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Edited Transcript of SAP.TO earnings conference call or presentation 8-Aug-19 5:00pm GMT

Q1 2020 Saputo Inc Earnings Call

MONTREAL Aug 16, 2019 (Thomson StreetEvents) -- Edited Transcript of Saputo Inc earnings conference call or presentation Thursday, August 8, 2019 at 5:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Kai Bockmann

Saputo Inc. - President and COO of Saputo Inc. & the International Sector

* Lino Anthony Saputo

Saputo Inc. - Chairman & CEO

* Marlene Robillard

Saputo Inc. - Director of Communications & Public Relations

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Conference Call Participants

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* Irene Ora Nattel

RBC Capital Markets, LLC, Research Division - MD of Global Equity Research

* Keith Howlett

Desjardins Securities Inc., Research Division - VP, Consumer Products & Merchandising Analyst and Retail Analyst

* Mark Robert Petrie

CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research & Research Analyst

* Michael Van Aelst

TD Securities Equity Research - Research Analyst

* Peter Sklar

BMO Capital Markets Equity Research - Analyst

* Vishal Shreedhar

National Bank Financial, Inc., Research Division - Analyst

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Presentation

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Operator [1]

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Greetings, and welcome to the Saputo Inc. Fiscal 2020 First Quarter Results Conference Call. (Operator Instructions) As a reminder, this conference is being recorded Thursday, August 8, 2019.

I would now like to turn the conference over to Lino Saputo, Jr. Please go ahead.

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Lino Anthony Saputo, Saputo Inc. - Chairman & CEO [2]

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Thank you, Suzie.

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Marlene Robillard, Saputo Inc. - Director of Communications & Public Relations [3]

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Good afternoon, everyone, and thank you for joining us today. The press release detailing our 2020 first quarter results was issued earlier today and is also available as we speak on our website at www.saputo.com. This call is being recorded and will be posted on our website for future reference. (Operator Instructions)

Before we proceed, please be reminded that some of the statements provided during this call are forward-looking. Such statements are based on assumptions that are subject to risks and uncertainties. Refer to our cautionary statements regarding forward-looking information in our annual report and our year-end releases and filings. Please treat any forward-looking information with caution, as our actual results could differ materially. We do not accept any obligation to update this information, except as required under securities legislation.

Lino A. Saputo, Jr., our Chair of the Board and Chief Executive Officer, will begin this conference by providing a brief overview of key highlights relating to the quarter of fiscal 2020, after which, he, along with Maxime Therrien, our Chief Financial Officer; and Kai Bockmann, President and Chief Operating Officer of Saputo Inc. and the International Sector, will proceed to answer your questions.

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Lino Anthony Saputo, Saputo Inc. - Chairman & CEO [4]

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Thank you, Marlene, and good afternoon to you all. Our fiscal 2020 first quarter results were released this morning and I'm pleased with the improvements we are seeing. They demonstrate we're making progress within challenging market conditions.

Consolidated revenues grew by 12.3% compared to the corresponding quarter last fiscal year. This increase is mainly related to higher sales volumes derived from recent acquisitions. Notably, the Dairy Crest acquisition contributed approximately $152 million in revenue for 11 weeks in the quarter. Revenues also benefited from a higher average block market and a higher average butter market in the U.S.

Higher international selling prices of cheese and dairy ingredients as well as higher selling prices in the domestic market in relation to the cost of milk as raw material in Canada and in the International Sector.

Our adjusted EBITDA amounted to $358 million, an increase of 16.4%, and adjusted net earnings increased by 2.9%. During the quarter, we faced the negative effects of lower sales volumes in the food and milk category in Canada, unfavorable market factors in the U.S. and recurrently higher costs in warehousing, handling, logistics and transportation. Accordingly, the Canada sector will focus on profitable sales volumes and keep reviewing overall activities to further alleviate low growth and competitive market conditions.

The U.S. sector will maintain its efforts on operational efficiencies and cost control in order to mitigate these impacts. The International Sector, which includes Australia and Argentina, will keep putting emphasis on innovation, while optimizing its product mix and customer portfolio, both domestically and internationally.

This sector will also focus on enhancing its operational flexibility to lessen the impact of fluctuations in market conditions.

In Australia, after a smooth integration, our united SDA platform sits on a solid foundation we can build on. In June, we met one-on-one with farmer suppliers in the region to reaffirm our long-term commitment to the Australian dairy industry.

For fiscal 2020, we faced the effects of a decrease in milk production. As a result, we expect greater competition in the sourcing of raw milk, which will keep putting downward pressure on margins. In light of this, our goal remains to process additional milk, channel the raw milk resource into higher-margin products and optimize the network at our disposal. We also aim to broaden our portfolio of products. As such, last April, we announced our intention to acquire the specialty cheese business of Lion-Dairy & Drinks, which produces, markets and distributes a variety of specialty cheeses under well-known Australian brands. This transaction remains subject to regulatory approvals and is expected to close in the second half of 2019.

The ACCC issued a press release yesterday identifying certain competitive issues related to the transaction. While a final decision has not yet been made, we will carefully review and continue to work closely with Lion and ACCC with a goal of obtaining approval as soon as possible.

In our new Europe sector, the integration of Dairy Division (UK) is moving forward as planned with Tom Atherton as COO. Our current focus is on aligning processes and systems while sharing best practices. We intend to expand our cheese making capabilities within this division through capital expenditures in our facilities.

As we move forward on our ERP journey, during the first half of calendar 2020, the company will deploy the ERP program in any remaining Dairy Division (Australia) facility and align SDA under a single system. Implementation activities have commenced within the Cheese Division (USA), and we will complete the journey with the Dairy Division (Canada).

In terms of the social, environmental and economic approach to the business, this year, we have stepped up efforts to deliver the Saputo promise. Under our environment pillar, over the years, we have made progress. However, we recognize there is still much more we can do. Thus, we are currently assessing possible solutions to ensure informed decision-making will guide us in the short- and long-term as we take additional steps to reduce the environmental impact of our activities.

In terms of our pledge towards nutrition and healthy living, on June 1, we mobilized our divisions and our community partners to ignite engagement as we celebrated the benefits of dairy products on World Milk Day.

We remain committed to the Saputo promise and will demonstrate leadership as we create further value for all stakeholders. I want to congratulate the team for their efforts during the quarter as we honor our long-standing commitment to manufacture quality products and keep shareholder value creation at the forefront of our strategy.

The dairy industry will continue to present some challenges. Having said this, we intend to capitalize on our expertise as we have in the past. Furthermore, we will pursue our growth strategy with a disciplined and responsible approach as leaders in the dairy industry.

And on that note, I thank you for joining our call, and we will now proceed to answer your questions. Suzie?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question coming from the line of Irene Nattel with RBC Capital Markets.

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Irene Ora Nattel, RBC Capital Markets, LLC, Research Division - MD of Global Equity Research [2]

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Just listening to you this morning -- I guess, this afternoon, Lino, when reading the release, the tone sounds slightly more optimistic, although recognizing the challenges. Can you talk about how the quarter unfolded? And also what you're seeing across different regions with regard to competitive intensity and where things may be getting, where you see maybe a little bit better or a little bit of erosion?

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Lino Anthony Saputo, Saputo Inc. - Chairman & CEO [3]

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Thank you very much for the question, Irene. And yes, the tone is a little bit more optimistic. We have come out of 2 years of very, very difficult environment within the dairy space. And at the same time that, that was going on, we had our SAP rollout, which was challenging and we had the startup of our Almena plant. On all 3 fronts, I think things have gotten much better. So there is a better balance between supply and demand on the global market, so that definitely is helping prices as we roll out dairy goods into the international market as well as domestically.

SAP in large part through the Saputo platform in the U.S., namely SDS, has been integrated. I would say that our team has gotten their swagger back. They have full visibility on their key drivers, key points that are dashboard indicators that provide them the historical data that they've been used to running their business with. And the Almena plant startup is behind us as well. So on those 3 fronts, I see that the worse is behind us. Perhaps, where I'm a bit cautious is a little bit in terms of, number one, in certain domestic markets where the competition continues to be active and perhaps some of that is driven by some of our competitors looking at market share rather than profitability. And so in some cases, we've got to step away from some volume and some business because the economics just don't make sense anymore, which, of course, impacts our volume and impacts our overhead absorption. So some of that continues.

I think we've got great teams in place in all of our platforms, and we're taking the right decision at the right time. And we're rightsizing our platforms to make sure that we continue to be an efficient operator.

Other things that perhaps create some caution for us would be the geopolitical issues that we see are happening primarily through the U.S. front, tariff wars with Mexico and with China. Those create a lot of instability for us and difficult for us to predict where and how those things will end. But overall, I say that we're optimistic that there is -- there are some very good things happening in the industry. I think there's some very good things happening within our organization. I believe we got the right people in place. I think over the course of last 18 months, 24 months, we've built really, really, really solid foundations and perhaps, our results haven't really reflected that, but I feel extremely comfortable about our positioning today.

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Irene Ora Nattel, RBC Capital Markets, LLC, Research Division - MD of Global Equity Research [4]

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That's great. And just one more, if I might. With regards to the Lion-Dairy & Drinks, it sounds from your comments as though you're confident that you can work with the ACCC and with Lion to a successful outcome, notwithstanding the concerns around pricing potential?

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Lino Anthony Saputo, Saputo Inc. - Chairman & CEO [5]

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Yes. So our desire is to be a specialty driver of dairy goods all over the world. And this acquisition of Lion specialty business fits right into our strategy. So I'm confident that we will find a way to make this work.

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Operator [6]

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Our next question coming from the line of Michael Van Aelst with TD Securities.

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Michael Van Aelst, TD Securities Equity Research - Research Analyst [7]

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First up, on the Dairy Crest acquisition, you've had it for a little bit now, so I'm just wondering what your initial observations are of the business now that you're running it? And where you see room to improve? And where you see room to grow that business?

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Lino Anthony Saputo, Saputo Inc. - Chairman & CEO [8]

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Yes. So last year, we talked about one of the smoothest and simplest integrations we've ever had was Saputo Dairy Australia. I would say that the U.K. business is probably even easier than that. We inherit a very experimented team, folks that know their business inside out, they know their markets inside out. Culturally, there was no disconnect at all between the way that we look at the world and the way that the former Dairy Crest looked at the world. They've embraced Saputo values and cultures. In fact, they celebrated Canada Day on July 1 and sent us all photos of how important it was for them to recognize that their mother company was Canadian. So things are running extremely well. The opportunities for us to improve, I think, would be in terms of milk collection. If we can get more suppliers to sell us their milk, then we will expand the infrastructure to be able to produce more dairy, more cheese for not just the domestic market, but for the international markets. Not that different from what we did when we acquired Warrnambool Cheese & Butter back in 2013, 2014. So I think that there's still some upside there. Again, some volatility related to Brexit. But I think that, that one will ultimately resolve itself. And once it does and we're collecting more milk, in fact, this year we have more milk than we had last year, I think that there will be opportunity for us to further expand that platform from a very, very strong milk base.

I'm not sure, maybe, Kai, if you have anything to add on that?

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Kai Bockmann, Saputo Inc. - President and COO of Saputo Inc. & the International Sector [9]

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Yes. There are also 2 specific areas that provide short- to medium-term opportunities for Dairy Crest. One would be on the export side. We will look to leverage the licenses, and also the business relationships we have in both Canada and United States to potentially bring in Dairy Crest or Cathedral City branded products. It's a tremendous product that offers a lot of opportunities on the export side of things.

And on the other side, ingredients as well is another part of the business that we don't talk a lot about, but in terms of the GOS side of the business, which is an input for the nutritional side of the business, there are a lot of opportunities to ramp it up as there is a lot of available capacity. So those would be 2 specific areas that we're looking to take advantage of in the short term.

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Michael Van Aelst, TD Securities Equity Research - Research Analyst [10]

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What did you say, the GOS? What is that?

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Kai Bockmann, Saputo Inc. - President and COO of Saputo Inc. & the International Sector [11]

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Yes, GOS, which is the key ingredient for nutritional infant formula products. We do have a lot of experience in Australia through our Warrnambool Cheese & Butter acquisition. We have that capability there. So we have some experience in terms of producing and selling those products, and we'll look to do the same at Dairy Crest.

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Lino Anthony Saputo, Saputo Inc. - Chairman & CEO [12]

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So Michael, just to put the GOS into context. It's a byproduct. So it's an offshoot of cheese production and highly specialized ingredients that are made for infant formula. And so as we're looking at opportunity for ourselves moving forward, back in 2004, WPC80 was an avenue that we felt we needed to get into because very few players were in it and the margins were actually quite high. Well, as you well know, WPC80 has become more commoditized because a lot of other people have followed our lead on that. And so we're looking for other avenues, GOS being one of them, and this GOS technology, in fact, we picked that up when we made the acquisition of Warrnambool Cheese & Butter, which is the primary offshoot of our byproduct in Australia.

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Michael Van Aelst, TD Securities Equity Research - Research Analyst [13]

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Okay. And then considering how well-run that business already seems to be and the margins how high they are, are you guys comfortable putting out some kind of a synergy target? Or is this because it's a new platform, you're not really expecting significant synergies?

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Lino Anthony Saputo, Saputo Inc. - Chairman & CEO [14]

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Yes. Because it's a new platform, there aren't significant synergies. There might be some synergies when you look at the administrative costs and perhaps trying to get with some of our suppliers to consider selling us some of their services into the U.K. at a lower cost than what the U.K. was paying previously. But we're -- I mean that's just the -- just small amounts of synergies that we would quantify. The platform is running well. As you indicated, the margins are quite high. Our primary focus is to maintain those margins. And then as the second step, as we increase production, then further lower costs and then improve upon that. But we're talking about, maybe, 1.5 years to 2 years out before we get there.

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Michael Van Aelst, TD Securities Equity Research - Research Analyst [15]

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Okay. You touched on ERP implementation. Can you remind us what your total costs are for that -- on an annual basis right now for that where they're running? And 100% -- does the 100% of this go away once you're done?

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Kai Bockmann, Saputo Inc. - President and COO of Saputo Inc. & the International Sector [16]

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No, the fact is -- from an ERP perspective, it's not only cost of bringing the SAP solution within our operation. We are currently elevating our technology across the board. So obviously, when we do that, this triggers additional costs. So it's not fair to say that all those additional costs will disappear. Although, yet -- once the journey is over, we certainly expect cost to be reduced. Our cost that we pay to our system integrator or consulting will definitely reduce, but obviously we'll just have additional costs relative to [high tea] or technology per se.

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Michael Van Aelst, TD Securities Equity Research - Research Analyst [17]

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Yes. So where are those ERP costs running right now?

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Kai Bockmann, Saputo Inc. - President and COO of Saputo Inc. & the International Sector [18]

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Right now, the -- I'm not going to throw a number in terms of the P&L or an EBITDA impact, but just want to clarify what I could share is the cost today, because we're very active in our Australian platform, very active in our U.S. division, remains quite high, so it was the case last year when we were probably more focused within the SDS division at the time, so we're quite -- still at the high level of spend and obviously, there will be a reduction in cost as we move forward and ultimate savings or reduced costs will be once the program has been completely run or done.

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Michael Van Aelst, TD Securities Equity Research - Research Analyst [19]

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And Canada is expected to be completed when?

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Kai Bockmann, Saputo Inc. - President and COO of Saputo Inc. & the International Sector [20]

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2022, I believe. 2022.

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Operator [21]

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Our next question coming from the line of Vishal Shreedhar with National Bank Financial.

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Vishal Shreedhar, National Bank Financial, Inc., Research Division - Analyst [22]

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Just want to take a few steps back. And it seems like a plant-based alternatives are really gaining steam in the marketplace. Wondering if management has a new modified view on where it stands on that?

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Lino Anthony Saputo, Saputo Inc. - Chairman & CEO [23]

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Well, the view is not that different than what we've been communicating, I think, over the course of last couple of quarters. We've recognized the changing demand of our consumers, and we, of course, need to adapt to that. I think plant-based will continue to grow, although I think it will continue to be a specialized market. Our orientation to plant-based is, number one, if there is an opportunity for us to make an acquisition in that space with a very strong brand already in the market, we would definitely take a look at that. But beyond that, I think that there is an opportunity for us, as low-cost processors, to co-pack some plant-based products for our -- some folks that are already in the space. Most of these people that are in this space have the ability to market and sell extremely well, but don't necessarily have the infrastructure to process. We could be good partners in that.

I was asked the question today at the AGM about -- specifically about this. And I make it -- made it very, very clear to our shareholders that we're not getting away from dairy in any way, shape or form. What we'll do in plant-based is we'll add to the platform, so that we can continue to be relevant to our consumers, specifically in the fluid milk space as a starting point.

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Vishal Shreedhar, National Bank Financial, Inc., Research Division - Analyst [24]

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Okay. Management has been very active -- management and the Board have been very active in making acquisitions over the last few years. And somewhat due to some of the dairy conditions and some other factors which you noted, the acquisitions don't seem to be as accretive as they were, call it, 10 years ago. Is that what management sees is the new kind of going forward operating procedure as multiples are bit higher in the commodity markets that you're entering or a bit more volatile than, call it, Canada and the U.S.? Should that -- is that the way we should think about it? Or should the older turns that Saputo get are those still in focus? Or can we still get them?

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Lino Anthony Saputo, Saputo Inc. - Chairman & CEO [25]

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I think that there's still upside opportunity for us anytime we make an acquisition. It's true, you're right, Vishal, when you say that the multiples are getting higher, and they are getting higher because there are more competitors that want to consolidate within the dairy space. But I would say that there are opportunities for us and perhaps maybe not as short term as what we may have seen in the past. I think the value of, say, MG acquisition is great. However, because MG had suffered for so long and taken so many bad decisions prior to our ownership, that -- it does take a couple of years for us to get out of that rut. Sometimes it's because the milk is lacking and we've got to convince suppliers to trust us. Sometimes because the infrastructure is lacking or the right infrastructure is lacking and we've got to order equipment and install it. So anytime we look at acquisitions, it's really with a strategic viewpoint in mind, making sure that we have the right assets in the right regions, manufacturing the right categories of products. When you're a smaller business and you make a medium-size acquisition, it has a massive impact and the -- I guess, the return on the investment is much greater in the shorter term and a shorter time frame. And the larger you get, the less impactful the business is despite the fact that you're buying a leader in certain categories. I just think it's a nature of the size of Saputo today. We're close to $15 billion in sales, even $1 billion acquisition sometimes doesn't move the needle, whereas $1 billion acquisition in 2004 was impactful for us.

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Operator [26]

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Our next question coming from the line of Mark Petrie with CIBC.

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Mark Robert Petrie, CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research & Research Analyst [27]

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I just wanted to ask specifically about the commodity environment in the U.S. And Lino, you called out seeking alternatives from the WPC80 market given the expansion of supply that you've seen over the last little while, but the spread to dry whey seem to have expanded back to kind of past highs. So it would just be helpful to hear a bit more commentary about what the biggest drivers of the improvement in the U.S. commodity environment were and then what your outlook is for the balance of the year?

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Lino Anthony Saputo, Saputo Inc. - Chairman & CEO [28]

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Yes. So the biggest drivers in the U.S. for us was the SDA platform, that now has visibility on their key indicators and they are driving better operational efficiencies at their plant level. That has helped quite a bit. We've taken on more volume, more customers on the -- in the SDA -- SDS platform. Also we had the run-up of the block cheese, so Saputo Cheese USA has benefited from that, even though the offset there was the California -- the sort of the old California milk pricing relative to USDA pricing, now that California is in USDA, and the byproducts has not been favorable. So we've had some pretty good offsets to some of the headwinds that we're still facing there.

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Mark Robert Petrie, CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research & Research Analyst [29]

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And then the outlook?

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Kai Bockmann, Saputo Inc. - President and COO of Saputo Inc. & the International Sector [30]

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In terms of your question around the commodities, yes, we have seen improvement across most of the commodity products, specifically on the -- on WPC80 and WPC35. We are seeing pressure, however, on the lower protein products, largely as a result of limited opportunities for export from our U.S. platform. You guys have all read about the issues with China in terms of the trade wars. So specifically, when we look at product categories, things like DPW and sweet whey are having a look for new markets as an outlet and that has had a negative impact in terms of price trends.

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Operator [31]

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Our next question coming from the line of Keith Howlett with Desjardins Securities.

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Keith Howlett, Desjardins Securities Inc., Research Division - VP, Consumer Products & Merchandising Analyst and Retail Analyst [32]

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Yes, I was wondering if you could amplify a bit on the comments you made on geopolitical risk related to Mexico and China. Where are we with respect to U.S. exports to Mexico? And is the issue in China mostly their impact on the global prices or your direct export volumes there feeling an impact?

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Kai Bockmann, Saputo Inc. - President and COO of Saputo Inc. & the International Sector [33]

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As I mentioned, my answer to the previous question, really where we're seeing an impact is on the lower protein items, DPW and sweet whey, but we have found alternate markets to send those products to. So in terms of your -- first part of your question in terms of the tension in terms of trade negotiations, we're seeing specifically, again, China. The government has actually asked importers to stop bringing in product altogether. And fortunately, we have a very well-diversified portfolio in terms of customers and markets that we can reallocate products to. So we've been able to kind of mitigate a lot of that risk.

In terms of our Australian platform, that actually is an advantage to us in that some of the markets that are traditionally serviced by the U.S., from an export standpoint, can be serviced from the Australian platform.

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Keith Howlett, Desjardins Securities Inc., Research Division - VP, Consumer Products & Merchandising Analyst and Retail Analyst [34]

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And in terms of Mexico, is that back to normal or not really?

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Kai Bockmann, Saputo Inc. - President and COO of Saputo Inc. & the International Sector [35]

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We do not see a huge impact in terms of our Mexico volumes. There was a bit of a short blip, if you will, last year, but in terms of velocity, we're seeing back to normal levels. And when you look at holistic level, when we look at the data from the U.S. Dairy Export Council, the numbers are actually quite robust at this point. The one area where there is an impact is on skim milk powder. But other than that, all the other ingredients sales from the U.S. platform are healthy.

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Keith Howlett, Desjardins Securities Inc., Research Division - VP, Consumer Products & Merchandising Analyst and Retail Analyst [36]

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And, if I might, just one last question on China. You would sort of preferred, as I understood, to export to Korea and Japan and other markets with sort of more stable demand patterns than China. How roughly big is China within your global export business?

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Kai Bockmann, Saputo Inc. - President and COO of Saputo Inc. & the International Sector [37]

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Well, China is the market you cannot ignore. Again, a lot of the lower protein items we would -- would find a home in the Chinese market. And for Australian platform, when you look at UHT provides tremendous export opportunities for us, milk sachets. So it's a critical market for us. But in our earlier calls, we talked about Japan and South Korea because those are the markets that are quite strategic in that they're able to withstand the volatility that we're seeing in the global dairy markets. So in terms of the higher value-added products, whether they're cheddars from Australia or retail products from our U.S. platform to South Korea, those would be the products that we would tend to focus in terms of exports to those 2 key markets, South Korea and Japan.

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Operator [38]

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(Operator Instructions) Our next question coming from the line of Peter Sklar with BMO Capital Markets.

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Peter Sklar, BMO Capital Markets Equity Research - Analyst [39]

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On Australia, for a couple of quarters now, you've talked about the milk shortage or the decline in milk production. Can you talk a little bit about the dynamics that are causing that? Is it weather or producers leaving the business? Just like to hear your take on it since you're on the ground there.

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Kai Bockmann, Saputo Inc. - President and COO of Saputo Inc. & the International Sector [40]

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Sure. It's a combination of factors. One is extreme weather conditions has had a dramatic impact in terms of overall milk production, specifically in the state of Victoria. We're seeing numbers 15% down year-over-year and in some areas within Victoria more than 20% down year-over-year. So from weather impact standpoint, that's had a negative impact.

The other developments are -- where we've gotten to is that there is just too much stainless steel in the system. There's excess capacity. And when there is excess capacity, there tends to be intensified competition around milk supply. So we're seeing a lot of competitors that are quite aggressive in terms of trying to get the milk to fill their assets. We also see a lot of new players coming online, smaller players, also aggressive in terms of trying to secure milk supply. So those 2 -- those are the 2 major developments in terms of what we're seeing right now, which has caused intensified competition from a milk supply standpoint.

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Lino Anthony Saputo, Saputo Inc. - Chairman & CEO [41]

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And Peter, I'm going to add one other thing to all of this. Despite the fact that the milk is declining in terms of overall production, our target on milk processed remains the same.

We're looking at 3 avenues of milk, so that we can keep the capacity utilizations of our plants at an efficient level. The first, of course, is our patron base. Meaning that there are farmers that want to sell us their milk and we will process the milk into dairy goods and sell them either domestically or internationally. The second would be third-party milk. So there are brokers out there that go out and secure milk and then resell it. So we are buying some third-party milk. And then the last avenue is co-pack. So as Kai mentioned, there is a lot of stainless steel in the system, not all the stainless steel is efficient or effective. And so through our discussions with some other players in the dairy space, we are offering them some compelling reasons for them to shutter their plants, move their milk to us and we can co-pack much cheaper with a higher quality than they can do if they would keep that plant open. And that negotiation with a number of different players has been quite successful. So our target for capacity utilization at this stage has not changed.

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Peter Sklar, BMO Capital Markets Equity Research - Analyst [42]

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And the milk shortage or the decline in milk production that's been experienced in Australia as a result of the weather, is that because the herd has declined or the herd has been less productive because of the heat?

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Lino Anthony Saputo, Saputo Inc. - Chairman & CEO [43]

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The herd has declined. There have been a few farmers, more than a few farmers -- there have been a number of farmers that have gotten out the industry. One, because of the last 2 years of economic conditions and the return that they were getting for their milk. The second was because of climate issues, where the land is very, very dry. And the third is, in some regions, they don't have water and to buy their water -- to have the rights to buy water is very, very costly as important as their feed costs. And that's creating an environment for them where they're saying, it was time for them to exit the dairy industry. So it's not that the cows are producing less milk, it's just that there are less cows in the system that are being milked today than there were even a year ago.

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Peter Sklar, BMO Capital Markets Equity Research - Analyst [44]

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Okay. And lastly, I just wanted to ask about the Canada situation, Lino. Like in the end, how do you think this is going to be resolved? This high level of competitive intensity has gone on for quite a period of time now. There just doesn't seem to be any resolution to it. I doubt if anyone is going to close their fluid milk capacity. How do you think this is all going to end up?

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Lino Anthony Saputo, Saputo Inc. - Chairman & CEO [45]

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Well, there are 2 stories to Canada, one is on the fluid side, the other one is on the cheese side. And on the cheese side, thankfully, we are the most effective, the most efficient, the most credible players on cheese. And so we've been able to defend ourselves extremely well. Where we walked away from some volume and some customers was on the fluid side, where things got to a point where the margins were either neutral or negative. And that's where we said that we're not going to exchange 4 quarters for $1 and absorb all that risk.

So on the fluid side, I will tell you that we will continue to focus on value-added categories and products. So perhaps you might have less volume, but the product mix is going to be much better. On the cheese side, we still continue to grow our base despite the fact that there are price wars. It's unfortunate. It seems that when one of our competitors decides to halt the price wars, the other one jumps in and tries to pick up market share. And there seems to be footballing back and forth with price incentives and wars. We choose not to play in those games, but unfortunately, we're part of the industry, so we are perhaps one of the casualties in it. But I think that we can take a good disciplined approach and still make that platform very, very profitable.

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Operator [46]

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Our next question is a follow-up question coming from the line of Michael Van Aelst with TD Securities.

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Michael Van Aelst, TD Securities Equity Research - Research Analyst [47]

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When you talk about doing co-packing for others in Australia and possibly elsewhere, how do we -- how should we look at the profitability or the margins for that business relative to producing the product for yourself?

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Kai Bockmann, Saputo Inc. - President and COO of Saputo Inc. & the International Sector [48]

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In terms of what specifically, Michael?

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Michael Van Aelst, TD Securities Equity Research - Research Analyst [49]

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Well, I'm assuming that since the selling price of the product is not going to change that much, I'd assume that you're just splitting the profit pool between you and the brand owner?

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Kai Bockmann, Saputo Inc. - President and COO of Saputo Inc. & the International Sector [50]

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No. Essentially, we would charge a toll fee. So let's say, it costs you $0.10 to manufacture an item for someone, you would charge them $0.15. So $0.10 to -- would be the cost and then you would add a profit to that service, so then, that would be the toll fee that you would generate. So you wouldn't necessarily share the profit in terms of what you would generate at the market level.

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Michael Van Aelst, TD Securities Equity Research - Research Analyst [51]

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Is that typically lower-margin business though than your own brands?

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Kai Bockmann, Saputo Inc. - President and COO of Saputo Inc. & the International Sector [52]

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Not necessarily. It depends on the product types and categories.

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Lino Anthony Saputo, Saputo Inc. - Chairman & CEO [53]

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So there are 2 benefits there. Number one, you generate a profit as you are tolling for someone else. And the second thing, don't forget is, especially in Australia, helps us reduce the overhead absorption. So it makes all the other categories of products that we are processing in that facility, that much more profitable.

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Michael Van Aelst, TD Securities Equity Research - Research Analyst [54]

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Okay. All right. Can you update us on where that WPC80 stands now?

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Lino Anthony Saputo, Saputo Inc. - Chairman & CEO [55]

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I think the last quarter WPC80 was around $2.75. The market we're looking at moving forward is either going to remain stable or perhaps go up to $3. However, to get back to the historical levels of $4 a pound on WPC80, I think, will not be seen again.

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Michael Van Aelst, TD Securities Equity Research - Research Analyst [56]

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Okay. And when, on a big picture, if you look back to fiscal '18 and fiscal '19, your EBITDA margins were over 11%. And I know you don't like to give guidance, but what would it take for Saputo to get back to those kind of profit margins?

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Lino Anthony Saputo, Saputo Inc. - Chairman & CEO [57]

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I think it will take a better balance between supply and demand, which we are on our way there. It will take, perhaps, players in the industry to stop giving away margin just for the sake of volume because we've had margin erosion over the course of last 24 months, specifically because competitors have gone out and have just taken haircuts. And in some cases, if we want to keep some business in certain areas and certain key select products, we've got to take that haircut as well. So we need a bit more stability on supply-demand and we need a bit more stability on the competitive front. While that's going on, of course, we're looking at the initiatives that we can take on internally so that we can become bigger, better and stronger, and as we become bigger, better and stronger, mitigate some of those losses that we have to give up to pricing competitive activities.

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Michael Van Aelst, TD Securities Equity Research - Research Analyst [58]

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So does the higher-margin Dairy Crest business offset, say, some of the other costs that have brought down margins like the transportation costs and things like that?

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Lino Anthony Saputo, Saputo Inc. - Chairman & CEO [59]

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It's not a complete offset because Dairy Crest, it is a smaller platform. It is going to help, but it's not going to completely 100% offset what we've given up on the competitive front.

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Operator [60]

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Our next question is a follow-up question coming from the line of Mark Petrie with CIBC.

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Mark Robert Petrie, CIBC Capital Markets, Research Division - Executive Director of Institutional Equity Research & Research Analyst [61]

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I just have a detailed model question, but I was wondering about the depreciation in the Europe segment. Just looks relatively high versus the size of that business. So you can take it off-line, if you want, but just curious if the Q1 number is the run rate or what's behind that?

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Kai Bockmann, Saputo Inc. - President and COO of Saputo Inc. & the International Sector [62]

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Well, the Q1 number is the run rate for 11 weeks. You've got to take into account the fact that the assets were valued as part of the purchase price allocation, so that they are fair market value, and there is a branded business, which we do depreciate the brand. So the additional value on fixed asset as well as the brand makes the number bigger if you're comparing with historical depreciation.

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Operator [63]

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Our next question is a follow-up question coming from the line of Keith Howlett with Desjardins Securities.

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Keith Howlett, Desjardins Securities Inc., Research Division - VP, Consumer Products & Merchandising Analyst and Retail Analyst [64]

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I was wondering where -- what's going on with the 2 plants that you have in Australia in Melbourne and Sydney that were sort of dedicated, as I understood it, to certain customers?

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Kai Bockmann, Saputo Inc. - President and COO of Saputo Inc. & the International Sector [65]

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Yes, you're referring to our Laverton and Erskine Park sites, which are our 2 primary fluid milk assets in Australia as part of the Murray Goulburn acquisition. One of the things we wanted to do out of the gates was to look to renegotiate our contract with Coles. Those 2 assets were specifically built for the Coles business, but we were not happy with the terms and conditions under that contract, so we're looking to foster collaborative approach in terms of how we could work together and we found resolution just recently. And that has allowed us to look at processing more milk through those 2 assets. So we are in the midst of finalizing some agreements to bring more milk through both facilities, which would pretty much get us to close to maximum capacity for both sites.

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Keith Howlett, Desjardins Securities Inc., Research Division - VP, Consumer Products & Merchandising Analyst and Retail Analyst [66]

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And then I had a question on the Canadian market. In terms of the competitive landscape, is -- are most of the products sold at retail individually so you sell cheese or you sell yogurt or you sell fluid milk? Or is there an attempt to bundle products all in a bigger package and sort of sell the portfolio as it were.

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Kai Bockmann, Saputo Inc. - President and COO of Saputo Inc. & the International Sector [67]

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It's different for every customer. Sometimes it's by product, but in many instances, it's by portfolio.

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Keith Howlett, Desjardins Securities Inc., Research Division - VP, Consumer Products & Merchandising Analyst and Retail Analyst [68]

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So in terms of your product breadth in Canada, do you have sufficient product breadth to offer that portfolio?

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Kai Bockmann, Saputo Inc. - President and COO of Saputo Inc. & the International Sector [69]

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Yes, we do.

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Lino Anthony Saputo, Saputo Inc. - Chairman & CEO [70]

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In fact, I would say that, perhaps, we have the greatest of value that we can bring to retailers because we've got coast-to-coast manufacturing footprint in every major province in Canada, which some of our competitors don't have. That's for fluid and that would also be for cheeses. So that is one benefit. And then yes, as you well indicated, Keith, the breadth of products that we offer, everything from fluid milk to cottage cheese, sour cream, butter, spreads, cheeses, not just commodity, but specialty value added, Italian specialty, French specialty. I mean there are very few companies that have the breadth of product that we have, including the brands that we acquired through these acquisitions resonate with consumers in different regions. We maintain those brands across the country. So as an example, Dairyland is a strong brand in Western Canada for fluid milk. Armstrong is a strong brand across the country in cheddar. Saputo is a strong brand in Italian specialty cheeses. All of those brands resonate with consumers. We bring them to market every single day. That complemented with our infrastructure, makes us very, very hard to compete with.

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Operator [71]

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Mr. Saputo, there are no further questions at this time. I will now turn the call back to you.

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Lino Anthony Saputo, Saputo Inc. - Chairman & CEO [72]

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Thank you, Suzie.

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Marlene Robillard, Saputo Inc. - Director of Communications & Public Relations [73]

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We thank you for taking part in this conference call. We hope you'll join us for the presentation of our fiscal 2020 second quarter results on November 7. Have a nice day.

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Operator [74]

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That does conclude the conference call for today. We thank you for your participation and ask that you please disconnect your line.