Koppers Holdings Inc. — Q1 2018 Form 10-Q Summary
Business context and reporting period
Koppers is an integrated global provider of treated wood products, wood-preservation chemicals, and carbon compounds. Its reportable segments are Railroad and Utility Products and Services (RUPS), Performance Chemicals (PC), and Carbon Materials and Chemicals (CMC). The filing covers the unaudited three months ended March 31, 2018, compared with the three months ended March 31, 2017. Results are seasonal, and first-quarter performance is not necessarily indicative of full-year results.
Financial performance and liquidity
| Metric | Q1 2018 | Q1 2017 | Change |
|---|---|---|---|
| Net sales | $406.1 million | $346.6 million | 17% |
| Operating profit | $43.3 million | $28.1 million | 54% |
| Operating margin | 10.7% | 8.1% | +2.6 percentage points |
| Income from continuing operations | $23.8 million | $4.7 million | Significant increase |
| Net income attributable to Koppers | $17.8 million | $4.4 million | Significant increase |
| Diluted EPS | $0.81 | $0.20 | Increase |
| Net cash used in operating activities | $29.0 million | $24.1 million | Use increased $4.9 million |
| Capital expenditures | $22.5 million | $14.9 million | Increase |
Cost of sales declined to 77% of sales from 79% in the prior-year quarter. The improvement was driven primarily by higher CMC margins, lower raw-material and shipping costs, and higher selling prices. SG&A increased to $38.1 million from $30.9 million, including $2.1 million of acquisition-related costs and higher salary, incentive, and stock-based compensation expense. Interest expense was $10.5 million versus $10.6 million. The prior-year period included a $13.3 million loss on extinguishment of debt; no comparable charge was recorded in 2018.
Cash and cash equivalents were $52.2 million at March 31, 2018, compared with $60.3 million at December 31, 2017. Working-capital investment was a significant cash drain, including increases of $41.7 million in accounts receivable and $10.7 million in inventories, partly offset by a $2.4 million increase in accounts payable. Total estimated liquidity was $320.3 million, consisting of cash of $52.2 million and $268.1 million of available revolving-credit capacity.
Total debt was $803.0 million at March 31, 2018, compared with $688.7 million at December 31, 2017. Debt consisted primarily of $271.9 million drawn on the revolving credit facility, $500.0 million of 6.00% senior notes due 2025, and $31.1 million of construction and other loans. The company reported compliance with its debt covenants; the fixed-charge coverage ratio was 3.03 versus a 1.10 minimum, and the secured leverage ratio was 1.45 versus a 2.75 maximum.
Material changes versus the prior comparable period
- CMC: Revenue increased 75% to $200.3 million and operating profit increased to $37.2 million from $0.6 million, reflecting higher carbon-pitch, carbon-black-feedstock, and naphthalene prices, higher carbon-pitch volumes, and a more efficient operating footprint.
- RUPS: Revenue declined 20% to $108.4 million and operating profit fell 88% to $1.1 million. Lower Class I railroad spending reduced crosstie demand, while weather delayed bridge-service projects and raw-material costs pressured margins.
- PC: Revenue was broadly stable at $97.4 million, but operating profit decreased 70% to $5.6 million. Higher copper costs, SG&A, unfavorable sales mix, and a $6.1 million unfavorable year-over-year impact from copper-swap valuation changes reduced profitability.
- MAER acquisition: On February 28, 2018, the company acquired M.A. Energy Resources for $66.1 million in cash, funded with revolving-credit borrowings. MAER provides crosstie recovery and alternative-fuel services. Purchase-accounting allocations remain preliminary.
- Accounting adoption: ASC 606 was adopted on January 1, 2018 using the modified retrospective method. The opening retained-earnings adjustment was a $0.3 million increase; the filing states the ongoing impact was immaterial to net income. The company also adopted updated hedge-accounting and pension-cost presentation guidance.
- Share repurchases and dividends: The company repurchased $7.4 million of common stock during the quarter. Its dividend was suspended in February 2015 and management does not expect to declare dividends for the foreseeable future.
Guidance, outlook, commentary, and unusual items
- Management expects 2018 capital expenditures, excluding acquisitions, of approximately $65 million to $75 million, primarily funded by operating cash flow.
- Management expects to use an additional $30 million to $40 million of working capital in 2018, primarily due to inventory and receivables/payables effects from a revised railroad crosstie supply agreement.
- CMC restructuring initiatives are expected to generate an additional $5.0 million to $11.5 million of restructuring and related charges through 2020, with approximately $30 million of future cash requirements through 2020. A new naphthalene unit at Stickney, Illinois, is expected to be completed in the second half of 2018.
- On April 10, 2018, the company acquired Cox Industries for approximately $200 million, funded with revolving-credit borrowings. Cox manufactures treated utility poles and pilings in the United States.
- On April 10, 2018, the company amended its credit arrangements to add a $100 million secured term loan, extend the revolving facility maturity to February 2023, and establish expected initial average borrowing rates of approximately 5%.
- Key operating risks include railroad capital-spending reductions, copper and other commodity-price volatility, coal-tar availability and pricing, foreign-exchange movements, interest rates, debt refinancing and covenant compliance, seasonal weather, and potential goodwill or long-lived-asset impairment.
- The company faces environmental and toxic-tort contingencies. Coal-tar-pitch litigation involved 85 plaintiffs in 47 cases at March 31, 2018; no reserve was recorded because loss probability and amount could not reasonably be estimated.
- Environmental reserves totaled $14.5 million. The company also accrued $2.1 million for estimated participation and de minimis settlement costs at the Portland Harbor and Newark Bay CERCLA sites, while acknowledging that ultimate costs could be materially higher.
- Tax estimates remain subject to change under the Tax Cuts and Jobs Act, including GILTI and the provisional transition-tax analysis. The estimated annual effective tax rate was 34.4%, and the quarterly effective rate was 27.9%.
Most important facts for investors to verify
- Whether the substantial Q1 CMC price and margin benefit is sustainable as coal-tar and carbon-pitch markets moderate.
- The pace of recovery, if any, in North American railroad crosstie demand and RUPS profitability.
- Integration results and final purchase accounting for MAER, and the financial contribution and leverage impact of the subsequent Cox acquisition.
- Operating cash-flow conversion, working-capital requirements, and the company’s ability to fund projected capital expenditures while reducing or managing debt.
- Compliance with revolving-credit and senior-note covenants after the Cox acquisition and the additional $100 million term loan.
- Potential cash costs from CMC restructuring, environmental remediation, CERCLA matters, coal-tar-pitch litigation, and other contingencies.
- Future effects of copper-price movements and derivative valuations on PC margins and comprehensive income.