Koppers Holdings Inc. 10-Q

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, acquisitions, restructuring, declines in the value of Koppers assets and the effect of any related impairment charges, 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,” “potential,” “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 and discussions with investors and analysts in the normal course of business through meetings, phone calls and conference calls, regarding future dividends, expectations with respect to sales, earnings, cash flows, operating efficiencies, restructurings, product introduction or expansion, the benefits of acquisitions and divestitures, or other matters as well as financings and debt reduction, 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, the impact of changes in commodity prices, such as oil and copper, on product margins; general economic and business conditions; inflation; potential difficulties in protecting our intellectual property; the ratings on our debt and our ability to repay or refinance our outstanding indebtedness as it matures; our ability to operate within the limits of our debt covenants; unexpected business disruptions; potential impairment of our goodwill and/or long-lived assets; demand for Koppers goods and services; competitive conditions; capital market conditions, including interest rates, borrowing costs and foreign currency rate fluctuations; availability of and fluctuations in the prices of key raw materials, such as coal tar, lumber and scrap copper; disruptions and inefficiencies in the supply chain; economic, political and environmental conditions in international markets; changes in laws; the impact of environmental laws and regulations; and unfavorable resolution of claims against us, as well as those discussed more fully elsewhere in this report 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, 2023. Overview We are a leading integrated global provider of treated wood products, wood preservation chemicals and carbon compounds. Our products and services are used in a variety of niche applications in a diverse range of end-markets, including the railroad, specialty chemical, utility, residential lumber, agriculture, aluminum, steel, rubber and construction industries. We serve our customers through a comprehensive global manufacturing and distribution network, with manufacturing capabilities in North America, South America, Australasia and Europe. We operate three principal businesses: RUPS, PC and CMC. Through our RUPS business, we believe that we are the largest supplier of railroad crossties to the Class I railroads in North America. Our other treated wood products include utility poles for the electric, telephone, and broadband utility industries in the United States and Australia and construction pilings in the United States. In addition, we provide untreated wood products and rail joint bars to the railroad markets and inspection services to the utility markets. We also operate a railroad services business that conducts engineering, design, repair and inspection services for railroad bridges and a business related to the recovery of used crossties, serving the same customer base as our North American railroad business. Through our PC business, we believe that we are the global leader in developing, manufacturing and marketing wood preservation chemicals and wood treatment technologies for use in the pressure treating of lumber for residential, industrial and agricultural applications. 18 Our CMC business processes coal tar into a variety of products, including creosote, carbon pitch, carbon black feedstock, naphthalene and phthalic anhydride, which are intermediate materials necessary in the pressure treatment of wood, and the production of aluminum, steel, carbon black, high-strength concrete, plasticizers and specialty chemicals . Non-GAAP Financial Measures We utilize certain financial measures that are not in accordance with U.S. generally accepted accounting principles (U.S. GAAP) to analyze and manage the performance of our business. We believe that adjusted EBITDA provides information useful to investors in understanding the underlying operational performance of the company, our business and performance trends, and facilitates comparisons between periods. The exclusion of certain items permits evaluation and a comparison between periods of results for business operations, and it is on this basis that our management internally assesses our performance. Adjusted EBITDA is the primary measure of profitability we use to evaluate our businesses. In addition, adjusted EBITDA is the primary measure used to determine the level of achievement of management's short-term incentive goals and related payout, as well as one of the measures used to determine performance and related payouts for certain performance share units granted to management. Although we believe that these non-GAAP financial measures enhance investors’ understanding of our business and performance, these non-GAAP financial measures should not be considered an alternative to GAAP financial measures and should be read in conjunction with the relevant GAAP financial measures. Other companies in a similar industry may define or calculate these measures differently than we do, limiting their usefulness as comparative measures. Because of these limitations, these non-GAAP financial measures should not be considered in isolation or as substitutes for performance measures calculated in accordance with GAAP. Adjusted EBITDA is a non-GAAP financial measure defined as income before interest, income taxes, depreciation, amortization and other adjustments. These other adjustments are items that we believe are not representative of underlying business performance. Adjusted items typically include certain expenses associated with impairment, restructuring and plant closure costs, significant gains and losses on asset disposals or business combinations, LIFO, mark-to-market commodity hedging and other unusual items. The LIFO expense adjustment removes the entire impact of LIFO and effectively reflects the results as if we were on a FIFO inventory basis. See Adjusted EBITDA reconciliation in the below section for the reconciliation from net income to adjusted EBITDA on a consolidated basis. We do not provide reconciliations of guidance for adjusted EBITDA and adjusted EPS to comparable GAAP measures, in reliance on the unreasonable efforts exception. We are unable, without unreasonable efforts, to forecast certain items required to develop meaningful comparable GAAP financial measures. These items include, but are not limited to, restructuring and impairment charges, acquisition-related costs, mark-to-market commodity hedging, and LIFO adjustments that are difficult to forecast for a GAAP estimate and may be significant. Outlook We remain committed to expanding and optimizing our business and making continued progress towards our long-term financial goals. After considering global economic conditions, as well as ongoing uncertainty associated with geopolitical and supply chain challenges, the following summarizes our 2024 financial goals: • sales of approximately $2.25 billion, • adjusted EBITDA of approximately $265 million to $280 million, and • capital expenditures, including capitalized interest but excluding acquisitions, of approximately $80 million to $90 million with approximately $23 million to $33 million of the total allocated to discretionary projects. Our keys to success for 2024 are the following: • For our RUPS segment, we need to (i) recoup cost increases, including the value of our creosote preservative in the market, (ii) ensure our facilities run uninterrupted to serve customer demand, (iii) maximize opportunities for increased volumes, including expanding our customer base into the Texas utility pole market, (iv) lower costs and (v) successfully integrate the Brown Wood asset acquisition with our domestic utility pole business. • For our PC segment, we need to (i) increase market share for certain newer product lines and (ii) improve gross margin by maintaining volumes and reducing operating costs. • For our CMC segment, we need to (i) optimize production from our yield enhancement project in Nyborg, Denmark, (ii) push acceptance of petroleum-blended products, which mitigates reductions in coal tar volumes and (iii) execute on domestic plant optimization projects. 19 Significant market indicators for our businesses include: • The Railway Tie Association’s estimate of total crosstie installations in 2024 is approximately 18.6 million ties, with approximately 14.7 million for Class I railroads. This is consistent with 2023 crosstie installations of approximately 18.5 million crossties with the small increase expected to be from the commercial market. • According to BMO Capital Markets, market demand for utility poles is expected to remain high throughout 2024 as a result of aging pole infrastructure, efforts to strengthen poles against larger and more frequent storms, and a need to add larger poles to support continued electrification and expansion of broadband access. In the first quarter of 2024, we experienced a decrease in volumes as a result of temporary customer overstock and budget realignment. We expect demand to return to normal levels in 2024. • Product demand for our PC business has historically been closely associated with consumer spending on home repair and remodeling projects in North America. The Leading Indicator of Remodeling Activity (LIRA) reported by the Joint Center for Housing Studies of Harvard University projects that annual homeowner renovation and maintenance expenditures will decline by over seven percent in the third quarter of 2024 before easing to just a 2.6 percent decline through the first quarter of 2025. Spending on home improvements and repairs are expected to drop from $463 billion to $451 billion over the next four quarters. While the LIRA projects a decrease in 2024, the outlook for our PC business remains relatively positive driven by improvements in the industrial markets and expected flat volumes for our residential business. • For the external markets served by our CMC business, we anticipate a slowdown in the near-term in manufacturing overall as well as in the steel, aluminum and carbon black industries. The availability of coal tar, the primary raw material for our CMC business, is linked to levels of metallurgical coke production. As the global steel industry, excluding Asia, has reduced the production of steel using metallurgical coke, the volumes of coal tar have been reduced. We are actively working to mitigate the impacts of long-term decline of coal tar supply by gaining market acceptance for petroleum-blended products. We are also investing in projects to increase distillation yields and balance raw material supply and cost with customer demand and pricing. Our businesses and results of operations are affected 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 material pricing and availability, in particular the cost and availability of hardwood lumber for railroad crossties, softwood lumber for utility poles, scrap copper prices, and the cost and amount of coal tar available in global markets, which is negatively affected by reductions in blast furnace 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, phthalic anhydride, and naphthalene; (iv) competitive conditions in global carbon pitch markets; and (v) changes in foreign exchange rates. Any or all of these factors could impact our actual results for 2024. 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, 2024 and 2023 Consolidated Results Net sales are summarized by segment in the following table: Three Months Ended March 31, 2024 2023 Change % Change (Dollars in millions) Railroad and Utility Products and Services $ 225.1 $ 213.1 $ 12.0 6 % Performance Chemicals 150.1 146.9 3.2 2 % Carbon Materials and Chemicals 122.4 153.4 (31.0 ) -20 % $ 497.6 $ 513.4 $ (15.8 ) -3 % 20 RUPS net sales increased largely due to $9.6 million of volume increases for crossties and a net $8.1 million of pricing increases across multiple markets, particularly for crossties and domestic utility poles. These increases were partly offset by lower activity in our maintenance of way businesses and a 4.2 percent volume decrease in our domestic utility pole business due to temporary customer overstock and budget realignment. Foreign currency changes compared to the prior year period had an unfavorable impact on sales in the current year period of $0.6 million, mainly from our Australian utility pole business. PC net sales increased as a result of volume increases of $6.8 million in the current year period, including a 6.1 percent volume increase in the Americas, primarily for our copper-based preservatives. These increases were partly offset by $3.3 million of lower prices in the Americas and Australasia. Foreign currency changes compared to the prior year period had an unfavorable impact on sales in the current year period of $0.2 million. CMC net sales decreased mainly due to $28.6 million of lower sales prices across most products, including carbon pitch where prices were down 24.6 percent globally, along with $11.5 million of lower volumes of carbon pitch and carbon black feedstock. The decreases in carbon pitch prices and volumes were driven by reduced market demand in the current year period. These decreases were partly offset by volume increases for phthalic anhydride. Foreign currency changes compared to the prior year period from our international markets had an unfavorable impact on sales in the current year period of $1.7 million. Cost of sales as a percentage of net sales was 81 percent, compared to 80 percent in the prior year period as the market driven reduction in CMC pricing, primarily carbon pitch, more than offset lower CMC raw material costs, particularly in North America and Australia. Significant items impacting cost of sales in individual operating segments are discussed as part of "Segment adjusted EBITDA and adjusted EBITDA margin" herein. Depreciation and amortization expenses were $2.1 million higher when compared to the prior year period as recent capital expenditures include increased investment in growth projects, such as the expansion of our RUPS facility in North Little Rock, Arkansas and a yield enhancement project at our CMC facility in Nyborg, Denmark. Additionally, asset retirement obligations in our European CMC operations increased during the first quarter of 2024 when compared to the prior year period. Selling, general and administrative expenses were $3.9 million higher when compared to the prior year period due mainly to an increase in compensation-related costs along with an increase in professional service expenses. Gain on sale of assets for the quarter ended March 31, 2023 was related to a sale of assets of our former coal tar distillation facility located in China. Interest expense was $3.1 million higher when compared to the prior year period due primarily to higher interest rates. Income tax expense decreased by $5.5 million when compared to the prior year period primarily due to lower income before income taxes. See Note 8 – Income Taxes. Segment Results Segment adjusted EBITDA and adjusted EBITDA margin is summarized in the following table: Three Months Ended March 31, 2024 2023 Change % Change (Dollars in millions) Adjusted EBITDA: Railroad and Utility Products and Services $ 17.7 $ 15.8 $ 1.9 12 % Performance Chemicals 29.8 26.3 3.5 13 % Carbon Materials and Chemicals 4.0 19.4 (15.4 ) -79 % Total Adjusted EBITDA $ 51.5 $ 61.5 $ (10.0 ) -16 % Adjusted EBITDA margin as a percentage of GAAP sales: Railroad and Utility Products and Services 7.9 % 7.4 % 0.5 % 7 % Performance Chemicals 19.9 % 17.9 % 2.0 % 11 % Carbon Materials and Chemicals 3.3 % 12.6 % -9.3 % -74 % 21 RUPS adjusted EBITDA increased due primarily to net sales price increases and $3.7 million from improved plant utilization, which combined to more than offset $10.6 million of higher operating, raw material and selling, general and administrative expenses. PC adjusted EBITDA increased primarily as a result of higher volumes. Lower sales prices were offset by raw material price decreases. CMC adjusted EBITDA decreased due to price and volume decreases along with lower North American plant utilization primarily due to a plant outage in January, partly offset by an $18.6 million reduction in raw material costs, particularly in Europe and North America. Segment Results Adjusted EBITDA Reconciliation. The following table reconciles net income to adjusted EBITDA on a consolidated basis: Three Months Ended March 31, 2024 2023 (Dollars in millions) Net income $ 13.0 $ 26.2 Interest expense 17.1 14.0 Depreciation and amortization 16.1 14.0 Income tax provision 4.4 9.9 Sub-total 50.6 64.1 Adjustments to arrive at adjusted EBITDA: LIFO expense (1) 2.6 0.3 (Gain) on sale of assets 0.0 (1.8 ) Mark-to-market commodity hedging gains (1.7 ) (1.1 ) Total adjustments 0.9 (2.6 ) Adjusted EBITDA $ 51.5 $ 61.5 (1) The LIFO expense adjustment removes the entire impact of LIFO and effectively reflects the results as if we were on a FIFO inventory basis. Cash Flow Net cash used in operating activities for the three months ended March 31, 2024 was $12.3 million compared to $15.3 million in the prior year. The improvement was primarily the result of lower working capital usage in the current year which more than offset the cash impact of lower net income in the current year period the reasons for which are discussed under results of operations. Net cash used in investing activities for the three months ended March 31, 2024 was $25.8 million compared to $28.5 million in the prior year driven primarily by capital expenditures. Capital expenditures were higher in the prior year period due to investment in growth projects, such as the expansion of our RUPS facility in North Little Rock, Arkansas which was completed in the fourth quarter of 2023 and a yield enhancement project at our CMC facility in Nyborg, Denmark which was completed in the first quarter of 2024. Net cash provided by financing activities for the three months ended March 31, 2024 was $23.0 million compared to $56.8 million in the prior year. The primary source of financing cash flows was net borrowings of $27.9 million and the primary uses of financing cash flows were payments related to taxes withheld under stock-based compensation plans and dividends paid. In the prior year, the primary source of financing cash flows was net borrowings of $63.5 million and the primary uses of financing cash flows were repurchases of common stock and dividends paid. Liquidity and Capital Resources Our Credit Facility is described in Note 11 – Debt. 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. The Credit Facility permits Koppers Inc. to make dividend payments to Koppers Holdings if certain conditions are met, including, among other permitted dividend payments, the ability to fund the payment of regularly scheduled dividends on and repurchases of Koppers Holdings common stock, in an aggregate amount per year not to exceed the greater of (a) $50.0 million in any fiscal year, with unused amounts in any fiscal year being carried over to the succeeding fiscal year, and (b) 6.0 percent of market capitalization. 22 Liquidity As of March 31, 2024, liquidity was approximately $340 million. Our need for cash in the next twelve months relates primarily to capital spending, purchase commitments, operating leases, working capital, debt service, pension plan funding, dividends and share repurchases. We may also use cash to pursue other potential strategic acquisitions or voluntary pension plan contributions, including pension plan settlements. Capital expenditures in 2024, excluding acquisitions, if any, are expected to total approximately $80 million to $90 million and are expected to be funded by cash from operations. We anticipate that our liquidity will continue to be adequate to fund our cash requirements for at least the next twelve months, and based on our current expectations, for the foreseeable future. We manage our working capital to increase our flexibility to pay down debt. Debt will fluctuate throughout any operating period based upon the timing of receipts from customers and payments to vendors. As of March 31, 2024, approximately 90 percent of accounts payable was current and ten percent was 1-30 days past due. As of December 31, 2023, approximately 85 percent of accounts payable was current and 15 percent was 1-30 days past due. Bank Debt Covenants The bank debt covenants that affect availability of the Credit Facility and which may restrict the ability of Koppers Inc. to pay dividends include the following financial ratios: • The total net leverage ratio is calculated as of the last day of each fiscal quarter in accordance with the Credit Facility definitions of consolidated total net debt divided by consolidated EBITDA and is not permitted to exceed 4.75. The total net leverage ratio as of March 31, 2024 was 3.2. In connection with the completion of the Brown Wood acquisition as described in Note 14 – Subsequent Events, the total net leverage ratio will not be permitted to exceed 5.00 from the second quarter of 2024 through the first quarter of 2025. • The cash interest coverage ratio, calculated as of the last day of each fiscal quarter, is not permitted to be less than 2.0. The cash interest coverage ratio as of March 31, 2024 was 3.9. We are currently in compliance with all covenants governing the Credit Facility. Our continued ability to meet these financial covenants may be affected by events beyond our control. Legal Matters The information set forth in Note 13 to the Condensed Consolidated Financial Statements of Koppers Holdings Inc. included in Item 1 of this Part I is incorporated herein by reference. Recently Issued Accounting Guidance The information set forth in Note 2 to the Condensed Consolidated Financial Statements of Koppers Holdings Inc. included in Item 1 of this Part I is incorporated herein by reference. Critical Accounting Policies There have been no material changes to our critical accounting policies as disclosed in our Annual Report on Form 10-K for the year ended December 31, 2023. Environmental and Other Matters The information set forth in Note 13 to the Condensed Consolidated Financial Statements of Koppers Holdings Inc. included in Item 1 of this Part I is incorporated herein by reference. 23 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK There are no material changes to the disclosure on this matter made in our Annual Report on Form 10-K for the year ended December 31, 2023.