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Edited Transcript of KRA earnings conference call or presentation 24-Oct-19 1:00pm GMT

Q3 2019 Kraton Corp Earnings Call

HOUSTON Oct 29, 2019 (Thomson StreetEvents) -- Edited Transcript of Kraton Corp earnings conference call or presentation Thursday, October 24, 2019 at 1:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Atanas H. Atanasov

Kraton Corporation - Senior VP & CFO

* H. Gene Shiels

Kraton Corporation - Director of IR

* Kevin M. Fogarty

Kraton Corporation - President, CEO & Director

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Conference Call Participants

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* James Michael Sheehan

SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst

* Joshua David Spector

UBS Investment Bank, Research Division - Equity Research Associate - Chemicals

* Roger Neil Spitz

BofA Merrill Lynch, Research Division - Director and High Yield Research Analyst

* Vincent Alwardt Anderson

Stifel, Nicolaus & Company, Incorporated, Research Division - Associate

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Presentation

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Operator [1]

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Good morning, and welcome to the Kraton Corporation's Third Quarter 2019 Earnings Conference Call. My name is Rose, and I will be your conference facilitator. (Operator Instructions) Today's conference is being recorded. If you have any objections, you may disconnect at this time.

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

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H. Gene Shiels, Kraton Corporation - Director of IR [2]

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Thank you, Rose. Good morning, and welcome to the Kraton Corporation Third Quarter 2019 Earnings Call. With me on the call this morning are Kevin Fogarty, Kraton's President and Chief Executive Officer; and Atanas Atanasov, Kraton's Senior Vice President and Chief Financial Officer. A copy of our third quarter news release and the related presentation material is available in the Investor Relations section of our website.

Before we review results for the third quarter of 2019, I'll draw your attention to the disclaimers on forward-looking information and the use of non-GAAP measures, which are included in the presentation this morning and in yesterday's earnings press release.

During the call, we may make certain comments that are not statements of historical fact and thus, constitute forward-looking statements. Investors are cautioned that there are risks, uncertainties and other factors that may cause Kraton's actual performance to be significantly different from the expectations stated or implied by any forward-looking statements we make today. Our forward-looking statements speak only as of the date they are made, and we have no obligation to update such statements in the future. Our business outlook is subject to a number of risk factors. As the format of this morning's presentation does not permit a full discussion of these risk factors, please refer to our forms 10-K, 10-Q and other regulatory filings available in the Investor Relations section of our website.

With regard to the use of non-GAAP financial measures, a reconciliation of each used non-GAAP financial measure to its most comparable GAAP financial measure was provided in yesterday's earnings release as well as the presentation we'll review this morning. Following our prepared comments, we'll open the line for questions. I'll now turn the call over to Kevin Fogarty. Kevin?

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Kevin M. Fogarty, Kraton Corporation - President, CEO & Director [3]

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Thanks, Gene. Good morning, everyone. Our third quarter of 2019 was a challenging quarter for Kraton. As indicated in our preannouncement on October 10, macroeconomic conditions deteriorated as the third quarter progressed, and this had an adverse impact on results for both our Polymer and Chemical segments. In late July, we shared our expectations for the second half of the year, and our review was predicated on customer conversations, year-to-date demand trends and in the case for Chemical segment, expectations regarding forward market pricing for alternative or related chemistries. Unfortunately, we did not foresee the significant weakening of demand fundamentals in China and broader Asia or decline of European -- or decline in European demand that we experienced as the quarter progressed. Given these factors, third quarter 2019 adjusted EBITDA of $80 million fell below our expectations. Relative to the third quarter of 2018, lower adjusted EBITDA for the Polymer segment was principally driven to lower sales volume as unit margins were favorable.

Our Chemical segment, the macroeconomic backdrop had implications for both volume and margins. Polymer segment adjusted EBITDA was $50.3 million in the third quarter, down 11.8% versus the third quarter of last year, principally due to lower sales volume as average unit margins improved versus the third quarter of last year. Cariflex sales volume was up 18.9% compared to the third quarter of 2018 on higher sales into surgical glove applications. However, Specialty Polymers sales volume decreased compared to the third quarter of 2018. Lubricant additive sales were lower than the third quarter of 2018 as anticipated as this was due to the inventory management actions by a major customer that we have referenced in prior quarters. However, demand was weaker in China and broader Asia, and we also saw demand fall in Europe with weaker sales into automotive and consumer durable markets.

Of note, however, North American sales volume was up compared to the third quarter of last year on solid growth in innovation-based sales and medical applications.

Volume in Performance Products also decreased compared to the third quarter of last year, primarily due to lower sales into paving and roofing applications as we faced competitive market conditions and higher customer inventories following the weather impact on second quarter activity. Although overall sales volume was down for the segment, average unit margins were up versus the year ago quarter and this contributed to an adjusted EBITDA margin of 19.2%, which was up 140 basis points compared to the third quarter of 2019.

The weaker macroeconomic fundamentals had a material impact on our Chemical segment, in which third quarter 2019 adjusted EBITDA was just below $30 million, down nearly 29% compared to the third quarter of last year. The decline was driven by a 12.3% decrease in segment sales volume compared to the third quarter of 2018 and lower pricing in our TOR chain.

In our Performance Chemicals business, we saw lower Tall Oil Rosin demand and lower sales of Tall Oil Fatty Acid upgrades into oil field and mining applications. We faced lower demand for rosin upgrades into adhesive and road marking applications. We also saw lower pricing for upgraded products in our CST chain, which was driven by an unprecedented decline in gum turpentine prices of over 40% in the quarter.

Despite the weaker-than-expected operating results in the third quarter, cash generation, however, remained quite positive. We reduced consolidated net debt by $81 million or $52 million, excluding the effect of foreign currency. While our full year expectations for adjusted EBITDA have been revised, we expect to continue to generate cash in the fourth quarter. On a full year basis, we now expect to reduce consolidated net debt by $120 million to $140 million, excluding the effect of foreign currency and any activity under our share repurchase authorization.

At this time, I'm going to turn the call over to our Chief Financial Officer, Atanas Atanasov, for a more in-depth financial review of the quarter. Atanas?

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Atanas H. Atanasov, Kraton Corporation - Senior VP & CFO [4]

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Thanks, Kevin, and good morning, everyone. Turning to Slide 5, I will review the third quarter results for our Polymer segment. The third quarter 2019 revenue for the Polymer segment was $261.6 million, and this was down $59.4 million or 18.5% compared to the third quarter of 2018. The revenue decrease reflects lower sales volume and lower average selling prices associated with lower average raw material costs. The negative effect of currency also accounts for $3.3 million of the revenue decrease albeit largely offsetting cost of goods sold. Overall sales for the Polymer segment was down 10% compared to the third quarter of 2018. Cariflex remained on its long-term growth trend in the quarter with sales volume up 18% compared to the third quarter of 2018. The increase was largely due to higher sales into surgical glove applications.

Specialty Polymers sales volume was down 18.9% compared to the third quarter of 2018.

As anticipated, sales into lubricant additive applications were lower than in the third quarter of 2018 associated with the inventory management program undertaken by a significant customer. On a year-to-date basis, the overall impact of lubricant additive sales has been as expected with a more significant impact in the third quarter of 2019 relative to sales in the third quarter of 2018. As Kevin said, during the third quarter, we saw a further deterioration of market demand in China and broader Asia associated with ongoing trade negotiations and the impact of tariffs. In addition, demand in Europe weakened notably. The weaker demand was particularly evident in automotive and compounding outlets, which serve key markets, such as consumer durables. Based upon available market data on a year-to-date basis, automotive production in China is down over 10% and sales are down by a comparable figure.

German automobile production is down 9%, with exports down 12%, and this would include exports into China. The U.S. market is not immune either. Sales of passenger cars is down over 9%, and while sales of light trucks are up slightly, overall U.S. auto sales are negative for the first 9 months of the year. Our HSBC sales in North America were up 17% compared to the third quarter of last year driven by higher sales of innovation grades and medical grades of HSBC polymers.

Performance Products sales volume was down 9.8% compared to the third quarter of 2018, primarily due to lower sales into paving and roofing applications in our core North American and European markets. In our view, nothing has fundamentally changed in global paving and roofing markets in terms of pent-up demand and project scope. However, given unfavorable weather in the second quarter of 2019, which adversely impacted activity sales, customers carried high product inventories into the third quarter. And while weather was more favorable during the third quarter, the effect of high customer inventories in conjunctions with ample product availability from industry participants contributed to intensified competitive dynamics during the quarter.

Sales into non-core paving and roofing markets, including Latin America, Australia and Japan, have not been impacted by adverse weather and were up 73% compared to the third quarter of 2018. Given the impact of lower overall sales volume, Polymer segment adjusted EBITDA was $50.3 million in the third quarter, down $6.7 million or 11.8% compared to the third quarter of 2018.

Adjusted gross profit was $947 per ton in the third quarter of 2019 versus $981 per ton in the third quarter of 2018. However, adjusted EBITDA margin for the Polymer segment was 19.2% in the third quarter, up 140 basis points compared to the third quarter of last year. The improvement was largely a function of improved product unit margins and lower costs, primarily SG&A.

Turning to year-to-date results for the Polymer segment. For the 9 months ended September 30, 2019, Polymer segment revenue was $820.5 million, down $127.6 million or 13.5% versus the first 9 months of 2019 -- 2018, forgive me. Drivers of the revenue decrease are similar to those in the third quarter, namely, sales volume and lower average selling prices associated with lower raw material costs. In addition, the negative impact of currency accounts for $18.3 million of the revenue decrease, albeit with a large offset in cost of sales. On a year-to-date basis, Polymer segment sales volume was down 7.9% compared to the first 9 months of 2018. Sales of Cariflex was up 11.4% versus the first 9 months of last year on higher sales into surgical glove applications, while specialty Polymer sales volume was down 12.1% on a lower sales into lubricant additive applications as I indicated earlier.

In addition, on a year-to-date basis, demand in China, broader Asia and Europe was lower with innovation-based HSBC sales in North America serving as a partial offset.

Year-to-date, Performance Products sales volume was down 8.3%. While lower sales of SBS into paving and roofing application, our core, North American and European markets was a significant driver, paving and roofing volume was up 15% in non-core markets, where adverse weather conditions did not negatively impact demand. We also had lower sales of SIS grades into adhesive applications in both North America and Europe.

For the 9 months ended September 30, 2019, Polymer segment adjusted EBITDA was $158.6 million, down $11.8 million or 6.9%, primarily due to lower sales volume in Specialty Polymers and Performance Products, partially offset by the 11.4% growth in Cariflex volume. As with the third quarter, average unit margins were higher than in the comparable period of the last year and Polymer segment adjusted EBITDA margin improved by 130 basis points to 19.3%.

Lastly, on a year-to-date basis, adjusted gross profit of $1,013 per ton was largely in line with $1,019 per ton we reported for the first 9 months of 2018.

I'll now move on to Slide 6 for a review of our Chemicals segment results. Chemicals segment revenue for the third quarter of 2019 was $182.6 million, down $19.5 million compared to $202.1 million in the third quarter of 2018. The revenue decrease reflects lower sales volume and lower pricing for TOR upgrades. In addition, negative effects of currency accounts for $3.8 million of the revenue decrease. The Chemicals segment sales volume was down 12.1% compared to the third quarter of 2018. While volume for Tires was up 2.4%, sales volume for Performance Chemicals was down 15%, reflecting lower TOR demand and lower sales of TOFA upgrades into the end market applications such as oil field and mining.

For our adhesive business, third quarter volume was down 7.5% and this was largely due to lower sales of rosin upgrades into adhesive and road marking applications. The further weakening of the global demand fundamentals in the third quarter compared with continued pressure from readily available and hydrocarbon-based C5 tackifiers in Asia and a 20% drop in gum rosin pricing pressured overall margins in our adhesive business. We also saw a significant drop in gum turpentine prices, which were down 40% compared to the second quarter of 2019, and this materially impacted pricing of upgraded products in our Crude Sulfate Turpentine chain as pricing is somewhat linked with combinant market applications. As a result, Chemicals segment adjusted EBITDA for the third quarter was $29.8 million, down 28.6% compared to the third quarter of 2018, and the adjusted EBITDA margin for the segment was down over 400 basis points or 16.3%.

This decrease reflects lower sales of upgraded product streams and the impact of higher raw material costs. Chemicals segment revenue for the 9 months ended September 30, 2019 was $575.4 million, down 6.5% or $40.3 million compared to the first 9 months of 2018. The decline is principally a function of lower sales volume and lower pricing in rosin end markets as well as $18.3 million of currency impact, which was largely offset in cost of sales. Year-to-date, overall sales volume was down 9.6%. Tires volume was up 2.2% versus the first 9 months of 2018 as we continued to leverage the expanded capacity at our [New York, France] plant and solid market demand for our tread enhancement Asian -- agent products.

Performance Chemicals sales volume was down 12.9% compared to the comparable 9 months' period in 2018. This was due to lower overall TOR demand, particularly in ink and adhesive applications, lower sales of TOFA and TOFA upgrades into oil field and mining markets and lower opportunistic sales of raw material costs in 2019, given some of the CTO constraints we faced in the first half of this year, in part due to the limitations from a minority supplier.

We also saw lower sales into our adhesive business unit, where sales volume was down 3.7% compared to the first 9 months of 2018. The volume decline reflects relatively weaker market conditions, ongoing pressure from hydrocarbon-based C5 tackifiers and weak gum rosin alternative pricing.

As a reminder, sales volume in the first half of 2019 was adversely impacted by lower production rates of upgraded product streams as a result of downtime at our Panama City, Florida site following Hurricane Michael. On a year-to-date basis, adjusted EBITDA for the Chemicals segment was $112.9 million, down $9.5 million or 7.8% compared to the first 9 months of last year with an associated margin of 19.6%.

Adjusting for revenue associated with the lost margin in our Panama City site during the hurricane-related production outage, the adjusted EBITDA margin for the first 9 months of 2019 would have been 19.3% as compared to 19.9% for the same period last year.

Turning to the consolidated results on Slide 7. Consolidated revenue for the third quarter was $444.2 million, down $78.9 million due to lower sales volume and other factors I covered in segment results, including an aggregate $7.1 million negative impact from changes in foreign currency. The third quarter 2019 consolidated adjusted EBITDA was $80.1 million or 18% of consolidated revenue, down $18.6 million compared to the $98.7 million reported in the third quarter of 2018. Third quarter adjusted EPS was $0.52 per diluted shares, and this was down $0.50 or 49% compared to the $1.02 per diluted share for the third quarter of 2018. For the 9 months ended September 30, 2019, consolidated revenue was $1.4 billion, down $168 million compared to the $1.56 billion for the first 9 months of 2018. As outlined in the segment commentary, lower sales volume was a significant driver in our revenue decrease along with lower average selling prices associated with lower raw material costs in the Polymer segment and lower rosin pricing and the impact of higher raw material cost in our Chemicals segment. In addition, the negative effect of foreign currency accounted for $34 million of the overall revenue decrease.

For the 9 months ended September 30, 2019, consolidated adjusted EBITDA was $271.5 million, down $21.4 million compared to the $292.9 million in 2018. Year-to-date, the consolidated adjusted EBITDA margin was 19.5% or 19.3% adjusting for revenue associated with lost margin in the hurricane-related outage in Panama City earlier this year. This compares to 18.7% in the comparable period last year. And for the first 9 months of 2019, adjusted EPS was $2.99, up $0.50 or 20.1% compared to $2.49 for the first 9 months of 2018.

Slide 8 provides our customary update of full year assumptions. As we have noted, the weakening of demand in China, broader Asia and Europe in conjunction with notable decreases in gum turpentine and gum rosin prices had a significant impact on third quarter results. Unfortunately, we do not expect improvement in these market conditions for the remainder of the year. As a result, we now expect that our full year 2019 adjusted EBITDA to be 10% to 15% below the low end of our prior guidance and therefore, in the range of $315 million to $330 million. While lower implied adjusted EBITDA for the year will reduce cash available for debt reductions, we do expect to reduce consolidated net debt by $120 million to $140 million, excluding the effect of foreign currency and activity under our share repurchase authorization.

Now turning to Slide 9 for a look at consolidated net debt. Despite the challenging operating results in the third quarter, we continue to generate cash. We reduced consolidated net debt by $80.6 million or $52.1 million, excluding the effect of foreign currency. In addition, we have repurchased an additional $5 million of shares during the quarter.

I will now turn back the call to Kevin for his closing comments.

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Kevin M. Fogarty, Kraton Corporation - President, CEO & Director [5]

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Okay. Thank you, Atanas. Now as I said, 2019 has proven to be a challenging year due to the impact of a number of external market factors, but we do not believe our results this year are representative of longer-term opportunity that exists here at Kraton. We've been through a disappointing paving season this year, not because there is a pent-up demand or projects, but because we had an unusually wet weather in the second quarter that delay activity. We therefore faced high customer inventories during the third quarter. The first quarter of 2019 was one of the highest sales volume quarters we have had for SBS as customers were preparing for the paving season. With the soft weather related -- with soft weather-related demand in North America and Europe in the second quarter, the significant purchases in the first quarter translated into a headwind by the time we got to the third quarter. However, September was the strongest demand month of the quarter and October demand has been good, and this is the demand pattern that we expect as the inventory issue is resolved.

As Atanas referenced, during the third quarter and on the year-to-date basis, paving and roofing volume in our markets outside of North America and Europe is up this year, and this gives us confidence that nothing has fundamentally changed in global paving and roofing markets. We expect to see continued growth in the years to come. In fact, as we have discussed previously, our forward expectations indicate the need for capacity over the next few years, and our planning for those capacity needs has not been altered by these current short-term conditions.

Now as you know, China has been an important growth market for our specialty HSBC product offerings and will continue to be an important market of growth in the years to come. However, it is clear, the uncertainty associated with trade negotiations and the disruption associated with tariffs is compounding weak consumer and customer sentiment in China. As we've described before, the impact on our business in China has been broad-based across many of the markets that we serve including automotive, protective films, consumer goods, medical and cable gels to name a few. What we know is that these end markets have not gone away and Kraton is defending its share aggressively for its core business and is focused on launching new innovative polymer solutions with our customers.

The simple fact is that in many of these applications, Kraton's overall product portfolio is unmatched. What we're unfortunately experiencing is a significant destocking and a desire on the part of customers to minimize purchases given near-term uncertainty. And while we can't say specifically when demand will improve, we saw a similar contraction in 2008 and 2009 and the rebound was significant.

As we look forward, we see an opportunity to continue to grow in attractive market segments, such as automotive, protective film and food packaging, leveraging our innovative, low molecular weight product grades produced in our HSBC plant in Mailiao, Taiwan.

In the current market, our value proposition and our position as an innovation leader is even more important, and we will continue to position Kraton for the future by driving innovation-led growth and by leveraging our unique portfolio to meet the evolving needs of our customers.

As many of you I'm sure can appreciate, there is a growing preference for sustainable solutions in the marketplace as well as discussion regarding the circular economy and of course, plastic waste. To meet these global objectives, our Polymer team is working actively with recyclers to enable compatibilization with PET and polyolefins using Kraton. A variety of existing Kraton grades are currently used as additives with customers in all major regions of the world. As to the broader topic of sustainability, Kraton's pine Chemical product offering is a real and cost-competitive alternative to hydrocarbon-based solutions. Despite significant societal demand for our industry to advance renewable solutions, we continue to see our industry defaulting to hydrocarbon-based solutions. It is, therefore, incumbent upon us as a leading supplier of sustainable solutions to continue advancing our renewable offerings in terms of both cost and quality. In doing so, we believe the ultimate consumer will value Kraton's sustainable, from-the-tree offerings.

Key examples of success today include the new generation of bio-based rosin ester tackifiers that are closing the gap with hydrocarbon-based C5 tackifiers in terms of quality and stability. Initial qualifications with customers were completed in the third quarter, and customer feedback is very positive. We're also actively working with customers on a new formulation for road marking applications that combines Kraton's bio-based rosin and SIS Polymer technologies to further improve performance and durability. We certainly recognized the opportunity to expand sustainable solutions to our industry and participate fully as a supplier of bio-based chemicals when we acquired our Chemical segment back in 2016.

Additionally, we have continued to develop new and used markets for our rosin products and as evidence, we are in the final stages of commissioning a new dispersion unit in Malaysia that is designed to meet specific needs of our customers in the Asia Pacific region. We expect that this unit will be up and running in early next year.

Other areas of innovation focus include a new class of Tall Oil Fatty Acids that will be suitable for use in personal care applications and other high end markets. And in our Tires business, we have just launched SYLVATRAXX 8000, a second generation of poly terpene, bio-based tread enhancement agents.

Through these efforts, Kraton is well positioned for future growth as the market shifts to sustainable options and -- as the market shifts to sustainable options will continue. Given these opportunities for growth in the future and our fundamental belief that some of the macro headwinds we are facing are temporary, we do not believe our results in the second half of 2019 are a measure of future performance. For example, we believe the long-term outlook for global paving and roofing markets remains favorable and as such, our results in the second and third quarters of this year should not result in the recalibration of paving and roofing demand expectations going forward.

Likewise, over a long period of time, our Polymer segment has exhibited growth that has been consistent with, if not above, rates of growth in global GDP. We continue to believe that truly differentiated parts of our portfolio should grow at a differential rate to global GDP over time, and that gets to the core of our innovation focus. I'll close by reiterating that while the near-term outlook remains uncertain, our leadership position in both our Polymer and Chemicals segments and our expectations for the innovation platforms under development position us well as the market growth returns.

With those comments, we're happy to open the call up for questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) Our first question is coming from the line of Josh Spector from UBS.

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Joshua David Spector, UBS Investment Bank, Research Division - Equity Research Associate - Chemicals [2]

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So just a question on the sequential move into Q4. I guess, if I look at the EBITDA, I know it's down somewhere between normal seasonality and maybe $15 million more. What's the biggest factor driving that kind of more decline? And is that on the Chemicals side? Or is it more on the Polymer side of the business?

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Kevin M. Fogarty, Kraton Corporation - President, CEO & Director [3]

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I think it's probably a little bit more leaning towards the Chemicals side because that fundamental we told you about in terms of the impact of the turpentine chain is driven by that gum rosin price. Our gum turpentine price decline is certainly more heavily weighted into the fourth quarter. But there's also the element of just -- when we -- we talked about it a minute ago, but if you look at our Polymer business, we still have the lubricant additive sales declines over the course. It's really more directed in the second half versus the first half.

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Joshua David Spector, UBS Investment Bank, Research Division - Equity Research Associate - Chemicals [4]

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Okay. That's helpful. And actually on the lube additive side. I guess, if I look at the LTM sales as a percent of specialty that you guys disclosed, it's still around 20%. That's roughly the level it was last year. Two years ago, that was more like 11%, 12%. Does that mean that there was a bigger sell-in last year and there wouldn't be as much of a recovery if auto stabilized? Or do you expect a recovery in that business that could be significant if auto is even stabilizes into next year?

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Kevin M. Fogarty, Kraton Corporation - President, CEO & Director [5]

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Well, look, again, my comments are that there's nothing structurally changing. I mean, it's obviously, a pretty -- it's a pretty down marketplace in the second half of the year. Automotive being one driver and certainly a driver for us in terms of our Specialty Polymer activity. But I'm not going to -- I'm sure many questions might be directed towards when we think things will improve. It's really difficult right now to kind of think about when that will happen, given the uncertainty that exists in the world. But what we do know is, is that there's no lack of discussion with our customers about innovation. And obviously, that's where we believe our future lies. So whether it's in an automobile application or any of the other innovations that we work towards, we're still seeing that momentum.

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Joshua David Spector, UBS Investment Bank, Research Division - Equity Research Associate - Chemicals [6]

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Maybe just if I could ask -- just a different way, not related with the outlook is just can you help me understand the sales pickup from like 2016, '17, to 2018, '19 that drove lube additives to the, like 10%, 11% of the segment to 20%. Was it that, that part got bigger? Or did the other parts get smaller?

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Kevin M. Fogarty, Kraton Corporation - President, CEO & Director [7]

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Well, I think the customer in this case, and we have one primary customer in the space, as you know, I think the customer obviously was enjoying some good momentum in the marketplace. And the decision they took this year was solely directed towards how they manage, if you will, the risk in their supply pool, and they decided that this year was a good year to bring down inventories, generate some cash and rely more heavily on just in time inventory.

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Operator [8]

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Our next question is coming from the line of Roger Spitz, Bank of America.

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Roger Neil Spitz, BofA Merrill Lynch, Research Division - Director and High Yield Research Analyst [9]

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In the past, you've given the relative profitability of USBCs, HSBCs and Cariflex, basically comparing them to profitability of HSBC, USBC and Cariflex, USBC. Would you care to update that, say, on an LTM basis?

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Atanas H. Atanasov, Kraton Corporation - Senior VP & CFO [10]

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Well, I'm not quite sure, Roger, what you're referring to. I think what we've talked about is the relative margin profile of the 3 businesses. And as I sit right here, I think everything you heard in our commentary is that we have consistently, through good times and more difficult times, been very diligent in terms of our margin profile, and so nothing's fundamentally changed in terms of the relative margin profile of those 3 key product, say, families.

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Roger Neil Spitz, BofA Merrill Lynch, Research Division - Director and High Yield Research Analyst [11]

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Got it. And in terms of -- within Chemicals, can you give a sense of (inaudible) between the CTO-based products and the CST-based products?

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Atanas H. Atanasov, Kraton Corporation - Senior VP & CFO [12]

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I can't remember if we've broken that out in the past. But relatively speaking, you're talking about something that would be much less than 1/3 would be the CST-based in the company, probably closer to 20%.

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Roger Neil Spitz, BofA Merrill Lynch, Research Division - Director and High Yield Research Analyst [13]

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20%. And...

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Atanas H. Atanasov, Kraton Corporation - Senior VP & CFO [14]

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I'm talking about 20% being CST now, Roger, not the other way around.

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Roger Neil Spitz, BofA Merrill Lynch, Research Division - Director and High Yield Research Analyst [15]

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Understood. Lastly, for terpene resins. Can you give a sense of either -- or both geographic split and/or end market split of your CST-based sales?

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Atanas H. Atanasov, Kraton Corporation - Senior VP & CFO [16]

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Well, from a geographical perspective, it's a very Asia-centric business for us and thus, the challenges that we just talked about here in the second half of the year. From a product perspective, it kind of -- we kind of supply mostly in the adhesive as well as the tire space and then some really niche applications in Asia that use the unique chemistry of the terpene derivatives.

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Roger Neil Spitz, BofA Merrill Lynch, Research Division - Director and High Yield Research Analyst [17]

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But is the CST adhesive, is it competing directly with either the C5 hydrocarbons and/or your CTO-based adhesive product (inaudible)?

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Atanas H. Atanasov, Kraton Corporation - Senior VP & CFO [18]

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No. It's a different level and grade of adhesive formulation of -- much higher-end application.

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Operator [19]

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Our next question is coming from the line of Jim Sheehan from SunTrust.

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James Michael Sheehan, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [20]

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What would you say your annual capacity is in CST products? And related to that, if you could comment on the gum rosin market, if gum turpentine prices decline by the magnitude that they just did, shouldn't production of both turpentine and rosin decline and then that would cause rosin prices to firm up?

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Atanas H. Atanasov, Kraton Corporation - Senior VP & CFO [21]

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Okay. So a couple of things. First of all, we're not going to break out our total capacity of those 2. But to your second question, absolutely. That was one of the fundamentals that clearly was driving the overall demand for gum tapping in China primarily is the attractiveness of the turpentine fraction. That turpentine fraction has, obviously, come off significantly in value, more in line with, quite frankly, the historical relationship between gum rosins and gum turpentine. And yes, we would presume that all else being equal that, that ought to bring some disciplined decision-making and behavior back to that marketplace.

In fact, we try to track that on a, if you will, a real-time basis, and our own internal analysis suggests that there's just not a lot of incentive right now to be tapping trees. One thing I want to mention, too, I think was brought from the prior question but is probably important to this discussion. The question was asked about our business. But you need to understand that the majority of turpentine, whether gum or CST-derived, really ends up in the aroma space for fragrances and fine -- flavors. And that's really important because obviously, that's a very high-end application. But it -- nevertheless, it weighs against the alternative of other markets that Kraton fundamentally serves. But we always recognize that these markets kind of trading units with one another. And our market position is directed towards perhaps one side of the space, but that doesn't mean we're not capable at all to serve the other side of the space, more the aroma chemical side.

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James Michael Sheehan, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [22]

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Great color. And on the Cariflex review, you say that's a few weeks away from being completed. Can you give an update on that, maybe some color on whether you're leaning towards divesting that business or keeping it? And where would you see purchase multiples and the market generally right now? Are they attractive or unattractive?

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Kevin M. Fogarty, Kraton Corporation - President, CEO & Director [23]

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Well, I'm not going to comment and handicap at all where that process is other than to reemphasize the statement we made on October 10 as well as last night in our press release, which we're just a few weeks away from making a final decision. But I mean, I can speak generally with respect to the overall M&A markets. This is the type of time through the economy where multiples are not where they were at the peak of the market. There's no -- I don't think anybody would debate that point. But I'm not going to handicap where we are in the process. It's taken longer than any of us here would have thought, but this is obviously a very important strategic decision for the company, and we're making sure that we're doing the full evaluation as you would expect with such a strategic attractive asset.

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James Michael Sheehan, SunTrust Robinson Humphrey, Inc., Research Division - Research Analyst [24]

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Great. And then on your CapEx. You've lowered the outlook a bit for 2019. Is that just a timing shift from 2020? Or have you actually lowered your expectations on CapEx for 2020 as well?

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Kevin M. Fogarty, Kraton Corporation - President, CEO & Director [25]

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Okay. We're not going to comment on 2020. But maybe I'll turn to Atanas to kind of give you a sense for how we're looking at CapEx generally speaking.

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Atanas H. Atanasov, Kraton Corporation - Senior VP & CFO [26]

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Yes. Thank you for your question. As you would see, our CapEx has been modestly decreased for 2019, and this is reflective really of the refocusing our efforts with respect to how we manage our cash and debt reduction, which we're laser-focused on. The reduction in CapEx is very modest for this year and to the point where you could say that some of it is timing, but as I said, the reduction is not material enough where it makes a difference. With respect to some of our larger plants, none of those have significantly changed.

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Operator [27]

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Our next question is coming from the line of Josh Spector from UBS.

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Joshua David Spector, UBS Investment Bank, Research Division - Equity Research Associate - Chemicals [28]

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So just a follow-up on the natural gum supply in Asia. I guess, just curious how quick the supplier response has been historically. So I understand, economically it might not make sense, but is that a pretty quick decision when you start to see things happen? And then once that does happen and you tap less, do you see -- is there a lot of inventory in the chain that needs to be worked through? Or is it a pretty quick turnaround?

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Kevin M. Fogarty, Kraton Corporation - President, CEO & Director [29]

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Well, gum tapping typically is also a seasonal business. So you're really looking at kind of midyear. And what we usually see at about this time is gum tapping, in a general sense, all else being equal, starting to slow now. But the reality is, is that the abrupt change obviously in the market for gum turpentine prices in particular, probably caught a lot of producers off guard as well. And so we watch it, as you can imagine, every week when the information gets posted in terms of availability and price points, and it's pretty clear that the correction happened in a very short period of time.

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Operator [30]

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Our next question is coming from the line of Vincent Anderson from Stifel.

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Vincent Alwardt Anderson, Stifel, Nicolaus & Company, Incorporated, Research Division - Associate [31]

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I was hoping you could walk me through the margin change in Polymers this quarter. It was touched on earlier. But if Cariflex grew from 13% of sales from last year to 19% of sales, your gross margins declined, or even excluding the inventory adjustments, were up by about 0.5%. I was kind of expecting a bigger impact from the mix shift towards the Cariflex products. So I was hoping you could just walk me through what happened this quarter and where we could see that playing out if this mix kind of persists?

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Kevin M. Fogarty, Kraton Corporation - President, CEO & Director [32]

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Well, I think that it's 2 things kind of at the same time. One is clearly with lower volumes. That puts pressure on the gross margins in the business just in general because of, obviously, fixed costs over a smaller volume. But I would also say that in the case of Cariflex, indeed, as you referenced, our volume was up nicely quarter-on-quarter, reflecting obviously, the fully lined out capacity we have in Brazil, our so-called direct-connect process. But in the process of doing that, obviously, the customers that we serve out of that plant, I would say, we've probably increased a higher load of our larger customers, and so it's not the same margin profile, of course, all the customers face as you might expect.

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Vincent Alwardt Anderson, Stifel, Nicolaus & Company, Incorporated, Research Division - Associate [33]

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Okay. That makes sense. And staying on Cariflex. Can you just talk about the purchasing patterns in the medical glove market? I was kind of surprised to see that kind of single-period growth from a disposable product and one I imagine has relatively little seasonality.

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Kevin M. Fogarty, Kraton Corporation - President, CEO & Director [34]

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It's -- again, this is a business that's always driven by replacement of natural rubber in be it the glove or the condom space. Primarily, we think that the growth in the third quarter was driven by glove growth. And this is consistent with what we've said about the business all along that Europe is the next great opportunity for our customers to continue that substitution or market penetration in the glove space.

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Vincent Alwardt Anderson, Stifel, Nicolaus & Company, Incorporated, Research Division - Associate [35]

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Okay. So would it be fair to characterize that maybe as a new business win then, a customer switching from natural to the synthetic?

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Kevin M. Fogarty, Kraton Corporation - President, CEO & Director [36]

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Oh, yes. Consumption of gloves, period, are not going up 20% a quarter, right? It's really a substitution from natural rubber.

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Vincent Alwardt Anderson, Stifel, Nicolaus & Company, Incorporated, Research Division - Associate [37]

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Okay. Excellent. And then lastly, I completely respect where you are in the process with the strategic review. But if I could ask the earlier question maybe a little bit differently. Over the next few weeks, could you maybe categorize what the last hurdles are? Is it competing offers? Is it competing structures? Or is it purely valuation right now?

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Kevin M. Fogarty, Kraton Corporation - President, CEO & Director [38]

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You could characterize it as, perhaps, all of the above. The fact of the matter is, is that what looks like a relatively straightforward and simple process from the outside are always, any process like this have been always nuanced by the uniqueness of the business, the uniqueness of the potential buyer group and of course, the uniqueness of what we have in terms of our business. And I'll just summarize it that way. And we're not going to be premature in making our decision obviously. We're going to make sure that I, along with the rest of the Directors on the Board, that anything we decide to do with this highly strategic business is well thought through. And everything we've said about the rationale for why we wanted to do this when we announced in February, I guess, versus where we are today is the same, which is it's all about a combination of crystallizing that value for the shareholders while at the same time, putting us in position, obviously, to deleverage the balance sheet.

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Operator [39]

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Our next question comes from the line of Roger Spitz, Bank of America.

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Roger Neil Spitz, BofA Merrill Lynch, Research Division - Director and High Yield Research Analyst [40]

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Can you give us a sense of price changes in Q3 year-over-year or sequentially in any of your bellwether, TOFA, TOR or terpene resins?

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Kevin M. Fogarty, Kraton Corporation - President, CEO & Director [41]

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Yes. Look, I think that clearly the most difficult chain in our chemical space continues to be the TOR chain. There's no question about that. For the most part, our TOFA chain is fairly stable, clearly with the declining oil price and therefore, fracking and rig activity commensurate with that, that's having an impact to some extent in our TOFA chain but not too dramatic. The challenge for us continues to be the TOR chain.

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Roger Neil Spitz, BofA Merrill Lynch, Research Division - Director and High Yield Research Analyst [42]

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Got it. And have you lost share in either CTO-based products or CST-based products?

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Kevin M. Fogarty, Kraton Corporation - President, CEO & Director [43]

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So if you define share in terms of against like pine Chemicals, no, we defend. But if you define share in terms of, obviously, the inter material, that's the challenge we've have had in the TOR chain, which is why we've got to go back to first principles in terms of what drives our value proposition. Our value proposition is the cost and quality and stability that compete against hydrocarbons. But at the same time, obviously recognizing that we have a sustainable offering from the trees. And so we're continuing to work very hard on making that case to these big OEM strategic customers, who we believe, ultimately, are going to be held accountable from the standpoint of how quickly they adopt sustainable solutions. On the CST side of the business, there's other examples to where we're competing against, what I would call, nonsustainable solutions in the space. And again, back to my comments, as a leader in this marketplace, it's up to us to obviously to make that case. We continue to work on our quality, we continue to work, obviously, on our overall stability and performance and make great improvements in those areas, but we've got to make that case to big OEM strategic buyers of these materials that our sustainable solution is the answer for their future.

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Roger Neil Spitz, BofA Merrill Lynch, Research Division - Director and High Yield Research Analyst [44]

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And lastly, Specialty Polymers HSBC. Are you exposed to auto? And if you are, what percent of auto is that? Just so I'm clear on that matter.

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Kevin M. Fogarty, Kraton Corporation - President, CEO & Director [45]

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Well, we're not exposed to auto too dramatically. Probably most if you look around the world, it's in Europe, in our HSBC business. And I dare say that for Europe, anyway, which represents about 20% of our overall HSBC business, it's a pretty reasonable part of the overall portfolio. And remember, we typically serve the automobile industry through our compounder customer base, who are dealing directly with the Tier 1s. But nevertheless, that's on the one hand. But on the other hand, it's typically with pretty specialty part of the portfolio application, and it continues to be the one that we certainly believe in because we think at the end of the day, HSBC solutions do offer tremendous performance choices for our customers. But in the immediate term, obviously with the slowdown in automobile output, it has impact on our business, and we think that's one of the bigger drivers of our European business having slowed down the third quarter.

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Operator [46]

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At this time, there are no further questions. I will now hand the call back to Mr. Gene Shiels. You may proceed.

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H. Gene Shiels, Kraton Corporation - Director of IR [47]

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Thank you, Rose. We want to thank all of our participants this morning for their thoughtful questions. I'll note that there's a replay of this morning's conference call, will be available later on this morning. And you can access that replay either through our website or by dialing (866) 480-3547. This concludes our call for this morning. Thank you.

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Operator [48]

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Thank you. This concludes the Kraton Corporation Third Quarter 2019 Earnings Conference Call. You may now disconnect.