Kraton Corporation
Q3 2014 Earnings Call Transcript

Published: 31 Oct 2014

[Operator:]

Good morning and welcome to the Kraton Performance Polymers Inc. Third Quarter 2014 Earnings Conference Call. My name is Rebecca; 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. Now I would now turn the call over to Mr. Gene Shiels, Director of Investor Relations.

[Gene Shiels:]

Thank you, Rebecca. Good morning, everyone and welcome to Kraton Performance Polymers third quarter 2014 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 yesterday’s news release is available in the Investor Relations section of our website, as our copies of the presentation we will review this morning. Before we review results for the third quarter, I will draw your attention to the disclaimers on forward-looking information and the use of non-GAAP measures included in our presentation this morning and in yesterday’s earnings press release. During the call, we may make certain comments that are not statements of historical fact and does constitute forward-looking statements. Investors are cautioned that there are risks, uncertainties and other factors that may cause Kraton’s actual performance to be significantly different from the expectations stated or implied by any forward-looking statements we will make today. Our forward-looking statements speak only as of the date they’re made and we have no obligation to update such statements in the future. Our business outlook is subject to a number of risk factors as the format of this morning’s presentation does not permit a full discussion of these risk factors. Please refer to our Forms 10-K, 10-Q and other regulatory filings that are available in the Investor Relations section of our website. With regard to the use of non-GAAP financial measures, all references to adjusted EBITDA, adjusted gross profit, and adjusted earnings or adjusted earnings per share in this call and in the presentation material exclude the impact of the spread between FIFO and estimated current replacement cost or ECRC. A reconciliation of EBITDA and adjusted EBITDA to net income or loss and a gross profit to adjusted gross profit as well as a reconciliation of net income or loss attributable to Kraton to adjusted net income was provided in yesterday’s earnings release and is included in the presentation material we will review this in this call. Following our prepared remarks, we will open the line for questions. I will now turn the call over to Kevin Fogarty.

[Kevin Fogarty:]

Thank you Gene and good morning everyone. Before we review our third quarter results, I want to draw your attention specifically to the announcement of yesterday’s press release that our board has approved a $50 million share repurchase program. Kraton’s board and management team clearly believe in Kraton’s strategic direction and growth prospects. Given our current market valuation, we believe the share repurchase program represents a prudent use of capital. It should allow our investors to see accretive benefits. We intend to fund the repurchase program through a combination of cash and debt and we currently have significant availability under our bank loans which are undrawn. Through the program, we expect to repurchase shares through open market transactions at prevailing market prices to privately negotiated transactions and/or through one or more trading programs under Rule 10b5-1. Based upon the strength of our balance sheet and our financial flexibility we believe the $50 million share repurchase program will not restrict our ability to pursue other strategic opportunities. Turning now to third quarter results on slide four. In terms of highlights for the quarter, I’m pleased to report that third quarter sales volume for our Cariflex end use was up significantly with 48% volume growth compared to the third quarter of 2013. With this growth our third quarter 2014 results for Cariflex represent company records for both sales volume and revenue. The balance of our portfolio, third quarter 2014 sales volume for adhesive sales coating end use was up 5% and this serve to offset a modest decline in advance materials. Our biggest challenge in the third quarter, however, was in our paving and roofing end use were economic and competitive conditions in Europe resulted in a 14% decline in paving and roofing sales volume compared to the third quarter of last year. For the quarter overall and concerning the headwinds in our European paving and roofing business, sales volume was down 2.8 kilotons compared to the third quarter of 2013. With the decrease driven by lower sales in our USBC product rates again predominantly in the paving and roofing end use. There are a number of positives in the quarter and these included continued growth and innovation sales with innovation sales volume up 7% compared to the third quarter of 2013. For the trailing 12-month period ended September 30, 2014, our vitality index did remain at 15%. In addition, during the quarter, Kraton generated cash from operating activities up $34 million excluding the $1.2 million deficit of our KFPC joint venture included in the consolidated cash from operations up $32.8 million generated in the third quarter. Substantially offsetting the cash use in the first half of the year. That is a high level overview of the quarter. Let’s now turn to slide five for a summary of third quarter financial results. Third quarter 2014 sales volume was 80.7 kilotons and this was down 2.8 kilotons or 3.4% compared to the third quarter of 2013. As I mentioned a moment ago, we saw strong year-on-year growth in Cariflex and our HSBC sales volume was essentially unchanged compared to the third quarter of 2013. So to reiterate the decrease of overall sales volume is attributable primarily to lower sales of USBC grades principally in the paving and roofing end use. Third quarter 2014 revenue was $319 million down $8.1 million or 2.5% compared to the $327.1 million in the third quarter of 2013. As Steve will speak to more in a few minutes, the revenue decrease was primarily the result of customer and product mix within specific end users, competitive pressure on pricing in the European paving and roofing markets and decreases in [indiscernible] prices. As the impact of lower sales volume in our USBC product set was substantially offset by the contribution from higher Cariflex sales volume. An income attributable to Kraton was $16.6 million or $0.50 per diluted share in the third quarter of 2014 compared to a net loss of 5.6 million or $0.17 per diluted share in the third quarter of 2013. Adjusted net income which is adjusted for specific items that are outlined in yesterday’s earnings release and excluding the per share impact of the negative spread between FIFO and ECRC was $0.35 performance diluted share in the third quarter of 2014 and this compares to adjusted earnings of $0.60 per share in the third quarter of 2013. Adjusted EBITDA which is defined as EBITDA net of the discrete items outlined in yesterday’s earnings release and excluding the spread between FIFO and ECRC was $39.4 million in the third quarter of 2014 and this compares to $44.8 million in the third quarter of 2013. While third quarter 2014 adjusted EBITDA decreased year-on-year in large part due to the weakness in European paving and roofing markets on a year-to-date basis adjusted EBITDA is $115.5 million up $9.6 million or 9.1% compared to the $105.9 million for the first nine months ended September 30, 2013. Turning now to slide 6 for more detail on our third quarter results for our foreign uses starting with Cariflex. Cariflex revenue was $40 million in the third quarter of 2014 up $11.7 million or 42% compared to the $28.2 million in the third quarter of 2013. This record quarterly revenue was largely a result of the 48% increase in sales volume I referred to in my opening remarks with the impact of higher revenue partially offset by the impact of customer mix on average selling prices and $500,000 negative effect from currency movements. The sales volume increase in the third quarter 2014 was largely driven by demand growth and surgical gloves applications. As we have discussed in prior quarters sales mix for Cariflex can vary from quarter-to-quarter depending on the relative contribution of overall sales between solid IR and Latex. In addition, different selling prices for solid IR and Latex or variation selling prices driven by either customer or specific applications within our Latex sales specifically surgical gloves versus condoms can have an impact from quarter-to-quarter. So while we had a strong volume growth in the quarter the specific mix was factor in comparing average selling prices in the third quarter of 2014 for those in the third quarter of 2013. Additionally, I’ll remind you that volume is not ratable throughout the year. Following a strong quarter for Cariflex in the first quarter of ’14 and with sales volume was up 36%, we had a number of questions about our second quarter 2014 Cariflex volume which was essentially flat compared to the second quarter of 2013. Despite this lumpiness sales volume on a year-to-date basis our Cariflex volume is up 28% compared to the first nine months of 2013. We continue to believe in the long-term growth potential that Cariflex represents. In order to support continued growth, we’ve exercised our option for the next increment of Latex capacity with our manufacturing partner in Japan. This capacity addition should come online in early 2016 and will support continuous sales growth in Latex application such as surgical gloves and condoms. Looking at a few details about our Cariflex end use I’ve seen in the upper right hand part of the slide. For the trailing 12-month period ending September 30th, 2014; 97% of our Cariflex sales are directed into medical applications such as surgical gloves, stoppers and condoms with the balance in industrial application such as coal seal adhesives. In the lower left hand part of the slide, the geographic revenue split for Cariflex remains concentrated in Asia with the significant number of Cariflex customers for glove and condom applications in the region. Lastly, reflecting the true specialty nature of Cariflex for the TTM period ending September 30, 19% of revenue was driven from innovation grades and the balance of the Cariflex coal portfolio is comprised of differentiated product rates. The change in the composition of innovation revenue from 28% at the end of the year 2013 to 19% at September 30 reflects the fact that certain Cariflex grades which have been in the market for 5 years and therefore rolling out of the innovation revenue bucket into the differentiated bucket in accordance with our internal designation. This does not necessarily indicate any change in product margin. Turning now to advanced materials on slide 7, third quarter of 2014 revenue was $74.2 million a decrease of $7 million or 8.6% from the $81.2 million reported in the third quarter of 2013. The decrease was due to product and customer mix and to a lesser extent a 3.4% decrease in sales volume. The decrease in sales volume was primarily due to lower sales in personal care applications partially offset by higher sales to other HSBC applications. At a lowered Q3 2014 sales into personal care applications compared to the third quarter of ’13 reflect the trend that we’ve discussed in recent quarters and with certain customers have shifted from HSBC chemistry to lesser differentiated and lower cost materials including USBC integration grades provided by Kraton. As we discussed last quarter, we believe the impact of this shift is largely over as evidence by the fact that volume and personal care applications in the third quarter of 2014 was essentially flat on a sequential basis. Innovation sales volume for advanced materials increased 8.2% in the third quarter of 2014 compared to the third quarter of 2013. With higher sales volume of HSBC innovation grades led by sales in to medical and auto and industrial applications and increased sales of USBC based innovation grades into personal care applications. End use revenue by application type is reflected in the upper right hand part of the slide. Evidence of our continued progress in PVC alternatives which are based upon HSBC chemistry for the trailing 12-month period ending September 30, 2014 with sales into medical applications represents 17% of TTM revenue up from 13% of TTM revenue at December 31, 2013 and sales into wire and cable applications represented 6% of TTM revenue at September 30th up from 3% the 12-month ending December 31, 2013. And showing in the lower right hand part of the slide, innovation grades now represent 30% of trailing 12-month revenue at September 30, 2014 up from 26% for the trailing 12-month period at year end 2013. The combined innovation and differentiated sales accounting for 67% of TTM revenue at September 30th. For our sealants, adhesive sales and coatings end use third quarter 2014 revenue was $119.1 million up $1.5 million or 1.3% compared to the third quarter of 2013. Sales volume increased 5% year-on-year, the revenue contribution from higher sales volume partially offset by lower average sales prices reflecting lower raw material cost primarily for isoprene and due impart to the negative impact of currency movements which had an adverse impact on revenue of approximately $0.5 million. The increase in sales volume was led by higher sales into pressure sensitive adhesive and industrial applications. Innovation sales volume also grew year-on-year led by increased sales into oil additive, protection film and oil gel applications. Looking at revenue composition for the ASC end use, in the lower right hand part of the slide for the trailing 12 month ending September 30th 5% of revenue was derived from innovation grades and 43% of revenue was derived from differentiated grades or total 48%, relatively unchanged from the TTM period at year-end 2013. Looking at our paving and roofing end use now on slide nine. Third quarter revenue was $85.6 million down $14 million or 14.2% the $99.7 million in the third quarter of 2013. This revenue decline was due primarily to lower sales volume in the European paving and roofing markets which was down 16% compared to the third quarter of 2013 and reflects economic and competitive dynamics which have an adverse impact primarily in August and September. As an overall sales volume for paving and roofing end use was down compared to the third quarter of 2013. We did see really good growth for HiMA led by sales in Europe but also in North American and South American markets. We encouraged by the growing interest in HiMA that we see globally. Sales trends have been encouraging in emerging market such as Brazil and most recently we completed the first road trial of HiMA technology in St. Petersburg, Russia. The extreme durability provided by HiMA was deemed ideal for the harsh conditions in St. Petersburg which included weather extremes and road wear resulting from studded winter tires. Continued success with HiMA has contributed to the growth in innovation sales in the paving and roofing end use which you have seen in the bottom right hand part of the slide no comprises 13% of TTM revenue at September 30th. Summing up the Kraton portfolio on slide 10; for the TTM period ending September 30, we’d continue to grow in 2014 Cariflex now represents 11% of total revenue up from 9% at year-end 2013. Advanced materials represents 25% at September TTM revenue. Adhesive sales and coatings is now 38% of TTM revenue and paving and roofing accounts for 26% of TTM revenue at September 30. Overall sales of innovation grades comprise 15% of the trailing 12-month revenue mix at quarter end resulting in a [indiscernible] of 15%. And sales of differentiated grades represent 45% of total revenue with combined innovation in differentiated grades comprising 55% of TTM revenue. With that summary, I’ll now turn the call over to our Chief Financial Officer, Steve Tremblay for more in-depth review with the financials. Steve?

[Steve Tremblay:]

Thank you, Kevin and good morning everyone. Let me start with the recap of third quarter sales volume and revenue before I get into discussion of gross profit EBITDA and EPS. Third quarter 2014 sales volume was 80.7 kilotons which was down 2.8 KT or 3.4% compared to 83.5 kilotons of sales volume in the third quarter of 2013. As Kevin said in his review, Cariflex sales volume was up 48% compared to the third quarter 2013 and ASC volume was up nearly 5%. However, sales volume in our paving and roofing end use was down 14% with the majority of that decline driven by lower sales volume into European paving and roofing markets. As a result sales revenue was $319 million in the third quarter of 2014 down $8 million or 2.5% compared to Q3 2013. Although sales volume was down year-on-year a decrease in sales volume was not a significant factor in the revenue decrease. As the revenue impact of lower USBC sales was largely offset by the revenue contribution from higher Cariflex sales volumes which sell at a higher unit price point than our USBC products. The adverse impact of currency movements accounted for $2 million of the revenue decrease with the balance of the decrease in revenue attributable to lower sales prices associated with 3 factors each of which Kevin touched on earlier. Gross product mix than demand weakness in competitive conditions in the European paving and roofing markets and finally lower average selling prices associated with lower average raw material costs. I’ll now move to slide 12 for a review of gross profit and adjusted gross profit. Gross profit on a U.S. GAAP basis was $63.8 million in the third quarter 2014 representing an increase of $16.4 million of 35% compared to $47.5 million in the third quarter 2013; excluding the negative spread between FIFO and ECRC of 1.8 million in the third quarter 2014 and $20.7 million in the third quarter 2013, as well as excluding other non-recurring items. Our adjusted gross profit was $64.7 million in the third quarter 2014 with an associated margin of 20.3% compared to $71.7 million in the third quarter 2013 with a margin that was 21.9%. The $7 million decline in adjusted gross profit was primarily due to the aforementioned weakness in paving and roofing business. And to a lesser extent we experience the decrease in HSBC margins compared to 20 Q3 2013 with a steep drop in raw material cost contributed to margin expansion in the last year’s prior third quarter. I do want to note however then on a sequential basis, our HSBC margins improved when compared to the second quarter of 2014. And finally and importantly partially offsetting these two factors was the favorable impact on gross profit from the significant increase in our Cariflex sales volumes. Adjusted gross profit therefore was $802 per ton in the third quarter 2014 compared to $866 per ton in the second quarter 2014 reflective of the negative operating environment Europe and to a lesser extent the impact of sales and customer mix within our Cariflex end users as Kevin mentioned in his earlier comments. Despite the margin pressure in the third quarter 2014 and the resulting impact on gross profit per ton on a year-to-date basis, our adjusted gross profit per ton was $850 in 2014, which is an improvement of $38 per ton from $812 per ton in the first nine months of 2013. As we think forward to the balance of the year, despite the seasonally low sales volume we typically see in the fourth quarter which can be a headwind with respect to gross profit per ton, we currently expect the gross profit per ton will increase in the fourth quarter to approximately $850 per ton. As we turn to slide 13, a few comments on adjusted EBITDA and finally adjusted EPS. As a result of the factors which we drive in the decline in adjusted gross profit our adjusted EBITDA declined $6 million to $39 million in Q3 2014. Our GAAP net income amounted to $16.6 million or $0.50 per diluted share in the third quarter of 2014 which compares to a net loss of $5.6 million or $0.17 per diluted share in the third quarter 2013. On an adjusted basis, EPS was $0.35 in the third quarter of 2014 and this reflects a reduction of $0.25 per diluted share of which $0.22 is associated with the decline in gross profit and we also had a $0.03 negative impact resulting from a higher tax provision. For the nine months ended September 30, adjusted net income was $1 per diluted share, an increase of $0.11 per share compared to adjusted net income of $0.90 per share for the nine months ended September 30, 2013. The increase in adjusted EPS largely reflects the aforementioned expansion in adjusted gross profit in 2014 compared to the first nine months of 2013. Slide 14, shows some relevant data on cash flow and debt for both the three and nine month period ended September 30, 2014. Take a moment to note that in this presentation, we provided a breakdown of consolidated data between Kraton on a standalone basis and cash flow items and debt associated with our consolidated KFPC joint venture which of course is the entity which is constructing our 30 kiloton HSBC plant in Taiwan. Consolidated operating cash flow for the three months ended September 30, 2014 was nearly $33 million, which includes a $1 million operating cash flow deficit at KFPC. The $34 million in cash generated by Kraton standalone in the third quarter substantially offset the cash flow deficit from the first half of 2014 and that third quarter performance was essentially in line with our earlier expectations. Third quarter 2014 CapEx was $29 million, this includes $11.3 million CapEx of the JV and on a year-to-date basis CapEx was $84.1 million and this again includes $33.8 million of CapEx in the KFPC joint venture. We closed September 30, with consolidated cash of $62.3 million, $22 million of which is the cash that remains at the KFPC to fund future CapEx and the balance is Kraton liquidity. Consolidated debt at September 30 was $351.9 million and although we close the joint venture financing in July as of the quarter end September we have yet to draw that $180 million facility. Net debt therefore was $311.6 at September 30, 2014 yielding a net debt to net capitalization ratio of approximately 38% and yielding leverage of 2.1 turns on an adjusted EBITDA basis at 9/30/2014. It is our usual practice at this point I’d like to close with the review of some selected guidance items for 2014. We now expect our full year 2014 research and development expenses to be approximately $32 million and we are also expecting SG&A cost in the year $89 million. I want to note that $89 million excludes $11.7 million of the transaction cost associated with LCY transactions and some modest restructuring and related charges which we incurred earlier in the year. Our depreciation expense for 2014 is expected to be $67 million and this represents an increase of about $1 million from our prior year estimates. We continue to expect 2014 interest to be $25 million and as shown on this slide we expect our full-year tax provision to be approximately $7 million. We pause for a moment, that $7 million excludes the valuation allowance benefit of $1.9 million which we recorded in the third quarter 2014. So on a GAAP basis this we translate into an expected full year tax provision of approximately $5 million. Moving to our view of full year earnings, we now expect full year 2014 adjusted EBITDA again excluding the spread between FIFO and ECRC to be in the range of $147 million to $150 million. Speaking of raw material, as outlined in yesterday’s earnings release given recent trends in raw material prices for the full year 2014, we now expect a negative spread between FIFO and ECRC at $5.5 million which when combined with the spread through September which would therefore indicate a negative spread in the fourth quarter of $12 million. In closing out our discussion of 2014 estimates, we want to provide an update of our view of the turnaround cost in 2014; these costs have been effectively unchanged at essentially $10 million throughout the balance of the year and are associated with scheduled turnaround activity at our sites in Belpre and Wesseling. The Belpre turnaround has been complete as of now and the activity of Wesseling remains underway. I’d like now to turn the call back to Kevin Fogarty for some closing comments. Kevin?

[Kevin Fogarty:]

Okay. Thank you, Steve. Before we turn the call over for some questions I’ll offer few final comments to summarize our third quarter results and provide some thoughts on the near term outlook. Based upon record results for Cariflex in the third quarter of 2014 and as evidenced by the 28% increase in year-to-date sales volume we believe the Cariflex remains on its expected growth trajectory. Therefore we have initiated the next latex capacity expansion which should be operational in the first part of 2016. Well they were not completely immune to economic conditions in Europe and elsewhere I’d characterize third quarter results for our adhesive sales and coatings and advanced materials end uses to be generally in line with our expectations. As discussed sales volume in adhesive sales and coatings was up 5% year-on-year and then sales volume decrease in advanced material this was primarily due to the lower sales volume in personal care markets which was partially offset by other HSBC sales. Lower sales into personal care applications reflect the market shift we’ve discussed over the last several quarters. We believe the shift has large record and that going forward the sale mix in the advanced materials and you should be stable. However, during the third quarter of 2014 we faced the challenging comparison against the sale volume in the third quarter of 2013 in which they impacted the shift has not fully realized. Looking at our innovation portfolio, we continue to see growth in the third quarter of 2014 with innovation sales volume up 7% year-on-year, certainly the most challenging aspect of the third quarter as we’ve discussed was difficult market environment for the European paving and roofing in these markets where our sales volume decrease 16%. Conditions in European paving and roofing markets we can significantly in August and weakness continued in the September or the impact of difficult economic environment weak underlying demand was compounded by strong competitive dynamics leading to margin pressure that we discussed. Thus far in the fourth quarter, weather conditions in Europe appear favorable and there is a possibility that this continued favorability in weather could extend the paving and roofing season. The paving and roofing we remain optimistic about the fourth quarter but we don’t repeat last reflect results which benefited from strong pre-buy activity following a significant drop in prices. Steve provided an update estimate for full year 2014 adjusted EBITDA of $147 million to $150 million certainly an extended paving season in the fourth quarter would be a significant contributor and our ability to reach the upper end of that range. Looking at raw material price environment we are now seeing downward pressure in butadiene resulting from apple supply and weakening demand. Asia smart [ph] prices declined in the last week, Europe is settled lower and we now expect that North American contract butadiene will decline in November by as much as $0.10 per pound following $0.02 per pound decline in October. At the same time, we’re seeing Brent Crude at four year loads and lower pricing for NAFTA which should lead to improved economics for heavy crackers relative to the favored economics of light cracking in the U.S. Overall they suggest the near term outlook for lower butadiene prices and a crude prices hold near current levels it could pretend a period of relative price stability for butadiene. Likewise we’re seeing downward movement in Isoprene pricing driven by lower crude prices and by increased supply following the start-up of Formosa’s 60 kiloton unit in Mailiao, Taiwan. Longer term implications of these raw material prices trends for Kraton, we believe is favorable particularly if they result in price stability. Lower relative and absolute cost for raw material should overtime translate into lower selling cost for our products and this should give our customers and innovation partners confidence and the relative price versus performance of Kraton’s SBC solutions particularly in comparison to lower cost and lower performing alternative chemistries which are typically allophonic based. In closing, I want to convey the firm commitment of Kraton to driving growth and maximizing value for our shareholders. As part of this ongoing commitment in early 2015 we plan to share details of a 3 legged strategy designed to reignite earnings growth and allow shareholder value. The strategy includes a cost reset to improve our overall competitive position, a strengthened emphasis on driving organic growth through innovation and the pursuit of strategic acquisitions in the specialty material space. This plan coupled with the share purchase program we announced yesterday is evidence of our commitment and believe in the long term potential and Kraton. At this time I’ll ask the operator to open the line for questions.

[Operator:]

Thank you. (Operator Instructions) Our first question comes from Jason Freuchtel with SunTrust. You may ask your question.

[Jason Freuchtel:]

It was a pleasant surprise to see the share repurchase authorization release last night. How would you characterize your appetite for repurchasing shares of the current valuation and has the board to set restrictions or guidelines in terms of the taste at which you can repurchase shares?

[Kevin Fogarty:]

Well, I think the answer is as I commented we certainly believe our shares are undervalued and we plan to be opportunistic in purchasing the shares with that authorization.

[Jason Freuchtel:]

And turning to the paving and roofing segment, how does that business respond the last time there is significant macro weakness in Europe. Is there any reason to believe that business will or should perform differently in the current environment and to clarify if there is an extended paving season in the fourth quarter, should that mitigate further potential weakness driven by the macro environment?

[Kevin Fogarty:]

The second part of your question at the end of the day I mean there is always a weather element to the paving and roofing business as we talked about and certainly if you had weak August and September period and you’ve got favorable weather conditions in the fourth quarter, the projects that were budgeted are going to try to get them done and we think that has led to the favorability we seen so far through October. That being said, Western Europe typically has been pretty immune over the last few years to the general economic headwind that has faced the overall economy in that region and what I’m talking about in terms of the paving and roofing space. But what we’ve seen here this year certainly in markets particularly that are more sensitive to competition from Asia and new capacity in Russia and I’m talking about places like Poland, Turkey and even parts of Eastern Europe, that’s where we see this competitive activity. And at the end of the day, you all know how our business model when it comes to the paving and roofing business, it’s a volume and price sensitive business and we’re always making decisions about what our pricing practices need to be -- should be in the context of our overall business recognizing those competitive pressures. And that’s kind of the way I would sum up this market that particularly when I think about it in the context of that additional capacity in Russia that came on in early 2014, we’re not surprised in many places with that competitive activity, but I’ll call out though HiMA which is our technology that drives a lot of the very competitively advantage growth in our paving and roofing business, is a technology that on the one hand it offset some of that decline but it’s also technology that has benefited in those very competitive markets and that’s why we specifically proud of this new St. Petersburg project that I spoke of.

[Jason Freuchtel:]

Okay, great. And then you have some cost savings from transitioning from coal to natural gas power boilers, some EBITDA contribution from your JV with Formosa starting up as well as potentially where capital expenditures impacting free cash flow in the next couple of years. Are there any other items like expected changes in working capital et cetera that you could comment on today that could likely impact free cash flow in the future?

[Steve Tremblay:]

The 2015 effect that you just called out is spot on. We would say here as a team as we look at ways to unlock cash flow in addition to the strategy that Kevin outline to grow EBITDA is we’ll take a continue hard look at our overall inventory of finished goods around the globe and we’re working pretty aggressively to see if we can, without changing materially our service model to our customers which is really important to us is reducing that inventory carry I mean I think we’ve done a really good job on receivables in the like. So the biggest opportunity for us as I see at longer term is continue to focusing on overall reduction in our inventory levels. We shouldn’t expect that in the next quarter or so in fact we’re actually gearing up for our turnaround activity next year, but we think there is some opportunity there we’re going to grab that pretty hard. You’re right to talk about the boiler project the JV thus starting early ‘16 we should such seeing a capital expenditure reduction but to get that boiler benefit we do have to continue to spend some money there. So, 2015 will likely still be at a relatively higher level of CapEx.

[Operator:]

Thank you. Our next question comes from Brian Maguire with Goldman Sachs. Your line is open.

[Brian Maguire:]

Steve, if I’m looking at the guidance for the SG&A and R&D it looks like it cut the SG&A maybe $10 million from the guidance last quarter and the R&D too. And there were kind of cut in the overall EBITDA there in $3 million so I guess imply the gross profit will be $12 million to $13 million less. Is that mostly due to the challenges in Europe in paving and roofing is that really where all the headwind is coming from or there is some other issues to really point out there?

[Steve Tremblay:]

That’s really the biggest headwind that we’ve got 14% volume decline in the third quarter alone 16% decline in Europe paving and roofing alone. Our Cariflex business as Kevin said is performing really nicely to the nine months HSBC business is hanging in there. Regarding the reduction in the R&D cost there is a little bit of modest reduction from the earlier estimates. We’ve been looking at our cost base like we should month in and month out, we found some opportunities to [indiscernible] spending the license spending so that reflected in the latest estimate. The biggest piece of our SG&A is continue tweaking down of our variable incentive compensation which we found us that’s not being able dig out of whole that we created in the first part of the year associated with those outages.

[Brian Maguire:]

And just early thinking about ‘15 you probably would expect some of that variable compensation that come back in or I guess getting how real is $89 million number for SG&A for the year or is that sort of just the function of the tough environment this year and you wouldn’t expect that next year?

[Kevin Fogarty:]

Brian, I appreciate the question and certainly that’s a kind of base assumption in terms of our business and as we look at for 2015, we’re obviously thinking about a business performance who justifies compensation payout. But that all being said as I mention we have a three lag of strategy that we intend to roll out early in ‘15 a part of that strategy is looking very aggressively at our cost in the context of not just at the manufacturing level not to stick to logistical level, not to stick to supply level but also with the SG&A and R&D level. We’re going to roll out a plan that we believe since what the business is going to need and aggressively make sure that every dollar that we’re spending particularly when it comes to SG&A and R&D is well justified.

[Brian Maguire:]

Okay. We’ll look for that update early next year and then just one last one thinking about the volume seasonality into the fourth quarter I think you mentioned a year ago was probably normally good fourth quarter was in pre-buying and it looks like volume maybe felt to 90,000 ton sequentially in the year with little bit more of a drop in raw prices like 2011 more like 16,000 ton, is that sort of the range and is the range of seasonality what end of those extreme, is it simple we’ll see this year?

[Steve Tremblay:]

Look, I don’t want to talk specifically about what we see in the fourth quarter I think to mention what -- as you know we don’t get back on the guidance but we did mention that we saw pretty unusual buying behavior in the fourth quarter of ‘13 that was driven by pre-buy. We don’t see that same program this year. There is a lot of different things even though you’ve got as you point out raw material decline in both quarters there for different reasons I think crude oil prices this time last year was still hovering in the $100 range and after price it resulting where therefore higher than they are as we look at fourth quarter this year. So it’s a different kind of structural set of conductions that is also the case when we look at our customer inventory positions. So it’s just the different market scenario and the reason we call those because we wanted to make people look that and as they thought about our fourth quarter and their own modeling they’re thinking about it in the context of what we will believe to be a more normalized purchasing pattern versus kind of pre-buy this time last year. But again the season in the Europe to the extent this final weather in these projects continue I mean obviously that’s what we’ll look to do to drive home in terms of ending the year on the higher end of that EBITDA guidance range I mean that’s certainly going to be an improving factor.

[Operator:]

Thank you. Our next question comes from Christopher Butler from Sidoti and Company.

[Christopher Butler:]

If we’re looking at Cariflex and I think you said this in your early remarks year-over-year and maybe look at the first nine months as oppose to just a quarter, the margin profile on Cariflex if I understand correctly hasn’t changed in that time frame, is that correct?

[Kevin Fogarty:]

Well, first of all we do want you to look at the quarter; we just don’t you to model the quarter as an annual number. But yes, think of it in terms of that annual trend and we’re optimistic about the trend which is why I called out that we’ve now exercised an option with our Japan supply partner to make sure that we’ve in capacity in the beginning of 2016 to serve that growth need of our customer and no they really haven’t I mean there hasn’t been any material change at all in the margin profile of the business, I call out there is always a mix issue with respect to whether or not we’ve got rubber sales or isoprene latex sales in the quarter and then everything we’re doing in terms of our product mix and looking at innovating a new target markets particularly for latex, we’re trying to drive that average mix up.

[Christopher Butler:]

And as you look at the new capacity with the cost basis be the same for the new capacity as we’ve seen with your existing production?

[Kevin Fogarty:]

Well any time you’re able to take advantage of a scale situation here obviously looking at improving your cost situation as well.

[Christopher Butler:]

If we’re looking at your gross profit per ton declining in the quarter sequentially could you talk to what the impact there was, the mix effect was relatively flat so you did have down volume in paving. Is that entirely -- that changed sequentially?

[Steve Tremblay:]

Sequentially it was, actually it is the $63 decline sequentially and more than half of that more than $30 of that was the effects of the paving market that we saw in Europe and the second largest contributing factor was the mix shift that Kevin said. So overall, profitability for Cariflex was up and on a unit margin basis it was a bit lower sequentially than the mix in the second quarter but again over half of that more than $30 of the $63 decline we would attribute to the paving and roofing situation in Europe.

[Christopher Butler:]

And as you look rebound to 850 in the fourth quarter, if you don’t see a significant improvement to the paving business, if mix doesn’t going to change overnight you have the increased turn around cost, could you speak to the improvement that you’re looking for?

[Kevin Fogarty:]

Well I think there is a couple of factors here but we’re not going to give you guidance on what that quarter gross profit forecast would be but a couple of factors will certainly contribute to it and by the way mix can change monthly in our business and certainly quarterly but the other thing is too with the decline in raw materials sometimes -- not sometimes all the time our goals for price rate strategy is to maintain some margin expansion as long as we can give the competitive conditions we are in and of course the uniqueness of the supply relative to those competitive alternatives. So those two factors can have a bearing even in the sequential quarterly basis relative to your third quarter and then when I talk about mix we can talk about it too in the context of product families more HSBC versus USBC more latex and Cariflex versus the other product families. So, there is a lot of factors that window that and we’re not alarmed it all by the rate of results in the fourth quarter in terms of what it resulted in, in the terms of our outlook for our business clearly as Steve just told you that paving and roofing headwind in Europe was a significant contributor and the good news is paving and roofing in Europe and at the end of the day paving has been that kind of a business and those projects still going to get done, the infrastructure still have to be taken care of and we’re well positioned to be the benefiting when that happens.

[Operator:]

Thank you, our next question comes from John McNulty with Credit Suisse. You may ask you question.

[Unidentified Analyst:]

Good morning guys, this is Rob [indiscernible] in for John. So just more in the competitive pressures in Europe, trying to get a feel on how to think about that going forward, it is just matter of kind of inventory you can normalize in the industry, where you’re getting players from other regions who typically haven’t played in the Europe market as much and if so how long you guys expect to see the impact from that?

[Kevin Fogarty:]

Well, I think again, there is never one issue its two or three issues typically so you have some new capacity, you’ve had kind of slowing down and buying trend, it wasn’t a great weather summer either in Europe if you had any chance to travel in that region. And then the raw material dynamics always existed but that can turn around and that’s why I called out that in October we’re seeing a nice weather pattern in Europe to extend the season. That being said, if you look structurally at the USBC business particularly for SBS around the globe on a supply demand basis, there is just not allowing new capacity beyond what we already know that has been called out and that means that, again as I just mentioned a moment ago, the projects, the infrastructure investment is going to get done and we want to make sure Kraton is not just in a position to serve, given where we are situated but also that we’ve got kind of competitive and even innovative grades that allow customers to have some decisions and some choices. And I think the trend we see in where high mouse being adopted, in places where those choices are being truly looked out on the basis of what we want customer to look which is the technological advantage and economic benefit it will create for customers and we’re very pleased that across all our end use markets we’ve got significant innovation that we can call out and differentiate ourselves and certainly our paving and roofing is no exception to that.

[Operator:]

Thank you. And our last question comes from John Roberts, UBS. Your line is open John. Mr. Roberts your line is open.

[Gene Shiels:]

We actually may have lost him.

[Operator:]

We already may have his mute on. Give him one more chance to un-mute. It appears that Mr. Roberts is not there. So I’ll turn it back to you Mr. Shiels for closing comments. Thank you.

[Gene Shiels:]

All right. Thank you Rebecca and we want to thank all of our participants this morning for their interest in Kraton. A replay of this call will be available later today. You may access the replay through our website at kraton.com by selecting the Investor Relations link and navigating to events. You may also access the telephonic replay; toll free number is 866-501-8771 and international callers may dial 203-369-1851. This concludes our remarks and our call this morning. Thank you.

[Operator:]

Thank you. This concludes the Kraton Performance Polymers, Inc. third quarter 2014 earnings conference call. You may now disconnect.