Kraton Performance Polymers' (KRA) CEO Kevin Fogarty on Q1 2016 Results - Earnings Call Transcript

| About: Kraton Performance (KRA)

Kraton Performance Polymers, Inc. (NYSE:KRA)

Q1 2016 Results Earnings Conference Call

April 28, 2016, 09:00 AM ET


Gene Shiels - Director of IR

Kevin Fogarty - President and CEO

Steve Tremblay - VP and CFO


Jason Freuchtel - SunTrust

Bill Hoffman - RBC Capital Markets

Mike Sison - KeyBanc

Chris Kapsch - BB&T Capital Markets

Edlain Rodriguez - UBS

Josh Spector - UBS

John Roberts - UBS


Good morning and welcome to the Kraton Performance Polymers Incorporated First Quarter 2016 Earnings Conference Call. My name is Prima and I will be your conference facilitator. At this time, all participants are in a listen-only mode. Following the Company's prepared remarks, there will be a question-and-answer period. [Operator Instructions] Today’s conference is being recorded. If you have any objections, you may disconnect at this time.

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

Gene Shiels

Thank you, Prima. Good morning and welcome to Kraton Performance Polymers' first quarter 2016 earnings call. With me on the call this morning are Kevin Fogarty, Kraton's President and Chief Executive Officer; and Steve Tremblay, Kraton's Executive Vice President and Chief Financial Officer. A copy of the news release we issued yesterday is available in the Investor Relations section of our website as those copies of the presentation we will review this morning.

Before we review our first quarter 2016 results, I’ll draw your attention to the disclaimers on forward-looking information and the use of non-GAAP measures included 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 thus 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 forward-looking statements speak only as of the date they are made and we have no obligation to update such statements in the future. 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 and adjusted EBITDA to net income or loss and a gross profit to adjusted gross profit, as well as a reconciliation of net income or loss attributable to Kraton to adjusted net income was provided in yesterday's earnings release and in the material this morning. Following our prepared remarks, we'll open the line for your questions.

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

Kevin Fogarty

Thanks Gene, and good morning everyone.

Our first quarter results reflect solid business performance and continued execution against our stated strategic objectives. In our Polymer segment we delivered another strong quarter following the record fourth quarter adjusted EBITDA we just posted last quarter.

First quarter 2016 adjusted EBITDA was $52 million, a record first quarter result and this is up from our previous first quarter record of $49 million which we reported in the first quarter of 2015. The $52 million is also the second highest quarterly adjusted EBITDA in the Company’s history.

We will highlight now some of the factors contributing to the strong performance in just a few minutes. As you all know, on January 6, we acquired Arizona Chemical and we now report this business under our chemical segment.

As you would expect since the close we have been executing on our plan to ensure stability in the business as we begin to leverage the growth opportunities we see for the segment. First quarter adjusted EBITDA for the chemical segment was $41 million reflecting stable business performance and profitability evidenced by the first quarter 2016 adjusted EBITDA margin of 23.1%.

Nevertheless, we do see opportunity improve overall profitability via targeted actions, to recover prior period loss sales specifically in our chemical intermediates business, disciplined use of analytical tools to ensure refinery balances are truly profit optimal, and by leveraging improved fundamentals of substitute product pricing in both our adhesive and chemical intermediates businesses. In fact, an improved trend was evident as the first quarter evolves.

In addition to integrating the Arizona acquisition including capturing transaction synergies, we remain on track to deliver $25 million to $28 million of cost reductions associated with our previously disclosed Polymer segment cost reduction initiatives in 2016 or by we recognized an incremental $3.7 million of cost reductions in the first quarter as we work toward our stated goal of $70 million by 2018.

And with respect to transaction synergies, we expect to realize $21 million to $27 million of synergies in 2016 targeting a total of $65 million by year end 2018. In the first quarter of this year, we achieved $2.9 million of our 2016 target.

Consistent with our commitment to rapidly de-lever following the acquisition of Arizona, in the first quarter we sell assets associated with our compounding business for $72 million and we used proceeds from the sale to reduce debt outstanding under our term loan.

This year we expect further reductions in net debt such that we expect to end the year with net debt of approximately $1.6 billion and through 2018 we expect an aggregate reduction in net debt of approximately $500 million.

In his comments later, Steve will walk you through the mechanics of how we intend to achieve our cost - excuse me, our debt reduction targets. Overall with solid quarter for the – from an operational and execution standpoint, so we could let's now turn to the numbers and review the performance of both the polymer and chemical segments in the first quarter.

First quarter 2016 sales volume for the Polymer segment was 75 kilotons up from 74 kilotons in the first quarter of 2015. First quarter revenue was $243 million down $18 million or 7% compared to $261 million in the first quarter of 2015.

Given that sales volume was up year-on-year, the decrease reflects lower average selling prices which are associated with lower raw material costs, as well as the effect of currency which had a negative impact of nearly $4 million.

As I just mentioned, adjusted EBITDA for our Polymer segment was $52 million or 21.5% of revenue and this was up $3 million compared to the $49 million we posted in the first quarter of 2015.

Overall, we are pleased with the strong performance for the Polymer segment in the first quarter particularly compared to the first quarter of 2015 on a business benefited from a significant and rapid decline in raw material prices driving gross profit to $1075 per ton.

While we did not had the same benefit from raw material price decline in the first quarter of this year, we did have another good quarter for Cariflex and the results also reflect incremental cost savings which contributed to gross profit of $1052 per ton. This is the second sequential quarter with adjusted gross profit above $1000 per ton following the $1035 per ton we posted in the fourth quarter of 2015.

Turning to the performance of our three Polymer segment businesses, as I said another good quarter for Cariflex with sales volume up 12% compared to the first quarter of 2015. The increase was largely driven by higher sales of the surgical gloves applications. I will just reiterate that we have said in recent quarters, we expect the growth trend for Cariflex to continue and we look forward to the late 2017 completion of our Cariflex project in Polenia which will provide incremental latex capacity to support the growth that we expect.

Specialty polymers volume was up 1% compared to the first quarter of 2015 with higher sales in the automotive and medical applications, particularly - partially offset by lower sales in the lubricant additive applications and to a lesser extent lower sales into personal care applications.

We've discussed in recent quarters the impact on lubricant additive sales in 2015 that resulted from an inventory management program by a major customer. We believe the impact of the inventory management program is largely complete and that the lower sales in the first quarter of 2016 compared to last year are primarily due to order timing.

Revenue for specialty polymers was $85 million and this was down $7 million or 7% near to the first quarter of 2015. Given the higher sales volume, the drivers of the revenue decrease for currency which accounted for a million dollars of the decline and lower average selling prices associated with lower raw material prices which accounts for the balance of the revenue decrease.

Sales volume for performance products was essentially flat compared to the first quarter of 2015 with higher sales into paving and personal care applications offset by lower sales into adhesives and roofing applications.

North American paving volume was up nearly 38% compared to the first quarter of 2015 and European paving volume was up nearly 75%. While the paving season has just started, we remain encouraged about the outlook for paving activity this year particularly in North America.

The first long term highway bill in nearly a decade which was signed at year's end has earmarked $205 billion for highway projects over the next 5 years. This provides confidence in project funding while lower input prices for asphalt and even our polymers allow more activity under constrained budgets.

Looking at the overall portfolio for our Polymer segment as evidenced by our continued success in our portfolio shift strategy for the trailing 12-month period ending March 31 2016, 59% of our revenue was driven by sales and a differentiated product range. This is up 200 basis points from 57% for the TTM period ending March 31, 2015.

As we look at results for our chemical segment, I’ll note that comparability against the first quarter of 2015 is slightly impaired by the fact that we closed the Arizona acquisition on January 6 of this year.

As such first quarter 2016 reported figures for the chemical segment are based upon the days in which we actually own the business and therefore not fully comparable to the full comparable quarter in 2015. You will note that on Slide 5 we provide sales volume and revenue on a full calendar quarter basis for the first quarter of 2016.

To give you a sense for the cadence of the business, I will reference first quarter 2016 volume and revenue on a full calendar quarter basis. On a full calendar quarter basis, first quarter 2016 sales volume for our chemical segment was 98.2 kilotons, down 2 kilotons or 2% compared to 100.2 kilotons in the first quarter of 2015.

On a full calendar quarter basis, revenue for our chemical segment in the first quarter of 2016 was $184 million down 20 million or 9.9% compared to $204 million in the first quarter of 2015. The main drivers of the volume decrease are related to tall oil fatty acid or TOFA sales volume.

Although adhesive benefited from an outage of a major competitor last year and therefore first quarter sales volume is down compared to the year ago quarter, first quarter results 2016 for adhesive business reflect margin stability and a good start to the year. Our chemical intermediates business showed the majority of the volume decline compared to the first quarter of 2015.

Adjusted EBITDA for the chemical segment was $41 million in the first quarter of 2016, and as I referenced earlier the margin profile of the business has remained resilient with the adjusted EBITDA margin of 23% continuing to multi-year trend of EBITDA margins in excess of 20%.

I should note here that despite the declines for selling prices, that we have seen in parts of the chemical segment primarily adhesives and chemical intermediaries, as indicated by the margin profile of the business, there has been a corresponding reduction input prices that does produce preserve profitability.

Looking at the four chemical segment businesses in more detail, again on a full calendar quarter basis, adhesive revenue was $66 million for the first quarter of 2016 and this was down $5.5 million or nearly 8% compared to the first quarter of 2015.

Sales volume was down 5% compared to the first quarter of 2015. The revenue and sales volume comparison against the year ago quarter reflect the fact that adhesive sales and margins in the first quarter of 2015 benefited once again from a competitor plant outage. However, overall pricing in the first quarter of 2016 remains strong compared to the prior year and compared to the fourth quarter of 2015.

First quarter 2016 revenue for the roads and construction business was $10.7 million up marginally from the first quarter of 2015. Roads and construction sales volume was up 3.5% compared to the first quarter 2015 driven by higher sales in the pavement marking which more than offset lower overall paving volumes.

Warmer weather conditions combined with passage of the Federal Highway spending bill and customer capacity expansions lead to a significantly higher purchase in the Southern United States more than offsetting lower sales in Europe.

Revenue for the tire business was $9.2 million for the three months ending March 31, 2016 and this compares to $9.7 million for the three months ending March 31 of 2015. The marginal decline was due to lower average selling prices resulted from lower average raw material cost and a different more competitive regional mix.

Overall volume was up 1.5%. First quarter 2016 results benefited from new qualifications in Asia, North America and Europe which were partially offset by lower volume in South America and the impact of first quarter customer inventory adjustments.

And lastly in our chemical intermediates business, sales volume was down 1% compared to the first quarter of 2015. First quarter 2016 revenue was $98 million down $14 million or nearly 13% compared to $112 million in the first quarter of 2015. Lower pricing on competitive industry offerings, the effective product mix and the impact of exchange rates were reflected in the lower average selling prices.

With regard to lower pricing on competitive industry offering, as you may know certain markets served by chemical intermediates such as oil field are currently experiencing weaker demand. Less than 5% of our overall sales mix for other pine chemical producers oil fields in particular has been more relevant.

Thus declines in drilling activity and associated lower consumption of drilling fluids has impacted overall TOFA and [indiscernible] demand causing a ripple effect in the form of additional supply in markets traditionally served by us.

As well against this backdrop and as mentioned previously, overtime the chemical intermediates business has experienced some share shift to competition. With the decision by prior management to absorb a significant portion of the CI or chemical intermediates sales volume to distributors being a major driver of this share shift.

Our teams are now working actively to accelerate the reversion to a direct sales model and rebuild relationships with our customers. We expect our efforts to yield results beginning in the second quarter with additional TOFA sales.

Looking forward we see increasing evidence that overall market trends could be improving. We see increasing hydrocarbon prices in Asia as a leading indicator. Crude oil appears to have bottomed out in April and is now trading above $40 a barrel. We also are seeing vegetable oil prices improving which is leading to some strengthening in pricing.

Additionally we are now diligently managing our refinery balances and are working to create new outlets for both TOR and TOFA. We have an excellent cost position and we have already seen positive trends in the first quarter. On this basis we are confident that we will revitalize the volume growth in our chemical intermediates business.

Now I would like to turn the call over to our Chief Financial Officer, Steve Tremblay for more in-depth financial reviews. Steve?

Steve Tremblay

Thank you, Kevin and good morning.

Slide 6 reflects a summary of operating results for the first quarter of 2016 which I will remind you includes the results of the chemical segment from January 6, 2016 to March 31, 2016. For comparative purposes only, we are providing pro forma combined revenue for the three months ended March 31, 2015.

Consolidated revenue in the first quarter 2016 amounted to $420 million compared to $465 million in the first quarter of 2015 including $204 million of Arizona Chemical revenue. The decline in revenue was largely driven by the effect of lower raw material cost in our Polymer segment which offset increased volumes in our Cariflex and specialty polymer groups within that segment.

With respect to the chemical segment, $6.9 million of the decline stems from the less than full calendar quarter in 2016. The balance reflects lower average selling prices in chemical intermediates and to a lesser degree lower sales volume in adhesives. In total on a consolidated basis, foreign currency was a headwind of $5.7 million in the first quarter.

Consolidated adjusted gross profit amounted to $138 million in the first quarter of 2016 which includes Arizona Chemical adjusted gross profit of $59 million and another solid quarter on our Polymer segment which posted adjusted gross profit of $79 million.

Within the Polymer segment, 2016 adjusted gross profit was essentially flat to the first quarter of 2015. As Kevin mentioned, the first quarter 2015 represents the highest adjusted gross profit in absolute terms, as well as on a per ton basis with both metrics in Q1 '15 benefiting from margin expansion driven by the rapid decline of raw material costs.

Against that challenging comparison, Polymer segment generated $79 million of adjusted gross profit in 2016 first quarter. At $152 per ton, this mark two consecutive quarters with a Polymer segment has eclipses a $1,000 per ton of adjusted gross profit.

The polymer results includes solid variable margins and $3.7 million of period-over-period lower operating cost, largely driven by the natural gas boiler project which came in line in the second half of 2015. We currently expect that project will deliver more than $10 million annual run rate savings we had been expecting.

Moving to the chemical segment. The adjusted gross profit of $59 million in the first quarter of 2016 includes $2.1 million, or nearly 50% of the anticipated $5 million of full year 2006 turn around costs, as well as a $1.8 million negative effect from foreign currency.

We made early progress in synergy driven operational improvements, generating $1.1 million in cost savings within the chemical segment since the acquisition.

Consolidated adjusted EBITDA of $93 million in the first quarter of 2016 reflects a record first quarter in our Polymer segment of $52 million with growth of $6.1 compared to the previous record of $49 million posted in Q1 2015, and following a $50 million Q4 2015.

Adjusted EBITDA margin was 21.5% in the first quarter of 2016 compared to 18.8% in the first quarter of 2015. In the chemical segment, adjusted EBITDA of $41 million equates to a healthy margin of 23.1%. This has the effective increase in the composite adjusted EBITDA margin by 70 basis points to 22.2%.

We've made good progress toward capturing synergies in the first quarter of 2016 with $2.9 million of EBITDA accretion coming from implemented synergies broken down as follows: $1.1 million in operational improvements in the chemical segment and $1.8 million in G&A synergies across both segments.

In addition, in the Polymer segment, we generated $3.7 million of adjusted EBITDA accretion compared to Q1 2015 from our cost reset initiatives. Including the savings of more than $19 million from these initiatives in 2015, we have banked $23 million toward our Polymer segment cost reset goal of $70 million through March 31, 2016.

I’ll provide some additional information on both the cost reset initiatives and the synergy capture later in these prepared remarks. Adjusted EPS in the quarter amounted $0.80 per diluted share, an increase of 5.3% compared to the first quarter of 2015.

Let's move now over to Slide 7 where we present the GAAP to non-GAAP results of operations for some additional comments. I do want to call out several of the items that comprised the bridge from GAAP EPS of $2.84 per diluted share to adjusted EPS of $0.80 per share.

In columns A and B, we have eliminated $11.5 million of cost associated with the synergy capture and integration activities. The loss associated with the refinancing which occurred at the closing of the Arizona deal is eliminated in column C.

In column D we exclude the one time purchase accounting adjustment opening inventory. And column E, removes the one-time gain from the sale of the compounding assets. And finally in column H, the release of the evaluation allowances in the quarter is removed to result in a more normalized tax provision for the quarter.

The resulting effective tax rate on an adjusted basis in the quarter is there for 5%.I will provide full year tax modeling assumptions with respect to the effective tax rate later in the material.

Turning to Slide 8 for an update of progress towards the $70 million of polymer cost reduction, we captured 19 million in 2015 which exceeded the $18 million goal. The year-over-year benefit of the boiler project in addition to the continuation of other targeted operational improvement initiatives is expected to result in a 2016 end year benefit ranging from $25 million to $28 million.

So from January 15 to the first quarter of 2016, we have gone in total of $23 million of savings. As a result, we continue to expect the realization of $70 million of EBITDA improvement by 2018. And we are still targeting a $50 million improvement in working capital, again in 2018.

With respect to certain key projects and their milestones, we anticipate startup of the HSPC facility in Taiwan in late 2016. We are in the engineering phases of both the USPC expansion in Bayer, France and the Cariflex direct configuration at our facility in Brazil.

Today we have not encountered any factors that would suggest the cost to achieve the full $70 million will deviate from $90 million to $95 million range which we previously disclosed.

Let's now move onto the deal synergies on Slide 9. Here again we remain on target to achieve the $65 million of synergies of which $25 million is expected to come from G&A actions and $40 million from operational cost improvements.

For us with respect to the G&A savings, we banked $1.8 million in savings since the closing of the transaction. And on a full year basis, we expect to generate $12 million to $15 million of G&A savings.

Moving to the operational synergy front, we’ve already banked $1.1 million in Q1 and currently anticipate 2016 will reflect $9 million to $12 million of improvements. Let me provide some examples of what we've accomplished so far.

We’ve generated savings by installing a new gas boiler at our Panama City refinery. We recently approved a capital project which will allow storage at logistic cost at our facility in Finland. And we have a number of activities which are proven to improve overall yield to our refineries. Each of these initiatives are in line with our deal thesis assumptions.

In summary, we continue to expect a total of a $135 million of value creation in 2018 when we combined the $65 million of deal synergies with a $70 million in cost reset initiatives.

On Slide 10, we present the role flow from December 31 2015 net debt for Kraton, as well as on a consolidated basis taking into account the consolidated activities of our joint venture in Taiwan.

As previously disclosed, the acquisition of Arizona Chemical and associated fees and expenses and the defeasement of the 6 and 3 quarter percent senior notes refunded through the issuance of $1.35 billion term loan, replacement of $40 million of new senior notes and drawings on the new ABL.

As a result Kraton net debt at closing of the Arizona acquisition was $1.73 billion. As we previously mentioned, during the first quarter, proceeds from the sale of compounding assets were totaling $72 million. We directly apply to reduce the outstanding term loan to $1.278 billion.

A couple of other items in the first quarter that are worth mentioning. We had an aggregate of $36 million of first quarter cash outflows broken down as follows: $18 million in transaction and integration costs, $15 million payment of variable compensation which was earned in 2015 and additional $3 million of cost to achieve the synergies to date.

As a result, net debt was reduced by $30 million since the acquisition and we expect to reduce net debt by an additional $100 million by year end 2015.

Slide 11 illustrates the meaningful cash flow profile of these combined businesses. One of the considerations when we analyze the combination of Kraton in Arizona was the ability to quickly de-lever to our target net leverage ratio of approximately 2.5 times. We continue to believe we will achieve this target by 2018.

Let me give you an example. If we were to assume the mid-point of the 2016 EBITDA guidance and the benefit of the synergies and the cost reductions, both of which are progressing as expected, the result is in aggregate of $1.27 billion of EBITDA in the three years ended December 31, 2018.

After providing for interest, taxes, and reinvestment of the business, we expect to generate cash flow of $500 million which we plan to apply to reduce indebtedness.

As we move to Slide 12, I want to turn to a discussion of our outlook for 2016. First, we are reaffirming our adjusted EBITDA guidance for the full year of 2016 which is $370 million to $390 million.

Let me focus on some items that have changed since our last communication back in February. We now estimate that 2016 revenue will be approximately $1.8 billion. Depreciation and amortization has been reduced to $125 million to $130 million. Interest is now anticipated to be $135 million to 140 million with a cash portion of that being $124 million. The balance comprise of the amortization of differed financing and original issue discount.

We expect an effective tax rate on a full year basis to be 20% to 25% more in line with our longer term expectations. And I will note that that tax rate does exclude the release of the valuation allowance of $86.6 million in the first quarter of 2016.

I would now like to turn the call back to Kevin for some of his closing comments. Kevin?

Kevin Fogarty

Okay, thank you Steve.

As we look forward to the balance of the year we are encouraged by the opportunities we see in both the Polymer and Chemical segments of our new Kraton. Our Polymer segment is off to a great start in 2016 with a strong first quarter. As we continue our portfolio shift, we see good momentum for especially polymers business in Europe and North America with our HSBC business in China and Asia being stable.

For our Performance Polymers business as we indicated the recently passed federal spending highway bill coupled with overall cost for bitumen, as well for paving activity this year, this expectation also applies to our Roads and Construction business in the Chemical segment. Overall the paving season is just beginning but we certainly remain optimistic.

Our current outlook for our adhesives businesses in both Polymer and Chemical segments respectively as for stability, overall demand should track global GDP aided by some key innovation projects.

In our tire business, we’re expecting solid trends over the next two quarters, through both winter tire build and the summer production schedule and from recent qualifications.

Lastly for our chemical intermediates business, as I’ve said we’ve initiated targeted actions to recover prior period loss sales. We’ve installed a discipline use of analytical tools to ensure our refinery balances are truly profit-optimal. And we see the opportunity to leverage improved fundamentals of substitute product pricing in both our Adhesive and Chemical Intermediates businesses. In fact, an improved trend was evident in the first quarter as it evolved.

In summary based upon our current outlook we still see adjusted EBITDA for 2016 falling in the range of $370 million to $390 million. Our ability to achieve this expectation is a function of both market conditions and our continued execution on our cost reduction plans and the synergy capture opportunity Steve just outlined.

I’m highly confident in our ability to deliver on this at later point with respect to cost reductions and synergy capture particularly given the progress we achieved on both fronts in the first quarter. We look forward to updating you on the progress as the year unfolds.

And at this time, I'll turn the call back to the operator for some questions.

Question-and-Answer Session


[Operator Instructions] Our first question comes from Jason Freuchtel of SunTrust. Sir, your line is open.

Jason Freuchtel

Hi, good morning guys. Great quarter. You've been saying some cost savings in the quarter was a little higher than expected, how much of the $3.7 million in cost savings was a result of the boiler project you've completed last year. And what is the total benefit you now expect to receive from the boiler project.

And then also how should we think about the cadence of the remaining savings and synergies through the rest of 2016?

Kevin Fogarty

Of that first quarter benefit, significantly all of that was the boiler project. If you recall that boiler project came online in the July, August timeframe. So the first quarter of last year didn't have any of that benefit in it.

But I will say that there was continued momentum across the entire portfolio of opportunities that make up a piece of that $70 million.

Jason Freuchtel

Okay. And then I guess do you have any guidance in terms of cadence of the remaining savings and synergies that you expect to achieve in 2016?

Steve Tremblay

Specifically by quarter, no I would suspect though given what I just said about the boiler project we have to receive, a similar kind of benefit from the boiler project in the second quarter, given the timing of that project and then that will dissipate as we move into the full year which will get us to that $25 million to $28 million that we spoke about.

You had a question Jason specifically about the boiler itself and how much it would exceed the $10 million. I'm going to say right now it's going to be at least the $11 million in full year benefit by the time we get to the year end it could be a bit more than that and that's - at this point a flywheel on the range.

With respect to the synergy package that we talked about both the G&A, the operational improvements, I would suspect would began to again follow a cadence in second quarter more a little bit accretive to the $1 million that we posted in the post and then start to ramp up in the balance of the year.

Some of those initiatives are a function of some modest capital spending which we haven’t yet to undertake. With respect to the G&A certainly what we generated in the first quarter given most of it was staffing related savings about two thirds of that were staffing related, the rest was some into expend. That should again continue to ramp up with the second quarter probably being in that same zipcode plus and then really gaining a lot attraction in the back half of the year.

Jason Freuchtel

Okay. Also I believe you indicated in the past you typically see some seasonality in your business as a result of the paving and roofing end markets. Has that paving - I guess given the favorable trends you're seeing in the paving and markets this year, well there be much of an incremental benefit from the paving and roofing end markets on a sequential basis to both segments.

And do you have an estimate for maybe how much benefit you saw from the passing of the highway bill or how that could be - how much of a benefit you could see in 2016 in your paving business?

Kevin Fogarty

So let me take the second question first. Needless to say I mean what I've said is given the fact that we got as you pointed out the highway bill now on record coupled that with the fact that literally all the input costs are now lower.

So even in otherwise, fine constraint budgets. There is more opportunity obviously to do more work. We categorize it is some of the best signals we've seen in the - particularly the North American business in quite a few years. And we don't want to talk too much just yet about the fact that the paving season have unfolded because there is always a weather factor that we need to cautious to, but that all being said, the start to the year is exactly is my comment said earlier, would be benefiting from those two factors.

And then of course I do want to remind you that this time last year we had a significant challenge operationally with respect to the late start up coming out of a turn around and bear, that impaired our second quarter as well, but we’re obviously not expecting that this year and saw all those things a positive.

With respect to the seasonality question though, needless to say I think that it's true that the paving parts of our business are going to be benefit from the second and third quarter. But the overall portfolio of sales is much bigger now, so the impact of that paving - particularly the paving part of our Polymer segment therefore is kind of somewhat dampen I suppose.

Jason Freuchtel

Okay. And for clarification, can you explain on the comment you made on the Chemical business that an improved trend was evident in the first – as the first quarter evolved. Where exactly are you seeing the optimism in the quarter is a primarily from the paving end market, as well as the changes you’ve made to the chemical intermediates segment?

Kevin Fogarty

My comment was specifically in terms of how the quarter evolved, the monthly cadence improved, January was a little slow, March was quite attractive and it was mostly in our CI business. And to the lesser expend, I suppose we could say the decent part of our Chemical segment is well, but mostly in chemical intermediates.

Jason Freuchtel

Okay, great. And I guess in terms of the Chemical segment volumes came down 2% just to clarify was that primarily driven by the unfavorable comparison in the adhesive segment. And with that, can you highlight the sub-actions, Kraton has implemented that could lead the volume growth over the course of the year in the chemical’s business?

Kevin Fogarty

Sure. So indeed I called though that last year at this time business had - one of suppliers in the industry had an out agent and a piece of the business benefited from that in our Chemical segment. So the comparison is what I was referring too.

Overall our adhesive business, we are very pleased with how it's doing and the margins we are enjoying and of course the growth prospects. With respect to the chemical intermediates business, I would say, our focus is on two fronts that are kind of directly attributable to our actions.

One is calling out specifically that past decisions to move quite a significant volume to third party distributor networks, both in the U.S. and Europe has not worked out the way it was intended and some share shift occurred as a result of that historically speaking and of course our view is distributors do play an important role in our business model but in the right types of accounts and the right types of business focus and we are going to needless to say much of a direct link with the end use customers.

And clearly three year plus or minus to have this impact full through into our businesses, is not going to take two months, three months to crack, but we are certainly putting an emphasis on it. It was indentified during due diligence and I am real proud the way the team is reorganized to pursue this really important market development stagey.

And then the second thing I would say too is, with respect to the chemical intermediates business itself, we are proud of the fact that our market position is truly global particularly in chemical intermediates and I think that’s unique in this industry and needless to say our Asia team is - I just returned from Asia myself and I can tell you our Asian team is a 100% focused on this endeavor.

And then the second part of what I said that we are working on is got to do more with the overall way in which we run our business. There is truly an optimization exercise. It must occur all the time when you're running these refineries because you end up producing four different products cuts and there needs to be some analytical discipline in how we do that, such that just because one part of our business is benefiting we want to make sure that we're not losing that incremental gain associated with other parts of the business that are underperforming.

So we view that much more in terms of an analytical model rigor and that we are applying that. And clearly this is 2016 priorities from the standpoint of how we see - we can control if you will the improvement of the business, not just rely solely on, what's happening in the marketplace.

Jason Freuchtel

Okay. As a follow up to continue to that last statement, is the chemical intermediates bucket of your chemical segment, is it appropriate to assume that sub-segment is entirely basic products or derivatize or upgrade that material before you sell the products.

Kevin Fogarty

We do both.

Jason Freuchtel

Okay, great. Thank you.


Thank you. The next question comes from Bill Hoffman of RBC Capital Markets. Your line is now open.

Bill Hoffman

Thanks for all the detail. Kevin I want to continue on the chemical intermediates slide, could you just help us - give us some kind of concept of volume metrically or EBITDA and you might get over the next - as soon as couple you time of time horizon.

Kevin Fogarty

Are you talking about the through the advent of these improvements I spoke of?

Bill Hoffman

Yes, just the shift back to direct sales and the rest.

Kevin Fogarty

I don't think I’m going to talk specifically about what we see is that opportunity from improvement but nevertheless given the fact that chemical intermediates represents of the combine company now somewhere around 25% plus or minus of our sales. And it’s the part of the business that we’d say is clearly that the one on which we see the most opportunity for improvement.

And I’m not calling out this specific improvements because and I didn't think it was going to be really and meaningful to the overall profitability of the company. And we certainly see it that way, that's why from day one we put in place new leadership, we put in place some definite scorecards and measures to ensure that we achieved this results and I can’t say enough about how I’m proud of the way the team is really behind these initiatives in a very short period of time.

Bill Hoffman

Thanks. And then just follow-on with that for the rest of the year on business. We’ve obviously seen a quick strong bounce back on oil prices , which is obviously moving up competitive pricing. Can you just talk through how you see your – because you talked always about sort of moving your price rate strategy into the Arizona side of business. Can you just talk through how you work through that with your customers and we can think about the potential impacts of that now that you’re seeing oil prices move back up, as it flows into the second quarter?

Kevin Fogarty

Well I think, what we’ve said in the past, and now over three months into it, we certainly stand behind that which is somewhere around two-thirds of the business you can relate to substitute pricing on three kind of broadly speaking product families.

One is C5, C9 tech fires, and to a lesser extent gum rosins in ATS space and then with respect to chemical intermediaries, yes we talk about it relative to the overall family of oil such as soybean oil or oiled acid and these are alternative price hitting mechanism.

In all three of those product families, you can kind of look at the business relative to energy indexing or energy components and therefore to your point as overall energy starts to move up, albeit what pace, I’m not smart enough to forecast for the balance of the year, but clearly to your point we’ve seen some indication of that here in the current period and when that does it has a direct impact obviously in those substitute products and through our price rate strategies as you described, we’ll move pricing along with it, consistent with that view.

And then the second part of price rate which is the part that again its very common in terms of Legacy Kraton, Legacy Arizona is making sure that we’re always seeking the highest value added part of the overall market mix and that’s the part of the business that I’m most encouraged of that the Arizona team now part of the Kraton team, has a direct focus on making sure that we’re always seeking out those higher value add sales. Not just because of the current margin perspective but also just the ability to sustain those margins overtime.

And that part of the business whether its pushing pricing to reflect higher raw material costs or higher substitute value added pricing in the marketplace, coupled with seeking those higher mix, I’m not concerned at all. I think historically speaking the Arizona colleagues have done a fantastic job and we’re just going to keep doing more of that.

Bill Hoffman

Do you expect to start to see real impact there on EBITDA generation starting in the second quarter is that taking longer than that?

Kevin Fogarty

Well I think that it depends to the magnitude of the crude oil increases but clearly I’d also say that, not only will allow us to move pricing up in that context but also some of these other products too as energy starts to move up should also create some demand in this particularly on the chemical intermediaries business.

And we want to make sure we’re well poised to serve that comment. I did comment earlier in my comments too, that clearly the oil field space has seen some pressure, it’s not a big part of our product mix, again less than 5% of sales, but for some of the people that also participate in the pine chemical industry, it has been historically a large part of their mix.

And to the extent obviously that activity starts to pick up a little bit. I suspect that there will be perhaps changing some of the way they directed some of their incremental sales here, back to those traditional market segments and again that should have a benefit with respect to our business as well because we won’t be seeing that kind of competitive pressures we’re seeing in certain pockets of our overall chemical intermediaries business in the short term.

Bill Hoffman

Great. And then just last question. On the historic Kraton business, given that you’re seeing this higher demand in paving and roofing segment staring in the first quarter. Can you just talk through about whether you have challenges from capacity standpoint this year before that Taiwan comes online serving all those markets and optimizing your mix?

Kevin Fogarty

Well just a reminder, and thank you for bringing up Taiwan by the way, but just the reminder, Taiwan is an hydrogenated styrenic block copolymer facility serving our specially polymers business and paving and roofing is an unhydrogenated products offering.

Bill Hoffman

Yes, but I'm just thinking in the paving and roofing site from a capacity standpoint.

Kevin Fogarty

I'm sorry, the question is do we have capacity available? At the end of the day, yes, we certainly are suited to serve the needs of the paving and roofing industry this summer, at least as we see it in terms of our forecast demand.

I would also point out that our plans particular plants in Europe are running really well. Our plant in Germany continues to demonstrate record productivity and record production each and every day, each and every month directly as result of the team's commitment obviously to those productively enhancements and that should manifest itself into additional capacity to serve this upcoming summer season.

Bill Hoffman

Great. Thank you very much.


Thank you. The next question comes from Mike Sison of KeyBanc. Your line is now open.

Mike Sison

Hi guys, nice start to the year. Kevin when you think about Arizona you owned it now for just three months, anything in particularly positive that you've seen either with the product lines from customers or just in general with the people.

Kevin Fogarty

Yes, that's a great question and is one very easy and near and dear to my heart up. I have spent time visiting with particularly some of our major customers and it's absolutely true in terms of what we kind of knew all along with respect to the market leadership and the relationships that our pine chemical based business has with some very strategic important customers.

And of course in a lot of those cases there are common customers that we had in legacy Kraton but nevertheless it just goes without saying that that's the kind of foundation and a direct result of the team and their commitment to those customer relationships that has put us in the position we are today that allow us to think about growing in the future.

And then the second thing that gives me great optimism too is the way in which the combined company is engaged with one another in a way in which we have not characterized anything in terms of cross sales opportunities between the two businesses, but I will tell you it's just really exciting to sit in these meetings when we are talking about how do we leverage one side of our company's technology now with the other side in a way in which it is going to be more meaningful and beneficial for the customers.

A good example of that if I may, would be in the paving and roofing business, Arizona developed a recycle asphalt technology that we think is very good. Our paving and roofing technology teams have looked at it and they're quite excited. And needless to say Kraton has great channels into the overall paving business.

Probably I think it would be true to say our channels are in the legacy polymer business are much stronger than Arizona was in the traditional bitumen modification part of the business and needless to say we are going to leverage that to drive sales more faster that either company would have done on a standalone basis.

Mike Sison

Okay, great. Can you maybe give us a little help in terms of seasonality for Arizona, you had a really nice first quarter, does it tend to get stronger into the second and third and fade into the fourth, is that kind of how the business trends?

Steve Tremblay

Hi Mike, let me try to answer that for you. The business is less seasonal than you are used to in our polymer business but the third quarter in this business has traditionally been the strongest quarter but quarter's one, two and four generally within 100 basis points or so they are pretty consistent, much more consistent than the old polymer business.

Mike Sison

Great. And then last one, in terms of the revenue assumption for the year $1.8 billion, it sounds like there could be good momentum in volume growth on both sides of the business but just curious what's the assumption Kevin when you think about that $1.8 billion. Are you expecting good growth, strong growth or a very modest growth for both businesses?

Kevin Fogarty

Well if you don't mind me saying, it's sometimes harder for us to forecast revenue than it is to forecast EBITDA because of the very nature of the underlying cost inputs that go into obviously the makeup of revenue and of course I am talking about the cost of hydrocarbon based raw material in our polymer business and pine based raw material which are energy derived in the chemical side of the business.

So we do our best to make that forecast but clearly the assumption is that through the volume growth initiatives that we are working diligently on particularly in places like chemical intermediates and of course everything you know about our innovation based portfolio in our polymer segment, couple that with assumptions fundamentally on how we see energy evolving over the course of the year, that leads to the revenue assumption and I dare say I am looking over to Steve right now but I dare say going from the previous guidance on revenue, this guidance probably reflects more than anything just a change in outlook with respect to the underlying energy components that build into that revenue.

Steve Tremblay

Yes Kevin it's absolutely correct, we took the revenue down from $1.9 billion to $1.8 billion but haven't moved off our 370 and 390 of guidance, so that was just really trying to get a better point of view in terms of where we see energy.

Like Kevin said, it's a tough number for us to get fundamental call for the environment hasn't significantly changed, it was more driven by expectations on input cost.

Mike Sison

Great, thank you.


Thank you. The next question comes from Chris Kapsch of BB&T Capital Markets. Your line is now open.

Christopher Kapsch

Good morning guys. Just following up on that last point on the chemical side of the business and your ability to preserve or forecast EBITDA more effectively than revenues. So it sounds like a part of that and you mentioned that this is a function of the index feedstock situation that you have with your supplier there.

Just wondering if you could provide any context on the nature of that agreement, I would believe it is a long term in nature but just in terms of the feedstock cost what are those index too and is there a lag, looks like it is as you pointed out in your formal comments help preserve margins in that business?

Kevin Fogarty

Well this is one Chris, I appreciate the question. All we have said and it is all we are going to say about that is to your point it is certainly a long-term, it does constitute a major part of our overall feedstock relationship in the chemical segment.

It is needless to say primarily if not entirely based on energy components albeit energy components are not always the same meaning that you know as we have to comment and we're acquiring feedstock from a pulper who has to backfill on that feedstock with energy to power their boiler system and make steam each one is a little bit different. It could be a function of are they using fuel or are they using natural gas and in some cases are they still using coal.

So there are the energy components there it is clear but you know what those references are what those indexes are, that is obviously pretty confidential.

Christopher Kapsch

Okay. But in terms of potential leader lag or basically the buffer to your margins, is it sort of real time or is there a month or two or quarter lag?

Kevin Fogarty

There is a little bit of a lag from the standpoint of when we see those either pass-through on the way up or as has been in the recent more period past, the decreases have kind of pass-through to us as a result of energy coming down.

But we want to try to run our businesses as real time as we can. And when we have discussions with our sales people we want to make sure that the customers appreciate so that it is a consistent message that at the end of the day we want to make sure the customers appreciate that, you know we are pricing our products as real time as we can and you know part of that price right strategy that we talked about earlier is being not just disciplined in terms of raising prices when we are seeing those cost increases occur but also doing so in a very consistent way such that our customers can predict our behavior

Christopher Kapsch

Okay. If I could further parse your comments on the intermediates business and not withstanding it sounds like some pickup in March you commented that TOFA sales are weak partly because of I guess alternative feedstock base materials and then partly because of overhang of supply to stay with the downturn in oilfield chemicals from other pine suppliers.

Just wondering like which has been more impactful to TOFA volumes, the former, the alternative, substitutes or the competition from excess TOFA supply?

Kevin Fogarty

I think that you know generally speaking we would say it is more in terms of absolute demand and meaning that combination of what you just commented on which is availability of supply coming in from other producers who otherwise might not be serving some of these basis and of course fundamentally we talked about vis-à-vis distributor network.

Christopher Kapsch

I see. And then I think you said that it's a little bit of excess TOFA and TOR supply on your hands currently given the slightly weaker backdrop for the intermediates end market that you are looking at opportunities to create new applications or demand for those products.

Just curious would those be, are you talking about further derivatizing a greater percentage of your TOFA and TOR products or finding just new home for these intermediates? Obviously you have talked about regaining the business that was lost in that strategic decision directive distribution but it sounds like you are alluding to opportunities above and beyond that?

Kevin Fogarty

I think the answer is both. I will tell you that you know one of our observations during the due-diligence and we can certainly confirm that now is that while chemical intermediates represented more than half of the sales of legacy Arizona chemical we don't think that that was matched up and neared up with types of resources both technical and market that we need to run this business and the teams that were in place certainly recognize that.

So in some basis we are in a little bit of rebelling stage, I think that in the short term obviously we are going to be looking at it more in terms of TOFA and TOR sales directly but longer term I can see us focusing a lot on developing derivatives.

So a couple of markets for example that certainly we would characterize as potential attraction for growth. Think about [Allocades] [ph] for example. I don’t think we have fully embedded at all the possibilities on where the chemical intermediaries business could be a long term position in that space.

Christopher Kapsch

Okay. And then just a quick one for Steve just on the waterfall on Page 11, which is the debt reduction sort of bridge. Just want to understand something there. So the adjusted cumulative EBITDA that you are pointing to there, that includes the synergies and cost reductions. But it looks as though you are assuming just flat EBITDA for the core business over those three years.

So I'm just wondering if that's the case and then if that is the case, then the goal of 2.5 times via 500 million in debt reduction by 2018 would be constituted as conservative I would think. You're going to grow your business organically at all over the next three years, is that right?

Steve Tremblay

Chris, it’s absolutely correct and the title in slide is an illustration, we have no plans to keep our EBITDA at the mid-point of the 2016 range but we've had a number of inquiries about the ability of the business to take us from where we are today with anomaly five turns of leverage down to 2.5.

And without giving future earnings guidance, which we don’t plan to do, this is effectively our very conservative case. You're absolutely correct. Just to confirm, it does assume the mid-point of the EBITDA range, and then it assumes the growth in the synergies and the cost reset initiatives which are on a couple of slides prior.

Christopher Kapsch

Okay. Thank you.


Thank you. The next question comes from Edlain Rodriguez of UBS. Your line is now open.

Edlain Rodriguez

Thank you. Good morning guys. Kevin, quick question for you. As you go about to try to recapture some of the Arizona's distribution business and try to fix that, how long do you think this will take? I mean is this something that’s going to take a year, two year or less or more than that?

Kevin Fogarty

Well, that's never easy to say because ultimately we can’t be inconsistent with our price right strategy and making sure we are pricing discipline wise in the marketplace. But I think at the end of the day, it certainly - it took 3 years, if I could call if that for it to occur. It’s not going to take 3 years to fix it. But it is not going to take 1 or 2 quarter either.

But I think the momentum right now to start and see some results beginning as early as this second quarter is clearly there.

Edlain Rodriguez

Okay, perfect. Thank you.


Thank you. The next question comes from Josh Spector of UBS. Your line is now open.

Josh Spector

Hi guys. Thanks for taking my question. Just a real quick one here. In terms of consumer demand and personal care, I think we’ve got some mis-signals from different companies that have reported so far.

I’m wondering what you’ve seen in the quarter and kind of what you’re seeing maybe now where things are maybe better or worse. If you are seeing some customers trade down in products or whether there is any destocking. Any insight would help.

Kevin Fogarty

I don't know that I’d characterize it in terms of seeing market downturn in that space for us, it’s been a very positive. In fact, it’s one of the reason why we’ve seen some growth in our overall differentiated, I’m now talking now about the Polymer segment as we have USBC offerings both SPS and SAS available to either directly to the personal care adhesives or Tier 1 suppliers into the industry.

Again, it’s an innovative business, always has been. We think it will always continue to be. Needless to say we were disappointed a couple of years ago to see part of our HSBC business go away but we also saw in turn some decisions on the part of some of those customers to adopt USBC technologies at the time.

Josh Spector

So in your slides, where you say lower sales and the personal care applications in the quarter, what is that calling out in the specialty side?

Kevin Fogarty

I think we noted that there is some decline is personal care and with HSBC business, it’s been a trade-off over the last couple of years between HSBC and USBC. The USBC benefits in our performance product business and our HSBC business in our specialty polymer business is probably where we’ve seen some impact.

But the overall trend, I guess what your question was asking about, no, we are not seeing anything negative.

Josh Spector

Okay. Thanks guys.


Thank you. The next question comes from John Roberts of UBS. Your line is now open.

John Roberts

Thanks guys. I guess that completes the tri-factor here. How much of your total oil fatty acid, total oil maybe combined isn't upgraded? I’m curious because once you get your debt down, could you invest in further integration there in more derivatives capacity?

Kevin Fogarty

Well, we are not going to talk about what percent is or isn’t. I mean, that's obviously pretty sensitive information. I’ll tell you that we’ve got a long list of opportunities how we think we want to be positioned down the road and we are not talking about major, major capital investment here.

We are talking about more commitment to the types of technical resources we need to employ to develop these ideas with our customers. And then at the end of the day, leveraging quite frankly in some cases, some available capacity we have today in the system already.

John Roberts

Thank you.


Thank you. We have another question from Jason Freuchtel of SunTrust. Your line is now open, sir.

Jason Freuchtel

Hi guys. Just have a couple of follow-ups. I think you indicated as part of your manufacturing optimization efforts, you'll be expanding high margin Cariflex capacity in Polenia. Roughly how large of the capacity increase will occur as a result of those optimization efforts?

Kevin Fogarty

Well, I think that's a good point. To be clear, as we’ve talked about, we are going to install a new technology down in Polenia which is going to allow us to directly couple manufacturing both the poly-isoprene rubber with latex manufacturers so direct couple there in Polenia on site.

So one of the attractions of this is not only it is that obviously it make the overall supply chain much more simple in terms of - today we moved a rubber as you know a long way before we turned it into latex. But the other part of the attraction is that it allowed us to invest in incremental latex capacity, a whole lot more capital effectively.

And ultimately, these incremental capacity that we would introduce as we time them well with the market gross are probably somewhere around 2.5 kilotons per unit, plus or minus, but that being said, I don't know how quickly or how intense we will have to introduce that capacity because it’s somewhat growth dependent and the first increment is what we called out here in the second half of '17.

But needless to say, we support this business. We will continue to support the good growth we’ve seen from our customers and if we need to do it even more rapidly than we have in the past, just because as the growth incurs, the increments of capacity becomes more relevant each and every time we introduce that capacity, we will be there to do so.

Jason Freuchtel

Okay. And I guess as we think about future capacity expansions for Cariflex, is it possible that you continue to expand capacity through JV or is it primarily going to be through these efforts in Polenia?

Kevin Fogarty

I think right now as we look forward, we will be focused on Polenia and leveraging this new technology development - this direct couple technology development that I just spoke of. I think when you were taking about the JV, you are talking about the fact that we manufacture with a third party relationship in Japan, and that’s the relationship that’s very important to us as well.

And we've grown with them over the years at quite a healthy rate. And certainly, we wouldn't be where we are today in terms of that business if it wasn’t for that very prosperous relationship.

Jason Freuchtel

Great. And then lastly, can you remind us what your targeted total SKUs you expect to eliminate as part of your complexity reduction program is? Can you quantify the impact of the 50 SKUs that have been eliminated today?

Steve Tremblay

The 50 SKUs in terms of overall inventory reduction, Jason and in terms of EBITDA, we are not significant. It's less than a $1 million or so across the laundry list of opportunities that we’ve looked at.

The SKU list, we are actually still developing that SKU list of total reduction. And candidly, it moves as we - what we do is we have a universe of opportunities that the team goes out and tries to identify ways to reduce and some wins and some don’t.

So to give you an absolute number of what the total SKUs will be in between now and 2018, that's really somewhat of a moving target. As you can imagine, and something like that activity, the list of opportunities which certainly equate to a number that could suggest a higher than $50 million if it’s a 100% success.

Again, for the reasons I indicated you dive into some of these opportunities. And for various reasons, you determine that the opportunity may not be as fruitful as one thought. So I really can't give total SKU reduction, it is meaningful and needs to be meaningful in order to drive that working capital reduction which we’re still committed too.

As far as the total component of the complexity reduction in terms of the $70 million of EBITDA improvement it's not insignificant but it's certainly not one of the individual biggest pieces.

Jason Freuchtel

Okay, great. Thanks guy.


Thank you. Now I would like to hand the call back to Mr. Gene Shiels for closing comments.

Gene Shiels

Thank you, Prima. I want to thank all of our participants this morning for their interest in Kraton and their insightful questions. A replay of this call will be available later this morning. You can access the replay through Kraton's website at, by selecting the Investor Relations link on the Home Page and then selecting Events from the menu on the Investor Relations Page. You can also access a telephonic replay and the number for that is 888-293-8914.

That completes our formal comments this morning. Thank you.


This concludes the Kraton Performance Polymers Incorporated first quarter 2016 earnings conference call. You may now disconnect.

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