Koppers Holdings Inc. Form 10-Q Summary
Reporting period: Quarter and nine months ended September 30, 2018; filed November 8, 2018. Koppers is an integrated global provider of treated wood products, wood-preservation chemicals, carbon compounds and related services. Its reportable segments are Railroad and Utility Products and Services (RUPS), Performance Chemicals (PC), and Carbon Materials and Chemicals (CMC). Results are seasonal and interim results may not represent full-year performance.
Financial performance and position
| Metric | Q3 2018 | Q3 2017 | 9M 2018 | 9M 2017 |
|---|
| Net sales | $442.7 million | $384.8 million | $1,284.8 million | $1,109.4 million |
| Operating profit | $31.2 million | $35.0 million | $96.8 million | $101.2 million |
| Operating margin | 7.0% | 9.1% | 7.5% | 9.1% |
| Income from continuing operations | $6.9 million | $20.0 million | $31.2 million | $45.6 million |
| Net income attributable to Koppers | $7.6 million | $19.8 million | $26.0 million | $43.9 million |
| Diluted EPS from continuing operations | $0.35 | $0.91 | $1.17 | $2.06 |
| Net cash from operating activities | Not separately presented | Not separately presented | $8.0 million | $48.5 million |
- Sales growth: Q3 sales increased 15%; nine-month sales increased 16%, primarily reflecting the 2018 acquisitions and higher CMC pricing.
- Profitability: Q3 operating profit declined 11% and nine-month operating profit declined 4%. Higher raw-material, transportation, acquisition and interest costs more than offset sales growth.
- Taxes: The Q3 effective tax rate was 55.5%, compared with 19.4% in the prior-year quarter. The nine-month rate was 43.9%, compared with 21.4%, driven partly by the Tax Act, GILTI and other discrete items.
- Cash flow: Operating cash flow fell $40.5 million year over year because of greater working-capital usage, particularly higher inventories and receivables. Investing cash outflow was $341.6 million, including $264.0 million for acquisitions and $81.4 million of capital expenditures.
- Liquidity: September 30 cash was $62.5 million. Available revolving-credit capacity was $131.3 million, producing estimated liquidity of $193.8 million, compared with $263.6 million at December 31, 2017. Approximately $57.7 million of cash was held by foreign subsidiaries.
- Debt: Total debt was $1,057.7 million at September 30, 2018, versus $688.7 million at year-end 2017. Debt consisted primarily of a $500.0 million 2025 senior-notes balance, $437.8 million of revolver borrowings, a $95.0 million term loan and $24.9 million of construction and other loans.
- Covenants: The company reported a fixed-charge coverage ratio of 1.53 versus a 1.10 minimum and a secured leverage ratio of 2.63 versus a 3.25 maximum. It was in compliance with its debt covenants.
- Balance sheet: Total assets increased to $1,535.6 million from $1,200.2 million, primarily due to acquisitions. Total equity declined to $79.4 million from $105.8 million, affected by share repurchases and accumulated other comprehensive losses.
Segment performance
| Segment | Q3 2018 sales | Q3 2018 operating profit | 9M 2018 sales | 9M 2018 operating profit |
|---|
| RUPS | $185.0 million | $5.8 million | $470.6 million | $5.9 million |
| Performance Chemicals | $108.2 million | $11.0 million | $320.7 million | $28.2 million |
| CMC | $149.5 million | $14.9 million | $493.5 million | $64.6 million |
- RUPS: Sales benefited from UIP and MAER acquisitions and commercial-tie activity, but operating profit declined because of lower Class I railroad crosstie treating volumes, higher lumber costs and a $6.0 million UIP inventory fair-value adjustment for the nine-month period.
- Performance Chemicals: Sales were broadly flat, while operating profit fell sharply because of higher copper, transportation and other raw-material costs, supply disruptions and weaker residential-market volumes.
- CMC: Nine-month operating profit increased substantially, supported by higher carbon-pitch, carbon-black-feedstock and naphthalene prices and a more efficient operating footprint. Q3 profit nevertheless declined because of lower margins in China and a temporary curtailment by the largest Chinese customer.
Material changes and unusual items
- On February 28, 2018, Koppers acquired MAER for $62.8 million of net cash consideration. On April 10, 2018, it acquired Cox Industries, renamed Koppers Utility and Industrial Products, for $201.2 million. Both acquisitions were funded with revolving-credit borrowings.
- Acquisition-related assets and liabilities were recorded using preliminary valuations; final valuations may materially change goodwill, intangible assets, depreciation, amortization and deferred taxes.
- The company adopted ASC 606 using the modified retrospective method. The opening retained-earnings adjustment was a $0.3 million increase; the nine-month 2018 impact reduced sales by $2.1 million and cost of sales by $2.0 million.
- The company adopted new hedge-accounting guidance and reclassified a $3.6 million unrealized gain, net of tax, from retained earnings to accumulated other comprehensive loss.
- Comprehensive loss attributable to Koppers was $0.9 million in Q3 and $11.2 million for nine months, compared with comprehensive income of $36.6 million and $73.1 million, respectively, in the prior-year periods. Currency and hedge losses were significant contributors.
- The company repurchased $31.7 million of common stock during the first nine months, including $29.2 million by the parent company in the consolidating cash-flow presentation. No dividend is expected for the foreseeable future.
Outlook, risks and contingencies
- Management expected 2018 capital expenditures, excluding acquisitions, of approximately $85 million to $90 million and additional working-capital usage of $30 million to $40 million, primarily for railroad inventory and receivables.
- Management estimated that a remaining transition by certain Class I railroads to supplier-held untreated inventory could require approximately $50 million of additional working capital and extend the revenue cycle by six to nine months.
- CMC restructuring initiatives were expected to generate an additional $9.5 million to $11.5 million of restructuring and related charges through 2020, with approximately $30 million of future cash requirements. The new Stickney, Illinois naphthalene unit was commissioned in Q3 2018.
- In October 2018, the company sold its Clairton, Pennsylvania facility, transferred $6.2 million of cash and expected to record a $6.1 million loss in Q4 2018.
- The company faces exposure to copper, lumber, coal tar, oil and other commodity prices; foreign exchange and interest rates; railroad and aluminum-industry demand; customer concentration; supply disruptions; and debt refinancing and covenant compliance.
- There were 87 plaintiffs in 48 coal-tar-pitch cases. No reserve was recorded because the probability and amount of loss could not reasonably be estimated.
- The company received an EPA letter concerning potential Clean Water Act and storage-tank compliance violations at facilities in West Virginia and Pennsylvania. Potential penalties and expenditures could not be estimated.
- Environmental liabilities included $12.7 million of accrued environmental reserves, including $2.1 million for estimated participation and de minimis settlement costs at the Portland Harbor and Newark Bay CERCLA sites. Additional recorded remediation liabilities applied to acquired sites.
- The company planned to adopt the new lease standard on January 1, 2019 using a modified retrospective approach. It expected no material income-statement or cash-flow effect but anticipated a material effect on total assets and liabilities; the amount had not yet been quantified.
Important facts for investors to verify
- Whether acquired UIP and MAER achieve expected operating improvements and synergies, and how final purchase-price accounting affects future earnings.
- Whether Class I railroad demand and crosstie inventory requirements improve or create the estimated additional working-capital burden.
- Whether PC margins recover as copper and other input costs stabilize, and the effect of outstanding copper-hedge losses.
- Whether CMC pricing, Chinese customer volumes and the Stickney facility generate sustainable margin improvement.
- Debt reduction capacity, revolver availability, covenant headroom and refinancing risk given the increase in leverage.
- Final tax effects of the Tax Act, GILTI, interest-deduction limitations and remaining uncertain tax positions.
- Potential cash costs from restructuring, environmental matters, EPA proceedings, coal-tar-pitch litigation and the Clairton sale.
