Koppers Holdings Inc. annual report, FY2017

Koppers Holdings Inc. 2017 Form 10-K Summary

Business context and reporting period

Koppers Holdings Inc. filed its Form 10-K for the fiscal year ended December 31, 2017. The company is a global supplier 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). Although the request references 2017 Q4, this filing covers the full fiscal year and includes unaudited fourth-quarter data.

RUPS serves railroad and utility markets, primarily with crossties, railroad infrastructure services, rail joint bars and Australian utility poles.
PC supplies copper-based wood preservatives and related treatment technologies.
CMC produces creosote, carbon pitch, naphthalene, phthalic anhydride and carbon black feedstock.

Financial performance and key metrics

Metric	2017	2016	Change
Net sales	$1,475.5 million	$1,416.2 million	+4%
Operating profit	$112.1 million	$86.4 million	+30%
Operating margin	7.6%	6.1%	+1.5 points
Income from continuing operations	$31.3 million	$27.1 million	+16%
Net income attributable to Koppers	$29.1 million	$29.3 million	Essentially flat
Diluted EPS	$1.32	$1.39	Down
Cash flow from operations	$101.8 million	$119.5 million	Down $17.7 million
Capital expenditures	$67.5 million	$49.9 million	+35%
Cash and equivalents	$60.3 million	$20.8 million	+ $39.5 million
Total debt	$688.7 million	$671.1 million	+$17.6 million

RUPS sales declined 13% to $512.6 million and operating profit declined 52% to $25.3 million. Lower railroad capital and operating spending, reduced crosstie volumes and commercial-market oversupply pressured results.
PC sales increased 5% to $411.2 million and operating profit increased 12% to $71.4 million, supported by North American wood-preservative volumes and favorable remodeling and existing-home trends.
CMC sales increased 26% to $551.7 million and operating profit improved to $27.4 million from a $23.6 million loss. Higher pricing, lower raw-material and shipping costs, and tighter coal-tar and carbon-pitch markets were key drivers.
Cost of sales declined to 78% of sales from 80%, reflecting improved CMC and PC margins that more than offset RUPS weakness.
Fourth-quarter sales were $366.1 million and operating profit was $12.2 million. Fourth-quarter net income attributable to Koppers was a $14.8 million loss, primarily reflecting a $20.5 million tax charge related to the Tax Cuts and Jobs Act.
The company paid no dividends in 2017 and has suspended its dividend since February 2015. It repurchased 100,000 shares for $3.9 million under its existing program.

Material changes versus prior comparable period

Management refinanced the capital structure in 2017 by issuing $500.0 million of 6.00% senior notes due 2025, repaying the term loan and retiring the 2019 senior notes. The refinancing generated a $13.3 million loss on extinguishment of debt.
The company entered into a $400.0 million senior secured revolving credit facility maturing in 2022. In February 2018, capacity was increased to $600.0 million.
Available revolver capacity at December 31, 2017 was $203.3 million after covenant and letter-of-credit restrictions. Total estimated liquidity, including cash, was $263.6 million.
CMC reduced its global coal-tar distillation footprint from 11 facilities at the beginning of 2014 to four at December 31, 2017. Additional restructuring charges of $5 million to $12 million and cash requirements of approximately $30 million are expected through 2020.
Impairment and restructuring charges were $16.2 million in 2017 versus $20.1 million in 2016. No goodwill impairment was recorded in 2017 or 2016; a $67.2 million CMC goodwill impairment was recorded in 2015.
Losses on pension settlements increased to $10.0 million from $4.4 million, including an $8.8 million charge related to annuitizing approximately $31.3 million of retiree obligations.
The effective tax rate was 48.1%, including $7.4 million from revaluing U.S. deferred tax assets and $13.1 million of estimated transition tax under the Tax Act. Excluding the Tax Act, the effective rate was 14.1%.

Liquidity, debt and financial condition

Debt consisted primarily of $500.0 million of 2025 Notes, $155.0 million drawn on the revolving facility and $33.7 million of construction and other loans.
The fixed-charge coverage ratio was 2.43 versus a 1.10 minimum; the senior secured leverage ratio was 0.95 versus a 2.75 maximum. Management reported compliance with all debt covenants.
Contractual cash obligations totaled $1.53 billion, including $688.7 million of debt principal, $236.9 million of interest, $171.5 million of operating leases and $427.1 million of purchase commitments.
Management expected 2018 capital expenditures of approximately $60 million and additional working-capital usage of $30 million to $40 million.
The pension deficit was $30.3 million and other post-retirement obligations were $11.1 million at year-end. Expected 2018 benefit-plan contributions were approximately $5.4 million.

Guidance, outlook, risks and unusual items

Management expected railroad crosstie replacement demand to be only marginally better in 2018 because North American Class I railroads continued to control spending and inventory.
Management anticipated continued favorable CMC market conditions in China and Australia, although delayed raw-material price increases were expected to partially offset the benefit in 2018.
PC demand was expected to benefit from residential repair and remodeling activity, with 2018 homeowner improvement spending projected by the cited industry indicator to approach $340 billion. Higher copper prices remained a margin risk despite hedging.
Key risks include cyclical railroad, housing, aluminum and specialty-chemical demand; commodity prices and supply for hardwood, scrap copper and coal tar; interest-rate and foreign-exchange movements; substantial leverage and covenant restrictions; adverse weather; environmental liabilities; litigation; pension underfunding; labor disruptions; and potential asset impairments.
Environmental reserves were $13.9 million at year-end, and 2018 environmental-control capital expenditures were expected to be approximately $10.9 million.
The company was involved in 48 coal-tar-pitch cases involving 87 plaintiffs and had not recorded a reserve because loss probability and amount could not reasonably be estimated. Portland Harbor and Newark Bay CERCLA matters also carried uncertainty; $2.2 million was accrued for estimated participation and de minimis settlements.
The company relies on Beazer East and Beazer Limited for certain historical environmental and product liabilities. The principal pre-closing environmental indemnity generally extends through July 2019, creating counterparty-performance risk.
Management and KPMG reported effective internal control over financial reporting, and KPMG issued an unqualified opinion on the consolidated financial statements.

Important facts for investors to verify

Whether the railroad spending cycle improves sufficiently to restore RUPS volumes and margins.
Whether CMC restructuring produces the expected earnings and cash-flow benefits without further closures or impairment charges.
The company’s ability to generate sufficient cash to fund 2018 capital expenditures, working capital, restructuring, pension contributions and debt service.
Compliance with revolving-credit and senior-note covenants as leverage, interest rates and operating performance change.
Final tax effects of the Tax Act, including transition-tax estimates, deferred-tax balances and future GILTI treatment.
Potential exposure from environmental remediation, toxic-tort litigation and the continued performance of Beazer-related indemnities.
The effect of the January 1, 2018 revenue-recognition adoption, which was expected to increase opening retained earnings by approximately $1 million and recognize approximately $5 million of previously deferred revenue.