Koppers Holdings Inc. quarterly report, Q3 FY2015

Koppers Holdings Inc. — 2015 Third-Quarter Form 10-Q

Reporting period: Three and nine months ended September 30, 2015, compared with the corresponding 2014 periods. The interim financial statements are unaudited, and results are subject to seasonal fluctuations.

Business Context

Koppers is a global producer of carbon compounds, chemicals, treated wood products and railroad-related services. Reportable segments are Carbon Materials and Chemicals (CMC), Railroad and Utility Products and Services (RUPS), and Performance Chemicals (PC). The PC and certain RUPS operations reflect the August 2014 acquisition of the Osmose Entities.

Financial Performance and Key Metrics

Metric	Q3 2015	Q3 2014	9M 2015	9M 2014
Net sales	$433.8 million	$440.1 million	$1,263.2 million	$1,128.3 million
Operating profit	$27.0 million	$17.3 million	$61.0 million	$31.1 million
Operating margin	6.2%	3.9%	4.8%	2.8%
Net income attributable to Koppers	$10.1 million	$(2.7) million	$15.7 million	$1.1 million
Diluted EPS	$0.49	$(0.14)	$0.76	$0.05
Net cash provided by operating activities	Not provided for quarter	Not provided for quarter	$95.1 million	$10.8 million

Q3 income from continuing operations attributable to Koppers was $10.2 million, compared with a $2.8 million loss in the prior-year quarter. Interest expense increased to $12.6 million from $11.9 million. The Q3 effective tax rate on pretax ordinary income before discrete items was 35.3%, compared with 94.2% in 2014. For the nine-month period, the comparable rates were 33.1% and 80.9%.

Segment Q3 operating profit was $17.7 million for RUPS, $9.7 million for PC, zero for CMC and $(0.4) million for Corporate. Nine-month operating profit was $48.1 million for RUPS, $31.6 million for PC, $(13.8) million for CMC and $(4.9) million for Corporate.

Cash Flow, Liquidity and Capital Structure

September 30 cash and cash equivalents were $33.0 million, down from $51.1 million at December 31, 2014.
Total debt was $763.1 million, down from $850.5 million; long-term debt was $718.0 million, and current maturities were $45.1 million.
Estimated liquidity was $139.1 million, consisting of $33.0 million of cash, $105.3 million of available revolving credit and $0.8 million under other credit facilities. Approximately $32 million of cash was held by foreign subsidiaries and would incur an estimated $13 million cash tax cost if repatriated.
Operating cash flow of $95.1 million benefited from lower working-capital usage, higher accounts payable, lower inventories and a $30.0 million advance payment under a Chinese supply agreement.
Investing cash outflow was $27.0 million, including $26.4 million of capital expenditures, $15.3 million of acquisitions and $14.7 million of divestiture and asset-sale proceeds.
Financing cash outflow was $96.3 million, principally reflecting debt repayments. The company paid $8.7 million of dividends, but declared no dividends to Koppers Holdings shareholders during 2015.
The company suspended its dividend in February 2015 and stated that it did not expect to declare dividends for the foreseeable future.
At September 30, 2015, the fixed-charge coverage ratio was 1.43 versus a 1.10 minimum, and the leverage ratio was 4.61 versus a 5.25 maximum. Management stated that the company was in compliance with its principal debt covenants.

Material Changes Versus the Prior Comparable Period

Q3 sales declined 1%, while nine-month sales increased 12%, primarily because the 2014 Osmose acquisition increased PC and RUPS revenue.
CMC Q3 sales fell 28% and nine-month sales fell 25%, driven by lower volumes, lower oil-linked selling prices for carbon black feedstock, phthalic anhydride and naphthalene, foreign exchange translation and weaker market conditions.
RUPS Q3 sales increased 6% and nine-month sales increased 14%, supported by stronger crosstie volumes, railroad customer restocking and acquired railroad-services revenue.
PC Q3 sales increased 102% and nine-month sales increased 501%, primarily reflecting a full period of consolidation after the Osmose acquisition. PC operating margin improved to 10.4% in Q3 and 11.4% for nine months from 2.8% in both 2014 comparison periods.
Operating profit increased 56% in Q3 and 96% for nine months, despite materially weaker CMC performance, because of PC and RUPS contributions and lower prior-year acquisition and integration costs.
Depreciation and amortization increased to $49.6 million for nine months from $29.8 million, primarily due to acquired businesses and accelerated depreciation associated with the Green Spring closure.
The company sold its North American utility pole business for $13.6 million of total consideration and recognized a $3.2 million gain. It also acquired the KMG creosote sales and distribution business for $15.1 million.

Guidance, Outlook, Risks and Unusual Items

Management expected the acquired Osmose businesses to add more than $400 million of 2015 sales with EBITDA margins above the company’s 12% target level; management stated that nine-month results were consistent with expectations.
2015 capital expenditures, excluding acquisitions, were expected to total approximately $42 million.
CMC is restructuring its operating footprint because of lower demand, weaker oil-linked pricing and declining coal-tar availability. The company planned to curtail distillation at Follansbee, West Virginia, at year-end 2015 and was evaluating additional curtailments or closures.
The adjacent carbon black and needle coke facilities supporting the KJCC project in China were delayed and were not expected to be fully operational until near the end of 2016. KJCC was not expected to satisfy certain financial covenants at December 31, 2015. The company was negotiating refinancing or amended covenants; failure could permit the lender to demand approximately $31.2 million of outstanding debt, secured by a revolving-credit letter of credit.
KJCC received a $30.0 million advance payment under an amended 50-year supply agreement. The amount was recorded as deferred revenue and will be recognized over the remaining contract term.
Material litigation and environmental contingencies include coal-tar pitch cases, the Gainesville class action, a Virgin Islands product-liability class action and CERCLA matters. The company generally had not recorded reserves where loss probability and amount could not be reasonably estimated.
Environmental liabilities totaled $20.0 million at September 30, 2015. The company also relies on indemnification from former owners for significant pre-acquisition environmental liabilities.
The company had a $9.5 million loan to related party TKK. TKK defaulted on scheduled repayments; management believed the principal remained collectible, so no loan-loss provision was recorded. The company separately recorded a $0.4 million write-down of its TKK investment.
Outstanding copper hedges had a fair-value liability of $9.3 million, and the company estimated that $4.9 million of unrealized losses, net of tax, would be reclassified into earnings over the following twelve months.

Most Important Facts to Verify

Whether CMC restructuring actions, including the Follansbee curtailment and potential additional closures, reduce costs without creating significant impairment, severance or environmental charges.
Whether KJCC completes refinancing or obtains covenant relief before December 31, 2015, avoiding acceleration of the related loan and use of revolving-credit capacity.
Whether PC and acquired RUPS businesses sustain expected sales and EBITDA margins as acquisition synergies and integration benefits mature.
Whether lower oil prices, coal-tar availability, aluminum and steel demand, copper prices and foreign exchange rates continue to pressure CMC margins.
Whether liquidity remains adequate after debt service, capital expenditures, restructuring costs, working-capital needs and potential environmental or litigation payments.
Whether the company can maintain compliance with fixed-charge coverage and leverage covenants while dividends remain suspended.
The ultimate exposure from unresolved litigation, environmental remediation and reliance on third-party indemnitors.