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Edited Transcript of SHLM earnings conference call or presentation 5-Apr-17 2:00pm GMT

Thomson Reuters StreetEvents

Q2 2017 A Schulman Inc Earnings Call

AKRON Jun 27, 2017 (Thomson StreetEvents) -- Edited Transcript of A Schulman Inc earnings conference call or presentation Wednesday, April 5, 2017 at 2:00:00pm GMT

TEXT version of Transcript

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Corporate Participants

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* Jennifer K. Beeman

A. Schulman, Inc. - VP of Corporate Communications & IR

* John William Richardson

A. Schulman, Inc. - CFO and EVP

* Joseph M. Gingo

A. Schulman, Inc. - Chairman, CEO and President

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Conference Call Participants

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* Dmitry Silversteyn

Longbow Research LLC - Senior Research Analyst

* Jacob P. Schowalter

Seaport Global Securities LLC, Research Division - Associate Analyst

* Jason Alexander Freuchtel

SunTrust Robinson Humphrey, Inc., Research Division - Associate

* Kevin William Hocevar

Northcoast Research Partners, LLC - VP and Equity Research Analyst

* Roger Neil Spitz

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

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Presentation

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Operator [1]

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Good day, ladies and gentlemen, and welcome to the A. Schulman Fiscal 2017 Second Quarter webcast. (Operator Instructions) As a reminder, today's conference call is being recorded.

I would now like to turn the conference over to Jennifer Beeman. Please go ahead.

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Jennifer K. Beeman, A. Schulman, Inc. - VP of Corporate Communications & IR [2]

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Thanks, Candace. Good morning, and welcome to A. Schulman's Second Quarter 2017 Conference Call.

I'm Jennifer Beeman, Vice President of Corporate Communications and Investor Relations for A. Schulman. Joining me today is Joe Gingo, Chairman, President and Chief Executive Officer; and John Richardson, Chief Financial Officer of A. Schulman.

You all should have received a copy of our press release, which was issued last night. Additionally, we have provided supplemental slides, which we will refer to during our prepared remarks. These are available on our website and are included in the webcast of this call.

I'd like to remind you that statements made during this conference call which are not historical facts may be considered forward-looking statements. Forward-looking statements involve risks and uncertainties that could cause actual events or results to differ materially from those expressed or implied. Additional information on factors that could cause results to differ is available in the company's most recent Form 10-K and Form 10-Q.

In addition, this conference call contains time-sensitive information that reflects management's best analysis only as of the date of this live call. A. Schulman does not undertake any obligation to publicly update or revise any forward-looking statements to reflect future events, information or circumstances that arise after the date of this call.

For further information concerning issues that could materially affect financial performance related to forward-looking statements, please refer to A. Schulman's quarterly earnings releases and periodic filings with the Securities and Exchange Commission.

I'd like to remind you that for the purpose of this phone call, we use certain non-GAAP measures. You can find the reconciliation of these non-GAAP measures to the nearest comparable GAAP results as an attachment to our second quarter earnings release, which has been posted on the website.

We'll now begin with remarks on the quarter from Joe, and then we'll open up the call to your questions.

With that, I'd like to turn it over to Joe Gingo. Joe?

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Joseph M. Gingo, A. Schulman, Inc. - Chairman, CEO and President [3]

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Thank you, Jennifer, and thank you for joining us this morning as we update you on our fiscal 2017 second quarter results. As you know, my comments will speak to the supplemental slides that are available on our Investor Relations website.

We'll begin on Slide 4 after the legal disclaimers, which you can read on your own. Let me begin by saying that I am highly encouraged by the progress we have made over the first half of this year. Through aggressive and dedicated sales efforts, particularly in our specialty carbon fiber Quantum products, we've seen exciting growth in our Engineered Composites product family. We have said that this business will be a growth platform for us in the future and we continue to actively engage customers with this positive momentum.

Our Asia Pacific and Latin American segments also had a strong quarter as a result of product mix improvements and solid Performance Materials sales. In Europe, we had year-over-year improvement in operating income despite the negative impact of foreign currency. This was partially a result of our recent business simplification efforts and faster reaction time to our customers.

As we have streamlined our global organization in hopes of becoming more customer-centric, we have proof that our actions are beginning to make a difference. For example, one key customer had expressed their displeasure with our customer service. The team listened to this feedback and took corrective action. We recently received a letter from an employee at this customer stating that our service has returned to our historical high levels. For me, that is the most important validation that our efforts are gaining traction and we are truly living by our guiding principles of open, honest, listen and accountable. As a reminder, these streamlining efforts are still on track for us to realize savings of approximately $6 million annually.

Our new Chief Commercial Officer, Gary Phillips, has been on the job for 4 months now and has been busy working with our regional leaders to align our regional sales organization and hire new sales directors. He has also added a sales operational director to his team. He has taken time to understand and evaluate our pricing functions and identified opportunities for us to make short and long-term improvements in our pricing practices.

I have also asked Gary to jump-start our sales efforts and part of that includes additional performance-based incentives for our sales team in fiscal 2017. The first business review with our sales management team is taking place in Europe this week, where we will discuss future growth opportunities and the execution plans needed to develop organic growth in the future. On the accountability front, he is driving a plan to create consistent metrics as well as global reporting and forecasting processes that will ensure our sales enhancements are sustainable and that our sales teams are working in tandem with our supply chain organization to increase our efficiency.

As a result of our actions, sales per day have grown in January and February and all regions have shown improvements. We will closely track month-over-month growth. Additionally, our sales teams are capitalizing on recent added capacity to provide additional products to our customer base.

When I came back as CEO, one of the changes I made was to have our innovation team report directly to me. With my experience as the Chief Technical Officer, I believe I know what a good innovation process looks like and I wanted to -- a more direct line of sight into what we're doing and could potentially do from an innovation standpoint.

As I examined our (inaudible) process with the team, we quickly understood that we can employ a light gate innovation path designed to have new technologies exit the pipeline in a much shorter period of time versus the traditional path, which can take up to 18 months. We are continuing to encourage our global innovation team to actively push cross-fertilization between regions with a keen eye on prioritization so that the products and solutions we are developing not only meet our customer's most challenging needs and get global traction when appropriate, but meet our profitability thresholds as well.

Last, I'll just briefly mention that last quarter, we announced our intention to close 2 plants, one in EMEA and one in US/Canada, with an expected annual savings of approximately $1.5 million beginning in late fiscal 2017. Both closures are moving along with no issues. We will also likely see cash proceeds of roughly $6 million to $8 million from the sale of shuttered plants by the end of calendar 2017.

We have provided a brief recap of our raw materials picture on Slide #5. As I am sure you have been hearing from others, we have seen inflation on olefins, which began in earnest during the fiscal second quarter and we see the same into the fiscal third quarter. Pricing trends appear to be similar between most regions, with our APAC region beginning to see raw material price decline. The basket we are calling Engineered Resins has experienced price increases since January, which has been driven by feedstock shortages and demand. Some easing of supply constraints and price moderation is expected later in fiscal third quarter. Most notably during the quarter, TiO2 saw significant pricing hikes and is forecasted to raise throughout the fiscal year.

As always, we introduce price increases as soon as possible after raw material prices rise. We experience a lag of one to 3 months depending on the product family. We experience the same lag when prices fall. The goal is to have the increases come quickly and the decreases slowly.

With that, I'd like to turn it over to John.

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John William Richardson, A. Schulman, Inc. - CFO and EVP [4]

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Thanks, Joe, and good morning, everyone.

I'll take a few minutes to review our financial highlights and operational details. I'll then comment on the company's balance sheet and cash flow, with an emphasis on our debt reduction progress. Lastly, I'll wrap up my comments with some thoughts on the second half earnings seasonality, which will be considerably different from last year.

Turning to Slide 6, we'll get to more detailed discussion of the top and bottom line in a moment. Before that, however, I would like to point out some highlights of the quarter. Echoing Joe's comments, we feel that our business unit realignment actions and restructuring efforts are now contributing to the financial results. Despite the lower revenue in the quarter, our team was able to maintain a stable gross margin, helped by operations effectively managing lower plant costs. Adjusted operating margin was 4.8%, roughly flat with the prior year, helped by sizable reductions to structural SG&A, part of the benefit of the product family streamlining strategy. These initiatives will continue to drive benefits in the future.

Now to the results. We recorded second quarter diluted earnings per share on a GAAP basis of $0.11 compared with a net loss of $0.01 in the year ago quarter. Both of these results contain considerable amounts of restructuring and related items. On an adjusted basis, excluding these certain items, our reported adjusted earnings per diluted share of $0.31 is consistent when compared with the $0.31 per share in the year ago period. A reconciliation table to bridge between GAAP and the adjusted results was provided in our press release last night.

Reported revenue for the quarter fell 3.9%. Adjusting for $13 million of foreign currency translations, our revenue declined 2%. While we are not satisfied with the year-over-year decline in revenue, I would note that these results are an improvement from the 6% year-over-year decline reported in the first quarter. Additionally, over 80% of the revenue decline occurred in December as we were only just beginning the streamlining of our product families. Price/mix also lessened the impact of the lower volume.

As discussed last quarter, we have now reorganized our business units and operate as 3 consolidated product families: Custom Concentrates and Services, Performance Materials and Global Engineered Products. Our Composite business outperformed, posting an 8% revenue growth, while Custom Concentrates and Services and Performance Materials declined 3% and 7%, respectively. These revenue declines are almost solely due to our U.S. and Canada region and is associated with the extensive manufacturing restructuring that is underway. On a local currency basis, all our other business segments delivered flat or increased revenues when compared with the prior year.

Moving now to profitability metrics. I'll discuss these on an adjusted or segment basis, excluding certain restructuring expenses. We believe that this adjusted comparison reflects a more accurate and consistent view of the profit drivers for our businesses.

Segment gross profit, excluding these items, was $91 million for the quarter, down $3 million or 4% from the year ago quarter. This was due to lower volumes, largely in U.S. and Canada, partially offset with favorable price/cost spread. Adjusted gross margin was 15.9%, slightly up from the year ago period. Adjusted operating income, excluding FX, was level with the prior year due to the management of SG&A. This resulted in the second quarter operating margin of 4.8%, essentially the same as 2016.

I'd like to mention a few other items that affect earnings. First, foreign currency translation. We estimate that the negative impact here amounted to $0.03 per share in the quarter and $0.05 per share year-to-date. The adjusted tax rate for the quarter was 19% due to a swing in the geographic source of income and resulted in a true-up of our annual tax rate. The tax rate for the second quarter of 2016 was 21%. For the full year, we expect the adjusted tax rate to be in the range of 24% to 25%.

Slide 7 provides revenue and EPS bridges to provide some visibility to the drivers of our top and bottom line momentum. Starting with the revenue bridge, the year-over-year reported revenue decline was primarily due to currency translation and lower volume shipments. The volume decline was primarily isolated in U.S. and Canada. Notably, the contribution from price/mix has turned positive as our sales organization focused more on price realization, especially in light of widespread signs of raw material inflation.

Moving to the EPS bridge. This quantifies the benefits of our product family simplification program, which has led to substantial SG&A reductions across the entire organization. These reductions were sufficient to offset the lower volumes. Finally, there is the above-noted impact of foreign currency exchange in the quarter.

Now, I'll review the business segments, beginning on Slide 8. In EMEA, reported revenues were $277 million for the quarter or flat year-over-year, excluding FX. This is a notable improvement from the 7% year-over-year revenue decline in the first quarter, excluding FX. Performance Material revenues fell slightly, offset by growth in Custom Concentrates and Services. Some of the more active markets in the quarter were building and construction and industrial. Our gains in the region were offset by in-sourcing moves by certain customers.

Operating income rose 6% as reported, a 10% gain when adjusted for currency. Operating margin of 6% rose 60 basis points and was helped by both favorable price/cost activity and lower personnel costs resulting from our product family simplification.

The US/Canada region revenue of $152 million declined 11%. Declines in both volume shipments and price/mix drove the results. Across the product categories, the drop was largely related to Performance Materials and is the result of complex consolidation efforts in Evansville. Joe will touch on that in more detail in a moment. Additionally, reformulation and line changes require customer requalification, and these customer approvals are slower than expected in the Custom Concentrates and Services product family.

As a result of the above, our operating margin fell to 3.6%. A partial offset from lower SG&A in the U.S. and Canada was lower during the quarter and as compared with fiscal 2016 both on a dollar and a percent-to-sales basis.

Turning to Slide 9, Latin America generated $40 million of revenue and was flat on a year-over-year basis, excluding FX. Shipment activity was mixed, with Performance Material product family posting a healthy gain helped by a stronger Mexican market, while Custom Concentrates and Services declined as we reduced our exposure to low-profit commodity products. A slight improvement in volume and improved price/cost spreads drove a 290 basis point improvement in operating margin to 13.9%.

Asia Pacific reported revenue of $49 million, up 12%, excluding FX, led by broad volume gains and improvements in price/mix. Both product families posted gains, led by Performance Material demand in the appliance and automotive markets. Segment operating margin was 10%. Price/mix was favorable, but SAG rose as we increased our sales force to support new regional activity.

Global Engineered Composites revenue for the quarter was $51 million, up 8% compared with the 5% year-over-year growth in the first quarter. Revenue growth was led by strong demand for our highly specialized Quantum products. This strong demand for Quantum led to both volume gains and a positive shift in price/mix. Quantum gains were enough to offset lower activity in bulk molding compounds. Operating margin of 8% was more than double the year ago level, helped by across the board improvements in price/cost spread, lower plant costs and lower SG&A.

Now, I'll move to cash flow and the balance sheet. Moving to Slide 10. We generated EBITDA of $47 million compared with $50 million in the prior year quarter. Working capital was a source of funds in the quarter. Net working capital dropped to 51 days on a trailing 12-month basis. This compares with 52 days last quarter and 54 days at the beginning of the fiscal year. Capital spending also increased by $4 million year-to-date to fund an increase in IT investments.

Net debt rose $7 million in the quarter to $901 million for a net leverage ratio of just over 4x. Despite this seasonal increase, net debt is still level compared with the beginning of the fiscal year. Our primary goal is cash generation and we remain focused on achieving our previously stated goal of 3.5 to 3.8x net leverage by the end of fiscal 2017. Since the purchase of Citadel in mid-2015, the company has paid down approximately $170 million of total debt.

In the second quarter, the company paid cash dividends of $0.205 or $6 million on common shares, with a dividend yield of roughly 2.7%. The company also paid approximately $1.9 million in dividends on its convertible special stock in the second quarter.

Now, lastly, I'd like to make a few comments about our earnings seasonality to help you better understand our progress toward our 2017 fiscal year target. Our earnings per share in fiscal 2016 were $0.79 in the third quarter and $0.47 in the fourth quarter. Based on our historical earnings performance, this earnings pattern was unusually skewed. We believe, because of a variety of factors, that include FX, tax rates, variable compensation expense, the rhythm of our business as a result of our streamlined product family structure and other initiatives, that our earnings in the back half of the year will be more level by quarter than in fiscal 2016.

So with that, I'll turn it back over to Joe.

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Joseph M. Gingo, A. Schulman, Inc. - Chairman, CEO and President [5]

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Thanks, John.

Moving to Slide #11. I want to mention 2 elements that could impact our fiscal 2017 results: First is foreign currency and the other is our consolidation effort in Evansville, Indiana. Related to foreign currency, I think it is helpful to understand that, in fiscal 2016, all of our foreign entities represented almost 80% of our operating income. Because our facilities are local to our customers, our business is transacted almost exclusively on a local currency basis. This means we bear a higher amount of currency translation risk compared with most other companies in the specialty chemicals sector.

Looking at the impact of currency translation, we are exposed to a variety of currency. However, we will focus in on the euro as it is the most significant exposure that we have. We pointed out in our last earnings call that our fiscal 2017 guidance was developed late in fiscal 2016 at a time when the euro-dollar conversion rate was at $1.13. Today, it is approximately $1.06. And as John mentioned previously, this has negatively impacted our earnings per share by $0.05 year-to-date. Every $0.01 change to the euro impacts our EPS by approximately $0.02 on a full year basis.

We don't attempt to forecast currency movements and do not build our guidance around any assumed changes over the course of the year. Our guidance was built on a euro rate of $1.13. For this reason, we think it is important for you to be aware that if the euro is $1.06 for the remainder of the year, along with no changes in other key operating currencies, the full year negative impact of currency translation could be estimated to be about $0.15 per share.

As many of you know, we have been working hard to sort through our profitability challenges in our US/Canada region. Evansville, Indiana has been the center of our focus. After the acquisition of Citadel, we had a total of 8 plants in Evansville and immediately began consolidation efforts. We moved quickly into a remediation mode once the fraudulent activity related to Lucent came to light. I believe it is fair to say that the consolidation has been complex from the very beginning.

If you turn to Slide #12, what you will note from the graphic is that we, in essence, had to merge 2 business models as we consolidated and integrated our business. A. Schulman primarily used only prime and wide-spec raw materials in its formulation, while Citadel used wide-spec down to post-consumer recycled raw materials. This made the reformulation and customer and underwriters laboratory requalification processes particularly difficult. We are taking time to reconfigure the business model in Evansville and make decisions as to what products could be produced better elsewhere. In some cases, we have had to alter our manufacturing processes and have added an extra pre-blending step as well as additional equipment to ensure our products consistently meet customer specifications and A. Schulman's high quality standards.

Lastly, we needed to eliminate low-margin product. Strategic actions are being feverishly implemented so that Evansville will regain profitability, but I caution that this kind of operational change can take time. While I am confident that we are now on the right path to a solution, there is a risk that we will not see a complete turnaround in this business until late this fiscal year.

So turning to the last slide. I will reiterate that fiscal 2017 is a reset year. I am proud of the men and women of A. Schulman who are working together to deliver value each and every day no matter the obstacle. Their work has given us 6 months of progress, and I look forward to reporting on our continued progress next quarter. Thank you.

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Jennifer K. Beeman, A. Schulman, Inc. - VP of Corporate Communications & IR [6]

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Thank you, Joe.

Candace, I think we are now ready for our Q&A portion of the call.

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Questions and Answers

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Operator [1]

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(Operator Instructions) And our first question comes from Roger Spitz of Bank of America.

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Roger Neil Spitz, BofA Merrill Lynch, Research Division - Director and High Yield Research Analyst [2]

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Regarding the fiscal '17 EBITDA headwind for Evansville consolidation, can you give us a view of what that headwind could be?

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Joseph M. Gingo, A. Schulman, Inc. - Chairman, CEO and President [3]

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I think, at this time, that's still -- it's very uncertain as exactly when the turnaround would take and it would be a real estimate on my part to try to give you a specific number.

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Roger Neil Spitz, BofA Merrill Lynch, Research Division - Director and High Yield Research Analyst [4]

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Okay. And maybe this is just holidays [ph] related, but in U.S. and Canada last year in fiscal '16, gross -- quarterly gross profit sort of ranged from $25 million to $33 million. And this year, you've had $20 million and $25 million and it sounds like Evansville was certainly a part of that and maybe there was more. But I'm wondering how much of this year's headwinds are sort of onetime in nature and when do they dissipate? Of course, you noted that the Evansville will probably dissipate towards the end of this fiscal year.

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John William Richardson, A. Schulman, Inc. - CFO and EVP [5]

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Yes, Roger. This is John. I think that the -- these are kind of onetime in nature for us. I think -- I mean, it's a long path to get Evansville sorted out, as Joe said, but we'd like to think that by the end of fiscal 2017, that we'll have the Evansville operation issues largely behind us.

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Joseph M. Gingo, A. Schulman, Inc. - Chairman, CEO and President [6]

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I want to reiterate, Roger. We have a lot of confidence in the plan. I think the plan is a very good, solid plan. We know what the problems are and they're being addressed. The issue obviously is speed of execution. We're not going to go so fast as that we can risk the end results, but we're going to really go as fast as we can.

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Operator [7]

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And our next question comes from Kevin Hocevar of Northcoast Research.

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Kevin William Hocevar, Northcoast Research Partners, LLC - VP and Equity Research Analyst [8]

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On Slide 7, you mentioned the price/cost was favorable in the quarter. So I'm wondering how much -- with inflation, you had a slide devoted to inflation. With what you're seeing now, what type of impacts do you expect the balance of the year? Do you expect price/cost to be a headwind in the third quarter as it takes -- I think, Joe, you mentioned one to 3 months to pass along price? Or what type of impacts do you ultimately expect from price/cost for the balance?

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John William Richardson, A. Schulman, Inc. - CFO and EVP [9]

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Well, I think some of the price/volume issues that we had -- I mean, things that we had that gave us a positive effect here in the quarter will carry forward as we go forward through the year. I mean, some of that -- I mean, as an example, in APAC, we had positive price/mix there and in certain parts of EMEA, we did. And those, we believe, will carry forward.

And as it relates to raw material inflation, as you are aware, I mean, we -- as our raw materials go up, we pass that along on a timely basis for us to our customers. And it depends on which business we're in, but, I mean, I would say that in the Custom Concentrates and Services, we get it to the customer a little bit faster than what we do in Engineered Plastics and Performance Materials where we have contractual arrangements. But I would say that we will get this to our customers in the one to 3-month time frame and be able to recover those cost increases.

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Joseph M. Gingo, A. Schulman, Inc. - Chairman, CEO and President [10]

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Yes. I would -- in support of what John is saying, if you think that these increases are coming in now, I think we'll be implementing over the next quarter. And as I said, Kevin, look, the goal is always the same. You get it in as fast as you can and you get them out as slow as you can. So I think over the year that will balance.

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Kevin William Hocevar, Northcoast Research Partners, LLC - VP and Equity Research Analyst [11]

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Okay. Got you. And then, Composites had a nice quarter and it looked like sales continue to get better. And you mentioned Quantum materials doing well, which is a mix improvement there. So and then in the Q, it looked like oil and gas end markets were improving. So I wondered if you could give us a little more detail on what's going good there? Is it some of the actions you're taking to maybe improve Quantum material sales? Or is it cement market improvements out of markets like oil and gas, which has been a headwind for a while? I'm wondering if you could comment on what's driving -- give a little more detail on what's driving the improvements there?

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Joseph M. Gingo, A. Schulman, Inc. - Chairman, CEO and President [12]

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I think it's a combination. Oil and gas is coming back, but nowhere to the extent that it previously was coming back. And what's it done in Quantum is it looked at other markets, and that's really been a big help for us as they're broadening their portfolios so that we can take the cycles in the various products in a better fashion.

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Kevin William Hocevar, Northcoast Research Partners, LLC - VP and Equity Research Analyst [13]

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Okay. And then, in terms of the sales guidance, you mentioned kind of, excluding that FX impact of $90 million, you'd still expect to be in that $2.5 billion to $2.6 billion range this year. So, I guess, if you included that it looks closer to $2.4 billion to $2.5 billion. But -- so I wondered what it would take to get toward the high end of that? Because it seems like you'd have to see pretty strong improvements from what we've seen in the first half here. So wondering, in your point of view, what we would have to see in order to hit the -- get to the higher end of that sales guidance range?

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Joseph M. Gingo, A. Schulman, Inc. - Chairman, CEO and President [14]

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I think we've got to see the continued economy growth that we're seeing. And it's not robust, but it seems very steady and it seems to be improving quarter-over-quarter. The biggest thing, as you know, around the world, there is a lot of confidence, particularly in the United States, in what's going to happen. If that confidence bears fruit and it results in additional orders, I think we have some upside. I think also, internally, that the reorganization has given us significant upside. So what we now have, as you might recall, Kevin, is one sales organization that sells all our products. I think that will give us a lot more cross-selling. And so I think we'll be able to take advantage of a lot more opportunities.

John, do you have anything to add?

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John William Richardson, A. Schulman, Inc. - CFO and EVP [15]

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I would just say that, I mean, when we built our plan, we built it around really kind of slow growth in the United States and Europe. I think in Europe it was 1.6% and the United States was 2% and Asia was 5% to 7%. I think, right now, China, the latest numbers that I saw was 6.5%. So I'm not sure that, at least according to current forecast, that we're going to get a lot out of growth. But I think going forward that, to reiterate what Joe has said, is that our business unit simplification efforts here, I think, are really going to have a positive impact on the profitability and the top line of this company. Clearly, having our one dedicated sales force, but also, I mean, the restructuring of our previous 6 business units down into 3 product families. You can see the benefit of that happening in this organization as we speak.

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Operator [16]

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And our next question comes from Fred Song [ph].

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Unidentified Analyst, [17]

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After you closing the 2 plants in the U.S. that you're closing, can you give me an idea what your kind of capacity utilization is across US/Canada?

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Joseph M. Gingo, A. Schulman, Inc. - Chairman, CEO and President [18]

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I'd say, to really answer that specifically, we will get back to you. Off the top of my head, I can't give you a good answer regarding that because, like, the plant in the U.S.A. affects one of our product units so -- and the plant in Europe affects one of our product units.

I'm positive we will have a better impact -- okay, I'll tell you what, but I have really the smart guys in this room so -- and I'm not one of them, but I've got a really smart guy in this room. And what he's just told me -- I'm going to answer your question right now. We're going to have a 69% versus prior year of 59%.

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Jennifer K. Beeman, A. Schulman, Inc. - VP of Corporate Communications & IR [19]

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The other way around.

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Joseph M. Gingo, A. Schulman, Inc. - Chairman, CEO and President [20]

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Other way around.

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Unidentified Analyst, [21]

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Sorry. 59, 5-9?

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Joseph M. Gingo, A. Schulman, Inc. - Chairman, CEO and President [22]

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Excuse me. 59% versus a prior year of 69%.

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John William Richardson, A. Schulman, Inc. - CFO and EVP [23]

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I think this is on the really -- is it's on a theoretical capacity. It's not on a 24/7 capacity.

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Jennifer K. Beeman, A. Schulman, Inc. - VP of Corporate Communications & IR [24]

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Yes.

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John William Richardson, A. Schulman, Inc. - CFO and EVP [25]

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And yes and we expect to be in the 60% range here both years. And so I think the important thing here is if you take a look at things like our Evansville plant, I believe that has probably driven down our capacity utilization somewhat. We mentioned to you also in my prepared remarks that in Custom Concentrates and Services, we were requalifying some products on new lines in a plant for a major customer and that has taken our capacity utilization down some as well. So we -- the other plants, I believe, are operating pretty much in line with our expectations.

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Operator [26]

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And our next question comes from Jacob Schowalter of Seaport Global.

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Jacob P. Schowalter, Seaport Global Securities LLC, Research Division - Associate Analyst [27]

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I'm calling in for Mike this morning. We were curious if incentive comp is expected to still be a $0.36 headwind to EPS or if you maybe pulled back on the accruals of it from your initial guidance?

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John William Richardson, A. Schulman, Inc. - CFO and EVP [28]

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Right. If you recall, when we put together our plan and discussed that at the Analyst Day in November, there was a significant difference in incentive compensation included in our plan this year versus what happened last year when very little incentive compensation was paid. And as we go through the year, the -- or as we go through this -- the first 6 months of the year, it's still kind of the same story. I mean, we're planning on paying incentive compensation this year. And at the rate that we have it forecasted for us, it's still going to be significantly greater than what was in the prior year amounts.

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Jacob P. Schowalter, Seaport Global Securities LLC, Research Division - Associate Analyst [29]

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Okay. And then, maybe some more color on how the consolidation process is going at the Lucent plants? And how the new business pipeline looks?

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Jennifer K. Beeman, A. Schulman, Inc. - VP of Corporate Communications & IR [30]

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Lucent plants, so that's really the Evansville.

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John William Richardson, A. Schulman, Inc. - CFO and EVP [31]

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That's the Evansville location that Joe discussed. I mean, one of the plants was specifically part of the Lucent subsidiary. So the Lucent plant is included in this consolidation effort.

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Joseph M. Gingo, A. Schulman, Inc. - Chairman, CEO and President [32]

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One of the things that might affect capacity is this. Initially, we had planned on -- we closed 3 plants in Evansville, but we were going to close 4. When I came in and looked at the product mix, I made the decision that we were going to keep one of those plants open and, therefore, that's probably why that capacity utilization number is a little skewed the way it is, with us less utilized.

But right now, we are operating in Evansville 4 plants and we started out with 8. And what we're doing right now is optimizing the manufacturing process. It could be streamlined a little bit more over time, but right now the goal is to get it right not to get -- I mean, I always want to get costs out, but at the same time you really have to be judicious when you're in a problem. We want to move slowly and accurately to resolve our problems and, therefore, we are not going to eliminate as many plants as we had originally planned.

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John William Richardson, A. Schulman, Inc. - CFO and EVP [33]

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And I think we have a good plan is in place right now. Well, I mean, I think the plan is in place. Execution as efficiently and quickly as possible now is the key. And as you take a look at U.S. and Canada, the profitability and the shrinkage of margins, you will see -- I would like to think and believe that you will see improvement there as we deal with this complex issue that we have in Evansville.

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Joseph M. Gingo, A. Schulman, Inc. - Chairman, CEO and President [34]

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The merging of the business models, I think -- and when I first came back in August of last year, I did not have an understanding of the complexity that we were facing. I am much more confident that we understand what the issue is and we have a good path going forward. You also have to remember that the day after I came in, I appointed a new head of US/Canada. So both of us have been spending a lot of time, along with the CFO and the COO, of analyzing the issues. We have our hands around the issues. We know what they are and now it's execution.

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Operator [35]

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And our next question comes from Jason Freuchtel of SunTrust.

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Jason Alexander Freuchtel, SunTrust Robinson Humphrey, Inc., Research Division - Associate [36]

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In relation to the headwind that's driven by lower volumes in US/Canada region this quarter, how do you think about the different impacts of focusing on higher margin business that may have lower volumes relative to the benefit of higher asset utilization?

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Joseph M. Gingo, A. Schulman, Inc. - Chairman, CEO and President [37]

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We are continuing to do that. I mean, that is the general focus throughout the company as we more specialize our lines. So that's always in the back of our mind and that's why I think you saw a margin improvement because some of that is reflected in that. So that is always a continued emphasis for us.

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John William Richardson, A. Schulman, Inc. - CFO and EVP [38]

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I think it's much more evident in our other regions where we see an improvement there, certainly in Latin America. We -- actually, in Custom Concentrates and Services, we walked away from some low-margin business. And actually that customer has now has come back to us because of the product that they had gotten from our competitor was not living up to their required specifications. So we've gone back with another product and we -- and so that really helped us from a price/mix standpoint. In Asia Pacific, we've had good improvement in price/mix, driven by making sure that we have our products priced in the region. So I think that, if you look around the world, we have good improvement there.

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Jason Alexander Freuchtel, SunTrust Robinson Humphrey, Inc., Research Division - Associate [39]

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Okay. And that leads into my next question. Lat Am appeared to be performing the best from a margin perspective in the quarter. What were your asset utilization rates in the Lat Am region? And do you have sufficient capacity to continue to increase volume and mix in Lat Am?

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Joseph M. Gingo, A. Schulman, Inc. - Chairman, CEO and President [40]

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Lat Am was around 66% utilization. So we have opportunities to more utilize our equipment in that region.

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Jason Alexander Freuchtel, SunTrust Robinson Humphrey, Inc., Research Division - Associate [41]

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Okay. Great. And then, I think you indicated that your operating income in Europe improved in part due to your simplification efforts, but it looked like pounds sold declined in the region. Were there other headwinds in Europe that mitigated the benefit of your simplification efforts? And should we anticipate pounds sold will increase going forward?

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Joseph M. Gingo, A. Schulman, Inc. - Chairman, CEO and President [42]

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Well, one thing -- John mentioned this in his conversation. We have some significantly large customers in sourced materials, particularly in our Custom Concentrates and Services business. That's a onetime event. I mean, going forward, that will also be the case. We did not lose the customer's business. The customer actually gave us more of his specialty business as he took the volume commodity in-house. And also probably is a little bit a help of our margin as that occurred, although our volume became a little bit less.

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John William Richardson, A. Schulman, Inc. - CFO and EVP [43]

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I think also, Joe, that as we mentioned in the first quarter, our distribution and service business in EMEA was particularly down in the first quarter and we had a little bit of drag in the second quarter also as we were bringing that team back up to what we -- to the volumes that we thought are appropriate.

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Joseph M. Gingo, A. Schulman, Inc. - Chairman, CEO and President [44]

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And we're seeing improvement in that group as we go.

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Jason Alexander Freuchtel, SunTrust Robinson Humphrey, Inc., Research Division - Associate [45]

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Okay. Great. And then, just for clarification, and I apologize if I missed this, but was the FX impact on your adjusted EBITDA for fiscal 2Q roughly $1.5 million and about $3 million year-to-date?

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John William Richardson, A. Schulman, Inc. - CFO and EVP [46]

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It's -- in terms of EPS, it's about $0.03 for the quarter and $0.05 year-to-date.

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Operator [47]

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(Operator Instructions) And our next question comes from Dmitry Silversteyn of Longbow Research.

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Dmitry Silversteyn, Longbow Research LLC - Senior Research Analyst [48]

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A couple of questions. First of all, on the APAC -- Asia Pacific business, it grew really nicely and I think it's not the first quarter it's done that. So I'm just trying to understand what the drivers there, whether it's just the Chinese economy doing well or a mix or repositioning of your business or picking up share?

And then, related to that and somewhat sort of on the other side of that question is your margin progression seemed to have lost a little bit of a momentum in Asia Pacific. You really had a nice increase in 2016, but as we get into 2017, you were up a little bit in the first quarter. It looks to be down a little bit year-over-year here in the second. Just trying to understand kind of continuing strong growth and the source of that versus margins that look to be flattening out.

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John William Richardson, A. Schulman, Inc. - CFO and EVP [49]

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Okay. Dmitry, this is John. Let me take a crack at it. First of all, in APAC, I think that we had the -- we had good growth in our volumes. I think it's 12%, excluding FX, I think is the number and it was spread across both Custom Concentrates and Services and in Performance Materials.

In Performance Materials, we had good volume in the appliance area and had good price/mix there as well. And also we had good growth in automotive. We had a big win in China with an automotive manufacturer, so that helped us. In the Custom Concentrates and Services also, I mean, are we -- and, I mean, just to kind of put things into perspective, I was looking recently, I think the population of Asia is 4.3 billion people, right? And there is a huge growth in people that are in the middle class and it's just -- like, in Custom Concentrates and Services, the personal care and hygiene area, I mean, is a high growth area for us. And one plant in particular that we have is running at full capacity in Asia and we actually had to import product in that country to satisfy the market. So I think those are kind of the positive things from it as it relates to volume.

As it relates to margin, we did have a little bit of shrinkage in our operating margin in the quarter. We did mention to you that we added -- that we restructured our organization there and we've actually [ph] added sales people. I think that the number is actually an additional 6 people that we've added to there and we're also continually looking to see whether we need to add more because of the growth in the market. And that kind of depressed our margins a little bit, but I think we're very -- we feel very strongly about the growth prospects in Asia. The Chinese market is growing at, depending upon who you talk about -- talk to about it, it's between 6% and 7%. And we think that we're in a good place there.

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Joseph M. Gingo, A. Schulman, Inc. - Chairman, CEO and President [50]

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I think also, Dmitry, we've seen a lot of strength in Southeast Asia. China is continuing to do well. India is doing what it's doing. But I think if you look at all of the areas that we're in, Southeast Asia, particularly our Indonesian and Malaysian operations, probably had the most significant growth.

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Dmitry Silversteyn, Longbow Research LLC - Senior Research Analyst [51]

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Okay, Joe. That's helpful. And then, if I can follow-up and just get some clarification on your earnings guidance cadence in the second half of the year. Am I understanding you correctly that you sort of expect $0.65 to $0.70 in each of the next 2 quarters? And if that's the case, is the difference sort of on year-over-year basis or however you want to look at it versus Street expectations going into this call, is that going to be mainly on margin or on the revenue distribution between the 2 quarters?

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John William Richardson, A. Schulman, Inc. - CFO and EVP [52]

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We're talking about the -- our EPS guidance, right?

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Dmitry Silversteyn, Longbow Research LLC - Senior Research Analyst [53]

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Right.

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John William Richardson, A. Schulman, Inc. - CFO and EVP [54]

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And what we're looking at there -- I mean, we had a lot of unusual stuff happening in the -- in last year's third quarter that actually just skewed the earnings per share in an unusual way. And we mentioned earlier in the call here about the bonus. I mean, there was -- there were changes in the bonus reserve last year that we don't expect to have replicated this year. We do have a lower tax rate. Our tax rate -- there was a tax rate adjustment in that quarter last year. Right now, we're looking at between 24% and 25% for our effective non-GAAP tax rate. And then, of course, the effect of foreign currency translation. We've got $0.10 that -- if the euro were to stay at the $1.06, which is where we did our forecast at, we've got a $0.10 headwind in the quarter -- I mean, in the year, which kind of split equally between quarters. So when we take a look at the EPS, we are looking at them being more level than what they were last year.

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Joseph M. Gingo, A. Schulman, Inc. - Chairman, CEO and President [55]

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I think, Dmitry, last year, in my mind, was an aberration. I think if you go back in prior years and look at the historical relationship between the third and fourth quarter, it would be much more representative of what's going to happen in the future.

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Jennifer K. Beeman, A. Schulman, Inc. - VP of Corporate Communications & IR [56]

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Do we have any further questions in the queue, Candace?

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Operator [57]

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There are no further questions at this time.

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Jennifer K. Beeman, A. Schulman, Inc. - VP of Corporate Communications & IR [58]

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Okay. Well, with that, we appreciate your interest this quarter and your support. And that concludes our call for today.

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Operator [59]

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Ladies and gentlemen, thank you for participating in today's conference. This does conclude the program and you may all disconnect. Have a great day, everyone.