Koppers Holdings Inc. — Form 10-K Summary
Reporting period: Fiscal year ended December 31, 2018, with selected fourth-quarter information. Koppers is a global provider of treated wood products, wood-preservation chemicals and carbon compounds operating through Railroad and Utility Products and Services (RUPS), Performance Chemicals (PC), and Carbon Materials and Chemicals (CMC).
Business Context and Reporting Period
- In February 2018, Koppers acquired Koppers Recovery Resources LLC (KRR), a used-crosstie and biomass recovery business.
- In April 2018, Koppers acquired Cox Industries, renamed Koppers Utility and Industrial Products (UIP), re-entering the North American utility-pole market.
- The two acquisitions had combined cash consideration of approximately $264.0 million and contributed $163.0 million of 2018 revenue.
- Operations are global; foreign subsidiaries generated approximately 40% of total sales.
Key Financial Metrics
| Metric | 2018 | 2017 | Change |
|---|---|---|---|
| Net sales | $1,710.2 million | $1,475.5 million | +16% |
| Operating profit | $110.4 million | $123.6 million | -11% |
| Operating margin | 6.5% | 8.4% | -1.9 points |
| Income from continuing operations | $28.8 million | $31.3 million | -8% |
| Net income attributable to Koppers | $23.4 million | $29.1 million | -20% |
| Diluted EPS from continuing operations | $1.08 | $1.36 | -21% |
| Net cash from operating activities | $78.3 million | $101.8 million | -23% |
| Capital expenditures | $109.7 million | $67.5 million | +62% |
| Cash and cash equivalents | $40.6 million | $60.3 million | -33% |
| Total debt | $1,002.6 million | $688.7 million | +46% |
Fourth quarter: Sales were $425.4 million, operating profit was $13.6 million, and net loss attributable to Koppers was $2.6 million, or diluted loss of $0.13 per share. The fourth quarter reflected normal seasonality, lower railroad demand and restructuring and asset-sale effects.
Segment Results
| Segment | 2018 Sales | 2017 Sales | 2018 Operating Profit | 2017 Operating Profit |
|---|---|---|---|---|
| RUPS | $634.8 million | $512.6 million | $5.9 million | $26.2 million |
| PC | $420.0 million | $411.2 million | $36.2 million | $71.4 million |
| CMC | $655.4 million | $551.7 million | $70.7 million | $28.0 million |
- RUPS: Sales increased primarily from UIP and KRR, but profit declined because of reduced Class I railroad crosstie treating volumes, higher lumber costs and a $6.0 million UIP inventory fair-value adjustment.
- PC: Sales rose modestly, but profit declined due to higher copper, transportation and other raw-material costs, supply disruptions and a net unfavorable $16.0 million change in copper-swap gains and losses.
- CMC: Profit improved materially from higher carbon-pitch, carbon-black-feedstock and naphthalene pricing, restructuring benefits and a more efficient footprint. Results were partly offset by lower volumes, higher raw-material costs and weaker China volumes.
Cash Flow, Liquidity and Debt
- Operating cash flow declined to $78.3 million, primarily because working capital used $20.3 million, including an $18.3 million inventory increase related to railroad customer inventory requirements and higher CMC raw-material prices.
- Investing cash flow was negative $376.4 million, including $264.0 million for acquisitions and $109.7 million of capital expenditures.
- Financing activities provided $282.8 million, including approximately $314.6 million of net borrowings and $31.8 million of share repurchases.
- Estimated liquidity at year-end was $219.6 million, consisting of $40.6 million of cash and $179.0 million of available revolving-credit capacity. Outstanding letters of credit used $31.9 million of commitments.
- Debt consisted primarily of a $500.0 million 6.00% Senior Notes issue due 2025, $390.0 million drawn on the revolving facility, a $92.5 million term loan due 2023 and other loans.
- The company was in compliance with its debt covenants. The fixed-charge coverage ratio was 1.35 versus a 1.10 minimum; senior secured leverage was 2.39 versus a 3.25 maximum; and total leverage was 4.73 versus a 5.50 maximum.
- Koppers has not declared a dividend since November 2014 and does not expect to declare dividends for the foreseeable future. The share-repurchase authorization had approximately $24.8 million remaining at year-end.
Material Changes Versus the Prior Period
- Revenue growth was acquisition-driven and also benefited CMC from higher selling prices, but consolidated profitability declined because RUPS and PC margins contracted.
- Cost of sales increased to 80% of sales from 78%, reducing consolidated operating margin to 6.5% from 8.4%.
- Interest expense increased to $56.3 million from $42.5 million because of higher average debt used to fund acquisitions.
- SG&A increased by $29.1 million, including $18.5 million of incremental UIP and KRR costs, $6.5 million of acquisition expenses and $3.3 million of higher compensation expense.
- Impairment and restructuring charges declined to $4.0 million from $16.2 million. However, the company recorded an $8.3 million loss on asset sales, including the Clairton facility and businesses in the United Kingdom.
- Net debt increased substantially, while cash declined because acquisition spending and capital expenditures exceeded operating cash flow.
- Consolidated shareholders’ equity declined to $56.2 million from $99.9 million, partly due to foreign-currency translation and hedge losses and share repurchases.
Guidance, Outlook, Risks and Unusual Items
- Management expected 2019 capital expenditures, excluding acquisitions, of approximately $30 million, funded from operations.
- Management expected railroad crosstie demand to stabilize and modestly improve in the second half of 2019, subject to lumber availability. A potential remaining customer transition to supplier-held untreated inventory could require approximately $50 million of additional working capital.
- CMC restructuring is expected to generate an additional $5.0 million to $7.0 million of restructuring and related charges through 2020, with approximately $20 million of future cash requirements through 2021.
- Environmental-control capital expenditures for 2019 were expected to be approximately $9.1 million. Environmental reserves totaled $10.1 million at year-end.
- Key risks include raw-material availability and pricing for lumber, coal tar and copper; cyclical railroad, housing, aluminum and chemical markets; foreign exchange and trade restrictions; variable-rate debt and LIBOR transition; covenant compliance; environmental obligations; litigation; pension underfunding; labor disruptions; cyber risks; and impairment of goodwill or long-lived assets.
- The company had $32.1 million of pension underfunding and $9.4 million of unfunded other post-retirement obligations. Expected 2019 benefit-plan contributions were approximately $3.6 million.
- Pending legal matters included coal-tar-pitch personal-injury cases, pavement-sealer cases and environmental proceedings. No reserve was recorded for the coal-tar-pitch or pavement-sealer lawsuits because the probability and amount of loss could not be reasonably estimated.
- The company had a $2.2 million reserve for estimated participation costs at the Portland Harbor and Newark Bay CERCLA sites. The EPA was also reviewing potential Clean Water Act and storage-tank compliance issues at several facilities.
- Management reported effective internal control over financial reporting, but excluded UIP and KRR from its 2018 assessment because they were acquired during the year and were still being integrated.
Investor Verification Checklist
- Verify whether RUPS railroad volumes and margins recover and whether the anticipated second-half 2019 demand improvement occurs.
- Assess whether UIP and KRR achieve expected synergies and become profitable after acquisition-related and purchase-accounting effects.
- Monitor copper, lumber and coal-tar prices, hedging results and the company’s ability to pass cost increases through to customers.
- Review debt maturities, revolving-credit availability and compliance with fixed-charge and leverage covenants.
- Evaluate cash conversion, inventory growth and the potential $50 million working-capital requirement from customer inventory-model changes.
- Track CMC restructuring cash costs, plant closures and the benefits from the new Stickney naphthalene unit.
- Review environmental reserves, EPA matters, CERCLA allocations and the July 2019 expiration provisions for certain Beazer East indemnification claims.
- Consider the effect of foreign exchange, tariffs, aluminum-market conditions and China customer pricing disputes on future revenue and margins.
- Confirm the accounting and control integration of UIP and KRR and the effect of ASC 606 revenue recognition and the new lease standard.