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0000320193
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10-Q
51
Derivative Financial Instruments The Company uses derivatives to partially offset its business exposure to foreign exchange risk.
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Foreign currency forward and option contracts are used to offset the foreign exchange risk on certain existing assets and liabilities and to hedge the foreign exchange risk on expected future cash flows on certain forecasted revenue and cost of sales.
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Generally, the Company’s practice is to hedge a majority of its existing material foreign exchange transaction exposures.
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However, the Company may not hedge certain foreign exchange transaction exposures due to immateriality, prohibitive economic cost of hedging particular exposures, or limited availability of appropriate hedging instruments.
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The Company’s accounting policies for these instruments are based on whether the instruments are designated as hedge or non-hedge instruments.
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The Company records all derivatives on the balance sheet at fair value.
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Derivatives that are not designated as hedges and the ineffective portions of cash flow hedges are adjusted to fair value through earnings.
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The effective portions of cash flow hedges are recorded in other comprehensive income until the hedged item is recognized in earnings.
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Changes in value of fair value hedges are offset against the changes in fair value of the hedged assets, liabilities, or firm commitments through earnings.
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As of June 28, 2008, the Company had a net deferred loss associated with cash flow hedges of approximately $5 million, net of taxes, all of which is expected to be reclassified to earnings by the end of the fourth quarter of 2008.
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The general nature of the Company’s risk management activities and the general nature and mix of the Company’s derivative financial instruments had not changed materially from the end of 2007.
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Note 3 - Condensed Consolidated Financial Statement Details (in millions) Other Current Assets Property, Plant, and Equipment Other Assets Accrued Expenses Non-Current Liabilities Note 4 - Income Taxes In the first quarter of 2008, the Company adopted the provisions of FIN 48.
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Upon adoption of FIN 48, the Company’s cumulative effect of a change in accounting principle resulted in an increase to retained earnings of $11 million.
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The Company had historically classified interest and penalties and unrecognized tax benefits as current liabilities.
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Beginning with the adoption of FIN 48, the Company classifies gross interest and penalties and unrecognized tax benefits that are not expected to result in payment or receipt of cash within one year as non-current liabilities in the Condensed Consolidated Balance Sheet.
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The total amount of gross unrecognized tax benefits as of the date of adoption of FIN 48 was $475 million, of which $209 million, if recognized, would affect the Company’s effective tax rate.
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As of June 28, 2008, the total amount of gross unrecognized tax benefits was $484 million, of which $204 million, if recognized, would affect the Company’s effective tax rate.
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The Company’s total gross unrecognized tax benefits are classified as non-current liabilities in the Condensed Consolidated Balance Sheet.
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The Company’s policy to include interest and penalties related to unrecognized tax benefits within the provision for income taxes did not change as a result of adopting FIN 48.
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As of the date of adoption, the Company had accrued $203 million for the gross interest and penalties relating to unrecognized tax benefits.
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As of June 28, 2008, the total amount of gross interest and penalties accrued was $250 million, which is classified as non-current liabilities in the Condensed Consolidated Balance Sheet.
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The Company is subject to taxation and files income tax returns in the U.S. federal jurisdiction and in many state and foreign jurisdictions.
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For U.S. federal income tax purposes, all years prior to 2002 are closed.
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The years 2002-2003 have been examined by the Internal Revenue Service (the “IRS”) and disputed issues will be taken to administrative appeals.
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The IRS is currently examining the 2004-2006 years.
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In major states and major foreign jurisdictions, the years subsequent to 1988 and 2000, respectively, generally remain open and could be subject to examination by the taxing authorities.
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Management believes that an adequate provision has been made for any adjustments that may result from tax examinations.
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However, the outcome of tax audits cannot be predicted with certainty.
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If any issues addressed in the Company’s tax audits are resolved in a manner not consistent with management’s expectations, the Company could be required to adjust its provision for income tax in the period such resolution occurs.
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Although timing of the resolution and/or closure of audits is highly uncertain, the Company does not believe it is reasonably possible that its unrecognized tax benefits would materially change in the next 12 months.
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Note 5 - Shareholders’ Equity Preferred Stock The Company has five million shares of authorized preferred stock, none of which is issued or outstanding.
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Under the terms of the Company’s Restated Articles of Incorporation, the Board of Directors is authorized to determine or alter the rights, preferences, privileges and restrictions of the Company’s authorized but unissued shares of preferred stock.
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Comprehensive Income Comprehensive income consists of two components, net income and other comprehensive income.
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Other comprehensive income refers to revenue, expenses, gains, and losses that under U.S. generally accepted accounting principles are recorded as an element of shareholders’ equity but are excluded from net income.
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The Company’s other comprehensive income consists of foreign currency translation adjustments from those subsidiaries not using the U.S. dollar as their functional currency, unrealized gains and losses on marketable securities categorized as available-for-sale, and net deferred gains and losses on certain derivative in...
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10-Q
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The following table summarizes components of total comprehensive income, net of taxes, during the three and nine-month periods ended June 28, 2008 and June 30, 2007 (in millions): The following table summarizes activity in other comprehensive income related to derivatives, net of taxes, held by the Company during the t...
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Based on the terms of individual option grants, options granted under the 2003 Plan generally expire 7 to 10 years after the grant date and generally become exercisable over a period of four years, based on continued employment, with either annual or quarterly vesting.
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The 2003 Plan permits the granting of incentive stock options, nonstatutory stock options, RSUs, stock appreciation rights, stock purchase rights and performance-based awards.
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As of June 28, 2008, approximately 53.9 million shares were reserved for future issuance under the 2003 Plan.
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Employee Stock Option Plan In August 1997, the Company’s Board of Directors approved the 1997 Employee Stock Option Plan (the “1997 Plan”), a non-shareholder approved plan for grants of stock options to employees who are not officers of the Company.
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Based on the terms of individual option grants, options granted under the 1997 Plan generally expire 7 to 10 years after the grant date and generally become exercisable over a period of four years, based on continued employment, with either annual or quarterly vesting.
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In October 2003, the Company terminated the 1997 Plan, and no new options can be granted from it.
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1997 Director Stock Option Plan In August 1997, the Company’s Board of Directors adopted a Director Stock Option Plan (the “Director Plan”) for non-employee directors of the Company, which shareholders approved in 1998.
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Pursuant to the Director Plan, the Company’s non-employee directors are granted an option to acquire 30,000 shares of common stock upon their initial election to the Board (“Initial Options”).
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The Initial Options vest and become exercisable in three equal annual installments on each of the first through third anniversaries of the grant date.
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On the fourth anniversary of a non-employee director’s initial election to the Board and on each subsequent anniversary thereafter, the director will be entitled to receive an option to acquire 10,000 shares of common stock (“Annual Options”).
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Annual Options are fully vested and immediately exercisable on their date of grant.
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As of June 28, 2008, approximately 320,000 shares were reserved for future issuance under the Director Plan.
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Rule 10b5-1 Trading Plans The following executive officers, Mr. Timothy D. Cook, Mr. Daniel Cooperman, Mr. Peter Oppenheimer, Mr. Philip W. Schiller, and Dr. Bertrand Serlet, have entered into trading plans pursuant to Rule 10b5-1(c)(1) of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), as of June...
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A trading plan is a written document that pre-establishes the amounts, prices and dates (or formula for determining the amounts, prices and dates) of future purchases or sales of the Company’s stock including the exercise and sale of employee stock options and shares acquired pursuant to the Company’s employee stock pu...
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Employee Stock Purchase Plan The Company has a shareholder approved employee stock purchase plan (the “Purchase Plan”), under which substantially all employees may purchase common stock through payroll deductions at a price equal to 85% of the lower of the fair market values as of the beginning and end of six-month off...
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Stock purchases under the Purchase Plan are limited to 10% of an employee’s compensation, up to a maximum of $25,000 in any calendar year.
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The number of shares authorized to be purchased in any calendar year is limited to a total of 3 million shares.
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As of June 28, 2008, approximately 6.2 million shares were reserved for future issuance under the Purchase Plan.
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Restricted Stock Units The Company’s Board of Directors has granted RSUs to members of the Company’s executive management team, excluding its Chief Executive Officer (“CEO”), as well as various employees within the Company.
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These RSUs generally vest over four years either at the end of the four-year service period, in two equal installments on the second and fourth anniversaries of the date of grant, or in equal installments on each of the first through fourth anniversaries of the grant date.
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Upon vesting, the RSUs are generally net share-settled to cover the required withholding tax and the remaining amount is converted into an equivalent number of shares of common stock.
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The compensation expense incurred by the Company for RSUs is based on the closing market price of the Company’s common stock on the date of grant and is amortized ratably on a straight-line basis over the requisite service period.
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The RSUs have been reflected in the calculation of diluted earnings per share utilizing the treasury stock method.
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Stock Option and Award Activity A summary of the Company’s stock option activity and related information for the nine months ended June 28, 2008 is set forth in the following table (stock option amounts and aggregate intrinsic value are presented in thousands): Aggregate intrinsic value represents the value of the Comp...
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Total intrinsic value of options at time of exercise was $584 million and $1.7 billion for the three and nine-month periods ended June 28, 2008, respectively, and $349 million and $961 million for the three and nine-month periods ended June 30, 2007, respectively.
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Shares of RSUs granted after April 2005 have been deducted from the shares available for grant under the Company’s stock option plans utilizing a factor of two times the number of RSUs granted.
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Similarly shares of RSUs cancelled have been added back to the shares available for grant under the Company’s stock option plans utilizing a factor of two times the number of RSUs cancelled.
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Outstanding RSU balances were not included in the outstanding options balances in the preceding table.
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A summary of the Company’s RSU activity and related information for the nine months ended June 28, 2008 is set forth in the following table (RSU amounts and aggregate intrinsic value are presented in thousands): There were no RSUs that vested during the three months ended June 28, 2008.
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RSUs that vested during the nine months ended June 28, 2008 had a fair value of $300 million as of the vesting date.
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There were no RSUs that vested during the three and nine months ended June 30, 2007.
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The Company recognized $133 million and $375 million of total stock-based compensation expense for the three and nine-month periods ended June 28, 2008, respectively, and $65 million and $174 million of total stock-based compensation expense for the three and nine-month periods ended June 30, 2007, respectively.
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Stock-based compensation expense capitalized as software development costs was not significant as of June 28, 2008 or June 30, 2007.
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The income tax benefit related to stock-based compensation expense was $55 million and $139 million for the three and nine-month periods ended June 28, 2008, respectively, and was $21 million and $49 million for the three and nine-month periods ended June 30, 2007, respectively.
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As of June 28, 2008, $1.3 billion of total unrecognized compensation cost related to outstanding stock options and RSUs is expected to be recognized over a weighted-average period of 2.98 years.
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Statement of Financial Accounting Standards (“SFAS”) No.
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123 (revised 2004), Share-Based Payment, requires the use of a valuation model to calculate the fair value of stock-based awards.
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The Company uses the Black-Scholes-Merton (“BSM”) option-pricing model to calculate the fair value of stock-based awards.
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The BSM option-pricing model incorporates various assumptions including expected volatility, expected life, and interest rates.
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The expected volatility is based on the historical volatility of the Company’s common stock over the most recent period commensurate with the estimated expected life of the Company’s stock options and other relevant factors, including implied volatility in market traded options on the Company’s common stock.
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The Company bases its expected life assumption on its historical experience and on the terms and conditions of the stock awards it grants to employees.
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Stock-based compensation cost is estimated at the grant date based on the award’s fair-value as calculated by the BSM option-pricing model and is recognized as expense ratably on a straight-line basis over the requisite service period.
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The weighted average assumptions used for the three and nine-month periods ended June 28, 2008 and June 30, 2007 and the resulting estimates of weighted-average fair value per share of options granted and of employee stock purchase plan rights during those periods are as follows: Note 6 - Commitments and Contingencies ...
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The Company does not currently utilize any other off-balance sheet financing arrangements.
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The major facility leases are for terms of 3 to 15 years and generally provide renewal options for terms of 3 to 7 additional years.
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Leases for retail space are generally for terms of 5 to 20 years, the majority of which are for 10 years, and often contain multi-year renewal options.
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As of September 29, 2007, the Company’s total future minimum lease payments under noncancelable operating leases were $1.4 billion, of which $1.1 billion related to leases for retail space.
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As of June 28, 2008, total future minimum lease payments related to leases for retail space increased $218 million to $1.3 billion, as compared to September 29, 2007.
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Accrued Warranty and Indemnifications The following table reconciles changes in the Company’s accrued warranties and related costs for the three and nine-month periods ended June 28, 2008 and June 30, 2007 (in millions): The Company generally does not indemnify end-users of its operating system and application software...
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Other agreements entered into by the Company sometimes include indemnification provisions under which the Company could be subject to costs and/or damages in the event of an infringement claim against the Company or an indemnified third party.
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However, the Company has not been required to make any significant payments resulting from such an infringement claim asserted against it or an indemnified third party and, in the opinion of management, does not have a potential liability related to unresolved infringement claims subject to indemnification that would h...
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Therefore, the Company did not record a liability for infringement costs as of either June 28, 2008 or September 29, 2007.
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Concentrations in the Available Sources of Supply of Materials and Product Although most components essential to the Company’s business are generally available from multiple sources, certain key components including, but not limited to, microprocessors, enclosures, certain liquid crystal displays (“LCDs”), certain opti...
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Many of these and other key components that are available from multiple sources including, but not limited to, NAND flash memory, dynamic random access memory (“DRAM”), and certain LCDs, are at times subject to industry-wide shortages and significant commodity pricing fluctuations.
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In addition, the Company has entered into certain agreements for the supply of critical components at favorable pricing, and there is no guarantee that the Company will be able to extend or renew these agreements at all or on similar favorable terms when they expire.
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Therefore, the Company remains subject to significant risks of supply shortages and/or price increases that can adversely affect gross margins and operating margins.
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In addition, the Company uses some components that are not common to the rest of the global personal computer, consumer electronics and mobile communication industries, and new products introduced by the Company often utilize custom components obtained from only one source until the Company has evaluated whether there ...
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If the Company’s supply of a key single-sourced component were to be delayed or curtailed, or in the event a key manufacturing vendor delays shipments of completed products to the Company, the Company’s ability to ship related products in desired quantities and in a timely manner could be adversely affected.
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The Company’s business and financial performance could also be adversely affected depending on the time required to obtain sufficient quantities from the original source, or to identify and obtain sufficient quantities from an alternative source.
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Continued availability of these components may be affected if those suppliers were to decide to concentrate on the production of common components instead of components customized to meet the Company’s requirements.
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Finally, significant portions of the Company’s CPUs, iPods, iPhones, logic boards, and other assembled products are now manufactured by outsourcing partners, primarily in various parts of Asia.
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A significant concentration of this outsourced manufacturing is currently performed by only a few of the Company’s outsourcing partners, often in single locations.
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Certain of these outsourcing partners are the sole-sourced suppliers of components and manufacturing outsourcing for many of the Company’s key products, including but not limited to assembly of most of the Company’s portable Mac computers, iPods, and iPhones.
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Although the Company works closely with its outsourcing partners on manufacturing schedules, the Company’s operating results could be adversely affected if its outsourcing partners were unable to meet their production commitments.
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