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Edited Transcript of MWA earnings conference call or presentation 6-Aug-19 1:00pm GMT

Q3 2019 Mueller Water Products Inc Earnings Call

ATLANTA Aug 12, 2019 (Thomson StreetEvents) -- Edited Transcript of Mueller Water Products Inc earnings conference call or presentation Tuesday, August 6, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* J. Scott Hall

Mueller Water Products, Inc. - President, CEO & Director

* Marietta Edmunds Zakas

Mueller Water Products, Inc. - Executive VP & CFO

* Whit Kincaid

Mueller Water Products, Inc. - Senior Director of IR and Corporate Development

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Conference Call Participants

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* Andrew Edouard Buscaglia

Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst

* Brian K. Lee

Goldman Sachs Group Inc., Research Division - VP & Senior Clean Energy Analyst

* Bryan Francis Blair

Oppenheimer & Co. Inc., Research Division - Director & Senior Analyst

* Deane Michael Dray

RBC Capital Markets, LLC, Research Division - Analyst

* Joseph Craig Giordano

Cowen and Company, LLC, Research Division - MD and Senior Analyst

* Walter Scott Liptak

Seaport Global Securities LLC, Research Division - MD & Senior Industrials Analyst

* Zane Adam Karimi

D.A. Davidson & Co., Research Division - Research Associate

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Presentation

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Operator [1]

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Welcome and thank you for standing by. (Operator Instructions) I would like to inform all parties that today's conference is being recorded. If you have any objections, you may disconnect at this time.

I would now like to turn the conference over to Whit Kincaid. Thank you. You may begin.

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Whit Kincaid, Mueller Water Products, Inc. - Senior Director of IR and Corporate Development [2]

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Good morning, everyone. Welcome to Mueller Water Products Third Quarter 2019 Conference Call. We issued our press release reporting results of operations for the quarter ended June 30, 2019 yesterday afternoon. A copy of it is available on our website, muellerwaterproducts.com. Discussing the third quarter's results and our outlook for 2019 are Scott Hall, our President and CEO; and Martie Zakas, our CFO. This morning's call is being recorded and webcast live on the internet. We have also posted slides on our website to help illustrate the quarter's results as well as to address forward-looking statements and our non-GAAP disclosure requirements.

At this time, please refer to Slide 2. This slide identifies non-GAAP financial measures referenced in our press release or in our slides and on this call and discloses the reasons why we believe that these measures provide useful information to investors. Reconciliations between non-GAAP and GAAP financial measures are included in the supplemental information within our press release and on our website.

Slide 3 addresses forward-looking statements made on this call. This slide includes cautionary information identifying important factors that could cause actual results to differ materially from those included in the forward-looking statements. Please review Slides 2 and 3 in their entirety. During this call, all references to a specific year or quarter, unless specified otherwise, refer to our fiscal year which ends on September 30. A replay of this morning's call will be available for 30 days at 1 (866) 457-5519. The archived webcast and corresponding slides will be available for at least 90 days in the Investor Relations section of our website. In addition, we will furnish a copy of our prepared remarks on Form 8-K later this morning.

I'll now turn the call over to Scott.

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J. Scott Hall, Mueller Water Products, Inc. - President, CEO & Director [3]

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Thanks, Whit. Thank you for joining us today to discuss our results for the third quarter of 2019. I am pleased with our performance in the quarter as the team has produced solid growth both in sales and adjusted EBITDA. Our consolidated net sales increased 9.6%. And our organic net sales increased 4.6% as we benefited from both higher pricing and shipment volumes.

Our gross margin improved 90 basis points to over 36%, excluding the impact of the inventory step-up at Krausz. This performance helped deliver adjusted EBITDA growth of 13% with favorable contributions from both Infrastructure and Technologies. We remain on track to meet the net sales and adjusted EBITDA target ranges we communicated in our second quarter earnings release.

We are focused on continuing our momentum in the fourth quarter and finishing the year on a strong note even as we compare performance to the fourth quarter of the prior year, in which we reported a 12% organic increase in net sales. Looking forward, with the support of our strong balance sheet, we will continue to maintain a balanced approach to capital allocation which I will address later on the call.

With that, I'll turn the call over to Martie.

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Marietta Edmunds Zakas, Mueller Water Products, Inc. - Executive VP & CFO [4]

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Thanks, Scott, and good morning, everyone. I will first discuss our third quarter consolidated financial results then review our segment performance. Our consolidated net sales for the third quarter increased 9.6% or $24.1 million to $274.3 million. This increase was primarily driven by the acquisition of Krausz as well as higher pricing and shipment volumes. Our gross profit this quarter improved to $97.2 million or 35.4% of net sales. This improvement was primarily due to increased net sales, which was partially offset by higher costs associated with inflation, manufacturing performance and a $2.3 million inventory step-up expense at Krausz. Material costs increased nearly 1% year-over-year in the quarter. As a reminder, our third quarter 2018 results included a $14.1 million warranty charge.

We delivered a 90 basis point improvement year-over-year in our gross margin excluding the impact of the inventory step-up expense and prior year warranty charge. Selling, general and administrative expenses were $47.5 million in the quarter, a $6.2 million increase over the prior year. The increase was primarily due to the addition of Krausz. SG&A as a percent of net sales was 17.3% in the third quarter compared to 16.5% in the prior year. Operating income was $47.2 million in the third quarter compared to $30.6 million in the prior year. Strategic reorganization and other charges were $2.5 million in the quarter versus $2.6 million in the prior year.

Adjusted operating income increased 9.9% or $4.7 million to $52 million in the third quarter. The increase was driven by higher adjusted operating income in Infrastructure, which was partially offset by corporate SG&A expenses and a slight decrease in adjusted operating performance at Technologies.

Adjusted EBITDA for the third quarter increased 13% or $7.5 million to $65.4 million. Consolidated adjusted EBITDA conversion margin was 31% compared to 17% in the prior year. For the last 12 months, adjusted EBITDA was $195.1 million or 20.4% of net sales. Over the prior 12-month period, we have increased adjusted EBITDA 10.8% or $19.1 million.

Our adjusted net income per share was $0.24 for the quarter compared to $0.19 in the prior year. Our 2019 quarterly adjusted EPS excludes the strategic reorganization and other charges mentioned earlier: The inventory step-up expense and $0.5 million of interest expense associated with the Walter Energy Accrual.

Turning now to segment performance, starting with Infrastructure. Infrastructure net sales increased 11.6% or $26.1 million to $250.2 million in the quarter. This increase was due to the sales from Krausz as well as higher pricing and shipment volumes. Organic net sales this quarter increased 6.1% versus the prior year. Adjusted operating income for the quarter increased 10.4% or $5.9 million to $62.9 million excluding the inventory step-up expense. The increase was primarily due to higher pricing and shipment volumes and the inclusion of Krausz, partially offset by higher costs associated with inflation, increased SG&A expenses and manufacturing performance. Adjusted EBITDA for the third quarter increased 12.1% or $8 million to $74.2 million, yielding an adjusted EBITDA margin of 29.7% for this segment. Adjusted EBITDA conversion margin was 31% compared to 19% in the prior year.

Moving on to Technologies. Technologies net sales decreased $2 million to $24.1 million in the quarter, driven by lower volumes at Metrology, which were partially offset by sales growth at Echologics. Adjusted operating loss increased $200,000 compared to $2 million in the prior year, primarily due to lower shipment volumes and manufacturing performance, partially offset by improved product mix and lower SG&A expenses. However, Technologies adjusted EBITDA improved $300,000 in the quarter.

Now I'll review our liquidity. Cash provided by operating activities for year-to-date 2019 was $17.8 million. The decrease compared to the prior year period was primarily driven by the timing of payments, including a $36 million increase in cash taxes and cash interest. We also invested $52.9 million in capital expenditures in the period, which is $26 million more than the prior year as we accelerated investments in our manufacturing capabilities, particularly our large casting foundry in Chattanooga.

At June 2019, we had total debt of $446.2 million and cash and cash equivalents of $140.7 million. At the end of the third quarter, our net debt leverage ratio was 1.6x.

I'll turn the call back to Scott to talk more about our results and outlook for 2019.

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J. Scott Hall, Mueller Water Products, Inc. - President, CEO & Director [5]

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Thanks, Martie. We are in the early stages of a transformational process as we take a company with a strong history of manufacturing iron and brass products for municipal and residential infrastructure to one that provides more intelligent, value-added solutions to help customers manage and deliver important resources. Our solid third quarter performance is a reflection of the progress we have made to date on our key strategies to create a strong foundation for future growth. Our team members continue to elevate their execution as we have faced a more challenging external environment from slower growth in housing starts and trade concerns, among other factors.

Through the first 3 quarters of the year, our consolidated net sales increased 6%, with adjusted EBITDA growth around 12%. As a result, we delivered a 38% adjusted EBITDA conversion margin versus 20% in the prior year. Our year-to-date adjusted EBITDA margin increased 110 basis points over the prior year to 20.2%, driven by improvements at both Infrastructure and Technologies. Infrastructure's year-to-date adjusted EBITDA increased nearly 8%. At Technologies, we continue to make progress on initiatives to improve margins which have led to a $2.5 million improvement in adjusted EBITDA through the first 3 quarters of the year.

Looking forward, with the support of our strong balance sheet, we will continue to maintain a balanced approach to capital allocation. As I have mentioned previously, our company underwent multiple decades of underinvestment. In general, capital investments to upgrade facilities were deprioritized. As a result, we will further accelerate capital investments to improve our manufacturing operations and enhance the technological fundamentals in our business.

We have previously discussed our large casting foundry expansion at our Chattanooga facility which will expand our product capabilities and improve costs for some of our specialty valve products. We remain on track to complete this project by the end of this year.

We are initiating a multiyear project at our brass manufacturing facility in Decatur, Illinois, which will enable us to unlock significant efficiencies for both Infrastructure and Technologies. Our Decatur operation, which includes a brass foundry, manufactures brass products and parts for valves and hydrants. The Decatur foundry has been critical to Mueller's success. In fact, the company was founded in Decatur over 150 years ago and some of the structures date back to the early 1900s. We believe further investment to expand capacity and technological capabilities will help us enhance execution of our key strategies, including accelerating new product development and cost efficiencies.

Over time, we expect that capital investments to modernize and expand our facilities, like the Decatur investment, will lead to non-price gross margin improvements and enhance our adjusted EBITDA conversion margins. Additionally, we expect these initiatives will drive above-market sales growth and improved manufacturing performance.

Over the next few years, we plan further reinvestment in our manufacturing base before returning to a more normalized level. As we improve our execution, we will also continue to return cash to shareholders through our ongoing share repurchase program and quarterly dividend. During the third quarter, we repurchased $10 million of stock. And most recently, we announced an increase in our quarterly dividend.

I will wrap up my comments with a review of our current full year 2019 expectations for consolidated results. During our fourth quarter, we anticipate growth in all of our end markets. We believe the municipal end market remains healthy despite challenges from severe weather and labor constraints. Our expectations for the residential construction end market remain positive despite the challenges from weather and slower growth in the housing starts during the year.

We anticipate that our 2019 full year consolidated net sales growth will be towards the lower end of the 7% to 9% range we communicated in our second quarter earnings release. However, we expect our adjusted EBITDA growth will be towards the midpoint of the 12% to 15% range previously provided. We are focused on finishing the year on a strong note and are excited about the opportunities ahead of us in 2020 and beyond.

Martie will now provide some final comments on our 2019 outlook.

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Marietta Edmunds Zakas, Mueller Water Products, Inc. - Executive VP & CFO [6]

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Thanks, Scott. For full year 2019, we expect that depreciation and amortization will be about $53 million. Corporate SG&A expenses are expected to be between $34 million and $35 million. Net interest expense is expected to be around $21 million. Our effective income tax rate for the full year is expected to be between 23% and 25%. Finally, we currently expect capital expenditures to be about $80 million. And we continue to evaluate additional investment opportunities.

With that, operator, please open the call for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question comes from Michael Wood with Nomura Instinet.

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Unidentified Analyst, [2]

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This is [Ryan] going on for Mike. You didn't change your end market assumptions for 2019. So just curious what's driving the shift to the lower end of the 7% to 9% sales range?

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J. Scott Hall, Mueller Water Products, Inc. - President, CEO & Director [3]

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Yes. I think we did change it a little bit and that we said at the lower end. Because I think that the housing starts in general have been below, I think, everybody's expectations. But I think that the fundamentals in the muni market, the fundamentals with what's left in housing is still good enough to get us to the bottom end of the range by the end of the year.

I think the other thing of import is that the -- I think the weather that we saw in Q2, especially slowed construction. And this slowed construction in muni and new housing starts. So we believe that there's enough family formations or household formations and with the most recent interest rate deduction that we will continue to see tepid demand for housing starts, not hot, but kind of warm.

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Unidentified Analyst, [4]

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Okay. Great. And then just one more on CapEx. You're guiding to increased CapEx spend $80 million from $60 million to $65 million previously. With only one quarter left in the fiscal year, how much of this multiyear CapEx project is going to be hitting this year? And then what should we expect CapEx to trend at maybe over the next 1 to 2 years?

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J. Scott Hall, Mueller Water Products, Inc. - President, CEO & Director [5]

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So I think that -- that's a great question, by the way. I think that the legacy of the business is that this is a business that I kind of think of as meeting somewhere -- figure around 4% of sales as a kind of a target for this kind of technology business, along with some legacy industrial capacity issues, so think about 4%. I think we were underinvested in for decades. And we have this period where this year, I think we're at 8% of sales. And I think that, that is an elevated level that we will see for 1 or 2 years.

And then in the long run, you should expect to kind of get back to around 4%. I think the other thing of import is that the amount of manufacturing productivity we get and the impact we both get from a power usage, water utilization, some of the ES&G considerations are also part of these investments. So I think we'll be elevated for this year and probably 2 more. And then we should get back to some kind of normal level of sales.

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Operator [6]

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Our next question comes from Deane Dray with RBC Capital Markets.

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Deane Michael Dray, RBC Capital Markets, LLC, Research Division - Analyst [7]

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One of the themes that we've seen this earnings season and more from the industrial companies are short-cycle pressures and destocking across distributors. Now look, you're in very different markets than some of these core industrial companies. But are you seeing any of those types of trends this quarter?

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J. Scott Hall, Mueller Water Products, Inc. - President, CEO & Director [8]

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No, I think we actually experienced that a little bit in Q2. If you think back about where we felt we were, we thought inventories were a little elevated at the end of Q1 as a result of the September price increase. We had another price increase in the end of February that probably flattened a little bit of our traditional distributor inventories. We kind of lived through that destocking, if you will, in Q2. And I think that the flow-through now with our main distributors is pretty good. I think that what they're seeing in the way of demand is what we're seeing.

So I think when you look at the waterworks space, in general, we're going to be pretty close to when you take their pipe and put it off to the side. It will be pretty much looking exactly like they do.

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Deane Michael Dray, RBC Capital Markets, LLC, Research Division - Analyst [9]

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Good. So that's the sell-in matching sell-through? Is that what you're referencing?

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J. Scott Hall, Mueller Water Products, Inc. - President, CEO & Director [10]

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Yes, perfect. Yes.

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Deane Michael Dray, RBC Capital Markets, LLC, Research Division - Analyst [11]

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Okay. And then on this manufacturing footprint investment. Can you flesh out a bit more the timing of this towards the end of the year? You did reference a manufacturing performance as one of the headwinds this quarter. So what was the triggering event? It's kind of a midstream year to make a decision, hey, we're going to start investing in the footprint here. That part makes sense. But what was the catalyst? And then I've got some follow-up in terms of what you expect the return should be on these investments.

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J. Scott Hall, Mueller Water Products, Inc. - President, CEO & Director [12]

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Well, thank you for the question. And let me kind of back up to a higher level for a minute and say that when we look at all of the foundries and we look at modernization opportunities, whether it's for automation or just moving away from cored furnaces to coreless and better power utilization, there's a lot of opportunities left in all of our melting technologies as it exists today.

In particular, when we looked at the upgrades in some of the facilities in Decatur, and went and toured and took a hard look, I thought that, as I referenced in my script, that investing more money in buildings that were opened in 1920 were the spacing between pillars and some of these kinds of things, I thought was a suboptimization utilization of capital and thought that we would be better with new facilities.

And I think the other big catalyst was talking with our employees there and the union and getting the assurances that we would have a skilled workforce be able to take us through this next-generation of technology in the plants. I felt good about it. And I'm not losing sight of the fact, last but not least, that as you look at these kinds of projects, I think, keep me honest here Martie, but I believe the -- it's in 2023 that the bonus depreciation treatment from a tax perspective will need to be renewed by Congress. And so as we looked at what within service and that we could get the favorable tax treatment on, we felt like since this was a multiyear project that we needed to kind of break ground and get going from a fairly -- fairly soon.

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Deane Michael Dray, RBC Capital Markets, LLC, Research Division - Analyst [13]

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And just I might have missed this, but what was the reference to the manufacturing performance as a headwind this quarter? And was that a catalyst in moving the decision along to ramp up investment?

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J. Scott Hall, Mueller Water Products, Inc. - President, CEO & Director [14]

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No, I think that we've always had a kind of transparency with you guys. And I was not terribly happy with how much productivity we got in manufacturing. I think that from an EBITDA point of view, it was okay. But I was expecting more. And I think that many people will remember our Q3 from a year ago, would have said, we had the first problems in Chattanooga, which really impaired our performance a year ago. And so this should have been a little bit easier comp for manufacturing. And I felt like it had some room for improvement there and that was what the comment was in reference to.

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Deane Michael Dray, RBC Capital Markets, LLC, Research Division - Analyst [15]

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That's helpful. And just last one for me. Just to clarify, are you prepared yet to talk about what kind of returns you get on this CapEx internal rate of return? Any sort of metrics like that would be helpful.

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J. Scott Hall, Mueller Water Products, Inc. - President, CEO & Director [16]

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Okay. I think where we are right now, Deane, is that we obviously have our internal hurdles that we have to meet. And that I think have our philosophy around [stretch] and stretch holdings involved. And I think I would prefer at this point to consult with IR and financing and say what we're going to say publicly. But I can assure you that our internal targets are fairly healthy returns on projects like this. But to give you a number, I'd rather defer, if I may.

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Operator [17]

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Our next question comes from Bryan Blair with Oppenheimer.

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Bryan Francis Blair, Oppenheimer & Co. Inc., Research Division - Director & Senior Analyst [18]

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I was hoping you could offer a little more detail on the fourth quarter outlook. If we exclude assumed Krausz contribution, still decent growth there baked into the fourth quarter and, obviously, a challenging comp with both segments. How should we think about growth in Infrastructure and Technologies in 4Q?

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J. Scott Hall, Mueller Water Products, Inc. - President, CEO & Director [19]

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Well, I think that the way to think about it is, we kind of say, we think we'll probably end up around the lower end of the range. So you can do the weighted average math to kind of get you that 7%-ish kind of number. But I think what we have that is still fairly healthy growth is the nuance of this is that we still have a lot of the Echologics DX nodes to ship. In Q3, we saw kind of technology sales disappointing. That was largely due to the lumpiness that we experienced with getting a lot of the Echo shipments that we were expecting to go to some West Coast customers, getting pushed into what is our fourth quarter.

And so that kind of, if you will, almost 2 quarters of demand for Echo in the components business, getting stacked at each other in the fourth quarter gives us the confidence that even if we have a similar housing environment, even if we have a similar muni environment that instead of detracting from growth that we expect Technologies to help with growth in Q4. And that's why we feel like we could be at that kind of low end of the range.

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Bryan Francis Blair, Oppenheimer & Co. Inc., Research Division - Director & Senior Analyst [20]

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Okay. That's helpful. And then I understand your fiscal '20 guidance not out yet. But from where you stand, can you speak the confidence in sustained growth next year? And maybe any difference in end market outlook as much as you have visibility to that right now?

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J. Scott Hall, Mueller Water Products, Inc. - President, CEO & Director [21]

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Right. I think that I'll couch it with given the interest rate environment, given the trade environment, as long as everything kind of calms down and settle down, I have no reason to believe there's any catalysts on the horizon to send us into a period of correction from an economic activity point of view.

So no, I think that we continue to see favorable market dynamics. Low interest rate environment, low housing inventory, the infrastructure aging problem has not been invested away. So I think that all of the fundamentals you would expect to, say, yes, it should grow again next year are in place.

On the other side of that, we have these storm clouds moving with trade, we have this discussion. It's almost like everybody is waiting to say what will send us into a recession because the expansion has -- I think we're now in the 10-year of the expansion. So these things are increased uncertainty. And so I believe that not borrowing something that sends us into a recession, that the fundamentals in water and water infrastructure and the fundamentals for housing and new development, curb and sewer, are all part of it. And you would expect them to provide growth next year and beyond.

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Marietta Edmunds Zakas, Mueller Water Products, Inc. - Executive VP & CFO [22]

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And probably just one other thing to remind you of is from a Krausz perspective. For our fiscal '19, we will have had 9 months of acquisition revenue. And as we move into 2020, it will just be our first quarter that will benefit from year-over-year with Krausz as a new entity for us.

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Bryan Francis Blair, Oppenheimer & Co. Inc., Research Division - Director & Senior Analyst [23]

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I appreciate the reminder. In terms of Krausz, how has the integration been to date? Any surprises? Is that business performing as expected?

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J. Scott Hall, Mueller Water Products, Inc. - President, CEO & Director [24]

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Yes. I think the integration is going very well. I think that we're seeing a good cooperation of both Mueller to Krausz, Krausz to Mueller. I think the sales teams are doing an excellent job of providing a united face. And the work that we're doing around harmonizing third-party representatives and getting our channel of distribution line, I think all of that is going very, very well. I think that we've had really good growth as well, both good a couple of record months during the year. So performing as expected. But as I've said, all along, you don't buy these kinds of companies for Q1 or Q2. You buy them for the multiyear investment. And we continue to believe that, that repair market is going to grow in double digits as this, if you will, the [weeble] curve of failures accelerates. And we think we're kind of in that inflection point.

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Bryan Francis Blair, Oppenheimer & Co. Inc., Research Division - Director & Senior Analyst [25]

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All makes sense. And one last quick one, if I can. The tax rate guide moved a couple of points lower. To what extent was that affected by discrete items this year? Or is 23% to 25% somewhat sustainable going forward?

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Marietta Edmunds Zakas, Mueller Water Products, Inc. - Executive VP & CFO [26]

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I think overall, as we look at the effective of tax rate for this year with the current guidance of about 23% to 25%. We did have a lower tax rate in the third quarter, as you saw, certainly, a few items for that. But I would call out the one of the reasons for this quarter was the reversal of uncertain tax position reserves that were reversed this quarter.

I think overall, again, not specific guidance looking out, but certainly, we are subject to the federal statutory tax rate of 21%. Certainly need to consider state taxes on top of that. And then just as a reminder, we've discussed with the tax law changes back in 2017, there were some previous deductions that we are able to take advantage of, and I'll call out the Section 199, or manufacturing deductions, that have been eliminated now as part of the tax law changes.

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Operator [27]

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Our next question comes from Brian Lee with Goldman Sachs.

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Brian K. Lee, Goldman Sachs Group Inc., Research Division - VP & Senior Clean Energy Analyst [28]

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Scott, I think during your prepared remarks around some of the elevated spending and investment here, you did mention specifically EBITDA margin conversion potential expanding. Can you maybe give us some sense of what you might be targeting there? Is it to get back to the historical kind of 35% to 40% drop through levels or maybe well above that? Any color there would be helpful.

And then just a time line around when some of this might start to show up in the results?

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J. Scott Hall, Mueller Water Products, Inc. - President, CEO & Director [29]

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Yes. Okay. So a bunch of questions there. Let's break it down. I think yes, the conversion margin, a couple of things I'm a little bit sensitive to and what you said there, Brian. One, our conversion margin, when the impact from inflation is normalized, that we've seen through the last 6 quarters, our conversions are in the 30s. And so this would obviously be expected to accelerate conversions. So I think that you're going to start to see better and better conversion margins as long as we get back to a stable commodity environment.

Secondly, I think that the timing for this, -- it's a long cycle project. Its real impacts are going to be the '22 and beyond basically. And I think it's -- we expect the impact to be wide-ranging in the context of not just -- without getting any of the competitive information, not just a cost improvement, but also some material breakthroughs that will allow us to fundamentally change the chemistry of what we make.

So without getting into anything more than that. I think that the cost outlook should be for improvement in '22 and beyond. And that the -- yes, you should expect conversion margins to be higher than they would be normally with these changes. And what was the third part of your question, I'm sorry?

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Brian K. Lee, Goldman Sachs Group Inc., Research Division - VP & Senior Clean Energy Analyst [30]

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You got it. It was just around the sort of targets and maybe the time line. So that's helpful. And maybe just related to that. As you think about the -- this kind of newer CapEx spending level being the new normal for the next couple of years here, thoughts around free cash flow conversion? Any sort of targeted range or levels we should be thinking about during this level or this heightened CapEx spending environment?

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Marietta Edmunds Zakas, Mueller Water Products, Inc. - Executive VP & CFO [31]

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Well, I think as we think about free cash flow, I think, certainly, as we're going to have higher levels of capital expenditures, that is going to adjust. What we've given as sort of a long-term guidance to be able to see free cash flow approximating our net income. But I think I would expect with these higher levels of CapEx that we're going to see that you won't see that over the next few years.

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Operator [32]

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Our next question comes from Zane Karimi with D.A. Davidson.

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Zane Adam Karimi, D.A. Davidson & Co., Research Division - Research Associate [33]

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So it looks like you still have a relatively positive view on the resi portion of your business. Can you provide any more color on what discussions you've been having with your customer channel in regards to the market? And then also, does it feel like they haven't found a bottom from the slowdown in this market?

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J. Scott Hall, Mueller Water Products, Inc. - President, CEO & Director [34]

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Well, I think our view, just to be clear, is that -- so we end up somewhere around, let's say, in that 1,150 to 1,200 housing starts kind of number. When it's all said and done, that bad Q2 kind of flows through. But Q3 and Q4, the 2 construction seasons, and we see the summer activity pick up for more subdivision curb and sewer going in. So that's our view.

So I don't know how to say, while I'm going to justify this view based on this, that or the other thing. But I think the pent-up demand that was created from the severe weather and the rainfall impacted resi construction as much as it impacted muni demand. And so I think we're starting to feel like there is push through and flow-through at the distribution channel to the contractor community. And that's what gives us confidence that our Q4, which I'll remind everybody ends September 30. So it's this -- summer construction season should be enough to give us the confidence that we'll continue to see a strong order book through the end of the year.

Where is the bottom? I think that the question that I would ask is, what are the fundamentals around household formation, around availability and inventory of new houses? What's happening with average price -- average house pricing? I think they're all paused a little bit, but they're not negative. There's low inventory. There is opportunity for housing sales to continue.

So I think that to call it dead or at the bottom is maybe a little premature. And so we think that, that number, we think long-term equilibrium is around 1.4 million to 1.5 million housing starts, and we continue to see ourselves being in that 200,000, 250,000 housing starts below that. So I think there is room for it to move up.

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Zane Adam Karimi, D.A. Davidson & Co., Research Division - Research Associate [35]

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Thank you for that color there. And then kind of change in topics here, but also the capital allocation priorities. You guys have talked about being internally focused right now. But can you also talk about the M&A pipeline? And how much of a focus is that for Mueller right now?

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J. Scott Hall, Mueller Water Products, Inc. - President, CEO & Director [36]

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So let me start by saying our capital allocation is to be balanced. And we bought $10 million worth of shares in the quarter. We just increased our dividend in the -- a couple of weeks ago. We have increased our capital spending. We've done an acquisition this year with Krausz. We continue to have an active acquisition pipeline. We believe in the strength of our balance sheet and the position that we have, both with relatively low net debt leverage that we can continue to do all of these things in a balanced approach. And we're committed to remaining balanced. So yes, we continue to look at M&A. And yes, we will continue to look at our investment opportunities, both internally, share buybacks and dividends.

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Operator [37]

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Our next question comes from Joe Giordano with Cowen.

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Joseph Craig Giordano, Cowen and Company, LLC, Research Division - MD and Senior Analyst [38]

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Just like going through the fourth quarter kind of implied guide using the low end of revenue in the midpoint of EBITDA, it's a pretty sizable year-on-year growth end margins. So can you kind of -- I think it's almost 20% year-on-year growth, so 17 something like that. And margins up 200 something basis points year-on-year. So you kind of talk me through where that's -- what are the major buckets where that's coming through?

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J. Scott Hall, Mueller Water Products, Inc. - President, CEO & Director [39]

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Yes, I think the biggest piece is going to be coming from the bump we get from Technologies. As I've referenced earlier, it's primarily a lot of pent-up kind of unit sales of the Echologics, EchoShore-DX and then just continue the execution in manufacturing. And then we're going to lap in September. We'll lap the September price increase. But we still have a fairly healthy conversion on the impact of having a -- basically being in a period right now in our valves and hybrids business of true price increases, one in September a year ago. And then another one in February. They are the main reasons.

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Joseph Craig Giordano, Cowen and Company, LLC, Research Division - MD and Senior Analyst [40]

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Is the commentary you're making on tech on the bump up in sales? Is that going to -- How does that impact profitability? And kind of related to that, is that kind of $100 million kind of run rate is that like the forward kind of expectation now? And if it is, what's required to meet kind of sustainable profitability there?

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J. Scott Hall, Mueller Water Products, Inc. - President, CEO & Director [41]

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Well, let me start by saying, tech overall, I'm relatively pleased with where the team has gotten both from managing the business closer, relatively small amount of growth there but we have $2.5 million of EBITDA improvement year-to-date through the first 9 months.

The second part of your question is, what do we need to get to kind of breakeven? I think the business, it is $100 million, $125 million. There's opportunities both from an efficiency point of view and from a price and discipline point of view that we should be able to get to breakeven when we scale a business that large. And we're still not there. But I think that talking to quarter area, we should have enough scale that we could be through breakeven.

With all of that said, we still have to take shares smartly. We have to grow our sales smartly and not just use price. We have to find other sources of sustainable strategic advantage. And one of those areas, which I've been saying for a long time is, and I think anybody who was at ACE got a little taste of it, is that the strategic importance of the Technologies group in order to put sensing abilities in our fire hydrants, in our valves, in our insertion valve is terribly strategically important for us in the long term.

And we just started with software introduction that can do both acoustics, low metering and pressure. We've got flushing technologies that are out there now as well. So I think that Technologies, let's call it, their contribution to where we are from the Infrastructure health and where we are from pricing power and where we are from channel power in the Infrastructure business is terribly important and I think we continuously overlook it.

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Operator [42]

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Our next question comes from Andrew Buscaglia with Berenberg.

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Andrew Edouard Buscaglia, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [43]

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Can you talk a little bit about your -- your CapEx is a little bit more elevated. Does that change the way you think about M&A? Was there a reason why you maybe pushed this operating part with a little more CapEx and that maybe M&A is not something you see is likely near term?

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J. Scott Hall, Mueller Water Products, Inc. - President, CEO & Director [44]

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No, I -- as I said, we want to be balanced. We'll continue to look at the M&A pipeline. We think we have the capacity to do both. I think that even on the cash flow conversion as we talked about but I still think we have opportunities, working capital opportunities, other ways to generate cash as well. So I think that we are going to be balanced.

But with that said, I think that we believe we're in a period that with the bonus depreciation structure that is certainly in our favor to go ahead and take advantage of the bonus depreciation through 2023 as much as we can. Because all that we'll do is trade the cash out for CapEx and turn it into cash out for cash taxes.

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Andrew Edouard Buscaglia, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [45]

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Yes. Okay. Okay. And then any reason why your SG&A -- I would have thought your SG&A would be a little bit lower across both segments. And then looking forward, should we be modeling sort of an elevated SG&A right now? It seems like your sales are going to come in at the low end of what you're expecting. So do you think that SG&A would maybe trend a little bit lower?

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J. Scott Hall, Mueller Water Products, Inc. - President, CEO & Director [46]

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Yes, I think that from this discussion from before. I think that you've got to take the piece that's the impact of the acquisition and maybe what we can do is call that out. But there's an infrastructure of people all around the world that's associated with Krausz. The Israeli facility, we have a dual facility running, the Tel Aviv facility, manufacturing facility will close at some point here in the, let's call it, the next 6 months. And we will have everything in area, and then you'll get some SG&A efficiencies there. But the largest increase, if you look for the past 2 years to our total SG&A spend has come in as a result of the Singer acquisition and the Krausz acquisition.

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Andrew Edouard Buscaglia, Joh. Berenberg, Gossler & Co. KG, Research Division - Analyst [47]

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Okay. Okay. And then, for me, just one last one. Your Technologies, your top line saw a decline. But seasonally, usually, Q4 tends to be strong. Should we think about that seasonality similar, I guess, I'm just looking at what it was last year. Is there anything -- any dynamics in the year end, where you might see a pickup and could still see year-over-year growth despite a tough comp from last year?

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J. Scott Hall, Mueller Water Products, Inc. - President, CEO & Director [48]

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No, I think that last year, everybody needs to remember we had the bulge of shipments that got hung up at the end of Q3. Shipping in Q4, I think it was around $2 million, $2.5 million. So it is a tough comp. That's such a lumpy business. And I would say that it's project-based and lumpy that I would expect -- I expect the lumpiness to help us in the Echo business, but I'm not sure what we have in the terms of visibility for meter shipments.

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Operator [49]

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Our next question comes from Walter Liptak with Seaport Global.

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Walter Scott Liptak, Seaport Global Securities LLC, Research Division - MD & Senior Industrials Analyst [50]

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Congratulations on a nice quarter. Wanted to ask about the EBITDA improvement in Technologies. So the EBITDA up 2.5% -- or $2.5 million year-to-date from last year. And the quarter was a little bit better. Is it something structural change? Or was it a mix? Why is the EBITDA in tech looking better this quarter?

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J. Scott Hall, Mueller Water Products, Inc. - President, CEO & Director [51]

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It's -- I think there's a combination of factors. There's -- they're running the business better, I believe. They're being more responsible around what business we take and what business we don't take. And we're not chasing volumes at breakeven on some of them. I think also that the distribution channel, as we've executed our strategy around getting our channels housed in order, if you will, and we are now picked up and we have primary relationships with some of the same large distributors that our valves and hydrants business has primary relationships with.

We're getting some operational efficiencies there because when you have large customers, you can actually see the demand. And you can make the schedule and you can avoid over time and you can avoid a lot of the inefficiencies that come with kind of whipsawing the plans around. So I think the $2.5 million has been a combination of price discipline and manufacturing efficiency improvements. I think about it on basically flat volume, it's all operational.

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Walter Scott Liptak, Seaport Global Securities LLC, Research Division - MD & Senior Industrials Analyst [52]

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Great. The fourth quarter, we are going to get close to the $100 million run rate. Could the fourth quarter be at a breakeven profit level?

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J. Scott Hall, Mueller Water Products, Inc. - President, CEO & Director [53]

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I don't think so. I think that we still got -- I'm just looking at the math where they are. I mean there would need to be a massive improvement in either margin or more cost containment. So I think it's -- I don't know what the number would be, Walt, but you can do the math.

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Walter Scott Liptak, Seaport Global Securities LLC, Research Division - MD & Senior Industrials Analyst [54]

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All right. We'll do our best. But you still get the price of manufacturing benefits, I guess. And just thinking about the channel inventory. You made some comments about how you're seeing the sell-through now into the fourth quarter with some of your contractors in municipal and resi. Could we -- are you saying that the inventory levels are good now, that any excess inventory from weather is now cleared out, and you're getting better sell-through into the fourth quarter?

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J. Scott Hall, Mueller Water Products, Inc. - President, CEO & Director [55]

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That's what we believe. I mean that's after the Q2 slowdown where we think there was some destocking from Q1 going on. When we do our monthly reconciliation for what they're saying versus what we're saying, those numbers where our product lines are pretty, pretty close. So that would indicate that the sell-through is matching pretty closely.

Well, I want to thank everybody for joining us this morning. I think one of the things I want to make sure everybody is left with. I'm very pleased with our third quarter performance. I think the growth in net sales and the adjusted EBITDA and adjusted EPS are all a testament to the execution the team has undertaken. I think that we have a little more room for improvement in manufacturing. But the channel execution, helping us get price, getting more price than inflation and even the impact of tariffs, which we didn't talk about this morning, all really, really positive.

And I think we remain on track to meet the net sales and adjusted EBITDA target ranges we communicated in our second quarter earnings release. Which, I think, given what was a difficult second quarter is also a testament to the culture of execution we're trying to build here.

So I think that we're focused on continuing our momentum. We believe our end markets remain healthy, I think, driven by steady growth in muni and with residential construction markets returning to steady growth this year. I think the team is excited about the future as we prioritize reinvestment in our people, processes and our facilities and I think it's a time for us to accelerate capital spending to operate our manufacturing capabilities, especially in our 3 foundries.

So I just want to reiterate that the strategies that we have been following that allow us to grow sales to improve conversion margin and drive adjusted EBITDA margin are what we're about executing. And I just want to thank you all for your interest, and I hope you have a great week. But once again, very pleased with the quarter. Thank you.

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Operator [56]

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Thank you. That does conclude today's conference. Thank you for participating. You may disconnect at this time.