Koppers Holdings Inc. — Form 10-Q Summary
Business Context and Reporting Period
Unaudited results cover the three and six months ended June 30, 2015, with comparisons to the corresponding 2014 periods. Koppers operates three reportable segments: Carbon Materials and Chemicals (CMC), Railroad and Utility Products and Services (RUPS), and Performance Chemicals (PC). Results are seasonal, with typically stronger second and third quarters.
The PC business and part of RUPS reflect the August 2014 acquisition of the Osmose entities. In January 2015, Koppers sold its North American utility pole business and acquired KMG Chemicals’ creosote sales and distribution business.
Financial Performance and Key Metrics
| Metric | Q2 2015 | Q2 2014 | Six months 2015 | Six months 2014 |
|---|---|---|---|---|
| Net sales | $431.6 million | $356.8 million | $829.4 million | $688.2 million |
| Operating profit | $26.0 million | $13.3 million | $34.0 million | $13.8 million |
| Income from continuing operations | $7.9 million | $0.8 million | $3.7 million | $0.7 million |
| Net income attributable to Koppers | $9.0 million | $1.6 million | $5.6 million | $3.8 million |
| Diluted EPS | $0.44 | $0.08 | $0.27 | $0.19 |
| Net cash from operating activities | Not separately provided | Not separately provided | $78.1 million | $(8.7) million |
Q2 operating margin was approximately 6.0%, compared with 3.7% in the prior-year quarter. Six-month operating margin was approximately 4.1%, compared with 2.0% in the prior-year period. Cost of sales was 83% of sales in Q2 2015 versus 87% in Q2 2014, primarily because of the higher-margin PC business and improved RUPS fixed-cost absorption.
- CMC: Q2 sales declined 24% to $158.4 million and operating profit fell to a $2.9 million loss from $3.8 million of profit. Lower carbon pitch and carbon black feedstock volumes, lower oil-linked selling prices, foreign exchange effects, and weak market conditions pressured results.
- RUPS: Q2 sales increased 15% to $170.9 million and operating profit rose 17% to $15.0 million. Higher crosstie volumes, railroad customer restocking, and acquired railroad services operations supported performance.
- PC: Q2 sales were $102.3 million and operating profit was $15.5 million, or 15.2% of sales. Six-month sales were $183.8 million and operating profit was $21.9 million, or 11.9% of sales.
Cash Flow, Debt, and Liquidity
- Six-month operating cash flow was $78.1 million, including a $30 million advance payment related to a revised Chinese soft-pitch supply agreement, $29.0 million of deferred revenue activity, and favorable accounts payable changes.
- Investing cash use was $20.1 million, including $17.3 million of capital expenditures and $15.3 million for acquisitions, partially offset by $12.5 million of divestiture and asset-sale proceeds.
- Financing cash use was $66.6 million, primarily reflecting $58.2 million of debt repayments, $8.7 million of dividends paid, and $1.0 million of deferred financing costs.
- Cash and cash equivalents were $51.2 million at June 30, 2015, essentially unchanged from $51.1 million at December 31, 2014.
- Total debt was $794.2 million, including $45.4 million of current maturities and $748.8 million of long-term debt, compared with $850.5 million at December 31, 2014.
- Estimated liquidity was $132.2 million, consisting of $51.2 million of cash, $80.2 million of available revolver capacity, and $0.8 million under other credit facilities. Approximately $50 million of cash was held by foreign subsidiaries and would incur an estimated $20 million cash tax cost if repatriated.
- The company reported compliance with its debt covenants. The fixed-charge coverage ratio was 1.66 versus a 1.10 minimum, and the leverage ratio was 4.76 versus a 5.25 maximum.
Material Changes Versus the Prior Comparable Period
- Sales increased 21% in both the quarter and first half, primarily because of the Osmose acquisition and stronger RUPS volumes, despite substantial CMC declines.
- Operating profit increased 95% in Q2 and 146% for the first six months, benefiting from the acquired PC business and improved RUPS performance.
- Interest expense increased to $12.9 million in Q2 and $25.9 million for the first half, up $6.3 million and $12.5 million, respectively, because of acquisition-related debt.
- Depreciation and amortization increased to $17.7 million in Q2 and $32.7 million for the first half, mainly because of the acquired businesses and accelerated depreciation related to the Green Spring plant closure.
- The effective tax rate on pretax ordinary income was 30.8% in both 2015 periods, versus 65.0% in Q2 2014 and 64.3% in the first half of 2014. The improvement reflected tax restructuring benefits and lower nondeductible closure costs; 2014 also benefited from a $5.7 million discrete tax benefit.
- No dividends were declared to Koppers Holdings shareholders during 2015. Management suspended the dividend in February 2015 and did not expect to declare dividends for the foreseeable future.
Guidance, Outlook, Risks, Contingencies, and Unusual Items
- Management expected the Osmose businesses to contribute more than $400 million of 2015 sales at EBITDA margins above the company’s 12% target; first-half results were described as consistent with expectations.
- 2015 capital expenditures, excluding acquisitions, were expected to be approximately $45 million.
- The Green Spring, West Virginia plant closure was expected to be completed by September 2015. The company recorded $2.7 million of severance and impairment charges and had $6.0 million of reserves for other historical restructuring activities at June 30, 2015.
- KJCC received a $30 million advance payment under a revised approximately 50-year Chinese supply agreement. The amount was recorded as deferred revenue and will be recognized over the remaining contract term. The revised pricing formula reflects unfavorable current market conditions.
- The company sold substantially all assets of its 50%-owned KSA Limited Partnership on July 10, 2015 and did not expect a material third-quarter impact.
- Key operating risks include lower oil and commodity prices, coal tar availability, copper and hardwood lumber costs, foreign exchange movements, economic and end-market demand, customer inventory changes, seasonality, acquisition integration, and interest rates.
- Material contingencies include coal-tar-pitch personal injury litigation, Gainesville environmental litigation, a Virgin Islands product-liability class action, CERCLA and other environmental matters, and reliance on indemnification from former owners. The company generally has not recorded reserves where loss probability and amounts could not reasonably be estimated.
- The company had a $9.5 million loan to TKK, a 30%-owned Chinese entity. TKK defaulted on its first $1.6 million installment due in June 2015; management nevertheless concluded the loan and related $2.0 million equity investment were recoverable and recorded no provision.
Investor Verification Points
- Verify whether CMC pricing and volume pressures, particularly in carbon black feedstock, phthalic anhydride, naphthalene, and carbon pitch, persisted after June 30, 2015.
- Assess the sustainability of the acquired PC and RUPS earnings and the extent to which reported growth reflects acquisition accounting rather than organic growth.
- Reconcile operating cash flow, particularly the $30 million customer advance and working-capital movements, with recurring cash generation.
- Monitor leverage, covenant headroom, revolver availability, debt maturities, and the company’s ability to resume dividends.
- Review the final purchase-price allocation for the Osmose acquisition, including the approximately $9.2 million increase in goodwill recorded since December 31, 2014.
- Evaluate potential exposure from environmental liabilities, product and toxic-tort litigation, the TKK loan default, and the company’s dependence on third-party indemnitors.