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Edited Transcript of SXP.TO earnings conference call or presentation 2-Aug-19 2:00pm GMT

Q2 2019 Supremex Inc Earnings Call

Aug 3, 2019 (Thomson StreetEvents) -- Edited Transcript of Supremex Inc earnings conference call or presentation Friday, August 2, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Guy Prenevost

Supremex Inc. - CFO & Corporate Secretary

* Stewart Emerson

Supremex Inc. - President, CEO & Director

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Conference Call Participants

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* Neil Linsdell

Industrial Alliance Securities Inc., Research Division - Head of Research and Equity Research Analyst of Consumer Products & Special Situations

* Danielle Ste-Marie

STE-MARIE Strategy & Communications Inc. - Principal Advisor

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Presentation

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Operator [1]

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Good morning. My name is Julie, and I will be your conference operator today.

At this time, I would like to welcome everyone to the Supremex Inc. Second Quarter Results Conference Call. (Operator Instructions)

Danielle Ste-Marie, Investor Relations for Supremex, you may begin your conference.

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Danielle Ste-Marie, STE-MARIE Strategy & Communications Inc. - Principal Advisor [2]

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Thank you, Julie. Good morning, ladies and gentlemen. My name is Danielle Ste-Marie. I am an independent adviser and act in an Investor Relations capacity for Supremex. With us today is Stewart Emerson, President and CEO; and Guy Prenevost, Chief Financial Officer and Corporate Secretary.

I would like to welcome you to today's conference call to discuss our financial and operational results for the second quarter ended June 30, 2019, which were released earlier today. This call will be held in English. (foreign language)

For a more detailed analysis of our results, please see our financial statements, our Management Discussion & Analysis and our press release disclosed earlier this morning and available on the company's website and on SEDAR.

In addition, we posted a presentation supporting this conference call, which is available through the webcast and on our website.

I would like to remind listeners that this conference call contains forward-looking information within the meaning of applicable Canadian securities laws, and I refer the audience to the forward-looking statements as detailed in the presentation supporting this conference call.

Furthermore, risks and uncertainties are discussed throughout the December 31, 2018, MD&A under the heading Risk Factors.

Unless stated otherwise, all figures are expressed in Canadian dollars. During this call and on the accompanying presentation, we use various non-IFRS measures, including adjusted EBITDA and adjusted net earnings. These terms are also defined in our MD&A.

With these formalities out of the way, I would like to turn the call over to Stewart Emerson, President and CEO at Supremex, to review this quarter's key operational highlights and recent events. Stewart?

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Stewart Emerson, Supremex Inc. - President, CEO & Director [3]

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Thank you, Danielle, and welcome, everyone. Revenues were up year-over-year from the strong contribution of our Canadian and U.S. envelope operations. Higher average selling prices, which were implemented to offset input cost inflation contributed to this quarter's performance.

Overall, we are generally pleased that our price to cost relationship on the envelope side is back where it was prior to the inflationary pressures of 2018 and early 2019.

With regard to volume reductions, we were aligned with industry declines in Canada and performed better than the industry in the U.S.

Our U.S. envelope operations continued to progress and do well in spite of the conclusion of our strategic production contract with a commercial partner, which ran its course and ended in the second quarter 2018.

We continue to fortify our position and grow sales, which in turn, allows us to feed volume to Canadian operations.

In fact, units produced in Canada for the U.S. market have increased 48% year-over-year, thus fulfilling our strategic plan to stabilize the envelope operations as the industry goes through secular decline.

On the packaging side of our business, our combined folding carton operations continued to perform well, mainly from the contribution of our acquisition of G2 Printing during the second quarter of 2018.

We are pleased that 2 years after the Stuart Packaging acquisition and 1 full year after the G2 acquisition, we are validating our M&A rationale and are in fact slightly ahead of target on our core folding carton strategy, and we have significant runway for growth.

We went live with a new ERP system in both folding carton locations on July 2 and as a testament to our IT team and the resilience of the employees, the project was an unqualified success.

We've established ourselves as the largest independent folding carton organization in the Quebec marketplace and have earned a growing reputation for our premium quality print and folding capabilities.

In Q1, we press release the acquisition of a new 41-inch 7-color UV-equipped KBA press, and we're excited to say the project is on budget and on time, and we expect the new capabilities and capacity to be online and fully operational by the end of next week. These are indeed exciting times for our folding carton business.

On the e-commerce packaging side, the loss of volume from a single e-commerce packaging customer continued to weigh on our volume for the quarter.

Late in the end of the second quarter of 2018, we lost a low-margin distributed piece of a contract with this customer, which represented approximately $1 million per quarter of sales.

Additionally, in Q2, we experienced a reduction in volume as a result of the customer running through its accumulated inventory, to facilitate a change to the design of the package. This impacted us by another $1 million in the quarter.

This inventory runout is now complete, and we are in full production of the new design. Also, on the positive side, we are not only in full production of the portion we had retained, but we also won back the portion we lost in Q2 2018. And now with a patent-pending product that we are manufacturing. We are now in full production of that product so we are excited about what lies ahead in the e-commerce fulfillment packaging.

On the revenue side, Durabox performed essentially in line with last year. However, on the probability side that the majority of the shortfall in the quarter, for Supremex, was from residual issues based with the startup of the Durabox corrugate facility.

We performed much better in March than we did in the beginning of Q1 and thought we were in line for a return to profitability in Q2. Unfortunately, we experienced some setbacks, and we continue -- but we continue to make progress. This proved not to be the case. However, entering the third quarter, we are in a much better position. We've refreshed the management, and our machines are now producing very well. We are producing more volume in less time than at any other point in our history.

We are now confident that our production issues related to the startup and commissioning of the new plant are largely behind us.

Now that we are producing extremely well and can be confident in our ability to service, the sales organization is focused on growing sales in line with the investment thesis.

With this, I'll turn the call over to Guy for a quick review of our financial results for the second quarter ended June 30, 2019.

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Guy Prenevost, Supremex Inc. - CFO & Corporate Secretary [4]

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Thank you, Stewart. Good morning, everyone. Revenue for the 3-month period ended June 30, 2019, increased by 1.7%, reaching $47.6 million. Revenue growth came entirely from the U.S. -- the Canadian and the U.S. envelope sales. Revenue from packaging and specialty products was lower in the second quarter of 2019 and accounted for 28.7% of the company's revenue in the quarter.

Revenue from the Canadian envelope market stood at $23.3 million, an increase of 6.2%. Higher average selling prices, which increased by 15.5% to offset inflationary pressures on input costs, more than compensated the reduction in volume of 8.1%, which was in line with Canada Post Transactional Mail volume decline for the quarter ended March 31, 2019.

Revenue from the U.S. envelope market stood at $10.7 million, an increase of 10.2%. The volume of units sold was down 1.9% while average selling prices increased by 12.4%, of which approximately 3.6% comes from a positive currency conversion and the balance from increased selling prices to offset the input cost inflation. The 1.9% volume decline experienced in the quarter was less than the 3.9% U.S. postal service first class mail decline during the quarter ending March 31, 2019.

Revenue from packaging products was $13.6 million, a decrease of 10.2%. As Stewart explained, greater than 100% of the revenue decline came from the lower volume -- from lower volumes from a single e-commerce packaging customer [depleting] accumulated inventory to facilitate a packaging redesign, which in part -- was in part mitigated by increased folding carton sales from 2018 packaging acquisition.

EBITDA was $6.6 million compared with $6.5 million in the second quarter of 2018. The adoption of IFRS 16 had a material impact on the company's statement of financial position and its statement of earnings as nearly all operating leases were capitalized with a corresponding liability while operating expenses were reduced by $1.3 million.

The adjusted EBITDA stood at $5.5 million compared with $6.1 million during the second quarter of 2018. A decrease of $0.6 million in adjusted EBITDA is mainly attributable to costs related to the startup of the new Durabox facility and reduced contribution from the lower sales volume in packaging and related products.

Adjusted EBITDA margin stood at 11.6% of the revenue, down from 13.1% in the equivalent quarter of 2018.

Net earnings amounted to $1.8 million, or $0.06 per share for the 3-month period ended June 30, 2019, compared with $3.1 million or $0.11 per share for the equivalent period of 2018. Adjusted net earnings reached $1.9 million, or $0.07 per share for the 3-month period ended June 30, 2019, compared with $3 million or $0.10 per share for the equivalent period of 2018.

Net cash flows from operating activities increased to $8.6 million, during the 6 months period ended June 30, 2019, up from $7.3 million in the equivalent period of 2018. Excluding the impact of IFRS 16, net cash flows from operating activities would have been $6 million, a $1.3 million decrease when compared to Q2 2018.

On August 1, 2019, the Board of Directors declared a quarterly dividend of $0.065 per common share, payable on October 16, 2019, to the shareholders of record at the close of business on September 30, 2019.

This dividend is designated as an eligible dividend for the purpose of Income Tax Act and any similar provincial legislation.

Our net debt-to-adjusted-EBITDA ratio remains at a conservative 2.06x.

I would now like to turn the call over to analysts for questions. Operator?

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Questions and Answers

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Operator [1]

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(Operator Instructions) Your first question comes from the line of Neil Linsdell from Industrial Alliance.

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Neil Linsdell, Industrial Alliance Securities Inc., Research Division - Head of Research and Equity Research Analyst of Consumer Products & Special Situations [2]

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Just want to focus in on the e-commerce contract that you're talking about. So for the process of events, so in Q3 last year, you lost part of the contract, but you retained other sales into that customer? Correct?

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Stewart Emerson, Supremex Inc. - President, CEO & Director [3]

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Correct.

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Neil Linsdell, Industrial Alliance Securities Inc., Research Division - Head of Research and Equity Research Analyst of Consumer Products & Special Situations [4]

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And the -- so there's 2 issues. One, you have the inventory destocking that impacted Q2, but that's all out of the system, so Q3, we should expect -- Q3 and beyond, we should expect that to go back to normal sales levels?

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Stewart Emerson, Supremex Inc. - President, CEO & Director [5]

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Correct. So there are 2 -- sorry, Neil, go ahead. Yes, on the portion that we had retained, it should go back to normal levels in Q3. And the portion we had lost in late Q -- the part we had lost in late Q2 2018, is now back in a product that we're manufacturing.

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Neil Linsdell, Industrial Alliance Securities Inc., Research Division - Head of Research and Equity Research Analyst of Consumer Products & Special Situations [6]

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Right. And you mentioned that, that was about $1 million a quarter, and you've mentioned that it was previously at a low margin because of the way you had to do the sourcing for the product, but now that you're looking at a new design, would that be at a higher margin than it was?

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Stewart Emerson, Supremex Inc. - President, CEO & Director [7]

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It falls into traditional manufacturing margins. Yes.

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Neil Linsdell, Industrial Alliance Securities Inc., Research Division - Head of Research and Equity Research Analyst of Consumer Products & Special Situations [8]

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Okay. That's good then.

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Stewart Emerson, Supremex Inc. - President, CEO & Director [9]

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Yes.

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Neil Linsdell, Industrial Alliance Securities Inc., Research Division - Head of Research and Equity Research Analyst of Consumer Products & Special Situations [10]

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And that's right from the beginning of Q3, could we expect that positive impact or is it kind of delayed a little bit?

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Stewart Emerson, Supremex Inc. - President, CEO & Director [11]

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It's delayed a little bit, but mid- to late -- mid to -- mid-August.

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Neil Linsdell, Industrial Alliance Securities Inc., Research Division - Head of Research and Equity Research Analyst of Consumer Products & Special Situations [12]

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Mid-August? Okay. So half the benefit in the month.

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Stewart Emerson, Supremex Inc. - President, CEO & Director [13]

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Yes.

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Neil Linsdell, Industrial Alliance Securities Inc., Research Division - Head of Research and Equity Research Analyst of Consumer Products & Special Situations [14]

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Okay. Okay, good. And then as you're still working on the efficiency of -- in the new Durabox facility, could you talk about just exactly where you are as far as the percentage efficiency that you want to get to? And where the focus has to be and what the improvements should be, maybe from a profitability standpoint?

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Stewart Emerson, Supremex Inc. - President, CEO & Director [15]

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Yes. So June and July, we produced 100% of our needs internally. In fact, we have more inventory now than we would like or have ever had both on the raw material and finished goods side. As we juggled through sort of the inefficiencies of Q1 and Q2, we didn't let customers down, but we didn't make it easy for them. So we tried to -- what we tried to do is build the inventory, get the stability, get back to the high levels of service that customers expect from us. And they've been getting it for the last couple of months. And now we can really turn our focus to growing the sales. We -- I know for the last 3 or 4 quarters, people have been asking me, okay, what about the sales, what about the sales on the corrugate side. We took a cautious approach on trying to grow sales until we were confident that we could service the customers appropriately. So we're producing April, May, June, July of 2019, we produced about 40% more corrugate than we did in April, May, June, July of 2018 under the old scenario. And we did it in about 40% less machine hour time.

So I mean we really think we've got the operations side. It can still be optimized, but if we really -- if we've got the operations side figured out, now it's just a matter of turning on the sales side, and we have some -- there's some easy outlets that we can turn fairly easily, like in-sourcing product that we're -- the envelope division currently buys externally. We could in-source that now, which starts next week. And I've been out meeting with all the customers, and I'm encouraged by their willingness to up their position with Supremex.

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Neil Linsdell, Industrial Alliance Securities Inc., Research Division - Head of Research and Equity Research Analyst of Consumer Products & Special Situations [16]

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Okay. So far this year, you were still, however, purchasing corrugate for your purposes and passing it through, basically that was 0-margin business. And...

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Stewart Emerson, Supremex Inc. - President, CEO & Director [17]

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Correct.

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Neil Linsdell, Industrial Alliance Securities Inc., Research Division - Head of Research and Equity Research Analyst of Consumer Products & Special Situations [18]

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But that's now done as of June, July?

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Stewart Emerson, Supremex Inc. - President, CEO & Director [19]

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Yes. It was essentially done in May, late May. So yes, June, July.

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Neil Linsdell, Industrial Alliance Securities Inc., Research Division - Head of Research and Equity Research Analyst of Consumer Products & Special Situations [20]

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Okay. So a little bit of improvement in towards the end of Q2, and really we should see a benefit into Q3 where you're getting margin on that sale that you weren't before?

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Stewart Emerson, Supremex Inc. - President, CEO & Director [21]

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Correct.

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Neil Linsdell, Industrial Alliance Securities Inc., Research Division - Head of Research and Equity Research Analyst of Consumer Products & Special Situations [22]

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Oh, good. And then on the envelopes, you talked about using the excess capacity in the Canadian envelope manufacturing to ship into the U.S. Do you expect that to continue to increase because you had done some rationalization in your Canadian operations to make them more efficient end of last year?

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Stewart Emerson, Supremex Inc. - President, CEO & Director [23]

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That was -- sorry, so that was completely -- that rationalization last year was completely indirectly were in salaried staff. It doesn't affect our capacity at all. We didn't check it. In fact, we're trying to grow our capacity. We've made good progress in the U.S. It's taken us longer than sort of expected, but the foundation we've been laying over the last couple of years really started to pay dividends. And to increase our production in Canada for the U.S. by 40-some-odd percent, almost 50%, year-over-year, not even just a quarter. I mean, over the first 6 months, producing almost 50% more in Canada for the U.S. is pretty staggering, and it's sort of a testament that how we're growing the sales down there. And we've also been a little bit -- candidly, we've been a little bit more aggressive in terms of bringing orders to Canada that they might have been running on less efficient equipment in the U.S., taking advantage of our capabilities, the equipment base and the Canadian dollar.

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Neil Linsdell, Industrial Alliance Securities Inc., Research Division - Head of Research and Equity Research Analyst of Consumer Products & Special Situations [24]

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Okay. So do you expect that to continue increasing then, the amount that you're shipping from Canada into the U.S.? Or is it more improving efficiency costs or what have you in the U.S.?

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Stewart Emerson, Supremex Inc. - President, CEO & Director [25]

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Oh, yes. We're really -- we didn't -- we expect to continue to oversell the capacity in the U.S. and produce it in Canada, which was the thesis all along.

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Neil Linsdell, Industrial Alliance Securities Inc., Research Division - Head of Research and Equity Research Analyst of Consumer Products & Special Situations [26]

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Right. And it's -- but on the transportation cost honored a bad detriment to that?

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Stewart Emerson, Supremex Inc. - President, CEO & Director [27]

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No. I mean, it doesn't make it easier, but I mean it's not something that we can't overcome.

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Neil Linsdell, Industrial Alliance Securities Inc., Research Division - Head of Research and Equity Research Analyst of Consumer Products & Special Situations [28]

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Okay. And lastly, I just want to talk about your free cash flow. So you've already got a 10%-plus dividend yield. The dividend has been stable. The excess cash you're talking about using between share buybacks and debt reduction, but you've also just -- and you've just increased your credit facility, correct?

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Stewart Emerson, Supremex Inc. - President, CEO & Director [29]

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Correct.

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Neil Linsdell, Industrial Alliance Securities Inc., Research Division - Head of Research and Equity Research Analyst of Consumer Products & Special Situations [30]

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So what would be -- I assume, the dividend is stable. It looks like it's very well supported. So what's your focus going to be for the excess cash that you have, is it going to be debt, is it going to be share buybacks? And the share buyback, when does that the current NCIB end?

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Guy Prenevost, Supremex Inc. - CFO & Corporate Secretary [31]

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NCIB ends on I think August 7 of this year. We purchased 115,000 shares in Q2 of this year. We feel that our share price is very much undervalued as it is. So this continues to be part of the Board's long-term strategy for capital allocation.

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Neil Linsdell, Industrial Alliance Securities Inc., Research Division - Head of Research and Equity Research Analyst of Consumer Products & Special Situations [32]

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So you could be much more aggressive on the NCIB with the cash that you have, rather than focusing more on the debt repayment?

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Guy Prenevost, Supremex Inc. - CFO & Corporate Secretary [33]

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We could, but again, it's capital allocation. We are also as part of our strategy, growth strategy includes acquisitions. So we have to balance all that.

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Neil Linsdell, Industrial Alliance Securities Inc., Research Division - Head of Research and Equity Research Analyst of Consumer Products & Special Situations [34]

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Okay. So for most of -- since you bring up acquisitions, most of the efforts seem to have been working on your manufacturing efficiencies, getting that aligned, now improving the sales of the -- out of Durabox. Where are you or what's your thought process now on the acquisition front? Do you have a lot of stuff in the pipeline?

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Stewart Emerson, Supremex Inc. - President, CEO & Director [35]

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I wouldn't categorize it as a lot, but we have a good pipeline. Sort of that -- across that spectrum of our sort of 5 operating units or products. So yes, we continue to move along those lines, but it's a long way between conversations and completion.

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Operator [36]

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(Operator Instructions) There are no further questions at this time. I will turn the call back over to Mr. Stewart Emerson.

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Stewart Emerson, Supremex Inc. - President, CEO & Director [37]

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Great. Thank you, Neil, for your questions there. Just on the closing comments. We continue to prioritize the organic growth of our packaging business in 2019 and build on our corrugate and folding carton CapEx. We expected a far better

quarter from Durabox and did not get it. We've been producing at good levels and doing so consistently and are now focused on sales growth and can continue to concentrate on returning this business unit to its full potential.

E-commerce is back to its exciting growth trajectory. Folding carton will be the beneficiary of improved capacity, capabilities and efficiencies associated with the new press and are already reaping the benefits of their ERP implementation. The envelope business continues to perform well, and with the price increase catch up largely complete and the growth we're enjoying in the U.S., we expect the envelope group to continue to be a strong cash flow generating unit.

As always, we remain dedicated to our objective of prudently achieving our 50-50 envelope packaging revenue split and creating value for our shareholders.

Most importantly, our cash flows remain strong and allow us to maintain a conservative level of debt, while we continue to invest in our long-term growth and diversification strategy. I want to thank all of our some 800 employees for the commitment, dedication and focus through a massive amount of change as we continue to evolve as a corporation.

This completes my closing remarks. I look forward to meeting you, again, on this call to discuss our third quarter results in November. Thank you, everyone, and have a great weekend.

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Operator [38]

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