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Executives

Nicholas Lamplough - Director

J. Brendan Barba - Founder, Chairman, Chief Executive Officer and President

Paul M. Feeney - Chief Financial Officer, Executive Vice President of Finance and Director

Analysts

Roger N. Spitz - BofA Merrill Lynch, Research Division

AEP Industries (AEPI) Q3 2013 Earnings Call September 10, 2013 10:00 AM ET

Operator

Good morning. My name is Jackie, and I will be your conference operator today. At this time, I would like to welcome everyone to the AEP Industries Inc. Third Quarter 2013 Results Conference Call. [Operator Instructions] Thank you. I would now like to turn the call over to Nick Lamplough. Mr. Lamplough, you may begin.

Nicholas Lamplough

Thank you. Before we get started, I would like to remark briefly about forward-looking statements. Except for historical information mentioned during the conference call, statements made by the management of AEP Industries are forward-looking statements that are made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward-looking statements involve known and unknown risks and uncertainties, which may cause the company's actual results in future periods to differ materially from forecasted results. Those risks included, but are not limited to, risks associated with pricing, volume and conditions of the markets. These and other risks are described in the company's filings with the SEC over the last 12 months, copies of which are available from the SEC or may be obtained from the company.

Today's format will be as follows. Brendan Barba, Chairman, President and CEO, will discuss operations; and then Paul Feeney, Executive Vice President of Finance and CFO, will discuss the financial results. After the prepared remarks, Brendan and Paul will be available for questions.

So without further delay, I would like to turn the call over to Mr. Barba. Brendan?

J. Brendan Barba

Good morning, everyone. Welcome to our third quarter conference call. I'm sure you've all seen a -- had a chance to read our release, and our results were less than anticipated or forecasted for the quarter. We continue to struggle with the lag in getting our prices up. That's always an issue when resin prices are going up. It certainly had been an issue this quarter. We had some volume issues, and I'll get into that in a little bit. Having said all of that, our adjusted EBITDA year-to-date is up for the year.

There's a lot of discussion about volume. We're obviously looking at it all the time and very concerned about it. There were a number of factors that influenced our volumes. On the positive side, we did have a slight increase of 0.3%, which was better than we did in the first quarter and second quarter where the numbers were slightly negative. What's affecting volume would be that we were price managing some of the businesses that we're in. We're getting very little help from the economy. We had some disruption of supply from the consolidation of Webster and Transco. Some significant amount of loss of capacity and volume happened as a result of the damage in a -- in transit of one of the Transco printing presses where we, unfortunately, missed the height of the season and needed that capacity but just didn't have it available. We had some July shutdowns for maintenance in some of our AEP plants. But having said all that, the single biggest factor, in our view, influencing this is that resin prices continue to be -- remain flat when customers are expecting relief in resin. It just hasn't happened, and they're just not ordering. They think it's going to go the other way, but it just hasn't happened yet.

One thing I want to assure everybody of: this is not an AEP issue. It's an industry issue. I have polled every resin supplier that we do business with, and every single one assures me that our volumes are actually not as bad as many of the people that they're currently supplying. Volumes are typically stronger in -- they are stronger right now in September. And historically, the last quarter is our best quarter as it relates to volume. So we are expecting that things will improve in the last quarter. I don't want to oversell it based on all of the issues that are out there and affects volume, but I think that's probably the fairest way to explain it to you.

On the operational side, with the -- I'll start with the Webster acquisition. We're almost completely done there. 11 of the 12 -- I'm sorry, 10 of the 11 lines ordered are now installed. The 11th line will be in production in November to start our new year, and basically, the transition would then be complete. The current staffing is about 20 people above our target of about 350, which is about half of what it was when we took over Webster. We expect by November we will have that staffing down to the targeted number.

And the Transco acquisition, it's now complete. All the printing presses that were moved from Canada, installed in our Bowling Green, Kentucky plant where we do high-value printed added -- high-value printed products. A year ago, we had 2 10-color presses in Bowling Green and today we have 5, and we're capable of running all of that equipment 24/7. We also increased our extrusion capacity in that plant by 7 million pounds, and that is up and running also right now. There were 3 co-ex lines. All were moved to AEP plants, 2 in Alsip, Illinois and 1 in Mountain Top, Pennsylvania and all are in production.

I mentioned the print press, that was a setback. We had damage to the press when they transferred it from Canada to the Bowling Green plant beyond our control. There's nothing we can do about it, and we were unable to fill all of the orders that were available to us. I've spent a number of meetings with our sales group, and they've assured me that we're regaining the volume as we're able to supply it. So it isn't -- shouldn't be anything that affects us on a long-term basis. As far as cost control is concerned, again, for the period, we did excellent job on cost control, which I'd like to tell you we usually do a very good job on that all the time.

In capacity expansions, we continue to expand our capacity in products and businesses where we are busy. Quick question, why would we be doing that in periods where we're not running at capacity? And that's the simple explanation that we're expanding in areas where we feel comfortable that we will run a high rate of capacity on that equipment. Specifically, we're adding the can liner line in November. It's about 5 million pounds through our Waxahachie plant. We are adding 9 million pounds for our custom films division in Alsip, Illinois, also for November. Custom films, another line, 9 million pounds for November in our Matthews, North Carolina plant. And I've already referenced the 7 million pounds that we're -- are now in place for our Bowling Green, Kentucky plant.

Resin. Resin has been a challenge for us. It's volatile. We have absorbed the $0.09. We expect -- there's a net of $0.05 on the table for 9/1, effective date 9/1. We're evaluating that increase. Again, volatile market, everyone in the business expected relief months ago. It still hasn't happened. And right now, we're looking at a possibility that, that resin increase will hold. But if it doesn't, we are not looking at immediate relief in resin until the seasonal period where --December and January, which are very slow periods in the industry, that would be when we'd be comfortable saying that resin prices will be coming down.

We're just in the process of finalizing our CapEx budgets for the year. I don't have a specific number for you today, but it's going to be substantially less than our 2013 CapEx budget.

As it relates to 2014, the 2 acquisitions are now basically complete. There's a little bit more work to do. It's been a huge undertaking. A huge amount of costs have been put into it. We've taken a huge amount of costs out of those businesses. We have many expenses that we incurred that are non-recurring like severance, pretty much eliminated. I talked to you about the staff reductions that are coming, again, by November. We've got the new capacity coming in. Almost all of that equipment will be available for the first week or first month of our new year. And I got to tell you, we're very, very optimistic about our 2014, how the company will do and the accrued benefits to our shareholders.

At this point, I'm going to turn it over to Paul Feeney.

Paul M. Feeney

Good morning, ladies and gentlemen. There was virtually no changes in our net sales profile in the third quarter of '13 as compared to the prior year. Net sales dollars are about the same. Per-unit selling prices are very much the same. And volume did increase 800,000 pounds, but on a 240-million pound base, it's not that big a deal. When we look at net sales for the 9-month period ended July 31, there was a decrease of $11 million or 1.4% to $844 million from $856 million in the prior year. This decrease was the result of a 1% decline in sales volume. There was virtually no change in average selling prices.

Year-to-date volume was 710 million pounds, down 6.2 million pounds from the 716 million pounds sold in the first 9 months of the prior year. We expect volume in the 2013 fiscal year will be down slightly from the prior year. Sales attributable to the Transco acquisition were negligible in the first quarter. But as equipment was installed and product was qualified, Transco sales grew to about $6.8 million as of the end of the third quarter.

Book gross profits for the third quarter increased -- I'm sorry, decreased $18.9 million to $37.7 million. Adjusting for the LIFO reserve change in both quarters and an increase in depreciation expense resulting from 2012 and 2013 capital expenditures, there was a gross profit decrease in the current period of about $2.7 million versus the same quarter of the prior year. This decrease is the result of overhead costs incurred resulting in the realignment of manufacturing facilities. I'm basically talking about Webster manufacturing facilities as well as the Transco transaction. Adjusted for LIFO, gross profit per pound in the current quarter is $0.151 a pound. And in the third quarter of the prior year, adjusted gross profit per pound was $0.169. And needless to say, we all know that we work for adjusted gross profit and we're very -- we are not happy with that number.

Gross profit for the 9 months ended 2013 decreased $17 million to $117.3 million. This includes a LIFO reserve increase in the current year-to-date period of $5.6 million as compared to a LIFO reserve decrease in the prior fiscal year of $7.1 million. Adjusting for this $12.7 million swing in LIFO reserve combined with $3.3 million of increased depreciation costs, there was a gross profit decrease in the current period of about $1 million versus the first 9 months of the prior fiscal year. Among other things, this includes under-absorption of overhead costs and increased costs resulting from the realignment of manufacturing facilities. Adjusting for LIFO, gross profit per pound for the current year-to-date period is $0.173. In the prior year, adjusted gross profit per pound was $0.177. It is down.

Operating expenses for the third quarter of fiscal 2013 were $31 million, a decrease of $700,000 compared to the comparable period of the prior year. This decrease was due to reductions in employee performance incentives and professional fees that more than offset about $5 million of increased delivery costs and severance expenses -- I'm sorry, that was not $5 million, that was $500,000.

For the first 9 months of fiscal 2013, operating expenses were $91 million, a decrease of $300,000 as compared to the prior fiscal year. The operating cost decrease in 2013 and the 2013 9-month period is primarily due to increased share-based compensation costs associated with the company's stock options and performance units, severance costs and increased inter-plant transportation costs related to the realignment of Webster facilities, which were more than offset by volume decreases, positive synergies relating to Webster and the absence of acquisition-related expenses incurred during the prior year. There are no significant changes to interest expenses. Details related to interest expense are provided in our 10-Q.

Net income for the 3 months ended July 31, 2013, was $1.8 million or $0.32 a share as compared to net income of $12.3 million or $2.20 per diluted share for the 3 months ended July 31, 2012. Net income for the 9 months ended July 31, 2013, was $9.8 million or $1.74 per diluted share as compared to net income of $17.5 million or $3.15 per diluted share for the 9 months ended July 31, 2012. The significant factor affecting net income between these reporting periods is the result of LIFO reserve fluctuations and depreciation, which are noncash items and which, on a before-tax basis, impacted comparative reported profits for the 3-month and 9-month periods ended July 31, 2013, by $16.4 million and $16.7 million, respectively.

During the third quarter, we identified an immaterial keying error in our operating system. The error had the effect of understating net sales, gross profit, operating income before taxes and adjusted EBITDA by $1,270,000 for the quarter and year-to-date period ended April 30, 2013. Taxes were understated by $432,000, and net income was understated by $838,000. EPS was understated by $0.15 per share. The circumstances which allowed this error to occur have been corrected. July 31, 2013, year-to-date financial information reflects these corrections.

As you know, we run the company for adjusted EBITDA, which was a fairly stable $14.4 million in the current quarter and $58 million year-to-date as compared to $16.4 million and $56.5 million in the same period of the prior fiscal year. The amount of cash dedicated to our discounting program continues to be around $50 million. CapEx in the third quarter was $12.7 million and is $38 million year-to-date. CapEx is expected to be in the area of $40 million for the 2013 year.

J. Brendan Barba

Does that say $45 million?

Paul M. Feeney

I'm sorry. That's $45 million for the year. Current availability is around $148 million.

With that, Brendan and I will take any questions you may have.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Roger Spitz with Bank of America Merrill Lynch.

Roger N. Spitz - BofA Merrill Lynch, Research Division

In terms of 2014 fiscal volumes versus '13, I expect you don't want to give any particular guidance, but can you tell us how to think about this? Should we think about this from fiscal '13 as GDP growth? Or should we think about some specific adjustments to '13 like the Transco line transfer issue or other catalysts we might think about?

Paul M. Feeney

There were a number of issues that affected us volume-wise in 2013. We do not necessarily look at 2013 as a base period for getting to 2014 numbers. We haven't completed our forecasting exercises for 2014. But I would expect that we would almost start at a 2012 level and basically reevaluate what we think will be happening to our overall business in 2014. We are really looking at 2013 as if it was an anomaly from a number of points of view, not exclusively the issues that arose from the machine being damaged in transit.

Roger N. Spitz - BofA Merrill Lynch, Research Division

Okay. And you're now expecting the CapEx for the...

Paul M. Feeney

I forgot to say, we will give you guidance on sales volume for 2014. But that will not happen until probably our January call, which, of course, talks about the results for our 2013 year. We will give you guidance on that.

Roger N. Spitz - BofA Merrill Lynch, Research Division

Okay, great. On the 2013 CapEx guidance of $45 million, last quarter you were looking at $36 million for the full year.

Paul M. Feeney

Yes, that's correct.

Roger N. Spitz - BofA Merrill Lynch, Research Division

Can you talk about the drivers for the increase, please?

Paul M. Feeney

The drivers are basically equipment associated with some of our businesses that are essentially sold out. And also, there were some catch-up costs that we really thought was going to come in, in 2014, but it's in already. So that's why we moved it from -- that's why there's an over-expenditure in the third quarter and we are looking at $45 million instead of a lower number in 2013. We do not expect 2014 expenditures to be anywhere near this number, this $45 million number.

Roger N. Spitz - BofA Merrill Lynch, Research Division

Can you ballpark it? I mean, just in a very broad scope?

Paul M. Feeney

We're not in a stage that we can ballpark it right now. We will give you that guidance also in January.

Roger N. Spitz - BofA Merrill Lynch, Research Division

All right. Very good. And lastly, what do you think about maintenance CapEx for your current configuration?

Paul M. Feeney

We're really looking at maintenance CapEx in the area of about $8 million to $9 million.

Operator

[Operator Instructions]

Paul M. Feeney

Okay. Well, what we're going to do at this stage is thank everybody for attending this conference call. You all know how to contact me and Brendan. Feel free to please do so if there are any questions that you would like to follow up on. Thank you very much.

J. Brendan Barba

Thank you, everybody.

Operator

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

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