Koppers Holdings Inc. quarterly report, Q3 FY2016

Koppers Holdings Inc. — Form 10-Q Summary

Business context and reporting period

Koppers Holdings Inc. filed its unaudited Form 10-Q for the quarter and nine months ended September 30, 2016. The company operates through Railroad and Utility Products and Services (RUPS), Carbon Materials and Chemicals (CMC), and Performance Chemicals (PC), serving railroad, utility, specialty chemical, aluminum, steel, construction, and treated-wood markets. Results are seasonal and interim results may not represent full-year performance.

Financial performance and position

Metric	Three months ended September 30, 2016	Three months ended September 30, 2015	Nine months ended September 30, 2016	Nine months ended September 30, 2015
Net sales	$371.1 million	$433.8 million	$1,103.0 million	$1,263.2 million
Operating profit	$27.7 million	$27.0 million	$67.5 million	$61.0 million
Net income attributable to Koppers	$12.1 million	$10.1 million	$22.9 million	$15.7 million
Diluted EPS	$0.58	$0.49	$1.09	$0.76
Operating margin	7.5%	6.2%	6.1%	4.8%
Cash flow from operations	Not separately provided for the quarter	Not separately provided for the quarter	$82.5 million	$95.1 million

Quarterly sales declined 14%, while operating profit increased 3% and diluted EPS increased 18%. For the nine-month period, sales declined 13%, but operating profit increased 11% and diluted EPS increased 43%. Cost of sales declined to 79% of sales in the quarter and 80% for the nine-month period, versus 83% and 84%, respectively, in the comparable periods.

RUPS sales were $145.7 million in the quarter, down 18%, and $461.5 million year to date, down 9%. Quarterly operating profit was $14.9 million, down 16%; year-to-date operating profit was $46.9 million, down 2%.
CMC sales were $117.8 million in the quarter, down 28%, and $337.5 million year to date, down 30%. Operating loss was $3.9 million in the quarter and $29.8 million year to date, compared with breakeven and a $13.8 million loss, respectively, in the prior-year periods.
PC sales were $107.6 million in the quarter, up 15%, and $304.0 million year to date, up 10%. Operating profit increased 81% to $17.6 million in the quarter and 66% to $52.6 million year to date.
Cash flow from operations decreased to $82.5 million, primarily because of higher accounts receivable usage and the absence of a $30.0 million customer advance received in 2015.
Capital expenditures were $32.2 million year to date, compared with $26.4 million in 2015. Investing cash outflow was $36.7 million.
Cash and cash equivalents were $17.7 million at September 30, 2016, compared with $21.8 million at December 31, 2015.
Total debt was $691.0 million, including $39.5 million of current maturities, compared with $734.8 million at December 31, 2015. Long-term debt, net of current maturities and debt issuance costs, was $642.0 million.
Estimated liquidity was $167.2 million, consisting of cash of $17.7 million, $148.3 million of available revolving-credit capacity, and $1.2 million under other credit facilities. Letters of credit used $41.7 million of commitments.
Total equity improved to $24.7 million from a deficit of $12.4 million at year-end 2015. Koppers shareholders’ equity improved to $20.3 million from a deficit of $18.5 million.

Material changes versus the prior comparable period

Revenue pressure continued in RUPS and CMC because of lower railroad spending, reduced Australian utility demand, weaker aluminum-related demand, lower commodity-linked pricing, and CMC production reductions.
PC materially improved due to higher North American volumes for copper-based preservatives and additives, favorable repair-and-remodeling trends, and increased demand for higher-retention treated wood products.
CMC restructuring and closure-related activities produced $16.1 million of impairment and restructuring charges in the first nine months, compared with $7.1 million in the prior-year period. The company also recorded a $2.1 million gain on the sale of United Kingdom CMC assets.
The company substantially discontinued coal tar distillation at Clairton, Pennsylvania, in July 2016; closed or sold additional CMC facilities in the United Kingdom and China; and continued its broader plan to reduce CMC facilities from 11 at the end of 2013 to four by the end of 2017.
The revolving credit facility was amended in April 2016, reducing capacity from $500.0 million to $300.0 million and revising leverage covenant requirements. The amendment resulted in a $2.0 million write-off of prior deferred financing costs.
The company suspended its dividend in February 2015 and does not expect to declare dividends for the foreseeable future. No dividends were paid or declared in the first nine months of 2016.

Guidance, outlook, risks, contingencies, and unusual items

Management expects 2016 RUPS revenue and profitability to decline slightly year over year because of lower Class I railroad capital spending, Australian utility softness, discontinued U.S. utility-pole toll treating, and lower pass-through pricing. Long-term railroad demand remains viewed favorably.
Management expects CMC restructuring to generate additional charges of approximately $10 million to $20 million through 2020, including approximately $1 million to $4 million of noncash charges, with estimated cash requirements of approximately $40 million through 2020. Additional closures or curtailments remain possible.
Capital expenditures for 2016, excluding acquisitions, were expected to total approximately $42 million to $47 million.
The company expects to record an estimated $4.5 million pension settlement loss in the fourth quarter of 2016 after approximately 400 terminated vested participants elected lump-sum or annuity payments totaling approximately $14 million.
A $9.5 million loan to a 30%-owned Chinese affiliate was in default, although management concluded the full principal remained collectible and recorded no provision. The company was also pursuing a potential sale of its 30% interest in the affiliate.
Environmental and litigation exposure remains significant. The company reported 103 plaintiffs in 55 coal-tar-pitch cases and has not accrued a reserve because loss probability and amount cannot reasonably be estimated. An unfavorable resolution could materially affect results.
Koppers is a potentially responsible party at the Portland Harbor and Newark Bay CERCLA sites. The proposed Portland Harbor remedy was estimated at approximately $800 million net present value and $1.2 billion undiscounted, but responsibility and allocation among more than 80 parties had not been determined.
Environmental remediation liabilities totaled $15.2 million, including $5.1 million for two U.S. sites and $5.7 million for three United Kingdom and Australian sites. The company also reported $36.2 million of asset-retirement obligations.
Key risks include commodity prices and availability, especially copper, coal tar, lumber, and oil; railroad and aluminum demand; foreign exchange and interest rates; debt refinancing and covenant compliance; asset impairments; environmental liabilities; litigation; and raw-material cost pass-through limitations.
The company was in compliance with its debt covenants at September 30, 2016. Fixed-charge coverage was 1.60 versus a minimum of 1.10, and leverage was 4.11 versus a maximum of 5.25.
On October 24, 2016, after the reporting period, the company agreed to a long-term lease of its Houston wood-treatment facility, which generated approximately $8 million of revenue in the first nine months of 2016.

Most important facts for investors to verify

Whether PC’s volume and margin gains can offset continued CMC losses and weaker RUPS demand.
The timing, cash cost, and final scope of CMC closures, restructuring charges, and environmental obligations.
Liquidity after scheduled debt repayments, capital expenditures, restructuring payments, and the expected pension settlement loss.
Compliance with leverage and fixed-charge covenants under the reduced $300.0 million revolving facility.
Recoverability of the $9.5 million related-party loan and the potential sale of the Chinese affiliate investment.
Potential exposure from coal-tar-pitch litigation, CERCLA sites, environmental remediation, and reliance on third-party indemnities.
Whether the filing’s outlook remains valid as railroad spending, aluminum production, oil prices, copper prices, and foreign exchange rates change.