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Edited Transcript of CSS earnings conference call or presentation 2-Aug-19 12:30pm GMT

Q1 2020 CSS Industries Inc Earnings Call

Philadelphia Aug 27, 2019 (Thomson StreetEvents) -- Edited Transcript of CSS Industries Inc earnings conference call or presentation Friday, August 2, 2019 at 12:30:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Christopher J. Munyan

CSS Industries, Inc. - President, CEO & Director

* Keith Pfeil;Chief Financial Officer

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Conference Call Participants

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* John Butler Walthausen

Walthausen & Co., LLC - CIO & Portfolio Manager

* Linda Ann Bolton-Weiser

D.A. Davidson & Co., Research Division - Senior Research Analyst

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Presentation

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Operator [1]

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Good morning. My name is James, and I will be your conference operator today. At this time, I'd like to welcome, everyone, to the CSS Industries Inc. Fiscal 2020 First Quarter Conference Call. (Operator Instructions)

Keith Pfeil, Chief Financial Officer. You may begin your conference.

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Keith Pfeil;Chief Financial Officer, [2]

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Good morning, and thank you for joining our conference call to discuss CSS Industries' first quarter results for fiscal year 2020 as well as an update on our outlook for fiscal 2020.

Sitting with me today is Chris Munyan, our President and Chief Executive Officer. During the course of this call, we will be providing certain forward-looking information. We ask you to look at yesterday's press release and read through the forward-looking cautionary statements that we've included there.

In addition, we will use certain non-GAAP measures in our discussion this morning, and we ask you to read through those sections of our press release that address the use of these items. The press release and related tables can be found on the Investor Relations portion of our website at cssindustries.com.

Chris will begin our discussion by providing some opening comments related to our first quarter.

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Christopher J. Munyan, CSS Industries, Inc. - President, CEO & Director [3]

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Thanks, Keith. Good morning, everyone. Our first quarter results were largely in line with our prior expectations. Because of the seasonal component of our business, we historically lose money in our first quarter. Net sales decreased 10.3% to $57.5 million in the first quarter as compared to prior year. Despite the decline in sales volume, our Q1 adjusted EBITDA loss was $6.8 million, essentially flat to the prior fiscal year first quarter.

Our first quarter results reflected the impact of our previously announced cost savings initiatives, and we continue to focus on maximizing the cost containment plans we've implemented. We also expect to work in additional business improvement plans during the remainder of fiscal 2020.

Coming back from the Q1 highlights, there are 2 things that I would like to underscore. First, we're very pleased with the strong base craft sales experienced in our business during the first quarter, which we continue to see earlier into our second quarter. Second, we are confident in achieving our previously announced cost savings initiatives, which is evidenced by our Q1 results.

Moving ahead, there are 2 initiatives mentioned in yesterday's press release that I would like to take a moment to discuss. The first one I'd like to touch on relates to debt and liquidity. We ended the quarter with $31.5 million of net debt compared to $9.4 million as of March 31, 2019. The increase in net debt is in line with our prior projections and primarily relates to the working capital cycle of our seasonal business as well as having a higher starting net debt balance due to the lower levels of income in the prior year.

The second item relates to our continued cost savings initiatives. The company continues to implement its cost-saving initiatives and is seeking to identify new areas of spending reductions.

During the recent quarter, we recorded $2.1 million restructuring expense related to headcount reductions, heavily focused on our legacy businesses. In addition, we continue to review underperforming product lines, specifically focusing on profit improvement actions within the specialty component of our gift business. We plan to continue to develop and implement plans to drive performance improvement within our gift business in fiscal 2020.

Now I'll turn it back to Keith, who will cover the financials in detail.

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Keith Pfeil;Chief Financial Officer, [4]

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Thanks, Chris. Turning attention to the financial results. We'll walk through our overall sales performance and results by category as well as comment on our income statement, balance sheet and cash flow.

Net sales for the first quarter were $57.5 million, which is a $6.6 million or 10.3% decrease over the prior year quarter. This reduction was driven by 2 primary factors. The first relates to our previously announced exit of the sports-licensed back-to-school category, which is worth $2.4 million of the decline. The second relates to $2.8 million of lower replenishment sales within our specialty gift business.

Looking at our sales by category, craft net sales were $35.7 million in the quarter compared to $35.3 million in the prior year quarter, representing a 1.1% increase over the prior year quarter. The increase was driven by higher sales related to ribbon and buttons, partially offset by lower sales of sewing patterns. The higher ribbon and bottom sales were driven by the timing of an annual reset with a major retailer as well as higher ribbon replenishment sales, which was driven by improved sales at retail. The lower pattern sales were attributable to the timing of a consignment replenishment program with a major craft chain, which occurred at the end of our first quarter, and which we expect to move these sales of these sewing patterns into the future quarters of fiscal 2020.

Our gift category net sales were $19.8 million in the quarter compared to $24 million in the prior year quarter, representing a 17.5% decline. The decline was primarily due to lower specialty sales of social stationary products as well as some slight declines in our packaging and wholesale products as well as our everyday trim-a-package products.

Our seasonal net sales were $2 million in the quarter, representing a 57.3% decline as compared to the prior year quarter. It is important to note that our fiscal first and fourth quarters are typically our lowest revenue quarters for seasonal. Consistent with what I had mentioned earlier, the driver of this decline was the impact of the previously announced exit of the sports-licensed back-to-school product line, which generated $2.4 million of sales in the prior fiscal year first quarter.

The first quarter of fiscal 2019 was the last quarter in which the company recorded significant net sales of sports-licensed back-to-school products, and we do not expect to report in the future fiscal quarters unfavorable quarter-to-quarter comparisons attributable to this exited product line.

Moving further into our income statement. Our consolidated gross profit on a GAAP basis was $12.1 million in the quarter compared to $11.6 million in the prior year quarter. Gross margin was 21% in the quarter compared to 18.2% in the prior year quarter. The increase in gross margin percent was primarily related to lower inventory step-up amortization related to our Simplicity and McCall acquisitions, partially offset by the mix of sales within our craft and gift categories.

Our adjusted gross profit was $12.5 million for the quarter compared to $17.1 million in the prior year quarter. Adjusted gross margin was 21.7% in the quarter compared to 26.7% in the prior year quarter, driven by the mix of sales within the craft and gift categories.

Selling, general and administrative expenses were $23 million in the quarter compared to $28.9 million in the prior year quarter. The decrease was attributable to lower costs, including salaries, medical benefits and travel expenses as a result of our cost savings initiatives. The company recorded $2.1 million of restructuring expenses in the current fiscal year quarter compared to $0 in the prior fiscal year quarter. These expenses were attributable to severance expense from the company's previously announced restructuring plan.

GAAP operating loss for the quarter was $13 million compared to $18.7 million in the prior fiscal year quarter.

The adjusted operating loss was $10 million for both the current year quarter and the prior fiscal year first quarter. The GAAP net loss for the quarter was $14.2 million compared to $18.5 million in the prior year quarter. The adjusted net loss was $12 million in the quarter compared to an $11.9 million net loss in the prior year quarter.

Net loss per share was $1.61 compared to $2.03 in the prior year quarter, and the adjusted net loss per share was $1.36 compared to an adjusted net loss of $1.31 in the prior year quarter.

Adjusted EBITDA was a loss of $6.8 million in the quarter compared to a loss of $6.7 million in the prior year quarter.

Turning to the balance sheet and cash flow. We ended the quarter with $12.3 million of cash and cash equivalents compared to $33.1 million at the end of the prior fiscal year first quarter. The lower balance was primarily due to lower levels of income within our overall business further increased by higher spending related to ongoing system implementation efforts.

Inventory decreased to $107.3 million at the end of the current period quarter from $117.9 million at the end of the prior fiscal year first quarter. This was primarily related to lower fair value step-up adjustments of inventories relating to our McCall and Simplicity product lines. Excluding the effect of the lower step-up inventory, inventory levels were $2.6 million lower at the end of the current period quarter and at the end of the prior fiscal year first quarter.

Accounts receivable decreased $6.2 million to $45.7 million as of June 30 from $51.9 million at the end of the prior fiscal year first quarter. Operating lease right-of-use assets of $49.3 million were recorded in the first quarter of fiscal 2020 as a result of the adoption of a new lease accounting standard.

Accounts payable decreased to $23.9 million as of June 30, 2019, compared to $25.8 million at the end of the prior fiscal year first quarter. The company ended the current period with $43.8 million in total debt compared to $40.4 million at the end of the prior fiscal year first quarter.

Operating lease liabilities of $48.3 million were recorded in the first quarter of fiscal 2020 as a result of the adoption of a new lease accounting standard. Cash used for operating activities during the quarter was $17.3 million for the 3 months ended June 30, 2019, compared to $15.4 million in the first 3 months of the prior fiscal year. The increase was primarily due to lower cash collections attributable to lower sales volume, partially offset by lower cash disbursements for inventory purchases.

Cash used for investing activities was $3.4 million in the current period quarter compared to $8.2 million in the first 3 months of the prior fiscal year. Capital expenditures were $3.5 million in the current period quarter compared to $3.2 million in the first quarter of the prior year. Cash provided by financing activities was $15.9 million in the current period quarter compared to $1.9 million used for financing activities in the first quarter of the prior fiscal year. Free cash flow was a use of $20.8 million in the current period quarter compared to a use of $18.6 million in the prior fiscal year quarter.

Now I'm going to turn it back to Chris to discuss our fiscal 2020 outlook as well as provide closing comments.

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Christopher J. Munyan, CSS Industries, Inc. - President, CEO & Director [5]

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Thanks, Keith. The lower SG&A results of our first quarter demonstrates the company's commitment to driving costs out of our business. We move ahead planning for continued declines in revenues as previously communicated, which will be offset by cost savings actions already implemented as well as additional cost-saving measures to improve overall results.

We acknowledge continued weakness in our gift business, and we'll be addressing this in fiscal 2020. Our domestic Christmas ribbon and bow production remains on track to ship on time such that we do not expect to see the execution issues experienced in the prior fiscal year.

Lastly, we remain optimistic about our combined legacy and acquired craft businesses as we continue to bring newness and innovation to the marketplace. Our overall message remains the same, which is to maximize cost cuts, drive working capital improvements, aggressively pay down debt and drive improved profitability and free cash flow. We expect full year fiscal 2020 net sales to be in the range of $355 million to $360 million, representing year-over-year erosion of minus 4% to minus 6%, driven by previously expected declines within our legacy businesses. Our net sales guidance was narrowed based on known seasonal commitments, leading us to guiding to the lower end of our range.

Our GAAP net loss is still expected to be in the range of $0 to $2 million compared to the net loss of $53.5 million in fiscal 2019, and adjusted EBITDA is expected to be in the range of $21 million to $23 million compared to $15 million in fiscal 2019. The expected growth in adjusted EBITDA is driven by the realization of cost savings initiatives, partially offset by lower sales volumes.

We're also providing guidance range of free cash flow for fiscal 2020, defined as operating cash flow minus capital expenditures. We expect free cash flow to be in the range of $14 million to $16 million, driven by a combination of cost savings, working capital improvements and reduced capital expenditures. This expected range compares to our fiscal 2019 free cash flow of negative $9.6 million.

Operator, let's open it up for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And your first question comes from the line of Linda Bolton-Weiser from D.A. Davidson.

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Linda Ann Bolton-Weiser, D.A. Davidson & Co., Research Division - Senior Research Analyst [2]

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So I was just curious about what you said about the sewing pattern business because that has really, to date, been a very consistent business with pretty high stability. So it was a little unusual to see it down year-over-year. Is there any way -- I mean, can you give a magnitude as to how much it was down? Was it like low single digit or mid-single digit or something like that? And then I think you said it had to do with the timing of a consignment program that will move the sales into a future period, but I don't think you said the next quarter. So is this -- are the sales being shifted into the next quarter or some future quarter? And can you quantify how much will shift into a future period?

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Keith Pfeil;Chief Financial Officer, [3]

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Linda, this is Keith Pfeil. Number one, the consignment program in the Q1 is down, I would say, mid-single digits. This relates to a consignment reset that's shifting from Q1 to Q2. So basically, it shipped at the end of our quarter, but we're not going to realize the sales of it until we get into our second quarter. Typically, when a program is shipped in, your initial billings will be greater because it's a refresh program. But to answer your question, it was a mid-single-digit number in Q1.

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Christopher J. Munyan, CSS Industries, Inc. - President, CEO & Director [4]

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Linda, this is Chris Munyan. I mean we're still very bullish on pattern. So when we look at point-of-sale data at retail, pattern sales continue to be strong. And these refreshes are to put new patterns in place that are going to address current fashion trends.

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Linda Ann Bolton-Weiser, D.A. Davidson & Co., Research Division - Senior Research Analyst [5]

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Okay, great. And then, you've done an extensive analysis on your business and you've exited some areas like the sports products area and everything. Are you done with that process? Or are you still looking at what you can do in some of these declining areas? I mean is it just that you need to discontinue more product lines? Or can you shed some light on kind of what your thoughts are regarding that thing?

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Christopher J. Munyan, CSS Industries, Inc. - President, CEO & Director [6]

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This is Munyan. I mean we're looking at other product lines within the business just to make sure that, on a stand-alone basis, the one that are contributing profit. So I think this year, we're going to still be evaluating what lines we should be in. I don't think we would make major change, but we're going to make adjustments in terms of what products we're selling into specialty markets versus what products we're taking stock positions on. So we just don't have the specific actions we can disclose, but we expect to disclose plans in the future, this year.

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Linda Ann Bolton-Weiser, D.A. Davidson & Co., Research Division - Senior Research Analyst [7]

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Okay. And then finally, of course, we got the news yesterday about the additional round of tariffs, which in my space is hitting some new things that were never impacted. Can you just refresh for us what your impacts have been so far? And does this new round affect you in any way?

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Christopher J. Munyan, CSS Industries, Inc. - President, CEO & Director [8]

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Linda, it's Chris Munyan, again. I mean we're -- again, this is new to us as of yesterday. So we're assessing which categories are specifically impacted. I do believe that most of the categories in this new round for us are more kids activity as well as items that we would sell in some Easter and Val categories. Almost all those we sell direct import, where we don't pay the duty, so we would have no tariff impact. On the previous tariffs announced, we've been working with our customers to raise prices. And so far, we see really minimal impact at all relating to the tariffs implemented because retailers need to pass it on to a higher price.

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Operator [9]

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(Operator Instructions) Our next question comes from the line of John Walthausen from Walthausen & Co.

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John Butler Walthausen, Walthausen & Co., LLC - CIO & Portfolio Manager [10]

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Congratulations on bringing the SG&A down that far. Should I extrapolate from that and assume that we're going to have less than $100 million of SG&A this fiscal year?

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Christopher J. Munyan, CSS Industries, Inc. - President, CEO & Director [11]

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I think -- John, I think, just one, if you look at the lower SG&A for the quarter, if you remember, our cost cuts were implemented really in May. So we're kind of -- when we look at June, I mean, for example, June cost cuts year-over-year were much higher than April and May, right? So I think that it's probably a fair thing to extrapolate to that level.

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John Butler Walthausen, Walthausen & Co., LLC - CIO & Portfolio Manager [12]

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Okay, great. But on the other side, I was surprised at how far the gross margin fell. And it seems like the quick explanation of it was mix. This seems like there's more to it than that. Can you break it down a little bit more on what the pressures on gross margin are and what we can do about that?

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Keith Pfeil;Chief Financial Officer, [13]

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John, this is Keith. I can cover that. When you think about the quarter, year-over-year, really, there is -- on an adjusted basis, there's a couple of things to consider. Number one, we commented that the pattern sales were down. Based on the earlier question, I commented that they are mid-single digits. When you look at patterns as a business line, the gross margins in that business are significantly higher than the rest of our business. So that number one has a very big impact.

Number two, we spoke about the specialty business sales being down in the quarter. Again, on a gross margin basis, those margins are higher than the average of the rest of our business.

And thirdly, we commented on some other softness within our gift lines. And that was really declines in our packaging and wholesale business as well as some of our trim-a-package ribbon areas. Some of that decline was based on mix of customers that carried some higher margins versus average of other customers. So really, there's 3 really discrete areas.

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Christopher J. Munyan, CSS Industries, Inc. - President, CEO & Director [14]

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One of the other areas too, John, that was in there as well, is we had a piece of business that we took that related to the anti-dumping order, that was an all-occasion business, that we had to take it because, again, it was in-scope product. That product was sold still in that first quarter. That product is going to be exited for the balance of the year.

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Keith Pfeil;Chief Financial Officer, [15]

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Yes. You will not see that the rest of the year.

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John Butler Walthausen, Walthausen & Co., LLC - CIO & Portfolio Manager [16]

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So if that goes away and the pattern sale should come back, some of the other pressures will probably remain. Is that correct?

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Keith Pfeil;Chief Financial Officer, [17]

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Yes. I mean I think we -- when we talk about where we see softness, we've talked about softness in Q1 within our gift business. And I think as we look out to the rest of the year, we are working to maximize initiatives that we already have in place, and we're continuing to review the other parts of our business that may not be performing and we are coming up with plans to address accordingly.

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John Butler Walthausen, Walthausen & Co., LLC - CIO & Portfolio Manager [18]

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Okay, good. And I guess, the final question I had, in terms of the continuing effort to lead the product line, that's following the same process that you said back last year with the consultant or is there something new that's happening there?

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Christopher J. Munyan, CSS Industries, Inc. - President, CEO & Director [19]

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No. I think when we talked about with the consultants is we have 2 processes. We have active SKU management, which is really at a SKU level versus a category level. So that's as we determine what items do we already own, John, and we're dropping and the other is new item creation process, which is as we decide what items we're going to work on in development. So those are separate processes and they're all EVA based. In terms of looking at product categories, we continue to run contribution levels at discrete product category levels as well as we can look at return on invested capital at those levels and make appropriate decisions to adjust cost or to exit or narrow those product lines.

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John Butler Walthausen, Walthausen & Co., LLC - CIO & Portfolio Manager [20]

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That's very helpful. And I have -- there's one more question. The other question is, you referenced to the gift business that, okay, it's under a lot of downward pressure right now, but you have thoughts for rejuvenating it for next year. Can you expand on that at all? Or...

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Christopher J. Munyan, CSS Industries, Inc. - President, CEO & Director [21]

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I mean I think, that -- we're looking at also in ways to rejuvenate the gift business, but I mean, that market is a huge market. Some of our categories, such as infant gift are relatively small categories, really don't have a lot of retail presence anymore. So if we were to rejuvenate it, we need to refocus on categories we can be more profitable on.

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Keith Pfeil;Chief Financial Officer, [22]

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Yes, I think, that it comes back to looking at when -- the gift category is a broad category, it's looking at where our investment is relative to our return and the places that generate higher levels of return are the places that really work to rejuvenate.

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Operator [23]

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And there are no further questions at this time. I'd like to turn the call back over to our presenters for some closing remarks.

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Christopher J. Munyan, CSS Industries, Inc. - President, CEO & Director [24]

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At this point in time, we appreciate everyone's questions. This is Keith's actually last day today, so we're going to miss Keith, but we're -- we have a strong group here. So if people have follow-up questions, they can actually reach out directly to me, and I'd be happy to cover questions. Thank you, again.

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Operator [25]

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