| AEP INDUSTRIES INC ITEM 1A RISK FACTORS Risk Factors You should carefully consider the risks and uncertainties we describe below and the other information in this Annual Report or incorporated by reference 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 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 harmed |
| Industry Risks Our business is dependent on the price and availability of resin, our principal raw material, and our ability to pass on resin price increases to our customers |
| The principal raw materials that we use in our products are polyethylene, polypropylene and polyvinyl chloride resins |
| Our ability to operate profitably is dependent, in large part, on the market for these resins |
| As these resins used by us are derived from petroleum and natural gas, prices fluctuate substantially as a result of changes in petroleum and natural gas prices, demand and the capacity of the companies that produce these products to meet market needs |
| Instability in the world markets for petroleum and natural gas could adversely affect the prices of our raw materials and their general availability |
| Our ability to maintain profitability is heavily dependent upon our ability to pass through to our customers the full amount of any increase in raw material costs |
| If there is overcapacity in the production of any specific product that we manufacture and sell, we frequently are not able to pass through the full amount of any cost increase |
| If resin prices increase and we are not able to fully pass on the increases to our customers, our results of operations and our financial condition will be adversely affected as they were in our European operations in fiscal 2004 |
| Intense competition in the flexible packaging markets may adversely affect our operating results |
| The business of supplying plastic packaging products is extremely competitive |
| We face intense competition from numerous competitors, several of which have extensive production facilities, well-developed sales and marketing staffs and greater financial resources than us |
| Competitive products are also available from a number of local manufacturers which specialize in the extrusion of a limited group of products, which they market nationally and a limited number of manufacturers of flexible packaging products who offer a broad range of products and maintain production and marketing facilities domestically and internationally |
| This results in competition which is highly price sensitive |
| We also compete on the basis of quality, service, timely delivery and differentiation of product properties |
| We believe that there are few barriers to entry into many of our product markets |
| As a result, we have experienced, and may continue to experience, competition from new manufacturers |
| Also, when new manufacturers enter the market for a plastic packaging product or existing manufacturers increase capacity, they frequently reduce prices to achieve increased market share |
| Companies can also develop products that have superior performance characteristics to our products |
| In addition, we compete with manufacturers of non-plastic packaging products, many of whom can offer consumers non-plastic packaging solutions |
| Many of these competitors have greater financial resources than we do and this competition could result in additional pricing pressures, reduced sales and lower margins |
| An increase in competition could result in material selling price reductions or loss of our market share |
| This could 12 ______________________________________________________________________ materially adversely affect our operations and financial condition |
| There can be no assurance that we will be able to compete successfully in the markets for our products or that competition will not intensify |
| We are subject to various environmental and health and safety laws and regulations which govern our operations and which may result in potential liability, and consumer preferences and ongoing health and safety studies on plastics and resins may adversely affect our business |
| Our operations are subject to various federal, state, local and foreign environmental laws and regulations which govern: · discharges into the air and water; · the storage, handling and disposal of solid and hazardous waste; · the remediation of soil and ground water contaminated by petroleum products or hazardous substances or waste; and · the health and safety of our employees |
| Compliance with these laws and regulations may require material expenditures by us |
| Actions by federal, state, local and foreign governments concerning environmental and health and safety matters could result in laws or regulations that could increase the cost of manufacturing our products |
| In addition, the nature of our current and former operations and the history of industrial uses at some of our manufacturing facilities expose us to the risk of liabilities or claims with respect to environmental and worker health and safety matters |
| We may also be exposed to claims for violations of environmental laws and regulations by previous owners or operators of our property |
| In addition, the presence of, or failure to remediate, hazardous substances or waste may adversely affect our ability to sell or rent any property or to use it as collateral for a loan |
| We also may be liable for costs relating to the investigation, remediation or removal of hazardous waste and substances from a disposal or treatment facility to which we or our predecessors sent waste or materials |
| Additionally, a decline in consumer preference for plastic products due to environmental considerations could have a material adverse effect on our business, financial condition and results of operations |
| Also, continuing studies of potential health and safety effects of various resins and plastics, including polyvinyl chlorides and other materials that we use in our products, are being conducted by industry groups, government agencies and others |
| The results of these studies, along with the development of any other new information, may adversely affect our ability to market and sell certain of our products or may give rise to claims for damages from persons who believe they have been injured by such products, any of which could adversely affect our operations and financial condition |
| The loss of a key supplier could lead to increased costs and lower profit margins |
| Worldwide resin costs comprised 73prca of our total consolidated cost of sales in fiscal 2005 |
| We rely on three principal suppliers for our resin that provided us with approximately 30prca, 23prca and 16prca, respectively, of our fiscal 2005 consolidated resin supply |
| The loss of any of these resin suppliers would force us to purchase resin in the open market, which may be at higher prices, until we could secure another source of resin and such higher prices may not allow us to remain competitive |
| In addition, the resin supply in our industry is limited, and a loss of one of our suppliers may not be replaceable through open market purchases or through a supply arrangement with another supplier |
| If we are unable to obtain resin in sufficient quantities, we may not be able to manufacture our products |
| Even if we were able to replace one of our resin suppliers through another supply arrangement, there can be no assurance that the terms that we enter into with such alternate resin supplier will be as favorable as the resin supply arrangements that we currently have |
| 13 ______________________________________________________________________ Company Risks We experience fluctuations in operating income, which may cause our stock price to fluctuate |
| Our operating income from continuing operations has been subject to significant quarterly and annual fluctuations |
| These fluctuations can be caused by: · global economic conditions; · competition; · variability in raw material prices; · acquisitions; · asset sales; · business restructuring initiatives; · seasonality; and · foreign currency fluctuations |
| These fluctuations make it more difficult for investors to compare our operating results to corresponding prior year periods |
| These fluctuations may also cause our stock price to fluctuate |
| You should not rely on our results of operations for any particular quarter or year as indicative of our results for a full year or any other period |
| We have limited contractual relationships with our customers and, as a result, our customers may unilaterally reduce the purchase of our products |
| We generally do not enter into long-term contractual relationships with our customers for the supply of our products |
| As a result, our customers may unilaterally reduce the purchase of our products or, in certain cases, terminate existing orders for which we may have incurred significant production costs |
| Any loss of several customers could in the aggregate materially adversely affect our operations and financial condition |
| Our business may be adversely affected by risks associated with foreign operations |
| Approximately 14prca of our fiscal 2005 net sales from continuing operations are generated from operations conducted outside North America |
| Conducting an international business inherently involves a number of difficulties and risks, including the following: · currency fluctuations; · restrictions on our ability to cause our subsidiaries to transfer cash to us; · requirements relating to withholding taxes on transfers from our subsidiaries to us; · inflation; · compliance with existing and changing regulatory requirements; · export restrictions, tariffs and other trade barriers; · difficulties in staffing and managing international operations and redundancy costs which limit our ability to reduce staff; · longer payment cycles; 14 ______________________________________________________________________ · problems in collecting accounts receivable; · political instability and economic downturns; · seasonal reductions in business activity in Europe during the summer months; and · potentially adverse tax consequences |
| We have experienced and may continue to experience any or all of these risks |
| Any of these factors may materially adversely affect our sales, profits, cash flow and financial position, which could adversely affect our stock price |
| Our international operations subject us to currency translation risk and currency transaction risk which could cause our results to fluctuate significantly from period to period and hinder us from making our debt service payments |
| The financial conditions and results of operations of each foreign subsidiary are reported in the relevant local currency and then translated into US dollars at the applicable currency exchange rate for inclusion in our consolidated financial statements |
| Exchange rates between these currencies, especially the euro, and US dollars in recent years have fluctuated significantly and may do so in the future |
| Furthermore, we incur currency transaction risk whenever one of our subsidiaries enters into either a purchase or a sales transaction using a different currency from the currency in which it receives revenues |
| Given the volatility of exchange rates, we may not be able to effectively manage our currency transactions and/or translation risks |
| Volatility in currency exchange rates may cause our profits to decrease or result in a loss |
| In addition, in recent years, as a result of the strength of the euro compared to the US dollar, our operating results in US dollars were positively affected upon translation |
| The positive impact of the strengthening euro may not continue in the future and may even reverse if the euro declines in value compared to the US dollar |
| We may, from time to time, experience problems in our labor relations |
| In North America, unions represent 267 employees, or 18prca of our North American workforce at October 31, 2005, under three collective bargaining agreements |
| One agreement expired in March 2005 in our West Hill, Ontario, Canada facility, and a new three-year collective bargaining agreement was approved expiring in March 2008, one agreement expires in February 2007, and the other agreement expires in January 2010 |
| Although we believe that our present labor relations with our North American employees are satisfactory, our failure to renew these agreements on reasonable terms could result in labor disruptions and increased labor costs, which could adversely affect our financial performance |
| Further, we have numerous collective bargaining agreements at our international facilities, covering substantially all of the hourly employees at these facilities |
| Changes in these agreements, over which we have no control, could adversely affect our operations and financial condition |
| We cannot assure you that our relations with the unionized portion of our workforce will remain positive or that it will not initiate a strike, work stoppage or slowdown in the future |
| In the event of such an action, our business, prospects, results of operations and financial condition could be adversely affected and we cannot assure you that we would be able to adequately meet the needs of our customers using our remaining workforce |
| In addition, we cannot assure you that we would not have similar actions with our non-unionized workforce or that our non-unionized workforce will not become unionized in the future |
| 15 ______________________________________________________________________ Loss of third-party transportation providers upon whom we depend or increases in fuel prices could increase our costs or cause a disruption in our operations |
| Strikes, slowdowns, transportation disruptions or other conditions in the transportation industry, including, but not limited to, shortages of truck drivers, disruptions in rail service, decreases in ship building or increases in fuel prices, could increase our costs and disrupt our operations and our ability to service our customers on a timely basis |
| In addition, rising fuel prices have resulted in increasing transportation costs and have adversely affected our operations and financial condition |
| Anti-takeover and change of control provisions may adversely affect our stockholders |
| Our directors are elected for three-year terms, so approximately one-third of the board is elected each year |
| We are subject to a Delaware statute regulating business combinations |
| These factors could discourage, hinder or preclude an unsolicited acquisition of our company and could make it less likely that stockholders receive a premium for their shares as a result of any such attempt |
| In addition, our Board of Directors may issue, without stockholder approval, shares of preferred stock |
| The preferred stock could have voting, liquidation, dividend or other rights superior to those of the common stock |
| Therefore, if we issue preferred stock, a person’s rights as a common stockholder may be adversely affected |
| A provision of our 7dtta875prca Senior Notes requires us, upon a change of control, to offer to purchase the outstanding Senior Notes |
| If a change of control were to occur and we could not obtain a waiver or if we do not have the funds to make the purchase, we would be in default under the Senior Notes, which could depress our stock price |
| A possible violation of European competition law could adversely affect us |
| In fiscal 2001, the European Commission served our Holland subsidiary with a notice to produce various documents and other evidence relating to its investigation of a possible violation of European Competition Law by that subsidiary |
| We cooperated in this investigation |
| No litigation has been instituted against us involving this matter |
| However, we are not in a position to evaluate the outcome of the investigation |
| If the litigation is instituted, a fine may be assessed |
| We are not in a position to predict whether litigation will be commenced and, if commenced, and our subsidiary is found guilty, that the fine would not be material |
| We are dependent on the management experience of our key personnel |
| We are dependent on the management experience and continued services of our executive officers, including J Brendan Barba, our President and Chief Executive Officer, and Paul M Feeney, our Chief Financial Officer |
| On May 9, 2005, we entered into employment agreements with Mr |
| Feeney, as well as each of the following executives of the Company: John J Powers, David J Cron, Paul C Vegliante, Robert Cron and Lawrence R Noll |
| These agreements are effective as of November 1, 2004 and have an initial term of three years and may be extended for successive periods of one year, unless either party gives written notice to the other at least 180 days prior to the expiration of the then current term that he or it does not wish to extend the agreement beyond the term |
| Other terms of the agreements include terms dealing with termination and the rights of the executive to payments following termination under certain circumstances and upon a change of control, confidentiality, non-competition, non-solicitation and related agreements, as well as other customary provisions |
| In addition, our continued growth depends on our ability to attract and retain experienced key employees |
| Competition for qualified employees is intense, and the loss of such persons, or an inability to attract, retain and motivate additional highly skilled employees, could have a material adverse effect on 16 ______________________________________________________________________ our results of operations and financial condition and prospects |
| There can be no assurance that we will be able to retain our existing personnel or attract and retain additional qualified employees |
| Our Chief Executive Officer owns a substantial amount of our common stock and has significant influence over our business |
| At October 31, 2005, J Brendan Barba, our President and Chief Executive Officer, beneficially owns 1cmam261cmam679 shares and presently has the right to acquire an additional 40cmam000 shares of our common stock |
| His ownership and voting control over approximately 15prca of our common stock gives him substantial influence on the outcome of corporate transactions or other matters submitted to the Board of Directors or stockholders for approval, including mergers, consolidations and the sale of all or substantially all of our assets, and also the power to prevent or cause a change in control |
| Barba is also our Chairman of the Board |
| If we fail to comply with Section 404 of the Sarbanes-Oxley Act of 2002, our reputation, financial condition and the value of the notes may be adversely affected |
| Beginning with the year ended October 31, 2005, Section 404 of the Sarbanes-Oxley Act of 2002 (Section 404) requires us to include an internal control report of management with our annual report on Form 10-K, which is to include management’s assessment of the effectiveness of our internal control over financial reporting as of the end of the fiscal year |
| That report also is required to include a statement that our independent registered public accounting firm has issued a report on management’s assessment and effectiveness of our internal control over financial reporting |
| In order to achieve compliance with Section 404 within the prescribed period, management has engaged outside consultants and adopted a work plan to assess the adequacy of our internal control over financial reporting, remediate any control weaknesses that may be identified, validate through testing that controls are functioning as documented and implement a continuous reporting and improvement process for internal control over financial reporting |
| The reports for fiscal 2005 are included in this annual report and include a material weakness related to the Company’s failure to maintain effective policies and procedures relating to accounting for income taxes, including the determination and reporting of deferred income tax assets and liabilities |
| Specifically, our policies and procedures did not provide for review of detailed analyses and supporting documentation by our Vice President and Treasurer and our Vice President and Controller |
| For subsequent fiscal years, we may not be able to complete the work necessary for our management to issue its management report in a timely manner, or any work that will be required for our management to be able to report that our internal control over financial reporting is effective |
| In addition, our independent registered public accounting firm may not be able to issue a report on management’s assessment and effectiveness of our internal control over financial reporting |
| Our failure to comply with Section 404, including issuing the management report and obtaining the report of our independent registered public accounting firm and the identification of material weaknesses in internal control over financial reporting, may materially adversely affect our reputation, our financial condition, and our stock price |
| 17 ______________________________________________________________________ Financial Risks We have a high level of debt relative to our equity, which reduces cash available for our business, which may adversely affect our ability to obtain additional funds and increases our vulnerability to economic or business downturns |
| We have a substantial amount of debt in relation to our shareholders’ equity |
| As of October 31, 2005, we had: · dlra192dtta6 million of total debt outstanding (not including capital lease obligations of dlra3dtta7 million); and · dlra6dtta2 million of total shareholders’ equity |
| Our substantial debt could have important consequences to you |
| For example, it could: · 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 |
| The terms of the Senior Notes do not prohibit us or our subsidiaries from issuing and incurring additional debt upon satisfaction of certain conditions |
| In addition, as of October 31, 2005, we would have been permitted to borrow up to an additional dlra120dtta3 million under our credit facility and an additional dlra9dtta2 in foreign credit facilities |
| If new debt is added to our current debt levels, the related risks described above that we and our subsidiaries face could intensify |
| To service our debt, we will require a significant amount of cash |
| Our ability to generate cash depends on many factors beyond our control |
| Our ability to service our debt and to fund our operations and planned capital expenditures will depend on our financial and operating performance |
| This, in part, is subject to prevailing economic conditions and to financial, business and other factors beyond our control |
| If our cash flow from operations is insufficient to fund our debt service obligations, we may be forced to reduce or delay capital expenditures, sell assets, obtain additional equity capital or indebtedness or refinance or restructure our debt |
| These alternative measures may not be successful and may not permit us to meet our scheduled debt service obligations |
| In the absence of such operating results and resources, we could face substantial cash flow problems and might be required to sell material assets or operations to meet our debt service and other obligations |
| We cannot assure you as to the timing of such sales or the proceeds that we could realize from such sales |
| We are subject to a number of restrictive debt covenants which may restrict our business and financing activities |
| Our credit facility, the indenture relating to the Senior Notes and the agreements relating to the indebtedness of our subsidiaries contain restrictive debt covenants that, among other things, restrict our ability to: · borrow money; · pay dividends and make distributions; 18 ______________________________________________________________________ · issue stock of subsidiaries; · make certain investments; · repurchase stock; · use assets as security in other transactions; · create liens; · enter into affiliate transactions; · merge or consolidate; and · transfer and sell assets |
| In addition, our credit facility and the agreements relating to the indebtedness of our subsidiaries also requires us to meet certain financial tests |
| These restrictive covenants may limit our ability to expand or to pursue our business strategies |
| Furthermore, any indebtedness that we incur in the future may contain similar or more restrictive covenants |
| Our ability to comply with the restrictions contained in our credit facility and the agreements relating to the indebtedness of our subsidiaries may be affected by changes in our business condition or results of operations, adverse regulatory developments or other events beyond our control |
| A failure to comply with these restrictions could result in a default under our credit facility and the agreements relating to the indebtedness of our subsidiaries, or any other subsequent financing agreement, which could, in turn, cause any of our debt to become immediately due and payable to which a cross-acceleration or cross-default provision applies |
| If our debt were to be accelerated, we cannot assure you that we would be able to repay it |
| In addition, a default could give our lenders the right to terminate any commitments that they had made to provide us with additional funds |