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Kraton Performance Polymers, Inc. (NYSE:KRA)

Q4 2012 Earnings Call

February 28, 2013 9:00 am ET

Executives

Gene Shiels - Director, IR

Kevin Fogarty - President & CEO

Steve Tremblay - VP & CFO

Analysts

Edward Yang - Oppenheimer

Mike Sison - KeyBanc

Brian Maguire - Goldman Sachs

Alex Yefremov - Bank of America-Merrill Lynch

Abhi Rajendran - Credit Suisse

Andy Cash - SunTrust Robinson Humphrey

Christopher Butler - Sidoti & Company

Gregg Goodnight - UBS

Bill Hoffman - RBC Capital Management

Operator

Good morning and welcome to the Kraton Performance Polymers Incorporated Fourth Quarter and Full Year ending 2012 Earnings Conference Call. My name is Marla and I will be your conference facilitator. At this time all participants are in a listen-only mode. Following the company's prepared remarks there will be a question-and-answer period. (Operator Instructions) Today's conference is being recorded. If you have any objections you may disconnect at this time.

I will now turn the call over to Mr. Gene Shiels, Director of Investor Relations.

Gene Shiels

Thank you, Marla. Good morning and welcome to Kraton Performance Polymers fourth quarter and full year 2012 earnings call. With me on the call this morning are Kevin Fogarty, our President and Chief Executive Officer; and Steve Tremblay, our Vice President and Chief Financial Officer.

Before we review results for the fourth quarter and full year 2012, I'll draw your attention to the disclaimers on the forward-looking information and the use of non-GAAP measures included in our presentation this morning and in yesterday's earnings press release. During our call this morning we may make certain comments that are not statements of historical facts and thus constitute forward looking statements.

Investors are cautioned that the risks, uncertainties and other factors that may cause Kraton's actual performance to be significantly different from expectations stated or implied by any forward looking statements we make today. Our business outlook is subject to a number of Risk Factors. As the format of this morning's presentation does not permit a full discussion of these Risk Factors, please refer to our Forms 10-K, 10-Q and other regulatory filings that are available on the Investor Relation section of our website.

With regard to the use of non-GAAP financial measures a reconciliation of EBITDA, adjusted EBITDA, and adjusted EBITDA at ECRC to net income or loss, and a gross profit at ECRC to gross profit is provided in yesterday's earnings release and is included in the appendix to the material we'll review on this call. Following our prepared remarks, we'll open the line for your questions.

I'll now turn the call over to Kevin Fogarty.

Kevin Fogarty

Thank you, Gene. Good morning everyone. Now before we review our fourth quarter and full year 2012 results, I would like to comment on a very significant and positive development for our Asia HSBC expansion plans.

I've just returned from Taiwan, and you've hopefully have seen from our press release just yesterday in Taiwan we executed a definitive documentation that provides for the formation of our 50/50 joint venture with Formosa Petrochemical Corporation, paving the way for the construction of a 30 kiloton HSBC plant at Formosa's Petrochemical site in Mailiao, Taiwan.

As we've previously disclosed, progress on the proposed joint venture project with Formosa was initially delayed as we waited granting of the necessary environmental permit. When the permit was awarded in July of last year, there were conditions associated with the permit that Formosa deemed too restrictive on its ability to conduct its operations at Mailiao. With no timeframe for potential resolution, it became necessary for us to move forward with a valuation of alternatives to build a HSBC plant on a standalone basis. Fortunately Formosa was successful in resolving the conditions associated with the permit and this progress led to the execution of documents yesterday in Taiwan.

Needless to say, we are extremely pleased with this recent development. We are honored to be aligned with Formosa one of the world's leading petrochemical chemicals, and we believe that our joint venture with Formosa provides the most attractive option for our HSBC Asia expansion plans, given factors such as onsite feedstock availability at Formosa's extensive resources, which will reduce execution risk and ensure successful completion of the project.

As you might have imagined we're now moving forward as quickly as we can with the project, based upon prior engineering design work, our current estimates of construction timeline, and subject to timely receipt of construction permits in a way, we anticipate mechanical completion as early as mid-2015.

As outlined in yesterday's press release, we expect the project to cost in excess of $200 million. Kraton and Formosa will each fund 50% of the capital needs of the joint venture, and we currently estimate that our share funding for the joint venture will be approximately $50 million, with approximately $40 million to be funded in 2013. It's our intension to pursue financing for the project at the joint venture level. We look forward to bringing you project updates as we move forward.

Now a significant aspect of the joint venture is that Kraton will retain rights to purchase all off-take from the plant, which we intend to market through our worldwide organization. While we will be obligated to purchase a minimum volume each year, the obligation corporates an escalating ramp-up schedule designed to balance joint venture success, with the anticipated growth we expect to see for our HSBC products, and new innovations.

Now, let me turn to results for the fourth quarter and full year 2012. Our fourth quarter sales volume was 67.2 kilotons, which was up 9% compared to the 61.9 kilotons we reported in the fourth quarter of 2011.

Sales revenue was $296 million, down approximately $8 million or 3% year-on-year. The revenue decrease reflects lower average product sales prices principally associated with lower monomer prices, as well as head wins associated with foreign currency exchange rates. And these factors were partially offset by the contribution from higher sales volume compared to the fourth quarter of 2011.

For the quarter, we reported a net loss of $29.5 million or $0.91 per share. This includes the impact of an increase in the valuation allowance associated with our deferred tax assets, which increased the fourth quarter net loss by $21.2 million or $0.66 per share.

Fourth quarter net loss also reflects charges of $1.4 million primarily arising from $1.1 million retirement plan settlement that reduced net income by approximately an additional $0.04 per share. Steve will discuss the increase in valuation allowance in more detail in his remarks.

Adjusted EBITDA for the quarter was $12.1 million, up from a negative $7 million in the fourth quarter of 2011. Excluding the impact of raw material price moves or on an estimated current replacement cost basis, fourth quarter 2012 adjusted EBITDA at ECRC was $22.4 million, and this compares to $29.7 million in the fourth quarter of 2011.

Cash provided by operating activities was $44 million in the fourth quarter 2011 compared to cash provided by operating activities of $61 million in the fourth quarter of 2011. This is a function of declines in feedstock prices and continued diligence in managing inventory on hand. Finished goods inventory at the end, at year-end was down on the order of three kilotons compared to 2011.

Looking at full year results, sales volume in 2012 was 313 kilotons. And this is up 3% from the 303 kilotons we reported in 2011. Sales revenue for 2012 was $1.42 billion, down approximately $14 million year-on-year for $1.44 billion in 2011, due to the adverse impact of changes in foreign currency exchange rates, which was partially offset by the revenue contribution from higher sales volume and higher average product sales prices compared to 2011.

For the full year, we recognized a net loss of $16.2 million or $0.50 per fully diluted share. This compares to a net income of $90.9 million or $2.81 per share in 2011. The impact of the full year change in valuation allowance increased the 2012 net loss by $30.7 million or $0.95 per diluted share. In addition, the 2012 net loss includes certain non-recurring and other items that increased the net loss by an additional $9.5 million or $0.30 per diluted share.

In 2011, a decrease in valuation allowance increased net income by approximately $17.3 million or $0.54 per diluted share and non-recurring and other charges reduced net income by $9.8 million or $0.31 per diluted share. Detail on these charges is provided in yesterday's earnings release.

2012 adjusted EBIDTA was $113 million compared to $194 million in 2011. And as Steve will cover in his discussion of the full year EBIDTA bridges, the extreme volatility in raw material prices that were experienced over the past two years resulted in a $97 million swing in FIFO effect from 2011 to 2012.

Excluding the impact of these raw material price moves, adjusted EBIDTA on a current replacement cost basis was $144 million in 2012, an improvement of $16 million from the $128 million posted in 2011. The 2012 adjusted EBIDTA at ECRC of $144 million is the second highest reported in the company's history.

And looking at full year cash flow, cash provided from operating activities was $146 million in 2012, up significantly from $65 million we generated in 2011.

Turning now to a review of fourth quarter results for our four end use markets, beginning with Cariflex. Fourth quarter 2012 revenue for our Cariflex end use was $29 million, up approximately $4 million or 14% compared to the fourth quarter of 2011. Excluding the $1.3 million impact of currency moves, revenue was up approximately $5 million or 19% compared to the fourth quarter of 2011. The revenue increase is attributable to a 13% increase in sales volume, driven by higher isoprene latex sales and by higher average sales prices.

For the full year of 2012, revenue was $106 million, up approximately $7 million or 7% compared to 2011. Again excluding the impact of foreign currency movements, revenue was up $13 million or 13% on higher sales volume and higher average sales prices.

Fourth quarter revenue for advanced materials was $81 million, down $2 million or 3% compared to the fourth quarter of 2011. The unfavorable impact of currency moves accounts for $1.5 million of the revenue decrease. The balance of the revenue decrease is attributable to lower average sales prices compared to the year ago quarter primarily associated with lower monomer cost, which were partially offset by the revenue contribution resulting from a 10% increase in sales volume compared to the fourth quarter of 2011.

The majority of the year-on-year sales volume increase was seen in HSPC product rates. Volume growth for the advanced materials was broad based in terms of market applications, but was led by personal care and consumer applications. Approximately half of the volume increase was driven by end use markets in Asia, the balance coming from North America and European markets.

With the innovation portfolio, volume growth was strongest in PVC alternatives, primarily in medical and wire and cable applications. Full year 2012 revenue for advanced materials was $383 million, down approximately $20 million or 5% compared to 2011. Excluding the $10 million impact from foreign currency exchange rates, sales revenue was down approximately 2%. Sales volume was down 3% as increased sales volumes or higher value HSPC products for consumer medical applications primarily in Asia-Pacific were offset by lower sales and less-differentiated products in all regions. Advanced materials innovation portfolio saw the most significant sales volume increases in PVC alternatives for medical and wire and cable applications.

Looking now at Slide 8. Fourth quarter revenue for adhesive sales and coatings was $110 million, down approximately $3million or 3% compared to the fourth quarter of 2011. The revenue decline is attributable to the negative impact of foreign currency movement and marginally lower average product prices associated with declines in monomer pricing, specially offset by higher sales volume compared to the fourth quarter of 2011.

Looking at the year-on-year improvement in sales volume, volume increases were led by pressure sensitive adhesive and printing plate applications. And in the ASC innovation portfolio volume growth was led by increased sales into printing plate oil field and oil gel applications.

Full year revenue for adhesive sales and coatings was $511 million, up approximately $11 million or 2% compared to 2011. Excluding the negative impact of foreign currency moves, sales revenue was up $34 million or 7%. Sales volume increased 3.7% compared to 2011 and the volume increases were broad based across all end use applications, with the largest volume increases occurring in industrial, pressure sensitive adhesives, non-woven and oil gel applications. Within the ASC innovation portfolio, annual volume increases were most notable in oil field putting plates and protected film applications.

Moving now to Slide 9, revenue for the paving and roofing end use was $76 million in the fourth quarter, down approximately $2 million or 2% compared to the fourth quarter of 2011. Looking at components of the revenue decrease excluding the $3.1 million negative impact from currency moves, revenue increased $1.6 million as higher sales volume more than offset lower average selling prices primarily due to lower butadiene cost relative to the fourth quarter of 2011. Sales volume in paving applications increased globally, the largest increase was seen in North America and Europe where sales were aided by favorable weather and an extended paving season. Roofing volume was essentially flat year-on-year as slightly lower sales volume in Europe offset increases in other geographies.

Looking at full year results for paving and roofing end use 2012 revenue was $421 million, down $8 million or 2% compared to 2011. Excluding the impact of foreign currency moves revenue increased $19 million or approximately 4% with the revenue contribution from higher sales volume partially offset by lower average sales prices again primarily due to lower average butadiene costs.

Sales volume increased nearly 8%. Global volume growth was seen primarily in paving applications with growth in all markets except North America, which continues to be impacted by the absence of government stimulus spending, which ended in July of 2011.

Increased volume in Europe, Middle East, South America, and Asia-Pacific paving markets more than offset a decline in the North American roofing volumes, which were impacted as the significant customer experienced to production outage.

Turning now to innovation. We closed the year with a vitality index of 14% essentially unchanged from last year, as we had growth in new innovation platforms that offset erosion of the index, as certain innovation grades passed the five year mark and rolled out of the vitality index calculation during the year. Excluding the impact of the innovations of all that rolled out of the vitality index because they passed that five-year mark, the index would have been 18% up 380 basis points compared to 2011.

Looking at year-over-year revenue growth for some of our key innovation platforms, revenue for oilfield applications was up 176%, for adhesive innovations up 90%, revenue from PVC alternatives was up 48%, sales into reactive SBS for printing plate applications was up 40%, revenue from paving applications was up 21%, and revenue from comfort bedding applications was up 14%.

I'll now turn this call over to Chief Financial Officer, Steve Tremblay, who will provide a financial review for the quarter. Steve?

Steve Tremblay

Thank you, Kevin, and good morning everybody.

As we turn to Slide 11, I'll speak to our sales volume and sales revenue for the fourth quarter of 2012. Q4 sales volume was 67 kilotons, up 5 KT or approximately 9% from the 62 kilotons we reported in Q4 '11.

Sales volume increased year-over-year in all four end use markets and was broad-based geographically, with Latin America up 28%, Asia-Pacific up 12%, North America up 7%, and Europe posting 6% year-over-year growth.

Fourth quarter sales revenue was $296 million, down approximately $8 million or 3% compared to the fourth quarter 2011.

Looking at the components of the year-on-year revenue decline the 8.6% increase in sales volume from the fourth quarter 2011 resulted in a revenue growth of $27 million. The higher sales volume was partially offset by lower average sales prices primarily a function of lower raw material costs. And the balance of the revenue decrease was attributable to changes in foreign currency exchange rates.

Looking at the components of the sequential revenue decrease, majority of decrease is attributable to lower sales volume, which translate into $50 million reduction in revenue, largely reflecting the seasonal decline in paving volume.

Moving over to gross profit, fourth quarter 2012 gross profit was $40 million, which compares to gross profit of $19 million in the fourth quarter of 2011. We have to exclude the spread between FIFO and estimated current replacement cost, at which point gross profit at ECRC was $50 million in the fourth quarter 2012 with a gross margin of 17%, compared to gross profit at ECRC of $56 million with a gross margin of 18% in the fourth quarter 2011.

Fourth quarter 2012, gross profit per ton at estimated current replacement cost was $743, and this is below our recent run rate and frankly did not meet our expectations. We do not believe this is indicative of the underlying business performance, however, relative to the third quarter of 2012, gross profit per ton was negatively impacted by the following items.

First, a series of production inefficiencies, which in the aggregate reduced gross profit per ton by approximately $40 per ton. We also experienced higher turnaround costs and other timing of other expenses in the fourth quarter compared to the third aggregating $60 per ton. And as we've mentioned in the past compared to the third quarter is a general seasonal decline in gross profit per ton due to the fixed cost absorption commensurate with lower sales volume in the fourth quarter of 2012 that amounted to $85 per ton. So if you adjust for these items, which again a non-indicative of the true run rate of the business, our gross profit per ton would have been approximately $930 in the fourth quarter of 2012.

I do want to mention that even in light of this on a full year basis, our gross profit per ton at current replacement cost improved to $836 per ton from $825 per ton in 2011.

I want to spend a moment and address the production inefficiencies that I just mentioned again aggregating around $40 per ton. We've identified the root causes of these issues and although there may be some lingering effect into the first months of 2013, we are very confident that our manufacturing personnel will return our production performance to the high standards we set for our global operations.

Let's now move to EBITDA. Adjusted EBITDA was $12 million in the fourth quarter 2012 compared to a negative $7million in the fourth quarter of 2011. On an estimated current replacement cost basis adjusted EBITDA amount to $22 million or 7.5% of the revenue in the fourth quarter of 2012 compared to $30 million or 9.7% of revenue in the fourth quarter of 2011.

The change in adjusted EBITDA from the fourth quarter of 2011 to the fourth quarter of 2012 includes $9 million of growth associated with the improved sales volume; you recall that was nearly 9%.

Recall that in the fourth quarter of 2011 raw material costs were dropping dramatically from the August peak and overtime we lowered average selling prices to our customers, which is reflected in the $21 million change in average selling prices.

Moving now to cost of goods sold, we in fact have a $10 million benefit, which includes changes in raw material costs. However these were partially offset by increased operating costs, including those caused by the production inefficiencies in Q4 of 2012 which I alluded to a moment ago.

Finally, EBITDA benefitted by $26 million due to the positive spread between FIFO and estimated current replacement cost.

And despite what we experienced in the fourth quarter relative to the fourth quarter of 2011, our margin above raw materials in 2012 continue to be at or above the levels we established through our price rise strategy.

Now, relative to sequential change in adjusted EBITDA, the seasonally lower volume had a downward effect on adjusted EBITDA of $16 million. The $30 million sequential increase in cost of goods sold includes the effects of the production inefficiencies and the timing of turnaround and other items again that I mentioned earlier in the conversation of gross profit. The lower volume and increased cost of sales were essentially offset by the change in the spread between FIFO and estimated current replacement cost.

We'll take a look now at the full year results. 2012 sales volume was 313 kilotons up 3% from 303 kilotons we reported in 2011. With the exception of North America, volume was up in all major geographic regions, with Asia-Pacific leading the way up 16%, South America 12%, and Europe up 5%.

As Kevin summarized in his comments, the volume decline in North America was due to lower sales volume in our paving and roofing end use and lower sales of less differentiated grades across certain of our other end users.

Within the paving and roofing end use, roofing volumes declined the most in part due to the production outage at an asphalt production facility that impacted a number of our customers and paving volumes were down to a lesser extent reflecting continued funding challenges.

Sales revenue of $1.42 billion was down $14 million from 2011. The decrease was largely due to changes in currency, which had a $67 million impact, partially offset by a $42 million contribution from higher sales volume, and $13 million in higher average year-over-year selling prices, which reflect changes in the raw materials. As a point of note on a currency adjusted basis our full year revenue would have been up 4%.

Gross profit in 2012 was $231 million and this compares to a full year 2011 gross profit of $316 million. However on an estimated current replacement cost, gross profit was $262 million in 2012 with a margin of 18.4% and this compares to gross profit of $250 million in an associated margin of 17.4%.

Adjusted EBITDA was $113 million in 2012 compared to $194 million in 2011 and excluding the spread between FIFO and ECRC 2012 adjusted EBITDA and estimated current replacement cost was $140 million or 10% of sales, up from $128 million or 9% of sales in 2011.

Looking more closely at the EBITDA bulk volume contributed $11 million of incremental EBITDA and higher average selling prices contributed an additional $13 million. On average raw material costs were lower than 2011, which was offset by a higher production costs, including the performance issues in Q4.

So therefore, the year-on-year the biggest driver in the change in adjusted EBITDA is the aforementioned change in spread between FIFO and ECRC, which was nearly $100 million year-on-year.

On Slide 15, we would like to provide an update of gross profit trends at FIFO in an estimated current replacement cost. First let me touch on the negative spread in the quarter between FIFO and ECRC, which amounted to $10.2 million, which was in line with the upper end of the range that we provided during our third quarter conference call.

As we look forward into the first quarter of 2013, we're currently estimating a negative spread not to exceed $3 million. Looking at the fourth quarter of 2012 gross profit per ton at ECRC, I want to reiterate the points I made earlier, specifically relative to the third quarter 2012 the $743 per ton reflects the under absorption of fixed cost due to lower seasonal volume, which amounts to approximately $85 per ton, and approximately $100 per ton reflecting the production inefficiencies, turnaround cost, and the timing of other items in the quarter. And again on a full year basis, gross profit per ton improved $11 per ton to $836 for the full year of 2012.

Although we've generated our benchmark $1,000 gross profit per ton in certain prior quarterly periods to stay in this level of unit profitability is, as we outlined in our August Investor Day, a key outcome of our stated multiyear endeavor to shift a portfolio to higher margin products.

Looking at net income and earnings per share, as Kevin mentioned in his remarks, net income and EPS include adjustments to our deferred taxes, as well as other items, which impact comparability. We've shown them here as well as in our press release.

First, the non-cash increase in the valuation allowance reflects our estimate of the net realized ability strictly for book purposes of net operating loss carry-forwards. Specifically the $0.91 per share loss in the fourth quarter of 2012 includes fully $0.66 associated with the increase in the valuation allowance and $0.04 associated with other items primarily pension settlement obligation.

On a full year basis, the $0.50 loss per share includes $0.95 due to the additional valuation allowance and $0.30 due to other items. A word on the valuation allowance, we've essentially at this point in time provided a reserve against nearly a 100% of our net operating losses.

Moving on to cash flow, a real strong year. We generated a $146 million of operating cash flow in 2012, which was up $82 million or more than a 100%, compared to operating cash flow of $65 million at 2011.

Average finished goods inventory was trimmed 16% in 2012 and day sales outstanding was reduced by two days. In addition to these key management achievements, our overall working capital position improved commensurate with the year-over-year decline in raw material costs.

Our CapEx in 2012 amount to $70 million, which included approximately $6 million associated with the Asia HSBC project. Net of debt repayments cash from financing activities was a positive $53 million. As a result of all these factors, cash on hand increased from $89 million at December 31, 2011, to $223 million at December 31, 2012.

And when you take this cash on hand into consideration, our net debt to net capitalization was a healthy 31% and net debt to adjusted EBITDA was approximately two turns at December 31.

Before I turn the call back over to Kevin, I'd like to provide some discrete guidance information on certain items, certain P&L items that we currently expect to take place in 2013.

First off 2013 interest expense is currently estimated to be $29 million that's in line with our 2012 interest expense.

Our current estimate for research and development expense is $35 million. This represents an increase in our, over our 2011 rate as we continue to support major initiatives including NEXAR and oilfield services, and in addition we provided for some redundant transition costs, as we await the completion of our all important semi-works plant to be constructed at our flagship Belpre site.

SG&A expenses expected to be $109 million. The increase here compared to 2011 is primarily related to non-cash and incentive compensation expenses.

Depreciation and amortization is expected to flow up to $60 million in 2012, and as a result of our current view of the geographic generation of pre-tax income as well as the moves we took with our valuation allowances in 2012, we're looking at a book tax rate of 12% in 2012.

Let me now turn the call back over to Kevin for his closing comments.

Kevin Fogarty

Great. Thanks Steve. If you look at 2013 we will be intently focused on a number of strategic initiatives. First, given the recent positive developments in Taiwan, we will be fully focused on all aspects of the HSBC project, completing final engineering design work, evaluating financing structures, investing other regulatory requirements such as applicable standard, regional construction and operating permits, and completing site service agreements, feedstock supply agreements, and other documents related to the joint venture.

Equally as important will be our emphasis on innovation and accelerating commercialization or market penetration of our newer innovation platforms. Related to our innovation focus is the ongoing construction of our semi-works plant in Belpre, which will play an important role in accelerating innovation and improving efficiency in our research and development organization. Semi-works plant is currently on schedule and on budget and we expect completion in the fourth quarter.

Related to our innovation objectives, specifically around innovation, and accelerating commercialization of new product platforms, is the ongoing portfolio shift we outlined in our Investor Day this past August. The shift in our portfolio composition towards higher value products with higher margins and profitability is underway and we'll be driven by continued success in innovation platforms such as NEXAR, products and solutions for oilfield applications, growth and volumes of products which provide alternatives to PVC in medical and wiring cable applications, and continued growth in Cariflex isoprene rubber and isoprene rubber latex volumes. Given the value in use for these new innovations they carry the premium margins that will enhance overall portfolio profitability for Kraton.

As many of you know that our first NEXAR commercialization is now official. We are very proud to see our patent innovation utilized in what our customer believes should be an industry transforming approach. Kraton stands ready to ramp-up production to serve our customers needs as the new offering gains market recognition.

Given the volatility, we have seen over the past two years for raw materials such as butadiene and the fact that over the past two years, price trends have diverged significantly from historical patterns and pricing fundamentals, I'm hesitant to provide much in a way of a long-term outlook. However with respect to butadiene, we have seen relative price stability through much of the fourth quarter of 2012 and into the first quarter of 2013. Following the recent price increases in the Asian spot market, driven in part by some capacity outages, the North American contract butadiene price has increased $0.07 in March to $0.84 following several months of no change.

Looking beyond March it is difficult to predict what may happen. But if we continue to see relative stability in monomer prices, preferably with an upper bias, it would provide a welcome change from the environment, which we've been operating and would alleviate the disruptive pressures on product prices, margins, and customer order patterns that we've experienced over the past two years.

While we expect the global economic outlook in the near-term and for much of 2013 to provide general uncertainty in so many of the regions and markets we serve. At Kraton, we must continue to demonstrate industry leadership as we seek new applications for Kraton's products. In other words, we must find ways to grow despite lagging industrial growth.

We're committed to accomplishing this through development and commercialization of innovation at an accelerated rate. Many of the platforms we've dedicated years to develop and invest towards are now becoming commercial reality. Making these higher value sales a richer part of our overall sales mix is our mission. Therefore baring any significant raw material or foreign exchange impacts, by design, we expect 2013 sales growth to be modest, while unit gross profit at ECRC should continue to improve consistent with what we experienced in 2012 versus 2011 and consistent with our portfolio ship strategy.

So, with that, I'd like to open the call up for some questions.

Question-and-Answer Session

Operator

Thank you. At this time, we are ready for the question-and-answer session. (Operator Instructions) My first question comes from Edward Yang with Oppenheimer.

Edward Yang - Oppenheimer

Steve talked about the product inefficiencies impacting the gross margin by ton by $40. Could you provide some additional color on what those production inefficiencies were?

Steve Tremblay

Yeah, Ed, how are you? I want to first say that they were unusual for our platform to experience these in any quarter, and in fact we measure plant reliability and downtime consistently, constantly. And in 2012, even though we had some issues in our fourth quarter, the full year reliability in our locations was outstanding. So I don't want to give the impression that these are anything systemic in how we're running our plants and we have all the confidence in the world as I mentioned earlier that we'll get these things fixed. We know how to run these plants well.

Essentially there are two big buckets and they were very much related that we had some unplanned downtime and we had some efficiencies in the plant that lowered what we call our first time prime, which is probably now is the rate by which you convert raw materials into first quality product. Those two factors resulted in increased energy costs, the downgrade of certain inventories to less than full value. Some of these were specifically related to unusual events in the quarter and some was candidly a lingering effect of some turnaround activity that we had in our third quarter. We just didn't startup as good as we frankly should have. So again there it's about $40 a ton in the quarter. I'll reiterate just again that we are committed to get this fixed.

Edward Yang - Oppenheimer

Okay. On the volume side you saw pretty strong momentum there volumes up almost 9%. Are you seeing that strength continue and what's your sense of customer inventory level at this point?

Kevin Fogarty

From an inventory perspective Ed, I mean we think based on what we're seeing, that inventories have been drawn down I guess and that customers are basically matching sales as best as they can to their own market poll now. Yeah, we would agree that we had nice volume momentum in the fourth quarter. But we're not going to talk specifically about the present quarter. But again I just, I always want to remind you to think above, when you compare 2012 and you think about 2013, you need to go back to the butadiene fundamentals. I mean they're extraordinary when you look at what happened to closeout 2011 and then open up 2012, the price moves in butadiene in those first three months -- actually the first four months of 2012 were extraordinary and not even comparable to what's happening in today's market.

And again I'll go back to my comments about my butadiene, or I'm willing is to speculate butadiene. The good news is we've seen fairly moderate butadiene activity only in the Asian spot market has been some increase and that's now led to $0.07 increase looking at March of this year.

Edward Yang - Oppenheimer

Okay. And just finally, you did mention that you raised prices in Asia, which level of confidence that those price increases will be realized and what are your competitors doing in Asia are they raising prices as well?

Kevin Fogarty

I think the answer to both those questions is yes and yes and that we're seeing evidence that our competition is sensitive to what's happening in feedstocks in Asia and adjusting pricing accordingly. And we, as you always know, our price strategies are very well far through and very consistent and we expect to see those prices increases faster.

Operator

Our next question comes from Mike Sison, KeyBanc.

Mike Sison - KeyBanc

Just wanted to get a better feel for your comments regarding profitability may be gross profit per ton on the ECRC basis in '13. Kevin, it sounded like it would just be a modest improvement with the volume growth you're expecting to look at and because I guess if you add back the 40 and 60 you should be -- you should start at least around 900 level right as we enter 2013?

Kevin Fogarty

Well, again you always have to recognize our business. We do have seasonal quarters. We had seasonal quarters on the low side in first and fourth and high side typically in the second and third. And just again, I call out what happened last year where as a result of what was going on with butadiene, it was pretty clear that that typical seasonal uplift we saw in the second quarter was not the case in the way in which the year unfolded because of that butadiene fundamental.

So, as I think about this year, my comments are that we expect from a revenue perspective to see moderation as we continue on this quest of portfolio shift to higher value added sales. But we do expect to see unit gross profit improvement commensurate with that product portfolio shift.

Mike Sison - KeyBanc

When I compared let's say 2012 your volumes per KT are above 2010, where your gross profit per ton on ECRC basis was a little over 900. Is there, if you grow your volumes again this year, you fix some of these production issues, any reason you want to be back at 2010 levels?

Kevin Fogarty

I'm not going to talk about specifically what level we expect to achieve other than the direction that we're on in terms of the trend line is improvement. And the good news is as I mentioned the part of the portfolio that's coming from innovation or the vitality index was 14% real sales just because something trended off didn't make it not an innovation in the sense of price and margin premium continues to improve therefore the shift is happening and improving, and we see no reason why we would even think about varying from that strategy because it's proving our point about how we in Kraton ought to be making sure that we're growing but growing at a profitable sense in a marketplace where we're a clear leader.

Mike Sison - KeyBanc

Okay. And last question on the Formosa JV, I think you mentioned it's going to be $100 million investment on your end?

Kevin Fogarty

Steve, I'll let you answer that.

Steve Tremblay

Currently what we think right now like it's about $50 million.

Mike Sison - KeyBanc

Oh, 50 million.

Steve Tremblay

That's right, yeah.

Mike Sison - KeyBanc

And how do you think about the return on that investment, how much do we expect to sort of bring in, in I guess 2015 and beyond?

Kevin Fogarty

So, Ed with time I'm sure that we will share more about how the venture will work economically. Clearly from the standpoint of how we're managing the asset, it's an extension of the Kraton Global Supply System and customers will have seen no difference in terms of the supply chain. That will just, it'll add a very critical state-of-the-art facility in one of the most attractive growth regions in the world. But in terms of the way in which the JV will work the JV itself is a production JV. And as I commented in my description of it there is a volume obligation but that translates into Kraton having full rights to pull all the volume it needs to satisfy customer growth. And therefore, if you think about it from an economic perspective we are 50% of the JV in terms of ownership but that doesn't necessarily translate in terms of what the economic benefit we expect to realize.

Operator

Our next question comes from Brian Maguire - Goldman Sachs.

Brian Maguire - Goldman Sachs

Kevin, a question on the long-term volume growth potentially for the business. I think in the past you said something on the order of 7.5% growth for SBCs, longer-term but in light of what the volume to come in the last couple of years I think for '13 you're guiding may be for a little bit more modest growth. Is a year since that the market has matured a little bit more and there is a slower growth rate going forward or is this just more of a temporary slowdown because of more cyclical factors?

Kevin Fogarty

Well I mean we've just come though Brian a couple of amazing years when you think about what's happened with raw material, and how that's provided for I think some mixed incentives for our customers as you look at SBCs. We're not wearing away from our view on long-term growth objectives that we expect to realize. But as you think about our innovation portfolio, do think about this that from a volume perspective all volume is not equal in Kraton. And we're focusing efforts on higher value added products and start at the high end of the chain mix are Cariflex and even HSBC and that the way in which you think about traditional volume across all SBCs are not equal, and we certainly believe it that way and that's how we're focused on the gross profit per ton that we're looking to achieve across the entire portfolio, but recognizing all volume is not equal in that.

Brian Maguire - Goldman Sachs

Okay, great. And could you also may be provide an update on your efforts to also the pricing strategy a bit, just to move customers towards more real time pricing. Are you having any attraction with that?

Kevin Fogarty

Well, the answer is we're absolutely focused on that for 2013 because we know it's a necessity. But the reality is other than what we just talked about in terms of raw material moves that we've seen thus far this year in Asia, first raw material move in the U.S. and really for the rest of the world has been coming up on March 1. And yeah, we're certainly focused on real time pricing and spent months educating our customers as to how that's going to work. So your question is, are we focused on it, yes. But we will -- we'll obviously need to work through that now as those raw material costs are to move.

Brian Maguire - Goldman Sachs

Just last one. One last one for Steve on the Formosa JV. I think you said that the total project cost would be about $200 million. But your 50% equity stake would be a $50 million commitment, is that implied would be about $100 million of project financing in there?

Steve Tremblay

Told you close, Brian. There's also an assumption in there that we'll be able to, there'll also be working capital that will have to be funded as well. So as we noted in the press release we expect the project to be less than $200 million. But if we premature right now given that we've just reenergized our Taiwan efforts and from an engineering standpoint to comment in any more granularity on the overall project cost. Again our $50 million will be matched with promotions and will be upfront prior to any leverage that will be put on the facility. When we know more about the capital, we'll happily share in a public form.

Operator

Our next question is from Kevin Mccarthy, Bank of America-Merrill Lynch.

Alex Yefremov - Bank of America-Merrill Lynch

Good morning, this is Alex Yefremov for Kevin. Just wanted to ask a follow-up question on profit sharing at the Formosa JV. Will the profit be shared on a 50-50 basis?

Kevin Fogarty

The profit in the joint venture will be shared on a 50-50 basis, but that doesn’t mean necessarily mean the profit of the overall sale of HSBC's will be shared that way.

Alex Yefremov - Bank of America-Merrill Lynch

And can you, I mean if you help us understand after mechanical completion of the plant in mid 2015, how long does it usually take up startup the plant, is it pretty quick process or it may take three to six months or so?

Kevin Fogarty

It can take up to six months. We haven't done this in a while as you know. Our expectation obviously is going to more efficient than that. And but the one thing we know about this partner that we have entered this JV with, this is a very capable organization in terms of execution of these types of projects not just from a cash standpoint, but also schedule standpoint.

So, as Steve just commented, we just reenergize, if I could use the word, that JV in a real sense; it's a real JV now, not a concept but its -- it is moving forward in an actual sense. And we're going to do everything we can to look at that schedule to see what can be done to accelerate it, because at the end of the day, we know that the project itself from the first time we had a conversation about it, it's already been delayed upwards of a year plus, and our customers certainly would like to see us as soon as possible to have first quality material coming out of that plant. So, we'll do what we can to move that schedule up, but it could take up to six months to kind of get the quality issues and production issues lined up.

Alex Yefremov - Bank of America-Merrill Lynch

Makes sense, thank you. And finally could you update us on the latest on application development for NEXAR?

Kevin Fogarty

Sure. So, we've always felt like NEXAR had three different markets for which we're going to be focused on, starting with water, next is energy efficiency, and then last is performance fibers. The performance fiber application of course with the commercialization of NEXAR this year is the first one to be real and we're really excited about that, because it is commercial. And the sales to make this year's commercial products in the marketplace actually occurred towards a latter part of last year, but now we're already looking at the sales that will be incumbent upon that market penetration for 2013 for a '14 season. So everything in regards to that commercialization is going as planned.

We do expect that the energy recovery that are going to be used in more high efficiency sustainable heat and ventilation equipment we expect that commercialization to occur this year as well.

And then, lastly, in terms of water, that's probably the one that was the original vision for the technology but it's proven to be probably the more challenging of the three in terms of meeting all the quality requirements but we haven't given up on that at all yet.

And I also want to mention in the case of the energy recovery system, for those of you who would ever have a chance to come out and see our research facility here in Houston, we actually have one unit operational providing the air conditioning and ventilation system for our research facility so that we have real time data tracking the benefits of this what we believe to be a superior technology and be happy share that with you.

Operator

Our next question is from John Mcnulty, Credit Suisse.

Abhi Rajendran - Credit Suisse

Hi. This is Abhi Rajendran calling in for John. Good morning.

Kevin Fogarty

Good morning, Abhi.

Abhi Rajendran - Credit Suisse

Couple of quick questions. So on margins even after backing out the effective inefficiencies and the turnaround related costs, the gross profit per ton in the quarter at ECRC was down year-over-year despite 9% higher volume. So can you just help us understand why this happened is the fixed cost absorption hit should have been better year-over-year?

Steve Tremblay

It actually did benefit, your point is well taken on the fixed cost absorption, but as you know our business is significantly impacted by sales mix of product. So if you look at full up to full up, we've tried to quantity those items at a discrete but other than that it's essentially the mix effect of the myriad of products that we produce and sell.

As Kevin mentioned, not all volume is the same volume at Kraton and the effect of end use volume in any product SKUs within the end use volumes, it can be significant. But we're in that nine handle which was we had a nine handle in the fourth quarter of this year which we think in an average fourth quarter is generally in line with the prior fourth quarters.

Abhi Rajendran - Credit Suisse

Okay.

Steve Tremblay

And you have to take into account what I mentioned earlier in the prepared comments that we saw this dramatic decline in feedstocks in the fourth quarter last year and our selling price moves lag behind that so there would have been some margin expansion associated with that anomaly, that is BD and all the feedstocks have normalized would therefore make the comp from fourth quarter '12 to fourth quarter '11 pretty challenging.

Abhi Rajendran - Credit Suisse

And then just a quick follow-up on HiMA. Can you give us an idea of how to think about HiMA's revenue contribution this year based on some of the field trials and tests you've conducted in some of the early commercial applications for the product? I think you'd said this product has a potential for about $50 million in revenues looking out four or five years but may be how that ramps up overtime?

Kevin Fogarty

Yeah, I'm not good to feel that I will share with you exactly what we expect to see in 2013 other than the HiMA penetration rate that we internally had planned around that drove the five year plan is still very much on track. We had real nice momentum in HiMA technologies around the world in both emerging economies as well as in places that tragically had suffered some pretty extreme weather and has caused pretty severe destruction places like New Zealand where the technology of choice as they look to rebuild has been our HiMA technology because of the merits that we espouse. So, we’re pleased with the direction the HiMA is on and have no reason to feel anything but positive about our five year plan.

Operator

Our next question is from Andy Cash, SunTrust Robinson Humphrey.

Andy Cash - SunTrust Robinson Humphrey

Hi good morning and congratulations on the JV, getting that back-on. I just had a couple of questions about the JV. First of all, I think on the trailing 12 basis your EBITDA margins overall almost $0.20 a pound. I was wondering if you could give us some guidance maybe what your base case is or EBITDA margins in the JV, I mean, won't it be one and a half times two times what kind of base case are you expecting there?

Kevin Fogarty

Look, Andy, we're obviously not going to do that. But if you look at Kraton overall, I mean this is an HSBC JV, not a JV that incorporates a USBC business. So, obviously it’s the higher end of our portfolio for a reason.

Andy Cash - SunTrust Robinson Humphrey

Right, but I mean could you just raise it for us I mean could have be as much as two times --

Gene Shiels

Andy, this is Gene, we're just not -- we're not prepared to go into that level of detail on the joint venture and the economics. We don't go into that level of detail in the economics of our overall business. So, we'll have to take a pass on that one.

Andy Cash - SunTrust Robinson Humphrey

Okay, just if I could just a couple of things about that, your 50-50 JV on the board how will tiebreakers decisions will be made and are there any sort of -- do you have any limitations on capital calls to the joint venture that you have in place?

Kevin Fogarty

Well, let me first start it is a 50-50 JV, so needless to say that implies that the parties need to agree or here things don't get done. But look this is Formosa in the context of one of the leading growth oriented petrochemical companies in the world and, if anything, it will be Kraton and its discipline with regard to growth and timing of growth capital that probably is going to set the outer boundaries for the JV. And I'd spent a lot of time with the Formosa leadership and there's no question on my mind that their vision of this thing would be bigger not just Phase 1.

Andy Cash - SunTrust Robinson Humphrey

Yeah, but $200 million might be without working capital. But there is a limitation, I mean what if it turns out that things aren't going right, its $250 million project. I mean do you guys, could you guys close it out at your $50 million investment or do you have to keep going?

Kevin Fogarty

We say that the capital cost is above $200 million but needless to say we've done a lot of work getting us to this point. So we've a really good feel for what we think the outer boundaries are if you'll the plus or minus around that number is right now.

Andy Cash - SunTrust Robinson Humphrey

Thanks. Just one final thing. Some of the U.S. aggregate producers are talking about a substantial pickup in demand for road paving, have you guys heard about that or is there sort of a lag between what they're saying and may be what you guys will see later in the year?

Kevin Fogarty

Well, there's no question there's usually a lag because they're probably out front with the contractor world. But look if there is an uptick in U.S. demand for paving, we'll be there and we'll benefit from the two but I've been around this business long enough to know that with what's going on in Washington DC these days, you can't count on that and we're not going to count on the year which is why we focus our efforts on innovation and quite frankly other parts of the world.

Operator

Our next question is from Christopher Butler, Sidoti & Company

Christopher Butler - Sidoti & Company

With the new JV back on track here, could you talk to the utilization regionally and why as a company it looks like you've room but you feel the need to put in more capacity in Asia, and does that then mean that may be there is room for restructuring in other regions?

Kevin Fogarty

Fair question. Again, I'll go back to my comment that I said earlier not all volume and capacity in sales are equal at Kraton. And clearly as you look at our availability supply growing market, HSBC is -- excuse me USBC much different than HSBC in our portfolio in that we've got USBC headroom to grow whereas HSBC is the one on which we watch very carefully and that's -- so don't -- we're not obviously sharing that information because it's quite competitive in terms of what our actual availability is to supplier growing market. But we're very pleased with the step to bring this JV back online because we know that relative to the standalone option the timing is much more attractive.

Christopher Butler - Sidoti & Company

So, stuttering less appealing capacity is not something that you're considering at this point?

Kevin Fogarty

No, we have no plans for such at this point.

Christopher Butler - Sidoti & Company

As we look at the vitality index there is a big shift that moved off the index five years ago. Could you remind us what that innovation was or what those products were that shift off? And it seems like you did a pretty good job of holding the line and offsetting that this year. So, is that a -- it sounds like it would be a good indicator going forward.

Kevin Fogarty

Yeah, just to be clear, you're talking about what went off five years ago, right?

Christopher Butler - Sidoti & Company

Right.

Kevin Fogarty

Yeah, we had a customer that was a paving and roofing customer actually. That was a major driver in the innovation metric as they commercialized one of our key innovations in paving and roofing back in that timeframe. Sadly and unrelated completely to the relationship with us, the parent corporation actually went into bankruptcy as a result of some crude oil trades. And that caused literally that whole market commercialization of that innovation to be set back almost two years because that customer and we actually did a fantastic job going to market assessing who was interested in this technology at the time and asked every person to step forth and give us their view on the commercialization strategy, volume ramp up, margin premiums they're willing to pay for this technology, and this company won that horse race in Kraton which we are very proud of. Unfortunately, the driver of their corporate balance sheet changed all of that about a year into the commercialization. So, we had to literally start over and that's literally what happened.

Christopher Butler - Sidoti & Company

And if I could squeeze one last in before the end of the hour, use of cash going forward with the joint venture your cash needs have come down considerably. What are you thinking?

Kevin Fogarty

I think it's the same order it's always been which is we want to look internally at the growth oriented projects because needless to say we think that will generate a much better return than things like delevering the balance sheet. And then, lastly, if we'd haven't gotten those great opportunities and we're still generating the attractive cash flow profile as we believe this company can yield and we will look to return some of that to shareholders, but no plans at this time.

Operator

Our next question is from Gregg Goodnight, UBS.

Gregg Goodnight - UBS

Your Asian JV is that being built with an eye for expandability? How long is it going to take you to fill that plan out? And would you be able to put another line in there at some point?

Kevin Fogarty

The answer to the second part is yeah, we've obviously designed into this plan that if or the site facility and the space and what not, even our relationship with Formosa that there is an expansion possibility.

The first part of the question which is what you're asking for in terms of volume ramp up, we're assuming there is a volume ramp up, I mean, 30 kilotons is a world scale increment of capacity, no question about it. So, we'll like everything we do, we believe we have a leadership role to play and a responsible role to play in the marketplace, and we're going to focused on the high end of our portfolio that's driven by renovation sales commensurate with this portfolio shift. But we do expect that obviously the volume ramp will be very methodical in the way in which we run the business.

Gregg Goodnight - UBS

The second question, you mentioned butadiene going up finally in the US after a few months of stability. I've noticed traditionally that when you had price increases they've traditionally been announced about March 1st. I assume there's nothing stopping if say butadiene does continue to ramp up on a monthly basis that you could introduce price increases on a mid-month basis?

Steve Tremblay

Yeah, there's nothing stopping us from the timing and there's also nothing requiring us to make announcements of price. We run our business that we think is the best way in which price increases can be communicated, and sometimes we choose to announce and sometimes we just choose to implement or both.

Operator

Our next question comes from Bill Hoffman, RBC Capital Management.

Bill Hoffman - RBC Capital Management

Most of the questions have been answered but just to follow on sort of the pricing issue, I just wondered if you guys could talk a little bit market dynamics here in the first quarter. Given the last couple of years we had this big run up in butadiene cost and it is now starting to sort of percolate out again. Are you feeling any pull forward in purchasing in through February at this point in time?

Steve Tremblay

Look, we're not going to talk about the quarter; we never do. I'll just go back to the comment I made, I think it was made in with the first question which is butadiene dynamics. It's materially different now than it was one year ago. And there is no question about as we reflect back on 2012 in that first quarter that those kind of butadiene price moves every customer had every incentive in the world to try to advance purchasing as best as they could. And so that dynamic of what's happening in terms of butadiene monomer cost increases doesn’t exist today. Beyond that we're not going to talk about the quarter.

Bill Hoffman - RBC Capital Management

Okay thanks, and then just one last question. Last year very impressive growth in the oil fields slight equation, what does it look this year for future growth opportunities, I mean, obviously not the same rate but?

Kevin Fogarty

When you’re beginning the growth curve on an innovation that is targeted towards a real technology advantage, one expects that the growth rates ought to be attractive. Yes, you’re starting from a low base but also you’re starting from a view of market substitution or penetration. So, this is one that we called out now a couple of times, we continue to call out. We’re really excited about it. We’re building a team around it and a technology platform that we think is adding significant competitive advantage to that industry. So, yeah, we’re real focused on it. We’re really excited about it but last year’s results in a relative basis look real impressive but an absolute basis we wanted them to be a much larger part of the portfolio.

Bill Hoffman - RBC Capital Management

Any sense of where you are in market penetration there?

Kevin Fogarty

Oh, gosh, real low. I mean we’re starting from a low position. This is a huge market space is what attracts us to it.

Operator

This concludes the question-and-answer session today.

Kevin Fogarty

Okay. Thank you, Marla. We’d like to thank all of our participants this morning for their interest in Kraton and their call for questions. A replay of this conference call will be available through April 23rd. To hear a replay of this conference call, access Kraton’s website at kraton.com, select the "Investor Relations" link at the top of the home page and select the "Events" tab. If you want to hear a telephonic replay, you may dial 866-430-8798 or international callers may dial 203-369-0944. That concludes our call.

Operator

Thank you. This concludes the Kraton Performance Polymers Incorporated fourth quarter and full year ended 2012 Conference Call. You may now disconnect from the conference. Thank you.

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