Koppers Holdings Inc. quarterly report, Q1 FY2020

Koppers Holdings Inc. — Q1 2020 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). This filing covers the three months ended March 31, 2020, compared with the three months ended March 31, 2019. Interim results are seasonal and may not be indicative of full-year performance.

The company classified its 75%-owned Koppers (Jiangsu) Carbon Chemical Company Limited (KJCC) business as discontinued operations after entering into an agreement to sell it in February 2020.

Financial performance and key metrics

Metric	Q1 2020	Q1 2019	Change
Net sales	$401.9 million	$376.9 million	7% increase
Operating profit	$13.6 million	$24.3 million	44% decrease
Operating margin	3.4%	6.4%	300 basis-point decline
Income from continuing operations	$1.9 million	$9.8 million	Decrease
Net income attributable to Koppers	$(1.4) million	$11.6 million	Decline
Diluted earnings per share	$(0.07)	$0.56	Decline
Net cash used in operating activities	$17.2 million	$14.3 million	Higher use of cash
Capital expenditures	$10.6 million	$11.0 million	Slight decrease

Cost of sales rose to 85% of sales from 80% in the prior-year quarter. Selling, general and administrative expense decreased by $2.2 million to $34.7 million, while interest expense declined by $2.2 million to $14.0 million. The income tax provision was $1.8 million; the filing describes this as a net tax benefit in the period, principally reflecting CARES Act provisions.

RUPS revenue increased 14% to $190.0 million and operating profit increased 6% to $9.2 million. Growth was driven primarily by higher crosstie and utility pole volumes.
PC revenue increased 13% to $111.4 million, but operating profit fell 68% to $4.1 million. Unrealized copper swap losses reduced operating profit by a net $11.1 million; excluding that effect, the PC operating margin would have been 10.9% rather than 3.7%.
CMC revenue decreased 10% to $100.5 million and operating profit fell 79% to $0.7 million, primarily because of lower carbon pitch prices and volumes, weaker aluminum-related demand, lower oil prices, and inventory write-downs.
Discontinued operations generated a $4.4 million loss versus $2.7 million of income in Q1 2019. KJCC sales declined to $9.9 million from $58.0 million, primarily due to COVID-19-related effects.

Balance sheet, debt, liquidity, and cash flow

Cash and cash equivalents were $54.2 million at March 31, 2020, compared with $32.3 million at December 31, 2019.
Total debt was $963.4 million, compared with $911.9 million at year-end 2019. Debt consisted primarily of $500.0 million of 6.00% senior notes due 2025, $383.1 million drawn on the revolving credit facility, and an $80.0 million term loan.
Total liabilities were $1.464 billion and total equity was $109.2 million at March 31, 2020.
Estimated liquidity was $184.1 million, consisting of $54.2 million of cash and $129.9 million of available revolving credit capacity. Approximately $53.0 million of cash was held by foreign subsidiaries.
The company had $7.5 million of outstanding letters of credit and remained in compliance with its debt covenants. The fixed-charge coverage ratio was 2.31, the total secured leverage ratio was 2.25, and the total leverage ratio was 4.63.
Operating cash use reflected unfavorable working-capital timing, including a $21.0 million increase in accounts receivable, partially offset by an $8.6 million inventory-related cash benefit.
Financing activities provided $50.3 million, including $54.1 million of net credit-facility borrowings, partially offset by $2.6 million of debt repayments and $1.2 million of share repurchases.

Material changes versus the prior comparable period

Sales increased 7%, but operating profit fell 44% as margins contracted from 6.4% to 3.4%.
Results were materially affected by COVID-19, particularly the KJCC discontinued operation and deteriorating external-market conditions.
PC profitability was significantly reduced by copper-derivative mark-to-market losses.
CMC profitability deteriorated because of weaker carbon pitch markets, lower prices and volumes, and oil-price-related impacts.
Accumulated other comprehensive loss increased substantially, driven by a $23.3 million currency translation loss and a $25.4 million unrealized loss on cash-flow hedges. Comprehensive loss attributable to Koppers was $49.7 million versus comprehensive income of $19.6 million in Q1 2019.
Debt increased by $51.5 million on a net basis, primarily to support liquidity during the pandemic and seasonal working-capital needs.
The company amended its credit agreement on February 26, 2020, including changes to LIBOR replacement language, mandatory prepayment provisions, leverage-ratio step-downs, and asset-disposition provisions.

Outlook, commentary, risks, and unusual items

Management stated that substantially all operations continued as critical infrastructure, although facilities in China and New Zealand were temporarily curtailed and subsequently returned to service. The company launched cost-reduction and cash-conservation initiatives and was evaluating federal relief under the CARES Act.

Management expected COVID-19 to continue negatively affecting operations, cash flows, and financial position, but stated that the financial impact could not yet be reasonably estimated.
RUPS demand was expected to be stable to slightly higher, although railroad traffic, customer capital spending, supply-chain conditions, and crosstie-replacement plans remained uncertain.
PC faced risks from declining home-remodeling activity, consumer spending, copper prices, and supply disruptions.
CMC expected North American and European carbon pitch and phthalic anhydride markets to be significantly affected by the pandemic, with continuing pressure from reduced aluminum and manufacturing demand.
Capital expenditures for 2020 were expected to be approximately $55 million to $65 million, funded by operating cash flow.
The KJCC transaction had a stated sale price of $107.0 million, subject to customary adjustments and approvals. Management estimated a gain of approximately $45 million and net cash proceeds of approximately $65 million. Closing was expected four to six months after signing; antitrust approval was filed in April 2020.
Additional CMC restructuring charges of approximately $2 million to $5 million and future cash requirements of approximately $14 million were expected through 2021.
Coal tar pitch litigation involved 64 plaintiffs in 34 pending cases. No reserve was recorded because the probability and amount of potential loss could not reasonably be estimated.
Environmental liabilities included $9.3 million of accrued environmental reserves, $2.2 million for estimated Portland Harbor and Newark Bay participation and settlements, and $4.3 million for certain U.S. acquired-site remediation obligations. The company also accrued estimated liabilities related to an Australian environmental proceeding and an EPA matter involving a proposed $2.8 million penalty.
Failure to maintain debt-covenant compliance could require additional financing, asset monetization, employee furloughs, reduced capital spending, or other cash-conservation measures.

Important facts for investors to verify

Progress, regulatory approval, closing date, final proceeds, and gain realization for the KJCC divestiture.
COVID-19 effects on demand, facility operations, customer collections, suppliers, and future covenant compliance.
Whether copper-derivative losses reverse or continue and how they affect PC margins and cash flow.
CMC carbon pitch pricing, aluminum-sector demand, oil-price effects, inventory valuation, and restructuring costs.
Debt availability, borrowing costs, covenant headroom, and the ability to fund the expected $55 million to $65 million of 2020 capital expenditures.
Exposure from coal tar pitch litigation, environmental proceedings, indemnification arrangements, and potential costs exceeding recorded reserves.
Final resolution of discontinued-operation accounting and any adjustments to the estimated KJCC sale proceeds.