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 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; existing and future adverse effects as a result of the coronavirus (COVID-19) pandemic; disruption in the U.S. and global financial markets; 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; potential impairment of our goodwill and/or long-lived assets; demand for Koppers goods and services; competitive conditions; interest rate and foreign currency rate fluctuations; availability and costs of key raw materials 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, 2019. 26 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 facilities located in North America, South America, Australasia, and Europe. We operate three principal businesses: Railroad and Utility Products and Services (“RUPS”), Performance Chemicals (“PC”) and Carbon Materials and Chemicals (“CMC”). Through our RUPS business, we believe that we are the largest supplier of wood crossties to the Class I railroads in North America. Our other treated wood products include utility poles for the electric and telephone utility industries in the United States and Australia and construction pilings. We also provide rail joint bar products as well as various services to the railroad industry. 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. 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, the production of aluminum, the production of carbon black, the production of high-strength concrete, and the production of plasticizers and specialty chemicals, respectively. Outlook Trend Overview 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 and 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. Effects of COVID-19 on our operations Our quarterly operating results may fluctuate due to a variety of factors that are outside of our control, including from the effects of the current pandemic. The COVID-19 outbreak began to have a global effect in the first quarter of 2020 and continues to have a significant impact on global markets driven by supply chain and production disruptions, workforce restrictions, reduced spending and other factors. During the COVID-19 pandemic, substantially all of our global businesses have continued to operate within a critical infrastructure sector (as established by the Cybersecurity & Infrastructure Security Agency of the U.S. Department of Homeland Security, as well as other governments worldwide), and as a result, we have been able to meet the demand of our customers in the various markets we serve. Our operations were temporarily curtailed in New Zealand after government restrictions required the temporary closure of operations during the first half of the year. Our remaining 31 facilities, principally in the United States, Canada, the United Kingdom, Australia and Denmark, were permitted to continue to operate. As of September 30, 2020, all facilities in our manufacturing network are fully operational. Another impact of the pandemic is that more individuals are spending more time in their homes, and as a result, big-box retailers are continuing to report strong demand for home improvement projects. Consequently, we are benefiting from higher sales volumes of our water-borne treatment solutions used in residential treated wood products. In the U.S., we expect that lumber treaters will continue working to fill the demand backlog and retailers will continue replenishing their inventory levels for the remainder of 2020. 27 Our focus during this period has been on the following key priorities: • Protecting the health and safety of employees, customers and supply chain partners through rapid deployment of new safety measures, including frequent communication and guidance to all employees on effective hygiene and disinfection, social distancing, limited and remote access and use of face masks. • Providing critical products and ongoing support to customers by communicating frequently, understanding their changing business needs and ensuring key raw materials are multi-sourced when possible. • Maintaining adequate liquidity and financial flexibility by launching several cost-reduction initiatives and contingency plans to raise and conserve cash in all aspects of our operations and utilizing available federal relief such as the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act, which we continue to evaluate. The full extent to which COVID-19 will adversely impact our business depends on future developments, which are highly uncertain and unpredictable, including new information concerning the ultimate severity of the outbreak and the effectiveness of actions globally to contain or mitigate its effects. Our condensed consolidated financial statements and discussion and analysis of financial condition and results of operations reflect estimates and assumptions made by us as of September 30, 2020. Events and changes in circumstances arising after September 30, 2020, including those resulting from the impacts of COVID-19, will be reflected in our estimates for future periods. Refer to the Liquidity section of Management’s Discussion and Analysis for the impact of the global pandemic on our liquidity. Railroad and Utility Products and Services We provide our customers with treated and untreated wood products, rail joint bars and services primarily for the railroad markets in the United States and Canada. We also operate a railroad services business that conducts engineering, design, repair and inspection services primarily for railroad bridges in the U.S. and Canada. In addition, we supply treated utility poles for the utility sector in the United States and Australia. The primary end-markets for RUPS is the North American railroad industry, which has an installed base of approximately 700 million wood crossties, and the investor-owned utility industry which utilizes wooden distribution and transmission poles. Both crossties and utility poles require periodic replacement. Historically, North American demand for crossties had been in the range of 22-25 million crossties annually. However, the crosstie replacement market has been significantly lower in recent years. According to the Railway Tie Association (“RTA”), the estimated total crosstie installations in 2019 were approximately 20 million, of which 15 million were for Class I railroads. For 2020, the RTA has projected that approximately 17 million crossties will be installed, given the uncertainties related to COVID-19. T hroughout 2020, freight-rail traffic continued to decline, and passenger railroads and transit systems suspended or canceled operations due to lower ridership from stay-at-home restrictions. The reduced activity prompted larger track maintenance windows to be available and, as a result, the railroad industry is managing to offset lower volumes with increased productivity as certain railroads are taking advantage of reduced track time to increase maintenance on their infrastructure. For distribution poles, nearly half of the installed base is over 40 years old and demand has historically been in the range of two to three million poles annually. On an overall basis, we believe that the rate at which utilities purchase utility poles will grow as they continue replacement programs within their service territories. As a whole, the key factors that drive growth in the utility poles market include growing global energy consumption as well as expansion of the global telecommunication industry. Now more than ever, utilities need to maintain their infrastructure to avoid interruptions in service as large sections of the population continue to work remotely due to the COVID-19 pandemic. As such, we anticipate that 2020 demand will be relatively stable to slightly higher, although certain utilities are having issues securing line hardware and transformers which could continue into 2021 . Longer term, we are evaluating opportunities to potentially expand our market presence in the U.S. as well as certain overseas markets. Regarding the supply chain, we expect that the availability of raw materials will remain consistent even with lumber in high demand. The supply of untreated crossties can vary at times based upon weather conditions in addition to other factors. We have a nationwide wood procurement team that maintains close working relationships with a network of sawmills. We procure untreated crossties, either on behalf of our customers, or for our own inventory for future treating. We also procure switch ties and various other types of lumber used for railroad bridges and crossings. Untreated crossties go through a six- to nine-month air seasoning process before they are ready to be pressure treated. After the air seasoning process is complete, the crossties are pressure treated using creosote-only treatment or a combined creosote and borate treatment. During any given year, there is a seasonal effect in the winter and spring months on our crosstie business depending on weather conditions for harvesting lumber and crosstie installation. 28 For the past several years, the major companies in the rail industry substantially reduced both operating and capital spending from peak spending levels, which had a negative impact on sales of various products and services that we provide to that industry. Current year revenues and profitability reflect an increase year-over-year due to a slight rise in demand as capital budgets have now stabilized for most North American Class I railroads. We currently supply all seven of the North American Class I railroads and have long-standing relationships with these customers. Approximately 70 percent of our North American sales are under long-term contracts and we believe that we are positioned to maintain or grow our current market position. According to the American Association of Railroads (“AAR”), even though rail traffic in 2020 lags significantly from the prior year, Class I railroad activities began improving in May and that has continued, particularly in intermodal units. Through September 30, 2020, total U.S. carload traffic decreased 15.3 percent from the same period last year, while intermodal units were lower by 5.9 percent. The combined U.S. traffic for carloads and intermodal units declined by 10.4 percent. According to the AAR, coal and other energy-related rail commodities remain challenged. However, intermodal traffic is closer than any other rail traffic category to pre-pandemic levels and continues to improve as retailers and others are restocking inventories to prepare for the upcoming holiday season. In terms of raw material, while forestry has generally been deemed essential during the COVID-19 outbreak and tie demand has remained consistent, sawmills are being hampered by low demand in other key markets such as wood fibers used in palettes or shipping containers or mats for the oil and gas industry. So far to date, we have not experienced a noticeable impact as sawmills are continuing to produce poles and crossties to maintain their operations and cash flow. The RTA reports that the availability of logs is near the ideal rate, as is the outlook for log availability over the next six to 12 months. We are reducing crosstie purchases to be more in line with prior year levels for the remainder of 2020 in order to stabilize inventory levels. In addition, we are receiving more dry ties from third parties for certain Class I customers and that should help maintain year-over-year treating levels in the second half of 2020. To date, all but one of our Class I customers have indicated that they expect to maintain their tie replacement programs for 2020; however these plans may change in future months due to a highly uncertain and unpredictable economic environment. From a long-term perspective, we believe there remains a need for sustained investment in infrastructure and capacity expansion. We believe that with our vertical integration capabilities in wood treatment and strong customer relationships, we will ultimately benefit from increased demand. Strategic Initiatives and Integration Synergies As part of optimizing our business, we continue to evaluate a number of opportunities to improve efficiencies in our operational processes, people and facilities. With 16 North American RUPS treating facilities operating at less than full utilization, our goal is to either capture more volume through the existing facilities or consolidate our operating footprint. In June 2020, we announced the closure of our Denver, Colorado facility and, as such, in the second quarter of 2020 we recorded charges of $5.8 million for asset retirement obligations, fixed asset write-offs and severance. As of September 30, 2020, we have discontinued treating activities at this location. As a result of this closure, we expect additional restructuring and related charges to earnings of approximately $4 to $9 million through 2021. Performance Chemicals The largest geographic market for wood treating chemicals sold by our PC business is in North America, and the largest application for our products is the residential remodeling market. We also have a market presence in Europe, South America, Australia, New Zealand and Africa. We believe that PC is the largest global manufacturer and supplier of water-based wood preservatives and wood specialty additives to treaters that supply pressure treated wood products to large retailers and independent lumber dealers. These retailers and dealers, in turn, serve the residential, agricultural and industrial pressure-treated wood market. Our primary products are copper-based wood preservatives, including micronized copper azole (“MicroPro®”) and micronized pigments (“MicroShades®”). Applications for these products include decking, fencing, utility poles, construction lumber and other outdoor structures. In North America, we are vertically integrated due to our manufacturing capabilities for copper compounds for our copper-based wood preservatives. We believe our vertical integration is part of our proprietary processes and reflects an important competitive advantage. As most of the products sold by PC are copper-based products, changes in the price and availability of copper can have a significant impact on product pricing and margins. We attempt to moderate the variability in copper pricing over time by entering into hedging transactions for the majority of our copper needs, which primarily range from six months up to 36 months. These hedges typically match expected customer purchases and receive hedge accounting treatment. From time to time, we enter into forward transactions based upon long-term forecasted needs of copper. These forward positions are typically marked to market. 29 Product demand for our PC business has historically been closely associated with consumer spending on home repair and remodeling projects, and therefore, trends in existing home sales serve as a leading indicator. Overall, the market for existing homes have rebounded and are show ing strong demand during the past several months . According to the National Association of Realtors® (“NAR”), total existing-home sales grew in September for the fourth consecutive month. According to the NAR, t otal existing home sales increased 9.4 percent from August, and up 20.9 percent from a year ago. The increased buying activity is attributed to record-low interest rates and higher demand for existing homes, which includes buyers of vacation homes given the flexibility to work remotely. According to the Leading Indicator of Remodeling Activity (“LIRA”) reported by the Joint Center for Housing Studies of Harvard University, moderate gains in homeowner spending for improvements and repairs are expected through much of 2021 as initial concerns of a possible pandemic-induced downturn have largely dissipated . The Remodeling Futures Program is no longer providing a downside range for its home remodeling outlook, given the resilience of housing markets. The LIRA projects annual growth in renovation and repair spending of 4.1 percent by the first quarter of 2021 with gains softening to 1.7 percent by the third quarter of 2021 . The Conference Board Consumer Confidence Index® increased in September, after declining in August. The Index now stands at 101.8, up from 86.3 in August . While the Index increased substantially in September, after back-to-back monthly declines, it remains below pre-pandemic levels . Consumers have a more favorable view of current business and labor market conditions, along with renewed optimism about the short-term outlook . Although the market data and projections for home improvements are continually changing, w e are anticipating continued strong demand for residential treated wood in North America, primarily in the U.S. In looking at residential renovation markets, businesses are indicating a more positive outlook for 2020 than at the beginning of pandemic. In addition, the housing industry reported an increase in the number of buyers who are actively pursuing the purchase of a new or existing home, which supports a continued favorable outlook. As homeowners are focusing on the importance of their homes in a work-life environment and with interest rates at historically low levels, we expect the pace to continue at least through 2020 and potentially into 2021. Regarding our supply chain, we continue to evaluate copper hedges for the 2021-2022 timeframe, which on average are at lower average costs compared with 2020. For 2020, we do not expect to see any additional benefits related to lower copper prices, since we are already fully hedged. However, we are expecting slightly higher costs in the second half of 2020, as we need to source higher cost intermediate raw material to fill the demand backlog. Carbon Materials and Chemicals The primary products produced by CMC are creosote, which is a registered pesticide in the United States and used primarily in the pressure treatment of railroad crossties, and carbon pitch, which is sold primarily to the aluminum industry for the production of carbon anodes used in the smelting of aluminum. We have reduced capacity in our CMC plants in North America and Europe over the past several years to levels required to meet creosote demand in North America for the treatment of railroad crossties. The CMC business currently supplies our North American RUPS business with its creosote requirements. On September 30, 2020, we sold KJCC to Fangda Carbon New Material Co., Ltd and C-Chem Co., Ltd., a subsidiary of Nippon Steel Chemical & Material Co., Ltd. KJCC was located in Pizhou, Jiangsu Province, China and was a 75 percent-owned coal tar distillation company which was part of our CMC segment. The sales price was $107.0 million, subject to adjustments for cash, debt and working capital as defined in the sale and purchase agreement. The pre-tax gain on the sale of KJCC was $44.1 million and the after tax gain on the sale was $35.8 million. The net cash proceeds to Koppers was $65.2 million, after noncontrolling interest, Chinese capital gain taxes, transaction costs and estimated working capital adjustments. Included in the cash proceeds is restricted cash of $2.3 million which is being held in an escrow account to cover potential customary indemnity claims by the buyers for a period of 18 months. In the third quarter of 2019, we ceased remaining production activities at our Follansbee, West Virginia facility. As a result of this action and other previously disclosed initiatives to reduce capacity in our CMC business, we expect additional restructuring and related charges to earnings of approximately $2 million to $5 million through 2021. The overall remaining future cash requirements for CMC plant closures still in progress are estimated to be approximately $13 million through 2021. 30 While the sale of carbon pitch remains a significant portion of our sales volume, the reduction of aluminum smelting capacity in the United States, Australia and Western Europe has led to sharply lower demand for carbon pitch over the past several years. Accordingly, we have experienced significantly lower sales volumes due to the reduction in aluminum production in parts of the world where the majority of our production facilities are located. However, beginning in 2018, aluminum production in the United States increased to some extent as tariffs have been imposed on certain imported steel and aluminum products that has stimulated restarts of previously idled capacity. This development has resulted in additional demand for carbon pitch in the United States that can likely only be sustained through a continuation of current trade policy. 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 also been reduced. For the past decade, the coal tar distillation industry has operated in an excess capacity mode, which further increased the competition for a limited amount of coal tar in North America. Over the past five years we have consolidated our operating footprint and significantly lowered production levels at the same time that we added distribution assets to move finished products from Europe to the United States more efficiently. As a result, our raw material needs in North America have been significantly less than historically required. In addition, we entered into several new long-term supply agreements starting in 2017 to further lower our exposure to coal tar availability risk and volatile end markets. For the external markets served by our CMC business, we expect that North America and Europe will continue to be significantly impacted by the COVID-19 pandemic. We have seen significant declines in auto manufacturing capacity and other industrial production markets, and consequently, that has resulted in lower demand for our products. Carbon pitch and phthalic anhydride markets have softened due to declines in demand as manufacturing activity in North America and Europe significantly slowed. In addition , end market pricing for some products has been under pressure in certain regions due to the significant fall in worldwide oil prices. Globally, coal tar raw material supply remains constrained due to reductions in blast furnace steel capacity. In North America, the pullback in steel production had led to lower domestic coal tar availability and an increase in raw material imports to North America at higher prices, while markets in Europe and Australia remain relatively steady. Although automakers had shut down in recent months, the demand for new cars has been improving and therefore, production has resumed for certain models in the second half of 2020. Overall, the cost of coal tar is decreasing in line with end markets, but lagging by approximately three months. 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 September 30, 2020 and 2019 Consolidated Results Net sales for the three months ended September 30, 2020 and 2019 are summarized by segment in the following table: Three Months Ended September 30, 2020 2019 Net Change (Dollars in millions) Railroad and Utility Products and Services $ 191.0 $ 198.8 -4 % Performance Chemicals 147.9 123.9 19 % Carbon Materials and Chemicals 98.6 111.5 -12 % $ 437.5 $ 434.2 1 % RUPS net sales decreased by $7.8 million or four percent compared to the prior year period. The sales decrease was primarily due to modest volume decreases in the commercial crosstie market as well as the domestic utility pole market, along with a slight unfavorable pricing impact of customer discounts in the Class I crosstie market in the current year period. Sales of crossties decreased by $9.2 million in the current year period. These decreases were offset, in part, by volume increases in our Australian utility pole market and our crosstie disposal business and pricing increases in our domestic utility pole market. 31 PC net sales in creased by $ 24 .0 million or 19 percent compared to the prior year period. The sales increase was due primarily to higher demand for copper-based preservatives in North America due to new customer additions and higher organic volumes driven by increased home repair and remodeling activities during the pandemic , along with an increase in sales volumes in our international markets resulting from pent-up demand due to several months of restrictions associated with the pandemic. CMC net sales decreased by $12.9 million or 12 percent compared to the prior year period due mainly to lower sales prices for carbon pitch, carbon black feedstock and phthalic anhydride as a result of depressed oil prices in the current year period. These decreases were offset, in part, by volume increases of carbon pitch in Australia and phthalic anhydride in North America. Foreign currency translation also had a favorable impact on sales in the current year period of $3.3 million. Cost of sales as a percentage of net sales was 75 percent for the quarter ended September 30, 2020 compared to 80 percent in the prior year quarter. Gross margin at PC was favorably impacted by higher sales volumes, a favorable sales mix and better absorption on higher production volumes. Improved margins at RUPS were due to a favorable sales mix in our Class I crosstie market and higher margins in our domestic utility pole and maintenance-of-way markets. Depreciation and amortization charges for the quarter ended September 30, 2020 were consistent with the prior year period . Impairment and restructuring charges for the quarter ended September 30, 2020 were consistent with the prior year period . The current year period included accelerated depreciation, demolition and other plant closure period costs related to the closure of our Denver, Colorado facility. The prior year period included accelerated depreciation related to the closure of our Follansbee, West Virginia facility. Selling, general and administrative expenses for the quarter ended September 30, 2020 were $2.5 million lower when compared to the prior year period due mainly to a decrease in consulting and professional service expenses as well as travel and facility related costs. Interest expense for the quarter ended September 30, 2020 was $3.6 million lower when compared to the prior year period primarily due to our lower average debt level and lower interest rates due to the recent decrease in LIBOR rates. Income tax expense for the quarter ended September 30, 2020 was $8.6 million, an increase of $5.7 million when compared to the prior year quarter. The increase is primarily due to i ncome before income taxes being $26.5 million higher in the quarter ended September 30, 2020 when compared to the prior year quarter. The increase is partially offset by a lower estimated annual effective income tax rate in the quarter ended September 30, 2020 when compared to the prior year quarter. Income tax expense as a percentage of pre-tax profit for the quarters ended September 30, 2020 and 2019 were 18.0 percent and 13.7 percent, respectively. Discrete items for the quarter ended September 30, 2020 and the quarter ended September 30, 2020 were approximately the same. See Note 10 – “Income Taxes” for further detail about the estimated annual effective income tax rate and about the specific discrete items. Discontinued operations for the quarter ended September 30, 2020 resulted in income of $0.6 million compared to $2.2 million in the prior year period due primarily to a year-over-year reduction in net sales of $31.9 million attributable to the economic effects of COVID-19 on our KJCC operations and lower end market demand. Gain on sale of discontinued operations for the quarter ended September 30, 2020 is related to the sale of our KJCC business in China in September 2020. See Note 4 – “Discontinued Operations” for further detail. 32 Segment Results . Segment operating profit for the three months ended September 30, 2020 and 2019 is summarized by segment in the following table: Three Months Ended September 30, 2020 2019 % Change (Dollars in millions) Operating profit (loss): Railroad and Utility Products and Services $ 15.0 $ 11.3 33 % Performance Chemicals 30.4 11.7 160 % Carbon Materials and Chemicals 13.7 14.0 -2 % Corporate (0.5 ) (0.4 ) -25 % $ 58.6 $ 36.6 60 % Operating profit as a percentage of net sales: Railroad and Utility Products and Services 7.9 % 5.7 % 2.2 % Performance Chemicals 20.6 % 9.4 % 11.2 % Carbon Materials and Chemicals 13.9 % 12.6 % 1.3 % 13.4 % 8.4 % 5.0 % RUPS operating profit increased by $3.7 million compared to the prior year period. Operating profit as a percentage of net sales increased to 7.9 percent from an operating profit of 5.7 percent in the prior year period. Operating profit as a percentage of net sales for the quarter ended September 30, 2020 was favorably impacted by higher margins in our domestic utility pole and maintenance-of-way markets, a favorable sales mix in our Class I crosstie market and lower selling, general and administrative costs in the current year period. PC operating profit increased by $18.7 million compared to the prior year period. Operating profit as a percentage of net sales increased to 20.6 percent from 9.4 percent in the prior year period. The current year period was favorably impacted by higher sales volumes in North America driven by increased home repair and remodeling activities during the pandemic, a favorable sales mix, better absorption on higher production volumes during the pandemic and lower selling, general and administrative costs. CMC operating profit decreased by $0.3 million compared to the prior year period. Operating profit as a percentage of net sales increased to 13.9 percent from an operating profit of 12.6 percent in the prior year period. Operating profit for the quarter ended September 30, 2020 was favorably impacted by volume increases of carbon pitch in Australia and phthalic anhydride in North America and lower selling, general and administrative costs in the current year period. These favorable factors were offset, in part, by lower sales prices for carbon pitch and carbon black feedstock globally and lower sales prices for phthalic anhydride in North America as a result of depressed oil prices in the current year period. Results of Operations – Comparison of Nine Months Ended September 30, 2020 and 2019 Consolidated Results Net sales for the nine months ended September 30, 2020 and 2019 are summarized by segment in the following table: Nine Months Ended September 30, 2020 2019 Net Change (Dollars in millions) Railroad and Utility Products and Services $ 590.9 $ 564.0 5 % Performance Chemicals 396.4 343.7 15 % Carbon Materials and Chemicals 288.7 347.2 -17 % $ 1,276.0 $ 1,254.9 2 % RUPS net sales increased by $26.9 million or five percent compared to the prior year period. The sales increase was primarily due to volume increases in the Class I and commercial crosstie markets as well as the domestic and Australian utility pole markets, along with price increases in the domestic utility pole market in the current year period. Sales of crossties increased by $24.2 million in the current year period. These increases were offset, in part, by volume decreases in our maintenance-of-way businesses and certain pricing discounts in the Class I crosstie market in the current year period. 33 PC net sales increased by $ 52.7 million or 15 percent compared to the prior year period. The sales increase was due primarily to higher demand for copper-based preservatives in North America due to new customer additions and higher organic volumes driven by increased home repair and remodeling activities during the pandemic, along with an increase in sales volumes in our international markets resulting from pent-up demand due to several months of restrictions associated with the pandemic. These increases were partially offset by an unfavorable impact from foreign currency translation in the current year period of $ 4.3 million. CMC net sales decreased by $58.5 million or 17 percent compared to the prior year period due mainly to lower sales prices for carbon pitch, carbon black feedstock, phthalic anhydride and naphthalene as a result of depressed oil prices in the current year period. Other contributing factors include lower sales volumes of carbon pitch and carbon black feedstock as a result of the pandemic. These decreases were offset, in part, by volume increases of carbon pitch in Australia. Cost of sales as a percentage of net sales was 79 percent for the nine months ended September 30, 2020 compared to 80 percent in the prior year period. Gross margin at PC was favorably impacted by higher sales volumes, a favorable sales mix and better absorption on higher production volumes. Improved margins at RUPS were due to a favorable sales mix in our Class I crosstie market and higher margins in our domestic utility pole and maintenance-of-way markets. Lower gross margins for CMC in the current year period were a result of lower sales prices for carbon pitch, carbon black feedstock and phthalic anhydride. Depreciation and amortization charges for the nine months ended September 30, 2020 were consistent with the prior year period . Impairment and restructuring charges for the nine months ended September 30, 2020 were consistent with the prior year period . The current year period primarily consists of charges for asset retirement obligations, fixed asset write-offs, severance, accelerated depreciation, demolition and other plant closure period costs related to the closure of our Denver, Colorado facility. The prior year period primarily consisted of asset retirement obligation charges, accelerated depreciation and inventory and fixed asset write-offs related to the closure of our Follansbee, West Virginia facility. Selling, general and administrative expenses for the nine months ended September 30, 2020 were $8.2 million lower when compared to the prior year period due mainly to a decrease in consulting and professional service expenses, travel and facility related costs and employee related benefits. Interest expense for the nine months ended September 30, 2020 was $8.7 million lower when compared to the prior year period primarily due to our lower average debt level and lower interest rates due to the significant decrease in LIBOR rates. Income tax expense for the nine months ended September 30, 2020 was $14.8 million, an increase of $5.1 million when compared to the prior year period. The increase is primarily due to i ncome before income taxes being $33.3 million higher in the period ended September 30, 2020 when compared to the prior year period. The increase is partially offset by a lower estimated annual effective income tax rate in the nine months ended September 30, 2020 when compared to the prior year period. Income tax expense as a percentage of pre-tax profit for the nine months ended September 30, 2020 and 2019 were 17.4 percent and 18.7 percent, respectively. Discrete items for the nine months ended September 30, 2020 and the nine months ended September 30, 2019 were approximately the same. See Note 10 – “Income Taxes” for further detail about the estimated annual effective income tax rate and about the specific discrete items. Discontinued operations for the nine months ended September 30, 2020 resulted in a loss of $3.8 million compared to income of $5.0 million in the prior year period due primarily to a year-over-year reduction in net sales of $93.1 million attributable to the economic effects of COVID-19 on our KJCC operations and lower end market demand. Gain on sale of discontinued operations for the nine months ended September 30, 2020 is related to the sale of our KJCC business in China in September 2020. See Note 4 – “Discontinued Operations” for further detail. 34 Segment Results. Segment operating profit for the nine months ended September 30, 2020 and 2019 is summarized by segment in the following table: Nine Months Ended September 30, 2020 2019 % Change (Dollars in millions) Operating profit (loss): Railroad and Utility Products and Services $ 40.4 $ 31.8 27 % Performance Chemicals 67.1 38.5 74 % Carbon Materials and Chemicals 15.9 30.3 -48 % Corporate (1.5 ) (1.7 ) 12 % $ 121.9 $ 98.9 23 % Operating profit as a percentage of net sales: Railroad and Utility Products and Services 6.8 % 5.6 % 1.2 % Performance Chemicals 16.9 % 11.2 % 5.7 % Carbon Materials and Chemicals 5.5 % 8.7 % -3.2 % 9.6 % 7.9 % 1.7 % RUPS operating profit increased by $8.6 million compared to the prior year period. Operating profit as a percentage of net sales increased to 6.8 percent from an operating profit of 5.6 percent in the prior year period. Operating profit as a percentage of net sales for the nine months ended September 30, 2020 was favorably impacted by higher margins in our domestic utility pole and maintenance-of-way markets, a favorable sales mix in our Class I crosstie market and lower selling, general and administrative costs in the current year period. PC operating profit increased by $28.6 million compared to the prior year period. Operating profit as a percentage of net sales increased to 16.9 percent from 11.2 percent in the prior year period. The current year period was favorably impacted by higher sales volumes in North America driven by increased home repair and remodeling activities during the pandemic, a favorable sales mix, better absorption on higher production volumes during the pandemic and lower selling, general and administrative costs. CMC operating profit decreased by $14.4 million compared to the prior year period. Operating profit as a percentage of net sales decreased to 5.5 percent from an operating profit of 8.7 percent in the prior year period. Operating profit for the nine months ended September 30, 2020 was negatively affected primarily by lower sales prices for carbon pitch, carbon black feedstock, phthalic anhydride and naphthalene as a result of depressed oil prices in the current year period. Other contributing factors include lower sales volumes of carbon pitch and carbon black feedstock as a result of the pandemic. These decreases were offset, in part, by volume increases of carbon pitch in Australia. Cash Flow Net cash provided by operating activities for the nine months ended September 30, 2020 was $65.5 million compared to net cash provided by operating activities of $57.0 million in the prior year period. The net increase of $8.5 million in cash provided by operations was due primarily to an increase in net income as well as a positive net change in certain other operating activities of $24.2 million from the prior year period, which had a favorable result on cash provided by operations in the current year period. These drivers were partly offset by higher working capital usage of $15.7 million compared to the prior year period, mainly due to an increase in accounts receivable in the current year period. Net cash provided by investing activities for the nine months ended September 30, 2020 was $35.0 million compared to net cash used in investing activities of $23.5 million in the prior year period. The net increase in cash provided by investing activities of $58.5 million is primarily due to net cash of $78.1 million provided by the sale of KJCC partly offset by an increase in capital expenditures of $17.0 million in the current year period. Net cash used in financing activities was $93.7 million for the nine months ended September 30, 2020 compared to $33.0 million of net cash used in financing activities in the prior year period. The cash used in financing activities in the nine months ended September 30, 2020 reflected net repayments of debt of $93.1 million and repurchases of common stock of $1.2 million related to long-term incentive compensation plans. The cash used in financing activities in the prior year period, reflected net repayments of $32.2 million and repurchases of common stock of $0.9 million. 35 Liquidity and Capital Resources We have a $600.0 million senior secured revolving credit facility and a $100.0 million secured term loan facility (collectively, the “Credit Facility”), as amended, with a maturity date of May 2024. The interest rate on the Credit Facility is variable and is based on LIBOR. 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 prohibits Koppers Inc. from making dividend payments to Koppers Holdings unless (1) such dividend payments are permitted by the indenture governing Koppers Inc.’s $500 million Senior Notes due 2025 (the “2025 Notes”), (2) no event of default or potential default has occurred or is continuing under our Credit Facility, and (3) we are in pro forma compliance with our fixed charge coverage ratio covenant after giving effect to such dividend. The indenture governing the 2025 Notes restricts Koppers Inc.’s ability to finance our payment of dividends if (1) a default has occurred or would result from such financing, (2) Koppers Inc., or 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 September 30, 2020, the basket totaled $217.2 million. Notwithstanding such restrictions, the indenture governing the 2025 Notes permits an additional aggregate amount of $0.30 per share each fiscal quarter 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 Credit Facility may restrict the ability of Koppers Inc. to pay dividends. Koppers Holdings last declared a dividend in November 2014 and does not expect to declare any dividends for the foreseeable future. Liquidity Borrowings under the Credit Facility are secured by a first priority lien on substantially all of the assets of Koppers Inc., Koppers Holdings and their material domestic subsidiaries. The 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 September 30, 2020, we had $305.7 million of unused revolving credit availability for working capital purposes after restrictions by various debt covenants and certain letter of credit commitments. As of September 30, 2020, $7.0 million of commitments were utilized by outstanding letters of credit. In the third quarter of 2020, we used the net proceeds of the KJCC sale to reduce our borrowings under the revolving credit facility. Under the terms of the Credit Facility, net proceeds must be used to reduce term loan borrowings within a specified period. Accordingly, we expect that we will repay term loans of approximately $10 to $20 million in the fourth quarter of 2020. Any amount of repaid term loan borrowings will not be available for future borrowing liquidity. In addition, as of December 31, 2020, our total secured leverage ratio will not be permitted to exceed 2.75 times and our total leverage ratio will not be permitted to exceed 5.0 times due to a scheduled reduction of these ratios under our credit agreement. We expect the effect of the step down of these covenant ratios to reduce our liquidity by approximately $50 million as of December 31, 2020. The following table summarizes our estimated liquidity as of September 30, 2020 (dollars in millions) : Cash and cash equivalents (1) $ 37.2 Amount available under Credit Facility 305.7 Total estimated liquidity $ 342.9 (1) Cash includes approximately $35.8 million held by foreign subsidiaries and excludes approximately $2.3 million of restricted cash. Our estimated liquidity was $254.6 million at December 31, 2019. 36 Our need for cash in the next twelve months relates primarily to contractual obligations which include debt service, pension plan funding, purchase commitments and operating leases, as well as working capital, capital maintenance programs and the funding of plant consolidation and rationalizations. We may also use cash to pursue other potential strategic acquisitions or voluntary pension plan contributions . Capital expenditures in 2020 , excluding acquisitions, if any, are expected to total approximately $5 5 to $ 6 0 million and are expected to be funded by cash from operations . We anticipate that our estimated liquidity adjusted for the pay down of the term loans and step down of the covenant ratios discussed above will continue to be adequate to fund our cash requirements for the next twelve months. Debt Covenants The covenants under the Credit Facility may restrict the availability to borrow or may restrict the ability of Koppers Inc. to pay dividends. The Credit Facility’s covenants include the following financial ratios: ◾ The fixed charge coverage ratio, calculated as of the end of each fiscal quarter for the four fiscal quarters then ended, is not permitted to be less than 1.10. The fixed charge coverage ratio at September 30, 2020 was 2.37. ◾ The total secured leverage ratio, calculated as of the end of each fiscal quarter for the four fiscal quarters then ended, is not permitted to exceed 3.00. The total secured leverage ratio at September 30, 2020 was 1.51. ◾ The total leverage ratio, calculated as of the end of each fiscal quarter for the four fiscal quarters then ended, is not permitted to exceed 5.25. The total leverage ratio at September 30, 2020 was 3.83. We are currently in compliance with all covenants governing the Credit Facility. Our continued ability to meet those financial ratios can be affected by events beyond our control, however, excluding possible acquisitions, we currently expect that our net cash flows from operating activities and funds available from our Credit Facility will be sufficient to provide for our working capital needs and capital spending requirements over the next twelve months. Effects of COVID-19 on our Liquidity As of September 30, 2020, we are in compliance with our debt covenants under the Credit Facility and had $342.9 million of liquidity to fund our operations. Our estimates and assumptions as of the date of this report indicate that we should remain in compliance with our debt covenants and we have identified actions we can implement to help maintain compliance if the impact of COVID-19 has a more pronounced impact on the economy, our business and our ability to generate cash flow and profits than estimated. These impacts are highly uncertain and unpredictable, and include the severity of the outbreak and the effectiveness of actions globally to contain or mitigate its effects. Accordingly, the financial effects of the pandemic on our business may have an adverse effect on the determination of, and compliance with, our debt covenants over the next twelve months. In the event we do not maintain compliance with our debt covenants, we may be required to pursue additional sources of financing to meet our financial obligations. Obtaining such financing is not guaranteed and is largely dependent upon market conditions and other factors. Further actions may be required to improve our cash position, including but not limited to, monetizing assets, implementing cost reductions including employee furloughs, and foregoing capital expenditures and other discretionary expenses. Legal Matters The information set forth in Note 18 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, 2019. Environmental and Other Matters The information set forth in Note 18 to the Condensed Consolidated Financial Statements of Koppers Holdings Inc. included in Item 1 of this Part I is incorporated herein by reference. 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, 2019. 37