Item 1.
Business.
THE COMPANY
General
We are a leading global specialty chemicals company that manufactures styrenic block copolymers (“SBCs”) and other engineered polymers. Effective with the January 6, 2016 acquisition of Arizona Chemical (the “Arizona Chemical Acquisition”), we are now also a leading global producer of value-added specialty products primarily derived from pine wood pulping co-products.
SBCs are highly-engineered synthetic elastomers, which we invented and commercialized over 50 years ago. We developed the first unhydrogenated styrenic block copolymers (“USBC”) in 1964 and the first hydrogenated styrenic block copolymers (“HSBC”) in the late 1960s. Our SBCs enhance the performance of numerous products by imparting greater flexibility, resilience, strength, durability and processability, and are used in a wide range of applications, including adhesives, coatings, consumer and personal care products, sealants, lubricants, medical, packaging, automotive, paving, roofing and footwear products. We also sell isoprene rubber (“IR”) and isoprene rubber latex (“IRL”) which are non-SBC products primarily used in applications such as medical products, personal care, adhesives, tackifiers, paints, and coatings.
Following the Arizona Chemical Acquisition, we also refine and further upgrade two primary feedstocks, crude tall oil (“CTO”) and crude sulfate turpentine (“CST”), into value-added specialty chemicals. Our pine-based specialty products are sold into adhesive, road and construction and tire markets, and we produce and sell a broad range of chemical intermediates into markets that include fuel additives, oilfield chemicals, coatings, metalworking fluids and lubricants, inks, flavors and fragrances and mining.
Presentation of Financial Statements.
References in this document to “Kraton,” “our company,” “we,” “our,” “ours” and “us” as used in this report refer collectively to Kraton Performance Polymers, Inc. and its consolidated subsidiaries. Furthermore, these references relate to the combined company including both the legacy Kraton and legacy Arizona Chemical businesses, except for historical financial information and except for the information included in Part II, Items 6 through 9A of the Annual Report on Form 10-K, which pertains to the legacy Kraton businesses only. The information in these items has been presented in this way to provide consistency with Kraton's 2014 financial statements.
This Form 10-K includes financial statements and related notes that present the consolidated financial position, results of operations, comprehensive income and cash flows of Kraton, and its subsidiaries. Kraton is a holding company whose only material asset is its investment in its wholly owned subsidiary, Kraton Polymers LLC. Kraton Polymers LLC and its subsidiaries own all of our consolidated operating assets.
Strategy
Over the past several years, we have implemented, and continue to implement, a range of strategic initiatives designed to improve our overall cost structure. Our strategic initiatives are intended to: (1) enhance our profitability and market position, with a focus on increasing our scale and optimizing our manufacturing footprint, (2) increase our overall margins and return on invested capital and (3) advance our portfolio of differentiated products, while, at the same time, expanding sales of our core product grades. Strategic initiatives currently include (1) manufacturing optimization, including through our expansion of USBC capacity at our Berre, France facility and leveraging the HSBC capacity under construction by our joint venture, KFPC, located in Mailiao, Taiwan to optimize global HSBC, (2) asset productivity, including through use of the natural gas boilers that replaced the coal-burning boilers at our Belpre, Ohio facility, (3) complexity reduction, including through integrated CariflexTM manufacturing, and (4) fixed costs management through reduction in selling, administrative and research costs. We realized approximately $19.4 million of total cost savings related to these initiatives during 2015.
Corporate History
Kraton Performance Polymers, Inc. was incorporated in 2009 under Delaware law and is the successor to a Delaware limited liability company, formed in 2003. In December 2009, we completed our initial public offering, and trading in our common stock commenced on the New York Stock Exchange. Certain affiliates of TPG Capital, L.P. and of J.P. Morgan Partners, LLC collectively owned a majority of our common stock following the initial public offering, but sold all of their holdings in our common stock through two secondary public offerings conducted in September 2010 and April 2011. On January 6, 2016, we completed the Arizona Chemical Acquisition. We conduct our business through Kraton Polymers LLC and its consolidated subsidiaries.
RECENT DEVELOPMENTS
Acquisition of Arizona Chemical
On January 6, 2016, we completed the Arizona Chemical Acquisition for a cash purchase price of $1.37 billion, subject to adjustment for cash, indebtedness, working capital and other items. We believe that the Arizona Chemical Acquisition extends our technology and market diversification, creates a more robust platform for growth, and enhances our opportunities to deepen our customer relationships by expanding our presence in our core markets. Arizona Chemical’s end use market exposure is highly complementary with that of Kraton, particularly in markets such as adhesives, roads and construction, fuel additives and lubricants, and oilfield chemicals. In addition, the renewable nature of Arizona Chemical’s product and technology offerings reduces our overall exposure to hydrocarbon-based feedstocks. See Note 3 Acquisition of Arizona Chemical to the consolidated financial statements for a further description of the Arizona Chemical Acquisition.
The $1.37 billion cash purchase price for the Arizona Chemical Acquisition, the cash tender offer and redemption of all of our outstanding 6.75% senior notes due March 1, 2019 (the “6.75% Senior Notes”), and the related acquisition and financing expenses for the Arizona Chemical Acquisition were funded through the following transactions:
•
A $1,350.0 million six-year senior secured first lien term loan facility,
•
A private offering of $440.0 million in aggregate principal amount of 10.5% senior notes due 2023, and
•
An amended and restated $250.0 million five-year asset-based revolving credit facility, $37.1 million of which was drawn on the closing date.
Our previously outstanding indebtedness under the 6.75% Senior Notes and the former asset-based revolving credit facility consisting of a $150.0 million U.S. senior secured revolving credit facility and a $100.0 million Dutch senior secured revolving credit facility (together, the “Senior Secured Credit Facilities”) were satisfied and canceled on January 6, 2016. See Note 19 Subsequent Events to the consolidated financial statements for a further description of the debt issued to finance the Arizona Chemical Acquisition.
Arizona Chemical Products and Commercial Applications. Following the Arizona Chemical Acquisition, we manufacture and sell high value products primarily derived from pine wood pulping co-products. We refine and further upgrade two primary feedstocks, CTO and CST, both of which are co-products of the wood pulping process, into value-added specialty chemicals. We refine CTO through a distillation process into four primary constituent fractions: tall oil fatty acids ( “TOFA”), tall oil rosin (“TOR”), distilled tall oil (“DTO”), and tall oil pitch (“Pitch”). We further upgrade TOFA, TOR and DTO into derivatives including dimer acids, polyamide resins, rosin resins, dispersions and disproportionated resins. We refine CST into terpene fractions, which can be further upgraded into terpene resins. The various fractions and derivatives resulting from our CTO and CST refining process provide for distinct functionalities and properties, determining their respective applications and end markets. We focus our resources on four target markets: (1) adhesives, (2) roads & construction, (3) tires and (4) chemical intermediates. Within our target markets, these products are sold into a diverse range of submarkets, including packaging, tapes and labels, pavement marking, high performance tires, fuel additives, oilfield and mining, coatings, metalworking fluids and lubricants, inks, and flavor and fragrances, among others.
While this business is based predominantly on the refining and upgrading of CTO and CST, we have the capacity to use both hydrocarbon-based raw materials, such as alpha-methyl-styrene (“AMS”), rosins and gum rosins where appropriate and, accordingly, are able to offer tailored solutions for our customers.
Arizona Chemical has a portfolio of innovations at various stages of development and commercialization, including:
•
adhesive tackifiers designed to enable the use of a higher amount of recycled content in packaging materials;
•
high solid adhesive dispersions for labels and tapes that allow for higher coating speeds, which lower process energy costs;
•
heat stable rheology, ink resins that reduce formulation complexity for ink manufacturers while improving ink performance;
•
high performance tire tread resins that promote wet grip, fuel economy and tire life;
•
fuel lubricity improvers that ensure low sulfur targets for diesel fuel can be met;
•
bitumen additives for the asphalt paving market that enable high recycled content in asphalt mixes; and
•
insolublemaleic rosin esters used in pavement marking binders that provide thermal oxidation resistance.
Adhesives. We offer a broad range of products to service target adhesives submarkets, including rosin-based tackifiers for packaging and pressure-sensitive adhesive applications, terpene-based tackifiers for bookbinding, hygiene and pressure-sensitive adhesive applications, AMS resins for bookbinding and pressure-sensitive adhesive applications and hot melt polyamides for flexible packaging.
Our tackifiers are primarily used in hot melt adhesives, which are heavily used in the packaging submarket. Our focus in packaging is to improve our competitive position by introducing higher stability tackifiers that work in new polymer systems. We believe our efforts to improve functionality of tackifier offerings will enable differentiated and profitable growth in emerging markets.
Roads and Construction. We provide various products for use in roads and construction applications. Within the pavement marking submarket, we provide rosin based binders for the thermoplastic pavement marking submarket. We have a long-standing history with our customers in this submarket and our manufacturing footprint enables us to provide stable supply, a significant competitive advantage. Within the paving submarket, we sell TOFA for the asphalt paving market and produce rosin esters, insoluble maleic-based tackifiers and niche products including bitumen additives. Our performance bitumen additives were developed specifically to address unmet needs of the asphalt paving market where our technology enables the use of reclaimed asphalt pavement at high levels in an asphalt mix, while meeting local performance specifications. We have a strong market position supported by our increasing expertise in bitumen chemistry for aged materials, a comprehensive understanding of market needs, innovative product solutions and a growing patent portfolio.
Tires. We sell a range of products that enhance the performance and manufacturing of high performance, winter, and all-season tires. Our terpene-based tread enhancement resins optimize wet grip of tire treads while maintaining rolling resistance and durability which contribute to improved vehicle fuel efficiency. We market our AMS-based tread enhancement additives with product attributes including rolling resistance, durability, wet grip enhancement and exceptional compatibility with rubber compounds, especially solution styrene butadiene rubber polymers. We also sell TOFA, DTO and rosins as processing aids which provide select functionalities at various steps in the rubber and tire manufacturing process.
Arizona Chemical was one of the first companies to supply tread enhancement resins to the tire industry and won early qualifications with innovative tire manufacturers. The quest for improved fuel economy has prompted the introduction of silica-based “green tires” of which certain of our products are a key component. AMS resins were the first tread enhancement additive commercialized beyond basic hydrocarbon tackifiers and offer a good balance of properties, price and performance ratio for current generation tires.
Chemical Intermediates. The chemical intermediates market serves various submarkets with a wide product offering and provides value across several different applications including, among others, fuel additives, oilfield chemicals, mining, coatings, metalworking fluids and lubricants, inks, flavors and fragrances. Our products sold into the chemical intermediates market include:
TOFA. Compared to other fatty acids obtained from various vegetable and animal origins, TOFA has a unique chemical composition characterized by distinctive features. For example:
•
in coatings, TOFA serves as a binder in solvent-based paints as well as in hybrid coatings, and is preferred over soybean oil due to its higher unsaturation, better reactivity, flexibility and compatibility;
•
in mining, TOFA is preferred over oleic acid as lower viscosity and higher affinity with the ore extract allow a higher recovery yield;
•
in oilfield chemicals, TOFA is preferred over oleic acid given its easier handling, better solubility in drilling muds, as well as higher surface activity and emulsifying power; and
•
in fuel additives, TOFA improves the lubricity of low-sulfur diesel fuel, preventing engine fuel pump wear.
Dimer Acids. Our dimer acids are used for the production of polyamide resins for epoxy coatings, flexographic inks, and high performance adhesive applications. In addition, dimer acids are building blocks in the production of corrosion inhibitors and emulsifiers for the production and recovery of petroleum and natural gas. Major competitors in this area include producers of dimer acid from other feedstocks such as rapeseed and cottonseed oil, and other producers of TOFA-based dimers.
TOR. TOR is used in all major rosin applications for the manufacture of adhesives, inks, pavement markers, rubber, paper and chewing gum.
DTO. DTO is one of the fractions resulting from the CTO refining process, consisting of a mixture of TOFA and rosin acids. Our DTO is primarily used as an emulsifier for metalworking fluids and lubricants, where our product offers performance attributes and, in many cases, replaces less environmentally friendly hydrocarbon-based chemicals. In these applications, it is sometimes used in place of TOFA.
Terpene Fractions. We supply terpene fractions, alpha-pinene and beta-pinene, mainly as specialty tackifiers for the adhesives market and tread enhancers for the tires market. We also sell CST directly to global flavor and fragrance producers.
Belpre Compounding Unit Asset Sale
On January 29, 2016, we sold certain assets to PolyOne Corporation (“PolyOne”) including intellectual property, inventory, equipment and other intangible assets associated with our Belpre, Ohio compounding unit (the “BCU”). The BCU is used to manufacture HSBC and USBC based compounds. The $72.0 million purchase price, which was paid in cash at closing, was used to pay down existing indebtedness. In connection with the sale, we entered into a seven year exclusive polymer supply agreement and a compound manufacturing agreement for a transition period of up to two years with PolyOne. Our historical compound sales have primarily been directed into personal care, protective film, consumer, medical & automotive applications, with the compound sales previously reported under the Specialty Polymers business line. Considering both the reduction in sales partially offset by the manufacturing agreement, we expect the divestiture to have a net impact on 2016 EBITDA of approximately $7.0 million.
OUR SBC BUSINESS
Products and Commercial Applications
Our polymer products are high performance elastomers that are engineered for a wide range of applications. Our products possess a combination of high strength and low viscosity, which facilitates ease of processing at elevated temperatures and high processing speeds. Our products can be processed in a variety of manufacturing applications, including injection molding, blow molding, compression molding, extrusion and hot melt, and solution applied coatings.
The majority of worldwide SBC production is dedicated to USBCs, which are primarily used in paving, roofing, adhesives, sealants, coatings, and footwear applications. HSBCs, which are significantly more complex and capital-intensive to manufacture than USBCs, are used in applications such as soft touch and flexible materials, personal hygiene products, medical products, automotive components and certain adhesives and sealant applications. IR and IRL are non-SBC products which are primarily used in surgical gloves and condoms.
We have a portfolio of innovations at various stages of development and commercialization, including:
•
polyvinyl chloride alternatives for wire and cable and medical applications;
•
polymers and compounds for soft skin and coated fabric applications for transportation and consumer markets;
•
highly-modified asphalt ("HiMA") for high-performance paving applications;
•
a family of high melt flow polymers for use in soft touch overmolding, protective cling films and other polymer modification applications;
•
NEXARTM polymers for heating, ventilation, air conditioning and breathable fabrics; and
•
synthetic cement formulations and polymers used for viscosity modification in oilfield applications.
Our polymer products are manufactured and our commercial activities are organized in the following product groups based upon polymer chemistry and process technologies:
Performance Products. For the years ended December 31, 2015, 2014 and 2013, our Performance Products, which are USBC products, generated revenue into the following product applications:
Our Performance Products impart characteristics such as:
•
resistance to temperature and weather extremes in roads and roofing;
•
resistance to cracking, reduced sound transmission and better drainage in porous road surfaces; and
•
increased processing flexibility in adhesive applications, such as packaging tapes and labels, and materials used in disposable diapers.
In paving and roofing applications, our Performance Products primarily consist of styrene-butadiene-styrene (“SBS”)-modified asphalt, which in roofing applications produces stronger and more durable felts and shingles, and in paving applications enhances the strength and elasticity of asphalt-based paving compositions over an extended temperature range. In paving applications, we believe our HiMA technology polymers will extend road life by allowing pavements to withstand heavy traffic loads and varying climate conditions. Our products primarily compete with chemicals such as styrene-butadiene rubber latex, acetates, polyphosphoric acids and thermoplastic materials like ethylene-propylene-diene-monomer (“EPDM”), polyethylene, atactic polypropylene and unmodified asphalts. We believe that customer choice for these markets is driven principally by total end-product cost, temperature performance, bitumen source and application.
In personal care applications, our Performance Products primarily consist of SBS and styrene-isoprene-styrene (“SIS") for the manufacturing of ultra-thin stretchable films used for the production of diapers. In addition, our SIS polymers are also used in the lamination process for other personal care products. Our products primarily compete against low priced alternatives such as metallocenes. We believe that customer choice for these markets is driven principally by total end-product cost and performance.
In adhesives applications, our Performance Products primarily compete with ethylene-vinyl acetate, polyolefines, and metallocene polyolefins. The choice between these materials is influenced by bond strength, specific adhesion, consistent performance to specification, processing speed, hot-melt application, resistance to water and total end-product cost. Our SBCs are compatible with many other formulating ingredients. We believe demand for utilization of SBC based adhesives is primarily driven by cost reduction and higher performance.
Specialty Polymers. Our Specialty Polymers are comprised of HSBC products which are significantly more complex to produce than our Performance Products, which are USBC products. As a result, our Specialty Polymers generally generate higher margins than our Performance Products. For the years ended December 31, 2015, 2014 and 2013, our Specialty Polymers revenue included sales into the following product applications:
Our Specialty Polymers impart characteristics such as:
•
improved flow characteristics for many industrial and consumer sealant and lubricating fluids;
•
soft feel in numerous consumer products such as razor blades, power tools, and automobile components;
•
impact resistance for demanding engineered plastic applications;
•
flexibility for wire and cable plastic outer layers;
•
stretch properties in disposable diapers and adult incontinence products;
•
resistance to ultraviolet light;
•
processing stability and viscosity; and
•
elevated temperature resistance
Our products primarily compete against a variety of chemical and non-chemical alternatives including, but not limited to, thermoplastic vulcanizate, thermoplastic polyurethane, PVC, thermoplastic polyolefin, polyethylene terephthalate, polycarbonate, polyamide and ethylene-propylene-diene-monomer based products. We believe demand for our Specialty Polymers portfolio is principally driven by customer-specific needs and by the ability to balance performance characteristics such as soft-touch, durability, stretch and impact.
Since many of our products are highly engineered and customized formulations, they require specialized product testing and validation, production and process evaluation. This results in a long lead time to achieve customer and industry established approvals. Our innovation led growth strategy focuses on translating the inherent strengths of our product technologies such as flexibility, resilience, impact and moisture resistance, and aesthetics (clarity and haptics) to target opportunities where we can expand and/or have the potential to create new market spaces for our solutions.
CariflexTM. We market our IR and IRL products under the Cariflex brand name. These products combine the key qualities of natural rubber, such as good mechanical properties and hysteresis, with purity and clarity enhancements, good flow, low gel content, and absence of nitrosamines and natural rubber proteins. For the years ended December 31, 2015, 2014 and 2013, our Cariflex revenue included sales into the following product applications:
IR (formed from polymerizing isoprene) is a high purity, non-SBC product. Our IR polymers are available as bales of rubber or as latex. We focus our IR polymers in demanding applications such as medical products, paints, coatings and specialized footwear. IRL (emulsion of IR in water) is a substitute for natural rubber latex, particularly in applications with high purity requirements, such as medical, healthcare, personal care and food contact operations. Our IRL is specialized polyisoprene latex with a controlled structure and low chemical impurity levels obtained through an anionic polymerization process followed by a proprietary latex processing step, both of which were first developed by us. IRL is durable, tear resistant, soft, transparent and odorless. In addition, the synthetic material is non-allergenic and has superior consistency and other advantages to natural rubber latex. IRL is predominately used in synthetic surgical gloves and condoms.
Our products primarily compete with natural rubber, conventional Ziegler Natta sourced solid IR, halo butyl rubber and several synthetic latex alternatives, notably neoprene, nitrile and polychloroprene latex rubber, as well as polyurethane.
We have undertaken several projects to support anticipated continued growth in demand for our CariflexTM products. During 2011, we successfully completed the expansion of our IRL capacity at our Paulinia, Brazil, facility, and more recently, two manufacturing line expansions were completed by our contracted supplier in Japan, more than doubling our previous capacity in Japan.
GENERAL
Sales and Marketing
Our business is predominantly based on a short sales cycle. We sell our products through a number of channels including a direct sales force, marketing representatives and distributors. We use third-party marketing representatives and distributors in markets where they have existing platforms and are more cost effective in completing market coverage. We have long-term relationships and a wide network of distributors across North America, Europe, Latin America and Asia Pacific.
Our sales personnel are primarily responsible for maintaining relationships with our customer base to provide product advice. In general, they arrange and coordinate contact between our customers and our research and development personnel to provide quality control and new product solutions. Our close interaction with our customers has allowed us to develop and maintain what we consider to be strong customer relationships.
For geographic reporting, revenue is attributed to the geographic location in which the customers’ facilities are located. See Note 14 Industry Segment and Foreign Operations to the consolidated financial statements for geographic reporting of revenue and long-lived assets. We generated our revenue from customers located in the following regions:
Competition
In each of our markets, we compete on the basis of a range of factors, including price, breadth of product availability, product quality and the speed of service from order to delivery. We believe our customers also base their supply decisions on the supplier’s ability to design and produce customized products and the availability of technical support. We also compete against a broad range of alternative materials throughout our product groups, including petrochemical, animal and vegetable-based substitutes.
Industry. Our most significant competitors in the specialty chemicals industry are: (1) other SBC producers, including Asahi Chemical, Chi Mei, Dynasol, Kuraray, Korea Kumho, LCY, LG Chemical, Sinopec, TSRC, Versalis, Sibur Voronezh and Zeon Corporation and, following the Arizona Chemical acquisition, (2) other pine chemical manufacturers, including Ingevity, Harima Lawter, Inc., Les Dérivés Résiniques et Terpéniques, Georgia-Pacific LLC, and Respol Group, (3) gum rosin processors, including Harima Lawter Inc. and (4) companies that refine and upgrade hydrocarbons or vegetable oil, including ExxonMobil Corp., Eastman Chemical Company, Archer-Daniels-Midland Company, BASF SE, Cargill, Inc., Energy Oleo Chemicals LLC, KLK Oleo, Oleon NV and Vantage Oleon Chemicals. Generally, however, we believe individual competitors do not compete across all of our product applications.
Sources and Availability of Raw Materials
For the production of SBCs, we use butadiene, styrene and isoprene (also referred to as “monomers”) as our primary raw materials in manufacturing our products. On a first-in, first-out basis of accounting (“FIFO”), these monomers together represented approximately $385.2 million, or 47.8%, of our total cost of goods sold for the year ended December 31, 2015.
For our SBC facilities in the U.S., we procure a substantial majority of our monomers from U.S. suppliers pursuant to contractual arrangements generally having terms ranging from one to two years, subject to renewal conditions. In Europe, we source our butadiene pursuant to long-term contracts in effect through 2040 and 2023 for our Wesseling, Germany, and Berre, France, facilities, respectively. We source styrene and isoprene in Europe through a variety of short term contractual arrangements. In Brazil, we generally purchase all our raw materials from local third-party suppliers under short term contractual arrangements. In Japan, butadiene and isoprene are supplied under our joint venture agreement with JSR Corporation (“JSR”) and styrene is sourced from local third-party suppliers.
Following the Arizona Chemical Acquisition, we have an exclusive long-term supply contract with International Paper, through 2027, pursuant to which they have agreed to sell to us, and we agreed to purchase from them, all of the CTO and CST produced at their paper mills. We also maintain long-standing relationships with other major suppliers of CTO and CST in the United States and Europe. Additionally, our CTO supply sources are further diversified by our ability to refine and process Black Liquor Soap (“BLS”) into CTO in the U.S. Most of Arizona Chemical's manufacturing facilities are located in close proximity to the facilities of our raw material suppliers, allowing us to procure our raw materials at a low delivered cost. Furthermore, we work directly with our suppliers at their production facilities to enhance their CTO and CST yields through technological improvements, which maximize our raw material supplies, improve the efficiency of our suppliers’ operations and enable us to foster strong, long-lasting relationships with them.
Operating Agreements
LyondellBasell operates our manufacturing facilities located in Berre, France, and Wesseling, Germany. LyondellBasell charges us fees based on specified costs incurred in connection with operating and maintaining these facilities as specified in each respective agreement. LyondellBasell employs and provides all staff, other than certain managers, assistant managers and technical personnel, whom we may appoint. The operating agreement for our Berre facility has an unlimited term, but is terminable as of any date after December 31, 2020 following a minimum 18 months notice by either party. The operating agreement for our Wesseling facility is effective through March 31, 2040 and termination requires a five year prior written notice.
Research, Development and Technology
Our research and development program is designed to develop new products and applications, provide technical service to customers, develop and optimize process technology, and assist in marketing new products. We spent $31.0 million, $31.4 million and $32.0 million for research and development for the years ended December 31, 2015, 2014 and 2013, respectively. We also engage in customer-sponsored research projects; with average spending of approximately $1.0 million a year for the three-year period ended December 31, 2015.
Our research and development activities are primarily conducted in laboratories in Houston, Texas, and Amsterdam, the Netherlands. In addition, we launched a semi-works facility in 2014 at our Belpre, Ohio, plant which accelerates polymer development efforts and commercialization of products including the reduction of customer qualification lead times. Following the Arizona Chemical Acquisition, we have additional research and development laboratories in Savannah, Georgia, Almere, the Netherlands, and Shanghai, China.
Patents, Trademarks, Copyrights and Other Intellectual Property Rights
We rely on a variety of intellectual property rights to conduct our business, including patents, trademarks and trade secrets. In 2015, we were awarded 63 patents for new products or applications, and at December 31, 2015, we had 989 granted patents and 328 pending patent applications. Following the Arizona Chemical Acquisition, we obtained an additional 225 granted patents, with a further 129 pending patent applications as of the transaction close date. These patents protect our innovative technologies and applications against infringement, and create long-term, sustainable competitive advantages in our core growth markets. Since patents are generally in effect for a period of 20 years from the filing date, and therefore, assuming most of these applications will be granted, a significant portion of our patent portfolio is expected to remain in effect for a long period. The granted patents and the applications cover both the United States and foreign countries. We do not expect that the expiration of any single patent or specific group of patents would have a material impact on our business and the overall profitability of our business is not dependent on any single patent, trademark, license or franchise.
Our material trademarks will remain in effect unless we decide to abandon any of them, subject to possible third-party claims challenging our rights. Similarly, our trade secrets will preserve their status as such for as long as they are the subject of reasonable efforts, on our part, to maintain their secrecy. We maintain a number of trade names which are protected by trademark laws.
Employees
As of December 31, 2015, we had 917 employees. In addition, 172 LyondellBasell manufacturing employees operate our manufacturing facilities and provide maintenance services in Europe under various operating and services arrangements. See “Operating Agreements.” As of the closing date of the Arizona Chemical Acquisition, Arizona Chemical had 1,112 employees.
Environmental Regulation
Our operations in the United States and abroad are subject to a wide range of environmental laws and regulations at the international, national, state and local levels. Matters pertaining to the environment are discussed in Part I, Item 1A.
Item 1A.
Risk Factors.
Failure to successfully integrate Arizona Chemical in the expected time frame may adversely affect our future results, including the realization of anticipated cost synergies and the incurrence of additional and/or unexpected costs in order to realize them.
The success of the Arizona Chemical Acquisition will depend substantially on our ability to realize the anticipated benefits and cost synergies from combining our business with Arizona Chemical’s business. To realize these anticipated benefits, the businesses must be successfully integrated and combined, and we will incur substantial costs to do so. We currently estimate the cost to achieve expected annual synergies of approximately $65.0 million (expected to be fully realized by 2018) to be approximately $50.0 million over the three-year period following closing of the Arizona Chemical Acquisition and in addition, we may incur future costs associated with integrating the businesses. There can be no assurance that we will be able to realize the anticipated cost synergies from the Arizona Chemical Acquisition in the anticipated amounts or within the anticipated timeframes or costs expectations, or at all.
The combined organization may not be able to achieve its objectives or expected synergies for a number of reasons, including, but not limited to, the following: (i) we may fail to integrate the Arizona Chemical business with our existing business into a cohesive, efficient enterprise; (ii) our resources, including management resources, are limited and may be strained, and the Arizona Chemical Acquisition may divert our management’s attention from initiating or carrying out programs to save costs or enhance revenues; (iii) our failure to retain key employees and contracts of Arizona Chemical; and (iv) there may be operating problems or liabilities that were not identified prior to closing of the Arizona Chemical Acquisition. In addition, costs to achieve anticipated synergies and benefits may exceed our estimates, and the actual integration may result in additional and unforeseen expenses, which could reduce the anticipated benefits of the Arizona Chemical Acquisition.
Assumptions relating to these cost synergies involve subjective decisions and judgments. Although our management team believes these estimates and assumptions to be reasonable, any of the assumptions could be inaccurate. The internal financial projections used to calculate anticipated cost synergies also do not take into account any circumstances or events occurring after the date on which they were prepared. These internal financial projections reflect assumptions as to certain business decisions that are subject to change. Accordingly, there can be no assurance that the internal financial projections and the related anticipated cost synergies will be realized or that actual results will not be significantly higher or lower than projected. We undertake no obligation to update or otherwise revise or reconcile these internal financial projections and the related anticipated cost synergies whether as a result of new information, future events or otherwise.
Our substantial indebtedness could adversely affect our financial condition and prevent us from fulfilling our obligations under our indebtedness, including our senior notes and our senior secured credit facilities.
As of December 31, 2015, we had $350.0 million principal amount of indebtedness outstanding in the form of the 6.75% Senior Notes and our former Senior Secured Credit Facilities which were undrawn, with available borrowing capacity of $165.5 million. In connection with the Arizona Chemical Acquisition we:
•
conducted a cash tender offer and redemption for the 6.75% Senior Notes;
•
entered into a new $1,350.0 million first lien term loan (the “Term Loan Facility”);
•
amended our former senior secured credit facilities to a $250.0 million asset-based credit facility (the “ABL Facility”), under which we drew $37.1 million; and
•
issued $440.0 million of 10.5% senior notes due 2023 (the “10.5% Senior Notes”).
Under our new Term Loan Facility and amended ABL Facility, we may request up to an aggregate of $350.0 million and $100.0 million, respectively, of additional facility commitments subject to compliance with certain covenants and other conditions. In addition, our KFPC joint venture executed a syndicated loan agreement in the amount of 5.5 billion new Taiwanese dollars ( “NTD”), or $167.5 million (converted at the December 31, 2015 exchange rate), to provide additional funding to construct the HSBC facility in Taiwan and to provide funding for working capital requirements and/or general corporate purposes. FPCC and Kraton Polymers LLC are the guarantors of the KFPC Loan Agreement with each guarantor guaranteeing fifty percent (50%) of the indebtedness, of which NTD 2.5 billion, or $76.9 million (converted at the December 31, 2015 exchange rate), of indebtedness was outstanding as of December 31, 2015.
Although the agreements governing the Term Loan Facility, the ABL Facility, the 10.5% Senior Notes, and the KFPC Loan Agreement contain restrictions on the incurrence of additional indebtedness, these restrictions are subject to a number of important exceptions, and additional indebtedness that we may incur from time to time to finance projects or for other reasons in compliance with these restrictions could be substantial. If we and our restricted subsidiaries incur significant additional indebtedness, the related risks that we face could increase.
Our indebtedness could:
•
make it more difficult for us to satisfy our financial obligations;
•
increase our vulnerability to adverse economic and industry conditions;
•
increase the risk that we breach financial covenants and other restrictions in our debt agreements, which can be exacerbated by volatility in the cost of our raw materials and the resulting impact on our earnings;
•
require us to dedicate a substantial portion of our cash flow from operations to make payments on our indebtedness, thereby reducing the availability of our cash flow to fund working capital, capital expenditures and other general corporate purposes;
•
limit our flexibility in planning for, or reacting to, changes in the business and industry in which we operate;
•
restrict us from exploiting business opportunities;
•
place us at a disadvantage compared to our competitors that have less debt and lease obligations; and
•
limit our ability to borrow additional funds for working capital, capital expenditures, acquisitions, debt service requirements, execution of our business strategy and other general corporate purposes or to refinance our existing debt.
Our ability to pay principal of and interest on indebtedness, fund working capital and make anticipated capital expenditures depends on our future performance, which is subject to general economic conditions and other factors, some of which are beyond our control. There can be no assurance that our business will generate sufficient cash flow from operations or that future borrowings will be available under the ABL Facility to fund liquidity needs, including debt service. Furthermore, if we decide to undertake additional investments in existing or new facilities, this will likely require additional capital, and there can be no assurance that this capital will be available.
Despite current indebtedness levels and restrictive covenants, we and our subsidiaries may incur additional indebtedness or we may pay dividends in the future. This could further exacerbate the risks associated with our substantial financial leverage.
We and our subsidiaries may incur significant additional indebtedness in the future under the agreements governing our indebtedness. Although the terms of the Term Loan Facility, the ABL Facility and the 10.5% Senior Notes contain restrictions on the incurrence of additional indebtedness and the payment of distributions to our equity holders, these restrictions are subject to a number of thresholds, qualifications and exceptions, and the additional indebtedness incurred, and distributions paid, in compliance with these restrictions could be substantial. Additionally, these restrictions also permit us to incur obligations that, although preferential to our common stock in terms of payment, do not constitute indebtedness. As of the date of this filing, $37.0 million was drawn on the ABL Facility with a remaining available borrowing capacity of $176.9 million. In addition, if new debt is added to our and/or our subsidiaries’ debt levels, the related risks that we now face as a result of our leverage would intensify.
Our current and future debt instruments may impose significant operating and financial restrictions on us and affect our ability to access liquidity.
Our current debt instruments do, and any future debt instruments may, contain a number of restrictive covenants that impose significant operating and financial restrictions on us. Under the terms of our ABL Facility, we are subject to a financial covenant requiring us to maintain a fixed charge coverage ratio of 1.0 to 1.0 if availability under the facility is below specified amounts. In addition, our Term Loan Facility includes a senior secured net leverage ratio covenant which shall not exceed 4.00:1.00 through March 31, 2017 reducing over time to 3.25:1.00 in 2019. In addition, our debt instruments may include restrictions on our ability to, in certain circumstances, among other things:
•
place liens on our or our restricted subsidiaries’ assets;
•
make investments other than permitted investments;
•
incur additional indebtedness;
•
merge, consolidate or dissolve;
•
sell assets;
•
engage in transactions with affiliates;
•
change the nature of our business;
•
change our or our subsidiaries’ fiscal year or organizational documents; and
•
make restricted payments (including certain equity issuances).
A failure by us or our subsidiaries to comply with the covenants and restrictions contained in the agreements governing our indebtedness could result in an event of default under such indebtedness, which could adversely affect our ability to respond to changes in our business and manage our operations. Upon the occurrence of an event of default under any of the agreements governing our indebtedness, the lenders could elect to declare all amounts outstanding to be due and payable and exercise other remedies as set forth in the agreements. Further, an event of default or acceleration of indebtedness under one instrument may constitute an event of default under another instrument. If any of our indebtedness were to be accelerated, there can be no assurance that our assets would be sufficient to repay this indebtedness in full, which could have a material adverse effect on our ability to continue to operate as a going concern.
To service our indebtedness, we will require a significant amount of cash.
Our ability to generate cash depends on many factors beyond our control, and any failure to meet our debt service obligations could harm our business, financial condition and results of operations. Our ability to make payments on and to refinance our indebtedness, and to fund working capital needs and planned capital expenditures, will depend on our ability to generate cash in the future. This, to a certain extent, is subject to general economic, financial, competitive, business, legislative, regulatory and other factors that are beyond our control, including, among other things, the costs of raw materials used in the production of our products.
If our business does not generate sufficient cash flow from operations or if future borrowings are not available to us in an amount sufficient to enable us to pay our indebtedness, or to fund our other liquidity needs, we may need to refinance all or a portion of our indebtedness, on or before the maturity thereof, sell assets, reduce or delay capital investments or seek to raise additional capital, any of which could have a material adverse effect on our operations. We might not generate sufficient cash flow to repay indebtedness as currently anticipated. In addition, we may not be able to effect any of these actions, if necessary, on commercially reasonable terms or at all. Our ability to restructure or refinance our indebtedness, will depend on the condition of the capital markets and our financial condition at such time. Any refinancing of our indebtedness could be at higher interest rates and may require us to comply with more onerous covenants, which could further restrict our business operations. The terms of existing or future debt instruments may limit or prevent us from taking any of these actions. In addition, any failure to make scheduled payments of interest and principal on our outstanding indebtedness would likely result in a reduction of our credit rating, which could harm our ability to incur additional indebtedness on commercially reasonable terms or at all. Our inability to generate sufficient cash flow to satisfy our debt service obligations, or to refinance or restructure our obligations on commercially reasonable terms or at all, would have a material adverse effect on our business, financial condition and results of operations.
Our variable rate indebtedness subjects us to interest rate risk, which could cause our debt service obligations to increase significantly.
Borrowings under the Term Loan Facility and the ABL Facility are at variable rates of interest and expose us to interest rate risk. Interest rates are currently at historically low levels. If interest rates increase, our debt service obligations on the variable rate indebtedness will increase even though the amount borrowed will remain the same, and our net income and cash flows, including cash available for servicing our indebtedness, will correspondingly decrease. Following the close of the Arizona Chemical Acquisition on January 6, 2016, approximately $1,350.0 million of our debt would have been variable rate debt, and, holding other variables constant, an increase or decrease in interest rates by 0.125% on our variable rate debt would increase or decrease our annual interest expense by approximately $1.7 million. Subsequent to the close of our Term Loan Facility, we entered into a series of interest rate swaps for a portion of the forecasted Term Loan Facility balance effective in January 2017 whereby we exchanged floating for fixed rate interest payments in order to reduce exposure to interest rate volatility. However, interest rate swaps we entered may not fully mitigate our interest rate risk.
Conditions in the global economy and capital markets may adversely affect the company’s results of operations, financial condition and cash flows.
Our products are sold in markets that are sensitive to changes in general economic conditions, such as automotive, construction and consumer products. Downturns in general economic conditions can cause fluctuations in demand for our products, product prices, sales volumes and margins. A decline in the demand for our products or a shift to lower-margin products due to deteriorating economic conditions could adversely affect sales of our products and our profitability and could also result in impairments of certain of our assets.
Our business and operating results have been affected by fluctuating commodity prices, volatile exchange rates and other challenges currently affecting the global economy and our customers. Uncertainty regarding global economic conditions poses a continuing risk to our business, as consumers and businesses may postpone spending in response to tighter credit, negative financial news or declines in income or asset values, which may reduce demand for our products. If global economic and market conditions, or economic conditions in key markets, remain uncertain or deteriorate further, our results of operations, financial condition and cash flows could be materially adversely affected.
The failure of our raw materials suppliers to perform their obligations under long-term supply agreements, or our inability to replace or renew these agreements when they expire, could increase our cost for these materials, interrupt production or otherwise adversely affect our results of operations.
Our manufacturing processes use the following primary raw materials: butadiene, styrene, isoprene, CTO, including black liquor soap that we refine into CTO and CST. We have entered into long-term supply agreements with Shell Chemicals, LyondellBasell, International Paper and others to supply our raw material needs in the United States and Europe.
In addition, most of our long-term contracts contain provisions that allow our suppliers to limit, or allocate, the amount of raw materials shipped to us below the contracted amount in certain circumstances. If we are required to obtain alternate sources for raw materials because a supplier is unwilling or unable to perform under raw material supply agreements, if a supplier terminates its agreements with us, if we are unable to renew our existing contract, or if we are unable to obtain new long-term supply agreements to meet changing demand, we may not be able to obtain these raw materials in sufficient quantities or in a timely manner, and we may not be able to enter into long-term supply agreements on terms as favorable to us, if at all. A lack of availability of raw materials could have a material adverse effect on our results of operations, financial condition and cash flows.
If the availability of isoprene is limited, we may be unable to produce some of our products in quantities or on economic terms sought by our customers, which could have an adverse effect on our sales of products requiring isoprene.
Isoprene is not widely available, and the few isoprene producers tend to use their production for captive manufacturing purposes or to sell only limited quantities into the world chemicals market. As a result, there is limited non-captive isoprene available for purchase in the markets in which we operate.
Currently, we source our isoprene requirements for the United States and Europe from a portfolio of suppliers. In Japan, we obtain the majority of our isoprene requirements from our joint venture partner, JSR, and from alternative suppliers as needed. In Brazil, isoprene is primarily obtained from local third party suppliers under short term contractual arrangements. These suppliers may not be able to meet our isoprene requirements, and we may not be able to obtain isoprene in quantities required for our operations on terms favorable to us, or at all. A lack of availability of isoprene in the quantities we require to produce products containing isoprene could have a material adverse effect on our results of operations.
Because there is limited non-captive isoprene availability, the market for isoprene is thin and prices are particularly volatile. Prices for isoprene are impacted by the supply and prices of natural and synthetic rubber, prevailing energy prices and the existing supply and demand of isoprene in the market. In the past, tight supply in the isoprene market has been exacerbated by operational problems of some key producers and reduced availability of crude C5 inputs for the extraction units. More recently, the trend toward lighter ethylene cracker feed slates has reduced the supply of crude C5 in the United States. This decrease has been replaced by imports of crude C5 and/or isoprene. Significant increases in the cost of isoprene could have a material adverse impact on our results of operations, financial condition and cash flows.
If the availability of butadiene is limited, we may be unable to produce some of our products in quantities or on economic terms sought by our customers, which could have an adverse effect on our sales of products requiring butadiene.
The North American market is structurally short of butadiene and has relied on imports of crude C4 and/or butadiene to balance demand. With the trend toward lighter ethylene cracker feed slates in the United States, there has been a reduction in the supply of crude C4. The North American market has been supplemented by imports of crude C4 and butadiene. Historically, the European market has been better balanced and provided exports to North America. Currently, our butadiene requirements in the United States are satisfied by several suppliers, and LyondellBasell is our major butadiene supplier in Europe. In general, the quantity of butadiene available in any one region is dependent on the cracking inputs of olefins plants, ethylene demand, inter-regional demand for butadiene and demand for other oil derivatives. Suppliers may not be able to meet our butadiene requirements, and we may not be able to obtain substitute supplies of butadiene from alternative suppliers in a timely manner or on favorable terms. A lack of availability of butadiene in the quantities we require to produce products containing butadiene could have a material adverse effect on our results of operations, financial condition and cash flows.
If the availability of styrene is limited, we may be unable to produce some of our products in quantities or on economic terms sought by our customers, which could have an adverse effect on facility utilization and our sales of products requiring styrene.
We satisfy our styrene requirements in the United States and Europe pursuant to purchase agreements with terms of one to two years, subject to renewal conditions. We have more than one supplier in each of these regions and also generally have alternatives for either modifying the contract, supply portfolio or obtaining spot supply. As contracts expire, we cannot give assurances that we will obtain new long-term supply agreements or that the terms of any such agreements will be on terms favorable to us, and consequently our future acquisition costs for styrene may therefore increase which could have a material adverse effect on our results of operations, financial condition and cash flows.
If the availability of CTO is limited, we may be unable to produce some of our products in quantities or on economic terms sought by our customers, which could have an adverse effect on facility utilization and the sales of products requiring CTO.
The availability of CTO is directly linked to the production output of kraft mills using pine as their source of pulp. As a result, there is a finite global supply of CTO, with global demand for kraft board driving the global supply of CTO, rather than demand for CTO itself. Most of the CTO made available for sale by its producers in North America is covered by long-term supply agreements, further constraining availability. We have a long-term supply contract with International Paper pursuant to which they sell to us all of the CTO produced at their paper mills. If International Paper, or any of our other suppliers for CTO, fail to meet their respective obligations under supply agreements or if we are otherwise unable to procure an adequate supply of CTO, we may be unable to produce the quantity of products needed to satisfy customer demand. There are other pressures on the availability of CTO. Some pulp or paper mills may choose to consume their production of CTO to meet their energy needs rather than sell the CTO to third parties. Also, there are regulatory pressures that may incentivize suppliers of CTO to sell CTO into alternative fuel markets rather than to historical end users. Furthermore, weather conditions have in the past and may in the future affect the availability and quality of pine trees used in the kraft pulping process and therefore the availability of CTO meeting our quality standards. A lack of availability of CTO in the quantities we require to produce products containing CTO could have a material adverse effect on our results of operations, financial condition and cash flows.
The European Union’s Directive 2009/28 on the promotion of the use of energy from renewable resources (“Renewable Energy Directive” or “RED”) and similar legislation in the United States and elsewhere may incentivize the use of CTO as a feedstock for production of alternative fuels.
In December 2008, the European Union adopted RED, which established a 20% EU-wide target for energy consumed from renewable sources relative to the EU’s gross final consumption of energy, as well as a 10% target for energy consumed from renewable sources in the transport section by 2020. In order to reach these targets, the RED established mandatory targets for each Member State (as defined in RED) and required each Member State to adopt a national renewable energy action plan setting forth measures to achieve its national targets. RED also established sustainability criteria for biofuels, which must be satisfied in order for the consumption of a fuel to count toward a Member State’s national targets. CTO-based biofuel currently fulfills RED’s biofuel sustainability criteria. In spring 2015, the EU adopted amendments to RED, expressly listing CTO as a residue- type feedstock whose use in biofuel would make that biofuel eligible for double counting towards national targets of the Member States, and at least two Member States additionally have or plan fiscal incentives for the domestic marketing of CTO-based and other qualifying biofuels. In addition to these developments in the European Union, various pieces of legislation regarding the use of alternative fuels have been introduced in the United States. Because the supply of CTO is inherently constrained by the volume of kraft pulp processing, any diversion of CTO for production of alternative fuels would reduce the available supply of CTO as the principal raw material of the pine chemicals industry. A reduced ability to procure an adequate supply of CTO due to competing new uses such as for biofuel production, could have a material adverse effect on our results of operations, financial condition and cash flows.
Increases in the costs of our raw materials could have an adverse effect on our financial condition and results of operations if those costs cannot be passed onto our customers.
Our results of operations are directly affected by the cost of raw materials. We use butadiene, styrene, and isoprene as our primary raw materials in our SBC Business. On a first-in, first-out (FIFO) basis, these monomers together represented approximately $385.2 million, $512.8 million and $609.5 million or 47.8%, 51.6% and 57.2% of our total cost of goods sold for the years ended December 31, 2015, 2014 and 2013, respectively. In connection with the Arizona Chemical Acquisition, CTO has become another one of our primary raw materials. Since the cost of these primary raw materials comprise a significant amount of our total cost of goods sold, the selling prices for our products and therefore our total revenue is impacted by movements in these raw material costs, as well as the cost of other inputs. In the past we have experienced erratic and significant changes in the costs of these raw materials, the cost of which has generally correlated with changes in energy prices, supply and demand factors, and prices for natural and synthetic rubber. The pricing for butadiene has historically been particularly volatile. Political unrest in the Middle East and market dislocation resulting from U.S. sanctions relating thereto could lead to increases in the price of crude oil, and, as a result, in the price of butadiene, styrene and isoprene. In addition, product mix can have an impact on our overall unit selling prices, since we provide an extensive product offering and therefore experience a wide range of unit selling prices. Because of the significant portion of our cost of goods sold represented by these raw materials, our gross profit margins could be adversely affected by changes in the cost of these raw materials if we are unable to pass the increases on to our customers.
Due to volatile raw material price increases, there can be no assurance that we can continue to recover raw material costs or retain customers in the future. As a result of our pricing actions, customers may become more likely to consider competitors’ products, some of which may be available at a lower cost. Significant loss of customers could result in a material adverse effect on our results of operations, financial condition and cash flows.
Significant fluctuations in raw material costs may result in volatility in our quarterly operating results and impact the market price of our common stock.
In periods of raw material price volatility, reported results under GAAP will differ from what the results would have been if cost of goods sold were based on estimated current replacement cost (“ECRC”). Specifically, in periods of declining raw material costs, reported gross profit will be lower under GAAP than under ECRC, and in periods of rising raw material costs, gross profit will be higher under GAAP than under ECRC. However, because raw material costs are difficult to predict, we cannot accurately anticipate fluctuations in monomer costs with precision, or effectively or economically hedge against the effects of any such change. If monomer costs fluctuate in a quarter, our results of operations will be affected, the magnitude of which could be significant, which could cause our earnings to depart from the periodic expectations of financial analysts or investors and, therefore, the market price of our common stock may be volatile as a result.
LyondellBasell Industries provides significant operating and other services under agreements that are important to our business. The failure of LyondellBasell to perform its obligations, or the termination of these agreements, could adversely affect our operations.
We have operating and service agreements with LyondellBasell Industries, or LyondellBasell, that are important to our business. We are a party to:
•
operating agreements under which LyondellBasell (in Berre, France, and Wesseling, Germany) operates and maintains our European manufacturing facilities and employs and provides substantially all of the staff for those facilities; these operating agreements also provide for site services, utilities, materials and facilities, which had previously been under separate agreements; and
•
lease agreements under which we lease our European manufacturing sites for our Polymers Business (a 96 kiloton capacity facility in Wesseling, Germany and an 85 kiloton capacity facility in Berre, France) from LyondellBasell.
Under the terms of the above agreements, either party is permitted to terminate the applicable agreement in a variety of situations. The operating agreement for our Berre facility has an unlimited term, but is terminable as of any date after December 31, 2020 following a minimum 18 months notice by either party. As of the date of this filing, no such notice has been given by either party. Should LyondellBasell fail to provide these services or should any operating agreement be terminated, we would be forced to obtain these services from third parties or provide them ourselves. Similarly, if in connection with or independent from the termination of an operating agreement, LyondellBasell terminates a facility lease, we would be forced to relocate our manufacturing facility. The failure of LyondellBasell to perform its obligations under, or the termination of, any of these agreements could materially adversely affect our operations and, depending on market conditions at the time of any such termination, we may not be able to enter into substitute arrangements in a timely manner, if at all, and if we are able to enter into a substitute arrangement, it may not be on terms as favorable to us.
Our industry is highly competitive, and we may lose market share to other producers of SBCs, pine based specialty chemicals or other products that can be substituted for our products.
Our industry is highly competitive, and we face significant competition from both large international producers and from smaller regional competitors. Our competitors may improve their competitive position in our core markets by successfully introducing new products, improving their manufacturing processes, or expanding their capacity or manufacturing facilities. Further, some of our competitors benefit from advantageous cost positions that could make it increasingly difficult for us to compete in markets for less-differentiated applications. If we are unable to keep pace with our competitors’ product and manufacturing process innovations or cost position, it could have a material adverse effect on our results of operations, financial condition and cash flows.
In addition, competition in the various product applications in which we compete is intense. Increased competition from existing or newly developed SBCs, pine-based specialty chemicals or other products may reduce demand for our products in the future and our customers may decide on alternate sources to meet their requirements. If we are unable to successfully compete with other producers of SBCs or refiners of CTO, or if other products can be successfully substituted for our products, our sales may decline. Our tall oil-based resins compete against hydrocarbon and gum-based resins in the adhesives and inks submarkets, and our TOFA competes against animal and vegetable-based fatty acids. We could be subject to pricing pressure from Chinese manufacturers of gum rosins, and hydrocarbon competitors have introduced metallocene-based products that compete directly with many of our adhesive tackifiers.
If we are not able to continue the technological innovation and successful commercial introduction of new products, our customers may turn to other producers to meet their requirements.
Our industry and the markets into which we sell our products experience periodic technological change and ongoing product improvements. In addition, our customers may introduce new generations of their own products or require new
technological and increased performance specifications that would require us to develop customized products. Innovation or other changes in our customers’ product performance requirements may also adversely affect the demand for our products. Our future growth and profitability will depend on our ability to gauge the direction of the commercial and technological progress in all key markets, and upon our ability to successfully develop, manufacture and sell products in such changing markets. In order to maintain our profit margins and our competitive position, we must continue to identify, develop and market innovative products on a timely basis to replace existing products. We may not be successful in developing new products and technology that successfully compete with newly introduced products and materials, and our customers may not accept, or may have lower demand for, any of our new products. Further, an important part of our strategy is the creation of demand for innovations that we develop and introduce to the markets. If we fail to keep pace with evolving technological innovations, fail to modify our products in response to our customers’ needs or fail to develop innovations that generate additional demand, then our business, financial condition and results of operations could be adversely affected as a result of reduced sales of our products or diminished return on investment in innovations.
Our business relies on intellectual property and other proprietary information, and our failure to protect our rights could harm our competitive advantages with respect to the manufacturing of some of our products.
Our success depends, to a significant degree, upon our ability to protect and preserve our intellectual property and other proprietary information relating to our business. However, we may be unable to prevent third parties from using our intellectual property and other proprietary information without our authorization or from independently developing intellectual property and other proprietary information that is similar to ours, particularly in those countries where the laws do not protect our proprietary rights to the same degree as in the United States. The use of our intellectual property and other proprietary information by others could reduce or eliminate any competitive advantage we have developed, potentially causing us to lose sales or otherwise harm our business. If it becomes necessary for us to litigate to protect these rights, any proceedings could be burdensome and costly, and we may not prevail.
In addition, we acquired a significant number of patents from Shell Chemicals. According to the agreements with Shell Chemicals relating to their contribution of these patents to us and our ownership of these patents, Shell Chemicals retained for itself fully-transferable and exclusive licenses to their use outside of the elastomers business, as well as fully-transferable non-exclusive licenses within the field of elastomers for certain limited uses in non-competing activities. Shell Chemicals is permitted to sublicense these rights. Shell Chemicals also retains the right to enforce these patents outside the elastomers field and recover any damages resulting from these actions.
Our patent applications and issued patents may not provide us with any competitive advantage and may be challenged by third parties. Our competitors may also attempt to design around our patents or copy or otherwise obtain and use our intellectual property and other proprietary information. Moreover, our competitors may already hold or have applied for patents in the United States or abroad that, if enforced or issued, could possibly prevail over our patent rights or otherwise limit our ability to manufacture or sell one or more of our products in the United States or abroad. With respect to our pending patent applications, we may not be successful in securing patents for these claims. Our failure to secure these patents may limit our ability to protect inventions that these applications were intended to cover. In addition, the expiration of a patent can result in increased competition with consequent erosion of profit margins.
It is our policy to enter into confidentiality agreements with our employees and third parties to protect our unpatented proprietary manufacturing expertise, continuing technological innovation and other trade secrets, but our confidentiality agreements could be breached or may not provide meaningful protection for our trade secrets or proprietary manufacturing expertise. Adequate remedies may not be available in the event of an unauthorized use or disclosure of our trade secrets and manufacturing expertise. Violations by others of our confidentiality agreements and the loss of employees who have specialized knowledge and expertise could harm our competitive position and cause our sales and operating results to decline as a result of increased competition. In addition, others may obtain knowledge of our trade secrets through independent development or other access by legal means.
The applicable governmental authorities may not approve our pending service mark and trademark applications. A failure to obtain trademark registrations in the United States and in other countries could limit our ability to obtain and retain our trademarks and impede our marketing efforts in those jurisdictions. Moreover, third parties may seek to oppose our applications or otherwise challenge the resulting registrations. In the event that our trademarks are successfully challenged, we could be forced to rebrand our products, which could result in loss of brand recognition and could require us to devote resources to advertising and marketing new brands.
The failure of our patents, trademarks or confidentiality agreements to protect our intellectual property and other proprietary information, including our processes, apparatuses, technology, trade secrets, trade names and proprietary manufacturing expertise, methods and compounds, could have a material adverse effect on our competitive advantages over other producers.
Our products may infringe on the intellectual property rights of others, which may cause us to incur unexpected costs or prevent us from selling our products.
Many of our competitors have a substantial amount of intellectual property. We cannot guarantee that our processes and products do not and will not infringe issued patents (whether present or future) or other intellectual property rights belonging to others, including, without limitation, situations in which our products, processes or technologies may be covered by patent applications filed by other parties in the United States or abroad.
From time to time, we oppose patent applications that we consider overbroad or otherwise invalid in order to maintain the necessary freedom to operate fully in our various business lines without the risk of being sued for patent infringement. If, however, patents are subsequently issued on any such applications by other parties, or if patents belonging to others already exist that cover our products, processes or technologies, we could be liable for infringement or have to take other remedial or curative actions to continue our manufacturing and sales activities with respect to one or more products.
We may also be subject to legal proceedings and claims in the ordinary course of our business, including claims of alleged infringement of the patents, trademarks and other intellectual property rights of third parties by us or our licensees in connection with their use of our products. Intellectual property litigation is expensive and time-consuming, regardless of the merits of any claim, and could divert our management’s attention from operating our business.
If we were to discover that our processes, technologies or products infringe the valid intellectual property rights of others, we might need to obtain licenses from these parties or substantially re-engineer our products in order to avoid infringement. We may not be able to obtain the necessary licenses on acceptable terms, or at all, or be able to re-engineer our products successfully. Moreover, if we are sued for infringement and lose, we could be required to pay substantial damages and/or be enjoined from using or selling the infringing products or technology. If we incur significant costs to litigate our intellectual property rights or to obtain licenses, or if our inability to obtain required licenses for our processes, technologies or products prevents us from selling our products, it could have a material adverse effect on our business and results of operations.
A major failure of our information systems could harm our business.
We depend on integrated information systems to conduct our business. We may experience operating problems with our information systems as a result of system failures, viruses, computer “hackers” or other causes. If our systems for protecting against these risks prove not to be sufficient, we could be adversely affected by, among other things, loss or damage of intellectual property, proprietary information, or customer data, having our business operations interrupted, and increased costs to prevent, respond to, or mitigate attacks on our systems. Any significant disruption or slowdown of our systems could cause customers to cancel orders or cause standard business processes to become inefficient or ineffective, which could adversely affect our results of operations, financial position or cash flows. Additionally, in connection with the Arizona Chemical Acquisition, integration activities for our separate ERP systems will begin in 2016. Disruption to the integration process could affect functionality, which could affect the conduct of our business.
Our business is subject to seasonality that may affect our quarterly operating results and impact the market price of our common stock.
Seasonal changes and weather conditions typically affect our sales in our paving (including roadmarkings), roofing and construction applications. In particular, sales volumes generally rise in the warmer months and generally decline during the colder months of fall and winter, or during abnormally wet seasons. In addition, sales into the ink submarket are typically highest in the third quarter of the year due to increased demand for holiday catalog printing. However, because seasonal weather patterns are difficult to predict, we cannot accurately estimate quarterly fluctuations in sales into our paving, roofing, construction, and ink submarkets in any given year.
Seasonality also affects the availability of CTO and CST, two of our primary raw materials. Yields of CTO and CST are higher during the first half of the year, generally peaking during the early summer months, due to the natural growth and associated chemical yield cycles of trees, in addition to higher yields from kraft pulping during the cooler months.
Chemical manufacturing is inherently hazardous, which could result in accidents that disrupt our operations or expose us to significant losses or liabilities.
Hazards associated with chemical manufacturing and the related storage and transportation of raw materials, products and wastes exist in our operations and the operations of other occupants with whom we share manufacturing sites. These hazards could lead to an interruption or suspension of operations and have an adverse effect on the productivity and profitability of a particular manufacturing facility or on us as a whole. These potential risks include, but are not necessarily limited to:
•pipeline and storage tank leaks and ruptures;
•
explosions and fires;
•
inclement weather and natural disasters;
•
terrorist attacks;
•
mechanical failure; and
•
chemical spills and other discharges or releases of toxic or hazardous substances or gases.
These hazards may result in personal injury and loss of life, damage to property and contamination of the environment, which may result in a suspension of operations and the imposition of civil or criminal penalties, including governmental fines, expenses for remediation and claims brought by governmental entities or third parties. The loss or shutdown of operations over an extended period at any of our major operating facilities could have a material adverse effect on our financial condition and results of operations. Our property, business interruption and casualty insurance may not fully insure us against all potential hazards incidental to our business.
We may be liable for damages based on product liability claims brought against our customers.
Many of our products provide critical performance attributes to our customers’ products that are sold to consumers who could potentially bring product liability suits in which we could be named as a defendant. For example, certain of the chemicals or substances that are used in our businesses, including alkyl phenols such as bisphenol A and nonylphenol, flammable solvents such as toluene, xylene and alcohols, and rosin, formaldehyde and resin dust, have been identified as having potentially harmful health effects. The sale of these products entails the risk of product liability claims. If a person were to bring a product liability suit against one of our customers, the customer may attempt to seek contribution from us. A person may also bring a product liability claim directly against us. A successful product liability claim or series of claims against us in excess of our insurance coverage, for which we are not otherwise indemnified, could have a material adverse effect on our financial condition or results of operations. There can be no assurance that our efforts to protect ourselves from product liability claims in this regard will ultimately protect us from any such claims.
As a global business, we are exposed to local business risks in different countries, which could have a material adverse effect on our financial condition or results of operations.
We have significant operations in foreign countries, including manufacturing facilities, research and development facilities, sales personnel and customer support operations. Currently, we operate, or others operate on our behalf, facilities in Brazil, Finland, France, Germany, Japan and Sweden, in addition to our operations in the United States. Furthermore, we are a 50/50 joint venture partner with FPCC to build, own and operate a 30 kiloton HSBC plant at FPCC’s petrochemical site in Mailiao, Taiwan.
Our foreign operations are subject to risks inherent in doing business in foreign countries, including, but not necessarily limited to:
•
new and different legal and regulatory requirements in local jurisdictions;
•
export duties or import quotas;
•
domestic and foreign customs and tariffs or other trade barriers;
•
potential staffing difficulties and labor disputes;
•
risk of non-compliance with the United States Foreign Corrupt Practices Act or similar anti-bribery legislation in other countries by agents or other third-party representatives;
•
managing and obtaining support and distribution for local operations;
•
increased costs of transportation or shipping;
•
credit risk and financial conditions of local customers and distributors;
•
potential difficulties in protecting intellectual property;
•
risk of nationalization of private enterprises by foreign governments;
•
potential imposition of restrictions on investments;
•
potentially adverse tax consequences, including imposition or increase of withholding and other taxes on remittances and other payments by subsidiaries;
•
foreign currency exchange restrictions and fluctuations;
•
local political and social conditions, including the possibility of hyperinflationary conditions and political instability in certain countries; and
•
civil unrest, including labor unrest, in response to local political conditions.
We may not be successful in developing and implementing policies and strategies to address the foregoing risks in a timely and effective manner at each location where we do business. Consequently, the occurrence of one or more of the foregoing risks could have a material adverse effect on our international operations or upon our financial condition and results of operations.
Compliance with extensive environmental, health and safety laws could require material expenditures, changes in our operations or site remediation.
The manufacturing of our products can present potentially significant health and safety concerns. Our products are also used in a variety of applications that have specific regulatory requirements such as those relating to products that have contact with food or are used for medical applications.
We use large quantities of hazardous substances and generate hazardous wastes in our manufacturing operations. Consequently, our operations are subject to extensive environmental, health and safety laws and regulations at the international, national, state and local level in multiple jurisdictions. These laws and regulations govern, among other things, air emissions, wastewater discharges, solid and hazardous waste management, site remediation programs and chemical use and management. Many of these laws and regulations have become more stringent over time and the costs of compliance with these requirements may increase, including costs associated with any necessary capital investments. In addition, our production facilities require operating permits that are subject to renewal and, in some circumstances, revocation. The necessary permits may not be issued or continue in effect, and renewals of any issued permits may contain significant new requirements or restrictions. The nature of the chemical industry exposes us to risks of liability due to the use, production, management, storage, transportation and sale of materials that are heavily regulated or hazardous and can cause contamination or personal injury or damage if released into the environment.
Because of the nature of our operations, we could be subject to legislation and regulation affecting the emission of greenhouse gases. In the last five years, the U.S. Environmental Protection Agency (“EPA”) promulgated regulations applicable to projects involving greenhouse gas emissions above a certain threshold, and the U.S. and certain states within the U.S. have enacted, or are considering, limitations on greenhouse gas emissions.
Jurisdictions outside the U.S. are also addressing greenhouse gases by legislation or regulation. In addition, efforts have been made and continue to be made at the international level toward the adoption of international treaties or protocols that would address global greenhouse gas emissions. These requirements to limit greenhouse gas emissions may require us to incur capital investments to upgrade our operations to comply with any future greenhouse gas emissions controls. While the impact of any such legislation, regulation, treaties or protocols is currently speculative, any such legislation, regulation, treaties or protocols, if enacted, may have an adverse effect on our operations or financial condition. Further, some scientific studies on the effect of the emission of greenhouse gases on climate suggest that adverse weather events may become stronger or more frequent in the future in certain of the areas in which we operate, although the scientific studies are not unanimous. Due to their location, some of our operations may be vulnerable to operational and structural damages resulting from hurricanes and other severe weather systems. Our insurance may not cover all associated losses. We are taking steps to mitigate physical risks from storms, but no assurance can be given that future storms will not have a material adverse effect on our business.
Compliance with environmental laws and regulations generally increases the costs of transportation and storage of raw materials and finished products, as well as the costs of storage and disposal of wastes. We may incur substantial costs, including fines, damages, criminal or civil sanctions and remediation costs, or experience interruptions in our operations for violations arising under environmental laws, regulations or permit requirements.
Regulation of our employees’ exposure to certain chemicals could require material expenditures or changes in our operations.
The Occupational Safety and Health Act (“OSHA”) in the United States and the Registration, Evaluation and Authorization of Chemicals (“REACH”), directive in Europe, prescribe limitations restricting exposure to a number of chemicals used in our operations, including butadiene, formaldehyde and nonylphenol, a raw material used in the manufacture of phenolic ink resins. Butadiene is a known carcinogen in laboratory animals at high doses and is being studied for its potential adverse health effects. Future studies on the health effects of these, and other, chemicals may result in additional regulations or new regulations that further restrict or prohibit the use of, and exposure to, such chemicals. Additional regulation of or requirements for these chemicals could require us to change our operations, and these changes could affect the quality of our products and materially increase our costs.
We may be subject to losses due to lawsuits arising out of environmental damage or personal injuries associated with chemical manufacturing.
We face the risk that individuals could, in the future, seek damages for personal injury due to exposure to chemicals at our facilities or to chemicals otherwise owned or controlled by us. We may be subject to future claims with respect to workplace exposure, workers’ compensation and other matters that are filed after the date of our acquisition of Shell Chemicals’ elastomers business. While Shell Chemicals has agreed to indemnify us for certain claims brought with respect to matters occurring before our separation from Shell Chemicals in February 2001, those indemnity obligations are subject to limitations, and we cannot be certain that those indemnities will be sufficient to satisfy claims against us. In addition, we face the risk that future claims would fall outside of the scope of the indemnity due either to the limitations on the indemnity or to their arising from events and circumstances occurring after February 2001. Finally, under certain of the lease and operating agreements under which LyondellBasell leases and provides services to our sites in Wesseling, Germany, and Berre, France, we are required to indemnify LyondellBasell in certain circumstances, including in certain circumstances for loss and damages resulting from LyondellBasell’s negligence in performing their obligations.
Some environmental laws could impose on us the entire cost of clean-up of contamination present at a facility even though we did not cause the contamination. These laws often identify the site owner as one of the parties that can be jointly and severally liable for on-site remediation, regardless of fault or whether the original activity was legal at the time it occurred. For example, our Belpre, Ohio, facility is the subject of a required remediation program to clean up past contamination at the site and at an adjacent creek and we are a party to that site clean-up order. While Shell Chemicals has posted financial assurance of $5.2 million for this program and has taken the lead in implementing the program, we may incur costs and be required to take action under this program. Similarly, the Shell Chemicals indemnity for remediation at the Belpre facility may not cover all claims that might be brought against us.
Our Paulinia, Brazil, facility also has on-site contamination resulting from past operations of Shell Chemicals. Although an indemnity from Shell Chemicals covers claims related to specified areas within the facility, we may be required to undertake and pay for remediation of these and other areas. The indemnity coverage from Shell Chemicals is limited in time and amount and we cannot rely upon it to cover possible future claims for on-site contamination separate from the areas specified in the indemnity. The Paulinia facility is also adjacent to a former Shell Chemicals site where we believe past manufacturing of hydrocarbons resulted in significant contamination of soil and groundwater and required relocation of nearby residents. It is our understanding that the Shell Chemicals portion of the site has changed ownership several times, which may impact financial responsibility for contamination on the site. While we are not aware of any significant contamination at our Paulinia facility, we could potentially be the subject of claims related to pesticide contamination and effects at some point in the future.
With respect to the Arizona Chemical Acquisition, International Paper provided an indemnification to the buyer with the divestiture of Arizona Chemical in February 2007. This indemnity covered specific known environmental liabilities and other environmental liabilities pertaining to former properties. At the closing of the Arizona Chemical Acquisition, Kraton was assigned the right to International Paper's indemnity for such environmental liabilities and assumed certain related obligations. Certain liabilities may fall outside the scope of the indemnity and therefore we cannot be certain that the indemnity will be sufficient to satisfy all environmental liabilities of Arizona Chemical.
In general, there is always the possibility that a third-party plaintiff or claimant, or governmental or regulatory authority, could seek to include us in an action or claim for damages, clean-up, or remediation pertaining to events or circumstances occurring or existing at one or more of our sites prior to the time of our ownership or occupation of the applicable site. In the event that any of these actions or claims were asserted against us, our results of operations could be adversely affected.
We are subject to customs, international trade, export control, antitrust, zoning and occupancy and labor and employment laws that could require us to modify our current business practices and incur increased costs.
We are subject to numerous regulations, including customs and international trade laws, export control, antitrust laws and zoning and occupancy laws that regulate manufacturers generally and/or govern the importation, promotion and sale of our products, the operation of factories and warehouse facilities and our relationship with our customers, suppliers and competitors. If these regulations were to change or were violated by our management, employees, suppliers, buying agents or trading companies, the costs of certain goods could increase, or we could experience delays in shipments of our goods, be subject to fines or penalties, or suffer reputational harm, which could reduce demand for our products and hurt our business and negatively impact our results of operations. In addition, changes in federal and state minimum wage laws and other laws relating to employee benefits could cause us to incur additional wage and benefits costs, which could negatively impact our profitability.
Legal requirements are frequently changed and subject to interpretation, and we are unable to predict the ultimate cost of compliance with these requirements or their effects on our operations. We may be required to make significant expenditures or modify our business practices to comply with existing or future laws and regulations, which may increase our costs and materially limit our ability to operate our business.
Fluctuations in currency exchange rates may significantly impact our results of operations and may significantly affect the comparability of our results between financial periods.
Our operations are conducted by our subsidiaries in many countries. The results of the operations and the financial position of these subsidiaries are reported in the relevant foreign currencies and then translated into U.S. dollars at the applicable exchange rates for inclusion in our consolidated financial statements. The main currencies to which we are exposed, besides the U.S. dollar, are the Euro, Japanese Yen, Brazilian Real, and Swedish Krona. The exchange rates between these currencies and the U.S. dollar in recent years have fluctuated significantly and may continue to do so in the future. A depreciation of these currencies against the U.S. dollar will decrease the U.S. dollar equivalent of the amounts derived from these operations reported in our consolidated financial statements and an appreciation of these currencies will result in a corresponding increase in such amounts. Because many of our raw material costs are determined with respect to the U.S. dollar rather than these currencies, depreciation of these currencies may have an adverse effect on our profit margins or our reported results of operations. Conversely, to the extent that we are required to pay for goods or services in foreign currencies, the appreciation of such currencies against the U.S. dollar will tend to negatively impact our results of operations. In addition, currency fluctuations may affect the comparability of our results of operations between financial periods.
We incur currency transaction risk whenever we enter into either a purchase or sale transaction using a currency other than the local currency of the transacting entity. From time to time, we use hedging strategies to reduce our exposure to currency fluctuations. Given the volatility of exchange rates, there can be no assurance that we will be able to effectively manage our currency transaction risks, that our hedging activities will be effective or that any volatility in currency exchange rates will not have a material adverse effect on our financial condition or results of operations.
We may have additional tax liabilities.
We are subject to income taxes and state taxes in the U.S., as well as numerous foreign jurisdictions. Significant judgment is required in determining our worldwide provision for income taxes. In the ordinary course of our business, there are many transactions and calculations where the ultimate tax determination is uncertain. Although we believe our tax estimates are reasonable, the final determination of tax audits and any related litigation could be materially different to that which is reflected in our consolidated financial statements. Should any tax authority take issue with our estimates, our results of operations, financial position and cash flows could be adversely affected.
Our formation of a joint venture to expand HSBC capacity in Asia is subject to risks and uncertainties.
We are a 50/50 joint venture partner with FPCC to build, own and operate a 30 kiloton HSBC plant at FPCC’s petrochemical site in Mailiao, Taiwan. Construction of the HSBC plant is ongoing; however, the plant may not be successfully constructed and operated within our expected timeframe or budget or yield expected results. In addition, the project remains subject to numerous known and unknown contingencies, including material governmental approvals and permitting; cost and availability of raw materials, labor and financing; weather and operational delays; and economic, political and other disruptions. If any of these risks materialize, it could have a material adverse effect on our prospects in Asia and our ability to meet demand for HSBC products.
In January 2014, a group of local residents in Mailiao, Taiwan, sued the Taiwanese Executive Yuan (the executive branch of the Taiwanese government) to overturn an appeal decision rendered by the Executive Yuan in which it had overturned a prior ruling of the Taiwan Environmental Protection Administration. The Taiwan EPA ruling in question required the inclusion of restrictive conditions relating to FPCC’s entire petrochemical site in Mailiao, Taiwan, which is the site of our joint venture with FPCC, in the environmental permit for the construction of the HSBC plant by our joint venture company. Neither we nor our joint venture is a party to the proceedings, nor do we or our joint venture have any right under Taiwan law to join the proceedings. The court in the proceeding has issued a ruling that could reinstate the restrictive conditions in FPCC’s environmental permit. The Executive Yuan and FPCC have appealed the ruling. The ruling conflicts with the prior appeal decision of the Executive Yuan, and if the ruling is not overturned, it could adversely impact the ability of the joint venture to obtain material operating permits in the future.
Our relationship with our employees could deteriorate, which could adversely affect our operations.
As a manufacturing company, we rely on our employees and good relations with our employees to produce our products and maintain our production processes and productivity. A significant number of our non-U.S. employees are subject to arrangements similar to collective bargaining arrangements. Following the Arizona Chemical Acquisition, we had approximately 23.4% of our combined United States employees represented by unions. In addition, a collective bargaining agreement at the Savannah, Georgia manufacturing facility is currently under negotiation. We may not be able to negotiate existing or future arrangements on satisfactory terms or at all, which may adversely affect our business. If these workers were to engage in a strike, work stoppage or other slowdown, our operations could be disrupted or we could experience higher labor costs, which could adversely affect our business, results of operations, cash flows and financial condition.
In addition, if our other employees were to become unionized, in particular our employees at our Belpre, Ohio, facility, we could experience significant operating disruptions and higher ongoing labor costs, which could adversely affect our business and financial condition and results of operations. Because many of the personnel who operate our European facilities are employees of LyondellBasell, relations between LyondellBasell and its employees may also adversely affect our business, results of operations, cash flows and financial condition.
Loss of key personnel or our inability to attract and retain new qualified personnel could hurt our business and inhibit our ability to operate and grow successfully.
Our success in the highly competitive markets in which we operate will continue to depend to a significant extent on our key employees. We are dependent on the expertise of our executive officers. Loss of the services of any of our executive officers could have an adverse effect on our prospects. We may not be able to retain our key employees or to recruit qualified individuals to join our company. The loss of key employees could result in high transition costs and could disrupt our operations.
We generally do not have long-term contracts with our customers and the loss of customers could adversely affect our sales and profitability.
With some exceptions, our business is based primarily upon individual sales orders with our customers. As such, our customers could cease buying our products from us at any time, for any reason, with little or no recourse. If multiple customers elected not to purchase products from us, our business prospects, financial condition and results of operations could be adversely affected.
A decrease in the fair value of pension assets could materially increase future funding requirements of the pension plans.
We sponsor defined benefit pension plans. The total projected benefit obligation of our defined benefit pension plan exceeded the fair value of the plan assets by approximately $55.0 million at December 31, 2015. We contributed $1.8 million to the pension plan in 2015. In connection with the Arizona Chemical Acquisition on January 6, 2016, we assumed responsibility for several additional international pension plans and one additional U.S defined benefit pension plan. The total projected benefit obligation of these additional international and U.S. pension plans exceeded the fair value of plan assets by approximately $28.7 million and $4.9 million as of December 31, 2015. Among the key assumptions inherent in the actuarially calculated pension plan obligation and pension plan expense are the discount rate and the expected rate of return on plan assets. If discount rates or actual rates of return on invested plan assets were to decrease, the pension plan obligation could increase materially. The size of future required pension contributions could result in our dedicating a substantial portion of our cash flow from operations to making the contributions, which could materially adversely affect our business, financial condition and results of operations.
Domestic or international natural disasters or terrorist attacks may disrupt our operations, decrease the demand for our products or otherwise have an adverse impact on our business.
Chemical related assets, and U.S. corporations such as ours, may be at a greater risk of future terrorist attacks than other possible targets in the U.S. and throughout the world. Moreover, extraordinary events such as natural disasters may negatively affect local economies, including those of our customers or suppliers. The occurrence of such events cannot be predicted, although they can be expected to continue to adversely impact the economy in general and our specific markets. The resulting damage from such an event could include loss of life, property damage or site closure. Any, or a combination, of these factors could adversely impact our results of operations, financial position and cash flows.
Delaware law and certain provisions of our organizational documents may make a takeover of our company more difficult.
Provisions of our charter and bylaws may have the effect of delaying, deferring or preventing a change in control of our company. A change of control could be proposed in the form of a tender offer or takeover proposal that might result in a premium over the market price for our common stock. In addition, these provisions could make it more difficult to bring about a change in the composition of our board of directors, which could result in entrenchment of current management. For example, our charter and bylaws:
•
establish a classified board of directors so that not all members of our board of directors are elected at one time;
•
require that the number of directors be determined, and provide that any vacancy or new board seat may be filled, only by the board;
•
do not permit stockholders to act by written consent;
•
do not permit stockholders to call a special meeting;
•
permit the bylaws to be amended by a majority of the board without shareholder approval, and require that a bylaw amendment proposed by stockholders be approved by two-thirds of all outstanding shares;
•
establish advance notice requirements for nominations for elections to our board of directors or for proposing matters that can be acted upon by stockholders at stockholder meetings; and
•
authorize the issuance of undesignated preferred stock, or “blank check” preferred stock, by our board of directors without shareholder approval.
Our Kraton Performance Polymers, Inc. Executive Severance Program and the equity arrangements with our executive officers also contain change in control provisions. Under the terms of these arrangements, the executive officers are entitled to receive significant cash payments, immediate vesting of options, restricted shares and notional shares, and continued medical benefits in the event their employment is terminated under certain circumstances within one year following a change in control, and with respect to certain equity awards, within two years following a change in control.
Any amounts accrued under the Kraton Polymers LLC Executive Deferred Compensation Plan are immediately payable upon a change of control. We disclose in proxy statements filed with the SEC potential payments to our named executive officers in connection with a change of control. Further, the terms of the indenture governing the 10.5% Senior Notes require us, upon certain change of control transactions, to repurchase our outstanding 10.5% Senior Notes at a price equal to 101.0% of their principal amount, plus any accrued and unpaid interest.
These arrangements and provisions of our organizational documents and Delaware law may have the effect of delaying, deferring or preventing changes of control or changes in management of our company, even if such transactions or changes would have significant benefits for our stockholders. As a result, these provisions could limit the price some investors might be willing to pay in the future for shares of our common stock.
We do not currently pay dividends and may not pay any dividends for the foreseeable future.
We do not currently pay dividends, and we may not pay dividends to our stockholders for the foreseeable future. The terms of the Term Loan Facility, the ABL Facility and the 10.5% Senior Notes limit our ability to pay cash dividends, and we may be subject to other restrictions on our ability to pay dividends from time to time. In addition, because we are a holding company, our ability to pay dividends depends on our receipt of cash dividends and distributions from our subsidiaries. Accordingly, investors must be prepared to rely on sales of their common stock after price appreciation to earn an investment return, which may never occur. Investors seeking cash dividends should not purchase our common stock. Any determination to pay dividends in the future will be made at the discretion of our board of directors and will depend upon our results of operations, financial condition, contractual restrictions, restrictions imposed by applicable law or the SEC and other factors that our board deems relevant.
We are a holding company with nominal net worth and will depend on dividends and distributions from our subsidiaries to pay any dividends.
Kraton Performance Polymers, Inc. is a holding company with nominal net worth. We do not have any assets or conduct any business operations other than our investments in our subsidiaries, including Kraton Polymers LLC. As a result, our ability to pay dividends, if any, will be dependent upon cash dividends and distributions or other transfers from our subsidiaries. Payments to us by our subsidiaries will be contingent upon their respective earnings and subject to any limitations on the ability of such entities to make payments or other distributions to us. In addition, our subsidiaries are separate and distinct legal entities and have no obligation to make any funds available to us.
Item 1B.
Item 1B.
Unresolved Staff Comments.
None.
Item 2.
Item 2.
Properties.
Our principal executive offices are located at 15710 John F. Kennedy Boulevard, Suite 300, Houston, Texas 77032.
We believe that our properties and equipment are generally in good operating condition and are adequate for our present needs. Production capacity at our sites can vary greatly depending upon feedstock, product mix and operating conditions. The following table sets forth our manufacturing facilities and principal products:
________________________________________________
(1)
The Belpre facility has approximately 175 kilotons of production capacity to which we are entitled. A portion of the HSBC capacity at the Belpre facility is owned by Infineum USA, a joint venture between Shell Chemicals and ExxonMobil that makes products for the lubricant additives business.
(2)
Our Wesseling, Germany and Berre, France manufacturing facilities are located on LyondellBasell sites. We lease the land, but own the manufacturing facilities and production equipment. We have operating agreements with LyondellBasell for various site services, utilities, materials and facilities.
(3)
The Kashima, Japan, manufacturing facility is owned and operated by a 50%-50% joint venture between us and JSR, named Kraton JSR Elastomers K.K. (“KJE”). We are generally entitled to 50% of this production pursuant to our joint venture agreement. JSR markets its portion of the production under its own trademarks, and we market our portion of the production under the Kraton® brand name although this amount may vary from time to time.
(4)
The Mailiao, Taiwan facility is under construction by our 50%-50% KFPC joint venture with FPCC. The joint venture leases the land, but owns the manufacturing facility and production equipment. Construction of the plant is ongoing with completion expected in 2016.
(5)
We own our BLS acidulation manufacturing facility located in Savannah, Georgia. However, this manufacturing facility is located on land that we lease from International Paper. This lease expires on February 28, 2057.
(6)
We own our manufacturing facility located in Oulu, Finland. However, this facility is located on land that we lease from Stora Enso Oy. This lease expires on August 31, 2046, with an option to extend the term until August 31, 2095.
Item 3.
Item 3.
Legal Proceedings.
In connection with the closing of the Arizona Chemical Acquisition on January 6, 2016, we assumed responsibility for an open legal proceeding related to a claim from a former customer, Mohawk Industries, Inc. On March 21, 2011, Arizona Chemical received a claim from this former customer relating to an alleged breach of warranty and breach of contract regarding delivery of resin products during the period from 2005 through 2009. In March 2014, the jury returned a verdict against Arizona Chemical for $70.1 million. In addition, the trial court entered two separate judgments against Arizona Chemical in April 2015 for attorneys’ costs and interest totaling $18.9 million. Arizona Chemical has filed appeals with the Florida First District Court of Appeal to dispute all three judgments. These claims are covered by insurance and we expect the insurance company to reimburse us for the full amount of any judgments that are upheld on appeal.
In January 2014, our Belpre, Ohio facility experienced a mechanical equipment failure due to inclement weather that resulted in a release of process solvents into nearby waterways. Applicable authorities were notified, and cleanup activities are complete. Kraton may be required to pay governmental fines or sanctions in excess of $100,000 in connection with this event.
We and certain of our subsidiaries, from time to time, are parties to various other legal proceedings, claims, and disputes that have arisen in the ordinary course of business. These claims may involve significant amounts, some of which would not be covered by insurance. While the outcome of these proceedings cannot be predicted with certainty, our management does not expect any of these other existing matters, individually or in the aggregate, to have a material adverse effect upon our financial position, results of operations, or cash flows.
For information regarding legal proceedings, including environmental matters, see Note 12 Commitments and Contingencies (subsections (b) and (d) of which are incorporated herein by reference) to the consolidated financial statements for further discussion.
Item 4.
Item 4.
Mine Safety Disclosures.
Not applicable.
PART II
Item 5.
Item 5.
Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities.
Our common stock is listed on the New York Stock Exchange (NYSE) under the symbol “KRA”. The following table sets forth the high and low intraday sales prices of our common stock per share, as reported by the NYSE.
We have not previously declared or paid any dividends or distributions on our common stock. As of February 22, 2016, we had approximately 95 shareholders of record of our common stock and approximately 4,245 beneficial owners.
Stock Performance Graph
The following graph reflects the comparative changes in the value from December 31, 2010 through December 31, 2015, assuming an initial investment of $100 and the reinvestment of dividends, if any, in (1) our common stock, (2) the S&P SmallCap 600 Index, and (3) the Dow Jones U.S. Specialty Chemicals Index. The information under this caption is not deemed to be “soliciting material” or to be “filed” with the SEC or subject to Regulation 14A or 14C under the Securities Exchange Act of 1934 or to the liabilities of Section 18 of the Securities Exchange Act of 1934, and will not be deemed to be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934, except to the extent we specifically incorporate it by reference into such a filing. Historical performance should not be considered indicative of future stockholder returns.
Total Return to Shareholders’
(Includes reinvestment of dividends)
Dividends
We have not previously declared or paid any dividends or distributions on our common stock and have instead deployed earnings to fund the development of our business. Any future determination to pay dividends will be at the discretion of our board of directors and will depend on our financial condition, results of operations, capital expenditure requirements, restrictions contained in current and future financing instruments and other factors that our board of directors deems relevant. Because we are a holding company, our ability to pay dividends depends on our receipt of cash dividends and distributions from our subsidiaries. The terms of the Term Loan Facility, the ABL Facility and the 10.5% Senior Notes restrict our ability and the ability of our subsidiaries to pay dividends, as may the terms of any of our future debt or preferred securities.
Repurchase of Equity Securities
Following is a summary of our repurchases of common stock during the year ended December 31, 2015.
No shares were repurchased in the months of May through July or October through December.
(a)
On October 27, 2014, our board of directors approved a share repurchase plan which allowed for the repurchase of outstanding shares of our common stock having an aggregate purchase price of up to $50.0 million. From the inception of the program through December 31, 2015, we repurchased a total of 2,549,683 shares of our common stock at an average price of $19.58 per share and a total cost of $50.0 million (including trading commissions). The share repurchase plan was financed with available cash and the program is now complete.
Item 6.
Item 6.
Selected Financial Data.
The selected financial data below should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” included under Item 7
Item 7.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
INTRODUCTION
Management’s Discussion and Analysis of Financial Condition and Results of Operations should be read in conjunction with Item 8. Financial Statements and Supplementary Data. This discussion contains forward-looking statements and involves numerous risks and uncertainties, including, but not limited to those described in Item 1A. Risk Factors and below under the caption “Factors Affecting Our Results of Operations.” Actual results may differ materially from those contained in any forward-looking statements.
OVERVIEW
We are a leading global specialty chemicals company that manufactures SBCs and other engineered polymers. SBCs are highly-engineered synthetic elastomers, which we invented and commercialized over 50 years ago. We developed the first USBCs in 1964 and the first HSBCs in the late 1960s. Our SBCs enhance the performance of numerous products by imparting greater flexibility, resilience, strength, durability and processability, and are used in a wide range of applications, including adhesives, coatings, consumer and personal care products, sealants, lubricants, medical, packaging, automotive, paving, roofing and footwear products.
The majority of worldwide SBC production is dedicated to USBCs, which are primarily used in paving, roofing, adhesives, sealants, coatings, and footwear applications. HSBC, which are significantly more complex and capital-intensive to manufacture than USBCs, are used in applications such as soft touch and flexible materials, personal hygiene products, medical products, automotive components, and certain adhesives and sealant applications. IR and IRL are non-SBC products which are primarily used in applications such as medical products, personal care, adhesives, tackifiers, paints, and coatings.
Our products are manufactured and our commercial activities are organized in the following product groups based upon polymer chemistry and process technologies:
2015 Financial Overview
•
Sales volume was 306.5 kilotons in 2015 compared to 305.6 kilotons in 2014.
•
Revenue was $1,034.6 million in 2015 compared to $1,230.4 million in 2014.
•
Gross profit was $228.7 million in 2015 compared to $237.1 million in 2014. Adjusted gross profit (non-GAAP) was $279.5 million in 2015 compared to $257.9 million in 2014.
•
Adjusted EBITDA (non-GAAP) was $166.8 million in 2015 compared to $147.2 million in 2014.
•
Net loss attributable to Kraton was $10.5 million or $0.34 per diluted share in 2015 compared to a net income of $2.4 million or $0.07 per diluted share in 2014.
•
Adjusted diluted earnings per share (non-GAAP) was $2.02 in 2015 compared to $1.16 in 2014.
•
For the year ended December 31, 2015 compared to the year ended December 31, 2014, foreign currency fluctuations had a negative impact on adjusted gross profit and adjusted EBITDA of $16.5 million and $11.0 million, respectively.
See “Part II, Item 6. Selected Financial Data” for reconciliation of adjusted gross profit, EBITDA, adjusted EBITDA and adjusted diluted earnings per share.
RESULTS OF OPERATIONS
Factors Affecting Our Results of Operations
Raw Materials. We use butadiene, styrene, and isoprene as our primary raw materials in manufacturing our products and our results of operations are directly affected by the cost of these raw materials. On a FIFO basis, these monomers together represented approximately $385.2 million, $512.8 million and $609.5 million or 47.8%, 51.6% and 57.2% of our total cost of goods sold for the years ended December 31, 2015, 2014, and 2013, respectively. Since the cost of our three primary raw materials comprise a significant amount of our total cost of goods sold, our selling prices for our products and therefore our total revenue is impacted by movements in our raw material costs, as well as the cost of other inputs.
The cost of these monomers has generally correlated with changes in energy prices and is generally influenced by supply and demand factors and prices for natural and synthetic rubber. In aggregate, average purchase prices for butadiene, isoprene and styrene were lower during 2015 compared to 2014, and lower in 2014 compared to 2013.
We use the FIFO basis of accounting for inventory and cost of goods sold, and therefore gross profit. In periods of raw material price volatility, reported results under FIFO will differ from what the results would have been if cost of goods sold were based on ECRC. Specifically, in periods of rising raw material costs, reported gross profit will be higher under FIFO than under ECRC. Conversely, in periods of declining raw material costs, reported gross profit will be lower under FIFO than under ECRC. In recognition of the fact that the cost of raw materials affects our results of operations and the comparability of our results of operations, we provide the difference, or spread, between FIFO and ECRC. For the years ended December 31, 2015, 2014, and 2013, reported results under FIFO were lower than results would have been on an ECRC basis by $50.7 million, $9.3 million, and $30.7 million, respectively.
International Operations and Currency Fluctuations. We operate a geographically diverse business, serving customers in over 70 countries from five manufacturing facilities on four continents. Our sales and production costs are mainly denominated in U.S. dollars, Euro, Japanese Yen, and Brazilian Real. From time to time, we use hedging strategies to reduce our exposure to currency fluctuations.
We generated our revenue from customers located in the following regions:
Our financial results are subject to gains and losses on currency translations, which occur when the financial statements of foreign operations are translated into U.S. dollars. The financial statements of operations outside the United States where the local currency is considered to be the functional currency are translated into U.S. dollars using the exchange rate at each balance sheet date for assets and liabilities and the average exchange rate for each period for revenue, expenses, gains and losses, and cash flows. The effect of translating the balance sheet into U.S. dollars is included as a component of accumulated other comprehensive income (loss). Any appreciation of the functional currencies against the U.S. dollar will increase the U.S. dollar equivalent of amounts of revenue, expenses, gains and losses, cash flows, and any depreciation of the functional currencies will decrease the U.S. dollar amounts reported. Our results of operations are also subject to currency transaction risk. We incur currency transaction risk when we enter into either a purchase or sale transaction using a currency other than the local currency of the transacting entity. The estimated impact from currency fluctuations amounted to a pre-tax loss of $9.8 million, a pre-tax income of $0.4 million and a pre-tax loss of $4.8 million for the years ended December 31, 2015, 2014, and 2013, respectively. The primary driver for the pre-tax loss in 2015 and the pre-tax income in 2014 was the change in foreign currency exchange rates between the Euro and U.S. dollar. The primary driver for our pre-tax loss in 2013 was the change in foreign currency exchange rates between the Japanese Yen and U.S. dollar.
Seasonality. Seasonal changes and weather conditions typically affect our Performance Products sales into paving and roofing applications, which generally results in higher sales volumes in the second and third quarters of the calendar year compared to the first and fourth quarters of the calendar year. Our other markets tend to show relatively little seasonality.
Year Ended December 31, 2015 Compared to Year Ended December 31, 2014
Revenue
Revenue was $1,034.6 million for the year ended December 31, 2015 compared to $1,230.4 million for the year ended December 31, 2014, a decrease of $195.8 million or 15.9%. The negative effect of currency movements accounted for $89.1 million of the decline. The remaining decline was due to lower average selling prices amounting to $112.2 million primarily driven by lower average raw material costs, partially offset by $5.5 million due to higher sales volumes. Sales volumes were 306.5 kilotons for the year ended December 31, 2015 compared to 305.6 kilotons for the year ended December 31, 2014.
With respect to revenue for each of our product groups:
•
Cariflex™ revenue was $142.9 million for the year ended December 31, 2015 compared to $138.6 million for the year ended December 31, 2014, an increase of $4.3 million or 3.1%. Cariflex sales volumes increased 10.2% compared to the year ended December 31, 2014, driven primarily by higher sales into surgical glove applications. Higher sales volume, amounting to $14.5 million, was partially offset by a $7.7 million negative effect from currency fluctuations and $2.5 million associated with lower selling prices primarily resulting from lower raw material costs.
•
Specialty Polymers revenue was $350.7 million for the year ended December 31, 2015 compared to $412.4 million for the year ended December 31, 2014, a decline of $61.7 million, or 15.0%. The negative effect of currency fluctuations accounted for $19.6 million of the decline. The remaining decline reflects a $27.4 million impact from lower average selling prices primarily related to lower raw material costs and $14.8 million due to a 3.4% decline in sales volumes. The decline in sales volume was largely due to lower sales into lubricant additive applications associated with inventory reduction measures by a significant customer, and, to a lesser extent, lower sales into personal care applications. Partially offsetting these declines were higher sales into medical, cable gel and consumer applications.
•
Performance Products revenue was $540.6 million for the year ended December 31, 2015 compared to $678.9 million for the year ended December 31, 2014, a decline of $138.3 million, or 20.4%. The decline includes a $61.8 million negative effect of currency fluctuations. The remaining decline was due to lower average selling prices primarily resulting from lower raw material costs. Sales volume increased modestly, despite the previously disclosed seven kilotons of lost production at our Wesseling and Berre facilities in the second quarter 2015. The increase in sales volume was driven by higher sales into North American paving applications and personal care applications, largely offset by lower sales into adhesives and roofing applications.
Cost of Goods Sold
Cost of goods sold was $806.0 million for the year ended December 31, 2015, a decline of $187.4 million, or 18.9%, compared to $993.4 million for the year ended December 31, 2014. The decline was due to lower raw material costs of $96.0 million, changes in foreign currency exchange rates of $74.0 million, and $12.4 million from the implementation of our previously announced cost reduction initiatives. In addition, cost of goods sold in 2014 included $10.4 million of costs associated with production downtime at two of our facilities. These decreases were partially offset by $5.4 million of higher other manufacturing costs.
Gross Profit
Gross profit was $228.7 million for the year ended December 31, 2015 compared to $237.1 million for the year ended December 31, 2014. Gross profit as a percentage of revenue was 22.1% and 19.3% for the years ended December 31, 2015 and 2014, respectively.
Operating Expenses
Research and development expenses were $31.0 million for the year ended December 31, 2015 compared to $31.4 million for the year ended December 31, 2014. The $0.4 million decrease includes $2.8 million of savings from the implementation of our previously announced cost reduction initiatives, largely offset by higher variable employee compensation and other operating costs.
Selling, general and administrative expenses were $117.3 million for the year ended December 31, 2015 compared to $104.2 million for the year ended December 31, 2014, an increase of $13.1 million, or 12.6%. This increase was primarily due to an $11.3 million increase in transaction and acquisition related costs, a $7.2 million increase in employee related expenses, primarily variable compensation expense, and a $2.3 million increase in other professional fees. These increases were partially offset by a $3.9 million positive effect from currency fluctuations and a $4.1 million reduction from the implementation of our previously announced cost reduction initiatives.
Depreciation and amortization was $62.1 million for the year ended December 31, 2015 compared to $66.2 million for the year ended December 31, 2014, a decrease of $4.1 million, of which $2.6 million was due to changes in foreign currency.
The $4.7 million impairment of long-lived assets in 2014 included $2.4 million related to engineering and design assets for projects we determined were no longer economically viable, $1.4 million related to information technology and office assets arising from restructuring activities, and $0.9 million related to other long-lived assets. We did not incur any impairment charges for the year ended December 31, 2015.
Interest expense, net
Interest expense, net was $24.2 million for the year ended December 31, 2015 compared to $24.6 million for the year ended December 31, 2014, a decrease of $0.4 million or 1.5%.
Income tax expense (benefit)
Income tax expense was $6.9 million and $5.1 million for the years ended December 31, 2015 and 2014, respectively. Our effective tax rate was 124.3% and 80.9% for the years ended December 31, 2015 and 2014, respectively. Our effective tax rates differed from the U.S. corporate statutory tax rate of 35.0%, primarily due to the mix of pre-tax income or loss earned in foreign jurisdictions and losses generated in the U.S. tax jurisdiction for which a full valuation allowance has been provided, as well as uncertain tax positions. See Note 11 Income Taxes, for further information.
We record a valuation allowance when it is more likely than not that some portion, or all, of the deferred tax assets will not be realized. As of December 31, 2015 and December 31, 2014, a valuation allowance of $100.1 million and $90.4 million, respectively, has been provided for net operating loss carryforwards and other deferred tax assets. We increased our valuation allowance by $9.7 million in 2015, which includes $13.9 million related to current period net operating losses in the U.S. jurisdiction, partially offset by a $2.7 million decrease related to the tax effect of unrealized pension gains, and a $1.5 million decrease related to changes in other comprehensive income (loss). We increased our valuation allowance by $0.4 million in 2014, which includes a $9.8 million increase related to changes in other comprehensive income (loss), partially offset by a $7.6 million decrease related to current year operating income and a $1.8 million decrease related to the assessment of our ability to utilize net operating loss carryforwards in future periods. We consider the reversal of deferred tax liabilities within the net operating loss carryforward period, projected future taxable income and tax planning strategies in making this assessment. Excluding the change in our valuation allowance, our effective tax rates would have been a 75.4% benefit and a 229.0% expense for the years ended December 31, 2015 and 2014, respectively. As of December 31, 2015, $87.9 million of the $100.1 million valuation allowance is associated with net deferred tax assets in the U.S. jurisdiction.
Following the Arizona Chemical Acquisition, we project that we will have sufficient combined pre-tax earnings in the U.S. to fully utilize net operating loss carryforwards within a reasonable projection period. Under ASC 805-740-30-3, the release of an acquirer’s existing valuation allowance resulting from an acquisition is recognized as an adjustment to the financial statements as of the acquisition date. As a result, we expect to release the valuation allowance related to the U.S. net deferred tax assets in 2016.
Net income (loss) attributable to Kraton
Net loss attributable to Kraton was $10.5 million, or $0.34 per diluted share, for the year ended December 31, 2015, a decrease of $13.0 million, compared to net income of $2.4 million, or $0.07 per diluted share, for the year ended December 31, 2014. Adjusted diluted earnings per share (non-GAAP) was $2.02 in 2015 compared to $1.16 in 2014. See Item 6. Selected Financial Data for a reconciliation of GAAP diluted earnings (loss) per share to adjusted diluted earnings per share.
Year Ended December 31, 2014 Compared to Year Ended December 31, 2013
Revenue
Revenue was $1,230.4 million for the year ended December 31, 2014 compared to $1,292.1 million for the year ended December 31, 2013, a decline of $61.7 million or 4.8% (a decline of $50.3 million or 3.9% excluding an $11.4 million negative effect from currency fluctuations) with $51.3 million of the decline attributable to lower average selling prices associated with lower average raw material costs. Sales volumes declined 7.9 kilotons or 2.5% from 313.5 kilotons for the year ended December 31, 2013 to 305.6 kilotons for the year ended December 31, 2014. The decrease in total sales volume did not have a material impact on the period-over-period change in revenue, as the revenue impact from lower sales volume in our Performance Products business was more than offset by the revenue contribution from increased sales volume in the higher revenue per ton CariflexTM and Specialty Polymers businesses.
With respect to revenue for each of our product groups:
•
Cariflex™ revenue was $138.6 million for the year ended December 31, 2014 compared to $116.0 million for the year ended December 31, 2013. The $22.6 million or 19.5% revenue increase (an increase of $25.4 million or 21.9% excluding a $2.8 million negative effect from currency fluctuations) was due to a 24.1% increase in sales volumes led by sales into surgical glove applications, and to a lesser extent, increased sales into condom and medical stopper markets. The revenue contribution from higher sales volume was partially offset by lower average selling prices due to lower isoprene costs.
•
Specialty Polymers revenue was $412.4 million for the year ended December 31, 2014 compared to $412.0 million for the year ended December 31, 2013. The $0.4 million or 0.1% revenue increase (an increase of $1.5 million or 0.4% excluding a $1.1 million negative effect from currency fluctuations) was due to a 4.6% increase in sales volume, which was offset by lower average selling prices reflective of lower raw material costs. The increase in sales volume was primarily due to growth in lubricant additives, cable gels, and polymer modification applications partially offset by lower volume into personal care applications.
•
Performance Products revenue was $678.9 million for the year ended December 31, 2014 compared to $762.9 million for the year ended December 31, 2013. The $84.0 million or 11.0% revenue decline (a decline of $76.5 million or 10.0% excluding a $7.5 million negative effect from currency fluctuations) was due to a 6.2% reduction in sales volumes and, to a lesser extent, lower average selling prices driven by lower butadiene and isoprene costs. The decline in sales volume was primarily due to lower paving and roofing volumes in Europe, lower paving volumes in Asia Pacific and lower volumes into packaging & industrial adhesives applications.
Cost of Goods Sold
Cost of goods sold was $993.4 million for the year ended December 31, 2014 compared to $1,066.3 million for the year ended December 31, 2013. The $72.9 million or 6.8% decrease was primarily driven by a $66.0 million reduction in raw material costs (including a period over period benefit of $21.5 million due to the spread between FIFO and ECRC), an $18.6 million decrease from lower sales volumes, and an $11.1 million decrease due to foreign currency fluctuations. Partially offsetting these decreases were $9.9 million of costs associated with the weather-related production downtime at our Belpre, Ohio, facility and an operating disruption from a small fire at our Berre, France, facility in the first quarter of 2014 and increases in other variable and manufacturing costs.
Gross Profit
Gross profit was $237.1 million for the year ended December 31, 2014 compared to $225.8 million for the year ended December 31, 2013. Gross profit as a percentage of revenue was 19.3% and 17.5% for the years ended December 31, 2014 and 2013, respectively.
Operating Expenses
Research and development expenses were $31.4 million for the year ended December 31, 2014 compared to $32.0 million for the year ended December 31, 2013, a decrease of $0.6 million or 2.0% primarily due to lower professional fees and maintenance costs partially offset by higher employee related costs. Research and development expenses were 2.5% of revenue for both of the years ended December 31, 2014 and 2013.
Selling, general and administrative expenses were $104.2 million for the year ended December 31, 2014 compared to $105.6 million for the year ended December 31, 2013, a decrease of $1.3 million or 1.3%. The decrease was primarily due to a $1.3 million decrease in employee related costs, a $1.0 million decrease in professional fees and a $0.8 million decrease in information technology costs. These decreases were partially offset by a $1.7 million increase in restructuring related costs and a $0.4 million increase in transaction and acquisition related costs. Selling, general and administrative expenses were 8.5% and 8.2% of revenue for the years ended December 31, 2014 and 2013, respectively.
Depreciation and amortization was $66.2 million for the year ended December 31, 2014 compared to $63.2 million for the year ended December 31, 2013, an increase of $3.1 million or 4.8%, largely due to capital expenditures.
We incurred impairments of long-lived assets of $4.7 million for the year ended December 31, 2014 related to engineering and design, information technology, and other long-lived assets. We did not incur any impairment charges for the year ended December 31, 2013.
Interest expense, net
Interest expense, net was $24.6 million for the year ended December 31, 2014 compared to $30.5 million for the year ended December 31, 2013, a decrease of $5.9 million or 19.3%. The decrease was primarily due to charges aggregating $5.8 million incurred in connection with our March 2013 refinancing and to lower outstanding indebtedness in 2014.
Income tax expense (benefit)
Our income tax provision was a $5.1 million expense and a $3.9 million benefit for the years ended December 31, 2014 and 2013, respectively. Our effective tax rate was 80.9% and 79.9% for the years ended December 31, 2014 and 2013, respectively. Our effective tax rates differed from the U.S. corporate statutory tax rate of 35.0%, primarily due to the mix of pre-tax income or loss earned in certain jurisdictions and the change in our valuation allowance.
We record a valuation allowance when it is more likely than not that some portion or all of the deferred tax assets will not be realized. As of December 31, 2014 and December 31, 2013, a valuation allowance of $90.4 million and $90.0 million, respectively, has been provided for net operating loss carryforwards and other deferred tax assets. We increased our valuation allowance by $0.4 million in 2014, which includes a $9.8 million increase related to changes in other comprehensive income (loss), partially offset by a $9.4 million decrease to the income tax provision. The $9.4 million is comprised of $7.6 million related to current year operating income and $1.8 million related to the assessment of our ability to utilize net operating loss carryforwards in future periods. We decreased our valuation allowance by $0.4 million in 2013, which includes a $0.5 million decrease due to changes in other comprehensive income (loss), partially offset by a $0.1 million increase to the income tax provision. The $0.1 million is comprised of $10.2 million related to current year operating losses, offset by a $10.1 million benefit related to the tax effect of unrealized pension gains. We consider the reversal of deferred tax liabilities within the net operating loss carryforward period, projected future taxable income and tax planning strategies in making this assessment. Excluding the change in our valuation allowance, our effective tax rates would have been a 229.0% expense and an 81.4% benefit for the years ended December 31, 2014 and 2013, respectively.
Net income (loss) attributable to Kraton
Net income attributable to Kraton was $2.4 million, or $0.07 per diluted share, for the year ended December 31, 2014, an increase in net income of $3.0 million, compared to a net loss of $0.6 million, or $0.02 per diluted share, for the year ended December 31, 2013. Adjusted diluted earnings per share (non-GAAP) was $1.16 in 2014 compared to $1.20 in 2013. See Item 6. Selected Financial Data for a reconciliation of GAAP diluted earnings (loss) per share to adjusted diluted earnings per share.
Critical Accounting Estimates
The preparation of financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make assumptions and estimates that directly affect the amounts reported in the consolidated financial statements. Certain critical accounting policies requiring significant judgments, estimates, and assumptions are described in this section. We consider an accounting estimate to be critical if (1) it requires assumptions to be made that are uncertain at the time the estimate is made and (2) changes to the estimate or different estimates that could have reasonably been used would have materially changed our consolidated financial statements.
We believe the current assumptions and other considerations used to estimate amounts reflected in our consolidated financial statements are appropriate. However, should our actual experience differ from these assumptions and other considerations used in estimating these amounts, the impact of these differences could have a material impact on our consolidated financial statements.
Allowance for Doubtful Accounts. The allowance for doubtful accounts is our best estimate of the amount of probable credit losses in our existing receivables and is determined based on our assessment of the credit worthiness of individual customers, historical write-off experience, and global economic data. We review the allowance for doubtful accounts quarterly. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. We do not have any off-balance sheet credit exposure related to our customers.
Inventories. Inventory values include all costs directly associated with manufacturing products and are stated at the lower of cost or market, primarily determined on a first-in, first-out basis. We evaluate the carrying cost of our inventory on a quarterly basis for this purpose. If the cost of the inventories exceeds their market value, provisions are made for the difference between the cost and the market value.
Property, Plant, and Equipment. Property, plant, and equipment are recorded at cost, net of accumulated depreciation. Major renewals and improvements that extend the useful lives of equipment are capitalized. Repair and maintenance costs are expensed as incurred. Disposals are removed at carrying cost less accumulated depreciation with any resulting gain or loss reflected in earnings. We capitalize interest costs which are incurred as part of the cost of constructing major facilities and equipment. Depreciation is recognized using the straight-line method over the following estimated useful lives:
Impairment of Long-Lived Assets. In accordance with the Impairment or Disposal of Long-Lived Assets Subsections of FASB ASC Subtopic 360-10, Property, Plant, and Equipment-Overall, long-lived assets, such as property, plant, and equipment, and purchased intangible assets subject to amortization are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If circumstances require a long-lived asset or asset group be tested for possible impairment, we first compare undiscounted cash flows expected to be generated by that asset or asset group to its carrying value. If the carrying value of the long-lived asset or asset group is not recoverable on an undiscounted cash flow basis, impairment is recognized to the extent that the carrying value exceeds its fair value. Fair value is determined through various valuation techniques including discounted cash flow models, quoted market values and third-party independent appraisals, as considered necessary.
Asset Retirement Obligations (“ARO”). Our ARO consists of estimated costs of dismantlement, removal, site reclamation, and similar activities associated with our facilities. We recognize the fair value of a liability for an ARO in the period in which we have an existing legal obligation associated with the retirement of our facilities and the obligation can reasonably be estimated. The associated asset retirement cost is capitalized as part of the carrying cost of the asset. The recognition of an ARO requires that we make numerous estimates, assumptions, and judgments regarding such factors as the existence of a legal obligation for an ARO; estimated probabilities, amounts and timing of settlements; the credit-adjusted risk-free rate to be used; discount rate; and inflation rates. In periods subsequent to initial measurement of the ARO, we recognize changes in the liability resulting from the accretion of the liability to its non-discounted amount and revisions to either the timing or the amount of the original estimate of undiscounted cash flows. Revisions also result in increases or decreases in the carrying cost of these assets. Increases in the ARO liability due to accretion is charged to depreciation and amortization expense. The related capitalized cost, including revisions thereto, is charged to depreciation and amortization expense. See Note 12 Commitments and Contingencies (subsection (c)) to the consolidated financial statements.
Contingencies. We are routinely involved in litigation, claims, and disputes incidental to our business. Professional judgment is required to classify the likelihood of these contingencies occurring. A contingency is categorized as probable, reasonably possible, or remote. A contingency is classified as probable if the future event or events are likely to occur. For the probable contingencies, a loss is accrued and disclosed as of the date of the financial statements if it is both probable that an asset has been impaired or a liability has been incurred at the date of the financial statements and the amount of loss can be reasonably estimated. A reasonably possible contingency occurs if the chance of the future event or events happening is more than remote but less than likely (reasonably possible but not probable). We disclose the loss contingencies in the footnotes to the financial statements but do not recognize any liability. A remote contingency is one where the chance of the future event or events occurring is slight. We neither accrue for nor disclose the liability in the notes to the financial statements.
Share-Based Compensation. Share-based compensation cost is measured at the grant date based on the fair value of the award. We recognize these costs using the straight-line method over the requisite service period. The Kraton Performance Polymers, Inc. 2009 Equity Incentive Plan (the “Equity Plan”) allows for the grant to key employees, independent contractors, and eligible non-employee directors of incentive stock options, non-qualified stock options (which together with the incentive stock options, are referred to herein as (“Options”)), stock appreciation rights, restricted stock awards, and restricted stock units, in addition to other equity or equity-based awards (including performance-based awards) as our board determines from time to time. We estimate the fair value of stock options using the Black-Scholes valuation model. Since our equity interests were privately held prior to our initial public offering we have limited publicly traded stock history, and as a result our estimated volatility is based on a combination of our historical volatility and similar companies’ stock that are publicly traded. Until such time that we have enough publicly traded stock history to estimate volatility based solely on our stock, we expect to estimate volatility of options granted based on a combination of our historical volatility and similar companies’ stock that are publicly traded. The expected term of options represents the period of time that options granted are expected to be outstanding. For all periods presented, we used the simplified method to calculate the expected term of options. The risk free interest rate for the periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. For all periods presented, the dividend yield is assumed to be zero based on historical and expected dividend activity. Forfeitures are based substantially on the history of cancellations of similar awards granted in prior years. See Note 4 Share-Based Compensation to the consolidated financial statements.
Income Taxes. We conduct operations in separate legal entities in different jurisdictions. As a result, income tax amounts are reflected in our consolidated financial statements for each of those jurisdictions.
Income taxes are recorded utilizing an asset and liability approach. This method gives consideration to the future tax consequences associated with the differences between the financial accounting and tax basis of the assets and liabilities as well as the ultimate realization of any deferred tax asset resulting from such differences. Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not that a tax benefit will not be realized. In determining whether a valuation allowance is required, the company evaluates primarily (a) the impact of cumulative losses in past years and (b) current and/or recent losses. A recent trend in earnings despite cumulative losses is a prerequisite to considering not recording a valuation allowance.
In assessing the realizability of deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. We consider the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, we believe it is more likely than not that we will realize the benefits of these deductible differences, net of the existing valuation allowances.
Benefit Plan Valuations. We sponsor a noncontributory defined benefit pension plan (“Pension Plan”) and an additional post-retirement benefit plan (“Retiree Medical Plan”). We annually evaluate significant assumptions related to the benefits and obligations of these plans. Our estimation of the projected benefit obligations and related benefit expense requires that certain assumptions be made regarding such variables as expected return on plan assets, discount rates, rates of future compensation increases, estimated future employee turnover rates and retirement dates, distribution election rates, mortality rates, retiree utilization rates for health care services, and health care cost trend rates. The determination of the appropriate assumptions requires considerable judgment concerning future events and has a significant impact on the amount of the obligations and expense recorded. We rely in part on actuarial studies when determining the appropriateness of certain of the assumptions used in determining the benefit obligations and the annual expenses for these plans.
The discount rates are determined annually and are based on rates of return of high-quality long-term fixed income securities currently available with maturities consistent with the projected benefit payout period. The expected long-term rate of return on assets is derived from a review of anticipated future long-term performance of individual asset classes and consideration of an appropriate asset allocation strategy, given the anticipated requirements of the Pension Plan, to determine the average rate of earnings expected on the funds invested to provide for the pension plan benefits. We also consider recent fund performance and historical returns in establishing the expected rate of return.
Movements in the capital markets impact the market value of the investment assets used to fund our Pension Plan. Future changes in plan asset returns, assumed discount rates, and various other factors related to our pension and post-retirement plans will impact future pension expenses and liabilities.
The estimated effect of alternate assumptions on the 2016 estimated annual expense for the Pension Plan and Retiree Medical Plan were performed at varying discount rates, expected return on assets, expected salary increase, and, in the case of our Retiree Medical Plan, health care cost increases.
The measurement date of the Pension Plan’s assets and obligations was December 31, 2015. We applied a 4.55% discount rate, assumed an 8.5% long term expected rate of return on plan assets and assumed an expected salary rate increase of 3.0%. The percentage of equity securities in our Pension Plan as of December 31, 2015 was approximately 57.1%, down from approximately 61.7% as of December 31, 2014, and the percentage of debt securities as of December 31, 2015 was approximately 33.5%, up from approximately 28.8% as of December 31, 2014. The plan’s strategic target asset allocation as of December 31, 2015 was 50% equity, 30% debt and 20% other, with the “other” component consisting of a global market fund and a real estate fund, among others. We have assumed that the funds in the “other” category together would behave similarly to debt and therefore included the 20% “other” as bonds in our assessment.
We estimated a range of returns on the plan assets using a historical stochastic simulation model that determines the compound average annual return (assuming these asset classes-stocks, bonds and cash) over a 20-year historical period (the approximate duration of our liabilities under the Pension Plan). The distribution of results from these simulations is then used to determine a median expected asset return.
Based on the plan’s current target asset allocation, the median estimate for future asset returns (before non-investment expenses) was 9.0%. The asset return assumption set for determining the 2015 FASB ASC 715 expense was 8.5%, after non-investment expenses paid by the Trust. For the past three years, non-investment related expenses have averaged 0.5%. Therefore, the 8.5% return after non-investment expenses assumption is equivalent to a gross assumption of 9.0% (8.5% + 0.5%). A 9.0% rate (before non-investment expenses) falls within an acceptable range of simulated asset returns, between the 40th and 60th percentile.
For the Pension Plan, a 100 basis point decrease in the assumed discount rate would result in a corresponding increase of $2.8 million in our estimated Pension Plan expense for 2016. A 100 basis point decrease from 8.5% in the rate of return on plan assets would result in a corresponding increase of $1.0 million and a 100 basis point increase in the expected salary rate would result in a corresponding increase of $1.1 million in expenses for 2016, in each case holding all other assumptions and factors constant.
For the Retiree Medical Plan, a 100 basis point decrease in the assumed discount rate would result in a corresponding increase of $0.4 million in our estimated expense and a 100 basis point increase in the assumed health care trend rate would result in a corresponding increase of $0.1 million in our estimated expense for 2016, in each case holding all other assumptions and factors constant. For additional information about our benefit plans, See Note 13 Employee Benefits to the consolidated financial statements.
Revenue Recognition. Sales are recognized in accordance with the provisions of ASC 605, Revenue Recognition-Overall, when the revenue is realized or realizable, and has been earned. Revenue for product sales is recognized when risk and title to the product transfer to the customer. Our products are generally sold free on board shipping point or, with respect to countries other than the United States, an equivalent basis. As such, title to the product passes when the product is delivered to the freight carrier. Our standard terms of delivery are included in our contracts of sale, order confirmation documents, and invoices. Shipping and other transportation costs charged to customers are recorded in both revenue and cost of goods sold. We have entered into agreements with some of our customers whereby they earn rebates from us when the volume of their purchases of our product reach certain agreed upon levels. We recognize the rebate obligation ratably, as a reduction of revenue.
LIQUIDITY AND CAPITAL RESOURCES
On January 6, 2016, we completed our acquisition of Arizona Chemical, a leading global producer of specialty chemicals and other products primarily derived from pine wood pulping co-products. We acquired Arizona Chemical for a cash purchase price of $1.37 billion, which is subject to adjustment for cash, indebtedness, working capital and other items. On January 6, 2016, the $1.37 billion cash purchase price, the cash tender offer and redemption of all outstanding 6.75% Senior Notes, and the related acquisition and financing expenses for the Arizona Chemical Acquisition were funded through the following transactions:
•
A $1,350.0 million senior secured term loan facility,
•
A private offering of $440.0 million in aggregate principal amount of 10.5% senior notes, and
•
An amended and restated $250.0 million asset-based revolving credit facility, $37.1 million of which was drawn on the closing date.
Our previously outstanding indebtedness under the 6.75% Senior Notes and the previous Senior Secured Credit Facilities were satisfied and canceled on January 6, 2016. As such, the following discussion focuses on the capital structure subsequent to the January 6, 2016 close of the above financing arrangements in conjunction with the Arizona Chemical Acquisition. For a description of our indebtedness outstanding at December 31, 2015, see Note 7 Long-Term Debt which is incorporated herein by reference.
In total, we incurred approximately $19.0 million of costs related to the close of the Arizona Chemical Acquisition, of which $18.5 million were recorded in selling, general and administrative expenses in the year ended December 31, 2015. Furthermore, we incurred approximately $59.0 million of debt financing costs associated with Arizona Chemical Acquisition, of which $8.8 million were capitalized in debt issuance costs in the December 31, 2015 consolidated balance sheet. In the first quarter of 2016, we also expect to recognize $9.1 million of cost for the early redemption premium on the 6.75% Senior Notes.
Description of the Senior Secured Term Loan Facility
In January 2016, Kraton Polymers LLC entered into a senior secured term loan facility in an aggregate principal amount equal to $1,350.0 million that matures on January 6, 2022 (the “Term Loan Facility”). Subject to compliance with certain covenants and other conditions, we have the option to borrow up to $350.0 million of incremental term loans plus an additional amount subject to a senior secured net leverage ratio.
The Term Loan Facility was issued at a price of 97.000%. Borrowings under the Term Loan Facility bear interest at a rate per annum equal to an applicable margin, plus, at our option, either (a) an adjusted LIBOR rate (subject to a 1.0% floor) determined by reference to the costs of funds for U.S. dollar deposits for the interest period relevant to such borrowing adjusted for statutory reserve requirements or (b) an alternate base rate (subject to a 2.0% floor) determined by reference to the highest of (1) the prime rate of Credit Suisse AG, (2) the federal funds effective rate plus 0.5% and (3) the one month adjusted LIBOR rate plus 1.0% per annum. In addition, we are required to pay customary agency fees. As of the date of this filing, the effective rate on the Term Loan Facility was 6.0% comprised of the 1.0% LIBOR floor plus a 5.0% applicable margin.
We are required to make scheduled quarterly payments on our term facility of 2.5% of the original principal amount per year through the end of the last quarter of 2016 and 5.0% thereafter, with the balance expected to be due and payable in full on January 6, 2022. Voluntary prepayments on the Term Loan Facility may be made without premium or penalty other than customary “breakage” costs with respect to LIBOR loans and other than a 1.0% premium in connection with certain repricing transactions consummated within a certain period of time after the closing of the Term Loan Facility. In the event we have consolidated excess cash flow for any fiscal year, we are required to prepay an amount of borrowings under the Term Loan Facility equal to at least 50% of such cash flow by the 90th day after the end of the fiscal year. The prepayment percentage is reduced to 25% if our senior secured net leverage ratio is under 2.5:1.0 or 0% if our senior secured net leverage ratio is below 2.0:1.0.
The Term Loan Facility is a senior secured obligation that is guaranteed by Kraton Performance Polymers, Inc. and each of our wholly-owned domestic subsidiaries. The Term Loan Facility contains a number of customary affirmative and negative covenants. These covenants include a senior secured net leverage ratio which shall not exceed, as of the last day of any fiscal quarter, 4.00:1.00 through March 31, 2017, which will decrease to 3.75:1.00 through March 31, 2018, 3.50:1.00 through March 31, 2019, and 3.25:1.00 thereafter. As of the date of this filing, we were in compliance with the covenants under the Term Loan Facility.
Description of the 10.5% Senior Notes due 2023
Kraton Polymers LLC and its wholly-owned financing subsidiary Kraton Polymers Capital Corporation issued $440.0 million aggregate principal amount of 10.5% senior notes that mature on April 15, 2023 (the “10.5% Senior Notes”). The 10.5% Senior Notes were issued at a price of 96.225% on January 6, 2016. The 10.5% Senior Notes are general unsecured, senior obligations and are unconditionally guaranteed on a senior unsecured basis by each of Kraton Performance Polymers, Inc. and each of our wholly-owned domestic subsidiaries. We pay interest on the notes at 10.5% per annum, semi-annually in arrears on April 15 and October 15 of each year, with the first interest payment due on October 15, 2016. Prior to October 15, 2018, we may redeem up to 40.0% of the aggregate principal amount of the notes with the net proceeds of certain equity offerings at a redemption price equal to 110.500% of the principal amount of the 10.5% Senior Notes plus accrued and unpaid interest, if any, to the date of redemption. After October 15, 2018, 2019, 2020, and 20121 and thereafter, we may redeem all or a part of the senior notes for 107.875%, 105.250%, 102.625%, and 100.000% of the principal amount, respectively.
Description of the ABL Facility
In January 2016, we entered into an amended and restated asset-based revolving credit facility which provides financing of up to $250.0 million (the “ABL Facility”). The ABL Facility is primarily secured by receivables and inventory, and borrowing availability under the facility is subject to borrowing base limitations based on the level of receivables and inventory available for security. Revolver commitments under the ABL facility consist of U.S. and Dutch revolving credit facility commitments, and the terms of the facility require the U.S. revolver commitment comprises at least 60.0% of the commitments under the facility.
The ABL Facility provides that we have the right at any time to request up to $100.0 million of additional commitments under this facility, provided that we satisfy additional conditions described in the credit agreement and provided further that the U.S. revolver commitment comprises at least 60.0% of the commitments after giving effect to such increase. We cannot guarantee that all of the lending counterparties contractually committed to fund a revolving credit draw request will actually fund future requests, although we currently believe that each of the counterparties would meet their funding requirements. The ABL Facility terminates on January 6, 2021; however, we may, from time to time, request that the lenders extend the maturity of their commitments; provided that at no time shall there be more than four different maturity dates under the ABL Facility.
Borrowings under the ABL Facility bear interest at a rate per annum equal to the applicable margin plus (1) a base rate determined by reference to the prime rate of Bank of America, N.A. in the jurisdiction where the currency is being funded or (2) LIBOR for loans that bear interest based on LIBOR. The initial applicable margin for borrowings under our ABL Facility is 0.5% with respect to U.S. base rate borrowings and 1.5% with respect to LIBOR or borrowings made on a European base rate. The applicable margin ranges from 0.5% to 1.0% with respect to U.S. base rate borrowings and 1.5% to 2.0% for LIBOR or borrowings made on a European base rate per annum based on the average excess availability for the prior fiscal quarter. In addition to paying interest on outstanding principal amounts under the ABL Facility, we are required to pay a commitment fee in respect of the unutilized commitments at an annual rate of 0.375%.
The ABL Facility contains a financial covenant requiring us to maintain a minimum fixed charge coverage ratio of 1.0 to 1.0 if availability under the facility is below a specified amount. Our failure to comply with this financial maintenance covenant would give rise to a default under the ABL Facility. If factors arise that negatively impact our profitability, we may not be able to satisfy this covenant. In addition, the ABL Facility contains customary events of default, including, without limitation, a failure to make payments under the facility, cross-default with respect to other indebtedness and cross-judgment default, certain bankruptcy events and certain change of control events. If we are unable to satisfy the covenants or other provisions of the ABL Facility at any future time, we would need to seek an amendment or waiver of such covenants or other provisions. The respective lenders under the ABL Facility may elect not to consent to any amendment or waiver requests that we may make in the future, and, if they do consent, they may do so on terms that are not favorable to us. In the event that we are unable to obtain any such waiver or amendment and we are not able to refinance or repay our ABL Facility, our inability to meet the covenants or other provisions of the ABL Facility would constitute an event of default, which would permit the bank lenders to accelerate the ABL Facility. Such acceleration may in turn constitute an event of default under our Term Loan Facility, 10.5% Senior Notes or other indebtedness. As of the date of this filing, we were in compliance with the covenants under the ABL Facility.
Description of the KFPC Loan Agreement
On July 17, 2014, KFPC executed a syndicated loan agreement (the "KFPC Loan Agreement") in the amount of 5.5 billion New Taiwanese Dollars ("NTD"), or $167.5 million (converted at the December 31, 2015 exchange rate), to provide additional funding to construct the HSBC facility in Taiwan and to provide funding for working capital requirements and/or general corporate purposes.
The KFPC Loan Agreement is comprised of a NTD 4.29 billion Tranche A, or $130.6 million (converted at the December 31, 2015 exchange rate), to fund KFPC’s capital expenditures, and a NTD 1.21 billion Tranche B, or $36.9 million (converted at the December 31, 2015 exchange rate), to fund working capital requirements and/or general corporate purposes. As of December 31, 2015, NTD 2.53 billion, or $76.9 million (converted at the December 31, 2015 exchange rate) was drawn and outstanding on the KFPC Loan Agreement. The facility period of the KFPC Loan Agreement is five years from January 17, 2015 (the first drawdown date). KFPC may continue to draw on the loan agreement for the first 28 months following the first drawdown date. Subject to certain conditions, KFPC can request a two-year extension of the term of the KFPC Loan Agreement.
The total outstanding principal amount is payable in six semi-annual installments with the first payment due on July 17, 2017 and each subsequent payment due every six months thereafter. The first five installments shall be in an amount equal to 10% of the outstanding principal amount and the final installment shall be in an amount equal to the remaining 50% of the outstanding principal amount. In the event the extension period is granted, the final 50% of the outstanding principal amount shall be repaid in five equal semi-annual installments with the first installment due on the original final maturity date.
The KFPC Loan Agreement is subject to a variable interest rate composed of a fixed 0.8% margin plus the three-month or six-month fixing rate of the Taipei Interbank Offered Rate (depending on the interest period selected by KFPC in the drawdown request or the interest period notice), subject to a floor of 1.7%. Interest is payable on a monthly basis.
The KFPC Loan Agreement contains certain financial covenants which change during the term of the KFPC Loan Agreement. The financial covenants include a maximum debt to equity ratio of 3.0 to 1.0 through 2016, which will decrease to 2.0 to 1.0 in 2017 and 1.2 to 1.0 in 2018; a minimum tangible net worth requirement of $50.0 million through 2018, which will increase to $100.0 million in 2019; and a minimum interest coverage ratio of 2.5 to 1.0 commencing in 2016, which will increase to 5.0 to 1.0 in 2017. In each case, these covenants are calculated and tested on an annual basis. Formosa Petrochemical Corporation and Kraton Polymers LLC are the guarantors of the KFPC Loan Agreement with each guarantor guaranteeing 50% of the indebtedness. At December 31, 2015, KFPC was in compliance with the covenants under the KFPC Loan Agreement. For additional information regarding our KFPC Loan Agreement, see “KFPC Loan Agreement" in Note 7 Long-Term Debt to the consolidated financial statements, which is incorporated herein by reference.
Known Trends and Uncertainties
Kraton Performance Polymers, Inc. is a holding company without any operations or assets other than the operations of its subsidiaries. Cash flows from operations of our subsidiaries, cash on hand, and available borrowings under our ABL Facility are our principal sources of liquidity.
Based upon current and anticipated levels of operations, we believe that cash flows from operations of our subsidiaries, cash on hand, and borrowings available to us will be sufficient to fund our expected financial obligations, planned capital expenditures, and anticipated liquidity requirements, including working capital requirements, our investment in the KFPC joint venture, debt payments, interest payments, benefit plan contributions, and income tax obligations.
Our cash flows are subject to a number of risks and uncertainties, including, but not limited to, earnings, sensitivities to the cost of raw materials, seasonality and fluctuations in foreign currency exchange rates. Because feedstock costs generally represent a substantial portion of our cost of goods sold, in periods of rising feedstock costs, we generally consume cash in operating activities due to increases in accounts receivable and inventory costs, partially offset by increased value of accounts payable. Conversely, during periods in which feedstock costs are declining, we generate cash flow from decreases in working capital.
Going forward, there can be no assurance that our business will generate sufficient cash flow from operations or that future borrowings will be available under the ABL Facility or any new credit facilities or financing arrangements to fund liquidity needs and enable us to service our indebtedness. As of the date of this filing, $37.0 million was drawn on the ABL Facility with a remaining available borrowing capacity of $176.9 million. Our available cash and cash equivalents are held in accounts managed by third-party financial institutions and consist of cash invested in interest bearing funds and operating accounts. To date, we have not experienced any losses or lack of access to our invested cash or cash equivalents; however, we cannot provide any assurance that adverse conditions in the financial markets will not impact access to our invested cash and cash equivalents.
We made contributions of $1.8 million to our pension plan for the year ended December 31, 2015 and $7.2 million for the year ended December 31, 2014. Following the close of the Arizona Chemical Acquisition on January 6, 2016, we assumed responsibility for several additional international pension plans and one additional U.S defined benefit pension plan. As a combined company, we expect our total pension plan contributions for the year ended December 31, 2016 to be approximately $6.9 million. Our pension plan obligations are predicated on a number of factors, the primary ones being the return on our pension plan assets and the discount rate used in deriving our pension obligations. If the investment return on our pension plan assets does not meet or exceed expectations during 2016, and the discount rate decreases from the prior year, higher levels of contributions could be required in 2017 and beyond.
As of December 31, 2015, we had $51.2 million of cash and short-term investments related to foreign operations that management asserts are permanently reinvested. As a result of net operating loss carryforwards, management estimates that no additional cash tax expense would be incurred if this cash were repatriated.
Turbulence in U.S. and international markets and economies may adversely affect our liquidity and financial condition, the liquidity and financial condition of our customers, and our ability to timely replace maturing liabilities and access the capital markets to meet liquidity needs, resulting in adverse effects on our financial condition and results of operations. However, to date we have been able to access borrowings available to us in amounts sufficient to fund liquidity needs.
Our ability to pay principal and interest on our indebtedness, fund working capital, make anticipated capital expenditures, and fund our investment in the KFPC joint venture depends on our future performance, which is subject to general economic conditions and other factors, some of which are beyond our control. “See Part I, Item 1A. Risk Factors” for further discussion.
Operating Cash Flows
Net cash provided by operating activities totaled $103.8 million for the year ended December 31, 2015 and $29.9 million for the year ended December 31, 2014. This represents a net increase of $74.0 million, which was primarily driven by changes in working capital. The net change in working capital provided cash flows of $46.1 million in 2015 compared to a use of cash of $53.2 million in 2014, a period-over-period increase in cash flows of $99.3 million. The period-over-period changes are as follows:
•
$63.4 million increase in cash flows associated with inventories of products, materials, and supplies, due to a decrease in inventory volumes for the year ended December 31, 2015 compared to an increase in inventory volumes for the year ended December 31, 2014. In addition, cash flows associated with inventories increased as a result of declining costs of raw material and finished goods inventories for the year ended December 31, 2015;
•
$27.5 million increase in cash flows associated with trade accounts payable primarily due to the timing of payments; and
•
$8.4 million net increase in cash flows due to the timing of payments of other items, including accounts receivable, related party transactions, taxes and pension costs.
Net cash provided by operating activities totaled $29.9 million for the year ended December 31, 2014 and $105.5 million for the year ended December 31, 2013. This represents a net decrease of $75.6 million, which was primarily driven by changes in working capital. The net change in working capital was a use of cash of $53.2 million in 2014 compared to a source of cash of $43.8 million in 2013; a period-over-period decline in cash flows of $97.0 million. The period-over-period changes are as follows:
•
$27.1 million decrease in cash flows associated with inventories of products, materials, and supplies, largely due to increases in quantities of finished goods inventories partially offset by decreases in the cost of raw material and finished goods inventories;
•
$50.3 million decrease in cash flows associated with trade accounts payable primarily due to the timing of payments and a decrease in the cost of raw materials; and
•
$33.8 million net decrease in cash flows due to the timing of payments of other items, including related party transactions, taxes, and pension costs; partially offset by
•
$14.2 million increase in cash flows associated with accounts receivable reflecting improved days sales outstanding and lower sales volumes.
Investing Cash Flows
Net cash used in investing activities totaled $128.7 million, $114.4 million and $88.7 million for the years ended December 31, 2015, 2014, and 2013, respectively.
Capital projects in 2015 included the following:
•
$69.1 million of capital expenditures incurred by KFPC in connection with the Taiwan plant construction;
•
$23.6 million related to projects to optimize the production capabilities of our manufacturing assets, which includes $9.5 million to comply with the MACT rule; and
•
$18.4 million related to health, safety and environmental, including infrastructure and maintenance projects.
Capital projects in 2014 included the following:
•
$44.3 million of capital expenditures incurred by KFPC in connection with the Taiwan plant construction;
•
$39.0 million related to projects to optimize the production capabilities of our manufacturing assets, which includes $26.8 million to comply with the MACT rule; and
•
$20.7 million related to health, safety, and environmental, including infrastructure and maintenance projects.
Expected Capital Expenditures.
We currently expect 2016 capital expenditures, excluding expenditures by the KFPC joint venture, will be approximately $100.0 million to $110.0 million. Included in this estimate is approximately $27.0 million for projects associated with our cost reset initiative, $7.0 million for projects to achieve operational synergies related to the integration of Arizona Chemical, and $50.0 million to $55.0 million for health, safety and environmental and infrastructure and maintenance projects. The remaining anticipated 2016 capital expenditures are primarily associated with projects to optimize the production capabilities of our manufacturing assets and to support our innovation platform.
We currently anticipate the total KFPC joint venture project construction cost will be approximately $200.0 million to $210.0 million; of which, 2015 capital expenditures were $69.1 million and 2016 capital expenditures will be approximately $70.0 million. The project has been funded with a combination of equity and debt financing. From the inception of the project to December 31, 2015, we and FPCC have each made equity investments of $41.6 million to KFPC. On July 17, 2014, KFPC executed the KFPC Loan Agreement in the amount of NTD 5.5 billion, or $167.5 million (converted at the December 31, 2015 exchange rate), to provide the debt portion of the project financing including funding for working capital and/or general corporate purposes. Kraton Polymers LLC and FPCC are guarantors of the KFPC Loan Agreement with each guaranteeing 50.0% of the indebtedness. See Note 7 Long-Term Debt to the consolidated financial statements for further discussion of the KFPC Loan Agreement.
Financing Cash Flows and Liquidity
Our consolidated capital structure as of December 31, 2015 was approximately 43.7% equity, 52.1% debt and 4.2% noncontrolling interest compared to approximately 52.5% equity, 42.9% debt and 4.6% noncontrolling interest as of December 31, 2014.
Net cash provided by financing activities totaled $47.1 million for the year ended December 31, 2015 compared to net cash used in financing activities of $24.4 million and $62.2 million for the years ended December 31, 2014 and 2013, respectively. In 2015, the KFPC joint venture drew $80.1 million on the KFPC Loan Agreement for construction funding partially offset by cash outflows of $31.3 million for repurchases of shares of our common stock as part of our share repurchase program approved in October 2014. In 2014, we repurchased $18.7 million in shares of our common stock as part of our share repurchase program approved in October 2014. In 2013, we repaid the $96.9 million remaining principal amount of term loans and received $41.6 million from FPCC, which represents their portion of the equity investment in the KFPC joint venture.
Other Contingencies
As a chemicals manufacturer, our operations in the United States and abroad are subject to a wide range of environmental laws and regulations at the international, national, state and local levels. These laws and regulations govern, among other things, air emissions, wastewater discharges, the use, handling and disposal of hazardous materials and wastes, occupational health and safety, including dust and noise control, site remediation programs and chemical registration, use and management.
Pursuant to these laws and regulations, our facilities are required to obtain and comply with a wide variety of environmental permits and authorizations for different aspects of their operations. Generally, many of these environmental laws and regulations are becoming increasingly stringent, and the cost of compliance with these various requirements can be expected to increase over time.
In the context of the separation in February 2001, Shell Chemicals agreed to indemnify us for specific categories of environmental claims brought with respect to matters occurring before the separation. However, the indemnity from Shell Chemicals is subject to dollar and time limitations. Coverage under the indemnity also varies depending upon the nature of the environmental claim, the location giving rise to the claim and the manner in which the claim is triggered. Therefore, if claims arise in the future related to past operations, we cannot give assurances that those claims will be covered by the Shell Chemicals’ indemnity and also cannot be certain that any amounts recoverable will be sufficient to satisfy claims against us.
In connection with International Paper's divestiture of Arizona Chemical in February 2007, International Paper provided an indemnity to the buyer for specific known environmental liabilities and other environmental liabilities pertaining to former properties. At the closing of the Arizona Chemical Acquisition, Kraton was assigned the right to International Paper's indemnity for such environmental liabilities and assumed certain related obligatoins. Certain liabilities may fall outside the scope of the indemnity and therefore we cannot be certain that the indemnity will be sufficient to satisfy all environmental liabilities of Arizona Chemical.
In addition, we may in the future be subject to claims that arise solely from events or circumstances occurring after February 2001 for legacy Kraton manufacturing sites or after February 2007 for legacy Arizona Chemical manufacturing sites, which would not, in any event, be covered by the Shell Chemicals or Internatonal Paper indemnities, respectively. While we recognize that we may in the future be held liable for remediation activities beyond those identified to date, at present we are not aware of any circumstances that are reasonably expected to give rise to remediation claims that would have a material adverse effect on our results of operations or cause us to exceed our projected level of anticipated capital expenditures.
Except for the foregoing, we currently estimate that any expenses incurred in maintaining compliance with environmental laws and regulations will not materially affect our results of operations or cause us to exceed our level of anticipated capital expenditures. However, we cannot give assurances that regulatory requirements or permit conditions will not change, and we cannot predict the aggregate costs of additional measures that may be required to maintain compliance as a result of such changes or expenses.
We had no material operating expenditures for environmental fines, penalties, government imposed remedial or corrective actions during the years ended December 31, 2015, 2014, or 2013.
Off-Balance Sheet Arrangements
We are not a party to any material off-balance sheet arrangements as of December 31, 2015, other than operating leases.
Contractual Obligations
Our principal outstanding contractual obligations relate to the senior notes and related interest payments, the operating leases of some of our facilities, the minimum purchase obligations required under our KFPC joint venture agreement and other agreements, and the feedstock contracts with LyondellBasell and others to provide us with styrene, butadiene, and isoprene. The following table summarizes our contractual cash obligations as of December 31, 2015 for the periods indicated.
________________________________________________
(1)
Included in this line are our estimated minimum purchases required under our KFPC joint venture agreement. Due to the indefinite term of this joint venture, we have based our minimum purchases on an assumed 20 year useful life of the facility.
(2)
Pursuant to operating agreements with LyondellBasell, we are currently paying the costs incurred by them in connection with the operation and maintenance of, and other services related to, our Berre, France, and Wesseling, Germany, facilities. These obligation are not included in this table.
(3)
Deferred income tax liabilities may vary according to changes in tax laws, tax rates and the operating results. As a result, it is impractical to determine whether there will be a cash impact to an individual year. All noncurrent deferred income tax liabilities have been reflected in “2021 and beyond.”
(4)
Due to uncertainties in the timing of the effective settlement of tax positions with the respective taxing authorities, we are unable to determine the timing of payments related to uncertain tax positions, including interest and penalties. Amounts beyond the current year are therefore reflected in “2021 and beyond.”
(5)
This represents our future pension contributions utilizing the following assumptions:
•
The plan was “frozen” at December 31, 2015;
•
All assets at December 31, 2015 were moved into a portfolio of high quality bonds whose cash flow matches the expected cash flow of the “frozen” plan. The yield on the portfolio of bonds as of December 31, 2015 is equal to the estimated PPA effective rate at January 1, 2016. Assets were assumed to remain in such portfolio until all obligations of the plan were paid out;
•
An estimated Pension Protection Act effective rate as of January 1, 2016 of 4.50%;
•
All contributions are made at the latest date allowable by law; and
•
All other assumptions as used in the 2015 funding actuarial valuation of the plan are met.
Impact of Inflation. Our results of operations and financial condition are presented based on historical cost. While it is difficult to accurately measure the impact of inflation due to the imprecise nature of the estimates required, we believe the effects of inflation, if any, on our results of operations and financial condition have been immaterial.
Item 7A.
Item 7A.
Quantitative and Qualitative Disclosures about Market Risk.
We are exposed to certain market risks, including risks from changes in interest rates, foreign currency exchange rates, and commodity prices that could impact our financial condition, results of operations, and cash flows. We selectively manage our exposure to these and other market risks through regular operating and financing activities as well as through the use of market risk sensitive instruments. We use such financial instruments as risk management tools and not for trading purposes. The market risk sensitive instruments that we have entered into as of December 31, 2015 consist of a series of non-deliverable forward contracts.
Interest rate risk. On January 6, 2016, we entered into a new Term Loan Facility and a new ABL Facility which bear interest at variable rates, thereby exposing us to interest rate risk. Subsequent to the close of our Term Loan Facility, we entered into a series of interest rate swaps for a portion of the forecasted Term Loan Facility balance effective in January 2017 whereby we exchanged floating for fixed rate interest payments in order to reduce exposure to interest rate volatility. However, interest rate swaps we entered may not fully mitigate our interest rate risk.
Foreign currency exchange risk. We conduct operations in many countries around the world. Our results of operations are subject to both currency transaction and currency translation risk. We incur currency transaction risk when we enter into either a purchase or sale transaction using a currency other than the local currency of the transacting entity. We are subject to currency translation risk because our financial condition and results of operations are measured and recorded in the relevant domestic currency and then translated into U.S. dollars for inclusion in our historical consolidated financial statements. We attempt to selectively manage significant exposures to potential foreign currency exchange losses based on current market conditions, future operating activities, and the associated cost in relation to the perceived risk of loss. The purpose of our foreign currency risk management activities is to minimize the risk that our cash flows from the sale and/or purchase of services and products in foreign currencies will be adversely affected by changes in exchange rates.
Periodically, we enter into foreign currency agreements to hedge or otherwise protect against fluctuations in foreign currency exchange rates. These agreements typically do not qualify for hedge accounting and gains/losses resulting from both the up-front premiums and/or settlement of the hedges at expiration of the agreements are recognized in the period in which they are incurred. In 2015, we entered into a series of foreign currency forward contracts to reduce our exposure to exchange rate volatility. These contracts were structured such that the underlying foreign currency exchange gains/losses would be offset by the mark-to-market impact of the hedging instruments and reduce the impact of foreign currency exchange movements throughout the year. The notional amounts of open foreign currency forward contracts were $24.1 million at December 31, 2015 and $46.9 million at December 31, 2014. The notional amounts of our forward contracts do not generally represent amounts exchanged by the parties, and thus are not a measure of our exposure or of the cash requirements related to these contracts. As such, cash flows related to these contracts are typically not material. The amounts exchanged are calculated by reference to the notional amounts and by other terms of the contracts, such as exchange rates.
In addition, in 2013 we entered into a series of non-deliverable forward and foreign currency option contracts to protect our net investment in various foreign subsidiaries against adverse changes in exchange rates by fixing the U.S. dollar/Euro exchange rate and the New Taiwan Dollar/Euro exchange rate. These contracts qualified for hedge accounting in accordance with ASC 815-35 “Net Investment Hedges” and typically settled weekly or monthly and all were settled at December 31, 2013. See Note 8 Fair Value Measurements, Financial Instruments and Credit Risk to the consolidated financial statements for further discussion.
We use sensitivity analysis models to measure the impact of a hypothetical 10% adverse movement of foreign currency exchange rates against the U.S. dollar. For our foreign currency transaction risk, a hypothetical 10% adverse change in the foreign currency exchange rates for all our foreign currency positions would result in a $1.7 million pre-tax loss for our net monetary assets denominated in currencies other than the respective entity's functional currency at December 31, 2015. For our foreign currency translation risk, a hypothetical 10% adverse change in the applicable average foreign currency exchange rates relative to the U.S. dollar in 2016 would negatively impact our pre-tax income by $10.5 million.
There are certain limitations inherent in the sensitivity analyses presented, primarily due to the assumption that interest rates and exchange rates change instantaneously in an equally adverse fashion. In addition, the analyses are unable to reflect the complex market reactions that normally would arise from the market shifts modeled. While this is our best estimate of the impact of the various scenarios, these estimates should not be viewed as forecasts.
Commodity price risk. We are exposed to commodity price risk due to our forward contractual purchase commitments for raw materials. Styrene, butadiene, and isoprene are primarily supplied by a portfolio of suppliers under long-term supply contracts and arrangements with various expiration dates. We are subject to future purchase commitments for these raw materials under minimum purchase contracts. Based on pricing as of December 31, 2015, a hypothetical 10.0% change in the market price for these raw materials would change our 2016 cost of goods sold by $16.6 million.
Item 8.
Item 8.
Financial Statements and Supplementary Data.
The financial statements are set forth herein commencing on page of this report.
Item 9.
Item 9.
Changes in and Disagreements with Accountants on Accounting and Financial Disclosure.
None.
Item 9A.
Item 9A.
Controls and Procedures.
Evaluation of Disclosure Controls and Procedures
An evaluation of the effectiveness of the design and operation of our disclosure controls and procedures (as defined in Rule 13a-15 under the Securities Exchange Act of 1934) was carried out under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer. As of December 31, 2015, based upon that evaluation, the Chief Executive Officer and Chief Financial Officer concluded that the design and operation of these disclosure controls and procedures were effective.
Management’s Annual Report on Internal Control over Financial Reporting
See Management’s Annual Report on Internal Control over Financial Reporting on page of the audited consolidated financial statements provided under Item 8 of this Form 10-K.
Attestation Report of the Registered Public Accounting Firm
See Report of Independent Registered Public Accounting Firm on page of the audited consolidated financial statements provided under Item 8 of this Form 10-K.
Changes in Internal Control over Financial Reporting
There has been no change in our internal control over financial reporting that occurred during the three months ended December 31, 2015 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
Item 9B.
Item 9B.
Other Information.
None.
PART III
Item 10.
Item 10.
Directors, Executive Officers and Corporate Governance.
Information in response to this item is incorporated by reference to our Proxy Statement relating to our 2016 annual meeting of shareholders. The Proxy Statement will be filed with the SEC within 120 days after the end of the fiscal year covered by this Form 10-K pursuant to Regulation 14A under the Exchange Act.
Item 11.
Item 11.
Executive Compensation.
Information in response to this item is incorporated by reference to our Proxy Statement relating to our 2016 annual meeting of shareholders. The Proxy Statement will be filed with the SEC within 120 days after the end of the fiscal year covered by this Form 10-K pursuant to Regulation 14A under the Exchange Act.
Item 12.
Item 12.
Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.
Information in response to this item is incorporated by reference to our Proxy Statement relating to our 2016 annual meeting of shareholders. The Proxy Statement will be filed with the SEC within 120 days after the end of the fiscal year covered by this Form 10-K pursuant to Regulation 14A under the Exchange Act.
Item 13.
Item 13.
Certain Relationships and Related Transactions, and Director Independence.
Information in response to this item is incorporated by reference to our Proxy Statement relating to our 2016 annual meeting of shareholders. The Proxy Statement will be filed with the SEC within 120 days after the end of the fiscal year covered by this Form 10-K pursuant to Regulation 14A under the Exchange Act.
Item 14.
Item 14.
Principal Accountant Fees and Services.
Information in response to this item is incorporated by reference to our Proxy Statement relating to our 2016 annual meeting of shareholders. The Proxy Statement will be filed with the SEC within 120 days after the end of the fiscal year covered by this Form 10-K pursuant to Regulation 14A under the Exchange Act.
PART IV
Item 15.
Item 15.
Exhibits and Financial Statement Schedules.
(a) 1. Financial Statements
The following financial statements are included in Item 8:
Kraton Performance Polymers, Inc.
(i)
The reports of KPMG LLP, Independent Registered Public Accounting Firm
(ii)
Consolidated Balance Sheets as of December 31, 2015 and 2014
(iii)
Consolidated Statements of Operations-years ended December 31, 2015, 2014, and 2013
(iv)
Consolidated Statements of Comprehensive Income (Loss)-years ended December 31, 2015, 2014, and 2013
(v)
Consolidated Statements of Changes in Equity-years ended December 31, 2015, 2014, and 2013
(vi)
Consolidated Statements of Cash Flows-years ended December 31, 2015, 2014, and 2013
(vii)
Notes to consolidated financial statements
2. Exhibits
The exhibits listed on the accompanying Exhibit Index are filed as part of this report and are on file with us.
(b) Exhibits
See Item 15(a) 2 above.
(c) Financial Statement Schedule
See Schedule II.
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
Date: February 24, 2016
Kraton Performance Polymers, Inc.
/S/ KEVIN M. FOGARTY
Kevin M. Fogarty
President and Chief Executive Officer
This report has been signed below by the following persons on behalf of the registrant and in the capacities indicated on February 24, 2016.
Signature
Title
/S/ KEVIN M. FOGARTY
President, Chief Executive Officer and a Director
(Principal Executive Officer)
Kevin M. Fogarty
/S/ STEPHEN E. TREMBLAY
Executive Vice President and Chief Financial Officer (Principal Financial Officer)
Stephen E. Tremblay
/S/ CHRIS H. RUSSELL
Chief Accounting Officer
(Principal Accounting Officer)
Chris H. Russell
/S/ ANNA C. CATALANO*
Director
Anna C. Catalano
/S/ STEVEN J. DEMETRIOU*
Director
Steven J. Demetriou
/S/ DOMINIQUE FOURNIER*
Director
Dominique Fournier
/S/ JOHN J. GALLAGHER, III*
Director
John J. Gallagher
/S/ BARRY J. GOLDSTEIN*
Director
Barry J. Goldstein
/S/ FRANCIS S. KALMAN*
Director
Francis S. Kalman
/S/ DAN F. SMITH*
Director
Dan F. Smith
/S/ KAREN A. TWITCHELL*
Director
Karen A. Twitchell
*By:
/S/ STEPHEN E. TREMBLAY
Stephen E. Tremblay
As attorney-in-fact
KRATON PERFORMANCE POLYMERS, INC.
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Management’s Annual Report on Internal Control over Financial Reporting
Our management is responsible for establishing and maintaining adequate internal control over financial reporting, as defined in Rules 13a-15(f) and 15d-15(f) of the Securities Exchange Act of 1934, as amended. Internal control over financial reporting, no matter how well designed, has inherent limitations. Therefore, even those systems determined to be effective can provide only reasonable assurance with respect to financial statement preparation and presentation. Further, because of changes in conditions, the effectiveness of internal control over financial reporting may vary over time.
Under the supervision and with the participation of our management, including our chief executive officer and chief financial officer, we conducted an evaluation to assess the effectiveness of our internal control over financial reporting as of December 31, 2015 based upon criteria set forth in the Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on our assessment, we believe that, as of December 31, 2015, our internal control over financial reporting is effective.
The effectiveness of our internal control over financial reporting as of December 31, 2015 has been audited by KPMG LLP, an independent registered public accounting firm, as stated in their report that is included herein.
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Kraton Performance Polymers, Inc.:
We have audited Kraton Performance Polymers, Inc.’s internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Kraton Performance Polymers, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Annual Report on Internal Control over Financial Reporting. Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit.
We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.
In our opinion, Kraton Performance Polymers, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control-Integrated Framework (2013) issued by COSO.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Kraton Performance Polymers, Inc. and subsidiaries as of December 31, 2015 and 2014, and the related consolidated statements of operations, comprehensive income (loss), changes in equity, and cash flows for each of the years in the three-year period ended December 31, 2015, and our report dated February 24, 2016 expressed an unqualified opinion on those consolidated financial statements.
/s/ KPMG LLP
Houston, Texas
February 24, 2016
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Kraton Performance Polymers, Inc.:
We have audited the accompanying consolidated balance sheets of Kraton Performance Polymers, Inc. and subsidiaries as of December 31, 2015 and 2014, and the related consolidated statements of operations, comprehensive income (loss), changes in equity, and cash flows for each of the years in the three-year period ended December 31, 2015. These consolidated financial statements are the responsibility of Kraton Performance Polymers, Inc.’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.
We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the consolidated financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Kraton Performance Polymers, Inc. and subsidiaries as of December 31, 2015 and 2014, and the results of their operations and their cash flows for each of the years in the three-year period ended December 31, 2015, in conformity with U.S. generally accepted accounting principles.
As discussed in Note 2 to the consolidated financial statements, Kraton Performance Polymers, Inc. changed its method of accounting for deferred income taxes effective January 1, 2014 due to the adoption of FASB ASU 2015-17, Balance Sheet Classification of Deferred Taxes.
We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Kraton Performance Polymers, Inc.’s internal control over financial reporting as of December 31, 2015, based on criteria established in Internal Control-Integrated Framework (2013) issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 24, 2016 expressed an unqualified opinion on the effectiveness of Kraton Performance Polymers, Inc.’s internal control over financial reporting.
/s/ KPMG LLP
Houston, Texas
February 24, 2016
KRATON PERFORMANCE POLYMERS, INC.
CONSOLIDATED BALANCE SHEETS
(In thousands, except par value)
See Notes to Consolidated Financial Statements
KRATON PERFORMANCE POLYMERS, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
(In thousands, except per share data)
See Notes to Consolidated Financial Statements
KRATON PERFORMANCE POLYMERS, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(In thousands)
See Notes to Consolidated Financial Statements
KRATON PERFORMANCE POLYMERS, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
(In thousands)
See Notes to Consolidated Financial Statements
KRATON PERFORMANCE POLYMERS, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
(In thousands)
See Notes to Consolidated Financial Statements
KRATON PERFORMANCE POLYMERS, INC.
Notes to Consolidated Financial Statements
INDEX
1. Description of Business, Basis of Presentation and Significant Accounting Policies
Description of Business. We are a leading global specialty chemicals company that manufactures SBCs and other engineered polymers. SBCs are highly-engineered synthetic elastomers, which we invented and commercialized over 50 years ago. We developed the first USBCs in 1964 and the first HSBCs in the late 1960s. Our SBCs enhance the performance of numerous products by imparting greater flexibility, resilience, strength, durability and processability, and are used in a wide range of applications, including adhesives, coatings, consumer and personal care products, sealants, lubricants, medical, packaging, automotive, paving, roofing and footwear products.
Basis of Presentation. The accompanying consolidated financial statements presented herein are for us and our consolidated subsidiaries, each of which is a wholly-owned subsidiary, except our 50% investment in our joint venture, Kraton Formosa Polymers Corporation (“KFPC”), located in Mailiao, Taiwan. KFPC is a variable interest entity for which we have determined that we are the primary beneficiary and, therefore, have consolidated into our financial statements. Our 50% investment in our joint venture located in Kashima, Japan, is accounted for under the equity method of accounting. All significant intercompany transactions have been eliminated.
Reclassifications. Certain amounts reported in the consolidated financial statements and notes to the consolidated financial statements for the prior periods have been reclassified to conform to the current reporting presentation.
Significant Accounting Policies. These financial statements reflect all normal recurring adjustments that are, in the opinion of management, necessary to fairly present our results of operations and financial position.
Use of Estimates. The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States of America requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the consolidated financial statements and the reported amounts of revenue and expenses during the reporting period. Actual results could differ from those estimates.
Significant items subject to such estimates and assumptions include
•
the useful lives of fixed assets;
•
allowances for doubtful accounts and sales returns;
•
the valuation of derivatives, deferred tax assets, property, plant and equipment, inventory, investments, and share-based compensation; and
•
liabilities for employee benefit obligations, environmental matters, asset retirement obligations, income tax uncertainties, and other contingencies.
Cash and Cash Equivalents. It is our policy to invest our excess cash in investment instruments whose value is not subject to market fluctuations, such as bank deposits or certificates of deposit. Other permitted investments include commercial paper of major U.S. corporations with ratings of A1 by Standard & Poor’s Ratings Group or P1 by Moody’s Investor Services, Inc., loan participations of major U.S. corporations with a short term credit rating of A1/P1 and direct obligations of the U.S. government or its agencies. We consider all investments having a remaining maturity, at the time of purchase, of three months or less to be cash equivalents.
Receivables. Receivables are recorded at the invoiced amount and do not bear interest. The allowance for doubtful accounts is our best estimate of the amount of probable credit losses in our existing receivables and is determined based on our assessment of the credit worthiness of individual customers, historical write-off experience, and global economic data. We review the allowance for doubtful accounts quarterly. Account balances are charged off against the allowance after all means of collection have been exhausted and the potential for recovery is considered remote. We do not have significant off-balance sheet credit exposure related to our customers.
Inventories. Our inventory is principally comprised of finished goods inventory and raw materials. Inventory values include all costs directly associated with manufacturing of our products. Inventories are stated at the lower of cost or market as primarily determined on a first-in, first-out basis. We evaluate the carrying cost of our inventory on a quarterly basis for this purpose. If the cost of the inventories exceeds their market value, provisions are made for the differences between the cost and the market value.
Derivative Instruments and Hedging Activities. We account for derivatives and hedging activities in accordance with ASC 815, “Derivatives and Hedging,” which requires entities to recognize all derivative instruments as either assets or liabilities in the balance sheet at their respective fair values. For derivatives designated in cash flow hedging relationships, changes in the fair value are either offset through earnings against the change in fair value of the hedged item attributable to the risk being hedged or recognized in accumulated other comprehensive income (loss), to the extent the derivative is effective at offsetting the changes in cash flows being hedged until the hedged item affects earnings.
For all hedging relationships, we formally document the hedging relationship and our risk-management objective and strategy for undertaking the hedge, the hedging instrument, the hedged transaction, the nature of the risk being hedged, how the hedging instrument’s effectiveness in offsetting the hedged risk will be assessed prospectively and retrospectively, and a description of the method used to measure ineffectiveness. We also formally assess both at the inception of the hedging relationship and on an ongoing basis, whether the derivatives that are used in hedging relationships are highly effective in offsetting changes in cash flows of hedged transactions. For derivative instruments that are designated and qualify as part of a cash flow hedging relationship, the effective portion of the gain or loss on the derivative is reported as a component of other comprehensive income (loss) and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. Gains and losses on the derivative representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings.
We discontinue hedge accounting prospectively when we determine that the derivative is no longer effective in offsetting cash flows attributable to the hedged risk, the derivative expires or is sold, terminated, or exercised, and the cash flow hedge is de-designated because a forecasted transaction is not probable of occurring, or we remove the designation of the cash flow hedge.
In all situations in which hedge accounting is discontinued and the derivative remains outstanding, we continue to carry the derivative at its fair value on the balance sheet and recognize any subsequent changes in its fair value in earnings. When it is probable that a forecasted transaction will not occur, we discontinue hedge accounting and recognize immediately in earnings gains and losses that were accumulated in other comprehensive income (loss) related to the hedging relationship.
Property, Plant, and Equipment. Property, plant, and equipment are stated at cost, net of accumulated depreciation. Major renewals and improvements which extend the useful lives of equipment are capitalized. Repair and maintenance costs are expensed as incurred. Disposals are removed at carrying cost less accumulated depreciation with any resulting gain or loss reflected in earnings. We capitalize interest costs which are incurred as part of the cost of constructing major facilities and equipment. Depreciation is recognized using the straight-line method over the following estimated useful lives:
Major Maintenance Activities. Major maintenance or turnaround costs are expensed as incurred.
Asset Retirement Obligations (“ARO”). We have determined that we have contractual or regulatory requirements to decommission and perform other remediation for many of our manufacturing and research facilities upon retirement. We account for ARO’s pursuant to the provisions of ASC 410-20, “Asset Retirement Obligations.” ASC 410-20 requires us to record the fair value of an ARO as a liability in the period in which we have a legal obligation associated with the retirement of tangible long-lived assets that result from the acquisition, construction, development, and/or normal use of the assets. The ARO is also capitalized as part of the carrying cost of the asset and is depreciated over the life of the asset. The recognition of an ARO requires us to make numerous estimates, assumptions, and judgments regarding such factors as the existence of a legal obligation for an ARO; estimated probabilities; amounts and timing of settlements; the credit-adjusted risk-free rate to be used; discount rate and inflation rates. Subsequent to the initial measurement of the ARO, the obligation is to be adjusted at the end of each period to reflect accretion of the liability to its non-discounted amount and changes in either the timing or the amount of the original estimated future cash flows underlying the obligation. Revisions also result in increases or decreases in the carrying cost of these assets. Increases in the ARO liability due to accretion is charged to depreciation and amortization expense. The related capitalized cost, including revisions thereto, is charged to depreciation and amortization expense.
Long-Lived Assets. In accordance with the Impairment or Disposal of Long-Lived Assets Subsections of ASC 360-10, “Property, Plant, and Equipment-Overall,” long-lived assets, such as property, plant, and equipment, and purchased intangible assets subject to amortization, are reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount of an asset may not be recoverable. If circumstances require a long-lived asset or asset group be tested for possible impairment, we first compare the undiscounted cash flows expected to be generated by that asset or asset group to its carrying value. If the carrying value of the long-lived asset or asset group is not recoverable on an undiscounted cash flow basis, impairment is recognized to the extent that the carrying value exceeds its fair value. Fair value is determined through various valuation techniques including discounted cash flow models, quoted market values and third-party independent appraisals, as considered necessary.
Intangible Assets. Intangible assets are stated at cost, net of accumulated amortization. We have intangible assets related to technology, customer relationships, tradenames/trademarks, and software as detailed in Note 5 Detail of Certain Balance Sheet Accounts to the consolidated financial statements. Intangible assets are amortized using the straight-line method over the asset's estimated useful life as follows:
Pension and Other Postretirement Plans. We sponsor a noncontributory defined benefit pension plan and an additional post-retirement benefit plan. We annually evaluate significant assumptions related to the benefits and obligations of these plans. Our estimation of the projected benefit obligations and related benefit expense requires that certain assumptions be made regarding such variables as expected return on plan assets, discount rates, rates of future compensation increases, estimated future employee turnover rates and retirement dates, distribution election rates, mortality rates, retiree utilization rates for health care services, and health care cost trend rates. The determination of the appropriate assumptions requires considerable judgment concerning future events and has a significant impact on the amount of the obligations and expense recorded. We rely in part on actuarial studies when determining the appropriateness of certain of the assumptions used in determining the benefit obligations and the annual expenses for these plans.
Investment in Unconsolidated Joint Venture. Our 50% equity investment in a manufacturing joint venture at our Kashima site is accounted for under the equity method with our share of the operating results of the joint venture classified within earnings of unconsolidated joint venture.
We evaluate our equity method investment for impairment when events or changes in circumstances indicate, in our judgment, that the carrying value of such investment may have experienced an other-than-temporary decline in value. When evidence of loss in value has occurred, we compare the estimated fair value of the investment to the carrying value of the investment to determine whether impairment has occurred. We assess the fair value of our equity method investment using commonly accepted techniques, and may use more than one method, including, but not limited to, recent third party comparable sales, internally developed analysis and analysis from outside advisors. If the estimated fair value is less than the carrying value and we consider the decline in value to be other than temporary, the excess of the carrying value over the estimated fair value is recognized in the financial statements as an impairment.
Debt Issuance Costs. We capitalize financing fees and other costs related to issuing long-term debt. We amortize these costs using the effective interest method, except for costs related to revolving debt, which are amortized using the straight-line method. The amortization of debt issuance costs are recorded in interest expense.
Contingencies. We are routinely involved in litigation, claims, and disputes incidental to our business. Professional judgment is required to classify the likelihood of these contingencies occurring. All relevant information that can be acquired concerning the uncertain set of circumstances needs to be obtained and used to determine the probability classification. A contingency is categorized as probable, reasonably possible, or remote. A contingency is classified as probable if the future event or events are likely to occur. For the probable contingencies, a loss is accrued and disclosed as of the date of the financial statements if it is both probable that an asset has been impaired or a liability has been incurred at the date of the financial statements and the amount of loss can be reasonably estimated. A reasonably possible contingency occurs if the chance of the future event or events happening is more than remote but less than likely (reasonably possible but not probable). We disclose the loss contingencies in the footnotes to the financial statements but do not recognize any liability. A remote contingency is one where the chance of the future event or events occurring is slight. We neither accrue for nor disclose the liability in the notes to the financial statements. For loss contingencies, our accounting policy is to expense legal costs as incurred.
Environmental Costs. Environmental costs are expensed as incurred unless the expenditures extend the economic useful life of the relevant assets. Costs that extend the economic useful life of assets are capitalized and depreciated over the remaining life of those assets. Liabilities are recorded when environmental assessments, or remedial efforts are probable, and the cost can be reasonably estimated.
Disclosures about Fair Value of Financial Instruments. For cash and cash equivalents, receivables, accounts payable, and certain accrued expenses, the carrying amount approximates fair value due to the short maturities of these instruments. For long-term debt instruments and interest rate swap agreements, fair value is estimated based upon market values (if applicable) or on the current interest rates available to us for debt with similar terms and remaining maturities. Considerable judgment is required in developing these estimates.
Revenue Recognition. Revenue is recognized in accordance with the provisions of ASC 605, “Revenue Recognition-Overall,” when the revenue is realized or realizable, and has been earned. Revenue for product sales is recognized when risk and title to the product transfer to the customer, which usually occurs at the time shipment is made. The majority of our sales are transacted with the shipping term free on board shipping point or, with respect to countries other than the United States, an equivalent basis. As such, title to the product passes when the product is delivered to the freight carrier. Our standard terms of delivery are included in our contracts of sale, order confirmation documents, and invoices. Shipping and other transportation costs charged to customers are recorded in both revenue and cost of goods sold. Revenue is recognized net of value-added taxes.
We have entered into agreements with some of our customers whereby they earn rebates from us when the volume of their purchases of our product reach certain agreed upon levels. We recognize the rebate obligation ratably as a reduction of revenue.
Research and Development Expenses. Research and development expenses are expensed as incurred.
Share-Based Compensation. Share-based compensation cost is measured at the grant date based on the fair value of the award. We recognize these costs using the straight-line method over the requisite service period. The Kraton Performance Polymers, Inc. Equity Incentive Plan (the “Equity Plan”) allows for the grant to key employees, independent contractors, and eligible non-employee directors of incentive stock options (for employees only), non-qualified stock options, stock appreciation rights, restricted stock awards, and restricted stock units, in addition to other equity or equity-based awards (including performance-based awards) as our board determines from time to time. We estimate the fair value of stock options using the Black-Scholes valuation model. Since our equity interests were privately held prior to our initial public offering, we have limited publicly traded stock history, and as a result our estimated volatility is based on a combination of our historical volatility and similar companies’ stock that are publicly traded. Until such time that we have enough publicly traded stock history to estimate volatility based solely on our stock, we expect to estimate volatility of options granted based on a combination of our historical volatility and similar companies’ stock that are publicly traded. The expected term of options represents the period of time that options granted are expected to be outstanding. For all periods presented, we used the simplified method to calculate the expected term of options. The risk free interest rate for the periods within the contractual life of the option is based on the U.S. Treasury yield curve in effect at the time of grant. For all periods presented, the dividend yield is assumed to be zero based on historical and expected dividend activity. Forfeitures are based substantially on the history of cancellations of similar awards granted in prior years. See Note 4 Share-Based Compensation to the consolidated financial statements.
Leases. Our leases entered into as of December 31, 2015 are classified as either operating or capital leases. A lease is deemed a capital lease when one of the following conditions is met: (1) ownership of the asset is transferred to the lessee at the end of the lease term, (2) the lease contains a bargain purchase option, (3) the lease term is 75% or more of the asset’s useful life, or (4) the net present value of minimum lease payments is equal to 90% or more of the asset’s fair market value. All other leases are classified as an operating lease. The capital lease obligation is classified as either a current liability or long term liability based on the lease payment schedule, and is offset by an asset purchased pursuant to the lease which is depreciated over the lesser of the lease term or the asset useful life, in accordance with our depreciation policy. For operating leases which contain escalating rent payment clauses, we use the straight-line method to record lease expense.
Income Taxes. We conduct operations in separate legal entities in different jurisdictions. As a result, income tax amounts are reflected in these consolidated financial statements for each of those jurisdictions.
Income taxes are recorded utilizing an asset and liability approach. This method gives consideration to the future tax consequences associated with the differences between the financial accounting and tax basis of the assets and liabilities as well as the ultimate realization of any deferred tax asset resulting from such differences. Valuation allowances are recorded to reduce deferred tax assets when it is more likely than not that a tax benefit will not be realized.
In assessing the realizability of deferred tax assets, we consider whether it is more likely than not that some portion or all of the deferred tax assets will not be realized. The ultimate realization of deferred tax assets is dependent upon the generation of future taxable income during the periods in which those temporary differences become deductible. We consider the scheduled reversal of deferred tax liabilities, projected future taxable income, and tax planning strategies in making this assessment. Based upon the level of historical taxable income and projections for future taxable income over the periods in which the deferred tax assets are deductible, we believe it is more likely than not that we will realize the benefits of these deductible differences, net of the existing valuation allowances.
We provide liabilities for uncertain tax positions for federal, state, local and international exposures relating to periods subject to audit. The development of liabilities for uncertain tax positions for these exposures requires judgment about tax issues, potential outcomes and timing. We assess tax positions and record tax benefits based upon management's evaluation of facts, circumstances, and information available at the respective reporting date. For those tax positions where it is more-likely-than-not that a tax benefit will be sustained, we have recorded the largest amount of tax benefit with a greater than 50% likelihood of being realized upon settlement with a tax authority. For those tax positions where it is not more-likely-than-not that a tax benefit will be sustained, no tax benefit has been recognized in the consolidated financial statements.
Foreign Currency Translation and Foreign Currency Exchange Rates. Financial statements of our operations outside the United States where the local currency is considered to be the functional currency are translated into U.S. dollars using the exchange rate at each balance sheet date for assets and liabilities and the average exchange rate for each period for revenue, expenses, gains, losses, and cash flows. The effects of translating such operations into U.S. dollars are included as a component of accumulated other comprehensive income (loss).
2. New Accounting Pronouncements
Adoption of Accounting Standards.
We have implemented all new accounting pronouncements that are in effect and that management believes would materially impact our financial statements.
New Accounting Standards
In May 2014, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) No. 2014-09, Revenue from Contracts with Customers, which provides a single comprehensive model for entities to use in accounting for revenue arising from contracts with customers and will supersede most current revenue recognition guidance. In August 2015, the effective date for the standard was deferred by one year and the standard is now effective for public entities for annual and interim periods beginning after December 15, 2017. Early adoption is permitted based on the original effective date. Our evaluation of this standard is currently ongoing and therefore, the effects of this standard on our financial position, results of operations and cash flows are not yet known.
In February 2015, the FASB issued ASU No. 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis. This standard changes the consolidation analysis currently required under U.S. GAAP. This ASU modifies the process used to evaluate whether limited partnerships and similar entities are variable interest entities (“VIEs”) or voting interest entities; affects the analysis performed by reporting entities regarding VIEs, particularly those with fee arrangements and related party relationships; and provides a scope exception for certain investment funds. The amendments in this update are effective for annual and interim periods beginning after December 15, 2015 and early adoption is permitted. We plan to adopt this standard in the first quarter of 2016 and we anticipate this standard will not have a material impact on our consolidated financial statements.
In April 2015, the FASB issued ASU No. 2015-03, Interest-Imputation of Interest. This standard requires that debt issuance costs related to a recognized debt liability be presented in the balance sheet as a direct deduction from the carrying amount of such debt liability. In adopting ASU 2015-03, companies must apply the guidance on a retrospective basis. The standard is effective for fiscal years, and interim periods within those years, beginning after December 15, 2015. We plan to adopt ASU 2015-03 in the first quarter of 2016. We have assessed the impact of this new standard on our Condensed Consolidated Financial Statements and concluded that it would have resulted in reductions of approximately $1.3 million, $12.2 million, and $13.5 million of other current assets, debt issuance costs, and long-term debt, respectively, as of December 31, 2015.
In July 2015, the FASB issued ASU No. 2015-11, Inventory (Topic 330): Simplifying the Measurement of Inventory. This standard changes the measurement principle for inventory from the lower of cost or market to the lower of cost or net realizable value. ASU 2015-11 defines net realizable value as the estimated selling price in the ordinary course of business, less reasonably predictable costs of completion, disposal, and transportation. The guidance must be applied on a prospective basis and is effective for periods beginning after December 15, 2016, with early adoption permitted. We have evaluated this standard and we anticipate that this standard will not have a material impact on our consolidated financial statements.
In September 2015, the FASB issued ASU No. 2015-16, Business Combinations (Topic 805): Simplifying the Accounting for Measurement-Period Adjustments. This standard requires that an acquirer recognize adjustments to provisional amounts that are identified during the measurement period in the reporting period in which the adjustment amounts are determined. This includes recording in the reporting period the effect on earnings of changes in depreciation, amortization or other income effects as a result of the change to the provisional amounts as if the accounting had been completed at the acquisition date. The standard is effective for fiscal years, and interim periods within those years, beginning after December 15, 2015. We plan to adopt this new standard in the first quarter of 2016 in connection with the Arizona Chemical Acquisition.
In November 2015, the FASB issued ASU No. 2015-17, Income Taxes (Topic 740): Balance Sheet Classification of Deferred Taxes. This standard requires entities to present deferred tax assets (“DTA”) and deferred tax liabilities (“DTL”) as non-current in a classified balance sheet. This ASU simplifies the current guidance, which requires entities to separately present DTAs and DTLs as current and non-current in a classified balance sheet. The standard is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016 and early adoption is permitted. In addition, the standard can be applied either prospectively to all deferred tax liabilities and assets or retrospectively to all periods presented. We have adopted ASU 2015-17 for the current reporting period and have applied the guidance on a retrospective basis. As a result, current and long-term deferred tax assets and liabilities reported in the consolidated balance sheet for the year ended December 31, 2014 have been reclassified to conform to the current reporting presentation. Our December 31, 2014 current and long-term DTAs decreased by $7.2 million and increased by $1.7 million, respectively, and our current and long-term DTLs decreased by $1.6 million and $3.9 million, respectively.
3. Acquisition of Arizona Chemical
On January 6, 2016, we completed our acquisition of Arizona Chemical, a leading global producer of specialty chemicals and other products primarily derived from pine wood pulping co-products. Arizona Chemical refines and further upgrades two primary feedstocks, crude tall oil (“CTO”), and crude sulfate turpentine (“CST”), into value-added specialty chemicals. These pine-based specialty chemicals are sold into adhesive, road and construction and tire markets, and Arizona Chemical produces and sells a broad range of chemical intermediates into markets that include fuel additives, oilfield chemicals, coatings, metalworking fluids and lubricants, inks, flavors and fragrances and mining.
We believe that the Arizona Chemical Acquisition extends our technology and market diversification, creates a more robust platform for growth, and enhances our opportunities to deepen our customer relationships by expanding our presence in our core markets. Arizona Chemical’s end use market exposure is highly complementary with that of Kraton, particularly in markets such as adhesives, roads and construction, coatings and oilfield chemicals. In addition, the renewable nature of Arizona Chemical’s product and technology offerings reduces our overall exposure to hydrocarbon-based feedstocks.
We acquired Arizona Chemical for a cash purchase price of $1.37 billion, which is subject to adjustment for cash, indebtedness, working capital and other items. The $1.37 billion cash purchase price for the Arizona Chemical Acquisition, the cash tender offer and redemption of all outstanding 6.75% senior notes due 2019, and the related acquisition and financing expenses for the Arizona Chemical Acquisition were funded through the following transactions:
•
A $1,350.0 million six-year senior secured first lien term loan facility,
•
A private offering of $440.0 million in aggregate principal amount of 10.5% senior notes due 2023, and
•
An amended and restated $250.0 million five-year asset-based revolving credit facility, $37.1 million of which was drawn on the closing date.
Our previously outstanding indebtedness under the 6.75% senior notes due 2019 and the former senior secured credit facilities were satisfied and canceled on January 6, 2016. See Note 19 Subsequent Events to the consolidated financial statements for a further description of the debt issued to finance the acquisition.
The Company will account for the Arizona Chemical Acquisition under the purchase method of accounting for business combinations. Accordingly, the purchase price will be allocated to the underlying net assets in proportion to estimates of their respective fair values. Any excess of the purchase price over the estimated fair value of the net assets acquired will be recorded as goodwill.
We have excluded the purchase price allocation and pro forma disclosures for the Arizona Chemical Acquisition as the initial accounting is currently incomplete. We are currently in the process of performing an initial valuation related to the acquired assets and liabilities. The Company will reflect the preliminary valuation of the net assets acquired in its first quarter 2016 condensed consolidated financial statements. In addition, the results of Arizona Chemical's operations will be included in the Company's consolidated financial statements as of the closing date of the Arizona Chemical Acquisition, January 6, 2016.
4. Share-Based Compensation
We account for share-based awards under the provisions of ASC 718, “Share-Based Payment,” which established the accounting for share-based awards exchanged for employee services. Accordingly, share-based compensation cost is measured at the grant date based on the fair value of the award and we expense these costs using the straight-line method over the requisite service period. Share-based compensation expense was approximately $9.0 million, $10.3 million and $7.9 million, net of tax effects of $0.0 million, $0.2 million, and $0.0 million for the years ended December 31, 2015, 2014, and 2013, respectively. We have historically recorded these costs in selling, general, and administrative expenses; however, beginning in the second quarter of 2013, a portion of these costs were recorded in cost of goods sold and research and development expenses. At December 31, 2015, there was approximately $0.8 million of unrecognized compensation expense related to non-vested option awards to be recognized over a weighted-average period of 1.07 years, approximately $7.0 million of unrecognized compensation expense related to awards of restricted stock and restricted share units expected to be recognized over a weighted-average period of 1.90 years, and $4.3 million of unrecognized compensation expense related to awards of performance share units expected to be recognized over a weighted-average period of 2.14 years.
Kraton Performance Polymers, Inc. 2009 Equity Incentive Plan. On November 30, 2009, our board of directors and our stockholders approved the Equity Plan and on May 25, 2011 and February 16, 2012, our board of directors and stockholders approved the amendment and restatement of the Equity Plan. The Equity Plan allows for the grant to key employees, independent contractors, and eligible non-employee directors of incentive stock options (to employees only), non-qualified stock options (which together with the incentive stock options, are referred to herein as (“Options”)), stock appreciation rights, restricted stock awards and restricted stock units, in addition to other equity or equity-based awards (including performance-based awards) as the compensation committee of our board, with respect to employees and independent contractors, and our full board, with respect to non-employee directors, determines from time to time.
Under the Equity Plan, there are a total of 4,350,000 shares of our common stock reserved for issuance. As of December 31, 2015 and 2014 there were 1,231,675 and 1,859,189 shares of our common stock available for issuance, respectively.
Stock Option Activity
Option activities for the year ended December 31, 2015 are as follows:
We did not grant stock options during 2015. We granted 158,118, and 131,321 options to our employees during the years ended December 31, 2014, and 2013, respectively. These options have a ten year term and vest in equal installments over three years. The weighted-average grant-date fair values of options granted during the years ended December 31, 2014 and 2013 were $12.32 and $12.30, respectively. There were 64,100, 103,873, and 52,971 options exercised during the years ended December 31, 2015, 2014, and 2013, respectively. The total intrinsic value of the options exercised was $0.4 million, $1.1 million and $0.5 million for the years ended December 31, 2015, 2014, and 2013, respectively.
The following table summarizes additional information regarding the outstanding and exercisable options at December 31, 2015.
(1) The intrinsic value of a stock option is the amount by which the market value of the underlying stock exceeds the exercise price of the option as of December 31, 2015.
Weighted-Average Assumptions for Option Pricing
Since our equity interests were privately held prior to our initial public offering, we have limited publicly traded stock history, and as a result, our estimated volatility is based on a combination of our historical volatility and similar companies’ stock that are publicly traded. Until such time that we have enough publicly traded stock history to estimate volatility based solely on our stock, we expect to estimate volatility of options granted based on a combination of our historical volatility and similar companies’ stock that are publicly traded. The expected term of options represents the period of time that options granted are expected to be outstanding. For all periods presented, we used the simplified method to calculate the expected term of options. The risk free interest rate for the periods within the expected term of the option is based on the U.S. Treasury yield curve in effect at the time of grant. For all periods presented, the dividend yield is assumed to be zero based on historical and expected dividend activity.
Restricted stock awards and Restricted stock units
We may grant to certain employees time-vested restricted stock awards and time-vested restricted share units. Holders of restricted share units do not have any beneficial ownership in the common stock underlying the restricted share units and the grant represents an unsecured promise to deliver common stock on a future date. Actual shares of common stock underlying the restricted share units will not be issued until the earlier of the passage of the vesting period, a change in control that also results in the termination of the grantee’s employment, or the death / disability of the participant. We awarded 280,353, 192,812, and 203,027 shares of restricted stock to our employees, which are subject to a three-year cliff vesting, during the years ended December 31, 2015, 2014, and 2013, respectively. We issued 32,584, 22,518, and 26,424 shares of restricted stock to members of the board of directors during the years ended December 31, 2015, 2014, and 2013, respectively, which vested on the grant date. We granted 52,845, 38,918, and 28,976 restricted share units to our employees during the years ended December 31, 2015, 2014, and 2013, respectively, which are subject to a three-year cliff vesting.
The following table represents the non-vested restricted stock awards and restricted share units granted, vested, and forfeited during 2015.
The total fair value of shares vested during the years ended December 31, 2015, 2014, and 2013 pursuant to restricted stock awards and restricted share units was $3.6 million, $4.6 million, and $0.9 million, respectively.
Performance share units
We may grant to certain employees performance share units, which vest after the achievement of performance criteria established at grant. Holders of performance share units do not have any beneficial ownership in the shares of our common stock underlying the performance share units, and the grant represents an unsecured promise to deliver shares of our common stock on a future date. The performance share units vest at the end of a three-year period assuming continued employment and assuming the Company’s achievement of the performance measures established by our Compensation Committee when the performance share units were initially granted. When performance share units vest, a number of shares of our common stock equal to 0% to 200% of the initial grant amount will be issued, depending on the level of achievement of such performance measures. We granted 240,536, 90,186, and 67,585 performance share units to our employees during the years ended December 31, 2015, 2014, and 2013, respectively.
The following table represents the non-vested performance share units granted, vested, and forfeited during 2015.
Weighted-Average Assumptions for Performance Share Unit Grant Date Fair Value
For the performance share units granted in 2015, a component of the performance targets was based on relative total shareholder return over the three-year performance cycle compared to an industry peer group. The weighted average fair value using a Monte Carlo simulation model and the corresponding weighted average assumptions for the performance share units granted during the year ended December 31, 2015 was as follows:
5. Detail of Certain Balance Sheet Accounts
________________________________________
(1)
Construction in progress includes $7.0 million of assets financed with short term capital leases as of December 31, 2014.
Aggregate depreciation expense for property, plant and equipment was approximately $50.5 million, $54.5 million, and $52.4 million for the years ended December 31, 2015, 2014, and 2013, respectively.
Aggregate amortization expense for intangible assets was approximately $11.2 million, $11.2 million, and $10.3 million for the years ended December 31, 2015, 2014, and 2013, respectively. Estimated amortization expense for each of the next five years is as follows:
Changes in accumulated other comprehensive income (loss) by component were as follows:
The following table provides details for amounts reclassified from accumulated other comprehensive income (loss) into net income in the consolidated statements of operations:
_________________________
(1)
These components are allocated between cost of good sold, selling, general and administrative and research and development expenses in the Consolidated Statement of Operations. See Note 13. Employee Benefits for further information related to net periodic benefit cost for pension and other post-retirement benefit plans.
6. Earnings per Share (“EPS”)
Basic EPS is computed by dividing net income attributable to Kraton by the weighted-average number of shares outstanding during the period. Diluted EPS is computed by dividing net income attributable to Kraton by the diluted weighted-average number of shares outstanding during the period and, accordingly, reflects the potential dilution that could occur if securities or other agreements to issue common stock, such as stock options, were exercised, settled, or converted into common stock and were dilutive. The diluted weighted-average number of shares used in our diluted EPS calculation is determined using the treasury stock method.
Unvested awards of share-based payments with rights to receive dividends or dividend equivalents, such as our restricted stock awards are considered to be participating securities and therefore the two-class method is used for purposes of calculating EPS. Under the two-class method, a portion of net income is allocated to these participating securities and therefore is excluded from the calculation of EPS allocated to common stock. These shares are subject to forfeiture and restrictions on transfer until vested and have identical voting, income and distribution rights to the unrestricted common shares outstanding. Restricted stock awards outstanding totaled 599,541, 489,543, and 416,662 at December 31, 2015, 2014, and 2013, respectively. Our weighted average restricted stock awards outstanding were 553,846, 491,698, and 392,329 for the years ended December 31, 2015, 2014, and 2013, respectively. We withheld 28,273 and 27,173 shares of restricted stock upon vesting to satisfy employee payroll tax withholding requirements for the years ended December 31, 2015 and 2014, respectively. We immediately retired all shares withheld and the transactions were reflected in additional paid in capital in the Consolidated Statements of Changes in Equity and as a purchase of treasury stock in the Consolidated Statements of Cash Flows.
Restricted share units in the amount of 138,002, 95,055, and 58,467 were outstanding at December 31, 2015, 2014, and 2013, respectively, including vested and non-vested restricted share units. The computation of diluted EPS includes weighted average restricted share units of 0, 84,658, and 0 for the years ended December 31, 2015, 2014, and 2013, respectively. The computation of diluted EPS excludes weighted average restricted share units of 134,038 and 52,784 for the years ended December 31, 2015 and 2013, respectively, as they are anti-dilutive due to a net loss attributable to Kraton for those periods.
Performance share units in the amount of 329,182, 137,206, and 67,585 were outstanding at December 31, 2015, 2014, and 2013, respectively. The computation of diluted EPS includes weighted average performance share units of 0, 28,902, and 0 for the years ended December 31, 2015, 2014, and 2013, respectively. The computation of diluted EPS excludes weighted average performance share units of 33,296 and 0 for the years ended December 31, 2015 and 2013, respectively, as they are anti-dilutive due to a net loss attributable to Kraton for those periods. In addition, the computation of diluted EPS also excludes the effect of performance share units for which the performance contingencies had not been met as of the reporting date, amounting to 296,684, 102,396, and 67,585 for the years ended December 31, 2015, 2014, and 2013, respectively.
Stock options in the amount of 1,465,609, 1,619,091, and 1,594,581 were outstanding at December 31, 2015, 2014, and 2013, respectively. The computation of diluted EPS includes stock options added under the treasury stock method, which amounted to 0, 205,949, and 0 for the years ended December 31, 2015, 2014, and 2013, respectively. The computation of diluted earnings per share excludes the effect of the potential exercise of stock options that are anti-dilutive, amounting to 1,465,609, 1,001,198, and 1,594,581 for the years ended December 31, 2015, 2014, and 2013, respectively.
The calculations of basic and diluted EPS are as follows:
Share Repurchase Program. On October 27, 2014, our board of directors approved a share repurchase program, which allowed for the repurchase of outstanding shares of our common stock having an aggregate purchase price of up to $50.0 million. We repurchased shares of our common stock in the open market at prevailing market prices and through a trading program under Rule 10b5-1. From the inception of the program through December 31, 2015, we repurchased a total of 2,549,683 shares of our common stock at an average price of $19.58 per share and a total cost of $50.0 million (including trading commissions). The share repurchase plan was financed with available cash and the program is now complete.
7. Long-Term Debt
Long-term debt consists of the following:
Senior Secured Credit Facilities. In March 2013, we entered into an asset-based revolving credit facility consisting of a $150.0 million U.S. senior secured revolving credit facility (the “U.S. Facility”) and a $100.0 million Dutch senior secured revolving credit facility (the “Dutch Facility”, and together with the U.S. Facility, the “Senior Secured Credit Facilities”). Borrowing under the Senior Secured Credit Facilities is subject to borrowing base limitations based on the level of receivables and inventory available for security.
We may request up to an aggregate of $100.0 million of additional revolving facility commitments of which up to an aggregate of $40.0 million may be additional Dutch revolving facility commitments, provided that we satisfy additional conditions described in the Senior Secured Credit Facilities, and provided further that the U.S. revolver commitment is at least 60% of the commitments after giving effect to such increase.
Kraton Polymers U.S. LLC and Kraton Polymers Nederland B.V. are the borrowers under the Senior Secured Credit Facilities, and Kraton Performance Polymers, Inc., Kraton Polymers LLC, Elastomers Holdings LLC and Kraton Polymers Capital Corporation are the guarantors for both the U.S. Facility and the Dutch Facility. In addition, K.P. Global Holdings C.V. and Kraton Polymers Holdings B.V. are guarantors for the Dutch Facility. The Senior Secured Credit Facilities terminate on March 27, 2018; however, we may from time to time request that the lenders extend the maturity of their commitments. Availability under the Senior Secured Credit Facilities is limited to the lesser of the borrowing base and total commitments (less certain reserves).
The Senior Secured Credit Facilities are primarily secured by receivables and inventory. The U.S. Facility provides for borrowings in the United States and is secured by assets located in the United States. The Dutch Facility provides for borrowings outside of the United States and is secured by assets located outside of the United States.
Borrowings under the U.S Facility (other than swingline loans) bear interest at a rate equal to, at the applicable borrower’s option, either (a) a base rate determined by reference to the greater of (1) the prime rate of Bank of America, N.A., (2) the federal funds rate plus 0.5% and (3) LIBOR plus 1.0%, or (b) a rate based on LIBOR, in each case plus an applicable margin. U.S. swingline loans shall bear interest at a base rate determined by reference to the greater of (1) the prime rate of Bank of America, N.A., (2) the federal funds rate plus 0.5% or (3) LIBOR plus 1.0%, in each case plus an applicable margin.
Borrowings under the Dutch Facility (other than swingline loans) bear interest at a rate equal to, at the applicable borrower’s option, either (a) a fluctuating rate, with respect to Euros, Pounds Sterling and Dollars outside of the U.S. and Canada, equal to the rate announced by the European Central Bank and used as a base rate by the local branch of Bank of America in the jurisdiction in which such currency is funded, or (b) a rate based on LIBOR, in each case plus an applicable margin. Dutch swingline loans bear interest at a fluctuating rate, with respect to Euros, Pounds Sterling and Dollars outside of the U.S. and Canada, equal to the rate announced by the European Central Bank and used as a base rate by the local branch of Bank of America in the jurisdiction in which such currency is funded.
The applicable margin is subject to a minimum of 0.5% and a maximum of 1.0% with respect to U.S. base rate loans, and a minimum of 1.5% and maximum of 2.0% for foreign base rate borrowings, and a minimum of 1.5% and maximum of 2.0% for both U.S. and foreign LIBOR loans and is subject to adjustment based on the borrowers’ excess availability of the applicable facility for the most recent fiscal quarter. Our effective interest rate for borrowings on the Senior Secured Credit Facilities was 2.03% for the year ended December 31, 2015.
In addition to paying interest on outstanding principal amounts under the Senior Secured Credit Facilities, the borrowers will be required to pay a commitment fee in respect of the unutilized commitments at an annual rate of 0.375%.
The Senior Secured Credit Facilities contain a financial covenant that if either (a) excess availability is less than the greater of (i) 12.5% of the lesser of the commitments and the borrowing base and (ii) $31,250,000 or (b) U.S. availability is less than the greater of (i) 12.5% of the lesser of the U.S. commitments and U.S. borrowing base and (ii) $18,750,000, then following such event, Kraton and its restricted subsidiaries must maintain a fixed charge coverage ratio of at least 1.0 to 1.0 for four fiscal quarters (or for a shorter duration if certain financial conditions are met). The Senior Secured Credit Facilities contain certain customary events of default, including, without limitation, a failure to make payments under the facility, cross-default and cross-judgment default, certain bankruptcy events and certain change of control events.
As of December 31, 2015, our available borrowing capacity was $165.5 million of which $0.0 million was drawn.
On January 6, 2016, the Senior Secured Credit Facilities were canceled and replaced with an amended and restated $250.0 million ABL Facility. See Note 19 Subsequent Events to the consolidated financial statements for a description of the amended and restated ABL Facility.
6.75% Senior Notes due 2019. Kraton Polymers LLC and its wholly-owned financing subsidiary Kraton Polymers Capital Corporation issued $350.0 million aggregate principal amount of 6.75% senior notes that were scheduled to mature on March 1, 2019 pursuant to an indenture dated February 11, 2011 as amended and supplemented by a supplemental indenture thereto dated March 20, 2012 (collectively, the “Indenture”). On January 6, 2016, the outstanding indebtedness under the 6.75% Senior Notes was satisfied and canceled with the issuance of $440.0 million of new 10.5% Senior Notes due 2023. See Note 19 Subsequent Events to the consolidated financial statements for a description of the new 10.5% Senior Notes.
Capital Lease. In January 2014, we entered into a 10 year capital lease with a principal amount of $7.0 million to fund a portion of our capital expenditures. In March 2015, this capital lease increased by $0.7 million based on final project construction costs.
KFPC Loan Agreement. On July 17, 2014, KFPC executed a syndicated loan agreement (the “KFPC Loan Agreement”) in the amount of 5.5 billion New Taiwan Dollars (“NTD”), or $167.5 million (converted at the December 31, 2015 exchange rate), to provide additional funding to construct the hydrogenated styrenic block copolymer (“HSBC”) facility in Taiwan and to provide funding for working capital requirements and/or general corporate purposes.
The KFPC Loan Agreement is comprised of a NTD 4.29 billion Tranche A, or $130.6 million (converted at the December 31, 2015 exchange rate), to fund KFPC’s capital expenditures, and a NTD 1.21 billion Tranche B, or $36.9 million (converted at the December 31, 2015 exchange rate), to fund working capital requirements and/or general corporate purposes. As of December 31, 2015, NTD 2.53 billion, or $76.9 million (converted at the December 31, 2015 exchange rate) was drawn on the KFPC Loan Agreement. The facility period of the KFPC Loan Agreement is five years from January 17, 2015 (the first drawdown date). KFPC may continue to draw on the KFPC Loan Agreement for the first 28 months following the first drawdown date. Subject to certain conditions, KFPC can request a two-year extension of the facility period of the KFPC Loan Agreement.
The total outstanding principal amount is payable in six semi-annual installments with the first payment due on July 17, 2017 and each subsequent payment due every six months thereafter. The first five installments shall be in an amount equal to 10.0% of the outstanding principal amount and the final installment shall be in an amount equal to the remaining 50.0% of the outstanding principal amount. In the event the extension period is granted, the final 50.0% of the outstanding principal amount shall be repaid in five equal semi-annual installments with the first installment due on the original final maturity date.
The KFPC Loan Agreement is subject to a variable interest rate composed of a fixed 0.8% margin plus the three-month or six-month fixing rate of the Taipei Interbank Offered Rate (depending on the interest period selected by KFPC in the drawdown request or the interest period notice), subject to a floor of 1.7%. Interest is payable on a monthly basis. For the year ended December 31, 2015, our effective interest rate for borrowings on the KFPC Loan Agreement was 1.8%.
The KFPC Loan Agreement contains certain financial covenants which change during the term of the KFPC Loan Agreement. The financial covenants include a maximum debt to equity ratio of 3.0 to 1.0 through 2016, which will decrease to 2.0 to 1.0 in 2017 and 1.2 to 1.0 in 2018; a minimum tangible net worth requirement of $50.0 million through 2018, which will increase to $100.0 million in 2019; and a minimum interest coverage ratio of 2.5 to 1.0 commencing in 2016, which will increase to 5.0 to 1.0 in 2017. In each case, these covenants are calculated and tested on an annual basis. Formosa Petrochemical Corporation and Kraton Polymers LLC are the guarantors of the KFPC Loan Agreement with each guarantor guaranteeing 50.0% of the indebtedness. At December 31, 2015, KFPC was in compliance with the covenants under the KFPC Loan Agreement.
Debt Maturities. The principal payments on our outstanding total debt as of December 31, 2015, are as follows:
See Note 8 Fair Value Measurements, Financial Instruments and Credit Risk to the consolidated financial statements for fair value information related to our long-term debt.
8. Debt Issuance Costs
We capitalize debt issuance costs related to issuing long-term debt and amortize these costs using the effective interest method, except for costs related to revolving debt, which are amortized using the straight-line method. Amortization of debt issuance costs and the accelerated write-off of debt issuance costs in connection with refinancing activities are recorded as a component of interest expense. We had net debt issuance costs of $15.9 million and $9.5 million (of which $2.4 million and $2.3 million were included in other current assets) as of December 31, 2015 and December 31, 2014, respectively. In connection with the March 2013 refinancing of our indebtedness, we charged to interest expense $5.1 million of unamortized debt issuance costs related to our previously existing indebtedness and we capitalized $4.8 million of debt issuance costs related to our new indebtedness. During the year ended December 31, 2014, our consolidated joint venture, KFPC, capitalized $0.5 million of debt issuance costs related to the KFPC Loan Agreement executed in July 2014. During the year ended December 31, 2015, we capitalized $8.8 million of debt issuance costs related to the debt financing associated with the Arizona Chemical Acquisition, which closed on January 6, 2016. See Note 3 Acquisition of Arizona Chemical for further discussion of the Arizona Chemical Acquisition and Note 19 Subsequent Events for a description of the debt financing. We amortized $2.2 million, $2.2 million, and $2.4 million (which excludes $5.1 million of accelerated amortization) of debt issuance costs for the years ended December 31, 2015, 2014, and 2013, respectively.
9. Fair Value Measurements, Financial Instruments, and Credit Risk
ASC 820, “Fair Value Measurements and Disclosures” defines fair value, establishes a consistent framework for measuring fair value and expands disclosure requirements about fair value measurements. ASC 820 requires entities to, among other things, maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.
ASC 820 defines fair value as the exchange price that would be received for an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.
ASC 820 specifies a hierarchy of valuation techniques based on whether the inputs to those valuation techniques are observable or unobservable. Observable inputs reflect market data obtained from independent sources, while unobservable inputs reflect our market assumptions.
In accordance with ASC 820, these two types of inputs have created the following fair value hierarchy:
•
Level 1-Inputs that are quoted prices (unadjusted) for identical assets or liabilities in active markets;
•
Level 2-Inputs other than quoted prices included within Level 1 that are observable for the asset or liability, either directly or indirectly, for substantially the full term of the asset or liability, including:
•
Quoted prices for similar assets or liabilities in active markets
•
Quoted prices for identical or similar assets or liabilities in markets that are not active
•
Inputs other than quoted prices that is observable for the asset or liability
•
Inputs that are derived principally from or corroborated by observable market data by correlation or other means; and
•
Level 3-Inputs that are unobservable and reflect our assumptions used in pricing the asset or liability based on the best information available under the circumstances (e.g., internally derived assumptions surrounding the timing and amount of expected cash flows).
Recurring Fair Value Measurements. The following tables set forth by level within the fair value hierarchy our financial assets and liabilities that were accounted for at fair value on a recurring basis as of December 31, 2015 and December 31, 2014, respectively. These financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. Our assessment of the significance of a particular input to the fair value measurement requires judgment, and may affect the valuation of their fair value and their placement within the fair value hierarchy levels.
The use of derivatives creates exposure to credit risk relating to potential losses that could be recognized in the event that the counterparties to these instruments fail to perform their obligations under the contracts. We seek to minimize this risk by limiting our counterparties to major financial institutions with acceptable credit ratings and monitoring the total value of positions with individual counterparties. In the event of a default by one of our counterparties, we may not receive payments provided for under the terms of our derivatives.
Nonrecurring Fair Value Measurements. Our long-lived assets, such as property, plant, and equipment, and purchased intangible assets subject to amortization are reviewed for impairment whenever events or changes in circumstances indicate that their carrying value may not be recoverable. When impairment has occurred, such long-lived assets are written down to fair value.
The following table sets forth by level within the fair value hierarchy our fair value measurements with respect to non-financial assets that are measured at fair value on a nonrecurring basis. Our assessment of the significance of a particular input to the fair value measurement requires judgment, and may affect the valuation of their fair value and their placement within the fair value hierarchy levels. See Note 10 Impairment and Restructuring Charges, for further discussion.
For the year ended December 31, 2015 and 2013 we determined that there was no impairment related to our long-lived assets.
The following table presents the carrying values and approximate fair values of our long-term debt as of December 31, 2015 and December 31, 2014:
Financial Instruments
Interest Rate Swap Agreements. Periodically, we enter into interest rate swap agreements to hedge or otherwise protect against interest rate fluctuations on a portion of our variable rate debt. These interest rate swap agreements are designated as cash flow hedges on our exposure to the variability of future cash flows.
On March 27, 2013, in connection with the refinancing of our credit facility, we terminated and settled an interest rate swap agreement, and as a result, recognized $0.7 million of interest expense for the year ended December 31, 2013.
We did not have any interest rate swap agreements in effect during the year ended December 31, 2015.
Fair Value Hedges. In April 2012, we entered into a series of non-deliverable forward contracts to reduce our exposure to fluctuations in the Canadian dollar (“CAD”) against the U.S. dollar associated with the funding of certain capital expenditures. These non-deliverable forward contracts qualified for hedge accounting and were designated as fair value hedges in accordance with ASC 815-25 “Fair Value Hedges.” These hedges were effective in offsetting our exposure to the CAD, and therefore the $0.1 million gain on these hedges was offset by the $0.1 million loss on the exposure associated with the funding of our semi-works facility for the year ended December 31, 2013. We did not have any fair value hedges in place during the years ended December 31, 2014 and 2015.
Net Investment Hedges. In June 2013, we entered into a TWD 450.0 million notional amount non-deliverable forward contract to protect our net investment in our subsidiary in Taiwan against adverse changes in exchange rates by fixing the New Taiwan Dollar/Euro exchange rate. This contract qualified for hedge accounting and was designated as a net investment hedge in accordance with ASC 815-35 “Net Investment Hedges.” For the year ended December 31, 2013, we recorded in accumulated other comprehensive loss an aggregate $0.5 million loss related to the settlement of the effective portion of this contract. We did not have any net investment hedges in place during the years ended December 31, 2015 and 2014.
Foreign Currency Hedges. Periodically, we enter into foreign currency agreements to hedge or otherwise protect against fluctuations in foreign currency exchange rates. These agreements typically do not qualify for hedge accounting and gains/losses resulting from both the up-front premiums and/or settlement of the hedges at expiration of the agreements are recognized in the period in which they are incurred. During the years ended December 31, 2015, 2014, and 2013, we entered into a series of foreign currency option and forward contracts to reduce our exposure to exchange rate volatility. The contracts were structured such that the underlying foreign currency exchange gains/losses would be offset by the mark-to-market impact of the hedging instruments and reduce the impact of foreign currency exchange movements throughout the period. These contracts did not qualify for hedge accounting. For the years ended December 31, 2015, 2014, and 2013, we recorded an aggregate loss of $5.8 million, $6.5 million, and $1.8 million, respectively, which are recorded in cost of goods sold. In all periods, these contracts are structured such that these gains/losses from the mark-to-market impact of the hedging instruments materially offset the underlying foreign currency exchange gains/losses to reduce the overall impact of foreign currency exchange movements throughout the period.
Credit Risk
Our customers are diversified by industry and geography with more than 850 customers in over 70 countries. We analyze the counterparties’ financial condition prior to extending credit and we establish credit limits and monitor the appropriateness of those limits on an ongoing basis. We also obtain cash, letters of credit, or other acceptable forms of security from customers to provide credit support, where appropriate, based on our financial analysis of the customer and the contractual terms and conditions applicable to each transaction.
10. Impairment and Restructuring Charges
During 2014, we determined that we had impaired long-lived assets and, as a result, recorded pre-tax impairment charges of $4.7 million. Of this amount, $2.4 million related to engineering and design assets for projects we determined were no longer economically viable, $1.4 million related to information technology and office assets associated with fourth quarter 2014 restructuring activities, and $0.9 million related to other long-lived assets. The $5.4 million carrying value of these long-lived assets was reduced to fair market value of $0.7 million. We used internally developed assumptions in determining the fair value of these long-lived assets, which are classified within level 3 of the fair value hierarchy.
For the years ended December 31, 2015, 2014, and 2013, restructuring and restructuring-related expenses amounted to $1.7 million, $3.0 million and $0.8 million, respectively. Restructuring expenses in 2015 were primarily comprised of professional services and advisory costs related to our cost reset initiative. Restructuring expenses for 2014 were comprised of severance expenses of $2.5 million and $0.4 million of other restructuring related costs, which are recorded primarily in selling, general and administrative expenses.
11. Income Taxes
Income taxes are recorded utilizing an asset and liability approach. This method gives consideration to the future tax consequences associated with the differences between the financial accounting and tax basis of the assets and liabilities as well as the ultimate realization of any deferred tax asset resulting from such differences.
Our income tax provision was a $6.9 million expense, a $5.1 million expense, and a $3.9 million benefit for the years ended December 31, 2015, 2014, and 2013, respectively. Our effective tax rates for the years ended December 31, 2015, 2014, and 2013 were a 124.3% expense, an 80.9% expense, and a 79.9% benefit, respectively. Our effective tax rates differed from the U.S. corporate statutory tax rate of 35.0%, primarily due to the mix of pre-tax income or loss earned in certain jurisdictions and the change in our valuation allowance. Excluding the change in our valuation allowance, our effective tax rates would have been a 75.4% benefit, a 229.0% expense, and an 81.4% benefit for the years ended December 31, 2015, 2014, and 2013, respectively.
The provision for income taxes is comprised of the following:
Income (loss) before income taxes is comprised of the following:
The provision for income taxes differs from the amount computed by applying the U.S. corporate statutory income tax rate to income (loss) before income taxes for the reasons set forth below:
Deferred income taxes reflect the net tax effects of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and the amounts used for income tax purposes, as well as net operating loss and tax credit carryforwards. The tax effects of temporary differences are comprised of the following:
As of December 31, 2015, we had $317.8 million of net operating loss carryforwards, of which $52.5 million relates to foreign jurisdictions and $265.3 million relates to the United States, which will expire beginning in 2024 through 2035, if not utilized. We expect to generate sufficient taxable income in future years that will allow utilization of the portion of the net operating loss carryforwards for which no valuation allowance has been provided.
We record a valuation allowance when it is more likely than not that some portion, or all, of the deferred tax assets will not be realized. As of December 31, 2015 and December 31, 2014, a valuation allowance of $100.1 million and $90.4 million, respectively, has been provided for net operating loss carryforwards and other deferred tax assets. We increased our valuation allowance by $9.7 million in 2015, which includes $13.9 million related to current period net operating losses in the U.S. jurisdiction, partially offset by a $2.7 million decrease related to the tax effect of unrealized pension gains, and a $1.5 million decrease related to changes in other comprehensive income (loss). We increased our valuation allowance by $0.4 million in 2014, which includes a $9.8 million increase related to changes in other comprehensive income (loss), partially offset by a $7.6 million decrease related to current year operating income and a $1.8 million decrease related to the assessment of our ability to utilize net operating loss carryforwards in future periods. We consider the reversal of deferred tax liabilities within the net operating loss carryforward period, projected future taxable income and tax planning strategies in making this assessment. Excluding the change in our valuation allowance, our effective tax rates would have been a 75.4% benefit and a 229.0% expense for the years ended December 31, 2015 and 2014, respectively. As of December 31, 2015, $87.9 million of the $100.1 million valuation allowance is associated with net deferred tax assets in the U.S. jurisdiction.
Following the acquisition of Arizona Chemical on January 6, 2016, we project that we will have sufficient combined pre-tax earnings in the U.S. to fully utilize net operating loss carryforwards within a reasonable projection period. Under ASC 805-740-30-3, the release of an acquirer’s existing valuation allowance resulting from an acquisition is recognized as an adjustment to the financial statements as of the acquisition date. As a result, we expect to release the valuation allowance related to the U.S. net deferred tax assets in 2016.
For the period ending December 31, 2015, the unremitted earnings of our foreign subsidiaries are permanently reinvested in the corresponding country of origin. Accordingly, we have not provided deferred taxes for the differences between the book basis and underlying tax basis in those subsidiaries or on the foreign currency translation adjustment amounts related to such operations.
We file income tax returns in the U.S. federal jurisdiction and in various state and foreign jurisdictions. For our U.S. federal income tax returns, the statute of limitations has expired through the tax year ended December 31, 2003. As a result of net operating loss carryforwards from 2004, the statute remains open for all years subsequent to 2003. In addition, open tax years for state and foreign jurisdictions remain subject to examination.
We recognize the tax impact of certain tax positions only when it is more likely than not those such positions are sustainable. The taxes are recorded in accordance with ASC 740-10, “Accounting for Uncertainty in Income Taxes,” which prescribes the minimum recognition threshold.
As of December 31, 2015 and December 31, 2014, we had $4.3 million and $4.7 million, respectively, of unrecognized tax benefits related to uncertain foreign tax positions, all of which, if recognized, would impact our effective tax rate. For the years ending December 31, 2015, 2014, and 2013, we recorded $0.2 million, $0.1 million, and $0.4 million in interest and penalties related to unrecognized tax benefits within the provision for income taxes. As of December 31, 2015 and December 31, 2014, we had $0.8 million and $0.6 million of penalties and interest included in the total unrecognized tax benefits. We believe that no current tax positions that have resulted in unrecognized tax benefits will significantly increase or decrease within one year.
The following presents a rollforward of our unrecognized tax benefits including associated interest and penalties.
12. Commitments and Contingencies
(a) Lease Commitments
We have entered into various long-term non-cancelable operating leases. Future minimum lease commitments at December 31, 2015 are as follows: 2016-$16.4 million; 2017-$10.9 million; 2018-$7.0 million; 2019-$6.0 million; 2020-$4.7 million; and 2020 and thereafter-$1.9 million. For the years ended December 31, 2015, 2014, and 2013, we recorded $18.1 million, $18.7 million and $11.2 million in rent expense, respectively.
(b) Environmental and Safety Matters
Our finished products are not generally classified as hazardous under U.S. environmental laws. However, our operations involve the handling, transportation, treatment, and disposal of potentially hazardous materials that are extensively regulated by environmental, health and safety laws, regulations, and permit requirements. Environmental permits required for our operations are subject to periodic renewal and can be revoked or modified for cause or when new or revised environmental requirements are implemented. Changing and increasingly stringent environmental requirements can affect the manufacturing, handling, processing, distribution and use of our chemical products and the raw materials used to produce such products and, if so affected, our business and operations may be materially and adversely affected. In addition, changes in environmental requirements can cause us to incur substantial costs in upgrading or redesigning our facilities and processes, including waste treatment, disposal, and other waste handling practices and equipment.
We conduct environmental management programs designed to maintain compliance with applicable environmental requirements at all of our facilities. We routinely conduct inspection and surveillance programs designed to detect and respond to leaks or spills of regulated hazardous substances and to identify and correct identified regulatory deficiencies. However, a business risk inherent with chemical operations is the potential for personal injury and property damage claims from employees, contractors and their employees, and nearby landowners and occupants. While we believe our business operations and facilities generally are operated in compliance, in all material respects, with all applicable environmental and health and safety requirements, we cannot be sure that past practices or future operations will not result in material claims or regulatory action, require material environmental expenditures, or result in exposure or injury claims by employees, contractors and their employees, and the public. Some risk of environmental costs and liabilities are inherent in our operations and products, as it is with other companies engaged in similar businesses.
Our Paulinia, Brazil, and Belpre, Ohio, facilities are subject to a number of actual and/or potential environmental liabilities primarily relating to contamination caused by former operations at those facilities. Some environmental laws could impose on us the entire costs of cleanup regardless of fault, legality of the original disposal, or ownership of the disposal site. In some cases, the governmental entity with jurisdiction could seek an assessment for damage to the natural resources caused by contamination from those sites. Shell Chemicals has agreed, subject to certain limitations, in time and amounts, to indemnify us against most environmental liabilities related to the acquired facilities that arise from conditions existing prior to the closing.
We had no material operating expenditures for environmental fines, penalties, government imposed remedial or corrective actions in each of the years ended December 31, 2015, 2014, and 2013.
(c) Legal Proceedings
We received notice from the tax authorities in Brazil assessing R$6.1 million or $1.5 million (converted at the December 31, 2015 exchange rate) in connection with tax credits that were generated from the purchase of certain goods which were subsequently applied by us against taxes owed. We have appealed the assertion by the tax authorities in Brazil that the goods purchased were not eligible to earn the credits. While the outcome of this proceeding cannot be predicted with certainty, we do not expect this matter to have a material adverse effect upon our financial position, results of operations or cash flows.
On January 28, 2014, we executed a definitive agreement (the “Combination Agreement”) to combine with the SBC operations of Taiwan-based LCY Chemical Corp. (“LCY”). The Combination Agreement called for LCY to contribute its SBC business in exchange for newly issued shares in the combined company, such that our existing stockholders and LCY would each own 50% of the outstanding shares of the combined enterprise.
On June 30, 2014, we notified LCY that our Board of Directors intended to withdraw its recommendation to our stockholders to approve the Combination Agreement unless the parties could agree upon mutually acceptable revised terms to the Combination Agreement. This notice cited the decline in operating results for LCY’s SBC business in the first quarter of 2014 and a related decline in forecasted results thereafter, together with the decline in our stock price and negative reactions from our stockholders. Following our notification of our Board’s intention to change its recommendation, the parties engaged in discussions to determine whether they could mutually agree to changes to the terms of the Combination Agreement that would enable our Board to continue to recommend that our stockholders approve the Combination Agreement. The parties engaged in numerous discussions subsequent to June 30, 2014 regarding possible revisions to the terms of the Combination Agreement.
On July 31, 2014, an explosion occurred in a pipeline owned by LCY in Kaohsiung, Taiwan, causing substantial property damage and loss of life, and numerous governmental and private investigations and claims have been initiated and asserted against LCY. On August 4, 2014, LCY notified us that it would no longer negotiate, and it would not agree to, any revisions to the terms of the Combination Agreement. On August 6, 2014, our Board withdrew its recommendation that our stockholders approve the Combination Agreement. On August 8, 2014, we received notice from LCY that LCY had exercised its right to terminate the Combination Agreement.
The provisions of the Combination Agreement provide for us to pay LCY a $25.0 million break-up fee upon a termination of the Combination Agreement following a withdrawal of our Board’s recommendation, unless an LCY material adverse effect has occurred and is continuing at the time of the withdrawal of our Board’s recommendation. In LCY’s notice terminating the Combination Agreement, LCY requested payment of such $25.0 million termination fee. On October 6, 2014, LCY filed a lawsuit against us in connection with our refusal to pay the $25.0 million termination fee. We believe that the impact upon LCY of the July 31, 2014 explosion in a gas pipeline in Kaohsiung, Taiwan, constitutes an LCY material adverse effect as defined in the Combination Agreement, and we have notified LCY that accordingly we are not obligated to pay the termination fee. On July 23, 2015, LCY's lawsuit was dismissed from the Delaware federal court on jurisdictional grounds. LCY has the right to re-file its suit in Delaware state court. As of the date of this filing, they had not re-filed their suit. While the ultimate resolution of this matter cannot be predicted with certainty, we do not expect any material adverse effect upon our financial position, results of operations, or cash flows from the ultimate outcome of this matter.
We and certain of our subsidiaries, from time to time, are parties to various other legal proceedings, claims, and disputes that have arisen in the ordinary course of business. These claims may involve significant amounts, some of which would not be covered by insurance. A substantial settlement payment or judgment in excess of our accruals could have a material adverse effect on our financial position, results of operations or, cash flows. While the outcome of these proceedings cannot be predicted with certainty, we do not expect any of these existing matters, individually or in the aggregate, to have a material adverse effect upon our financial position, results of operations, or cash flows.
(d) Asset Retirement Obligations (“ARO”)
The changes in the aggregate carrying amount of our ARO liability are as follows:
For a portion of our ARO liability related to the decommissioning of the coal boilers at our Belpre, Ohio, facility, we recorded a $3.7 million receivable from Shell Chemicals as of December 31, 2015 pursuant to the indemnity included in the February 2001 separation agreement, which serves to offset the related ARO asset which is included in property, plant, and equipment.
(e) Production downtime
In the first quarter of 2014, we experienced weather-related downtime at our Belpre, Ohio facility. In addition, our facility in Berre, France, experienced an operating disruption resulting from a small fire that impacted one of the production lines at this facility. We incurred $10.3 million of net costs in the year ended December 31, 2014 associated with these two events.
13. Employee Benefits
(a) U.S. Retirement Benefit Plan. We have a U.S. noncontributory defined benefit pension plan (“Pension Plan”) which covers all salaried and hourly wage employees in the United States who were employed by us on or before December 31, 2005. Employees who began their employment with us after December 31, 2005 are not covered by our Pension Plan. The benefits under the Pension Plan are based primarily on years of service and employees’ pay near retirement. For our employees who were employed as of March 1, 2001 and who: (1) were previously employed by Shell Chemicals; and (2) elected to transfer their pension assets to us, we consider the total combined Shell Chemicals and Kraton service when calculating the employee’s pension benefit. For those employees who: (1) elected to retire from Shell Chemicals; or (2) elected not to transfer their pension benefit, only Kraton service (since March 1, 2001) is considered when calculating benefits.
The 2015 measurement date of the Pension Plan’s assets and obligations was December 31, 2015. Based on the funded status of our Pension Plan as of December 31, 2015 and 2014, we reported a decrease in our accumulated other comprehensive loss of approximately $3.2 million and an increase of $28.6 million, respectively, and a related change in accrued pension obligations.
Information concerning the pension obligation, plan assets, amounts recognized in our financial statements and underlying actuarial and other assumptions are as follows:
The accumulated benefit obligation for the Pension Plan was $140.8 million and $145.1 million at December 31, 2015 and 2014, respectively.
Estimated Future Benefit Payments. The following benefit payments, which reflect expected future service, as appropriate, are expected to be paid:
Net Periodic Pension Costs. Net periodic pension costs consist of the following components:
Significant Assumptions. Discount rates are determined annually and are based on rates of return of high-quality long-term fixed income securities currently available and expected to be available during the maturity of the pension benefits.
Our management relied in part on actuarial studies in establishing the expected long-term rate of return on assets assumption. The study includes a review of anticipated future long-term performance of individual asset classes and consideration of the appropriate asset allocation strategy given the anticipated requirements of the Pension Plan to determine the average rate of earnings expected on the funds invested to provide for the Pension Plan benefits. While the study gives appropriate consideration to recent fund performance and historical returns, the assumption is primarily a long-term, prospective rate. Based on our most recent study, the expected long-term return assumption for our Pension Plan effective for 2015 will remain at 8.5%.
Pension Plan Assets. We maintain target allocation percentages among various asset classes based on an investment policy established for our Pension Plan. The target allocation is designed to achieve long term objectives of return, while mitigating downside risk and considering expected cash flows. The plan’s strategic target allocation as of December 31, 2015 was 50.0% equity, 30.0% debt, and 20.0% other, consisting of real estate funds, hedge funds, and commodity funds. The latter was assumed to behave similar to debt securities and therefore we included this 20.0% asset allocation as bonds in the model. Our investment policy is reviewed from time to time to ensure consistency with our long term objective. Our Pension Plan asset allocations at December 31, 2015 and 2014 by asset category are as follows:
No pension assets were invested in debt or equity securities of Kraton at December 31, 2015 and 2014.
The inputs and methodology used for valuing securities are not an indication of the risk associated with investing in those securities. The following is a description of the primary valuation methodologies used for assets measured at fair value:
•
Common/Collective Trust Funds: Valued at the net asset value per unit held at year end as quoted by the funds.
•
Mutual Funds, Real Estate Funds, and Other Funds: Valued at the net asset value of shares held at year end as quoted in the active market.
A summary of total investments for our pension plan assets measured at fair value is presented below. See Note 9 Fair Value Measurements, Financial Instruments, and Credit Risk to the consolidated financial statements for a detailed description of fair value measurements and the hierarchy established for Level 1, 2, and 3 valuation inputs.
__________________________________________
(a)
Strategies are generally to invest in equity or debt securities, or a combination thereof, that match or outperform certain predefined indices.
(b) Other Retirement Benefit Plans. Certain employees were eligible to participate in non-qualified defined benefit restoration plans (“BRP”), which were intended to restore certain benefits under the Pension Plan in the United States and the Kraton Savings Plan in the United States, which would otherwise be lost due to certain limitations imposed by law on tax-qualified plans.
On November 26, 2014, the Company terminated the Pension Plan BRP effective November 30, 2014. As a result of this termination, future benefit accruals were eliminated and the lump sum amount for each participant was paid in December 2015. As such, a curtailment event was recognized at December 1, 2014 resulting in a curtailment expense of $0.4 million in the year ended December 31, 2014 and a settlement expense of $0.8 million in the year ended December 31, 2015.
For the years ended December 31, 2015, 2014, and 2013, we made contributions related to the Pension Plan BRP of $2.3 million, $0.1 million, and $0.0 million, respectively. Due to the termination and final settlement, there was no remaining liability for this plan as of December 31, 2015. As of December 31, 2014, $2.2 million was recognized as a component of other current liabilities.
(c) Postretirement Benefits Other Than Pensions. Health and welfare benefits are provided to benefit eligible employees in the United States who retire from Kraton and were employed by us prior to January 1, 2006. Retirees under the age of 65 are eligible for the same medical, dental, and vision plans as active employees, but with an annual cap on premiums that vary based on years of service and ranges from $7,000 to $10,000 per employee. Our subsidy schedule for medical plans is based on accredited service at retirement. Retirees are responsible for the full cost of premiums for postretirement dental and vision coverage. In general, the plans stipulate that health and welfare benefits are paid as covered expenses as incurred. We accrue the cost of these benefits during the period in which the employee renders the necessary service.
Employees who were retirement eligible as of February 28, 2001, have the option to participate in either Shell Chemicals' or Kraton's postretirement health and welfare plans.
ASC 715, “Compensation-Retirement Benefits,” requires that we measure the plans’ assets and obligations that determine our funded status at the end of each fiscal year and the 2015 measurement date of the plans’ assets and obligations was December 31, 2015. We are also required to recognize as a component of accumulated other comprehensive loss the changes in funded status that occurred during the year that are not recognized as part of new periodic benefit cost.
Based on the funded status of our postretirement benefit plan as of December 31, 2015 and 2014, we reported a decrease in our accumulated other comprehensive loss of approximately $3.4 million and an increase of $4.1 million, respectively, and a related change in accrued pension obligations.
Information concerning the plan obligation, the funded status and amounts recognized in our financial statements and underlying actuarial and other assumptions are as follows:
___________________________________________
(1)
Shell Chemicals has committed to a future cash payment related to retiree medical expenses based on a specified dollar amount per employee, if certain contractual commitments are met. We have recorded an asset of approximately $10.1 million and $9.9 million as our estimate of the present value of this commitment as of December 31, 2015 and 2014, respectively.
Net periodic benefit costs consist of the following components:
Discount rates are determined annually and are based on rates of return of high-quality long-term fixed income securities currently available and expected to be available during the maturity of the postretirement benefit plan.
Assumed health care cost trend rates have a significant effect on the amounts reported for the health care plans. A 1.0% change in assumed health care cost trend rates would have the following effect (in thousands):
(d) Kraton Savings Plan. The Kraton Savings Plan, as adopted on March 1, 2001, covers substantially all U.S. employees, including executive officers. Through automatic payroll deduction, participants have the option to defer up to 60% of eligible earnings in any combination of pretax and/or post-tax contributions, subject to annual dollar limitations set forth in the Internal Revenue Code. Under this plan, we have two types of employer contributions:
(1) For our standard contributions, we make matching contributions of 50.0% of the first 6.0% contributed by the employee after completing one year of service, and we make matching contributions of 100.0% of the first 6.0% contributed by the employee after completing five years of service.
(2) For our enhanced contributions, we make employer contributions of 3.0% for employees who have less than five years of service and a 4.0% contribution for employees who have five or more years of service.
For our employees who were employed as of February 28, 2001, and who were previously employed by Shell Chemicals, we recognize their Shell Chemicals years of service for purposes of determining employer contributions under our Plan. Our contributions to the plan for the years ended December 31, 2015, 2014, and 2013, were $4.1 million, $4.0 million, and $3.7 million, respectively.
14. Industry Segment and Foreign Operations
We operate in one segment for the manufacturing and marketing of engineered polymers. In accordance with the provisions of ASC 280, “Segment Reporting,” our chief operating decision-maker has been identified as the President and Chief Executive Officer, who regularly reviews operating results to make decisions about allocating resources and assessing performance for the entire company. Since we operate in one segment and in one group of similar products, all financial segment and product group information required by ASC 280 can be found in the consolidated financial statements.
Our products are manufactured and our commercial activities are organized in the following product groups based upon polymer chemistry and process technologies:
During the years ended December 31, 2015, 2014, and 2013, no single customer accounted for 10.0% or more of our total revenue.
For geographic reporting, revenue is attributed to the geographic location in which the customers’ facilities are located. Long-lived assets consist primarily of property, plant, and equipment, which are attributed to the geographic location in which they are located and presented at historical cost. Following is a summary of revenue by geographic region:
Following is a summary of long-lived assets by geographic region:
15. Related Party Transactions
We own a 50.0% equity investment in a SBC manufacturing joint venture in Kashima, Japan. Our due to related party liability on the consolidated balance sheet is related to this joint venture and the purchases from the joint venture amounted to $30.4 million, $40.3 million, and $50.7 million for the years ended December 31, 2015, 2014, and 2013, respectively.
We own a 50% variable interest in KFPC, a HSBC manufacturing joint venture in Mailiao, Taiwan. The KFPC joint venture is fully consolidated in our financial statements, and our joint venture partner, Formosa Petrochemical Corporation (“FPCC”), is a related party affiliate. Under the terms of the joint venture agreement, FPCC is to provide certain site services and raw materials to KFPC. Charges from and amounts due to FPCC are immaterial through the period ended December 31, 2015. See Note 16 Variable Interest Entity, for further discussion related to the KFPC joint venture.
In 2015, one of our board members, Steven Demetriou, was appointed as the Chief Executive Officer of Jacobs Engineering which has historically supplied site maintenance and engineering services for our Belpre, Ohio facility. Our total purchases from Jacobs Engineering in 2015 were $12.4 million and our outstanding payable to them was $0.3 million as of December 31, 2015.
16. Variable Interest Entity
We hold a variable interest in a joint venture with FPCC to build, own and operate a 30 kiloton HSBC plant at FPCC’s petrochemical site in Mailiao, Taiwan. Kraton and FPCC are each 50% owners of the joint venture company, KFPC. Under the provisions of an offtake agreement with KFPC, we have exclusive rights to purchase all production from KFPC. Additionally, the agreement requires us to purchase a minimum of eighty percent of the plant production capacity each year at a defined fixed margin. This offtake agreement represents a variable interest which provides us the power to direct the most significant activities of KFPC and exposes us to the economic variability of the joint venture. As such, we have determined that we are the primary beneficiary of this variable interest entity; and therefore, we have consolidated KFPC in our financial statements and reflected FPCC’s 50% percent ownership as a noncontrolling interest.
The following table summarizes the carrying amounts of assets and liabilities as of December 31, 2015 and 2014 for KFPC before intercompany eliminations. See Note 7 Long Term Debt, for further discussion related to the KFPC Loan Agreement executed on July 17, 2014.
17. Supplemental Guarantor Information
Kraton Polymers LLC and Kraton Polymers Capital Corporation, a financing subsidiary, (collectively, “the Issuers”), are co-issuers of the 6.75% senior notes due March 1, 2019. The 6.75% senior notes are fully and unconditionally guaranteed on a joint and several basis by KPPI, the parent company of the Issuers, and Elastomers Holdings LLC, which is a U.S. holding company and a 100% owned subsidiary of Kraton Polymers LLC, (collectively,“the Guarantors”). Our remaining subsidiaries are not guarantors of the 6.75% senior notes. We do not believe that separate financial statements and other disclosures concerning the guarantor subsidiaries would provide any additional information that would be material to investors in making an investment decision.
KRATON PERFORMANCE POLYMERS, INC.
CONSOLIDATING BALANCE SHEET
December 31, 2015
(In thousands, except par value)
____________________________________
(1)
Kraton Polymers LLC and Kraton Polymers Capital Corporation, a financing subsidiary, collectively, the Issuers, are co-issuers of the 6.75% senior notes due March 1, 2019. Kraton Polymers Capital Corporation has minimal assets and income. We do not believe that separate financial information concerning the Issuers would provide additional information that would be material to investors in making an investment decision.
KRATON PERFORMANCE POLYMERS, INC.
CONSOLIDATING BALANCE SHEET
December 31, 2014
(In thousands, except par value)
_______________________________________
(1)
Kraton Polymers LLC and Kraton Polymers Capital Corporation, a financing subsidiary, collectively, the Issuers, are co-issuers of the 6.75% senior notes due March 1, 2019. Kraton Polymers Capital Corporation has minimal assets and income. We do not believe that separate financial information concerning the Issuers would provide additional information that would be material to investors in making an investment decision.
KRATON PERFORMANCE POLYMERS, INC.
CONSOLIDATING STATEMENT OF OPERATIONS
Year ended December 31, 2015
(In thousands)
_____________________________________
(1)
Kraton Polymers LLC and Kraton Polymers Capital Corporation, a financing subsidiary, collectively, the Issuers, are co-issuers of the 6.75% senior notes due March 1, 2019. Kraton Polymers Capital Corporation has minimal assets and income. We do not believe that separate financial information concerning the Issuers would provide additional information that would be material to investors in making an investment decision.
KRATON PERFORMANCE POLYMERS, INC.
CONSOLIDATING STATEMENT OF OPERATIONS
Year ended December 31, 2014
(In thousands)
_____________________________________
(1)
Kraton Polymers LLC and Kraton Polymers Capital Corporation, a financing subsidiary, collectively, the Issuers, are co-issuers of the 6.75% senior notes due March 1, 2019. Kraton Polymers Capital Corporation has minimal assets and income. We do not believe that separate financial information concerning the Issuers would provide additional information that would be material to investors in making an investment decision.
KRATON PERFORMANCE POLYMERS, INC.
CONSOLIDATING STATEMENT OF OPERATIONS
Year ended December 31, 2013
(In thousands)
_____________________________________
(1)
Kraton Polymers LLC and Kraton Polymers Capital Corporation, a financing subsidiary, collectively, the Issuers, are co-issuers of the 6.75% senior notes due March 1, 2019. Kraton Polymers Capital Corporation has minimal assets and income. We do not believe that separate financial information concerning the Issuers would provide additional information that would be material to investors in making an investment decision.
KRATON PERFORMANCE POLYMERS, INC.
CONSOLIDATING STATEMENT OF COMPREHENSIVE INCOME (LOSS)
Year ended December 31, 2015
(In thousands)
_____________________________________
(1)
Kraton Polymers LLC and Kraton Polymers Capital Corporation, a financing subsidiary, collectively, the Issuers, are co-issuers of the 6.75% senior notes due March 1, 2019. Kraton Polymers Capital Corporation has minimal assets and income. We do not believe that separate financial information concerning the Issuers would provide additional information that would be material to investors in making an investment decision.
KRATON PERFORMANCE POLYMERS, INC.
CONSOLIDATING STATEMENT OF COMPREHENSIVE INCOME (LOSS)
Year ended December 31, 2014
(In thousands)
_____________________________________
(1)
Kraton Polymers LLC and Kraton Polymers Capital Corporation, a financing subsidiary, collectively, the Issuers, are co-issuers of the 6.75% senior notes due March 1, 2019. Kraton Polymers Capital Corporation has minimal assets and income. We do not believe that separate financial information concerning the Issuers would provide additional information that would be material to investors in making an investment decision.
KRATON PERFORMANCE POLYMERS, INC.
CONSOLIDATING STATEMENT OF COMPREHENSIVE INCOME (LOSS)
Year ended December 31, 2013
(In thousands)
_____________________________________
(1)
Kraton Polymers LLC and Kraton Polymers Capital Corporation, a financing subsidiary, collectively, the Issuers, are co-issuers of the 6.75% senior notes due March 1, 2019. Kraton Polymers Capital Corporation has minimal assets and income. We do not believe that separate financial information concerning the Issuers would provide additional information that would be material to investors in making an investment decision.
KRATON PERFORMANCE POLYMERS, INC.
CONSOLIDATING STATEMENT OF CASH FLOWS
Year ended December 31, 2015
(In thousands)
_____________________________________
(1)
Kraton Polymers LLC and Kraton Polymers Capital Corporation, a financing subsidiary, collectively, the Issuers, are co-issuers of the 6.75% senior notes due March 1, 2019. Kraton Polymers Capital Corporation has minimal assets and income. We do not believe that separate financial information concerning the Issuers would provide additional information that would be material to investors in making an investment decision.
KRATON PERFORMANCE POLYMERS, INC.
CONSOLIDATING STATEMENT OF CASH FLOWS
Year ended December 31, 2014
(In thousands)
_____________________________________
(1)
Kraton Polymers LLC and Kraton Polymers Capital Corporation, a financing subsidiary, collectively, the Issuers, are co-issuers of the 6.75% senior notes due March 1, 2019. Kraton Polymers Capital Corporation has minimal assets and income. We do not believe that separate financial information concerning the Issuers would provide additional information that would be material to investors in making an investment decision.
KRATON PERFORMANCE POLYMERS, INC.
CONSOLIDATING STATEMENT OF CASH FLOWS
Year Ended December 31, 2013
(In thousands)
________________________________________
(1)
Kraton Polymers LLC and Kraton Polymers Capital Corporation, a financing subsidiary, collectively, the Issuers, are co-issuers of the 6.75% senior notes due March 1, 2019. Kraton Polymers Capital Corporation has minimal assets and income. We do not believe that separate financial information concerning the Issuers would provide additional information that would be material to investors in making an investment decision.
18. Selected Quarterly Financial Data (Unaudited)
The following table sets forth a summary of Kraton Performance Polymers, Inc.’s quarterly financial information for each of the four quarters ended December 31, 2015 and December 31, 2014:
_______________________________________
(1)
The first quarter of 2014 was negatively impacted by approximately $13.0 million of charges associated with production downtime at our Belpre, Ohio, and Berre, France, facilities and charges of approximately $9.2 million related to professional fees for the terminated combination agreement with LCY.
(2)
Results for the second quarter of 2015 were negatively impacted by approximately $13.2 million of unplanned production issues and higher turnaround costs. The second quarter of 2014 included charges of approximately $3.8 million related to professional fees for the terminated combination agreement with LCY.
(3)
The third quarter of 2015 included $5.0 million of transaction related costs, primarily associated with the Arizona Chemical Acquisition. The third quarter of 2014 included a $4.2 million benefit from a reduction in estimated transaction fees related to the terminated combination agreement with LCY and a $1.0 million benefit from an insurance recovery related to the first quarter 2014 production downtime at our Belpre, Ohio, facility and a $1.9 million tax benefit due to a reduction of income tax valuation allowance related to the assessment of our ability to utilize net operating losses in future periods.
(4)
The fourth quarter of 2015 included $15.0 million of transaction related costs, primarily associated with the Arizona Chemical Acquisition. The fourth quarter of 2014 included $2.3 million of restructuring and other charges and $4.7 million of impairments of long lived assets. The fourth quarter of 2014 also included approximately $1.7 million benefit from insurance recoveries and reductions in estimated expenses related to the first quarter 2014 production downtime at our Belpre, Ohio, facility.
Basic and diluted earnings per share are computed independently for each of the quarters presented. Therefore, the sum of quarterly basic and diluted per share information may not equal annual basic and diluted earnings per share.
19. Subsequent Events
Financing Associated with the Arizona Chemical Acquisition. In connection with the Arizona Chemical Acquisition, our previously outstanding indebtedness under the 6.75% Senior Notes and the previous Senior Secured Credit Facilities were satisfied and canceled on January 6, 2016. Following is a description of the debt instruments entered into in connection with the Arizona Chemical Acquisition. See Note 3 Acquisition of Arizona Chemical to the consolidated financial statements for a further description of the Arizona Chemical Acquisition.
Senior Secured Term Loan Facility. In January 2016, Kraton Polymers LLC entered into a senior secured term loan facility in an aggregate principal amount equal to $1,350.0 million that matures on January 6, 2022 (the “Term Loan Facility”). Subject to compliance with certain covenants and other conditions, we have the option to borrow up to $350.0 million of incremental term loans plus an additional amount subject to a senior secured net leverage ratio.
The Term Loan Facility was issued at a price of 97.000%. Borrowings under the Term Loan Facility bear interest at a rate per annum equal to an applicable margin, plus, at our option, either (a) an adjusted LIBOR rate (subject to a 1.0% floor) determined by reference to the costs of funds for U.S. dollar deposits for the interest period relevant to such borrowing adjusted for statutory reserve requirements or (b) an alternate base rate (subject to a 2.0% floor) determined by reference to the highest of (1) the prime rate of Credit Suisse AG, (2) the federal funds effective rate plus 0.5% and (3) the one month adjusted LIBOR rate plus 1.0% per annum. In addition, we are required to pay customary agency fees. As of the date of this filing, the effective rate on the Term Loan Facility was 6.0% comprised of the 1.0% LIBOR floor plus a 5.0% applicable margin.
We are required to make scheduled quarterly payments on the Term Loan Facility of 2.5% of the original principal amount per year through the end of the last quarter of 2016 and 5.0% thereafter, with the balance expected to be due and payable in full on January 6, 2022. Voluntary prepayments on the Term Loan Facility may be made without premium or penalty other than customary “breakage” costs with respect to LIBOR loans and other than a 1.0% premium in connection with certain repricing transactions consummated within a certain period of time after the closing of the Term Loan Facility. In the event we have consolidated excess cash flow for any fiscal year, we are required to prepay an amount of borrowings under the Term Loan Facility equal to at least 50% of such cash flow by the 90th day after the end of the fiscal year. The prepayment percentage is reduced to 25% if our senior secured net leverage ratio is under 2.5:1.0 or 0% if our senior secured net leverage ratio is below 2.0:1.0.
The Term Loan Facility is a senior secured obligation that is guaranteed by Kraton Performance Polymers, Inc. and each of our domestic wholly-owned subsidiaries. The Term Loan Facility contains a number of customary affirmative and negative covenants. These covenants include a senior secured net leverage ratio which shall not exceed, as of the last day of any fiscal quarter, 4.00:1.00 through March 31, 2017, which will decrease to 3.75:1.00 through March 31, 2018, 3.50:1.00 through March 31, 2019, and 3.25:1.00 thereafter. As of the date of this filing, we were in compliance with the covenants under the Term Loan Facility.
10.5% Senior Notes due 2023. Kraton Polymers LLC and its wholly-owned financing subsidiary, Kraton Polymers Capital Corporation, issued $440.0 million aggregate principal amount of 10.5% senior notes that mature on April 15, 2023 (the “10.5% Senior Notes”). The 10.5% Senior Notes were issued at a price of 96.225% on January 6, 2016. The 10.5% Senior Notes are general unsecured, senior obligations and are unconditionally guaranteed on a senior unsecured basis by each of Kraton's wholly-owned domestic subsidiaries. We pay interest on the notes at 10.5% per annum, semi-annually in arrears on April 15 and October 15 of each year, with the first payment of interest due on October 15, 2016.
ABL Facility. In January 2016, we entered into an amended and restated asset-based revolving credit facility which provides financing of up to $250.0 million (the “ABL Facility”). The ABL Facility is primarily secured by receivables and inventory, and borrowing availability under the facility is subject to borrowing base limitations based on the level of receivables and inventory available for security. Revolver commitments under the ABL Facility consist of U.S. and Dutch revolving credit facility commitments, and the terms of the ABL Facility require the U.S. revolver commitments comprise at least 60.0% of the outstanding commitments under the facility.
The ABL Facility provides that we have the right at any time to request up to an aggregate of $100.0 million of additional commitments under this facility, provided that we satisfy additional conditions described in the credit agreement, and provided further that the U.S. revolver commitment comprises at least 60.0% of the commitments after giving effect to such increase. The ABL Facility terminates on January 6, 2021; however, we may, from time to time, request that the lenders extend the maturity of their commitments; provided that at no time shall there be more than four different maturity dates under the ABL Facility.
Obligations under the ABL Facility are unconditionally guaranteed by Kraton Performance Polymers, Inc. and each of our domestic wholly-owned subsidiaries including Arizona Chemical Holdings Corporation and its domestic wholly-owned subsidiaries (collectively, the “ABL U.S. Guarantors”). Certain foreign obligations under our ABL Facility, in addition to being guaranteed by the ABL U.S. Guarantors, will be unconditionally guaranteed by Kraton Polymers Nederland B.V., Kraton Polymers Holdings B.V., KP International C.V. and K.P. Global Holdings C.V. The ABL Facility terminates on January 6, 2021; however, we may, from time to time, request that the lenders extend the maturity of their commitments. Availability under the ABL Facility is limited to the lesser of the borrowing base and total commitments (less certain reserves).
Borrowings under the ABL Facility bear interest at a rate per annum equal to the applicable margin plus (1) a base rate determined by reference to the prime rate of Bank of America, N.A. in the jurisdiction where the currency is being funded or (2) LIBOR for loans that bear interest based on LIBOR. The initial applicable margin for borrowings under our ABL Facility is 0.5% with respect to U.S. base rate borrowings and 1.5% with respect to LIBOR or borrowings made on a European base rate. The applicable margin ranges from 0.5% to 1.0% with respect to U.S. base rate borrowings and 1.5% to 2.0% for LIBOR or borrowings made on a European base rate per annum based on the average excess availability for the prior fiscal quarter. In addition to paying interest on outstanding principal amounts under the ABL Facility, we are required to pay a commitment fee in respect of the unutilized commitments at an annual rate of 0.375%.
The ABL Facility contains a financial covenant that if either (a) excess availability is less than the greater of (i) 12.5% of our borrowing base and (ii) $31,250,000 or (b) U.S. availability is less than the greater of (i) 12.5% of our borrowing base in the United States and (ii) $18,750,000, then following such event, Kraton and its restricted subsidiaries must maintain a fixed charge coverage ratio of at least 1.0 to 1.0. The ABL Facility contains certain customary events of default, including, without limitation, a failure to make payments under the facility, cross-default and cross-judgment default, certain bankruptcy events and certain change of control events. As of the date of this filing, we were in compliance with the covenants under the ABL Facility.
As of the date of this filing, $37.0 million was drawn on the ABL Facility with a remaining available borrowing capacity of $176.9 million
Belpre Compounding Unit Asset Sale. On January 29, 2016, we sold certain assets to PolyOne Corporation(“PolyOne”) in connection with the closing of our Belpre, Ohio compounding unit (the “BCU”). These assets included intellectual property, inventory, equipment and other intangible assets. Before closing, the BCU was used to manufacture HSBC and USBC based compounds. The $72.0 million purchase price, which was paid in cash at closing, was used to pay down existing indebtedness. In connection with the sale, we entered into a seven year exclusive polymer supply agreement and a compound manufacturing agreement for a transition period of up to two years with PolyOne. Following transition of the business to PolyOne, we expect to realize fixed cost savings arising from the sale of the business. The sale and related closing of the BCU are part of our strategic initiatives designed to improve our overall cost structure. Our historical compound sales have primarily been directed into personal care, protective film, general compounds for consumer, medical & automotive applications, with the compound sales previously reported under the Specialty Polymers business line.
Evaluation of Other Subsequent Events. We have evaluated significant events and transactions that occurred after the balance sheet date and determined that there were no other events or transactions that would require recognition or disclosure in our consolidated financial statements for the period ended December 31, 2015.
Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Kraton Performance Polymers, Inc.:
Under date of February 24, 2016, we reported on the consolidated balance sheets of Kraton Performance Polymers, Inc. and subsidiaries as of December 31, 2015 and 2014, and the related consolidated statements of operations, comprehensive income (loss), changes in equity, and cash flows for each of the years in the three-year period ended December 31, 2015, which are included in Kraton Performance Polymers, Inc.’s annual report on Form 10-K. In connection with our audits of the aforementioned consolidated financial statements, we also audited the related consolidated financial statement schedule II-Valuation and Qualifying Accounts and Reserves (financial statement schedule) in Kraton Performance Polymers, Inc.’s annual report on Form 10-K. This financial statement schedule is the responsibility of Kraton Performance Polymers, Inc.’s management. Our responsibility is to express an opinion on this financial statement schedule based on our audits.
In our opinion, the financial statement schedule, when considered in relation to the basic consolidated financial statements taken as a whole, presents fairly, in all material respects, the information set forth therein.
/s/ KPMG LLP
Houston, Texas
February 24, 2016
KRATON PERFORMANCE POLYMERS, INC.
SCHEDULE II-VALUATION AND QUALIFYING ACCOUNTS AND RESERVES
For the Years Ended December 31, 2015, 2014, and 2013
(In thousands)
EXHIBIT INDEX
Item 15. Exhibits
The following is a list of all exhibits filed as a part of this annual report on Form 10-K, including those incorporated by reference.
E-1
E-2
E-3
+
Denotes management contract or compensatory plan or arrangement.
*
Filed herewith.
E-4