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Edited Transcript of FBHS earnings conference call or presentation 26-Apr-17 8:30pm GMT

Thomson Reuters StreetEvents

Q1 2017 Fortune Brands Home & Security Inc Earnings Call

DEERFIELD Apr 29, 2017 (Thomson StreetEvents) -- Edited Transcript of Fortune Brands Home & Security Inc earnings conference call or presentation Wednesday, April 26, 2017 at 8:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Brian Lantz

Fortune Brands Home & Security, Inc. - Senior Viced President of Communications & Corporate Administration

* Christopher J. Klein

Fortune Brands Home & Security, Inc. - CEO and Director

* E. Lee Wyatt

Fortune Brands Home & Security, Inc. - CFO and SVP

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Conference Call Participants

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* John Lovallo

BofA Merrill Lynch, Research Division - VP

* Michael Jason Rehaut

JP Morgan Chase & Co, Research Division - Senior Analyst

* Philip H. Ng

Jefferies LLC, Research Division - Equity Analyst

* Robert C. Wetenhall

RBC Capital Markets, LLC, Research Division - Analyst

* Scott L. Rednor

Zelman & Associates LLC - VP of Research

* Stephen Kim

Evercore ISI, Research Division - Senior MD, Head of Housing Research Team and Fundamental Research Analyst

* Timothy Ronald Wojs

Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst

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Presentation

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Operator [1]

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Good afternoon. My name is Kelly, and I'll be your conference operator today. At this time, I would like to welcome everyone to the Fortune Brands First Quarter 2017 Earnings Results Conference Call. (Operator Instructions) Thank you.

I would like to turn the call over to Mr. Brian Lantz, Senior Vice President of Communication and Corporate Administration. You may begin your conference call.

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Brian Lantz, Fortune Brands Home & Security, Inc. - Senior Viced President of Communications & Corporate Administration [2]

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Good afternoon, everyone, and welcome to the Fortune Brands Home & Security quarterly investor conference call and webcast. We are pleased to be here today to provide an update on our progress during the first quarter of 2017. Hopefully, everyone has had a chance to review the news release issued earlier. The news release and the audio replay of the webcast of this call can be found in the Investors section of our fbhs.com website.

I want to remind everyone that the forward-looking statements we make on the call today, either in our prepared remarks or in the associated question-and-answer session, are based on current expectations and the market outlook and are subject to certain risks and uncertainties that may cause actual results to differ materially from those currently anticipated. These risks are detailed in our various filings with the SEC such as our annual report on 10-K. The company does not undertake to update or revise any forward-looking statements, which speak only to the time at which they are made.

Any references to operating profit, earnings per share or cash flow on today's call will focus on our results on a before charges and gains basis, with the exception of cash flow, unless otherwise specified. With me on the call today are Chris Klein, our Chief Executive Officer; and Lee Wyatt, our Chief Financial Officer. Following our prepared remarks, we've allowed some time to address questions that you may have.

I will now turn the call over to Chris.

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Christopher J. Klein, Fortune Brands Home & Security, Inc. - CEO and Director [3]

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Thank you, Brian, and thanks to everyone for joining us today. Our teams delivered strong sales and profit gains in the first quarter as the home products market continued to expand.

Our core businesses performed well across all segments, and we remain focused on driving profitable growth. Based on our solid first quarter performance, the momentum we have inside of our businesses and the favorability of our tax rate, we're increasing our full year EPS outlook.

Let me first spend some time on our view of the U.S. home products market. Next, I will provide my perspective on our business performance in the first quarter. We will then provide more details on our first quarter performance and 2017 outlook.

Starting with our view of the U.S. home products market. In the first quarter, the market for our home products continued to grow, with clear strength in new construction and the repair and remodel market growing at the pace we planned. We estimate that repair and remodel activity grew below the full year rate as expected due to the unusually high growth in the first quarter of 2016. Single-family new construction grew high single digits.

Repair and remodel activity remains steady overall, with consumers continuing to pursue on-trend styling and upgrades. Like we saw in the second half of 2016, the first quarter had some softness at the very high end after 2 years of strong growth. But R&R overall is tracking well and product mix continue to improve across our categories.

New construction demand came in a little ahead of our expectations in the first quarter. Single-family activity continued to outpace multifamily, a relative benefit to our company which sells more into single-family homes, and entry-level demand continued to accelerate.

Importantly, the basket of our forward-looking indicators continues to support strong underlying demand for the balance of the year. Financing at affordable rates continues to be accessible. Jobs and wage growth continue to look positive. And builders and contractors seem to be making progress on attracting more labor into the industry. Order patterns, new home permits and housing starts remain on a strong trajectory as we look into the balance of the year.

In terms of overall activity, however, the first quarter is seasonally slower, and the busier periods of the year for home products are just underway.

Even with these positive indicators, it's too early to increase our full year market outlook. Our overall assumption remains that the U.S. home products market, which impacts 70% of our sales, grows at a combined 6% to 7% rate for the full year in 2017. We'll closely monitor market activity as we move through the busier spring season, and we will determine any further upside to our market assumption as the year unfolds.

Now let me provide some perspective on our business performance. For the first quarter, sales increased 7% in total. Importantly, total company operating margin increased to 10.3%, with solid profitable growth across all segments. This operating margin improvement was particularly impressive for the seasonally light first quarter.

Starting with our Cabinet segment. We continue to follow a disciplined strategy focused on profitable growth. Our consistent pace of product innovation and our high levels of reliable service to our channel partners continue to drive solid sales and profit growth.

In the first quarter, our overall Cabinet sales were up 4% versus the prior year comp, which is up 34%. In-stock cabinets and vanities and dealer stock cabinets experienced the strongest growth in the quarter.

Dealer sales overall were flat against a 16% organic growth rate last year and were up low single digits, excluding slower sales of our luxury product lines.

Product mix across the channel continues to improve, and we're focused on capturing incremental demand in our new construction product lines and cross-selling to our broad dealer network. Our home center in-stock cabinets and vanity sales grew strong double digits due to successful new programs and product upgrades.

Our Cabinet team has been partnering with our customers to consistently balance inventory levels with production to increase efficiency and meet strong customer demand.

The remaining portion of our Cabinets business, which includes home center semi-custom, builder direct in select markets and Canada, grew low single digits led by builder direct. We remain disciplined in our approach to these segments with our focus on where we can partner with customers to capture profitable growth. Product mix continues to improve in these channels, contributing to the gain in our operating margin.

Overall, for Cabinets, we continue to execute well across multiple facets of a complex category with a focus on disciplined, profitable growth. Our plants are increasingly more efficient, and we still have the capacity to handle sales growth.

In the balance of the year, we'll continue to invest in targeted growth, enhancing our displays and deepening our partnerships with dealers, home centers and builders. The impact of our consistent execution can be seen in our sales gains against a very tough prior year comp, our stronger mix and our improving margins.

For our Plumbing segment, sales were up 12% for the quarter, including the benefit of prior year acquisitions. Organic sales were up mid-single digits with growth across all our channels, including wholesale, retail, Canada and China.

POS ran a little above sales, so channel inventory exited the quarter a little light, which should position us well for the balance of the year. Operating margin was solid and in line with our expectation for the first quarter as we plan higher levels of investment to drive sales growth above market later in the year.

We continue to position our Plumbing business for growth. In the past few months, we rolled out successful new marketing programs, continue to develop and introduce new products and added key personnel to the team.

China sales increased high single digits versus the prior year, but were up mid-teens in local currency with growth across all channels. China continues to be an attractive growth market for us. Housing market activity there continues to be robust despite some early government efforts to somewhat slow it down. And we're optimistic about our long-term business model in China.

Doors reported sales were up 8% for the quarter against the double-digit comp in the first quarter of 2016. Door products again saw sales growth driven by solid gains in both the wholesale channel, which primarily serves new construction; and in retail, which has exposure to R&R.

Consumers have responded well to our new shaker door offerings and Therma-Tru continues to benefit from the recent rollout of a new retail strategy that includes an enhanced product lineup, simpler and more intuitive displays and better sales support for our customers' retail associates.

In wholesale, we continue to benefit from strong new construction placements and our enhanced distribution.

In the Security segment, sales increased 7% from the prior year quarter. The growth was driven by double-digit increases in our international and safety channels and includes a modest benefit from customers pulling forward some orders into the first quarter.

Operating margin was strong and reflects the benefit of the completed integration of SentrySafe into Master Lock in the second half of last year.

So to recap the quarter, results were strong and a bit better than planned. We again executed well on the U.S. home products market that is continuing to grow as we expected. Our teams are delivering profitable growth and margin improvement off of that momentum.

Before I wrap up, let me reiterate our plan to drive incremental long-term value. We continue to believe that we can create meaningful incremental shareholder value by using our strong cash flow and balance sheet to make strategic acquisitions, repurchase our shares and increase our dividend.

We continue to have active discussions with a number of potential acquisition targets. The volume and pace of activity has picked up over the past few months, and we've enhanced our M&A team. While the timing remains uncertain, we're assessing a number of opportunities and are encouraged by the quality of these businesses and their potential fit with our organization.

At the beginning of March, we announced that our board approved a new $300 million share repurchase authorization, bringing the total amount authorized for share repurchase to nearly $500 million. We'll continue to use share repurchases opportunistically as a vehicle to generate attractive returns, consistent with prior practice.

Over the next 3 years, we continue to believe that we have the potential to deploy more than $2.5 billion to drive incremental growth and shareholder value.

To sum up, the demand for our home products remains strong, as we expected. And the year is off to a better start than we planned, especially given the difficult comp to last year. Our basket of indicators continues to look solid, and the comps are more reasonable in the back half of the year. So we feel confident in the full year and have increased our EPS guidance accordingly.

Now I'd like to turn the call over to Lee, who will review our financial performance and provide detail on our increased EPS outlook for 2017.

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E. Lee Wyatt, Fortune Brands Home & Security, Inc. - CFO and SVP [4]

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Thanks, Chris. As Brian mentioned, to best reflect ongoing business performance, the majority of my comments will focus on income before charges and gains.

Let me start with our first quarter results. Sales were $1.2 billion, up 7% from a year ago. Consolidated operating income for the quarter was $122 million, up 17% or $17 million compared to the same quarter last year.

Total company operating margin increased 80 basis points to 10.3%, and we remain on track to achieve our goal of around 14% operating margin for the year. EPS were $0.53 for the quarter versus $0.42 in the same quarter last year, increasing 26%. And we are ahead of plan due to stronger-than-expected operating performance and a favorable tax rate.

Now let me provide more color on segment results. Our Cabinet sales were $574 million, up $24 million or 4% versus the prior year quarter. Dealer sales were flat at $273 million and increased 2% from the prior year, excluding premium. Our prior year comp was challenging for dealer as sales grew 16% in the first quarter of 2016.

In-stock cabinets and vanity sales of $129 million increased 19%. The remaining sales for home center semi-custom, builder direct and Canada increased 2%, led by a double-digit increase in builder direct. After nearly tripling operating income in the first quarter of 2016, operating income for the Cabinet segment increased 25% or $10 million over the prior year quarter. Operating margin for the quarter was up 140 basis points to 8.2%. For the full year, we continue to expect an operating margin approaching 12% compared to 10.8% in 2016, with sales growing at market and at the lower end of our total company guidance of 6% to 8%, as we target profitable sales and remain committed to margin expansion to drive shareholder value.

Turning to Plumbing. Sales for the first quarter were $378 million, up $40 million or 12%, led by U.S. retail and wholesale and China. Excluding acquisitions, sales were up mid-single digits in the quarter.

Operating income increased to $73 million. Operating margin for this segment was 19.2% and in line with our expectations as we accelerate investment spending into the first half of this year to drive sales growth above market. For the full year, we expect to achieve operating margin of around 21% in Plumbing, with sales growth in the low double digits.

Door sales were $102 million, up $8 million or 8% from the prior year quarter. Operating income increased $4 million. Operating margin for this segment was 7.8%, a 330-basis-point increase from the prior year. We continue to expect full year Door sales to be in the middle of our total company range of 6% to 8%. And full year operating margin for this segment could reach 14% versus 13.2% last year.

Security sales were $133 million in the first quarter, up 7% to the prior year. Sales were ahead of plan in the quarter as this segment typically grows at a slightly lower rate than our home products businesses. Segment operating income increased by $3.5 million to $15 million, and the operating margin was 11.3%, up 200 basis points from the prior year. For the full year, we continue to expect operating margin of around 15% in Security, with sales growing mid-single digits.

To sum up consolidated first quarter performance, sales increased 7% and EPS were ahead of plan at $0.53, overcoming challenging comps from the prior year. Our total company operating margin was 10.3%, up 80 basis points from the prior year, with an incremental margin, excluding acquisitions, of 28%. We're squarely on track to reach our 2017 and long-term goal for operating margin.

Turning to the balance sheet. Our March 31 balance sheet remains solid with cash of $211 million, debt of $1.5 billion, and our net debt-to-EBITDA leverage is 1.6x. We currently have $600 million drawn on our $1.25 billion revolving credit facility, leaving us ample capacity to fund potential acquisitions and share repurchases as we move into higher cash flow generating quarters of the year.

In the first quarter, we repurchased over 0.5 million shares for approximately $27 million. Our approach to share repurchase continues to be opportunistic and focused on where we can generate significant returns on our activity. As Chris mentioned, we have nearly $500 million remaining on our current share repurchase authorization.

Turning last to the details of our outlook for 2017. We again had a strong start to the year and continue to assume 6% to 7% U.S. home products market growth and total global market growth of 5% to 6%.

We remain encouraged by signs in the basket of market indicators we track, and we continue to make growth investments across our businesses to remain well positioned for the demand coming at us.

Based on the market assumption, our 2017 sales outlook remains unchanged at 6% to 8% growth versus the prior year. However, we've increased our full year EPS outlook based on our strong first quarter performance and the favorable impact of stock-based compensation on our tax rate. Our outlook for 2017 EPS is now in the range of $3 to $3.12 versus $2.75 last year. The increase is based on higher first quarter operating performance of $0.02 and $0.04 from a lower tax rate from equity compensation. The full year outlook now includes $0.09 from this tax benefit.

We continue to expect 2017 free cash flow of around $450 million with a conversion rate of over 90%. The annual EPS outlook includes the following assumptions: interest expense of around $50 million; a tax rate of 31.5%; average fully diluted shares of approximately 156 million; and commodity cost inflation across our businesses of $0.10 to $0.12 of full year EPS, which is unchanged from our original outlook.

First quarter commodity costs were in line with our plan and full year expectations remain unchanged in our guidance.

In summary, we're off to a strong start to 2017. First quarter market growth was good, with some upside in new construction demand, and we delivered strong sales and profit growth and increased our operating margin. We are well positioned to use our balance sheet and cash flow to drive incremental shareholder value through acquisitions and share repurchases.

I will now pass the call back to Brian.

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Brian Lantz, Fortune Brands Home & Security, Inc. - Senior Viced President of Communications & Corporate Administration [5]

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Thanks, Lee. That concludes our prepared remarks on the first quarter of 2017. We will now begin taking a limited number of questions. (Operator Instructions)

I will now turn the call back over to the operator to begin the question-and-answer session. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Tim Wojs from Baird.

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Timothy Ronald Wojs, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [2]

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I guess, my first question, just thinking about the market outlook. I know you said it was too early to raise it, but I guess my question is, what would you need to see in the marketplace to get you comfortable with raising that guidance, especially with easier comps in the back half of the year? And then, I guess, secondarily, is there anything that you're seeing in the marketplace that is giving you any sort of pause or any sort of hesitation?

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Christopher J. Klein, Fortune Brands Home & Security, Inc. - CEO and Director [3]

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Yes, I think it's almost like give me another month and I could have made a better call. We saw increased momentum coming out of March into April. April orders were strong across the board. So I'd say, things are lining up for some upside down the road. And you're right, second half comps, much easier. As we came into the year, the first quarter comps looked pretty hairy as you kind of stare at how well we did last year. And so we're sitting here today feeling good about lapping those and doing really well in the first quarter, momentum coming out and into the kind of second half. The new construction side, everything looks pretty good, I guess, to the extent that labor frees up so that they can actually build what looks like a very strong pipeline coming at them around orders, permits, converting that into starts and building out. And for us, there's a quarter to 2-quarter lag off all that activity. But that's lining up pretty nicely kind of deeper into the second quarter into the second half. So that piece, I'm pretty comfortable with. On R&R, kind of the core looks very good. We're starting to see some improvement on the premium end. I talked about a little bit that we saw, again, some weakness in the first quarter, but it was getting better versus the second half. I'm also encouraged, if you look at the recent existing housing turnover, that the high end of that existing housing turnover sales in the market picked up. And that's good for us, again, with some lag. I look into the second half, maybe September, October, November, could see a pickup there, too. So I'd say, it's lined up good. It's kind of like just a little bit more just because the start of the spring season for us really starts kind of mid-February and then kind of picks up steam as it goes. So I don't see anything in terms of headwind. Interest rates actually, again, back from where we were at the beginning of the year, feel a lot more stable, a bit improved from the start of the year. Not to say that you couldn't see some increases over time, but not concerned there. So I'd say everything we're looking at looks pretty good right now.

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Timothy Ronald Wojs, Robert W. Baird & Co. Incorporated, Research Division - Senior Research Analyst [4]

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Okay. Okay. That's great. And then maybe just on the Plumbing investments. Is there any way to frame how much those investments were maybe in the first quarter and how we should think about it in the first half here and then maybe what -- how you expect price costs, specifically in the Plumbing business, to play out through the year?

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Christopher J. Klein, Fortune Brands Home & Security, Inc. - CEO and Director [5]

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No, I'll give you an overview. Just -- it's very much our strategy. We talked about last year, we formed the Global Plumbing Group. We talked about holding margins at kind of 21% range and investing in growth. This quarter is always softest in terms of margin. Last year, we underinvested in the first quarter because we were waiting for some marketing activity to kick in. So really, it's around kind of generally following our strategy of investment in more brand spend, more focus on digital. We're ramping up the pace of new product introductions. We brought in some talent around it. So kind of roll that all altogether, 19% is about what we planned. It's right on where we planned. And we're still looking at 21% for the full year cumulative by the end of the year. Lee can go into a little bit more detail if you'd like.

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E. Lee Wyatt, Fortune Brands Home & Security, Inc. - CFO and SVP [6]

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Yes, just to quantify slightly. As Chris said, remember, last year, we spent light in the first half of the year and then we doubled down in the second half with media spend, for example, with $6 million incremental each of the last 2 quarters. So this is just kind of normal. We're moving back to normal timing in the first quarter. So I'd say there's probably around $7 million of spend. The largest portion of that is around the things Chris defined, around media, digital, those kind of things. And this is more normal spend rate for us. So for the full year, it's not very much increased incremental. It's just more timing. So we will hit 21%. If you go back to a normal year like 2015, you would have seen us in the first quarter hit about a 19.5% operating margin for Plumbing and then finish the year a little under 21%, 20.7%. So we're just back to normal timing. This is -- it's right on plan.

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Operator [7]

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Your next question comes from Bob Wetenhall from RBC Capital Markets.

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Robert C. Wetenhall, RBC Capital Markets, LLC, Research Division - Analyst [8]

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I just wanted to ask you, outside of the Plumbing business, whether you're looking at the margin expansion you had, especially in Doors, over 300 basis points and 200 basis points in Security. Was this tracking in line with your expectations? Or was execution better than you expected?

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Christopher J. Klein, Fortune Brands Home & Security, Inc. - CEO and Director [9]

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It was a little better. Yes, as I said, I kind of came in the first quarter a little bit worried just about the comps we were running up against. And we had, had some pretty good margin expansion in the first quarter last year. So it was a little bit better, kind of roughly in line. I'd say the overall theme is disciplined growth. So we're looking at all the parts of the market, be it in doors, plumbing, cabinets, that can give us some good growth with margin. And that's really what was in our plan. But I'd say, we were maybe a little bit better than we started with.

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Robert C. Wetenhall, RBC Capital Markets, LLC, Research Division - Analyst [10]

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What could drive more margin expansion? Or are you where you think you should be given the growth rate and the pace of the business?

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Christopher J. Klein, Fortune Brands Home & Security, Inc. - CEO and Director [11]

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So it depends by business. I think you kind of go across -- you go around the horn. As I just talked about, Plumbing, we really want to drive 21% margin with above-market growth. And that's the strategy. And that's where we're investing. And that's where we're growing. And that drives shareholder value. In Cabinets, we're going to move up margin this year. And that's really focused on the more profitable segments of the market. And so a heavy focus in the dealer segment, heavy focus on in-stock. We're still participating in builder direct and special order in home centers, but we're being disciplined there. And so we're looking at where is the market healthy. If you look at Doors, similar approach. We made some investments in distribution on the wholesale side. Retail, we've made some good investments. So it's really, I'd just say, as we're sitting here looking at the markets, where are there more attractive segments, driving new products into those segments, driving our activity toward that and not chasing every little piece of business that is dilutive. So I guess that's kind of the broad brush. In Security, we talked about the fact that margin is rising because of the conversion of the Security business and -- or the SentrySafe business and folding that into the Master Lock business. And so that's driving planned margin expansion.

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Robert C. Wetenhall, RBC Capital Markets, LLC, Research Division - Analyst [12]

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It's -- the execution's great. Just switching over to the balance sheet and then I'll pass it on. Net debt sitting in at 1.6x. You have over $200 million of cash on the balance sheet at the end of the quarter. Can you talk about the M&A pipeline? It sounds like there's pretty healthy valuations now, at least we see it in the public market. What's the opportunity set and how do you figure out the right bolt-on? Obviously, GPG is a focus point for the company, but would you look in other areas like SentrySafe, the way you did that with Security?

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Christopher J. Klein, Fortune Brands Home & Security, Inc. - CEO and Director [13]

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Thank you. So I'd guess I'd say, we're working on it. There's a lot underway. We are focused in Plumbing. And we're looking at a number of different opportunities. We're looking in our Security segment. We're looking in some adjacencies. I'd say valuations are higher. But we've shown in the past we'll pay a fair value for a very well-run business where the margin is strong and we can count on the growth. And typically, we can take that kind of business and create value here by combining it with some things that we do. I'd say, where we're getting hung up on value would be the average-type businesses that want to command more premium-type valuations. And so those numbers don't come together. But as I've always said, I mean, I'm encouraged when there's a lot of activity because we refer to it as quality at-bats. And when you get more quality at-bats, typically, it leads to a few hits. And I think that's what we feel like right now is that, that level of activity can support some -- getting some things done into this year.

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Operator [14]

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Your next question comes from John Lovallo from Bank of America.

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John Lovallo, BofA Merrill Lynch, Research Division - VP [15]

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First question, I guess, you made an interesting comment on builders and contractors making some progress in attracting new labor into the market. I was wondering if you can maybe just expand on that a bit. Are you seeing that in particular regions and any particular trades? And what do you think is driving this?

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Christopher J. Klein, Fortune Brands Home & Security, Inc. - CEO and Director [16]

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So I guess I'd say that, I'd start with kind of the overall noise level where we were just hearing through a lot of channels this time last year or even back into '15 that there really was a crunch and that the building cycle was getting elongated. I think it's still an issue, but I think they proactively addressed it, bringing more labor into the pipeline and bringing more training into areas where they can actually train, not skilled trades like plumbers and electricians, but more in framers, roofers and other labor. So I think it's still a concern, but it feels like less of a concern now. I know they've worked on it. And I also know they're working on land and bringing more land in the pipeline. So I have a bit more confidence as you look at the reported numbers around orders in the spring selling season and you look at the reported permitting that we can convert that for our business. And you kind of look at how long does it take to convert that into revenue for us, that, that should convert into second half revenue for us kind of in that September, November, December, real busy time for us. So that's where I'm encouraged, where in prior years I might have been a little bit more concerned just are they going to -- what's the pace of that building? And is it going to get stretched out kind of deep into next year?

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John Lovallo, BofA Merrill Lynch, Research Division - VP [17]

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Okay. That's really helpful. And then, I guess, just do you guys have any softwood lumber exposure in the Door business?

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Christopher J. Klein, Fortune Brands Home & Security, Inc. - CEO and Director [18]

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Not really. A little bit on trim, but nothing that -- it's not going to really hit us. I mean, as we look at lumber, it's really hardwoods for us. And hardwoods have been pretty stable. We anticipated a little bit of inflation and we put that into our guidance beginning of the year, and it's tracking to what we've assumed. So the softwood thing isn't a -- doesn't really impact us.

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Operator [19]

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Your next question comes from Scott Rednor from Zelman & Associates.

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Scott L. Rednor, Zelman & Associates LLC - VP of Research [20]

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Quick question on Plumbing. I mean, Chris, the sales trends that we see have been pretty volatile the past few quarters. I was just hoping maybe you could identify anything that's unusual on a quarterly basis and maybe just talk to what you're seeing. And demand level, it seems like when you smooth out some of the noise that you guys are seeing on shipments, that sell-through is a lot more positive than might be interpreted.

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Christopher J. Klein, Fortune Brands Home & Security, Inc. - CEO and Director [21]

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Yes, I'd say that -- I guess the way I've observed it is, the core of the business, which is the core wholesale, the core retail has kind of been tracking mid-single digits for a while now. And so that -- there's not much volatility in that. It's kind of moving around a midpoint in mid-single digits. I think where you see some surges, we may have had some new product introductions or some promotional activity or some other things that could have contributed to some of that or if there was some pull ahead, ahead of a price increase. So I think that's where I've seen some volatility. The core has been reasonably stable. And the investments we're making are, frankly, to kind of move that middle point up and to invest -- to drive on a regular cadence through more new product introductions, through stronger marketing, advertising efforts to drive that middle core up. So that's kind of really where the focus and energy is.

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Scott L. Rednor, Zelman & Associates LLC - VP of Research [22]

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And just realizing that faucets is one of the categories that was earliest to recover, I think, during the depths of the downturn. The argument was, if the faucet breaks, you're going to fix it because it's smaller ticket. Do you think the category growth is going to be slower going forward just as the cycle matures?

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Christopher J. Klein, Fortune Brands Home & Security, Inc. - CEO and Director [23]

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I don't think so. I think that there is a part of that market that is incredibly stable, which is kind of grows at 1% or 2%, which is the piece you're talking about. On top of that, there's R&R and new construction. And so obviously, our investments over the last 12 months in expanding the Global Plumbing Group, acquiring ROHL, Perrin & Rowe, Riobel and then some of the things we're looking at are really expanding our presence on that R&R side. And in new construction, we remain very strong. So especially with the top 80 builders, we have a very strong market share position there and continue to participate as that market grows. So no, I don't -- I see some strong growth in that sector. It's frankly why we're looking at making more investments there, organic investments as well as looking at anything from an acquisition standpoint. We like Plumbing. I think it's a strong sector. You look at this market overall, continues to perform well. So yes, I think it's in great shape.

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Scott L. Rednor, Zelman & Associates LLC - VP of Research [24]

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Okay. Great. And then just finally, obviously, a lot of inflation across your categories, whether it's metals on plumbing, the plywood tariff on cabinets, steel elsewhere. Just relative to the commentary that inflation's tracking expectations, maybe just talk about your ability to kind of navigate what's been a pretty benign cost environment. And this year, it seems like, even over the past 3 months, some of the commodities have continued to tick up.

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Christopher J. Klein, Fortune Brands Home & Security, Inc. - CEO and Director [25]

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Yes. Actually, I'll let Lee talk. I've been talking too much. Lee, -- overall, is one of -- we kind of -- we plan for it and we plan for commodity increases. And it's in the guidance. But over time, we're able to get both through cost takeouts as well as some pricing. Historically, if you look back over 1-year, 3-year, 5-year, we recover rises in commodities, which is really the environment we've been living in for 8, 9 years we've had this cycle. So while we had some compression in commodities over the last 18 months, what is more normal is a rising commodity environment and us having to react to that, and we've shown our ability to do that.

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E. Lee Wyatt, Fortune Brands Home & Security, Inc. - CFO and SVP [26]

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Yes, just as you think about kind of the numbers around inflation, we said last year, we actually had a net benefit of $0.10 to $0.12 in our EPS. This year, in our guidance, we built around $0.12 of inflation. We built that in being fairly modest in the first quarter and then building through the year. The first quarter was kind of right on what we thought. We haven't really had to change that guidance because it still looks like it's on that path. We have a lot of ways to kind of offset inflation as well beyond just pricing. When you have our size and our scale and our sourcing and our supply chain, we've got a lot of ways to use material substitution, alternate sources. There's many ways beyond pricing. And we look at those other ways first to offset that inflation before we kind of go to price. So we've built around $0.12 in, and I think we're on track so far, and we think we can manage it.

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Operator [27]

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Your next question comes from Stephen Kim from Evercore ISI.

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Stephen Kim, Evercore ISI, Research Division - Senior MD, Head of Housing Research Team and Fundamental Research Analyst [28]

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Wanted to just follow-up. I thought I heard you mention something about added personnel in Plumbing. And when you were talking about your accelerated investment spending, you also sort of talked about creating the GPG group. I just want to make sure, was there a degree to which added personnel costs factored into some of the accelerated -- accelerated spending in the quarter? Or did I just kind of mishear that?

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Christopher J. Klein, Fortune Brands Home & Security, Inc. - CEO and Director [29]

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That was really more around upgrading that team. So as you know, we changed leadership there. And in turn, we brought in some stronger talent across in marketing, in sales. And so I would describe it as additive as much as upgrading. And so you've got that upfront cost in terms of what it takes to bring onboard some people. But from a run rate standpoint, we're not increasing the personnel cost basis of the business, but we are upgrading the talent there. And you kind of look at that in conjunction with the focused investments in digital marketing, in advertising, increasing the cadence of product introductions, which does cost more to turn the products faster, sell them out on the strong ones, pull out the other ones quicker and roll in more innovation and just ramping that pipeline generates higher pace of sales, but it costs them to roll that stuff through.

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Stephen Kim, Evercore ISI, Research Division - Senior MD, Head of Housing Research Team and Fundamental Research Analyst [30]

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Got it. Okay. And then in the Cabinet's business, you had mentioned that, I believe, luxury was a drag. And so I think that, I assume, based on the numbers that luxury was down, I want to get a sense for how much it was down, what you think the significance of that is? And did you see any mirroring of that kind of trend in any of your other product segments outside of Cabinet?

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Christopher J. Klein, Fortune Brands Home & Security, Inc. - CEO and Director [31]

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So it was down. I mean, last year, if you look at the first quarter last year in the premium segment, we were up low double digits. And then this year, you look at where that segment is today, and we're down slightly. Relative to where that was in the second half, it was down much more significantly. So against a strong comp on the premium side, it's getting better. I'd still say there is some weakness overall in the high-level R&R market, and I expect that will improve this year as we've got more reasonable comps and as well as we start to see some turnover in the existing housing stock at the higher price points. Those things should drive it. This is typical of -- these are pretty high-end markets. So think South Florida, think pockets up the East Coast, think about San Francisco, Los Angeles. So these are really cities where you've got very high-end remodeling going on. This is above and beyond kind of the core of the marketplace. And this is isolated to some very premium brands. And so we like that market long term, but it has been a cyclical market over time. When we saw initially a lot of R&R activity coming back in the market, I think, back 2013, 2014, a lot of the wealthier households who were participating in the recovery of the stock market were taking cash out and they were remodeling and these markets were performing quite well. And that really rode us through 2015. And so we started to see some weakness emerge here in 2016, but it's -- I think that will come back and should be okay. Certainly, tax relief could help.

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Stephen Kim, Evercore ISI, Research Division - Senior MD, Head of Housing Research Team and Fundamental Research Analyst [32]

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Got it. But not so much -- you're not really seeing that so much outside of Cabinets maybe by virtue of the fact that in your Cabinet segment, that premium segment is just so -- is so particularly high end and maybe above what you're targeting in Plumbing, for example, or Doors?

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Christopher J. Klein, Fortune Brands Home & Security, Inc. - CEO and Director [33]

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Yes. And I think it's -- there is -- I'd say there is some of it that leaks over into some other parts of the market, but you can't really see it as well. So we think Cabinets is isolated to specific brands. And so brands tied to dealers that are doing very high-end work. And so that's where you can isolate it and say that's where it looks. Is it a piece of some other parts of the business? Well, sure. I mean, if you're remodeling less $1 million, $2 million houses, then the doors that they're putting in aren't as frequently being upgraded and bathrooms aren't upgraded, but we see it more discretely on the Cabinet side.

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Operator [34]

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Your next question comes from Phil Ng from Jefferies.

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Philip H. Ng, Jefferies LLC, Research Division - Equity Analyst [35]

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Nice to see Cabinets growth and actually operating leverage really accelerate from softer back half of last year. What's driving that momentum? And how are you thinking about growth of the overall market?

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Christopher J. Klein, Fortune Brands Home & Security, Inc. - CEO and Director [36]

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It's really our -- it's our strategy. So it's focusing on the parts of the market where we're good and where there's good margin there. So the core, the semi-custom market, especially on the value side of that, our in-stock cabinets and vanities, some of the builder business that our dealers serve, that's all been very strong. And we're being very disciplined in terms of how we might participate in the promotional activity. And so you can see that in our margins. I mean, you can compare us to other cabinet guys out there and see where our margins are expanding and theirs may not be expanding. And there is a correlation between how heavy you're promoting and what's happening to your margins. So we can talk a lot, and we do talk about it a lot, but I'd say, the performance is in the numbers. And you've seen the expansion on the Cabinet margin year-over-year, and we set it up well in the first quarter. And I'm really proud of those guys. I mean, the first quarter comp from last year and the expansion we saw in that margin last year and then to expand it again, to the extent they did this year with some growth, that was not easy, but it's focused on execution and all the little stuff in what they do. And they're executing really well. So I think the market in cabinets, if you look out over the balance of the year, certainly, new construction is going to help. I do see improvement coming at us on the kind of core of the semi-custom special order market. Our comps in the second half are definitely going to be easier than what we saw in the first 5 months or so of 2016, where things were quite strong. So I'm feeling good about where we're at. I think we got through the toughest sequence of the year on cabinets, which was the first 4 months. And so I see some good momentum coming at us for the balance of the year.

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Philip H. Ng, Jefferies LLC, Research Division - Equity Analyst [37]

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Got you. And just sticking with that theme, I mean, you kind of emphasized disciplined growth or profitable growth. And I think what you've said was, you're expecting Cabinet growth to track more in line with the broader market. So are you seeing more pricing competition, more promotional activity that's going to continue throughout the year? Or -- and is this kind of more like a sensing event where you think that you're going to reaccelerate and track -- outpace the broader market again going into next year?

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Christopher J. Klein, Fortune Brands Home & Security, Inc. - CEO and Director [38]

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I'd say, we're being thoughtful about that assumption. So what I'm counting on is that we are going to be able to participate in the parts of the market that we're really winning strong right now and driving margin expansion and not participating heavily in those markets that are more promotional-driven. If those parts of the market get a little bit more stable, then you can see a little bit more growth. But we're not going to be chasing that volume down there if others are promoting down there. And we don't have to. We're showing really nice top line growth and strong margin expansion. It's the strategy. It's working. It's a lot of hard work. It's 5,500 dealers across the country. It's a broad portfolio of brands. And it's getting all the little stuff right. And so that's what's driving the core of the business and what we're driving as our guidance for the year. If you saw some firming up on promotions, then that's gravy for us. I mean, others might need that to actually make their year, but for us, that's just gravy.

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Operator [39]

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Your last question comes from Michael Rehaut from JPMorgan.

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Michael Jason Rehaut, JP Morgan Chase & Co, Research Division - Senior Analyst [40]

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First question, just trying to drill down a little bit on the guidance and the raise and talking about the enthusiasm also in terms of potentially some upside to your market outlook. So just so I understand, when you talk about the $0.06 raise of guidance, $0.02 from the strong first quarter performance, I believe you had said that the sales growth numbers and the market kind of grew in line with expectations, if I heard that right. And so where did the upside come from? I noticed you said that Security sales was a little better than expected. I don't know if that translated to better margin as well.

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E. Lee Wyatt, Fortune Brands Home & Security, Inc. - CFO and SVP [41]

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Yes. So our guidance for the year on sales was 6% to 8%. And we had thought in the first quarter, we would be at the low end of that. And actually, in the first half, at the low end, and then the last half of the year, we'd be at the upper end of that 6% to 8%. Actually, we came in around 7% of sales in the first quarter. So actually did a little bit better kind of across the board than we thought. Remember, we had such brutal comps last year. And so we were a little cautious, and it just came in better than we thought about it, almost 1 point. So that drove a lot of the performance. And then obviously, the operating margin continued to improve nicely as we planned. So I think it's that combination that drove it.

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Michael Jason Rehaut, JP Morgan Chase & Co, Research Division - Senior Analyst [42]

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And so that upside was kind of across your different segments in terms of the little better-than-expected sales, not just Security?

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Christopher J. Klein, Fortune Brands Home & Security, Inc. - CEO and Director [43]

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Yes. I mean, I'd say we came in -- and you looking back, you'd say, maybe we were a little cautious. But coming into the quarter, the first quarter, we're sitting here in January looking at some pretty extraordinary comps, the first quarter of '16 was very, very strong. And so we came in with what we thought were some pretty realistic assumptions. And as the quarter unfolded, when we hit March, it started to accelerate. And so it was a stronger feeling kind of across the portfolio that it's picking up. And that's what we're showing in the numbers really kind of ticked across the whole portfolio.

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Michael Jason Rehaut, JP Morgan Chase & Co, Research Division - Senior Analyst [44]

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I mean, absolutely, Chris, without a doubt, I mean, when we're on the road in the fourth quarter, I mean, the tough comp, and that's something that we were looking at last conference call as well. So certainly, understand that and very strong performance there. I guess, just looking also at -- shifting to the Plumbing margins. Appreciate the explanation around the 19%, and it makes sense in terms of the investments, and you reiterated your full year. So just mathematically, if you're still thinking about that 21% margin for the full year in that segment, I presume that for 2Q, and I know you don't like to get too detailed one -- in the out quarter, but it would seem to me that you'd expect to hit, if not exceed, that 21% for the full year in the quarter just from a mathematical standpoint.

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E. Lee Wyatt, Fortune Brands Home & Security, Inc. - CFO and SVP [45]

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Yes, I think it might build a little bit. The second half comps, our margins will be a little bit better, but the second quarter comp should be strong as well. So I think it will build a little bit, but I think the second quarter comp margin will be much higher than 19% for sure.

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Operator [46]

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That is the end of the question-and-answer session. I will now turn the call back over to the presenters for closing remarks.

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Brian Lantz, Fortune Brands Home & Security, Inc. - Senior Viced President of Communications & Corporate Administration [47]

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Thank you. We'd like to thank everyone for attending the call today and look forward to speaking with all of you again very soon. Thank you.

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Operator [48]

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This concludes today's conference call. You may now disconnect.