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Edited Transcript of OMN earnings conference call or presentation 29-Mar-17 3:00pm GMT

Thomson Reuters StreetEvents

Q1 2017 OMNOVA Solutions Inc Earnings Call

FAIRLAWN Jun 1, 2017 (Thomson StreetEvents) -- Edited Transcript of OMNOVA Solutions Inc earnings conference call or presentation Wednesday, March 29, 2017 at 3:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Anne P. Noonan

OMNOVA Solutions Inc. - CEO, President and CEO

* Paul F. DeSantis

OMNOVA Solutions Inc. - CFO and SVP

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Conference Call Participants

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* Atha Baugh

MJX Asset Management, Research Division - Managing Director/Portfolio Manager

* Curtis Alan Siegmeyer

KeyBanc Capital Markets Inc., Research Division - Associate

* Daniel Dalton Rizzo

Jefferies LLC, Research Division - Equity Analyst

* Katherine Anne Griffin

Deutsche Bank AG, Research Division - Research Associate

* Miklavz Bevc

CVC Credit Partners, LLC - Investment Director

* Rosemarie Jeanne Morbelli

G. Research, LLC - Research Analyst

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Presentation

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Operator [1]

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Ladies and gentlemen, thank you for standing by, and welcome to the OMNOVA Solutions First Quarter 2017 Earnings Discussion. (Operator Instructions) As a reminder, today's call is being recorded.

I'll turn the conference over to your host, Ms. Anne Noonan, CEO. Please go ahead.

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Anne P. Noonan, OMNOVA Solutions Inc. - CEO, President and CEO [2]

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Thank you, John, and good morning, everyone. It's a great pleasure to speak with you today. In a moment, I will provide an overview of important operational developments, progress on our strategic direction and our outlook for the business. But first, I'll turn it over to Paul to make comments on forward-looking statements and to summarize our financial performance in the quarter.

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Paul F. DeSantis, OMNOVA Solutions Inc. - CFO and SVP [3]

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Thanks, Anne, and good morning, everyone. During this conference call, OMNOVA representatives may make forward-looking statements as encouraged by the Private Securities Litigation Reform Act of 1995. All statements in this conference call and in subsequent discussions with the company's management other than historical information are forward-looking statements. These statements represent management's current judgment on expectations for future results and other matters. A variety of risk factors highlighted in the company's Form 10-K and in our most recent earnings release could cause business conditions and the company's actual results to differ materially from those expected by the company or expressed in the company's forward-looking statements.

In addition, certain financial measures referred to during this call are non-GAAP financial measures. For an explanation and reconciliation of these non-GAAP measures, see our most recent earnings release and investor presentation published periodically on the company's website.

Here's a quick snapshot of our first quarter. Sales in Performance Chemicals and for the entire company were up year-over-year, excluding the $3.7 million of sales attributable to the nonstrategic business in India, which was sold during the first quarter of last year. The sales growth came from a combination of pricing and growth in key specialty lines, offset by volume declines primarily in the Performance Materials' carpet and paper lines. SG&A was flat with the exception of adjustments and incentive comp plans related to stock price movements compared to last year. Working capital improved by 5 days from the same period last year while adjusted leverage declined from 3.9x to 3.6x adjusted EBITDA. U.S. cash was $23 million. We recorded $1 million of severance costs in the first quarter. We expect to record an additional $4 million to $6 million related to an early retirement program, the streamlining activities associated with the new corporate support structure and additional costs to prepare the Calhoun, Georgia manufacturing plant site for sale.

Thank you, and I'll now turn the call back over to Anne.

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Anne P. Noonan, OMNOVA Solutions Inc. - CEO, President and CEO [4]

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Thanks, Paul. Good morning, everyone. During the first quarter, adjusted segment profitability in both segments was up year-over-year in spite of significant raw material price escalation. Volume grew in some of our key specialty lines, including laminates, nonwovens and elastomeric modifiers. We saw an improvement of $0.01 in EPS, making this the eighth consecutive quarter in which we have reported growth in adjusted year-over-year earnings. We also saw improvement in our net leverage ratio compared with the first quarter of last year. Order delays in oil and gas resulted in a slow February after a couple of strong quarters, but we expect gradual, though sometimes volatile, recovery going forward. Also, we continue to address the profitability issues in our Chinese coated fabrics business. In early March, we implemented cost-reduction actions to react to current market conditions while we analyzed various long-term options to improve profitability and return on invested capital.

I want to update you on progress we made over the quarter on a number of strategic fronts fundamental to our future success. From a new product perspective, our vitality index for the first quarter was 27%, which was up from 21% in last year's first quarter. We have a number of new products we are launching this year primarily to further fuel growth in our specialty businesses, which we expect to be margin and volume accretive. This will be the second year of new product introductions resulting from our refocused and revitalized new product development pipeline.

I'm going to highlight 2 new products we are launching next week. At the nonwovens show in Switzerland, we are introducing our new-generation SoftWick product. This innovative product features silicone-free technology that improves wickability for better fluid management plus improved softness across a wide range of nonwoven material substrates, resulting in lower total -- total costs with better performance. At the European Coatings Show, we are launching Hydro PLIOLITE 211. It is our innovative, environmentally preferred, new water-based product for intumescent coatings, which provide structural fire protection as an alternative to solvent-based products.

Additionally, in early March, we closed on the acquisition of Creole Chemical, a Texas-based company with sales of approximately $5 million. We are excited about adding Creole's sales and technical expertise, along with their portfolio of technology and customers, to our oil and gas business. They offer both cementing and stimulation additives utilized in the upstream sector of the oil industry. This acquisition is aligned with our oil and gas strategy to extend our product offerings into attractive market segments we have targeted for growth while also reducing our dependence on deep sea drilling.

During the quarter, we continued to implement the One OMNOVA support structure as we resegment the business. This means that we will have streamlined functions such as single organizations for sales, innovation, supply chain, operations and finance. We expect to realize approximately $3 million in annualized savings beginning in the third quarter as this new organization is implemented. But the primary benefit will be to allow us to be much more agile in responding to market opportunities and growing profitability with our target customers while also eliminating artificial internal sources of complexity.

Our new key account-focused sales team continued to make progress driving new sales. For the first quarter, we added 38 new wins that will help sustain consistent growth and profitability. In addition, our sales pipeline continues to strengthen with specialty opportunities as we fully leverage our commercial excellence initiatives. Work to redefine our segments is progressing, and we expect to be in a position to publish the new segments at the end of the second quarter. We will be organizing around a specialty segment we will call Specialty Solutions and a more mature business segment, which we will call Performance Materials. We anticipate that the specialty segment will have margins in the mid-teens range and will represent approximately 55% of the business. The Performance Materials segment is anticipated to have approximately 45% of the business with overall single-digit margins. Our strategy calls for growth and profitability in cash from both segments and volume growth at twice the underlying market rate in the specialty segment once we are fully up to speed.

During the quarter, we experienced increases in many of our raw materials with the largest increases in butadiene. For example, the price we paid in the month of February for butadiene was 44% higher than in January and almost 3x higher than February 2016. Pricing execution is critical to allow us to sustain our service and innovation model. Approximately 80% of our butadiene sales are covered by index contracts. Those contracts reset prices anywhere from 1 to 3 months later, delaying, but not eliminating, our ability to recoup margin losses. In addition, we have been implementing price increases for volume not covered by index pricing. It is not a popular action from our customers' perspective, but these raw material increases are industry-wide and not OMNOVA-specific.

We are working with our specialty customers who are not covered by index pricing to help them communicate the need for price increases to their customers. We are seeing evidence of price traction as our customers pass price increases through their value chain. We expect to protect margins over the pricing cycle with recovery of any first half shortfall in the second half as prices catch up with raw material costs.

In summary, we remain committed to consistently driving increased shareholder value through our specialization strategy, underpinned by an agile, flexible foundation to support our 2 business models. We expect the changes we have made, the [profits] improvements we have implemented, the strong innovation and sales pipelines we have developed and the dynamic and top quality team we have assembled to continue to drive growth.

Thank you. Paul and I are ready to address any questions.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And first on the line, we have David Begleiter with Deutsche Bank.

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Katherine Anne Griffin, Deutsche Bank AG, Research Division - Research Associate [2]

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This is Katherine Griffin on for David. And I know you kind of touched on this. But could you talk a little bit more about the price increases in the nonindex business and how successful they have been and if you expect to fully implement them?

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Anne P. Noonan, OMNOVA Solutions Inc. - CEO, President and CEO [3]

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Yes. We -- our price increases in the non -- just to remind everyone, the nonindex business is only 20% of our butadiene purchases. And in that portion, we've announced now 3 price increases. Butadiene, as you know, has spiked significantly in that time frame. We are getting traction on price. Obviously, different portions of the business have different elasticity. But overall, we expect to cover the pricing and raw material escalation in the business on the nonindex portion.

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Katherine Anne Griffin, Deutsche Bank AG, Research Division - Research Associate [4]

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And then also wondering about China automotive trends. This is another sort of consecutive quarter about a -- with weak sales into China automotive. So I'm just curious as to what your perspective is on demand, either now or through the year.

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Anne P. Noonan, OMNOVA Solutions Inc. - CEO, President and CEO [5]

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Yes. China automotive has, in general, gone down, but our situation is really driven by the loss of a major contract customer that was basically a strong volume sale for us. And so we've been -- while we've been trying to refill the pipeline, the automotive market has declined somewhat. As we said last quarter, we have -- we are addressing this. We have a plan to fix this for our business. In the meantime, we have actually taken some cost reductions in the short term just to bring costs down as volumes are challenged. However, we are evaluating a number of options to fix this permanently for the business as we go into Q2.

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Operator [6]

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Our next question is from Rosemarie Morbelli of Gabelli & Company.

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Rosemarie Jeanne Morbelli, G. Research, LLC - Research Analyst [7]

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Anne, I was wondering -- my understanding, following up on the Chinese customer loss, my understanding was that by now, you have just about anniversaried the loss of that one customer. Could you touch on what else is going on in that particular business?

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Anne P. Noonan, OMNOVA Solutions Inc. - CEO, President and CEO [8]

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Well, the loss of that customer has been gradual over time, Rosemarie. So it's not completely -- we still sell some product to that customer. So this has been kind of a decline. We feel we're getting to the bottom of it. But as you know, when you're not filling your plants with volume and while we have a robust sales pipeline, it's not come to full fruition. So trying to cover that fixed cost has been an issue, and the automotive market isn't very robust. So overall, we just have that gap between having the large volume come out of this contract manufacturing volume and the new volume coming in as we continue to validate more customers.

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Rosemarie Jeanne Morbelli, G. Research, LLC - Research Analyst [9]

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What is the capacity utilization right now? And what is the reasonable expectation in another couple of quarters?

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Paul F. DeSantis, OMNOVA Solutions Inc. - CFO and SVP [10]

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The plant utilization, Rosemarie? You broke up in your question.

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Rosemarie Jeanne Morbelli, G. Research, LLC - Research Analyst [11]

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I am sorry. Yes, this is what I meant. And I apologize for my voice, which is worse, and the usual accent.

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Anne P. Noonan, OMNOVA Solutions Inc. - CEO, President and CEO [12]

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Yes. It's -- Rosemarie, I don't have the exact number off the top of my head, but it's very low, less than 50%, which is where our challenges are coming from obviously.

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Rosemarie Jeanne Morbelli, G. Research, LLC - Research Analyst [13]

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So is it a combination of several manufacturing lines and you can eliminate some and produce something else in that plant? Or is it a question -- well, I don't know what the solution is. If you could help me understand that.

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Anne P. Noonan, OMNOVA Solutions Inc. - CEO, President and CEO [14]

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Well, we're looking at a number of solutions. This business really has some solvent-based and water-based technology. We're looking at a multitude of strategic options as we look at how we could optimize the overall size and the performance of the business.

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Rosemarie Jeanne Morbelli, G. Research, LLC - Research Analyst [15]

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Okay. And if I may, you talked about the Performance Material having a single-digit margin. So this is 45% of your revenues. How -- what single digit do we have? Is it between 3 and 5? Is it between 5 and 9? Could you help us with that?

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Anne P. Noonan, OMNOVA Solutions Inc. - CEO, President and CEO [16]

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It's between 5 and 9, Rosemarie. And that's been a significant improvement. Our Performance Materials now has had the seventh quarter of year-on-year improvement, driven by the actions we took last year restructuring our manufacturing footprint and resetting pricing in our traditional markets.

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Rosemarie Jeanne Morbelli, G. Research, LLC - Research Analyst [17]

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And what do you think 2, 3 years out that margin can improve to?

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Anne P. Noonan, OMNOVA Solutions Inc. - CEO, President and CEO [18]

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Well, our goal is for that part of the business to get to double digits. I think that's a realistic goal overall. And that's going to be driven by our continued focus on driving increases on the bottom line and also cash generation so we can fund growth of the rest of the business. As we've said before, our goal, ultimately, is to have more of our portfolio drive our specialization strategy. But these businesses have improved significantly and continue to show an excellent focus on operational excellence.

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Operator [19]

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Our next question is from Laurence Alexander with Jefferies.

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Daniel Dalton Rizzo, Jefferies LLC, Research Division - Equity Analyst [20]

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Dan Rizzo on for Laurence. So you mentioned butadiene pricing and the actions you've taken there. I was just wondering what your thoughts were on styrene if it's as much of a headwind or if [you quote up] or just what your thought is behind that input and prices you might be taking to offset that.

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Anne P. Noonan, OMNOVA Solutions Inc. - CEO, President and CEO [21]

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Yes. We took price increases across all of our portfolio on raw material escalation. Styrene has not been as -- has escalated as suddenly as butadiene. It has different dynamics. In fact, we started seeing some styrene escalation last year, and we continue to drive consistent price increases to cover that. So it's really not -- the big one that we have, and we're chasing after is butadiene [market], Dan.

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Daniel Dalton Rizzo, Jefferies LLC, Research Division - Equity Analyst [22]

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Okay. And then you mentioned in the press release -- I don't know if you told everybody on the call, you did a small purchase in the last quarter. I was wondering if you can quantify that at all or if there's -- or if it's more, I don't know, technology based and just what your thoughts are going forward with similar transactions.

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Anne P. Noonan, OMNOVA Solutions Inc. - CEO, President and CEO [23]

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Yes. It was a small acquisition. It's about $5 million in revenue, Creole Chemical. What it gets us is really it expands our customer base and our portfolio. So it's more a portfolio of products. So it's not pure technology based; I would say, it's more a product portfolio planned customer diversification. And it also gets us not to be so reliant on the deep sea drilling. So it gets us into cementing and stimulation as well.

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Daniel Dalton Rizzo, Jefferies LLC, Research Division - Equity Analyst [24]

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Okay. And then you mentioned the vitality index, I think, was 27%. Is there a particular goal you may have had in the past that you have in mind for vitality index? Or are you kind of where you think you should be?

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Anne P. Noonan, OMNOVA Solutions Inc. - CEO, President and CEO [25]

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On the vitality index percent, there's 2 goals. There's one, to keep it above 25%, and the other is to continuously improve the profitability of that pipeline that's in there. And last quarter, we reported that we had improved by about 800 basis points year-over-year on a full year basis on the quality of the pipeline. So we continue to focus on the quality, and what drives that is having more specialization and more specialty new products coming out.

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Operator [26]

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And we'll go to Curt Siegmeyer with KeyBanc Capital Markets.

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Curtis Alan Siegmeyer, KeyBanc Capital Markets Inc., Research Division - Associate [27]

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One on the Laminates and Films. Sales growth was pretty impressive there, 9%. It seems like a pretty nice sequential improvement. So I was just wondering if there were any onetime type of events or like channel filler or anything of that nature that maybe we shouldn't expect to repeat going forward?

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Anne P. Noonan, OMNOVA Solutions Inc. - CEO, President and CEO [28]

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No. There really isn't. I would say, the laminates portion of it is really coming from just fruition of our sales pipeline starting to come through. We had strength in recreational vehicle and in kitchen and bath again and in our food service. So that's kind of consistently, we've had a strategy to drive growth there. The other area is the luxury vinyl tile. And that has been -- we started sales in the fourth quarter on that, and that's been ramping up. So there's been a ramp-up there kind of in line with our expectations as we continue to grow with that particular customer.

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Curtis Alan Siegmeyer, KeyBanc Capital Markets Inc., Research Division - Associate [29]

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Okay, great. And then on the raw materials side, you did mention in the press release some lower raws that benefited the Engineered Surfaces business. So I was just wondering what exactly you're seeing there that are trending lower in the quarter. And maybe any quantification around that as to how much that benefited op income.

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Paul F. DeSantis, OMNOVA Solutions Inc. - CFO and SVP [30]

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Yes. That was -- I didn't even -- Curt, this is Paul. Sorry. I didn't even break that out because it was so small. It was just -- those were just tiny, little blips on Engineered Surfaces because, overall, we were just up slightly in terms of our earnings increase. So that was just a small change. Just a couple hundred thousand at the very most, just from the whole mix of raws and everything else.

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Curtis Alan Siegmeyer, KeyBanc Capital Markets Inc., Research Division - Associate [31]

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Okay. Got it. And what's maybe a good tax rate we should assume for the year given the benefit in the first quarter?

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Paul F. DeSantis, OMNOVA Solutions Inc. - CFO and SVP [32]

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Yes. So on a non-GAAP basis, we're -- we continue to use 30%. So that's a flat number that we use whenever we calculate our non-GAAP earnings. This -- we had the -- what drove our GAAP tax rate to be so favorable were some changes in some tax legislation and some, basically, onetime items in Europe. So that won't persist throughout the year. So our expectation is that our tax rate will approach a more normal tax rate on a GAAP perspective as we work our way through the year.

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Operator [33]

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The next question is from Atha Baugh with MJX Asset Management.

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Atha Baugh, MJX Asset Management, Research Division - Managing Director/Portfolio Manager [34]

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Just quickly -- and I apologize, just focused on the margins again. But I'm assuming there's just a slight lag on price -- butadiene prices in the first quarter. So what -- was there any impact? I mean, what was the actual impact on margins from the butadiene price during the quarter?

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Paul F. DeSantis, OMNOVA Solutions Inc. - CFO and SVP [35]

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Yes. So that's a good question. So if we take a look at what's going on with our margins in the first quarter, there are 3 effects that we really have to pay attention to. That's the inner relationship between the timing and the slope of raw material increases, our price increases and then the legacy value of our inventory, right, because we've been buying our inventory. And so we've been building up lower -- effectively lower-cost inventory in the face of those increases in raw material prices. So our expectation from the -- rolling into the second quarter is that, given how steep the raw material price increases were, particularly the January to February increase in butadiene, although we're confident we're going to get it all back between the combination of pricing and both the index pricing and the price increases, we think we're going to have somewhere between the $2.5 million to $3.5 million unfavorable impact in the second quarter as we -- just given the slope of those cost increases, our price increase, the timing of it and the like. And then we expect to get that back in the third and fourth quarter based on our expectations.

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Atha Baugh, MJX Asset Management, Research Division - Managing Director/Portfolio Manager [36]

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Well, that's great. Yes, that's great color. So now -- and you think, though, that you see the pricing -- now, is it the fact that pricing will kind of level off? Or is it the fact -- not the pricing but your cost will level off? Or is it the fact that the pricing you take will have impact for the second and third -- I mean, for the third and fourth quarter?

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Anne P. Noonan, OMNOVA Solutions Inc. - CEO, President and CEO [37]

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I think it's a combination of both. So we see -- if you had listened to IHS, cost is probably leveling off and going down in the second half. However, we have different price elasticity in our business because we have a mix of specialty and index pricing. So we tend to be able to hold on to some of that price once we get it because we do price based on value of the innovation that we bring to our customers as well as raw materials.

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Atha Baugh, MJX Asset Management, Research Division - Managing Director/Portfolio Manager [38]

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Got it. Okay. Perfect. And then just a final question. So the Creole acquisition. So is that just -- the acquisition, did that come straight from free cash flow? Or was there a usage on the RC?

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Paul F. DeSantis, OMNOVA Solutions Inc. - CFO and SVP [39]

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No. That was just straight from free cash flow.

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Operator [40]

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(Operator Instructions) And with the line of Mik Bevc with CVC Credit.

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Miklavz Bevc, CVC Credit Partners, LLC - Investment Director [41]

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Just a quick question from me was looking at your, I guess, paper and carpet chemicals, it looks like we have seen sort of a stabilization at the market just based on the results you reported. Is that right?

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Anne P. Noonan, OMNOVA Solutions Inc. - CEO, President and CEO [42]

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Well, if you look at paper and carpet, obviously, paper has been declining over time from a volume perspective. We took the necessary actions last year both with respect to restructuring our manufacturing footprint and our pricing to improve profitability and continue to do that, grow the bottom line. Paper seems to have slowed. Whether the decline has stopped, we'll watch it. One month does not make a trend. In our particular numbers, there were certain customer movements that kind of complicate the volumes a little bit as well, where we had a customer in paper shut down a mill and a customer in carpet. But we expect those to come back as the year proceeds. So more to see on that with respect to the actual demand.

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Operator [43]

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And allowing a few moments, no further questions coming in.

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Anne P. Noonan, OMNOVA Solutions Inc. - CEO, President and CEO [44]

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Okay. So thank you for your thoughtful questions. I would like to leave you with the following summary thoughts. We have spent the last few years restructuring the Performance Chemicals business with a focused effort to drive operational excellence. We are streamlining the functional portion of the organization to position the entire company for sustained growth. This restructuring will result in more agile and responsive marketing, selling and innovation processes across the board, allowing us to better respond to market opportunities with key customers. We have begun to see some early momentum on specialty growth, but we're not there yet. We need to consistently be at 2x the underlying market growth rate. Also, we have now had 8 quarters in row of year-over-year adjusted segment operating profit growth in Performance Chemicals and adjusted earnings per share growth for the whole company as a whole. We remain committed to delivering consistent shareholder value enhancement over time.

Have a great day, and we look forward to speaking with you next quarter to review continued progress against our strategic objectives.

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Operator [45]

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Ladies and gentlemen, the digitized telephone replay is scheduled from today, April (sic ? March) 29, 2017 at 1 p.m. Eastern time until April 18, 2017, at 11:59 p.m. Eastern time. Also, an audio replay will be available on the OMNOVA Solutions' website, www.omnova.com, until noon Eastern time on April 18, 2017.

That does conclude your conference for today. Thank you for your participation. You may now disconnect.