AEP Industries' CEO Discusses F1Q 2014 Results - Earnings Call Transcript

| About: AEP Industries (AEPI)

AEP Industries, Inc. (NASDAQ:AEPI)

F1Q 2014 Earnings Conference Call

March 13, 2014 10:00 AM ET

Executives

Nicholas Lamplough - IR, Director

Brendan Barba - President and CEO

Paul Feeney - EVP, Finance and CFO

Analysts

Roger Spitz - Bank of America Merrill Lynch

Bob Franklyn - Prudential Financial

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. First Quarter 2014 Results Conference Call. All lines have been placed on mute to prevent any background noise. 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, 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?

Brendan Barba

Thank you, Nick. Good morning everyone. Welcome to our first quarter conference call. Our results for the first quarter on both volume and earnings were below forecast and certainly below expectations. Volumes were affected by a number of factors. We had severe snowstorms in various parts of the country that affected our manufacturing plants that actually had to shutdown. Shipments were also curtailed for similar reasons. The first quarter, and everyone should understand this is always our slowest quarter. This one just happened to be slower, somewhat affected by the above -- the last few items that I brought up. And the sales feedback is just that the economy was slow and it wasn’t as a result of losing anything. We just didn’t see much activity.

Second quarter volumes will be stronger. We expect continued volume increases in the third and fourth quarter and the same continuing increases in earnings as a result of better volumes. February volumes are already up a 1 million pounds. March backlogs are strong and we will absolutely increase volumes in 2014.

I’d like to go just a quick discussion about our Transco acquisition which is basically complete. All the equipment has been moved. Right now we’re really have more than doubled the size of our print department from 2 to 5 presses and we are spending a huge amount of time and money training people to get them ready for whatever increased business comes our way.

The Webster acquisition, the staffing has been reduced from 700 people down to about 350. We continue to install equipment in this plant in 2014. The equipment that we’re purchasing, we look at it as without risk. It’s really product that we are currently importing, so we have the business, it’s just a matter of making it cheaper and we can make it cheaper than importing the product. That will certainly have a positive impact on lowering our cost, improving services and improving cash flow.

In our Montgomery, Alabama plant we’re installing high-density capacity, again product that we purchased from imports. We are adding 5 million pounds of capacity. The product should be running by June. No exact date, but just the date of June is the best I can give you for right now. We’re also installing on a converting machine that will produce about a 1 million pounds. That million pounds will increase our utilization of our extrusion department which is not sold out, and that will also help, that is supposed to come on stream in July 2014. And we have an automation project which is really a long-term project, probably a couple of years. It is five phases. We are in phase 1 right now. We expect that to be complete by July of 2014 and we are expecting staff reduction of a minimum of 50% with the installation of that equipment.

We continue to expand production capacity in 2014 despite substantial available capacity in some of our businesses. The investments in 2014 are in areas where we are busy and need more capacity. These investments will again lower cost, improve service, assists us growing our business in various divisions. Specific installations in our Waxahachie plant in December, in our canliner division we brought on and it’s up and running about 8 million pounds of added capacity. In Alsip, Illinois in our custom films division, we are adding 10 million pounds of capacity. It comes on the end of this month. In our North Carolina facility we are adding 10 million pounds of capacity in our custom films business it’s starting in April of 2014 and also in our North Carolina plant we have a stretch film line, a [cached] [ph] stretch film line that’s coming on-stream. We’ll add about 25 million pounds of capacity that start date is really for 2015. It takes us about a year to get that equipment. So, we ordered in 2014 and it will be installed and running in 2015.

In our Mountain Top, Pennsylvania plant, we are adding about 8 million pounds of capacity in our custom films and canliner division with a start date of about June 15th. Total expansion companywide is 65 million pounds with 40 million coming in 2014 to 25,000 which is the stretch line over a 25 million coming on in 2015. No further expansions or new I shouldn’t say expansions we may be bugged some equipment or -- but new equipment we have nothing on order that’s the first time that that’s happened in a long time. We don’t expect anything. We’ve put on quite a bit of capacity. We expect CapEx for 2014 to be about $35 million and CapEx in 2015 will be substantially below the 35 million number but I don’t have a number for you right now.

I’d like to spend some time on resin and its effects on our business. 2014 we had $0.14 in resin increases on three separate price increase occasions. Again each increase of a penny represents about a $1 million that we have to pay us on to the customers. This is not an AEP problem it’s an industry problem. Everybody in the business has the same problem we do. Margins get squeezed because it takes time to get our prices up. It’s a simple fact that’s been like this since I’ve been in the business there is very little that we can do to change that. Last year, we made some attempts to change that by shortening some of the protection periods in our contracts and we wound up losing the contracts. Some of that explains why volumes were down last year.

So clearly we’re not in that mode any longer. We’re not going to do that any longer. We just have to write out whatever the legs are in the contractual business that we have that’s by contract and the transactional business also takes time to get up but it certainly comes about faster than most of the contracts that we have. Again always negative variances going on when resin prices are going up especially when they raise it $0.04 or $0.05. And looking at 2014, we see the same pattern developing. 21, we had a $0.04 increase it held they have another increase announced for 41 it’s a $0.06 increase.

While we’re evaluating that increase right now and trying to gather information from the suppliers it should be well understood that the market is very tight for resin and they have been able to get the increases and for sure a part of this increase will hold and possibly all of it will hold. So we’ll be dealing with the same price increase lag in this quarter as we have to during any price increase. For the balance of the year, we do not expect any more increases after the $0.06, which is it will be flat. That will certainly give us some relief and hopefully that forecast is accurate.

I know there is a lot of questions about, why we would be adding capacity when we’re not sold out. I think I explained that. We’re adding it where we are buying it on the outside, and we’re adding it where we are busy as a Company. And I’m going to tell you that I’m very, very comfortable with the investments that we made in 2013 and 2014. We expect these substantial investments and we’re very aware that we spent a lot of money last year and this year that they’re going to have a positive effect on our business, improve earnings and certainly create shareholder value.

That’s pretty much it from my end Paul.

Paul Feeney

Good morning, ladies and gentlemen. I’d like to quickly review the financial results of the first quarter and then throw this out to questions which I’m assuming will be many. Net sales in the first quarter increased $5.4 million. The 2% increase in the Company’s net sales was the result of a 7% increase in average selling prices, partially offset by a 4% decline in sales volume. Volume in the quarter was 220 million pounds as compared to about 230 million pounds in the first quarter of 2013.

Book gross profits for the quarter resulted -- decreased $17.9 million, this includes LIFO reserve increase in the current quarter of $1.9 million compared to a LIFO reserve decrease in the prior year’s quarter of $3.1 million. Adjusting for this $5 million swing in the LIFO reserve movement in both quarters and a $2.1 million increase to depreciation there was a gross profit decrease in the current quarter of about $10.8 million versus the same quarter of the prior year. The primary factor negatively impacting first quarter gross profit was the Company’s inability to pass increased resin costs through to customers. Basically, what we’re talking about here is that contraction in the material margin.

Gross profits were also negatively impacted by -- but to a much lesser extent by increased manufacturing costs and decreased volumes which combined to produce an under absorption of overhead expenses. Gross profit per pound in the current quarter is $0.112 a pound and was $0.18 a pound in the same quarter of the prior year.

Adjusted for LIFO, gross profit per pound in the current quarter is $0.12 compared to $0.172 in the prior year. Operating expenses decreased $2.5 million due primarily to decreased share based compensation cost, delivery, selling and salary expenses. Interest expense increased in the first quarter by $200,000 and that resulted from a increase in credit line borrowings. We operate the Company to maximize adjusted growth EBITDA which was a disappointing $7.5 million in the quarter as compared to $17.9 million in the prior period.

Net income for the current period is a $0.67 loss per share as compared to a $1.25 profit in the prior fiscal quarter. The amount of cash dedicated to our discounting program continues to be about $50 million. CapEx in the quarter was around $9.3 million and is expected to be in the area of $35 million for the year. Current cash availability is approximately $120 million. We have recently announced a $10 million stock buyback plan. This announcement was during a period when we were not able to buy any share. So, at this point there has been no activity in that buyback plan.

That concludes my comments and I’d like to throw this conference call out to questions at this time.

Question-and-Answer Session

Operator

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

Roger Spitz - Bank of America Merrill Lynch

Hi. Good morning guys.

Brendan Barba

Good morning Roger.

Roger Spitz - Bank of America Merrill Lynch

Speaking about the competitive environment that you called out in the press release and your comments, has it become more intense perhaps because of the slow volumes or can you speak about that?

Brendan Barba

No. I wouldn’t say that, I don’t hear a huge amount of complaining from the sales department that there’s deals going on all over the place in the first quarter. I think the competition recognizes that’s really it wasn’t a lot of activity, but I will tell you that any time we raise prices, you run the risk that the customer will go out and get five bids and that does happen and you may or may not -- a business that you have, you may not get that, that’s the part of the downside to the market moving up, there is always business at risk, when you do that. But by the same token we’re not in a position to eat the $0.04. So we really, really focus on getting our prices up.

Roger Spitz - Bank of America Merrill Lynch

Okay. These two comments I think I heard you say, that firstly you didn’t -- you likely didn’t lose any market share in the quarter and that you still expect fiscal ’14 volumes to be up from fiscal ’13. Did I hear both of those correctly?

Brendan Barba

Yes, sir.

Roger Spitz - Bank of America Merrill Lynch

Okay. Chem Data shows LLDPE resin prices flat from September ’13 through January ’14, if that’s right, that would suggest that the effect of price lag is fairly long, is that the right way to think about it in this environment?

Brendan Barba

Well, contractual business is we’re bound by whatever the contract says, whatever that period of protection is and they vary customer-to-customer. The transactional business gets moved and don’t forget we’re in many, many polyethylene businesses, the stretch business runs differently than the custom films business and some of it is done on a regional basis so that we raise our prices in conjunction with the competition. If we push our prices out before their announced price increase or after their price announced increase and we don’t support it, then volume will go away. They can place it with the latest date, if I say you’re up January 1 and the competition says you’re up January 20th, they don’t have to buy from us they can buy it from the competition because they have another 20 days. That’s may be a better way of explaining it.

Roger Spitz - Bank of America Merrill Lynch

I get it. I guess one of the things in the past the way I understood the model, how the business model may be, I don’t fully understand it, but the way I understood it was that you have this great discounting program with your suppliers that allows you in rising price environments like we’re seeing, to sort of be able to do a better buy in than perhaps than your competition and that you can sort of help roughly better match the resin price increases with the pushing through the product price increases. Is that fair or is it polyethylene resin is very tight these days. That’s why they are getting such high prices, that, you know what that’s a great model but it breaks down when things are or breaks down a bit when things are just this tight in polyethylene?

Brendan Barba

That’s correct. The simple answer is that, everybody attempts to do whatever they can do to buy-in and that meets, the market determines how much of that you’re allowed to do and right now the market’s tight for resin, why would they give us any better deal when they can get $0.04 a pound for it the following month, so it’s a struggle, we had one vendor that put us on a 90% cut back, we got 10%- Exxon in their high density products went with a 10% allocation. I mean that’s crazy and that’s very unusual and is not representative of the market but that’s what, there are other companies that are on allocation. It’s a tight market for resin.

Roger Spitz - Bank of America Merrill Lynch

I understand, okay, thank you very much.

Brendan Barba

All right Roger.

Operator

Our next question comes from the line of Bob Franklyn with Prudential Financial.

Bob Franklyn - Prudential Financial

To follow-up on those resin questions, I don’t have yours or Roger’s breadth of knowledge, if the market’s tight, but consumes are generally weak what’s driving the tightness?

Brendan Barba

They’re exporting, I think if, I don’t have it in front of me, but the Chem Data report that he just referred to, there was only a slight amount of growth in the domestic markets for low density, linear low density and I don’t recall if that included high density, I’m going to say in the 1% range. That was what the growth of the resin suppliers were. But exports are 20%, so the market is tight because they’re able to export substantial amounts of resin and they’ve been no new capacity of any significance put on in the United States for many, many, many, many years. Some debottlenecks but no new -- the new capacity comes in 2016 and ’17 and it’s going to be substantial.

Bob Franklyn - Prudential Financial

Okay, if, you expect it to be flat after I think you said April 1 that increase, what gives you that information?

Brendan Barba

The best feedback that I can get from my suppliers.

Bob Franklyn - Prudential Financial

Okay, but if they’re exporting, are they telling you where it’s going and why that would level off.

Brendan Barba

No, they’re not going to tell me that.

Bob Franklyn - Prudential Financial

All right, by country or continent?

Brendan Barba

No.

Bob Franklyn - Prudential Financial

All right, what percentage of your business at this point is contractual versus, I guess…

Brendan Barba

In our sales or in resin contracts?

Bob Franklyn - Prudential Financial

In your sales.

Brendan Barba

I think it’s about 25%, Paul can you confirm that number.

Paul Feeney

It’s between 25 and 35.

Bob Franklyn - Prudential Financial

Okay, so 25% to 35% you got some form of pass through, is that right?

Paul Feeney

Yes.

Bob Franklyn - Prudential Financial

And then, how are you feeling about cash flow this year? I know that you gave us a CapEx number, you feel like you’re going to be breaking even, a little negative, a little positive?

Paul Feeney

Well, our forecasts are that it’s going to be a positive cash flow, but, positive free cash flow, and I think we’re staying with that.

Bob Franklyn - Prudential Financial

Okay, thank you.

Operator

(Operator Instructions) And we have no further questions at this time.

Paul Feeney

Ladies and gentlemen, thanks for joining us today. If there’re any personal questions or questions that stand on their own, please don’t hesitate to contact us. Thank you very much.

Brendan Barba

Thank you everyone. Take care.

Operator

Thank you, this concludes today’s conference call. You may now disconnect.

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