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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-K

[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF

THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended October 31, 2009

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 0-14550

 

 

AEP INDUSTRIES INC.

(Exact name of registrant as specified in its charter)

 

Delaware

(State or other jurisdiction of
incorporation or organization)

 

22-1916107

(I.R.S. Employer
Identification No.)

125 Phillips Avenue, South Hackensack, New Jersey

(Address of principal executive offices)

 

07606-1546

(Zip code)

Registrant’s telephone number, including area code: (201) 641-6600

Securities registered pursuant to Section 12(b) of the Act:

 

Title of each class

 

Name of each exchange on which registered

Common Stock, $0.01 par value   Nasdaq Global Select Market

Securities registered pursuant to Section 12(g) of the Act:

None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    ¨  Yes    x  No

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    ¨   Yes    x  No

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.    x  Yes    ¨  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    ¨  No

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.  ¨

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.

 

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    x  No

The aggregate market value of the common stock held by non-affiliates of the registrant as of April 30, 2009 was $41,761,337, based upon the closing price of $20.33 as reported by the Nasdaq Global Select Market on such date. Shares of common stock held by officers, directors and holders of more than 5% of the outstanding common stock have been excluded from this calculation because such persons may be deemed to be affiliates; such exclusion shall not be deemed to constitute an admission that any such person is an affiliate of the registrant.

The number of shares of the registrant’s common stock outstanding as of January 11, 2010 was 6,840,083.

DOCUMENTS INCORPORATED BY REFERENCE

Portions of the proxy statement for the 2010 annual meeting of stockholders are incorporated by reference into Part III of this report to the extent described herein.

 

 

 


Table of Contents

AEP INDUSTRIES INC.

INDEX TO FORM 10-K

 

          Page
Number

Cautionary Note Regarding Forward-Looking Statements

   3

PART I

ITEM 1.

   Business    4

ITEM 1A.

   Risk Factors    12

ITEM 1B.

   Unresolved Staff Comments    20

ITEM 2.

   Properties    20

ITEM 3.

   Legal Proceedings    21

ITEM 4.

   Submission of Matters to a Vote of Security Holders    21

PART II

ITEM 5.

   Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities    21

ITEM 6.

   Selected Financial Data    24

ITEM 7.

   Management’s Discussion and Analysis of Financial Condition and Results of Operations    25

ITEM 7A.

   Quantitative and Qualitative Disclosures about Market Risk    41

ITEM 8.

   Financial Statements and Supplementary Data    43

ITEM 9.

   Changes in and Disagreements with Accountants on Accounting and Financial Disclosure    43

ITEM 9A.

   Controls and Procedures    43

ITEM 9B.

   Other Information    44

PART III

ITEM 10.

   Directors, Executive Officers and Corporate Governance    44

ITEM 11.

   Executive Compensation    44

ITEM 12.

   Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters    44

ITEM 13.

   Certain Relationships and Related Transactions, and Director Independence    45

ITEM 14.

   Principal Accountant Fees and Services    45

PART IV

ITEM 15.

   Exhibits and Financial Statement Schedules    45

Signatures

   90

 

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Cautionary Note Regarding 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, our ability to continue to maintain sales and profits of our operations, the implementation of our Board-approved plan to restructure and realign the Atlantis Plastics Films businesses, 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 costs associated with the shutdown of the Fontana and Cartersville plants (acquired as part of Atlantis acquisition on October 30, 2008); the continuing impact of the U.S. recession, the continuing impact of 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 this Annual Report on Form 10-K. Given these uncertainties, you should not place undue reliance on any such forward-looking statements. Except as required by law, we assume no obligation to update these forward-looking statements, even if new information becomes available in the future.

 

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PART I

 

ITEM 1. BUSINESS

Overview

AEP Industries Inc., founded in 1970 and incorporated in Delaware in 1985, is a leading manufacturer of plastic packaging films in North America. We manufacture and market an extensive and diverse line of polyethylene, polyvinyl chloride and polypropylene 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 and textile industries.

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.

We manufacture both industrial grade products, which are manufactured to general industry specifications, and specialty products, which are manufactured under more exacting standards to assure certain required chemical and physical properties. Specialty products generally sell at higher margins than industrial grade products.

Fiscal 2009 Developments

On October 30, 2008, we completed the acquisition of substantially all of the assets of the stretch films, custom films and institutional products divisions of Atlantis Plastics, Inc. (“Atlantis”) for a purchase price of $98.8 million after expenses and the net working capital true-up. Atlantis maintained a significant presence in many of its product categories, which are used in a variety of applications, including storage, transportation, food packaging and other commercial and consumer applications. Atlantis also converted some institutional products internally from custom films. This transaction enhanced our position as the preferred supplier of flexible packaging solutions.

Concurrently with the closing of the Atlantis acquisition, our Board approved a plan to realign and reorganize the Atlantis businesses. Management finalized its reorganization plan in October 2009. In addition to the shutdown of the acquired Fontana, California plant which commenced in November 2008, we shut down the acquired Cartersville, Georgia plant on October 31, 2009. Costs of approximately $5.9 million associated with shutting down these plants have been recorded as an adjustment to the allocation of the purchase price. Costs associated with this restructuring include severance costs, lease costs, costs to be incurred as a result of the contractual obligation to put the facilities back to their original condition, equipment dismantling costs and operating costs of the facilities from November 1, 2009 until lease expiration. We expect to complete the restructuring activities related to the Fontana facility during fiscal 2010 and by July 2015 for the Cartersville facility (commensurate with the expiration of the Fontana and Cartersville leases).

AEP and Atlantis were significant competitors in the plastic films industry for many years, competing to sell similar products to a similar customer base. One of the primary factors in AEP’s determination to pursue and consummate the Atlantis acquisition was the potential realization of synergistic benefits derived from SKU consolidation, logistical savings, resin cost savings and product cost efficiencies. Immediately upon the completion of the acquisition, AEP began the process of reducing and combining SKUs, reformulating common products to their most effective common denominator and changing the manufacturing location of certain products to maximize operating and logistical efficiencies. We devoted significant time and efforts throughout fiscal 2009 to achieve these synergistic benefits. However, as a result of the foregoing, no meaningful operational or financial information exists subsequent to the acquisition that segregates the impact of Atlantis from AEP as a whole. Therefore, although the Atlantis acquisition materially impacted AEP’s net sales and results of operations for fiscal 2009, information contained in this Form 10-K does not include any separate information regarding Atlantis.

 

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Our focus has been and continues to be to use excess cash to pay down debt. At October 31, 2009, our consolidated debt was $170.0 million, a decrease of $79.2 million from prior year’s balance of $249.2 million. In March 2009, our Company’s Board authorized the Senior Note Repurchase Program, under which we may repurchase a portion of the 2013 Notes in privately negotiated transactions, funded by proceeds from sale-leaseback transactions up to $8.0 million and borrowings under the Credit Facility up to $3.0 million. On April 1, 2009, the Company repurchased and retired $14.8 million (principal amount) of our 2013 Notes at a price of 62.8% of par. The cash paid was $9.4 million which included $0.1 million of accrued interest. In connection with the partial retirement, we recognized a gain on extinguishment of debt of $5.3 million, which is the difference between the repurchase amount of $9.3 million and the principal amount retired of $14.8 million, net of the pro-rata write-off of the unamortized debt financing costs related to the 2013 Notes of $0.2 million. On November 2, 2009, the Board terminated the 2009 Senior Note Repurchase Program and authorized the 2010 Senior Note Repurchase Program which allows the Company to spend up to $25.0 million to repurchase its outstanding 2013 Notes.

We incurred approximately $23.8 million of capital expenditures during fiscal 2009 related primarily to an expansion of our North Carolina plant, a new Co-Ex line in our Pennsylvania plant (production began in September 2009) and energy cost reduction equipment in our Pennsylvania plant, the purchase of the land and building in our Minnesota plant, and a new computer operating system throughout the Company.

Products

We are a leading manufacturer of plastic packaging films in North America. We manufacture and market an extensive and diverse line of polyethylene, polyvinyl chloride and polypropylene flexible packaging products, with consumer, industrial and agricultural applications. Flexible packaging and film products are thin, ductile bags, sacks, labels and films used for food and non-food consumer, agricultural and industrial items. The flexible packaging and film products manufactured by us are used in a variety of industries, including the packaging, transportation, beverage, food, automotive, pharmaceutical, chemical, electronics, construction, agricultural and textile industries.

The following table summarizes our product lines:

 

Product

  

Material

  

Examples of Uses

custom films

   polyethylene co-extruded and custom designed monolayer film   

•     drum, box, carton, and pail liners

•     furniture and mattress bags

•     films to cover high value products magazine overwrap

PROformance® films

   Co-extruded polyolefin films and custom designed monolayer films   

•     cereal box liners

•     fresh cut produce packaging

•     frozen foods

•     medical

stretch (pallet) wrap

   polyethylene   

•     pallet wrap

polyvinyl chloride wrap

   polyvinyl chloride   

•     food and freezer wrap

printed and converted films

   polyethylene   

•     printed shrink films

•     printed, laminated, converted films for
flexible

•     packaging to consumer markets

 

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Product

  

Material

  

Examples of Uses

other products and specialty films

   unplasticized polyvinyl chloride polyethylene   

•     battery labels

•     credit card laminate

•     retail and institutional films and products

•     twist wrap

•     canliners

•     table covers, aprons, bibs and gloves

•     agricultural films

Net sales by product line for each of the years ended October 31, 2009, 2008 and 2007 are as follows:

 

     2009    2008    2007
     (in thousands)

Custom films

   $ 240,182    $ 336,439    $ 284,916

PROformance® films (a)

     77,804      18,189      15,023

Stretch (pallet) wrap

     217,999      184,516      166,070

Polyvinyl chloride wrap

     77,870      88,672      81,803

Printed and converted films

     9,659      10,006      7,974

Other products and specialty films

     121,305      124,409      110,532
                    

Total

   $ 744,819    $ 762,231    $ 666,318
                    

 

(a) Prior to this report, PROformance films was classified as part of custom films. Due to the Atlantis acquisition and management’s emphasis on this product line, we are presenting PROformance separately. We have revised fiscal 2008 and 2007 amounts to reflect the revised presentation.

No single customer accounted for more than 10% of net sales in any year. No single customer accounted for more than 10% of our accounts receivable balance at October 31, 2009. See Note 13 in our consolidated financial statements for information regarding the Company’s operations by geographical area (United States and Canada).

Custom Films

We believe that the strength of our custom film operations lies in our variety of product applications, high quality control standards, well-trained and knowledgeable sales force and commitment to customer service. Most of the custom films manufactured by us, which may be as many as 35,000 separate and distinct products in any given year, are custom designed to meet the specific needs of our customers.

We manufacture a broad range of custom films, generally for industrial applications, including sheeting, tubing and bags. Bags are drum, box, carton and pail liners that are usually cut, rolled or perforated. These bags can also be used to package specialty items such as furniture and mattresses. We also manufacture films to protect items stored outdoors or in transit, such as boats and cars, and a wide array of shrink films, barrier films and overwrap films.

We also manufacture a full range of co-extruded films, and custom designed monolayer films designed specifically to service the flexible packaging market. These films are capable of being printed and laminated by third party flexible packaging converters and are used in the food, pharmaceutical, medical businesses and in a variety of other flexible packaging end users.

PROformance® Films

The Atlantis acquisition broadened our array of products in this product line, in line with our strategy of improving and investing in value-added products with higher margins. This group offers a full range of coextruded polyolefin films, and custom designed monolayer films designed specifically to service the flexible

 

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packaging market. Capable of being printed and laminated by flexible packaging applications, our PROformance® films are used for food, pharmaceutical and medical applications and are available in up to five layers for applications requiring strength, clarity, sealability, barrier properties against oxygen or moisture transmission, and breathability for preserving freshness.

Stretch (Pallet) Wrap

We manufacture the most complete line of stretch film products for both hand wrap and rotary applications, using both monolayer and co-extruded constructions used to wrap pallets of industrial and commercial goods for shipping or storage. We also market a wide variety of pre stretch and high performance products designed for commodity and specialty uses.

Polyvinyl Chloride Wrap

We manufacture specifically formulated in-store and pre-store films with our Resinite® line of polyvinyl chloride (“PVC”) food wrap for the supermarket and industrial markets. We offer a broad range of products with approximately 65 different formulations. Our Griffin, Georgia facility also manufactures dispenser (ZipSafe® cutter) boxes containing polyvinyl chloride food wrap for sale to consumers and institutions, including restaurants, schools, hospitals and penitentiaries. These institutional polyvinyl chloride food wrap products are marketed under several private labels and under our own Seal Wrap® name. These stretch and shrink PVC films are used for packaging of fresh red meats, poultry, fish, fruits, vegetables and bakery products. We also provide PVC films for windowing, blister packaging and aseptic shrink bundling film in the industrial marketplace.

Printed and Converted Films

We manufacture six, eight and ten color printing, solventless lamination, bags, pouches and wicketed bags. Our printed and converted films provide printed rollstock to the food and beverage industries and other manufacturing and distributing companies. We also convert printed rollstock to bags and pouches for use by bakeries, fresh or frozen food processors, manufacturers or other dry goods processors.

Other Products and Specialty Films

We manufacture unplasticized polyvinyl chloride (“UPVC”) film for use in battery labels, twist films, credit card laminates, PVC films for sale to retailers for use by consumers and a variety of film products with agricultural applications such as mulch films, fumigation films and sileage films. We also produce disposable consumer and institutional plastic products for the food service, party supply and school/collegiate markets, marketed under the Sta-Dri® brand name. Products produced include table covers and skirts, aisle runners, aprons, bibs, gloves, boots, freezer/storage bags, saddle pack bags, locker wrap and custom imprint designs.

Manufacturing and Raw Materials

We currently conduct our manufacturing operations in the United States and Canada. We manufacture both industrial grade products, which are manufactured to industry specifications or for distribution from inventory, and specialty products, which are manufactured under more exacting standards to assure that their chemical and physical properties meet the particular requirements of the customer or the specialized application appropriate to its intended market. Specialty products generally sell at higher margins than industrial grade products.

We manufacture our film at twelve large, geographically dispersed, integrated extrusion facilities throughout North America, which also have the ability to produce other flexible packaging products. The size and location of those facilities, as well as their capacity to manufacture multiple types of flexible packaging products and to re-orient equipment as market conditions warrant, enable us to achieve savings and minimize overhead and transportation costs, and to better serve our customers and remain competitive.

 

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See Item 2, “Properties” for a discussion of product lines manufactured at each facility as of October 31, 2009.

Production

In the film manufacturing process, resins with various properties are blended with chemicals and other additives to achieve a wide range of specified product characteristics, such as color, clarity, tensile strength, toughness, thickness, shrinkability, surface friction, transparency, sealability and permeability. The gauges of our products range from less than one mil (.001 inches) to more than 10 mils (.01 inches). Our extrusion equipment can produce printed products and film up to 40 feet wide. The blending of various kinds of resin combined with chemical and color additives is computer controlled to avoid waste and to maximize product consistency. The blended mixture is melted by a combination of applied heat and friction under pressure and is then mechanically mixed. The mixture is then forced through a die, at which point it is expanded into a flat sheet or a vertical tubular column of film and cooled. Several mixtures can be forced through separate layers of a co-extrusion die to produce a multi-layered film (co-extrusion), each layer having specific and distinct characteristics. The cooled film can then be shipped to a customer or can be further processed and then shipped. Generally, our manufacturing plants operate 24 hours a day, seven days a week.

We regularly upgrade or replace older equipment in order to keep abreast of technological advances and to maximize production efficiencies by reducing labor costs, waste and production time. During the past five fiscal years, we made significant capital improvements, including the purchase and lease of new state-of-the-art extrusion equipment and the upgrading of older equipment.

Raw Materials

We manufacture film products primarily from polyethylene, polypropylene and polyvinyl chloride resins, all of which are available from a number of domestic and foreign suppliers. We select our suppliers based on the price, quality and characteristics of the resins they produce. We currently purchase resins from most of the major North American resin suppliers and believe any combination of purchases from such suppliers, as well as other suppliers we do not currently do business with, could satisfy our ongoing resin requirements. Our top three suppliers of resin during fiscal 2009 supplied us with 36%, 24% and 19%, respectively. Given the significant effect of resin costs on our operations and financial results, we have elected to focus our purchases with three suppliers in order to take advantage of the volume rebates which are customary among resin suppliers and critical to our success. Although the plastics industry has from time to time experienced shortages of resin supply and we have limited contractual protections in the event of such shortage, we believe we are well positioned to deal with such risks given our significant relationships and history with existing suppliers, as well as suppliers with whom we currently do not do business.

The resins used by us are produced from petroleum and natural gas. Instability in the world markets for petroleum and natural gas could adversely affect the prices of our raw materials, and this could have an adverse effect on our profitability if the increased costs cannot be passed on to customers. See Item 1A, “Risk Factors.”

Backlog

Our total backlog at October 31, 2009 was approximately $53.4 million, compared with approximately $44.3 million at October 31, 2008. We do not consider any specific month’s backlog to be a significant indicator of sales trends due to the various factors that influence backlog.

Quality Control

We believe that maintaining the highest standards of quality in all aspects of our manufacturing operations plays an important part in our ability to maintain our competitive position. To that end, we have adopted strict

 

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quality control systems and procedures designed to test the mechanical properties of our products, such as strength, puncture resistance, elasticity, abrasion characteristics and sealability, which we regularly review and modify as appropriate.

Marketing and Sales

We believe that our ability to continue to provide superior customer service will be critical to our success. Even in those markets where our products are considered commodities and price is the single most important factor, we believe that our sales and marketing capabilities and our ability to timely deliver products can be a competitive advantage. To that end, we have established good relations with our suppliers and have long-standing relationships with most of our customers, which we attribute to our ability to consistently manufacture high-quality products and provide timely delivery and superior customer service. We serve approximately 3,500 customers worldwide, none of which individually accounted for more than 4% of our net sales in fiscal 2009.

We believe that our research and development efforts, our high-efficiency equipment, which is automated and microprocessor-controlled, and the technical training given to our sales personnel enhance our ability to expand our sales in all of our product lines. An important component of our marketing philosophy is the ability of our sales personnel to provide technical assistance to customers. Our sales force regularly consults with customers with respect to performance of our products and the customer’s particular needs and then communicates with appropriate research and development staff regarding these matters. In conjunction with the research and development staff, sales personnel are often able to recommend a product or suggest a resin blend to produce the product with the characteristics and properties which best suit the customer’s requirements. Because we have expanded and continue to expand our product lines, sales personnel are able to offer a broad line of products to our customers.

We generally sell either directly to customers who are end-users of our products or to distributors, including nation-wide brokers, for resale to end-users. In fiscal 2009, 2008 and 2007 approximately 61%, 62%, and 61%, respectively, of our worldwide sales were directly to distributors with the balance representing sales to end-users.

Distribution

We believe that the timely delivery of our products to customers is a critical factor in our ability to maintain our market position. In North America, all of our deliveries are by dedicated third parties, while we continue to monitor and control through a web based “On Demand” Transportation Management System (TMS) software. The TMS system provides detailed reports, tracking of every shipment to customer delivery and carrier management. This enables us to better control the distribution process and ensure priority handling and direct transportation of products to our customers, thus improving the speed, reliability and efficiency of delivery.

Because of the geographic dispersion of our plants, we are able to deliver most of our products within a 500 mile radius of our plants. This enables us to reduce our use of warehouse space to store products. However, we also ship products great distances when necessary and export from the United States and Canada.

Research and Development

We have a research and development department with a staff of approximately 17 persons. In addition, other members of management and supervisory personnel, from time to time, devote various amounts of time to research and development activities. The principal efforts of our research and development department are directed to assisting sales personnel in designing specialty products to meet individual customer’s needs, developing new products and reformulating existing products to improve quality and/or reduce production costs. During fiscal 2009, we focused a significant portion of our research and development efforts analyzing and merging the comparable products lines of AEP’s existing products with those of Atlantis. Our research and development department has developed a number of products with unique properties, which we consider

 

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proprietary, certain of which are protected by patents. In fiscal 2009, 2008 and 2007, we spent $1.8 million, $1.1 million and $1.0 million, respectively, for research and development activities for continuing operations. Research and development expense is included in cost of sales in our consolidated statements of operations.

Intellectual Property

We own a number of patents, trademarks and licenses that relate to some of our products and manufacturing processes, and apply for new patents on significant product and process developments when appropriate. Although we believe that our patents and trademarks collectively provide us a competitive advantage, we are not dependent on any single patent or trademark. Rather, we believe our success depends on our marketing, manufacturing, and purchasing skills, as well as our ongoing research and development and unpatented proprietary know-how. We believe that the expiration or unenforceability of any of our patents, trademark registrations or licenses would not be material to our financial position or results of operations.

Competition

The business of supplying plastic packaging products is extremely competitive, and we face competition from a substantial number of companies which sell similar and substitute packaging products. Some of our competitors are subsidiaries or divisions of large, international, diversified companies with extensive production facilities, well-developed sales and marketing staffs and substantial financial resources.

We compete principally with (i) local manufacturers, who compete with us in specific geographic areas, generally within a 500 mile radius of their plants, (ii) companies which specialize in the extrusion of a limited group of products, which they market nationally, and (iii) a limited number of manufacturers of flexible packaging products who offer a broad range of products and maintain production and marketing facilities domestically and internationally.

Because many of our products are available from a number of local and national manufacturers, competition is highly price-sensitive and margins are relatively low. We believe that all of our products require efficient, low cost and high-speed production to remain cost competitive. We believe we also compete on the basis of quality, service and product differentiation.

We believe that there are few barriers to entry into many of our markets, enabling new and existing competitors to rapidly affect market conditions. As a result, we may experience increased competition resulting from the introduction of products by new manufacturers. In addition, in several of our markets, products are generally regarded as commodities. As a result, competition in such markets is based almost entirely on price and service.

Environmental Matters

We believe that there are no current environmental matters which would have a material adverse effect on our financial position, results of operations or liquidity. See discussion of environmental risk factors in Item 1A, “Risk Factors.”

Employees

At October 31, 2009, we had approximately 2,000 full and part time employees worldwide, including officers and administrative personnel. We have three collective bargaining agreements covering 298 employees, which expire in January 2010, February 2010, and March 2011, respectively. While we believe that our relations with our employees are satisfactory, a dispute between our employees and us could have a material adverse effect on our business, which could affect our financial position, results of operations and liquidity.

 

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Executive Officers of the Registrant

At January 14, 2010, our executive officers are as follows:

 

Name

   Age   

Position

J. Brendan Barba

   68    Chairman of the Board of Directors, President and Chief Executive Officer

Paul M. Feeney

   67    Executive Vice President, Finance and Chief Financial Officer and Director

John J. Powers

   45    Executive Vice President, Sales and Marketing

David J. Cron

   55    Executive Vice President, Manufacturing

Paul C. Vegliante

   44    Executive Vice President, Operations

Lawrence R. Noll

   61    Vice President, Tax and Administration, and Director

James B. Rafferty

   57    Vice President, Treasurer and Secretary

Linda N. Guerrera

   42    Vice President and Controller

J. Brendan Barba is one of our founders and has been our President and Chief Executive Officer and a director since our inception in January 1970. In 1985, Mr. Barba assumed the additional title of Chairman of the Board of Directors.

Paul M. Feeney has been our Executive Vice President, Finance and Chief Financial Officer and a director since December 1988. From 1980 to 1988, Mr. Feeney was Vice President and Treasurer of Witco Corporation.

John J. Powers has been our Executive Vice President, Sales and Marketing since March 1996. Prior thereto, he was Vice President-Custom Film Division since 1993 and held various sales positions with us since 1989.

David J. Cron has been our Executive Vice President, Manufacturing since July 1997. Prior thereto, he was Vice President, Manufacturing, a plant manager and held various other positions with us since 1976.

Paul C. Vegliante has been our Executive Vice President, Operations since December 1999. Prior thereto, he was our Vice President, Operations since June 1997 and held various other positions with us since 1994.

Lawrence R. Noll has been our Vice President, Tax and Administration since April 2007. Prior thereto, he was our Vice President and Controller since 1996, a director since February 2005 and our corporate Secretary from April 2005 to April 2007. Previously, he served as Vice President, Finance since 1993 and was our corporate Secretary from 1993 to 1998. He also served as a director from 1993 to 2004. He was employed as our Controller from 1980 to 1993.

James B. Rafferty has been our Vice President and Treasurer since November 1996 and Secretary since April 2007. Prior thereto, he was our Assistant Treasurer since July 1996. From 1989 to 1995, Mr. Rafferty was Director of Treasury Operations at Borden, Inc.

Linda N. Guerrera has been our Vice President and Controller since April 2007. Prior thereto, she was our Director of Financial Reporting from September 2006 to April 2007 and our Assistant Controller—International Operations from October 1996 to September 2006. Prior to joining the Company, Ms. Guerrera was a manager at Arthur Andersen LLP in New York City.

Certain family relationships exist between our directors and executive officers; Messrs. Powers and Vegliante are the sons-in-law of Mr. Barba; Messrs. Barba and Cron are cousins; and Ms. Guerrera is the daughter-in-law of Mr. Feeney.

 

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Available Information

Our Internet address is www.aepinc.com. In the “Investor Relations” section of our website, we post the following filings as soon as reasonably practicable after they are electronically filed with or furnished to the SEC: our annual report on Form 10-K, our quarterly reports on Form 10-Q, our current reports on Form 8-K, our proxy statement on Form 14A related to our annual stockholders’ meeting and any amendments to those reports or statements filed or furnished pursuant to Section 13(a) or 15(d) of the Securities Exchange Act of 1934, as amended. All such filings are available on our Investor Relations web site free of charge. Copies of any of the above-referenced information will also be made available, free of charge, by calling (201) 641-6600 or upon written request to: Corporate Secretary, AEP Industries, Inc., 125 Phillips Avenue, South Hackensack, NJ 07606. The content on our website is not incorporated by reference into this Form 10-K unless expressly noted.

 

ITEM 1A. RISK FACTORS

You should carefully consider each of the risks and uncertainties described below and elsewhere in this Annual Report on Form 10-K, as well as any amendments or updates reflected in subsequent filings with the SEC. We believe these risks and uncertainties, individually or in the aggregate, could cause our actual results to differ materially from expected and historical results and could materially and adversely affect our business operations, results of operations, financial condition and liquidity. Further, additional risks and uncertainties not presently known to us or that we currently deem immaterial may also impair our results and business operations.

Industry Risks

Our business is dependent on the price and availability of resin, our principal raw material, and our ability to pass on resin price increases to our customers.

The principal raw materials that we use in our products are polyethylene, polypropylene and polyvinyl chloride resins. Our ability to operate profitably is dependent, in a large part, on the markets for these resins. We use resins that are derived from petroleum and natural gas, and therefore prices of such resins fluctuate substantially as a result of changes in petroleum and natural gas prices, demand and the capacity of resin suppliers. Instability in the world markets for petroleum and natural gas could adversely affect the prices of our raw materials and their general availability. Economic conditions in the United States during fiscal 2009 were difficult with global and financial markets experiencing substantial disruption.

Our ability to maintain profitability is heavily dependent upon our ability to pass through to our customers the full amount of any increase in raw material costs. Since resin costs fluctuate significantly, selling prices are generally determined as a “spread” over resin costs, usually expressed as cents per pound. 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 a higher gross profit margin. 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. If there is overcapacity in the production of any specific product that we manufacture and sell, we frequently are not able to pass through the full amount of any cost increase. If resin prices increase and we are not able to fully pass on the increases to our customers, our results of operations, financial condition and liquidity will be adversely affected.

Intense competition in the flexible packaging markets may adversely affect our operating results.

The business of supplying plastic packaging products is extremely competitive. The competition in our market is highly price sensitive; we also compete on the basis of quality, service, timely delivery and

 

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differentiation of product properties. We face intense competition from numerous competitors, including from local manufacturers which specialize in the extrusion of a limited group of products, which they market nationally, and a limited number of manufacturers of flexible packaging products which offer a broad range of products and maintain production and marketing facilities domestically and internationally. Certain of our competitors may have extensive production facilities, well-developed sales and marketing staffs and greater financial resources than we do. We believe that there are few barriers to entry into many of our product markets. As a result, we have experienced, and may continue to experience, competition from new manufacturers. When new manufacturers enter the market for a plastic packaging product or existing manufacturers increase capacity, they frequently reduce prices to achieve increased market share. In addition, we compete with other packaging product manufacturers, many of which can offer consumers non-plastic packaging solutions. Many of these competitors have greater financial resources than we do and such competition can result in additional pricing pressures, reduced sales and lower margins. An increase in competition could result in material selling price reductions or loss of our market share, which could materially adversely affect our operations and financial condition. There can be no assurance that we will be able to compete successfully in the markets for our products or that competition will not intensify.

We are subject to various environmental and health and safety laws and regulations which govern our operations and which may result in potential liability. In addition, consumer preferences and ongoing health and safety studies on plastics and resins may adversely affect our business.

Our operations are subject to various federal, state, local and foreign environmental laws and regulations which govern:

 

   

discharges into the air and water;

 

   

the storage, handling and disposal of solid and hazardous waste;

 

   

the remediation of soil and ground water contaminated by petroleum products or hazardous substances or waste; and

 

   

the health and safety of our employees.

Compliance with these laws and regulations may require material expenditures by us. Actions by federal, state, local and foreign governments concerning environmental and health and safety matters could result in laws or regulations that could increase the cost of manufacturing our products. In addition, the nature of our current and former operations and the history of industrial uses at some of our manufacturing facilities expose us to the risk of liabilities or claims with respect to environmental and worker health and safety matters. We may also be exposed to claims for violations of environmental laws and regulations by previous owners or operators of our property. In addition, the presence of, or failure to remediate, hazardous substances or waste may adversely affect our ability to sell or rent any property or to use it as collateral for a loan. We also may be liable for costs relating to the investigation, remediation or removal of hazardous waste and substances from a disposal or treatment facility to which we or our predecessors sent waste or materials.

Additionally, a decline in consumer preference for plastic products due to environmental considerations could have a material adverse effect on our business, financial condition and results of operations. Also, continuing studies of potential health and safety effects of various resins and plastics, including polyvinyl chlorides and other materials that we use in our products, are being conducted by industry groups, government agencies and others. The results of these studies, along with the development of any other new information, may adversely affect our ability to market and sell certain of our products or may give rise to claims for damages from persons who believe they have been injured by such products, any of which could adversely affect our operations and financial condition.

 

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Company Risks

The existing global economic and financial market environment has had and may continue to have a negative effect on our business and operations.

The existing global economic and financial market environment has caused, among other things, a general tightening in the credit markets, lower levels of liquidity, increases in the rates of default and bankruptcy, lower consumer and business spending, and lower consumer net worth, all of which has had and may continue to have a negative effect on our business, results of operations, financial condition and liquidity. Many of our customers, distributors and suppliers have been severely affected by the current economic turmoil. Current or potential customers and suppliers may no longer be in business, may be unable to fund purchases or determine to reduce purchases, all of which has and could continue to lead to reduced demand for our products, reduced gross margins, and increased customer payment delays or defaults. Further, suppliers may not be able to supply us with needed raw materials on a timely basis, may increase prices or go out of business, which could result in our inability to meet consumer demand or affect our gross margins. We are also limited in our ability to reduce costs to offset the results of a prolonged or severe economic downturn given certain fixed costs associated with our operations, difficulties if we overstrained our resources, and our long-term business approach that necessitates we remain in position to respond when market conditions improve.

The timing and nature of any recovery in the credit and financial markets remains uncertain, and there can be no assurance that market conditions will significantly improve in the near future or that our results will not continue to be materially and adversely affected. Such conditions make it very difficult to forecast operating results, make business decisions and identify and address material business risks. The foregoing conditions may also impact the valuation of certain long-lived or intangible assets that are subject to impairment testing, potentially resulting in impairment charges which may be material to our financial condition or results of operations. See “—Financial Risks” below for a discussion of additional risks to our liquidity resulting from the current economic and financial market environment.

The loss of a key supplier could lead to increased costs and lower profit margins.

The majority of the resins purchased by the Company are purchased under supply contracts which are typically renewed annually. In 2009 the Company purchased approximately 36%, 24% and 19% of its resin requirements from its three largest suppliers. Each of these suppliers produce resins in multiple locations, and should any one, or a combination of these locations fail to meet the Company’s needs, the Company believes sufficient capacity exists among its remaining contract holders, the open market and the secondary markets to supply any shortfall that may result. Nevertheless, it is not always possible to replace a specialty resin without a disruption in our operations and replacement of significant supply is often at higher prices.

The Company negotiates and awards its supply contracts annually. The resin contracts generally serve to establish the basic terms and conditions between the parties, but do not bind us in a materially significant way. Should any of our existing relationships fail to bid or survive the bid process, the position previously enjoyed by that contract holder typically migrates to another supplier. While this process has served the Company well in the past, there is no guarantee that the future replacement of any supplier will always result in a more effective and efficient relationship in the future.

We have limited contractual relationships with our customers and, as a result, our customers may unilaterally reduce the purchase of our products.

A substantial portion of our business is in the merchant market, in which we do not have long-term contractual relationships with our customers. As a result, our customers may unilaterally reduce the purchase of our products or, in certain cases, terminate existing orders for which we may have incurred significant production costs. The loss of several customers could, in the aggregate, materially adversely affect our operations and financial condition.

 

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Many of our larger packaging customers are multinational companies that purchase large quantities of packaging materials. Many of these companies are purchasers with centralized procurement departments. They generally enter into supply arrangements through a tender process that solicits bids from several potential suppliers and selects the winning bid based on several attributes, including price and service. The significant negotiating leverage possessed by many of our customers and potential customers limits our ability to negotiate supply arrangements with favorable terms and creates pricing pressure, reducing margins industry wide. In addition, our customers may vary their order levels significantly from period to period, and customers may not continue to place orders with us in the future at the same levels as in prior periods. In the event we lose any of our larger customers, we may not be able to quickly replace that revenue source, which could harm our financial results.

Loss of third-party transportation providers upon whom we depend or increases in fuel prices could increase our costs or cause a disruption in our operations.

We depend upon third-party transportation providers for delivery of our products to our customers. Strikes, slowdowns, transportation disruptions or other conditions in the transportation industry, including, but not limited to, shortages of truck drivers, disruptions in rail service, decreases in ship building or increases in fuel prices, could increase our costs and disrupt our operations and our ability to service our customers on a timely basis.

We may, from time to time, experience problems in our labor relations.

Unions represent 298 employees, or 15% of our workforce, at October 31, 2009, under three collective bargaining agreements which expire in January 2010, February 2010 and March 2011, respectively. Although we believe that our present labor relations with our employees are satisfactory, our failure to renew these agreements on reasonable terms could result in labor disruptions and increased labor costs, which could adversely affect our financial performance.

We cannot assure you that our relations with the unionized portion of our workforce will remain positive or that such employees will not initiate a strike, work stoppage or slowdown in the future. In the event of such an action, our business, prospects, results of operations and financial condition could be adversely affected and we cannot assure you that we would be able to adequately meet the needs of our customers using our remaining workforce. In addition, we cannot assure you that we will not have similar actions with our non-unionized workforce or that our non-unionized workforce will not become unionized in the future.

We are dependent on the management experience of our key personnel and our ability to attract and retain additional personnel.

Our future success depends to a large extent on the experience and continued services of our key managerial employees, including J. Brendan Barba, our Chairman, President and Chief Executive Officer, and Paul M. Feeney, our Executive Vice President, Finance, and Chief Financial Officer. We do not maintain key-person insurance for any of our officers. We may not be able to retain our executive officers and key personnel or attract additional qualified key employees in the future. Competition for qualified employees is intense, and the loss of such persons, or an inability to attract, retain and motivate additional highly skilled employees, could have a material adverse effect on our results of operations and financial condition and prospects. There can be no assurance that we will be able to retain our existing personnel or attract and retain additional qualified employees.

Our executive officers beneficially own a substantial amount of our common stock and have significant influence over our business.

At October 31, 2009, our executive officers beneficially owned 1,363,229 shares of our common stock and have the right to acquire an additional 148,439 shares of our common stock. Their ownership and voting control

 

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over approximately 20% of our common stock gives them significant influence on the outcome of corporate transactions or other matters submitted to the Board of Directors or shareholders for approval, including acquisitions, mergers, consolidations and the sale of all or substantially all of our assets.

Our business is subject to risks associated with manufacturing processes.

We internally manufacture our own products at our production facilities. While we maintain insurance covering our manufacturing and production facilities, including business interruption insurance, a catastrophic loss of the use of all or a portion of our facilities due to accident, fire, explosion, labor issues, weather conditions, other natural disaster or otherwise, whether short or long-term, could have a material adverse effect on us.

Unexpected failures of our equipment and machinery may result in production delays, revenue loss and significant repair costs, injuries to our employees, and customer claims. Any interruption in production capability may require us to make large capital expenditures to remedy the situation, which could have a negative impact on our profitability and cash flows. Our business interruption insurance may not be sufficient to offset the lost revenues or increased costs that we may experience during a disruption of our operations.

Failure to successfully implement a new core operating system may adversely affect our business operations.

We are currently and will continue to be highly dependent on automated systems to record and process Company and customer transactions and certain other components of the Company’s financial statements. As of November 1, 2009, we began implementing phase one of a new integrated operating system so that we can improve our ability to address the needs of our customers, as well as to create additional efficiencies and strengthen internal controls over our financial reporting. We may not be able to successfully implement the new system in an effective or timely manner or could fail to complete all necessary data reconciliation or other conversion controls when implementing the new system. In addition, we may incur significant increases in costs and encounter extensive delays in the implementation and rollout of our new operating system. Failure to effectively implement our new operating system may adversely affect our operations as well as customer perceptions and our internal controls over financial reporting.

Financial Risks

Capital markets have experienced a significant period of dislocation and instability, which has had and could continue to have a negative impact on the availability and cost of capital.

The general disruption in the U.S. capital markets has impacted the broader financial and credit markets and reduced the availability of debt and equity capital for the market as a whole. These conditions could persist for a prolonged period of time or worsen in the future. Our ability to access the capital markets may be restricted at a time when we would like, or need, to access those markets, which could have an impact on our flexibility to react to changing economic and business conditions. The resulting lack of available credit, increased volatility in the financial markets and reduced business activity could materially and adversely affect our business, financial condition, results of operations and our ability to obtain and manage our liquidity. In addition, the cost of debt financing, and other important financing terms, may be materially adversely impacted by these market conditions.

Credit market developments may reduce availability under our credit agreement.

Due to the volatile state of the credit markets during the past few years, there is risk that lenders, even those with strong balance sheets and sound lending practices, could fail or refuse to honor their legal commitments and obligations under existing credit commitments, including but not limited to: extending credit up to the maximum permitted by a credit facility, allowing access to additional credit features and otherwise accessing capital and/or honoring loan commitments. If our lender(s) fail to honor their legal commitments under our credit facility, it

 

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could be difficult in the current environment to replace our credit facility on similar terms. Although we believe that our operating cash flow, access to capital markets and existing credit facilities will give us the ability to satisfy our liquidity needs for at least the next 12 months, the failure of any of the lenders under our credit facility may impact our ability to finance our operating or investing activities.

To service our debt or redeem such debt upon a change of control, we will require a significant amount of cash. Our ability to generate cash depends on many factors beyond our control.

Our ability to service our debt and to fund our operations and planned capital expenditures will depend on our operating performance. This, in part, is subject to prevailing economic conditions and to financial, business and other factors beyond our control. If our cash flow from operations is insufficient to fund our debt service obligations, we may be forced to reduce or delay capital expenditures, sell assets, obtain additional equity capital or indebtedness or refinance or restructure our debt. These alternative measures may not be successful and may not permit us to meet our scheduled debt service obligations. In the absence of such operating results and resources, we could face substantial cash flow problems and might be required to sell material assets or operations to meet our debt service and other obligations. We cannot assure you as to the timing of such sales or the proceeds that we could realize from such sales or if additional debt or equity financing would be available on acceptable terms, if at all. As of October 31, 2009, we could have borrowed up to an additional $113.3 million under our U.S. credit facility and an additional $4.6 million in our Canadian credit facility.

A provision of our senior notes requires us, upon a change of control, to offer to purchase the outstanding senior notes. If a change of control were to occur and we could not obtain a waiver or if we do not have the funds to make the purchase, we would be in default under the senior notes, which could, in turn, cause any of our debt to which a cross-acceleration or cross-default provision applies to become immediately due and payable. If our debt were to be accelerated, we cannot assure you that we would be able to repay it.

We are subject to a number of restrictive debt covenants which may restrict our business and financing activities.

Our credit facility, the indenture relating to our senior notes and the agreements relating to the indebtedness of our subsidiaries contain restrictive debt covenants that, among other things, restrict our ability to:

 

   

borrow money;

 

   

pay dividends and make distributions;

 

   

issue stock of subsidiaries;

 

   

make certain investments;

 

   

repurchase stock;

 

   

use assets as security in other transactions;

 

   

create liens;

 

   

enter into affiliate transactions;

 

   

merge or consolidate; and

 

   

transfer and sell assets.

In addition, our credit facility and the agreements relating to the indebtedness of our subsidiaries also require us to maintain certain financial tests. These restrictive covenants may limit our ability to expand or to pursue our business strategies. Furthermore, any indebtedness that we incur in the future may contain similar or more restrictive covenants.

 

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Our ability to comply with the restrictions contained in our credit facility, our senior notes and the agreements relating to the indebtedness of our subsidiaries may be affected by changes in our business condition or results of operations, adverse regulatory developments or other events beyond our control. A failure to comply with these restrictions could result in a default under our credit facility, our senior notes and the agreements relating to the indebtedness of our subsidiaries, or any other subsequent financing agreement, which could, in turn, cause any of our debt to which a cross-acceleration or cross-default provision applies to become immediately due and payable. If our debt were to be accelerated, we cannot assure you that we would be able to repay it. In addition, a default could give our lenders the right to terminate any commitments that they had made to provide us with additional funds.

Risks Related to an Investment in Our Common Stock

Our common stock price may be volatile.

The market price of our common stock has fluctuated regularly in the past. The market price of our common stock will continue to be subject to significant fluctuations in response to a variety of factors, including:

 

   

fluctuations in operating results, including as a result of changes in resin prices, LIFO reserve, and the other variables;

 

   

our liquidity needs and constraints;

 

   

the business environment, including the operating results and stock prices of companies in the industries we serve;

 

   

changes in general conditions in the U.S. and global economies or financial markets, including those resulting from war, incidents of terrorism and natural disasters or responses to such events;

 

   

announcements concerning our business or that of our competitors or customers;

 

   

acquisitions and divestitures;

 

   

the introduction of new products or changes in product pricing policies by us or our competitors;

 

   

change in earnings estimates or recommendations by research analysts who track our common stock or the stocks of other companies in our industry or failure of analysts to cover our common stock;

 

   

changes in accounting standards, policies, guidance, interpretations or principles;

 

   

sales of common stock by our employees, directors and executive officers;

 

   

prevailing interest rates; and

 

   

perceived dilution from stock issuances.

Some companies that have had volatile market prices for their securities have been subject to securities class action suits filed against them. If a suit were to be filed against us, regardless of the outcome, it could result in substantial costs and a diversion of our management’s attention and resources. This could have a material adverse effect on our business, results of operation and financial condition.

Shares of common stock eligible for future sale, and additional equity offerings by us, may adversely affect our common stock price.

The market price of our common stock could decline as a result of sales of substantial amounts of additional shares of our common stock in the public market or in connection with future acquisitions, or the perception that such sales could occur. This could also impair our ability to raise additional capital through the sale of equity securities at a time and price favorable to us. As of October 31, 2009 under our certificate of incorporation, as amended, we are authorized to issue 30 million shares of common stock, of which approximately 6.9 million shares of common stock were outstanding and approximately 0.3 million shares of common stock were issuable

 

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related to the exercise of currently outstanding stock options and 0.2 million shares of common stock were issuable related to settlement of performance units if the performance unit holders elected settlement in stock.

We may also decide to raise additional funds through public or private equity financing to fund our operations or for other business purposes. New issuances of equity securities would reduce your percentage ownership in us and the new equity securities could have rights and preferences with priority over those of our common stock.

Our stock repurchase program could increase the volatility of the price of our common stock.

On June 6, 2008, our board of directors approved an $8.0 million stock repurchase program. Repurchases may 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 our debt covenants. The existence of our stock repurchase program and any purchases under this program could result in an increase in the market price of our stock. In addition, purchases under this repurchase program could reduce the liquidity for our stock. Further, the program does not obligate us to acquire any particular amount of common stock and the program may be suspended at any time at our discretion, and any discontinuation could cause the market price of our stock to decline.

In fiscal 2009 there were no repurchases made under the new $8.0 million stock repurchase program.

Delaware law and our charter documents may impede or discourage a takeover, which could cause the market price of our shares to decline.

We are a Delaware corporation and the anti-takeover provisions of Delaware law imposes various impediments to the ability of a third party to acquire control of us, even if a change of control would be beneficial to our existing shareholders. For example, Section 203 of the Delaware General Corporation Law may discourage, delay or prevent a change in control by prohibiting us from engaging in a business combination with an interested shareholder for a period of three years after the person becomes an interested shareholder.

In addition, our restated certificate of incorporation and second amended and restated by-laws contain provisions that may discourage, delay or prevent a third party from acquiring us, even if doing so would be beneficial to our shareholders. These provisions include:

 

   

requiring supermajority approval of shareholders for certain business combinations or an amendment to, or repeal of, the by-laws;

 

   

prohibiting shareholders from acting by written consent without board approval;

 

   

prohibiting shareholders from calling special meetings of shareholders;

 

   

establishing a classified board of directors, which allows approximately one-third of our directors to be elected each year;

 

   

limitations on the removal of directors;

 

   

advance notice requirements for nominating candidates for election to our board of directors or for proposing matters that can be acted upon by shareholders at shareholder meetings;

 

   

permitting the board of directors to amend or repeal the by-laws; and

 

   

permitting the board of directors to designate one or more series of preferred stock.

Our issuance of preferred stock could adversely affect holders of our common stock.

We are currently authorized to issue one million shares of preferred stock in accordance with our restated certificate of incorporation, none of which is issued and outstanding. Our board of directors has the power, without shareholder approval, to set the terms of any such series of preferred stock that may be issued, including

 

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voting rights, dividend rights, and preferences over our common stock with respect to dividends or if we liquidate, dissolve or wind up our business and other terms. If we issue preferred stock in the future that has preference over our common stock with respect to the payment of dividends or upon our liquidation, dissolution or winding up, or if we issue preferred stock with voting rights that dilute the voting power of our common stock, the rights of holders of our common stock or the market price of our common stock could be adversely affected.

 

ITEM 1B. UNRESOLVED STAFF COMMENTS

Not applicable.

 

ITEM 2. PROPERTIES

Our principal executive and administrative offices are located in a leased building in South Hackensack, New Jersey.

The following table describes the manufacturing facilities we own or lease as of October 31, 2009. Substantially all of the owned properties are pledged as collateral under our various credit facilities and the Wright Township, Pennsylvania facility is pledged under the Pennsylvania Industrial Loans. The following chart sets forth the square footage of our manufacturing facilities, including warehousing space:

 

Location

   Approximate
Square Footage
   Types of Film
Produced

North America

     

Griffin, Georgia

   322,000    PVC food wrap, UPVC

Wright Township, Pennsylvania

   430,000    Custom, PROformance and
stretch

Matthews, North Carolina

   394,000    Custom and stretch

Alsip, Illinois

   182,000    Custom

West Hill, Ontario, Canada

   138,000    PVC food wrap

Chino, California

   259,000    Custom and stretch

Waxahachie, Texas

   216,000    Custom

Tulsa, Oklahoma *

   126,000    Stretch

Nicholasville, Kentucky *

   125,000    Stretch

Mankato, Minnesota *

   104,000    Custom, PROformance

Mankato, Minnesota *

   65,000    Institutional products

Bowling Green, Kentucky (under lease ending October 31, 2010)

  

165,000

  

Printed and converted, custom,
PROformance

       

Total

   2,526,000   
       

 

* These properties were acquired from Atlantis on October 30, 2008.

In addition, we have manufacturing facilities located in each of Fontana, California and Cartersville, Georgia that were acquired from Atlantis on October 30, 2008. Production in the Fontana location ceased in November 2008 and is under a lease ending December 15, 2010. Production in Cartersville ceased on October 31, 2009 and is under a lease ending July 31, 2015.

We believe that all of our properties are well maintained and in good condition, and that the current operating facilities are adequate for present and immediate future business needs.

As of October 31, 2009, our manufacturing facilities had a combined average annual production capacity exceeding one billion pounds. The acquisition of the Atlantis facilities, exclusive of Fontana and Cartersville, added approximately 200 million pounds of capacity.

 

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ITEM 3. LEGAL PROCEEDINGS

We are, from time to time, party to litigation arising in the normal course of our business. We believe that there are currently no legal proceedings the outcome of which would have a material adverse effect on our financial position or our results of operations.

 

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

Not applicable.

PART II

 

ITEM 5. MARKET FOR REGISTRANT’S COMMON EQUITY, RELATED STOCKHOLDER MATTERS AND ISSUER PURCHASES OF EQUITY SECURITIES

Market Information

Our common stock is quoted on the Nasdaq Global Select Market under the symbol “AEPI.” The high and low closing prices for our common stock, as reported by the Nasdaq Global Select Market for the two fiscal years ended October 31, 2008 and 2009, respectively, are as follows:

 

     Price Range

Fiscal Year and Period

   High    Low

2008

     

First quarter (November-January)

   $ 38.40    $ 28.72

Second quarter (February-April)

     32.54      26.10

Third quarter (May-July)

     28.57      16.71

Fourth quarter (August-October)

     21.75      12.42

2009

     

First quarter (November-January)

   $ 20.73    $ 13.16

Second quarter (February-April)

     20.33      11.08

Third quarter (May-July)

     31.91      20.81

Fourth quarter (August-October)

     41.32      31.50

On January 11, 2010, the closing price for a share of our common stock, as reported by the Nasdaq Global Select Market, was $39.98.

Holders

On January 11, 2010, our common stock was held by approximately 1,500 stockholders of record. A substantially greater number of holders are beneficial owners whose shares are held of record by banks, brokers and other financial institutions.

Dividends

No dividends have been paid to stockholders since December 1995. The payment of future dividends is within the discretion of the board of directors and will depend upon business conditions, our earnings and financial condition and other relevant factors. The payments of future dividends, however, are restricted and subject to a number of covenants under our Loan and Security Agreement and under the Indenture pursuant to which our 7.875% Senior Notes were issued. The Company does not anticipate paying dividends in the foreseeable future.

 

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Purchases of Equity Securities by the Issuer

The table below sets forth the total number of shares of our common stock that we repurchased in each month of the quarter ended October 31, 2009.

 

2009 period

   Total number of
shares purchased (a)
   Average price paid
per share
   Total number of
shares purchased
as part of publicly
announced plans
or programs
   Approximate
dollar value of
shares that may
yet be purchased
under the plans or
programs (b)

August 1-August 31

   —      $ —      —      $ 8,000,000

September 1-September 30

   1,523    $ 38.03    —        8,000,000

October 1-October 31

   1,207    $ 39,60    —        8,000,000
                       

Total

   2,730    $ 38.72    —      $ 8,000,000

 

(a) Represents shares of common stock of the Company tendered to the Company by the holders of stock options for the payment of option exercise prices. During the quarter ended October 31, 2009, the Company did not purchase any shares of its common stock pursuant to its publicly announced share repurchase program.
(b) On June 6, 2008, our Board approved an $8.0 million stock repurchase program, subject to covenant restrictions. Repurchases may 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 our debt covenants. The program does not obligate us to acquire any particular amount of common stock and the program may be suspended at any time at our discretion.

 

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Performance Graph

The following graph compares, for the five-year period ended on October 31, 2009, the cumulative total stockholder return on our common stock against the cumulative total return of:

 

   

the S&P 500 Index and

 

   

a peer group consisting of twelve publicly traded plastic manufacturing companies that we have selected. The companies in the peer group are as follows: Aptar Group, Astronics Corporation, Ball Corporation, Bemis Company, Inc., Crown Holdings, Inc., Intertape Polymer Group Inc., Pactiv Corporation, Silgan Holdings Inc., Sonoco Products Company, Spartech Corporation, Dean Foods Company and West Pharmaceutical Services, Inc.

The graph assumes $100 was invested on October 31, 2004 in our common stock, the S&P 500 Index and the peer group consisting of twelve companies, and the reinvestment of all dividends.

LOGO

 

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ITEM 6. SELECTED FINANCIAL DATA

The following table presents our selected financial data. The table should be read in conjunction with Item 7, “Management’s Discussion and Analysis of Financial Condition and Results of Operations, and Item 8, Financial Statements and Supplementary Data”, of this Annual Report on Form 10-K.

 

     For the Year Ended October 31,  
     2009     2008     2007     2006     2005  
     (in thousands, except per share data)  

Consolidated Statement of Operations Data:

          

Net sales

   $ 744,819      $ 762,231      $ 666,318      $ 697,233      $ 633,273   

Gross profit

     160,436        96,822        139,152        151,236        123,878   

Operating income

     60,387        9,593        52,866        66,964        43,324   

Interest expense

     (15,749     (15,731     (15,551     (15,437     (27,492

Other income (expense), net

     4,785        916        779        (7,703     813   

Income (loss) from continuing operations before (provision) benefit for income taxes

     49,423        (5,222     38,094        43,824        16,645   

(Provision) benefit for income taxes (1)

     (18,994     8,534        (15,217     (8,432     (15,269

Income from continuing operations

     30,429        3,312        22,877        35,392        1,376   

Income (loss) from discontinued operations

     1,099        8,932        7,175        27,537        (51,998

Net income (loss)

   $ 31,528      $ 12,244      $ 30,052      $ 62,929      $ (50,622

Basic Earnings (Loss) per Common Share:

          

Income from continuing operations

   $ 4.48      $ 0.49      $ 3.05      $ 4.20      $ 0.16   
                                        

Income (loss) from discontinued operations

   $ 0.16      $ 1.32      $ 0.96      $ 3.27      $ (6.12
                                        

Net income (loss) per common share

   $ 4.65      $ 1.80      $ 4.00      $ 7.46      $ (5.95
                                        

Diluted Earnings (Loss) per Common Share:

          

Income from continuing operations

   $ 4.45      $ 0.48      $ 2.99      $ 4.14      $ 0.16   
                                        

Income (loss) from discontinued operations

   $ 0.16      $ 1.31      $ 0.94      $ 3.22      $ (6.03
                                        

Net income (loss) per common share

   $ 4.61      $ 1.79      $ 3.93      $ 7.35      $ (5.87
                                        

Cash dividends declared and paid

     —          —          —          —          —     
     2009     2008     2007     2006     2005  

Consolidated Balance Sheet Data (at period end):

          

Total assets

   $ 360,070      $ 390,840      $ 328,792      $ 336,080      $ 311,323   

Total debt (including current portion)

     170,000        249,155        184,077        182,802        180,575   

Shareholders’ equity

     75,800        40,140        42,370        57,593        6,195   

 

(1) Benefit for income taxes from continuing operations for the year ended October 31, 2008 includes $7.0 million in benefits arising from previously unrecognized tax benefits resulting from the completion in September 2008 of an IRS examination for fiscal 2005 and 2006.

 

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ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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 and

 

   

New Accounting Pronouncements

Investors should review this MD&A in conjunction with the consolidated financial statements and related notes included in Item 8, “Financial Statements and Supplementary Data”, of this Annual Report on Form 10-K.

Overview

AEP Industries Inc. is a leading manufacturer of plastic packaging films. We manufacture and market an extensive and diverse line of polyethylene, polyvinyl chloride and polypropylene 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.

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, polypropylene 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. In recent years, the market for these resins has been extremely volatile, with record price increases followed by significant decreases and vice versa. 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.

As discussed further in Item 1, “Business” of this Annual Report on Form 10-K, we acquired substantially all of the assets of the stretch films, custom films and institutional products division of Atlantis Plastics, Inc. (“Atlantis”) for a purchase price of $98.8 million after expenses and the net working capital true up. Atlantis

 

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maintained a significant presence in many of its product categories, which are used in a variety of applications, including storage, transportation, food packaging and other commercial and consumer applications. Atlantis also converted some institutional products internally from custom films. This transaction enhanced our position as the preferred supplier of flexible packaging solutions.

Market Conditions

Fiscal 2009 was a challenging year. In addition to the difficult economic conditions in the United States with global and financial markets experiencing substantial disruption, the plastic packaging industry was extremely competitive due to consolidation and pricing pressures. Despite these difficult market conditions, we were successful in mitigating the economic impact on many of our businesses. Results benefited from lower resin prices (average resin prices decreased by 35%, or $0.27 per pound, during fiscal 2009 in comparison to fiscal 2008), higher volumes driven primarily from the Atlantis acquisition, synergies resulting from the Atlantis acquisition and cost reduction strategies.

Following a decline in average resin costs in the first quarter of 2009, resin costs steadily increased during the next nine months and thereby negatively impacting our gross profit. We believe that resin prices will more than likely continue to rise during fiscal 2010 with volatility continuing to be driven by increasing worldwide demand combined with domestic reductions in production capacity. We believe that the marketplace in which we sell our products will remain very competitive, and is further complicated by adverse economic circumstances affecting many of our customers, distributors and suppliers. There can be no assurance that we will be able to pass on resin price increases on a penny-for-penny basis in the future, if such costs were to increase.

Forecasts for fiscal 2010 generally call for a weak economy in the United States, with the continuation of the economic recession. It is difficult to predict the duration and depth of the economic slowdown and the impact on our business, but we expect that the weak economy will have a negative impact on our volumes and will put a strain on our resources and those of our customer and suppliers. We have implemented cost-reduction initiatives, including accelerating the consolidation of staffing, facilities and products related to the Atlantis acquisition that are designed to increase efficiency and preserve financial resources in order to meet the challenges of this volatile economic environment, as well as take advantage of opportunities in the marketplace. We are limited, however, in our ability to reduce costs to offset the results of a prolonged or severe downturn given the fixed cost nature of our business combined with our long term business strategy which demands that we remain in a position to respond when market conditions improve. We believe we are taking appropriate steps to minimize the impact of these conditions, primarily through staff reductions, shut downs of idle equipment and plant closures.

Company Developments in Fiscal 2009

 

   

On October 30, 2008, we completed the acquisition of substantially all of the assets of the stretch films, custom films and institutional products divisions of Atlantis. During fiscal 2009, we completed the consolidation of the Atlantis manufacturing facilities. At the time of the acquisition, we acquired six manufacturing facilities: three stretch plants, including one located in Fontana, California which we commenced shutting down in November 2008 (production was consolidated into our Chino, California plant); two custom films plants, including one located in Cartersville, Georgia which was closed on October 31, 2009; and one institutional products facility.

 

   

On April 1, 2009, we repurchased and retired $14.8 million (principal amount) of our 2013 Notes at a price of 62.8% of par. We recognized a gain on extinguishment of debt of $5.3 million.

 

   

We incurred approximately $23.8 million of capital expenditures during fiscal 2009 related primarily to an expansion of our North Carolina plant, a new Co-Ex line in our Pennsylvania plant (production began in September 2009) and energy cost reduction equipment in our Pennsylvania plant, the purchase of the land and building in our Minnesota plant, and a new computer operating system throughout the Company.

 

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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 costs 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.

Unless otherwise noted, the following discussion regarding results of operations relates only to results from continuing operations.

Results of Operations

AEP and Atlantis were significant competitors in the plastic films industry for many years, competing to sell similar products to a similar customer base. One of the primary factors in AEP’s determination to pursue and consummate the Atlantis acquisition was the potential realization of synergistic benefits derived from SKU consolidation, logistical savings, resin cost savings and manufacturing and operating cost efficiencies. Immediately upon the completion of the acquisition, AEP began the process of reducing and combining SKU’s, reformulating common products to their most effective common denominator and changing the manufacturing location of certain products to maximize operating and logistical efficiencies. We have devoted significant time and effort throughout fiscal 2009 to achieve these synergistic benefits. However, as a result of the foregoing, no meaningful operational or financial information exists subsequent to the acquisition that segregates the impact of Atlantis from AEP as a whole. Therefore, although the Atlantis acquisition materially impacted AEP’s net sales and results of operations for fiscal 2009, the following Management’s Discussion and Analysis of Financial Condition and Results of Operations does not include any separate information regarding Atlantis.

 

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Table of Contents

Fiscal 2009 Compared to Fiscal 2008

The following table presents selected financial data for fiscal 2009 and 2008 (dollars per lb. sold is calculated by dividing the applicable consolidated statement of operations category by pounds sold in the period):

 

     For the Year Ended October 31,    % increase
/(decrease)
of $
    $
increase/
(decrease)
 
     2009    2008     
     $    $ Per lb.
sold
   $    $ Per lb.
sold
    
     (in thousands, except for per pound data)  

Net sales

   $ 744,819    $ 0.97    $ 762,231    $ 1.16    (2.3 )%    $ (17,412

Gross profit

     160,436      0.21      96,822      0.15    65.7     63,614   

Operating expenses:

                

Delivery

     37,690      0.05      36,425      0.05    3.5     1,265   

Selling

     38,675      0.05      31,866      0.05    21.4     6,809   

General and administrative

     23,691      0.03      18,596      0.03    27.4     5,095   
                                      

Total operating expenses

   $ 100,056    $ 0.13    $ 86,887    $ 0.13    15.2   $ 13,169   
                                      

Pounds sold

        764,795 lbs.         659,887 lbs.     

Net Sales

Net sales for fiscal 2009 decreased $17.4 million, or 2.3%, to $744.8 million from $762.2 million for fiscal 2008. The decrease was the result of a 14.8% decrease in average selling prices coinciding with decreases in resin costs from the prior year, negatively affecting net sales by $112.5 million, partially offset by a 15.9% increase in sales volume driven primarily by the Atlantis acquisition and positively affecting net sales by $103.3 million. Consolidated sales volume for fiscal 2009 was below management’s expectations due to the adverse effects of the economic recession, primarily in our construction and housing related products (affecting our custom film sales). Fiscal 2009 also included an $8.2 million negative impact of foreign exchange relating to our Canadian operations.

Gross Profit

Gross profit for fiscal 2009 increased $63.6 million to $160.4 million from $96.8 million for fiscal 2008. The improvement in gross profit is primarily due to increased volume and lower resin costs combined with cost saving programs including the shut down and consolidation of the Fontana, California plant into our Chino, California plant and internal efficiency initiatives designed to align production with demand at our manufacturing facilities. The gross profit for fiscal 2009 included a decrease in the LIFO reserve of $20.1 million which positively impacted gross profit for fiscal 2009. Fiscal 2009 also included $1.4 million of negative impact of foreign exchange relating to our Canadian operations. Gross profit in fiscal 2008 was negatively impacted by significant increases in resin costs and a $13.5 million increase in the LIFO reserve.

Operating Expenses

Operating expenses for fiscal 2009 increased $13.2 million, or 15.2%, to $100.1 million from the prior fiscal year, but remained flat on a per-pound-sold basis. The increase in operating expenses is primarily due to higher delivery and selling expenses resulting from greater volumes sold in the current fiscal year, higher salaries and employee-related costs as a result of an approximately 20% increase in the Company’s headcount due to the Atlantis acquisition, combined with increased general and administrative expenses due to higher share-based compensation costs recorded in fiscal 2009 associated with stock options and performance units and increased accruals related to employee cash performance incentives. General and administrative expenses in the current

 

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fiscal year also include costs related to transitional services associated with the Atlantis acquisition. General and administrative expenses in the prior fiscal year included approximately $1.6 million, excluding professional fees, related to the settlement of a commercial dispute and approximately $0.4 million of advisory costs incurred as a result of our exploration of strategic alternatives related to our subsidiary in the Netherlands which was completed in April 2008. Fiscal 2009 includes $1.0 million favorable effect of foreign exchange decreasing reported total operating expenses.

Other Operating Income (Expense)

Other operating income for fiscal 2009 was $7,000 and represented net gains on sales of fixed assets as compared to $0.3 million in expense during fiscal 2008 which represented net losses on sales of fixed assets.

Interest Expense

Interest expense for fiscal 2009 remained flat at $15.7 million as compared to the prior fiscal year, resulting primarily from lower interest rates on Credit Facility borrowings and lower interest expense on our 2013 Notes as a result of the extinguishment of $14.8 million of the 2013 Notes on April 1, 2009, offset by higher average borrowings on our Credit Facility during fiscal 2009 as compared to the prior fiscal year, higher amortization of fees associated with the Amended Credit Facility, and interest expense incurred on the new capital leases originating on March 27, 2009.

Gain on Extinguishment of Debt

On April 1, 2009, we repurchased and retired $14.8 million (principal amount) of the Company’s 2013 Notes at a price of 62.8% of par. The cash paid was $9.4 million, which included $0.1 million of accrued interest. In connection with the partial retirement, we recognized a $5.3 million gain on extinguishment of debt, which is the difference between the repurchase amount of $9.3 million and the principal amount retired of $14.8 million, net of the pro-rata write-off of the unamortized debt financing costs related to the 2013 Notes of $0.2 million.

Other, net

Other, net for fiscal 2009 amounted to $0.5 million in expense, as compared to $0.9 million in income for fiscal 2008. The expense in fiscal 2009 is primarily attributable to higher foreign currency losses in the current period as compared to gains in the prior period resulting from changes in foreign exchange rates and an increase in unrealized losses on foreign currency denominated payables and receivables resulting primarily from the deterioration during the current year of the U.S. dollar to the Canadian dollar.

Income Tax (Provision) Benefit

The provision for income taxes for fiscal 2009 was $19.0 million on income from continuing operations before the provision for income taxes of $49.4 million. The difference between our effective tax rate of 38.4% and the U.S. statutory tax rate of 35.0% primarily relates to the provision for state taxes in the United States, net of federal benefit (+3.3%).

The benefit for income taxes for fiscal 2008 was $8.5 million on loss from continuing operations before the benefit for income taxes of $5.2 million. Included in this amount is a $7.0 million tax benefit arising from previously unrecognized tax benefits resulting from the completion in September 2008 of an IRS examination for fiscal years 2005 and 2006. The difference between the effective tax rate of 28.5%, excluding the $7.0 million benefit, and the U.S. statutory tax rate of 34.0% primarily relates to the following: (i) $0.2 million for state taxes in the United States, net of federal benefit (+4.1%); and (ii) $0.2 million true-up of prior year’s estimates in the United States (-4.7%).

 

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Discontinued Operations—Fiscal 2009 Compared to Fiscal 2008

In April 2008, we completed the sale of our Netherlands operation. Our Netherlands operation was a component of our consolidated entity, and as such requires discontinued operations reporting treatment. The financial statements at and for fiscal 2009 and 2008 also include as discontinued operations our Spanish operation which is in liquidation. In addition, fiscal 2008 also includes our UK operations.

A consolidated summary of the operating results of discontinued operations for fiscal 2009 and 2008 is as follows:

 

     For the Year
Ended October 31,
 
     2009    2008  
     (in thousands)  

Net sales

   $ —      $ 56,238   

Gross profit

     —        5,436   

Income from discontinued operations

     85      898   

Gain from disposition

     —        10,708   

Income tax benefit (provision)

     1,014      (2,674

Income from discontinued operations

   $ 1,099    $ 8,932   

Income from discontinued operations for fiscal 2009 represent income in our Spanish subsidiary resulting from the refund of value added taxes which had been fully reserved against. The income tax benefit of the discontinued operations for fiscal 2009 includes a $1.0 million income tax benefit related to a $2.6 million intercompany bad debt write-off associated with our Spanish subsidiary. The bad debt write-off will be taken as a deduction on our U.S. federal income tax return. The results of the discontinued operations for fiscal 2008 include the activity of our Netherlands operation up until its disposition on April 4, 2008, the gain on disposition of our Netherlands operation, and $0.3 million of income in our Spanish subsidiary resulting from the return of a deposit held for a tax assessment under appeal.

Included in the gain from disposition from discontinued operations for fiscal 2008 is $6.9 million of realized foreign currency exchange gains before provision for taxes ($4.1 million after tax) resulting from the settlement of all intercompany loans, denominated in Euros ($5.1 million of which had been previously recognized in accumulated other comprehensive income at October 31, 2007), $1.5 million gain on sale of AEP Netherlands, after all costs to sell, and the reclassification of AEP Netherlands accumulated foreign currency translation gains into income in the amount of $2.3 million.

 

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Table of Contents

Fiscal 2008 Compared to Fiscal 2007

The following table presents selected financial data for fiscal 2008 and 2007 (dollars per lb. sold is calculated by dividing the applicable consolidated statement of operations category by pounds sold in the period):

 

     For the Year Ended October 31,    % increase
/(decrease)
of $
    $
increase/
(decrease)
 
     2008    2007     
     $    $ Per lb.
sold
   $    $ Per lb.
sold
    
     (in thousands, except for per pound data)  

Net sales

   $ 762,231    $ 1.16    $ 666,318    $ 1.01    14.4   $ 95,913   

Gross profit

     96,822      0.15      139,152      0.21    (30.4 )%      (42,330

Operating expenses:

                

Delivery

     36,425      0.05      34,629      0.05    5.2     1,796   

Selling

     31,866      0.05      31,849      0.05    0.1     17   

General and administrative

     18,596      0.03      19,762      0.03    (5.9 )%      (1,166
                                      

Total operating expenses

   $ 86,887    $ 0.13    $ 86,240    $ 0.13    0.8   $ 647   
                                      

Pounds sold

        659,887 lbs.         660,988 lbs.     

Net Sales

Net sales for fiscal 2008 increased $95.9 million, or 14.4%, to $762.2 million from $666.3 million for fiscal 2007. The increase was the result of a 13.9% increase in average selling prices, driven primarily by higher resin costs, positively affecting net sales by $92.7 million, partially offset by a 0.2% decrease in sales volume which negatively affected net sales by $1.2 million. Fiscal 2008 also included $4.4 million of positive impact of foreign exchange relating to our Canadian operations.

Gross Profit

Gross profit for fiscal 2008 decreased $42.4 million to $96.8 million from $139.2 million for fiscal 2007. The decrease in gross profit was primarily due to lagging increases in selling prices during a period of unprecedented resin price increases, as well as a $13.5 million increase in the LIFO reserve during the current year ($3.4 million of this amount relates to the increase of approximately 20.9 million pounds of inventory in connection with the Atlantis acquisition) and a slight decrease in pounds sold. Fiscal 2008 also included $0.7 million of positive impact of foreign exchange relating to our Canadian operations.

Operating Expenses

Operating expenses for fiscal 2008 increased $0.6 million, or 0.8%, to $86.9 million as compared to fiscal 2007. Included in general and administrative expenses for fiscal 2008 is a payment of approximately $1.6 million, excluding professional fees, related to a commercial dispute. Other increases are primarily due to an increase in delivery expense due to higher fuel costs, an increase in bad debt expense resulting from a customer’s bankruptcy and advisory costs incurred as a result of our exploration of strategic alternatives related to our subsidiary in the Netherlands (sale was completed in April 2008), partially mitigated by a decrease in our accrual for bonuses and a decrease in compensation costs recorded for our share-based compensation. Fiscal 2008 also includes $0.5 million unfavorable effect of foreign exchange increasing total operating expenses.

Other Operating Expense

Other operating expense for fiscal 2008 was $0.3 million and represented net losses on sales of fixed assets during the period as compared to net losses on sales of fixed assets of $46,000 in fiscal 2007.

 

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Interest Expense

Interest expense for fiscal 2008 increased $0.2 million to $15.7 million from $15.5 million in fiscal 2007, resulting primarily from higher average borrowings on our Credit Facility during fiscal 2008 as compared to fiscal 2007, partially offset by lower interest rates on Credit Facility borrowings.

Other, net

Other, net for fiscal 2008 amounted to $0.9 million in income, as compared to $0.8 million in income for fiscal 2007. The increase is primarily due to an increase of $0.5 million in foreign currency transaction gains, partially offset by income in fiscal 2007 of $0.3 million from interest income on tax refunds in our New Zealand subsidiary.

Income Tax Benefit (Provision)

The benefit for income taxes for fiscal 2008 was $8.5 million on loss from continuing operations before the benefit for income taxes of $5.2 million. Included in this amount is a $7.0 million tax benefit arising from previously unrecognized tax benefits resulting from the completion in September 2008 of an IRS examination for fiscal years 2005 and 2006. The difference between the effective tax rate of 28.5%, excluding the $7.0 million benefit, and the U.S. statutory tax rate of 34.0% primarily relates to the following: (i) $0.2 million provision for state taxes in the United States, net of federal benefit (+4.1%); and (ii) $0.2 million true-up of prior year’s estimates in the United States (-4.7%).

The provision for income taxes for fiscal 2007 was $15.2 million on income from continuing operations before the provision for income taxes of $38.1 million. The difference between the effective tax rate of 39.9% and the U.S. statutory tax rate of 35% primarily relates to the following: (i) $1.7 million provision for state taxes in the United States (+4.5%), no federal tax benefit was recognized in fiscal 2007 as the Company is not in a state tax paying position; and (ii) a $0.2 million true-up of prior year’s estimates (-0.5%).

Discontinued Operations—Fiscal 2008 Compared to Fiscal 2007

In April 2008, we completed the sale of our Netherlands operation. Our Netherlands operation was a component of our consolidated entity, and as such requires discontinued operations reporting treatment. The financial statements at and for fiscal 2008 and 2007 also include as discontinued operations our UK and Spanish operations which are in liquidation. The financial statements at and for fiscal 2007 also include as discontinued operations our Australian land and building, which was sold in the fourth quarter of fiscal 2007.

A consolidated summary of the operating results of discontinued operations for fiscal 2008 and 2007 is as follows:

 

     For the Year
Ended October 31,
     2008     2007
     (in thousands)

Net sales

   $ 56,238      $ 119,697

Gross profit

     5,436        12,261

Income from discontinued operations

     898        6,716

Gain from disposition

     10,708        459

Income tax provision

     (2,674     —  

Income from discontinued operations

   $ 8,932      $ 7,175

Net sales and gross profit of the discontinued operations decreased $63.5 million and $6.8 million, respectively, during fiscal 2008 as compared to fiscal 2007 and primarily represents the activity of our

 

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Netherlands operation. The Netherlands operation was sold on April 4, 2008 and therefore, prior fiscal year amounts include seven additional months of activity. Prior to the disposition, net sales and gross profit of our Netherlands operation were positively affected by an increase in average selling prices combined with a positive effect of foreign exchange, partially offset by a decrease in sales volume resulting from a decrease in demand in specialty products and decreased material margins due to lagging sale price increases over rising resin costs.

Included in income from discontinued operations for fiscal 2008 is $0.4 million of income from our Spanish subsidiary resulting primarily from the return of a deposit held for a tax assessment under appeal. The asset had been fully reserved in fiscal 2005 as we believed it was more likely than not that the deposit would not be recovered. In exchange for the release of the deposit, the U.S. company issued a standby letter of credit, reducing availability under our Credit Facility. We do not believe we will need to perform under this standby letter of credit. Also included in income is a loss in UK of $0.3 million which primarily includes reclassification of UK’s accumulated foreign currency translation losses.

Included in gain from disposition from discontinued operations for fiscal 2008 is $6.9 million of realized foreign currency exchange gains before provision for taxes ($4.1 million after tax) resulting from the settlement of all intercompany loans, denominated in Euros ($5.1 million of which had been previously recognized in accumulated other comprehensive income at October 31, 2007), a $1.5 million gain on sale of AEP Netherlands, after all costs to sell, and the reclassification of AEP Netherlands accumulated foreign currency translation gains into income in the amount of $2.3 million.

Included in income from discontinued operations in fiscal 2007 is $2.5 million of income from the reclassification of Australia’s accumulated foreign currency translation gains, $0.6 million of rental income received during fiscal 2007 from our land and building in Sydney, Australia, and $0.3 million of foreign currency gains. No tax provision has been recognized for the $2.5 million reclassification of Australia’s accumulated foreign currency translation gains into income for fiscal 2007. Also included in income for fiscal 2007 is a $0.3 million reversal of provisions established at the time of sale of certain assets and liabilities of our New Zealand operation in May 2005 relating to non-collection of trade receivables (used as basis of cash advance to us by the buyers of the New Zealand operation) and clean-up of leased properties. The fiscal 2007 income from discontinued operations also includes interest income earned and expenses paid by our Spanish operation and expenses incurred by our UK operations during the period. The gain from disposition in fiscal 2007 of $0.5 million includes a $0.4 million gain on the sale of our land and building in Sydney, Australia and a $29,000 final settlement on closing balance sheet adjustments related to our Bordex operation sold in July 2006.

Liquidity and Capital Resources

Summary

Company Developments in Fiscal 2009

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 and to buy back shares of our common stock and 2013 Notes.

Despite the challenging financial markets and economic conditions, AEP maintains a strong financial position. We have a strong balance sheet and liquidity that provides us with financial flexibility. As market conditions change, we continue to monitor our liquidity position. We ended fiscal 2009 with a net debt position (current bank borrowings plus long term debt less cash and cash equivalents) of $169.7 million, compared with $248.9 million at the end of fiscal 2008. In addition to our normal operating activities:

 

   

On October 30, 2008, we completed the acquisition of substantially all of the assets of the stretch films, custom films and institutional products divisions of Atlantis for an initial purchase price of $99.2 million, prior to expenses and the net working capital true-up. The acquisition was funded with $70.1

 

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million of borrowing under our Credit Facility, $23.0 million with cash on hand, and the remaining $6.1 million was a deposit made by us in August 2008 and held in escrow. We paid $1.6 million of expenses related to the acquisition. During the first half of fiscal 2009, we settled the net working capital true-up with Atlantis and received $2.0 million, which has been reflected as a reduction in the purchase price bringing the adjusted purchase price to $98.8 million after expenses.

 

   

Our focus has been and continues to be to use excess cash to pay down debt. At October 31, 2009, our consolidated debt was $170.0 million, a decrease of $79.2 million from prior year’s balance of $249.2 million. We had average borrowings under the Credit Facility of approximately $37.6 million and $17.7 million, with a weighted average interest rate of 3.3% and 5.8%, during fiscal 2009 and 2008, respectively. In March 2009, our Company’s Board authorized the Senior Note Repurchase Program, under which we may repurchase a portion of the 2013 Notes in privately negotiated transactions, funded by proceeds from sale-leaseback transactions up to $8.0 million and borrowings under the Credit Facility up to $3.0 million. On April 1, 2009, the Company repurchased and retired $14.8 million (principal amount) of our 2013 Notes at a price of 62.8% of par. The cash paid was $9.4 million which included $0.1 million of accrued interest. On November 2, 2009, the Board terminated the 2009 Senior Note Repurchase Program and authorized the 2010 Senior Note Repurchase Program which allows the Company to spend up to $25.0 million to repurchase its outstanding 2013 Notes.

 

   

During the second quarter of fiscal 2009, we entered into a transaction with GE Capital, whereby GE Capital purchased certain of our manufacturing equipment for $7.0 million and leased the equipment back to us under two six-year capital leases. The interest rates on the capital leases range from 3.9% to 8.5% with the weighted average rate of 5.78%. The proceeds from the sale-leaseback were used to repurchase a portion of the 2013 Notes discussed above.

 

   

We incurred approximately $23.8 million of capital expenditures during fiscal 2009 related primarily to an expansion of our North Carolina plant, a new Co-Ex line in our Pennsylvania plant (production began in September 2009) and energy cost reduction equipment in our Pennsylvania plant, the purchase of the land and building in our Minnesota plant, and a new computer operating system throughout the Company.

Our working capital amounted to $74.1 million at October 31, 2009 compared to $105.8 million at October 31, 2008. The decrease in working capital of $31.7 million was primarily due to a decrease in accounts receivable resulting from lower sales revenue in fiscal 2009 as compared to fiscal 2008, a decrease in other current assets resulting primarily from the receipt of prepaid inventory and supplier credits (primarily arising from the Atlantis acquisition), and an increase in accrued expenses resulting from increased accruals related to employee cash performance incentives and reserves established for the shutdown of Fontana and Cartersville, partially offset by a decease in accounts payable resulting from the timing of payments and a reduction in resin prices.

We believe that our cash flow from operations, assuming no material adverse change, combined with the availability of funds under our Credit Facility and credit lines available to our Canadian subsidiary for local currency borrowings, will be sufficient to meet our working capital and debt service requirements and planned capital expenditures for at least the next twelve months. However, continued world-wide financial market disruption may have a negative impact on our financial performance and position in the future. We believe the flexibility of our strong balance sheet affords us the opportunity to weather uncertain economic events from a position of strength and we remain confident in our ability to access capital to meet our strategic growth needs. At October 31, 2009, we had an aggregate of approximately $117.9 million available under our various worldwide credit facilities.

 

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Market Conditions

The general disruption in the U.S. capital markets has impacted the broader financial and credit markets and reduced the availability of debt and equity capital for the market as a whole. These conditions could persist for a prolonged period of time or worsen in the future. Although we are confident in our ability to access capital to meet our growth needs, there is a risk given the current economic environment that the capital markets may be restricted at a time when we would like, or need, to access those markets, which could have an impact on our flexibility to react to changing economic and business conditions, our ability to refinance our existing debt and our ability to consummate acquisitions. In addition, the cost of debt financing and the proceeds of equity financing may be materially adversely impacted by these market conditions. Further, in the current volatile state of the credit markets, there is risk that any lenders, even those with strong balance sheets and sound lending practices, could fail or refuse to honor their legal commitments and obligations under existing credit commitments, including but not limited to: extending credit up to the maximum permitted by a credit facility, allowing access to additional credit features and otherwise accessing capital and/or honoring loan commitments.

Cash Flows

The following table summarizes our cash flows from operating, investing and financing of our continuing operations and net cash flows from our discontinued operations for each of the past three fiscal years:

 

     For the Years Ended October 31,  
     2009     2008     2007  
     (in thousands)  

Total cash provided by (used in) continuing operations:

      

Operating activities

   $ 88,052      $ 40,798      $ 51,207   

Investing activities

     (21,691     (100,623     (14,058

Financing activities

     (67,011     60,090        (46,511

Net cash provided by discontinued operations

     —          1,023        8,308   

Effect of exchange rate changes on cash

     727        (1,610     432   
                        

Increase (decrease) in cash and cash equivalents

   $ 77      $ (322   $ (622
                        

Note: See consolidated statements of cash flows included in Item 8, “Financial Statements and Supplementary Data”, of this Annual Report on Form 10-K for additional information.

Operating Activities

Our cash and cash equivalents were $0.3 million at October 31, 2009, as compared to $0.2 million at October 31, 2008. Net cash provided by operating activities from continuing operations during the fiscal year ended October 31, 2009 was $88.1 million, and was comprised of income from continuing operations of $30.4 million adjusted for non-cash operating charges totaling $17.2 million. Cash provided by operating activities also includes a $25.5 million decrease in accounts receivable resulting primarily from a decrease in sales revenue coinciding with decreases in resin costs, $25.3 decrease in inventories resulting from lower resin prices and lower finished goods quantities on hand, and a decrease of $8.8 million in current assets resulting primarily from the receipt of prepaid inventory and supplier credits associated with Atlantis. Cash used in operating activities primarily includes a $19.6 million decrease in accounts payable as a result of timing of payments and a reduction in resin prices.

Investing Activities

Net cash used in investing activities from continuing operations during fiscal 2009 was $21.7 million, resulting from $23.8 million in capital expenditures, partially offset by the receipt of $2.0 million from the final settlement of working capital with Atlantis.

 

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Financing Activities

Net cash used in financing activities from continuing operations during fiscal 2009 was $67.0 million, resulting primarily from $62.5 million in repayments under our Credit Facility and $1.9 million of repayments of our Pennsylvania loans and foreign borrowings, partially offset by $1.1 million of proceeds received from issuance of our common stock from our employee stock purchase plan and stock option plan. In addition, during the second quarter, we entered into a sale-leaseback transaction with GE Capital, whereby we received $6.6 million. In connection with the sale-leaseback transaction, GE Capital made the $0.4 million final payment to the vendors of the machinery. We used the proceeds of the sale-leasebacks combined with borrowings under our Credit Facility to repurchase and retire $14.8 million (principal amount) of the Company’s 2013 Notes at a price of 62.8% of par. The cash paid for the repurchase of the 2013 Notes was $9.3 million plus $0.1 million of accrued interest.

Discontinued Operations

There was no cash activity in the discontinued operations of our Spanish subsidiary during fiscal year 2009.

Sources of Liquidity

Debt

We maintain a secured credit facility with Wachovia Bank N.A. as initial lender thereunder and as agent for the lenders thereunder, which was last amended on October 30, 2008 (the “Amended Credit Facility”). The Amended Credit Facility has a maximum borrowing amount of $150.0 million, including a maximum of $20.0 million for letters of credit, and matures on December 15, 2012. We can reduce commitments under the Credit Facility at any time after October 30, 2009.

We utilize the Amended 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. Borrowings and letters of credit available under the Amended Credit Facility are limited to a borrowing base based upon specific advance percentage rates on eligible domestic assets (including receivables), subject, in the case of inventory, equipment and real property, to amount limitations. The sum of eligible domestic assets at October 31, 2009 and 2008 supported a borrowing base of $122.0 million and $150.0 million, respectively. Availability was reduced by the aggregate amount of letters of credit outstanding totaling $1.2 million and $0.9 million at October 31, 2009 and 2008, respectively. Borrowings outstanding under the Credit Facility were $7.5 million and $70.0 million at October 31, 2009 and 2008, respectively. Therefore, availability at October 31, 2009 and 2008 under the Credit Facility was $113.3 million and $79.1 million, respectively.

In addition to the amounts available under the Credit Facility, we also maintain a secured credit facility at our Canadian subsidiary which is used to support operations and is serviced by local cash flows from operations. Borrowings outstanding and availability under the Canadian credit facility were zero and $4.6 million, respectively, at October 31, 2009.

Please refer to Note 8 of the consolidated financial statements for further discussion of our debt.

Capital Leases

During the second quarter of fiscal 2009, we entered into a transaction with GE Capital, whereby GE Capital purchased certain of the Company’s manufacturing equipment for $7.0 million and leased the equipment back to the Company under two six-year capital leases. At October 31, 2009, we had $6.4 million in obligations under capital leases which represents the present value of the future minimum lease payments, less amounts representing interest. The current portion of these obligations is included in accrued liabilities and the long-term

 

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portion is included in other long-term liabilities in the consolidated balance sheets. The interest rates on the capital leases range from 3.9% to 8.5% with the weighted average rate of 5.78%. As a result of the capital lease treatment, the equipment will remain a component of property, plant and equipment in the Company’s consolidated balance sheet and continue to be depreciated. No gain or loss was recognized related to this transaction.

Repurchase Programs

With Board approval, we repurchased and retired $14.8 million (principal amount) of the Company’s 2013 Notes at a price of 62.8% of par on April 1, 2009. The cash paid was $9.4 million which included $0.1 million of accrued interest. We used proceeds from sale-leaseback transactions and borrowings under our Credit Facility to fund the buyback of the 2013 Notes. On April 14, 2009, our Board approved an increase to the previously authorized Senior Note Repurchase Program to a total of $25.0 million (representing an additional $14.0 million from the initial approval), increasing availability to $15.7 million under such program. On November 2, 2009, the Board terminated the 2009 Senior Note Repurchase Program and authorized the 2010 Senior Note Repurchase Program which allows the Company to spend up to $25.0 million to repurchase its outstanding 2013 Notes. In addition, on June 6, 2008, the Board approved a new $8.0 million stock repurchase program (the “June 2008 stock repurchase program”). Repurchases for both the 2010 Senior Note Repurchase Program and the June 2008 stock repurchase program may be made in the open market, privately negotiated transactions or by other means from time to time, subject to conditions, applicable legal requirements and other factors, including the limitations set forth in our debt covenants. The amounts involved in any such transactions, individually or in the aggregate, may be material and may be funded from available cash or from additional borrowings. The programs do not obligate us to acquire any particular amount of the 2013 Notes or our Company stock and the programs may be suspended at any time at management’s discretion.

Contractual Obligations and Off-Balance-Sheet Arrangements

Contractual Obligations and Commercial Commitments

Our contractual obligations and commercial commitments as of October 31, 2009 are as follows:

 

     For the Years Ending October 31,
     Borrowings    Interest on Fixed
Rate
Borrowings
   Capital
Leases,
Including
Amounts
Representing
Interest
   Operating
Leases
   Total
Commitments
     (in thousands)

2010

   $ 531    $ 12,698    $ 1,386    $ 5,993    $ 20,608

2011

     441      12,683      1,386      4,301      18,811

2012

     145      12,674      1,386      3,833      18,038

2013 (1)

     167,827      6,361      1,386      3,657      179,231

2014

     89      48      1,386      3,205      4,728

Thereafter

     967      225      578      2,314      4,084
                                  

Total (2)

   $ 170,000    $ 44,689    $ 7,508    $ 23,303    $ 245,500
                                  

 

(1) Borrowings include $160.2 million Senior Notes due on March 15, 2013 and $7.5 million of outstanding borrowings under our Amended Credit Facility which is due December 15, 2012.
(2) Borrowings include $7.5 million of variable rate borrowings (outstanding borrowing under our Amended Credit Facility). See Note 8 of the Consolidated Financials Statements for further discussion of our debt.

 

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In addition to the amounts reflected in the table above:

Concurrently with the closing of the Atlantis acquisition, our Board approved a plan to realign and reorganize the Atlantis businesses. Management finalized its reorganization plan in October 2009. In addition to the shutdown of the acquired Fontana, California plant which commenced in November 2008, we shut down the acquired Cartersville, Georgia plant on October 31, 2009. Costs of approximately $5.9 million associated with shutting down these plants have been recorded as an adjustment to the allocation of the purchase price. Costs associated with this restructuring include additional severance costs, lease costs, costs to be incurred as a result of the contractual obligation to put the facilities back to their original condition, equipment dismantling costs and operating costs of the facilities from November 1, 2009 until lease expiration. We expect to complete the restructuring activities related to the Fontana facility during fiscal 2010 and by July 2015 for the Cartersville facility (commensurate with the expiration of the Fontana and Cartersville leases). Due to the current market conditions in the respective areas, no sublease income has been assumed.

For tax purposes, the $5.3 million gain on extinguishment of debt, net will be deferred under Internal Revenue Code Section 108(i) as amended by the American Recovery and Reinvestment Act of 2009. The gain on extinguishment of debt, net will be recognized as taxable income in our Federal tax return ratably over the fiscal years beginning October 31, 2014 through October 31, 2018. The deferred tax liability associated with this gain is reflected in deferred tax liability in the consolidated balance sheet at October 31, 2009.

We expect to incur approximately $15.0 million of capital expenditures during fiscal 2010. At October 31, 2009, we had commitments of approximately $5.5 million for the purchase or construction of capital assets. We plan to fund these capital expenditures through cash flows from operations.

We have approximately $0.1 million of unfunded pension benefit obligations at October 31, 2009 related to our Canadian operation. We expect to contribute approximately $0.4 million during fiscal 2010 to fund the Canadian defined benefit plan. With regards to the US’ 401(k) Savings and Employee Stock Ownership Plan (“ESOP”), we estimate contributing approximately $2.5 million in cash in February 2010 to our 401(k) and ESOP plan effective for the 2009 ESOP year contributions.

We expect 69,647 performance units to vest during fiscal 2010, provided that each employee continues to be employed by the Company on the respective anniversary dates. Settlement of the units is based on the Company’s stock price on the anniversary date and will be settled at the employees’ option in cash, Company stock, or a combination.

Between November 9 and November 20, 2009, we repurchased under our June 2008 stock repurchase program, 52,500 shares of our common stock in the open market an average cost of $36.84 per share, totaling $1.9 million.

In November 2009, we received approximately $4.5 million as a dividend from our Canadian subsidiary.

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 the Company’s 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 customer rebates and incentives, product returns, doubtful accounts, inventories, including LIFO inventory valuations, acquisitions, including cost associated with the restructuring of the Atlantis plants, litigation and contingency accruals, income taxes, including assessment of unrecognized tax benefits for uncertain tax positions, share-based compensation, leasing arrangements, 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.

Revenue Recognition. We recognize revenue when products are shipped and the customer takes ownership and assumes risk of loss, which generally occurs on the date of shipment, collection of the relevant receivable is probable, persuasive evidence of an arrangement exists and the sales price is fixed and determinable. Concurrently, we record reductions to revenue for customer rebate programs, returns, promotions or other incentive programs that are estimated using historical experience and current economic trends. Material differences may result in the amount and timing of net sales for any period if management makes different judgments or uses different estimates.

Allowance for Doubtful Accounts. Management estimates the allowance for doubtful accounts by analyzing accounts receivable balances by age, applying historical trend rates of write offs to the average accounts receivable balances over the last 60 months. When it is deemed probable that a customer account is uncollectible, that balance is added to the calculated reserve. Actual results could differ from these estimates under different assumptions and may be affected by changes in general economic conditions.

Inventory Reserves. Management reviews our physical inventories at each business unit to determine the obsolescence of inventory on hand. These deemed obsolescent items are considered scrap. We maintain our United States inventory on the LIFO method of inventory valuation, except for supplies and printed and converted finished goods. The LIFO inventory is reviewed quarterly for net realizable value and adjusted accordingly.

Litigation Reserves. Management’s current estimated ranges of liabilities related to pending litigation are based on input from legal counsel and our best estimate of potential loss. Final resolution of the litigation contingencies could result in amounts different from current accruals and, therefore, have an impact on our consolidated financial results in a future reporting period. At October 31, 2009, we are involved in routine litigation in the normal course of our business and based on facts currently available we believe such matters, net of insurance recoveries, will not have a material adverse impact on our results of operations, financial position or liquidity.

Income Taxes. Management accounts for income taxes using an asset and liability approach. Such approach results in the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the book carrying amounts and the tax basis of assets and liabilities. As part of the process of preparing our consolidated financial statements, management is required to estimate income taxes in each of the jurisdictions in which we operate. This process involves estimating actual current tax expense together with assessing temporary differences resulting from differing treatment of items for tax and accounting purposes. These differences result in deferred tax assets and liabilities, which are included in our consolidated balance sheet.

 

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The realizability of our deferred tax assets is primarily dependent on the future taxable income of the entity to which the deferred tax asset relates. Management assesses the likelihood that such deferred tax assets will be recovered from future taxable income and to the extent management believes that recovery is not likely, a valuation allowance must be established. Should the future taxable income of such entities be materially different from management’s estimates, an additional valuation allowance may be necessary in future periods. Such amounts, if necessary, could be material to our results of operations and financial position.

Effective November 1, 2007, we are required to recognize in our consolidated financial statements the impact of a tax position if that position is more likely than not of being sustained based on the technical merits of the position. There is a two-step approach for evaluating uncertain tax positions. Step one, recognition, requires us to determine if the weight of available evidence indicates that a tax position is more likely than not to be sustained upon audit, including resolution of related appeals or litigation processes, if any. Step two, measurement, is based on the largest amount of benefit, which is more likely than not to be realized on settlement with the taxing authority. Additionally, we are required to accrue interest and related penalties, if applicable, on all tax exposures for which reserves have been established consistent with jurisdictional tax laws. Interest and penalties on tax reserves continue to be classified as provision for income taxes in our consolidated statements of operations. For purposes of intraperiod allocation, we include changes in reserves for uncertain tax positions related to discontinued operations in continuing operations.

The recognition and measurement of uncertain tax positions involves significant management judgment. The ultimate resolution of uncertain tax positions could result in amounts different than the amounts reserved for, and, therefore have an impact on our consolidated financial results in the future.

Share-Based Compensation. Share-based compensation expense is measured at the grant date based on the fair value of the award and is recognized as expense over the vesting period. The Company uses the Black Scholes option pricing model to estimate the fair value of stock options on the date of grant. The Black-Scholes option-pricing model incorporates various assumptions including expected volatility, expected term and risk-free interest rates. We estimate the expected volatility using the historical stock price volatility of our stock over the estimated term of our stock options. We determine the expected term of our stock options based on historical experiences. In addition, judgment is required in estimating the forfeiture rate on stock awards. We calculate the expected forfeiture rate based on average historical trends sorted by separate employee groups, including executive officers and directors. Fluctuations in the market that affect these estimates could have an impact on the resulting compensation cost. Additionally, compensation cost for the portion of awards for which the requisite service has not been rendered that are outstanding as of the adoption date is recognized over the remaining service period after the adoption date.

Impairment. We review our long-lived assets, such as property, plant and equipment and intangible assets, such as trade names and customer relationships, primarily associated with the Atlantis acquisition, for impairment whenever events or changes in circumstances indicate that the carrying amount of these assets may not be recoverable. Factors we consider important that could trigger an impairment review include:

 

   

Significant underperformance relative to expected historical or projected future operating results;

 

   

Significant change in the manner of or use of the acquired assets or the strategy of our overall business;

 

   

Significant negative industry or economic trends;

 

   

Significant decline in our stock price for a sustained period; and

 

   

Our market capitalization relative to net book value.

Recoverability is measured by a comparison of the carrying amount of an asset to future undiscounted cash flows expected to be generated by the asset. If the assets were considered to be impaired, the impairment to be recognized would be measured by the amount by which the carrying value of the assets exceeds their fair value.

 

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Fair value is determined based on discounted cash flows, recent buy offers or appraised values, depending on the nature of the asset. Assets to be disposed of are valued at the lower of the carrying amount or their fair value less disposal costs. Actual realizable values or payments to be made may differ from such estimates, and such differences will be recognized as incurred or as better information is received. Our estimate as to fair value is regularly reviewed and subject to change as new information is made available.

We perform an annual assessment as to whether or not goodwill is impaired. We performed our annual impairment analysis on September 30 based on a comparison of the Company’s market capitalization to its book value at that date. On September 30, 2009, 2008 and 2007, we concluded that there was no impairment because our market capitalization was above book value. On October 31, 2009 our market capitalization was above book value. Our policy is that impairment of goodwill will have occurred if the market capitalization of our company were to remain below book value for a reasonable period of time. If we determine that an impairment has occurred, we would perform a second test to determine the amount of impairment loss. In the second test, the fair value of our company is estimated using comparable industry multiples of cash flows as part of an effort to measure the value of implied goodwill. We also review our financial position quarterly for other triggering events.

Acquisitions. We allocate at the time of acquisition, the cost of a business acquisition to the specific tangible and intangible assets acquired and liabilities assumed based upon their relative fair values. Significant judgments and estimates are often made to determine these allocated values, and may include the use of appraisals, market quotes for similar transactions, discounted cash flow techniques or other information we believe is relevant. The finalization of the purchase price allocation will typically take a number of months to complete, and if final values are materially different from initially recorded amounts adjustments are recorded. Any excess of the cost of a business acquisition over the fair values of the net assets and liabilities acquired is recorded as goodwill which is not amortized to expense. Any excess of the fair value of the net tangible and identifiable intangible assets acquired over the purchase price (negative goodwill) is allocated on a pro-rata basis to long-lived assets, including identified intangible assets. If negative goodwill exceeds the amount of those assets, the remaining excess shall be recognized as an extraordinary gain in the period which the acquisition is completed. As discussed above, goodwill is required to be tested for impairment on an annual basis, and between annual testing dates if events or circumstances change.

We established reserves for the Atlantis restructuring activities, which included lease costs, severance and facility costs, as part of the acquisition cost. Upon finalization of the restructuring plans or settlement of obligations for less than the expected amount, any excess reserves are reversed with a corresponding decrease in identifiable intangible assets and property, plant and equipment.

A new accounting standard on accounting for business combinations will apply to business acquisitions we consummate after November 1, 2009.

Recently Issued Accounting Pronouncements

Please refer to Note 2 of the consolidated financial statements for discussion on recently issued accounting pronouncements.

 

ITEM 7A. 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.

 

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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 October 31, 2009, the carrying value of our total debt was $170.0 million of which approximately $162.5 million was fixed rate debt (2013 Notes and the Pennsylvania Industrial Loans). As of October 31, 2009, the estimated fair value of our 2013 Notes was approximately $155.4 million. As of October 31, 2009, the carrying value of our Pennsylvania Industrial Loans was $2.3 million which approximates fair value.

Floating rate debt at October 31, 2009 and 2008 totaled $7.5 million and $71.3 million, respectively. Based on the floating rate debt outstanding during fiscal 2009 (our Credit Facility), a one-percent increase or decrease in the average interest rate would result in a change to interest of approximately $0.4 million.

Foreign Exchange

We enter into derivative financial instruments (principally foreign exchange forward contracts) primarily to hedge intercompany transactions and 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.

The success of our hedging activities depends upon the accuracy of our estimates of various balances and transactions denominated in non-functional currencies. To the extent our estimates are correct, gains and losses on our foreign currency contracts will be offset by corresponding losses and gains on the underlying transactions. We had a total of 12 and 5 open foreign exchange forward contracts outstanding at October 31, 2009 and 2008, respectively, with total notional contract amounts of $13.8 million and $8.5 million, respectively, all of which have maturities of less than one year. The net fair value of foreign exchange forward contracts was a net asset of $0.1 million and a net liability of $0.6 million at October 31, 2009 and 2008, respectively.

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.

See Note 15 to the Consolidated Financial Statements for further discussion.

Our Canadian subsidiary had third party outstanding debt of zero and $1.3 million on October 31, 2009 and 2008, respectively. Such debt is generally denominated in the functional currency of the borrowing subsidiary. We believe that this enables us to better match operating cash flows with debt service requirements and to better match foreign currency-denominated assets and liabilities, thereby reducing our need to enter into foreign exchange forward contracts.

Commodities

We use commodity raw materials, primarily resin, and energy products in conjunction with our manufacturing process. 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.

 

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ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA

The following financial statements and accompanying schedule and related report of our independent registered public accounting firm are set forth in a separate section of this Form 10-K beginning on page 46 and are hereby incorporated by reference.

 

Report of Independent Registered Public Accounting Firm

   46

Financial Statements:

  

Consolidated Balance Sheets as of October 31, 2009 and 2008

   47

Consolidated Statements of Operations for the years ended October 31, 2009, 2008 and 2007

   48

Consolidated Statements of Shareholders’ Equity and Comprehensive Income for the years ended October 31, 2009, 2008 and 2007

   49

Consolidated Statements of Cash Flows for the years ended October 31, 2009, 2008 and 2007

   50

Notes to Consolidated Financial Statements

   51

Financial Statement Schedule:

  

Schedule II: Valuation and Qualifying Accounts

   89

 

ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE

Not applicable.

 

ITEM 9A. 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 management, including our Chief Executive Officer and Chief Financial Officer (together, the “Certifying Officers”), as appropriate, to allow for timely decisions regarding required disclosure.

As of October 31, 2009, 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. Based upon that evaluation, the Certifying Officers concluded that our disclosure controls and procedures were effective as of October 31, 2009.

Management Report on Internal Control Over Financial Reporting

Our management is responsible for establishing and maintaining adequate internal control over financial reporting to provide reasonable assurance regarding the reliability of our financial reporting and the preparation of financial statements for external purposes in accordance with U.S. generally accepted accounting principles. Internal control over financial reporting includes those policies and procedures that: (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of our assets; (ii) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with U.S. generally accepted accounting principles, and that our receipts and expenditures are being made only in accordance with authorizations of our management and Board; and (iii) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use or disposition of our assets that could have a material effect on the financial statements.

Our management, including our Certifying Officers, recognizes that our internal control over financial reporting cannot prevent or detect all error and all fraud. A control system, no matter how well designed and

 

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operated, can provide only reasonable, not absolute, assurance that the control system’s objectives will be met. 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. Further, 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. The design of any system of controls is based in part on 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.

Management, with the participation of the Certifying Officers, assessed our internal control over financial reporting as of October 31, 2009, the end of our fiscal year. Management based its assessment on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on this assessment, management has concluded that our internal control over financial reporting was effective as of October 31, 2009.

Our independent registered public accounting firm, KPMG LLP, independently assessed the effectiveness of our internal control over financial reporting as stated in their report included herein.

Changes in Internal Control over Financial Reporting

There was no change in our internal controls over financial reporting that occurred during our most recently completed fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

ITEM 9B. OTHER INFORMATION

None.

PART III

 

ITEM 10. DIRECTORS, EXECUTIVE OFFICERS AND CORPORATE GOVERNANCE

The information required by this item is set forth under the following captions in our proxy statement to be filed with respect to the 2010 annual meeting of stockholders (the “Proxy Statement”), all of which is incorporated herein by reference: “Proposal No. 1—Election of Directors,” “Board Matters—The Board of Directors and Committees,” “Board Matters—Corporate Governance,” “Certain Relationships and Related Person Transactions,” “Additional Information—Section 16(a) Beneficial Ownership Reporting Compliance,” and “Additional Information-Requirements for Submission of Stockholder Proposals and Nominations for 2011 Annual Meeting.”

 

ITEM 11. EXECUTIVE COMPENSATION

The information required by this item is set forth under the following captions in our Proxy Statement, all of which is incorporated herein by reference: “Compensation Discussion and Analysis,” “Executive Compensation Tables,” “Board Matters—Director Compensation,” “Compensation Committee Interlocks and Insider Participation,” and “Compensation Committee Report.”

 

ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND RELATED STOCKHOLDER MATTERS

The information required by this item is set forth under the following captions in our Proxy Statement, all of which is incorporated herein by reference: “Additional Information—Equity Compensation Plans” and “Security Ownership of Certain Beneficial Owners and Management.”

 

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ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS, AND DIRECTOR INDEPENDENCE

The information required by this item is set forth under the following captions in our Proxy Statement, all of which is incorporated herein by reference: “Certain Relationships and Related Person Transactions” and “Board Matters—The Board of Directors and Committees.”

 

ITEM 14. PRINCIPAL ACCOUNTANT FEES AND SERVICES

The information required by this item is set forth under the following captions in our Proxy Statement, all of which is incorporated herein by reference: “Audit Committee Matters.”

PART IV

 

ITEM 15. EXHIBITS AND FINANCIAL STATEMENT SCHEDULES

 

(a)    1. Financial Statements:

The financial statements of the Company filed in this Annual Report on Form 10-K are listed in Part II, Item 8.

 

  2. Financial Statement Schedule:

The financial statement schedule of the Company filed in this Annual Report on Form 10-K is listed in Part II, Item 8.

 

  3. Exhibits:

The exhibits required to be filed as part of this Annual Report on Form 10-K are listed in the attached Index to Exhibits.

 

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REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM

The Board of Directors and Shareholders

AEP Industries Inc.:

We have audited the accompanying consolidated balance sheets of AEP Industries Inc. and subsidiaries as of October 31, 2009 and 2008, and the related consolidated statements of operations, shareholders’ equity and comprehensive income, and cash flows for each of the years in the three-year period ended October 31, 2009. In connection with our audits of the consolidated financial statements, we also have audited financial statement schedule II. We also have audited AEP Industries Inc.’s internal control over financial reporting as of October 31, 2009, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). AEP Industries Inc.’s management is responsible for these consolidated financial statements and financial statement schedule, for maintaining effective internal control over financial reporting, and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on these consolidated financial statements and financial statement schedule, and an opinion on the Company’s internal control over financial reporting based on our audits.

We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement and whether effective internal control over financial reporting was maintained in all material respects. Our audits of the consolidated financial statements included examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. Our audit of internal control over financial reporting included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audits also included performing such other procedures as we considered necessary in the circumstances. We believe that our audits provide a reasonable basis for our opinions.

A company’s internal control over financial reporting is a process designed 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. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of AEP Industries Inc. and subsidiaries as of October 31, 2009 and 2008, and the results of their operations and their cash flows for each of the years in the three-year period ended October 31, 2009, in conformity with U.S. generally accepted accounting principles. Also in our opinion, the related financial statement schedule II, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein. Also in our opinion, AEP Industries Inc. maintained, in all material respects, effective internal control over financial reporting as of October 31, 2009, based on criteria established in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission.

As discussed in Notes 9 and 11 to the consolidated financial statements, the Company changed its method of accounting for defined benefit plans at the end of the fiscal year ended October 31, 2007 due to the adoption of the standard requiring full recognition of the overfunded or underfunded status of defined benefit plans and changed its method of accounting for uncertain tax positions on November 1, 2007 due to the adoption of the standard on accounting for uncertain tax positions.

 

  /s/ KPMG LLP
 

 

Short Hills, New Jersey

January 14, 2010

 

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AEP INDUSTRIES INC.

CONSOLIDATED BALANCE SHEETS

AS OF OCTOBER 31, 2009 AND 2008

(in thousands, except share amounts)

 

     October 31,  
     2009     2008  
ASSETS     

CURRENT ASSETS:

    

Cash and cash equivalents

   $ 301      $ 224   

Accounts receivable, less allowance for doubtful accounts of $5,214 and $3,434 in 2009 and 2008, respectively

     75,681        102,579   

Inventories, net

     73,197        78,020   

Deferred income taxes

     8,699        12,427   

Other current assets

     8,603        12,683   

Assets of discontinued operations

     612        450   
                

Total current assets

     167,093        206,383   

PROPERTY, PLANT AND EQUIPMENT, at cost, less accumulated depreciation and amortization

     175,963        164,305   

GOODWILL

     9,514        10,894   

INTANGIBLE ASSETS, net of accumulated amortization of $430 and $155 in 2009 and 2008, respectively

     2,602        3,353   

DEFERRED INCOME TAXES

     —          925   

OTHER ASSETS

     4,898        4,980   
                

Total assets

   $ 360,070      $ 390,840   
                
LIABILITIES AND SHAREHOLDERS’ EQUITY     

CURRENT LIABILITIES:

    

Bank borrowings, including current portion of long-term debt

   $ 531      $ 1,826   

Accounts payable

     55,379        74,691   

Accrued expenses

     36,716        23,762   

Liabilities of discontinued operations

     366        317   
                

Total current liabilities

     92,992        100,596   

LONG-TERM DEBT

     169,469        247,329   

DEFERRED INCOME TAXES

     11,447        1,328   

OTHER LONG-TERM LIABILITIES

     10,362        1,447   
                

Total liabilities

     284,270        350,700   

COMMITMENTS AND CONTINGENCIES

    

SHAREHOLDERS’ EQUITY:

    

Preferred stock $1.00 par value; 1,000,000 shares authorized; none issued

     —          —     

Common stock $0.01 par value; 30,000,000 shares authorized; 11,011,842 and 10,909,659 shares issued in 2009 and 2008, respectively

     110        109   

Additional paid-in-capital

     107,509        105,808   

Treasury stock at cost, 4,160,158 shares in 2009 and 2008, respectively

     (129,682     (129,682

Retained earnings

     96,342        64,814   

Accumulated other comprehensive income (loss)

     1,521        (909
                

Total shareholders’ equity

     75,800        40,140   
                

Total liabilities and shareholders’ equity

   $ 360,070      $ 390,840   
                

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

FOR THE YEARS ENDED OCTOBER 31, 2009, 2008 AND 2007

(in thousands, except per share data)

 

     2009     2008     2007  

NET SALES

   $ 744,819      $ 762,231      $ 666,318   

COST OF SALES

     584,383        665,409        527,166   
                        

Gross profit

     160,436        96,822        139,152   

OPERATING EXPENSES:

      

Delivery

     37,690        36,425        34,629   

Selling

     38,675        31,866        31,849   

General and administrative

     23,691        18,596        19,762   
                        

Total operating expenses

     100,056        86,887        86,240   

OTHER OPERATING INCOME (EXPENSE):

      

Gain (loss) on sales of property, plant and equipment, net

     7        (342     (46
                        

Operating income

     60,387        9,593        52,866   

OTHER INCOME (EXPENSE):

      

Interest expense

     (15,749     (15,731     (15,551

Gain on extinguishment of debt, net

     5,285        —          —     

Other, net

     (500     916        779   
                        

Income (loss) from continuing operations before (provision) benefit for income taxes

     49,423        (5,222     38,094   

(PROVISION) BENEFIT FOR INCOME TAXES

     (18,994     8,534        (15,217
                        

Income from continuing operations

     30,429        3,312        22,877   

DISCONTINUED OPERATIONS:

      

Income from discontinued operations

     85        898        6,716   

Gain from disposition

     —          10,708        459   

Benefit (provision) for income taxes

     1,014        (2,674     —     
                        

Income from discontinued operations

     1,099        8,932        7,175   
                        

Net income

   $ 31,528      $ 12,244      $ 30,052   
                        

BASIC EARNINGS PER COMMON SHARE:

      

Income from continuing operations

   $ 4.48      $ 0.49      $ 3.05   
                        

Income from discontinued operations

   $ 0.16      $ 1.32      $ 0.96   
                        

Net income per common share

   $ 4.65      $ 1.80      $ 4.00   
                        

DILUTED EARNINGS PER COMMON SHARE:

      

Income from continuing operations

   $ 4.45      $ 0.48      $ 2.99   
                        

Income from discontinued operations

   $ 0.16      $ 1.31      $ 0.94   
                        

Net income per common share

   $ 4.61      $ 1.79      $ 3.93   
                        

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

 

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AEP INDUSTRIES INC.

CONSOLIDATED STATEMENTS OF SHAREHOLDERS’ EQUITY AND COMPREHENSIVE

INCOME

FOR THE YEARS ENDED OCTOBER 31, 2009, 2008 AND 2007

(in thousands)

 

    Common Stock   Treasury Stock     Additional
Paid-in-

Capital
  Accumulated
Other
Comprehensive
Income

(Loss)
    Retained
Earnings
  Comprehensive
Income
 
    Shares   Amount   Shares   Amount          

BALANCES AT OCTOBER 31, 2006

  10,768   $ 108   2,882   $ (76,386   $ 101,663   $ 9,690      $ 22,518  

Issuance of common stock pursuant to stock purchase plan

  17           565      

Issuance of common stock upon exercise of stock options

  75     1         1,131      

Issuance of common stock upon settlement of performance units

  1           27      

Share-based compensation

            815      

Buyback of common stock

      1,129     (48,992        

Net income

                30,052   $ 30,052   

Translation adjustments

              4,277          4,277   

Pension plan minimum liability, net of tax

              165          165   

Cumulative effect of the adoption of the FASB standard on accounting for defined benefit plans, net of $368 of taxes

              (752    

Translation adjustment reversals into income

              (2,512       (2,512
                     

Comprehensive income

                $ 31,982   
                                                 

BALANCES AT OCTOBER 31, 2007

  10,861   $ 109   4,011   $ (125,378   $ 104,201   $ 10,868      $ 52,570  

Issuance of common stock pursuant to stock purchase plan

  29           572      

Issuance of common stock upon exercise of stock options

  15           133      

Issuance of common stock upon settlement of performance units

  5           92      

Share-based compensation

            810      

Buyback of common stock

      149     (4,304        

Net income

                12,244   $ 12,244   

Translation adjustments

              (4,282       (4,282

Change in deferred prior service cost and actuarial losses, net of tax

              (322       (322

Amortization of prior service cost, net of tax (including $30 related to AEP Netherlands)

              84          84   

Translation adjustments and unamortized prior service cost reversals into income related to AEP Netherlands and AEP UK

              (7,257       (7,257
                     

Comprehensive income

                $ 467   
                                                 

BALANCES AT OCTOBER 31, 2008

  10,910   $ 109   4,160   $ (129,682   $ 105,808   $ (909   $ 64,814  

Issuance of common stock pursuant to stock purchase plan

  40     1         596      

Issuance of common stock upon exercise of stock options

  61           532      

Issuance of common stock upon settlement of performance units

  1           16      

Share-based compensation

            557      

Net income

                31,528   $ 31,528   

Translation adjustments

              2,578          2,578   

Change in deferred prior service cost and actuarial losses, net of tax

              (208       (208

Amortization of prior service cost, net of tax

              60          60   
                     

Comprehensive income

                $ 33,958   
                                                 

BALANCES AT OCTOBER 31, 2009

  11,012   $ 110   4,160   $ (129,682   $ 107,509   $ 1,521      $ 96,342  
                                           

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

FOR THE YEARS ENDED OCTOBER 31, 2009, 2008 AND 2007

(in thousands)

 

     2009     2008     2007  

CASH FLOWS FROM OPERATING ACTIVITIES:

      

Net income

   $ 31,528      $ 12,244      $ 30,052   

Income from discontinued operations

     1,099        8,932        7,175   
                        

Income from continuing operations

     30,429        3,312        22,877   

Adjustments to reconcile income from continuing operations to net cash provided by operating activities:

      

Depreciation and amortization

     19,058        13,712        13,894   

Gain on extinguishment of debt, net

     (5,285     —          —     

Change in LIFO reserve

     (20,149     13,477        7,906   

Amortization of debt fees

     1,101        875        860   

Provision for losses on accounts receivable and inventories

     1,131        1,089        339   

Change in deferred income taxes

     17,036        (8,484     2,685   

Utilization of deferred tax assets related to worthless stock deductions

     —          —          11,128   

Share-based compensation expense

     4,036        370        3,337   

Other

     306        342        46   

Changes in operating assets and liabilities, net of effects of Atlantis acquisition in fiscal 2008:

      

Decrease (increase) in accounts receivable

     25,504        (4,375     (6,044

Decrease (increase) in inventories

     25,252        (4,486     (9,867

Decrease (increase) in other current assets

     8,769        (1,267     886   

Increase in other assets

     (1,192     (591     (181

(Decrease) increase in accounts payable

     (19,622     30,856        6,275   

Increase (decrease) in accrued expenses

     1,785        (4,066     (2,667

(Decrease) increase in other long-term liabilities

     (107     34        (267
                        

Net cash provided by operating activities

     88,052        40,798        51,207   

CASH FLOWS FROM INVESTING ACTIVITIES:

      

Capital expenditures

     (23,846     (27,984     (14,264

Acquisition of Atlantis

     —          (99,805     —     

Net working capital true-up related to Atlantis acquisition

     1,975        —          —     

Net proceeds from dispositions of property, plant and equipment

     180        402        206   

Net proceeds from sale of discontinued operations

     —          26,764        —     
                        

Net cash used in investing activities

     (21,691     (100,623     (14,058

CASH FLOWS FROM FINANCING ACTIVITIES:

      

Net (repayments) borrowings of Credit Facility

     (62,486     62,400        2,511   

Repurchase of 2013 Senior Notes

     (9,320     —          —     

Proceeds from sale leaseback transactions

     6,638        —          —     

Repayments of Pennsylvania Industrial Loans

     (507     (384     (345

Borrowings of Pennsylvania Industrial Loans

     —          1,740        —     

Net (repayments) proceeds of current foreign debt

     (1,376     1,565        (911

Principal payments on capital lease obligations

     (621     —          —     

Buyback of common stock

     —          (4,304     (48,992

Payment of debt issuance costs

     —          (1,428     —     

Proceeds from issuance of common stock

     597        572        565   

Proceeds from exercise of stock options

     532        133        1,132   

Other

     (468     (204     (471
                        

Net cash (used in) provided by financing activities

     (67,011     60,090        (46,511

CASH FLOWS FROM DISCONTINUED OPERATIONS

      

Net cash provided by operating activities

     —          3,502        5,831   

Net cash (used in) provided by investing activities

     —          (155     6,542   

Net cash used in financing activities

     —          (2,168     (2,923

Effects of exchange rate changes on cash in discontinued operations

     —          (156     (1,142
                        

Net cash provided by discontinued operations

     —          1,023        8,308   

EFFECTS OF EXCHANGE RATE CHANGES ON CASH

     727        (1,610     432   
                        

Net increase (decrease) in cash

     77        (322     (622

CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR

     224        546        1,168   
                        

CASH AND CASH EQUIVALENTS AT END OF YEAR

   $ 301      $ 224      $ 546   
                        

SUPPLEMENTAL CASH FLOW INFORMATION:

      

Reclassification from intangibles to property, plant and equipment upon exercise of option to purchase land and building

   $ 1,105      $ —        $ —     
                        

Equipment financed through capital lease obligation

   $ 407      $ —        $ —     
                        

Equipment financed through buyout of operating lease deposit

   $ 156      $ —        $ —     
                        

Equipment financed through capital lease obligation in discontinued operations

   $ —        $ —        $ 579   
                        

Atlantis transaction costs yet to be paid

   $ —        $ 953      $ —     
                        

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

 

(1) BUSINESS

AEP Industries Inc., (the “Company”) is a manufacturer of plastic packaging films in North America. The Company manufactures and markets a wide range of polyethylene, polyvinyl chloride and polypropylene flexible packaging products, with consumer, industrial and agricultural applications. The plastic packaging films are primarily used in the packaging, transportation, beverage, food, automotive, pharmaceutical, chemical, electronics, construction, agriculture and textile industries.

On October 30, 2008, the Company completed the acquisition of substantially all of the assets of the stretch films, custom films and institutional products divisions of Atlantis Plastics, Inc. (“Atlantis”) for a purchase price of $98.8 million after expenses and the net working capital true-up. Atlantis maintained a significant presence in many of its product categories, which are used in a variety of applications, including storage, transportation, food packaging and other commercial and consumer applications. Atlantis also converted some institutional products internally from custom films. This transaction enhanced our position as the preferred supplier of flexible packaging solutions.

 

(2) SIGNIFICANT ACCOUNTING POLICIES

Fiscal Year:

The Company’s fiscal year-end is October 31.

Principles of Consolidation:

The consolidated financial statements include the accounts of all subsidiaries. All intercompany transactions have been eliminated.

Revenue Recognition:

The Company recognizes revenue when products are shipped and the customer takes ownership and assumes risk of loss, which is generally on the date of shipment, collection of the relevant receivable is probable, persuasive evidence of an arrangement exists and the sales price is fixed and determinable. Concurrently, the Company records reductions to revenue for estimated returns and customer rebates, promotions or other incentive programs that are estimated using historical experience and current economic trends. Material differences may result in the amount and timing of net sales for any period if management makes different judgments or uses different estimates.

Cost of Sales:

The most significant components of cost of sales are materials, including packaging, fixed manufacturing costs, labor, depreciation, inbound freight charges, utility costs used in the manufacturing process, any inventory adjustments, including LIFO adjustments, purchasing and receiving costs, research and development costs, quality control costs, and warehousing costs.

Delivery:

Delivery costs represent all costs incurred by the Company for shipping and handling of its products to the customer, including transportation costs paid to third party shippers.

Selling, General & Administrative:

Selling and general and administrative expenses consist primarily of personnel costs (including salaries, bonuses, commissions and employee benefits), facilities and equipment costs and other support costs including utilities, insurance and professional fees.

 

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Cash and Cash Equivalents:

The Company considers all highly liquid investments purchased with an initial maturity of three months or less to be cash equivalents.

Trade Accounts Receivable:

Trade accounts receivables are recorded at the invoice amount and do not bear interest. The allowance for doubtful accounts is the Company’s best estimate of the amount of probable credit losses in the Company’s existing accounts receivable. The Company determines the allowance based on historical write-off experience and an evaluation of the likelihood of success in collecting specific customer receivables. The Company reviews its allowance for doubtful accounts monthly. Past due balances over 90 days and over a specified amount are reviewed individually for collectability. Account balances are charged off against the allowance after all means of collection have been exhausted and potential for recovery is considered remote. In addition, the Company maintains allowances for customer returns, discounts and invoice pricing discrepancies, primarily based on historical experience. The Company does not have any off-balance-sheet exposure related to its customers.

Use of Estimates:

The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America 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 financial statements and the reported amounts of revenues and expenses during the reporting period. These estimates and assumptions are based on management’s best estimates and judgment. Management evaluates its estimates and assumptions on an ongoing basis using historical experience and other factors, including the current economic environment, which management believes to be reasonable under the circumstances. We adjust such estimates and assumptions when facts and circumstances dictate. Volatility in the credit, equity, and foreign currency markets and in the world markets for petroleum and natural gas, and declines in consumer spending have combined to increase the uncertainty inherent in such estimates and assumptions. As future events and their effects cannot be determined with precision, actual results could differ significantly from these estimates. Changes in estimates resulting from continuing changes in the economic environment will be reflected in the financial statements in future periods, as necessary.

The Company’s significant estimates include those related to product returns, customer rebates and incentives, doubtful accounts, inventories, including LIFO inventory valuations, acquisitions, including costs associated with the restructuring of the Atlantis plants, litigation and contingency accruals, income taxes, share-based compensation and impairment of long-lived assets and intangibles, including goodwill.

Property, Plant and Equipment:

Property, plant and equipment are stated at cost. Depreciation and amortization are computed using the straight-line method over the estimated useful lives of the assets. The cost of property, plant and equipment and the related accumulated depreciation and amortization are removed from the accounts upon the retirement or disposal of such assets and the resulting gain or loss is recognized at the time of disposition. Maintenance and repairs that do not improve efficiency or extend economic life are charged to expense as incurred.

Leases:

The Company operates certain warehousing facilities, office buildings and machinery and equipment under operating leases with terms greater than one year and with minimum lease payments associated with these agreements. Rent expense is recognized on a straight-line basis over the expected lease term. Within the provisions of certain leases, there are predetermined fixed escalations of the minimum rental payments over the base lease term (none of the leases contain renewal periods, lease concessions, including capital

 

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improvement funding, or contingent rental clauses). The effects of the escalations have been reflected in rent expense on a straight-line basis over the lease term, and the difference between the recognized rental expense and the amounts payable under the lease is recorded as deferred lease payments. The amortization period for leasehold improvements is the term used in calculating straight-line rent expense or their estimated economic life, whichever is shorter.

Impairment Charges:

Property, plant and equipment, and purchased intangibles subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. Recoverability of assets to be held and used is measured by a comparison of the carrying amount of an asset to estimated undiscounted future cash flows expected to be generated by the asset. If the carrying amount of an asset exceeds its estimated undiscounted future cash flows, an impairment charge is recognized by the amount by which the carrying amount of the asset exceeds the fair value of the asset. Fair value is determined based on discounted cash flows, recent buy offers or appraised values, depending on the nature of the asset. Assets to be disposed of are separately presented in the consolidated balance sheets and reported at the lower of the carrying amount or the fair value less costs to sell, and are no longer depreciated. The asset and liabilities of a disposed group, classified as held for sale, are presented separately in the appropriate asset and liability sections of the consolidated balance sheet.

Foreign Currency Translation:

Financial statements of international subsidiaries are translated into U.S. dollars using the exchange rate at each balance sheet date for assets and liabilities and the weighted average exchange rate for each period for revenues, expenses, gains and losses. Translation adjustments are recorded as a separate component of accumulated other comprehensive income (loss) in the consolidated balance sheets and foreign currency transaction gains and losses are recorded in other income (expense) in the consolidated statements of operations.

Derivative Instruments:

The Company enters into derivative financial instruments (principally foreign exchange forward contracts against the Canadian dollar and New Zealand dollar) primarily to hedge intercompany transactions and trade sales and forecasted purchases. The Company does not apply hedge accounting for these transactions. Foreign currency forward contracts reduce the Company’s 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.

Research and Development Costs:

Research and development costs are charged to expense as incurred and included in cost of sales in the consolidated statements of operations. Research and development costs in continuing operations was approximately $1.8 million, $1.1 million and $1.0 million during fiscal 2009, 2008 and 2007, respectively.

Acquisitions:

The Company allocates at the time of acquisition, the cost of a business acquisition to the specific tangible and intangible assets acquired and liabilities assumed based upon their relative fair values. Significant judgments and estimates are often made to determine these allocated values, and may include the use of appraisals, market quotes for similar transactions, discounted cash flow techniques or other information the Company believes relevant. The finalization of the purchase price allocation will typically take a number of months to complete, and if final values are materially different from initially recorded amounts adjustments are recorded. Any excess of the cost of a business acquisition over the fair values of the net assets and liabilities acquired is recorded as goodwill which is not amortized to expense. Any excess

 

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of the fair value of the net tangible and identifiable intangible assets acquired over the purchase price (negative goodwill) is allocated on a pro-rata basis to long-lived assets, including identified intangible assets. If negative goodwill exceeds the amount of those assets, the remaining excess shall be recognized as an extraordinary gain in the period in which the acquisition is completed. Recorded goodwill is required to be tested for impairment on an annual basis, and between annual testing dates if events or circumstances change.

The Company established reserves for the Atlantis restructuring activities, which included lease costs, severance and facility costs, as part of the acquisition cost. Upon finalization of the restructuring plans or settlement of obligations for less than the expected amount, any excess reserves are reversed with a corresponding decrease in identifiable intangible assets and property, plant and equipment.

A new accounting standard on accounting for business combinations will apply to business acquisitions we consummate after November 1, 2009.

Share-Based Compensation:

The Company recognizes in the financial statements all costs resulting from share-based payment transactions at their fair values. Compensation cost for the portion of the awards for which the requisite service had not been rendered that were outstanding as of November 1, 2005 is recognized in the consolidated statements of operations over the remaining service period after such date based on the award’s original estimate of fair value.

Income Taxes:

Income taxes are accounted for using the asset and liability method. Such approach results in the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the book carrying amounts and the tax basis of assets and liabilities. Valuation allowances are established where expected future taxable income, the reversal of deferred tax liabilities and development of tax strategies does not support the realization of the deferred tax assets.

The Company and its subsidiaries file separate foreign, state and local income tax returns and, accordingly, provide for such income taxes on a separate company basis.

Goodwill:

Goodwill represents the excess of the purchase price over the fair value of net assets acquired in purchase business combinations. The Company has determined that it consists of a single reporting unit for the purpose of the goodwill impairment test. The Company performs its annual impairment analysis on September 30 based on a comparison of the Company’s market capitalization to its book value at that date. On September 30, 2009, 2008 and 2007, the Company concluded that there was no impairment because the Company’s market capitalization was above book value. On October 31, 2009, the Company’s market capitalization was above book value. The Company’s policy is that impairment of goodwill will have occurred if the market capitalization of the Company were to remain below book value for a reasonable period of time. If the Company determines an impairment has occurred, it will perform a second test to determine the amount of the impairment loss. In the second test, the fair value of the Company is estimated using comparable industry multiples of cash flows as part of an effort to measure the value of implied goodwill.

Fair Value of Financial Instruments:

Cash and cash equivalents, accounts receivable, accounts payable and accrued expenses reflected in the consolidated financial statements equal or approximate their fair values because of the short-term maturity of those instruments. The fair value of the Company’s debt and foreign currency contracts is discussed in Note 14 and 15.

 

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Concentration of Risk:

Financial instruments that potentially subject the Company to concentrations of credit risk consist primarily of cash equivalents and trade receivables.

The Company places its cash equivalents with high-quality financial institutions and limits the amount of credit exposure with any one financial institution.

The Company sells its products to a large number of geographically diverse customers in a number of different industries, thus spreading the trade credit risk. The Company extends credit based on an evaluation of the customer’s financial condition, generally without requiring collateral. The Company performs ongoing credit evaluations of its customers’ financial condition and maintains appropriate allowances for anticipated losses. No single customer accounted for more than 10% of net sales during any year. No single customer accounted for more than 10% of the Company’s account receivable balance at October 31, 2009.

The Company purchases its resin from three principal suppliers that provided the Company with approximately 36%, 24% and 19%, respectively, of the Company’s fiscal 2009 resin supply.

The Company has three collective bargaining agreements in North America representing approximately 15% of its workforce.

Earnings Per Share (EPS):

Basic earnings per share (“EPS”) is calculated by dividing net income by the weighted average number of shares of common stock outstanding during the period. Diluted EPS is calculated by dividing net income 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 Year Ended
October 31,
     2009    2008    2007

Weighted average common shares outstanding:

        

Basic

   6,787,186    6,784,184    7,507,708

Effect of dilutive securities:

        

Options to purchase common stock

   47,877    57,415    139,966
              

Diluted

   6,835,063    6,841,599    7,647,674

At October 31, 2009, 2008 and 2007, the Company had 27,000, 120,780 and 27,000 stock options outstanding, respectively, that could potentially dilute earnings per share in future periods that were excluded from the computation of diluted EPS as their exercise price was higher than the Company’s average stock price.

Comprehensive Income:

Comprehensive income consists of net income and other gains and losses that are not included in net income, but are recorded directly in the consolidated statements of shareholders’ equity, such as the unrealized gains and losses on the translation of the assets and liabilities of the Company’s foreign operations and gains or losses, prior service costs and transition assets or obligations associated with pension benefits, net of tax, that have not been recognized as components of net periodic benefit cost, and changes in deferred prior service costs and net actuarial losses, net of tax.

 

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Recently Issued Accounting Pronouncements

In June 2009, the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“Codification”) became the single source of authoritative accounting principles recognized by the FASB to be applied by nongovernmental entities in the preparation of financial statements in conformity with U.S. GAAP. Rules and interpretive releases of the Securities and Exchange Commission under the authority of the federal securities law are also sources of GAAP for SEC registrants. The Codification did not create any new GAAP standards but incorporated existing accounting and reporting standards into a new topical structure with a new referencing system to identify authoritative accounting standards, replacing the prior references.

In September 2006, the FASB issued a standard which defines fair value, establishes a framework for measuring fair value and expands disclosures about fair value measurements. In February 2008, the FASB delayed the effective date by one year for nonfinancial assets and nonfinancial liabilities that are recognized or disclosed at fair value in the financial statements on a nonrecurring basis. In October 2008, the FASB issued additional guidance, effective immediately, for determining the fair value of a financial asset when the market for that asset is not active to clarify the application of the provisions of the guidance for fair value measurements in an inactive market and how an entity would determine fair value in an inactive market. The Company adopted this guidance for financial assets and financial liabilities at the beginning of fiscal year 2009. The adoption of this guidance for financial assets and liabilities had no effect on the Company’s consolidated financial statements other than expanded disclosure requirements (see Note 14 to the Consolidated Financial Statements). The adoption of this guidance for non-financial assets and liabilities which is effective for the Company’s fiscal year beginning November 1, 2009 will have no material impact on our consolidated financial statements at the date of adoption, although it may impact the way that fair value for non-financial assets and liabilities is determined in future periods.

In April 2008, the FASB issued an amendment to the standard pertaining to intangible assets. This guidance discusses determination of the useful life of intangible assets and amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset. This guidance is intended to improve the consistency between the useful life of an intangible asset determined under the guidance for goodwill and other intangible assets and the period of expected cash flows used to measure the fair value of the asset. This guidance is effective for the Company’s fiscal year beginning November 1, 2009. Early adoption is prohibited. The Company does not expect the adoption of this guidance to have an impact on its consolidated financial statements.

In December 2008, the FASB issued an amendment to the standard pertaining to retirement benefits. This guidance requires enhanced disclosures about the plan assets of a Company’s defined benefit pension and other postretirement plans. The enhanced disclosures required by this guidance are intended to provide users of financial statements with a greater understanding of: (1) how investment allocation decisions are made, including the factors that are pertinent to an understanding of investment policies and strategies; (2) the major categories of plan assets; (3) the inputs and valuation techniques used to measure the fair value of plan assets; (4) the effect of fair value measurements using significant unobservable inputs on changes in plan assets for the period; and (5) significant concentrations of risk within plan assets. This guidance is effective for the Company’s fiscal year ending October 31, 2010. The adoption of this guidance will have no impact on our consolidated financial statements other than the expanded disclosure requirements.

In April 2009, the FASB issued standards that require fair value disclosures in both interim as well as annual financial statements in order to provide more timely information about the effects of current market conditions on financial instruments. These standards are effective for interim and annual periods ending after June 15, 2009. We adopted these standards as of July 31, 2009. These standards had no impact on our consolidated financial statements other than the expanded disclosure requirements (see Note 14 to the Consolidated Financial Statements).

 

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In May 2009, the FASB issued a standard which establishes general standards of accounting and disclosure for events that occur after the balance sheet date but before the financial statements are issued. It is effective for interim and annual periods ending after June 15, 2009, and accordingly, we adopted this standard during the third quarter of 2009 (see Note 19 to the Consolidated Financial Statements).

 

(3) ACQUISITIONS

Atlantis Plastics Films

On October 30, 2008, the Company completed the acquisition of substantially all of the assets of the stretch films, custom films and institutional products divisions of Atlantis Plastics, Inc. and certain of its subsidiaries (“Atlantis”) for a purchase price of $99.2 million in cash, before expenses of approximately $1.5 million. The net assets acquired included approximately $56.8 million of net working capital. The purchase price was subject to a post-closing net working capital true-up of no more than plus or minus $2.5 million. The acquisition was conducted under the supervision of the United States Bankruptcy Court for the Northern District of Georgia-Atlanta Division in connection with Atlantis’ voluntary petition for Chapter 11 protection. All pre-petition liabilities were excluded from the acquisition. The purpose of the acquisition was to synergistically complement the Company’s existing businesses. The $6.1 million deposit previously funded by the Company in August 2008 into escrow was paid to the seller, and the Company funded the remaining purchase price with $70.1 million under its revolving credit facility and $23.0 million with cash on hand. Concurrently with the acquisition of Atlantis, the Company entered into an amendment to its existing Credit Facility (see Note 8 for further discussion).

During the first half of fiscal 2009, the Company settled the net working capital true-up with Atlantis. The Company received $1.5 million on January 29, 2009 and $0.5 million on April 2, 2009. The full $2.0 million has been reflected as a reduction in the purchase price bringing the adjusted purchase price to $98.8 million after expenses.

The Company preliminarily allocated the total purchase price of $100.8 million (which included acquisition related costs of $1.5 million) to the tangible and identifiable intangible assets acquired and liabilities assumed based on their estimated fair values at the date of acquisition and using information available at that time. Concurrently with the closing of the Atlantis acquisition, the Board approved a plan to realign and reorganize the Atlantis businesses. Management finalized its reorganization plan in October 2009. In addition to the shutdown of the acquired Fontana, California plant which commenced in November 2008, the Company completed the shut down of the acquired Cartersville, Georgia plant on October 31, 2009. Costs of approximately $5.9 million associated with shutting down these plants have been recorded as an adjustment to the allocation of the purchase price. Costs associated with this restructuring include additional severance costs, lease costs, costs to be incurred as a result of the contractual obligation to put the facilities back to their original condition, equipment dismantling costs and operating costs of the facilities from November 1, 2009 until lease expiration, including estimated costs for security service, minimal utilities and property taxes. The Company expects to complete its restructuring activities related to the Fontana facility during fiscal 2010 and by July 2015 for the Cartersville facility (commensurate with the expiration of the Fontana and Cartersville leases). Due to the current market conditions in the respective areas, no sublease income has been assumed.

After revising preliminary estimates and obtaining more information regarding liabilities assumed regarding the shut down of the Fontana and Cartersville plants, the Company adjusted the preliminary purchase price allocation.

 

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The following table represents the purchase price and related preliminary and final allocations to the fair values of the assets acquired and liabilities assumed, after proportionately allocating the negative goodwill resulting from the transaction to property, plant and equipment and intangible assets.

 

     Final
Allocation At
October 31,
2009
    Preliminary
Allocation At
October 31,
2008
 
     (in thousands)  

Cash paid for certain assets and liabilities of Atlantis Plastics Films (final allocation includes $2.0 million net working capital true-up )

   $ 97,200      $ 99,276   

Acquisition costs

     1,632        1,481   
                

Total purchase price

     98,832        100,757   
                

Assets acquired and liabilities assumed:

    

Accounts receivable

     31,940        30,599   

Allowance for doubtful accounts

     (2,956     (597
                

Accounts receivable, net

     28,984        30,002   

Inventories, net

     23,958        24,041   

Other current assets

     9,180        9,193   

Deferred income taxes (current)

     2,265        424   

Property, plant and equipment

     45,324        40,857   

Deferred income taxes (long term)

     —          1,261   

Other assets

     616        616   

Intangible assets (including option to purchase property – See Note 6 for discussion)

     3,787        3,158   

Accounts payable

     (2,098     (2,098

Accrued expenses

     (5,019     (4,962

Restructuring reserve (recorded in accrued expenses and long term liabilities)

     (5,900     (50

Deferred income tax liability

     (2,265     (1,685
                

Net assets acquired

   $ 98,832      $ 100,757   
                

The roll forward of the restructuring reserve, included in accrued expenses in the consolidated balance sheets, is as follows:

 

     Severance     Facility Closure
Costs
   Lease Costs    Operating
Costs
   Total  
     (in thousands)  

Balance at October 31, 2008

   $ 50      $ —      $ —      $ —      $ 50   

Additional restructuring costs

     210        2,350      2,280      1,010      5,850   

Payments during fiscal 2009

     (173     —        —        —        (173
                                     

Balance at October 31, 2009

   $ 87      $ 2,350    $ 2,280    $ 1,010    $ 5,727   
                                     

The following unaudited pro forma information summarizes the results of operations for the fiscal years ended October 31, 2008 and 2007, as if the Atlantis acquisition had been completed as of November 1, 2007 and 2006. The pro forma information below gives effect to actual operating results prior to the acquisition. Adjustments for additional interest expense related to the borrowings made under the Amended Credit Facility and amortization of the related deferred financing costs, depreciation expense based on the fair value of the newly acquired property, plant and equipment using the Company’s depreciation policy, amortization expense related to separately identifiable intangible assets using the straight-line method over a weighted average life of

 

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12 years and the increase in the LIFO reserve related to the Atlantis inventory added to the Company’s LIFO layers are reflected in the pro forma information. These pro forma amounts do not purport to be indicative of the results that would have actually been obtained if the acquisition had occurred as of the beginning of the periods presented or that may be obtained in the future.

 

     For the Year Ended
October 31,
     2008     2007
     (in thousands,
except per share data)

Net sales

   $ 1,048,512      $ 939,323

Operating income

   $ 4,187      $ 59,734

Income (loss) from continuing operations

   $ (9,670   $ 21,129

Net income (loss)

   $ (738   $ 28,304

Basic Earnings (Loss) Per Common Share:

    

Income (loss) from continuing operations

   $ (1.43   $ 2.81
              

Income from discontinued operations

   $ 1.32      $ 0.96
              

Net income (loss) per common share

   $ (0.11   $ 3.77
              

Diluted Earnings Per Common Share:

    

Income (loss) from continuing operations

   $ (1.43   $ 2.76
              

Income from discontinued operations

   $ 1.32      $ 0.94
              

Net income (loss) per common share

   $ (0.11   $ 3.70
              

 

(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 and for U.S. supplies and printed and converted 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:

 

     October 31,
     2009    2008
     (in thousands)

Raw materials

   $ 34,442    $ 32,677

Finished goods

     35,543      42,617

Supplies

     3,248      3,537
             
     73,233      78,831

Less: Inventory reserves

     36      811
             

Inventories, net

   $ 73,197    $ 78,020
             

The LIFO method was used for determining the cost of approximately 87% and 84% of total inventories at October 31, 2009 and 2008, respectively. Inventories would have increased by $11.6 million and $31.7 million at October 31, 2009 and 2008, respectively, if the FIFO method had been used exclusively. During fiscal 2009, 2008 and 2007, the Company had certain decrements in its LIFO pools, which reduced cost of sales by $0.1 million, $0 and $0.1 million, respectively. Because of the Company’s continuous manufacturing process, there is no significant work in process at any point in time.

 

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(5) PROPERTY, PLANT AND EQUIPMENT

A summary of the components of property, plant and equipment and their estimated useful lives is as follows:

 

     October 31,   

Estimated Useful Lives

     2009    2008   
     (in thousands)     

Land

   $ 8,738    $ 7,713   

Buildings

     79,107      67,689    15 to 31.5 years

Machinery and equipment

     329,199      303,190    5 to 9 years

Furniture and fixtures

     10,964      9,797    3 to 9 years

Leasehold improvements

     2,546      2,436    Lesser of lease term or useful lives of 6 to 25 years

Motor vehicles

     349      349    3 years

Construction in progress

     5,428      14,503   
                
     436,331      405,677   

Less: Accumulated depreciation and amortization

     260,368      241,372   
                

Property, plant and equipment, net

   $ 175,963    $ 164,305   
                

Maintenance and repairs expense was approximately $9.5 million, $7.8 million, and $6.8 million for the years ended October 31, 2009, 2008 and 2007, respectively.

 

(6) GOODWILL AND INTANGIBLE ASSETS

Changes in the carrying amount of goodwill during the years ended October 31, 2009 and 2008 are as follows:

 

     (in thousands)  

Goodwill at October 31, 2007

   $ 12,273   

Realization of deferred tax assets related to Borden Global Packaging acquisition

     (1,379
        

Goodwill at October 31, 2008

     10,894   

Realization of deferred tax assets related to Borden Global Packaging acquisition

     (1,380
        

Goodwill at October 31, 2009

   $ 9,514   
        

 

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Changes in the carrying amount of intangible assets during the years ended October 31, 2009 and 2008 are as follows:

 

     Customer
List
(Mercury)
    Tradenames
(Atlantis)
    Leasehold
Interests
    Customer
relationships
    Total  
     (in thousands)  

Balance at October 31, 2007

   $ 253      $ —        $ —        $ —        $ 253   

Amortization

     (58     —          —          —          (58

Atlantis acquisition (see Note 3)

     —          931        894        1,333        3,158   
                                        

Balance at October 31, 2008

     195        931        894        1,333        3,353   

Exercise of option to purchase property

     —          —          (1,105     —          (1,105

Amortization

     (59     (85     (21     (110     (275

Final reallocation of negative goodwill (see Note 3)

     —          123        229        277        629   
                                        

Balance at October 31, 2009

   $ 136      $ 969      $ (3   $ 1,500      $ 2,602   
                                        

Included in leasehold interests was the Company’s option to purchase a Mankato, Minnesota property (previously under an operating lease) from the lessor (the City of Mankato) for a purchase price of $2.3 million minus 50% of that portion of each rental payment that would be considered principal reduction (increasing to 75% during the last 24 months of the lease term). The Company allocated $1.1 million of value to this option to purchase. The Company exercised this option to purchase on June 26, 2009 for $1.4 million. The allocated value of the option to purchase was reclassified to property, plant and equipment at the time of purchase.

Amortization periods over a straight-line basis are as follows:

 

     In Years

Customer list

   6

Trade names—Linear Films

   10

Trade names—Sta-Dri

   20

Customer relationships

   13

Unfavorable lease

   6.8

Favorable lease

   2

 

(7) ACCRUED EXPENSES

At October 31, 2009 and 2008, accrued expenses consist of the following:

 

     October 31,
     2009    2008
     (in thousands)

Payroll and employee related

   $ 12,076    $ 6,538

Customer rebates

     5,825      6,080

Interest

     1,631      1,790

Taxes (other than income)

     1,879      1,509

Accrual for performance units

     1,942      600

Accrued professional fees

     837      2,131

Current portion of capital lease

     1,041      —  

Income taxes payable

     113      20

Reserve for Atlantis restructuring (see Note 3) (a)

     3,727      50

Reserve for product liability claim (b)

     4,660      —  

Other

     2,985      5,044
             

Accrued expenses

   $ 36,716    $ 23,762
             

 

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(a) Total reserve for Atlantis restructuring is $5.7 million at October 31, 2009, of which $2.0 million is recorded in other long-term liabilities.
(b) This claim was settled in December 2009. The amount is indemnified by the Company’s insurance carrier except for $25,000 representing the insurance deductible. The asset related to the insurance recovery is included in other current assets in the consolidated balance sheet at October 31, 2009.

 

(8) DEBT

A summary of the components of debt is as follows:

 

     October 31,
2009
   October 31,
2008
     (in thousands)

Credit facility (a)

   $ 7,514    $ 70,000

7.875% senior notes due 2013 (b)

     160,160      175,000

Pennsylvania Industrial Loans (c)

     2,326      2,833

Foreign bank borrowings (d)

     —        1,322
             

Total debt

     170,000      249,155

Less: current portion

     531      1,826
             

Long-term debt

   $ 169,469    $ 247,329
             

 

(a) Credit facility

The Company maintains a secured credit facility with Wachovia Bank N.A. as initial lender thereunder and as agent for the lenders thereunder, which was last amended on October 30, 2008 to increase the maximum borrowing amount from $125.0 million to $150.0 million and extending the maturity to December 15, 2012 (the “Amended Credit Facility”). The Amended Credit Facility has a maximum borrowing amount of $150.0 million, including a maximum of $20.0 million for letters of credit, and matures on December 15, 2012. The Company can reduce commitments under the Credit Facility at any time after October 30, 2009.

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 average borrowings under the Credit Facility of approximately $37.6 million and $17.7 million, with a weighted average interest rate of 3.3% and 5.8%, during fiscal 2009 and 2008. Under the Amended Credit Facility, interest rates are based upon Excess Availability (as defined) at a margin of the prime rate (defined as the greater of Wachovia’s prime rate and the Federal Funds rate plus 0.50%) plus 0% to 0.25% for overnight borrowings and LIBOR plus 2.25% to 2.75% for LIBOR borrowings up to six months.

Borrowings and letters of credit available under the Amended Credit Facility are limited to a borrowing base based upon specific advance percentage rates on eligible domestic assets (including receivables), subject, in the case of inventory, equipment and real property, to amount limitations. The sum of eligible domestic assets at October 31, 2009 and 2008 supported a borrowing base of $122.0 million and $150.0 million, respectively. Availability was reduced by the aggregate amount of letters of credit outstanding totaling $1.2 million and $0.9 million at October 31, 2009 and 2008, respectively. Borrowings outstanding under the Credit Facility were $7.5 million and $70.0 million at October 31, 2009 and 2008, respectively. Therefore, availability at October 31, 2009 and 2008 under the Credit Facility was $113.3 million and $79.1 million, respectively.

The Credit Facility is secured by mortgages and liens on most of the Company’s domestic assets and on 66% of the Company’s ownership interest in certain foreign subsidiaries. The secured domestic assets had a net carrying value of $296.2 million and $315.6 million at October 31, 2009 and 2008, respectively.

 

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The Amended Credit Facility contains customary bank covenants, including, but not limited to, financial covenants, 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 Amended Credit Facility also provides for events of default. If an event of default occurs and is continuing, amounts due under the Amended Credit Facility may be accelerated and the commitments to extend credit thereunder terminated.

If Excess Availability under the Credit Facility is less than $15.0 million, a springing lock-box 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 lock-box remain in place until the Excess Availability exceeds $15.0 million for 30 consecutive days. During any period in which the lock-box is activated, all debt outstanding under the Credit Facility would be classified as a current liability, which classification may materially affect the Company’s working capital ratio. Excess Availability under the Credit Facility ranged from $60.7 million to $113.3 million during fiscal 2009 and from $66.0 million to $123.0 million during fiscal 2008.

The Company has an unused line fee related to the Credit Facility. During fiscal 2009, 2008 and 2007, the Company paid unused line fees of approximately $0.3 million, $0.2 million and $0.3 million, respectively, which are included in general and administrative expenses in the consolidated statements of operations.

The Company has paid and capitalized $1.6 million of fees related to the Amended Credit Facility. These fees, along with the unamortized fees of $0.2 million related to the Original Credit Facility, are being amortized on a straight line basis over 50 months, the term of the Amended Credit Facility.

The Company was in compliance with the financial and other covenants at October 31, 2009 and October 31, 2008.

(b) 7.875% Senior Notes due 2013

On March 18, 2005, the Company completed the sale of $175 million aggregate principal amount of 7.875% Senior Notes due March 15, 2013 (“2013 Notes”) through a private offering.

With Board approval, we repurchased and retired $14.8 million (principal amount) of the Company’s 2013 Notes at a price of 62.8% of par on April 1, 2009. The cash paid was $9.4 million which included $0.1 million of accrued interest. The Company used proceeds from sale-leaseback transactions and borrowings under its Credit Facility to fund the buyback of the 2013 Notes. In connection with the partial retirement, the Company recognized a gain on extinguishment of debt of $5.3 million, which is the difference between the repurchase amount of $9.3 million and the principal amount retired of $14.8 million, net of the pro-rata write-off of the unamortized debt financing costs related to the 2013 Notes of $0.2 million. On April 14, 2009, the Board approved an increase to the previously authorized Senior Note Repurchase Program to a total of $25.0 million (representing an additional $14.0 million from the initial approval), increasing availability to $15.7 million under such program. On November 2, 2009, the Board terminated the 2009 Senior Note Repurchase Program and authorized the 2010 Senior Note Repurchase Program which allows the Company to spend up to $25.0 million to repurchase its outstanding 2013 Notes. Repurchases may be made in the open market, privately negotiated transactions or by other means from time to time, subject to conditions, applicable legal requirements and other factors, including the limitations set forth in our debt covenants. The amounts involved in any such transactions, individually or in the aggregate, may be material and may be funded from available cash or from additional borrowings. The program does not obligate us to acquire any particular amount of the 2013 Notes and the program may be suspended at any time at management’s discretion.

The 2013 Notes mature on March 15, 2013, and contain certain customary covenants that, among other things, limit the Company’s ability and the ability of its subsidiaries to incur additional indebtedness, pay dividends, sell assets, merge or consolidate or create liens. The Company was in compliance with all of these covenants at October 31, 2009 and October 31, 2008.

 

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Interest is paid semi-annually on every March 15th and September 15th.

The 2013 Notes are subject to redemption, at the option of the Company, in whole or in part, at any time on or after March 31, 2009 and prior to maturity at certain fixed redemption prices plus accrued interest. The 2013 Notes do not have any sinking fund requirements. The 2013 Notes contain a provision that in the event of a change in control, the Company is required to offer to purchase the outstanding 2013 Notes. If a change of control were to occur and the Company was unable to obtain a waiver or did not have funds to make the purchase, the Company would be in default under the 2013 Notes.

During fiscal 2005, $5.5 million of fees were paid and capitalized related to the issuance of the 2013 Notes. These fees are being amortized on a straight line basis over eight years, the term of the 2013 Notes. During each of the fiscal years 2009, 2008 and 2007, in addition to the pro-rata write-off in April 2009 of the unamortized debt financing costs of $0.2 million discussed above, the Company amortized approximately $0.7 million into interest expense related to these fees in the consolidated statements of operations.

(c) Pennsylvania Industrial Loans

The Company has certain amortizing fixed rate term loans in connection with the construction in fiscal 1995 and the expansion in fiscal 2008 of its Wright Township, Pennsylvania manufacturing facility. The following are outstanding at October 31, 2009 and 2008:

A $0.3 million five year fixed rate 5.0% loan, originated in October 2008, due on November 1, 2013, of which $0.3 million and $0.3 million outstanding at October 31, 2009 and 2008, respectively;

A $1.4 million fifteen year fixed rate 4.75% loan, originated in October 2008, due November 1, 2023, of which $1.3 million and $1.4 million was outstanding at October 31, 2009 and 2008, respectively;

A $2.0 million fifteen year fixed rate 2.0% loan, due on July 1, 2011, of which $0.3 million and $0.4 million was outstanding at October 31, 2009 and 2008, respectively; and

A $3.3 million fifteen year fixed rate 2.0% loan, due on July 1, 2011, of which $0.4 million and $0.7 million was outstanding at October 31, 2009 and 2008, respectively.

These financing arrangements are secured by the real property of the manufacturing facility located in Wright Township, Pennsylvania, which had a net carrying value of $12.6 million at October 31, 2009.

(d) 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 and $1.3 million outstanding in Canada at October 31, 2009 and 2008, respectively. The weighted average interest rate on the Canadian credit facility for fiscal 2009 and 2008 was 4.0% and 6.5%, respectively. Availability under the Canadian credit facility at October 31, 2009 and October 31, 2008 was $4.6 million and $2.8 million, respectively.

 

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

 

     (in thousands)

2010

   $ 531

2011

     441

2012

     145

2013

     167,827

2014

     89

Thereafter

     967
      
   $ 170,000
      

Cash paid for interest during fiscal 2009, 2008 and 2007 was approximately $14.6 million, $15.4 million and $15.6 million, respectively, including interest paid by the discontinued operations of zero, $0.4 million and $0.9 million in fiscal 2009, 2008 and 2007, respectively.

 

(9) PENSIONS AND RETIREMENT SAVINGS PLAN

The Company sponsors a defined contribution plan in the United States and defined benefit and defined contribution plans in its Canadian location. Total expense for these plans for 2009, 2008 and 2007 was $2.6 million, $2.5 million and $2.3 million, respectively.

401(k) Savings and Employee Stock Ownership Plan

Employees of the Company in the United States who have completed one year of service (with the exception of those employees covered by a collective bargaining agreement at its California facility) may participate in a 401(k) Savings and Employee Stock Ownership Plan (the “Plan”). Effective for the fiscal 2006 plan year and thereafter, the Company has and will contribute cash to the Plan. Prior to this, the Company contributed common stock held in treasury.

The Company makes contributions to the Plan equal to 1% of a participant’s compensation for the Plan year and matches 100% of the first 3% and 50% of the following 2% of each participant’s 401(k) contribution with a maximum of 5% of the participant’s annual compensation. In fiscal 2009, 2008 and 2007, the Company contributed $2.2 million $2.0 million and $1.9 million in cash to the Plan in fulfillment of the 2008, 2007 and 2006 contribution requirement, respectively.

Effective January 1, 2007, the Plan was amended to permit participants 55 and over with three or more years of service to diversify up to 100 percent of the company’s contributions previously allocated to the Company’s stock to a variety of funds. Participants under the age of 55 with three or more years of service are permitted to diversify 33%, 66% and 100% during the plan years (January to December) ended 2007, 2008 and 2009, respectively. The diversification remains subject to the otherwise applicable securities law restrictions on making investments changes regarding the Company’s stock.

At October 31, 2009, there were 340,693 shares of the Company’s common stock held by the Plan, representing approximately 5% of the total number of shares outstanding. Shares of the Company’s common stock credited to each member’s account under the Plan are voted by the trustee under instructions from each individual plan member. Shares, for which no instructions are received, along with any unallocated shares held in the Plan, are not voted.

Defined Contribution Plans

The Company sponsors a defined contribution plan in Canada. The plan covers full time employees and provides for a base employer contribution of 4.5% of salary plus an additional matching contribution of 50% of employee contributions up to 5% (for a maximum employer contribution of 7% of salary). The Company’s contributions related to these plans for each of fiscal 2009, 2008 and 2007 totaled approximately $0.2 million.

 

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Defined Benefit Plans

The Company has a defined benefit plan in Canada. Benefits under this plan are based on specified amounts per year of credited service. The Company funds these plans in accordance with the funding requirements of local law and regulations.

In September 2006, the FASB issued a standard requiring the Company to fully recognize and disclose an asset or liability for the overfunded or underfunded status of its benefit plans in its financial statements. Prior accounting standards allowed an employer to delay recognition of certain economic events that affected the costs of providing postretirement benefits and to disclose the overfunded or underfunded status of a plan in the notes to the financial statements. This standard eliminates the delayed recognition of actuarial gains and losses and prior service costs and credits that arise during the period and requires employers to recognize these items as components of other comprehensive income, net of tax. The recognition and disclosure requirements were effective for the Company’s fiscal year ended October 31, 2007. Upon adoption, additional minimum pension liabilities and related intangible assets were derecognized. As of October 31, 2007, the adoption adjustments related to recognition of previously unrecognized prior service cost and net actuarial losses for Canada and AEP Netherlands (sold in April 2008) are discussed below.

 

     Pre-Adoption    
Adoption
Adjustments
    Post-
Adoption
 
     (in thousands)  

Assets:

      

Deferred income taxes

   $ —        $ 368      $ 368   

Liabilities:

      

Other long-term liabilities

     (3,881     (1,120     (5,001

Shareholders’ equity:

      

Accumulated other comprehensive income (loss)

   $ —        $ (752   $ (752

The net periodic pension costs for the Canadian defined benefit plan for fiscal 2009, 2008 and 2007 was $217,000, $162,000 and $152,000, respectively.

The funded status of the Canadian defined benefit plan and the net amount recognized in the consolidated balance sheets and in accumulated other comprehensive income (loss) is shown below (based on an October 31 measurement date):

 

     October 31,  
     2009     2008  
     (in thousands)  

Pension benefit obligation at end of year

   $ 3,321      $ 2,567   

Fair value of plan assets at end of year

   $ 3,192      $ 2,400   
                

Funded status

   $ (129   $ (167
                

Amounts recognized in the consolidated balance sheets consist of:

    

Other long-term liabilities

   $ (129   $ (167

Other assets

     —          —     

Amounts recognized in the accumulated other comprehensive income (loss):

    

Prior service cost

   $ (890   $ (881

Net actuarial loss

     (519     (313

Tax

     437        370   
                

Net amount recognized, after tax

   $ (972   $ (824
                

Accumulated benefit obligation

   $ 3,321      $ 2,564   

 

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The estimated net actuarial gain and prior service cost that will be amortized from accumulated other comprehensive income into net periodic pension cost in fiscal 2010 are:

 

     (in thousands)

Amortization of prior service cost

   $ 94

Amortization of net actuarial loss

     16
      

Total

   $ 110
      

It is the objective of the plan sponsors to maintain an adequate level of diversification to balance market risk, to prudently invest to preserve capital and to provide sufficient liquidity while maximizing earnings for near-term payments of benefits accrued under the plans and to pay plan administrative expenses. Plan assets are diversified across several investment managers and are generally invested in liquid funds that are selected to track broad market equity and bond indices. Investment risk is carefully controlled with plan assets rebalanced to target allocations on a periodic basis and continual monitoring of investments managers performance. The assumption used for the expected long-term rate of return on plan assets is based on the long-term expected returns for the investment mix of assets currently in the portfolio. Historical return trends for the various asset classes in the class portfolio are combined with anticipated future market conditions to estimate the rate of return for each class. These rates are then adjusted for anticipated future inflation to determine estimated nominal rates of return for each class. The following table presents the weighted average actual asset allocations as of October 31, 2009 and 2008 and the target allocation of pension plan assets for fiscal 2010:

 

     October 31,     Target
Allocation
 
     2009     2008    

Canadian equity securities

   30   29   34

International equity securities

   32   31   25

Debt securities

   37   36   36

Other

   1   4   5
                  

Total

   100   100   100
                  

The Company expects to contribute a total of approximately $0.4 million to its Canada defined benefit plans during fiscal 2010.

 

(10) SHAREHOLDERS’ EQUITY

Share-Based Compensation

At October 31, 2009, the Company has two types of share-based plans: stock option plans, which provide for the granting of stock options and performance units to officers, directors and key employees of the Company, and an employee stock purchase plan. Total share-based compensation expense related to the Company’s stock options plans and employee stock purchase plan are recorded in the consolidated statements of operations as follows:

 

     For the Year Ended
October 31,
     2009    2008    2007
     (in thousands)

Cost of sales

   $ 833    $ 80    $ 902

Selling expense

     938      92      798

General and administrative expense

     2,265      198      1,637
                    

Total

   $ 4,036    $ 370    $ 3,337
                    

 

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Stock Option Plans

The Company’s 1995 Stock Option Plan (“1995 Option Plan”) expired on December 31, 2004, except as to options granted prior to that date. The Company’s Board of Directors (the “Board”) adopted the AEP Industries Inc. 2005 Stock Option Plan (“2005 Option Plan”) and the Company’s shareholders approved the 2005 Option Plan at its annual shareholders meeting. The 2005 Option Plan became effective January 1, 2005 and will expire on December 31, 2014. The 2005 Option Plan provides for the granting of incentive stock options which may be exercised over a period of ten years, and the issuance of stock appreciation rights, restricted stock, performance units and non-qualified stock options, including fixed annual grants to non-employee directors. Under the 2005 Option Plan, each non-employee director receives a fixed annual grant of 2,000 stock options as of the date of the annual meeting of shareholders. The Company has reserved 1,000,000 shares of the Company’s common stock for issuance under the 2005 Option Plan. 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 2009, 2008 and 2007 has been made from new shares. At October 31, 2009, 590,634 shares are available to be issued under the 2005 Option 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.

The table below presents the weighted average assumptions used to calculate the fair value of stock options granted during the years ended October 31, 2009, 2008 and 2007.

 

     For the Year Ended October 31,  
     2009     2008     2007  

Expected volatility

     54.51     56.88     60.58

Expected life in years

     7.5        7.5        7.5   

Risk-free interest rates

     2.26     3.67     4.68

Dividend rate

     0     0     0

Weighted average fair value per option at date of grant

   $ 9.95      $ 20.47      $ 28.22   

 

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The following table summarizes the Company’s stock option plans as of October 31, 2009 and changes during each of the three year periods ended October 31, 2009:

 

     1995
Option
Plan
    2005
Option
Plan
    Total
Number
Of
Options
    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, 2006 (174,657 options exercisable)

   377,752      18,600      396,352      $ 16.90    $ 6.90-51.00      

Granted

   —        12,000      12,000      $ 42.60    $ 42.60      

Exercised

   (76,453   —        (76,453   $ 15.62    $ 6.90-46.00      

Forfeited/Cancelled

   (8,958   (2,000   (10,958   $ 14.01    $ 9.30-33.84      

Expired

   (2,000   —        (2,000   $ 46.00    $ 46.00      
                             

Options outstanding at October 31, 2007 (177,714 options exercisable)

   290,341      28,600      318,941      $ 18.09    $ 6.90-51.00      

Granted

   —        24,000      24,000      $ 32.73    $ 27.36-38.10      

Exercised

   (14,674   —        (14,674   $ 9.08    $ 6.90-9.30      

Forfeited/Cancelled

   (4,948   —        (4,948   $ 9.18    $ 7.87-9.30      

Expired

   (13,000   —        (13,000   $ 45.63    $ 35.25-46.50      
                             

Options outstanding at October 31, 2008 (215,011 options exercisable)

   257,719      52,600      310,319      $ 18.63    $ 6.90-51.00      

Granted

   —        12,000      12,000      $ 17.07    $ 17.07      

Exercised

   (64,063   (800   (64,863   $ 10.38    $ 6.90-32.80      

Forfeited/Cancelled

   (992   —        (992   $ 9.30    $ 9.30      

Expired

   (1,000   —        (1,000   $ 26.63    $ 26.63      
                             

Options outstanding at October 31, 2009

   191,664      63,800      255,464      $ 20.66    $ 7.87-51.00    4.6    3,812
                             

Vested and expected to vest at October 31, 2009

   191,664      63,800      255,464      $ 20.66       4.6    3,812
                             

Exercisable at October 31, 2009

   191,664      20,000      211,664      $ 18.78       3.9    3,501
                             

The table below presents information related to stock option activity for the years ended October 31, 2009, 2008 and 2007:

 

     For the Year Ended
October 31,
     2009    2008    2007
     (in thousands)

Total intrinsic value of stock options exercised

   $ 1,532    $ 265    $ 2,453

Total fair value of stock options vested

   $ 579    $ 531    $ 801

Share-based compensation expense related to the Company’s stock options recorded in the consolidated statements of operations for the years ended October 31, 2009, 2008 and 2007 was $0.3 million, $0.6 million and $0.6 million, respectively. No compensation cost related to stock options was capitalized in inventory or any other assets for the years ended October 31, 2009, 2008 and 2007, respectively. For fiscal 2009, 2008 and 2007 there were no excess tax benefits recognized resulting from share-based compensation awards as the Company was not in a federal tax paying position.

 

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As of October 31, 2009, there was $0.7 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 3.3 years.

Non-vested Stock Options

A summary of the Company’s non-vested stock options at October 31, 2009 and changes during fiscal 2009 are presented below:

 

Non-vested stock options

   Shares     Weighted Average
Grant Date Fair
Value

Non-vested at October 31, 2008

   95,308      $ 13.49

Granted

   12,000      $ 9.95

Vested

   (63,412   $ 9.13

Forfeited/cancelled

   (96   $ 6.51
        

Non-vested at October 31, 2009

   43,800      $ 18.83
        

If an employee is terminated for any reason by the Company, or due to disability or retirement, any outstanding stock options that are exercisable as of the termination date may be exercised until the earlier of (1) three months following the termination date and (2) the expiration of the stock option term. If an employee ceases to be employed due to death, any outstanding stock options will become exercisable in full and the beneficiary may exercise such stock options until the earlier of (1) one year following the date of death and (2) the expiration of the stock option term. Notwithstanding the foregoing, the Compensation Committee retains discretionary authority at any time, including immediately prior to or upon a change of control, to accelerate the exercisability of any award.

Performance Units

The 2005 Option Plan also provides for the granting of Board approved performance units (“Units”). Outstanding Units are subject to forfeiture based on an annual EBITDA (earnings before interest, taxes, depreciation and amortization) or Adjusted EBITDA (EBITDA, as adjusted for share-based compensation expense) performance goal as determined and adjusted by the Board. If the Company’s EBITDA or Adjusted EBITDA equals or exceeds the performance goal, no Units will be forfeited. If the Company’s EBITDA or 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 EBITDA or Adjusted EBITDA is less than the performance goal. If EBITDA or 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.

The Units will immediately vest (subject to pro-ration, if such termination event occurs during or as of the end of the fiscal year in which the initial grant was made) in the event of (1) the death of an employee, (2) the permanent disability of an employee (within the meaning of the Internal Revenue Code of 1986, as amended) or (3) a termination of employment due to the disposition of any asset, division, subsidiary, business unit, product line or group of the Company or any of its affiliates. In the case of any other termination, any unvested performance units will be forfeited. Notwithstanding the foregoing, the Compensation Committee retains discretionary authority at any time, including immediately prior to or upon a change of control, to accelerate the exercisability of any award, or the end of a performance period. 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.

 

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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 will recognize 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 related to the Units was approximately $3.5 million of expense, $0.4 million of income (resulting from the decrease in the Company’s stock price at October 31, 2008), and $2.5 million of expense for the years ended October 31, 2009, 2008 and 2007, respectively. During the year ended October 31, 2009, the Company paid $0.6 million in cash and issued 611 shares of its common stock, in each case net of withholdings, in settlement of the vesting of Units occurring during fiscal 2009. During the year ended October 31, 2008, the Company paid $0.5 million in cash and issued 4,749 shares of its common stock, in each case net of withholdings, in settlement of the vesting of Units occurring during fiscal 2008. During the year ended October 31, 2007, the Company paid $0.9 million in cash and issued 600 shares of its common stock, in each case net of withholdings, in settlement of the vesting of Units occurring during fiscal 2007. At October 31, 2009 and October 31, 2008, there were $1.9 million and $0.6 million in current liabilities and $2.0 million and $0.8 million in long-term liabilities, respectively, related to outstanding Units.

The following table summarizes the Units as of October 31, 2009 and changes during each of the three year periods ended October 31, 2009:

 

     2005
Option
Plan
         Weighted
Average
Exercise
Price
   Weighted
Average
Remaining
Contractual
Term
(years)
   Aggregate
Intrinsic
Value
$(000)

Units outstanding at October 31, 2006

   163,333              

Units granted

   29,700              

Units exercised

   (33,066           

Units forfeited or cancelled

   (3,700           
                 

Units outstanding at October 31, 2007

   156,267              

Units granted

   58,014              

Units exercised

   (38,040           

Units forfeited or cancelled

   (60,881   A         
                 

Units outstanding at October 31, 2008

   115,360            1.6    $ 2,258

Units granted

   165,450      B    $ 0.00      

Units exercised

   (39,040      $ 0.00       $ 914

Units forfeited or cancelled

   (7,950           
                 

Units outstanding at October 31, 2009

   233,820         $ 0.00    1.8    $ 8,156
                 

Vested and expected to vest at October 31, 2009

   228,670         $ 0.00    1.8    $ 7,976
                 

Exercisable at October 31, 2009

   —                
                 

 

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(A) The 2008 grants of Units have been forfeited in their entirety because the Company did not achieve at least 80% of the fiscal 2008 EBITDA performance goal.
(B) 100% of the 2009 EBITDA performance goal has been met.

Employee Stock Purchase Plan

The Company’s 2005 Employee Stock Purchase Plan (“2005 Purchase Plan”) became effective July 1, 2005 and will expire on June 30, 2015. The 2005 Purchase Plan provides for an aggregate of 250,000 shares of the Company’s common stock to be made available for purchase by eligible employees of the Company, including directors and officers, through payroll deductions over successive six-month offering periods. The purchase price of the common stock under the 2005 Purchase Plan is 85% of the lower of the closing sales price per share of the Company’s common stock on Nasdaq on either the first or last trading day of each six-month offering period. During the years ended October 31, 2009, 2008 and 2007, 40,638, 29,209 and 17,568 shares were purchased, respectively, by employees pursuant to the 2005 Purchase Plan.

Total share-based compensation expense related to the 2005 Purchase Plan was $0.2 million for each of the years ended October 31, 2009, 2008 and 2007.

Treasury Shares

On November 1, 2007, the Company’s Board approved a stock repurchase program under which the Company was authorized to purchase up to $5.0 million of its common stock. On January 11, 2008, the Board increased the amount with which the Company may repurchase its common stock from $5.0 million to $8.0 million (“the January 2008 repurchase program”). Between January 24 and May 7, 2008, the Company repurchased under the January 2008 repurchase program, 149,410 shares of its common stock in the open market, totaling $4.3 million.

On June 6, 2008, the Board terminated the January 2008 repurchase program (which had approximately $3.7 million remaining as of such date) and approved a new $8.0 million stock repurchase program (the “June 2008 stock repurchase program”). Repurchases may 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. The program does not obligate the Company to acquire any particular amount of common stock and the program may be suspended at any time at the Company’s discretion. Through October 31, 2009, there were no repurchases made under the June 2008 stock repurchase program.

Between November 9 and November 20, 2009, the Company repurchased under its June 2008 stock repurchase program, 52,500 shares of its common stock in the open market an average cost of $36.84 per share, totaling $1.9 million.

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.

 

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(11) INCOME TAXES

The U.S. and foreign components of income (loss) from continuing operations before (provision) benefit for income taxes are as follows:

 

     For the Year Ended
October 31,
     2009    2008     2007
     (in thousands)

U.S.

   $ 48,068    $ (7,359   $ 33,930

Foreign

     1,355      2,137        4,164
                     

Total

   $ 49,423    $ (5,222   $ 38,094