Kraton Corporation
Q3 2012 Earnings Call Transcript

Published:

  • Operator:
    Good and welcome to the Kraton Performance Polymers Incorporated Third Quarter ended September 30th 2012 Earnings Conference Call. My name is Marla and I will be your conference facilitator. At this time all participants are in a listen-only mode. Following the company’s prepared remarks there will be a question-and-answer period. (Operator Instructions) Today’s conference is being recorded. If you have any objections you may disconnect at this time. And now I will turn the call over to Mr. Gene Shiels of Director of Investor Relations.
  • Gene Shiels:
    Thank you, Marla. Good morning, everyone and welcome to Kraton Performance Polymers third quarter 2012 earnings call. With me on the call this morning are Kevin Fogarty, our President and CEO and Steve Tremblay, our Vice President and Chief Financial Officer. Before we review results for the third quarter, I’ll refer you to the disclaimers on forward looking information and the use of non-GAAP measure 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 facts and thus constitute forward looking statements. Investors are cautioned that the risks, uncertainties and other factors that may cause Kraton’s actual performance to be significantly different from the expectations stated or implied by any forward looking statements we make today. Our business outlook is subject to a number of risk factors and 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 the reconciliation of EBITDA, adjusted EBITDA and adjusted EBITDA to estimated current replacement cost to net income and a gross profit at ECRC to gross profit which provided in yesterday’s earnings release and is included in the appendix to the material overview on this call. Following the prepared remarks, we’ll open the line for your question. I’ll now turn the call over to Kevin Fogarty.
  • Kevin Fogarty:
    Thanks Gene, and good morning everyone. Our third quarter results reflect market dynamics that were generally in line with the expectations we outlined in our second quarter conference call in early August. Following significant volatility for raw materials primarily butadiene through July of this year as we anticipated prices for these inputs moderated for the balance of the third quarter. As a result, in the third quarter, we saw less disruptions in customer buying patterns resulting from raw material price moves than we saw in the second quarter. Giving the trend of monomer prices, we had also projected that the associated negative FIFO effect in the third quarter would be approximately $40 million, as outlining yesterday’s press release, this was the case as we announced the negative $38 million FIFO effect similar to our expectations. We’d also anticipated improvement in our current cost margins in the third quarter and as we reported yesterday, current cost gross profit was $1010 per ton in the third quarter of 2012 compared to $894 per ton in the third quarter of 2011 and $820 per ton in the second quarter of 2012. As in the second quarter, during the third quarter, we continued to observe the general weakening in demand across a number of markets, nevertheless, our third quarter sale volume have 79.3 kiloton was up 2 kilotons or 2% year-on-year compared to the 77.6 kiloton we reported in the third quarter of 2011. In addition, sales volume for the nine months ended September 30th was up 2% compared to the first nine months of 2011, where the key reasons for our year-on-year volume growth is our continued success in Asia, particularly in China, driven by expansion in our customer base with companies we truly value, creating product offerings and value proposition. However, sales revenue for the third quarter was $346 million, down approximately 15% year-on-year on the $36 million reduction in product prices, which was driven by reductions in feedstock stock cost primarily Betadine and due to the $25 million adverse effect of foreign exchange movements. These two items were partially offset by the higher sales volume that I just described. We reported a net loss of $15.5 million or $0.48 per diluted share in the third quarter. In addition to the negative $38 million FIFO effect in the third quarter. We also recognized a $5.4 million impairment charge, which had a negative effect of approximately $0.10 per diluted share. Third quarter adjusted EBITDA was $10 million, down 58 million from the 71 million posted in the third quarter of 2011. However, this reflects a $70 million period-to-period change in inventory valuation at FIFO. On a current cost – on a current replacement cost basis, third quarter 2012 adjusted EBITDA was $51 million, a 31% increase from the comparable figure of 39 million in the third quarter of 2011. We’re also generated $33 million of cash from operating activities in the third quarter 2012. An increase of $44 million from the 11 million of cash used in operating activities in the year ago period. Year-to-date, we’ve generated $102 million in cash from operations compared to less than $4 million for the first nine months of 2011. Looking now at our four end used markets, beginning with advanced materials. Third quarter revenue for advanced materials was $94 million, down 8 million or 8% compared to the third quarter of 2011. Of the $8 million, revenue declined 4 million as attributable to changes in foreign exchange rates and the balance is due to lower average sales prices, which are related to the decline of monomer prices, primarily, due to butadiene. Sales volume increased year-on-year, led by increases in differentiated offerings and consumer product and medical applications, partially, offset by lower sales in to personal care and wire and cable applications as compared to the third quarter of 2011. ASC revenue in the third quarter was $117 million, down 25 million or approximately 18% compared to the third quarter of 2011. The revenue decreased reflects lower sales volume compared to the third quarter of 2011. Lower average product prices reflect the decline in feedstock prices primarily due to butadiene and changes in foreign currency exchange rates which accounted for nearly 8 million of the $25 million revenue decline. Looking specifically at the decline in sales volume the decrease is due to the timing of sales into lubricant additive applications as these sales are not linear throughout the year. Excluding lubricant additive sales, ASC would have been up year-on-year led by increased sales into pressure sensitive pieces, printing plates and industrial applications. Turning now to slide six, revenue for the paving and roofing end use was $102 million in the third quarter down 22 million or 17% as compared to the third quarter 2011. Changes in foreign currency once again accounted for 11 million up year-on-year revenue decline. And the balance of the revenue decline is attributable to lower average sales prices driven by lower butadiene pricing, with these two factors being partially offset by higher sales volume which was up 12% year-on-year. Sales volumes increased in all markets with the exception of North America where paving volume and to a lesser extent roofing volume declined year-on-year. Outside of the U.S. however, paving volume grew in some of our target markets in Asia, particularly, Australia and the Middle East. In addition sales of our high model or highly modified asphalt offerings increased in the third quarter of 2012 as compared to the similar period in 2011. Lastly in our Cariflex end use for the third quarter 2012 revenue was $24 million down approximately 3 million or 12% compared to the third quarter of 2011. Of the roughly $3 million decline of revenue, 2 million was the function of foreign currency moves and balance was due to lower sales volumes, largely due to the timing of buying patterns by certain customers. The lower sales volume was partially offset however by higher average selling prices compared to the third quarter of 2011. Although the timing of customer purchase results in variation in sales volume from quarter-to-quarter, for the first nine months of 2012 Cariflex sales volumes is up 6% compared to the first nine months of 2011. Turning now to innovation for the trailing 12 month period ending September 30th, our vitality index remained at 13% essentially unchanged from June. As I indicated last quarter, as some of our innovation grades passed the five-year mark they roll out of the index, but continue to commend the margin premium and therefore including the innovation volumes that rolled out over the TTM period our vitality index would have stood at 17%. I’ll provide you now with some updates on some of our key innovation platforms looking at year-over-year revenue growth for the TTM period. Revenue for adhesive innovations was 82%, comfort bedding was up 75%, sales of reactive SBS or printing plates was up 41%, sales into oilfield applications was up 31%. Revenue from PVC alternatives and applications such as medical packaging was up 22% and polychloroprene rubber replacement was up 19%. I’ll now like to take a moment to provide you with an update of our Asian HSBC project. As we announced about one month ago, the framework agreement with Formosa expired on September 30th and was not extended due to the conditions associated with approval on the environmental permit, which was deemed by Formosa to be twist, restrictive and limiting on its overall operation at the Mailiaose. As a result, we are now moving forward with our own plans to build a 30 kiloton HSBC plant in the Asia Pacific region on a standalone basis. Now, I’ll perhaps preempt the few questions that may followed by stating that the spite progress in the weeks since our announcement, we do not yet have an update on timing or final estimated cost for the project. As we speak, our team is in Asia conducting an in-depth review of a number of sites that we are previously identified in 2010 and in early 2011. As you would expect, until the final site is determined it is not feasible for us to provide an update on timing or estimate of the ultimate project cost. We do want to reiterate however that our plan is to build the same plant we designed for the Mailiaose, but an alternative location and this plant will be located on and near an industrial site which will have access to feedstock utilities and another key sites services. In other words, this is not a green field project. Furthermore, a significant portion of the engineering design work conducted to-date will be applicable to the new location. This is a standalone project we’ll be refunding a 100% of the project cost, but we do intend we evaluate franchising options for the project that maybe attractive. And ultimately, we would be also be retaining 100% of the project taken almost. We look forward to providing you with additional updates in the near future. Now I would like to turn the call over to our Chief Financial Officer Steve Tremblay, who will give you more in-depth financial review, Steve?
  • Steve Tremblay:
    Thank you, Kevin. And good morning everyone. Turn to slide eight, few comments on our sales volume and sales revenue to the extent upon Kevin’s highlights. Third quarter sales volume of 79.3 kilotons representing increase of nearly 2 kiloton compared to 77.6 kiloton in the year ago quarter and the similar increase of over 2 kilo tonnes compared to 77KT we recorded in the second quarter 2012. Through – for the September quarter, therefore, our year-to-date sales volume is 246 kilo tonnes up 5KT or 2% compared to the first nine months of 2011. By end used, sales revenue increased year-over-year and paving and roofing and advanced materials end used markets. And as Kevin mentioned, adhesive sales and coatings end used, the year-on-year decline in sales volume was entirely due to the timing of sales lub additives, as sales volumes outside of lubricant additives was up more than 4% year-on-year. In a similar vein, the year-on-year decline in sales volume for Cariflex is largely a function timing of buying patterns by our customers. On a geographic basis, year-to-date volume was up globally except in North America, with the strongest growth coming out of Asia and Europe, where of course the volume gains of 21% and 5% respectively. The decline in North America sales volumes was larger due to lower sales volume in our paving and end used. I want to remind you however that globally our paving and roofing volume was up year-on-year. Moving now to sales revenue. Third quarter 2012 sales revenue was $343 million, down $59 million or 15% from 402 million in Q3 2011. Of the $59 million decrease, 25 million is attributable to currency and 36 million reflects lower average selling prices associated directly with the declines in across the monomers, primarily Betadine. On a sequential basis, sales revenue declined $33 million or 9% from the second quarter 2012. Again, largely due to lower average selling prices of $35 million, resulting from lower raw material prices and a $4 million reduction from currency partially offset by the effect of the increase in sales volume which amount to $6 million in terms of revenue. Third quarter 2012 gross profit was $43 million with the gross margin of 12.5%. This compares to gross profit of $101 million in the third quarter 2011 with the gross margin of 25.2% and $74 million in the second quarter of 2012 with the gross margin of 19.6%. Comparability, however, between the periods presented here is significantly influenced by the bulk of raw material markets where we have exclude the spreads between the FIFO and estimated current replacement cost in each of these periods that they record at 2012 gross profit on current cost or ECRC basis is $80.4 million, which compared to Q3 2011 would have represented growth of $11 million or 16% and growth of $21 million or 35% compared to Q2 2012. The gross margins therefore on an ECRC basis are as follows. 23.5% in the third quarter 2012, up from 17.3% in the third quarter 2011 and 15.8% in the second quarter 2012. I will refer you to the calculation of gross profit on an estimated current costs basis which is included in the appendix of this material as well as to the press release. We’ve isolated the effect of FIFO versus ECRC in the EBITDA bridges along with the other profitability drivers. On a year-over-year basis lower raw material costs resulted in lower average selling prices and lower cost of goods sold. As you know, our price rate strategy is designed to maintain overtime unit margins. In the third quarter, the net of changes in unit selling prices and unit cost of goods sold had a net positive effect of $19 million on EBITDA. As you can see on the slide, the single largest driver in our quarter-over-quarter performance was the $70 million negative effect from raw material volatility. This $70 million represents the spread between the $32 million positive FIFO effect in Q3 2011 and the $38 million negative FIFO effect in the third quarter of 2012. Compared to the second quarter 2012 the drivers are very much the same. Current cost margin expansion of $20 million on lower cost of goods sold at $55 million more than offset the lower raw material-driven decline in average selling prices of $35 million and finally the negative FIFO versus ECRC spread representing a $52 million decline in reported results. The adjusted EBITDA margins therefore on an estimated current cost basis are nearly 15% in the third quarter 2012, up from 9.7% in the third quarter of 2011 and up from 8% in the second quarter of 2012. Here again the calculation of EBITDA, adjusted EBITDA and adjusted EBITDA at ECRC is included in the appendix of this material as well as the press release. Looking now at slide 10, in our second quarter conference call as Kevin mentioned we estimated that raw material price volatility and the related impact on inventory valuation and therefore cost of goods sold would have a $40 million impact on our third quarter. The actual Q3 impact was $38 million and as you can see in the top chart this quarter and the fourth quarter of 2011 are the two largest negative spreads in company history. I want to come back to that point later in the material when we cover up cash flow and the cap structure. We are expected to expand unit margins on a current gross base as the year progress, commencer with the pricing actions we took earlier in the year who respond to rise in feedstock. As you can see, we have indeed enhanced margins during 2012, with third quarter 2012 gross profit kiloton of $1010 up 13% year-on-year and up 23% sequentially. Looking forward, our current views that average monomer costs may decline slightly through year end, driven by lower BD prices. Based upon this view, and considering the tale of that of current inventory that will flow through the P&L, in the fourth quarter as well as all the other assumptions in these estimate the spread, we anticipate a fourth quarter negative spread between FIFO and ECRC of between $5.0 million to $10.0 million. I remind you the magnitude of the spread in the fourth quarter could be significantly different from this current estimate, if monomer prices inventory levels are materially different from our current expectations. Turning to slide 11, few comments on the operating statement. Since I have covered revenue and the factors impacting gross profit in the earlier bridges, a little my comments through a few select items here, Research and Development expenses increase approximately $700,000 compared to the year ago quarter, reflecting cost associated with capability additions to our R&D staff and some associated facility costs. Looking at SG&A expense, SG&A decline almost $2.5 million or 9% year-on-year, due to a $1.2 million reduction in expenses associated with the proposed JV with Formosa and an additional $800,000 resulting from changes in currency. The amount of reduction in depreciation and the amortization was primarily driven by changes in currency exchanges rates. And as Kevin mentioned in the third quarter, we recognized the $5.4 million impairment charge, of which 3.4 million related to capitalized cost associated with the proposed plant in Taiwan and $2 million related to other long-lived assets. Let’s move down to the discussion of our overall effective tax rate, which in the quarter is approximately 10% and on a full year, the raise approximately 25%. The difference is between these effective tax rates and the 16% effective tax rate we guided during the second quarter was related a mix of pre-tax earnings among various tax jurisdictions in which we operate. And the ongoing assessment of the ability to utilized net operating losses in future periods. Let me take a moment to quantify the effect of the actual tax rate versus earlier expectations. The third quarter 2012 tax expense was therefore $1.1 million higher and on a year-to-date basis, the tax expense was $1.5 million higher than each of those been calculated the 16% effective tax rate originally assumed. Third quarter 2012 net loss was $15.5 million or $0.48 per diluted share, which compares to net income of $43 million of $1.33 per diluted share in the third quarter 2011. Our third quarter 2012 net loss includes $0.10 per share dilution, largely due to the aforementioned impairment charges. Here again, impacting comparability of earnings per share with the accounting treatment associated with the acceptability the utilized NOLs for book purposes, which decreased our diluted EPS per share, diluted EPS by $0.30 for the three months ended September 30, 2012 and increased our diluted earnings per share by $0.34 for the three months ended September 30, 2011 set differently a $0.64 net change in EPS. We are pleased with overall cash flow performance in the third quarter and through the first nine months of 2012. Our cash conversion cycle improved 19% from year end 2011 and finished goods inventory measured in kilotons was down 8%. Coupled with declining raw material costs we generated cash flow from operating activities of $33 million in the third quarter bringing us to a $102 million of operating cash flow to the first nine months of 2012. With respect to liquidity at December 30, 2012 we had cash on hand of $202 million and net debt sort of $246 million, resulting in a net debt to capitalization ratio approximately $0.32 as of September 30 and a net debt to trailing 12 month adjusted EBITDA of 2.6 times. We did apply a portion of our strong operating cash flow to reduce term loan debt at December 30. As I mentioned in the discussion of raw material volatility, the negative spreads between FIFO and estimated current replacement cost in Q4 2011 and Q3 2012 were the highest in company history. Thus the TTN period ending September 30 included a $57 million negative effect on earnings. As we viewed this effect during the quarter and we elected to make a $40 million pre-payment under our outstanding term loan at quarter end to provide additional cushion against the maximum core tons of leverage currently allowed in our senior credit agreement. We ended the quarter with leverage as defined in that credit agreement of 3.6 to 1 which is below the core tons allowed. On slide 13 we present our current estimate of some specific P&L items for the full year 2012 which are unchanged from the estimates provided during the second quarter earnings conference call, expect for the effective tax rate assumption which we are increasing to 25% in line with the ETR through September 30, 2012. Each of these estimates is based upon our view at this time and is subject to revisions should circumstances change and we undertake no duty to update these assumptions to the balance of the year. I’d like now to turn the call back to Kevin Fogarty for some closing comments.
  • Kevin Fogarty:
    Thanks Steve. Reflecting on our first nine months in 2012, I am pleased with the progress we are making as we move forward with the strategic initiatives that we believe will drive that portfolio transformation that we outlined at our August 2nd Investor Day. These initiatives include our continued focus on innovation to accelerate the commercialization of key market development platforms. And in this regard we have added additional resources in support of these key activities. In addition I am pleased that despite the continued volatility in raw materials in 2012 and the resulting effects on customer buying patterns, our sales volume for the first nine months of 2012 was up 2% compared to the first nine months of 2011. No question in the near term worldwide economic outlook is uncertain, but we remain cautiously optimistic about the overall outlook for our fourth quarter. Looking forward we are fairly constructive about the near term outlook in North America and Asia. In fact our sales volume in the Asia Pacific region is up in 2012, as we expand our customer base particularly in China where we continue to see growth in companies with an entrepreneurial spirit to value Kraton for an innovation product offering, service model and expansion plans. It shouldn’t surprise you that we remain cautious about the near term outlook for Europe. In our favor is the fact that we have a broad diversification to a wide variety of end use markets and geographies that favor the stronger economies in the Euro Zone that said, giving the uncertain worldwide economic outlook – we are seeing a little incentive for customers to build inventories in the current environment particularly in advance of year end. With respect to our view on raw material prices, based upon recent price data, we anticipate that butadiene pricing may moved down slightly through yearend with relative stability and string in (inaudible) pricing. And as Steve indicated, we expect to record a negative FIFO spread between $5 million and $10 million in the fourth quarter of 2012. With that we’ll be happy now to open the call up for some questions.
  • Operator:
    (Operator Instructions) And our first question comes from John McNulty from Credit Suisse.
  • Unidentified Analyst:
    Hi, good morning. This is (inaudible) I am calling in for John.
  • Kevin Fogarty:
    Good morning, Abi.
  • Unidentified Analyst:
    Couple of quick questions, so you highlighted I guess a slowing global marketplace with some puts and takes regionally, I guess looking at 4Q volumes, could you touch on how we should be thinking about either the sequential drop or at least on a year-over-year basis versus a 4Q last year, where you saw some volume weakness do you expect kind of continue modest volume growth?
  • Gene Shiels:
    Abi this is Gene. You probably know that we’ve not given explicit volume guidance for the fourth quarter, so the only thing I can remind you and that in the fourth quarter of last year, we saw, obviously the impact of declining raw material prices and the associated de-stocking, So it’s done the great one to (inaudible) on the fourth quarter plays out, but as Kevin said, we’re kind of constructive about the view. So I’ll leave to that.
  • Unidentified Analyst:
    Okay. Fair enough. And then just quick follow-up on raw materials, I guess, do you think relative somewhat overcorrected due to the weak macro and some tight inventory management from buyers and maybe you can touch on what you expect from RAS looking at early 2013 as you mean a more normal demand environment?
  • Kevin Fogarty:
    This is Kevin. I think I’ve given up for a long time ago, trying to predict, rational or why the raw material cost and particularly Betadine behaved the way they do in the short-term, both upwards and downwards. The – but that being said, there is always been some kind of historical relationship that we’ve observed that’s kind of not necessarily followed through this last few years as this like cracking fundamental is taken whole. But there is a relationship between underlying energy value, i.e. accrued an after values in Betadine and those relationships seem to be kind of imbalanced today. As we look at next year, we do the same thing, probably you do. We take a consultant’s view in terms of our own internal planning process because that’s the best information we have, I’ll just leave to that.
  • Unidentified Analyst:
    Okay. Got in. Then one last quick one if I may, could you maybe talk a little bit more about why the North American paving and roofing markets were weak and maybe where your outlook is maybe looking out to early next year especially when HiMA starting to ramp-up in some do the domestic regions?
  • Steve Tremblay:
    I take the second part of your question first, I mean, we are very optimistic about our HiMA technology. Pretty much everybody that we’ve engaged with that has used this innovation, I can say are pleased and part of the fact they have engaged us in that kind of technology shift for the specific project. As far as North America is concerned, if you look this is the continuation of the same trends that we have seen in North America over the last four or five years which is depleted state budgets, transportation bills that have been held up in congress and rising cost of inputs that are not supported by increased budgets due to the project. So therefore with fixed budgets and increased inputs to make a load all components not just the asphalt or not just our polymer, then you have you know truly limited funds to take or repay the mileage necessary to keep up and that’s a trend that just you know has been underway for several years in 2012 is no different. And you know on election cycle I think road and infrastructure discussions as it pertains to stimulus has been talked about but I don’t think it’s a major driver of some of today’s budget discussion.
  • Unidentified Analyst:
    Okay. Great. Thanks very much.
  • Operator:
    Our next question is from Mike Sison, KeyBanc.
  • Mike Sison:
    Hey, good morning, guys.
  • Kevin Fogarty:
    Hi, Mike.
  • Mike Sison:
    In terms of Cariflex looks like growth there has started to slow. Can you sort of give us an update on what you think the – long term growth rate there is – has had sort of pick in terms of penetrating some of the replacement products it has in the past?
  • Kevin Fogarty:
    Hi, Mike. This is Kevin. I appreciate your question. Now – first of all, nothing has changed as far as our view about Cariflex and future of Cariflex in fact I think we’ve told investors and analysts that we execute a new contract with our supply – key supplier in Japan to expand capacity and that project is certainly – believe the project is for the most part complete and will startup very soon. So our outlook on Cariflex remains very good. Now remember Cariflex has made up of two parts. It’s made up of the polyisoprene rubber that we produce in Belfry and then the latex form that we produce in Brazil as well as in Japan and the latex is used as a primary feedstock to polyisoprene rubber itself. So we sell the rubber externally and we use it internally. I will make note that while I think the overall volume for Cariflex, the combined in other words, was up 6% in the nine month period. The latex part of the business was up more than twice of that, so almost 13%. So the latex part which is the glove conversions, condoms and medical application that we’ve called out and certainly talked about in the Investor Day still remains very good and the rubber part as we called out in the earnings call just a few moments ago is really timing issue associated with the couple of customers.
  • Mike Sison:
    Right. Okay. And then in terms of HSBC expansion in Asia that you are looking at to do on a standalone basis, could you remind us sort of the importance of doing that. In addition, we’ve seen 300 kilotons now roughly on annualized basis as a I recall you have some capacity, a lot of capacity that you can – that you could still use. Is there any way to maybe convert some of those plans versus expanding or is the expansion really something you need to do?
  • Kevin Fogarty:
    Thanks Mike. Look, the project is a very critical project in terms of grade down the future. And it’s important for everybody understand we said this before that the HSBC that we produce at all our plants is different, in terms of, the quality and the types of grade slate we expect to produce in these plants. And as we said about this new project for Asia, this is the truly the state-of-the-art technology that we believe we are fight advantage in terms of producing and certainly, is key to many new innovation platforms that we called out for investors. So, yeah, it is a very important project. Now as to the question about conversion, at the end of the day, two things I’d say about that one is the plans that could be converted the USBC Plants in another words that could be compared with HSBC are not in the right location are not in Asia. And then secondly, these USBC plants are profitable in their own rights, so by converting and taking away that profitability that makes ineffective if you do the math right, that conversion all the more expensive. And so from our standpoint, there should be a standalone project that we are very confident in our ability to select the site. Most of the engineering, heavy lifting engineering work has been done already associated with the Taiwan joint ventures. So now it’s just a matter of replicating that activity at a two butadiene sites and the team is on the ground as I mentioned just few moments ago, well underway doing that. And one other things we are discovering two is and I know that feedstocks is always an important driver in our business, could we talk about a lot, but we have discovered in the process of looking at these alternatives sites and by the way, as you knew that for most see, one of the drivers was availability of 700,000 Betadine on site. But as we’ve looked around the region particularly in China, our eyes have been open to the amount of Betadine development activity underway be it as construction or project development activity for on purpose Betadine, which we think is a very good trend and give us even more confidence in our ability to not only build and construct and operate the plant, but also provide that key feedstock. And I remind you this is a 30 kilo tonne project. This is not a USBC project, this is an HSBC project. So at most the 30 kilo tonne project for Kraton needs only 20,000 to 25,000 tonnes of Betadine. So we think the surety supply is – there are number of options for us, our ability to pull up the project in timely manner, on the standalone basis now. We feel very good about and just a matter picking the right facility that satisfies all our key operating criteria.
  • Mike Sison:
    Got it. And one quick follow-up. Thanks. That was helpful. In terms of your raw material procurement, is there a way to maybe streamline that or reduce the monthly inventory you carry in order to reduce the volatility you have with the changes in Betadine prices?
  • Steve Tremblay:
    Yeah, Mike, the driver really of that the volatility is less on the mono raw material. We carry relatively little raw material. You recall much comes through the well in Europe. Our tenant landlord relationship with LBI. So really comes down to managing finished goods, which – that’s why I made the comment that we’re actually down around 8% or 9% finished goods. That’s really our focus is more on managing the finished goods. And again, I think, you know that as we carry what we believe to be the right amount of inventory to meet our customer needs across the lighter ray of product offerings that we offer especially needing to cover that like everybody else in our industry cover that that global footprint out of a relatively limited number of sites.
  • Mike Sison:
    Got it. Great. Thank you.
  • Operator:
    Our next question comes from Gregg Goodnight, UBS.
  • Gregg Goodnight:
    Good morning all. Challenging quarter to analyze your comments very helpful. Kevin you mentioned that you are not in a position to talk about timing and cost of your Asian plant, but will you mention what your target is for timing of site selection going forward?
  • Kevin Fogarty:
    Yes, suffices to say that we are moving as rapidly and responsibly as we can. But I think it’s certainly with on relative possibility that by the end of first quarter we will have to complete that exercise.
  • Gregg Goodnight:
    Okay. Great. Steve your – you mentioned effective tax rate for the year is now expected at 25% does that also apply to the fourth quarter?
  • Steve Tremblay:
    Yeah, you can make that assumption, Gregg relative to – you know the seasonality of our business is heavy volume and therefore EBITDAs Q2 and Q3, and slightly lowers in Q1 and Q4. So we will be entering as period of seasonality low volume and therefore you know pre-tax will be commensurate with that volume relative to second and third.
  • Gregg Goodnight:
    What are your expectations for valuation, allowance, adjustments to your tax say in fourth quarter for next year?
  • Steve Tremblay:
    For 2013?
  • Gregg Goodnight:
    Yes.
  • Steve Tremblay:
    Yeah, we haven’t – we haven’t carry out our overall plan. That’s going to be a function of where we end obviously this year and then what our flow I’d call is for the next two plus years. Our current view and the reason that we’ve been diligent in the past given the effective tax rate disclosures without the effect of movements in the VA is to give you sense of whether your effective tax would be without that accounting and we’ve been gravitating in the load amid 20%, have some changes in valuation allowance.
  • Gregg Goodnight:
    Good. So effective tax rate for 2013 any guidance at this point.
  • Steve Tremblay:
    Not at this point I’d be getting over my skis a little bit.
  • Gregg Goodnight:
    Okay. Thanks for your help guys.
  • Steve Tremblay:
    Sure.
  • Operator:
    Our next question is from Edward Yang from Oppenheimer.
  • Edward Yang:
    Hi, good morning Kevin.
  • Kevin Fogarty:
    Hi, Ed.
  • Edward Yang:
    I know Gene punted on the earlier volume question would like to try to reconcile your cautious comments on the economy with your relatively upbeat tone when Kraton’s on volume trends. Is the delta really just customer destocking that’s finally done and what do you think is the underlying demand rate at stable inventory levels. You mentioned that volumes were up 2% in the quarter and for the year so is that you have a good run rate going forward.
  • Kevin Fogarty:
    Well, you know we have always tried to make a case that our expectation as we grow our business at 2X GDP problem is that GDP metric is one that we can be duetting all day long right now. And certainly as we look at our business, different regions in different end users we are seeing different pockets of impact from the economy as well as very encouraging developments particularly around our innovation platform. So it’s not one answer from the standpoint of trying to bucket if you will, my comment about being constructive about our business, but I will tell you that at the end of the day, nothing is changed in terms of our strategy, nothing is changed in terms of how we look at our business and the portfolio transformation that we are well on our way and the innovation platforms that we have been developing have not slowed in terms of our focus on them, nor the customers that we are working with and developing in commercialization. So its economy right now that clearly is uncertain in many places the world like Europe, but on the other hand I already told you about how we see, our Asia business particularly in China full this year and that’s been quite encouraging.
  • Edward Yang:
    Okay. That’s helpful. And Steve noted the nice margin expansion that you saw at constant raw materials on your gross margin per ton, went back over $1000 a ton, how sustainable is that, during the quarter did you see any benefit from pricing lags versus falling butadiene, do you have recur any of that back?
  • Steve Tremblay:
    Yeah, Ed., we – the expansion in margin that we saw in the third quarter getting us to that $1000 a ton which we continue to believe is if you will jumping off point where our future innovations are going to take us and grow from that. You’ll notice in the EBITDA analysis and then the prepared comments that we talked about an expansion in margin – the faster rate of decline of raw material versus the selling prices and that is just a continuation of what we keep doing which is price right strategy. We were chasing raw material cost increases up until July before the market turned over, we would diligently increasing pricing around the globe, although we were lagging like we do traditionally and now the third quarter reflects a reversal of that. So it’s – we’re just seeking to that state of strategy. And we’re not going to deviate from that. We continue to believe however that a $1,000 a tonne is a good starting point run rate, certainly variability from quarter-to-quarter associated with customer and product mix as well as the overall absorption of fixed cost in the lower fourth quarters and lower first quarters. Generally have a negative impact on those margin per tonnes of anywhere between a $1,000 and $150 a tonne. But that’s seasonality which is structural to the business and nothing that would indicate within those fourth quarters that we have done anything that would take us away from our run rate assumption of $1,000 again as our starting point from which we expect to grow the business.
  • Edward Yang:
    Okay. And Betadine has been fairly stable in the last couple of months, October and November have been unchanged. But it will probably pick back up again in terms of the volatility. So could you provide us with an update on your progress in terms of further optimizing your contracts and your pricing strategy and tightening up the lags between Betadine price changes and your ability to pass through those cost in a timely fashion?
  • Kevin Fogarty:
    Yeah, I mean, look, you hit the nail and headed real-time price is certainly our objective, now we’re going to see another 2012 repeat itself in terms of these remarkable monthly moves on Betadine price in the course of the first four, five, six to seven months of the year and then have that completely unwind in the second half of the year this way. I don’t know like I said earlier we’re not going to be able to predict, but we will do everything in our power to apply more of a real-time pricing mentality into our commercial strategies in the particularly as we go into the New Year when as history has presented itself anyway has seen most of that raw material escalation. So – now did want to mention by the way earlier that about our growth profit per ton that you were asking Steve about – just to reminder that Steve is absolutely correct in terms of how we base our business expectations, but as we layer in NEXAR our membrane technology and more and more Cariflex sales and more and more high end HSBC sales as we bring on this new project. I mean these things are all designed to allow for that portfolio shift, to allow for the mix effect if you will of superior margin business to raise that expectation of performance overtime and that’s exactly what our strategy is and so – you know the current period the $1,000 a ton now having achieved it. I think is a good performance for the company. But as we look long term clearly, you know, we are focusing on expanding that through the types of products that we are going to be commercializing through our innovation portfolio.
  • Edward Yang:
    Okay. Excellent. Thank you.
  • Operator:
    Our next question comes from Christopher Butler with Sidoti & Company.
  • Christopher Butler:
    Hi. Good morning everyone.
  • Kevin Fogarty:
    Hi, Chris.
  • Christopher Butler:
    You stole little bit of my thunder with your last answer, but you know looking at this quarter, some of your higher margin product seems to have been – the volume seem to have been depressed. So even looking at your strong $1,000 gross ton number would that have been higher if you have had a more normal product mix?
  • Kevin Fogarty:
    Well, I was looking to try to move that number north with a more attractive product mix. I think what I wanted to call out in the call is in those specific areas like Cariflex there were some timing issues and we don’t measure the business in terms of quarter-to-quarter as you might expect. We look at how the business does on an annual basis year-on-year to make sure that we are at or above our internal expectations and as I mentioned earlier Cariflex is made up of both isoprene rubber as well as the latex form and the isoprene rubber certainly had some timing challenges. The Cariflex business continues to show and demonstrate nice growth and we expect that trend to continue.
  • Christopher Butler:
    And as we look at the timing shift is this something that’s going to help the fourth quarter or is this gets smooth out over few quarters.
  • Kevin Fogarty:
    Again I think it’s better to be thinking about that business on year to year basis because of that timing, but yeah, I think I’ll leave it at that. This is – when I look at the – when I think about the key customers that this impacted, we certainly work with them on our annual business and how they make their own production requirements mirror our supply requirements on a quarter-to-quarter basis it’s a tough call.
  • Christopher Butler:
    And looking at the mess up here in New York and New Jersey, any thoughts on how the hurricane may help demand next year and the upcoming election and thoughts on how that may impact next year on the paving and roofing side?
  • Kevin Fogarty:
    Chris we really do not have enough time to answer those two questions, but let me just say two things, one is first and foremost to all our friends on the phone we know you guys many of you’ve gone through a pretty tough time this past week and we in Texas as are most sensitive of that because we’ve gone through some of those tough times doing and we should nothing but the best and safety first of course, certainly I was expecting the question about how that might impact our business and the bottom line is there is no impact per se at our facilities in Ohio, but it’s clear that some of the port activities in the North East are impacted by Sandy and the followed from Sandy. And so, we know we do everything in our power within this quarter to make sure we are making the adjustments we need to bolt on keep feedstock supply as well as making sure we are able to ship our products to our customers and the fortunate things about our logistical system is we’ve got a lot of flexibility into it, which is why we have this global footprint in the first place that’s all – that’s part of that service model offering that we are second to no one in the industry in our view. Now, as it affects next year, I think it’s too soon to tell, but – my guess is there is a construction impact sadly because of the devastation that we’ve all seen. So there is certainly we would expect to see some construction impact both in the infrastructure part of our business as well as the both the industrial and residential housing, there is a lot of parts of our business that are impacted there. So, it’s too soon to tell, but if you look around the globe with some or the other tragic events like in Japan, like in New Zealand and we’ve seen some impact following the year as a result of those sad nature devastations. I am not going to comment on the election, whatsoever, because it would be just a speculation.
  • Christopher Butler:
    I appreciate your time.
  • Operator:
    Our next question is from Brain Maguire, Goldman Sachs.
  • Brain Maguire:
    Hi, good morning.
  • Kevin Fogarty:
    Good morning.
  • Steve Tremblay:
    Hey, Brian.
  • Brain Maguire:
    Steve, you – on slide 10 you mentioned we had another quarter here with the kind of abnormal difference between the current replacement cost, gross profit at about $1,000 a ton and the FIFO gross profit at about 535, just trying to think about where its – what’s kind of a normalized number that strip out some of the noise from the inventory impact there. I know you have mentioned in the past that overtime this start to contract towards each other and if we have a period of stable monomer prices, which we maybe hopefully entered here it’s been stable for the last couple of months we’d eventually get to a point where those two should conversion come to and have a meeting point, somewhere closer to middle of where there a – so just trying to like get to that point, if – is the right way to look at it, kind of where that these the average of gross profit per ton of FIFO basis has been and versus where it’s been on the current replacement cost basis and then splitting the difference there, and if you did that word, you think you kind of come out here.
  • Steve Tremblay:
    Great question Brian. When we talked about in the past, the somewhere between the middle has been – in those periods of extreme volatility like we have in this period, A; we set that as more of the midpoint to kind of the floor, for example, back in I am not saying slide in years, in periods, where the FIFO margins were north of 1300 and current gross margins were in the 900 range that would indicated and implied steady stare operating rate of somewhere around the $1,000 a ton. A little bit different this quarter given when in the month that effect of the $38 million frankly took place, right it was in the quarter, but it depends on which months, stripping out the noise, the way we view the business is on that current gross basis, because it does indeed take up the noise of that – of that inventory volatility. So overtime if there steady feedstock environment subject to quest – differences in product mix and alike, but if the monomers remain absolutely constant you know we would – we would be printing $1,000 current cost margins.
  • Brain Maguire:
    And that...
  • Steve Tremblay:
    And that would then definitely that would be the same as FIFO margins, right, because FIFO and current cost would definitely be the same value.
  • Brain Maguire:
    So then in that $1,000 of ton you think you’ve already kind of marked the prices – you sell your products to where the monomers went you know during the quarter or in other words there wouldn’t be any price get back that would take that below a $1,000 a ton?
  • Steve Tremblay:
    That’s correct.
  • Brain Maguire:
    Okay.
  • Steve Tremblay:
    Yeah.
  • Brain Maguire:
    And just one – last one if I may. Just you know, just talking about the volume trends, you know, which up overall, you know, given the macro backdrop is – that pretty good although, you might have thought you get some restocking and may be eventually we will get that but how do you kind of assess where your competition volumes are going and are you concerned about a share shift that’s been going on or you know what do you kind of just seeing in the overall industry?
  • Kevin Fogarty:
    I think we talked about the competition before. And the fact of the matter is that most of the competition that we face you know kind of played a different level than Kraton does, particularly on the HSBC side of our portfolio. On the USB say side of the portfolio, I think, that there is certainly additional capacity that we are aware of are particularly coming out of Asia and you know that from time to time they do have an influence on you know customer buying patterns in that sense, but look I think that unlike other polymer and chemical businesses, you know, Kraton is focused and where Kraton positions itself in the market at the price points we sell at that is commencer with innovation and the total service model offering. The competition doesn’t play the same type of dynamic that they do in other polymer business certainly as far as Kraton is concerned. That all being said, we don’t really measure share as a key performance driver for Kraton, because at the end of day as I said before, our number one objective here is in order for us to grow profitably. We have to find new applications for Kraton that don’t exist today in the marketplace, in other words create the market as opposed to take share in the market which just isn’t a performance drive for us.
  • Brain Maguire:
    Okay. Thanks very much.
  • Operator:
    Thank you sir. This does conclude the question-and-answer session. Now I would like to hand the call back to Mr. Gene Shiels for closing comments
  • Gene Shiels:
    Thank you, Marla. I’d also like to thank all of the participants this morning for their interest in Kraton. Just as a reminder, a replay of this call will available beginning at about 11 eastern today and will be available through November 15. You can access that replay from our website kraton.com selecting the investor relations link at the top of the homepage and then selecting events. You can also hear a telephonic replay of this call by dialing 866-349-4505 and international callers may dial 203-369-0029. This concludes our call. You may now disconnect.
  • Operator:
    This concludes the Kraton Performance Polymers Incorporated third quarter ended September 30th 2012 earnings conference call. You may now disconnect.