Winpak Ltd — Management Reports 2020

Mar 3, 2020

MANAGEMENT’S DISCUSSION AND ANALYSIS

Forward-looking statements: Certain statements made in the following Management’s Discussion and Analysis contain forward-looking statements including, but not limited to, statements concerning possible or assumed future results of operations of the Company. Forward-looking statements represent the Company’s intentions, plans, expectations and beliefs, and are not guarantees of future performance. Such forward-looking statements represent Winpak’s current views based on information as at the date of this report. They involve risks, uncertainties and assumptions and the Company’s actual results could differ, which in some cases may be material, from those anticipated in these forward-looking statements. Factors that could cause results to differ from those expected include, but are not limited to: the terms, availability and costs of acquiring raw materials and the ability to pass on price increases to customers; ability to negotiate contracts with new customers or renew existing customer contracts with less favorable terms; timely response to changes in customer product needs and market acceptance of our products; the potential loss of business or increased costs due to customer or vendor consolidation; competitive pressures, including new product development; industry capacity, and changes in competitors’ pricing; ability to maintain or increase productivity levels; ability to contain or reduce costs; foreign currency exchange rate fluctuations; changes in governmental regulations, including environmental, health and safety; changes in Canadian and foreign income tax rates, income tax laws and regulations. Unless otherwise required by applicable securities law, Winpak disclaims any intention or obligation to publicly update or revise this information, whether as a result of new information, future events or otherwise. The Company cautions investors not to place undue reliance upon forward-looking statements.

General Information

The following discussion and analysis dated March 3, 2020 was prepared by management and should be read in conjunction with the consolidated financial statements prepared in accordance with International Financial Reporting Standards (IFRS). The following discussion and analysis is presented in US dollars except where otherwise noted. The consolidated financial statements include the accounts of all subsidiaries. The Company’s functional and reporting currency is the US dollar. The Company has filed a separate Management’s Discussion and Analysis for its fourth quarter of 2019, which is available on the Company’s website at www.winpak.com or on SEDAR at www.sedar.com.

The fiscal year of the Company ends on the last Sunday of the calendar year. As a result, the Company’s fiscal year is usually 52 weeks in duration, but includes a 53[rd] week every five to six years. The 2019 and 2018 fiscal years are both comprised of 52 weeks.

Company Overview

The Company provides three distinct types of packaging technologies: a) rigid packaging and flexible lidding, b) flexible packaging and c) packaging machinery. Each is deemed to be a separate operating segment.

The rigid packaging and flexible lidding segment includes the rigid containers, lidding and specialized printed packaging product groups. Rigid containers include portion control and single-serve containers, as well as plastic sheet, custom and retort trays, which are used for applications such as food, pet food, beverage, dairy, industrial and healthcare. Lidding products are available in die-cut, daisy chain and rollstock formats and are used for applications such as food, dairy, beverage, industrial and healthcare. Specialized printed packaging provides packaging solutions to the pharmaceutical, healthcare, nutraceutical, cosmetic and personal care markets.

The flexible packaging segment includes the modified atmosphere packaging, specialty films and biaxially oriented nylon product groups. Modified atmosphere packaging extends the shelf life of perishable foods, while at the same time maintains or improves the quality of the product. The packaging is used for a wide range of markets and applications, including fresh and processed meats, poultry, cheese, medical device packaging, high performance pouch applications and high-barrier films for converting applications. Specialty films include a full line of barrier and non-barrier films which are ideal for converting applications such as printing, laminating and bag making, including shrink bags. Biaxially oriented nylon film is stretched by length and width to add stability for further conversion using printing, metalizing or laminating processes and is ideal for food packaging applications such as cheese, fluid and viscous liquids, and industrial applications such as book covers and balloons.

Packaging machinery includes a full line of horizontal fill/seal machines for preformed containers and vertical form/fill/seal pouch machines for pumpable liquid and semi-liquid products and certain dry products.

Selected Financial Information

Selected Financial Information	Selected Financial Information
Millions of US dollars, except per share and margin amounts		2019	2018	2017
	Revenue Income from operations Net income attributable to equity holders of the Company Gross proft margin Earnings per share(cents) Reconciliation of EBITDA Net income Income tax expense Net fnance (income) expense Depreciation and amortization EBITDA	873.8 155.0 114.8 31.3% 177 118.1 41.7 (4.8) 43.5 198.5	889.6 150.1 108.9 30.4% 168 111.6 40.0 (1.5) 40.1 190.2	886.8 162.7 119.3 31.2% 184 122.7 38.8 1.2 37.5
				200.2

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MANAGEMENT’S DISCUSSION AND ANALYSIS

Overall Performance

• ∆ Revenue was $15.8 million or 1.8 percent less than the all-time high of $889.6 million attained in 2018. Normalizing for the 2019 business acquisition that was completed at the beginning of the fourth quarter, volumes declined by 1.3 percent. Revenue contraction also reflected the negative impact of selling price and mix changes and a weaker Canadian dollar which resulted in revenue decreases of $6.4 million and $2.7 million respectively.

• ∆ Gross profit margins advanced by nearly one percentage point from the prior year to 31.3 percent. The significant reduction in raw material costs for two of the Company’s main resins was the overriding factor behind the increase and overshadowed the related lower selling price pass-throughs to customers on formal price indexing programs as well as the elevated fixed manufacturing overhead costs that stemmed from recent capital expenditures.

• ∆ Net income attributable to equity holders of the Company of $114.8 million surpassed the prior year’s net income attributable to equity holders of the Company of $108.9 million by 5.4 percent. Significantly higher gross profit margins and net finance income, in addition to the favorable tailwind provided by foreign exchange, were partially offset by higher operating expenses and the decrease in sales volumes.

• ∆ Cash and cash equivalents ended the year at $397.2 million, an increase of $52.8 million from the start of the year, despite funding investing activities of $100.9 million. Winpak continued to generate robust cash flow from operating activities. There are no short-term borrowings or long-term debt outstanding.

Highlights

• ∆ Raw materials: The annual average cost of raw materials declined considerably by 12.2 percent in 2019, after rising in each of the previous two years.

• ∆ Operating expenses: Higher personnel costs and pre-production expenses contributed to a higher level of operating expenses, reducing earnings per share by 3.0 cents.

• ∆ Foreign exchange: Favorable translation differences in regards to Canadian dollar monetary assets and liabilities were recorded in 2019 whereas in 2018, unfavorable translation differences arose. Paired with the beneficial impact of the weaker Canadian dollar in relation to the US dollar, foreign exchange augmented earnings per share by 4.5 cents.

• ∆ Capital expenditures: Capital expenditures in 2019 totaled $58.1 million, reflecting new extrusion, thermoforming and converting capacity as well as the building expansion that will support the new biaxially oriented polyamide (BOPA) line.

• ∆ Business acquisition: On October 1, 2019, the Company signed a definitive agreement and closed the acquisition with respect to all the business (net assets including property and plant) of privately owned Cheringal Associates, Inc. and Norwood Printing, Inc. collectively (“Control Group”) located in Norwood, New Jersey. Control Group provides specialized printed packaging formats to select markets. The purchase price of $42.7 million was paid from cash resources on hand. The acquired business now operates as Winpak Control Group Inc. (WCGI). Winpak’s financial performance for the year ended December 29, 2019 reflects the operating results of WCGI since October 1, 2019, including revenue of $5.2 million, and income from operations of $0.2 million.

• ∆ Financing and investing: Cash flow from operating activities reached $160.0 million and provided the foundation to fund the current year’s capital projects of $58.1 million and the $42.7 million purchase of Control Group. During 2020, the Company will leverage its cash resources on hand and generate additional cash flow from operations, funding its targeted investing and financing activities. Management will continue to appraise strategic acquisition opportunities together with implementing its focused organic capital investment program, both dedicated to enhancing long-term shareholder returns.

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Results of Operations

Components of total increase (decrease) in earnings per share (EPS)

Results of Operations Components of total increase(decrease) in earnings per share(EPS)
	2019	2018	2017
Organic growth	(2.5)	(2.0)	10.0
Gross proft margins	6.0	(3.5)	(8.5)
Operating expenses, net fnance income (expense) and non-controlling interests	0.0	1.0	0.5
Income taxes	1.0	(7.0)	18.5
Foreign exchange	4.5	(4.5)	2.5
Total increase(decrease)in EPS(cents)	9.0	(16.0)	23.0

Ongoing operations

Organic growth is the effect on net income due entirely to increased sales volumes and excludes the influence of acquisitions, divestitures and foreign exchange. In 2019, this lowered EPS by 2.5 cents in comparison to the prior year.

Gross profit margins expanded in 2019 as the heightened spread between selling prices and raw material costs was only partially offset by the contraction caused by the rise in manufacturing costs in relation to relatively unchanged sales volumes.

Higher net finance income propelled EPS forward by 4.0 cents. Meanwhile, the elevation in operating expenses lowered EPS by 3.0 cents and a further 1.0 cent EPS reduction was caused by the higher proportion of earnings attributable to non-controlling interests.

The effective income tax rate dropped by half a percentage point, adding 1.0 cent to EPS.

Foreign exchange had a positive impact of 4.5 cents on EPS versus the previous year. On average, the Canadian dollar was weaker compared to its US counterpart in 2019. This positive occurrence, in tandem with the turnaround in foreign exchange translation differences on Canadian net monetary items from losses in the prior year to gains in the current year, accounted for the favorable result.

Revenue

Revenue
Revenue Change				Millions of US dollars
		2019				2018			2017
Volume (decrease) increase		(11.9)				(10.4)			50.4
Business acquisition		5.2				-			-
Price and mix (losses) gains		(6.4)				12.4			11.9
Foreign exchange(losses) gains		(2.7)				0.9			1.9
Total(decrease)increase in revenue		(15.8)				2.9			64.2

For 2019, revenue of $873.8 million represented a decrease of $15.8 million or 1.8 percent compared to 2018 revenue of $889.6 million. Volumes, in total, declined by 1.3 percent from the prior year after adjusting for the incremental volume from the Control Group acquisition, which added 0.5 percent to 2019 revenue. The rigid packaging and flexible lidding operating segment experienced a 7 percent contraction in volumes. Volumes for the rigid container product group were restrained, influenced by the contraction in specialty beverage and retort tray shipments. Conversely, the lidding product group benefitted from inroads made with respect to specialty beverage die-cut lidding. The flexible packaging operating segment advanced by 4 percent. Robust growth in biaxially oriented nylon volumes reflected the heightened activity at key accounts. Gains at protein and dairy producers, most notably in Mexico, generated modest volume growth in modified atmosphere packaging while specialty films experienced lighter activity in the year. Within the packaging machinery operating segment, volume growth was healthy at 9 percent. Compared to 2018, selling price and mix changes had a negative effect on revenue of 0.7 percent. Foreign exchange reduced reported revenues by another 0.3 percent.

Gross profit margins

For the current year, gross profit margins climbed to 31.3 percent of revenue versus the 2018 level of 30.4 percent. This resulted in an overall increase in EPS of 6.0 cents. The sizeable decline in raw material costs for two of the Company’s principal resins was a significant factor as the related selling price adjustments passed along to customers on contractual price indexing arrangements did not take effect until the second half of 2019. This resulted in an expansion in gross profit margins, raising EPS by 9.5 cents. With sales volumes receding marginally in the current year and fixed manufacturing costs rising, due to targeted capital expenditures in recent years, gross profit margins were negatively impacted which tempered EPS by 3.5 cents.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

Winpak’s average raw material index, which represents the weighted cost of the Company’s eight primary raw materials, fell by 12.2 percent from the 2018 average. The change in raw material pricing varied amongst the different raw materials. Polyethylene and polypropylene resin costs were markedly lower, decreasing by 19 percent and 25 percent respectively.

Raw Material Index

	2019	2018	2017
(Decrease)increase in index compared toprioryear	(12.2%)	2.5%	9.5%

Expenses

For the 2019 fiscal year, operating expenses, adjusted for foreign exchange and the acquisition of Control Group, grew at a rate of 0.9 percent in relation to the drop in sales volumes, generating a decline in EPS of 3.0 cents. During 2019, additional one-time personnel costs were incurred due to the closure and relocation of an administration office. Pre-production costs in 2019 were $0.9 million higher than 2018 and related primarily to new production lines being commercialized along with new product development.

Foreign Exchange

Foreign Exchange
	2019	2018	2017
Year-end exchange rate of CDN dollar to US dollar	0.765	0.733	0.795
Year-end exchange rate of US dollar to CDN dollar	1.308	1.365	1.258
Appreciation (depreciation) of CDN dollar vs. US dollar year-end
exchange rate compared to theprioryear	4.4%	(7.8%)	7.6%
Average exchange rate of CDN dollar to US dollar	0.752	0.776	0.769
Average exchange rate of US dollar to CDN dollar	1.329	1.289	1.301
(Depreciation) appreciation of CDN dollar vs. US dollar average
exchange rate compared to theprioryear	(3.1%)	0.9%	2.4%

Winpak utilizes the US currency as both its reporting and functional currency. However, with approximately 59 percent of its production capacity located in Canada, it is exposed to foreign exchange risks and records foreign currency differences on transactions and translations denominated in Canadian dollars as well as other foreign currencies. With a production facility located in Mexico, the Company is also exposed to foreign exchange risks on costs denominated in Mexican pesos but these are less significant.

On a net basis, foreign exchange had a favorable impact on EPS of 4.5 cents in 2019 compared to the prior year. Approximately 10 percent of revenues and 20 percent of costs in the current year were denominated in Canadian dollars. The net outflow of Canadian dollars exposes Winpak to transaction differences arising from exchange rate fluctuations. The depreciation in the average exchange rate of the Canadian dollar in relation to the US dollar in 2019 of 3.1 percent increased EPS by 2.0 cents compared to 2018. As part of the Company’s hedging program to manage this risk, the foreign exchange contracts that matured during 2019 were at a less advantageous average exchange rate, generating foreign exchange losses. Less significant foreign exchange losses were incurred on these financial instruments in the prior year and the relative change decreased EPS by 0.5 cents. In contrast, translation differences, which arise when Canadian dollar monetary assets and liabilities are translated at exchange rates that change over time, raised EPS by 3.0 cents in the current year in comparison to 2018.

Summary of quarterly results

Thousands of US dollars, except earnings per share (EPS) amounts (cents)

Quarter ended March 31 June 30 September 29 December 29		2019	EPS 44 48 44 41 177	Quarter ended April 1 July 1 September 30 December 30		2018
	Revenue 224,035 219,618 212,734 217,456 873,843	Net income 28,429 31,086 28,578 26,679 114,772*			Revenue 221,665 225,191 220,647 222,138 889,641	Net income* 26,361 28,042 27,835 26,683 108,921	EPS
							41 43 43 41
							168

*attributable to equity holders of the Company

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Various factors affect timing of the Company’s earnings during the course of a year. Typically, seasonal factors contribute to stronger revenue and net income in the second and fourth quarters compared to the first and third quarters. Factors influencing seasonal trends are the higher demand for certain food products in advance of the summer season and the greater number of holidays in the fourth quarter. During the third quarter, revenue and net income are typically lower due to reduced order levels and plant maintenance shutdowns scheduled to coincide with the summer. Sudden and substantial changes in the rate of exchange between the Canadian and US dollars from one quarter to another may cause revenue and net income to vary from the historic trend. Similarly, sudden and significant changes in the cost of raw materials consumed from one quarter to another can be expected to increase or decrease net income in a manner that does not conform to the normal pattern. Furthermore, unexpected adverse weather conditions could influence the supply and price of raw materials or customer order levels, and the timing of commercializing new manufacturing equipment can cause revenue and net income to depart from established trends.

The following items influenced the timing of the Company’s reported results beyond historic trends. In the current year, revenue in the first and second quarter was elevated primarily due to the timing of selling price reductions being passed on to customers on contractual price indexing arrangements which did not take meaningful effect until the second half of 2019. The purchase of Control Group in the fourth quarter of 2019 favorably influenced revenue. Conversely, 2019 fourth quarter revenue was negatively affected by a major customer’s reduced volumes as the Company is supplying a lesser share of the business with its conversion to a recyclable product. Operating expenses in the fourth quarter of 2019 were affected by elevated pre-production costs and expenses incurred for a pension plan settlement, lowering net income. Operating expenses in the fourth quarter of 2018 were impacted by higher personnel costs and employee benefit expenses, reducing net income.

Cash Flow, Liquidity and Capital Resources

At December 29, 2019, Winpak’s cash and cash equivalents balance totaled $397.2 million, an advancement of $52.8 million from the prior year-end. This increase resulted from cash provided by operating activities of $160.0 million less disbursements for investing activities of $100.9 million and financing activities of $6.3 million.

Operating activities

Cash from operating activities amounted to $160.0 million. A notable improvement of $8.0 million was realized in cash generated from operating activities before changes in working capital which totaled $199.4 million. This was offset in part by a further investment in working capital for the current year of $4.2 million. Trade and other receivables grew by $6.0 million due to the timing of cash receipts. Income tax payments were $37.8 million, up $4.5 million from the previous year due to greater tax installments mandated by higher taxable income levels. Employee defined benefit plan contributions of $2.5 million were funded during the year. Finally, net finance income rose by $5.1 million due to elevated cash and cash equivalents amounts and higher interest rates during the year.

Investing activities

Investing activities in 2019 reached $100.9 million, including plant and equipment additions of $58.1 million and the acquisition of Control Group at a price of $42.7 million. Intangible asset purchases amounted to $0.1 million. The main plant and equipment expenditures included: the completion of the new flexible packaging facility in Querétaro, Mexico; a new extrusion line at the Senoia, Georgia plant; two new thermoforming lines at the Sauk Village, Illinois operation; and the building expansion in Winnipeg, Manitoba that will house the new state-of-the-art BOPA line. Over the long term, Winpak’s expenditures for maintaining the existing equipment’s capabilities have averaged approximately 2 percent of revenue.

Financing activities

Financing activities in 2019 consisted of dividends to common shareholders of $5.8 million and payments relating to lease liabilities of $0.5 million. A regular quarterly dividend of $0.03 Canadian was paid. The Company’s objectives in managing capital are to have sufficient liquidity to pursue organic growth along with strategic acquisitions so that an appropriate rate of return on investments is provided to shareholders.

Resources

Investments to drive organic and acquisitive growth can be significant, requiring substantial financial resources. A range of funding alternatives is available including cash and cash equivalents, cash flow provided by operations, additional debt facilities, issuance of equity or a combination thereof. An informal investment grade credit rating allows the Company access to relatively low interest rates on debt. The Company currently has unused operating lines of $38 million, which are believed adequate for liquidity purposes. Based on discussions with various financial institutions, Winpak believes that additional credit can be arranged from banks and other major lenders as required. The Company is confident that all 2020 requirements for capital expenditures, payment of lease liabilities, working capital, and dividend payments can be financed from cash resources, cash provided by operating activities and unused credit facilities.

Risks and Financial Instruments

The Company recognizes that net income is exposed to changes in market interest rates, foreign exchange rates, prices of raw materials and risks regarding the financial condition of customers and financial counterparties. These market conditions are regularly monitored and actions are taken, when appropriate, according to Winpak’s policies established for the purpose. Despite the methods employed to manage these risks, future fluctuations in interest rates, foreign exchange rates, raw material costs and counterparty financial condition can be expected to impact net income.

Winpak’s policy regarding interest expense is to fix interest rates on between one- and two-thirds of any long-term debt outstanding. The Company may enter into derivative contracts or fixed-rate debt to minimize the risk associated with interest rate fluctuations. For the past ten years, Winpak has not had any long-term debt outstanding.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

With respect to foreign exchange risk, Winpak employs hedging programs to minimize risks associated with changes in the value of the Canadian dollar relative to the US dollar. To the extent possible, the Company maximizes natural currency hedging by matching inflows from revenue in a currency with outflows of costs and expenses denominated in the same currency. For the remaining exposure, the Company’s foreign exchange policy requires that between 50 and 80 percent of the Company’s net requirement of Canadian dollars for the ensuing 9 to 15 months will be hedged at all times with forward or zero-cost option contracts. The Company may also enter into foreign currency forward contracts when equipment purchases will be settled in other foreign currencies. Purchases of foreign exchange products for the purpose of speculation are not permitted. Transactions are only conducted with certain approved Schedule 1 Canadian financial institutions.

Significant fluctuations in foreign exchange rates represent a material exposure for the Company’s financial results. Hedging programs employed may mitigate a portion of exposures to short-term fluctuations in foreign currency exchange rates. However, the Company’s financial results over the long term will inevitably be affected by sizeable changes in the value of the Canadian dollar relative to the US dollar. Winpak estimates that each time the exchange rate strengthens or weakens by one Canadian cent against the US dollar, net income, with respect to transaction differences, will decrease or increase, respectively, by approximately 0.7 of a US cent per share.

During 2019, certain foreign currency forward contracts matured and the Company realized pre-tax foreign exchange losses of $1.6 million. As at December 29, 2019, the Company had US to CDN dollar foreign currency forward contracts outstanding with notional amounts of $35.0 million. The pretax unrealized foreign exchange gain on these contracts of $0.5 million was recorded in other comprehensive income.

Winpak has not participated in any derivatives market for raw materials. Winpak is not aware of any instrument that fully mitigates fluctuations in raw material costs over the long term. To manage this risk, Winpak has entered into formal selling price-indexing agreements with certain customers whereby changes in raw material prices are reflected in selling price adjustments, albeit with a three to four-month time lag. For 2019, 69 percent of Winpak’s revenue was governed by selling price-indexing agreements. For all other customers, the Company responds to changes in raw material costs by adjusting selling prices on a customer-by-customer basis. However, market conditions can have an impact on these price adjustments such that the combined impact of selling price adjustments and changes in raw material costs can be significant to Winpak’s net income.

Credit risk arises from cash and cash equivalents held with banks, derivative financial instruments (foreign currency forward and option contracts), as well as credit exposure to customers, including outstanding accounts receivable. The Company assesses the credit quality of counterparties, taking into account their financial position, past experience and other factors. Management regularly monitors customer credit limits, performs credit reviews and, in certain cases, insures accounts receivable balances against credit losses. The Company also sells certain extended term trade receivables without recourse to financial institutions in exchange for cash. The Company invests its excess cash on a short-term basis, to a maximum of six months, with financial institutions and/or governmental bodies that must be rated ‘AA’ or higher for CDN financial institutions and ‘A-1’ or higher for US financial institutions by recognized international credit rating agencies or insured 100 percent by the US government or a ‘AAA’ rated Canadian federal or provincial government. Nonetheless, unexpected deterioration in the financial condition of a counterparty can have a negative impact on the Company’s net income in the case of default.

The Company enters into contractual obligations in the normal course of business operations. These obligations, as at December 29, 2019, are summarized below.

Contractual Obligations			Payment due, by	Payment due, by	period(thousands of US dollars)	period(thousands of US dollars)	period(thousands of US dollars)
		Total	1year		2 - 3years		4 - 5 Years		After 5years
Leases		10,380	1,112		2,613		2,778		3,877
Purchase obligations		29,741	27,502		2,239		-		-
Total contractual obligations		40,121	28,614		4,852		2,778		3,877

Looking Forward

In 2019, the North American food packaging markets exhibited nominal growth. Winpak’s sales volumes receded slightly due to weak/lost rigid container business which overshadowed the positive volume gains realized from the Company’s other product groups. During 2019, considerably lower raw material resin costs for polyethylene and polypropylene provided the catalyst for elevated gross profit margins and earnings advancement. The decline in these resin costs resulted in lower customer selling prices as 69 percent of the Company’s revenues are indexed to the price of raw materials albeit with a three to four-month time lag. In 2020, a key strategic focus for the Company will be to continue developing and expanding its portfolio of recyclable/reusable products to meet customers’ expectations for sustainable plastic food packaging. Winpak expects revenues and earnings to advance from sales volume growth however, there is a degree of uncertainty on timing as customers control the onboarding of new business. Sales volumes are projected to expand in the flexible lidding and flexible packaging segments. The new Mexican flexible packaging facility is fully operational and will provide local customers with unique, high-quality print technology capabilities for the protein and cheese markets. The acquisition of Control Group will provide an uplift to revenues and earnings. In addition, this strategic investment provides Winpak with the ability to realize synergies and pursue new business opportunities with its clients. Rigid container sales volumes will expand from new business being secured with customers, including new product launches however, this growth will be more than offset by the reduced participation in supplying the specialty beverage business with the new recyclable polypropylene cup. Competitive selling price pressures are prevalent which will apply pressure on gross profit margins. As raw material resin costs declined marginally in the

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fourth quarter of 2019, downward pressure will be applied on selling prices in the first quarter of 2020. Polyethylene and polypropylene resin costs are forecast to rise in the first half of the year however, these resin costs should still be lower from a year-over-year perspective. Production costs may be elevated as new and retrofitted extrusion lines strive to achieve commercial status, the extent of which will depend on the technical challenges that may be encountered. Gross profit margins are not expected to deviate from levels attained in recent years by more than a few percentage points. The Company will continue to focus on elevating operational performance by reducing production waste, introducing lower cost raw material formulations and improving productivity. With the reduction in US interest rates in the second half of 2019 and the potential for further interest rate reductions in 2020, finance income will be negatively affected in the coming year.

Capital expenditures of $60 to $70 million are forecasted for 2020. To secure future organic growth prospects, cash resources will be put towards capital projects that significantly elevate the Company’s material science acumen and technical capabilities with new production technologies and processes to drive the development of recyclable/reusable products that North American customers are now trying to effectively source. In this regard, two cast coextrusion lines are undergoing substantial modifications and upgrades, at the modified atmosphere packaging plant in Winnipeg, Manitoba, to broaden the Company’s product portfolio with a new generation of recyclable/reusable high-barrier thermoformable transparent films. Both retrofit projects are scheduled to be completed by the end of 2020. Other major capital expenditures being completed in the upcoming year include: a new extrusion line will be operational by the end of the first quarter at the Senoia, Georgia specialty films facility; additional capacity from a polypropylene thermoforming line is planned to be commercial in the second quarter at the Sauk Village, Illinois rigid container plant; the packaging machinery operations will be relocating in the fourth quarter from San Bernardino to Rialto, California, occupying a new, significantly larger leased facility to accommodate future growth requirements; and the state-of-the-art biaxially oriented polyamide (BOPA) line and building expansion in Winnipeg, Manitoba continues to move forward with the new line projected to be commercial in the first quarter of 2021. Winpak’s strong financial resources enable management to assess strategic business acquisition opportunities that meet and align with its principal competencies in sophisticated plastic packaging for food, beverage and healthcare applications providing enhanced long-term shareholder returns.

Accounting Policy Changes

The following accounting standards came into effect commencing in the Company’s 2019 fiscal year:

Uncertainty Over Income Tax Treatments

In June 2017, IFRIC Interpretation 23 “Uncertainty over Income Tax Treatments” was issued and aims to reduce diversity in how companies recognize and measure a tax liability or tax asset when there is uncertainty over income tax treatments. The Interpretation was implemented with retrospective application, effective December 31, 2018, and had no impact on the Company’s consolidated financial statements.

Employee Benefit Plan Amendment, Curtailment or Settlement

In February 2018, amendments to IAS 19 “Employee Benefits” were issued to specify how an entity determines pension expenses when changes to a defined benefit plan occur. When a change to a plan takes place, including an amendment, curtailment or settlement, IAS 19 requires an entity to remeasure its employee benefit plan liability or asset. The amendments require an entity to use the updated assumptions from this remeasurement to determine current service cost and the net finance cost for the remainder of the reporting period after the change to the plan occurs. The amendments were implemented with prospective application, effective December 31, 2018, and had no impact on the Company’s consolidated financial statements.

Leases

The Company has adopted IFRS 16 “Leases” with a date of initial application of December 31, 2018. The new standard introduces a balance sheet recognition and measurement model for lessees, eliminating the distinction between operating and finance leases. As a result, most leases are recognized on the balance sheet. Certain exemptions apply for short-term leases and leases for low-value assets. Lessors continue to classify leases as operating and finance leases. IFRS 16 replaces IAS 17 “Leases” and the related interpretations.

As a result of the adoption of IFRS 16, the Company’s accounting policies have been updated (see note 4 to the consolidated financial statements). The adoption of IFRS 16 did not impact the Company’s accounting policies for lessors. The consequential financial impact of the adoption of IFRS 16 is presented in note 3 and lease disclosures are presented in note 23.

The Company has applied IFRS 16 using the modified retrospective approach and therefore the comparative information has not been restated and continues to be reported under IAS 17. On initial application, the Company has elected to record right-of-use assets based on the corresponding lease liability. Right-of-use assets and lease liabilities of $568 were recorded as of December 31, 2018, with no net impact on retained earnings. When measuring lease liabilities, the Company discounted lease payments using its incremental borrowing rate at December 31, 2018. The weighted-average rate applied was 4.5%. For leases with a lease term ending within 12 months of the date of initial application, the Company has elected to apply the practical expedient to account for them as short-term leases. The Company recognizes the lease payments associated with these leases as an expense on a straight-line basis over the lease term.

Critical Accounting Estimates and Judgments

The Company believes the following accounting estimates and judgments are critical to determining and understanding the operating results and the financial position of the Company.

Aggregation of operating segments – Judgment is applied in aggregating operating segments into a reportable segment. Aggregation occurs when the operating segments have similar economic characteristics and have similar products, production processes, types of customers and distribution methods.

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MANAGEMENT’S DISCUSSION AND ANALYSIS

Business combinations – The determination of fair value associated with identifiable property, plant and equipment and intangible assets following a business combination requires management to make assumptions. More specifically, this is the case when the Company calculates fair values using appropriate valuation techniques, which are generally based on a forecast of expected future cash flows for intangible assets, and on a replacement cost approach, an income-based approach and/or a market-based approach for property, plant and equipment. These valuations are closely related to the assumptions made by management about the future return on the related assets and the discount rate applied. Significant changes to these assumptions could significantly change the fair values associated with intangible assets following a business combination, which would impact the amortization expense.

Employee benefit plans – Accounting for employee benefit plans requires the use of actuarial assumptions. The assumptions include the discount rate, rate of compensation increase, mortality rate and healthcare costs. These assumptions depend on underlying factors such as economic conditions, government regulations and employee demographics. These assumptions could change in the future and may result in material adjustments to employee benefit plan assets or liabilities.

Impairment of property, plant and equipment and intangible assets – An integral component of impairment testing is determining the asset’s recoverable amount. The determination of the recoverable amount involves significant management judgment, including projections of future cash flows and the appropriate discount rate. The cash flows are derived from the financial forecast for the next five years and do not include restructuring activities that the Company is not yet committed to or significant future investments that will enhance the asset’s performance of the cash-generating unit (CGU) being tested. Qualitative factors, including market presence and trends, strength of customer relationships, strength of local management, strength of debt and capital markets, and degree of variability in cash flows, as well as other factors, are considered when making assumptions with regard to future cash flows and the appropriate discount rate. The recoverable amount is most sensitive to the discount rate used for the discounted cash flow model as well as the expected future cash inflows and the growth rate used for extrapolation purposes. A change in any of the significant assumptions or estimates could result in a material change in the recoverable amount. The company has nine CGUs, of which the carrying values for three include goodwill and must be tested for impairment annually.

Timing of revenue recognition – Significant judgment is required to determine whether revenue should be recognized over time or at a point in time. To assess whether any revenue should be recognized over time, the Company analyzes customer-specific products without alternative use to determine whether a legally enforceable right to payment exists as performance is completed, including a reasonable return.

Leases – Management assesses at lease commencement date whether it is reasonably certain to exercise lease extension options. In addition, assumptions are made as to the discount rate applied to the lease liability. If there is a significant event or significant change in circumstances within the Company’s control, these judgments and assumptions could change and may result in material adjustments to right-of-use assets and lease liabilities.

Disclosure Controls and Internal Controls

Disclosure controls

Management is responsible for establishing and maintaining disclosure controls and procedures in order to provide reasonable assurance that material information relating to the Company is made known to them in a timely manner and that information required to be disclosed is reported within time periods prescribed by applicable securities legislation. There are inherent limitations to the effectiveness of any system of disclosure controls and procedures, including the possibility of human error and the circumvention or overriding of the controls and procedures. Accordingly, even effective disclosure controls and procedures can only provide reasonable assurance of achieving their control objectives. Based on management’s evaluation of the design and effectiveness of the Company’s disclosure controls and procedures, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that these controls and procedures are designed and operating effectively as of December 29, 2019 to provide reasonable assurance that the information being disclosed is recorded, summarized and reported as required.

Internal controls over financial reporting

Management is responsible for establishing and maintaining adequate internal controls over financial reporting to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with IFRS. Internal control systems, no matter how well designed, have inherent limitations and therefore can only provide reasonable assurance as to the effectiveness of internal controls over financial reporting, including the possibility of human error and the circumvention or overriding of the controls and procedures. Management used the Internal Control – Integrated Framework published by the Committee of Sponsoring Organizations of the Treadway Commission (COSO 2013) as the control framework in designing its internal controls over financial reporting. Based on management’s design and testing of the effectiveness of the Company’s internal controls over financial reporting, the Company’s Chief Executive Officer and Chief Financial Officer have concluded that these controls and procedures are designed and operating effectively as of December 29, 2019 to provide reasonable assurance that the financial information being reported is materially accurate. During the fourth quarter ended December 29, 2019, there have been no changes in the design of the Company’s internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, its internal controls over financial reporting.

Other

Additional information relating to the Company is available on the Company’s website at www.winpak.com or SEDAR at www.sedar.com, including the Annual Information Form dated March 3, 2020.

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