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Edited Transcript of IPLP.TO earnings conference call or presentation 14-Aug-19 2:00pm GMT

Q2 2019 Ipl Plastics Inc Earnings Call

Aug 17, 2019 (Thomson StreetEvents) -- Edited Transcript of Ipl Plastics Inc earnings conference call or presentation Wednesday, August 14, 2019 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Alan Walsh

IPL Plastics Inc. - CEO & Executive Director

* Pat Dalton

IPL Plastics Inc. - CFO & Executive Director

* Paul Meade

IPL Plastics Inc. - Head of IR

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Conference Call Participants

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* Ben Jekic

GMP Securities L.P., Research Division - Director and Special Situations Analyst, Equity Research

* David A. O'Brien

Goodbody Stockbrokers, Research Division - Investment Analyst

* Elizabeth Johnston

Laurentian Bank Securities, Inc., Research Division - Analyst

* Frederic Tremblay

Desjardins Securities Inc., Research Division - Analyst

* Scott Douglas Fromson

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

* Zachary Evershed

National Bank Financial, Inc., Research Division - Analyst

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the IPL Plastics Inc. Second Quarter 2019 Financial Results Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. I would now like to introduce your host for today's conference, Mr. Paul Meade, Investor Relations. You may begin.

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Paul Meade, IPL Plastics Inc. - Head of IR [2]

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Thank you, Katherine, and welcome everybody to today's call. Just before we begin, I would like to remind listeners that certain statements about future events made on this conference call are forward-looking in nature and are based on certain assumptions and analysis made by the company. Please refer to the cautionary statements on forward-looking information on Slide 2 for more information. And please note that we will discuss several non-IFRS financial measures this morning and that all figures are in U.S. dollars unless otherwise stated.

I'll now hand the call over to Alan Walsh, CEO of IPL Plastics for his presentation.

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Alan Walsh, IPL Plastics Inc. - CEO & Executive Director [3]

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Thank you, Paul, and good morning, everyone. I'm joined this morning as usual by Pat Dalton, our Chief Financial Officer. As normal, after our prepared remarks, we will hold a question-and-answer session.

Turning to Slide 3 and the key quarter 2 developments. We are very pleased with our second quarter performance. Net income for quarter 2 was $8.5 million, a very significant increase of $11.1 million from a net loss of $2.6 million in quarter 2, 2018. This was driven primarily by an improved operating performance and reduced one-off costs from quarter 2, 2018 related to the IPO and refinancing transaction costs.

Adjusted EBITDA increased strongly by 25.1% to $28.5 million. Our EBITDA margins have been returned to industry appropriate levels across all 3 divisions due to lower resin costs, cost reductions and improved operational efficiencies.

Large Format Packaging & Environmental Solutions margins increased by 6.6% to 16.5%. Consumer Packaging Solutions margins increased by 3% to 20.6% and Returnable Packaging Solutions margins increased by 8.4% to 24.4%. This improved margin performance was delivered on a 5.4% revenue decline due primarily to 3 factors: firstly, adverse foreign exchange translation movements; secondly the temporary trading issues previously highlighted in RPS in Q1; and thirdly, a reduction in new environmental container rollouts in quarter 2, 2019 when compared with a particularly high quarter for environmental container tenders in quarter 2, 2018. These factors were partially offset by the revenue contribution from Loomans, price increases and volume growth in the CPS division in North America.

I am delighted to report that CPS has successfully secured the largest ever sales contract in its history, for IML dairy containers in the U.S. This contract will continue to drive organic growth and generate revenue from 2020 onwards with capital investment of $6.5 million in 2019 and $2.5 million in 2020 required to support the contracts.

I am also happy to report that the operation improvement program at LF&E is progressing well as indicated by the 6.6% EBITDA margin increase in the quarter to 16.5%. The recovery from adverse temporary trading issues at RPS is also on track as demonstrated by the significant improvement in performance over quarter 1, 2019 and the adjusted EBITDA margin of 24.4% in the quarter. RPS delivered adjusted EBITDA of $6.5 million in quarter 2, 2019, an improvement of 16% on the $5.6 million in quarter 2, 2018.

Loomans has proven to be a very strong addition to IPL. Trading and integration are progressing as we expected, and we are excited about the potential of the business.

Slide 4 summarizes our 2019 to '22 sustainability strategy. This is at the center of our business model in terms of new product development and redesigning existing products to enhance recyclability and reuse across all 3 divisions. IPL has embraced this change and is making a positive impact across the value chain now driven by KPIs such as recycled content as well as leveraging plastic and packaging material where its key advantages are being highly functional in terms of molding flexibility, lightweight yet strong with good recovery and reuse potential at the end of life compared to the alternatives.

Turning to Slide 5. IPL's business model aims to maximize the use of recycled and reusable plastic material. This is a major opportunity for IPL as globally replacing just 20% of single-use plastic packaging with reusable alternatives offers an opportunity worth at least $10 billion. Replacing nonrecyclable packaging which will happen through regulation enhances growth opportunities further.

When we examine IPL's product range across all 3 divisions, over half of our products already positively contributes to the circular economy. We see increased regulatory activity across the EU, U.S. and Canada as a positive game-changer in terms of creating a greater pool of recycled raw material for use in our product line, which in turn will change customer and consumer recycling habits while benefiting the wider environment.

In IPL, we have developed new sustainability KPIs which are aligned with these changes. As of March next year, we will disclose the amount of recycled content used in our business as previously aligned in our sustainability strategy.

Looking at our divisions and how they play in the circular plastic economy. In LF&E, our environmental carts, bins and caddies enhance segregation of waste at source and enable plastic polymer reuse back into the circular economy. Waste generation is forecast to increase by 70% to 2050 and recovery rates remain favorable in many countries. We believe IPL's environmental product range, which in 2018 was 17% of group revenue, are the solution to improving waste recovery rates and turning a waste cost stream into an income stream from municipalities through this new and growing circular economy. Many of our environmental products can have up to 100% recycled content, which highlights the potential IPL has to use even greater volumes of recycled plastics in the years ahead.

We are already delivering on this in our LF&E business in Europe. We are using approximately 50% recycled content across our full product range. We are also ramping up our efforts to incorporate increased demands of recycled content in our environmental products in North America subject to availability of treatable recycled polymers.

In addition to our environmental products, our industrial and material handling product range, which makes up 8% of 2018 revenue, is also made with varying amounts of recycled content up to 100%. These products include waste cisterns, manhole covers, drainage systems, agricultural and horticultural crates, [meal trains], baskets, chairs, boxes, tiles, material handling containers and flowing grids.

Recently, we have just launched a new paint container with up to 38% recycled content for a global brand which is a very exciting development.

Looking at our Returnable Packaging Solutions division where the business model focuses exclusively on our reuse model. Our automotive and Ag bins reduce reliance on traditional single-use packaging such as flexible plastic and corrugated packaging. This range of fully reusable products made up 17% of our 2018 revenue.

Our IsoBin range of large bulk containers are delivering sustainable solutions throughout the global logistics and supply chain industries. The key advantages of this range include the standardizing of reusable packaging, reducing space requirements, lightweighting and reducing corrugated packaging waste.

Life cycle analysis of our reusable Ag corrugate range of bins when compared to traditional woven corrugated export bins show significant advantages and replacement cost are considered single-use products as traditional bins are commonly disposed of after they reach their destination. Our unique design, lightweight and stackability extends the reusable lifespan to 45 return transport trips and delivers both significant long-term savings and circular benefits. We also have a take-back program for damaged and older bins. We have recently invested in a new grinder and repelletizer to reuse them again in repelletized raw material form in our production process, demonstrating that the circular reuse commonly is well established and central to our RPS business model.

In our Consumer Packaging division, changes in consumer behavior, government regulation and customer commitments are rapidly altering the type of consumer packaging being used with growing demand for fully recyclable packaging central to this change. The waste industry significantly lags optimum recovery of recyclable material. However, catch-up driven by regulation on investments is now taking place.

All our CPS packaging is recyclable, and this division has significant growth opportunities to displace non-recyclable packaging, which we believe are likely to be phased out by the changing waste regulatory environment. These new approaches and innovation for recyclable packaging solutions will also replace existing content packaging options with new well-designed products for a circular economy, such as products currently produced by IPL. Our recent exciting development in consumer packaging is the emergence of chemical recycling, which recycles materials at the molecular level. IPL in partnership with a polymer supplier and a large global customer has recently achieved this launching of packaging products in July 2019 using chemically recycled polymers. This beneficial disruptive innovative product is a first for the ice cream industry.

Turning to Slide 6. I would like to highlight how industry is responding to our product range by recognizing our contribution to the new plastics economy and our alignment to the global commitment. In summary, we welcome the rapid increase of regulation in the industry and changing consumer and customer practices towards reuse, which will increase both capture and subsequent use of recycled plastic materials and will ultimately benefit the environment at large. I will now pass it over to Pat to discuss our second quarter financial performance in more detail.

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Pat Dalton, IPL Plastics Inc. - CFO & Executive Director [4]

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Okay. Thanks Alan. So we have some introductory remarks, I would like to say that I am pleased with the strong improvement and business performance in the quarter and the return of divisional margins to industry-appropriate levels. It's also very pleasing to be able to report a very significant decline in one-off transactions, reorganization and integration cost in the business.

While our full year fiscal 2019 business performance expectations remain unchanged, it is important to draw attention to the need for some adjustments for seasonality to quarterly expectations currently in the marketplace. As has been explained previously, Q1 is our weakest quarter. Q2 and Q3 are our strongest quarters, and Q4 is normally stronger than Q1. Some rebalancing to industry models which do not reflect this trend.

Slide 7. Now turning to a summary of our Q2 results on Slide 7. Revenue in Q2 2019 was $168.6 million, a decline of 5.4% compared to $178.3 million in the second quarter last year. The decline was primarily attributable to negative foreign exchange translation movements due to the strengthening of the U.S. dollar, due to temporary trading delays in the RPS business and a reduction in new environmental container rollouts in the LF&E division. The reduction in revenue was partially offset by the contribution from the Loomans business, by price increases and volume growth in the CPS division in North America.

Gross profit increased by 22.1% to $37.8 million in the quarter compared to $31 million in Q2 2018. Our adjusted EBITDA rose 25.1% to $28.5 million in the quarter versus $22.8 million last year.

Gross profit margin was 22.4%, up 5% from 17.4% a year ago, while adjusted EBITDA margin increased 4.1% to 16.9% compared to 12.8% in the prior year quarter. As Alan noted earlier, the improvement to industry-appropriate margins reflects lower resin costs, operational improvement measures and the acquisition of Loomans. These benefits were partially offset by lower revenue and the other cost increases.

Net income in the quarter was $8.5 million, an $11.1 million improvement from the net loss of $2.6 million in the second quarter last year. The positive variance is primarily due to a higher adjusted EBIT, lower finance costs and a significant decline in one-off costs compared to Q2 2018 when we incurred significant one-off costs related to our initial public offering and global refinancing transactions. Net income in Q2 2019 was reduced by higher income tax due to our improved results.

Adjusted net income of $10.3 million in Q2 2019 compared to $8.7 million last year, and pro forma adjusted diluted earnings per share increased strongly by 19% to $0.19 per share.

Moving to Slide 8. Slide 8 shows the fiscal 2019 revenue and adjusted EBITDA bridge for the second quarter and 6 months year-to-date periods. Please note that we have broken out the Loomans revenue in the upper-left corner of each chart for comparative purposes as we did not own it in the comparative period in the prior year.

You can see the revenue decline in both periods primarily due to lower volumes with an $18.7 million reduction in Q2. This primarily reflects the impact of the temporary crating delays experienced in our RPS division of $8.1 million, temporary reduced demand from CPS' largest European customer of $3.9 million as they managed their inventory holding levels and new environmental container rollouts which amounted to approximately $5.6 million when compared with the particularly high quarter for environmental container tenders in Q2 2018. The decline in revenue is either due to seasonal or trending factors which are a normal part of our business' trading environment.

Revenue in the quarter was also -- I mean the uptake was also impacted by unfavorable foreign exchange movements which amounted to $6.6 million in Q2 2019 and $11 million in the period year-to-date. Price increases had a positive impact on revenue as you can see from the chart.

With regard to adjusted EBITDA, we had a strong positive benefit in both periods from price increases and reduction in cost of goods sold, reflecting the impact of our operational improvement program and resin cost reductions.

Price increases boosted adjusted EBITDA by $2.8 million in Q2 and $6.6 million year-to-date, while lower cost of goods sold increased adjusted EBITDA by $4.5 million and $2.8 million in Q2 and year-to-date periods, respectively.

You can also see that the adoption of IFRS 16 boosted adjusted EBITDA by $1 million in the second quarter and by $1.9 million year-to-date. The positive factors impacting adjusted EBITDA were partially offset by the impact of lower volumes in both periods and by higher SG&A expenses in the year-to-date periods.

The increase in SG&A includes the incremental overhead cost of being a public company which are estimated at $1 million per quarter. The strengthening of the U.S. dollar against the other operating currencies in the group and other foreign exchange gains in prior periods reduced our EBIT -- adjusted EBITDA by $2.4 million and $3.4 million in Q2 2019 and year-to-date periods, respectively.

Moving to Slide 9. Slide 9 details our key Q2 margin drivers. Here you can see that adjusted EBITDA amounted to 17% of revenue in the quarter, an increase from approximately 13% in Q2 2018. Revenue cost as a percentage of revenue decreased from 40% of revenue in Q2 2018 to 38% in Q2 2019 driven by the resin price reductions. In addition, you can see that freight costs have stabilized in fiscal 2019 following spikes last year.

Labor cost increased in North America in fiscal '19 -- 2019 due to general wage inflation and new labor agreements.

Slide 10. Turning to the resin pricing slide. Resin costs have declined from their peak levels last year. Index prices in North America dropped by 16.1% for polypropylene in the second quarter compared to Q2 last year while polyethylene prices were broadly flat. In Europe, polypropylene declined by 1.7% year-over-year while polyethylene was down by 3.5%.

The completion of the resin tender in 2018 and the decline in resin cost, especially polypropylene in North America has positively impacted by our margin performance in the quarter. The consensus outlook is for resin prices to remain relatively stable for the remainder of the third quarter.

Moving to Slide 11. I'm now turning to the detail of our divisional performance and starting with our large format and environment division on Slide 11. We have substantial gross profit and adjusted EBITDA growth due to lower resin costs, operational improvements and the adoption of IFRS 16, partially offset by higher labor costs and lower revenue related to a temporary slowdown in our environmental container rollouts. The volume and the timing of public tenders for these containers is highly variable and dependent on economic conditions in the markets where they are needed.

Revenue in the LF&E division declined by $9.1 million or 10.5% to $77.6 million from $86.7 million in Q2 last year. LF&E revenue in North America dropped by $4.1 million or 7.2% to $52.5 million. In Europe, the large format and environmental revenue dropped by $5 million or 16.7% to $25.1 million. These declines were largely due to the lower rollouts of our environmental containers as well as foreign exchange movements. These negative impacts were partially offset by stronger prices, lower costs especially resin, a more favorable product mix as well as benefits of the IFRS 16 accounting treatment.

Gross profit in LF&E was $15.7 million compared to $11.9 million last year. Our gross profit margin increased to 20.3% from 13.7% in Q2 2018. Adjusted EBITDA improved to $12.8 million from $8.6 million last year. Our adjusted EBITDA margin increased strongly by 6.6% from 9.9% in Q2 last year to 16.5% this year.

Slide 12. Moving to the CPS division on Slide 12. Revenue was $59.6 million in the second quarter of 2019, an increase of $10.2 million from $49.4 million in the prior year quarter. CPS revenue increased by USD 800,000 or 2.1% in North America to $38.3 million. The increase was attributable to volume growth and price increases.

In Europe, CPS revenue rose by $9.4 million or 79.6% to $21.3 million. This is driven by the acquisition of Loomans which contributed $13.2 million of revenues. Sales volumes of our food packaging products increased also. These positive impacts were partially offset by a temporary reduction in demand from the division's largest European customer. There were unfavorable foreign exchange movements which impacted revenue in both Europe and in North America.

CPS had solid margin improvements due to positive volume and pricing as well as contributions from Loomans and the adoption of IFRS 16. Gross profit increased to $13.3 million compared to $9.5 million in Q2 last year while gross profit margin rose to 22.2% from 19.2% last year. Adjusted EBITDA increased by $3.6 million to $12.3 million compared to $8.7 million last year and adjusted EBITDA margin rose by 3% to 20.6% from 17.6% in the prior year quarter.

Slide 13. Moving on to Slide 13. We generated strong growth in margins and adjusted EBITDA in the RPS Division due primarily to lower resin costs and a realignment of this division's cost base during the first quarter of 2019 following the temporary trading delays disclosed in Q1. Severe adverse weather conditions in the United States reduced agricultural bin sales, and automotive bin sales were also delayed. These impacts were partially offset by a higher sales of our Macro product line in the second quarter.

It is important to note that sales of agricultural bin units increased by 112% in the second quarter of 2019 compared to the first quarter of 2019 and that there is a relatively strong order backlog in place for Q3 due to a later-than-usual citrus and apple crop harvest. Agricultural products made up 65% of our revenues at this division.

With regard to the automotive bins, the RPS division has actively engaged with other automakers to begin to diversify its automotive customer base, and it remains our expectation to secure a purchase order for the outstanding auto bin contract during H2 of 2019.

Revenue in the RPS division was $26.5 million in Q2 2019, a decline of $8.2 million from $34.7 million in the second quarter last year. However, gross profit was $7.6 million, a slight increase from $7.4 million last year, while gross profit margin increased from 21.3% in Q2 last year to 28.6%. Adjusted EBITDA was $6.5 million, up from $5.6 million last year and adjusted EBITDA margin rose strongly by 8.4% from 16% in Q2 last year to 24.4% in this quarter.

Turning on to Slide 14, which analyzes the other adjusted EBITDA movements in the period. Overall, our other adjusted EBITDA in Q2 2019 compared to Q2 2018 was adversely impacted by a net $3 million increase of overheads.

And you can see from the slide, we incurred increased central overhead costs due to investments in additional SG&A costs, following the completion of the IPO, of approximately $1 million.

This was partially offset by the positive benefit from the adoption of IFRS 16. Secondly, we incurred adverse foreign exchange movements in Q2 2019 compared to Q2 2018 which gave rise to an overall adverse impact on EBITDA of $1.4 million in the quarter. In addition, lower, metal prices negatively impacted the EBITDA contribution from our small U.K. Metals business by $800,000.

Slide 15. Turning to Slide 15. You can now see on this slide that our key balance sheet metrics reflect increased leverage well after the end of fiscal 2018. This is partially attributable to the Loomans acquisition, which was completed in March 2019.

Working capital as at June 30, 2019, was $128.8 million compared to $88.2 million at the end of December 2018. Our investment in working capital typically peaks in the first half of the year and then unwinds over the remainder of the year, so the large increase in working capital at the end of Q2 is normal.

Total assets increased to $903 million at June 30 compare to $751.6 million at December 31. Net debt increased to $342.9 million at the end of the second quarter and shareholders' equity stood at $363.5 million.

Our net debt to equity ratio increased to 0.94 to 1x at the end of Q2 compared with 0.61x to 1 at the end of fiscal 2018. Our financial leverage ratio which is defined as net debt to the last 12 months adjusted EBITDA increased to 3.64x from 2.7x in the same period. On a like-for-like basis, which excludes the impact of IFRS 16, our ratio was at 3.57x at June 30, 2019. We expect to return our financial leverage ratio to approximately 3x by the end of fiscal 2019. This is slightly higher than what we previously forecast at the end of Q1 of 2.7x. The slight increase reflects the increased capital raised through the new CPS dairy IML contract in the U.S. of $6.5 million in 2019.

Finally, our trailing 12-month interest coverage ratio was 5.74x at June 30, 2019, compared to 4.84x at the end of December 2018.

Moving to Slide 16. On Slide 16, here, you will find a reconciliation of our adjusted free cash flow for the second quarter and 6-month periods in 2019 and 2018. Note that net cash inflow from operating activities was $14.5 million in Q2 2019 compared to just $0.1 million in the prior period quarter. Adjusted free cash flow improved by $13.1 million from a deficit of $3.7 million in Q2 last year to a positive $9.4 million this year. The improved cash flows were primarily due to our strong adjusted EBITDA performance in the second quarter and our reduced buildup of working capital.

In the year-to-date period, net cash inflow from operating activities was $15.9 million compared to an outflow of $16.8 million last year, while adjusted free cash flow was $2.1 million compared to a deficit of $27.4 million last year.

Slide 17. Slide 17 details transaction, reorganization and integration costs. These amounted to just $0.7 million and $3.3 million in the second quarter and 6-month periods in 2019, respectively. These costs were significantly down from the $15.2 million and $18.1 million (sic) [$18.3 million], respectively, in the same periods last year.

Moving to Slide 18. On Slide 18, you'll see that total CapEx spending in the first half of fiscal 2019 was $29.0 million. That total includes $22.9 million of strategic and development CapEx and $6.1 million of maintenance CapEx. Overall, CapEx spending declined by $5.5 million compared to the same period last year, reflecting the near completion of our substantial CapEx program. We currently expect to incur CapEx -- of the range of $39 million to $44 million in fiscal 2019. This is higher than our prior estimates due to the large new contract received in our CPS division which requires $6.5 million of capital in the current year. I will now turn it back to Alan.

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Alan Walsh, IPL Plastics Inc. - CEO & Executive Director [5]

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Thanks, Pat. We remain positive and confident on the outlook for our business. Our LF&E and CPS divisions are performing satisfactorily. Polypropylene prices which have declined significantly from their highs last year are expected to remain relatively stable through the remainder of the third quarter. The profitability of our RPS division improved in the second quarter despite the tempering issues in the agricultural and automotive markets. We continue to expect fiscal 2019 adjusted EBITDA in this division to be at least in line with fiscal 2018. We are fairly optimistic about the performance in future for Loomans and the feedback from our new customers in this business is supportive of this view.

In conclusion, we continue to expect a solid improvement in trading performance in fiscal 2019 excluding the positive impact of the Loomans acquisition. This positive outlook reflects our performance to date, the ongoing benefits of our cost improvement program and other initiatives we are taking and the underlying strength of and confidence in our business. Pat and I would now be pleased to answer any questions you may have. So operator, please open the line for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from David O'Brien with Goodbody.

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David A. O'Brien, Goodbody Stockbrokers, Research Division - Investment Analyst [2]

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Firstly, just on CPS, obviously a very encouraging contract in North America. Can you help us -- give us a sense of how meaningful that would be in revenue terms when it' starts to kick in? And should we be thinking about it as the back half of 2020 and into 2021 and some timing about how maybe we factor it in? And in regards to the related investment in CapEx, can you just remind us what the hurdle rates in terms of returns that you guys seek when deploying so much capital?

And on a separate point you've spoken about cost optimization through the pieces. It's clearly had a positive impact during the period. Could you quantify what it's contributed to in the performance and how we should view it for the full year?

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Pat Dalton, IPL Plastics Inc. - CFO & Executive Director [3]

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Pat Dalton here. I'll deal with those 3 questions. First of all, in terms of CPS contracts, just in terms of how we analyze our contracts, generally, the way we view CapEx investment, we normally expect a CapEx commitment of, let's take $100, to generate somewhere between $125 or $150 in annual revenues thereafter. So if you take this in terms of this, well this contract, we expect it to be closer to $200 in terms of the CapEx investments.

So that gives you pretty clear in terms of revenue. In terms of the start of that contract, we expect that contract, hopefully, maybe to kick in with effect from 1 January. And maybe if we get a little lucky, start with production in the last month of December of 2019. So pretty much immediately from 2020 onwards as a run rate.

In terms of our CapEx investment hurdles, normally, we look to kind of 15% IRR, look for payback periods of typically 3 years, if we can get there but 3 to 5 will certainly be doable. This one will certainly be well within the 3 years. And the CapEx per se is underpinned by a significant commitment in terms of volume with the customers, so pretty well secure capital investment in this scenario.

And maybe finally just to deal with your question on the cost optimization plan. I think if you look at the -- there's probably 2 -- SG&A bridges in each of the divisions. I think it's pretty clear in terms of those SG&A bridges, you'll see that's pretty favorable in all divisions. And there is obviously some benefit through the COGs line in each of the bridges as well. So I would say that, overall, the optimization program certainly has had a fairly material impact in our year-to-date results.

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Operator [4]

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Our next question comes from Scott Fromson with CIBC.

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Scott Douglas Fromson, CIBC Capital Markets, Research Division - Director of Institutional Equity Research & Research Analyst [5]

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Just a little bit more on the consumer contract. How much CapEx in Q2 was related to that new contract? I think you said $6.5 million for the year. How much was spent in Q2, please?

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Pat Dalton, IPL Plastics Inc. - CFO & Executive Director [6]

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We spent $3 million in Q2.

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Scott Douglas Fromson, CIBC Capital Markets, Research Division - Director of Institutional Equity Research & Research Analyst [7]

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Okay. So I guess CapEx was a bit higher than I would have expected. And also, on the third party returnable contract, is that delayed in Q3? Or are we going to see revenues in the next 2 quarters?

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Alan Walsh, IPL Plastics Inc. - CEO & Executive Director [8]

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Yes, Scott. It's Alan here. We certainly anticipate the POs as Pat said in his comments, we certainly anticipate the POs for the balance of the initial contract to materialize at some point in quarter 3.

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Scott Douglas Fromson, CIBC Capital Markets, Research Division - Director of Institutional Equity Research & Research Analyst [9]

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Okay. All right. And what's your outlook for free cash flow for the rest of the year? I know you've talked about CapEx. You've talked about working capital. Is there going to be room for deleveraging?

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Pat Dalton, IPL Plastics Inc. - CFO & Executive Director [10]

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Yes, Scott. We certainly believe there will be significant room for deleveraging. So if you look at the guidance that we've given around our year-end leverage position we expect to get back in from the 3.6 pretty close to the 3x by year-end. So we would expect the business to be strongly free cash flow generative in the next 6 months.

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Operator [11]

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Our next question comes from Elizabeth Johnston with Laurentian Bank.

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Elizabeth Johnston, Laurentian Bank Securities, Inc., Research Division - Analyst [12]

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So just going back to the RPS contract of the automotive customer. Assuming that the purchase order does come through sometime in Q3, I guess it's reasonable to expect that revenue from that would be coming back in the Q4. Is that what we should understand?

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Alan Walsh, IPL Plastics Inc. - CEO & Executive Director [13]

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Yes, pretty much immediately, Elizabeth, once we receive the PO.

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Elizabeth Johnston, Laurentian Bank Securities, Inc., Research Division - Analyst [14]

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Okay, great. And in that same segment, you mentioned the agriculture business headwinds you've had on that for the first half of the year but backlog remains strong. Can you just talk a little bit about what -- more about why you have that confidence that these volumes will continue? Maybe just talk a little bit more about backlog and anything else that's relevant for that.

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Alan Walsh, IPL Plastics Inc. - CEO & Executive Director [15]

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Yes. We have we seen a significant pickup in Q2 volumes over 100% pickup on Q1, and we've got a pretty strong order book looking out into quarter 3. I think if you look at that business, it was pretty significantly impacted by weather in the first 4 or 5 months of the year, unprecedented levels of rainfall on the coasts, the West Coast of the U.S. in particular. And what we've seen is that had led to a delay in placing orders. And so sitting here today, we've got a pretty healthy outlook on the order book for quarter 3 and into quarter 4. We will see I think some back ending of volumes this year but it won't, just to be clear, it won't make up for all of the lost volumes in the first half of the year. But notwithstanding that, we have reiterated and I'll just reiterate again we do expect RPS to deliver performance on an EBITLA level this year in line with last year.

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Elizabeth Johnston, Laurentian Bank Securities, Inc., Research Division - Analyst [16]

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Okay. Great. And just turning over to the CPS, CPS I think, the reduced revenue from your large customer in Europe, maybe you can get some more color on why this pulled back in the quarter or the first half and what your expectation is for the second half of the year from them?

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Alan Walsh, IPL Plastics Inc. - CEO & Executive Director [17]

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Yes. I think it was just really the deal was inventory holding levels at their end and managing that where they had to slow down production volumes for themselves. We're already see that picking back up as we sit here today. And we expect that to turn back into normal production volumes from September onwards up to end of the year. So I think we see that refreshing back to normal levels. It's not -- this isn't something new. We've had this with that customer a couple of times in our experience. It happened to us back in 2017, 2018 as well. So it's also the cyclical nature of that business as well.

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Elizabeth Johnston, Laurentian Bank Securities, Inc., Research Division - Analyst [18]

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And are you able to disclose what percentage of revenue within CPS this customer represents? I know from your disclosure at IPO, there, you have no single customer more than 5% of global. I'm just trying to get a little more granular on this.

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Pat Dalton, IPL Plastics Inc. - CFO & Executive Director [19]

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About 3% of revenues. It's about 3% of our total revenues.

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Elizabeth Johnston, Laurentian Bank Securities, Inc., Research Division - Analyst [20]

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Okay. Great. And just a follow-up question on the new contract within CPS as well. Is this a new customer or a new product from an existing customer?

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Alan Walsh, IPL Plastics Inc. - CEO & Executive Director [21]

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It's not a new customer to the group, but it's a new product for this particular customer.

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Elizabeth Johnston, Laurentian Bank Securities, Inc., Research Division - Analyst [22]

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So it's a customer you're already serving in one of your existing segments?

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Alan Walsh, IPL Plastics Inc. - CEO & Executive Director [23]

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Correct.

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Elizabeth Johnston, Laurentian Bank Securities, Inc., Research Division - Analyst [24]

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Okay. And these kinds of large contracts, what's kind of the sales cycle behind this? How long would it take to get something like this on board?

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Alan Walsh, IPL Plastics Inc. - CEO & Executive Director [25]

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Probably from a sales perspective, I mean this is, I suppose, following through on something that we've been saying in terms of the conversion from historical forms of packaging to IML in particular sectors. We have spoken about this before. The sales cycles for this has probably been 6 to 9 months. Effectively, we're running higher at this point in time, as Pat said, to try and bring in that contract on-stream as quickly as we can but there's some significant work at our end in terms of ordering molds and installing machines and some infrastructure spend, et cetera, that we have to make. The customer would like us to bring this on stream as quickly as we can, in 2019 if we could. Whether we can do that or not remains to be seen. So we may see some revenue from this in quarter 4 this year, but certainly, we're pretty clear we need to have this production-ready for January 2020.

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Operator [26]

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Our next question comes from Zachary Evershed with National Bank Financial.

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Zachary Evershed, National Bank Financial, Inc., Research Division - Analyst [27]

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Given what you've seen in the quarter so far, will the weakness in municipal tenders at LF&E continue into Q3?

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Alan Walsh, IPL Plastics Inc. - CEO & Executive Director [28]

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I think if I just maybe break that into 2 parts, Zack, to answer that question. If I look at Europe, first of all the corresponding quarter in 2018, how that, you could say that normally high level of rollout programs. And we secured 2 pretty significant rollout programs, which haven't repeated this year. So that's one impact. That's normal for this business by the way. That doesn't signal any underlying weakness in the business or anything like that. In the North American market, I think we've just seen a delay in certain projects that we're working on coming for approval. And there's a pretty healthy pipeline of opportunities there. We're in discussions with all of the significant waste players in both the U.S. and Canadian markets in terms of enhancing our position in that marketplace given the investments that we've made there over the last 12 to 18 months. So I think it's just the nature of that particular business. And it can be a little bit lumpy at times. If you look at how that market's evolved when you move from an early phase rollout stage to a more mature market, and that lumpiness can dissipate a little bit as top up wins and sales become more relevant than rollouts, I think the North American market is still in its infancy in terms of rollouts. So it's just the nature of that particular segment.

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Zachary Evershed, National Bank Financial, Inc., Research Division - Analyst [29]

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That's helpful. Would you say that Q3 was also abnormally high in Europe?

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Alan Walsh, IPL Plastics Inc. - CEO & Executive Director [30]

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Last year?

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Zachary Evershed, National Bank Financial, Inc., Research Division - Analyst [31]

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That's right.

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Alan Walsh, IPL Plastics Inc. - CEO & Executive Director [32]

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Yes. So those 2 particular contracts that I referenced would have spanned quarter 2 and quarter 3 last year.

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Zachary Evershed, National Bank Financial, Inc., Research Division - Analyst [33]

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Excellent. And then going back to the extent of the backlog for agriculture bins in place for Q3, do you think the volumes will be up quarter-over-quarter versus Q2?

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Pat Dalton, IPL Plastics Inc. - CFO & Executive Director [34]

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I think we will have a different product mix. You will recall that last year we had a fairly significant number of apple bin sales driven by the new F29 bin that was introduced newly onto the market so you have a significant take-up in that bin type. And you recall that last year in terms of the citrus market, it was down because of the weather conditions in the citrus market. So I think that we will have a different mix of bin sales in Q3 2019 compared with Q3 2018.

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Alan Walsh, IPL Plastics Inc. - CEO & Executive Director [35]

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I should also say, Zachary, that we would also expect that given where resin input costs are into that business at this point in time, we obviously a fair level of visibility around what Q3 looks like at this point in time in our business.

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Operator [36]

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Our next question comes from Mark Wilde with BMO Capital Markets.

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Unidentified Analyst, [37]

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This is Jesse on for Mark. Just starting, if you can kind of talk about how municipalities are changing their outlooks given the difficulties in the recycling market?

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Alan Walsh, IPL Plastics Inc. - CEO & Executive Director [38]

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We haven't seen any change in that space. Certainly from a European perspective, we haven't and neither in the North American space have we seen that either. A lot of the programs we're looking at in the North American market would revolve around organic waste streams.

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Unidentified Analyst, [39]

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Okay. That's helpful. And then just last one for me. Can you just talk more about the runway you see for your margins going forward with resin costs and on the labor cost side?

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Alan Walsh, IPL Plastics Inc. - CEO & Executive Director [40]

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Yes. Well, if you take the LF&E business and the CPS business and the RPS business, I'll just comment around the RPS business given where that's effectively, at the outset of that business very limited cash flow arrangements. We've very good visibility around where polypropylene is for Q3 at this point in time. So as we would say, good visibility on at least maintaining the current margins in terms of productiveness at this point for Q3. Looking at the LF&E business and the CPS business, CPS business, pretty much 100% pass-through business. So -- and when you look back at the history, I would say solid margin, EBITDA margin even during 2018 when resin prices, certainly polypropylene, were at certainly very elevated levels. So probably needless to say that the margins in the CPS business [will] continue pretty where they are. And then maybe looking at the LF&E business, as we see it, key drivers of the margins in this business and the 2 margin improvement -- in terms of the improvements, first of all, our cost initiatives. Second, we talk about resin price reductions. And I think it's important to understand when you look at our LF&E business, pretty much about 75% of that business is a polyethylene business. And if you look at what happened in polyethylene between Q2 last year and Q3 -- and Q2 of this year, very little movement in polyethylene prices. So when you look at the improvement in the cost of goods sold of that business, most of that -- or some of it is actually due to our resin tender that we completed at the back end of 2019 -- or 2018. And therefore, as we sit here today, we certainly believe that there will be -- we hope to maintain pretty close to those margin levels in our LF&E business. So as we sit here today, given that we have a pretty, I would say almost a benign resin environment, pretty good visibility that we shouldn't have any margin surprises into Q3.

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Operator [41]

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Our next question comes from Frederic Tremblay with Desjardins Capital Markets.

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Frederic Tremblay, Desjardins Securities Inc., Research Division - Analyst [42]

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First question would be on the IML business, great success obviously with the new contract. I was wondering if you could speak on the pipeline of future opportunities there. Are you sensing significant traction from customers for IML in North America specifically?

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Alan Walsh, IPL Plastics Inc. - CEO & Executive Director [43]

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We have a healthy pipeline of opportunities there, both for what we call custom projects, working with customers specifically on our own range of products and that's across both North America and the European market. And we've seen a pretty significant pickup in our packaging business in Europe as we started to bear the fruits of the investment that we made in our packaging facility in Cork, in Ireland, a couple of years ago.

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Frederic Tremblay, Desjardins Securities Inc., Research Division - Analyst [44]

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Okay. And in your RPS segment, can you provide a bit more detail on the progress in terms of expanding the customer base in automotive? And is your sense that it will be possible to add customers following the completion of the purchase order for your current customer?

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Alan Walsh, IPL Plastics Inc. - CEO & Executive Director [45]

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Yes. One of the things I have mentioned on the last call which was continuing, obviously, is the diversification of the customer base within RPS. And that is something that is getting active attention at the moment. We've increased our sales resources in that space as well. We've also sold a small volume of things to a range of customers in terms of trial production runs for that particular product. So I think the challenge from a sales perspective is the conversion time from when you start having discussions with a customer, given that leads to a PO and with a product like this in particular and there's a pretty significant investment in testing and trialing, et cetera before something like this can be rolled out in a live environment. So it's under active consideration internally at the moment. And also we're in discussions about a range of variations of that product as well, both with the existing customer but also new customers as well. So there's a lot of potential, is how I would describe it, in that product. But the conversion time is just going to take some time to materialize.

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Frederic Tremblay, Desjardins Securities Inc., Research Division - Analyst [46]

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Okay. And last question for me would be on the competitive environment. Have you noticed any significant changes in the competitive intensity in any of your segments?

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Alan Walsh, IPL Plastics Inc. - CEO & Executive Director [47]

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From a European perspective, what I would say, nothing abnormal outside of regular competition. In fact, some -- maybe some opportunities starting to appear given some fairly significant M&A transactions in that space over the last period of time. In the North American market, it's a competitive environment. Is there anything again abnormal happening from the competitive space outside of normal course? No. I think our margins across the 3 divisions speak for themselves and as Pat said, that's where we'd like to keep them for the foreseeable future.

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Operator [48]

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Our next question comes from Ben Jekic with GMP Securities.

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Ben Jekic, GMP Securities L.P., Research Division - Director and Special Situations Analyst, Equity Research [49]

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Just a couple of questions on the CPS order. And I apologize if some of the questions have been asked. I just want to understand, so most of the pickup in terms of incremental contribution will be 2020. Is that correct?

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Alan Walsh, IPL Plastics Inc. - CEO & Executive Director [50]

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Correct.

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Ben Jekic, GMP Securities L.P., Research Division - Director and Special Situations Analyst, Equity Research [51]

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And you did say, so it's a new product you're providing for the existing customer. But is that a new product for you or something that you haven't made before or haven't made it as much?

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Alan Walsh, IPL Plastics Inc. - CEO & Executive Director [52]

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No. It's a product that we actually had developed some time ago for this particular segment that we were trying to trial with various customers. So essentially, what's happening here is the customer is consolidating a range of existing packaging types that they have for this particular product into the new IML container.

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Ben Jekic, GMP Securities L.P., Research Division - Director and Special Situations Analyst, Equity Research [53]

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Okay. And you did mention, Alan, that there's going to be some incremental -- some additions with the equipment and everything to support this contract? So is it fair to assume that then there would be very little in the sensible kind of learning curve, that the margins should be reasonable from the get go? Or should we see sort of lower margins in the beginning and then improvements over time?

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Alan Walsh, IPL Plastics Inc. - CEO & Executive Director [54]

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No. I think the margins should be pretty much there from the get go. And then obviously, what I was talking about there was really the set up of the machines, the systems. We've some infrastructure spend to make in our facility -- and that's all going at the moment. This will be a pretty automated production cell -- or number of production cells for this product so that the labor content is pretty minimal. And this is something that we do day in day out. So as I said earlier, this is a question of being production-ready for 1 January next year and sooner if we can because the customer would like this to be switched on as quickly as possible.

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Ben Jekic, GMP Securities L.P., Research Division - Director and Special Situations Analyst, Equity Research [55]

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Okay. Great. And the last question on the CapEx, so $39 million to $44 million this year. Can you at least directionally suggest what we might look for in 2020, barring of course any new signings?

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Pat Dalton, IPL Plastics Inc. - CFO & Executive Director [56]

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I think, Ben, we'd certainly be trying to get our CapEx into somewhere around the -- overall into a 25% to 30% of the EBITDA range in 2020.

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Operator [57]

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We have a follow up from Scott Fromson with CIBC.

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Scott Douglas Fromson, CIBC Capital Markets, Research Division - Director of Institutional Equity Research & Research Analyst [58]

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Just a quick question on your thought on acquisitions, please.

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Alan Walsh, IPL Plastics Inc. - CEO & Executive Director [59]

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Thought on acquisitions, Scott, there's plenty of opportunities out there. We have -- our leverage is where it's at. We're focused on deleveraging between now and the end of the year. We will continue both exploring the market opportunities, and plus our balance sheet obviously is [rolled] out at the moment. And we're quite conservative individuals, so don't expect to see any significant M&A transactions in the short term.

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Operator [60]

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That's all the questions we have for today. I'd like to turn it back to Mr. Alan Walsh for any closing comments.

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Alan Walsh, IPL Plastics Inc. - CEO & Executive Director [61]

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Thank you. That concludes our call this morning. Everybody, thank you for participating, and we look forward to speaking to you again when we announce our Q3 results in November. Thank you.

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Operator [62]

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Ladies and gentlemen, thank you for participating in today's conference. This concludes the program. You may all disconnect. Everyone, have a great day.