A. Schulman (SHLM) Bernard Rzepka on Q1 2016 Results - Earnings Call Transcript

| About: A. Schulman, (SHLM)

A. Schulman, Inc. (NASDAQ:SHLM)

Q1 2016 Results Earnings Conference Call

December 11, 2015, 10:00 AM ET

Executives

Jennifer Beeman - Vice President of Corporate Communications and Investor Relations

Bernard Rzepka - President and Chief Executive Officer

Joseph J. Levanduski - Vice President, Chief Financial Officer

Analysts

Rosemarie Morbelli - Gabelli & Company

Chris Ryan - Bank of America Merrill Lynch

Mike Harrison - Seaport Global

Kevin Hocevar - Northcoast Research

Jason Freuchtel - SunTrust

Michael Sison - KeyBanc Capital Markets

Dmitry Silversteyn - Longbow Research

Operator

Good day, ladies and gentlemen, and welcome to the A. Schulman Fiscal 2016 First Quarter Webcast. At this time, all participant lines are in a listen-only mode to reduce background noise, but later we will be conducting a question-and-answer session. Instructions will follow at that time. [Operator Instructions]

I would now like to introduce your first speaker for today, Jennifer Beeman. You have the floor ma'am.

Jennifer Beeman

Thank you, Andrew. Good morning and welcome to A. Schulman's first quarter 2016 conference call. I'm Jennifer Beeman, Vice President of Corporate Communications and Investor Relations for A. Schulman. By now, you all should have received a copy of our press release, which was issued earlier this morning. Joining me today is Bernard Rzepka, President and Chief Executive Officer; and Joe Levanduski, Executive Vice President and Chief Financial Officer for A. Schulman.

Before we begin, I'd like to remind you that statements made during this conference call, which are not historical facts, may be considered forward-looking statements. Forward-looking statements involve risks and uncertainties that could cause actual events or results to differ materially from those expressed or implied. Additional information on factors that could cause results to differ is available in the company's most recent Form 10-K and Form 10-Q.

In addition, this conference call contains time-sensitive information that reflects management's best analysis only as of the date of this live call. A. Schulman does not undertake any obligation to publicly update or revise any forward-looking statements to reflect future events, information or circumstances that could arise after the date of this call. For further information concerning issues that could materially affect financial performance related to forward-looking statements, please refer to A. Schulman's quarterly earnings releases and periodic filings with the Securities and Exchange Commission.

I'd also like to remind you that for purposes of this phone call today, we will use non-GAAP measures of segment gross profit, SG&A expense including certain items, segment operating income, operating income excluding certain items, net income excluding certain items, net income per diluted share excluding certain items, and adjusted EBITDA. These financial measures are also used by management to monitor and evaluate the ongoing performance of the company and to allocate resources. You can find the reconciliation of these non-GAAP measures to the nearest comparable GAAP results as an attachment to our first quarter earnings release which has been posted on our website.

With that, I'd now like to begin by turning the call over to Bernard Rzepka. Bernard?

Bernard Rzepka

Thank you, Jennifer, and thank you all for joining us this morning as we update you on our fiscal 2016 first quarter results. Before we begin, I'd like to wish you all a happy and healthy New Year. Also I am not satisfied with our bottom line results. We are pleased with our continued progress towards our strategic vision of transforming A. Schulman into a highly profitable premier plastics solution provider.

We saw yet another quarter of year-over-year improvement in profitability. Adjusting for certain items, we increased gross margin by 260 basis points and operating margin by 120 basis points over the prior year's period.

Looking at our results on an apples-to-apples basis, excluding the recent Citadel acquisition and the impact of foreign exchange rate, all of our segments showed gross margin expansion. This achievement despite a continued challenging economic environment is a result executing on our '3S' initiatives of Safety, Smart Sales, and Smart Savings. In particular, we are aggressively pursuing strategies to improve mix as well as implementing proactive operational improvements and restructuring efforts.

However, U.S. and Canada segment revenues fell short of our internal targets and as we encountered challenging external and internal headwinds due to the significant downturns in the oil and gas markets and the destruction caused by the Lucent matter. I will address this further in a moment.

Looking at our other reporting segments, I am very pleased with solid results in Europe, Middle East and Africa despite quarter-over-quarter hedge [ph] volumes. On a local currency basis we experienced a 100 basis point improvement in adjusted gross margins largely related to a stronger product mix and a favorable raw material pricing.

Latin America had strong volume growth with revenues increasing nearly 21% up significantly from the 12.7% growth in the fourth quarter. We generated a near record adjusted gross margin of 21.5% nearly double that of the prior year. These results were driven by our market expansion excellence and operational improvements resulting in 12.4% adjusted operating income margins which is a record for the business.

Asia Pacific contributed nicely despite significant slower markets. Adjusted gross margin was 17.2% up 350 basis points from the year ago. Adjusted gross profit mostly benefited from volume increases related to the investment in our capacity expansion in China and net price mix improvement.

The Engineered Composites segment was in line with our expectations and contributed an adjusted gross margin of 25.4%. While organic volume was up slightly, additional growth was hampered by the reduced activity in fracking.

During the quarter we named Frank Roederer as EC's new Senior Vice President and General Manager. Frank was the Vice President of Masterbatch Solutions in our European, Middle East, Africa segment and replaces Kevin Andrews who has taken a CEO position at another company.

Frank is a natural leader with a proven track record of building cohesive productive teams. We are expecting great things from Frank and his team.

Overall, our results have proved that our shift to value added specialized product is working, but we are far from finished. Our integration of Citadel continues to accelerate nicely. This quarter we generated $3.8 million in hard synergies coming from all of our activities and are on pace toward our fiscal 2016 commitment of delivering $20 million in tangible cost productions. Regarding our hard [ph] synergies the previously announced consolidation of our Engineered Plastics subsidiary in Evansville is on schedule. We expect to significantly improve efficiencies of the remaining EP plant in Evansville through investing approximately U.S. $5 million.

For this facet of the integration plan our goal is to deliver approximately $9.5 million in annualized savings and thus we are tracking ahead of the $9 million target that we initially anticipated and is part of our operational synergies.

Additionally, we have already initiated significant sales and marketing integration efforts. These include coordinating our combined offerings and at key customers such as Bosch and John Deere. Many of our global strategy key accounts are excited about our expanded offerings. Discussions and projects are already underway around future business projects as we offer our newly broadened portfolio of value added solutions to these customers.

As a reminder, these global strategic accounts or customers have meaningful impact on our growth based on the size and potential growth opportunities. They allow us to forge collaborative partnerships to quickly drive innovation and globally, and we closely align with our strategic goals to create an environment to support our mutual success.

Lastly, we are in the process of standardizing our customer relationship management or CRM platform across our U.S. and Canada region which would improve our sales and marketing efficiencies and accelerate revenue growth.

Over the next several years we are confident that we will generate significant additional revenue growth or opportunities through our combination with Citadel. While these gains will take time to develop, we believe that the profit impacts from this incremental business will win ultimately the targets, will ultimately exceed the target of our hard [ph] synergies. So the Citadel integration, or as the Citadel integration is unfolding we are delivering synergic cost savings and incremental revenue gains which are close at hand.

As we reported last quarter, we hit an obstacle in the form of the Lucent quality matter. As we previously reported, we discovered that two Citadel plants formerly owned by Lucent discrepancies between laboratory data and product certifications. At A. Schulman we work hard every day to provide our customers with high quality products that meet the most stringent certifications along with service that exceeds their expectations. This is how we have built lasting trust with our customers and an excellent reputation in the market.

Given the Lucent situation that we acquired we suddenly faced a significant challenge that was foreign to how we conduct business. We took immediate decisive actions including implementing strict protocol designs to meet customer standards and certification requirements for all future shipments.

To date we have notified all affected customers and I am encouraged that no customers or other parties have initiated recalls or have made material claims against the company or have sought to terminate their relationships with us. As a result of our actions we did incur $4.9 million of costs related to this matter in the quarter. These include product and manufacturing operational improvements dedicated internal resources and reduction inventory value and additional legal and investigative expenses.

We have nearly completed our internal investigation and are focused on remediation. Further, we have presented a written claim notice to the seller and to the escrow agent. We are clearly disappointed with this turn of events for a number of reasons including the fact that it will delay our ability to reflect the full value of this strategic asset. However, I am proud of the manner in which we responded and how our integrated team has worked so diligently and effectively to mitigate the impact.

We are living by our guiding principle, Open, Honest, Listen and Accountable in order to protect our reputation for quality and service which is vital to deliver sustainable growth. Beyond the Lucent issue, we saw sluggish demand in the quarter in our U.S. and Canada region. Some of our domestic end markets have slowed down. As an illustration, the quarterly North American manufacturing service fell to a level of 40.5 in November which indicates some traction. It is the second weakest ratings since 2008-2009 financial downturn. We saw customer orders slowdown as the calendar year end approached.

However, in Europe which still represents about 50% of our revenue we are seeing sequential improvement in manufacturing activity. For example, the Eurozone manufacturing PMI ended the year at 50.3 index level nearly the highest level since before the financial downturn. Our core revenue growth in the region has improved throughout the year and December marked a continuation of this trend.

Turning to our smart savings efforts, I believe to report we continue to make solid progress with our Manufacturing for Success program which launched last year with a few pilots launched in the U.S. Through this program we are strengthening our organizational development for functional activities and operational effectiveness as well as optimizing our manufacturing footprint.

During the quarter we delivered roughly $1 million of savings with an with an incremental $5 million projected for the remainder of the year. The program has been so successful that we have begun the same process in our Asia Pacific regions and are in the final planning stage to replicate it in Europe beginning the second half of the fiscal year.

As we have said in the past, we are determined to capitalize on any attractive process of growth despite the slow global economy. We continue to see growth in high performance compounds related to the automotive, electrical and electronic markets in EMEA. To address this specialty demand we have expanded our existing compounding capacities by adding two new production lines in our Kerpen plant in Germany.

In addition to the twin-screw extruders the company has invested in a fully automatic factory line. This investment is in line with the expansion of our product portfolio and particularly with the production of our new range of Ecotran PPS compounds.

We mentioned last quarter that we planned to expand our masterbatch color production capacity in China. This new facility will produce our premium color additives for packaging, automotive, agriculture and sports leisure, home customers in China and other growing markets throughout Asia Pacific. This state-of-the-art facility will further expand our color capabilities globally and enable us to support the accelerating growth of our customers with specialized advanced material.

We expect that the plant will become operational in the second half of fiscal 2016. While we are busy with integration and cost saving and key initiatives, we remain keenly focused on innovation investments as the means to drive profitable organic growth. One recent success is our development of a new long life heat resistant nylon grade Schulamid XT 180 [ph] for automotive under the hood applications. This is an example of our ability to innovate and coordinate the launch of a new product simultaneously across several regions to support the growth of our important global customers.

Now I will turn the call over to Joe Levanduski for a more detailed review of our financial results of the quarter. Joe?

Joseph J. Levanduski

Thanks and good morning everyone. Let me take a few minutes to review the first quarter results. Net sales for fiscal 2016 first quarter increased $34 million or 5.6% compared with the prior year quarter. The Citadel acquisition added $111 million or 18% to sales growth. This was partially offset by $62 million of negative foreign currency translation. The negative earnings impact of the foreign currency translations amounted to $0.02 per share.

Excluding acquisition and currency, our legacy revenues declined 2.4%. As Bernard mentioned, also this was attributed to the U.S. and Canada region.

Gross profit excluding certain items was $109 million for the quarter up 25% for the first quarter of fiscal 2015. This increase was primarily due to the positive contributions from Citadel, effective material cost managements, and the benefit of our restructuring actions. This led to an adjusted gross margin of 116.8% an increase of 250 [ph] basis points over the year ago period. Excluding both, Citadel and currency translations our adjusted gross margin improved by 150 basis points.

Now let's turn to our business segments. In EMEA reported net sales were $328.1 million for the quarter definable 11.6% compared with the prior year quarter. Excluding the negative foreign exchange translation impact of $44 million legacy EMEA revenue rose 0.3% despite the 0.5% volume decline the volume increase in average price per pound. EMEA's adjusted gross profit excluding certain products declined $2 million compared with the prior year quarter. Excluding foreign exchange translation adjusted gross profit was $3.9 million or nearly 8% and adjusted gross margin expanded to 100 basis points or 14.4%.

The U.S. and Canada region saw 23% revenue increase to $178.3 million in the first quarter due to Citadel's contribution of $59.1 million of Engineered Plastics sales. Excluding the acquisition, a minor impact of currency U.S. and Canada legacy sales held 17% across our Masterbatch and Specialty Powders business units as well as Engineered Plastics. The declines in Masterbatch and Specialty Powders were primarily driven by certain tolling customers who destocked their inventory and shifted some production in-house. The decline in Engineered Plastics is a result of the team's intense focus to resolve the previously disclosed Lucent quality reporting matter.

U.S. and Canada's growth profit excluding certain items were $13.3 million for the quarter an increase of $5.7 million or 0.3% from the prior year. Adjusted gross margin held at 17%, despite the revenue decline. Credit is primarily due to our Manufacturing for Success program, effective material cost management and the result of past restructuring and cost reduction efforts.

Latin America was a notable bright spot. Regional revenues were reported down 2%, but excluding our large negative foreign currency translation of $7.6 million revenue increased almost 21%. This was driven by market expansion, operational efficiencies resulting from prior year's strategic initiatives in South America and a surge of masterbatch activity. On the heels of a 13.4% volume increase and the completion of regional restructuring actions, adjusted gross profit rose by over 17% to $9.7 million. Adjusted gross margins of 21.5% was nearly double the year ago level.

In APAC net sales were $45.7 million for the quarter a decline of 1% from the prior year quarter efforts within the negative foreign exchange translation of $6.7 million. Gross profit for APAC, excluding certain items, were $7.9 million for the quarter, an increase of $600,000, almost 9% from a year ago. This led to an adjusted gross margin of 17.2% up 350 basis points from the prior year period.

Engineered Composites, our newest business segment was launched on June 1, upon the acquisition of Citadel. EC delivered net sales of $51.9 million and adjusted gross profit of $13.2 million or a strong 25.4% adjusted gross margin which was similar to the fourth quarter results. Results were up modestly compared with an adjusted year ago level prior to our acquisition.

Now looking briefly at our balance sheet, adjusted net leverage on a pro forma basis at the date of acquisition has declined from 4.1 times to 3.85 times as of November 30, 2015, reflecting the strength of our cash flow from operations and our ability to pay down debt quickly. Net debt of $940 million is down $29 million from fiscal year end. So far in the second quarter we have paid down 10 million euro denominated term debt. We remain focused on achieved our previously stated goal of 2.5 times net leverage in fiscal 2017.

Capital expenditures for the first quarter were $7.4 million compared with $10.3 million for the prior year period and were related to our ongoing investments due to standard manufacturing and technical capabilities. Fiscal 2016 we expect capital spending to be approximately $55 million versus our pro forma of $50 million in fiscal 2015.

Depreciation expense in the first quarter amounted to $12 million compared with $9 million in the prior year period. The Citadel acquisition and the $3.3 million of depreciation expense in the first quarter. Amortization expense totaled $7 million in the quarter versus $4.1 million in the prior year period. The amortization expense associated with the Citadel acquisition amounted to $6.3 million of the total.

Working capital days increased to 63 days compared to 61 days at year end on a trailing 12-month basis. This increased is mainly driven by the including of Citadel into the calculation. Given our history of managing working capital efficiencies, we see this as an opportunity to greatly improve our cash flow generated from working capital in 2016, which will assist us further in our debt reduction plans. Despite the slight increase in working capital days, operating cash flow for the quarter was $14 million compared to $10.3 million in the prior period.

Adjusted EBITDA was $57.9 million or $44.4% increase from the $40.1 million in the year ago period. In the first quarter the company paid cash dividends of $0.205 or $6 million on common shares. The company also paid approximately $1.8 million in dividends on the convertible special stock in the first quarter. The dilution related to the special stock dividend at $0.06 per share in the first quarter is in line with our annual guidance.

On an adjusted basis, the first quarter tax rate was approximately 28% in line with our expectation for the full year rate. As a result of our accelerated debt payments we expect our annual interest expense to be between $53 million and $54 million down from our original expectation of $55 million.

As stated in the last quarter, we believe the operational results of Citadel acquisition net of interest and tax expense would contribute $0.40 to $0.45 per share of accretion in fiscal 2016. While we remain confident that the long term value of the Citadel acquisition remains intact and accretive in this fiscal year the unexpected cost and distraction of the Lucent remediation as well as the depressed oilfield service market will make this range unattainable in the current fiscal year.

We have identified a number of challenges, but as you know our seasoned team has always been proactive. To that end we’ve already initiated another layer of cost reduction and earnings improvement actions that will address these challenges and enable us to deliver on our current year guidance.

These actions include general and administrative savings, driving faster execution of restructuring initiatives, expanding the Manufacturing for Success program in the U.S. and abroad and reducing interest expense by accelerating debt repayments. From these actions we will expect to realize well in excess of $5 million in annual savings in fiscal 2016 to allow us to deliver on our guidance.

This concludes my prepared remarks and I will turn the call back over to Bernard.

Bernard Rzepka

Thanks, Joe. Our fiscal 2016 is off to a challenging start due to external and internal headwinds. I feel confident about our strategy and our guidance of $2.80 to $2.85 per diluted share which represents 20% increase from a year ago. We have several strong growth catalysts in place to move the company forward. We are on course to deliver another year of significant earnings growth for A. Schulman.

With that I’ll turn the call back to Jennifer.

Jennifer Beeman

Thank you, Bernard. Andrew, we would like to open up the call now for Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] Our first question comes from the line of Rosemarie Morbelli from Gabelli & Company. Your line is open.

Rosemarie Morbelli

Thank you. Good morning and happy New Year.

Jennifer Beeman

Good morning.

Bernard Rzepka

Hi, Rosemarie.

Joseph J. Levanduski

Yes, good morning.

Rosemarie Morbelli

I was wondering, okay so the first quarter really has quite a bit of negative data incorporated in it and yet you haven’t changed your yearend expectations for EPS of $2.80 to $2.85. What kind of expectation do you have in terms of FX because the dollar is stronger now than it was when you reported the fourth quarter, therefore FX at least for all of the companies that have reported so far is going to be more of a negative then the anticipated?

And then I am guessing that this is the $5 million of additional savings based on your new action if I understood that properly is not going to be enough to effect that, so what are we looking at in the next three quarters that is going to be so much stronger than the first quarter?

Bernard Rzepka

Rosemarie, here is Bernard speaking. I'll try to take the first part of your questions and then Joe will the later one. Yes, we had as we just reported not a strong quarter; however, Joe just guided you through a couple of activities which we are doing in addition which at least would save U.S. $5 million we are thinking that it will be more than that. As you know towards the first quarter is not the strongest quarter and we’re just gradually getting into all the synergies from our Citadel exhibition this quarter it was Joe, $3.8 million, so in total $20 million so this will come. And provided that we will see an environmental like we saw in 2015 which was choppy at best we believe that we can achieve our guidance. And the next question was?

Joseph J. Levanduski

Yes, regarding the FX rate, Rosemarie the – if you think about it from a Euro perspective when we put out the guidance, the FX rate in the Euro to dollar was roughly about $1.09, $1.10 and during the fiscal first quarter, the rate averaged about a $1.07 sitting around $1.09 right now. That compares to about a $1.25 in the first quarter last year.

So we had a significant or more significant impact of the FX rate in the first quarter and we’ll probably see more impact in the second quarter, but depending on where the FX rate goes which you know we don’t speculate on the direction of the FX rate, if it stays at these levels, we should start seeing more of a favorable impact as we get into the second half of the year.

Overall, compared to where the average was for the year of 2015 and that these kind of rates that we see today, we feel it will have a nominal impact on the full-year guidance and it was factored into our guidance at these levels already. So we don’t anticipate on a full-year basis the FX rate being more than $0.05 negative impact to the full year.

Rosemarie Morbelli

Okay. Thanks, that is helpful. And regarding the Citadel integration, how much progress are you making on consolidating the back office? Do you feel that you are doing as much as necessary or do you feel that you should accelerate that in the next three quarters?

Bernard Rzepka

Actually Rosemarie we are ahead of what we expected, but there is certainly more to do and the teams are focusing on this.

Joseph J. Levanduski

Yes, and Rosemarie if I could just remind the buckets that we had for our synergies was about $11 million coming out of our sourcing initiatives about $9 million in the operational efficiencies that Bernard talked about are already about $9.5 million is what our new expectation is. We had SG&A savings of about $1 million in the first quarter, we achieved $1.2 million.

So we’re well ahead of pace from that perspective and then to the Citadel acquisition of TCG, there was an additional $4 million of synergies that combined those four buckets accounted for about $25 million is what our target is and we indicated that we should achieve $20 million of all synergies in fiscal 2016.

As Bernard mentioned, we did $3.8 million of savings in the first quarter. I think we’re well on track to deliver the $18 million or $20 million of synergies for the full year. The synergies will, especially from the operational synergies will be more backend loaded as we are in the final process to consolidate the facilities and have it built. So, we anticipate getting $4 million of synergies in fiscal 2016, but you’ll find it to be third, fourth quarter driven.

Rosemarie Morbelli

And then lastly if I may, so we are talking about $20 million and $25 million by the end of 2017 and based on the actions that you just mentioned, the additional $5 million should we add that $5 million to 2017 results? In other words by the end of 2017 you will be on the run rate of $30 million instead of $25 million?

Joseph J. Levanduski

Yes the $5 million is incremental actions that we are taking over and above our stated average.

Bernard Rzepka

It’s not only in Citadel Rosemarie, it’s across the entire company.

Rosemarie Morbelli

Sure, no I understand and well, I guess I do have another one, you mentioned that you were seeing progress or improvement sequentially in Europe and automotive was part of one of the areas of improvement. Yet we seem to average kind of top of the growth rate in terms of new cars. Could you help me understand how you are seeing that improvement if the number of cars produced does not grow next year versus this year?

Bernard Rzepka

We are not only focused just on Rosemarie on the – just overall car productions. We as you know in the specialized segments. So we do not support a lot of these mass produced cars, but we look into specialized segments, BMWs, Audis, Mercedes, that’s where we really strike with all our products and we do not see in the luxury segment a slowdown.

The big question is which you raised and the discussion is ongoing here in U.S. and Canada of course to how will this proceed now in 2016 and I might give you maybe a little bit of an input there with our guidance. We were really looking as well how is December and January now the first days of business are unfolding. We have been surprised by a slowdown of business in U.S. and Canada.

We have been doing very well in the other region as you see by the data, but this slowdown started really in November. It continued to some degree in December, but business started to come back in the first days of January to normal. So we believe there is a certain impact from the strong dollar in the business here in the U.S. and Canada. That’s what we’re hearing from some customers, but we don’t see that there will be a significant slowdown maybe automotive, electronics, household and so on.

Rosemarie Morbelli

Thank you very much.

Bernard Rzepka

You’re welcome.

Operator

Thank you. Our next question comes from the line of Roger Spitz from Bank of America Merrill Lynch. Your line is open.

Chris Ryan

Hi this is Chris Ryan sitting in for Roger here. Thanks for taking my question.

Jennifer Beeman

Sure.

Chris Ryan

My first question is how much EBITDA did Citadel contribute from November 2014 to May 2015 or in another words how much EBITDA are you adding to get to the pro forma 3.85 times net leverage?

Bernard Rzepka

Joe, we have this data?

Joseph J. Levanduski

Yes, I think from - we don’t break down Citadel and EBITDA because obviously as we’re innovating the businesses is a little bit more challenging, but we have – when we acquired the business in total, we had on an annualized basis about $75 million of EBITDA for the business that we acquired. So as we continue to see some softness in the oilfield services and some of the ongoing cost of the Citadel Lucent matter that obviously has taken that number down slightly, but I think overall that’s probably the data points that I could provide to you right now.

Chris Ryan

Okay. Can you say whether that pro forma includes synergies or not?

Joseph J. Levanduski

No that $75 million was pre-synergies so the $25 million in total synergy buckets would be an add to that.

Chris Ryan

Okay. Thank you. And then for the Lucent cost why didn’t you add back for the full about $4.9 million in the quarter and for next quarter how should we think about the Lucent cost for next quarter?

Bernard Rzepka

Yes, if I can answer that the ongoing cost that we maintained within our non-GAAP results, the $1.2 million are that we incurred to produce materials within sort of certification, within standards. That includes adding other materials to the production process to change your production process running it on different types of capacity to ensure we can deliver to the standards and so these are going to be ongoing costs.

And from a transparency standpoint, we want to be very clear that the cost we’re excluding or what we feel are non-recurring costs and not the ongoing cost of doing business. We have obviously work to do, to minimize that ongoing cost impact and on an ongoing basis, we anticipate probably in the neighborhood of similar types of results that we see in the first quarter for the full year.

Chris Ryan

Okay. Thank you. And what were the year-over-year pounds growth in U.S. and Canada and LATAM excluding Citadel Plastics?

Bernard Rzepka

Excluding the Citadel EP side of the business, I think now one second, I missed the numbers that I have the total from U.S., Canada perspective is EP volume was 30.1 million pound in fiscal 2015 in just EP, U.S. side and in the fiscal 2016 the pounds were down at 27.5 million pounds. So that decline that included some of the Citadel EP business.

We have to look this afterwards and check this for you. We will bring that number back to you.

Chris Ryan

Okay, okay thank you. That’s all my questions for now.

Operator

Thank you. Our next question comes from the line of Mike Harrison from Seaport Global. Your line is open.

Mike Harrison

Hi, good morning.

Jennifer Beeman

Good morning.

Bernard Rzepka

Good morning.

Mike Harrison

Just, just quickly on the Lucent matter, how much revenue headwind did that generate in the first quarter and how much should we assume that that's an ongoing revenue headwind number?

Bernard Rzepka

When you look at what we know now and we believe we know, probably 70% to 80% now of what the headwind could be, we believe it is in the range of revenues of about U.S. $15 million to $20 million. You might remember we quote out last time that the both plants out of the 21 I believe we purchased that the total revenue in both plants were $71 million so, it’s, the maximum we see really coming off revenue contraction there is about $20 million. Obviously the teams are working very, very hard to not get to this number, but that’s what we know so far.

Mike Harrison

Okay and did we see that for call at $4 million, $5 million revenue headwind in Q1 or is there so little bit more to come?

Joseph J. Levanduski

We’re not quite sold the full $4 million to $5 million because, the business is developing we should in the beginning of this quarter some material and some of this business is certainly a threat what customers told us really, some of the business we lost already but as I reported to you we didn’t lose any customers so far and that’s a key for us.

Mike Harrison

Okay and then in terms of the U.S., Canada business you mentioned some tolling volumes were taking in-house, how should I think about the margin impact of that I guess typically, I think of tolling volumes as being pretty low margin, but at the same time they help improve utilization and improve the fixed cost through?

Bernard Rzepka

Yes, absolutely, I think I called it out in my speech that there has been a significant impact in volume in the U.S. and Canada region, but we kept, at for this region pretty high gross margin I think Joe about 17.6% to 17.8%. So the impact as you say is a little use these volumes in some of our plants like Evansville, [indiscernible], Bayshore following some of our Specialty Powder plants to fit our lines into support some of our suppliers. But as you are pretty aware the whole commodity business is under a lot of pressure here in the U.S. and that’s why we've seen this decline in volume. So either our tolling customers pushed the orders forward into year and some of the business is coming back again all this simply pulled it and they still have it in-house.

Mike Harrison

Alright and the last one from me is just on the Composites business, I was a little surprised to see the gross margin flat quarter-on-quarter compared to Q4 despite what I assume would be just some seasonal revenue decline. Can you discuss a little bit what the puts and takes were around gross margin? I saw the utilization rates for example went down was there something in the margin that offset that as you look sequentially?

Joseph J. Levanduski

Mike, we are actually pleased that we kept the margin where it is because we had severe headwind and so have to see severe headwind in the oil and gas business is affecting business. This has been, a bright spot in sea business for the last three or four quarters they had like we had in the Specialty Powder business too. Specialties, they are in the market but you were aware of what’s happening there in the market. So there were they were very, very little say as in the segment and that it significant profitability, but we were able to win other businesses, to offset some of this.

Mike Harrison

Alright, thanks very much.

Joseph J. Levanduski

You’re welcome.

Jennifer Beeman

Thanks.

Operator

Thank you. Our next question comes from the line of Kevin Hocevar from Northcoast Research. Your line is open.

Kevin Hocevar

Good morning everybody.

Jennifer Beeman

Good morning Kevin.

Bernard Rzepka

Good morning Kevin.

Kevin Hocevar

You mentioned in the U.S., Canada segment impacts from these destocking as well as customers pulling production in house, so I’m wondering if you could help quantify how much of that was destocking and versus customers pulling it in-house. I guess I’m trying to get a sense of how much that all continue going forward versus what was captured within the quarter?

Bernard Rzepka

Yes, that’s very hard for us to differentiate because obviously when a customer says to us, they will pull this in-house, we do just – how much they do now in house if it’s getting done at all so, I think Joe has good answer to this question, you have some more detail on that Joe?

Joseph J. Levanduski

Well, I think from a tolling perspective between based our facility in Texas which manages the CMBS polling volume wise were down about £3.7 million year-over-year and then on the SP side which is probably tolling end in some roto business down about an additional £3.4 million. So, I can’t say that all that is tied to the recent strong ends but that’s probably puts that in perspective from a pound perspective.

Kevin Hocevar

Got you, thanks that’s helpful and with these issues, these Lucent issues that, I’m assuming started with the old owner of the business and you kind of inherited it. Do you have any recourse that you can take against the seller if this becomes, may be even now or if it becomes a bigger issue?

Bernard Rzepka

You are now taking about the Lucent?

Kevin Hocevar

Right.

Bernard Rzepka

Yes, we haven’t I think I mentioned into my script that we are performed seller – and the escrow agent hollow claims and we are putting forward.

I just want to make one comment about this tolling businesses, some of these businesses we inherited two from some other acquisitions and it is a very, very a strategic direction that we want a few tolling and commodity businesses as possible. So we recently have invested two new extruders down in LaPorte and these two, these machines will be up and running April and May this year.

And this is a very key shift too in this business where we move up the later and what is specialized because this tolling volumes as somebody mentioned in the call are not really that attractive in terms of a margin anyhow, plus it’s a very, very sexy business and I’m simply fed up to report to you, every quarter why this is going up and down. It is not really vital for us. I think it just shows that the commodity market is here in the U.S. and Canada and not only in U.S. and Canada.

Kevin Hocevar

Okay, great and then final question. In terms of the oil and gas end markets obviously those markets are challenged, but I think last year, not only where the markets challenging in the fiscal 15, but also your customers were pretty heavily destocking if I am remembering correctly. So are you coming up on any easier comps that year-over-year impacts might lessen or just that the markets or - markets continue to deteriorate and the year-over-year impacts are going to be kind of comparable to what we saw in the first quarter?

Bernard Rzepka

I think as well, we – for a number of reasons we believe we hit the bottom now. We are gaining in some since I’ll say commodity activities are very active there. We’re gaining some new business, but generally you see as well that what happens out in the oil and gas markets, that’s very, very challenging for our customers. And we all thought that 2016 we will see oil prices of maybe 55, 60 and we just learnt that it will be probably the opposite.

So I think we hit the bottom. We, let's put it like this, we cannot be hurt much by it anymore. Joe, in fact if the oil prices come back and some of our activities come into fruition we would have an upside actually.

Kevin Hocevar

All right, thank you very much.

Bernard Rzepka

Okay, next question?

Operator

Our next question comes from the line of Jason Freuchtel from SunTrust. Your line is open.

Jason Freuchtel

Hey, good morning.

Bernard Rzepka

Good morning, hello.

Operator

[Operator Instructions] Please stand by, your conference will resume momentarily.

Bernard Rzepka

Sorry, we didn’t hear any question.

Jason Freuchtel

Sorry about that, I guess I'll go ahead and ask my question, what percent of your legacy…

Jennifer Beeman

I’m sorry Jason; you can continue we can hear you.

Jason Freuchtel

Okay, sorry about that, what percent of your legacy EBIT in the first quarter was exposed to the energy end markets and how does that compare to last year? And similarly what percent of this Citadel business EBIT was exposed to energy end markets in the first quarter and how does that compare to 2015?

Joseph J. Levanduski

When we talk about energy markets in the EC side of the business it’s more dealing with materials that go into the fracking activity and obviously that has been you’re well off pace from what we seen historically and what the business has seen historically. But it is more disproportionate volume versus profitability. I think from a quarter-to-quarter perspective it sounds pretty significantly it is about 69% quarter-to-quarter about 3.6 million pounds, but the profitability is obviously much more disappointing that the total from fiscal 2014 this is prior to our acquisition first quarter is about 5.2 million pounds.

Those are down pretty significantly as you imagine from a profitability standpoint and much bigger impact on a pro forma comparative. But as Bernard mentioned, as we go forward, the expectation is that the fracking activity is going to remain at these levels. So if there is any rebound in the price of oil and fracking activity starts turning upward then that would be applied to us.

Bernard Rzepka

And I have to help you Joe here, because we as you probably know we don’t share on very certain segments profitability, so please understand that.

Jason Freuchtel

Sure. That’s fair. Okay, and I guess the operating rate for the EC segment was 55%, can you quantify the impact that energy markets had on the operating rate or is that a normalized utilization rate?

Bernard Rzepka

The impact is very little because, yes the impact is little because as Joe said it’s a small proportion of the business in terms of the volume but very profitable.

Jason Freuchtel

Okay. So should we expect the EC utilization rate to I guess pick up in the future or is 55% a number we should expect going forward?

Bernard Rzepka

In short term no, medium to long-term yes, one way or the other because we came out and bought the business to significantly improve this business and grow the business and we see even in U.S. and Canada because 80% of the business is here has been a slow environment last quarter. We saw still growth in the business so we are bit above the business. However, you know too about our smart savings activities. If we don’t get decent utilization rates which in this business I don’t get 65% to 70% we will take appropriate actions there to save costs in operations.

Jason Freuchtel

Okay. Great and then I think you mentioned that SAS synergies could exceed your $25 million cost synergy target, can you quantify the potential impact from SAS synergies and when should they start to develop?

Bernard Rzepka

We are looking into this currently and putting all the programs together and we’re still heading I think in this summer for our Investor Day Jennifer. So until then we have the data ready, but I would be disappointed if we would not talk about a significant impact of the SAS synergies after our meetings with customers and what they told me personally too.

Jason Freuchtel

Okay. And then - and lastly just for clarification, do you have an expectation of when the issues surrounding Lucent will be completely resolved?

Bernard Rzepka

Completely resolved it’s a very difficult word to say. I am thinking that we are - what is the expression with it tied?

Jennifer Beeman

Rolling out…

Bernard Rzepka

Rolling out, that is right, that is what Jennifer had told me, it’s rolling out. So I think we have worked through the majority of the internal work which we have to do to do the business as much as we can and hopefully grow it, but there will be still one or two quarters before we probably can come back to you and say we’re pretty relieved and we have worked to resolve all of these issues.

Jason Freuchtel

Okay. Great, thank you.

Jennifer Beeman

Thank you.

Bernard Rzepka

Thank you.

Operator

Our next question comes from the line of Mike Sison from KeyBanc. Your line is open.

Michael Sison

Hey good morning.

Jennifer Beeman

Good morning, Mike.

Joseph J. Levanduski

Good morning, Mike.

Michael Sison

Joe I thought, I just want to clarify a couple of things, did you - I think you commented that you had hoped the Citadel acquisition would be $0.45 to $0.50 accretive in fiscal 2016?

Joseph J. Levanduski

$0.40 to $0.45.

Michael Sison

Oh $0.40 to $0.45, okay. So and then you’re going to miss that because of Lucent and you’re going to overcome that with $5 million incremental savings. That represents about somewhere $0.10 to $0.15. So is that a good representative of the shortfall for Lucent in terms of your outlook?

Joseph J. Levanduski

No, basically we start to look to an accretive range which obviously the nature of the Lucent matter is very full as we would all imagine, it’s customer driven. So there is a lot of activity that’s going on and distraction that's going on within the organization and we had some expectation for some of our business that is trying more to do oil and gas markets and then pricing activity out there.

So while the $0.40 to $0.45 spends were our initial expectations for accretiveness, we’re taking the guidance off the table because it’s just too difficult at this juncture to put it above the range out there. We’re not saying that is not - that there is going to be zero impact. We indicated that it is still an accretive deal for us in fiscal 2016, but it’s just difficult for us to put the confidence level around the guidance range at this point.

So we will see that $5 million in excess, so $5 million of incremental savings to help to offset that. And we will still see positive contribution of the Citadel acquisition in fiscal 2016.

Michael Sison

Got it. And then I mean you’ve talked about demand generally speaking coming weaker than expected. Is that a shortfall in terms of your outlook this year as well to some degree?

Joseph J. Levanduski

Just to clarify this is about the U.S. and Canada segment.

Michael Sison

Yes U.S. and Canada I’m sorry.

Joseph J. Levanduski

In the other four segments out of the five we are pretty confident that we will get to our targets. Yes it is a short answer.

Michael Sison

Okay. So that – so I’m encouraged that you maintain the full year in terms of $2.80, $2.85, but where does the, just maybe give us a little bit better understanding where the confidence is given you talked about difficulty in assessing exactly where Citadel will be U.S. and Canada is going to be short, but it’s not your biggest segment I guess.

Joseph J. Levanduski

Yes.

Michael Sison

Where does the confidence come in to maintain that outlook for this year?

Joseph J. Levanduski

If you look at the - just if you look at the segment U.S., Canada account presence around 30% of our business roughly Europe is still the biggest one with 50, so that’s a one part, I talked a little bit about the external environment which what we believe we’ve seen here in the U.S., Canada segment is that the strong U.S. dollar impacts some of the businesses of our customers. This will I’m pretty sure what we see beginning in January reside and come back to business to us because U.S., Canada is a strong market you see in the jobs reports in December and a lot of the business here internally in this country is being supported.

I don’t think that there will be a big issue in the automotive and electronics markets we probably will not see 80 million cars being built next year, but it will be a significant number. Then you see the strength in Latin America, you see the strength as well of our business despite some hedge wins in Asia-Pacific, you see the improvements I think we called it our five years improvements of profitability.

I believe it’s much more, but we start counting that. So, this company in judging even a margin of 2% we’re talking about margin consistently of close to 6 and we want to develop it further. And then there is lastly all our savings activities, which I believe we do a lot of that, but we can still do better which we will focus on. So that’s why we are confident provided that we see a similar environment I call it similar choppy environment like 2015.

Michael Sison

Great and then one last one, is there a way you can help us may be understand a little bit how much of the outlook you’re going to get in the first half is it like 30%, 35% EPS comes in the first half, the rest comes in the second half? What it kind of seems like off the cuff from my math, but any help in understanding when we start to see that growth this year?

Joseph J. Levanduski

Yes, I’m not sure if this response will be helpful, but let me give you what I can. We don’t provide quarterly guidance as you are aware it’s a very fluid process and things move from quarter-to-quarter frequently on. So we can’t give that kind of clarity.

However, as you know, our third quarter tends to be the strongest quarter historically speaking and we anticipate that to be the same this year. In addition to that, we have a significant amount of the synergies I think I had mentioned about like the restructuring on the Evansville facilities that we’re consolidating. We will see a lion’s share of all synergies develop in the third and primarily the fourth quarter. So I think the second half will be stronger than the first half, if you put those together.

Michael Sison

Okay. Thank you.

Operator

Thank you. Our next question comes from the line of Dmitry Silversteyn from Longbow Research. Your line is open.

Dmitry Silversteyn

Good morning. Thanks for taking my questions.

Bernard Rzepka

Good morning.

Jennifer Beeman

Good morning.

Dmitry Silversteyn

A lot of my questions have been answered, but I would just like to follow-up on the composites question. Again you had sort of sequentially down revenues, but not SG&A which was flat versus the previous quarter. So I guess does this have more fixed SG&A cost business than your Masterbatch and Engineering Materials business or we sort of what’s going on with SG&A costs not moving in tandem with the revenues lines?

Bernard Rzepka

No, it certainly Dmitry is not fixed and we are looking at Joe said in his script that we’ve seen additional opportunities in G&A costs which we ever think to grow and develop phase and R&D. So we will keep on investing in that. But of course we are looking into additional savings in G&A cost. And by the way it is not only true for the EC business, it’s true for all our businesses.

Dmitry Silversteyn

Okay. All right. So I guess my question is so is the reason the costs reflect where the SG&A costs were flat in the November quarter versus the August quarter?

Bernard Rzepka

Yes.

Dmitry Silversteyn

All right. If you look at your business in Asia-Pacific, how much of that is China and sort of what is the second leading geography that you’re exposed to is it Australia or is it some other country in the APAC region?

Bernard Rzepka

No it’s China, Indonesia, Malaysia followed then by India that’s roughly the priorities and the so the it- significant input in there is second impact in China, we continued to invest into China, I think some were surprised about the result there, but I would like always to remind that the entire Asia Pacific segment is relatively small we have from the beginning and setting these operations up really focus on specializing.

When you look at the subsidy I talked about which we will, getting into operational in Shanghai, its - for small extruders focus on the color business which is highly profitable and which is supported by international customers which are moving into this region and so we really are in a very, very small specialized segment there which we don’t see any contraction or any issues there, but if challenging markets I mean if you are in China, you are in Asia Pacific in commodities is a very tough time, but we are in very specialized segments.

Dmitry Silversteyn

Okay but Bernard aren’t you moving into sort of border markets in Asia-Pacific wasn’t that part of your strategy to grow volumes to go from this high niche business into sort of the middle of the pyramid, and if that’s the case those efforts are being hampered by what was going in the region?

Bernard Rzepka

Yes, brought in our sense here is still for China, very, very specialized but given the changes in the last 12 to 18 months which we see in these economies, we really do a lot of work to really specialize. So, India for instance where we put in a second plant that make sense to go more into the broad markets that’s what we do. In China we stay away from it as much as possible.

Dmitry Silversteyn

Okay, then switching gears to Latin America, which obviously was a strong point in this quarter how much of Latin America division for you is Mexico is more than half?

Bernard Rzepka

Yes, it’s more than half.

Joseph J. Levanduski

That’s right, it’s for us, it’s a strong business but we continued to grow despite, headwinds our Brazilian business and our Argentinean business which is a bright spot and we think it will continue that way.

Dmitry Silversteyn

The Brazilian devaluation obviously must be hurting you, but sort of the market that demand still okay in the region or as order – exposure – in Brazil?

Bernard Rzepka

The business and the economies particularly in Brazil is terrible, but we have several businesses tells you something about our flexibility. So we focus lot in areas like packaging, agriculture now in this region and not so much in automotive and electronics because this business is very, very difficult to say the least in Brazil. We focused too on other countries which we actually supply from our plants in this region including Mexico like [indiscernible] for instance and these are nice good development areas for our activities and do pretty well.

Dmitry Silversteyn

Got it and then just I’d like to finish up the questions on Latin America do you have an much of an exposure to Venezuela, do you have any properties or assets in the area or you importing it from other regions? If you are certain – country…

Bernard Rzepka

No.

Dmitry Silversteyn

Okay, good and then the final question on sort of a little bit longer term strategy. Your joint venture with the Saudi’s in the Middle East, how is that progressing, I mean I know it's still two, three years out before we should start seeing any impact of that, but given what’s going on in the world, is there any change to the timetable either pulling it forward or backing off of it? Could you talk about your appetite for continuing expansion in that region?

Bernard Rzepka

We are not walking away from it, we are breaking ground and building the plant together with our partner and one of the key areas which I was talking about and Joe tried to get across, we are really moving along well in our strategy to specialize business. And if you look at this Saudi Arabia or the glut of oil and gas, I mean Saudi Arabia whatever happens in the world will be always the most competitive area. However, were there really suffer and struggle too like most is in the commodity but what we are there together for them is certainly not commodity is specialty. So I think, medium and long term these businesses in the Middle East and Africa were developed well and our joint venture would not that will do – we do well too.

Dmitry Silversteyn

Okay, thank you Bernard.

Bernard Rzepka

Yes, you are welcome.

Operator

Thank you. Our next question comes from the line of [indiscernible] from Rogge Global Partners. Your line is open.

Unidentified Analyst

Hi, good morning everyone. Your net leverage perform of $3.85 that you mentioned if I calculate backwards I kind of get a $2.62 LDM EBITDA just to be clear does that $2.62 does that include potential expected synergies or not?

Joseph J. Levanduski

No, it would be on a pro forma basis so it will be through the end of November. So there will be some synergies included in it but it was then really on in that process so not a significant amount.

Unidentified Analyst

Okay, so not the whole $20 million that you are talking about?

Joseph J. Levanduski

Yes, correct.

Unidentified Analyst

Okay, thank you very much. And then going back to the destocking and tolling that you talked about, can you give me an idea what it made in terms of revenue I know the margin is slower when in terms of revenue what is the impact or what was the impact?

Joseph J. Levanduski

Just give me one second please, $37 million.

Unidentified Analyst

Quarter-over-quarter?

Joseph J. Levanduski

Yes, for the quarter.

Unidentified Analyst

Thank you very much.

Joseph J. Levanduski

That’s included in roto business – those – line share would be…

Unidentified Analyst

I see, okay thank you. That’s all I have.

Joseph J. Levanduski

Thank you.

Bernard Rzepka

Thank you.

Operator

Thank you. Our next question comes from Roger Spitz with Bank of America Merrill Lynch. Your line is open.

Chris Ryan

Hi, yes, this is Chris Ryan for Roger again so couple of follow up questions for the tollers likely to pull business in-house why did they choose to pull it in-house and what do you think the rest of further pounds being pulled in house in the future in this quarter, going forward?

Bernard Rzepka

What we believe they pulled this in house again as I said before as the finally to produced in-house because they have said sitting there with very little orders, with the operating the, commodity business in the U.S. and worldwide in the last couple of quarters that was an issue underutilized assets. So if you have tolling business out there you will want to feed your own capacity. So, that’s what we are doing.

Chris Ryan

And so going forward how much of a risk do you think it is that further pounds would be pulled in-house?

Bernard Rzepka

It’s a short term business for us too, so we get, an outlook for four to six weeks and not more what we see now in beginning of January and said before that even the some of this business is coming back again but this can change of course depending on the market in the next two to three months.

So I’m actually expecting that we will have in the tolling and commoditized business headwinds will continue as long as you have all the glut of materials around and over capacities.

Chris Ryan

Okay, thank you. That’s all my questions.

Operator

Thank you. We have time for one more question today. This one is from the line of Rosemarie Morbelli from Gabelli & Company. Your line is open.

Rosemarie Morbelli

Thank you. Just quickly what is the size of your tolling business currently?

Bernard Rzepka

We just said it is about $37 million for the quarter.

Rosemarie Morbelli

I thought that that was – I thought that $37 million was the amount of decline during the quarter?

Bernard Rzepka

Yes, almost everything which we had in this business went last quarter – tends to happen Rosemarie if you know the commodity markets suffer that the customers pull most of the volume out of factories which are done by others.

Rosemarie Morbelli

So if I understand properly, at this stage at the end of the first quarter, there is no tolling coming out of your facility?

Bernard Rzepka

Let's put it like this since you know we, I will not disclose any business detail to you or anybody else how much we have, but it is 70% to 80% of what we are having. So the majority is not with us anymore.

Rosemarie Morbelli

Okay.

Bernard Rzepka

Over the last quarter and I’m expecting that we will have a next quarter not as big in terms of the revenue as we had last quarter, but there will be one.

Rosemarie Morbelli

Okay. So if no tolling comes back in-house then we should see the margin improvement overall regardless of what happens to regardless of what you do internally just because tolling is no longer there?

Bernard Rzepka

Yes, I mean we have of course some unabsorbed costs which hits you, but it will be not a big hit and Rosemarie as I said before I think we announced one or two quarters ago that we are investing in our LaPorte and Bayshore facility with two brand new machines which are redesigned for these very businesses for specialties which this business is growing well. So we will be less dependent coming forward in the next couple of months on tolling business.

Rosemarie Morbelli

Okay. Great, thanks.

Bernard Rzepka

You’re welcome.

Operator

Thank you. That is all the time that we have for questions today. So I would like to turn the call back over to management for closing remarks.

Jennifer Beeman

Thank you and thank you all for your questions today. Before we conclude, Bernard I would like to turn it over to you for brief closing statements.

Bernard Rzepka

Yes, thank you. I want to again express my confidence in our outlook. While fiscal 2016 is off to a challenging start, we had several strategies which we discussed in place now delivering benefits which support our guidance of $2.80 to $2.85 per diluted share. We have a variety of strong growth catalysts in place to move the company forward. Thank you.

Jennifer Beeman

Thank you all and that concludes our conference.

Operator

Ladies and gentlemen, thank you again for your participation in today’s conference. This now concludes the program and you may all disconnect your telephone at this time. Everyone have a great day.

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