Below is transcript of the AEP Industries (NASDAQ:AEPI)’s Fourth Quarter Fiscal Year 2014 Earnings Call, held on January 15, 2015, at 10:00 a.m. EST. Ksa Capital Management, Nokomis Capital and Renaissance Technologies was among AEP Industries (NASDAQ:AEPI) shareholders at the end of the third quarter.
AEP Industries (NASDAQ:AEPI) is a manufacturer of plastic packaging films in North America. The manufacture and market a diverse line of polyethylene and polyvinyl chloride flexible packaging products, with consumer, industrial and agricultural applications. The Company’s plastic packaging films are used in the packaging, transportation, beverage, food, automotive, pharmaceutical, chemical, electronics, construction, agriculture and textile industries.
Host:
Nick Lamplough – Director, AEP Industries Inc.
Company Representatives:
Brendan Barba – Chairman, President and Chief Executive Officer, AEP Industries Inc.
Paul Feeney – Executive Vice President Finance and Chief Financial Officer, AEP Industries Inc.
Analyst:
Richard Kus – Jefferies
Scott Gessner – Barclays
Dan Khoshaba – KSA Capital
Matt Sherwood – Cooper Creek Partner.
Operator: Good Morning. My name is Lorie and I will be your conference operator today. At this time I would like to welcome everyone to the AEC industries incorporated fiscal year 2014 results conference call. All lines have been placed on mute to prevent any background noise. After the speakers remarks there will be a question and answer session. If you like to ask a question during this time simply press *1 on your telephone keypad. If your question has been answered and you wish to remove yourself from the queue press the pound key. Thank you. Mr. Lamplough you may begin your conference.
Nick Lamplough: Thank you. Before we get started I would like to remark briefly about forward looking statements. Except for historical information mentioned during the conference call, statements made by the management AEP industries are forward-looking statements that are made pursuant to the safe harbor provisions of the private security litigation reform act of 1995. Forward-looking statements involve known and unknown risks and uncertainties which may cause the company’s actual results and future periods to differ materially from forecasted results. Those risks included but are not limited to risks associated with pricing, volume and conditions of the markets. Those and other risks are described in the company’s filings with the SEC over the last 12 months, copies of which are available from SEC or may be obtained from the company.
During this call we will also discuss a Nine GAP Financial Measure. Please refer to the table included in our press release for reconciliation of this 9 gap measure to the comparable GAP measure and related discussion thereof. Today’s format will be as follows:
Brendan Barba Chairman, President and CEO will discuss operations and then Paul Feeney Executive Vice President Finance and CFO will discuss the financial results. After the prepared remarks Brendan and Paul will be available for questions. So without further delay I would like to turn the call over to Mr. Barba. Brendan.
Brendan: Thank you Nick. Good morning everyone. Welcome to 2014 year end conference call. I am sure you all had a chance to read our release and clearly results for the year were disappointing we might even add very disappointing. The single biggest issue that we faced and it was a huge issue for the company was twenty six months of continuous resin increases and all the years I have been in the business I have never seen that happened before. There is always some increases and they usually offset during the same year with price decreases that just didn’t happened for two years. We had 23 cents in increases which is approximately $220 million a year of increases that we have to pass on to customers and clearly we are unable to pass all of it along. Our increases are always subject to contractual legs, portion of all businesses contractually, contractual transactional legs we move with the competition it just that simple, we can’t be raising prices until the competition does. We certainly had customer’s resistance when you have multiple increases, increase after increase after increase, customers push back and sometimes you lose business because of that type of activity and the net result is we suffered from severe margin compression.
Volume also declined 1% we certainly weren’t expecting to do better than that. There is a small reason for some of the decline which is that we exited three product lines. Our retail business we exited ceiling lock color business, also in our retail business we exited slider and in our printed division we exited laminations, so total volume involved in those three product lines is about 6 million pounds. Volumes increased in the third and fourth quarter and we will continue increase volumes in 2015. We did a good job on cost control, we were very focused on our overall labor cost. Labor is our second biggest cost after resin so it’s always on our list of the most important projects to take out of costs. As of October 31, 2013 AEP had 2555 employees, at the end of the fiscal year 10/31/14 we had 2486 employees.
I would like to add that we also increased capacity and added staff to some of new lines that we put in and we feel very comfortable that we’ve got those costs very well under control. The other cost that we could not control, we consider out of our control like electric and freight those are function of the market and they also went up dramatically during the year. We did as you know a while ago couple years ago a year-and-half ago two transactions, two acquisitions one was Transco a printer in Canada and we have completed that, consolidation is complete with staff being trained in on new plant and where the equipment went, Bowling Green Kentucky. We’ve done some consolidations there and we’re ready to roll now [inaudible] staff to meet sales forecasts. In Webster acquisition I would say that the consolidation is— we are considering it complete with the exception that we have two automation projects that are ongoing and kind of long-term projects that are not easy to accomplish what we trying to accomplish so it’s taking longer than we wanted or expected. It’s too early for us to really say how much additional staffing will come out until we get final results with the manufacture of the equipment and as I said that’s an ongoing project but as of right now our staffing has been dropped from the time of the acquisition of 714 to 341 employees.
Also would like to talk a little bit about our 2014 capacity increases. Most of this capacity is in place now with the exception of a few million pounds of capacity that’s the last extruder that we have coming in and that should be starting around March. In our printer division we added 6 million pounds of shooting capacity. In our Bowling Green Kentucky plant, in our Matthews North Carolina plant we installed 25 million pounds of stretched capacity. We will also be shutting down a very old extruder that produces about 6 million pounds so we will have about the net increase in capacity added to that plant in for stretch from 19 million pounds. We also did some significant increases in capacity for the year in our custom films division, in our Mountaintop Pennsylvania plant we added 8 million pounds, in our Alsip Illinois plant would added 10 million pounds, in our Matthews North Carolina plant we added 14 million pounds, line upgrades accounted for about another 3 million miscellaneously over all of the other remaining plants and in Montgomery Alabama which is the home of our retail business, the part of the acquisition that we did with Webster, we have installed 4 million pounds of capacity, for our custom films division, this is our sixth manufacturing location for custom films. Total for the whole company is about 70 million pound minus 6 million pounds of product that is been mothballed.
Let me talk a little bit about resin, clearly it’s a huge issue to AEP and everybody in our business it’s our number one cost. The way we have described resin over last couple years is that it’s a very volatile market. I’ve already told you that we had 23 cents and continuous price increases and negative effects it has on the company. I am happy to report that as of November of this year resin prices are down 3 cents, in December they fell another 4 cents. We are anticipating 4 cents additional in January and in February we expect resin cost to come down again although we are not putting a number on it, we are really evaluating it as we speak. Those who follow the market understand that the world market is— basically polyethylene is produced out of oil, not natural gas and you can see what’s happened to the oil market, it has collapsed, this is making resin cost in foreign operations much cheaper and it’s really limiting the ability of the North American companies to export. That in itself is enough to create a turnaround on this and some give back on this continuous increases that we’ve suffered over the last couple of years.
For our capex — I would like to start by acknowledging that we have invested a huge amount of money in the company over the last 2 years and I just told you about some of the capacity increases that we are making. We get it, we understand that we’ve made a lot of investments, they didn’t look too good to us in 2014 and again resin had a huge amount to do with that. We are correcting that now, we do not need any more capacity, and our capex for the year is projected to be about $23 million. We have nothing on order other than one line I told you that comes in March and we have no anticipation for any additional equipment. I can also tell you confidently that we do not need any capacity, we are not holding back on expansion at any business because we are not willing to make the investment, we don’t need it we just need to increase sales and we will increase sales significantly in 2015. Management is absolutely confident that the steps we have taken to lower cost and increase our capacity will really create significant shareholder value in 2015. That concludes my portion of program I will turn it over to Paul Feeney.
Paul: Good Morning Ladies and Gentlemen. Just a few financial highlights and then I will go to questions. I will start with net sales, in the 4th quarter they are increased $17.4 million to $316.7 million. The increase was a result of a 5% increase in average selling prices combined with 0.5 % increase in sales line. The selling price increase was a result of partial pass through of higher resin prices to customers in the current quarter. Volume in the quarter was 250 million pounds an increase of 1.2 million pounds from the 248.8 million pounds sold in the fourth quarter of fiscal 2013. Net sales of $1,193,000,000 in fiscal 2014 was an increase of $49 million of 4.3 % over the $1,144,000,000 recorded in the prior fiscal year. This increase was a result of a 6 % increase in average selling prices partially offset by 1.2% decline in sales line. Fiscal 2014 volume was 948 million pounds down 11.5 million pounds from 959 million pounds sold in fiscal 2013.
We believe this year to date, decline in sales volume was a result of a number of factors including increasing customer resistance to unprecedented sale price increases over a sustained period of time, inclement weather in our first and second quarters and the failure of segments of our economy to fully participate in the recent recovery that we’ve experienced. We are happy that we are able to report volume increases in our third and fourth quarters and although we expect our market price to continue to be extremely competitive we think we will record market share gain in 2015.
Gross profit for the fourth quarter decreased $3 million to $34 million, adjusted to LIFO reserve fluctuations in both quarters there was a gross profit decreased in the current period of about $8.4 million versus the fourth quarter of the prior fiscal year. Adjusted to LIFO, gross profit per pound in the current quarter is 13.3 cents; in the fourth quarter of the prior fiscal year adjusted gross profit per pound was 16.7 cents. Again that decline in gross profit per pound is primarily the result of our failure to pass through resin cost increases. For gross profit of fiscal 2014 decreased $32.6 million to $121.9 million, this includes a LIFO reserves increased in the current year, year to date period of $3.6 million as compared to LIFO reserves increase in the prior year’s fiscal period of $9.9 million. Adjusting for LIFO increases in both periods and an increase in depreciation expense of $3.1 million there was a gross profit decline in the current period of about $35 million versus the prior fiscal year. Again this gross profit decline is largely attributable to our failure to pass through resin cost increases. Adjusting for LIFO gross profit per pound for the current fiscal year is 13.2 cents. In the prior fiscal year adjusted gross profit per pound was 17.1 cents. The decline in gross profits in both the 2014 4th quarter and the current fiscal year results from reduced material margins and the inability to pass through customers, increased material cost and relatively small increases in manufacturing costs. Our 3rd and 4th quarter results were marginally helped by sales volume increases in those periods. But the overall volumes declined for the 2014 year is still having a negative effect on year to date results.
Operating expenses of fiscal 2014 were $113.9 million, a decrease of $7.2 million as compared to the prior fiscal year. The operating cost decrease in 2014 are primarily there to reduced share based compensation cost, associated with the company’s stock options and performance units combining with the absence of unusually high severance cost and inter plant transportation costs recorded in the prior year, partially [inaudible] fell also by a $2.1 million increase in bad debts expense evaded to account receivable which may not be collectable. During the year we recovered $2.1 million in business interruption expenses which were incurred prior year. That recovery was from business interruption insurance and we waited to the relocation of certain equipment from Montreal Canada to Bowling Green Kentucky. Fiscal 2014 interest expense increased $900,000 due to increased borrowings under our credit facility. Net loss of fiscal 2014 was $5.5 million or [inaudible] share as compared to net income of $10.7 million or a [inaudible] share of fiscal 2013. We run the company [inaudible] which was $46.1 million for 2014 as compared to $75.9 million in the prior fiscal year, we continued with this kind of program which is around $50 million at the current time. Capex for 2014 was $26.5 million and our capex forecast is expected to be in the area of $23 million for the year. We expect a 2015 volume increase of about 3%. Availability under our credit facilities currently is about $100 million with that thanks for your attention and we’re available to answer any question you put forward. Thank You.
Operator: At this time I would like to remind everyone if you like to ask a question please press * then number 1 on your telephone keypad. If your question has been answered and you wish to remove yourself from the queue press the pound key. We ask that you please pick up your handset to provide optimal sound quality. Your first question comes from line of Richard Kus of Jefferies.
Richard: Hey Guys. Good Morning. My first question is on the behavior of some of your customers. Have you found that as polyethylene prices have declined, these guys have been delaying purchases waiting for lower prices such that you know you guys while you are experiencing lower raw material cost you are not getting the full benefit margin?
Brendan: Yes. That’s a typical, as prices go up the customers try and book specially in stock businesses they try and grab as much inventory as they can get hold of and as prices go down they order as little as possible to keep them operating and again most of that takes place in our stock businesses.
Richard: OK and that’s something that you would expect to impact your fiscal first-quarter and may be bleed a little bit into the fiscal second-quarter?
Brendan: Yes.
Richard: OK. And then you mentioned the 3% volume growth is what your expectation is for fiscal 2015, what are the drivers underlining this?
Brendan: Well we have added capacity in places where we were busy in the past, the capex that we made during the last couple years has tried to address areas where we can relieve backlogs, we were out for five, six weeks so we a have good likelihood of running that equipment, new product development is always the driver behind what we are doing and in some instances where we have to get down and dirty we get down and dirty.
Richard: OK, OK. I think that’s it for me right now thank you very much.
Operator: Once again if you like to ask question please press *1. Your next question comes from line of Dan Khoshaba of KSA Capital.
Dan: Good Morning Guys. Well Brendan your comments at the end of your initial remarks were that you expected the current year 2015 to be a year were company creates I thinks it’s a substantial shareholders value and you know I believe -correct me if I am wrong- but part of that is what you’re seeing in terms of the moderating . . . its not the declining price of resins, some of that is the lower capex. The capex that you put in place which is obviously gonna run more efficiently so the fundamental picture is going to look better and we are all pleased about that but when you talk about shareholder value Brendan you also consider may be that your. . . now that you are done with a what was a huge really -I think you will agree- capex program over the last few year that part of that shareholder value might come from you know generating substantial free cash flow and perhaps beginning to give that path to shareholders which you know today they have not benefited at least not yet from all of that capex. Do you have any thoughts on that side of the — ?
Brendan: I think Paul can chip in on this also but generally speaking at every directors meeting there is an open discussion and it’s always on the agenda about steps we can take and we did buy back some shares, we have discussed dividends, shares etc. it’s an ongoing. We don’t have any specific plans on doing anything this year. I think we just want to sell out what we have sold to generate the type of cash flow that we used to in prior periods and that’s about what’s our goal of the year.
Dan: So if I could just follow up on that and if your CAPEX is going down and you have the kind of year you think you could have and you generate cash, how do you reduce your debt level? you think your debt is too high at this point or why wouldn’t you either do large special dividends or something else if things work out the way we all hope of course or is it your view that paying down debt would be a better use?
Brendan: I would let Paul answer that question.
Paul: Dan, returning cash to our shareholders is something we talk about all the time and most recently we returned about $20 million to our shareholders via a 529,000 share repurchase. I think it was in the second quarter of a prior fiscal year. At the present time however to consider returning more cash to the shareholders when our leverage ratios are really quite high might not be such a good idea and that is one of the things that the board has debated and studied very very carefully. We as a company believe we are here to– our sole purpose of existence is to return is to create shareholder value as opposed to strictly returning cash to shareholders and we believe we create that shareholder value I am talking about by increasing earnings, by paying down debt, sometimes by investing in the company and of course by returning cash to shareholders via either a dividend or stock buyback. All of those activities we as a company have actively engaged them. A brief review of our balance sheet at year end will show total paid in capital in the area of the $113 million, that since the inception of the company and a treasury stock alone of a $190 million. That to me indicates that we have returned to the shareholders approximately $77 million beyond what they have ever given us. So our efforts to return cash to shareholders will continue but not at the expense of breaking the bank which is the creation of shareholder value so that’s kind of where we are, that’s where the directors came away from the discussion I am gonna say at the most recent meeting which might have been 2 days ago.
Dan: And you feel that you guys have the appropriate amount of the same discipline when the board is deciding on spending what has been hundreds of millions of dollars on CAPEX, the last few years that you know breaking the bank and the expected return that you are gonna get on that investment I guess we are gonna see overtime what kind of return we get of that.
Paul: Well that’s right.
Dan: Yea… OK. Alright, thank you
Paul: There is no question that our investments over the past two or three years has been risked, I mean we know that. And are we risking shareholder position? Absolutely. But we are risking over position as shareholders also.
Dan: Thank you.
Operator: Once again if you want to ask a question please press *1. The Next question comes from the line of Matt Sherwood of Cooper Creek Partner.
Matt: Hi Guys. Just had a quick question on the volumes, I guess in response to the earlier question you suggested that volumes could be impacted by the price decrease in the first half ,you’re looking for 3% growth over the course of the year, would that just be sort of second half weighted or how are you looking at it?
Brendan: Its always weighted heavily in the last quarter because the seasonal factors in our business always our first quarters are worse than improves each quarter into the last quarter which sometimes can represent from memories somewhere around [inaudible] volume.
Matt: Right. I wasn’t asking so much about seasonality but you on your growth rates, you know you are projecting your end year growth but you just said in response to the earlier question that the growth rate could be impacted in the first and second quarter.
Brendan: Yeah in the short term, in the first quarter we believe that will happen, but that only leaves pent-up demand. I mean when the customer doesn’t buy anything and he keeps his inventory as low as possible to take advantage of the price decreases effectively. As they level off, that activity is gonna stop and he is gonna buy back to normal quantities so we believe it recovers.
Matt: Alright. I had a question on how the pass through of lower raw material, lower resin prices works in a volume growing environment because last time we saw a decline of this magnitude in resin prices, -volumes yeah at least on a Proforma basis because you made the acquisition- had been impacted so you know just how do we look at how much your pricing has to respond in light of the lower resin prices?
Brendan: Yea. It’s pretty much an impossible question to answer because in some of our businesses contractual and it goes with contractual, whatever the contract calls for some of it is transactional, a lot of it is transactional and we are in many many markets and we are probably working at 9 divisions. They all operate differently, they all operate with different competition but we see ourselves as a beneficiary as these resin prices are coming down and giving us relief that we just choked on over 2 years.
Matt: That’s great and in terms of contract, are these what? I guess an index of resin or are they for some portion of time? How do you look at the contractual business?
Brendan: We have contracts that vary from 30 days to 60 days to 90 days and in some cases extended periods of time protection but it’s done only in like one division where we do that—- but it’s across the board it various by the customer and it varies based on the business that are in.
Matt: Alright and then the final question you know if you look at the competitive environment you know versus 2012 for example when you had a more reasonable resin price environment you know how is it changed when you say it’s more competitive and it’s harder to achieve the sort of margins that you achieved and how would you like to be competitive in terms of it?
Brendan: The way I think about our business is almost the way you look at airline business. For years they choked on very high oil prices and gasoline prices and in fact that made those businesses very very difficult to make a profit in, but over time and after that you go through that horrible cycle which we’ve come through we are not alone we see all the competition has suffered very very similar same thing that we have. So we expect that it’s gonna be more order in the marketplace and people just as intent on regaining margin as AEP is.
Matt: OK.
Operator: Your next question comes from line of Scott Gessner of Barclays.
Scott: Good Morning. Just a quick follow up on a couple of those points there. You mentioned throughout the year you tried to pass through I think you said 3 price increases or number of price increases. Specifically September though that price increase went through in the space of what turned out to be some actual resin declines coming after that. Then you talked about the effectiveness of the September price increase specifically.
Brendan: It went through and then they gave it back at a later period that’s about when it all ended and in November they gave it back.
Scott: Right and if you look back at 2014, how should we think about the amount of the resin increases actually capturing pricing because I am trying to figure out what the negative impact of higher resin versus pricing that wasn’t quite as high on your end in 2014?
Paul: If you look at 2014 we were behind resin price increases in every single quarter. I don’t have in front of me the amounts that we were behind in the first and second quarter but in the third and fourth quarter we were behind an average of $6 million at the gross profit level, that’s how far we were behind. For this year we were behind about 28 million, let’s say about $28 million that’s how much. On resin price increases of $230 million that mean we were behind about 3 cents a pound something like that.
Scott: Ok and then just lastly on obviously what were resin is going to have some sort of impact on working capital needs as you move into 2015 based on their current decline in resin, not even forecasting any future declines. How should we think about the impact on working capital?
Paul: Well very clearly our investment in working capital is going to decline, accounts receivable is going to decline because we are gonna have to give back some of these resin cost declines to the customers. So to the extent that we do that our investment in accounts receivable is going to decline if resin prices go down 7 cents where they are now and they may be 11 cents by the end of this month, I’m expecting you are going to see a penny for penny decline in our investment inventory and the truth is we typically end up with I’m gonna say close to 80 million pounds of inventory something like that. So 80 million pounds times 7 cents it’s $5.6 million or times 11 cents it’s $8 million. That’s kind of which you are looking at.
Scott: Right… Ok. So we had meaningful numbers. Yes?
Paul: Yes. Our working capital requirement is going to decline. No question about it.
Scott: And just lastly then on I mean we are talking about TET here but what about some of the more specialty resins that you see similar declines within the specialty resins as well?
Brendan: Yea the first two decreases were across the board. Any resin type I’m not aware of any that they didn’t decrease I believe that’s statement is that isn’t 100% sure it’s 95% sure. Yeah
Scott: Ok… Thank you I appreciate the caller.
Operator: At this time there are no further questions and now can I call Mr. Brendan Barba for any additional or closing remarks.
Brendan: Thank you everyone for attending the call we appreciated and as always if you have any questions that you would like to forward to either Paul or myself, we would be happy to answer that for you. Thanks again take care.
Paul: Thank you ladies and gentlemen.
Operator: Thank you for participating in the AEP Industries Incorporated fiscal year 2014 results conference call. In and out.
