Kraton Corporation
Q4 2017 Earnings Call Transcript

Published: 21 Feb 2018

[Operator:]

Good morning and welcome to the Kraton Corporation Fourth Quarter 2017 Earnings Conference Call. My name is Karla, and I will be your conference facilitator. At this time, all participants are in 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. You may begin.

[Gene Shiels:]

Thank you, Karla. Good morning and welcome to the Kraton Corporation fourth quarter 2017 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 covering our fourth quarter and full year results as well as a related presentation material we will review this morning are available in the Investor Relations section of our website. Before we review the fourth quarter and full year 2017 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. 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. Regarding the use of non-GAAP financial measures a reconciliation of each used non-GAAP financial measure to its most comparable GAAP financial measure was provided in yesterday’s earning release and as well as in the presentation material for this morning. Lastly, I’ll remind our listeners that all references to full year 2016 financial results for the chemical segment are from January 6, 2016 the date of acquisition through December 31, 2016 excluding the stub period, January 1st to January 5th. For the January 1st to January 5th stub period sales volumes for the chemical segment was approximately 3.3 kilotons and revenue was approximately $6.9 million. Following the prepared remarks, we’ll open the line for your questions. I’ll now turn the call over to Kevin Fogarty.

[Kevin Fogarty:]

Thank you Gene and good morning everyone. As outlined in yesterday’s earnings release Kraton reported adjusted EBITDA of $85.5 million for the fourth quarter of 2017. And this was up $8 million or nearly a 11% comparison to the fourth quarter of 2016. But this fourth quarter result we delivered full year 2017 adjusted EBITDA of $374 million in line with the full year expectation we shared back in October and up $20 million or nearly 6% compared to the $354 million we reported in 2016. Our Polymer segment posted strong results in 2017 on improved unit margins and growth in sales volume. Fourth quarter adjusted EBITDA for the segment of $50.8 million was up nearly 21% compared to the year-ago quarter, and for the full year, Polymer adjusted EBITDA was $223 million, representing an increase of nearly 22% compared to 2016. The full year 2017 adjusted EBITDA margin for this segment was 18.6%, up 70 basis points compared to 2016, reflecting the continued shift towards a higher value Specialty Polymer portfolio offering. I’ll also point out the Polymer segment posted these strong results despite a $7.6 million fourth quarter negative impact associated with processing issues some of our customers experienced with the direct-connect Cariflex material produced in Paulinia, Brazil. Although the material produced in both Brazil net defined specifications, we revised the processing issues by certain of our customers in the fourth quarter. In response, we have made a number of manufacturing stabilization changes that we believe will address these issues, and we’re, of course, fully committed to continue to work with our customers to resolve the processing issues. Turning to our Chemical segment. Fourth quarter adjusted EBITDA was $34.7 million in line with the year ago quarter. Adjusted EBITDA for the full year was $151 million, with an associated margins of 20%. While full year results for this segment were down in comparison to 2016, this was largely due to weakness in the first half of 2017. In fact, we are encouraged by the trends in the Chemical segment following the first quarter of 2017, which we believe with the trough forsegment margins. We saw notable improvement in pricing and margins in our TOFA portfolio in the second half of 2017 and stabilization of the pressures exerted by low-cost C5 alternatives on our adhesives portfolio. As such, second half 2017 adjusted EBITDA for the Chemical segment was up nearly 10% compared to the first half of the year, and we continue to have good business momentum as we enter 2018. Kraton delivered adjusted earnings of $2.85 per diluted share in 2017 and this was up 21% compared to the $2.36 we posted for full year 2016. This marks the third consecutive year of double-digit growth in adjusted earnings per share. During the year, we delivered and we achieved a number of significant milestones. As it relates to our synergy capture and operational cost improvement initiatives, as of September 30, we had delivered the full $65 million of transaction synergies and operational cost improvements associated with the acquisition of our Chemical segment, one year ahead of our original plan. With regard to the $70 million of cost improvements in our Polymer segment, we delivered an incremental $13 million of cost reductions in 2017, ending the year with capture of approximately $45 million of our $70 million goal. During the year, we also continued to deliver on our commitment to delever our balance sheet. In 2017, we reduced Kraton net debt by $163 million, exceeding the high-end of our expected range of $125 million to $150 million by $13 million. We have made great strides strengthening our balance sheet, and from the date of the Arizona Chemical acquisition through year-end 2017, we have reduced Kraton net debt by $281 million. I’m pleased to say we remain on track to achieve our target leverage of approximately three turns in 2019. This time, I’m going to turn the call over to Steve Tremblay, our Chief Financial Officer, for a more in-depth financial review of the quarter and full year 2017 results. Steve?

[Steve Trembley:]

Thank you, Kevin. Let’s turn to Slide 5, and I’ll begin with the overview of the consolidated results for the fourth quarter. Fourth quarter 2017 revenue was $467 million compared to $415 million in the fourth quarter of 2016. The 12% increase in revenue was largely the result of improved selling prices. Foreign currency was a positive influence on revenue of approximately $12 million in the quarter. But in terms of adjusted EBITDA, currency did not have a material period-over-period affect in both the fourth quarter nor on a full year basis. Adjusted EBIDTA expended by 10.7% to $85.5 million in the fourth quarter of 2017. Adjusted EBITDA margin was a healthy 18.3% in the fourth quarter 2017. GAAP EPS of $2.17 per share includes $1.60 per share benefit from the recently enacted tax reform legislation. Excluding this and other items as reflected in the Appendix of this material and the press release, non-GAAP EPS of $0.67 per share represents growth of 131% compared to $0.29 per share generated in Q4 2016. As a note, the processing issues in Brazil, which Kevin alluded to, negatively impacted EPS by $0.24 per share on a GAAP and non-GAAP basis in the quarter. Let’s move to the Polymer segment results for the fourth quarter on Slide 6 of the material. Revenue for the Polymer segment was $280 million for the three months ended December 31, 2017 compared to $239 million for the three months ended December 31, 2016. The 17% increase in revenue was largely due to increased selling prices, and to a lesser extent, of 3% increase in overall sales volumes. For the three months ended December 31, 2017 the Polymer segment generated nearly $51 million of adjusted EBITDA compared to $42.1 million for the three months ended December 31,2016, an increase of $8.7 million or 20.7%. The increase in adjusted EBITDA was due to increases in selling prices and the increase in sales volume. As a result, adjusted EBITDA margin improved 60 basis points to 18.2% in the fourth quarter of 2017 compared to 17.6% in the comparable quarter of 2016. The fourth quarter Polymer segment performance was generated despite the impact of customer experience processing issues with our Cariflex product line, which Kevin again, addressed earlier. Historically speaking, this was strong Q4 for the Polymer segment and culminates a year where adjusted EBITDA improved to $223 million. This marks the fourth year of consecutive adjusted EBITDA growth compared to $141 million in 2013. This impressive growth is owing to our price-right strategy, which includes reaching the portfolio and our focus on cost management. Over the same period, margin has improved 770 basis points to 18.6% for the full year of 2017. Moving to the Chemical segment. Revenue for the Chemical segment was $187 million for the fourth quarter of 2017 compared to $177 million in the fourth quarter of 2016. The 6% increase in revenue reflects the benefit of increased selling prices, partially offset by lower sales volume. For the three months ended December 31, 2017, the Chemical segment generated adjusted EBITDA of $34.7 million, in-line with the fourth quarter of 2016. During the quarter, we saw results for the TOFA chain improve compared to 2016. This improvement, however, was mitigated by higher costs, including some maintenance costs, which we do not believe are necessarily systemic moving forward. What’s really encouraging in the Chemical segment adjusted EBITDA is the progression we experienced throughout 2017. Illustrated on this slide, adjusted EBITDA was $79 million in the second half of 2017, which was up compared to both the second half of 2016 and the first half of 2017. This change in trajectory indicates the margin pressures in adhesives and for TOFA products, which have intensified in the second half of 2016 and continued into the first quarter of 2017, which began to improve as we moved through the second half of 2017. Higher realized pricing, particularly for TOFA products, led to an increase of average unit margins in the second half of 2017. As a result of these positive business drivers, adjusted EBITDA for the second half 2017 was up 9.5% compared to the first half of 2016 and we currently continue to see good Chemical segment business momentum, as we enter 2018. Let’s move on to the full year overall results. On a consolidated basis, 2017 revenue was $1.96 billion or an increase of $216 million compared to 2016. Revenue for the Polymer segment was approximately $1.2 billion for the year ended 2017 compared to $1 billion for the year ended December 31, 2016. The 17% increase in Polymer segment revenue was largely due to higher selling prices, which was critical in preserving unit margins in a rising raw material environment. In addition, composite volumes in the segment improved by 3%. Moving now to the Chemical segment. Revenue was $761 million in 2017 compared to $719 million for the full year 2016. The 6% increase in revenue was driven by improved sales volumes and improved selling prices. Consolidated adjusted EBITDA improved $20 million or 5.7% to $374 million in 2017 with a margin of 19.1%. This growth in consolidated adjusted EBITDA was the result of a $40 million or 22% improvement in Polymer segment adjusted EBITDA, resulting from higher selling prices and volume. The Chemical segment posted adjusted EBITDA was $151 million. Despite the favorable second half of the year trends, the year-over-year comparable was negatively impacted by the margin pressures which began in the second half of 2016. To that end, and as I mentioned earlier, more than a 100% of the decline in full year adjusted EBITDA in our Chemical segment was incurred in the first half of the year. Adjusted EPS of $2.85 per share was up $0.49 or nearly 21% compared to 2016. Our adjusted and GAAP EPS excludes the $0.24 per share charge associated with the Cariflex issues in Brazil. Before we move onto cash flow, I want to update you on the cost reduction initiatives. As we noted at the end of Q3, we have fully realized the $65 million of cost synergies associated with the Arizona acquisition, effectively one year ahead of schedule. With respect to the Polymer segment, we generated approximately $13 million of incremental savings in 2017, bringing the project-to-date benefit to approximately $45 million. Looking forward, we currently anticipate garnering a substantial portion of the balance of the savings toward our $70 million goal by 2018, subject to the direct connect start up. On Slide 9, I’m pleased to report another solid year of cash flow generation and debt reductions. Kraton net debt was reduced by $163 million in 2017, eclipsing the $150 million high end of our guidance and bringing total net debt reductions since we closed the transaction to $281 million. Including the JV debt, leverage improved to 4.3 turns at the end of 2017, which is improvement of 0.5 turn since 2016 and more than a full turn since we closed the deal. We continue to have confidence in the cash flow profile of Kraton and are committed to further debt reductions, while prudently investing for future growth. Turning now to Slide 10. We have the components of our debt capital structure, which are really unchanged from September 30. Since we closed the transaction, however, we have right sized the senior tranches of debt and lowered the cost of our senior debt by 220 basis points. We believe we have another opportunity to lower the cost of capital in 2018 by addressing the existing 10.5% senior notes. Now before I turn the call back to Kevin, I want to spend some time speaking to our current outlook for 2018. We currently anticipate 2018 adjusted EBITDA will be approximately $400 million. This estimate assumes that stabilization actions that we have implemented to address the Cariflex direct connect processing issues will continue on the current trend, and therefore, no material additional charges will be incurred. This estimate also assumes the continuation of the Polymer cost reset initiatives, which as I mentioned earlier, would drive approximately $20 million of incremental benefit in 2018. These cost reductions have the effect of offsetting inflation and a modest $3 million increase in companywide turnaround costs. One item impacting comparability between 2018 and 2018 is the accounting for the startup costs associated with the Taiwan facility. In years prior to 2018, certain costs were properly classified as startup in nature, and were, therefore, excluded from adjusted EBITDA. In 2017, and as reflected in the full year reconciliation of net income to adjusted EBITDA, including in the release and in this earnings presentation, startup costs were approximately $15 million were excluded from adjusted EBITDA, again in 2017. Beginning in 2018, we are no longer in the startup phase, and therefore, all costs incurred by the JV will be included in adjusted EBITDA, including any unabsorbed costs, as we continue to ramp up to full capacity. From a net debt perspective, our 2018 cash flow expectation cost for the continuation of the deleveraging we demonstrated in 2016 and 2017. We currently anticipate reducing net debt, excluding the JV or the KFPC net debt by approximately $125 million. This estimate is less than the 2017 improvement in net debt owing to the timing of certain items, including interest payments, certain financing activities and an increase in inventory commensurate with the startup of the HSBC plant in Taiwan. And based on this guidance, we expect leverage will close 2018 below four turns. I’ll close with a reminder that 2018 guidance was specific line items such as noncash compensation, interest expense, our overall tax rate and the like are included in the Appendix to this earnings material. I’ll now turn the call back over to Kevin Kevin Fogarty for his remarks. Kevin?

[Kevin Fogarty:]

Okay, great. And thank you, Steve. For Kraton, 2017 was a year of good execution of progress on multiple fronts. The year presented us with the opportunity to further leverage our Polymer portfolio strengths as we did so by delivering both growth and margin expansion, despite the substantial raw material headwinds we faced in the first quarter of 2017. For our Chemical segment, following the margin pressures that had intensified in the second half of 2016, we began 2017, with what we now believe to be trough margins for the segment. As the year progressed, we saw margin stabilization in our adhesive business, which has been impacted by the availability of lowcost C5 hydrocarbon alternatives, and we saw notable improvement in market dynamics for our TOFA portfolio. TOFA pricing and margins begin to recover in the second quarter of 2017 and into the back of the year. As such, Chemical segment results reflect the improvement we had anticipated, where second half 2017 adjusted EBITDA up 9.5% compared to the first half of the year. The favorable business performance we delivered in 2017 translated into solid cash generation, allowing us to exceed our debt reduction targets for the year. We also took steps to further optimize our capital structure through the addition of a euro tranche to our term loan and repricing of the U.S. tranche. Our sites are now firmly on addressing our 10.5% senior notes. On the operational front, with numerous projects underway in 2017 related to our various cost-reduction initiatives, our teams did a tremendous job, delivering the $65 million of operational costs outs [ph] in G&A reductions associated with the acquisition of our Chemical segment, one year ahead of schedule. We also made great strides in qualifying product grades in Mailiao, which is instrumental in the volume ramp we expect this year. And the USBC expansion in Berre has gone very well, with anticipated completion by the end of March. And now we’re focused on building upon the successes we had in 2017. Thus far in 2018, we have seen a continuation of the business fundamentals and positive outlook demand trends we experienced in 2017. With these market conditions, we have announced price increases for TOFA, Tor and related derivatives in our Chemical segment as well as for our HSBC products grades in our Polymer segment. We are optimistic that we will see another season of strong paving demand and continued growth in our HSBC portfolio that could translate into another strong performance for the Polymer segment this year. As for Cariflex, we maintain our view that it is a long-term growth business with extremely attractive margins. Based on our progress to date, we believe we are on track to resolve the processing issues certain of our customers experienced in the fourth quarter. And lastly, for our Chemical segment, we expect volume growth and continued margin recovery in 2018. Longer term, we continue to believe that our Chemical segment will return to its historical levels of pricing and margins, at which point, the accretive nature of our cost reduction efforts can be fully appreciated. And with those comments, we like now to open the call up for some of your questions.

[Operator:]

Thank you. [Operator Instructions] Our first question came from the line of Mr. Jason Freuchtel of SunTrust. Your line is now open.

[Jason Freuchtel:]

Hi, good morning.

[Kevin Fogarty:]

Hi, Jason.

[Steve Trembley:]

Hi, Jason.

[Jason Freuchtel:]

In terms of your $400 million in EBITDA guidance, what would you characterize are the largest year-over-year headwinds you’re expecting? Would it be the new accounting treatment for the Taiwan startup costs? And with that, can you comment on whether you’re able to offset inflation costs over the past several years?

[Steve Trembley:]

Hi, Jason. We would say that we have definitely been able to offset inflation. When you take into account $45 million of cost reductions effectively beginning in 2015 and forward, those have been instrumental and at least offsetting inflation. Globally, our biggest inflationary pressure year-over-year is relative to what I’m sure a lot of other companies face, which is rising health and benefit costs and salary increases, some of which as we said repeatedly year-over-year, have been geographically or legislatively mandated, depending on the geographies in which we operate. So we’ve effectively offset that. I mentioned a little bit of headwind. It’s a small headwind of $3 million of turnaround cost that’s in our Chemical segment. We expect that to normalize down to flat as we move into 2019 and 2020. So yes, I think we have offset those headwinds. On the accounting change, certainly, that’s a one-off item. We shouldn’t be talking about that as we talk about 2019 against 2018 about a year from now. But it is a real impact to the comparability between 2017 and 2018.

[Jason Freuchtel:]

Okay. Thank you. And how long do you anticipate would take the ramp to normalize past utilization levels that your Mailiao Taiwan facility.

[Steve Trembley:]

We continue to support the thesis that it’s about a full year ramp up. We would say that we had nice success last year, although small volumes into the marketplace. And as we mentioned in the press release, we believe we will be meaningful production this year. But still, it’s going to take us 2018 and then maybe three years beyond that to fully get to the 30 kT of design capacity. But 2018 is a nice transition year for us. We are expecting good volume, and we’re expecting to continue with the customer qualification in earnest.

[Jason Freuchtel:]

Okay. And in terms of your free cash flow guidance, what are the certain items you’ve referenced in the release. And how should we think about the magnitude of potential working capital here from ramping up your production at the Mailiao Taiwan facility?

[Steve Trembley:]

The single largest item individual item impacting comparability between the two years, Jason, again, $163 million to $125 million is the ramp up of the transition inventory in Mailiao. I’m hesitant to give that number out, because it does relate to our – of course, our production costs of that facility, which we want to keep internal. The other items are traditional items where the tax refund of the year of 2017. And as we refinance the term loan, as we refinanced our terms loans last year and replaced it with the 7% notes, we actually shifted one interest payment into 2018. That’s about $14 million. But again, the single largest item is the inventory, second largest item would be that inventory shift. That would be that interest shift. Other than that, the structural components of our cash flow remain intact.

[Jason Freuchtel:]

Okay. And I believe this was the third straight quarter you’ve exceeded $1000 in gross profit per ton in the Polymer segment, is it safe to assume now that Kraton should be able to achieve $1000 in gross profit per ton in the Polymer segment now on a sustainable basis?

[Steve Trembley:]

I was waiting for that question, Jason. We had a target in 2018 in the middle of 2015, our last Investor Day, we targeted $1000 a ton of gross profit per ton in 2018. We’re actually happy that we got there in 2017. It is in fact the third quarter. Our view is it’s sustainable. We’ll be clearly in reach, and we have a lot of confidence that with the way we see the business progressing this year, that we that we don’t expect to go backwards in 2018.

[Kevin Fogarty:]

And Steve, if I may, the only thing that I would add to that is in addition to the continued progress we make on pricing and margins and shifting to higher value portfolio, we also have to remember too we’ve got some cost initiatives that will be signed in the Polymer business this year that will help that gross profit metric.

[Jason Freuchtel:]

Okay. Great. Thank you.

[Operator:]

Thank you. Another question came from the line of Chris Kapsch of Loop Capital Markets. Your line is now open.

[Chris Kapsch:]

Yes, good morning. I had a question about the Cariflex issue. Just want to make sure I understand. You – in your formal comments you mentioned that the product that technical specs, but some customers are having the processing issues. So just wondering to appease them, did you have to provide them some of the legacy product or were you able to identify what other characteristics of the new product might be causing the process issues despite being in spec? And when do you think you’ll have confidence that in fact, this new production process will in fact, be copacetic with these key customers? Thanks.

[Kevin Fogarty:]

Chris, it’s Kevin. First of all, couple of questions here. The first one is, as you recall, our supply chain is set up such that we produce material with the new technology in Brazil as well as we produce material through our supplier relationship in Japan with a third party that we’ve been in business with for quite some time. And I guess, to use your words, that third party does use and continues to use the existing technology or their conventional technology. So we have that kind of supply chain flexibility, obviously, during this period to ensure that from a customer perspective, they continue to see volume they need. That all being said, with respect to the actual issues down in Brazil, we – of course, we recognize that this was a startup of a new technology and we’re not entirely surprised that there are some issues associated with that type of new material that the customers experienced, clearly disappointed. But the good news is, once again, Kraton has expertise in this field that we believe the second to none and it was all hands on deck to make sure that we address some of the issues as we saw it in our production facility through our stabilization efforts, and our customers continue to work very diligently with this because they want to see this new technology just be successful as we do because they know that is going to be supply source of the future for their growth. And we’re pleased with the direction that we’ve taken, and we’re pleased with the progress we’ve made so far. I think we’ll be in a pretty good position by the time we get to the next earnings call, shall we say, what’s that, Stephen, about six weeks? And we continue to make progress every day that will be able to give you a more fulsome update.

[Chris Kapsch:]

Okay. That’s helpful. And then I also just wanted to take another stab at sort of reconciling the narrative of how the businesses are doing versus the EBITDA guide of $400 million at this juncture. Obviously, there’s some apples and oranges, some positives, some drags, but based on the fact that in the Polymers business, you just mentioned that you’re kind of ahead of plan in terms of achieving this gross profit margin per ton target. In the Pine Chemicals segment, you have sort of easy for staff comps when the pressure sort of troughed. So given a little bit of organic growth given a little bit of cost takeout and not withstanding, it sounds like there’s incremental headwind associated with Taiwan. Is it fair to say that you might be disappointed if you don’t surpass $400 million in EBITDA for 2018?

[Steve Trembley:]

Well, look, we give guidance here, it’s the middle of February looking at the full year, and we try to take into account what we truly believe are the positive momentum builders that we have and characterize during this earnings call against what could be some of the offsets that we may face over the course of the year. So we try to give that balanced view in this guidance. But needless to say, you’ve got a management team who are all collectively focused on, as always, meeting and exceeding every target we ever give, and I’ll leave it at that. I will point out though that with respect to our two business segments, clearly, we’ve got very positive momentum in our polymer business, just like as you categorized it. But I would also say in our Chemical segment, I’ve only been associated with this industry, this business, for the last two years, and I daresay that as we think about today, relative to this same call we made a year ago and maybe the same call we made two years ago, I think we feel much better about where we are today than we were then.

[Chris Kapsch:]

Right, okay. And just one number, I want to make sure I understood this correct. The start up costs that in prior accounting were roughly $15 million but did not run through the P&L, is that the right number in terms of a headwind in that business for 2018?

[Steve Trembley:]

The right way to think about it, Chris, is the headwinds associated with production capability yields unabsorbed fixed. So we won’t know the exact number that we would have added back if we applied that convention till we get effectively done with 2018. So I would think about in terms of the $15 million was the high point of the start up costs, which was 2017. In 2016, that same number was around $6 million. So it’s a number that would flow likely within that range depending of course on how the production startup goes

[Chris Kapsch:]

That’s helpful. Thank you guys.

[Steve Trembley:]

Thanks Chris.

[Operator:]

Our next question came from the line of James Finnerty of Citi. Your line is now open.

[James Finnerty:]

Hey, good morning.

[Steve Trembley:]

Good morning.

[James Finnerty:]

Just on the modeling, your guidance has $400 million of EBITDA. How should we think about that relative to seasonality relative to 2017, the majority of EBITDA was in the second half, should we just think it in similar fashion?

[Steve Trembley:]

Well, I think, it’s true to say that for our business, second and third quarter, because of the effect of paving in our Polymer business, that tends to have a little bit of a positive benefit relative to Q1 and Q4 in the Polymer segment. So I think that you should take that into consideration, and we have the same issue associated with our Chemical business of course with the paving season associated with road markings. And so, I think there’s just probably a bias towards a higher degree of quarterly cadence in Q2 and Q3 but not extraordinary.

[James Finnerty:]

Okay, great. And in terms of excellence facility in Singapore, we have been watching it to see if there’s an impact of Chemical segment in terms of new hydrocarbon supply. Just give us any thoughts or any data points that you’ve seen there so far?

[Steve Trembley:]

Well, certainly, we know that the project I think you’re referring to has started up and is a material impact in terms of supply. I’ll point out that this is a, in the C5 hydrocarbon space, is just considered to be kind of the premier grades of those tackifier family – that tackifier family, which means at the end of the day, it’s not necessarily a direct substitute for what we do. The way we look at it, it just might backup material in the chain. But so far, the impact of that startup and that significant increase in capacity has been absorbed quite affectively into the marketplace from our observations.

[James Finnerty:]

Okay, thank you. And just lastly, you mentioned the potential refinancing of the high coupon notes. Is that something you’re thinking about doing it at first call is that the best way to think about it? On as you approach that?

[Steve Trembley:]

We look at it opportunistically, but for sure, the First Call on October 15 is our first chance we’ve had to really look seriously about that tranche of acquisition-related debt. So more to follow – more to come as we move into the year.

[James Finnerty:]

And just in terms of the debt reduction, would that – should we think about maybe some of that debt not being completely refinanced or would most of the debt reduction take place at the secured part of the capital structure?

[Steve Trembley:]

The latter. The latter was what we plan to do. We plan to, if we do something with the 10.5%, so we take those out and use that cash flow to reduce the prepayable term debt.

[James Finnerty:]

Great. Thanks very much.

[Steve Trembley:]

You welcome.

[Operator:]

Our next question came from the line of Mr. Mike Sison with KeyBanc. Your line is now open.

[Mike Sison:]

Hey guys, nice end of the year. In terms of the Polymer segment, how much more cost savings will impact 2018 and I guess sort of give us a similar commentary for the Chemical segment.

[Kevin Fogarty:]

Hey Mike. We are looking at around $20 million of incremental cost reductions in the Polymer segment could be a little higher. We could stretch to get the whole $70 million, perhaps, in 2018, but our planning case is more about $20 million, which would leave about $5 million or so to fall into 2019. And that’s only because of the timing of some projects, we’ve been obviously, pretty busy with couple of issues here lately. As part of the Chemical segment, we have in the third quarter, we mentioned that we had achieved the $65 million. We believe that the new standard operating procedures, if you will, that the team has put in place will continue to garner year-over-year improvements in variable and fixed. But we classify those as just good manufacturing capability and they’re going to be part of our existing playbook 2018 and also years forward. Just like the cost reductions in the Polymer segment, which actually flow outside of the $70 million as well. So we view those as you’ve got to do them every year as opposed to definitive programs, if you will.

[Mike Sison:]

All right, okay. So, I mean, it sounds like you can get to the $400 million on cost savings on its own. So I might have missed some of the negatives you might see in 2018 but if you think about some volume growth, how much leverage should you get in Chemicals and Polymers if your volume outlook comes – unfolds as you think for 2018?

[Steve Trembley:]

As I said in my comments a few minutes ago, Mike, we have great momentum in both our Chemical and Polymer business, that’s a fact, we talked about it. If you look at it amongst the three product families, so starting with our polymer business. USBC, obviously, is a function of the upcoming paving season and the shift we’ve made from roofing to paving, particularly, in Europe, and that has proven to be a good development for us. The whole transportation Highway build associated expenditures and monies that are finally, budgeted has translated into good volume outlook. So we’re looking at our Polymer business very positively, but at the same time as well, recognize that there were some raw material volatility trends, if I could call it that way, in the way that 2017 should go that we’re not expecting to happen the same way or, shall we say, the same type of extraordinary quarter-to-quarter, and in some cases, month-to-month changes. So we take a more reasonable view, if you will, in terms of volume – excuse me, margin progression in our Polymer business. On the Chemical side of the equation, I am not going to tell you that at the end of the day, we are back to historical highs whatsoever in the case of our adhesive business. What I’m saying is, is that relative to where we’ve been in the last couple of years, that trajectory now in the business is the right direction. And then on the TOFA side, clearly, there have been some pretty dramatic changes in terms of industry structure and our positioning in the industry, which gives us confidence in terms of that business being a business that will we’ll see margin improvement in 2018 versus where it’s been.

[Mike Sison:]

Right, great. And just one last question, if you think about the Chemical segment with a little over $150 million EBITDA in 2017, when you think longer term, what do you think the potential for that business is, whatever two, three years out?

[Steve Trembley:]

Look, I don’t think I’m going to give you a projection of where we think the business is going to be two, three years out. But the way to look at our business in terms of our market position, the technology we offer, the customer relations which we have, and of course, our pricing strategies, we don’t see any reason why we can’t return to that level of profitability that the business has had and experienced, historically speaking.

[Mike Sison:]

And that was like 20% EBITDA margins, right?

[Steve Trembley:]

Well, we’re already there. We’re talking about much higher numbers. Again, reflective of the true value add we provide to the Chemical industry.

[Mike Sison:]

Right, great. Thank you.

[Operator:]

Another question came from the line of Mr. John Roberts of UBS. Your line is now open

[John Roberts:]

We’ve had a lot of volatility in crude oil. How have your CTO cost tracked in the lower-end products of the refinery, and they kind of CTO in those lower end refinery products sort of tracked with crude oil?

[Kevin Fogarty:]

I think the CTO, I mean, there’s some lag involved in the relationship, but clearly, CTO, as we’ve talked about, is a function of energy costs, so I’ll say it that way. Not 100% crude oil but energy cost in general. So you can think about it almost as an index with some provisions in terms of the timing of the impact of those indexes. So, clearly, our CTO costs therefore with the rising crude oil, as you note, have gone up. And that’s part of the equation, obviously, in our pricing strategy but not all.

[John Roberts:]

Okay. And then China is a large player in the lower end of the block copolymer marketplace, and I think Sinochem may actually be the largest. Are they being affected at all by the tighter environmental regulations and is there anything happening in the lower end where you don’t participate that might be making things better or worse in the higher end, where you do participate?

[Kevin Fogarty:]

It’s tough to answer the second part of your question, to say it that way, because generally speaking, the player you referenced, they’re not necessarily a major – a direct competitor of ours. As you know, I mean, we play in a certain part of the marketplace, where customers truly value the combination of technology and service that we offer. But there’s no question that if you think about China overall, you’ve got two things going, I think, positive for the overall industry structure. One is, maybe what you referenced that in some cases, there have been some actions taking in China that might impact the ability of certain parts of the industry to produce material at historical levels. How that affect individual players, it’s really hard to get your hands on to be honest. We try as you might expect, but it’s difficult. But at the same time too, the underlying growth still continues. And if I think about that lower part of the value chain that you spoke of, clearly, China is still relying heavily when it comes to fundamental SBS on not just roads but also for footwear and footwear development. So there is certainly growth and the combination of that growth with potentially some supply limitations as you noted can’t be a good thing, albeit not necessarily in a direct sense to us but in a direct sense to us but in the indirect sense relative to the overall supply demand balance in the industry.

[John Roberts:]

And then, Steve, how do we think about tax reform on a go-forward basis, ignoring the one-time items in the quarter? Your tax rate has always been a little challenging to estimate. So don’t really know what to think of now that we’ve had the reform.

[Steve Trembley:]

Thanks, John. We would have said before reform tax rate in the 25% to slightly under 30%. We will call that out now in the 20% to 25% on a GAAP and an adjusted basis. But we don’t expect much change in our overall cash tax position over the near term. As we analyze the impact of tax reform clearly, the overall rate will change, and we will get an EPS benefit that more at least equally as more important, perhaps more importantly is our cash tax requirement over the near- term is still going to be in the $10 million to $15 million range.

[John Roberts:]

Thank you.

[Operator:]

Another question came from the line of Mr. Jason Freuchtel of SunTrust. Your line is now open.

[Jason Freuchtel:]

Hi ,Thank you for taking some calls. First, I had a clarification on the $15 million impact from the accounting change. Is it safe to assume that as production ramps, cost through the P&L will decline over time? So that the cost experienced in 2018 could actually be lower than $15 million?

[Steve Trembley:]

Perhaps, but I would guide rue you to not materially. We are assuming that all the fixed cost will be incurred in the P&L. We are not expecting to increase fix spending in the JV asset over time. So there may be a modest pickup as we increased years in terms of the semivariables that would impact overall variable cost absorption, but Jason, I wouldn’t be modeling additional improvement necessarily, what’s really important to point out though is that the $374 million of EBITDA in 2017, did benefit from that $15 million which effectively mutes growth but we won’t be talking about when we talk about 2018 to 2019 and 2019 to 2020.

[Jason Freuchtel:]

Okay, understood. And can you discuss how much of the sequential decline in the Chemical segment was driven by either a change in mix, other one-off items are just seasonality? And with that, can you comment on whether you’ve seen any impact to the supply demand fundamentals for your adhesive offering from recent C5 hydrocarbon resin capacity coming online or has that additional capacity primarily impacted more specialized offerings that you don’t really compete with Kraton’s adhesive offering?

[Steve Trembley:]

Well, on the second point, you made, Jason, that clearly there is an element of supply increase in the C5 chain clearly as a result of the start up through Singapore that was referenced earlier. What we’re saying is that, that doesn’t necessarily compete against our offering but it might back up to supply chains from other C5 producers just because as that startup brings material into the high end of the value offering, that causes people to shift material into the lower parts of the offering, which therefore, ends up maybe competing against our rosin ester offerings. That’s kind of how we see the marketplace unfolding. As to your point about sequential decline, Q3, I assume to Q4 that you’re referencing, that was mostly in the adhesive part of our business. And at the end of the day, what is that significant but we had some evidence that the margins that we had elevated to in the third quarter, we didn’t clear them quite forward into the fourth quarter. But again, relative to where we’ve been, we think over that two-quarter period we’re in good shape from here particularly with the price increase momentum that we have now announced going into the second quarter.

[Jason Freuchtel:]

Okay. Thank you. And if the euro rates stayed where it is today, should that benefit Kraton in 2018? And was the FX impact included in your EBITDA guidance?

[Steve Trembley:]

We’re not – we didn’t modeled the $25 million, we modeled the $20 million in the $400 million so there could be some modest upside. You think about it in terms of a 10% movement in all the currencies is on a plus or minus around $5 million of EBITDA based on our sales mix today.

[Jason Freuchtel:]

Great. And then one last one. I guess, it look like CapEx may be going up a little bit in 2018 from some additional projects you have coming online. How should we think about maintenance CapEx going forward. That’s it for me. Thank you. Good luck in the quarter.

[Steve Trembley:]

Thanks, Jason. Including in the $100 million in 2018 we got about $14 million still earmarked to achieve the cost reduction initiatives and that will be effectively zero moving forward on that Polymer initiative. We do have some rather large maintenance CapEx in 2018 which won’t repeat, but at this point, I’m going to hold back on any discussions about 2019 and 2018, I certainly wouldn’t expect them to be higher than where we are today.

[Operator:]

We show there is no other questions on the queue. I’d like to hand the call back to Mr. Gene Shiels for closing comments.

[Gene Shiels:]

Thank you, Karla. We like to thank all of our participants for their interest and thoughtful questions this morning. I will note that there is a replay of this call that will begin later this morning and you can access that replay by dialing 866-395-9164. With that we’ll conclude our call this morning. Thank you.

[Operator:]

Thank you. This concludes the Kraton Corporation fourth quarter 2017 earnings conference call. You may now disconnect.