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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

 

x

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

For the Quarterly Period Ended April 30, 2011

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 0-14450

 

 

AEP Industries Inc.

(Exact name of registrant as specified in its charter)

 

Delaware		22-1916107
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)
125 Phillips Avenue South Hackensack, New Jersey		07606
(Address of principal executive offices)		(Zip code)

(201) 641-6600

(Registrant’s telephone number, including area code)

Not Applicable

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

 

 

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

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

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

 

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

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

The number of outstanding shares of the registrant’s common stock, $0.01 par value, as of June 7, 2011 was 6,137,888.

 

 

 

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AEP INDUSTRIES INC.

TABLE OF CONTENTS

 

				Page Number
PART I		FINANCIAL INFORMATION
ITEM 1:		Financial Statements			3
		Consolidated Balance Sheets at April 30, 2011 (unaudited) and October 31, 2010			3
		Consolidated Statements of Operations and Other Comprehensive (Loss) Income for the three and six months ended April 30, 2011 and 2010 (unaudited)			4
		Consolidated Statements of Cash Flows for the six months ended April 30, 2011 and 2010 (unaudited)			5
		Notes to Consolidated Financial Statements			6
ITEM 2:		Management’s Discussion and Analysis of Financial Condition and Results of Operations			23
ITEM 3:		Quantitative and Qualitative Disclosures About Market Risk			34
ITEM 4:		Controls and Procedures			35
PART II		OTHER INFORMATION
ITEM 1:		Legal Proceedings			35
ITEM 1A:		Risk Factors			35
ITEM 2:		Unregistered Sales of Equity Securities and Use of Proceeds			38
ITEM 3:		Defaults Upon Senior Securities			38
ITEM 4:		[Removed and Reserved]			38
ITEM 5:		Other Information			38
ITEM 6:		Exhibits			38
		Signatures			40

 

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PART I—FINANCIAL INFORMATION

 

Item  1.

FINANCIAL STATEMENTS

AEP INDUSTRIES INC.

CONSOLIDATED BALANCE SHEETS

(in thousands, except share amounts)

 

		April 30, 2011				October 31, 2010
		(unaudited)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents		$	10,901			$	1,049
Accounts receivable, less allowance for doubtful accounts of $3,993 and $4,345 in 2011 and 2010, respectively			100,241				86,625
Inventories, net			92,065				72,978
Deferred income taxes			2,683				3,336
Other current assets			4,219				3,262
Assets of discontinued operations			200				188
Total current assets			210,309				167,438
PROPERTY, PLANT AND EQUIPMENT, at cost, less accumulated depreciation and amortization of $292,509 and $281,292 in 2011 and 2010, respectively			167,586				169,343
GOODWILL			7,445				8,135
INTANGIBLE ASSETS, net of accumulated amortization of $857 and $726 in 2011 and 2010, respectively			2,050				2,181
OTHER ASSETS			6,931				3,699
Total assets		$	394,321			$	350,796
LIABILITIES AND SHAREHOLDERS’ EQUITY
CURRENT LIABILITIES:
Bank borrowings, including current portion of long-term debt		$	26,680			$	441
Accounts payable			79,041				72,564
Accrued expenses			20,641				23,886
Total current liabilities			126,362				96,891
LONG-TERM DEBT			201,282				185,259
DEFERRED INCOME TAXES			2,594				4,836
OTHER LONG-TERM LIABILITIES			6,272				7,180
Total liabilities			336,510				294,166
COMMITMENTS AND CONTINGENCIES
SHAREHOLDERS’ EQUITY:
Preferred stock, $1.00 par value; 970,000 shares authorized; none issued			—				—
Series A junior participating preferred stock, $1.00 par value; 30,000 shares authorized; none issued			—				—
Common stock, $0.01 par value; 30,000,000 shares authorized; 11,093,271 and 11,086,485 shares issued in 2011 and 2010, respectively			111				111
Additional paid-in capital			109,343				109,047
Treasury stock at cost, 4,955,783 and 4,942,783 shares in 2011 and 2010, respectively			(150,781	)			(150,424	)
Retained earnings			96,163				95,776
Accumulated other comprehensive income			2,975				2,120
Total shareholders’ equity			57,811				56,630
Total liabilities and shareholders’ equity		$	394,321			$	350,796

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

AND OTHER COMPREHENSIVE (LOSS) INCOME

(UNAUDITED)

(in thousands, except per share data)

 

		For the Three Months Ended April 30,								For the Six Months Ended April 30,
		2011				2010				2011				2010
NET SALES		$	248,540			$	215,662			$	466,267			$	372,832
COST OF SALES			218,670				189,857				406,887				328,982
Gross profit			29,870				25,805				59,380				43,850
OPERATING EXPENSES:
Delivery			11,296				10,360				21,589				18,454
Selling			8,786				9,247				17,497				17,650
General and administrative			5,441				4,963				10,912				10,801
Total operating expenses			25,523				24,570				49,998				46,905
OTHER OPERATING INCOME (EXPENSE):
Gain (loss) on sales of property, plant and equipment, net			4				(7	)			(18	)			203
Operating income (loss)			4,351				1,228				9,364				(2,852	)
OTHER (EXPENSE) INCOME:
Interest expense			(5,652	)			(3,850	)			(9,465	)			(7,610	)
Other, net			(48	)			191				59				226
Loss before benefit for income taxes			(1,349	)			(2,431	)			(42	)			(10,236	)
BENEFIT FOR INCOME TAXES			671				934				429				3,839
Net (loss) income		$	(678	)		$	(1,497	)		$	387			$	(6,397	)
BASIC (LOSS) EARNINGS PER COMMON SHARE:
Net (loss) income per common share		$	(0.11	)		$	(0.22	)		$	0.06			$	(0.94	)
DILUTED (LOSS) EARNINGS PER COMMON SHARE:
Net (loss) income per common share		$	(0.11	)		$	(0.22	)		$	0.06			$	(0.94	)
		For the Three Months Ended April 30,								For the Six Months Ended April 30,
		2011				2010				2011				2010
Consolidated Statements of Other Comprehensive (Loss) Income:
Net (loss) income		$	(678	)		$	(1,497	)		$	387			$	(6,397	)
Other comprehensive income:
Foreign currency translation adjustments			644				448				807				825
Amortization of prior service cost, net of tax			24				20				48				40
Comprehensive (loss) income		$	(10	)		$	(1,029	)		$	1,242			$	(5,532	)

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

 

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AEP INDUSTRIES INC.

CONSOLIDATED STATEMENTS OF CASH FLOWS

(UNAUDITED)

(in thousands)

 

		For the Six Months Ended April 30,
		2011				2010
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)		$	387			$	(6,397	)
Adjustments to reconcile net income (loss) to net cash used in operating activities:
Depreciation and amortization			10,893				10,726
Change in LIFO reserve			13,372				17,275
Share-based compensation expense			1,381				925
Write-off of 2013 senior notes issuance costs			1,034				—
Change in deferred income taxes			(1,044	)			(3,909	)
Amortization of debt fees			543				550
Provision for losses on accounts receivable and inventories			347				220
Premium on purchase of 2013 senior notes			334				—
Other			1				(117	)
Changes in operating assets and liabilities:
Increase in accounts receivable			(13,167	)			(7,830	)
Increase in inventories			(32,130	)			(17,345	)
Increase in other current assets			(786	)			(183	)
Increase in other assets			(277	)			(60	)
Increase (decrease) in accounts payable			6,128				(628	)
Decrease in accrued expenses			(4,946	)			(10,037	)
Decrease in other long-term liabilities			(145	)			(155	)
Net cash used in operating activities			(18,075	)			(16,965	)
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures			(8,557	)			(5,249	)
Net proceeds from dispositions of property, plant and equipment			22				287
Net cash used in investing activities			(8,535	)			(4,962	)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of 8.25% 2019 senior notes			200,000				—
Repurchase of 7.875% 2013 senior notes			(134,056	)			—
Net (repayments) borrowings from Credit Facility			(23,745	)			24,386
Repayments of Pennsylvania Industrial Loans			(271	)			(264	)
Principal payments on capital lease obligations			(543	)			(513	)
Buyback of common stock			(357	)			(1,934	)
Proceeds from issuance of common stock			—				398
Proceeds from exercise of stock options			47				172
Fees paid and capitalized related to issuance of 2019 notes			(4,260	)			—
Other			(257	)			(479	)
Net cash provided by financing activities			36,558				21,766
EFFECTS OF EXCHANGE RATE CHANGES ON CASH			(96	)			256
Net increase in cash			9,852				95
CASH AND CASH EQUIVALENTS AT BEGINNING OF PERIOD			1,049				301
CASH AND CASH EQUIVALENTS AT END OF PERIOD		$	10,901			$	396
SUPPLEMENTAL CASH FLOW DISCLOSURE:
Cash paid during the period for interest		$	8,158			$	7,013
Cash paid during the period for income taxes		$	525			$	284

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

 

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AEP INDUSTRIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

 

(1)	BASIS OF PRESENTATION

The accompanying consolidated financial statements include the accounts of AEP Industries Inc. and all of its subsidiaries (the “Company”). All significant intercompany transactions and balances have been eliminated in consolidation. In management’s opinion, all adjustments necessary for the fair presentation of the consolidated financial position as of April 30, 2011, the consolidated results of operations for the three and six months ended April 30, 2011 and 2010, and consolidated cash flows for the six months ended April 30, 2011 and 2010, respectively, have been made. The consolidated results of operations for the three and six months ended April 30, 2011 are not necessarily indicative of the results to be expected for the full fiscal year.

The consolidated financial information included herein has been prepared by the Company, without audit, for filing with the U.S. Securities and Exchange Commission (the “Commission”) pursuant to the rules and regulations of the Commission. The consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America, which require management to make estimates and assumptions that affect the reported amounts of assets and liabilities, the disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amount of revenues and expenses during the reporting period. On an on-going basis, management evaluates its estimates and judgments, including those related to customer rebates and incentives, product returns, doubtful accounts, inventories, including LIFO inventory valuations, litigation and contingency accruals, income taxes, including valuation of deferred taxes and assessment of unrecognized tax benefits for uncertain tax positions, share-based compensation, leasing arrangements, impairment of long-lived assets and intangibles, including goodwill, acquisitions, and costs associated with the restructuring of the Atlantis plants. Management bases its estimates and judgments on historical experience and various other factors, including the current economic environment, which it believes to be reasonable under the circumstances. The Company adjusts 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 to estimates resulting from continuing changes in the economic environment will be reflected in the financial statements in future periods, as necessary.

Certain information and footnote disclosures normally included in audited consolidated financial statements prepared in accordance with accounting principles generally accepted in the United States of America have been omitted. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended October 31, 2010, filed with the Commission on January 14, 2011.

The Company evaluates all subsequent events prior to filing and has implemented all new accounting pronouncements that are in effect and that may impact its financial statements, and the Company does not believe that there are any other new accounting pronouncements that have been issued that would be expected to have a material impact on its financial position, results of operations or cash flows.

 

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AEP INDUSTRIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

(2)	EARNINGS (LOSS) PER SHARE

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

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

 

		For the Three Months Ended April 30,								For the Six Months Ended April 30,
		2011				2010				2011				2010
Weighted average common shares outstanding:
Basic			6,137,654				6,849,541				6,140,046				6,836,050
Effect of dilutive securities:
Options to purchase shares of common stock			—				—				35,745				—
Diluted			6,137,654				6,849,541				6,175,791				6,836,050

For the three months ended April 30, 2011 and the three and six months ended April 30, 2010, the Company had 39,676, 41,472 and 54,342 stock options outstanding, respectively, that could potentially dilute earnings per share in future periods that were excluded from the computation of diluted EPS because their effect would have been anti-dilutive. For the three months ended April 30, 2011 and 2010, the Company had 95,180 and 98,180 stock options outstanding, respectively, and for the six months ended April 30, 2011 and 2010, the Company had 117,180 and 27,000 stock options outstanding, respectively, that could potentially dilute earnings per share in future periods and were excluded from the computation of diluted EPS as their exercise price was higher than the Company’s average stock price during those periods.

 

(3)	ACQUISITIONS

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 an adjusted purchase price of $98.8 million after expenses. The purchase price was allocated to the specific tangible and intangible assets acquired and liabilities assumed, including the restructuring of the Atlantis plants, based upon the relative fair value, after allocating the negative goodwill resulting from the transaction to property, plant and equipment and intangible assets.

Concurrent with the closing of the Atlantis acquisition, the Company’s Board of Directors (the “Board”) approved a plan to realign and reorganize the Atlantis businesses. Management finalized its reorganization plan in October 2009. The Company completed the shutdowns of the acquired Fontana, California plant in November 2008, and the acquired Cartersville, Georgia plant in October 2009. Costs of approximately $5.9 million associated with shutting down these plants were 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

 

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AEP INDUSTRIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

(3)	ACQUISITIONS (Continued)

 

facilities from November 1, 2009 until lease expiration, including estimated costs for security service, minimal utilities and property taxes. The Company completed its restructuring activities related to the Fontana facility in December 2010 and expects to complete such activities in the Cartersville facility by July 2015 (commensurate with the expiration of the Fontana and Cartersville leases, respectively). The Company has entered into a sublease for the Cartersville property aggregating approximately $0.4 million in sublease income for the period January 2011 to July 2015 and as such, the estimated future costs associated with this facility have been reduced. Due to this sublease and the settlement of certain obligations for less than expected, $2.2 million of the $5.9 million restructuring reserve was reversed in the fourth quarter of fiscal 2010 with a corresponding $2.1 million decrease in property, plant and equipment and a $0.1 million decrease in intangible assets.

The roll forward of the restructuring reserve, included in accrued expenses ($0.3 million and $0.4 million at April 30, 2011 and October 31, 2010, respectively) and other long-term liabilities ($0.6 million and $0.8 million at April 30, 2011 and October 31, 2010, respectively) in the consolidated balance sheets, is as follows:

 

		Severance				Facility Closure Costs				Lease Costs				Operating Costs				Total
		(in thousands)
Balance at October 31, 2009		$	87			$	2,350			$	2,280			$	1,010			$	5,727
Payments during the first six months of fiscal 2010			(81	)			(518	)			(402	)			(237	)			(1,238	)
Payments during the remainder of fiscal 2010			—				(442	)			(419	)			(216	)			(1,077	)
Adjustment to reserve			—				(1,313	)			(444	)			(443	)			(2,200	)
Balance at October 31, 2010			6				77				1,015				114				1,212
Payments during the first six months of fiscal 2011			—				(41	)			(193	)			(34	)			(268	)
Balance at April 30, 2011		$	6			$	36			$	822			$	80			$	944

 

(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:

 

		April 30, 2011				October 31, 2010
		(in thousands)
Raw materials		$	34,136			$	27,600
Finished goods			54,525				41,892
Supplies			3,489				3,596
			92,150				73,088
Less: Inventory reserve			85				110
Inventories, net		$	92,065			$	72,978

 

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AEP INDUSTRIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

(4)	INVENTORIES (Continued)

 

The LIFO method was used for determining the cost of approximately 87% and 85% of total inventories at April 30, 2011 and October 31, 2010, respectively. Inventories would have increased by $35.5 million and $22.1 million at April 30, 2011 and October 31, 2010, respectively, if the FIFO method had been used exclusively. Since the actual valuation of inventory under the LIFO method can only be made at the end of the fiscal year based on inventory levels and costs at that time, the interim LIFO calculations are based on management’s best estimate of expected fiscal year-end inventory levels and costs. Due to the volatility of resin pricing, the Company consistently uses current pricing as its estimate of fiscal year-end costs. Therefore, interim LIFO calculations are subject to the final fiscal year-end LIFO inventory valuation. Because of the Company’s continuous manufacturing process, there is no significant work in process at any point in time.

 

(5)	GOODWILL AND INTANGIBLE ASSETS

Changes in the carrying amount of goodwill during the six months ended April 30, 2011 are as follows:

 

		(in thousands)
Goodwill at October 31, 2010		$	8,135
Realization of deferred tax assets related to Borden Global Packaging acquisition			(690	)
Goodwill at April 30, 2011		$	7,445

Changes in the carrying amount of intangible assets during the six months ended April 30, 2011 are as follows:

 

		Customer List (Mercury)				Tradenames (Atlantis)				Leasehold Interests				Customer relationships				Total
		(in thousands)
Balance at October 31, 2010		$	78			$	828			$	(29	)		$	1,304			$	2,181
Amortization—Quarter 1 2011			(15	)			(23	)			2				(29	)			(65	)
Amortization—Quarter 2 2011			(14	)			(23	)			1				(30	)			(66	)
Total Amortization—2011			(29	)			(46	)			3				(59	)			(131	)
Balance at April 30, 2011		$	49			$	782			$	(26	)		$	1,245			$	2,050

Total amortization of intangible assets for the three months and six months ended April 30, 2010 was $76,000 and $153,000, respectively.

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

 

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AEP INDUSTRIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

(6)

DEBT

A summary of the components of debt is as follows:

 

		April 30, 2011				October 31, 2010
		(in thousands)
Credit facility(a)		$	—			$	23,745
7.875% senior notes due 2013(b)			26,438				160,160
8.25% senior notes due 2019(c)			200,000				—
Pennsylvania Industrial Loans(d)			1,524				1,795
Foreign bank borrowings(e)			—				—
Total debt			227,962				185,700
Less: current portion			26,680				441
Long-term debt		$	201,282			$	185,259

 

(a) Credit Facility

The Company maintains a secured credit facility with Wells Fargo Bank N.A., successor to Wachovia Bank N.A., as initial lender thereunder and as agent for the lenders thereunder, which was last amended and restated on October 30, 2008 (the “Credit Facility”). The 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 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 $46.8 million and $40.3 million, with a weighted average interest rate of 2.8% and 3.1%, during the three months ended April 30, 2011 and 2010, respectively. The Company had average borrowings under the Credit Facility of approximately $42.9 million and $32.9 million, with a weighted average interest rate of 2.8% and 3.2%, during the six months ended April 30, 2011 and 2010, respectively. Under the Credit Facility, interest rates are based upon Excess Availability (as defined therein) at a margin of the prime rate (defined as the greater of Wells Fargo’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 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 the eligible assets at April 30, 2011 and October 31, 2010 supported a borrowing base of $150.0 million and $128.0 million, respectively. Availability was reduced by the aggregate amount of letters of credit outstanding totaling $0.5 million and $0.8 million at April 30, 2011 and October 31, 2010, respectively. Availability at April 30, 2011 and October 31, 2010 under the Credit Facility was $149.5 million and $103.5 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 Credit Facility provides for events of default. If an event of default occurs and is continuing, amounts due under the Credit Facility may be accelerated and the commitments to extend credit thereunder terminated. The Credit Facility also contains covenants, including, but not limited to,

 

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AEP INDUSTRIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

(6)	DEBT (Continued)

 

limitations on the incurrence of debt and liens, the disposition and acquisition of assets, the entry into mergers and consolidations, and the making of investments and restricted payments, including the payment of cash dividends. The key financial covenants are applicable only if the Excess Availability is below a specified amount. In particular, if at any time average Excess Availability is less than $35.0 million for the immediately preceding fiscal quarter, a fixed charge coverage ratio test of 1.0x must be met. In addition, a minimum EBITDA (as defined therein) covenant of $35.0 million for the preceding 12-month period is triggered at any time Excess Availability is less than $25.0 million, and an annual capital expenditure limitation of $35.0 million is triggered at any time Excess Availability is less than $20.0 million. In addition, 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 $74.1 million to $149.5 million during the six months ended April 30, 2011 and from $70.2 million to $116.6 million during the six months ended April 30, 2010.

The Company was in compliance with the financial and other covenants at April 30, 2011 and October 31, 2010.

(b) 7.875% Senior Notes due 2013

On April 18, 2011, the Company completed the early settlement of a cash tender offer (the “Tender Offer”) and consent solicitation (the “Consent Solicitation,” and together with the Tender Offer, the “Offer”) with respect to $133,722,000 aggregate principal amount of 7.875% Senior Notes due 2013 (the “2013 Notes”), which represented approximately 83.49% of the outstanding aggregate principal amount of the 2013 Notes. Under the Offer, the Company accepted all 2013 Notes in the early settlement that were validly tendered and not withdrawn for payment. Holders of such 2013 Notes received $1,002.50 per $1,000 principal amount of the 2013 Notes (which included the early tender payment of $10.00 per $1,000 principal amount of the Notes), plus accrued and unpaid interest. Accordingly, the Company paid $133.7 million to the 2013 Note holders plus a $0.3 million cash premium. Additionally, $1.0 million of accrued interest was paid to the 2013 Note holders.

An additional $5,000 aggregate principal amount of 2013 Notes were validly tendered and not withdrawn as of April 29, 2011, the expiration date for the Tender Offer, with payment occurring on May 2, 2011. These and the remaining 2013 Notes that were not tendered and purchased pursuant to the Offer remained outstanding at April 30, 2011.

In connection with the early settlement of the 2013 Notes, the Company recorded a $1.4 million charge to interest expense in the consolidated statement of operations for the three and six months ended April 30, 2011. The charge included a $0.3 million cash premium paid to settle the 2013 Notes, as discussed above, as well as a write-off of $1.1 million representing the unamortized portion of debt issuance costs associated with the original issuance.

In connection with the Consent Solicitation and effective April 18, 2011, the indenture governing the 2013 Notes was amended by eliminating substantially all of the restrictive covenants and certain of

 

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(6)	DEBT (Continued)

 

the default provisions contained in the existing indenture. The Company was in compliance with all of the remaining covenants at April 30, 2011.

On November 2, 2009, the Board terminated the 2009 Senior Note Repurchase Program and authorized the 2010 Senior Note Repurchase Program which allowed the Company to spend up to $25.0 million to repurchase its outstanding 2013 Notes. On March 31, 2011, the Board terminated the 2010 Senior Note Repurchase Program. No repurchases were made under the 2010 Senior Note Repurchase Program.

Please refer to Note 12 for discussion of the redemption of the remaining 2013 Notes.

(c) 8.25% Senior Notes due 2019

On April 18, 2011, the Company completed the sale of $200 million aggregate principal amount of 8.25% Senior Notes due 2019 (the “2019 Notes”) through a private offering.

The 2019 Notes mature on April 15, 2019, and the indenture governing the 2019 Notes contains certain customary covenants that, among other things, limit the Company’s ability and the ability of its subsidiaries to incur additional indebtedness, declare or pay dividends, purchase or redeem its capital stock, make investments, sell assets, merge or consolidate, guarantee or pledge any assets or create liens. The Company was in compliance with all of these covenants at April 30, 2011.

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

The 2019 Notes will be redeemable at the option of the Company, in whole or in part, at any time on or after April 15, 2014 and prior to maturity at certain fixed redemption prices plus accrued and unpaid interest. The 2019 Notes may be redeemed, in whole or in part, at any time prior to April 15, 2014 at a redemption price equal to 100% of the principal amount of the 2019 Notes plus a make-whole premium together with accrued and unpaid interest. In addition, the Company may redeem up to 35% of the 2019 Notes prior to April 15, 2014, using net proceeds from certain equity offerings.

Interest is paid semi-annually on April 15 and October 15 of each year beginning on October 15, 2011.

During the second quarter of fiscal 2011, approximately $4.8 million of fees were capitalized ($4.3 million of which was paid) related to the issuance of the 2019 Notes. These fees will be amortized on a straight line basis over eight years, the term of the 2019 Notes.

(d) 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. 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 $12.1 million at April 30, 2011.

 

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(6)	DEBT (Continued)

 

(e) Foreign Bank Borrowings

In addition to the amounts available under the Credit Facility, the Company also maintains a secured credit facility at its Canadian subsidiary, used to support operations, which is generally serviced by local cash flows from operations. There was zero outstanding under this arrangement at April 30, 2011 and October 31, 2010, respectively. Availability under the Canadian credit facility at April 30, 2011 and October 31, 2010 was $5.3 million and $4.9 million, respectively.

Fair Value Measurements

The fair value of the 2013 Notes and 2019 Notes are based on quoted market rates (Level 1). The Company believes that the carrying value of the Company’s Pennsylvania Industrial Loans approximates its fair value based on observable inputs (Level 2). The carrying value and fair value of the Company’s fixed rate debt at April 30, 2011 and October 31, 2010 are as follows:

 

		April 30, 2011								October 31, 2010
		Carrying Value				Fair Value				Carrying Value				Fair Value
		Amounts in 000s
2013 Notes		$	26,438			$	26,488			$	160,160			$	161,922
2019 Notes			200,000				204,626				—				—
Pennsylvania Industrial Loans			1,524				1,524				1,795				1,795
Total		$	227,962			$	232,638			$	161,955			$	163,717

 

(7)	ACCRUED EXPENSES

At April 30, 2011 and October 31, 2010, accrued expenses consist of the following:

 

		April 30, 2011				October 31, 2010
		(in thousands)
Payroll and employee related		$	5,847			$	7,675
Customer rebates			4,464				6,076
Interest			862				1,656
Taxes (other than income)			1,886				2,255
Accrual for performance units			1,766				1,409
Accrued professional fees			952				1,100
Current portion of capital lease			1,134				1,101
Reserve for Atlantis restructuring (see Note 3)			308				425
Other			3,422				2,189
Accrued expenses		$	20,641			$	23,886

 

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(Unaudited)

 

(8)	SHAREHOLDERS’ EQUITY

Share-Based Compensation

At April 30, 2011, the Company has a share-based plan which provides for the granting of stock options and performance units to officers, directors and key employees of the Company. The Company also had an employee stock purchase plan which was terminated effective immediately following the end of the six-month offering period ended June 30, 2010. 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 Three Months Ended April 30,								For the Six Months Ended April 30,
		2011				2010				2011				2010
		(in thousands)
Cost of sales		$	85			$	(62	)		$	192			$	128
Selling expense			100				(23	)			210				180
General and administrative expense			527				(29	)			979				617
Total		$	712			$	(114	)		$	1,381			$	925

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 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 2011 and 2010 has been made from new shares. At April 30, 2011, 523,803 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

 

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(8)	SHAREHOLDERS’ EQUITY (Continued)

 

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 three and six months ended April 30, 2011 and 2010.

 

		For the Three Months Ended April 30,								For the Six Months Ended April 30,
		2011				2010				2011				2010
Risk-free interest rates			2.87	%			3.21	%			2.87	%			3.21	%
Expected life in years			7.5				7.5				7.5				7.5
Expected volatility			42.62	%			54.10	%			42.62	%			54.10	%
Dividend rate			0	%			0	%			0	%			0	%
Weighted average fair value per option at date of grant		$	14.19			$	16.08			$	14.19			$	16.08

The following table summarizes the Company’s stock option plans as of April 30, 2011, and changes during the six months ended April 30, 2011:

 

		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, 2010 (184,009 options exercisable)			151,409				75,400				226,809			$	22.87			$	7.87-51.00				4.0			$	1,410
Granted			—				10,000				10,000			$	28.36			$	28.36
Exercised			(4,777	)			—				(4,777	)		$	9.72			$	9.30-11.74
Forfeited/Cancelled			—				—				—				—				—
Expired			(3,000	)			—				(3,000	)		$	51.00			$	51.00
Options outstanding at April 30, 2011			143,632				85,400				229,032			$	23.02			$	7.87-42.60				3.6			$	2,031
Vested and expected to vest at April 30, 2011			143,632				85,400				229,032			$	23.02								3.6			$	2,031
Exercisable at April 30, 2011			143,632				50,600				194,232			$	22.10								2.7			$	1,893

The table below presents information related to stock option activity for the three and six months ended April 30, 2011 and 2010:

 

		For the Three Months Ended April 30,								For the Six Months Ended April 30,
		2011				2010				2011				2010
		(in thousands)
Total intrinsic value of stock options exercised		$	20			$	5			$	82			$	1,125
Total fair value of stock options vested		$	277			$	190			$	336			$	249

 

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(8)	SHAREHOLDERS’ EQUITY (Continued)

 

Share-based compensation expense related to the Company’s stock options recorded in the consolidated statements of operations for the three and six months ended April 30, 2011 was approximately $128,000 and $199,000, respectively, and $68,000 and $135,000 for the three and six months ended April 30, 2010, respectively. No compensation cost related to stock options was capitalized in inventory or any other assets for the three and six months ended April 30, 2011 and 2010. For the three and six months ended April 30, 2011 and 2010, there were no excess tax benefits recognized resulting from share-based compensation awards as the Company was not in a federal tax paying position.

As of April 30, 2011, there was $0.5 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 3.4 years.

Non-vested Stock Options

A summary of the Company’s non-vested stock options at April 30, 2011 and changes during the six months ended April 30, 2011 are presented below:

 

Non-vested stock options		Shares				Weighted Average Grant Date Fair Value
Non-vested at October 31, 2010			42,800			$	17.85
Granted			10,000			$	14.19
Vested			(18,000	)		$	18.67
Forfeited			—				—
Non-vested at April 30, 2011			34,800			$	16.38

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 (a) three months following the termination date and (b) 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 employee’s beneficiary may exercise such stock options until the earlier of (a) one year following the date of death and (b) 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 Adjusted EBITDA performance goal, as determined and adjusted by the Board. If the Company’s Adjusted EBITDA equals or exceeds the performance goal, no Units will be forfeited. If the Company’s Adjusted EBITDA is between 80% and less than 100% of the performance goal, such employee will forfeit such number of Units equal to (a) the Units granted multiplied by (b) the percentage Adjusted EBITDA is less than the performance goal. If Adjusted EBITDA is below 80% of the performance goal, the employee will forfeit all Units. Subsequent to the satisfaction of the performance goal, the vesting of the Units will occur equally over five years on the first through the fifth anniversaries of the grant date, provided that such person continues to be employed by the Company on such respective dates.

 

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(8)	SHAREHOLDERS’ EQUITY (Continued)

 

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.

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 (income) related to the Units was approximately $584,000 and $1.2 million for the three and six months ended April 30, 2011, respectively and $(244,000) (resulting from the decrease in the Company’s stock price) and $667,000 for the three and six months ended April 30, 2010, respectively. At April 30, 2011 and October 31, 2010, there are $1.8 million and $1.4 million in current liabilities, respectively, and $1.0 million and $1.1 million in long-term liabilities, respectively, related to outstanding Units.

The following table summarizes the Units as of April 30, 2011, and changes during the six months ended April 30, 2011:

 

		2005 Option Plan				Weighted Average Exercise Price				Weighted Average Remaining Contractual Term (years)				Aggregate Intrinsic Value $(000)
Units outstanding at October 31, 2010			160,790			$	0.00				1.4			$	3,918
Units granted			52,931			$	0.00
Units exercised			(35,680	)		$	0.00							$	896
Units forfeited or cancelled			(1,200	)
Units outstanding at April 30, 2011			176,841			$	0.00				1.7			$	5,334
Vested and expected to vest at April 30, 2011			174,591								1.7			$	5,266
Exercisable at April 30, 2011			—

 

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(8)	SHAREHOLDERS’ EQUITY (Continued)

 

During the six months ended April 30, 2011, the Company paid $0.6 million in cash and issued 2,009 shares of its common stock (issued from new shares), net of withholdings, in settlement of the vesting of Units occurring during the first six months of fiscal 2011. During the six months ended April 30, 2010, the Company paid $0.9 million in cash, net of withholdings, in settlement of the vesting of Units occurring during the first six months of fiscal 2010.

Employee Stock Purchase Plan

The Company terminated the Company’s 2005 Employee Stock Purchase Plan, as amended (“2005 Purchase Plan”), effective immediately following the end of the six-month offering period ended June 30, 2010.

The 2005 Purchase Plan became effective July 1, 2005 and provided 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 was 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 three and six months ended April 30, 2010, zero and 17,285 shares were purchased, respectively, by employees pursuant to the 2005 Purchase Plan. At July 1, 2010, 99,264 shares remained unsold under the 2005 Purchase Plan and were subsequently deregistered.

Total share-based compensation expense related to the 2005 Purchase Plan was approximately $62,000 and $123,000 for the three and six months ended April 30, 2010, respectively.

Treasury Shares

On June 6, 2008, the Board approved an $8.0 million stock repurchase program (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 at an average cost of $36.84 per share, totaling $1.9 million.

On June 7, 2010, the Board terminated the June 2008 Repurchase Program (which had approximately $6.1 million remaining as of such date) and approved a new $10.0 million stock repurchase program (the “June 2010 Repurchase Program”). During fiscal 2010 through August 3, 2010, the Company repurchased under its June 2010 Stock Repurchase Program 186,200 shares of its common stock in the open market at an average cost of $25.68 per share, totaling $4.8 million.

On August 4, 2010, the Board authorized a $6.5 million increase to the June 2010 Repurchase Program. On August 5, 2010, the Company repurchased 400,476 shares of its common stock from investment funds affiliated with KSA Capital Management, LLC (“KSA Capital”), whose managing member is Daniel D. Khoshaba (who served as a director on the Company’s Board at such time), in a privately negotiated transaction at an aggregate purchase price of $10.9 million, or $27.28 per share (including brokerage commissions). The purchase price per share represented a discount of 4.8% to the previous day’s closing price of the Company’s common stock.

 

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(8)	SHAREHOLDERS’ EQUITY (Continued)

 

On September 15, 2010, the Board terminated the June 2010 Stock Repurchase Program (which had approximately $0.8 million remaining as of such date) and approved a new $8.0 million stock repurchase program (the “September 2010 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. During the fiscal year 2010, the Company repurchased under its September 2010 Stock Repurchase Program 143,449 shares of its common stock in a privately negotiated transaction and in the open market at an average cost of $21.62 per share, totaling $3.1 million.

During the first six months of fiscal 2011, the Company repurchased 13,000 shares of its common stock under the September 2010 Stock Repurchase Program in the open market at an average cost of $27.46 per share, totaling approximately $357,000. As of April 30 2011, $4.5 million remained available for repurchase under such program.

Preferred Shares

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

On March 31, 2011, the Company adopted a stockholder rights plan (the “Rights Plan”), which entitles the holders of the rights to purchase from the Company 1/1,000^th of a share of Series A Junior Participating Preferred Stock, par value $1.00 per share, at a purchase price of $150.00 per share, as adjusted ( a “Right”), upon certain trigger events. In connection therewith, on March 31, 2011, the Company’s Board authorized 30,000 shares of Series A Junior Participating Preferred Stock and it declared a dividend of one Right per each share of common stock of the Company outstanding as of April 11, 2011. Each 1/1,000^th of a share of Series A Junior Participating Preferred Stock has terms that are substantially the economic and voting equivalent of one share of the Company’s common stock. However, until a Right is exercised or exchanged in accordance with the provisions of the Rights Plan, the holder thereof will have no rights as a stockholder of the Company, including, but not limited to, the right to vote for the election of directors or upon any matter submitted to stockholders of the Company. The Rights Plan has a three-year term and the Board may terminate the Rights Plan at any time (subject to the redemption of the Rights for a nominal value). The Rights may cause substantial dilution to a person or group (together with all affiliates and associates of such person or group and any person or group of persons acting in concert therewith) that acquires beneficial ownership of 15% or more of the Company’s stock on terms not approved by the Board or takes other specified actions.

 

(9)	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. A valuation allowance is established against deferred tax assets and is recorded when management estimates that it is more likely than not that the asset will not be realized.

 

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(9)	INCOME TAXES (Continued)

 

In November 2009, the Company received approximately $4.5 million as a dividend from its Canadian subsidiary at no federal tax cost due to the utilization of tax attributes.

The benefit for income taxes for the three and six months ended April 30, 2011 was $0.7 million and $0.4 million on a loss before the benefit for income taxes of $1.3 million and $42,000, respectively. The difference between the Company’s effective tax rate for the three and six months ended April 30, 2011 and the U.S. statutory tax rate, primarily relates to the differential in the U.S and the Canadian statutory rates, a reduction in the valuation allowance for foreign tax credits, and a benefit for state taxes in the United States, net of federal benefit, partially offset by a provision for foreign taxes paid.

The benefit for income taxes for the three and six months ended April 30, 2010 was $0.9 million and $3.8 million on a loss before the benefit for income taxes of $2.4 million and $10.2 million, respectively. The difference between the effective tax rate of 38.4 percent and 37.5 percent for the three and six months ended April 30, 2010, respectively, and the U.S. statutory tax rate of 35.0 percent, primarily relates to the benefit for state taxes in the United States, net, true-up of deferred taxes as a result of a reduction in the Canadian statutory tax rate, provision for state taxes and utilization of previously reserved foreign tax credits related to U.S. receipt of the Canadian dividend.

(10) SEGMENT AND GEOGRAPHIC INFORMATION

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

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

 

		For the Three Months Ended April 30, 2011
		United States				Canada				Total
		(in thousands)
Sales—external customers		$	228,935			$	19,605			$	248,540
Intercompany sales			10,433				—				10,433
Gross profit			25,600				4,270				29,870
Operating income			2,043				2,308				4,351

 

		For the Three Months Ended April 30, 2010
		United States				Canada				Total
		(in thousands)
Sales—external customers		$	197,634			$	18,028			$	215,662
Intercompany sales			10,496				—				10,496
Gross profit			23,293				2,512				25,805
Operating income			790				438				1,228

 

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(10)	SEGMENT AND GEOGRAPHIC INFORMATION (Continued)

 

		For the Six Months Ended April 30, 2011
		United States				Canada				Total
		(in thousands)
Sales—external customers		$	430,995			$	35,272			$	466,267
Intercompany sales			18,407				—				18,407
Gross profit			51,592				7,788				59,380
Operating income			5,932				3,432				9,364

 

		For the Six Months Ended April 30, 2010
		United States				Canada				Total
		(in thousands)
Sales—external customers		$	341,327			$	31,505			$	372,832
Intercompany sales			17,466				—				17,466
Gross profit			38,713				5,137				43,850
Operating (loss) income			(3,909	)			1,057				(2,852	)

Net sales by product line are as follows:

 

		For the Three Months Ended April 30,								For the Six Months Ended April 30,
		2011				2010				2011				2010
		(in thousands)
Custom films		$	85,607			$	74,683			$	158,367			$	127,406
Stretch (pallet) wrap			81,672				66,655				154,681				114,821
PROformance® films			21,463				16,677				38,201				28,706
Polyvinyl chloride wrap			34,344				31,700				68,069				60,002
Printed and converted films			2,788				2,447				5,256				4,533
Other specialty			22,666				23,500				41,693				37,364
Total		$	248,540			$	215,662			$	466,267			$	372,832

The Company has revised the 2010 presentation to conform with the 2011 presentation to include certain product lines contained within other specialty to polyvinyl chloride wrap.

(11) COMMITMENTS AND CONTINGENCIES

Capital Lease Commitments:

During the second quarter of fiscal 2009, the Company entered into a transaction with General Electric Capital Corporation (“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. The interest rates on the capital leases range from 3.9% to 8.5% with a weighted average rate of 5.78%. The current portion of these obligations is included in accrued liabilities and the long-term portion is included in other long-term liabilities in the consolidated balance sheets. As a

 

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AEP INDUSTRIES INC.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)

(Unaudited)

 

(11)	COMMITMENTS AND CONTINGENCIES (Continued)

 

result of the capital lease treatment, the equipment remained a component of property, plant and equipment in the Company’s consolidated balance sheet and will continue to be depreciated. No gain or loss was recognized related to this transaction.

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

 

For the years ending October 31,		Capital Leases
Remainder of 2011		$	693
2012			1,386
2013			1,386
2014			1,386
2015			578
Thereafter			—
Total minimum lease payments			5,429
Less: Amounts representing interest			588
Present value of minimum lease payments			4,841
Less: Current portion of obligations under capital leases			1,134
Long-term portion of obligations under capital leases		$	3,707

Claims and Lawsuits:

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

(12) SUBSEQUENT EVENT

On May 2, 2011, the Company provided a redemption notice to the holders of the outstanding 2013 Notes, representing $26,433,000 aggregate principal amount. The redemption price consisted of 100% of the aggregate principal amount of the outstanding 2013 Notes, plus accrued and unpaid interest to, but not including, June 2, 2011. On June 2, 2011, the Company redeemed all of the remaining 2013 Notes and accordingly paid $26.4 million plus $0.4 million of accrued and unpaid interest. The Company will write off the remaining debt issuance costs of $0.2 million associated with the original issuance during the third quarter of fiscal 2011.

 

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Item  2.

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

Overview

Forward-Looking Statements

Management’s Discussion and Analysis of Financial Condition and Results of Operations and other sections of this report contain “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements represent our goals, beliefs, plans and expectations about our prospects for the future and other future events, such as our ability to generate sufficient working capital, the amount of availability under our credit facility, the anticipated pricing in resin markets, our ability to continue to maintain sales and profits of our operations, and the sufficiency of our cash balances and cash generated from operating, investing, and financing activities for our future liquidity and capital resource needs. Forward-looking statements include all statements that are not historical fact and can be identified by terms such as “may,” “intend,” “might,” “will,” “should,” “could,” “would,” “anticipate,” “expect,” “believe,” “estimate,” “plan,” “project,” “predict,” “potential,” or the negative of these terms. Although these forward-looking statements reflect our good-faith belief and reasonable judgment based on current information, these statements are qualified by important factors, many of which are beyond our control, that could cause our actual results to differ materially from those in the forward-looking statements, including, but not limited to: the availability of raw materials; the ability to pass raw material price increases to customers in a timely fashion; the implementation of the final phase of a new operating system; the continuing impact of the U.S. recession and the global credit and financial environment and other changes in the United States or international economic or political conditions; the potential of technological changes that would adversely affect the need for our products; price fluctuations which could adversely impact our inventory; and other factors described from time to time in our reports filed or furnished with the U.S. Securities and Exchange Commission (the “SEC”), and in particular those factors set forth in Item 1A “Risk Factors” in our Annual Report on Form 10-K for the year ended October 31, 2010 and other reports subsequently filed with the SEC, including this report (see Part II, Item 1A). Given these uncertainties, you should not place undue reliance on any such forward-looking statements. The forward-looking statements included in this report are made as of the date hereof or the date specified herein, based on information available to us as of such date. Except as required by law, we assume no obligation to update these forward-looking statements, even if new information becomes available in the future.

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

 

•

Overview

 

•

Results of Operations

 

•

Liquidity and Capital Resources

 

•

Contractual Obligations and Off-Balance-Sheet Arrangements

 

•

Critical Accounting Policies

 

•

New Accounting Pronouncements

Investors should review this MD&A in conjunction with the consolidated financial statements and related notes included in this report under Item 1, our Annual Report on Form 10-K for the fiscal year ended October 31, 2010 and reports filed thereafter with the SEC, and other publicly available information.

 

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Company 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. 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 of November 1, 2009, we implemented the initial phase of a new integrated operating system to improve our ability to address the needs of our customers, as well as to create additional efficiencies and strengthen internal control over financial reporting. During the six months ended April 30, 2011 and 2010, we incurred and charged to operations approximately $0.1 million and $1.3 million, respectively, in consulting costs related to improving user functionality of the system. During the first half of fiscal 2011, we began implementing the final phase of our new system, which is centered in our manufacturing facilities. Completion is expected in early fiscal 2012.

Concurrent with the closing of the Atlantis acquisition, our Board approved a plan to realign and reorganize the combined businesses. We completed the shutdown of the acquired Fontana, California plant in November 2008, and the acquired Cartersville, Georgia plant in October 2009. The consolidation of these plants has been completed, with all manufacturing lines from the Fontana and Cartersville plants either producing in, or are in the process of being installed in our other plants. Approximately $0.9 million remains in the Atlantis restructuring reserve as of April 30, 2011 and primarily relates to lease costs, net of sublease income, and certain operating costs of the Cartersville plant, which lease ends in July 2015.

In April 2011, we issued $200.0 million aggregate principal amount of 2019 Notes, and we used a portion of the proceeds to repurchase $133.7 million aggregate principal amount of 2013 Notes and repay outstanding borrowings under our Credit Facility of $23.7 million. In June 2011, we redeemed the remaining $26.4 million aggregate principal amount of 2013 Notes.

Market Conditions

As discussed above, the primary raw materials used in the manufacture of our products are polyethylene, polypropylene and polyvinyl chloride resins. In recent years, the market for resins has been extremely volatile, with record price increases followed by significant decreases and vice versa.

 

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The trend of increasing resin prices has continued in 2011 with resin prices increasing $0.11 per pound since February 1, 2011. On a comparative basis, average resin cost during the three and six months ended April 30, 2011 were 6% higher or $0.04 per pound, and 13% higher or $0.08 per pound, than the average resin cost during the three and six months ended April 30, 2010, respectively. We believe that resin prices will continue to fluctuate widely during the remainder of fiscal 2011 due to production issues among the resin suppliers, combined with fluctuating prices of oil and natural gas and exporting activities. Resin price increases have been announced for May and June and are expected to hold. These steadfast resin cost increases magnify the importance of adjusting sell prices on a timely basis. Furthermore, the industry is currently experiencing a shortage of certain raw materials. At this time, we have been able to secure sufficient supply to meet our production needs; however, the shortage has further increased raw material costs. There can be no assurance that we will be able to continue to secure sufficient supply or be able to pass on resin price increases on a penny-for-penny basis in the future, if such costs were to continue to increase.

The marketplace in which we sell our products remains very competitive, and has been further complicated in recent years by adverse economic circumstances affecting many of our customers, distributors and suppliers. We have seen positive signs of stabilization in our markets, although the impacts of the recent recession continue. Our net sales volume has increased 15% in the first six months of fiscal 2011 compared to the prior period, which is primarily attributable to increased demand from our customers as well as increased market share due to our market leadership, consolidation and bankruptcies of competitors, and fewer new market entrants. In spite of such net sales growth, net sales forecasts for the remainder of 2011 remain uncertain. It is difficult to predict the continuing impact of the economic slowdown on our business. The economy may continue to strain the resources of our customers, distributors and suppliers and negatively impact our businesses and operations. Resin prices continue to increase faster than the amounts that have been passed through to our customers. We have implemented cost-reduction initiatives in recent years that are designed to increase efficiency and improve the way we run our business to meet the challenges of a volatile economic environment, as well as take advantage of opportunities in the marketplace. We are limited, however, in our ability to reduce costs 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 have taken appropriate steps to minimize the impact of these conditions, primarily through staff reductions, shut downs of idle equipment and plant closures.

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 to third party providers

 

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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.

Results of Operations—Second Quarter of Fiscal 2011 Compared to Second Quarter of Fiscal 2010

The following table presents unaudited selected financial data for the three months ended April 30, 2011 and 2010 (dollars per lb. sold is calculated by dividing the applicable consolidated statements of operations category by pounds sold in the period):

 

		For the Three Months Ended
		April 30, 2011								April 30, 2010								% increase/ (decrease) of $
		$				$ Per lb. sold				$				$ Per lb. sold								$ increase/ (decrease)
		(in thousands, except for per pound data)
Net sales		$	248,540			$	1.12			$	215,662			$	1.02				15.2	%		$	32,878
Gross profit			29,870				0.13				25,805				0.12				15.8	%			4,065
Operating expenses:
Delivery			11,296				0.05				10,360				0.05				9.0	%			936
Selling			8,786				0.04				9,247				0.04				(5.0	)%			(461	)
General and administrative			5,441				0.02				4,963				0.03				9.6	%			478
Total operating expenses		$	25,523			$	0.11			$	24,570			$	0.12				3.9	%		$	953
Pounds sold							221,979 lbs.								211,052 lbs.

Net Sales

The increase in Net sales for the three months ended April 30, 2011 was the result of a 9% increase in average selling prices primarily attributable to the pass-through of higher resin costs to customers during the comparable periods, positively affecting net sales by $19.7 million, combined with a 5% increase in sales volume positively affecting net sales by $12.2 million. The second quarter of fiscal 2011 also included a $1.0 million positive impact of foreign exchange relating to our Canadian operations.

Gross Profit

There was a $9.3 million increase in the LIFO reserve during the second quarter of fiscal 2011 versus a $15.2 million increase in the LIFO reserve during the second quarter of fiscal 2010, representing a decrease of $5.9 million year-over-year. Excluding the impact of the LIFO reserve change during the quarter, gross profit decreased $1.8 million primarily due to a lag in selling price increases as resin prices increased an average of $0.11 per pound during the second quarter of fiscal 2011, partially offset by increased sales volumes and improved plant utilization. The second quarter of fiscal 2011 also included a $0.2 million positive impact of foreign exchange relating to our Canadian operations.

 

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Operating Expenses

The increase in operating expenses is primarily due to increased volumes sold in the second quarter of fiscal 2011 increasing operating expenses by $0.7 million and an increase of $0.7 million related to share-based compensation costs associated with our stock options and performance units, partially offset by a decrease of $0.3 million of consulting costs associated with the implementation of our new operating system. Furthermore, the positive impact on operating expenses of cost cutting initiatives implemented in the prior fiscal year was partially mitigated by rising fuel costs. The second quarter of fiscal 2011 also includes a $0.1 million unfavorable effect of foreign exchange increasing reported total operating expenses.

Interest Expense

Interest expense for the three months ended April 30, 2011 increased $1.8 million to $5.7 million as compared to the prior fiscal year period. Included in interest expense for the three months ended April 30, 2011 are the write-off of unamortized issuance costs of $1.0 million related to the 2013 Notes, the early tender fee paid to the 2013 Note holders of $0.3 million, and $0.2 million of fees related to the partial repurchase of the 2013 Notes. Without these items, interest expense increased $0.3 million from the same period in the prior fiscal year and is primarily due to the partial settlement of the 2013 Notes and the issuance of the 2019 Notes, resulting in an increase in interest rates (7.785% to 8.25%) and aggregate principal amount (from $160.2 million to $200.0 million).

Income Tax Provision

The benefit for income taxes for the three months ended April 30, 2011 was $0.7 million on a loss before the benefit for income taxes of $1.3 million. The difference between our effective tax rate of 49.7 percent for the three months ended April 30, 2011 and the U.S. statutory tax rate of 35.0 percent, primarily relates to the differential in the U.S and the Canadian statutory rates (+9.5%) and a benefit for state taxes in the United States, net of federal benefit (+8.9%), partially offset by a provision for foreign taxes paid (-3.4%).

The benefit for income taxes for the three months ended April 30, 2010 was $0.9 million on a loss before the benefit for income taxes of $2.4 million. The difference between the effective tax rate of 38.4 percent and the U.S. statutory tax rate of 35.0 percent primarily relates to the benefit for state taxes in the United States, net, and the true-up of state taxes and utilization of previously reserved foreign tax credits related to U.S. receipt of the Canadian dividend.

Results of Operations – First Six Months of Fiscal 2011 Compared to First Six Months of Fiscal 2010

The following table presents unaudited selected financial data for the six months ended April 30, 2011 and 2010 (dollars per lb. sold is calculated by dividing the applicable consolidated statements of operations category by pounds sold in the period):

 

		For the Six Months Ended
		April 30, 2011								April 30, 2010								% increase/ (decrease) of $				$ increase/ (decrease)
		$				$ Per lb. sold				$				$ Per lb. sold
		(in thousands, except for per pound data)
Net sales		$	466,267			$	1.10			$	372,832			$	1.01				25.1	%		$	93,435
Gross profit			59,380				0.14				43,850				0.12				35.4	%			15,530
Operating expenses:
Delivery			21,589				0.05				18,454				0.05				17.0	%			3,135
Selling			17,497				0.04				17,650				0.05				(0.9	)%			(153	)
General and administrative			10,912				0.03				10,801				0.03				1.0	%			111
Total operating expenses		$	49,998			$	0.12			$	46,905			$	0.13				6.6	%		$	3,093
Pounds sold							423,978 lbs.								370,123 lbs.

 

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Net Sales

The increase in Net sales for the six months ended April 30, 2011 was the result of a 9% increase in average selling prices primarily attributable to the pass-through of higher resin costs to customers during the comparable periods, positively affecting net sales by $32.7 million, combined with a 15% increase in sales volume positively affecting net sales by $59.0 million. The first six months of fiscal 2011 also included a $1.7 million positive impact of foreign exchange relating to our Canadian operations.

Gross Profit

There was a $13.4 million increase in the LIFO reserve during the first six months of fiscal 2011 versus a $17.3 million increase in the LIFO reserve during the first six months of fiscal 2010, representing a decrease of $3.9 million year-over-year. Excluding the impact of the LIFO reserve change during the six months, gross profit increased $11.6 million primarily due to increased sales volumes and improved plant utilization, partially offset by a lag in selling price increases during the period. The first six months of fiscal 2011 also included a $0.4 million positive impact of foreign exchange relating to our Canadian operations.

Operating Expenses

The increase in operating expenses is primarily due to increased volumes sold in the first six months of fiscal 2011 increasing operating expenses by $3.4 million and an increase of $0.4 million related to share-based compensation costs associated with our stock options and performance units, partially offset by a decrease of $0.5 million of consulting costs associated with the implementation of our new operating system. Furthermore, the positive impact on operating expenses of cost cutting initiatives implemented in the prior fiscal year was partially mitigated by rising fuel costs. The first six months of fiscal 2011 also includes a $0.2 million unfavorable effect of foreign exchange increasing reported total operating expenses.

Interest Expense

Interest expense for the six months ended April 30, 2011 increased $1.9 million to $9.5 million as compared to the prior fiscal year period. Included in interest expense for the six months ended April 30, 2011 are the write-off of unamortized issuance costs of $1.0 million related to the 2013 Notes, the early tender fee paid to the 2013 Note holders of $0.3 million, and $0.2 million of fees related to the partial repurchase of the 2013 Notes. Without these items, interest expense increased $0.4 million from the same period in the prior fiscal year. The partial settlement of the 2013 Notes and the issuance of the 2019 Notes resulted in an increase in interest expense for the six months ended April 30, 2011 as compared to the prior fiscal year period of $0.3 million primarily due to an increase in interest rates (7.785% to 8.25%) and aggregate principal amount (from $160.2 millions to $200.0 million) of the senior notes.

Income Tax Provision

The benefit for income taxes for the six months ended April 30, 2011 was $0.4 million on a loss before the benefit for income taxes of $42,000 The difference between our effective tax rate for the six months ended April 30, 2011 and the U.S. statutory tax rate, primarily relates to the differential in the U.S and the Canadian statutory rates, a reduction in the valuation allowance for foreign tax credits, and a benefit for state taxes in the United States, net of federal benefit, partially offset by a provision for foreign taxes paid.

The benefit for income taxes for the six months ended April 30, 2010 was $3.8 million on a loss before the benefit for income taxes of $10.2 million. The difference between the effective tax rate of 37.5 percent and the U.S. statutory tax rate of 35.0 percent primarily relates to the benefit for state taxes in the United States, net, true-up of deferred taxes as a result of a reduction in the Canadian statutory

 

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tax rate, and a provision for state taxes, withholding taxes paid and utilization of previously reserved foreign tax credits related to U.S. receipt of the Canadian dividend.

Reconciliation of Non-GAAP Measures to GAAP

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

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

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

 

		Second Quarter Fiscal 2011				Second Quarter Fiscal 2010				April YTD Fiscal 2011				April YTD Fiscal 2010
		(in thousands)				(in thousands)				(in thousands)				(in thousands)
Net (loss) income		$	(678	)		$	(1,497	)		$	387			$	(6,397	)
Benefit for taxes			(671	)			(934	)			(429	)			(3,839	)
Interest expense			5,652				3,850				9,465				7,610
Depreciation and amortization expense			5,525				5,482				10,893				10,726
Increase in LIFO reserve			9,285				15,178				13,372				17,275
Other non-operating expense (income)			48				(191	)			(59	)			(226	)
Non-cash share-based compensation			712				(114	)			1,381				925
Adjusted EBITDA		$	19,873			$	21,774			$	35,010			$	26,074

Liquidity and Capital Resources

Summary

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

 

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Despite the challenging financial markets and economic conditions in recent years, we continue to maintain a strong balance sheet and sufficient liquidity to provide us with financial flexibility. During April 2011, we successfully completed the sale of $200 million aggregate principal amount of 2019 Notes through a private offering, the proceeds of which were used to repurchase $133.7 million aggregate principal amount of 2013 Notes, as well as pay the related tender premium, accrued and unpaid interest and related fees received to date, and pay a portion of the amounts outstanding under our Credit Facility. In June 2011, we redeemed the remaining $26.4 million aggregate principal amount of 2013 Notes and paid $0.4 million of accrued and unpaid interest. Availability under our Credit Facility and credit line available to our Canadian subsidiary for local currency borrowings was an aggregate of $154.8 million at April 30, 2011. As of April 30, 2011, we had a net debt position (current bank borrowings plus long term debt less cash and cash equivalents) of $217.1 million, compared with $184.7 million at the end of fiscal 2010. The increase is due to the partial settlement of the 2013 Notes and the issuance of the 2019 Notes.

Our working capital amounted to $83.9 million at April 30, 2011 compared to $70.5 million at October 31, 2010. We use the LIFO method for determining the cost of approximately 87% of our total inventories at April 30, 2011. Under LIFO, the units remaining in ending inventory are valued at the oldest unit costs and the units sold in cost of sales are valued at the most recent unit costs. Therefore, the effect of using LIFO is lower inventory values, higher cost of sales and lower taxable income. If the FIFO method for valuing inventory had been used exclusively, working capital would have been $119.4 million and $92.6 million, respectively. During the six months ended April 30, 2011, the LIFO reserve increased $13.4 million to $35.5 million as a result of rising resin costs and increased inventory levels. Despite the negative effects on our results of operations and our financial position (an increase to cost of sales of $13.4 million for the six months ended April 30, 2011 and a reduction of inventory of $35.5 million at April 30, 2011), we believe the use of LIFO maximizes our after tax cash flow from operations.

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

Cash Flows

The following table summarizes our cash flows from operating, investing, and financing of our operations for each of the six months ended April 30, 2011 and 2010:

 

		For the Six Months Ended April 30,
		2011				2010
		(in thousands)
Total cash (used in) provided by:
Operating activities		$	(18,075	)		$	(16,965	)
Investing activities			(8,535	)			(4,962	)
Financing activities			36,558				21,766
Effect of exchange rate changes on cash			(96	)			256
Increase in cash and cash equivalents		$	9,852			$	95

 

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

 

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Operating Activities

Our cash and cash equivalents were $10.9 million at April 30, 2011, as compared to $1.1 million at October 31, 2010. Net cash used in operating activities during the six months ended April 30, 2011 was $18.1 million, which includes net income of $0.4 million adjusted for non-cash operating income totaling $26.9 million primarily related to depreciation and amortization and change in LIFO reserve. Cash used by operating activities includes a $32.1 million increase in inventories excluding the non-cash effects of LIFO reflecting higher resin costs and our increased investment in inventory, a $13.2 million increase in accounts receivable reflecting higher selling prices and volumes sold, partially offset by a $1.2 million net increase in accounts payable and accrued expenses as a result of timing of payments.

Investing Activities

Net cash used in investing activities during the six months ended April 30, 2011 was $8.5 million, resulting from capital expenditures during the period.

Financing Activities

Net cash provided by financing activities during the six months ended April 30, 2011 was $36.6 million, resulting primarily from $200.0 million of proceeds received related to the issuance of our 2019 Notes. This was partially offset by the purchase of our 2013 Notes for $134.0 million (including the premium payment of $0.3 million), repayments under our Credit Facility of $23.7 million, repurchases of our common stock totaling $0.4 million, $0.5 million of capital lease payments and $0.3 million of repayments of our Pennsylvania loans.

Sources and Uses of Liquidity

Issuance of 8.25% Senior Notes—2019

On April 18, 2011, we completed the sale of $200 million aggregate principal amount of 2019 Notes due April 15, 2019 (“2019 Notes”) through a private offering. Interest is paid semi-annually on April 15 and October 15, beginning October 15, 2011.

The proceeds of the offering were used to repurchase a portion of our 2013 Notes, as well as pay the tender premium, accrued and unpaid interest, and related fees received to date, and repay a portion of the amounts outstanding under our Credit Facility.

7.875% Senior Subordinated Notes—2013

On April 18, 2011, we completed the early settlement of our tender offer with respect to $133.7 million aggregate principal amount of 2013 Notes. Under the tender offer, we paid approximately $134.0 million to repurchase such 2013 Notes, including $0.3 million of cash premium, and we also paid $1.0 million of interest accrued from March 15 to April 18.

An additional $5,000 aggregate principal amount of 2013 Notes were validly tendered and not withdrawn as of April 29, 2011, the expiration date for the Tender Offer, with payment occurring on May 2, 2011. These and the remaining 2013 Notes that were not tendered and purchased pursuant to the Offer remained outstanding at April 30, 2011.

In June 2011, we redeemed the entire remaining $26.4 million aggregate principal amount of 2013 Notes. The redemption price consisted of 100% of the aggregate principal amount of the outstanding 2013 Notes, plus accrued and unpaid interest. Accordingly, we paid $26.4 million plus $0.4 million of accrued and unpaid interest.

 

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Credit Facility

We maintain a credit facility with Wells Fargo Bank N.A., successor to Wachovia Bank N.A, as initial lender thereunder and as agent for the lenders thereunder, which was last amended and restated on October 30, 2008 (the “Credit Facility”). The Credit Facility is secured by mortgages and liens on most of our domestic assets and on 66% of our ownership interest in certain foreign subsidiaries. The 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 utilize the Credit Facility to provide funding for operations and other corporate purposes through daily bank borrowings and/or cash repayments to ensure sufficient operating liquidity and efficient cash management. Availability at April 30, 2011 and October 31, 2010 under the Credit Facility was $149.5 million and $103.5 million, respectively.

In addition to the amounts available under the Credit Facility, we also maintain a credit facility at our Canadian subsidiary which is used to support operations and is serviced by local cash flows from operations. There were no borrowings outstanding under the Canadian credit facility at April 30, 2011 and October 31, 2010. Availability under the Canadian credit facility at April 30, 2011 and October 31, 2010 was $5.3 million and $4.9 million, respectively,

Please refer to Note 6 of the consolidated financial statements for further discussion of our debt.

Repurchase Programs

On November 2, 2009, our Board of Directors terminated the 2009 Senior Note Repurchase Program and authorized the 2010 Senior Note Repurchase Program which allowed us to spend up to $25.0 million to repurchase our outstanding 2013 Notes. The 2010 Senior Note Repurchase Program was terminated in March 2011. No repurchases were made under the 2010 Senior Note Repurchase Program.

On September 15, 2010, our Board of Directors terminated the June 2010 Stock Repurchase Program (which had approximately $0.8 million remaining as of such date) and approved a new $8.0 million stock repurchase program (the “September 2010 Stock Repurchase Program”). As of April 30, 2011, $4.5 million remained available for repurchase under such program. Please refer to Note 8 of the consolidated financial statements for further discussion of the program.

Contractual Obligations and Off-Balance-Sheet Arrangements

Contractual Obligations and Commercial Commitments

Our contractual obligations and commercial commitments as of April 30, 2011 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)
Remainder of 2011(1)		$	26,609			$	8,591			$	693			$	2,865			$	38,758
2012			145				16,562				1,386				4,826				22,919
2013			152				16,554				1,386				4,245				22,337
2014			89				16,548				1,386				3,518				21,541
2015			87				16,544				578				1,780				18,989
Thereafter(2)			200,880				58,069				—				679				259,628
Total		$	227,962			$	132,868			$	5,429			$	17,913			$	384,172

 

(1)	Borrowings include $26.4 million aggregate principal amount of 2013 Senior Notes, which we redeemed on June 2, 2011.

 

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(2)	Borrowings include $200 million aggregate principal amount of 2019 Notes. See Note 6 of the consolidated financial statements for further discussion of our debt.

In addition to the amounts reflected in the table above:

Concurrent with the closing of the Atlantis acquisition in October 2008, our Board approved a plan to realign and reorganize the Atlantis businesses. We completed the shutdowns of the acquired Fontana, California plant in November 2008 and the acquired Cartersville, Georgia plant in October 2009. All manufacturing lines from the Fontana and Cartersville plants are either producing in, or are in the process of being installed in our other plants. Approximately $0.9 million remains in the Atlantis restructuring reserve as of April 30, 2011 and primarily relates to lease costs, net of sublease income, and certain operating costs of the Cartersville plant, which lease ends in July 2015. We estimate paying $0.1 million during the remainder of fiscal 2011, net of sublease income, related to the restructuring reserve and $0.8 million thereafter.

We expect to incur approximately $7.0 million of capital expenditures during the remainder of fiscal 2011.

Off-Balance Sheet Arrangements

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

Effects of Inflation

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

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, litigation and contingency accruals, income taxes, including valuation of deferred taxes and assessment of unrecognized tax benefits for uncertain tax positions, share-based compensation, impairment of long-lived assets and intangibles, including goodwill, and acquisitions, including costs associated with the restructuring of the Atlantis plants. Management bases its estimates and judgments on historical experience and various other factors that are believed to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities that are not readily apparent from other sources. Actual results may differ from these estimates under different assumptions or conditions.

Our critical accounting policies are described in detail in Item 7 “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and in the notes to the consolidated financial statements in our Annual Report on Form 10-K for the fiscal year ended October 31, 2010, filed with the U.S. Securities and Exchange Commission on January 14, 2011. There were no material changes to our critical accounting policies during the six months ended April 30, 2011.

 

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New Accounting Pronouncements

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

 

Item  3.

Quantitative and Qualitative Disclosures about Market Risk

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

Interest Rates

The fair value of our fixed interest rate debt varies with changes in interest rates. Generally, the fair value of fixed rate debt will increase as interest rates fall and decrease as interest rates rise. At April 30, 2011, the carrying value of our total debt was $228.0 million of which all was fixed rate debt (2013 Notes, 2019 Notes and the Pennsylvania Industrial Loans). As of April 30, 2011, the estimated fair value of our 2013 Notes was approximately $26.5 million and the estimated fair value of our 2019 Notes was approximately $204.6 million. As of April 30, 2011, the carrying value of our Pennsylvania Industrial Loans was $1.5 million which approximates fair value.

Floating rate debt at April 30, 2011 and October 31, 2010 totaled zero and $23.7 million, respectively. Based on the floating rate debt outstanding during fiscal 2011 (our Credit Facility), a one-percent increase or decrease in the average interest rate during the prior would have resulted in a change to interest expense of approximately $0.2 million.

Foreign Exchange

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

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

Commodities

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

We are exposed to market risk from changes in plastic resin prices that could impact our results of operations and financial condition. Generally, we acquire resin at market prices and do not use financial instruments to hedge commodity prices. Our plastic resin purchasing strategy is to deal with only high-quality, dependable suppliers. We believe that we have maintained strong relationships with these key suppliers and expect that such relationships will continue into the foreseeable future. The resin market is a global market and, based on our experience, we believe that adequate quantities of plastic resins will be

 

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available at market prices, but we can give no assurances as to such availability or the prices thereof. See “Management’s Discussion and Analysis of Financial Condition and Results of Operations—Overview—Market Conditions” for further discussion of market risks related to resin prices.

 

Item  4.

Controls and Procedures

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC rules and forms and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial Officer (together, the “Certifying Officers”), as appropriate, to allow for timely decisions regarding required disclosure.

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

As of April 30, 2011, the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of management, including the Certifying Officers, of the effectiveness of the design and operation of our disclosure controls and procedures as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act. Our disclosure controls and procedures are designed to provide reasonable assurance of achieving their stated objectives and our Certifying Officers concluded that our disclosure controls and procedures were effective at a reasonable assurance level as of April 30, 2011.

Changes in Internal Control over Financial Reporting

There was no change in our internal control over financial reporting that occurred during the six months ended April 30, 2011 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II—OTHER INFORMATION

 

Item  1.

Legal Proceedings

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

 

Item  1A.

Risk Factors

You should carefully consider the risks and uncertainties we describe in our Annual Report on Form 10-K for the fiscal year ended October 31, 2010, and in other reports filed thereafter with the SEC, including this report, before deciding to invest in or retain shares of our common stock. These are not the only risks and uncertainties that we face. Additional risks and uncertainties that we do not currently know about or that we currently believe are immaterial, or that we have not predicted, may

 

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also harm our business operations or adversely affect us. If any of these risks or uncertainties actually occurs, our business, financial condition, operating results or liquidity could be materially and adversely affected.

The risks related to the 2013 Notes disclosed in our Annual Report on Form 10-K for the fiscal year ended October 31, 2010 are substantially similar to the risks related to the 2019 Notes. Therefore, all references to Senior Notes in the risk factors discussed in Item 1A. “Risk Factors” in such Annual Report on Form 10-K are hereby deemed references to the 2019 Notes. As of April 30, 2011, the following are material changes in the risk factors previously disclosed in such Annual Report on Form 10-K and additional risks you should consider:

Our substantial debt could adversely affect our financial health and prevent us from fulfilling our obligations under the notes.

Following the offering of the 2019 Notes and the repurchase of all of the 2013 Notes, we have a substantial amount of debt. As of April 30, 2011, we have $228.0 million of total debt outstanding and $4.8 million of capital lease obligations.

Our substantial debt could have important consequences. For example, it could:

 

•

make it more difficult for us to satisfy our obligations;

 

•

increase our vulnerability to general adverse economic and industry conditions;

 

•

require us to dedicate a substantial portion of our cash flow from operations to payments on our debt, thereby limiting our ability to fund working capital, capital expenditures and other general corporate purposes;

 

•

limit our flexibility in planning for, or reacting to, changes in our business and the industry in which we operate;

 

•

place us at a competitive disadvantage compared to our competitors that may have less debt; and

 

•

limit, among other things, our ability to borrow additional funds.

We and our subsidiaries may be able to incur substantial additional debt in the future. At April 30, 2011, we would have been permitted to borrow up to an additional $154.8 million under the Credit Facility and our Canadian credit facility, in each case based on the respective available borrowing base.

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 stockholders. 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 stockholder for a period of three years after the person becomes an interested stockholder.

In addition, our restated certificate of incorporation and fifth 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 stockholders. These provisions include:

 

•

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

 

•

prohibiting stockholders from acting by written consent without board approval;

 

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•

prohibiting stockholders from calling special meetings of stockholders;

 

•

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 stockholders at stockholder 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.

Further, on March 31, 2011, our Board adopted a stockholder rights plan, which is designed to assure that all of our stockholders receive fair and equal treatment in the event of any proposed takeover of the Company and to guard against partial tender offers, open market accumulations and other abusive or coercive tactics without paying stockholders a control premium. The stockholder rights plan may have anti-takeover effects by discouraging potential proxy contests and other takeover methods, particularly those that have not been negotiated with the Board, and the stockholder rights plan may also inhibit the acquisition of a controlling position in our common stock. Therefore, transactions may not occur that stockholders would otherwise support and/or from which they would receive a substantial premium for their shares over the current market price. The stockholder rights plan may also make it more difficult to remove members of the current Board or management.

Future acquisitions inherently involve significant risks and uncertainties.

We continually review acquisition opportunities that will enhance our market position, expand our product lines and provide sufficient synergies. Any of the following risks associated with future acquisitions, individually or in aggregate may have a material adverse effect on our business, financial condition, operating results or stock price:

 

•

difficulties in realizing anticipated financial or strategic benefits of such acquisition;

 

•

diversion of capital from other uses and potential dilution of stockholder ownership;

 

•

the risks related to increased indebtedness, as well as the risk such financing will not be available on satisfactory terms or at all;

 

•

disruption of our ongoing business or the ongoing acquired business, including impairment of existing relationships with our employees, distributors, suppliers or customers or those of the acquired companies;

 

•

diversion of managements attention and other resources from current operations, including potential strain on financial and managerial controls and reporting systems and procedures;

 

•

difficulty in integrating acquired operations, including restructuring and realigning activities, personnel, technologies and products, including the loss of key employees, distributors, suppliers or customers of acquired businesses;

 

•

inability to realize cost savings, sales increases or other benefits that we anticipate from such acquisitions, either as to amount or in the expected time frame;

 

•

assumption of known and unknown liabilities, some of which may be difficult or impossible to quantify; and

 

•

non-cash impairment charges or other accounting charges relating to the acquired assets.

 

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Item  2.

Unregistered Sales of Equity Securities and Use of Proceeds

The table below sets forth the total number of shares of our common stock that we repurchased in each month of the quarter ended April 30, 2011.

 

Fiscal 2011 period		Total number of shares purchased				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
February 1-February 28			7,100			$	28.52				—			$	4,542,192	(a)
March 1-March 31			—			$	—				—			$	4,542,192
April 1-April 30			—			$	—				—			$	4,542,192
Total			7,100			$	28.52				—			$	4,542,192

 

(a)	On September 15, 2010, our Board terminated the June 2010 Repurchase Program and approved a new $8.0 million stock repurchase program (the “September 2010 Stock Repurchase Program”). Please refer to Note 8 of the Consolidated Financial Statements for further discussion of the program.

 

Item  3.

Defaults Upon Senior Securities

None

 

Item  4.

Removed and Reserved

 

Item  5.

Other Information

None

 

Item  6.

Exhibits

 

Exhibit #				Description
	3.1			Form of Certificate of Designations of Series A Junior Participating Preferred Stock of the Company (incorporated herein by reference to Exhibit A of Exhibit 4.1 to the Company’s Current Report on Form 8-K, filed on March 31, 2011)
	4.1			Rights Agreement, dated March 31, 2011, by and between the Company and American Stock Transfer & Trust Company, LLC, as Rights Agent (incorporated herein by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K, filed on March 31, 2011)
	4.2			Indenture, dated as of April 18, 2011, by and between the Company and The Bank of New York Mellon Trust Company, N.A., as trustee (incorporated herein by reference to Exhibit 4.1 to the Company’s Current Report on Form 8-K, filed on April 18, 2011)
	4.3			Form of 8.25% Senior Note due 2019 (incorporated herein by reference to Exhibit A of Exhibit 4.1 to the Company’s Current Report on Form 8-K, filed on April 18, 2011)
	4.4			Registration Rights Agreement, dated April 18, 2011, by and among the Company, Merrill Lynch, Pierce, Fenner & Smith Incorporated and Wells Fargo Securities, LLC (incorporated herein by reference to Exhibit 4.3 to the Company’s Current Report on Form 8-K, filed on April 18, 2011)

 

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Exhibit #				Description
	4.5			First Supplemental Indenture, dated as of April 18, 2011, between the Company and The Bank of New York Mellon (f/k/a The Bank of New York), as trustee (incorporated herein by reference to Exhibit 4.4 to the Company’s Current Report on Form 8-K, filed on April 18, 2011)
	10.1	*		Purchase Agreement for the Company’s 8.25% Senior Notes due 2019, dated April 7, 2011
	31.1	*		Certification of the Chief Executive Officer filed pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
	31.2	*		Certification of the Chief Financial Officer filed pursuant to Section 302 of the Sarbanes-Oxley Act of 2002
	32.1	*		Certification of the Chief Executive Officer furnished pursuant to Section 906 of the Sarbanes-Oxley Act of 2002
	32.2	*		Certification of the Chief Financial Officer furnished pursuant to Section 906 of the Sarbanes-Oxley Act of 2002

 

*	Filed herewith

 

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SIGNATURES

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

 

		AEP Industries Inc.
Dated: June 9, 2011		By:		/S/ J. BRENDAN BARBA
				J. Brendan Barba Chairman of the Board, President and Chief Executive Officer (principal executive officer)
Dated: June 9, 2011		By:		/S/ PAUL M. FEENEY
				Paul M. Feeney Executive Vice President, Finance and Chief Financial Officer (principal financial officer)

 

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