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KOP > SEC Filings for KOP > Form 10-Q on 7-May-2014All Recent SEC Filings

Show all filings for KOPPERS HOLDINGS INC.

Form 10-Q for KOPPERS HOLDINGS INC.


7-May-2014

Quarterly Report


ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This report and any documents incorporated herein by reference contain "forward-looking statements" within the meaning of the Private Securities Litigation Reform Act of 1995 and may include, but are not limited to, statements about sales levels, restructuring, profitability and anticipated expenses and cash outflows. All forward-looking statements involve risks and uncertainties. All statements contained herein that are not clearly historical in nature are forward-looking, and words such as "believe," "anticipate," "expect," "estimate," "may," "will," "should," "continue," "plans," "intends," "likely," or other similar words or phrases are generally intended to identify forward-looking statements. Any forward-looking statement contained herein, in press releases, written statements or documents filed with the Securities and Exchange Commission, or in Koppers communications with and discussions with investors and analysts in the normal course of business through meetings, phone calls and conference calls, regarding expectations with respect to sales, earnings, cash flows, operating efficiencies, product introduction or expansion, the benefits of acquisitions and divestitures or other matters as well as financings and repurchases of debt or equity securities, are subject to known and unknown risks, uncertainties and contingencies. Many of these risks, uncertainties and contingencies are beyond our control, and may cause actual results, performance or achievements to differ materially from anticipated results, performance or achievements. Factors that might affect such forward-looking statements, include, among other things, Koppers may not be able to successfully integrate the wood preservatives business and/or the railroad services business of Osmose or such integration may take longer to accomplish than expected; the expected cost savings and any synergies from the acquisition may not be fully realized within the expected timeframes; disruption from the acquisition may make it more difficult to maintain relationships with clients, associates or suppliers; the required governmental approvals of the acquisition may not be obtained on the proposed terms and schedule; the required financing for the acquisition may not be obtained on the proposed terms and schedule; general economic and business conditions; demand for Koppers goods and services; competitive conditions; interest rate and foreign currency rate fluctuations; availability of key raw materials and unfavorable resolution of claims against us, as well as those discussed more fully elsewhere in this release and in documents filed with the Securities and Exchange Commission by Koppers, particularly our latest annual report on Form 10-K and subsequent filings. We caution you that the foregoing list of important factors may not contain all of the material factors that are important to you. In addition, in light of these risks and uncertainties, the matters referred to in the forward-looking statements contained in this report and the documents incorporated by reference herein may not in fact occur. Any forward-looking statements in this report speak only as of the date of this report, and we undertake no obligation to update any forward-looking statement to reflect events or circumstances after that date or to reflect the occurrence of unanticipated events.

The following discussion and analysis of our financial condition and results of operations should be read in conjunction with the unaudited financial statements and related notes included in Item 1 of this Part I as well as the audited consolidated financial statements and the related notes included in our Annual Report on Form 10-K for the year ended December 31, 2013.

We are a leading integrated global provider of chemicals, carbon compounds and treated wood products and services. Our products are used in a variety of niche applications in a diverse range of end-markets, including the aluminum, railroad, specialty chemical, utility, rubber, concrete, and steel industries. We serve our customers through a comprehensive global manufacturing and distribution network, with manufacturing facilities located in the United States, Australia, China, the United Kingdom, Denmark and Canada.

We operate two principal businesses: Carbon Materials and Chemicals ("CMC") and Railroad and Utility Products and Services ("RUPS").

Through our CMC business, we process coal tar into a variety of products, including carbon pitch, creosote, carbon black feedstock, naphthalene and phthalic anhydride, which are intermediate materials necessary in the production of aluminum, the pressure treatment of wood, the production of carbon black, the production of high-strength concrete, and the production of plasticizers and specialty chemicals, respectively. Through our RUPS business, we believe that we are the largest supplier of railroad crossties to the North American railroads. Our other treated wood products include utility poles for the electric and telephone utility industries in North America and Australia. We also provide rail joint bar products as well as various services to the railroad industry.

In April 2014, we announced that we have signed a stock purchase agreement to acquire the wood preservation and railroad services businesses of Osmose Holdings, Inc. for a base purchase price of $460 million subject to customary closing conditions.


The base purchase price includes the value of an anticipated 338(h)(10) tax election that is expected to provide cash tax savings over the next 15 years. Revenues for these businesses in 2013 were approximately $390 million. The closing is expected to occur in the third quarter of 2014. We plan to finance the purchase through a combination of a $300 million term loan and an increase in our revolving credit facility to $500 million from $350 million.

In January 2014, we announced the acquisition of a crosstie treating plant in Ashcroft, British Columbia, Canada from Tolko Industries, Inc. for a purchase price of approximately $30 million. The facility, which is estimated to provide approximately $30 million in annual revenue, gives Koppers an operating presence in the Canadian railroad market.

In October 2012 we entered into an agreement with Nippon Steel and Sumikin Chemical ("Nippon") and several other entities to develop and construct a fully integrated coal tar based carbon products complex in Pizhou City, Jiangsu Province, China. The complex will include a 300,000 metric ton tar distillation facility that will be majority-owned by Koppers, as well as a carbon black plant and a needle coke plant that will be owned by Nippon. A significant portion of the products produced at the tar distillation plant will be sold under a long-term contract with Nippon to supply their carbon black and needle coke plants. The project has commenced and construction of the tar distillation plant is expected to be completed in mid-2014. We expect construction of the carbon black and needle coke plants to be completed by the end of 2014. We will be selling all of our production from the new facility into the domestic Chinese market until carbon black and needle coke facilities are completed.

In October 2013, we were informed by the Tangshan Government of its intention to close the coke batteries owned and operated by our joint venture partner, Tangshan Iron and Steel Group Co., Ltd ("TISCO"), in Tangshan, China. The Tangshan Government has ordered the closure of these coke batteries in an effort to improve the air quality in the Tangshan area. One of TISCO's two coke batteries was recently shut down and we have been informed that the other coke battery adjacent to KCCC is scheduled to be shut down by the end of June 2014. The Company's 60-percent owned subsidiary, KCCC, is located adjacent to TISCO's coke facility and relies on its operations for a significant portion of raw material supply, utilities and other shared services. Closure of the TISCO coke batteries directly impacts KCCC's ability to operate its coal tar distillation plant and the Company has determined that it is unable to continue coal tar distillation activities at the site once TISCO ceases production activities at the adjacent facility. The Company is continuing to evaluate its options, which include transitioning to a new location or entering into other strategic partnerships with other unrelated coal tar distillation companies.

The closure or relocation of KCCC's coal tar distillation facility would have a material adverse effect on our business, financial condition, cash flow and results of operations. For the year ended December 31, 2013, KCCC contributed operating profit of approximately $3.3 million after deducting profit attributable to non-controlling interests. As of March 31, 2014, after recording an impairment charges of $4.0 million in the fourth quarter of 2013 and $4.7 million in the first quarter of 2014, the remaining net book value of fixed assets subject to impairment was $2.5 million. This amount will be reflected in depreciation expense over the next four months on an accelerated basis reflecting management's estimate of the remaining useful life of the assets.

The Company believes it would be able to continue fulfilling current domestic Chinese customers and its export commitments with capacity at Koppers (Jiangsu) Carbon Chemical Company Limited, which is scheduled for production start-up in mid-2014, its other 30-percent owned Chinese company and other commercial relationships in China. However, the Company's margin on export sales may be negatively affected as a result of these actions.

Outlook

Trend Overview

Our businesses and results of operations are impacted by various competitive and other factors including (i) the impact of global economic conditions on demand for our products, including the impact of imported products from competitors in certain regions where we operate; (ii) raw materials pricing and availability, in particular the cost and availability of hardwood lumber for railroad crossties, and the cost and amount of coal tar available in global markets, which is negatively affected by reductions in steel production; (iii) volatility in oil prices, which impacts the cost of coal tar and certain other raw materials, as well as selling prices and margins for certain of our products including carbon black feedstock and phthalic anhydride; (iv) competitive conditions in global carbon pitch markets; and (v) changes in foreign exchange rates.

The availability of coal tar is linked to levels of metallurgical coke production. As the global steel industry has reduced production of steel and metallurgical coke the volumes of coal tar by-product were also reduced. Our ability to obtain coal tar and the price we are able to negotiate has a significant impact on the level of profitability of our business. Many of our sales


contracts include provisions that allow for price increases based on increases in the price of raw materials, which has allowed us to generally maintain profit dollars in our core businesses. However, significant increases in raw material costs can result in margin dilution if only the increased cost of the raw material is passed on to the customer. Additionally, in certain regions such as China that have competing markets for coal tar, or in regions where the available supply of our products exceeds demand, we may not be able to recover raw material cost increases in the selling prices for our end products.

The primary product produced by CMC is carbon pitch, which is sold primarily to the aluminum industry to be used in the production of carbon anodes. The smelting of aluminum requires significant amounts of energy, which is a major cost component for the aluminum industry. As a result, new production facilities are being built in regions with low energy costs such as the Middle East, while regions with higher energy costs such as the United States, Australia and Western Europe have seen significant amounts of smelting capacity idled or closed over the last several years. Our operations in China have generally had lower profit margins than our operations in the mature regions due to a difficult pricing environment in the Middle East and in China as those regions have experienced an excess supply of pitch.

Our businesses and results of operations were also negatively affected in 2012 and 2013 by difficult economic conditions in Europe. Certain key end markets experienced significant reductions in demand that have negatively affected the profitability for most of our products produced and sold in Europe, and we expect this to continue for at least the forseeable future. Additionally, during 2013 our profitability in North America was negatively impacted by increased levels of imports from competitors in Europe due to weak end-market demand there.

As a result of the items noted above, we are curtailing operations at several of our global CMC facilities including Follansbee, West Virginia, Uithoorn, The Netherlands, and Portland, Oregon in an effort to reduce costs and improve profitability. The curtailments resulted in charges to earnings of approximately $9.6 million in the fourth quarter of 2013 and are expected to result in cost savings of approximately $9 million in 2014.

There may be additional curtailments or closures at our other facilities as part of our efforts to reduce our cost structure and improve capacity utilization in our businesses.

Several of our products, particularly carbon black feedstock and phthalic anhydride, have end market pricing that is linked to oil. Historically, when oil prices increase we have benefited in terms of revenues and profitability from the higher pricing for these products as the cost of coal tar has not increased proportionally with oil. However, in recent years our coal tar costs have demonstrated a stronger correlation to the price of oil, which has resulted in higher raw material and finished product costs to the extent that the price of oil has increased.

The primary end-market for RUPS is the North American railroad industry, which has a large installed base of wood crossties that require periodic replacement. As a result, our sales volumes for crossties and our operating results for this business have historically been relatively stable. However, our railroad business can be negatively affected by weather conditions that make it difficult for sawmills that provide our raw material to harvest timber from the forests. Additionally, some of our Class I railroad customers, who make up the largest portion of our business, may reduce inventory levels at certain times to manage working capital, which can adversely affect our volumes and profitability during certain periods.

In the second half of 2013 and first quarter of 2014 we experienced reduced purchases of untreated crossties due to increased competition from other hardwood lumber products. This competition has resulted in higher prices and reduced availability for crossties that may result in reduced sales volumes for crossties for us in 2014.

Seasonality and Effects of Weather on Operations

Our quarterly operating results fluctuate due to a variety of factors that are outside of our control, including inclement weather conditions, which in the past have affected operating results. Operations at some of our facilities have at times been reduced during the winter months. Moreover, demand for some of our products declines during periods of inclement weather. As a result of the foregoing, we anticipate that we may experience material fluctuations in quarterly operating results. Historically, our operating results have been significantly lower in the first and fourth calendar quarters as compared to the second and third calendar quarters.


Results of Operations - Comparison of Three Months Ended March 31, 2014 and 2013

Consolidated Results

Net sales for the three months ended March 31, 2014 and 2013 are summarized by
segment in the following table:



                                                      Three Months Ended March 31,
                                                         2014                 2013         Net Change
(Dollars in millions)
Carbon Materials and Chemicals                  $       202.6        $       230.5                -12 %
Railroad and Utility Products and Services              128.8                139.9                 -8 %
                                                $       331.4        $       370.4                -11 %

CMC net sales decreased by $27.9 million or 12 percent compared to the prior year period due to lower sales volumes for all major products and lower sales prices for all major products except naphthalene.

Lower sales volumes and prices for carbon pitch, driven by a difficult pricing environment, reduced sales by six percent compared to the prior year quarter.

Lower distillate sales volumes and prices decreased sales by four percent compared to the first quarter of 2013 due mainly to lower sales volumes and prices for carbon black feedstock sold from China.

Sales of coal tar chemicals declined by one percent of sales as decreases in phthalic anhydride sales prices in the U.S. of two percent more than offset higher sales prices for naphthalene of one percent of sales. Lower sales prices for phthalic anhydride were due to lower prices for orthoxylene, and lower sales volumes for naphthalene were due to reduced end-market demand.

RUPS net sales decreased by $11.1 million or eight percent compared to the prior year period. The sales decrease was due primarily to lower sales volumes for untreated crossties as a result of competitive conditions in the hardwood lumber markets combined with difficult weather conditions for loggers.

Cost of sales as a percentage of net sales was 86 percent for the quarter ended March 31, 2014 compared to 87 percent for the quarter ended March 31, 2013.

Depreciation and amortization for the quarter ended March 31, 2014 was $1.6 million higher when compared to the prior year period due mainly to depreciation and amortization for the Ashcroft wood treating facility that was acquired in January 2014 and accelerated depreciation related to our facilities in Uithoorn, the Netherlands and Tangshan, China.

Impairment and restructuring charges of $15.5 million for the quarter ended March 31, 2014 were related to the ceasing of distillation of the Uithoorn facility of $10.8 million combined with impairment charges related to the Tangshan facility of $4.7 million.

Selling, general and administrative expenses for the quarter ended March 31, 2014 were $3.7 million higher when compared to the prior year period due mainly to approximately $3.5 million of consulting expenses related to acquisitions, operations improvement projects, and plant startup costs.

Other income for the quarter ended March 31, 2014 was $0.3 million lower when compared to the prior year due mainly to lower earnings from equity affiliates.

Interest expense for the quarter ended March 31, 2014 was $6.8 million as compared to $6.9 million in the prior year period as a result of slightly lower average borrowings in the current quarter.

Income taxes for the quarter ended March 31, 2014 were $13.1 million lower when compared to the prior year period due to a significant reduction in pre-tax income, an increased effective tax rate, and a significant discrete tax benefit. The increase in the effective tax rate on pretax ordinary income and before discrete items to 72.9 percent compared to 38.4 percent in the prior year quarter is attributed to the non-deductibility of certain expenses such as closure costs related to the Uithoorn facility. Discrete items included in income taxes for the quarter ended March 31, 2014 were a net tax benefit of $5.5 million which was primarily related to management's decision that a deferred tax liability for certain undistributed earnings of its European subsidiaries was no longer necessary as these earnings are permanently reinvested.


Segment Results

Segment operating profit for the three months ended March 31, 2014 and 2013 is
summarized by segment in the following table:



                                                            Three Months Ended March 31,
                                                        2014                        2013          % Change
(Dollars in millions)
Operating (loss) profit:
Carbon Materials and Chemicals              $           (8.8 )          $           13.1              -167 %
Railroad and Utility Products and
Services                                                11.1                        12.3               -10 %
Corporate                                               (1.8 )                      (0.5 )               0 %
                                            $            0.5            $           24.9               -98 %
Operating profit as a percentage of net
sales:
Carbon Materials and Chemicals                          (4.3 )%                      5.7 %           -10.0 %
Railroad and Utility Products and
Services                                                 8.6 %                       8.8 %            -0.2 %
                                                         0.2 %                       6.7 %            -6.5 %

CMC operating profit decreased by $21.9 million or 167 percent over the prior year period. Operating loss as a percentage of net sales for CMC amounted to 4.3 percent compared to operating profit of 5.7 percent in the prior year quarter. Operating profit for the three months ended March 31, 2014 was negatively affected by $17.2 million of impairment and plant closure charges related to the Uithoorn facility in The Netherlands and the KCCC facility in China. Additionally, operating profit was negatively impacted by lower sales prices for phthalic anhydride and difficult weather conditions.

RUPS operating profit decreased by $1.2 million or 10 percent compared to the prior year period. Operating profit as a percentage of net sales for RUPS decreased to 8.6 percent from 8.8 percent in the prior year quarter. Operating profit for the three months ended March 31, 2014 was negatively impacted by lower sales volumes of untreated crossties due in part to difficulties in obtaining adequate raw material supplies as a result of competition for hardwood lumber combined with difficult weather conditions.

Cash Flow

Net cash used by operating activities was $13.7 million for the quarter ended March 31, 2014 as compared to net cash provided by operating activities of $5.7 million for the quarter ended March 31, 2013. The net decrease of $19.4 million in cash from operations was due primarily to lower net income and $7.2 million of non-cash tax benefits.

Net cash used in investing activities was $44.4 million for the quarter ended March 31, 2014 as compared to net cash used in investing activities of $6.2 million for the quarter ended March 31, 2013. The increase in net cash used by investing activities of $38.2 million is due to the acquisition of a wood treating facility in January 2014 combined with a higher level of capital expenditures in the first quarter of 2014 compared to the prior year period.

Net cash provided by financing activities was $30.2 million for the quarter ended March 31, 2014 as compared to net cash used in by financing activities of $7.5 million for the quarter ended March 31, 2013. The difference is due mainly to net borrowings of $37.2 million in the first quarter of 2014 compared to no net borrowings in the first quarter of 2013. The borrowing activity was due the Ashcroft acquisition and the plant construction costs at the Jiangsu, China facility.

Dividends paid were $5.0 million in the quarter ended March 31, 2014, the same as the quarter ended March 31, 2013. On May 2, 2014, our board of directors declared a quarterly dividend of 25 cents per common share, payable on July 7, 2014 to shareholders of record as of May 19, 2014.


Liquidity and Capital Resources

Restrictions on Dividends to Koppers Holdings

Koppers Holdings depends on the dividends from the earnings of Koppers Inc. and its subsidiaries to generate the funds necessary to meet its financial obligations, including the payment of any declared dividend of Koppers Holdings. Koppers Inc.'s credit agreement prohibits it from making dividend payments to us unless (1) such dividend payments are permitted by the indenture governing Koppers Inc.'s Senior Notes and (2) no event of default or potential default has occurred or is continuing under the credit agreement. The indenture governing Koppers Inc.'s Senior Notes restricts its ability to finance our payment of dividends if (1) a default has occurred or would result from such financing,
(2) a restricted subsidiary of Koppers Inc. which is not a guarantor under the indenture is not able to incur additional indebtedness (as defined in the indenture), and (3) the sum of all restricted payments (as defined in the indenture) have exceeded the permitted amount (which we refer to as the "basket") at such point in time.

The basket is governed by a formula based on the sum of a beginning amount, plus or minus a percentage of Koppers Inc.'s consolidated net income (as defined in the indenture), plus the net proceeds of Koppers Inc.'s qualified stock issuance or conversions of debt to qualified stock, plus the net proceeds from the sale of or a reduction in an investment (as defined in the indenture) or the value of the assets of an unrestricted subsidiary which is designated a restricted subsidiary. At March 31, 2014 the basket totaled $212.7 million. Notwithstanding such restrictions, the indenture governing Koppers Inc.'s Senior Notes permits an additional aggregate amount of $20.0 million each fiscal year to finance dividends on the capital stock of Koppers Holdings, whether or not there is any basket availability, provided that at the time of such payment, no default in the indenture has occurred or would result from financing the dividends.

In addition, certain required coverage ratios in Koppers Inc.'s revolving credit facility may restrict the ability of Koppers Inc. to pay dividends. See "-Debt Covenants."

Liquidity

The Koppers Inc. revolving credit facility agreement provides for a revolving credit facility of up to $350.0 million at variable interest rates. Borrowings under the revolving credit facility are secured by a first priority lien on substantially all of the assets of Koppers Inc. and its material domestic subsidiaries. The revolving credit facility contains certain covenants for Koppers Inc. and its restricted subsidiaries that limit capital expenditures, additional indebtedness, liens, dividends and investments or acquisitions. In addition, such covenants give rise to events of default upon the failure by Koppers Inc. and its restricted subsidiaries to meet certain financial ratios.

As of March 31, 2014, we had $299.8 million of unused revolving credit availability for working capital purposes after restrictions by various debt covenants and certain letter of credit commitments. As of March 31, 2014, $35.2 million of commitments were utilized by outstanding letters of credit.

The following table summarizes our estimated liquidity as of March 31, 2014 (dollars in millions):

            Cash and cash equivalents(1)                       $  54.7
            Amount available under revolving credit facility     299.8
            Amount available under other credit facilities        15.2

            Total estimated liquidity                          $ 369.7

(1) Cash includes approximately $54 million held by foreign subsidiaries, which . . .

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