AEPI Aep Industries Inc.

Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

 

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the Quarterly Period Ended July 31, 2014

OR

 

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from              to             

Commission file number 001-35117

 

 

AEP Industries Inc.

(Exact name of registrant as specified in its charter)

 

Delaware		22-1916107
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
95 Chestnut Ridge Road Montvale, New Jersey		07645
(Address of principal executive offices)		(Zip code)

(201) 641-6600

(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months, and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer		¨		Accelerated filer		x
Non-accelerated filer		¨  (Do not check if a smaller reporting company)		Smaller reporting company		¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    Yes  ¨    No  x

The number of outstanding shares of the registrant’s common stock, $0.01 par value, as of September 5, 2014 was 5,080,596.

 

 

 

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AEP INDUSTRIES INC.

TABLE OF CONTENTS

 

				Page Number
PART I		FINANCIAL INFORMATION
ITEM 1:		Financial Statements			3
		Consolidated Balance Sheets at July 31, 2014 (unaudited) and October 31, 2013			3
		Consolidated Statements of Operations for the three and nine months ended July  31, 2014 and 2013 (unaudited)			4
		Consolidated Statements of Comprehensive Income (Loss) for the three and nine months ended July  31, 2014 and 2013 (unaudited)			5
		Consolidated Statements of Cash Flows for the nine months ended July 31, 2014 and 2013 (unaudited)			6
		Notes to Consolidated Financial Statements (unaudited)			7
ITEM 2:		Management’s Discussion and Analysis of Financial Condition and Results of Operations			23
ITEM 3:		Quantitative and Qualitative Disclosures About Market Risk			32
ITEM 4:		Controls and Procedures			33
PART II		OTHER INFORMATION
ITEM 1:		Legal Proceedings			35
ITEM 1A:		Risk Factors			35
ITEM 2:		Unregistered Sales of Equity Securities and Use of Proceeds			35
ITEM 3:		Defaults Upon Senior Securities			35
ITEM 4:		Mine Safety Disclosures			35
ITEM 5:		Other Information			35
ITEM 6:		Exhibits			35
		Signatures			36

 

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PART I—FINANCIAL INFORMATION

Item 1. FINANCIAL STATEMENTS

AEP INDUSTRIES INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except share amounts)

 

		July 31, 2014				October 31, 2013
		(unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents		$	1,598			$	13,319
Accounts receivable, less allowance for doubtful accounts of $2,776 and $2,992 in 2014 and 2013, respectively			118,089				112,605
Inventories, net			95,398				97,091
Deferred income taxes			10,351				6,300
Other current assets			7,633				5,389
Total current assets			233,069				234,704
PROPERTY, PLANT AND EQUIPMENT, at cost, less accumulated depreciation and amortization of $371,416 and $348,519 in 2014 and 2013, respectively			219,260				220,314
GOODWILL			6,871				6,871
INTANGIBLE ASSETS, net of accumulated amortization of $2,282 and $1,894 in 2014 and 2013, respectively			4,130				4,518
OTHER ASSETS			5,060				5,156
Total assets		$	468,390			$	471,563
LIABILITIES AND SHAREHOLDERS’ EQUITY
CURRENT LIABILITIES:
Bank borrowings, including current portion of long-term debt		$	2,822			$	3,335
Accounts payable			82,309				80,579
Accrued expenses			32,003				32,144
Total current liabilities			117,134				116,058
LONG-TERM DEBT			261,058				238,931
DEFERRED INCOME TAXES			26,673				25,610
OTHER LONG-TERM LIABILITIES			3,748				5,551
Total liabilities			408,613				386,150
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS’ EQUITY:
Preferred stock, $1.00 par value; 970,000 shares authorized; none issued			—				—
Series A junior participating preferred stock, $1.00 par value; 30,000 shares authorized; none issued			—				—
Common stock, $0.01 par value; 30,000,000 shares authorized; 11,215,691 and 11,207,049 shares issued in 2014 and 2013, respectively			112				112
Additional paid-in capital			112,889				112,527
Treasury stock at cost, 6,135,095 and 5,605,783 shares in 2014 and 2013, respectively			(189,810	)			(169,826	)
Retained earnings			136,848				142,064
Accumulated other comprehensive (loss) income			(262	)			536
Total shareholders’ equity			59,777				85,413
Total liabilities and shareholders’ equity		$	468,390			$	471,563

The accompanying notes to consolidated financial statements are an integral part of these statements.

 

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AEP INDUSTRIES INC.

CONSOLIDATED STATEMENTS OF OPERATIONS

(UNAUDITED)

(in thousands, except per share data)

 

		For the Three Months  Ended July 31,								For the Nine Months  Ended July 31,
		2014				2013				2014				2013
NET SALES		$	308,846			$	291,873			$	876,305			$	844,589
COST OF SALES			275,634				254,204				788,517				727,273
Gross profit			33,212				37,669				87,788				117,316
OPERATING EXPENSES:
Delivery			13,297				13,308				37,766				39,310
Selling			9,475				10,373				27,263				29,486
General and administrative			5,960				7,278				18,020				22,281
Total operating expenses			28,732				30,959				83,049				91,077
OTHER OPERATING INCOME:
Business interruption insurance recovery			2,050				—				2,050				—
Operating income			6,530				6,710				6,789				26,239
OTHER INCOME (EXPENSE):
Interest expense			(4,945	)			(4,567	)			(14,661	)			(13,965	)
Gain on bargain purchase of a business			—				—				—				1,001
Other, net			16				224				87				308
Income (loss) before (provision) benefit for income taxes			1,601				2,367				(7,785	)			13,583
(PROVISION) BENEFIT FOR INCOME TAXES			(366	)			(579	)			2,569				(3,825	)
Net income (loss)		$	1,235			$	1,788			$	(5,216	)		$	9,758
BASIC EARNINGS (LOSS) PER COMMON SHARE:
Net income (loss) per common share		$	0.24			$	0.32			$	(0.97	)		$	1.75
DILUTED EARNINGS (LOSS) PER COMMON SHARE:
Net income (loss) per common share		$	0.24			$	0.32			$	(0.97	)		$	1.74

The accompanying notes to consolidated financial statements are an integral part of these statements.

 

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AEP INDUSTRIES INC.

CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(UNAUDITED)

(in thousands)

 

		For the Three Months  Ended July 31,								For the Nine Months  Ended July 31,
		2014				2013				2014				2013
Net income (loss)		$	1,235			$	1,788			$	(5,216	)		$	9,758
Other comprehensive income (loss):
Foreign currency translation adjustments			42				(345	)			(896	)			(470	)
Amortization of prior service cost and actuarial net loss, net of tax of $12 and $16 for the three months ended July 31, 2014 and 2013 and $34 and $48 for the nine months ended July 31, 2014 and 2013, respectively			33				43				98				136
Total other comprehensive income (loss)			75				(302	)			(798	)			(334	)
Comprehensive income (loss)		$	1,310			$	1,486			$	(6,014	)		$	9,424

 

 

 

The accompanying notes to consolidated financial statements are an integral part of these statements.

 

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AEP INDUSTRIES INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(in thousands)

 

		For the Nine Months Ended July 31,
		2014				2013
CASH FLOWS FROM OPERATING ACTIVITIES:
Net (loss) income		$	(5,216	)		$	9,758
Adjustments to reconcile net income to net cash used in operating activities:
Depreciation and amortization			23,966				20,884
Gain on bargain purchase of a business			—				(1,001	)
Change in LIFO reserve			4,637				5,566
Amortization of debt fees			715				715
Provision for losses on accounts receivable and inventories			186				269
Change in deferred income taxes			(2,941	)			1,408
Share-based compensation expense			150				5,301
Excess tax benefit from stock option exercises			—				(1,161	)
Other			(67	)			118
Changes in operating assets and liabilities:
Increase in accounts receivable			(7,997	)			(1,223	)
Increase in inventories			(3,082	)			(6,517	)
Increase in other current assets			(1,122	)			(2,192	)
Decrease (increase) in other assets			298				(70	)
Increase in accounts payable			1,845				12,703
Decrease in accrued expenses			(194	)			(6,111	)
Increase (decrease) in other long-term liabilities			61				(62	)
Net cash provided by operating activities			11,239				38,385
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures			(21,430	)			(38,745	)
Net proceeds from dispositions of property, plant and equipment			345				225
Net cash used in investing activities			(21,085	)			(38,520	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings (repayments) from credit facility			21,700				(2,760	)
Repurchases of common stock			(19,984	)			—
Proceeds from capital lease obligations			658				4,134
Repayments of Pennsylvania Industrial Loans			(68	)			(113	)
Principal payments on capital lease obligations			(2,263	)			(2,073	)
Principal payments on mortgage loan note			(92	)			(89	)
Proceeds from exercise of stock options			—				572
Excess tax benefit from stock option exercises			—				1,161
Payments of withholding taxes on performance units			(1,235	)			(1,275	)
Net cash used in financing activities			(1,284	)			(443	)
EFFECTS OF EXCHANGE RATE CHANGES ON CASH			(591	)			(259	)
Net decrease in cash			(11,721	)			(837	)
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD			13,319				2,807
CASH AND CASH EQUIVALENTS AT END OF PERIOD		$	1,598			$	1,970
SUPPLEMENTAL CASH FLOW DISCLOSURE:
Equipment financed through capital lease obligation		$	1,679			$	1,107
Cash paid during the period for interest		$	9,762			$	9,325
Cash paid during the period for income taxes		$	1,674			$	2,903

The accompanying notes to consolidated financial statements are an integral part of these statements.

 

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AEP INDUSTRIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

(1) BASIS OF PRESENTATION

The accompanying consolidated financial statements include the accounts of AEP Industries Inc. and all of its subsidiaries (the “Company”). All significant intercompany transactions and balances have been eliminated in consolidation. In management’s opinion, all adjustments necessary for the fair presentation of the consolidated financial position as of July 31, 2014, the consolidated results of operations and consolidated comprehensive income (loss) for the three and nine months ended July 31, 2014 and 2013, and the consolidated cash flows for the nine months ended July 31, 2014 and 2013, respectively, have been made. The consolidated results of operations for the three and nine months ended July 31, 2014 are not necessarily indicative of the results to be expected for the full fiscal year.

The consolidated financial information included herein has been prepared by the Company, without audit, for filing with the U.S. Securities and Exchange Commission (the “Commission”) pursuant to the rules and regulations of the Commission. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America, which require management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amount of revenues and expenses during the reporting period. On an on-going basis, management evaluates its estimates and judgments, including those related to product returns, customer rebates and incentives, doubtful accounts, inventories, including LIFO inventory valuations, acquisitions, pension obligations, incurred but not reported medical and workers’ compensation claims, litigation and contingency accruals, income taxes, including valuation of deferred taxes, share-based compensation and impairment of long-lived assets and intangibles, including goodwill. Management bases its estimates and judgments on historical experience and various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying value of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Certain information and footnote disclosures normally included in audited annual consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended October 31, 2013, filed with the Commission on January 14, 2014.

The Company evaluates all subsequent events prior to filing and has implemented all new accounting pronouncements that are in effect and that may materially impact its financial statements.

New Accounting Pronouncements Not Yet Effective

Unless otherwise discussed, the Company believes that the impact of recently issued accounting pronouncements that are not yet effective will not have a material impact on the its financial position, results of operations or cash flows.

In June 2014, the Financial Accounting Standards Board (“FASB”) issued ASU No. 2014-12 (ASU 2014-12), Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period, which requires that a performance target that affects vesting and that could be achieved after the requisite service period be treated as a performance condition. ASU 2014-12 is effective for annual periods and interim periods within those annual periods beginning after December 15, 2015, which is the Company’s first quarter of fiscal year 2017. Early adoption is permitted.

 

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AEP INDUSTRIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

(1) BASIS OF PRESENTATION (Continued)

 

In May 2014, the FASB issued ASU No. 2014-09 (ASU 2014-09), Revenue from Contracts with Customers, which supersedes nearly all existing revenue recognition guidance under U.S. GAAP. The new standard requires a company to recognize revenue when it transfers goods or services to customers in an amount that reflects the consideration that the company expects to receive for those goods or services. Additionally, the guidance requires improved disclosures to help users of financial statements better understand the nature, amount, timing, and uncertainty of revenue and cash flows arising from contracts with customers. ASU 2014-09 is effective for annual reporting periods beginning after December 15, 2016, including interim periods within that reporting period, which is the Company’s first quarter of fiscal year 2018. Early application is not permitted. The new standard allows for the amendment to be applied either retrospectively to each prior reporting period presented or retrospectively as a cumulative-effect adjustment as of the date of adoption. The Company is evaluating the effect that ASU 2014-09 will have on its consolidated financial statements and related disclosures, including which transition method it will adopt.

Discontinued Operations

In April 2014, the FASB issued ASU No. 2014-08 (ASU 2014-08), Presentation of Financial Statements (Topic 205) and Property, Plant, and Equipment (Topic 360): Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity, which raises the threshold for disposals to qualify as discontinued operations. Under the new guidance, a disposal representing a strategic shift that has (or will have) a major effect on an entity’s financial results or a business activity classified as held for sale, should be reported as discontinued operations. ASU 2014-08 also expands the disclosure requirements for discontinued operations and adds new disclosures for individually significant dispositions that do not qualify as discontinued operations. ASU 2014-08 is effective prospectively for fiscal years, and interim reporting periods within those years, beginning after December 15, 2014, which is the Company’s first quarter of fiscal year 2016. Early adoption is permitted, but only for disposals (or classifications as held for sale) that have not been reported in the financial statements previously issued or available for issuance. As of July 31, 2014, there have been no disposals or classifications as held for sale by the Company that would be subject to ASU 2014-08.

(2) EARNINGS PER SHARE

Basic (loss) earnings per share (“EPS”) is calculated by dividing net income (loss) by the weighted average number of shares of common stock outstanding during the period. Diluted EPS is calculated by dividing net income (loss) by the weighted average number of common shares outstanding, adjusted to reflect potentially dilutive securities (options) using the treasury stock method, except when the effect would be anti-dilutive.

The number of shares used in calculating basic and diluted earnings per share is as follows:

 

		For the Three Months Ended July 31,								For the Nine Months Ended July 31,
		2014				2013				2014				2013
Weighted average common shares outstanding:
Basic			5,080,596				5,598,309				5,404,865				5,564,334
Effect of dilutive securities:
Options to purchase shares of common stock			6,067				38,240				—				34,020
Diluted			5,086,663				5,636,549				5,404,865				5,598,354

 

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AEP INDUSTRIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

(2) EARNINGS PER SHARE (Continued)

 

For each of the three month and nine month periods ended July 31, 2014 and 2013, the Company had 10,000 and zero stock options outstanding, respectively, that could potentially dilute earnings per share in future periods but were excluded from the computation of diluted EPS because their exercise price was higher than the Company’s average stock price during the respective periods. For the nine months ended July 31, 2014, the Company had 14,328 stock options outstanding that could potentially dilute earnings per share in future periods that were excluded from the computation of diluted EPS because their effect would have been anti-dilutive given the net loss during the period.

(3) ACQUISITIONS

Transco Plastics Industries Ltd.

On November 8, 2012, the Company completed its purchase of certain machinery and equipment and related assets necessary to manufacture printed, converted and custom films of Transco Plastics Industries Ltd. (“Transco”), a Quebec company, for a purchase price of $5.3 million (deposit was made and included in other assets at October 31, 2012), excluding a one-year commission and transition service costs. The Company financed the transaction through a combination of cash on hand and availability under its credit facility.

The Transco acquisition expanded the Company’s presence in the plastic packaging industry and enhanced the Company’s suite of products. The acquisition resulted in a gain on bargain purchase as the seller was motivated to sell these assets since they were no longer a part of the seller’s intended ongoing business and the seller was under a time constraint to vacate the building in which these assets were located.

The Company concluded that the Transco acquisition represented a business because it is an integrated set of activities and assets that is capable of being conducted and managed for the purpose of providing a return to the Company and its shareholders. As such, the acquisition has been accounted for using the acquisition method of accounting which requires, among other things, that assets acquired and liabilities assumed be recognized at their fair values as of the acquisition date. The following table summarizes the amounts recognized for assets acquired and liabilities assumed as of the acquisition date.

 

		Allocation At October 31, 2013
		(in thousands)
Property, plant and equipment		$	5,380
Intangible asset (customer relationships)			1,500
Total identifiable assets acquired			6,880
Deferred income tax liability			579
Total liabilities assumed			579
Net identifiable assets acquired			6,301
Purchase price			5,300
Gain on bargain purchase		$	1,001

 

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AEP INDUSTRIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

(3) ACQUISITIONS (Continued)

 

Upon the determination that the Company was going to recognize a gain related to the bargain purchase of Transco, the Company reassessed its assumptions and measurement of identifiable assets acquired and liabilities assumed, and concluded that the valuation procedures and resulting measures were appropriate. As a result, the Company determined that the fair values of assets acquired and liabilities assumed exceeded the purchase price by approximately $1.0 million, which was recorded as a gain on bargain purchase in its consolidated statement of operations for the nine months ended July 31, 2013.

The intangible asset is being amortized over a straight-line basis over ten years.

The results of operations for Transco have been included in all periods presented.

During the fiscal year 2013 relocation of equipment purchased from Transco to the Company’s Bowling Green, Kentucky facility, a print press was damaged in transit. The damages sustained resulted in a delay in the start-up of the machinery and the Company’s inability to supply certain customers. The Company filed a business interruption claim related to the lost margins from this incident. During the third quarter of fiscal 2014, the Company collected $2,050,000 in business interruption insurance recoveries, which is recorded as a component of operating income in the consolidated statement of operations for the three and nine months ended July 31, 2014. The insurance award was net of a $500,000 deductible. The Company is pursuing recovery of the deductible.

(4) INVENTORIES

Inventories, stated at the lower of cost (last-in, first-out method (“LIFO”) for the U.S. operations, and the first-in, first-out method (“FIFO”) for the Canadian operation, supplies and printed and converted finished goods for the U.S. operation, and certain finished goods) or market, include material, labor and manufacturing overhead costs, less vendor rebates. The Company establishes a reserve in those situations in which cost exceeds market value.

Inventories are comprised of the following:

 

		July 31, 2014				October 31, 2013
		(in thousands)
Raw materials		$	53,596			$	48,467
Finished goods			82,293				83,363
Supplies			5,207				6,322
			141,096				138,152
Less: LIFO reserve			(45,698	)			(41,061	)
Inventories, net		$	95,398			$	97,091

The LIFO method was used for determining the cost of approximately 85% of total inventories at July 31, 2014 and October 31, 2013. Since the actual valuation of inventory under the LIFO method can only be made at the end of the fiscal year based on inventory levels and costs at that time, the interim LIFO calculations are based on management’s best estimate of expected fiscal year-end inventory levels and costs. Due to the volatility of resin pricing, the Company consistently uses current pricing as its estimate of fiscal year-end costs. Therefore, interim LIFO calculations are subject to the final fiscal year-end LIFO inventory valuation. Because of the Company’s continuous manufacturing process, there is no significant work in process at any point in time.

 

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AEP INDUSTRIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

(5) DEBT

A summary of the components of debt is as follows:

 

		July 31, 2014				October 31, 2013
		(in thousands)
Credit facility (a)		$	47,300			$	25,600
8.25% senior notes due 2019 (b)			200,000				200,000
Pennsylvania industrial loan (c)			988				1,056
Mortgage loan note (d)			3,131				3,223
Capital leases (e)			12,461				12,387
Foreign bank borrowings (f)			—				—
Total debt			263,880				242,266
Less: current portion			2,822				3,335
Long-term debt		$	261,058			$	238,931

 

(a)	Credit Facility

The Company is party to the Second Amended and Restated Loan and Security Agreement (the “credit facility”), dated February 22, 2012, with Wells Fargo Bank National Association (“Wells Fargo”), successor to Wachovia Bank N.A., as a lender thereunder and as agent for the secured parties thereunder. The maximum borrowing amount under the credit facility is $150.0 million with a maximum for letters of credit of $20.0 million. The credit facility’s maturity date is February 21, 2017.

The Company utilizes the credit facility to provide funding for operations and other corporate purposes through daily bank borrowings and/or cash repayments to ensure sufficient operating liquidity and efficient cash management. The Company had weighted average borrowings under the credit facility of $68.8 million and $27.9 million, with a weighted average interest rate of 2.3% and 2.9% during the three months ended July 31, 2014 and 2013, respectively. The Company had weighted average borrowings under the credit facility of $52.8 million and $24.0 million, with a weighted average interest rate of 2.7% and 3.0% during the nine months ended July 31, 2014 and 2013, respectively. Under the credit facility, interest rates are based upon the Quarterly Average Excess Availability (as defined therein) at a margin of the prime rate (defined as the greater of Wells Fargo’s prime rate or the Federal Funds rate plus 0.5%) plus 0% to 0.25% or LIBOR plus 1.75% to 2.50%.

Borrowings and letters of credit available under the credit facility are limited to a borrowing base based upon specific advance percentage rates on eligible accounts receivable and inventory, subject, in the case of inventory, to amount limitations. The sum of the eligible assets at July 31, 2014 and October 31, 2013 supported a borrowing base of $150.0 million. Availability was reduced by the aggregate amount of letters of credit outstanding totaling $2.1 million and $1.1 million at July 31, 2014 and October 31, 2013, respectively. Availability at July 31, 2014 and October 31, 2013 under the credit facility was $100.6 million and $123.3 million, respectively. The credit facility is secured by liens on most of the Company’s domestic assets (other than real property and equipment) and on 66% of the Company’s ownership interest in certain foreign subsidiaries.

The credit facility provides for events of default. If an event of default occurs and is continuing, amounts due under the credit facility may be accelerated and the commitments to extend credit thereunder terminated, and the rights and remedies of the lenders may be exercised including rights with respect to the collateral securing the obligations under the credit facility. The credit facility also contains covenants, including, but not limited to,

 

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AEP INDUSTRIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

(5) DEBT (Continued)

 

limitations on the incurrence of debt and liens, the disposition and acquisition of assets, and the making of investments and restricted payments, including the payment of cash dividends. The credit facility has a fixed charge coverage ratio test of 1.0x, which test is triggered when Excess Availability is below $22.5 million for the immediately preceding fiscal quarter.

In addition, if Excess Availability under the credit facility is less than $25.0 million, a springing cash dominion is activated and all remittances received from customers in the United States will automatically be applied to repay the balance outstanding. The automatic repayments through the springing cash dominion remain in place until Excess Availability exceeds $25.0 million, and no other event of default has occurred and is continuing, in each case for 30 consecutive days. Excess Availability under the credit facility ranged from $54.7 million to $137.8 million during the nine months ended July 31, 2014 and from $95.7 million to $150.0 million during the nine months ended July 31, 2013.

During fiscal 2012, the Company capitalized $1.3 million of fees related to the credit facility. These fees, along with the unamortized fees of $0.4 million related to the prior credit facility, are being amortized on a straight line basis over 60 months, the term of the credit facility.

The Company was in compliance with the financial covenants at July 31, 2014 and October 31, 2013.

 

(b)	8.25% Senior Notes due 2019

The Company has $200 million aggregate principal amount of 8.25% senior notes due 2019 (the “2019 notes”).

The 2019 notes mature on April 15, 2019, and the indenture governing the 2019 notes contains certain customary covenants that, among other things, limit the Company’s ability and the ability of its subsidiaries to incur additional indebtedness, declare or pay dividends, purchase or redeem its capital stock, make investments, sell assets, merge or consolidate, guarantee or pledge any assets or create liens. The Company was in compliance with all of these covenants at July 31, 2014 and October 31, 2013.

The 2019 notes do not have any sinking fund requirements. If the Company experiences certain changes in control, it must offer to repurchase all of the 2019 notes at a price equal to 101% of the principal amount, plus accrued and unpaid interest. In addition, if the Company sells certain assets, under certain circumstances, it must offer to repurchase the 2019 notes pro rata up to a maximum amount equal to the proceeds of such sale at 100% of the principal amount, plus accrued and unpaid interest.

The 2019 notes are redeemable at the option of the Company, in whole or in part, at certain fixed redemption prices plus accrued and unpaid interest.

Interest is paid semi-annually on April 15 and October 15 of each year.

The Company capitalized $4.9 million of fees related to the issuance of the 2019 notes. These fees are being amortized on a straight line basis over eight years, the term of the 2019 notes.

 

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AEP INDUSTRIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

(5) DEBT (Continued)

 

(c)	Pennsylvania Industrial Loan

The Company has an amortizing fixed rate term loan in connection with the expansion in fiscal 2008 of its Wright Township, Pennsylvania manufacturing facility, due November 1, 2023, with an interest rate of 4.75%. This financing arrangement is secured by the real property of the manufacturing facility located in Wright Township, Pennsylvania, which had a net carrying value of $10.6 million at July 31, 2014.

 

(d)	Mortgage loan note

On July 25, 2012, concurrent with the purchase of the Company’s corporate headquarters building in Montvale, New Jersey, the Company entered into a mortgage loan note (the “mortgage note”) having a principal amount of $3,360,000 with TD Bank, N.A. The mortgage note bears interest at a rate equal to one-month LIBOR plus 1.75% and matures on August 1, 2022. Interest is paid monthly. The mortgage note is secured by the Montvale building.

In connection with the mortgage note, the Company also entered into a ten-year floating-to-fixed interest rate swap agreement with TD Bank, N.A. with a notional value of $3,360,000, the then outstanding principal balance on the mortgage note. The interest rate swap fixes the interest rate at 3.52% per year and matures on July 25, 2022 (see Note 9 for further discussion).

 

(e)	Capital leases

From time to time, the Company enters into capital leases for certain of its machinery and equipment. The interest rates on the capital leases range from 3.5% to 8.5%, with a weighted average interest rate of 4.5%. As a result of the capital lease treatment, the equipment remains as a component of property, plant and equipment in the Company’s consolidated balance sheet and is depreciated in accordance with the Company’s depreciation policy.

Under the terms of the capital leases, the payments are as follows:

 

For the years ending October 31,		Capital Leases
		(in thousands)
2014		$	824
2015			2,812
2016			2,429
2017			2,429
2018			2,430
Thereafter			2,794
Total minimum lease payments			13,718
Less: Amounts representing interest			1,257
Present value of minimum lease payments			12,461
Less: Current portion of obligations under capital leases			2,610
Long-term portion of obligations under capital leases		$	9,851

 

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AEP INDUSTRIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

(5) DEBT (Continued)

 

(f)	Foreign bank borrowings

In addition to the amounts available under the credit facility, the Company also maintains a secured credit facility at its Canadian subsidiary, used to support operations, which is generally serviced by local cash flows from operations. There was zero outstanding under this arrangement at July 31, 2014 and October 31, 2013. Availability under the Canadian credit facility at July 31, 2014 and October 31, 2013 was $5.0 million in Canadian dollars or US$4.6 million and US$4.8 million, respectively.

Principal payments required on all debt outstanding during each of the next five fiscal years are as follows:

 

		(in thousands)
		Debt				Capital leases				Total
2014		$	52			$	707			$	759
2015			214				2,422				2,636
2016			222				2,123				2,345
2017			47,532				2,202				49,734
2018			242				2,284				2,526
Thereafter			203,157				2,723				205,880
		$	251,419			$	12,461			$	263,880

(6) ACCRUED EXPENSES

At July 31, 2014 and October 31, 2013, accrued expenses consist of the following:

 

		July 31, 2014				October 31, 2013
		(in thousands)
Payroll and employee related		$	7,793			$	10,072
Customer rebates			8,194				7,733
Interest			4,946				762
Accrual for performance units			1,521				4,037
Other (A)			9,549				9,540
Accrued expenses		$	32,003			$	32,144

 

(A)	No individual item exceeded 5% of current liabilities.

 

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AEP INDUSTRIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

(7) SHAREHOLDERS’ EQUITY

Share-Based Compensation

The Company has a share-based plan which provides for the granting of stock options, restricted stock, performance units and other awards to officers, directors and key employees of the Company. Total share-based compensation expense (income) related to the Company’s share-based plans is recorded in the consolidated statements of operations as follows:

 

		For the Three Months Ended July 31,								For the Nine Months Ended July 31,
		2014				2013				2014				2013
		(in thousands)
Cost of sales		$	104			$	251			$	(36	)		$	826
Selling expense			103				284				(41	)			905
General and administrative expense			347				1,264				227				3,570
Total		$	554			$	1,799			$	150			$	5,301

Share-Based Plans

At the annual meeting of shareholders of the Company on April 9, 2013, shareholders approved the AEP Industries Inc. 2013 Omnibus Incentive Plan (the “2013 Plan”). The 2013 Plan provides for the award to non-employee directors and key employees of the Company of options, restricted stock, restricted stock units, stock appreciation rights, performance awards (which may take the form of performance units or performance shares) and other awards to acquire up to an aggregate of 375,000 shares of the Company’s common stock. These shares of common stock may be made available from authorized but unissued common stock, from treasury shares or from shares purchased on the open market. The issuance of common stock resulting from the exercise of stock options and settlement of the vesting of performance units (for those employees who elected shares) during fiscal 2014 and 2013 was made from new shares.

As a result of shareholder approval of the 2013 Plan, all awards of stock and stock unit awards subsequent to April 9, 2013 have been granted under the 2013 Plan and no new awards have been made after such date under the AEP Industries Inc. 2005 Stock Option Plan (the “2005 Option Plan”), which expired in October 2013 except as to awards previously granted prior to that date. At July 31, 2014, 309,831 shares were available to be issued under the 2013 Plan.

Stock Options

The fair value of options granted is estimated on the date of grant using a Black-Scholes options pricing model. Expected volatilities are calculated based on the historical volatility of the Company’s stock. Management monitors stock option exercise and employee termination patterns to estimate forfeitures rates within the valuation model. Separate groups of employees, including executive officers and directors, that have similar historical exercise behavior are considered separately for valuation purposes. The expected holding period of stock options represents the period of time that stock options granted are expected to be outstanding. The risk-free interest rate is based on the Treasury note interest rate in effect on the date of grant for the expected term of the stock option.

 

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AEP INDUSTRIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

(7) SHAREHOLDERS’ EQUITY (Continued)

 

There were no options granted during the nine months ended July 31, 2014 or 2013.

The following table summarizes the Company’s stock option plan as of July 31, 2014, and changes during the nine months ended July 31, 2014:

 

		2005 Option Plan				Weighted Average Exercise Price per Option				Option Price Per Share				Weighted Average Remaining Contractual Term (years)				Aggregate Intrinsic Value $(000)
Options outstanding at October 31, 2013 (50,846 options exercisable)			72,446			$	29.62			$	17.07-42.60				4.5			$	2,159
Granted			—				—				—
Exercised			—				—				—
Forfeited/Cancelled			—				—				—
Expired			—				—				—
Options outstanding at July 31, 2014			72,446			$	29.62			$	17.07-42.60				4.0			$	825
Vested and expected to vest at July 31, 2014			72,446			$	29.62								4.0			$	825
Exercisable at July 31, 2014			61,646			$	29.36								3.4			$	721

The table below presents information related to stock option activity for the three and nine months ended July 31, 2014 and 2013:

 

		For the Three Months Ended July 31,								For the Nine Months Ended July 31,
		2014				2013				2014				2013
		(in thousands)
Total intrinsic value of stock options exercised		$	—			$	246			$	—			$	4,158
Total fair value of stock options vested		$	—			$	—			$	155			$	210

The fair value of the options, less expected forfeitures, is amortized over five years on a straight-line basis. Share-based compensation expense related to the Company’s stock options recorded in the consolidated statements of operations for the three and nine months ended July 31, 2014 was approximately $20,000 and $76,000, respectively and approximately $30,000 and $103,000 for the three and nine months ended July 31, 2013, respectively. No compensation cost related to stock options was capitalized in inventory or any other assets for the three and nine months ended July 31, 2014 and 2013, respectively. For the three and nine months ended July 31, 2014, there were no excess tax benefits recognized resulting from share-based compensation awards, respectively, which reduced taxes otherwise payable. For the three and nine months ended July 31, 2013, there were zero and $1.2 million in excess tax benefits recognized resulting from share-based compensation awards, respectively, which reduced taxes otherwise payable. For fiscal 2012, there was $1.3 million in excess tax benefits recognized resulting from share-based compensation awards, which reduced taxes otherwise payable, and is included in additional paid in capital at July 31, 2014 and October 31, 2013, respectively.

 

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AEP INDUSTRIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

(7) SHAREHOLDERS’ EQUITY (Continued)

 

As of July 31, 2014, there was $0.1 million of total unrecognized compensation cost related to non-vested stock options granted under the plans. That cost is expected to be recognized over a weighted-average period of 2.2 years.

Non-vested Stock Options

A summary of the Company’s non-vested stock options at July 31, 2014 and changes during the nine months ended July 31, 2014 are presented below:

 

Non-vested stock options		Shares				Weighted Average Grant Date Fair Value
Non-vested at October 31, 2013			21,600			$	14.86
Granted			—				—
Vested			(10,800	)		$	14.36
Forfeited			—				—
Non-vested at July 31, 2014			10,800			$	15.36

Performance Units

The 2013 Plan provides for, and the 2005 Option Plan provided for, the granting of Board approved performance units (“Units”). Outstanding Units are subject to forfeiture based on an annual Adjusted EBITDA performance goal, as determined and adjusted by the Board. If the Company’s Adjusted EBITDA equals or exceeds the performance goal, no Units will be forfeited. If the Company’s Adjusted EBITDA is between 80% and less than 100% of the performance goal, such employee will forfeit such number of Units equal to (a) the Units granted multiplied by (b) the percentage Adjusted EBITDA is less than the performance goal. If Adjusted EBITDA is below 80% of the performance goal, the employee will forfeit all Units. Subsequent to the satisfaction of the performance goal, the vesting of the Units will occur equally over five years on the first through the fifth anniversaries of the grant date, provided that such person continues to be employed by the Company on such respective dates. For each Unit, upon vesting and the satisfaction of any required tax withholding obligation, the employee has the option to receive one share of the Company’s common stock, the equivalent cash value or a combination of both.

Due to the cash settlement feature, the Units are liability classified and are recognized at fair value, depending on the percentage of requisite service rendered at the reporting date, and are remeasured at each balance sheet date to the market value of the Company’s common stock at the reporting date.

As the Units contain both a performance and service condition, the Units have been treated as a series of separate awards or tranches for purposes of recognizing compensation expense. The Company recognizes compensation expense on a tranche-by-tranche basis, recognizing the expense as the employee works over the requisite service period for that specific tranche. The Company has applied the same assumption for forfeitures as employed in the Company’s stock option plans, discussed above.

Total share-based compensation expense (income) related to the Units was approximately $465,000 and $(155,000) for the three and nine months ended July 31, 2014, respectively, and $1.7 million and $5.1 million for

 

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AEP INDUSTRIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

(7) SHAREHOLDERS’ EQUITY (Continued)

 

the three and nine months ended July 31, 2013, respectively. At July 31, 2014 and October 31, 2013, there was $1.5 million and $4.0 million in accrued expenses, respectively, and $1.9 million and $3.4 million in long-term liabilities, respectively, related to outstanding Units.

The following table summarizes the Units as of July 31, 2014, and changes during the nine months ended July 31, 2014:

 

		2005 Option Plan				2013 Option Plan				Total Number Of Units				Weighted Average Exercise Price				Weighted Average Remaining Contractual Term (years)				Aggregate Intrinsic Value $(000)
Units outstanding at October 31, 2013			204,161				—				204,161			$	0.00				1.5			$	12,134
Units granted			—				52,896				52,896			$	0.00
Units exercised			(73,450	)			—				(73,450	)		$	0.00							$	3,882
Units forfeited or cancelled			(1,200	)			—				(1,200	)
Units outstanding at July 31, 2014			129,511				52,896				182,407			$	0.00				1.8			$	7,433
Vested and expected to vest at July 31, 2014			127,111				—	(A)			127,111			$	0.00				1.5			$	5,180

 

(A)	The Company believes that it is more likely than not that the 52,896 Units granted in 2014 will be forfeited in their entirety as the Company is not expected to achieve at least 80% of the Adjusted EBITDA performance goal in such fiscal year.

During the nine months ended July 31, 2014, the Company paid $2.4 million in cash and issued 1,067 shares of its common stock (issued from new shares), in each case net of withholdings, in settlement of the vesting of certain Units occurring during the nine months of fiscal 2014. During the nine months ended July 31, 2013, the Company paid $2.5 million in cash and issued 757 shares of its common stock (issued from new shares), in each case net of withholdings, in settlement of the vesting of certain Units occurring during the nine months of fiscal 2013.

Restricted Stock

In accordance with the revised non-employee director compensation program beginning in fiscal 2013, each non-employee director receives an annual restricted stock award with a grant date fair value of $55,000 under the 2013 Plan (4,698 shares and 7,575 shares granted, in aggregate, on April 12, 2013 and April 8, 2014, respectively). During the one-year restricted period, the restricted stock entitles the participant to all of the rights of a shareholder, including the right to vote the shares and the right to receive any dividends thereon. Prior to the end of the restricted period, restricted stock generally may not be sold, assigned, pledged, or otherwise disposed of or hypothecated by participants.

The share-based compensation expense associated with the restricted stock is based on the quoted market price of the Company’s common stock on the date of grant. The Company recognizes share-based compensation associated with the restricted stock on a straight-line basis over the term which is one year. Total share-based compensation expense related to the restricted stock recorded in the consolidated statements of operations for the three and nine months ended July 31, 2014 was approximately $69,000 and $229,000, respectively. Total share-

 

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AEP INDUSTRIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

(7) SHAREHOLDERS’ EQUITY (Continued)

 

based compensation expense related to the restricted stock recorded in the consolidated statements of operations for the three and nine months ended July 31, 2013 was approximately $83,000 and $110,000, respectively. As of July 31, 2014, there was $0.2 million of total unrecognized compensation cost related to restricted stock. That cost is expected to be recognized over eight months.

Treasury Shares

In February 2014 the Company’s Board authorized a stock repurchase program (the “February 2014 Stock Repurchase Program”) under which the Company could purchase up to $10.0 million of the Company’s common stock. Repurchases could be made in the open market, in privately negotiated transactions or by other means, from time to time, subject to market conditions, applicable legal requirements and other factors, including the limitations set forth in the Company’s debt covenants.

In March 2014, the Company repurchased under its February 2014 Stock Repurchase Program, 21,312 shares of its common stock in the open market at an average cost of $40.99 per share, totaling $0.9 million. On April 8, 2014, the Board approved an increase to the February 2014 Stock Repurchase Program, which had approximately $9.1 million remaining available for repurchases, to $19.1 million (an increase of $10.0 million). On April 21, 2014, the Company repurchased 508,000 shares of its common stock (the “Purchase”) owned by Crown Cork & Seal Company, Inc. Pension Plan (“Crown”) for approximately $19.1 million (priced at a 1% discount to a mid-day market price on Nasdaq on April 3, 2014, the date that agreement was reached as to the purchase price). The Purchase was made pursuant to a purchase agreement by and between the Company and KSA Capital Management, LLC, which had investment discretion over the purchased shares pursuant to an investment management agreement between KSA Capital Management, LLC and Crown. Following such transaction, there is no amount available for repurchases under the Company’s February 2014 Stock Repurchase Program.

Preferred Shares

The Board may direct the issuance of up to one million shares of the Company’s $1.00 par value Preferred Stock and may, at the time of issuance, determine the rights, preferences and limitations of each series.

On March 28, 2014, the Company adopted an amended and restated stockholder rights plan (the “Rights Plan”), which entitles the holders of the rights to purchase from the Company 1/1,000^th of a share of Series A Junior Participating Preferred Stock, par value $1.00 per share, at a purchase price of $330.00 per share, as adjusted (a “Right”), upon certain trigger events. The Rights Plan amends and restates in its entirety that certain rights plan dated as of March 31, 2011. The Company’s Board declared a dividend of one Right per each share of common stock of the Company outstanding as of April 11, 2011. Rights are also issued in respect of all shares of common stock issued by the Company thereafter, prior to the distribution date or expiration date (each as defined in the Rights Plan), or in accordance with other specified events set forth in the Rights Plan. Each 1/1,000^th of a share of Series A Junior Participating Preferred Stock has terms that are substantially the economic and voting equivalent of one share of the Company’s common stock. However, until a Right is exercised or exchanged in accordance with the provisions of the Rights Plan, the holder thereof will have no rights as a shareholder of the Company. The Rights Plan has a three-year term ending March 31, 2017 and the Board may terminate the Rights Plan at any time (subject to the redemption of the Rights for a nominal value). The Rights may cause substantial dilution to a person or group (together with all affiliates and associates of such person or group and any person or group of persons acting in concert therewith) that acquires beneficial ownership of 10% or more of the Company’s stock on terms not approved by the Board or takes other specified actions.

 

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AEP INDUSTRIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

(8) SEGMENT AND GEOGRAPHIC INFORMATION

The Company’s operations are conducted within one business segment—the production, manufacture and distribution of plastic packaging products, primarily for the food/beverage, industrial and agricultural markets. The Company operates in the United States and Canada.

Operating income includes all costs and expenses directly related to the geographical area.

 

		For the Three Months Ended July 31, 2014
		United States				Canada				Total
		(in thousands)
Sales—external customers		$	287,252			$	21,594			$	308,846
Intercompany sales			11,412				—				11,412
Gross profit			28,989				4,223				33,212
Operating income			4,410				2,120				6,530

 

		For the Three Months Ended July 31, 2013
		United States				Canada				Total
		(in thousands)
Sales—external customers		$	273,745			$	18,128			$	291,873
Intercompany sales			8,863				—				8,863
Gross profit			33,945				3,724				37,669
Operating income			5,081				1,629				6,710

 

		For the Nine Months Ended July 31, 2014
		United States				Canada				Total
		(in thousands)
Sales—external customers		$	818,720			$	57,585			$	876,305
Intercompany sales			33,477				—				33,477
Gross profit			78,159				9,629				87,788
Operating income			3,075				3,714				6,789

 

		For the Nine Months Ended July 31, 2013
		United States				Canada				Total
		(in thousands)
Sales—external customers		$	789,955			$	54,634			$	844,589
Intercompany sales			27,110				—				27,110
Gross profit			105,052				12,264				117,316
Operating income			20,311				5,928				26,239

 

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AEP INDUSTRIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

(8) SEGMENT AND GEOGRAPHIC INFORMATION (Continued)

 

Net sales by product line are as follows:

 

		For the Three Months Ended July 31,								For the Nine Months Ended July 31,
		2014				2013				2014				2013
		(in thousands)
Custom films		$	97,716			$	84,468			$	273,482			$	249,521
Stretch (pallet) wrap			93,072				88,916				263,476				255,671
Food contact			45,664				48,218				135,779				137,487
Canliners			32,415				33,392				92,341				93,256
PROformance® films			19,625				18,203				52,550				53,477
Printed and converted films			8,215				8,189				19,502				20,579
Other products and specialty films			12,139				10,487				39,175				34,598
Total		$	308,846			$	291,873			$	876,305			$	844,589

(9) FAIR VALUE MEASUREMENTS

Fair Value Measurements

The carrying amount reported in the consolidated balance sheets for cash and cash equivalents, accounts receivable, inventories, other current assets, accounts payable and accrued expenses approximates fair value because of the short-term nature of these assets and liabilities. The fair value of the Company’s variable rate debt (credit facility) approximates fair value due to the availability and floating rate for similar instruments.

The carrying value and fair value of the Company’s fixed rate debt at July 31, 2014 and October 31, 2013 are as follows:

 

		July 31, 2014								October 31, 2013
		Carrying Value				Fair Value				Carrying Value				Fair Value
		(in thousands)
2019 notes		$	200,000			$	211,250			$	200,000			$	216,626
Mortgage loan note (a)			3,131				3,131				3,223				3,223
Pennsylvania industrial loans			988				988				1,056				1,056
Capital leases			12,461				12,461				12,387				12,387
Total		$	216,580			$	227,830			$	216,666			$	233,292

 

(a)	The Company entered into an interest rate swap fixing the variable rate loan to a fixed rate loan at an interest rate of 3.52% per year.

The fair value of the 2019 notes and the mortgage note are based on quoted market rates (Level 1). The Company derives its fair value estimates of the Pennsylvania industrial loans and the capital leases based on observable inputs (Level 2). Observable market inputs used in the calculation of the fair value of the Pennsylvania industrial loans and the capital leases include evaluating the nature and terms of each instrument, considering prevailing economic and market conditions, and examining the cost of similar debt offered at the balance sheet date.

 

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AEP INDUSTRIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

(9) FAIR VALUE MEASUREMENTS (Continued)

 

The interest rate swap is recorded at fair value on the Company’s consolidated balance sheets using an income approach valuation technique based on observable market inputs (Level 2). Observable market inputs used in the calculation of the fair value of interest rate swaps include pricing data from counterparties to these swaps.

As of July 31, 2014, the notional amount and the fair value of the interest rate swap were $3,131,256, and an asset of $94,940, respectively. As of October 31, 2013, the notional amount and the fair value of the interest rate swap were $3,222,790, and an asset of $94,519, respectively. The Company recorded a $7,208 loss and a $421 gain on the mark-to-market on the interest rate swap in interest expense in the consolidated statement of operations for the three and nine months ended July 31, 2014, respectively. The Company recorded a gain of $187,564 and $198,410 on the mark-to-market on the interest rate swap in interest expense in the consolidated statement of operations for the three and nine months ended July 31, 2013, respectively.

(10) COMMITMENTS AND CONTINGENCIES

The Company and its subsidiaries are subject to claims and lawsuits which arise in the ordinary course of business. On the basis of information presently available and advice received from counsel representing the Company and its subsidiaries, it is the opinion of management that the disposition or ultimate determination of such claims and lawsuits against the Company will not have a material adverse effect on the Company’s financial position, results of operations, or liquidity.

 

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Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

Overview

Forward-Looking Statements

Management’s Discussion and Analysis of Financial Condition and Results of Operations and other sections of this report contain “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements represent our goals, beliefs, plans and expectations about our prospects for the future and other future events, such as our ability to generate sufficient working capital, the amount of availability under our credit facility, the anticipated pricing in resin markets, our ability to continue to maintain sales and profits of our operations, and the sufficiency of our cash balances and cash generated from operating, investing, and financing activities for our future liquidity and capital resource needs. Forward-looking statements include all statements that are not historical fact and can be identified by terms such as “may,” “intend,” “might,” “will,” “should,” “could,” “would,” “anticipate,” “expect,” “believe,” “estimate,” “plan,” “project,” “predict,” “potential,” or the negative of these terms. Although these forward-looking statements reflect our good-faith belief and reasonable judgment based on current information, these statements are qualified by important factors, many of which are beyond our control, that could cause our actual results to differ materially from those in the forward-looking statements, including, but not limited to: the availability of raw materials; the ability to pass raw material price increases to customers in a timely fashion; the continuing impact of the U.S. recession and the global credit and financial environment and other changes in the United States or international economic or political conditions; the potential of technological changes that would adversely affect the need for our products; price fluctuations which could adversely impact our inventory; and other factors described from time to time in our reports filed or furnished with the U.S. Securities and Exchange Commission (the “SEC”), and in particular those factors set forth in Item 1A “Risk Factors” in our Annual Report on Form 10-K for the year ended October 31, 2013 and other reports subsequently filed with the SEC. Given these uncertainties, you should not place undue reliance on any such forward-looking statements. The forward-looking statements included in this report are made as of the date hereof or the date specified herein, based on information available to us as of such date. Except as required by law, we assume no obligation to update these forward-looking statements, even if new information becomes available in the future.

Management’s Discussion and Analysis of Financial Condition and Results of Operations (MD&A) is designed to provide a reader of our financial statements with a narrative explanation from the perspective of our management on our business, financial condition, results of operations, and cash flows. Our MD&A is presented in six sections:

 

•

Overview

 

•

Results of Operations

 

•

Liquidity and Capital Resources

 

•

Contractual Obligations and Off-Balance-Sheet Arrangements

 

•

Critical Accounting Policies

 

•

New Accounting Pronouncements

Investors should review this MD&A in conjunction with the consolidated financial statements and related notes included in this report under Item 1, our Annual Report on Form 10-K for the fiscal year ended October 31, 2013 and reports filed thereafter with the SEC, and other publicly available information.

Company Overview

AEP Industries Inc. is a leading manufacturer of plastic packaging films. We manufacture and market an extensive and diverse line of polyethylene and polyvinyl chloride flexible packaging products, with consumer, industrial and agricultural applications. Our plastic packaging films are used in the packaging, transportation, beverage, food, automotive, pharmaceutical, chemical, electronics, construction, agriculture, carpeting, furniture and textile industries.

 

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We manufacture plastic films, principally from resins blended with other raw materials, which we either sell or further process by printing, laminating, slitting or converting. Our processing technologies enable us to create a variety of value-added products according to the specifications of our customers. Our manufacturing operations are located in the United States and Canada.

The primary raw materials used in the manufacture of our products are polyethylene and polyvinyl chloride resins. The prices of these materials are primarily a function of the price of petroleum and natural gas, and therefore typically are volatile. Since resin costs fluctuate, selling prices are generally determined as a “spread” over resin costs, usually expressed as cents per pound. Consequently, we review and manage our operating revenues and expenses on a per pound basis. The historical increases and decreases in resin costs have generally been reflected over a period of time in the sales prices of the products on a penny-for-penny basis. Assuming a constant volume of sales, an increase in resin costs would, therefore, result in increased sales revenues but lower gross profit as a percentage of sales or gross profit margin, while a decrease in resin costs would result in lower sales revenues with higher gross profit margins. Further, the gap between the time at which an order is taken, resin is purchased, production occurs and shipment is made, has an impact on our financial results and our working capital needs. In a period of rising resin prices, this impact is generally negative to operating results and in periods of declining resin prices, the impact is generally positive to operating results.

Market Conditions

As discussed above, the primary raw materials used in the manufacture of our products are polyethylene (“PE”) and polyvinyl chloride (“PVC”) resins, which total approximately 92% and 7%, respectively, of our total plastic resin purchases by volume. In recent years, the market for resins has been extremely volatile. Average PE resin costs during the three and nine months ended July 31, 2014 were 11% or $0.08 per pound higher and 14% or $0.10 per pound higher, respectively, than the average PE resin costs during the three and nine months periods ended July 31, 2013. Additionally, we have been experiencing volatility in PVC resin costs. Following an increase of $0.03 per pound in each month of the three months ended April 30, 2014 ($0.09 in total), PVC resin cost decreased $0.015 per pound during the quarter ended July 31, 2014.

The steady increases in PE resin costs in recent periods are due to tighter supplier inventory levels in North America. Currently, unplanned outages at several of the North American PE suppliers are expected to cause further tightness in supply resulting in anticipated price increases in PE resin through the remainder of the fiscal year. We believe both PE and PVC resin pricing will remain volatile throughout the remainder of fiscal 2014. Long range, the industry is forecasting approximately 10 billion pounds of new PE resin capacity in North America by 2018. We believe that this new capacity will result in reduced PE resin costs, although the timing and magnitude of the impact is uncertain.

The marketplace in which we sell our products remains very competitive, and has been further complicated in recent years by adverse economic circumstances straining the resources of our customers, distributors and suppliers. Due to the very difficult current market conditions, we do not expect in fiscal 2014 to meet or exceed our 2013 sales volume. In order to maintain margins, it is essential that resin cost increases be matched by selling price adjustments. During periods of rising resin costs, the time lag in adjusting sell prices for those customers whose prices adjust periodically, are index price based, or change as the result of a competitive bid process, will have a negative impact on earnings. There can be no assurance that we will be able to pass on resin price increases on a penny-for-penny basis on a timely basis, shorten the time lag in adjusting sell prices, win in a competitive bid process or will be able to continue to secure sufficient resin supply.

In recent years, we have implemented cost-reduction initiatives and invested in machinery and equipment to increase efficiency to meet the challenges of a volatile economic environment, as well as take advantage of opportunities in the marketplace. We are limited, however, in our ability to reduce costs that are fixed in nature. Rising costs in freight, utility, packaging and health costs have negatively impacted our results. To partially offset these cost factors, we attempted in June 2014 to implement a non-resin price increase in most of our product lines. Due to resistance from our customers, we were unable to implement this non-resin price increase.

 

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Defined Terms

The following table illustrates the primary costs classified in each major operating expense category:

 

Cost of Sales:		Materials, including packaging
		Fixed manufacturing costs
		Labor, direct and indirect
		Depreciation
		Inbound freight charges, including intercompany transfer freight charges
		Utility costs used in the manufacturing process
		Research and development costs
		Quality control costs
		Purchasing and receiving costs
		Any inventory adjustments, including LIFO adjustments,
		Warehousing costs
Delivery Expenses:		All costs related to shipping and handling of products to customers, including transportation costs by third party providers
Selling, General and Administrative Expenses:		Personnel costs, including salaries, bonuses, commissions and employee benefits
		Facilities and equipment costs
		Insurance
		Professional fees, including audit and Sarbanes-Oxley compliance

Our gross profit may not be comparable to that of other companies, since some companies include all the costs related to their distribution network in cost of sales and others, like us, include costs related to the shipping and handling of products to customers in delivery expenses, which is not a component of our cost of sales.

Results of Operations—Third Quarter of Fiscal 2014 Compared to Third Quarter of Fiscal 2013

The following table presents unaudited selected financial data for the three months ended July 31, 2014 and 2013 (dollars per lb. sold is calculated by dividing the applicable consolidated statements of operations category by pounds sold in the period):

 

		For the Three Months Ended																% increase/ (decrease) of $				$ increase/ (decrease)
		July 31, 2014								July 31, 2013
		$				$ Per lb. sold				$				$ Per lb. sold
		(in thousands, except for per pound data)
Net sales		$	308,846			$	1.28			$	291,873			$	1.22				5.8	%		$	16,973
Gross profit			33,212				0.14				37,669				0.16				(11.8	)%			(4,457	)
Operating expenses:
Delivery			13,297				0.06				13,308				0.06				(0.1	)%			(11	)
Selling			9,475				0.04				10,373				0.04				(8.7	)%			(898	)
General and administrative			5,960				0.02				7,278				0.03				(18.1	)%			(1,318	)
Total operating expenses		$	28,732			$	0.12			$	30,959			$	0.13				(7.2	)%		$	(2,227	)
Pounds sold							241,881 lbs.								240,050 lbs.

 

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Net Sales

The increase in net sales for the three months ended July 31, 2014 was the result of a 5% increase in average selling prices, primarily attributable to the partial pass-through of higher resin costs to customers during the comparable periods, positively affecting net sales by $15.8 million and a 1% increase in sales volume positively affecting net sales by $2.3 million. The third quarter of 2014 also included a $1.1 million negative impact of foreign exchange relating to our Canadian operations.

Gross Profit

There was a $1.9 million decrease in the LIFO reserve during the third quarter of fiscal 2014 versus a $1.4 million decrease in the LIFO reserve during the third quarter of fiscal 2013, representing a decrease of $0.5 million year-over-year. Excluding the impact of the LIFO reserve change during the quarter and an increase in depreciation expense of $0.6 million, gross profit decreased $4.4 million primarily resulting from our inability to completely pass through the entirety of increased resin costs on a timely basis to our customers and higher manufacturing costs, primarily electricity, insurance and employee benefits, partially offset by increased volumes sold.

Operating Expenses

Operating expenses decreased $2.2 million during the third quarter of fiscal 2014 versus the third quarter of fiscal 2013 primarily due to a $1.1 million decrease in share-based compensation costs associated with our stock options and performance units, a decrease of $0.3 million related to severance paid in fiscal 2013 associated with the Webster Industries acquisition, and a decrease of $0.2 million in provisions related to employee cash performance incentives.

Business Interruption Insurance Recovery

During the fiscal year 2013 relocation of equipment purchased from Transco to our Bowling Green, Kentucky facility, a print press was damaged in transit. The damages sustained resulted in a delay in the start-up of the machinery and our inability to supply certain customers. We filed a business interruption claim related to the lost margins from this incident. During the third quarter of 2014, we collected $2,050,000 in business interruption recoveries, which is recorded as a component of operating income in the consolidated statement of operations for the three months ended July 31, 2014.

Interest Expense

Interest expense for the three months ended July 31, 2014 increased $0.4 million as compared to the prior year period resulting primarily from higher average borrowings on our credit facility during the quarter increasing interest expense by $0.2 million and a $0.2 million decrease in unrealized gains on our interest rate swap as compared to the prior year period.

Income Tax Provision

The provision for income taxes for the three months ended July 31, 2014 was $0.4 million on income before the provision for income taxes of $1.6 million. The difference between our effective tax rate of 22.9 percent for the three months ended July 31, 2014 and the U.S. statutory tax rate of 35.0 percent, primarily relates to a true-up of prior year estimates in the United States and the differential in the U.S. and Canadian statutory rates, partially offset by the provision for state taxes in the United States, net of federal benefit.

The provision for income taxes for the three months ended July 31, 2013 was $0.6 million on income before the provision for income taxes of $2.4 million. The difference between our effective tax rate of 24.5 percent for the three months ended July 31, 2013 and the U.S. statutory tax rate of 35.0 percent, primarily relates to the differential in the U.S. and Canadian statutory rates and a true-up of prior year estimates in the United States, partially offset by a provision for state taxes in the United States, net of federal benefit.

 

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Results of Operations—Nine Months of Fiscal 2014 Compared to Nine Months of Fiscal 2013

The following table presents unaudited selected financial data for the nine months ended July 31, 2014 and 2013 (dollars per lb. sold is calculated by dividing the applicable consolidated statements of operations category by pounds sold in the period):

 

		For the Nine Months Ended																% increase/ (decrease) of $				$ increase/ (decrease)
		July 31, 2014								July 31, 2013
		$				$ Per lb. sold				$				$ Per lb. sold
		(in thousands, except for per pound data)
Net sales		$	876,305			$	1.26			$	844,589			$	1.19				3.8	%		$	31,716
Gross profit			87,788				0.13				117,316				0.17				(25.2	)%			(29,528	)
Operating expenses:
Delivery			37,766				0.05				39,310				0.06				(3.9	)%			(1,544	)
Selling			27,263				0.04				29,486				0.04				(7.5	)%			(2,223	)
General and administrative			18,020				0.03				22,281				0.03				(19.1	)%			(4,261	)
Total operating expenses		$	83,049			$	0.12			$	91,077			$	0.13				(8.8	)%		$	(8,028	)
Pounds sold							697,847 lbs.								710,476 lbs.

Net Sales

The increase in net sales for the nine months ended July 31, 2014 was the result of a 6% increase in average selling prices, primarily attributable to the partial pass-through of higher resin costs to customers during the comparable periods, positively affecting net sales by $51.7 million, partially offset by a 2% decrease in sales volume negatively affecting net sales by $15.9 million. The volume decrease was primarily attributed to soft customer demand in certain of our product lines. The nine months of 2014 also included a $4.1 million negative impact of foreign exchange relating to our Canadian operations.

Gross Profit

There was a $4.6 million increase in the LIFO reserve during the nine months of fiscal 2014 versus a $5.5 million increase in the LIFO reserve during the nine months of fiscal 2013, representing a decrease of $0.9 million year-over-year. Excluding the impact of the LIFO reserve change during the nine months and an increase in depreciation expense of $2.8 million, gross profit decreased $27.6 million primarily resulting from our inability to completely pass through the entirety of increased resin costs on a timely basis to our customers, decreased volumes sold and higher manufacturing costs, primarily electricity, insurance and employee benefits.

Operating Expenses

Operating expenses decreased $8.0 million during the nine months of fiscal 2014 versus the nine months of fiscal 2013 primarily due to a $4.3 million decrease in share-based compensation costs associated with our stock options and performance units, a decrease in delivery expenses due primarily to lower volumes sold ($1.1 million), a decrease of $1.2 million related to salaries and severance associated with the Webster Industries acquisition, and a decrease of $0.2 million in provisions related to employee cash performance incentives.

Business Interruption Insurance Recovery

During the fiscal year 2013 relocation of equipment purchased from Transco to our Bowling Green, Kentucky facility, a print press was damaged in transit. The damages sustained resulted in a delay in the start-up of the machinery and our inability to supply certain customers. We filed a business interruption claim related to the lost margins from this incident. During the third quarter of 2014, we collected $2,050,000 in business interruption recoveries, which is recorded as a component of operating income in the consolidated statement of operations for the nine months ended July 31, 2014.

 

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Interest Expense

Interest expense for the nine months ended July 31, 2014 increased $0.7 million as compared to the prior year period resulting primarily from higher average borrowings on our credit facility during the period increasing interest expense by $0.5 million and a $0.2 million decrease in unrealized gains on our interest rate swap as compared to the prior year period.

Gain On Bargain Purchase of a Business

Gain on bargain purchase of $1.0 million during the nine months ended July 31, 2013 resulted from the fair value of the identifiable assets acquired in the Transco acquisition exceeding the purchase price (see Note 3).

Income Tax Provision

The benefit for income taxes for the nine months ended July 31, 2014 was $2.6 million on a loss before the benefit for income taxes of $7.8 million. The difference between our effective tax rate of 33.0 percent for the nine months ended July 31, 2014 and the U.S. statutory tax rate of 35.0 percent, primarily relates to net permanent differences and foreign taxes paid or accrued during the period on Canadian undistributed earnings, partially offset by a true-up of prior year estimates in the United States, the differential in the U.S. and Canadian statutory rates, and by the benefit for state taxes in the United States, net of federal.

The provision for income taxes for the nine months ended July 31, 2013 was $3.8 million on income before the provision for income taxes of $13.6 million, which includes the gain on bargain purchase of $1.0 million which is non-taxable. The effective tax rate including the gain on bargain purchase is 28.2 percent. The difference between our effective tax rate of 28.2 percent for the nine months ended July 31, 2013 and the U.S. statutory tax rate of 35.0 percent, primarily relates to the non-taxable gain on bargain purchase, the differential in the U.S. and Canadian statutory rates and net permanent difference relating to our Section 199 manufacturing deduction, partially offset by a provision for state taxes in the United States, net of federal benefit.

Reconciliation of Non-GAAP Measures to GAAP

We define Adjusted EBITDA as net income (loss) before discontinued operations, interest expense, income taxes, depreciation and amortization, changes in LIFO reserve, other non-operating income (expense) and share-based compensation expense (income). We believe Adjusted EBITDA is an important measure of operating performance because it allows management, investors and others to evaluate and compare our core operating results, including our return on capital and operating efficiencies, from period to period by removing the impact of our capital structure (interest expense from our outstanding debt), asset base (depreciation and amortization), tax consequences, changes in LIFO reserve (a non-cash charge/benefit to our consolidated statements of operations), other non-operating items and share-based compensation. Furthermore, we use Adjusted EBITDA for business planning purposes and to evaluate and price potential acquisitions. In addition to its use by management, we also believe Adjusted EBITDA is a measure widely used by securities analysts, investors and others to evaluate the financial performance of our company and other companies in the plastic films industry. Other companies may calculate Adjusted EBITDA differently, and therefore our Adjusted EBITDA may not be comparable to similarly titled measures of other companies.

Adjusted EBITDA is not a measure of financial performance under U.S. generally accepted accounting principles (GAAP), and should not be considered in isolation or as an alternative to net income (loss), cash flows from operating activities and other measures determined in accordance with GAAP. Items excluded from Adjusted EBITDA are significant and necessary components to the operations of our business, and, therefore, Adjusted EBITDA should only be used as a supplemental measure of our operating performance.

 

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The following is a reconciliation of our net income (loss), the most directly comparable GAAP financial measure, to Adjusted EBITDA:

 

		Third Quarter Fiscal 2014				Third Quarter Fiscal 2013				July YTD Fiscal 2014				July YTD Fiscal 2013
		(in thousands)
Net income (loss)		$	1,235			$	1,788			$	(5,216	)		$	9,758
Provision (benefit) for taxes			366				579				(2,569	)			3,825
Interest expense			4,945				4,567				14,661				13,965
Depreciation and amortization expense			8,039				7,343				23,966				20,884
(Decrease) increase in LIFO reserve			(1,938	)			(1,407	)			4,637				5,566
Gain on bargain purchase of a business			—				—				—				(1,001	)
Other non-operating income			(16	)			(224	)			(87	)			(308	)
Share-based compensation			554				1,799				150				5,301
Adjusted EBITDA		$	13,185			$	14,445			$	35,542			$	57,990

Liquidity and Capital Resources

Summary

We have historically financed our operations through cash flows generated from operations and borrowings by us and our subsidiaries under various credit facilities. Our principal uses of cash have been to fund working capital, including operating expenses, debt service and capital expenditures. In addition, we evaluate acquisitions of businesses or assets and repurchases of our equity and debt from time to time. Generally, our need to access the capital markets is limited to refinancing debt obligations and funding significant acquisitions. Market conditions may limit our sources of funds and the terms for these financing activities. As market conditions change, we continue to monitor our liquidity position.

We continue to maintain what we believe to be a strong balance sheet and sufficient liquidity to provide us with financial flexibility. As of July 31, 2014, we had a net debt position (current bank borrowings plus long term debt less cash and cash equivalents) of $262.3 million, compared with $228.9 million at the end of fiscal 2013. In addition to funding our working capital needs and capital expenditures, during March and April 2014, we repurchased shares of common stock totaling approximately $20.0 million. Availability under our credit facility and credit line available to our Canadian subsidiary for local currency borrowings was an aggregate of $105.2 million at July 31, 2014.

Our working capital amounted to $115.9 million at July 31, 2014 compared to $118.6 million at October 31, 2013. We used the LIFO method for determining the cost of approximately 85% of our total inventories at July 31, 2014. Under LIFO, the units remaining in ending inventory are valued at the oldest unit costs and the units sold in cost of sales are valued at the most recent unit costs. If the FIFO method for valuing inventory had been used exclusively, working capital would have been $161.6 million and $159.7 million at July 31, 2014 and October 31, 2013, respectively. During the nine months ended July 31, 2014, the LIFO reserve increased $4.6 million to $45.7 million primarily as a result of increased resin costs. Despite the possible negative effects on our results of operations and our financial position (an increase to cost of sales of $4.6 million for the nine months ended July 31, 2014 and a reduction of inventory of $45.7 million at July 31, 2014), we believe the use of LIFO maximizes our after tax cash flow from operations.

We believe that our expected cash flows from operations, assuming no material adverse change, combined with the availability of funds under our worldwide credit facilities, will be sufficient to meet our working capital and debt service requirements and planned capital expenditures for at least the next 12 months.

 

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Cash Flows

The following table summarizes our cash flows from operating, investing, and financing of our operations for each of the nine months ended July 31, 2014 and 2013:

 

		For the Nine Months Ended July 31,
		2014				2013
		(in thousands)
Total cash provided by (used in):
Operating activities		$	11,239			$	38,385
Investing activities			(21,085	)			(38,520	)
Financing activities			(1,284	)			(443	)
Effect of exchange rate changes on cash			(591	)			(259	)
Decrease in cash and cash equivalents		$	(11,721	)		$	(837	)

 

Note:

See consolidated statements of cash flows included in Item 1, Financial Statements, of this Form 10-Q for additional information.

Operating Activities

Our cash and cash equivalents were $1.6 million at July 31, 2014, as compared to $13.3 million at October 31, 2013. Cash provided by operating activities during the nine months ended July 31, 2014 was $11.2 million, which includes a net loss of $5.2 million adjusted for non-cash items totaling $26.6 million primarily related to depreciation and amortization of $24.0 million and an increase in LIFO reserve of $4.6 million. Cash used in operating activities includes an $8.0 million increase in accounts receivable reflecting higher net sales in the third quarter of fiscal 2014 versus the fourth quarter of 2013 and a $3.1 million increase in inventories, excluding the non-cash effects of LIFO, due primarily to higher resin costs.

Investing Activities

Net cash used in investing activities during the nine months ended July 31, 2014 was $21.1 million, resulting primarily from capital expenditures during the period mainly in our food bag, retail canliner and custom product lines.

Financing Activities

Net cash used in financing activities during the nine months ended July 31, 2014 was $1.3 million, resulting primarily from $20.0 million in repurchases of our common stock partially offset by $21.7 million in borrowings under our credit facility.

Sources and Uses of Liquidity

Credit Facility

We maintain a credit facility with Wells Fargo. The credit facility matures on February 21, 2017 and has a maximum borrowing amount of $150.0 million with a maximum for letters of credit of $20.0 million. The credit facility is secured by liens on most of our domestic assets (other than real property and equipment) and on 66% of our ownership interest in certain foreign subsidiaries.

We utilize the credit facility to provide funding for operations and other corporate purposes through daily bank borrowings and/or cash repayments to ensure sufficient operating liquidity and efficient cash management. Availability at July 31, 2014 and October 31, 2013 under the credit facility was $100.6 million and $123.3 million, respectively.

 

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In addition to the amounts available under the credit facility, we also maintain a credit facility at our Canadian subsidiary which is used to support operations and is serviced by local cash flows from operations. There were no borrowings outstanding under the Canadian credit facility at July 31, 2014 and October 31, 2013. Availability under the Canadian credit facility at July 31, 2014 and October 31, 2013 was $5.0 million Canadian dollars (US$4.6 million and US$4.8 million, respectively).

Please refer to Note 5 of the consolidated financial statements for further discussion of our debt.

Contractual Obligations and Off-Balance-Sheet Arrangements

Contractual Obligations and Commercial Commitments

Our contractual obligations and commercial commitments as of July 31, 2014 are as follows:

 

		For the Years Ending October 31,
		Borrowings (1)				Interest on Fixed Rate Borrowings (2)				Capital Leases, Including Amounts Representing Interest				Operating Leases				Total Commitments
		(in thousands)
Remainder of 2014		$	52			$	8,290			$	824			$	1,981			$	11,147
2015			214				16,653				2,812				7,161				26,840
2016			222				16,644				2,429				4,515				23,810
2017			47,532				16,634				2,429				3,123				69,718
2018			242				16,625				2,430				1,475				20,772
Thereafter			203,157				8,776				2,794				878				215,605
Total		$	251,419			$	83,622			$	13,718			$	19,133			$	367,892

 

(1)

Borrowings include $47.3 million under our credit facility maturing on February 21, 2017, $200.0 million aggregate principal amount of 2019 Notes, a $3.1 million ten-year mortgage note due July 2022 related to the purchase of the Company’s corporate headquarters, and $1.0 million of a Pennsylvania Industrial loan. See Note 5 of the consolidated financial statements for further discussion of our borrowings.

(2)	In connection with the mortgage note on the Company’s corporate headquarters, we entered into a ten-year floating-to-fixed interest rate swap agreement with TD Bank, N.A that fixes the interest rate at 3.52% per year and matures on July 25, 2022.

In addition to the amounts reflected in the table above:

We have revised our capital expenditures forecast for fiscal 2014 downward to $28 million. We expect to incur approximately $7 million of capital expenditures during the remainder of fiscal 2014. The capital expenditures during the fiscal year and for the remainder of the fiscal year are focused on our food bag, retail canliner and custom product lines.

Off-Balance Sheet Arrangements

We do not engage in any off-balance sheet financing arrangements with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, that have or are reasonably likely to have a current or future effect on our financial condition, changes in financial condition, revenues or expenses, results of operations, liquidity, capital expenditures or capital resources.

Effects of Inflation

Inflation is not expected to have a significant impact on our business.

 

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Critical Accounting Policies

Our discussion and analysis of our financial condition and results of operations are based upon our consolidated financial statements, which have been prepared in accordance with accounting principles generally accepted in the United States of America. The preparation of these consolidated financial statements requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amount of revenues and expenses during the reporting period. On an on-going basis, management evaluates its estimates and judgments, including those related to product returns, customer rebates and incentives, doubtful accounts, inventories, including LIFO inventory valuations, acquisitions, pension obligations, incurred but not reported medical and workers’ compensation claims, litigation and contingency accruals, income taxes, including valuation of deferred taxes, share-based compensation, and impairment of long-lived assets and intangibles, including goodwill. Management bases its estimates and judgments on historical experience and various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Our critical accounting policies are described in detail in Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in the notes to the consolidated financial statements in our Annual Report on Form 10-K for the fiscal year ended October 31, 2013, filed with the U.S. Securities and Exchange Commission on January 14, 2014.

There were no material changes to our critical accounting policies during the nine months ended July 31, 2014.

New Accounting Pronouncements

We have implemented all new accounting pronouncements that are in effect and that may impact our financial statements and do not believe that there are any other new accounting pronouncements that have been issued that might have a material impact on our financial position, results of operations or cash flows.

Please refer to Note 1 of the consolidated financial statements for further discussion of new accounting pronouncements not yet effective.

 

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

We are exposed to market risk from changes in interest rates and foreign currency exchange rates, which may adversely affect our results of operations and financial condition. We seek to minimize these risks through operating and financing activities and, when deemed appropriate, through the use of derivative financial instruments. We do not purchase, hold or sell derivative financial instruments for trading purposes.

Interest Rates

The fair value of our fixed interest rate debt varies with changes in interest rates. Generally, the fair value of fixed rate debt will increase as interest rates fall and decrease as interest rates rise. At July 31, 2014, the carrying value of our total debt was $263.9 million of which $216.6 million was fixed rate debt (2019 notes, mortgage note, capital leases and the Pennsylvania industrial loan). As of July 31, 2014, the estimated fair value of our 2019 notes, which had a carrying value of $200.0 million, was $211.2 million. As of July 31, 2014, the carrying value of our mortgage note, capital leases and the Pennsylvania industrial loan was $16.6 million which approximates fair value because the interest rates on these debt instruments approximate market yields for similar debt instruments.

In order to manage the exposure to interest rate risks inherent in variable rate debt, as is the case in the mortgage note, we entered into a floating-to-fixed interest rate swap agreement with TD Bank, N.A. with a

 

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notional value of $3,360,000, the then outstanding principal balance on the mortgage note. The interest rate swap fixed the interest rate at 3.52% per year and matures on July 25, 2022. The notional amount and fair value at July 31, 2014 of the interest rate swap was $3,131,256 and an asset of $94,940 respectively.

Floating rate debt at July 31, 2014 and October 31, 2013 totaled $47.3 million and $25.6 million, respectively. Based on the average floating rate debt outstanding during the nine months ended July 31, 2014 (our credit facility), a one-percent increase or decrease in the average interest rate during the period would have resulted in a change to interest expense of $0.4 million for the nine months ended July 31, 2014.

Foreign Exchange

We enter into derivative financial instruments (principally foreign exchange forward contracts) primarily to hedge intercompany transactions, trade sales and forecasted purchases. Foreign currency forward contracts reduce our exposure to the risk that the eventual cash inflows and outflows, resulting from these intercompany and third party trade transactions denominated in a currency other than the functional currency, will be adversely affected by changes in exchange rates.

We do not use foreign currency forward contracts for speculative or trading purposes. We enter into foreign exchange forward contracts with financial institutions and have not experienced nonperformance by counterparties. We anticipate performance by all counterparties to such agreements.

The gain (loss) on the fair value for these foreign exchange forward contracts is recognized in other, net in the consolidated statement of operations and amounted to approximately $14,000 and $9,000 for the three and nine months ended July 31, 2014, respectively, and approximately $(51,000) and $(26,000) for the three and nine months ended July 31, 2013, respectively, with a total notional value of $3.8 million and $0.8 million at July 31, 2014 and October 31, 2013, respectively. The fair value of these contracts was immaterial at July 31, 2014. Based on the average forward exchange contracts outstanding during the nine months ended July 31, 2014, a one-percent increase or decrease in the foreign exchange rate during the period would have resulted in a change to other, net of approximately $17,000 for the nine months ended July 31, 2014.

Commodities

We use commodity raw materials, primarily resin, and energy products in conjunction with our manufacturing process. Generally, we acquire such components at market prices and do not use financial instruments to hedge commodity prices. As a result, we are exposed to market risks related to changes in commodity prices in connection with these components.

We are exposed to market risk from changes in resin prices that could impact our results of operations and financial condition. Our resin purchasing strategy is to deal with only high-quality, dependable suppliers. We believe that we have maintained strong relationships with these key suppliers and expect that such relationships will continue into the foreseeable future. The resin market is a global market and, based on our experience, we believe that adequate quantities of plastic resins will be available to us at market prices, but we can give no assurances as to such availability or the prices thereof. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Overview—Market Conditions” for further discussion of market risks related to resin prices.

 

Item 4.

Controls and Procedures

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms and that such information is accumulated and communicated to our

 

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management, including our Chief Executive Officer and Chief Financial Officer (together, the “Certifying Officers”), as appropriate, to allow for timely decisions regarding required disclosure.

In designing and evaluating disclosure controls and procedures, management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable, not absolute, assurance of achieving the desired objectives. Also, the design of a control system must reflect the fact that there are resource constraints and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all control systems, no evaluation of controls can provide absolute assurance that misstatements due to error or fraud will not occur or that all control issues and instances of fraud, if any, have been detected. These inherent limitations include the realities that judgments in decision-making can be faulty and that breakdowns can occur because of simple error or mistake. The design of any system of controls is based, in part, upon certain assumptions about the likelihood of future events and there can be no assurance that any design will succeed in achieving its stated goals under all potential future conditions.

As of July 31, 2014, the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of management, including the Certifying Officers, of the effectiveness of the design and operation of our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act. Our disclosure controls and procedures are designed to provide reasonable assurance of achieving their stated objectives and our Certifying Officers concluded that our disclosure controls and procedures were effective at a reasonable assurance level as of July 31, 2014.

Changes in Internal Control over Financial Reporting

There was no change in our internal control over financial reporting that occurred during the three months ended July 31, 2014 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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PART II—OTHER INFORMATION

 

Item 1.

Legal Proceedings

We are involved in routine litigation in the normal course of our business. The proceedings are not expected to have a material adverse impact on our results of operations, financial position or liquidity.

 

Item 1A.

Risk Factors

You should carefully consider the risks and uncertainties we describe in our Annual Report on Form 10-K for the fiscal year ended October 31, 2013, and in other reports filed thereafter with the SEC, before deciding to invest in or retain shares of our common stock. We do not believe there are any material changes to the risk factors discussed in Item 1A. “Risk Factors” in our Annual Report on Form 10-K for the fiscal year ended October 31, 2013.

 

Item 2.

Unregistered Sales of Equity Securities and Use of Proceeds

None

 

Item 3.

Defaults Upon Senior Securities

None

 

Item 4.

Mine Safety Disclosures

None

 

Item 5.

Other Information

None

 

Item 6.

Exhibits

 

Exhibit #		Description
31.1*		Certification of the Chief Executive Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
31.2*		Certification of the Chief Financial Officer, pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
32.1**		Certification of the Chief Executive Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
32.2**		Certification of the Chief Financial Officer, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
101.INS*		XBRL Instance Document
101.SCH*		XBRL Taxonomy Extension Schema Document
101.CAL*		XBRL Taxonomy Extension Calculation Linkbase Document
101.DEF*		XBRL Taxonomy Extension Definition Linkbase Document
101.LAB*		XBRL Taxonomy Extension Label Linkbase Document
101.PRE*		XBRL Taxonomy Extension Presentation Linkbase Document

 

*	Filed herewith

**	Furnished herewith

 

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

 

		AEP Industries Inc.
Dated: September 9, 2014		By:		/S/ J. BRENDAN BARBA J. Brendan Barba Chairman of the Board, President and Chief Executive Officer (principal executive officer)
Dated: September 9, 2014		By:		/S/ PAUL M. FEENEY Paul M. Feeney Executive Vice President, Finance and Chief Financial Officer (principal financial officer)

 

36

Exhibit 31.1

CHIEF EXECUTIVE OFFICER’S 302 CERTIFICATION

I, J. Brendan Barba, certify that:

1. I have reviewed this Quarterly Report on Form 10-Q of AEP Industries Inc. for the quarterly period ended July 31, 2014;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s Board of Directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

Date: September 9, 2014

/s/ J. BRENDAN BARBA

J. Brendan Barba Chief Executive Officer

Exhibit 31.2

CHIEF FINANCIAL OFFICER’S 302 CERTIFICATION

I, Paul M. Feeney, certify that:

1. I have reviewed this Quarterly Report on Form 10-Q of AEP Industries Inc. for the quarterly period ended July 31, 2014;

2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report;

3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;

4. The registrant’s other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have:

(a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;

(b) Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision, to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;

(c) Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and

(d) Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and

5. The registrant’s other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s Board of Directors (or persons performing the equivalent functions):

(a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and

(b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.

 

Date: September 9, 2014

/s/ PAUL M. FEENEY

Paul M. Feeney Chief Financial Officer

Exhibit 32.1

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of AEP Industries Inc. (the “Company”) on Form 10-Q for the quarterly period ended July 31, 2014, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, J. Brendan Barba, Chief Executive Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:

 

1.

The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

 

2.

The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

 

Date: September 9, 2014

/s/ J. BRENDAN BARBA

J. Brendan Barba Chief Executive Officer

Exhibit 32.2

CERTIFICATION PURSUANT TO

18 U.S.C. SECTION 1350,

AS ADOPTED PURSUANT TO

SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002

In connection with the Quarterly Report of AEP Industries Inc. (the “Company”) on Form 10-Q for the quarterly period ended July 31, 2014, as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Paul M. Feeney, Chief Financial Officer of the Company, certify, pursuant to 18 U.S.C. § 1350, as adopted pursuant to § 906 of the Sarbanes-Oxley Act of 2002, that:

 

1.

The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and

 

2.

The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company.

 

Date: September 9, 2014

/s/ PAUL M. FEENEY

Paul M. Feeney Chief Financial Officer