Kraton Corporation
Q1 2013 Earnings Call Transcript

Published: 2 May 2013

[Operator:]

Good morning and welcome to the Kraton Performance Polymers Inc. First Quarter 2013 Earnings conference call. My name is Jane 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. If you would like to ask a question, please press star, one on your touchtone phone. Today’s conference is being recorded. If you have any objections, you may disconnect at this time. And now I’d like to turn the call over to Mr. Gene Shiels, Director of Investor Relations. Thank you.

[Gene Shiels:]

Thank you Jane. Good morning everyone and welcome to Kraton Performance Polymer’s First Quarter 2013 Earnings call. With me on the call this morning are Kevin Fogarty, our President and Chief Executive Officer, and Steve Tremblay, our Vice President and Chief Financial Officer. A copy of the news release issued yesterday is available on the Investors Relations section of our website, as are copies of the slides we will review this morning. Before we review first quarter 2013 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 our call this morning, 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 expectations stated or implied by any forward-looking statements we make today. Our business outlook is subject to a number of risk factors. As the format of this morning’s presentation does not permit a full discussion of these risk factors, please refer to our Forms 10-K, 10-Q and other regulatory filings that are available in the Investor Relations section of our website. With regard to the use of non-GAAP financial measures, a reconciliation of EBITDA, adjusted EBITDA and adjusted EBITDA at ECRC to net income or loss, and a gross profit at ECRC to 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 is included in the appendix to the material we will review this morning. Following our prepared remarks, we’ll open the line for questions. I’ll now turn the call over to Kevin Fogarty.

[Kevin Fogarty:]

Thank you Gene, and good morning everyone. As we outlined in yesterday’s earnings release, our results in the first quarter of 2013 reflect a significant change in butadiene pricing dynamics compared to the first quarter of 2012. In setting the stage for our discussion of first quarter 2013 results, I think it is important to highlight how this change impacted our results for the quarter, particularly with respect to comparison of our first quarter 2013 sales volume of 78 kilotons to the record sales volume of 90 kilotons we reported in the first quarter of 2012, and in evaluating the resulting year-over-year decline in sales revenue. In the first quarter of 2012, our sales volume benefited from a number of factors, including a recovery in demand from destocking that occurred in the fourth quarter of 2011 as butadiene prices were declining from the third quarter 2011 highs. After declining through the fourth quarter of 2011, butadiene prices rebounded sharply in the first quarter of 2012, increasing over 50% from year-end 2011 to the April 2012 peak, and this led to some pull forward of volume from the second quarter of 2012. In addition, favorable weather in the first quarter of 2012 in Europe and North America contributed to strong overall demand in our paving and roofing end use. In sharp contrast to the volatility in butadiene prices in the fourth quarter of 2011 and first quarter of 2012, butadiene prices were relatively stable in the months leading up to and over the course of the first quarter of this year. Customer demand in the first quarter of 2013 was therefore more reflective of underlying market conditions and less driven by management of inventory relative to actual or anticipated raw material moves. First quarter 2012 weather conditions were also quite different from last year as cold and wet weather in both Europe and North America constrained activity in our paving and roofing end use. As a result, it is difficult to make a direct comparison of Q1 2013 results versus the first quarter of 2012. As many of you know, our second quarter sales volumes are typically higher than the first quarter due to seasonality in the paving and roofing business. Last year, however, our second quarter sales volume was actually lower than the first quarter for the reasons I just described. Given that we expect our second quarter 2013 sales volume to be higher than the second quarter of 2012, we believe a comparison of the first half 2013 sales volume to first half 2012 sales volume will be a more informative period-to-period comparison as it will normalize the quarter-specific impacts of raw material volatility. With this as a backdrop, our first quarter 2013 sales revenue was $340 million, down $68 million compared to the $408 we reported in the first quarter of last year. The largest factor in the revenue decline was lower sales in the quarter, which accounts for 52 million or 76% of the $68 million revenue decrease from the first quarter of 2012. Lower average butadiene prices were also a factor in the year-on-year decrease in our sales revenue and accounted for 10 million or approximately 14% of the revenue decline compared to the first quarter of 2012. We often remind investors that our average selling prices reflect changes in raw material costs as we work to maintain unit variable margins at or above threshold level through our price right strategy. Because of this disciplined approach, top line results are not always the best indicator of our business performance. Specifically, although butadiene costs were lower on average and this was reflected in the lower average selling prices, on a variable cost basis our unit margins actually increased year-on-year. On a GAAP basis, we reported a net loss of $3.7 million or $0.12 per share in the first quarter of 2013. Adjusted EPS, excluding the write-off of debt issuance costs and costs to settle an interest rate swap which occurred in conjunction with the first quarter refinancing of our senior bank facility and other minor charges, was $0.07 per diluted share. As Steve will discuss in more detail in his comments, the first quarter GAAP loss also includes a $7.6 million or $0.24 per share impact arising from our inability to recognize a tax benefit associated with net operating losses generated in the quarter. Adjusted EBITDA for the first quarter was $28.7 million, down $14 million compared to the first quarter of 2012. Included in the $28.7 million is an adverse impact of approximately $3 million arising from continuation of the production issues we discussed last quarter. Excluding the impact of raw material price moves or on an estimated current replacement cost basis, first quarter 2013 adjusted EBITDA at ECRC was $29.2 million, and this compares to $39.6 million in the first quarter of 2012. The $500,000 difference between the first quarter of 2013 adjusted EBITDA at FIFO and at ECRC reflects the relative stability in raw material prices leading up to and during the quarter. Cash provided used in operating activities was $20.8 million in the first quarter of 2013, and this compares to cash provided by operating activities of $56.1 million in the first quarter of 2012. The decrease in operating cash flow reflects an inventory build in the quarter which we expect to be reduced over the course of the second quarter. A portion of the inventory build reflects actions taken in advance of the planned two to three-week turnaround at our Wesseling, Germany facility later this year. Turning now to first quarter results and our four end use markets, starting with Cariflex. Our Cariflex end use delivered solid results in the first quarter. Sales revenue was up $4 million or 19%, and excluding the adverse impact of foreign currency revenue would have been up 5 million or 23%. We continue to focus on growing our core volumes for Cariflex, diversifying our customer base, and developing new markets for our Cariflex IR and IR Latex products. Our results in the first quarter reflect success on all fronts. First quarter revenue growth benefited from higher sales volume primarily in surgical glove and other medical sales, and from increased sales of innovation grades. In addition, average selling price increased across the Cariflex portfolio. Sales revenue for our advanced materials end use was $97 million, down 9% or $9 million compared to the first quarter of 2012. Excluding changes in foreign currency, revenue would have declined 8 million or 8%. The decline in sales revenue was primarily a function of lower average selling prices which reflects lower average raw material costs, primarily for butadiene, as sales volumes were essentially flat. Once again, some of the volume pull forward we experienced in the first quarter of 2012 was in advanced materials, and this helps to put the Q1 2013 sales volume relative to Q1 2012 in context. Looking at the advanced materials innovation portfolio, we saw growth in personal care and medical applications, but this was offset by lower volumes in consumer and wiring cable applications. Turning now to Slide 6, sales revenue for our adhesive, seals and coatings end use was $131 million, down 19 million or 12% compared to the first quarter. Again, excluding the $2.7 million adverse impact of foreign currency moves, revenue would have declined 16 million or 11%. Lower revenue compared to the first quarter of 2012 was driven by lower average selling prices associated with changes in raw material pricing and lower sales volume. Excluding the timing effect of sales into lubricant additive applications, sales volume was down 3%, reflecting lower sales in pressure sensitive adhesive and elastic non-woven applications. With respect to the timing of lubricant additive applications, we expect sales volumes to increase in the second quarter of 2013. In addition, we expect sales in the cable gel applications to improve, aided by improvement in infrastructure spending resulting from further emphasis on economic stimulus in China. Turning now to our paving and roofing end use, first quarter 2013 sales revenue was down 44 million or 34% compared to the first quarter of 2012. The adverse impact of currency moves reduced revenue by roughly $700,000. As previously discussed, butadiene pricing and weather were the most significant factors accounting for the lower sales revenue compared to the first quarter of 2012. Overall sales volume was down 27% year-on-year primarily in North America and Europe paving markets, and to a lesser extent European roofing markets. The revenue decline also reflects lower average selling prices associated with lower butadiene pricing. For the 12 months ending March 31, 2013, our Vitality Index was 14%. Excluding the impact of innovation volumes that rolled out of our Vitality Index in the TTM period simply because they passed the five-year mark since initial commercialization, the Index would have been 19%, up over 500 basis points compared to the trailing 12-month period which ended March 31, 2012. Looking at trailing 12-month year-over-year revenue growth for some of our key innovation platforms, revenue for oil field applications was up 147%, revenue for sales of HiMA and paving and roofing were up 120%, revenue from adhesive applications was up 29%, sales into PVC alternatives was up 22%, revenue from protective film applications was up 19%, and revenue for reactive SBS for printing plate applications was up 9%. These six platforms alone account for approximately 70 million of the total innovation revenue for the trailing 12-month period. I’ll now turn the call over to our Chief Financial Officer, Steve Tremblay, who will provide more financial detail on the quarter. Steve?

[Stephen Tremblay:]

Thank you Kevin. Good morning. With respect to sales volume, let me remind you of the atypically high volume in the first quarter of 2012 that Kevin described in his comments. The resulting 90 kilotons of sales volume was record shipping rate for a calendar first quarter and the 12 kiloton decline in Q1 2013 was predominantly due to lower sales in our paving and roofing end use, indicative of the butadiene and weather dynamics. The balance of the decline was due to lower sales in our adhesives, sealants and coatings end use, including timing associated with lubricant additive applications. That said, from a more comparable perspective the 78 kilotons in the first quarter of 2013 was generally in line with the 73 kilotons in Q1 2010 and the 81 kilotons in Q1 2011. Sequentially, Q1 2013 volume was up 11 kilotons or 16% compared to the fourth quarter 2012. Looking at the components of the revenue decline compared to the first quarter of 2012, the lower sales volume accounts for $52 million of the $68 million decline, lower selling prices generally related to lower raw material costs accounts for 10 million of the revenue decline, with the balance largely due to changes in foreign currency rates. Here again the year-over-year dynamics in our paving and roofing end use accounted for nearly two-thirds of the revenue decline. The sequential revenue increase over Q4 2012 is attributable to a broad-based 11 kT increase in sales volume partially offset by lower product prices. Moving to Slide 9, a few comments about profitability and margins. Gross profit for the quarter was $60 million with a margin of 17.6% compared to $76 million or 18.5% of revenue in the first quarter of 2012. As illustrated on the adjusted EBITDA bridge, the decline in gross profit was the result of lower sales volume and average selling prices as well as the effective of the negative spread between FIFO and ECRC and the production issues, the latter of which lowered gross profit by approximately $3 million. These factors were offset by net lower other cost of goods sold, which includes lower raw material costs and the positive timing effect on cost of goods sold associated with an inventory build in Q1 2013 in advance of the planned Q2 turnaround, which is contrasted with the significant inventory draw in 2012. Sequentially, gross profit is up $20 million from $40 million in the fourth quarter 2012 with an associated margin of 13.4% due to the higher volume in Q1 2012 compared to the fourth quarter of the prior year, as well as the positive impact of the change in the spread between FIFO and ECRC, partially offset by lower average selling prices, the latter of which includes the effect of lower raws and mix. Adjusted EBITDA for the first quarter of 2013 was $29 million with an associated margin of 8.4% compared to $43 million or 10.5% of revenue in the first quarter 2012. The year-over-year decline again reflects the lower sales volume and average selling prices and the negative spread between FIFO and ECRC, partially offset by lower other cost of goods sold. As for the sequential change in adjusted EBITDA, the $17 million improvement was the result of higher sales volume and the ECRC benefit which more than offset the lower average selling prices. The increase in selling, admin and research costs was largely due to the timing of variable compensation expenses in the quarter. Slide 10 presents an updated look at gross profit trends at FIFO and on an estimated current replacement cost basis. As stated earlier, the spread between FIFO and ECRC in the first quarter of 2012 was a negative $500,000 and indeed the most benign impact we have had over the five-year time frame presented herein. Recently the main nomination for butadiene in North American was down roughly $0.05 per pound. Taking this into consideration, in the second quarter 2013 we are now projecting a negative spread between FIFO and estimated current replacement cost of approximately $3 million. First quarter 2013 gross profit amounted to $772 per ton. In the near term, we expect any lingering effects from the production issues will be substantially less than the $38 per ton negative impact experienced in the first quarter. Also, we expect Q2 gross profit per ton to benefit from the normal fixed spending absorption commensurate with second quarter volume, which as Kevin mentioned we expect will be higher than the first quarter sales volume. This benefit, however, will be more than offset by the timing of inventory levels. As I noted earlier, we built inventory in Q1 and will significantly draw inventory in Q2 given the turnaround activities planned in the quarter coupled with the expected increase in overall sales volumes. Although the decline in inventory will have a positive influence on cash flow, the timing of inventory build versus draws is expected to dampen gross profit per ton when viewed on a sequential basis. Having discussed the major components of the P&L in our discussion of gross profit and adjusted EBITDA, I want to briefly comment on our first quarter refinancing of our senior credit facility, which has a bearing on interest expense; and I have a few points to make on our first quarter 2013 tax provision. During the first quarter, we refinanced a senior credit facility and put in place an asset-backed credit facility which aggregates $250 million, the availability of which is subject to the traditional inventory and accounts receivable levels. Through this transaction, we paid of our senior term loan which had an outstanding balance of $97 million at December 31, 2012 and have therefore extended our debt maturity schedule. Our outstanding debt now consists of the $350 million of notes which are due 2019 and $40 million currently outstanding under the new ABL facility. This new facility increases our overall financial flexibility and has the effect of lowering our overall cost of capital. We’ve reflected the latter in our revised guidance of certain discrete items, which I plan to cover shortly. In conjunction with this transaction, we took a charge of $5.7 million in the quarter associated with debt issue costs of the prior facility and costs related to terminating interest rate swaps. These charges were recorded in interest expense. Now with respect to the tax provision in the quarter, as we noted in our fourth quarter earnings review, we are fully reserved for deferred tax assets associated with net operating losses in certain jurisdictions. In the first quarter 2013, included in our overall pre-tax loss of $2.4 million were losses for which the statutory tax rate would have yielded a tax benefit of $7.6 million. However, since we continue to fully reserve for our deferred tax assets, we did not recognize this benefit; and had we been able to recognize the benefit of these originating net operating losses, our net income would have been higher by the $7.6 million. Looking at a few specifics on our balance sheet and cash flow, as Kevin noted, in the first quarter 2013 operating activities consumed $21 million in cash versus $56 million provided in the first quarter of 2012. A significant portion of the period-over-period change was the increase in inventory which, as noted earlier, we currently expect will be reduced by June 30. Balance sheet cash at March 31 amounted to $136 million. I need to note that the joint venture with FPCC is now consolidated in our results, so for purposes of determining credit stats we have excluded $31 million of cash that currently resides at the JV level which will be used for future CAPEX. So on a standalone basis, cash declined to $105 million at March 31 from $223 million at December 31, 2012. In addition to the seasonal operating cash flow decline, the bank refinancing used cash of $60 million, CAPEX amounted to $15 million, and our share of the initial investment in the joint venture was an additional $15 million cash outflow. With that, our debt to net capitalization remains a healthy 37% at quarter-end, and our net debt to trailing 12-month adjusted EBITDA was 2.9 turns. On Slide 12, we provide an update of specific P&L items for the full year 2013. I remind you that these estimates are based upon our current view and are subject to change as we move through the year. We now expect full-year 2013 interest expense to be $32 million. This figure includes the charges of $5.7 million associated with the refinancing transaction, so excluding these charges interest expense would be projected to be approximately $26 million on a run rate basis. We are currently maintaining our estimates for research and development, SG&A and depreciation expenses, and in addition although the first quarter effective tax rate differed from the 12% full-year estimate, we are currently holding to the 12% estimate for our effective tax rate. This estimate is subject to a number of factors, including the mix of pre-tax earnings in the various jurisdictions in which we operate. With that, I’d like to now turn the call back to Kevin for some closing comments.

[Kevin Fogarty:]

Thanks Steve. Before we open the call up for questions, I have a few closing comments which are primarily centered around our outlook in the current business environment. Thus far in the earnings season, you have heard many of our peers discuss their views of the global economic climate. Our views are very similar. We continue to monitor economic conditions in Europe, Asia and the emerging economies very closely. Economic activity has clearly slowed across the euro zone and Asia. In China specifically, expansion continues although at a slower pace than over the past few years. Lastly and anecdotally, there is evidence that a slowdown in consumer spending is translating into weaker end use market demand in Europe, Asia and in the U.S. Our long-term view of Asia, however, remains positive and in the near term we see the potential impact that stimulus programs may actually provide some positive momentum for our infrastructure projects, increasing demands for products such as cable gels. In South America, particularly in Brazil, we see opportunity for continued penetration of our paving products, HiMA in particular, given infrastructure developments that are underway. Overall as it relates to our innovation portfolio, growth is driven by market penetration and adoption of superior technologies, and this generally occurs at rates exceeding growth rates in the base economic demand. Over the past two quarters, it appears that volatility in butadiene prices has abated and this has been largely driven by weaker tire demand and the reduction of natural rubber prices. Although the main nomination in North America was down $0.05 per pound, it is not a significant move given that a $0.07 move upwards was experienced in March. We believe relative stability will continue into the second quarter; however, while I’m not prepared to provide a butadiene projection for the balance of the year, I’d like to make a few comments on structured butadiene supply dynamics. As the old adage in the petrochemical industry goes, the only true cure for high prices is high prices. As many of you are aware, in China alone there are as many as eight four-purpose butadiene projects in various stages of planning and construction. In the U.S. given the structural change in cracker economics supported by shale gas activity, there is a view that the chemical industry will be in favorable feedstock environment for years to come. This is resulting in plans for cracker capacity expansions which are a few years away but which, if realized, will add incremental C4 capacity to the marketplace. The current stability in butadiene prices is a much more positive environment for Kraton than we have experienced certainly since over the course of 2011 and 2012. Our discussions with customers are now less about pricing actions and more about new products and solving technical challenges, and these are the conversations we prefer to have with our customers. In this environment, we will continue to employ our price right strategy. As many of you know, we have moved a portion of our portfolio to real-time pricing, and should volatility return we are prepared to take additional steps to expend real-time pricing in our portfolio. As for the Asia HSBC project, having executed joint venture documents on February 27, Kraton and Formosa have already made initial capital contributions to the venture and we are working diligently on a number of issues that include completion of final engineering work and analysis of financing structures, as well as a number of other operational and organizational considerations. I’m extremely pleased with our relationship with Formosa and with the progress we are making on the project. We are working toward mechanical completion in mid-2015 and we look forward to providing you with project updates in the quarters to come. Our focus of course remains on innovation and accelerating the commercialization of our new products, as well as expanding into new geographical markets and end use applications, as we are doing with Cariflex IR products. Through this focus, we expect a significant shift in our portfolio composition over the next five years driven by growth in sales of our differentiated and innovation grades, and it is through this portfolio shift that we will achieve the margin expansion targets that we have established for the company. With those comments now complete, we would like to open up the call for some questions.

[Operator:]

Thank you. [Operator instructions] Our first question comes from Andy Cash with SunTrust. Your line is open.

[Andy Cash:]

Hello. Just a couple questions. In your comments from the release yesterday, you’re talking about how the first half of ’13 versus the first half of ’12 will be a more informative period. So now that we’re into May, could you say that the volume in the first half of ’13 will be closely comparable to first half ’12, or is there still just too much uncertainty to make a call on that?

[Gene Shiels:]

Andy, this is Gene. We can’t give obviously specific volume guidance – we don’t do that. But clearly as we said in the release, currently our view is that second quarter ’13 volume would exceed that of last year. You need to look at the weather reports – obviously we’re expecting additional cold weather here in the U.S., and that always has an impact on paving and roofing activity. But we do believe, given the abnormality in last year’s Q1 that, as Kevin said, kind of reversed first quarter and second quarter volumes last year, that probably makes more sense to kind of analyze the business on a first half-first half basis.

[Andy Cash:]

Okay, well we’ll definitely do that. The second question is from a financial—you know, what is your unused borrowing capacity now, Steve?

[Stephen Tremblay:]

At the time of the filing—at the time of the closing, Andy, it was below the 250 because we hadn’t secured the Dutch borrowing base facility yet. But as of the current filing date, we’re around $120 million and that would be net of the 40 million drawn.

[Andy Cash:]

Okay. And as you think about the full year, do you think that—I know there’s a lot of puts and takes and it’s really hard to predict where raw materials are going, but do you think that your cash from operations will cover your expected CAPEX for the full year?

[Stephen Tremblay:]

Let me talk about the first quarter first. It’s a seasonally cash use quarter for us. That was clearly indicative in our performance. Working cap was in the range of where we would expect it to be, around 28% of revenue. Again, first quarter should be higher – we target 25 to 27. We’ve guided to a CAPEX number of 80 to $85 million. We’ve got—we still continue to believe that the investment in the JV will be in the $40 million area by the time the year ends. So if you look at those cash flow dynamics, which are essentially unchanged from the prior guidance, we clearly think we’ve got the wherewithal to see ourselves through to the end of the year without any significant changes in our overall net debt to cap and leverage statistics.

[Andy Cash:]

Okay, that’s very helpful. And just if I could ask one last question – if you go back to Page 7 of your slide deck, the Vitality Index, you’ve got—you’re listing a number of products that are up sharply year-over-year on a trailing 12 basis. Then looking at the sales, sales are sliding down a little bit over the last couple years. Are these products being offset by loss in share of other products? I mean, why wouldn’t the sales be increasing over the last few years? Perhaps—maybe you’ve got some plans to boost the amount of new products over the next 12 months or so.

[Kevin Fogarty:]

Well the good news—Andy, it’s Kevin. About our Vitality Index, it’s a measure of the relative sales portfolio. It’s not a measure of the absolute, and what I mean by that is it’s really trying to draw a comparison to that portfolio shift metric that we have targeted ourselves to achieve, and certainly the impact of what we’ve seen in raw materials across the base business would have the same effect on what’s happening with respect to the part of the portfolio that we’re targeting for innovation growth.

[Andy Cash:]

But can you tell from a unit volume perspective that your—are you losing business to some other products? I know you intentionally lost business a few years ago because it was low price business, but are you losing in some of your better products?

[Kevin Fogarty:]

No, I mean—I think the challenge in Kraton continues to be that we need to make sure that we’re replacing innovation and differentiated sales that’s going out, as we characterize sometimes, as the bottom end or the base part of the business, and that continues to be, I think, a dynamic and I don’t think that that is accelerated or increased any further than what we talked about, even just last year during our investor day.

[Andy Cash:]

Okay, thanks a lot.

[Operator:]

Our next question comes from Kevin McCarthy with Bank of America. Your line is open.

[Alex Yfrema:]

Good morning, this is Alex Yfrema for Kevin. I just wanted to ask a clarification question on gross profit per ton. On a replacement cost basis, given the net impact of various one-off factors in the first quarter, do you expect gross profit per ton to improve in the second quarter, and how do you expect it to compare to an annual average in 2013?

[Kevin Fogarty:]

I’ll just make a couple comments and then Steve, go ahead. What we’re saying is clearly as the cadence of the business more reflects typical Kraton in that volume increases into the second quarter, then there should be an offsetting benefit associated with what we call FCA absorption, or in other words fixed cost absorption associated with that increased sales. However, what Steve commented on in his notes is just wanting to remind people that because we have a turnaround plan in our inventory cycle this year, we are going to be drawing quite a bit of inventory into the second quarter which therefore brings back through the P&L some of the fixed cost absorption when it went on the balance sheet originally. We just wanted to call that out for you as you look at your gross profit projection. Now needless to say, from Kraton’s standpoint as you go from Q1 to Q2, we’re not going to give guidance on whether or not we expect just the underlying business run rate margin to improve associated with that quarterly move, because we’re measuring our margin expansion over much longer periods of time in quarter to quarter associated with the portfolio shift. But just in terms of the way in which the P&L is affected, you just need to take those fixed cost absorption dynamics into account.

[Stephen Tremblay:]

And those dynamics, as you know our business, production and sales, we generally match those on a trailing 12-month basis pretty tightly over time, so what Kevin just described and I alluded to in my comments are really confined to discrete quarter-over-quarter events that have a normal normalization by the time one reaches the end of a trailing 12-month period.

[Alex Yfrema:]

If I may clarify this further, would you say that the impact of these two factors roughly offsets each other? In other words, the higher fixed cost absorption, because of higher volumes versus de-stocking Q2 turnaround plans, are they about the same in magnitude or not?

[Stephen Tremblay:]

Yeah, as I mentioned in my prepared comments, the absorption over spending will likely be more than offset by the timing of these inventories sequentially.

[Alex Yfrema:]

Okay, thank you. And can you give us any details of the financial impact of the turnaround and maybe more precise timing in which quarter we might expect that?

[Stephen Tremblay:]

It’s a two to three-week turnaround currently scheduled for the second quarter.

[Alex Yfrema:]

Second quarter. And the approximate impact on EBITDA, would you be able to tell us that?

[Stephen Tremblay:]

No. We’re not going to provide that discrete level.

[Kevin Fogarty:]

But any additional costs associated with that, Steve, are included in the fixed cost guidance you gave.

[Stephen Tremblay:]

Yeah, indeed. Right.

[Alex Yfrema:]

All right, great. And finally if I may, you mentioned some new customers for Cariflex. Could you maybe talk a little bit more about that – who are the new customers and what are the applications?

[Kevin Fogarty:]

Yeah, from the period beginning probably two and a half years ago, we recognized that our Cariflex technology was going to have benefits not just in the surgical glove space but a variety of other markets, so we certainly targeted growing the condom space, as you know, and other types of healthcare applications. But in addition to that, there are other users of our latex in the glove space as well, and I think that as you look at that business, we just think it’s the right strategy to kind of diversify both geographically as well as with two or three other leading glove customers to make sure that we’re able to support and continue to support the growth as we see in the future.

[Alex Yfrema:]

Great, thank you.

[Operator:]

Our next question comes from John McNulty, Credit Suisse. Your line is open.

[Abhi Rajendran:]

Hi, this is Abhi Rajendran calling in for John. Good morning. A couple quick questions. Can you give us an update on the launch of NEXAR into Columbia’s apparel line? I believe there were some weather-related issues that may have delayed its ramp from when it became commercially available, but how do you see its uptake as we kind of move into the spring and summer months?

[Kevin Fogarty:]

Yeah, I’m not sure where the weather comes from, although I suppose—I heard it was minus 15 in Denver this morning, so I don’t think you need NEXAR for sweat activated cooling, at least if you’re running outside. But from an update perspective, we’re watching the way in which the OEM in this case, our partner, has gone to market with this product. We’re very impressed with the way they’ve aggressively approached it and positioned it in a number of retail outlets, as well as on the web, and everything we’re seeing is at or above our expectations.

[Abhi Rajendran:]

Okay, great. And then as some of the production issues are, I think, largely over and as you kind of go through the year, assuming modest volume growth, do you think you can get to a double-digit adjusted EBITDA margin for the full year?

[Gene Shiels:]

Yeah Abhi, this is Gene. We’re going to have to avoid that question. That’s kind of getting into the realm of specific guidance, so I’m going to take a pass on that.

[Abhi Rajendran:]

Okay, fair enough. Maybe just one last quick one – in terms of raw materials, Asian butadiene has come in recently, while North American and European butadiene haven’t really per se. Do you see any opportunities to import some butadiene from Asia, just to take advantage of this?

[Kevin Fogarty:]

I think that we watch every market as we should as a diligent buyer of the materials, but we, unlike other people, believe in contracting for quite a large portion of our needs to ensure that we have that critical C4 molecule to satisfy our customer needs. So at the end of the day, we don’t play a lot in the sport market – from time to time perhaps, but generally speaking as we’ve talked about before, our contracting strategy is what drives our business model.

[Abhi Rajendran:]

Okay, great. Thanks very much for the color.

[Operator:]

Our next question comes from Gregg Goodnight with UBS. Your line is open.

[Bill Carroll:]

Thank you. This is Bill Carroll in for Gregg. EBITDA margins were a bit lighter than we expected. Certainly lower volumes were most likely a factor, but we would have expected a benefit from a better mix, given the lower paving and roofing sales. So what may have constricted margin performance in the quarter besides the volumes?

[Kevin Fogarty:]

Well, I don’t think that we’re going to be able to talk specifically about our level of how we did relative to what your expectations are, but what we would tell you is just like our strategy outlines, our goal in terms of margin expansion over time comes from the portfolio shift associated with the successful growth in innovation commercialization. That is something that we absolutely believe in, so if I look at first quarter results, there was some successes that we’re very pleased with, with respect to how our Cariflex business is unfolding and the rest of the innovation platforms that I just outlined in my comments. But needless to say with the volume shortfall that we were looking for relative to the kind of volume trend that we would have expected to continue to see in first quarter and then see evolve over the course of the year as we’re looking to grow, we would share your view that the difficult economic environment we’re in probably limited sales; and then that pull forward effect, I think, was meaningful. I don’t think it changes anything in terms of what we’re trying to do with the business, and as I said in my comments, the butadiene environment makes that discussion a whole lot more robust with our customers in terms of the kind of things we like to talk to them about, which is growing the innovation pipeline. We’d just like to see that stability continue and that way we can be focused on the things that are really going to drive our growth, and particularly on the parts of the business that we know we can have an innovation differentiation strategy successfully applied, and HSBC and Cariflex certainly are key to that.

[Bill Carroll:]

Okay, thanks. And one more if I could – can you share some of the details of the new asset-based lending facility in terms of the borrowing base, advance rates versus receivables and inventory, and whether real estate is included in that base?

[Stephen Tremblay:]

Yeah, there’s no real estate included in the base. It’s a pretty traditional facility. There’s a U.S. tranche which is 150 million, there is a Dutch tranche which is 100 million. Again, the advance rates are very standard 85% on receivables and 65% of qualified inventories, again in those two jurisdictions, the U.S. and Europe. Interest rate is a grid based on availability that ranges from L150 to L2, so again cheaper than the term loan and the revolver that we replaced. I’d call it a very standard sort of ABL package.

[Bill Carroll:]

Great, thank you.

[Operator:]

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

[Edward Yang:]

Hi, good morning. Could we circle back to this adjusted EBITDA per ton guidance again? A lot of different puts and takes there – you’re going to see better volume, even have an inventory build. Do you expect adjusted EBITDA per ton to be up sequentially, and if so—up or down sequentially, and if so, what are you using as a base? Are you using the base as you reported in the first quarter which included the $3 million manufacturing and efficiencies, or excluding?

[Stephen Tremblay:]

Hey Ed, good morning. Let’s try to go through it. First quarter 2013 is our base because we do manage that gross profit per ton and track it very much on a sequential basis. So 772 was the gross profit we printed in the first quarter. There was $38 a ton associated with the $3 million of fourth quarter production issues that rolled in. Because some of that is related to even first quarter production, there will be a small percentage of that $38 per ton which we expect to linger in, so that’s going to—the way I think about it or you should think about it is 772 plus 38 gets to around 810, but there’s going to be some degradation associated with a small piece of those production issues, which you just have to roll through the P&L as the inventory turns. And then as I noted, clearly as we expect volume to increase, there’s favorability with respect to margin per ton. Less dramatic, of course, favorability than what you would see in a traditional fourth quarter versus a big second quarter because our first quarter was not a terribly weak first quarter, but there will be some lift there. But as I mentioned earlier and Kevin has mentioned, the fact that we had to build inventory in advance of the turnaround is likely going to more than offset that kind of seasonal fixed lift. So that’s the bridge as we think about it. The biggest item that will benefit the second quarter will be the correction of the production issues, but one should not be thinking about a seasonal lift associated with higher volume because some of that higher volume will be serviced by reducing ending inventory.

[Edward Yang:]

Okay, that’s helpful. And thinking longer term, your target of $1,000 per ton there, is that something that you’ll see in 2014, or is it two or three years out?

[Kevin Fogarty:]

I don’t think we’re going to say. I mean, I think the slide that we showed shows we’ve achieved it in certain select quarters already. Our issue is the sustainability of that $1,000 per ton, which we’d like to see occur across all the quarters in a calendar year, and we’re not going to talk about when we expect to achieve it. Just know that everything we do here with respect to the portfolio shift and accelerating those efforts as best we can is directed towards meeting or exceeding that goal.

[Edward Yang:]

Okay. And on your comments around volumes, a lot of different puts and takes there as well with the restocking and the weather. What do you think the underlying trend is? Your advanced materials volumes were essentially unchanged. That wouldn’t have been affected by weather or restocking. Is that kind of a good run rate at this moment?

[Kevin Fogarty:]

No, I think I made comments that advanced materials did have some of that pull forward effect. I mean, that can be affected too in terms of—again, go back to what happened with respect to butadiene and our pricing strategy and how customers want to position their purchases accordingly and their stock values. So it was just not near as extreme as it was in paving and roofing – that’s the point we tried to make. But generally speaking at the end of the day, you have a couple things going on here. In the case of paving and roofing, you have that pull forward effect and destocking effect clearly that will have a much different volume sequential cadence now as we think about stable butadiene prices this year, or at least going into the second quarter. But you do have the weather issue that we need to be thinking about. Again, I mean, just amazed to listen to the weather report in the whole northern tier of the U.S. this morning. It was incredible, and of course when you have that kind of weather, you simply can’t do paving projects. It’s not a question of—you know, the weather is foul. The paving activity just doesn’t work when weather is that cold and there’s moisture. On our advanced materials business, it’s a business that’s driven by a number of industry sectors and some of those sectors clearly are impacted by what’s happening in the general economy – we can’t deny that. But on the other hand as we think about our innovation growth, it’s a substitution effect. It’s replacing other materials. It’s in many ways, therefore, immune from what’s happening with the general economy. So you have offsetting factors in each case, and I think that from our standpoint—look, this is not the healthiest marketplace we’ve ever seen as Kraton, clearly, just because of what’s happening in the marketplace. But we’re pleased with the fact that we have in our portfolio diversification, so that allows things like anything we’re doing with medical to not have the impact associated with what’s happening in the general economy. PVC substitution – those are things that continue to go on very well. But then there’s other parts of the business clearly that are affected, and they are mainly driven around what are some of the consumer products that we serve.

[Edward Yang:]

Okay. I apologize for the background noise – I’m here at the Dupont analyst meeting and trying to find a quite corner here. Your long-term view was always, to your point with the innovation, that you’re going to grow at a multiple GDP, but if GDP is flat then you’re not going to grow much volume at all, and you had some comments about economic slowing in Europe and Asia. So does that translate to a volume expectation that’s flat? Is that the underlying trend going forward?

[Kevin Fogarty:]

I promise you we don’t have volume expectations of our innovation portfolio growing flat. I think we’ve commented, though, that the overall portfolio of Kraton will not have that 2X GDP kind of level simply because we’ve got that portfolio shift going on, and be wary of that. But as far as our innovation goes, our expectation is certainly not anything associated with a flat number.

[Edward Yang:]

Okay. And then just finally, the yen has depreciated significantly. One of your strongest competitors is based in Japan. Are you seeing any change in competitive behavior related to the change in currency markets?

[Kevin Fogarty:]

I don’t think I’ll get into what’s happening in terms of competitive behavior of customers, but yeah, we’re very mindful of what’s happening with the yen as well. For parts of our business, that’s helpful; and other parts of our business that gives us a headwind.

[Edward Yang:]

All right, thank you.

[Operator:]

Our next question comes from Sumit Rocham. Your line is open.

[Sumit Rocham:]

Hey, good morning. Just sticking with the volumes here, if I look into the second quarter and try and hash out a normal seasonality number, would it be reasonable to look at ’08 and ’10 where they’re up mid-teens sequentially over the first quarter, or would that be a little aggressive?

[Kevin Fogarty:]

Again, we’re not going to talk about absolutes; but I think with this butadiene environment we find ourselves in, but for the issue associated with weather, than historical seasonality trends, yeah, are more indicative of how we see 2013.

[Sumit Rocham:]

And would you consider those normal years, or--?

[Kevin Fogarty:]

You know, I guess I would just say and emphasize once again that when we’re back in more stable butadiene environments, that’s the trend we would expect to realize here where you have the big volumes of Kraton sales being driven by paving and roofing, which are traditionally the second and third quarter summer seasons.

[Sumit Rocham:]

Okay. And then if I look at the first half as a whole in 2012, was there a broader pre-buy versus the second half? Were there any volumes in the second half of the year that were pulled forward in the first quarter, making the second half of ’13 a bit of an easier comp for you?

[Kevin Fogarty:]

It’s difficult to kind of assess exactly which quarter a pull forward effect had impact, but I think the heavier emphasis is on the sequential quarter as opposed to two and three out. I mean, people do volume plan. As I go back and recast history, there’s no question that as we thought about what life was like in February and March last year, I don’t think anybody anticipated this would come to a screeching halt in April the way it did. So that, though, kind of reflects I think in probably that second quarter effect, so it’s difficult for me to say that there’s a whole lot of third and fourth quarter effect, because you simply really don’t know. You just know that at the end of the day there’s a pretty quick change in purchase patterns in the immediate period.

[Sumit Rocham:]

Okay. And then in the release, there was some fine print along the lines of evaluation of acquisition transactions. I know you’re tied up a bit with the JV and a lot of energy going into that, but could you just give us your thoughts around M&A more broadly?

[Stephen Tremblay:]

We can’t talk about M&A more broadly. The little footnote you saw was some consulting costs that we routinely do around market assessments and the like.

[Sumit Rocham:]

Okay, thank you.

[Operator:]

We have no further questions at this time. I’ll now hand the call back to Gene Shiels for closing comments.

[Gene Shiels:]

All right, thank you Jane. We’d like to thank all of our participants this morning for their interest in Kraton and for their questions. A replay of this call will be available on the Investor Relations section of our website beginning later today and will be available through May 16. If you’d like to access a replay, U.S. callers can dial a toll-free number, 800-873-2012, international callers may dial 203-369-3375. I’ll turn it back to you, Jane.

[Operator:]

That does conclude the Kraton Performance Polymers Inc. First Quarter 2013 Earnings conference call. Thank you for participating. You may now disconnect.