Koppers Holdings Inc. 2019 First-Quarter Form 10-Q Summary
Business Context and Reporting Period
Koppers Holdings Inc. is an integrated global provider of treated wood products, wood-preservation chemicals, and carbon compounds serving railroad, utility, construction, chemical, aluminum, steel, and related markets. The filing covers the three months ended March 31, 2019, compared with the three months ended March 31, 2018. Results are seasonal, and first-quarter performance is not necessarily indicative of full-year results.
- Reportable segments: Railroad and Utility Products and Services (RUPS), Performance Chemicals (PC), and Carbon Materials and Chemicals (CMC).
- The April 2018 acquisition of Cox Industries, renamed Koppers Utility and Industrial Products (UIP), materially affected the year-over-year comparison.
Financial Performance and Key Metrics
| Metric | Q1 2019 | Q1 2018 | Change |
|---|
| Net sales | $434.9 million | $406.1 million | Up 7% |
| Operating profit | $28.4 million | $43.3 million | Down 34% |
| Operating margin | 6.5% | 10.7% | Down 4.2 percentage points |
| Income from continuing operations | $12.4 million | $23.8 million | Down 48% |
| Net income attributable to Koppers | $11.5 million | $17.8 million | Down 35% |
| Diluted EPS | $0.55 | $0.81 | Down 32% |
| Net cash used in operating activities | $14.4 million | $29.0 million | Improved by $14.6 million |
- Cost of sales increased to 81% of sales from 77%, primarily reflecting lower CMC gross margins and higher raw-material costs.
- Interest expense increased to $16.7 million from $10.5 million because of higher average debt used to fund the UIP and KRR acquisitions.
- The reported income tax benefit was $0.1 million versus tax expense of $9.2 million in the prior-year quarter. Favorable discrete tax items, primarily reversals of unrecognized tax benefits following audit closures, generated a $3.8 million net benefit.
- Comprehensive income attributable to Koppers increased to $19.5 million from $10.1 million, principally because of favorable cash-flow-hedge results and currency translation adjustments.
Segment Results
| Segment | Q1 2019 Sales | Year-over-Year Sales | Q1 2019 Operating Profit | Operating Margin |
|---|
| RUPS | $166.1 million | Up 53% | $8.7 million | 5.2% |
| PC | $99.0 million | Up 2% | $12.8 million | 12.9% |
| CMC | $169.8 million | Down 15% | $7.4 million | 4.4% |
- RUPS benefited from the UIP acquisition, improved crosstie volumes, higher commercial crosstie demand, and stronger rail-services activity.
- PC benefited from higher North American and Australasian volumes, favorable product mix, pricing, and a $6.6 million year-over-year benefit from changes in unrealized copper-swap gains and losses.
- CMC was adversely affected by lower carbon-pitch prices in China, lower carbon-black-feedstock and phthalic-anhydride volumes, higher raw-material costs, and foreign-exchange effects.
Cash Flow, Debt, and Liquidity
- Operating cash use improved to $14.4 million from $29.0 million, primarily because of lower working-capital usage, although net income declined.
- Investing cash use was $9.3 million versus $85.1 million, reflecting the absence of the $62.9 million of prior-year acquisition spending and lower capital expenditures.
- Financing activities provided $20.8 million, including $34.0 million of increased credit-facility borrowings and $12.6 million of long-term debt repayments.
- Cash and cash equivalents were $38.1 million at March 31, 2019, compared with $40.6 million at December 31, 2018.
- Total debt was $1,024.2 million, including $424.0 million drawn on the revolving credit facility, a $90.0 million term loan, $500.0 million of 2025 Senior Notes, and $10.2 million of construction and other loans.
- Estimated liquidity was $177.3 million, consisting of $38.1 million of cash and $139.2 million of available revolving-credit capacity. Approximately $34.6 million of cash was held by foreign subsidiaries.
- At March 31, 2019, the fixed-charge coverage ratio was 1.50 versus a minimum of 1.10; the total secured leverage ratio was 2.57 versus a maximum of 3.25; and the total leverage ratio was 4.99 versus a maximum of 5.50. The company stated that it was in compliance with all debt covenants.
- On May 1, 2019, the credit facility was amended to extend its termination date to May 1, 2024 and revise certain covenant definitions.
Material Changes, Outlook, and Unusual Items
- The company adopted the new lease standard on January 1, 2019, recognizing approximately $119 million of right-of-use assets and lease liabilities. The adoption had no material effect on reported earnings or cash flows.
- Management expects 2019 capital expenditures of approximately $30 million, excluding acquisitions, funded by operating cash flow.
- Management expects $25 million to $40 million of annualized benefits over five years from strategic initiatives and integration synergies, with approximately $10 million expected in 2019.
- RUPS demand was expected to remain stable, with modest improvement in crosstie demand. Lumber availability and potential China-U.S. trade tariffs could constrain untreated-crosstie procurement. A remaining customer transition to a supplier-held inventory model could require approximately $50 million of additional working capital and extend the revenue cycle by approximately six to nine months.
- PC margins remain exposed to copper prices. The company has implemented pricing actions and hedges a majority of expected copper requirements.
- CMC expects continued pressure from raw-material costs, carbon-pitch pricing, competition, and reduced aluminum-related demand. The company expects approximately $6.0 million of additional restructuring charges through 2020 and approximately $20 million of cash requirements for CMC plant closures through 2021.
- The company has not recognized incremental revenue related to a pricing dispute with a significant customer in China, although management believes higher pricing may be contractually supportable.
- The company suspended its common-stock dividend in February 2015 and does not expect to declare dividends for the foreseeable future.
Risks, Contingencies, and Legal Matters
- There were 65 plaintiffs in 35 coal-tar-pitch cases pending at March 31, 2019. No reserve was recorded because the probability and amount of loss could not be reasonably estimated.
- Ten Minnesota municipalities filed federal lawsuits concerning alleged contamination from coal-tar-based pavement sealers. The company has not recorded a reserve.
- The company faces environmental and remediation obligations, including a $2.2 million reserve for Portland Harbor and Newark Bay CERCLA matters, $5.0 million for certain acquired U.S. sites, and $1.4 million for an acquired Australian site.
- The company received an EPA letter concerning potential Clean Water Act and storage-tank compliance violations at three facilities. Potential penalties or other costs could not be estimated.
- Environmental indemnification from Beazer East covers certain pre-1988 liabilities, but failure or inability of indemnitors to perform could materially affect Koppers.
- Key operating and financial risks include commodity prices, raw-material availability, demand and competition, interest and foreign-exchange rates, debt refinancing and covenant compliance, environmental obligations, litigation, and potential goodwill or long-lived-asset impairment.
Important Facts for Investors to Verify
- Whether CMC pricing, raw-material costs, and demand recover sufficiently to offset the segment’s 80% operating-profit decline.
- Whether RUPS integration and strategic initiatives deliver the expected 2019 and five-year benefits.
- Working-capital requirements associated with crosstie inventory and customer procurement-model changes.
- Compliance with leverage and fixed-charge coverage covenants as operating results and cash flows fluctuate.
- Progress and cash costs of CMC closures and other restructuring actions.
- Developments in the China customer pricing dispute, coal-tar-pitch litigation, pavement-sealer litigation, EPA matter, and environmental indemnification arrangements.
- The sustainability of liquidity given $1.024 billion of total debt, limited revolver availability, seasonal cash needs, and expected contractual obligations.
