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EX-32.1 - EXHIBIT 32.1 - Kraton Corpkraexhibit321q32016.htm
EX-31.2 - EXHIBIT 31.2 - Kraton Corpkraexhibit312q32016.htm
EX-31.1 - EXHIBIT 31.1 - Kraton Corpkraexhibit311q32016.htm
EX-10.4 - EXHIBIT 10.4 - Kraton Corpkraexhibit104.htm
EX-10.3 - EXHIBIT 10.3 - Kraton Corpkraexhibit103.htm
EX-10.2 - EXHIBIT 10.2 - Kraton Corpkraexhibit102.htm
EX-10.1 - EXHIBIT 10.1 - Kraton Corpkraexhibit101.htm
 

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
 
FORM 10-Q
 
 
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended September 30, 2016
¨
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
Commission File Number 001-34581
kratonlogoa06.jpg
 
Kraton Corporation
(Exact Name of Registrant as Specified in its Charter)
 
 

Delaware
20-0411521
(State or other jurisdiction of
incorporation or organization)
(I.R.S. Employer
Identification No.)
 
 
15710 John F. Kennedy Blvd.
Suite 300
Houston, TX 77032
281-504-4700
(Address of principal executive offices, including zip code)
(Registrant’s telephone number, including area code)
 
  

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  ý    No  ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  ý    No  ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Securities Exchange Act. (Check one):
Large accelerated filer:
ý
 
Accelerated filer:
¨
Non-accelerated filer:
¨
 
Smaller reporting company:
¨
 
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  ý
Number of shares of Kraton Corporation Common Stock, $0.01 par value, outstanding as of October 24, 2016: 30,916,346.

 


Index to Quarterly Report
on Form 10-Q for
Quarter Ended September 30, 2016
 
 
PART I. FINANCIAL INFORMATION
Page
 
 
 
 
 
  
 
 
 
 
  
 
 
 
 
 
  
 
 
 
 
 
  
 
 
 
 
 
  
 
 
 
 
 
  
 
 
 
 
 
  
 
 
 
 
 
  
 
 
 
 
  
 
 
 
 
  
 
 
 
 
  
 
 
 
 
PART II. OTHER INFORMATION
 
 
 
 
 
  
 
 
 
 
  
 
 
 
 
  
 
 
 
 
 
  

2


CAUTIONARY STATEMENT REGARDING FORWARD-LOOKING INFORMATION
Some of the statements in this Quarterly Report on Form 10-Q under the headings “Condensed Consolidated Financial Statements” and “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and elsewhere contain forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. We may also make written or oral forward-looking statements in our periodic reports on Forms 10-K, 10-Q and 8-K, in press releases and other written materials and in oral statements made by our officers, directors or employees to third parties. Statements that are not historical facts, including statements about our beliefs and expectations, are forward-looking statements. Forward-looking statements are often characterized by the use of words such as “outlook,” “believes,” “estimates,” “expects,” “projects,” “may,” “intends,” “plans” or “anticipates,” or by discussions of strategy, plans or intentions; anticipated benefits of or performance of our products; beliefs regarding opportunities for new, differentiated applications and other innovations; adequacy of cash flows to fund our working capital requirements; our investment in the joint venture with Formosa Petrochemical Corporation (“FPCC”); our expectations regarding indebtedness to be incurred by our joint venture with FPCC; expected synergies and cost savings associated with the acquisition of Arizona Chemical Holdings Corporation (now known as AZ Chem Holdings LP, “Arizona Chemical”); debt payments, interest payments, benefit plan contributions, and income tax obligations; our anticipated 2016 capital expenditures, health, safety and environmental and infrastructure and maintenance projects, projects to optimize the production capabilities of our manufacturing assets and to support our innovation platform; our ability to fully access our senior secured credit facilities; expectations regarding our counterparties’ ability to perform, including with respect to trade receivables; estimates regarding the tax expense of repatriating certain cash and short-term investments related to foreign operations; expectations regarding differentiated applications; our ability to realize certain deferred tax assets and our beliefs with respect to tax positions; expectations regarding our full year effective tax rate; estimates related to the useful lives of certain assets for tax purposes; expectations regarding our pension contributions for fiscal year 2016; estimates or expectations related to monomer costs, ending inventory levels and related estimated charges; the outcome and financial impact of legal proceedings; and projections regarding environmental costs and capital expenditures and related operational savings. Such forward-looking statements involve known and unknown risks, uncertainties, assumptions and other important factors that could cause the actual results, performance or our achievements, or industry results, to differ materially from historical results, any future results, or performance or achievements expressed or implied by such forward-looking statements. There are a number of risks and uncertainties that could cause our actual results to differ materially from the forward-looking statements contained in this report. Further description of these risks and uncertainties and other important factors are set forth in this report, in our latest Annual Report on Form 10-K, including but not limited to “Part I, Item 1A. Risk Factors” and “Part II, Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” therein, and in our other filings with the Securities and Exchange Commission, and include, but are not limited to, risks related to:
failure to successfully integrate Arizona Chemical in the expected time frame, which 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;
failure to successfully achieve the expected synergies or significant delays in achieving such expected synergies in connection with the Arizona Chemical Acquisition;
our substantial indebtedness, which could adversely affect our financial condition and prevent us from fulfilling our obligations under our current and future indebtedness;
we may incur additional indebtedness or we may pay dividends in the future, which could further exacerbate the risks associated with our substantial financial leverage;
our current and future debt instruments may impose significant operating and financial restrictions on us and affect our ability to access liquidity;
to service our indebtedness, we will require a significant amount of cash;
our variable rate indebtedness subjects us to interest rate risk, which could cause our debt service obligations to increase significantly;
conditions in the global economy and capital markets;
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;
limitations in the availability of raw materials we need to produce our products in the amounts or at the prices necessary for us to effectively and profitably operate our business;
the promotion of the use of energy from renewable resources and similar legislation in the United States and elsewhere may incentivize the use of crude tall oil (“CTO”) as a feedstock for production of alternative fuels, reducing the availability of CTO in the amounts or prices necessary for our business;
significant fluctuations in raw material costs may result in volatility in our quarterly operating results and impact the market price of our common stock;

3


our reliance on LyondellBasell Industries for the provision of significant operating and other services;
competition from other producers of styrenic block copolymers and from producers of products that can be substituted for our products;
our ability to produce and commercialize technological innovations;
our ability to protect our intellectual property, on which our business is substantially dependent;
the possibility that our products infringe upon the intellectual property rights of others;
a major failure of our information systems, which could harm our business;
seasonality in our business may affect our quarterly operating results;
the inherently hazardous nature of chemical manufacturing;
product liability claims and other lawsuits arising from environmental damage, personal injuries, other damages associated with chemical manufacturing or our products;
political, economic and local business risks in the various countries in which we operate;
health, safety and environmental laws, including laws that govern our employees’ exposure to chemicals deemed harmful to humans;
regulation of our company or our customers, which could affect the demand for our products or result in increased compliance and other costs;
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;
fluctuations in currency exchange rates;
we may have additional tax liabilities;
our formation of a joint venture to expand hydrogenated styrenic block copolymers capacity in Asia;
our relationship with our employees;
loss of key personnel or our inability to attract and retain new qualified personnel;
the fact that we generally do not enter into long-term contracts with our customers;
a decrease in the fair value of our pension assets could require us to materially increase future funding requirements of the pension plan;
domestic or international natural disasters or terrorist attacks may disrupt our operations;
Delaware law and some provisions of our organizational documents that make a takeover of our company more difficult;
our expectation that we will not pay dividends for the foreseeable future; and
we are a holding company with nominal net worth and will depend on dividends and distributions from our subsidiaries to pay any dividends.
There may be other factors of which we are currently unaware or that we deem immaterial that may cause our actual results to differ materially from the expectations we express in our forward-looking statements. Although we believe the assumptions underlying our forward-looking statements are reasonable, any of these assumptions, and, therefore, also the forward-looking statements based on these assumptions could themselves prove to be inaccurate.
Forward-looking statements are based on current plans, estimates, assumptions and projections, and therefore you should not place undue reliance on them. Forward-looking statements speak only as of the date they are made, and we undertake no obligation to update them publicly in light of new information or future events.


4


Presentation of Financial Statements
The terms “Kraton,” “our company,” “we,” “our,” “ours” and “us” as used in this report refer collectively to Kraton Corporation, formerly known as 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.
This Form 10-Q includes financial statements and related notes that present the condensed consolidated financial position, results of operations, comprehensive income (loss), and cash flows of Kraton. Kraton Corporation 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.

5


Report of Independent Registered Public Accounting Firm
The Board of Directors and Stockholders
Kraton Corporation:
We have reviewed the accompanying condensed consolidated balance sheet of Kraton Corporation and subsidiaries (the “Company”) as of September 30, 2016, the related condensed consolidated statements of operations, and comprehensive income (loss), for the three-month and nine-month periods ended September 30, 2016 and 2015, and the related condensed consolidated statements of changes in equity, and cash flows for the nine-month periods ended September 30, 2016 and 2015. These condensed consolidated financial statements are the responsibility of the Company’s management.
We conducted our reviews in accordance with the standards of the Public Company Accounting Oversight Board (United States). A review of interim financial information consists principally of applying analytical procedures and making inquiries of persons responsible for financial and accounting matters. It is substantially less in scope than an audit conducted in accordance with the standards of the Public Company Accounting Oversight Board (United States), the objective of which is the expression of an opinion regarding the financial statements taken as a whole. Accordingly, we do not express such an opinion.
Based on our reviews, we are not aware of any material modifications that should be made to the condensed consolidated financial statements referred to above for them to be in conformity with U.S. generally accepted accounting principles.
We have previously audited, in accordance with standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheet of Kraton Corporation and subsidiaries as of December 31, 2015, and the related consolidated statements of operations, comprehensive income (loss), changes in equity, and cash flows for the year then ended (not presented herein); and in our report dated February 24, 2016, we expressed an unqualified opinion on those consolidated financial statements. In our opinion, the information set forth in the accompanying condensed consolidated balance sheet as of December 31, 2015 is fairly stated, in all material respects, in relation to the consolidated balance sheet from which it has been derived.
/s/ KPMG LLP
Houston, Texas
October 27, 2016

6



PART I. FINANCIAL INFORMATION

Item 1.
Condensed Consolidated Financial Statements.

KRATON CORPORATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(In thousands, except par value) 

 
September 30, 2016
 
December 31, 2015
 
(unaudited)
 
 
ASSETS
 
 
 
Current assets:
 
 
 
Cash and cash equivalents
$
143,548

 
$
70,049

Receivables, net of allowances of $847 and $244
209,867

 
105,089

Inventories of products
321,845

 
264,107

Inventories of materials and supplies
20,717

 
12,138

Other current assets
68,134

 
29,956

Total current assets
764,111

 
481,339

Property, plant, and equipment, less accumulated depreciation of $420,907 and $382,157
905,117

 
517,673

Goodwill
753,928

 

Intangible assets, less accumulated amortization of $135,361 and $100,093
451,576

 
41,602

Investment in unconsolidated joint venture
11,608

 
11,628

Debt issuance costs
3,803

 
1,337

Deferred income taxes
5,218

 
3,867

Other long-term assets
23,332

 
21,789

Total assets
$
2,918,693

 
$
1,079,235

LIABILITIES AND EQUITY
 
 
 
Current liabilities:
 
 
 
Current portion of long-term debt
$
23,135

 
$
141

Accounts payable-trade
134,560

 
59,337

Other payables and accruals
157,330

 
91,011

Due to related party
14,907

 
14,101

Total current liabilities
329,932

 
164,590

Long-term debt, net of current portion
1,698,952

 
415,591

Deferred income taxes
213,776

 
9,070

Other long-term liabilities
141,305

 
96,992

Total liabilities
2,383,965

 
686,243

Commitments and contingencies (note 11)
 
 
 
Equity:
 
 
 
Kraton stockholders' equity:
 
 
 
Preferred stock, $0.01 par value; 100,000 shares authorized; none issued

 

Common stock, $0.01 par value; 500,000 shares authorized; 30,916 shares issued and outstanding at September 30, 2016; 30,569 shares issued and outstanding at December 31, 2015
309

 
306

Additional paid in capital
358,798

 
349,871

Retained earnings
258,179

 
147,131

Accumulated other comprehensive loss
(116,611
)
 
(138,568
)
Total Kraton stockholders' equity
500,675

 
358,740

Noncontrolling interest
34,053

 
34,252

Total equity
534,728

 
392,992

Total liabilities and equity
$
2,918,693

 
$
1,079,235


See Notes to Condensed Consolidated Financial Statements
7



KRATON CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)
(In thousands, except per share data)
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
Revenue
$
454,143

 
$
269,012

 
$
1,328,715

 
$
786,349

Cost of goods sold
318,887

 
201,202

 
967,744

 
624,542

Gross profit
135,256

 
67,810

 
360,971

 
161,807

Operating expenses:
 
 
 
 
 
 
 
Research and development
9,693

 
7,597

 
30,383

 
23,345

Selling, general, and administrative
42,769

 
26,917

 
135,845

 
77,488

Depreciation and amortization
31,977

 
16,145

 
93,913

 
46,852

Operating income
50,817

 
17,151

 
100,830

 
14,122

Disposition and exit of business activities

 

 
40,001

 

Loss on extinguishment of debt

 

 
(13,423
)
 

Earnings of unconsolidated joint venture
94

 
95

 
274

 
273

Interest expense, net
(33,870
)
 
(6,151
)
 
(101,450
)
 
(17,975
)
Income (loss) before income taxes
17,041

 
11,095

 
26,232

 
(3,580
)
Income tax benefit (expense)
(2,198
)
 
(3,076
)
 
83,024

 
(4,135
)
Consolidated net income (loss)
14,843

 
8,019

 
109,256

 
(7,715
)
Net loss attributable to noncontrolling interest
717

 
427

 
1,792

 
1,141

Net income (loss) attributable to Kraton
$
15,560

 
$
8,446

 
$
111,048

 
$
(6,574
)
Earnings (loss) per common share:
 
 
 
 
 
 
 
Basic
$
0.50

 
$
0.27

 
$
3.60

 
$
(0.21
)
Diluted
$
0.49

 
$
0.27

 
$
3.56

 
$
(0.21
)
Weighted average common shares outstanding:
 
 
 
 
 
 
 
Basic
30,221

 
30,503

 
30,137

 
30,779

Diluted
30,783

 
30,849

 
30,557

 
30,779


See Notes to Condensed Consolidated Financial Statements
8



KRATON CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)
(Unaudited)
(In thousands)
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
Net income (loss) attributable to Kraton
$
15,560

 
$
8,446

 
$
111,048

 
$
(6,574
)
Other comprehensive income (loss):
 
 
 
 
 
 
 
Foreign currency translation adjustments, net of tax of $0
3,994

 
(14,972
)
 
27,311

 
(38,787
)
Unrealized loss on cash flow hedges, net of tax benefit of $27 and $2,737 for 2016 respectively
(48
)
 

 
(5,354
)
 

Other comprehensive income (loss), net of tax
3,946

 
(14,972
)
 
21,957

 
(38,787
)
Comprehensive income (loss) attributable to Kraton
19,506

 
(6,526
)
 
133,005

 
(45,361
)
Comprehensive income (loss) attributable to noncontrolling interest
339

 
(2,717
)
 
(199
)
 
(2,579
)
Consolidated comprehensive income (loss)
$
19,845

 
$
(9,243
)
 
$
132,806

 
$
(47,940
)

See Notes to Condensed Consolidated Financial Statements
9



KRATON CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CHANGES IN EQUITY
(Unaudited)
(In thousands)
 
 
Common Stock
 
Additional Paid in Capital
 
Retained Earnings
 
Accumulated Other Comprehensive Loss
 
Total Kraton Stockholders' Equity
 
Noncontrolling Interest
 
Total Equity
Balance at December 31, 2014
$
318

 
$
361,342

 
$
168,041

 
$
(99,218
)
 
$
430,483

 
$
37,668

 
$
468,151

Net loss

 

 
(6,574
)
 

 
(6,574
)
 
(1,141
)
 
(7,715
)
Other comprehensive loss

 

 

 
(38,787
)
 
(38,787
)
 
(1,438
)
 
(40,225
)
Retired treasury stock from employee tax withholdings

 
(570
)
 

 

 
(570
)
 

 
(570
)
Retired treasury stock from share repurchases
(16
)
 
(20,930
)
 
(10,375
)
 

 
(31,321
)
 

 
(31,321
)
Exercise of stock options
1

 
1,021

 

 

 
1,022

 

 
1,022

Non-cash compensation related to equity awards
2

 
6,599

 

 

 
6,601

 

 
6,601

Balance at September 30, 2015
$
305

 
$
347,462

 
$
151,092

 
$
(138,005
)
 
$
360,854

 
$
35,089

 
$
395,943

 
 
 
 
 
 
 
 
 
 
 
 
 
 
Balance at December 31, 2015
$
306

 
$
349,871

 
$
147,131

 
$
(138,568
)
 
$
358,740

 
$
34,252

 
$
392,992

Net income (loss)

 

 
111,048

 

 
111,048

 
(1,792
)
 
109,256

Other comprehensive income

 

 

 
21,957

 
21,957

 
1,593

 
23,550

Retired treasury stock from employee tax withholdings
(1
)
 
(966
)
 

 

 
(967
)
 

 
(967
)
Exercise of stock options
1

 
2,624

 

 

 
2,625

 

 
2,625

Non-cash compensation related to equity awards
3

 
7,269

 

 

 
7,272

 

 
7,272

Balance at September 30, 2016
$
309

 
$
358,798

 
$
258,179

 
$
(116,611
)
 
$
500,675

 
$
34,053

 
$
534,728


See Notes to Condensed Consolidated Financial Statements
10



KRATON CORPORATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
(In thousands)
 
Nine Months Ended September 30,
 
2016
 
2015
CASH FLOWS FROM OPERATING ACTIVITIES
 
 
 
Consolidated net income (loss)
$
109,256

 
$
(7,715
)
Adjustments to reconcile consolidated net income (loss) to net cash provided by operating activities:
 
 
 
Depreciation and amortization
93,913

 
46,852

Amortization of debt premium and original issue discount
4,893

 
(130
)
Amortization of debt issuance costs
5,343

 
1,668

(Gain) loss on disposal of property, plant, and equipment
452

 
(60
)
Disposition and exit of business activities
(40,001
)
 

Loss on extinguishment of debt
13,423

 

Earnings from unconsolidated joint venture, net of dividends received
136

 
90

Deferred income tax benefit
(4,343
)
 
(2,270
)
Release of valuation allowance
(86,631
)
 

Share-based compensation
7,272

 
6,601

Decrease (increase) in:
 
 
 
Accounts receivable
(18,114
)
 
(9,693
)
Inventories of products, materials, and supplies
44,035

 
50,462

Other assets
(3,044
)
 
(2,022
)
Increase (decrease) in:
 
 
 
Accounts payable-trade
(2,981
)
 
(2,988
)
Other payables and accruals
(401
)
 
1,548

Other long-term liabilities
4,631

 
1,536

Due to related party
(1,710
)
 
(2,306
)
Net cash provided by operating activities
126,129

 
81,573

CASH FLOWS FROM INVESTING ACTIVITIES
 
 
 
Kraton purchase of property, plant, and equipment
(62,885
)
 
(42,384
)
KFPC purchase of property, plant, and equipment
(16,995
)
 
(46,097
)
Purchase of software and other intangibles
(4,691
)
 
(1,763
)
Acquisition, net of cash acquired
(1,312,105
)
 

Sale of assets
72,803

 

Net cash used in investing activities
(1,323,873
)
 
(90,244
)
CASH FLOWS FROM FINANCING ACTIVITIES
 
 
 
Proceeds from debt
1,782,965

 
30,000

Repayments of debt
(480,133
)
 
(30,000
)
KFPC proceeds from debt
24,368

 
55,622

Capital lease payments
(105
)
 
(99
)
Purchase of treasury stock
(967
)
 
(31,891
)
Proceeds from the exercise of stock options
2,625

 
1,022

Settlement of interest rate swap
(5,155
)
 

Debt issuance costs
(57,646
)
 

Net cash provided by financing activities
1,265,952

 
24,654

Effect of exchange rate differences on cash
5,291

 
(6,002
)
Net increase in cash and cash equivalents
73,499

 
9,981

Cash and cash equivalents, beginning of period
70,049

 
53,818

Cash and cash equivalents, end of period
$
143,548

 
$
63,799

Supplemental disclosures:
 
 
 
Cash paid during the period for income taxes, net of refunds received
$
7,788

 
$
5,435

Cash paid during the period for interest, net of capitalized interest
$
56,972

 
$
21,690

Capitalized interest
$
4,022

 
$
3,342

Supplemental non-cash disclosures:
 
 
 
Property, plant, and equipment accruals
$
30,494

 
$
16,023

Asset acquired through capital lease
$

 
$
681


See Notes to Condensed Consolidated Financial Statements
11



KRATON CORPORATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)
1. General
Description of our Business. 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. The operating results of Arizona Chemical have been included in these financial statements since January 6, 2016, the date of the Arizona Chemical Acquisition.
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, and paving and roofing products. We also manufacture and 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.
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.
References in this report to “Kraton,” “our company,” “we,” “our,” “ours” and “us” as used in this report refer collectively to Kraton Corporation 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 prior to the January 6, 2016 Arizona Chemical Acquisition.
Basis of Presentation. The accompanying unaudited Condensed 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. These interim financial statements should be read in conjunction with the consolidated financial statements included in our Annual Report on Form 10-K for the fiscal year ended December 31, 2015 and reflect all normal recurring adjustments that are, in the opinion of management, necessary to present fairly our results of operations and financial position. Amounts reported in our Condensed Consolidated Statements of Operations are not necessarily indicative of amounts expected for the respective annual periods or any other interim period, in particular due to the effect of seasonal changes and weather conditions that typically affect our sales into paving, roadmarking, roofing and construction applications. In particular, sales volumes into these applications are generally higher in the second and third quarter of the calendar year as warm and dry weather is more conducive to paving and roofing activity.
Significant Accounting Policies. Our significant accounting policies have been disclosed in Note 1 Description of Business, Basis of Presentation, and Significant Accounting Policies in our most recent Annual Report on Form 10-K. In connection with the Arizona Chemical Acquisition, we updated our accounting policies as follows.
Goodwill and Other Intangible Assets. We record goodwill when the purchase price of an acquired business exceeds the fair value of the net identifiable assets acquired. Goodwill and intangible assets are allocated to the reporting unit level based on the estimated fair value at the date of the Arizona Chemical Acquisition.
Goodwill and other indefinite-lived intangible assets are tested for impairment at the reporting unit level annually or more frequently as deemed necessary. Our annual measurement date for testing impairment is October 1st. The impairment test includes a comparison of the carrying value of net assets of our reporting units, including goodwill, with their estimated fair values. If the carrying value exceeds the estimated fair value, an impairment charge is recognized in the period in which the review is performed.
There have been no other changes to the accounting policies as disclosed in our most recent Annual Report on Form 10-K. The accompanying unaudited Condensed Consolidated Financial Statements we present in this report have been prepared in accordance with our policies.

12



Use of Estimates. The preparation of the Condensed 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 Condensed Consolidated Financial Statements and the reported amounts of revenues 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 long-lived assets;
estimates of fair value for assets acquired and liabilities assumed in business combinations;
allowances for doubtful accounts and sales returns;
the valuation of derivatives, deferred tax assets, property, plant and equipment, intangible assets, inventory, investments, and share-based compensation; and
liabilities for employee benefit obligations, environmental matters, asset retirement obligations (“ARO”), income tax uncertainties and other contingencies.
Income Tax in Interim Periods. We conduct operations in separate legal entities in different jurisdictions. As a result, income tax amounts are reflected in these Condensed Consolidated Financial Statements for each of those jurisdictions. Tax laws and tax rates vary substantially in these jurisdictions and are subject to change based on the political and economic climate in those countries. We file our tax returns in accordance with our interpretations of each jurisdiction’s tax laws. We record our tax provision or benefit on an interim basis using the estimated annual effective tax rate. This rate is applied to the current period ordinary income or loss to determine the income tax provision or benefit allocated to the interim period.
Losses from jurisdictions for which no benefit can be realized and the income tax effects of unusual and infrequent items are excluded from the estimated annual effective tax rate. Valuation allowances are provided against the future tax benefits that arise from the losses in jurisdictions for which no benefit can be realized. The effects of unusual and infrequent items are recognized in the impacted interim period as discrete items.
The estimated annual effective tax rate may be significantly affected by nondeductible expenses and by our projected earnings mix by tax jurisdiction. Adjustments to the estimated annual effective income tax rate are recognized in the period during which such estimates are revised.
We have established valuation allowances against a variety of deferred tax assets, including net operating loss carryforwards, foreign tax credits and other income tax credits. Valuation allowances take into consideration our expected ability to realize these deferred tax assets and reduce the value of such assets to the amount that is deemed more likely than not to be recoverable. Our ability to realize these deferred tax assets is dependent on achieving our forecast of future taxable operating income over an extended period of time. We review our forecast in relation to actual results and expected trends on a quarterly basis. If we fail to achieve our operating income targets, we may change our assessment regarding the recoverability of our net deferred tax assets and such change could result in a valuation allowance being recorded against some or all of our net deferred tax assets. A change in our valuation allowance would impact our income tax benefit (expense) and our stockholders’ equity and could have a significant impact on our results of operations or financial condition in future periods.

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 affect our financial statements.
In February 2015, the Financial Accounting Standards Board (the “FASB”) issued Accounting Standards Update (“ASU”) No. 2015-02, Consolidation (Topic 810): Amendments to the Consolidation Analysis. This standard changes the consolidation analysis currently required under U.S. generally accepted accounting principles (“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 adopted this standard in the first quarter of 2016 and there was no 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 adopted this standard in the first quarter of 2016. As a result of retrospective application, the adoption of this standard resulted in reductions of approximately $1.3 million, $12.1 million, and $13.5 million of other current assets, debt issuance costs, and

13



long-term debt, respectively, as of December 31, 2015. Furthermore, we had a material change in debt issuance costs in association with the financing for the Arizona Chemical Acquisition in the first quarter of 2016. See Note 8 Long Term Debt for further information about debt issuance costs as of September 30, 2016.
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 adopted this standard in the first quarter of 2016 and will apply such guidance on our recording of the Arizona Chemical Acquisition. See Note 3 Acquisition of Arizona Chemical for further information about the measurement period for this acquisition.
New Accounting Standards
In May 2014, the FASB issued ASU No. 2014-09, Revenue from Contracts with Customers, updated by ASU No. 2015-14 Deferral of the Effective Date, 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 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 do not expect there to be a material impact on our consolidated financial statements.
In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842). This standard requires that an entity must recognize in the statement of financial position a liability to make lease payments (the lease liability) and a right-of-use asset representing its right to use the underlying asset for the lease term. For leases with a term of twelve months or less, a lessee is permitted to make an accounting policy election by class of underlying asset not to recognize lease assets and liabilities. The standard is effective for fiscal years, and interim periods within those years, beginning after December 15, 2018 and early adoption is permitted. 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 March 2016, the FASB issued ASU 2016-09, Improvements to Employee Share-Based Payment Accounting (Topic 817). The ASU changes seven aspects of the accounting for share-based payment award transactions, including: (1) accounting for income taxes; (2) classification of excess tax benefits on the statement of cash flows; (3) forfeitures; (4) minimum statutory tax withholding requirements; (5) classification of employee taxes paid on the statement of cash flows when an employer withholds shares for tax-withholding purposes; (6) practical expedient - expected term (nonpublic only); (7) intrinsic value (nonpublic only). The standard is effective for fiscal years, and interim periods within those years, beginning after December 15, 2016, and early adoption is permitted. 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 August 2016, the FASB issued ASU 2016-15, Statement of Cash Flows (Topic 230). The ASU addresses eight specific cash flow issues with the objective of reducing the existing diversity in practice. The standard is effective for fiscal years, and interim periods within those years, beginning after December 15, 2017, and early adoption is permitted. 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.

3. Acquisition of Arizona Chemical
On January 6, 2016, we acquired all of the capital stock of Arizona Chemical for a purchase price of $1,361.9 million. In accordance with the sale and purchase agreement, we finalized the purchase price with the sellers and received $5.1 million of cash during the nine months ended September 30, 2016.
The $1,361.9 million 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:

14



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.
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 8 Long-Term Debt to the Condensed Consolidated Financial Statements for a further description of the debt issued to finance the Arizona Chemical Acquisition.
We have accounted for the Arizona Chemical Acquisition using the purchase method of accounting for business combinations. Accordingly, the purchase price has been allocated to the underlying assets and liabilities in proportion to their respective fair values. The excess of the purchase price over the estimated fair value of the net assets acquired has been recorded as goodwill. Following the close of the Arizona Chemical Acquisition, the operating results of Arizona Chemical are reported as a separate operating segment, “Chemical segment”. See Note 13 Industry Segments and Foreign Operations for further information.
For the three and nine months ended September 30, 2016, respectively, we recognized $6.6 million and $25.1 million of transaction and integration related costs which are included in selling, general, and administrative expenses in the Condensed Consolidated Statements of Operations.
The following table summarizes the preliminary purchase price allocation for the Arizona Chemical Acquisition. This allocation is based on management’s estimates, judgments, and assumptions which are subject to change upon final valuation and should be treated as preliminary values. We have not finalized the allocation of the purchase consideration to the estimated fair value of (1) property, plant, and equipment; (2) intangible assets; (3) deferred income taxes and uncertain tax positions, and we are continuing to review all of the working capital acquired.
 
Weighted Average Amortization Period
Fair Value
 
 
(In thousands)
Cash
 
$
49,835

Inventories(1)
 
122,305

Litigation asset
 
94,204

Accounts receivable and other current assets
 
118,394

Property, plant, and equipment
 
350,584

Intangible assets:(2)
12.9 years
 
Contractual Agreements
12 years
260,400

Customer Relationships
17 years
25,000

Technology
16 years
100,000

Trade Name
10 years
50,000

Software
3-5 years
4,140

Goodwill(3)
 
753,874

Other long-term assets
 
3,662

 
 
 
Current liabilities
 
(128,070
)
Income tax liabilities
 
(301,285
)
Leases
 
(422
)
Other long-term liabilities
 
(140,681
)
Purchase price
 
1,361,940

 
 
 
Cash
 
49,835

Purchase price, net of cash acquired
 
$
1,312,105

_______________________
(1)
An adjustment of approximately $24.7 million was recorded to reflect Arizona Chemical's inventories at fair value and increased cost of sales by the same amount for the nine months ended September 30, 2016.

15



(2)
Aggregate amortization expense was approximately $26.8 million from January 6, 2016 through September 30, 2016. Estimated amortization expense 2016$35.1 million; 2017$35.6 million; 2018$35.4 million; 2019$35.4 million; and 2020$34.4 million.
(3)
During the third quarter of 2016, we adjusted the preliminary purchase price allocation based on further review of the assets acquired and liabilities assumed. Based on additional analysis of the underlying contracts, we decreased the customer relationship intangible asset by $80.0 million and increased the contractual agreement intangible asset by $70.0 million.  The remaining adjustments related to various working capital accounts that required fair value modifications, primarily related to current liabilities and income tax liabilities.  Each of these measurement period adjustments correspondingly increased goodwill.
Goodwill has been calculated as the excess of the consideration transferred over the net assets acquired and represents the estimated future economic benefits arising from other assets acquired that could not be individually identified and separately recognized. See Note 13 Industry Segments and Foreign Operations for further information regarding our reportable segments. Goodwill recognized as a result of the acquisition is not deductible for tax purposes.
We are continuing to evaluate the option to apply pushdown accounting, which would result in recording the various assets acquired and liabilities assumed at their fair value at the date of the Arizona Chemical Acquisition in each domestic and foreign legal entity of Arizona Chemical for financial reporting purposes.
The fair value of acquired identifiable intangible assets was determined using the “income approach” on an individual project basis. In performing these valuations, the key underlying probability-adjusted assumptions of the discounted cash flows were projected revenues, gross margin expectations, and operating cost estimates, when appropriate. The valuations were based on the information that was available as of the acquisition date and the expectations and assumptions that have been deemed reasonable by the Company’s management. There are inherent uncertainties and management judgment required in these determinations. The fair value measurements of the assets acquired and liabilities assumed were based on valuations involving significant unobservable inputs, or Level 3 in the fair value hierarchy.
The purchase price of Arizona Chemical exceeded the net acquisition-date amounts of the identifiable assets acquired and the liabilities assumed. Cash flows used to determine the purchase price included strategic and synergistic benefits specific to the Company, which resulted in a purchase price in excess of the fair value of identifiable net assets. The purchase price also included the fair values of other assets that were not identifiable, not separately recognizable under accounting rules (e.g., assembled workforce) or of immaterial value in addition to a going-concern element that represents the Company's ability to earn a higher rate of return on the group of assets than would be expected on the separate assets as determined during the valuation process.
Arizona Chemical contributed revenue and net income of $542.6 million and $37.1 million, respectively, to the consolidated operating results of Kraton for the period from January 6, 2016 through September 30, 2016. The following unaudited pro forma information presents consolidated information as if the Arizona Chemical Acquisition had occurred on January 1, 2015:
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
 
(In thousands, except per share data)
Revenue
$
454,143

 
$
476,493

 
$
1,328,715

 
$
1,407,306

Net income (loss) attributable to Kraton
$
15,560

 
$
11,406

 
$
135,840

 
$
10,715

Earnings per share
 
 
 
 
 
 
 
Basic
$
0.50

 
$
0.37

 
$
4.41

 
$
0.34

Diluted
$
0.49

 
$
0.36

 
$
4.35

 
$
0.34

The unaudited pro forma information presented above is for information purposes only and is not necessarily indicative of the operating results that would have occurred had the Arizona Chemical Acquisition been consummated at the beginning of the period, nor is it necessarily indicative of future operating results. The unaudited pro forma amounts above have been calculated after applying Kraton's accounting policies and adjusting the Arizona Chemical results to reflect (1) the additional depreciation and amortization that would have been charged assuming the fair value adjustments to property, plant, and equipment and intangible assets had been applied from January 1, 2015; (2) the elimination of historical interest expense for Arizona Chemical as this debt was paid off by the previous owners; (3) the additional interest expense resulting from the debt issued to fund the Arizona Chemical Acquisition; (4) the elimination of transaction-related costs; (5) the effect of purchase price accounting on inventory valuation; and (6) an adjustment to tax-effect the aforementioned unaudited pro forma adjustments using an estimated aggregate statutory income tax rate of the jurisdiction to which the above adjustments relate. The unaudited pro forma amounts do not include any potential synergies, cost savings or other expected benefits of the Arizona Chemical Acquisition.


16



4. Disposition and Exit of Business Activities
Exit of NEXARTM 
In June 2016, we exited our NEXARTM product line due to the loss of certain key customers. We recorded a loss related to this exit activity of $8.6 million in the nine months ended September 30, 2016. This loss includes $5.3 million for the write off of inventory and associated disposal costs and $3.2 million for the write off of fixed assets.
Disposition of Joint Venture
In May 2016, as the result of a legal settlement with our joint venture partner BASF, S.A., we dissolved our joint venture in Paulinia, Brazil. As part of the settlement, we obtained 100% interests in the joint venture and the real estate, building, and other assets of the joint venture located at our Paulinia manufacturing facility. In accordance with ASC 323-10-35 Dissolution of a Joint Venture, we recorded a gain of $3.2 million during the nine months ended September 30, 2016 for the fair market value of these assets less the carrying value of our investment in the joint venture.
Sale of Belpre Compounding Unit
On January 29, 2016, we sold certain assets including intellectual property, inventory, equipment, and other intangible assets associated with our Belpre, Ohio, compounding unit (the “BCU”) for total proceeds of $72.8 million, of which $72.0 million was used to pay down existing indebtedness during the first quarter of 2016. The BCU is used to manufacture HSBC and USBC based compounds. We recognized a gain on the sale of $45.4 million during the nine months ended September 30, 2016. In connection with the sale, we entered into an exclusive polymer supply agreement with a seven year term and a compound manufacturing agreement for a transition period of up to two years with the purchaser. Our historical compound sales have primarily been directed into personal care, protective film, consumer, medical and automotive applications, with the compound sales primarily reported under the Specialty Polymers product group.

5. Share-Based Compensation
We account for share-based awards under the provisions of ASC 718, Compensation—Stock Compensation. 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 $2.1 million and $2.0 million for the three months ended September 30, 2016 and 2015, respectively, and $7.3 million and $6.6 million for the nine months ended September 30, 2016 and 2015, respectively.


17



6. Detail of Certain Balance Sheet Accounts
 
September 30, 2016
 
December 31, 2015
 
(In thousands)
Inventories of products:
 
 
 
Finished products
$
230,932

 
$
211,273

Work in progress
4,618

 
4,501

Raw materials
86,295

 
48,333

Total inventories of products
$
321,845

 
$
264,107

 
 
 
 
Intangible assets:
 
 
 
Contractual agreements
$
261,051

 
$

Technology
145,965

 
45,553

Customer relationships
60,207

 
35,145

Tradenames/trademarks
77,390

 
26,562

Software
42,324

 
34,435

Intangible assets
586,937

 
141,695

Less accumulated amortization:
 
 
 
Contractual agreements
16,421

 

Technology
42,825

 
35,833

Customer relationships
31,031

 
28,170

Tradenames/trademarks
23,880

 
18,819

Software
21,204

 
17,271

Total accumulated amortization
135,361

 
100,093

Intangible assets, net of accumulated amortization
$
451,576

 
$
41,602

 
 
 
 
Other payables and accruals:
 
 
 
Employee related
$
31,240

 
$
23,850

Interest payable
40,176

 
8,004

Arizona Chemical transaction accrual

 
18,267

Property, plant, and equipment accruals
24,352

 
16,142

Other
61,562

 
24,748

Total other payables and accruals
$
157,330

 
$
91,011

 
 
 
 
Other long-term liabilities:
 
 
 
Pension and other post-retirement benefits
$
120,100

 
$
85,997

Other
21,205

 
10,995

Total other long-term liabilities
$
141,305

 
$
96,992



18



Changes in accumulated other comprehensive loss by component were as follows:
 
Cumulative Foreign Currency Translation
 
Net Unrealized Loss on Cash Flow Hedges
 
Net Unrealized Loss on Net Investment Hedges
 
Benefit Plans Liability, Net of Tax
 
Total
 
(In thousands)
December 31, 2014
$
(21,870
)
 
$

 
$
(1,926
)
 
$
(75,422
)
 
$
(99,218
)
Other comprehensive loss before reclassifications
(38,787
)
 

 

 

 
(38,787
)
Amounts reclassified from accumulated other comprehensive loss

 

 

 

 

Net other comprehensive loss for the year
(38,787
)
 

 

 

 
(38,787
)
September 30, 2015
(60,657
)
 

 
(1,926
)
 
(75,422
)
 
(138,005
)
 
 
 
 
 
 
 
 
 
 
December 31, 2015
(65,995
)
 

 
(1,926
)
 
(70,647
)
 
(138,568
)
Other comprehensive income (loss) before reclassifications
27,311

 
(5,354
)
 

 

 
21,957

Amounts reclassified from accumulated other comprehensive income (loss)

 

 

 

 

Net other comprehensive income (loss) for the year
27,311

 
(5,354
)
 

 

 
21,957

September 30, 2016
$
(38,684
)
 
$
(5,354
)
 
$
(1,926
)
 
$
(70,647
)
 
$
(116,611
)


19



7. 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 is excluded from the calculation of EPS allocated to common stock. Our restricted stock awards are subject to forfeiture and restrictions on transfer until vested and have identical voting, income and distribution rights to the unrestricted common shares outstanding. Our weighted average restricted stock awards outstanding were 653,434 and 558,431 for the three months ended September 30, 2016 and 2015, respectively, and 671,722 and 553,400 for the nine months ended September 30, 2016 and 2015, respectively. We withheld shares of restricted stock of 55,580 and 27,947 for the nine months ended September 30, 2016 and 2015, respectively, to satisfy employee payroll tax withholding requirements and none withheld during the three months ended September 30, 2016 and 2015, respectively. We immediately retired all shares withheld and the transactions were reflected in additional paid in capital in the Condensed Consolidated Statements of Changes in Equity and as a purchase of treasury stock in the Condensed Consolidated Statements of Cash Flows.
The computation of diluted EPS includes weighted average restricted share units of 172,933 and 143,204 for the three months ended September 30, 2016 and 2015, respectively, and 175,798 for the nine months ended September 30, 2016. The computation of diluted EPS excludes weighted average restricted share units of 133,317 for the nine months ended September 30, 2015, as they are anti-dilutive due to a net loss attributable to Kraton for each period.
The computation of diluted EPS includes weighted average performance share units of 32,498 and 32,498 for the three months ended September 30, 2016 and 2015, respectively, and 32,498 for the nine months ended September 30, 2016. The computation of diluted EPS excludes weighted average performance share units of 33,564 for the nine months ended September 30, 2015, as they are anti-dilutive due to a net loss attributable to Kraton for each period. 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 496,220 for the three and nine months ended September 30, 2016 and 279,328 for the three and nine months ended September 30, 2015.
The computation of diluted EPS includes stock options added under the treasury method of 357,303 and 170,602 for the three months ended September 30, 2016 and 2015, respectively, and 212,005 for the nine months ended September 30, 2016. The computation of diluted EPS excludes the effect of the potential exercise of stock options that are anti-dilutive, amounting to 906,954 and 1,472,988 for the three and nine months ended September 30, 2015, respectively.

20



The calculations of basic and diluted EPS are as follows:
 
 
 
 
 
 
 
 
 
 
 
 
 
Three Months Ended September 30, 2016
 
Three Months Ended September 30, 2015
 
Net Income Attributable to Kraton
 
Weighted Average Shares Outstanding
 
Earnings Per Share
 
Net Income Attributable to Kraton
 
Weighted Average Shares Outstanding
 
Earnings Per Share
 
(In thousands, except per share data)
Basic:
 
 
 
 
 
 
 
 
 
 
 
As reported
$
15,560

 
30,874

 
 
 
$
8,446

 
31,061

 
 
Amounts allocated to unvested restricted shares
(329
)
 
(653
)
 
 
 
(152
)
 
(558
)
 
 
Amounts available to common stockholders
15,231

 
30,221

 
$
0.50

 
8,294

 
30,503

 
$
0.27

Diluted:
 
 
 
 
 
 
 
 
 
 
 
Amounts allocated to unvested restricted shares
329

 
653

 
 
 
152

 
558

 
 
Non participating share units

 
205

 
 
 

 
175

 
 
Stock options added under the treasury stock method

 
357

 
 
 

 
171

 
 
Amounts reallocated to unvested restricted shares
(323
)
 
(653
)
 
 
 
(150
)
 
(558
)
 
 
Amounts available to stockholders and assumed conversions
$
15,237

 
30,783

 
$
0.49

 
$
8,296

 
30,849

 
$
0.27

 
Nine Months Ended September 30, 2016
 
Nine Months Ended September 30, 2015
 
Net Income Attributable to Kraton
 
Weighted Average Shares Outstanding
 
Earnings Per Share
 
Net Loss Attributable to Kraton
 
Weighted Average Shares Outstanding
 
Loss Per Share
 
(In thousands, except per share data)
Basic:
 
 
 
 
 
 
 
 
 
 
 
As reported
$
111,048

 
30,809

 
 
 
$
(6,574
)
 
31,332

 
 
Amounts allocated to unvested restricted shares
(2,422
)
 
(672
)
 
 
 
116

 
(553
)
 
 
Amounts available to common stockholders
108,626

 
30,137

 
$
3.60

 
(6,458
)
 
30,779

 
$
(0.21
)
Diluted:
 
 
 
 
 
 
 
 
 
 
 
Amounts allocated to unvested restricted shares
2,422

 
672

 
 
 
(116
)
 
553

 
 
Non participating share units

 
208

 
 
 

 

 
 
Stock options added under the treasury stock method

 
212

 
 
 

 

 
 
Amounts reallocated to unvested restricted shares
(2,390
)
 
(672
)
 
 
 
116

 
(553
)
 
 
Amounts available to stockholders and assumed conversions
$
108,658

 
30,557

 
$
3.56

 
$
(6,458
)
 
30,779

 
$
(0.21
)


21



8. Long-Term Debt
Long-term debt consists of the following:
 
September 30, 2016
 
December 31, 2015
 
Principal
 
Discount
 
Debt Issuance Costs
 
Total
 
Principal
 
Premium
 
Debt Issuance Costs(1)
 
Total
 
(In thousands)
Term Loan
$
1,278,000

 
$
(35,708
)
 
$
(33,122
)
 
$
1,209,170

 
$

 
$

 
$
(6,000
)
 
$
(6,000
)
10.5% Senior Notes
440,000

 
(16,509
)
 
(17,951
)
 
405,540

 

 

 
(2,819
)
 
(2,819
)
6.75% Senior Notes

 

 

 

 
350,000

 
651

 
(4,268
)
 
346,383

KFPC Loan Agreement
106,128

 

 
(280
)
 
105,848

 
76,912

 

 
(378
)
 
76,534

Capital lease obligation
1,529

 

 

 
1,529

 
1,634

 

 

 
1,634

Total debt
1,825,657

 
(52,217
)
 
(51,353
)
 
1,722,087

 
428,546

 
651

 
(13,465
)
 
415,732

Less current portion of total debt
23,135

 

 

 
23,135

 
141

 

 

 
141

Long-term debt
$
1,802,522

 
$
(52,217
)
 
$
(51,353
)
 
$
1,698,952

 
$
428,405

 
$
651

 
$
(13,465
)
 
$
415,591

 
_____________________________________________ 
(1) Prior to the adoption of ASU No. 2015-03, debt issuance costs of $1.3 million and $12.1 million were previously recorded in other current assets and debt issuance costs, respectively in the Consolidated Balance Sheet as of December 31, 2015.
Debt Issuance Costs. We capitalize the 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 are recorded as a component of interest expense and the accelerated write-off of debt issuance costs in connection with refinancing activities are recorded as a component of loss on extinguishment of debt. In conjunction with the closing of the Arizona Chemical Acquisition on January 6, 2016, we amended and restated our asset-based revolving credit facility (“ABL Facility”) and the debt issuance costs associated with these efforts were recorded within other current assets and debt issuance costs in the accompanying Condensed Consolidated Balance Sheets. We deferred $61.3 million of debt issuance costs related to the debt financing in conjunction with the Arizona Chemical Acquisition, of which $8.8 million was deferred in the fourth quarter of 2015, $1.7 million was carried over from our previous debt issuance costs and $50.8 million was deferred during the nine months ended September 30, 2016. In connection with our January 2016 refinancing, we charged to interest expense $5.0 million of unamortized debt issuance costs related to our previously existing indebtedness. We had net debt issuance cost of $56.3 million as of September 30, 2016, of which $5.0 million related to our ABL Facility is recorded as an asset (of which $1.2 million was included in other current assets) and $51.4 million is recorded as a reduction to long-term debt. We amortized $1.8 million and $0.6 million during the three months ended September 30, 2016 and 2015, respectively, and $5.3 million and $1.7 million during the nine months ended September 30, 2016 and 2015, respectively.
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.
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.

22



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 50.0% of such cash flow by the 90th day after the end of the fiscal year. The prepayment percentage is reduced to 25.0% 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 Corporation and each of its 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. The $72.0 million received from the sale of compounding assets was used to pay down existing indebtedness under the Term Loan Facility. As a result, our next scheduled principal payment is not due until the third quarter of 2017.
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 are general unsecured, senior obligations and are unconditionally guaranteed on a senior unsecured basis by each of Kraton Corporation 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, and paid the first interest payment on October 14, 2016. Prior to October 15, 2018, we may redeem up to 40.0% of the aggregate principal amount of the 10.5% Senior Notes with the net proceeds of certain equity offerings at a redemption price equal to 110.5% 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 2021 and thereafter, we may redeem all or a part of the 10.5% Senior Notes for 107.875%, 105.250%, 102.625%, and 100.0% of the principal amount, respectively.
ABL Facility. In January 2016, we entered into an amended and restated ABL Facility which provides financing of up to $250.0 million. We did not have any borrowings drawn under this facility as of September 30, 2016. The ABL Facility is primarily secured by receivables and inventory, and borrowing availability under the ABL 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 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 the 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 un-utilized commitments at an annual rate of 0.375%.

23



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 ABL facility is below a specified amount. Our failure to comply with this financial 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 ABL 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 the 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 the 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.
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 $175.3 million (converted at the September 30, 2016 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 $136.7 million (converted at the September 30, 2016 exchange rate), to fund KFPC’s capital expenditures, and a NTD 1.21 billion Tranche B, or $38.6 million (converted at the September 30, 2016 exchange rate), to fund working capital requirements and/or general corporate purposes. As of September 30, 2016, NTD 3.3 billion, or $106.1 million (converted at the September 30, 2016 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 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. For the three and nine months ended September 30, 2016, our effective interest rate for borrowings on the KFPC Loan Agreement was 1.80%.
The KFPC Loan Agreement contains certain financial covenants that 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 at the end of the year of 2016, which will increase to 5.0 to 1.0 at the end of the year of 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.

24



Debt Maturities. The remaining principal payments on our outstanding total debt as of September 30, 2016, are as follows:
 
Principal Payments
 
(In thousands)
October 1, 2016 through September 30, 2017
$
23,135

October 1, 2017 through September 30, 2018
88,882

October 1, 2018 through September 30, 2019
88,892

October 1, 2019 through September 30, 2020
120,741

October 1, 2020 through September 30, 2021
67,688

Thereafter
1,436,319

Total debt
$
1,825,657

See Note 9 Fair Value Measurements, Financial Instruments, and Credit Risk for fair value information related to our long-term debt.

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 are 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 September 30, 2016 and December 31, 2015. 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, which judgment may affect the valuation of their fair value and placement within the fair value hierarchy levels.

25



 
 
 
 
 
Fair Value Measurements at Reporting Date Using
 
Balance Sheet Location
 
September 30, 2016
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
 
 
 
(In thousands)
Derivative asset – current
Other current assets
 
$
33

 
$

 
$
33

 
$

Retirement plan asset – noncurrent
Other long-term assets
 
2,508

 
2,508

 

 

Derivative liability – current
Other payables and accruals
 
(2,409
)
 

 
(2,409
)
 

Derivative liability – noncurrent
Other long-term liability
 
(5,620
)
 

 
(5,620
)
 

Total
 
 
$
(5,488
)
 
$
2,508

 
$
(7,996
)
 
$

 
 
 
 
 
Fair Value Measurements at Reporting Date Using
 
Balance Sheet Location
 
December 31, 2015
 
Quoted Prices in Active Markets for Identical Assets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
 
 
 
(In thousands)
Retirement plan asset – current
Other current assets
 
$
272

 
$
272

 
$

 
$

Retirement plan asset – noncurrent
Other long-term assets
 
1,636

 
1,636

 

 

Total
 
 
$
1,908

 
$
1,908

 
$

 
$

The following table presents the carrying values and approximate fair values of our long-term debt.
 
September 30, 2016
 
December 31, 2015
 
Carrying Value
 
Fair Value
 
Carrying Value
 
Fair Value
 
(In thousands)
Term Loan (significant other observable inputs – level 2)
$
1,278,000

 
$
1,290,780

 
$

 
$

10.5% Senior Notes (quoted prices in active market for identical assets – level 1)
$
440,000

 
$
494,441

 
$

 
$

6.75% Senior Notes (quoted prices in active market for identical assets – level 1)
$

 
$

 
$
350,000

 
$
350,000

Capital lease obligation (significant other observable inputs – level 2)
$
1,529

 
$
1,529

 
$
1,634

 
$
1,634

KFPC Loan Agreement
$
106,128

 
$
106,128

 
$
76,912

 
$
76,912


26



Financial Instruments    
Interest Rate Swap Agreements. Periodically, we enter into interest rate swap agreements to hedge or otherwise protect against interest rate fluctuation 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 February 18, 2016, we entered into a series of interest rate swap agreements in an effort to convert a substantial portion of our future interest payments pursuant to the Term Loan Facility to a fixed interest rate. On February 18, 2016, we entered into two interest rate swaps, each with a notional value of $323.9 million, an effective date of January 3, 2017 and a maturity date of December 31, 2020. We entered into two more interest rate swaps on March 21, 2016, each with a notional value of $138.8 million, an effective date of January 3, 2017 and a maturity date of December 31, 2020. We recorded an unrealized loss of $8.0 million in accumulated other comprehensive income (loss) related to the effective portion of these interest rate swap agreements for the nine months ended September 30, 2016.
Foreign Currency Hedges. Periodically, we enter into foreign currency agreements to hedge or otherwise protect against fluctuations in foreign currency exchange rates. These agreements 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. For the three months ended September 30, 2016 and 2015, we settled these hedges and recorded a loss of $0.1 million and a loss of $1.9 million, respectively, and for the nine months ended September 30, 2016 and 2015, we settled these hedges and recorded a gain of $1.4 million and a loss of $5.9 million, respectively, which are recorded in cost of goods sold in the Condensed Consolidated Statements of Operations. 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.
On January 6, 2016, we acquired several foreign currency forward contracts from Arizona Chemical, which are used to manage future cash flows with respect to exchange rate fluctuations. One of our subsidiaries, Arizona Chemical BV, a Netherlands based entity with a Euro functional currency, is a party to foreign currency forward contracts to purchase Swedish Krona and United States Dollars to hedge certain intercompany foreign exchange exposures. We have designated both of these forward contracts as a cash flow hedge. These contracts were entered into on various dates beginning in October 2015 through January 6, 2016 with various maturity dates from January 2016 through December 2016. The notional amount of these contracts was EUR 2.1 million or $1.8 million (converted at the September 30, 2016 exchange rate). We recorded an unrealized loss of $0.1 million in accumulated other comprehensive income (loss) related to the effective portion of these forward contracts for the nine months ended September 30, 2016.
Credit Risk
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, which we seek to minimize by limiting our counterparties to major financial institutions with acceptable credit ratings and by 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.
We analyze our 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.


27



10. Income Taxes
Income tax expense was $2.2 million and $3.1 million for the three months ended September 30, 2016 and 2015, respectively, and income tax benefit was $83.0 million and income tax expense was $4.1 million during the nine months ended September 30, 2016 and 2015, respectively. Our effective tax rate was an expense of 12.9% and 27.7% for the three months ended September 30, 2016 and 2015, respectively. Our effective tax rate was a benefit of 316.5% and an expense of 115.5% for the nine months ended September 30, 2016 and 2015, respectively. Our effective tax rates differ from the U.S. corporate statutory tax rate of 35.0%, primarily due to the mix of our pretax income or loss generated in various jurisdictions, permanent items, uncertain tax positions, and changes in our valuation allowances. During the nine months ended September 30, 2016, our pretax earnings in the Netherlands, Sweden, and Finland decreased our effective tax rate due to the statutory rates of 25%, 22%, and 20%, respectively. During the nine months ended September 30, 2015, our pretax earnings in the Netherlands decreased our effective tax rate as the statutory rate is 25% and losses generated in Taiwan increased our effective tax rate as the statutory rate is 17%.
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.
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
 
(In thousands)
Income taxes at the statutory rate
$
5,964

 
$
3,883

 
$
9,181

 
$
(1,253
)
State taxes, net of federal benefit
1,114

 

 
521

 

Foreign tax rate differential
(2,436
)
 
(3,628
)
 
(6,018
)
 
(3,920
)
Permanent differences
(2,934
)
 
510

 
(265
)
 
1,547

Uncertain tax positions
292

 
178

 
928

 
490

Valuation allowance
176

 
2,696

 
(87,404
)
 
8,091

Return to provision adjustments
33

 
(521
)
 
33

 
(483
)
Other
(11
)
 
(41
)
 

 
(337
)
Income tax expense (benefit)
$
2,198

 
$
3,076

 
$
(83,024
)
 
$
4,135


 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
Income taxes at the statutory rate
35.0
 %
 
35.0
 %
 
35.0
 %
 
35.0
 %
State taxes, net of federal benefit
6.5

 

 
2.0

 

Foreign tax rate differential
(14.3
)
 
(32.7
)
 
(22.9
)
 
109.5

Permanent differences
(17.2
)
 
4.6

 
(1.0
)
 
(43.2
)
Uncertain tax positions
1.7

 
1.6

 
3.5

 
(13.7
)
Valuation allowance
1.0

 
24.3

 
(333.2
)
 
(226.0
)
Return to provision adjustments
0.2

 
(4.7
)
 
0.1

 
13.5

Other

 
(0.4
)
 

 
9.4

Effective tax rate
12.9
 %
 
27.7
 %
 
(316.5
)%
 
(115.5
)%

28



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 September 30, 2016 and December 31, 2015, we had recorded a valuation allowance of $43.9 million and $100.1 million, respectively, against our net operating loss carryforwards and other deferred tax assets. As part of the Arizona Chemical Acquisition, we reassessed the need for a valuation allowance against our net operating loss deferred tax assets. In our assessment, we consider the level of historical and projected future taxable income expected to be generated. We increased our valuation allowances by $0.2 million for the three months ended September 30, 2016, primarily related to current period net operating losses. We increased our valuation allowance by $2.7 million for the three months ended September 30, 2015, primarily related to current period net operating losses in the U.S. tax jurisdiction. During the nine months ended September 30, 2016, we released $56.2 million of the valuation allowances, of which $87.4 million primarily related to our U.S. net operating loss carryforwards and other deferred tax assets, partially offset by $31.2 million of new valuation allowances assumed in connection with the Arizona Chemical Acquisition. We increased our valuation allowances by $7.0 million for the nine months ended September 30, 2015, which included $8.1 million related to current period net operating losses, partially offset by a $1.1 million decrease related to changes in other comprehensive income (loss).
In purchase accounting, we recorded $61.9 million of deferred taxes on the U.S. parent’s inside basis differences of the acquired foreign assets of Arizona Chemical.
As of September 30, 2016 and December 31, 2015, we had total unrecognized tax benefits of $11.1 million and $4.3 million, respectively, related to uncertain tax positions, all of which, if recognized, would impact our effective tax rate. During the three months ended September 30, 2016 and 2015, we had a decrease in uncertain foreign tax positions of $2.5 million and an increase of $0.2 million, respectively. We had an increase of $6.8 million during the nine months ended September 30, 2016, primarily related to assumed uncertain tax positions in the United States in connection with the Arizona Chemical Acquisition. We had a $0.2 million increase to uncertain foreign tax positions during the nine months ended September 30, 2015. We recorded interest and penalties related to unrecognized tax benefits within the provision for income taxes. During the next twelve months we anticipate decreasing our unrecognized tax benefits by $1.9 million related to certain of our European tax positions as a result of the expiration of the statute of limitations. We are continuing to evaluate the uncertain tax positions assumed in connection with the Arizona Chemical Acquisition.
We file income tax returns in the U.S. federal, 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 of limitations remains open for all years subsequent to 2003. In addition, open tax years for state and foreign jurisdictions remain subject to examination.
      
    
11. Commitments and Contingencies
(a) Lease Commitments
We have entered into various long-term non-cancelable operating leases. Future minimum lease commitments at September 30, 2016 are as follows: 2016—$7.6 million; 2017—$21.9 million; 2018—$15.3 million; 2019—$12.6 million; 2020—$10.9 million; and 2021 and thereafter—$15.3 million.
(b) 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 of Arizona Chemical. 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. Arizona Chemical has filed appeals with the Florida First District Court of Appeal to dispute all three judgments. On May 20, 2016, the appellate court affirmed the jury's verdict on the merits in the underlying case. On July 18, 2016, the appellate court reversed and remanded the trial court’s judgment related to interest. On July 19, 2016, the appellate court affirmed the trial court’s judgment related to the attorneys’ costs. On August 26, 2016, the parties entered into a Mutual Release and Settlement Agreement resolving all matters between the parties. The judgment was fully satisfied by the insurance company in accordance with the terms of the agreement. On September 27, 2016, the Florida Supreme Court issued an order voluntarily dismissing all appeals filed in the matter.
We received an initial notice from the tax authorities in Brazil during the fourth quarter of 2012 in connection with tax credits that were generated from the purchase of certain goods which were subsequently applied by us against taxes owed. The tax authorities are currently assessing R$6.1 million, or $1.9 million (converted at the September 30, 2016 exchange rate). 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.

29



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 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.
(c) Asset Retirement Obligations.
The changes in the aggregate carrying amount of our ARO liabilities are as follows:
 
Nine Months Ended September 30,
 
2016
 
2015
 
(In thousands)
Beginning balance
$
10,078

 
$
10,394

Obligations assumed in Arizona Chemical Acquisition
1,908

 

Additional accruals
2,146

 

Accretion expense
303

 
319

Obligations settled
(3,780
)
 
(25
)
Foreign currency translation, net
138

 
(306
)
Ending Balance
$
10,793

 
$
10,382

We assumed $1.9 million of an ARO liability from Arizona Chemical as of January 6, 2016 associated with the demolition and decommissioning of manufacturing facility assets. For a portion of our ARO liability related to the decommissioning of the coal boilers at our Belpre, Ohio, facility, we have recorded a liability and corresponding receivable of

30



$3.8 million and $3.6 million as of September 30, 2016 and 2015, respectively, pursuant to the indemnity included in the February 2001 separation agreement from Shell Chemicals.
(d) Environmental Obligations.
In connection with the Arizona Chemical Acquisition, we assumed environmental obligations associated with historical site matters. As of September 30, 2016 we have recorded a liability of $3.1 million and a corresponding receivable of $3.1 million relating from an indemnification agreement with International Paper, Arizona Chemical's former owner.
There have been no other material changes to our Commitments and Contingencies disclosed in our most recently filed Annual Report on Form 10-K.


31



12. Employee Benefits
Retirement Plans.
The components of net periodic benefit costs related to pension benefits are as follows: 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2016
 
2015
 
2016
 
2015
 
U.S Plans
 
Non-U.S. Plans
 
U.S Plans
 
Non-U.S. Plans(1)
 
U.S Plans
 
Non-U.S. Plans
 
U.S Plans
 
Non-U.S. Plans(1)
 
(In thousands)
Service cost
$
771

 
$
566

 
$
883

 
$

 
$
2,518

 
$
1,642

 
$
2,648

 
$

Interest cost
1,828

 
632

 
1,620

 

 
5,514

 
2,264

 
4,860

 

Expected return on plan assets
(2,344
)
 
(698
)
 
(2,115
)
 

 
(7,011
)
 
(2,593
)
 
(6,345
)
 

Amortization of prior service cost
648

 
5

 
1,060

 

 
2,048

 
17

 
3,180

 

Net periodic benefit cost
$
903

 
$
505

 
$
1,448

 
$

 
$
3,069

 
$
1,330

 
$
4,343

 
$

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