  Lead underwriter Goldman Sachs at the time prognosticated $120MM in revenue for the company by 2002; at the time ACPW’s revenues over the previous twelve months totaled $2MM.  As it were, revenue peaked at $22MM in 2001 before falling to $8MM by 2003.  By this time, the funds raised in the IPO had already been used to lease/equip a 127k sq ft manufacturing facility to support projected sales volumes.  Simply put, there is a lot of unabsorbed overhead embedded in the company’s gross margins, currently on a run rate of 25-30%.  As it expands, ACPW should benefit from a high degree of operating leverage and has the capacity to support revenues of $200MM with little incremental capital expenditure.
  • Management is increasingly focused on growing its direct sales channel.  Historically, most of ACPW were made indirectly through OEM partner Caterpillar.  Caterpillar is ACPW’s primary OEM customer and its largest single customer.  CAT accounted for 35%, 31%, 40% of total revenue in ’06, ’07, and ’08, respectively.   By selling away from CAT, directly into its end markets, ACPW is able to build a service book.  The recurring, 50-60% contribution margin service business is the hidden gem here.  Over the long term, management expects to be able to drive servicing fees to 20-25% of total revenue.

Ownership / Board

The period 2003-2006 was marked by headcount reductions and a management / board shakeup.  Led by founder Joseph Pinkerton, previous management came into the company with tremendous intellectual property and a great patent portfolio but had failed to successfully commercialize product. With new leadership, ACPW would emerge with increased emphasis on sales and marketing on a worldwide basis.

On a fully diluted, combined basis, insiders own 8.5% of the company. Several directors as well as the CEO purchased material amounts of stock over the course of 2008 and 2009.

Current Valuation

We started looking at this company when it traded at $.30/share and acquired our position at prices between $.72 and $.80 per share.  At this point the shares are a bit rich.  The sell-side’s been upping their price targets and liquidity has flown into the company’s shares.  I think the hot money’s got to come out and would suggest accumulating shares as the company cheapens, perhaps below 1.60/share should it again touch those levels.  At the end of the day, this is a company to be owned for a long time. A long long time…

We believe the company can grow to exceed $150MM in revenue over three to five years (and if things go really right for it, revenues can go wayyyyy higher), over which time we expect the adjusted net income margin to increase to 11%.  We also expect over this time the company will have accumulated cash of $25MM (including $17MM from the exercise of options).  We attach a $25MM value to the company’s $180MM in net operating loss carryforwards and value the operating assets at 20x fully-taxed earnings, resulting in an EV of $330MM and market cap of $380MM, resulting in a per share price of ~$4.50… again over the next few years.  A 20x multiple is warranted ACPW’s substantial competitive advantage, attractive growth prospects, clean balance sheet, and a business model with a significant chunk of recurring, high-margin revenues.

Key Risks

We believe the key risk to the company lies in an intensification of competitive pressures and therefore pressures on product pricing and margins.  Should battery based technology become more competitive or should the rotary suppliers develop a technological edge versus flywheel mechanics, we would expect end market demand to respond accordingly.  Additionally, given the early-stage nature of this company, results are likely to be volatile and clumpy.  The company may in the future need to raise additional equity capital which could dilute the stakes of current shareholders, but I’m doubting it will have to to get to where I think it’s bound to go.

Disclosure: As of the publication date of this report, Prescience Investment Group holds an equity position in this company.

Disclaimer: Following publication of the report, the authors and contributors may transact in the securities of the company covered herein. The authors of this report have obtained all information contained herein from sources they believe to be accurate and reliable and have included references where available and practical. However, such information is presented “as is,” without warranty of any kind– whether express or implied. The authors of this report make no representation, express or implied, as to the accuracy, timeliness, or completeness of any such information or with regard to the results to be obtained from its use. All expressions of opinion are subject to change without notice, and the authors do not undertake to update or supplement this report or any of the information contained herein. Use of this research is at your own risk. You should do your own research and due diligence before making any investment decision with respect to securities covered herein, including, but not limited to, the suitability of any transaction to your risk tolerance and investment objectives.

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