Koppers Holdings Inc. quarterly report, Q3 FY2013

Koppers Holdings Inc. 2013 Q3 Form 10-Q Summary

Business context and reporting period

Koppers is a global producer of chemicals, carbon compounds, and treated wood products serving aluminum, railroad, utility, specialty chemical, rubber, concrete, and steel markets. Its two reportable segments are Carbon Materials and Chemicals (CMC) and Railroad and Utility Products and Services (RUPS). This unaudited Form 10-Q covers the three and nine months ended September 30, 2013, compared with the corresponding 2012 periods. Results are seasonal and interim results may not indicate full-year performance.

Financial performance and position

Metric	Q3 2013	Q3 2012	9M 2013	9M 2012
Net sales	$395.2 million	$387.9 million	$1,136.5 million	$1,180.1 million
Operating profit	$39.1 million	$30.8 million	$92.5 million	$100.7 million
Operating margin	9.9%	7.9%	8.1%	8.5%
Net income attributable to Koppers	$19.1 million	$16.0 million	$44.5 million	$52.0 million
Diluted EPS	$0.92	$0.77	$2.13	$2.49
Operating cash flow	Not provided for quarter	Not provided for quarter	$65.6 million	$54.5 million

Segment sales: Q3 CMC sales were $241.6 million, essentially flat year over year, while RUPS sales increased 5% to $153.6 million. For the first nine months, CMC sales declined 9% to $692.4 million and RUPS sales increased 5% to $444.1 million.
Segment operating profit: Q3 CMC profit increased 18% to $21.8 million and RUPS profit increased 39% to $17.8 million. Nine-month CMC profit declined 27% to $47.4 million, while RUPS profit increased 26% to $46.6 million.
Margins: Q3 consolidated operating margin improved to 9.9% from 7.9%. The nine-month margin declined to 8.1% from 8.5%. Q3 cost of sales was 84% of sales versus 85% in the prior-year quarter.
Cash flow and capital spending: Nine-month operating cash flow increased $11.1 million, primarily from lower working-capital investment. Capital expenditures increased to $29.4 million from $15.8 million, largely for the Pizhou, China coal tar facility. Free cash flow after capital expenditures was approximately $36.2 million before other investing items.
Liquidity: Cash and cash equivalents were $72.4 million at September 30, 2013, including $1.5 million of restricted cash. Estimated liquidity was $364.9 million, consisting of cash, $286.9 million of unused revolving-credit availability, and $5.6 million under other facilities.
Debt: Long-term debt was $296.4 million, principally 7 7/8% Senior Notes due 2019. The $300 million revolving facility had no borrowings outstanding, and $9.1 million of commitments were used by letters of credit. The company was in compliance with its debt covenants; the fixed-charge coverage ratio was 1.5 versus a 1.10 minimum, and the leverage ratio was 1.73 versus a 4.0 maximum.
Balance sheet: Total assets were $761.1 million versus $780.0 million at December 31, 2012. Total liabilities declined to $576.4 million from $611.9 million, while total equity increased to $184.7 million from $168.1 million.
Shareholder returns: The quarterly dividend increased to $0.25 per share from $0.24. The company repurchased $17.5 million of common stock during the first nine months and declared another $0.25 dividend payable January 6, 2014.

Material changes versus the prior comparable periods

Q3 results improved despite only 2% sales growth, reflecting higher operating profit in both segments, lower prior-year outage and pitch-tank-leak charges, lower SG&A, and a $1.1 million environmental reserve reversal.
Nine-month sales, operating profit, net income, and diluted EPS declined because of weaker CMC performance, particularly lower carbon pitch volumes and prices, European economic weakness, aluminum-smelter closures, and lower phthalic anhydride demand amid increased European imports.
RUPS performance strengthened from higher treated-crosstie volumes and the November 2012 acquisition of an Australian utility-pole business. However, untreated crosstie volumes began declining in Q3 because of increased competition from lumber markets.
The effective tax rate before discrete items increased to 46.4% from 35.2% in Q3 and to 43.0% from 34.7% for the first nine months, mainly because of changes in the geographic mix of earnings.
Capital expenditures rose substantially due to construction of the new majority-owned coal tar distillation facility in Pizhou, China. Construction was expected to be completed in mid-2014.

Guidance, outlook, risks, contingencies, and unusual items

Excluding acquisitions and the China coal tar facility, 2013 capital expenditures were expected to be approximately $40 million. Approximately $25 million of additional spending on the China facility was expected during the remainder of 2013, funded by cash and incremental financing.
Management expected to borrow up to approximately $32 million under a committed loan facility for the China construction project and notified lenders of its intention to increase the revolving facility to $350 million, subject to approval.
Management expected operating cash flow and available revolver capacity to fund liquidity needs for at least the next twelve months.
Low European demand, imported competition, coal tar availability and pricing, oil-price volatility, foreign exchange movements, and competitive carbon-pitch markets remain significant operating risks.
The company was curtailing its Follansbee, West Virginia tar-distillation operations. The curtailment was expected to produce approximately $4 million of annual cost savings and an estimated $1.2 million charge in Q4 2013. Additional curtailments or closures were possible.
The Tangshan Government ordered closure of two coke batteries operated by Koppers’ partner, TISCO, by March 15, 2014. Koppers’ 60%-owned KCCC facility depends on TISCO for raw materials, utilities, and shared services. Closure or relocation could materially adversely affect results. KCCC contributed approximately $3.5 million of 2012 operating profit after noncontrolling interests, and its fixed assets had a net book value of approximately $15 million at September 30, 2013.
The discontinued Kurnell, Australia facility had approximately $9.7 million of closure-related reserves at September 30, 2013, with closure expected to be completed during 2015 and total future closure costs estimated at approximately $0.3 million beyond recorded amounts.
Coal-tar-pitch toxic-tort litigation involved approximately 110 plaintiffs in 60 cases. No reserve was recorded because loss probability and amount could not reasonably be estimated.
Environmental and other contingencies include Portland Harbor and Newark Bay CERCLA matters, Australian remediation obligations, a Netherlands business-interruption arbitration claim of approximately $1.7 million, and other litigation. The company states that unfavorable resolutions could materially affect results, cash flow, or financial condition.
The company had $11.8 million of environmental reserves at September 30, 2013, including $5.9 million for Kurnell remediation, and remained dependent in part on indemnification from former owner Beazer East for certain pre-1988 environmental liabilities.

Most important facts for investors to verify

Whether the Tangshan coke-battery closure results in a KCCC shutdown, relocation, impairment, or margin reduction.
Progress, funding, and final cost of the Pizhou, China facility and the related committed financing.
Whether CMC demand and margins recover from European weakness, aluminum-smelter closures, Chinese competition, and lower phthalic anhydride volumes.
Whether untreated-crosstie shortages and lumber-market competition reduce RUPS sales and profitability in 2014.
Completion and cost of Follansbee curtailment actions, including the expected Q4 2013 charge and annual savings.
Changes in tax rates, foreign earnings mix, and the availability of foreign-held cash, which would incur an estimated $21 million tax cost if repatriated.
Developments in toxic-tort, environmental, CERCLA, arbitration, and other unreserved contingencies.
Compliance with revolving-credit and Senior Note covenants, continued dividend capacity, and the proposed increase in revolver availability.