Overview

Management's Discussion and Analysis of Financial Condition and Results of Operations and other sections of this report contain "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. These forward-looking statements represent our goals, beliefs, plans and expectations about our prospects for the future and other future events, such as our ability to generate sufficient working capital, the amount of availability under our credit facility, our ability to continue to maintain sales and profits of our operations, the implementation of our Board-approved plan to restructure and realign the recently acquired Atlantis Plastics Films businesses, and the sufficiency of our cash balances and cash generated from operating, investing, and financing activities for our future liquidity and capital resource needs. Forward-looking statements include all statements that are not historical fact and can be identified by terms such as "may," "intend," "might," "will," "should," "could," "would," "anticipate," "expect," "believe," "estimate," "plan," "project," "predict," "potential," or the negative of these terms. Although these forward-looking statements reflect our good-faith belief and best 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 integration of Atlantis Plastics with us; the ongoing U.S. recession, the existing global credit and financial crisis and other changes in the United States or international economic or political conditions, such as fluctuations in interest or foreign exchange rates and inflation; the potential of technological changes that would adversely affect the need for our products; price fluctuations which could adversely impact our inventory; effects of rising fuel costs; 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, 2008 and other reports subsequently filed with the SEC. Given these uncertainties, you should not place undue reliance on any such forward-looking statements. Except as required by law, we assume no obligation to update these forward-looking statements, even if new information becomes available in the future.

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:

º •
º Overview

º •
º Results of Operations

º •
º Liquidity and Capital Resources

º •
º Contractual Obligations and Off-Balance-Sheet Arrangements

º •
º Critical Accounting Policies

º •
º 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, 2008, other reports filed with the SEC and other publicly available information.

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 principal 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. The market for these resins has been extremely volatile, resulting in record price increases followed by significant decreases. 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.

We acquired substantially all of the assets of the Plastic Films segment of Atlantis Plastics, Inc. ("Atlantis"). Atlantis operated this segment through three divisions-stretch films, custom films and institutional products-with production in six plants located throughout the United States. Atlantis maintained a significant presence in many of its product categories, which are used in a variety of applications, including storage, transportation, food packaging and other commercial and consumer applications. Atlantis also converted some institutional products internally from custom films. This transaction enhances our position as the preferred supplier of flexible packaging solutions. The acquisition of Atlantis has provided us a stronger array of products and service to meet the needs of both companies' customers. Please refer to Note 3 of the consolidated financial statements for further discussion of the Atlantis acquisition.

Following a year of rapidly increasing resin prices, the cost of resin decreased during the first quarter of fiscal 2009. Resin prices were lower during the three months ended January 31, 2009 as compared to the three months ended January 31, 2008 (an average decrease of $0.27 per pound or 37%). Although resin and energy costs have recently declined, it is not known whether resin and energy prices will remain lower or will revert to increasing price levels. We believe that the marketplace in which we sell our products remains very competitive, and is further complicated with many of our customers, distributors and suppliers adversely affected by the current economic turmoil. There can be no assurance that we will be able to pass on resin price increases on a penny-for-penny basis in the future, if such prices were to increase.

Forecasts for fiscal 2009 generally call for a weakening economy in the United States, with the continuation of the economic recession. It is difficult to predict the duration and depth of the economic

slowdown and the impact on our business, but we expect that a weak economy will continue to strain the resources of our customers, distributors and suppliers and negatively impact our businesses and operations. We are limited in our ability to reduce costs to offset the results of a prolonged or severe downturn given certain fixed costs associated with our operations, difficulties if we overstrained our resources, and our long-term business approach that necessitates we remain in position to respond when market conditions improve. However, we believe we have taken appropriate steps to minimize the impact of these conditions, primarily through the acquisition in October 2008 of Atlantis (and the related reorganization of such business) and the completion of our amended and restated Credit Facility.

     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
            Selling, General and    Personnel costs, including
            Administrative          salaries, bonuses, commissions and
            Expenses:               employee benefits
                                    Facilities and equipment costs
                                    Insurance
                                    Professional fees, including audit
                                    and Sarbanes-Oxley compliance

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

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

Results of Operations-First Quarter of Fiscal 2009 Compared to First Quarter of Fiscal 2008

AEP and Atlantis were significant competitors in the plastic films industry for many years, competing to sell similar products to a similar customer base. One of the primary factors in AEP's determination to pursue and consummate the Atlantis acquisition was the potential realization of synergistic benefits derived from SKU consolidation, logistical savings, resin cost savings and product

cost efficiencies. Immediately upon the completion of the acquisition, AEP began the process of reducing and combining SKU's, reformulating common products to their most effective common denominator and changing the manufacturing location of certain products to maximize operating and logistical efficiencies. For example, within a week of the Atlantis closing, AEP shut down Atlantis' Fontana, CA facility and began to implement a plan under which the customers previously serviced by Fontana would, in the future, be serviced by AEP's Chino, CA plant or Atlantis' Tulsa plant. We expect to devote significant time and efforts throughout fiscal 2009 to achieve these synergistic benefits. However, as a result of the foregoing, no meaningful operational or financial information exists subsequent to the acquisition that segregates the impact of Atlantis from AEP as a whole. Therefore, although the Atlantis acquisition materially impacted AEP's net sales and results of operations for the first quarter of fiscal 2009, the foregoing Management's Discussion and Analysis of Financial Condition and Results of Operations does not include any separate information regarding Atlantis.

The following table presents unaudited selected financial data for the three months ended January 31, 2009 and 2008 (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
                        January 31, 2009             January 31, 2008
                                                                              % increase/         $
                                 $ Per lb.                    $ Per lb.       (decrease)      increase/
                       $            sold            $            sold            of $         (decrease)
                                         (in thousands, except for per pound data)
Net sales          $ 180,212   $         1.09   $ 173,698   $         1.10             3.8 %  $     6,514
Gross profit          48,084             0.29      27,838             0.18            72.7 %       20,246
Operating
expenses:
  Delivery             9,108             0.06       8,530             0.06             6.8 %          578
  Selling              9,034             0.05       7,982             0.05            13.2 %        1,052
  General and          5,373             0.03       4,924             0.03             9.1 %          449
  administrative

  Total            $  23,515   $         0.14   $  21,436   $         0.14             9.7 %  $     2,079
  operating
  expenses

Pounds sold                      164,810 lbs.                 157,462 lbs.

Net sales for the first quarter of fiscal 2009 increased $6.5 million, or 3.8%, to $180.2 million from $173.7 million for the first quarter of fiscal 2008. The increase was the result of a 1.0% increase in average selling prices, positively affecting net sales by $1.0 million, and a 4.7% increase in sales volume, driven by the Atlantis acquisition. Consolidated first quarter sales volume was 20 to 25% below expectations due to destocking activities by our customers and the adverse effects of the economic recession. The first quarter of fiscal 2009 also included a $2.6 million negative impact of foreign exchange relating to our Canadian operations.

Gross profit for the first quarter of fiscal 2009 increased $20.3 million to $48.1 million from $27.8 million in the same quarter in the prior fiscal year. The increase in gross profit was primarily due to a $29.8 million decrease in the LIFO reserve during the current period resulting from a decrease in resin prices during the first quarter of fiscal 2009. The first quarter of fiscal 2009 also included $0.4 million of negative impact of foreign exchange relating to our Canadian operations.

Operating expenses for the three months ended January 31, 2009 increased $2.1 million, or 9.7%, to $23.5 million from the comparable period in the prior fiscal year. The first quarter of fiscal 2009 includes $0.4 million favorable effect of foreign exchange decreasing reported total operating expenses. The increase in operating expenses is primarily due to higher delivery and selling expenses resulting from greater volumes sold in the current period, combined with an increase in general and administrative expenses resulting primarily from transitional service costs and increased professional services fees related to Sarbanes-Oxley compliance associated with Atlantis. Included in general and administrative expenses in fiscal 2008 are expenses of $0.3 million related to advisory costs incurred as a result of our exploration of strategic alternatives related to our Netherlands subsidiary.

Interest expense for the three months ended January 31, 2009 increased $0.3 million to $4.3 million from $4.0 million in the prior period, resulting primarily from higher average borrowings on our Credit Facility during the three months ended January 31, 2009 as compared to the same period in the prior fiscal year, partially offset by lower interest rates on Credit Facility borrowings.

Other, net for the three months ended January 31, 2009 amounted to $0.2 million in expense, as compared to $0.4 million in income for three months ended January 31, 2008. The decrease in other income is primarily attributable to higher foreign currency losses in the current period as compared to the prior period resulting from changes in foreign exchange rates and an increase in unrealized losses on foreign currency denominated payables and receivables.

The provision for income taxes for the three months ended January 31, 2009 was $7.9 million on income from continuing operations before the provision for income taxes of $20.0 million. The difference between our effective tax rate of 39.4 percent and the U.S. statutory tax rate of 35.0 percent primarily relates to the following: (i) $0.9 million provision for state taxes in the United States, net of federal benefit (+4.6%); and (ii) the utilization of net operating losses of the foreign operations (-0.2%).

The provision for income taxes for the three months ended January 31, 2008 was $1.1 million on income from continuing operations before the provision for income taxes of $2.7 million. The difference between our effective tax rate of 40.4 percent and the U.S. statutory tax rate of 35.0 percent primarily relates to the following: (i) $0.1 million provision for state taxes in the United States, net of federal benefit (+2.4%); (ii) a $0.1 million benefit for the utilization of net operating losses of the foreign operations (-2.6%); and
(iii) provision for income taxes on intercompany income received by the U.S. company from discontinued operations (+5.3%).

Results of Discontinued Operations-First Quarter of Fiscal 2009 Compared to First Quarter of Fiscal 2008

In April 2008, we completed the sale of our Netherlands operation. Our Netherlands operation was a component of our consolidated entity, as defined by SFAS No. 144, and as such requires discontinued operations reporting treatment. As a result, the financial statements for the three months ended January 31, 2008 have been restated to reflect the Netherlands operation as a discontinued operation. The financial statements at January 31, 2009 and October 31, 2008 and for the three months ended January 31, 2009 and 2008 also include as discontinued operations our UK and Spanish operations which are in liquidation.

A consolidated summary of the operating results of discontinued operations for the three months ended January 31, 2009 and 2008 is as follows:

                                                   For the Three Months
                                                    Ended January 31,
                                                 2009          2008
                                                      (in thousands)
           Net sales                              $  -     $       31,291
           Gross profit                              -              2,953
           Income from discontinued operations       -                359
           Income tax provision                      -                  -
           Income from discontinued operations    $  -     $          359

The results of the discontinued operation for the three months ended January 31, 2008 represent the activity of our Netherlands operation. The Netherlands operation was sold on April 4, 2008 and therefore, there was no activity in our Netherlands operation during the three months ended January 31, 2009. There was no activity during the three months ended January 31, 2009 and 2008 in our Spain and UK operations. The liquidation of the UK operation was completed in October 2008.

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.

We ended the first quarter of fiscal 2009 with a net debt position (current bank borrowings plus long term debt less cash and cash equivalents) of $211.6 million, compared with $248.9 million at the end of fiscal 2008. The improvement in our net debt position was driven primarily by cash provided by operating activities of $42.1 million, partially reduced by capital expenditures of $6.1 million.

Our working capital amounted to $82.1 million at January 31, 2009 compared to $105.8 million at October 31, 2008. The decrease in working capital of $23.7 million was primarily due to a decrease in accounts receivable resulting from lower sales revenue in the first quarter of fiscal 2009 as compared to the fourth quarter of fiscal 2008 and a decrease in other current assets resulting primarily from the receipt of prepaid inventory and supplier credits, partially offset by a decrease in accounts payable resulting from the timing of payments and a reduction in resin prices.

We believe that our cash flow from operations, assuming no material adverse change, combined with the availability of funds under our Credit Facility and credit lines available to our Canadian subsidiary for local currency borrowings, will be sufficient to meet our working capital and debt service requirements and planned capital expenditures for at least the next twelve months. However, continued world-wide financial market disruption may have a negative impact on our financial performance and position in the future. We believe the flexibility of our strong balance sheet affords us the opportunity to weather uncertain economic events from a position of strength and we remain confident in our ability to access capital to meet our strategic growth needs. At January 31, 2009, we had an aggregate of approximately $105.2 million available under our various worldwide credit facilities.

The general disruption in the U.S. capital markets has impacted the broader financial and credit markets and reduced the availability of debt and equity capital for the market as a whole. These conditions could persist for a prolonged period of time or worsen in the future. Our ability to access the capital markets may be restricted at a time when we would like, or need, to access those markets,

which could have an impact on our flexibility to react to changing economic and business conditions. In addition, the cost of debt financing and the proceeds of equity financing may be materially adversely impacted by these market conditions. Further, in the current volatile state of the credit markets, there is risk that any lenders, even those with strong balance sheets and sound lending practices, could fail or refuse to honor their legal commitments and obligations under existing credit commitments, including but not limited to:
extending credit up to the maximum permitted by a credit facility, allowing access to additional credit features and otherwise accessing capital and/or honoring loan commitments.

Cash Flows

    The following table summarizes our cash flows from operating, investing, and
financing of our continuing operations and net cash flows from our discontinued
operations for each of the three months ended January 31, 2009 and 2008:

                                                               For the Three Months
                                                                Ended January 31,
                                                                 2009         2008
                                                                  (in thousands)
 Total cash provided by (used in) continuing operations:
     Operating activities                                     $    42,057   $ (18,152 )
     Investing activities                                          (4,513 )    (5,281 )
     Financing activities                                         (36,784 )    23,249
 Net cash provided by discontinued operations                           -         190
 Effect of exchange rate changes on cash                             (570 )        50

 Increase in cash and cash equivalents                        $       190   $      56

Our cash and cash equivalents were $0.4 million at January 31, 2009, as compared to $0.2 million at October 31, 2008. Net cash provided by operating activities from continuing operations during the three months ended January 31, 2009 was $42.1 million, and was comprised of income from continuing operations of $12.1 million adjusted for non-cash operating income totaling $17.2 million. Cash provided by operating activities includes a $33.5 million decrease in accounts receivable resulting primarily from a decrease in sales revenue in the first quarter of fiscal 2009 as compared to the fourth quarter of fiscal 2008, $28.3 million decrease in inventories resulting from decreased resin prices and a decrease of $5.6 million in current assets resulting primarily from the receipt of prepaid inventory and supplier credits associated with Atlantis. Cash used in operating activities primarily includes an $18.2 million decrease in accounts payable as a result of timing of payments and a reduction in resin prices.

Net cash used in investing activities from continuing operations during the three months ended January 31, 2009 was $4.5 million, resulting from $6.1 million in capital expenditures, partially offset by the receipt of $1.5 million from the partial settlement of working capital with Atlantis.

Net cash used in financing activities from continuing operations during the three months ended January 31, 2009 was $36.8 million, resulting primarily from . . .