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Executives

Nicholas Lamplough - Director

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

Paul Feeney - Chief Financial Officer, Executive Vice President - Finance

Analysts

Donovan Chaney - Wells Fargo

Roger Spitz - Merrill Lynch

Dan Khoshaba - KSA Capital

AEP Industries Inc (AEPI) Q4 2013 Earnings Conference Call January 15, 2014 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 Incorporated Fiscal Year 2013 Results Conference Call. After the speakers’ remarks, there will be a question-and-answer session. (Operator Instructions) Thank you.

Mr. Lamplough, you may begin your conference.

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. Those 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

Thank you. Good morning everyone, welcome to our 2013 year end conference call.

I would like to start with a few operational highlights that had some major impacts on our company in 2013. I want to start with a negative and we had to do with resin price increases. Resin continued its upward spiral with three large increases in 2013 totaling $0.14 a pound. Annualized in our polyethylene businesses, these increases totaled $120 million or $10 million a month that we need to pass on just to be even, staggering numbers. Passing on these increases is always a challenge, we deal with these increases in two different ways contract pricing -- simply contract prices move up based on the contract.

Transitional business, this is a function of the marketplace, we increased our prices along with in conjunction basically with what competition does, if the competition lags, we are forced to be slowing our increases down also. Again, function in the marketplace is nothing we can do about it. This does have a negative impact on earnings and had – did have a negative impact on earnings in 2013.

We expect 2014 resin prices to be less volatile than 2013, this will have a positive effect on our 2014 earnings. Having said this, the suppliers have announced another $0.04 increase effective February 1st. We are in the process of evaluating this increase regardless of whether this increases holds or not, we see 2014 resin prices more stable than 2013.

We had a couple of – two big things that took place for the company in 2013, which were difficult to do and disruptive to our overall operations or dilutive is probably a better word. We made two acquisitions. First was Webster Industries, which is a retail polyethylene business located in Montgomery, Alabama. This is a new business for AEP. It’s a huge market in excess of a billion pounds, excellent purchase price, we really did not overpay for the business. We saw a huge synergies most of it in labor. And last year, when we started there were 714 people. Today there were about 350 people and we recognized all the synergies that we said we would.

That was in Phase I and Phase II is something that we are in the process of implementing as we speak but that will be – that will take us about another year and that will be – that’s mostly automation projects and that will also be taking out additional cost, so we are not prepared to discuss that yet as we are running some trials. Once the trials are determined that we can receive the full value on the equipment, we will implement Phase II completely but until that is confirmed, we are not really making any announcements on that. We believe because the equipment manufacture is very good that we will achieve those, so I thought it would be worth bringing up.

We really have taken care of the vast majority of our non-occurring operational cost. They are pretty much behind us. Another positive thing, January 1, we entered into a five-year contract with the Union in Montgomery for about 2% a year with some help on insurance. We are pleased with that contract as the new kid on the block; we could ill-afford a strike, so we were able to put together the contract the union was good to work with. And I think everybody is happy. This is evaluated business with huge market potential, again, over a billion pounds brand new market to AEP. On the upside earnings in 2014 and forward look really good.

We did a second acquisition, a company called Transco in Canada. Clearly the timing was poor, but we don’t determine when the companies are going to be sold and this became an emergency acquisition. We had a limited amount of time to move out of the facility and unlike the Webster acquisition, this one was moving everything out of the existing building. It’s a value-added business. It’s core to AEP. It was a purchase of opportunity. We paid $5.3 million for this business. We moved all the equipment out of Canada, its all installed in AEP plants, most of it went to our Bowling Green, Kentucky plant. There were 2 10-color presses. Each press is worth about $5 million to give you an idea of value, three co-ex lines and three bag machines.

Printed business is a core business as I said before, and it’s really, really, we are very pleased with what we were able to accomplish in a short year here. And again, most of the costs were out of this business they are non-reoccurring and that’s also very positive for us in 2014.

We continue to invest in our business in 2014, by division our institutional can liner business, we have installed and its running, 8 million pounds of added capacity in our Waxahachie, Texas plant, it’s not that easy to say. Eight million pounds were added – will be added to our Mountain Top, Pennsylvania plant about the middle of June. In our stretch division, we are adding 25 million pounds of cash capacity in our Matthews, North Carolina plant that should come on-stream around the third quarter of 2014. By the time it’s installed, debugged extra, it will really be up a line that will be used more in 2015 than in 2014. Stretch lines take about a year to get, so we need to do some planning well in advance and use our couple of year out forecast to make that – to do that correctly.

And again, in the retail polyethylene business, we are adding 5 million pounds of capacity in our Montgomery, Alabama plant and that should be running somewhere around May of 2014. We are adding two lines in our custom films division, each line will produce about 10 million pounds, one will be starting in April of 2014 and the other one in May of 2014. Total capacity for the year is 66 million pounds.

We understand we have surplus capacity, overall in the company but these investments fall into a little bit of a special category. I guess four different categories. One would be capacity needed on products where we are historically busy. The second would be products we purchased, which we will now be manufacturing clearly there is no risk on that investment. Capacity needed to lower costs and replace old non-productive equipment that’s an ongoing process and it’s a part of what we do all the time. And capacity needed based on sales forecast with historically accurate forecast. So we feel very comfortable even though we are clearly undersold that where these investments are being made, we will be able to keep the lines running.

In closing, I just want to say that 2013 was a very, very difficult year for us. The two acquisitions put a huge amount of strain on our management group, teams and we are all glad that’s behind us. We had many, many management meetings and I can tell you that I have never seen our people higher than what they think we can accomplish in 2014 and moving forward. So we are really optimistic about our opportunities in 2014.

That concludes my portion. Paul?

Paul Feeney

Good morning, ladies and gentlemen. I would just like to go through some financial metrics that affected us in 2013.

Net sales in the fourth quarter were $299.3 million, a 1% increase over the $296.2 million reported for the fourth quarter of 2012. Pre-unit selling prices were up about 4% over the prior year. Volume in the quarter was 248.8 million pounds, a decrease of 8.4 million pounds from the 257.2 million pounds sold in the fourth quarter of fiscal 2012.

Net sales in the fiscal year ended October 31, 2013, decreased $8.7 million or three-quarters of 1% to $1,143.9 million from $1,152.5 million in the prior fiscal year. Net sales were negatively affected in the quarter and year-to-date by a decline in sales volume.

Volume in 2013 was 959.2 million pounds down 14.6 million pounds from the 973.8 million pounds sold in the prior fiscal year. We expect volume in 2014 will increase over fiscal 2013 levels but current activity in our market make it impossible to estimate the rate of increase with confidence at this time.

Sales attributable to the Transco acquisition were about $10 million, this is a disappointing result and was due to damage sustained by newly purchased equipment while in transit to our facility in Bowling Green, Kentucky.

Book gross profits for the fourth quarter of 2013 decreased $11.3 million to $37.2 million. Adjusted for LIFO reserve changes in both the current and prior quarters and an increase to depreciation expenses of $1.8 million resulting from 2012 and 2013 capital expenditures. There was a gross profit decrease in the current period of about $11.1 million versus the same quarter over the prior year. This decrease is the result of increased manufacturing expenses.

Adjusted for LIFO, gross profit per pound in the current quarter is $0.167 a pound; in the fourth quarter of the prior year adjusted gross profit per pound was $0.211 a pound.

Book gross profits for 2013 fiscal year decreased $28.3 million to $154.5 million. This includes a LIFO reserve increase in the current year to-date period of $9.9 million as compared to a LIFO reserve decrease in the prior year’s fiscal period of $1.2 million. Adjusting for the $11.1 million of LIFO reserve changes in both periods combined with $5.1 million of increased depreciation cost. There was a gross profit decrease in the current period of about $12.1 million versus the prior fiscal year.

Among other things, this includes increased manufacturing cost, under absorption of overhead cost and increased cost resulting from the realignment of manufacturing facilities. Adjusting for LIFO, gross profit per pound for the current year is $0.171 pound as compared to adjusted gross profit per pound of $0.186 in 2012.

Operating expenses for the fourth quarter of fiscal 2013 were $30.1 million, a decrease of $5.4 million compared to the prior year. This decrease was due to reductions in employee performance incentives, professional fees and share-based compensation costs.

For the 2013 fiscal year, operating expenses were $121.1 million, a decrease of $5.7 million as compared to the prior fiscal year. The operating cost decreased in 2013 is primarily due to again, reduced share-based compensation cost associated with company’s stock options and performance units, volume decreases, positive synergies related to Webster and the absence of acquisition related expenses incurred in the prior year. These decreases more than offset increased severance costs and increased delivery costs related to the realignment of Webster facilities.

There are no significant changes to interest expenses between the periods covered in this conference call. Details related to interest expenses are provided in our 10-K.

Net income for the 3 months ended October 31, 2013, was $1 million or $0.18 per diluted share as compared to net income of $5.7 million or a $1.1 per diluted share for the 3 months ended October 31, 2012.

Net income for the year ended October 31, 2013, was $10.7 million or $1.92 per diluted share as compared to net income of $23.2 million or a $4.16 per diluted share for the 2012 fiscal year.

The significant factor affecting net income between these reporting periods is the result of LIFO reserve fluctuations and depreciation, which are non-cash items and which, on a before-tax basis adversely impacted reported profits for 2013 by $16.7 million.

We run the company for adjusted EBITDA, which was $75.9 million in 2013 fiscal year as compared to $84.2 million for the same period of the prior year. Our 2013, capital expenditures were entirely supported by internally generated funds. The increase in 2013 debt of about $25 million is more than offset by a corresponding increase in net current assets of $31 million adjusted for LIFO.

The amount of cash dedicated to our discounting program continues to be around $50 million. CapEx for the year was around $46.7 million and is expected to be in the area of $36 million for 2014. Current availability in the company at the present time is about $140 million.

With that, I conclude my financial presentation and I will throw this conference call open for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Donovan Chaney with Wells Fargo.

Donovan Chaney - Wells Fargo

Hey, good morning, gentlemen and thanks for taking the question.

J. Brendan Barba

Good morning.

Paul Feeney

Good morning to you.

Donovan Chaney - Wells Fargo

I just have one quick question about revolver draw down, it looks like you guys drove down the revolver probably partly for working capital. And then maybe it looks like some went on to the balance sheet. I was wondering if you could just kind of talk about your kind of why you do that cash on to the balance sheet and if you – if there is some acquisitions maybe that are kind of looming out there or just sort of what’s your thoughts were there?

Paul Feeney

Well, we have utilized our revolver many times during the past fiscal year. And at year end our revolver does represent some draw down. Primarily because we have funded or increased our net current assets by about let’s say $31 million. That increase is primarily in the area of inventory. And now don’t forget, inventory our numbers in the current period did or affected by $9.9 million LIFO reserve. So you don’t – you have to add that back to the current period inventory to put things on a comparative basis. But primarily, our revolver is used to balance that activities that are happening in current operations. We do look at acquisitions throughout the year, however, we didn’t -- aside from the Transco acquisition what happened earlier in November, we have done no acquisitions that we don’t have any reserves established for an acquisition.

Donovan Chaney - Wells Fargo

Okay. That’s helpful Paul. So the $13 million or so of cash that looks like its on the balance sheet as of the end of the quarter, is that just a function of kind of where the end of the quarter happened in the flow through of money for your different needs?

Paul Feeney

Yes. That’s true.

Donovan Chaney - Wells Fargo

Okay. That’s great. Thanks a lot.

Operator

Our next question comes from the line of Roger Spitz with Merrill Lynch.

J. Brendan Barba

Good morning, Roger.

Roger Spitz - Merrill Lynch

Hey, good morning.

Paul Feeney

Hey, Roger. How are you?

Roger Spitz - Merrill Lynch

Great. Hopefully can hear me all right. I apologize, I’m on a cell phone. Could you tell us what percent of your pounds or sales are subject to contractual resins pass-through? I think historically, it was like at 20% or so and in of that that is contractually kind of through what is the lag time, is that one month resets?

Paul Feeney

Approximately 30% of all that was sales are covered by contracts. Most of those contracts, the pricing resets between 1 and 3 months. In our retail business and that would be our Webster business. Most of those contracts reset after a year. So what I would really tell you is somewhere around, I’m going to say $15 million to $20 million worth of contracts are – that have a price reset of around a year. But all of the rest of them are resets between one and three months.

Roger Spitz - Merrill Lynch

Okay, great. All right. It sounds like the volume decline you experienced were related to in-house operating issues, do you have a sense of what underlying industry market demand volume growth or decline was?

Paul Feeney

We have actually thought that 2013 was going to be a pretty good year for us volume wise. We entered the year essentially price managing a significant portion of our business. But half-way through the year, we realized that that our volume was not going to grow the way we thought it was going to. And we had to move half of our price management activities. We think that 2013 was generally a pretty flat year for our entire industry. Many as you know much of our competition are private companies and they don’t report volume numbers but those that are public nobody has been reporting strong volume growth in their businesses.

Roger Spitz - Merrill Lynch

Okay. Thank you for that. And last one, I know this is historically very hard to do because it’s varies by product line. But just, if you can give us any sense at all of the way you might think about it, your overall operating rates based on your volumes and total capacity?

J. Brendan Barba

Well, it does vary tremendously from division to division, but I guess Paul, you have something you could comment on that. I don’t know if we have that available immediately but both numbers which you are asking for Roger on the all the operations versus all capacity?

Roger Spitz - Merrill Lynch

Right. I’m trying to figure out whether you are at -- anything within plus or minus 5% or 10% just total both number just to give a sense of it?

Paul Feeney

You are talking about capacity utilization, right, Roger?

Roger Spitz - Merrill Lynch

Yes. You were at --

Paul Feeney

Yes.

Roger Spitz - Merrill Lynch

70%, 90%, you know, that’s all I’m looking for, basically not able to do a number on it some times?

Paul Feeney

I think the best thing I can give you is between our polyethylene and PVC businesses. Our PVC businesses are in the high 80s right now, well, not right now, but throughout 2013 were in the 80s. And now our polyethylene businesses throughout 2013 was giving full recognition that there are very, very busy periods and we have been adding capacity but those things considered our capacity utilization numbers are probably in the low 80s for polyethylene.

Roger Spitz - Merrill Lynch

Okay. Thank you for that. Appreciate it.

Paul Feeney

Okay.

Operator

(Operator Instructions) Our next question comes from the line of Dan Khoshaba with KSA Capital.

Dan Khoshaba - KSA Capital

Good morning, gentlemen.

J. Brendan Barba

Good morning, Dan.

Paul Feeney

Good morning, Dan.

Dan Khoshaba - KSA Capital

Guys I’m just taking an estimate or a stab at the potential impact from the disruptions at Transco and Webster. And it seems to me like based on the 10-K yesterday and just taking a guess at Webster that maybe there was a $30 million, $40 million impact on revenue that came from disruptions, does that sound roughly, right?

J. Brendan Barba

Not on Webster, it doesn’t no.

Dan Khoshaba - KSA Capital

Not talking about in total –

J. Brendan Barba

Now that’s –

Dan Khoshaba - KSA Capital

Okay. So you don’t feel like you lost any revenue or anything meaningfully from Webster. And on Transco, you said revenues were $10 million, but you were expecting $30 million, I wasn’t sure if there was something similar to that on Webster?

Paul Feeney

We did not lose very much business in Webster. We may have lost a little bit. Our problem on Webster was really cost driven and it had to do with a significant amount of transportation cost that it was incurred because we were basically making product in Texas and distributing that product from Alabama and we were making product in Alabama distributing it from Texas. We were in the process of sorting those activities out but delays in installing certain equipment in Texas made that sort of movement absolutely necessary and it was disruptive and cost consuming but we did not to a significant degree upset our sales volume numbers there.

J. Brendan Barba

Maybe if I could just supplement that a little bit. It’s a little bit complicated for us because Webster did business as one company and they combined institutional products with retail products. And we separated those because we produced our institutional products in Waxahachie, Texas and we are now producing only retail products in Montgomery, Alabama where they did both. But there was some bids in institutional products where we lost the bids and that did affect the volume. I’m not aware of any or I can’t think of any off hand in the retail end of the business where we lost any significant bids.

I mean, you know, bids are everyday every month as bids going on, you win some or you lose some but two that I can think of that was significant affected to Waxahachie volumes but not the Montgomery volumes.

Dan Khoshaba - KSA Capital

Okay, great. And just a follow-up how long do you think it will be before you solve the shipping cost inefficiencies at Webster or have you already finished those?

J. Brendan Barba

Those are pretty much done. I think the last what – I guess you are referring to the movement from because of space issues and the pound issues that we had. We had to start making product in Waxahachie shipping it to Montgomery because they had the space and we didn’t and then shipping it back. And we are basically in February, I believe, we transitioned the last customer back to Waxahachie where we put on some additional space, some leased space to accommodate need for that extra warehouse space.

Dan Khoshaba - KSA Capital

Okay, all right.

J. Brendan Barba

So I say by February.

Dan Khoshaba - KSA Capital

Okay, all right. So you are almost have that taken care off. And was that a material cost that we are talking, 100s and 1000s of dollars or maybe couple of million dollars or what kind of impact would that have had?

J. Brendan Barba

From memory it was in the $500,000, $550,000 range annualized and we will make all of that go away minus the warehouse cost and its somewhere around positive $300,000 and that’s a rough estimate and I don’t have those numbers in front of me.

Dan Khoshaba - KSA Capital

Okay. And then do you expect to get the additional $20 million at Transco that you did not have, but a portion of that budgeted into 2014?

J. Brendan Barba

We are working on that. There is a couple of issues with product development. And there is a couple of issues where our credibility was hurt in the marketplace because of the damage to the printing press which happened in the very height of the season.

Dan Khoshaba - KSA Capital

Right.

J. Brendan Barba

So that we had to go back to customers and with egg on our face and say we don’t have that capacity to supply you and that was some of the existing business that Transco had.

Dan Khoshaba - KSA Capital

Got you, got you. Do you anticipate Brendan that you will get back at least is there kind of like a number maybe half of that at a minimum or --?

J. Brendan Barba

Yes. I feel comfortable that we will pick up. I can’t give you a number Dan because we are right in the midst of requalification and going through this as we speak. So I really don’t have a good answer for you right now. I can tell you that we will increase the volume this year out of Bowling Green, but I can’t really quantify it for you.

Dan Khoshaba - KSA Capital

Right. Got you. Okay. Thanks guys.

J. Brendan Barba

Thank you.

Operator

And ladies and gentlemen, this concludes today’s Q&A portion of today’s conference call.

J. Brendan Barba

Okay. Thank you everyone. Get to us always if you have any questions. Please don’t hesitate to call Paul and myself.

Paul Feeney

Have a good day, everybody. Bye.

J. Brendan Barba

Thank you. Bye-bye.

Operator

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

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