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Kraton Performance Polymers, Inc. (NYSE:KRA)

Q2 2014 Earnings Conference Call

July 31, 2014 09:00 ET

Executives

Gene Shiels - Director, Investor Relations

Kevin Fogarty - President and Chief Executive Officer

Steve Tremblay - Vice President and Chief Financial Officer

Analysts

Jason Freuchtel - SunTrust

John McNulty - Credit Suisse

Edward Yang - Oppenheimer

Brian Maguire - Goldman Sachs

Bill Carroll - UBS

Christopher Butler - Sidoti

John Roberts - UBS

Operator

Good morning and welcome to the Kraton Performance Polymers Incorporated Second Quarter 2014 Earnings Conference Call. My name is Priscilla 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 would now turn the call over to Mr. Gene Shiels, Director of Investor Relations.

Gene Shiels - Director, Investor Relations

Thank you, Priscilla. Good morning, everyone and welcome to Kraton Performance Polymers second quarter 2014 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. A copy of yesterday’s news release is available in the Investor Relations section of our website, as our copies of the presentation we will review this morning.

Before we review results for the second quarter, I will draw your attention to the disclaimers on forward-looking information and the use of non-GAAP financial measures in our presentation this morning and in yesterday’s earnings press release. During the call, we may make certain comments that are not statements of historical fact and does constitute forward-looking statements. Investors are cautioned that there are risks, uncertainties and other factors that may cause Kraton’s actual performance to be significantly different from the 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 available in the Investor Relations 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 and adjusted gross profit to ECRC to gross profit as well as a reconciliation of net income or loss attributable to Kraton to adjusted net income or loss was provided in yesterday’s earnings release and is included in the appendix to the material we will review this morning. Following our prepared remarks, we will open the line for questions.

I will now turn the call over to Kevin Fogarty.

Kevin Fogarty - President and Chief Executive Officer

Thanks, Gene and good morning everyone. As we turn to Slide 4, I will begin with a review of the financial highlights for the second quarter of 2014. During the quarter, we continued to deliver growth in our high value HSBC products, with overall sales volume for HSBC grades up 5.5% year-on-year. In addition, our Cariflex end use continued on its long-term growth trend with year-to-date sales volume up 17.8% compared to the first half of 2013. These were clearly factors contributing to the second quarter 2014 adjusted EBITDA at ECRC that was the second highest second quarter in the company’s history.

Second quarter sales volume was 78.4 kilotons and this was up 1.2% from 77.5 kilotons in the second quarter of 2013. Sales volume increased in all of the end uses with the exception of advanced materials, which I will cover in a few minutes. Sales revenue in the second quarter was $323.8 million, a decrease of $10.8 million or 3.2% compared to the $334.5 million in the second quarter of 2013, with the decrease largely reflecting lower average selling prices associated with lower raw material costs compared to the year ago quarter.

Net income attributable to Kraton was $11.1 million or $0.33 per diluted share in the second quarter. And this reflects an increase of $7.3 million or $0.21 per share compared to the net income of $3.8 million or $0.12 per diluted share in the second quarter of 2013. Adjusting for items outlined in yesterday’s new release principally transaction costs and startup costs associated with our Asian joint venture, second quarter 2014 adjusted net income was $15.2 million or $0.46 per diluted share, up from net income of $5 million or $0.15 per diluted share in the second quarter of 2013.

Adjusted EBITDA at estimated current replacement cost or ECRC was $38.6 million in the second quarter of 2014, an increase of $6.6 million compared to $32 million posted in the second quarter of 2013. This $38.6 million in conjunction with $37.5 million adjusted EBITDA at ECRC posted in the first quarter of 2014 brings year-to-date adjusted EBITDA at ECRC to $76.1million. Based upon results for the first half of the year and current expectations for the back half of the year we continue to expect full year 2014 adjusted EBITDA at ECRC to be $150 million.

Turning now to results for our four end use markets, sales revenue for our Cariflex end use was $29.2 million in the second quarter 2014, unchanged from the year ago quarter. Sales volume was up 1% compared to the second quarter 2013, while average selling prices decreased compared to the second quarter of 2013 reflecting lower cost for isoprene. Second quarter 2014 revenue reflects an $800,000 benefit associated with favorable currency movements. Excluding this benefit revenue would have been down the same $800,000 per year. As we have discussed previously our Cariflex business can reflect some lumpiness quarter-to-quarter due to sales mix and the fact that the customers do not buy ratably throughout the year. Although second quarter sales volume was up modestly compared to second quarter 2013, for the first half of 2014 Cariflex sales was up 17.8% compared to 2013.

We believe our Cariflex end use will continue to reflect a long-term trend of double-digit volume growth. For the trailing 12-months period ending June 14, the geographic revenue split for Cariflex remains highly concentrated in Asia. And this reflects the fact that a significant number of Cariflex customers in glove and condom applications are located in the region. As for revenue by end use application we continue to work on diversification of Cariflex into industrial and adhesive applications, but for today the majority of the Cariflex sales are in medical applications including surgical gloves, condoms, medical stoppers and needle shields. Lastly reflecting the specialty nature of Cariflex for the TTM period ending June 14, 23% of revenue was derived from innovation grades in the balance of Cariflex portfolio is in differentiated product grades.

Turning to now slide 6, second quarter sales revenue for the Advanced Materials end use was $81.7 million, down $9.5 million or 10.4% compared to sales revenue of $91 million in the second quarter 2013. Excluding $1.1 million benefit associated with favorable currency moves, revenue would have been down $10.5 million or 11.5%. The revenue climb was due to lower sales volume compared to the second quarter of 2013 ended lower average selling prices reflecting lower raw material costs principally butadiene. The decline in sales volume was primarily attributable to volume in personal care and consumer applications partially offset by increased volumes into PVC alternatives in medical and wiring cable applications.

The decrease in personal care volume is associated with the trend that we have addressed in the last two quarters in which we have seen a shift from HSBC based applications to lesser differentiated and lower cost materials including USBC formulations that we have developed. For the second quarter 2014 this shift accounts for about 1 kilo ton of lower HSBC volume compared to the second quarter of 2013. And on a year-to-date basis, the impact on HSBC volume has been about 2 kilo tons.

Last quarter I commented that with respect to this shift where we have seen a move from HSBC based solutions, our plan is to direct that HSBC volume in other applications as evidenced by our efforts and despite the loss of some HSBC personal care volume Kraton’s total second quarter 2014 HSBC volume was up 5.5% compared to the year ago quarter. And this was led by increase in HSBC based PVC replacement products for medical and wiring cable applications in the Advanced Materials end use and higher sales of HSBC products in adhesive sales and coatings end use which I will speak to in a moment. We believe this shift in personal care has largely been implemented, therefore we believe that going forward the incremental impact on our sales mix for advanced materials should be minimal. As such we expect that HSBC based personal care volumes in the third and fourth quarters of this year will be very similar to that of the second quarter.

As can be seen on the upper right hand side of the slide despite this shift personal care continues to represent 28% of TTM revenue. And this reflects sales of both HSBC products and our USBC based innovation grades for personal care. Medical applications now represent 14% of the portfolio and wiring cable represents 3% of TTM revenue. Looking at the lower right hand side of the slide for the trailing 12 months ended June 30, 2014, 30% of revenue for Advanced Materials was derived with innovation grades and 37% from differentiated products. During the quarter, sales volume for innovation grade polymers for applications such as USBC based personal care and in consumer and automotive and industrial applications increased compared to the second quarter of 2013.

Turning now to sales revenue for adhesive sales and coatings, revenue was up. Revenue was $128.2 million, up $2.1 million or 1.7% compared to the second quarter of 2013. Compared to the year ago quarter, currency movements benefited revenue by $1.1 million. The year-on-year revenue increase reflects higher sales volumes, including a 15.6% increase in HSBC sales volumes partially offset by lower average selling prices, associated with lower raw material costs for butadiene and isoprene compared to the second quarter of 2013. The increase in sales volume compared to the second quarter of 2013 was primarily due to higher HSBC-based sales into lubricant additive and sealing and caulk applications and higher USBC-based sales led by increased sales into industrial and printing plate applications. For the trailing 12-month period ending June 2014, 5% of revenue was derived from innovation sales and 44% was comprised of differentiated product grades.

And finally, turning now to paving and roofing end use on Slide 8, sales revenue for the second quarter 2014 was $84.6 million, down $3.3 million or 3.7% compared to the year ago quarter. Excluding a $1.7 million benefit from currency moves in the second quarter of 2014, revenue would have been down $4.9 million or 5.6%. Given the modest increase in sales volume, the revenue plan reflects lower average sales prices associated with lower raw material costs for butadiene. North American paving volume was up a significant 62% compared to the second quarter of 2013 as sales volume in the year ago quarter was substantially hindered by poor weather conditions. The increase in North American paving volume was largely offset by lower paving volumes in Asia and lower roofing volumes in Europe compared to the second quarter of 2013.

We believe the lower paving volumes in Asia is due in part to project delays in markets such as Australia, where we believe will lead to increased activity in the third quarter. While the lower roofing demand in Europe reflects relatively strong demand in the fourth quarter of ‘13 and first quarter of ‘14, which was aided by extremely favorable weather. For the trailing 12-month period ending June 30, 2014, 12% of paving and roofing revenue was from sales of innovation grades and 19% of sales were from differentiated grades. Within the innovation portfolio, we continue to see growth and demand for our HiMA technology, particularly in South American markets.

Turning to Page 9 for a breakdown of total Kraton revenue for the trailing 12-month period ending June 30, Cariflex represents 10% of total revenue, advanced materials represents 26% of total revenue, paving and roofing comprises also 26% of revenue, and adhesive sales and coatings represents 38% of TTM revenue. Looking at portfolio composition for the TTM period ending June 2014, 15% of revenue was derived from innovation grades, reflecting our vitality index and 39% of TTM revenue was from differentiated grades.

Before my closing comments, I am going to turn the call over to Steve to give a more in-depth financial review for the quarter. Steve?

Steve Tremblay - Vice President and Chief Financial Officer

Thank you, Kevin. Let’s start with a recap of second quarter top line performance and then go into gross profit. Total sales volume of 78.4 kilotons in the second quarter was up 1.2% from 77.5 kilotons reported in the second quarter of 2013. This overall growth reflects a 5.5% increase in volume in our HSBC product family, which was mitigated by lower USBC sales volume. Capsulizing Kevin’s comments from an end use perspective, volume for adhesive sales and coatings was up nearly 6%, with increases in both HSBC and USBC product grades and paving and roofing in Cariflex were both up modestly in sales volume compared to the second quarter 2013.

In advanced materials, the total sales volume was down 5.6%, on lower sales of USBC products. Sales revenue was $323.8 million in the second quarter of 2014, down $10.8 million year-on-year with lower average selling prices associated with decrease in raw material cost of $22 million partially offset by a $7 million contribution from the increase in sales volume and more favorable mix, while favorability and foreign currency rates amount of $4 million rounded out the change in total revenue.

On both a FIFO and ECRC basis, gross profit in the second quarter of 2014 improved when compared to the second quarter of 2013. On a FIFO basis, second quarter 2014 gross profit was $72.1 million, about 22.3% of sales revenue, up $12.2 million from $59.9 million or 17.9% of sales revenue in the second quarter 2013. Excluding the impact of inventory holding gains and losses, which was a positive $4.3 million in the second quarter 2014 and a negative $2.3 million in the second quarter of last year, gross profit at ECRC was $67.8 million in the second quarter 2014, up $5.6 million or 9% from $62.2 million in the second quarter 2013. As a result, gross profit at ECRC was $865 per ton in the second quarter 2014, up from $802 per ton in the year ago quarter.

On the top of Slide 11, we show the reconciliation from EBITDA to adjusted EBITDA at ECRC for the quarters ended June 30, 2013 and 2014. The adjustments consist of our normal and customary non-cash and non-recurring items with non-cash compensation costs and the LCY related transaction cost comprising nearly all of the items bridging GAAP EBITDA to adjusted EBITDA. Taking these items into consideration and netting out the $4.3 million positive spread between FIFO and ECRC for Q2 2014, adjusted EBITDA at ECRC was $38.6 million for the second quarter. I do want to make a note here that the favorable spread of $4.3 million between FIFO and ECRC was $1.7 million or the equivalent of $0.05 per share, less than the $6 million guidance we provided in our Q1 earnings update.

The $38.6 million posted in the second quarter is up $6.6 million or 21% compared to adjusted EBITDA at ECRC of $32 million in the second quarter of 2013 with the higher sales volume and favorable mix accounting for $3 million of the growth. An additional $3 million of EBITDA growth was provided by low cost of goods sold primarily driven by lower raw material costs and to a lesser extent changes in other manufacturing costs, which more than offset the raw material driven decline in average selling prices. Second quarter 2014 adjusted EBITDA margin was 11.9%, which represents an improvement of over 200 basis points over the Q2 2013 margin of 9.6%. As Kevin mentioned to the first half of 2014, our adjusted EBITDA at ECRC stands at $76.1 million compared to $61.2 million in the first half of 2013, an improvement of $15 million.

Slide 12 shows earnings per share data for 2014 and 2013. On a GAAP basis, EPS improved from $0.12 per share in Q2 2013 to $0.33 per share in 2014. Excluding certain items, principally the LCY transaction costs, adjusted EPS improved threefold from $0.15 per share in the second quarter of 2013 to $0.46 per share in the second quarter of 2014. And through June 30, 2014, our adjusted EPS is $0.91 per share compared to $0.22 per share in the first half of 2013.

On Slide 13, a few comments about cash flow and our balance sheet, cash used in operating activities in the first half of 2014 was $51.6 million. All of which resulted from the operating cash flow deficit from the first quarter. The year-over-year decline in operating cash flow reflects a number of factors, including the LCY transaction fees, the cost associated with the first quarter 2014 production outages and an increase in finished goods inventory of nearly 7 kilotons since 12/31, which have been built in advance of scheduled turnaround activities later this year.

As I alluded to earlier, this operating cash flow deficit through June was a function of the deficit in the first quarter and a modest surplus in the second quarter. We currently expect the second half of the year will be cash flow positive and will likely offset the deficit through the first half. As most of you know, the most significant unknown however is the raw material environment in the back half of this year.

With respect to investing activities through June 30, 2014, total capital expenditures were $54.8 million and that includes $22.5 million incurred by a consolidated JV in Taiwan, associated with our new HSBC facility currently under construction. Excluding the JV spending, the remaining $32.3 million is in line with our $75 million to $80 million guidance for full year 2014 CapEx, again excluding the JV spending. Cash on hand at June 30, was $66 million of which $36.5 million was cash at the JV. As a result, total liquidity at June 30 was $261 million including $232 million available on our existing bank lines. Those bank lines are undrawn at June 30.

Net debt calculated on a basis that excludes cash of our consolidated joint venture was $324 million at quarter end and net debt to net capitalization was 38%. And finally net debt to trailing 12-month adjusted EBITDA was 2.4 turns at June 30, 2014. And finally as we previously announced, we did close $183 million facility which will provide the debt financing for the Taiwan HSBC facility. This facility was also undrawn at June 30. When drawn, Kraton and Formosa Petrochemical Corporation will each guarantee 50% of that outstanding indebtedness.

Let me close with the review of selected guidance for the full year 2014. We now expect that research and development expense will be approximately $34 million for the year. And SG&A costs will be approximately $99 million, excluding for comparability purposes the estimated full year 2014 LCY transaction costs. The downward revision from earlier estimates of SG&A spending is indicative of revised estimates for variable compensation and a variety of cost management initiatives. Depreciation expense is expected to be $66 million, a modest increase from prior guidance which reflects the timing of when assets are placed in service. Interest expense continues to be expected at a $25 million rate for the year. And the full year tax provision is also unchanged at $7 million for full year 2014.

Reiterating Kevin’s earlier comments with respect to full year earnings, we continue to expect 2014 adjusted EBITDA at ECRC will be approximately $150 million. On the raw material front, based upon current raw material price trends, we anticipate a negative spread between FIFO and ECRC of approximately $1 million in Q3. And we have revised downward our full year expectation by nearly $3 million or approximately $0.09 per share. With respect to adjusted EPS, therefore our current expectation taking into account the revised FIFO versus ECR spread is a revised range of $1.40 to $1.50 per diluted share.

As I mentioned in the discussion of working capital, we have built approximately 7 kilo tons of finished goods inventory as we prepare for turnaround activity at our Belpre and Wesseling sites in the second half of 2014. I think it’s worthy to note that the second half turnaround costs will therefore be approximately $4 million higher than the second half 2013 turnaround costs. Commensurate with these activities we therefore currently expect the second half turnaround expenses will be $7.4 million compared to approximately $2 million in the first half resulting in 2014 turnaround expenses of approximately $10 million. And again our second half turnaround expenses are expected to be approximately $4 million higher than the second half of last.

With that I would like to turn the call back to Kevin for his closing comments.

Kevin Fogarty - President and Chief Executive Officer

Okay. Thank you, Steve. Now during the second quarter, we continue to focus on growth and our differentiated Cariflex isoprene rubber and isoprene rubber latex products and on driving increased sales into applications served by our higher value HSBC product grades. Over the past three quarters, we have discussed with you current trends in personal care applications which include a shift in some volume in our Advanced Materials end use form HSBC products to USBC products. Given the limited impact on Kraton’s overall portfolio I will offer a few final thoughts to put this topic in context.

First although the shift has occurred, personal care continues to be a meaningful business for our Advanced Materials end use. Simply stated and recognition of market demand some customers have expressed a desire for lower cost, lesser differentiated solutions and Kraton has responded by developing innovation grade polymers based on USBC chemistry. This is what Kraton does best. We use our innovation expertise to address specific customer needs. Second, we believe the shift has largely been implemented and we have outlined for you the impact on second quarter 2014 and year-to-date HSBC sales volume for Advanced Materials that this shift represents.

Our second quarter 2014 HSBC sales volume was up 5.5% compared to the second quarter of 2013 and we continue to believe that this will be able to offset the lower HSBC volumes in personal care with increased HSBC sales in other applications through out portfolio. And lastly going forward we believe the incremental impact on sales volume mix for Advance Materials will be minimal.

With respect to our over very strategic areas of focus we continue to make progress on the construction of our HSBC capacity expansion in Mailiao, Taiwan working towards plant startup and plant operation in early 2016. Two weeks ago we completed financing arrangements for the consortium of banks in Taiwan that will provide construction funding and working capital requirements for the joint venture. This financing was arranged on very attractive terms and we look forward to the successful completion of the project and our ongoing relationship with Formosa.

Having completed construction of our semi-works facility at year end at our Belpre, Ohio facility and with first polymer production being achieved in the first quarter, this asset is now operating as an integral component in our innovation process. I think it is fair to say that the semi-works facility has garnered significant interest from our innovation focused customers. Also at Belpre work continues under our strategic energy project through which we are converting our coal fired boilers to natural gas. We continue to expect that upon completion this project results in savings of approximately $10 million per year at Belpre.

And finally with respect to our proposed combination with the SBC business of LCY as you are most likely aware on June 30, we issued a press release stating that our Board of Directors had notified LCY of its intent to withdraw its recommendation that shareholders approved the combination with LYC’s SBC business. As stated in the press release under a combination agreement Kraton was required to provide LCY with at least five business days notification of its intention to withdraw the recommendation. And if requested by LCY, Kraton must negotiate in good faith with LCY regarding proposed changes to the combination agreement. The press release also made clear that we do not intend to make further public comments regarding the status of the proposed combination unless and until we either enter into an amendment to the combination agreement or we determine the negotiations with respect to an amendment of the combination agreement have been abandoned. I hope you can therefore appreciate we will have to reserve any further commentary including responses to any potential questions about the transaction status for a future date.

That said, at this time I will be happy to ask the operator to open the call up for questions regarding the quarter that we just presented.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from Jason Freuchtel with SunTrust. Your line is now open.

Jason Freuchtel - SunTrust

Hi, good morning guys.

Kevin Fogarty

Hi Jason

Jason Freuchtel - SunTrust

Your vitality index has increased nicely over the last year, has the increase primarily been related to the Omni-Freeze product or specifically what other innovative HSBC applications have been contributing to the higher percentage of revenues. And then do you have an expectation of where the vitality index could trend over the next year or so?

Kevin Fogarty

So and thank you Jason, clearly the lead driver in terms of the vitality index momentum is associated with our HSBC product focused on PVC replacement for wiring cable and medical applications that we have spoken of on many occasions. It’s just a clear differentiator in the overall Kraton product offering. So indeed it’s a major part of the overall portfolio shift efforts here. In terms of where we think it could be headed we had and have continued to focus on originally a 20% expectation of what innovation based sales would represent relative to the overall portfolio and we continue to believe that that’s very much achievable through the portfolio shift efforts and of course our commitment, continued commitment to R&D as evidenced by the semi-work startup in the Belpre.

Jason Freuchtel - SunTrust

Okay. And can you remind us what your longer term and normalized expectation is for capital expenditures to support Kraton and its innovative offerings and can you also walk us through how you weigh investing for future innovative growth opportunities versus returning cash to shareholders in the form of a dividend or special dividend?

Steve Tremblay

Jason, I would say the last couples of our CapEx where we have been in that $70 million to $80 million range is sought of peak level of spending for Kraton with projects that we have had the semi-works project the re-instrumentation project and now the boiler project which we just embarked upon and Kevin spoke about a more normal number of us over the nearer term once those projects are through is in the $40 million to $50 million range. As far as evaluating returns to shareholders in terms of dividend or a share buyback was a certainly board level conversations that we have routinely at this point. Our view is that the capital projects that we have including continuing to fund the HSBC project out way the benefits of those – uses of cash. I’ll tell you that on an innovation perspective, we don’t believe that is it significant amount of CapEx required to drive the 20% that Kevin spoke about in terms of getting the vitality index.

Jason Freuchtel - SunTrust

Okay, great. And what level of leverage would you be comfortable putting on the balance sheet.

Steve Tremblay

We’ve launched at the 2.4 terms that we have now is a public company on a net basis is a comfortable range for us. I don’t have a absolute top end. I would say that two to three terms is a very comfortable range for us. To the extent that, there was an investment opportunity that required us to incur additional indebtedness – as you know interest rates are awfully attractive today. If there was an opportunity represented itself that was a strategic in nature that required a near-term increase in leverage above the three terms. We would entertain that subject to being quickly deleveraging back to that comfortable two to three terms.

Jason Freuchtel - SunTrust

Okay. I appreciated guys.

Operator

Our next question is from John McNulty with Credit Suisse. Your line is now open.

John McNulty - Credit Suisse

Yes, good morning. Thanks for taking my questions. So, quick question on the CapEx for the foremost project. Can you remind us how much more is left to be spent from your side and/or if the remaining portion will be covered by the financing that you just put in place.

Steve Tremblay

Good morning, john. Our current expectation is that the equity infusion that we put in which is around $42 million from inception to today. So, obviously from most would have kicked in the same $42 million. We believe that that’s going to be hit from our cash. So, we do expect that the facility that we just raise which is in the order of $183 million will be sufficient to fund the project through its construction phase as well as provide us with some working capital needs as we start to plan up. If they were to be any additional equity because of timing or the like later on in the project, we haven’t deviated from a total potential equity investment which be at $50 million versus the $42 million we put in to-date. But our current planning case is the facility covers the CapEx and working capital. The expectation for CapEx on the project this year is in the $70 million to $75 million range, which has been revised downward from earlier expectations that is strictly because of the timing of the spending doesn’t indicate the timing of the project has been – has deviated.

John McNulty - Credit Suisse

Okay, great, that’s helpful. And then a question on Cariflex, so, clearly there was a lot of lumpiness you’re still running at a pretty strong run rate for the year or at least for the first half of the year. I guess how should we think about kind of the annual growth rate given what 17% first half start like, how should we think about the growth rate and if – for the remainder of the year, should we be really kind of thinking that it’s more along lines of what you saw in 2Q or is it more of the average or I guess how should we think about that growth.

Kevin Fogarty

I think, John, we continue to maintain double-digit growth rate so the results we’ve achieved in the first half of the year is pretty much in line with our expectations and again your comment about, I hate to use that word lumpiness, but it is I mean, if not these customers aren’t ratable because of the volume that we’re talking about.

John McNulty - Credit Suisse

Okay, okay. And then on the U.S. paving side, I know the whether I’m sure makes it incredibly tough to figure out what the real kind of normalized demand poll is right now. But I mean, any stab at that if things are starting to show signs of life whether it’s based on new contract activity or whatever I guess, any update there would be helpful?

Kevin Fogarty

I think you mentioned the U.S. specifically, right.

John McNulty - Credit Suisse

Yes.

Kevin Fogarty

So from a U.S. perspective, I mean, I think the year we’re having the combination of the first half and the first quarter, second quarter is kind of from our perspective a okay year, I wouldn’t call it certainly a year in which there is major step up in investment activity, now what I call it a down year, I think the overall combination is kind of in line. Certainly, where is – I think you heard me say we know that there is lot of pent-up demand in terms of work that needs to be done in the overall U.S. Highway System. And we know that Congress continues to abate spending packages, but you can imagine that there is just not a lot of optimism that these things are going to get resolved in short order. So, this is kind of the new-new, if you will, in terms of the run rate in the business and for Kraton of course you have also heard us say that, that means that we have got to go focus on other place in the world, where there is definite commitment to infrastructure investment. And I am talking about obviously developing economies like what’s happening and has been happening down South America and of course in places like India, where we know that there is going to be significant investment over the next 5, 10, 20 years and we are certainly going to play a role in that.

John McNulty - Credit Suisse

Okay, fair enough. And then maybe just one last question, with regard to the boiler project and the $10 million of savings that come in when that’s completed, does that roll in gradually like does it kind of – do you get parts of the facility up in the boilers shifted over or is this all kind of a flip to switch type operation. And then when it does, I guess can you give us some color as to the timing of when that $10 million starts to roll in?

Kevin Fogarty

Well, this is a combination of energy costs, maintenance costs, and certainly even some fixed costs. So, at the end of the day, the energy costs component ought to be fairly ratable in terms of how quickly we are able to see it. And then of course the more fixed components once the project is all lined out and complete, then we will be able to realize those benefits. So, overall, I mean we should be able to see those benefits in a relatively short order certainly less than two years perhaps as soon as one.

John McNulty - Credit Suisse

Great, thanks very much for the color.

Operator

Our next question comes from Edward Yang with Oppenheimer. Your line is now open.

Kevin Fogarty

Good morning, Ed.

Edward Yang - Oppenheimer

I just wanted to square away the guidance a bit, because you have reiterated the EBITDA at ECRC a $150 million, but you trimmed the GAAP EPS and so that’s – so basically you are reiterating the core guidance, but the difference in between the two is just raw material volatility?

Steve Tremblay

That’s correct, Ed. Yes, we had – that’s $0.09 per share or so that I talked about in the remarks of the change in raw material.

Edward Yang - Oppenheimer

Okay. So, does that mean that you think that butadiene prices are going to rollover from here and maybe provide an update on July and August BD?

Steve Tremblay

Sure. While the expectation that from earlier to where we are today which drove that adjustment that we talked about, it’s around – rough round $100 a ton from earlier in the year expectations to where we currently see BD. So, that’s really driving our change in view of what the spread will be. We are looking right now at a July versus June, that’s about flat again. So, this change is events that have taken place since the last official update with you. And it’s tough to call butadiene. So, our current view is that it may have some upward pressure in the balance of the year. So, our call is flat to upward.

Edward Yang - Oppenheimer

Got it. So, again the core outlook hasn’t changed over the last few months, but some normal noise around the raw material outlook basically?

Steve Tremblay

That’s correct.

Edward Yang - Oppenheimer

And just Kevin, you mentioned that this customer behavior in advanced material where they were downgrading to USBC from HSBC on price, but when I look at your selling price, it has been down negative and part of that has been the raw material pass-through. So, just going forward as you have, let’s just say that your raw material pass-through continues to go down. Does that mean the spread between your HSBC products and your USBC products, is that widened, narrow, or stay the same as raw material pass-throughs go up or down I just want to gauge? I would think that your HSBC products are more value-based versus raw material pass-throughs, so does that – how would that influence customer behavior in terms of would they want to look at upgrade or downgrading some of their purchases?

Kevin Fogarty

So, in terms of raw material component, it’s exactly the same. But I think you correctly state that the different value proposition allows Kraton to manage obviously raw material movements with more discretion. And clearly in the case of anything that’s associated with more differentiated application, be it USBC or HSBC, clearly that gives us more latitude to employ our price right and manage raw material swings selectively.

Edward Yang - Oppenheimer

Okay. And just finally on I know you said you are not going to give an update on the negotiations with LCY, but maybe qualitatively what are some of the thing is that the Board thought were relative – relevant points to address obviously prices one, but would it be Board representation on the combined company or what are some of the other factors that you thought were imported in the first round of negotiations and now relevant to renegotiating the second round?

Gene Shiels

This is Gene. I think we are going to have to stick to Kevin’s comment. It’s a delicate time right now. We just want to be very careful and therefore we are just not going to make any comments unfortunately about the transaction.

John McNulty - Credit Suisse

Alright, fair enough. Thank you, guys.

Gene Shiels

Thanks.

Kevin Fogarty

Thanks.

Operator

Your next question comes from Brian Maguire with Goldman Sachs. Your line is now open.

Brian Maguire - Goldman Sachs

Hi, good morning, guys.

Kevin Fogarty

Good morning.

Steve Tremblay

Hi, Brian.

Brian Maguire - Goldman Sachs

Kevin, at the high level I was hoping you might take a stab at kind of bridging to the $150 million EBITDA guidance for the year, my number is excluding the outages in the first quarter, it look like it is about $70 million in the first half, I am not sure if that’s the right number or the right basis to be looking on it if its including or excluding the stock-based comp, but given the increased turnaround cost in the second half and so the normal seasonality seem like normally will be down a little bit in the second half, but just wanted to get you view if there is something different in that where the second half might be flat with the first half this year?

Steve Tremblay

Yes. I will take a stab with that, it’s Steve and Kevin can certainly add in. The first half on apples-to-apples basis with $150 million is $76 million which does include the non-cash comp add back that you had mentioned. So we are looking at $74 million second half 2014 to get to that $150 million. So basically the second half in line with the first half again as you mentioned taking out the unusual item, the outages in the first half. That comps against $80 million or so second half last year which was one of the best second halves we have had second best second half we had so pretty tough comp. But here again with the turnaround costs accounting for $4 million of that we are basically tracking towards the year second half that looks pretty close to the second half, the second half of last year and delivering that – delivers the EBITDA of $150 million which is quite honestly second only to 2010 where we printed around $183 million. So it’s a second half that has to act, with a lot of moving pieces, but it should deliver the same overall level of EBITDA as the first half.

Brian Maguire - Goldman Sachs

Okay, that helps. And I guess just thinking out longer term about volume growth, any change in thinking about what the growth opportunity is in – for the SBC market, is it a – I think we used talk about GDP plus grower, it’s been a little bit below that, but you mentioned rather in some of the other issues that might have been accounting for that in the last year or two, but looking forward do you think of it still the GDP plus grower or are we thinking more like a GDP grower going forward?

Kevin Fogarty

I definitely think about everything associated with our innovation and differentiated part of the portfolio as a GDP plus grower Brian. I mean as evidenced by what we are doing in things like the HSBC portfolio particularly around PVC substitutions. So that part is clear, it’s the other part of the business that call it little under 50% of the overall mix that while the industry globally is still growing at GDP plus. Kraton’s ability to compete in some of that growth is what we have been focused on in terms of trying to address that issue. And so from the standpoint is the industry still attractive, absolutely is our position in the industry particularly in innovation and differentiated give us an opportunity to grow at or above the industry rates, yes indeed. But we just got obviously look at it from the standpoint of the overall portfolio as well and make sure we are addressing those challenges.

Brian Maguire - Goldman Sachs

Okay. And then just lastly when do you expect to schedule the shareholder vote on the LCY transaction and is there any kind of qualitative update you can provide on how their business is trending?

Kevin Fogarty

Well, like I said in my comments and like Gene just reiterated we are not going to – we are not going to make any further statements on anything that may or may not be going on including any potential shareholder vote Brian.

Brian Maguire - Goldman Sachs

Okay. Thanks very much.

Operator

Our next question is from Bill Carroll with UBS. Your line is now open.

Kevin Fogarty

Good morning Bill.

Operator

Mr. Carroll, please check your mute button.

Bill Carroll - UBS

Yes, good morning, thanks. On the lower USBC volumes that you’ve seen in advanced materials in the quarter, would you attribute much of that to the oversupply factors that we saw, which was driving the weak LCY volumes?

Kevin Fogarty

No, no, I mean, when we talk about USBC particularly advanced materials we’re talking about especially grades that we deal with and so whether could be a timing effect, but the fact is again the businesses that we are focus on particularly as we think about USBC in advanced materials are typically driven by either innovation or differentiated technology.

Bill Carroll - UBS

Okay, got it. And then on the new credit facility does that have any covenants that are tied to the LCY deal?

Kevin Fogarty

Maybe clear that the new credit facility is the fund our HSBC construction in Taiwan. So, it’s completely disengaged from anything that relates to the proposed LCY transaction. But there are traditional covenants in that debt agreement, debt ratio, interest coverage, tangible network and the like.

Bill Carroll - UBS

Okay, so, it’s not cost collateralized with any other facilities.

Kevin Fogarty

No, in fact our existing facilities I’m specifically carve out our guarantee of the debt, the purposes of calculating covenants on our – if you will our base level of indebtedness.

Bill Carroll - UBS

Okay, got it. Thanks.

Kevin Fogarty

You bet.

Operator

Our next question is from Christopher Butler with Sidoti. Your line is now open.

Christopher Butler - Sidoti

Hi, good morning everyone.

Kevin Fogarty

Hi, Chris.

Christopher Butler - Sidoti

Looking at your gross profit for time and ECRC basis, you’ve been consistently hear for the trailing 12 months in that $850 to up towards $900 per ton range. And I know you talked about $1,000 is kind of a target. When you need to do to bridge that gap is this just a volume story and getting some of your businesses on track or is there more needed?

Steve Tremblay

So, I mean, that is absolutely that the expectation we have about our overall portfolio with respect to portfolio shift that is going to drive that margin expansion. And what we have to do we have to needed to say increase the percent of sales coming from innovation and differentiated. Such that we can see that trend that we’ve been on which has been a good trend continue as we move towards $1,000 goal. And it’s no more complicated than that now in terms of the activity to support that effort, significant as we do here. The investment we make in R&D. The market development activities going on with our partners, innovation partners in the marketplace on the prioritization because that’s critical when you’re running in innovation based strategy is the bread and butter that we’re all about your Kraton. So, continue to do what we’re doing, look for every opportunity we can to streamline and do it more effectively and efficiently. But nevertheless that’s the DNA of Kraton, which is developing new applications for Kraton that do not exist today and quite frankly do not exist in the marketplace today.

Christopher Butler - Sidoti

I appreciate your time.

Operator

Our next question is from John Roberts with UBS. Your line is now open.

John Roberts - UBS

Good morning. I will try one more on LCY, but I think I know the answer. Your regulatory filing on the deal discussed your exploration of other deals before you entered in the exclusive agreement with LCY. Are you still under that exclusivity or have some of the other discussions maybe resurfaced?

Kevin Fogarty

Hey, John, that’s – that’s probably a little bit more grey in terms of discussion topic. But I’m just going to right now that we’re not going to talk about anything like that other than to say that from a Kraton perspective, we have a solid business and we have a business that’s going to a have a pretty solid year this year and the innovation trends are good and strong year in Kraton. We’re going to continue to focus on that. And beyond that, we’re going to look for opportunities to increase shareholder value anyway we can and that’s a combination as it’s always been of certainly focusing on the organic growth associated with our innovative pipeline, but if the opportunities in the marketplace out there in the future and we’ll pursue them as well.

John Roberts - UBS

And then as a follow-up, Cariflex is up strongly year-to-date, but it had a little bit of a pass or correction in the current quarter. Do you think that was related to the drop in natural rubber, which would have affected latex alternatives or maybe because it’s causing some downward pricing yourself, there is just an inventory pullback that might be occurring over a short period?

Kevin Fogarty

No, I can unequivocally say that there is nothing to do. In fact, the progress we have made this year is I think just a reflection of the Cariflex value itself in that we are doing it in a fairly low cost natural rubber environment to which you hinted, but nothing in terms of second quarter choppiness as I have described it had to do with that. We continue to stand behind our view of the overall growth of that business and I don’t think our customers really focus it all on whether or not a purchase order they issued was associated with any particular time of the year. They just – they obviously feel as we do, which is this is an advantage product, it’s substitution based growth, which means with that comes basically big lifts as we saw for example in the first quarter and then some steady state and then we will big lifts again.

John Roberts - UBS

Thank you.

Operator

There are no other questions in the queue at this time. (Operator Instructions)

Kevin Fogarty - President and Chief Executive Officer

Priscilla, if there are no more questions, I guess we will proceed with wrapping up the call. We would like to thank all our participants this morning for their interest in Kraton and for their thoughtful questions. A replay of this call will be available from approximately 11 AM Eastern today through August 14. To hear the replay, you may access the replay on Kraton’s website www.kraton.com navigate to the Investor Relations link and select Events from the menu at the top of the page. You may also listen to a telephonic replay at 800-231-7741 and international callers may dial 402-200-9685. That concludes our call this morning. Thank you.

Operator

Thank you for joining. This concludes the conference call. All parties may disconnect at this time.

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Source: Kraton Performance Polymers' (KRA) CEO Kevin Fogarty on Q2 2014 Results - Earnings Call Transcript

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