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Sigma-Aldrich (NASDAQ:SIAL)

Q3 2011 Earnings Call

October 25, 2011 11:00 am ET

Executives

Rakesh Sachdev - Chief Executive Officer, President and Director

Kirk A. Richter - Interim Chief Financial Officer, Vice President and Treasurer

Sondra Brown -

Analysts

S. Brandon Couillard - Jefferies & Company, Inc., Research Division

Summit Roshan - KeyBanc Capital Markets Inc., Research Division

Paul R. Knight - Credit Agricole Securities (NYSE:USA) Inc., Research Division

Jonathan P. Groberg - Macquarie Research

Daniel Arias - UBS Investment Bank, Research Division

Tracy Marshbanks - First Analysis Securities Corporation, Research Division

Isaac Ro - Goldman Sachs Group Inc., Research Division

Peter Lawson - Mizuho Securities USA Inc., Research Division

Julian Cochran - Leerink Swann LLC, Research Division

Quintin J. Lai - Robert W. Baird & Co. Incorporated, Research Division

Unknown Analyst -

Operator

Good day, ladies and gentlemen, and welcome to the Sigma-Aldrich Quarter 3 2011 Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to your host for today, Ms. Sondra Brown. Ma'am, you may begin.

Sondra Brown

Good morning, and welcome to Sigma-Aldrich Third Quarter 2011 Earnings Conference Call. This is Sondra Brown, Director of Investor Relations. With me today are Rakesh Sachdev, our President and CEO; and Kirk Richter, our Vice President, Treasurer Interim Chief Financial Officer. In today's call, Kirk will lead us with a review of our third quarter performance. Rakesh will follow that discussion with an update on the activities that contributed to our third quarter results and our outlook for all of 2011. After completing those reviews, we'll open up the call for your questions and comments. We will be using a slide presentation as part of today's call. That presentation can be viewed on our Investor Relations website at www.sigmaaldrich.com.

Before beginning the review, I wish to remind you that today's comments include forward-looking statements about future activities and our expectations for sales, earnings, cash flow and other possible future results. While we believe these expectations are based on reasonable assumptions, actual results may differ materially due to any number of factors, including the risk factors listed in our annual report on Form 10-K for the year ended December 31, 2010, and in the cautionary statement that is included in today's release and in our slides. We have no plans to update these forward-looking statements after this conference.

Also in today's conference call, we are providing information on non-GAAP financial measures. That information, which consists of currency and acquisition-adjusted sales growth, operating income and related margins, net income and EPS results on both an adjusted and reported basis and free cash flow reconciled to net cash provided by operating activities is also contained in today's earnings release which is posted on our website and in the appendix to today's presentation that begins with Slide 15. With that, Kirk Richter will lead us through our third quarter results. Kirk?

Kirk A. Richter

Thank you, Sondra and good morning to all of you. Our Q3 sales were $626 million, a reported increase of 11% over last year's third quarter. Our organic sales growth, which excludes the impact of changes in foreign currency exchange rates and acquisitions, was 4%. Our Research and SAFC businesses contributed to this growth at 4% and 2%, respectively. I'll review those increases shortly. Acquisitions added another 2% and changes in foreign currency exchange rates contributed 5% to the overall increase in reported sales over the prior year.

Our third quarter net income of $117 million is a 26% increase over last year's third quarter. Reported diluted EPS was $0.95, a gain of 25% over the prior year. On a comparable basis, excluding restructuring charges, adjusted net income of $118 million and adjusted diluted EPS of $0.96 increased by 15% and 16%, respectively, over the 2010 levels. We are now largely complete with the restructuring activities we announced late in 2009. These activities resulted in $1 million or $0.01 per share charge of after-tax restructuring in the quarter. We expect no additional restructuring charges in the fourth quarter of 2011 related to these programs.

In the third quarter of 2010, we recorded restructuring charges of $3 million or $0.02 per share, and impairment charges of $7 million or $0.05 per share. As a result of the efficiencies that we have begun to achieve from these restructuring actions, our EPS will benefit by about $0.10 as compared with the run rate prior to the actions some of which was realized this year. Our Q3 free cash flow of $90 million was $32 million less than the amount generated in the third quarter of 2010 but greater than the $77 million generated in the second quarter of 2011. Higher net income was offset by a planned working capital increase in inventories to support sales growth in select markets and to enhance customer service levels.

Now looking at our results for the first 9 months of 2011, our sales grew organically by 6%. In addition to growing our sales largely in line with expectation, we continue to be pleased with our double-digit growth in earnings in each of the first 3 quarters of 2011. Our adjusted net income was $354 million, and adjusted diluted EPS of $2.88 for the 9 months achieved 20% and 16% growth on a reported and adjusted basis, respectively. Free cash flow was down from the 2010 levels due to our planned increase in inventory but remained at a healthy $300 million with increased net income offset by working capital increases. Major uses of that cash include the repurchase of 2.1 million shares which returned $134 million to shareholders, acquisitions of $75 million, capital expenditures of $73 million and $65 million for dividends.

Now let's review our sales performance for the third quarter and first 9 months of 2011 in more detail. The 4% organic growth in Q3 for our research business matched our first-half performance and largely met our expectations in the current market environment. Our research sales in the U.S and Europe grew organically in the low single digits, while the Asia-Pacific and Latin America research business increased to near double digits, consistent with our performance in 2011's first half. Our acquisitions of Vetec Resource Technology Corporation and Cerilliant contributed 3% and currency added 6% to the reported research sales growth in Q3.

Our Q3 sales for SAFC were in line with the first 2 quarters of 2011 at $180 million, which is the second highest reported sales quarter for SAFC in our history. This was a 2% organic increase over 2010's Q3 but down from the 13% organic growth we've reported in the first half of 2011. As we mentioned in the Q2 conference call, because of the significantly higher comparables achieved in quarters 3 and 4 of 2010, we did expect to report lower organic sales growth in the second half than that achieved in the first half. Sales of our industrial media to biopharma customers continue to perform at or above our expectations. Hitech sales dollars remained in-line with prior quarter levels in 2011. However, sales growth was lower than the previous quarter due to a strong comp a year ago and some supplier delivery constraint this quarter which have now been resolved.

Our Supply Solutions business shows some softness and was off of its pace from the first half of the year. With growth in this business for the quarter in the low single digits, we are obviously watching this closely. Our SAFC pharmaceutical business for custom APIs continue to be challenged this quarter. It is down slightly as compared with last year in both the third quarter and the first 9 months as market conditions continue to be difficult for custom APIs. We do expect sales of our SAFC business to remain on track to deliver high single-digit growth for the full year.

After removing the effects of restructuring cost and incremental amortization cost associated with our recent acquisitions, our adjusted operating income margin in the third quarter was 26.4% or 100 basis-point improvement over 2010. I want to reiterate that we have mentioned on previous calls that our operating margins in 2011 are planned to hold steady compared to 2010 as we consciously invest in key growth strategies that are expected to provide above market returns in future years. We are committed to making continued progress and accordingly, our adjusted operating income margin for the first 9 months of this year is 26.5%, an expansion of 40 basis points from the same period in 2010.

As previously mentioned, our free cash flow for the first 9 months of 2011 was $300 million. The contribution from higher net income in the first 9 months of 2011 was exceeded by planned working capital increases. This cash usually was largely due to higher accounts receivable levels, as well as higher inventory levels to enhance service in the faster growing markets in Asia-Pacific and Latin America and other select markets. Our capital expenditures to date in 2011 were $73 million, slightly higher than 2010. We expect capital expenditures of approximately $120 million for the full year 2011 compared to $99 million for all of 2010. We are making investments in the high-growth emerging markets of China, India and Taiwan to support our growing Research business and to meet the strong demand for our SAFC Hitech products.

Now I'll ask Rakesh to comment on some of the operating highlights in Q3, as well as our 2011 forecast. Rakesh?

Rakesh Sachdev

Thanks, Kirk and good morning, to everyone. I'll start with an overview of our strategic priorities to provide context for our Q3 progress. Sales growth at above market rates and improving profitability remain our strategic priorities despite the fact that some of our end markets have come under pressure in recent months.

In the Research business, we remain focused on innovation and product leadership in the faster-growing segments of analytical chemistry, selected areas of biology and material science. Additionally, we plan to continue expanding our product breadth and enhancing our customer service and distribution capabilities to provide the convenience that our research customers have come to expect. We have new products coming online for proteomics, epigenomics and molecular biology in Q4 to support the ongoing introduction of new products and focus areas of antibodies and specialty biochemicals. Just a few examples include new high throughput kits and accessories for nucleic acid purification. We have added additional validated antibodies and next-generation products for quantitative PCR and the whole genome amplification.

In SAFC, we are driving growth in several areas of cell culture media for biological drugs. As part of this, we are offering a suite of capabilities to our biological manufacturing customers that includes capabilities around linking antibody conjugates and high-potency manufacturing. Additionally, we are also expanding capacity to produce chemicals used in electronic applications such as for the manufacture and development of LEDs, semiconductors and solar panels. The emerging markets have been and we expect that they are going to continually be strong markets for us to drive organic growth in research and our SAFC businesses.

Additionally, our e-commerce platform is a very important channel to our markets and provides excellent convenience and service through outstanding content and search tools. We are continuously building upon and improving the tools required to enhance the user experience. We are also expanding local language capabilities. As an example, we recently added search experience in Chinese with translated product pages. Our balance sheet remains strong and we intend to deploy our capital structure to complement our organic growth through selective acquisitions. And we were pleased with the recent rating upgrade by Standard & Poor's to A+ from A.

Since last December, we have invested about $150 million in 3 bolt-on acquisitions and we are very pleased with their performance so far. Our acquisition pipeline continues to be full and we have a team dedicated to bringing on board the best opportunities. In Q3, our analytic chemistry initiative benefited from positive customer response to our new applications in the environmental, food and beverage sectors, including those added by our recent acquisitions in that space. These acquisitions added 12% to the growth for analytical in this quarter consistent with what we had experienced in the second quarter.

In the biology area, we achieved reported growth of 12% and organic growth of 6%, also consistent with Q2. This increase was largely driven by higher demand for our biomolecule products including antibodies, our functional genomic products, and the expanding offering of our Zinc Finger Nuclease products. These technologies are growing mid- to high single digits and we continue to invest in initiatives that are broadening the availability of our zinc finger offering to a wider group of customers through new and innovative applications.

Our performance and material science products for research continue to exceed our expectations with double-digit organic growth in the quarter. This growth came from all geographies led by the U.S.. In addition to current applications and semiconductors and LEDs, we are collaborating to develop novel energy and other electronic materials, including rare earth materials and quasi-crystals for applications and hydrogen storage, batteries and security devices.

We continue to experience consistent demand in SAFC in Q3. Solid demand for our industrial media products used in the production of biological drugs continues to be impactful for our SAFC business with mid-single-digit growth. We saw our Hitech business growth moderate during the quarter due primarily to a 2010 comparable. We continually to see a reasonable demand for materials and precursors for use in semiconductor and LED applications. And we fully expect this business to achieve double-digit organic sales growth for the full year compared to 2010.

Geographically, our North American sales growth of 3% was impacted by the slower growth of SAFC, specifically in our custom Pharma business and Supply Solutions business. Research growth was 3% and acquisitions added another 5% of the growth of the North American Research business. Sales growth in the third quarter and our European business was 2%, organically matching our Q2 performance with research growing 4% organically. Our international region, which includes Asia-Pacific and Latin America markets, had strong organic sales growth of 9%. In our focus markets of China, India and Brazil, combined Q3 organic sales growth was 25%. With a 16% contribution from the acquisition of Vetec, our focus markets grew by 41% on a constant currency basis.

Internet superiority remains a key initiative. A key to the success is making our site more user-friendly. We recently rolled out both improved search capability and product pages based on customer input. During the third quarter of 2011, we had $11.8 million visits to our website compared to 9.7 million in Q3 of 2010 or a 22% increase. In Q3, the percentage of research sales through the electronic commerce channels remained at 50%, the same rate achieved in the first half of 2011, with additional growth expected from the addition to our e-commerce platform of new products from our recently acquired businesses.

Now let me highlight a few specifics achieved on our strategic initiatives in the third quarter. We are capitalizing on the growing demand for our Zinc Finger Nuclease products. We are increasing manufacturing capacity to allow us to bring the technology to a broader research audience, thereby increasing access to these groundbreaking products and the potential for scientific discovery. We have expanded our capabilities to provide knockout zinc fingers for every mouse and rat gene to complement our existing range of knockout ZFNs for the entire human genome. We also introduced a new composer-targeted integration kit to provide better tools and access for the research community to advance genomic engineering strategies.

We launched our first offering of Zinc Finger Nuclease-modified Chinese hamster ovary cell lines. These products are designed for use in the production of biopharmaceuticals and enable customers to reach the market faster and more cost effectively by reducing timeliness for early-stage biological drug development. These cell lines' distinctive features should appeal to organizations looking to build a robust and comprehensive therapeutic protein monoclonal antibody manufacturing platform. We signed an agreement with the U.S. Department of Energy Ames Laboratory to collaborate on the development of rare earth materials and quasi-crystal product applications.

In China, our expansion in Wuxi should be on line in Q4 of 2011. This will enable us to package and distribute more competitively priced products for the local Chinese markets, building on prior efforts to take advantage of opportunities in this fast-growing market. In India, in early Q3, we completed the expansion of our Bangalore packaging and distribution center. This 57,000 square-foot expansion, which includes packaging operations for the first time in India, enables us to enhance service levels of both the local and regional markets and provides us a cost-competitive facility from which we can competitively service other regions of the globe. These operations complement the long-standing manufacturing capabilities we have in India.

And for SAFC, we just completed the consolidation of our liquid media facilities, which was a final step in our restructuring effort. Our updated facilities expand our capacity, improve and update our quality systems, so they are consistent with the highest standards of our customers. Further, these facilities provide improved assurance of uninterrupted supply to our customers. We're also moving forward with our new Taiwan facility which is expected to come online in early 2012. We will ramp up production during the first half of next year and plan to build out a second phase of the site throughout 2012. When up and running, this site will employ 120 people in a science park in Southern Taiwan. This facility is being built to strategically respond to global shortages of trimethyl gallium and trimethyl indium. And it will also support multi-use small batch chemistry production.

Now I'll review our 2011 outlook. As I said, there is uncertainty in some of our end markets. But we have weathered uncertainty before. In 2008 and 2009, we had positive organic growth in both years despite the recession. So let me talk about how we think we should end up for 2011. Organic sales growth is expected to be in the mid-single digit range for 2011, unchanged from our previous outlook. The macroeconomic environment and the austerity measures in the U.S. and Europe add a layer of instability to our end markets. However, we are cautiously optimistic that our initiatives to enhance and highlight the product capabilities of our Research business, coupled with our focus on the Asian and Latin American markets should enable us to achieve low to mid-single digit organic sales growth in our Research business in the fourth quarter. Our recent acquisitions are expected to contribute about 1% to 2% to the full year organic sales growth expectation. And at current exchange rates, currency is expected to increase reported sales growth by about 4% over the prior year.

Our outlook for adjusted diluted EPS in Q4 is $0.85 to $0.93 with an expected tax rate in the quarter of 30% to 31%. This tax rate is higher than what we have previously guided of 29% to 30%. And this higher tax rate will have an approximately $0.03 negative impact to the fourth quarter's otherwise reportable diluted EPS. We expect a smaller currency benefit in Q4 than previously considered by about $0.02. Our adjusted diluted earnings per share through 9 months is $2.88 implying a full year outlook of $3.73 to $3.81 compared to a $3.60 to $3.75 in our previous outlook. This revised full year outlook assumes an effective tax rate of 28% to 29% down from 29% to 30% we have previously guided. EPS guidance excludes any restructuring or other special charges.

As I previously indicated, we are raising our guidance to $3.73 to $3.81. As you can see from this slide, there are essentially 3 primary reasons for this change. First, throughout the year we have been performing better than expected. This impact was approximately $0.06 in our revised guidance. Second, we are reducing our tax rate for the year to 28% to 29% which provides a $0.05 benefit. And lastly, at the prevailing exchange rates we expect currency to have a negative $0.02 impact compared to our previous guidance. That brings you to the revised guidance range of $3.73 to $3.81 for adjusted diluted EPS. And we expect free cash flow to be about $400 million, no change from our previous guidance.

Let me assure you that our entire Sigma-Aldrich team is committed to achieving these results. And I look forward to updating you on our progress in the next conference call. Again, I want to thank you for your support and ongoing interest in our company. And on behalf of the worldwide Sigma-Aldrich organization, I thank you for joining us today.

And now let's open up the call for your comments and questions.

Question-and-Answer Session

Operator

[Operator Instructions] And our first question today comes from the line of Jon Groberg from Macquarie Capital.

Jonathan P. Groberg - Macquarie Research

Just two. One is just a clarification around the earnings guidance. I'm trying to understand, you take your -- looks like what you did is you're now excluding restructuring that you weren't excluding in the previous quarters. Because I had -- I kind of knew [ph] at $2.83 through the first 3 quarters, $0.94, $0.93 and $0.96, but you're saying you're $2.88. I'm trying to make sure we're calibrating from the same level here and then thinking about how that impacts your guidance for the rest of the year.

Rakesh Sachdev

Jon, this is Rakesh. It is actually excluding restructuring. In fact, $2.88 is the accumulated EPS adjusted for any restructuring. I think the difference is the tax rate differential in Q1. So it's really -- and that's what we have outlined, is that we're getting a $0.05 or $0.06 tax benefit in our revised guidance. So if you go back and look at what we've reported, excluding restructuring for the first 3 quarters, it is at $2.88. The only difference is the tax rate.

Jonathan P. Groberg - Macquarie Research

Okay. So just to be clear, when you talk about the $0.10 or so and that you had this year, the extra $0.10 in EPS associated with some of these initiatives that will roll off, that's $0.10 -- that's been excluded already from this year, so you're not going to see in that benefit? Or is that $0.10 of additional spending that as you think about 2012 will no longer be there?

Rakesh Sachdev

No, no, the $0.10 I think that we talked about was the benefits that we are going to get from the restructuring actions that we have been taking. And what we have consistently said is that we will get about $0.10 on an annual run rate from the restructuring actions because it really got completed at the end of Q3. So we are seeing some benefit this year but the bulk of the benefit is going to come in 2012. [indiscernible] It's only going to come in.

Jonathan P. Groberg - Macquarie Research

So on these adjusted numbers -- because on the adjusted number that you've reported so far for this year and that you've reported in '11, you'd expect there to be an additional $0.10 as you move into 2012 from these initiatives, as they've completed and you start to accrue the benefits of them?

Rakesh Sachdev

It'll be most of $0.10. I think they've got probably, I don't have the exact numbers, maybe a couple of pennies this year. That's in -- directionally correct.

Jonathan P. Groberg - Macquarie Research

Okay I just I want to make it's clear because there's a little confusion here from investors. And then the second question is about the end markets, I guess. Maybe would you mind stratifying them in a little bit more detail, kind of geographically what you're seeing? And within those geographies, kind of your different buckets as to how they're doing?

Rakesh Sachdev

Sure. Let me make some comments because let's put it in 3 big buckets. It's academia, it's the pharma and then the industrial market. And I would say that if you look at academia and break it out between North America, Europe and the rest of the world, I would say let me start over the rest of the world. If you look at what we're all seeing in Asia-Pacific and Latin America in academia, we generally remain fairly positive in most of the countries in the international markets. China is strong, South Korea is strong, Brazil is strong and we're also seeing a slow recovery in academia in Japan. I would say where there is some softness in academic funding it's probably in 3 places: It's Australia, it's India, and it's in Singapore. And I would say that makes up a small piece of our total international business, so we're not really concerned. So when I look at the international area for us and academia, positive. When I look at North America, which is where I'm sure people have a lot of questions and we have been speaking very extensively with all our customers in academia, I mean, there's clearly pressure on equipment budgets. But I'll tell you, there's diversity. The private universities are generally doing well. So when you look at the Cornells of the world and the Columbias and the Washoes [ph], I think there you're still seeing growth in academic funding. You've got some state schools that are under pressure, under budget pressure, and we would expect some of those state schools to see lower funding by as much as 5%, so 1% to 5%. Then you have different states. So if you look at the whole state of Texas, you see a very positive outlook towards academic funding. You have things like the Cancer Prevention Institute of Texas that's pumping a lot of money. NIH, yes, I think there will be pressure on the NIH funding mostly in 2012 and 2013. I still maintain that for consumables like what our company does, I would say that we tend to be shielded somewhat. So overall, North America is still, we are very selective wherever we go. I would say that we are watching the academic markets in North America but we're not terribly concerned at this stage. And I would say in Europe, we actually have not seen any decline in the academic funding so far. I mean we obviously have to watch 2 countries. We're watching carefully Spain and Italy, but I would say that generally, what we're seeing is fairly static budgets to maybe even some smaller increases. And there are little shifts taking place between scientific disciplines and academia and we are very aware of sort of where the money is going. But that's just the whole academic scene around the world. Now if you move on to the Pharma and CRO business, as again as we see it, there's continued outsourcing of research projects. Clearly the big pharma companies are doing that. There seems to be more increased focus on development, then an ongoing and accelerating interest and high throughput applications. And then certainly we are seeing increased demand for faster run rate consumables such as the DNA purification kits, extraction and so on. I would say generally, the mid-tier pharma industry is holding better for us particularly in Europe. And same thing in international and Asia-Pacific, there is some pressure I think specially in the CRO markets in India but other than that, things don't seem to have changed for us much and Pharma has been fairly flat overall. I would say that Pharma and research, we are still growing. We have grown in Q3. We grew for the first 9 months, where you think headwinds in pharma is really an SAFC business and that's what Kirk talked about. And I would say finally, on the industrial businesses, we have some bright spots in industrial especially in North America and medical initiative, which is tailored towards the environmental and food and beverage. That remains strong and that caters to a lot of industrial segments. I would say in Europe, generally, I think we are seeing some slowness in Germany in our industrial markets. But generally, in the international markets, we remain quite positive for local demand and most of the industrial sector. There's clearly an increased focus on quality and differentiated products. And if we look at international markets, we continue to grow double digits in the industrial markets. So that's just high-level. That's kind of what we are seeing in our end markets. We are cautious, but I think it's not unexpected what are seeing and we still feel pretty good with all the initiatives that we have in play. I'm sorry that's a long answer to your question but I know that a lot of people probably in queue probably have the same question.

Operator

Our next question comes from the line of Tracy Marshbanks form First Analysis.

Tracy Marshbanks - First Analysis Securities Corporation, Research Division

I guess a little bit of a follow-up question touching on those markets. You had an interesting choice of words, layer of instability. To me that sort of implies you're seeing sporadic buying patterns, project starts, stop. What's the -- how is sporadic or instability being manifested since you used that word?

Rakesh Sachdev

Yes, I guess I was making a general statement. We don't see that layer of instability in the consumables business. Our consumables business is very steady Eddie. But in talking to -- and we've been spending a lot of time with our customers in light of all the questions we've been getting. But clearly, I'm sure I would say when you look at the high capital spending, there's clearly lumpiness. I think there are people who are talking to us about -- that they are being very cautious at our customer end. But we have not seen, if you're talking about order cancellations, we have not. In fact, we haven't even seen orders being pushed out to the next quarter. But sometimes, you tend to see. So we haven't seen that. I think there's just general uncertainty with our customers about what's happening with budgets and funding.

Tracy Marshbanks - First Analysis Securities Corporation, Research Division

Yes, that makes more sense that it was for a broadly applied, and particularly to capital equipment. A little bit on SAFC, a couple of questions. Just trying to get the trajectory of that business, because you got a lot of things going on. First, you mentioned a supply constraint that's been resolved. Is that likely to be a material impact?

Rakesh Sachdev

No, we've had a couple of suppliers who had some issues. I think there was an issue in one of their plants. They have resolved that and that was in our Hitech business and it really affected us only in Q3. It's not going to affect us in Q4. What I would say is that if you've had stronger comps, I'll tell you, we have also been somewhat capacity constrained in the Hitech business, which has muted our growth somewhat. With the capacity expansion that we are putting in place, both in our existing facilities as well as the new facility that's coming up in Taiwan. It's going to really change. It really opened up several doors in 2012. I know we're not giving 2012 guidance now but I think I can tell you sitting today, that with what we have been doing in this business, we are well-positioned for some very impressive growth in 2012.

Tracy Marshbanks - First Analysis Securities Corporation, Research Division

You're going exactly where I was going to question because I knew you have the capacity coming on. So I think that answers that. And sort of the broad question of how you participate and given some of the noise in the -- particularly Hitech. I mean Solar has certainly gone through trials and tribulations this year. There's been discussions in LEDs about overcapacity in pricing, Cree [ph] recently reporting. On the other hand, you seem to have been insulated from that. Could you just discuss, are these things impacting you and how you're navigating and performing in that sort of environment?

Rakesh Sachdev

I think when you look at LEDs, let me just say there are 3 primary drivers for demand in LEDs. One is the LED backlighting growth which is for TV, laptops, cellphones and that's what you're referring to. You then have the general lighting growth, which is also growing and it's going to explode. And then the penetration rate of LED into TV lighting, which is a fluorescent, is the other driver. What I would say that clearly, I think there has been some overbuild of TVs and so the TV growth has been fairly flat. But what's interesting, what's happening is a number of LEDs in these applications is growing quite significantly. So for us, it isn't necessarily just the units of TVs but it's the number of LED units being applied in that same application. And at some point in one of the conferences, will show you how that growth is accelerating much more than just the number of TVs, the number LEDs. So we are very bullish on the -- because what we do is supply chemicals that's a function of the number of small LEDs that go into these applications. And what I would say is that over the next several years, this growth is going to be solidly in the double-digits and we still stand by that. So you asked a question on pricing. No, we have not been affected by pricing so far. I mean I think down the road, we are very cognizant that in many of these applications, pricing does become an issue. Again, it's like any of our businesses, what we provide is a very small dollar value of the total application. And so we are usually not on the radar screen when it comes to pricing.

Operator

Our next question comes from the line of Quintin Lai from Robert W. Baird.

Quintin J. Lai - Robert W. Baird & Co. Incorporated, Research Division

A couple of questions here. So one, you talked about kind of the resiliency of your business and coupled with the fact that you've already kind of done a restructuring here, other competitors have talked about trimming their work staff in light of the end markets. So as you're looking out kind of 2012 and beyond, do you feel pretty good about where your cost structure is now?

Rakesh Sachdev

Quintin, the cost structure is always a journey, right? So one of the things that we are working very hard is this whole continuous improvement process, and I believe that never ends. And so productivity gains in the company are going to be the mantra forever. And so we are going to continue to find ways of operating more efficiently through a lot of our continuous improvement formalized processes that we have. And I would say that whether we look for a step change in the cost structure through our footprint, I mean that's always something that we evaluate. But it's really a combination of continuous improvement plus step changes, where appropriate, and those are things we continue to do. So to answer your question clearly there are opportunities for us to affect the cost structure.

Quintin J. Lai - Robert W. Baird & Co. Incorporated, Research Division

And then with the investment that you've had with the increase in the working capital and building up the inventory in some of you distribution sites outside the United States, have you started to see the positive impacts of that? Or is that something that could accelerate over the next few quarters?

Rakesh Sachdev

Well, we're certainly seeing the positive impact. We are seeing our service levels have now been higher than they are today in the international markets. I think we're doing a very good job for our customers. What I would say though, Quintin, is that as we localize more of our packaging and distribution in places like China and India, they're going to start shipping products in bulk which, today, we're not doing because we're just starting off. And once that happens, in fact, we will reduce the inventory of finished goods because we'll be packaging and storing in those local countries. But for a while, I think we will see these elevated levels of inventory. But over time, we have a plan to actually reverse that.

Quintin J. Lai - Robert W. Baird & Co. Incorporated, Research Division

And then final question from me. You talked about the acquisition that you've made integrating nicely. Rakesh, what are you seeing in the environment now? Are prices for potential targets favorable these days?

Rakesh Sachdev

I would say generally, yes, Quintin. We always have -- I think I mentioned it at the last call. We are actively always looking at, at least about 10 or 12 companies for acquisitions. They generally tend to be in the bolt-on area. We have some very exciting things. And I would say that for the most part, this is a process of negotiating because of a lot of these companies are private companies. And I would say for the most part, valuations are not out of line today. I mean it's different than what it was a couple of years ago.

Operator

Our next question comes from the line of Dan Arias from UBS.

Daniel Arias - UBS Investment Bank, Research Division

Rakesh, just given your comments on Wuxi expansion project ramping up and what that will enable you to do, can you just talk about the pricing dynamic in China. And then I guess more broadly, just given that most of your consumables competitors are putting similar China plans in place, how do you go about maintaining or taking share there?

Rakesh Sachdev

So as I'd said, you know there's a whole segment in China that we have not participated, what we call the Tier 2 markets. So on the eastern corridor China, where the big universities are, where people still tend to use high-quality reagents and chemicals, we have had a good share there. But when you go inside China, when you go to the Wuxans [ph] and other places, we have not participated in their market because I think just the expectations of the customer are different and the price point is different. What Wuxi will allow us to do frankly, and we have -- I think we are approaching close to 1,000 products that we are starting off in Wuxi that will allow us to penetrate these inner markets with what we call as value branding, and the prices are lower. But then our costs are going to be significantly lower and what's interesting is that our margins are not sacrificed. And in fact, even at the lower price points, our margins might be enhanced for these new markets that we open up. Now we believe we have the first mover advantage. We have been in China, I think, for what we do longer than anybody else and I think we will capitalize on that position.

Daniel Arias - UBS Investment Bank, Research Division

Okay, thanks very much for that. And then maybe just a comment on the impact on commodities during the quarter and then looking forward what you might think about 4Q there.

Rakesh Sachdev

Yes, the biggest impact on commodity is the biggest inflationary impact is clearly still in freight. And I think our guys are doing a pretty good job in trying to optimize liens and shipments and the right mix between air and ocean to really counter some of that inflation that we are seeing in freight. But clearly, we have seen this year, I would say, in the last several months, a slight uptick in our freight cost. In some cases, we recover that but in other cases, we always try and offset it first so it's just more optimization of our freight. But I would say that's the biggest piece that we have seen so far. Other than that, most of our input raw material is not that prone to inflationary pressures. The other thing is the petroleum products, but there, we had some increase and I think I mentioned that we took some pricing actions to offset some of that.

Operator

Our next question comes from the line of Isaac Ro from Goldman Sachs.

Isaac Ro - Goldman Sachs Group Inc., Research Division

Thanks for taking the question. The first one would be on the guidance for the year on operating margins to be filed. If you could maybe parse that a little bit more whether that's something we're going to see at the gross margin level or is there an unusual expense item that would pick up maybe SG&A level or something of that nature in the fourth quarter?

Rakesh Sachdev

No, I think gross margins, other than mix, we don't expect any adverse impact on gross margin. And so I think it's really a little bit of a fluctuation as around SG&A because we are taking up some programs and spending and including R&D but we have been adding more sales and marketing oomphing up in the international markets ahead of us getting the sales and profits. But I would say, and we are taking up our investments in e-business as I talked about. We've got some other things that we're working on. I would say that would be where you would see some of the -- where you might see anything.

Isaac Ro - Goldman Sachs Group Inc., Research Division

Okay that's helpful. And then just secondly, you note a big picture here [ph], we've talked about the China opportunity, long-term obviously is exciting. But in the near-term there has been concern about whether or not some end markets in that region are slowing down a little bit. And if you could may be remind us how your regional end-market exposure in China differs from your global end market exposure. And as we think about that slight difference, where you might be looking for potential pressure just given the lead times in this business versus the capital equipment business, so it might be a little harder call. But just trying to figure about where we should be sensitive on headline risk going forward.

Rakesh Sachdev

Yes, I don't know. We have not seen a slowdown nor do we see through our conversations with our customers in China. I think, I believe we grew over 25% in China again this quarter. That's been consistent. As far as exposure to end markets, we've done a pretty good job in China also working with the Pharma companies, clearly embraced us as a strong partner, especially in the whole Shanghai region, we're working well with them. Our Pharma business continues to grow there. Our SAFC business, frankly, has a huge opportunity in China that we haven't even taken advantage of especially in Supply Solutions, because there's a growing need for high-quality cGMP products in China and that's the next initiative that we're going to capitalize on. And as I said, we are opening up new markets with our Tier 2 product side. We remain fairly bullish about China. So that's all I can say right now.

Operator

Our next question comes from the line of Peter Lawson from Mizuho Securities.

Peter Lawson - Mizuho Securities USA Inc., Research Division

Rakesh, just on lower tax rate. I may have missed this but is that sustainable or is there a onetime benefit in there?

Kirk A. Richter

Sure, I think what we said both in the first quarter when we had an advantage and in the third quarter, that those came from a onetime use of some loss carryforwards and also some releases of statues and favorable tax law in some states gave us the first quarter advantage. I think the other thing, the political football that keeps getting kicked back and forth and it's off the tables for right now for 2012 is the R&D tax credit again. So no, those onetime things aren't sustainable. We don't expect them to repeat and then you got the added headwind from R&D credit until the Congress elects to do something in 2012.

Peter Lawson - Mizuho Securities USA Inc., Research Division

And then Rakesh what do you worry most about for the 2012, in the business?

Rakesh Sachdev

Well, I think as a company we are trying to be very focused. Clearly, for us, it's important to understand we're the spending is going to take place with our customers. We've got to chase where the dollars are going and that's what we're doing, is making sure that we're getting the organization focused on what's really important. I always said we are blessed with a great business model in this company. And while there's certainly a lot of talk around us about the uncertainties, and we certainly don't want to minimize that but we feel pretty good. I mean look at what happened in 2008 and 2009. I mean those are real global recession years and we actually had record years. We had a record 2009 and then we followed that with a record 2010. And we're going to do the same thing in 2011. So execution is key. I think we have a pretty good strategy laid out and I think this team is absolutely committed to execute on all fronts.

Peter Lawson - Mizuho Securities USA Inc., Research Division

There's no 1 particular end market or business line that kind of worries you about comps, et cetera?

Rakesh Sachdev

Well, I think there are some businesses that we are focused on trying to improve. The SAFC Pharma business is one that I'd like to see us stabilize. Again, it's 5%, 6% of the total company, So it's not that large but it's a business that we want to try and fix because we have made some investments on that business. I think I feel pretty good about the international markets. I feel pretty good generally about what we're doing in the U.S. I think Europe, there's -- in southern Europe there's some uncertainties, but again, that's not where we have a lot of exposure. Our exposure is more to central Europe and to northern Europe but I think what I worry about is making sure that we can capitalize on the opportunities because there are lots of them and do it with some speed and efficiency. And not just organically, mind you. We are buying a lot of bolt-on companies. There's a lot of synergies that we can capture and we want to make sure that we are able to do that and deliver that for our shareholders.

Peter Lawson - Mizuho Securities USA Inc., Research Division

Is there any change in the balance of buybacks versus acquisitions of use of cash?

Rakesh Sachdev

No. And I would say that it's been pretty consistent and Kirk can tell you. We did probably a larger buyback in Q3. We thought that the share prices are muted. There'll be a token opportunity and I think we bought probably twice as much as we would normally buy in a quarter in the third quarter.

Operator

Our next question comes from the line Derik DeBruin [ph] from Bank of America.

Unknown Analyst -

So I'm a bit confused, which is nothing unusual but -- so I'm looking at your $0.98 reporting in Q1; I'm looking at your first quarter press release, as well as your first quarter slide; and nowhere in either of those do you see that $0.98. Are you adding that $0.04 in tax restructuring back to get to that $0.98 number? Because it's $0.94 in your slides for Q1.

Rakesh Sachdev

The $0.98 is what we reported without restructuring and we had $0.04 from tax. So it was really, the $0.94 that you're referring to is the $0.98 adjusted for $0.04 and tax to $0.94. But the reported number excluding restructuring was $0.98.

Unknown Analyst -

Okay. The reported number is -- the reported number is $0.97 -- okay I'm just looking at the second bullet in your first quarter release, which basically says -- it basically says $0.94 there, which is kind of what's in the Bloomberg number. So I'm just trying to figure out where's the discrepancy in the numbers.

Kirk A. Richter

The $0.98 is included in the first 9 months number and included in the guidance for the year. So we intended to say that, that was an item that wouldn't repeat in Q1 but we did included it in our guidance for the year.

Rakesh Sachdev

So what we have done is just taken out this tax completely and -- our full year guidance has the 28% to 29% tax rate. And that's why we said we have bridged from our previous guidance. I think you should look [indiscernible] -- Sondra do you have the -- well, you can take this offline with Derik. But I'm very certain that the number for Q1 excluding restructuring is $0.98.

Unknown Analyst -

Okay, we can have this conservation offline. Let's stick with this to another topic. So I'm looking at your Q3 number and it's a 27% tax rate on Q3, which is in your Slide 12, versus the 26% which you have in your press release. I'm just wondering how do you get to -- and also, I'm also trying to figure out what's the tax on that difference in 0.4% in operating margin to get there. I'm having trouble making all the numbers work.

Kirk A. Richter

I think the 26% is the Q3 number and I guess the 27% you're referring to is the year-to-date number.

Unknown Analyst -

No I'm looking at your Slide 12.

Rakesh Sachdev

The 27% is that before restructuring. That's a GAAP.

Unknown Analyst -

And is that before acquisitions as well, the 27%?

Rakesh Sachdev

No.

Unknown Analyst -

So then to get to your 26.4% operating margin you've got to assume that 28% tax rate then?

Rakesh Sachdev

Well there's no tax in operating margins.

Unknown Analyst -

But to make the adjusted EPS work, right?

Rakesh Sachdev

Okay, you've lost me now. At least...

Unknown Analyst -

Okay we'll take this offline. But I'm just saying there's clearly some confusion in terms of the numbers. I've got a lot of hits from investors so I'm clearly not the only one kind of struggling with what's kind of embedded with your old and new guidance because there seems to be at least $0.06 or $0.07 that nobody can kind of account for. So we'll take it offline.

Rakesh Sachdev

I think part of the difference is the $0.94 to $0.98, I think that's the only difference but that's the tax rate difference. There shouldn't be any other confusion about anything else. But why don't we take it offline?

Operator

Our next question comes from the line of Paul Knight from CLSA.

Paul R. Knight - Credit Agricole Securities (USA) Inc., Research Division

An earlier call today mentioned that the move by pharma and generics into large molecule was perhaps benefiting the business. Are you seeing that in your area and are you seeing, do you think, the effect of all the human genome sequencing in the market? Or I guess the other way to answer it is, what are you doing in your product portfolio to address these changes in the market?

Rakesh Sachdev

So clearly, you're right. The large molecule business -- so if you look at biopharma, focused on large molecules, also that's growing at about 78% and our participation at least in the SAFC space is largely through the industrial media business, you know, where we supply the media in which the proteins are grown. And that business that's why for us has been doing quite well because we are expecting, I would say, a lot of the major blockbusters. I would say the other opportunity that for us in the future that this is going to become a decent-sized opportunity is biosimilars in the emerging markets. And so we are already working with several potential customers who will offer that opportunity for us for our products. But you're absolutely right on. I mean the large molecules is where there's a lot of growth and we are participating in that.

Paul R. Knight - Credit Agricole Securities (USA) Inc., Research Division

On my recent trip to China, the one thing that seemed to strike me from domestic and multinational pharmas was their manufacturing expansion plans. I know you're obviously a research-oriented firm but on the manufacturing growth in these markets, how much will you participate in that?

Rakesh Sachdev

Yes, but again, close to a third of our business is not tied to research, so that's our Fine Chemicals business. And within the Fine Chemicals which is almost a third of our business, one of the rising stars is our Bioscience business, which is where we manufacture industrial media for production of drug. That's not for research. And today, if you go to south San Francisco, where the who's who of biological drug manufacturing, we are in, I would say, 70% to 80% of those drugs. And we are doing the same thing in Asia. We are working with the local biopharma companies to help them produce biological drugs and this is not, again I want to reiterate it, in manufacturing.

Paul R. Knight - Credit Agricole Securities (USA) Inc., Research Division

That was originally an Australian asset, was it not? And does that background and culture, does that position you better, you think, in the Asian markets or does it matter?

Rakesh Sachdev

No, I think the Australia you're talking about probably is Serum [ph] but no, we bought a company that was really a U.K.- and U.S.-based. So it was really a U.S. and European play that we made when we bought this company. But really got us into the map of biological drugs through the media.

Paul R. Knight - Credit Agricole Securities (USA) Inc., Research Division

And then last, your antibody catalog I hear there's been a lot of additions to it. Can you quantify what's happened on your antibody product lines?

Rakesh Sachdev

I think I'm trying to remember the exact -- we've been adding a lot here right? I think we have close to about 50,000 antibodies today in our portfolio. Some we source, some we manufacture in places like Israel. We have both polyclonal as well as monoclonal antibodies.

Operator

Our next question comes from the line of Summit Roshan from KeyBanc.

Summit Roshan - KeyBanc Capital Markets Inc., Research Division

Just looking at the gross margin line here, it's a nice sequential improvement in the quarter. And is that mostly effect of higher prices falling through? And just wanted to get an idea of directionally where that goes in the fourth quarter.

Rakesh Sachdev

Yes, I would say it's a combination of several things, Summit. I would say pricing is a small factor because we've used pricing largely to offset some of the inflationary increases. I would say we were helped a little bit from FX on the gross margin side, it's small. But really, a big piece comes just because of volume. You know, our contribution margins are very good and so every time we expand our business, assuming the mix is not negative, because some products we make more and some products we make less, we get more than 50% of the bottom line of the contribution from these. And that's really what keeps expanding our gross margins. That's, I would say, the biggest piece is volumes, and to a small extent, I would say, is FX and price. And then, of course, the continuous improvements that we keep making.

Summit Roshan - KeyBanc Capital Markets Inc., Research Division

Okay. Thank you. And then looking back to '08 and '09, you accelerated buyback during those periods. And just assuming we fall back into similar conditions, would you be willing to do something similar at this point? In the third quarter, you referred to about 1.8 million shares. Do you think that rate could continue going to 4Q and into 2012?

Kirk A. Richter

I think it's always a balance between investment. As Rakesh said earlier, our top priority is looking at acquisitions which enhance the top line. But yes, we wouldn't rule out stepping up the share repurchase if we have the cash available to do that but acquisitions are still our top priority there.

Rakesh Sachdev

Yes, but we wouldn't rule out to looking at, when the time is right, to doing share buybacks.

Operator

Our next question comes from the line of John Shane [ph] from Shane & Company [ph].

Unknown Analyst -

Rakesh, Kirk, I'm interested in getting some perspective, a little more perspective on acquisitions and I'm asking really from a perspective of a long-term buy side investor. Obviously acquisitions are a potential source of growth and value creation but there's always a risk of eroding value if the prices are paid too high. So I guess both of those potentials in mind, I'm curious -- I guess you'd said you'd spent $150 million in the last year or so. So can you give some -- I'm sure it varies depending on what you're seeing, but can you give some general guidance on the size of acquisitions that you're thinking about? What multiples do you anticipate paying and if there are any limits to the multiples? Just playing with the numbers that you've released, it looks you paid around 3x sales because you said $150 million for a total $50 million in sales. I mean, I can sort of guesstimate what that might be as a multiple of income if I apply your margins to the acquisitions, but I don't really know. And then lastly, any thoughts on what currency whether you tend to favor cash, stock or would consider both?

Kirk A. Richter

I think on terms of acquisitions, what we are looking for is either bolt-on technologies or businesses that would enhance the channel distribution. Also on the financial side, we'd like businesses that will help that above market rate growth and that provide at least the same type of returns we're getting from our core business. That said, we're willing to take dilution early on and sometimes you do that with some of the initial charges when you write up some of the assets. But x that, we expect the same type of return that we get from our existing businesses and the 3 we've acquired certainly have that potential to add those kind of margins. If we look at share repurchases again, that's going to be a secondary consideration, but also something we look at. So in terms of sales multiples, I would say a 3 multiple is very comfortable. We could go higher than that and get the same type of returns at a slightly higher sales multiple. And I think it depends on the type of business and the trajectory. But I would say that typically what we look at on these bolt-on acquisitions the valuations can range on an EBITDA multiples anywhere from 6x, 7x to typically about 11x, 12x, unless it is a very highly superior growth business where we might pay a little more. But I would say that's typically in the range of where we find the opportunities.

Unknown Analyst -

Are there a size limits in your mind or was it just all -- I mean, I assume it just depends on what's out there and not on...

Rakesh Sachdev

Obviously, there are just more in share [ph] numbers of smaller bolt-on acquisitions in our space. So you don't have very many large businesses. So that's where I would say we spend most of the time the folks look at that. But it depends on sort of the strategic value of a business. We don't want to be so defining that we don't look at something that's very small if it's the right opportunity, or something that's reasonably sized if it's the right opportunity.

Operator

Our next question comes from the line of Jon Wood from Jefferies.

S. Brandon Couillard - Jefferies & Company, Inc., Research Division

This is Brandon Couillard in for Jon this morning. Kirk, can you give us the impact of FX on EPS in the third quarter? And do you have an updated outlook on the anticipated impact to EPS from foreign currency for the year?

Kirk A. Richter

I think we got a -- probably our most significant benefit in the third quarter that was in the $0.07 range.

Rakesh Sachdev

No, about $0.05.

Kirk A. Richter

Sorry, $0.05 in the third quarter. And as we've said, we backed that what we have achieved on a year-to-date basis down by a couple of pennies in the fourth quarter based on what the exchange rates did at the end of the quarter, slightly below where they were for the full quarter.

S. Brandon Couillard - Jefferies & Company, Inc., Research Division

Okay. And then any chance you could go ahead and give us the impact of price versus volume in the third quarter? And then what are your expectations for pricing contribution in the fourth.

Kirk A. Richter

I think pricing has stayed fairly consistent in that 1.5% to 2% range and that would be our expectation going forward.

S. Brandon Couillard - Jefferies & Company, Inc., Research Division

And then just lastly, can you give us some color on the factors behind the higher 4Q tax rate?

Kirk A. Richter

Sure I think, as we've said, the advantage we saw early in the year and in the third quarter were one-offs. So I think we'll go back to what we would consider a more sustainable run rate later in the year.

Operator

Our next question comes from the line of Dan Leonard from Leerink Swann.

Julian Cochran - Leerink Swann LLC, Research Division

This is actually Julian Cochran in for Dan this morning. I had a question. Can you talk about how the business trended throughout the quarter? Did you see any noticeable change in order rate towards the end of the quarter in research?

Rakesh Sachdev

Not particularly. I would say that fairly consistent, I think if you just look at the months. July was reasonably strong. August showed some depth, but again that was partly because of the vacations in Europe for us and it seemed to be a little more extended this time. And then September started off reasonably strong for us and then we had a few days in September that seemed a little soft. But there is no pattern for us at least not a run rate business. It's very, very small, the changes, when they do business.

Julian Cochran - Leerink Swann LLC, Research Division

And then, secondly, you may have touched or you touched on this or you touched on this from earlier with your comments with regard to cost structure and restructuring. But has there been any change in the way you're managing the business now that we are operating in a more uncertain environment in terms of being more cautious in headcount or capital spend or anything, anything like that, that you can touch on?

Rakesh Sachdev

So I return, capital spend we have been pretty consistent. We have put a plan together and that's what we are executing. We're not deferring any of our capital investments. I would say generally, just when you're faced with this kind of noise about just the global macro environment, I would say that we are put more on alert. We want to be a little more cautious. But I would say that we haven't announced any cutbacks or anything, but we're just very watchful and that's what we're going to continue to do. I think it's the right thing to do in this environment.

Operator

Our next question ace follow-up from the line of Quintin Lai from Robert W. Baird.

Quintin J. Lai - Robert W. Baird & Co. Incorporated, Research Division

Just to go back kind of to the whole guidance issue. The previous guidance that you had, $3.60 to $3.75 that always assume $0.98 of Q1. Is that right?

Rakesh Sachdev

Yes.

Quintin J. Lai - Robert W. Baird & Co. Incorporated, Research Division

And so the upward revision that's going on now is just the change in the tax rate and that's not a reversal of the Q1 number?

Rakesh Sachdev

No. We said the 3 things, Quintin. We clearly are performing -- based on our original guidance, we are now saying our performance clearly has been exceeding what we thought we would do. And I would say that's a big part of the drive of revising our guidance. Tax rate is another big part. And then they're going to see, on the prevailing exchange rates, they got a little worse for us, and so we're knocking off about $0.02 the way we build up the guidance. So that's how we got to the $3.73 to, sorry, $3.82.

Quintin J. Lai - Robert W. Baird & Co. Incorporated, Research Division

Got it. I think that was where the confusion is. I think first call's got a 94, which is why there's a discrepancy in some of the models that are out there. But when you try it apples-to-apples, essentially, the raise in guidance is still off of the same basis.

Rakesh Sachdev

Exactly, yes. Thanks for clarifying.

Operator

And we are now out of allotted time for questions. I would now like to turn the conference back over to management for any closing remarks.

Sondra Brown

We want to thank everyone for their participation. And remind you we do expect to release results for the fourth quarter of 2011 before the market opens on February 8, 2012 and we will follow that with a conference call on the same day at 10 a.m. Central time. And that concludes today's conference.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program and you may all disconnect. Have a great rest of the day.

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