Item 7. Management’s Discussion and Analysis
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
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: 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, telephone, and broadband utility industries in the United States and Australia and construction pilings in the U.S. We also provide rail joint bar products as well as various services to the railroad industry in North America.
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 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 without disruption. In the U.S., Koppers was designated as an essential business, as determined by the Cybersecurity and Infrastructure Security Agency (CISA) within the Department of Homeland Security. As a result, we have been able to meet the demands of our customers in the various markets we serve by continuing to operate to transport critical goods, provide power and connectivity to homes and businesses, and keep our infrastructure running reliably.
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 deployment of new safety measures, including frequent communication and guidance to all employees on effective hygiene and disinfection, social distancing, limiting access to facilities, remote work when possible 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 in the United States.
28
Koppers Holdings Inc. 2020 Annual Report
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. Since March 2020, some of our facilities have temporarily curtailed operations as a result of government restrictions or as a result of our proactive measures to limit the potential spread of COVID-19 among our employees. Our business will continue to be impacted by such restrictions and protective measures for the foreseeable future. Our consolidated financial statements and discussion and analysis of financial condition and results of operations reflect estimates and assumptions made by us as of December 31, 2020. Events and changes in circumstances arising after December 31, 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 450 million wood crossties, and the 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 million to 25 million crossties annually. However, the crosstie replacement market has been significantly lower in recent years. According to the Railway Tie Association (“RTA”), the reported total crosstie installations in 2020 were approximately 18 million, of which 14 million were for Class I railroads. 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. Given the continuing uncertainties related to COVID-19, the RTA is forecasting modest increases of 2.7 percent in 2021 and 3.6 percent in 2022, primarily from the commercial market while Class I volumes are expected to remain at relatively similar demand levels.
For distribution poles, nearly half of the installed base is over 40 years old and demand has historically been in the range of two million 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 2021 demand will be relatively stable to slightly higher, as the overall industry is trending toward expanded and upgraded transmission networks. Longer term, we are evaluating opportunities to potentially expand our market presence in the U.S. as well as certain overseas markets.
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. 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”), railroads began 2020 with uncertainty due to weakness in the manufacturing sector and lower port activity caused by trade disputes. In the early months of 2020, railroad traffic reported near-record declines, but ultimately rebounded to close to pre-pandemic levels by the end of the year, sparked by sharply higher grain and intermodal shipments along with the reopening of auto assembly plants. In 2020, total U.S. carload traffic decreased 12.9 percent from the prior year, while intermodal units declined by 1.8 percent. The combined U.S. traffic for carloads and intermodal units was lower by 7.2 percent than the prior year. Looking ahead to 2021, the AAR stated that a significant amount of ongoing network investments has made the industry more adaptable and better able to adjust to the demands of a wide range of operational and market conditions.
From a long-term perspective, we believe there remains an overall 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.
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In terms of raw material s , we expect the availability of pole supply to remain consistent even with lumber in high demand . For untreated crossties , the supply 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. W hile 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. Consistent with typical seasonality, the RTA reports that the current availability of logs is slightly below the ideal rate, as is the outlook for log availability over the next six to 12 months.
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. Concurrent with the decision to close the Denver facility, we announced our plan to modernize and upgrade parts of our treating network, specifically at our facility in North Little Rock, Arkansas, which will be primarily funded through proceeds from the sale of non-core assets, which includes the Denver facility.
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 and fire-retardant chemicals (“FlamePro®”). Our copper-based wood preservatives include 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.
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 are showing strong demand. According to the National Association of Realtors® (“NAR”), total existing-home sales grew in December for the fourth consecutive month. According to the NAR, total existing home sales increased 0.7 percent from November, and up 5.6 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. For 2020 as a whole, total home sales performed at their highest levels since 2006 and the momentum is expected to carry into 2021, with more buyers expected to enter the market.
30
Koppers Holdings Inc. 2020 Annual Report
According to the Leading Indicator of Remodeling Activity (“LIRA”) reported by the Joint Center for Housing Studies of Harvard University, there was 3.5 percent year-over-year growth in 2020 home renovation and repair expenditures. The LIRA projects annual growth in renovation and repair spending of 3.8 percent by year-end 2021 . The remodeling market continues to benefit from a strong housing market – including accelerating growth in homebuilding, sales and home equity. In addition to routine replacement and repair projects, homeowners are likely to pursue more and larger discretionary home improvements this year as the broader economy recovers.
The Conference Board Consumer Confidence Index® improved moderately in January, after decreasing in December. The Index now stands at 89.3, up from 87.1 in December. In addition, consumers’ expectations regarding the economy and jobs showed improvement and the percent of consumers who said they intend to purchase a home in the next six months increased, suggesting that the pace of home sales should remain robust in early 2021.
D uring the pandemic, there has been a shift with more individuals 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 during 2021.
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 continued positive outlook, at least through mid-2021. 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 into 2021.
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 estimated final net cash proceeds to Koppers will total $65.2 million, after payment for Chinese capital gain taxes, transaction costs and estimated working capital adjustments.
In the third quarter of 2019, we ceased remaining production activities at our Follansbee, West Virginia facility and, i n February 2021, we completed the sale of the 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 $10 million through 2021.
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 were imposed on certain imported steel and aluminum products, which 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.
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For the external markets served by our CMC business, we expect that North America and Europe will continue to be negatively impacted in 2021 by the COVID-19 pandemic. We have seen declines in industrial production markets which 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 has 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. 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 Years Ended December 31, 2020 and December 31, 2019
Consolidated Results
Net sales for the years ended December 31, 2020 and 2019 are summarized by segment in the following table:
Year Ended December 31,
2020
2019
Net Change
(Dollars in millions)
Railroad and Utility Products and Services
$
759.1
$
733.5
3
%
Performance Chemicals
526.3
448.3
17
%
Carbon Materials and Chemicals
383.7
455.2
-16
%
$
1,669.1
$
1,637.0
2
%
RUPS net sales for the year ended December 31, 2020 increased by $25.6 million, or three percent, compared to the prior year. The sales increase was primarily due to volume increases in the Class I crosstie market as well as the domestic and Australian utility pole markets, along with price increases in the domestic utility pole market in the current year. Sales of crossties increased by $16.8 million in the current year. These increases were offset, in part, by volume decreases in the commercial crosstie market and our maintenance-of-way businesses in the current year.
PC net sales for the year ended December 31, 2020 increased by $78.0 million, or 17 percent, compared to the prior year. 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 $5.1 million.
CMC net sales for the year ended December 31, 2020 decreased by $71.5 million, or 16 percent, compared to the prior year 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 in North America and naphthalene in Europe and Australia as a result of the economic conditions. These decreases were offset, in part, by volume increases of carbon pitch and carbon black feedstock in Australia.
Cost of sales as a percentage of net sales was 78 percent for the year ended December 31, 2020, compared to 80 percent in the prior year. 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, phthalic anhydride and naphthalene.
Depreciation and amortization charges for the year ended December 31, 2020 were consistent with the prior year .
Impairment and restructuring charges were $0.5 million higher when compared to 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.
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Koppers Holdings Inc. 2020 Annual Report
Selling, general and administrative expenses for the year ended December 31, 2020 were $ 5.2 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 year ended December 31, 2020 was $12.8 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. In the third quarter of 2020, we used the net proceeds of the KJCC sale to reduce our borrowings under the Credit Facility.
Income taxes for the year ended December 31, 2020 were $21.0 million higher when compared to the prior year period. Both periods included various tax costs or benefits that significantly influenced income taxes.
For the year ended December 31, 2020, our income tax provision benefitted by a total of $13.3 million from our ability to utilize prior year carryforwards related to the limitation on our U.S. interest expense deduction in addition to increased prior year deductions for interest expense as a result of the CARES Act.
For the year ended December 31, 2019, our tax provision was favorably impacted due to a legal entity restructuring and tax audit closures. We completed a Dutch legal entity restructuring project, which resulted in an intra-entity transfer of certain intangible assets and intellectual property. This transaction resulted in the recognition of a deferred tax asset of $14.9 million. We also recorded a favorable tax benefit of $4.3 million for the year ended December 31, 2019 for the reversal of various unrecognized tax benefits due to the closure of a U.S. tax audit.
Income tax expense as a percentage of income before income taxes for the years ended December 31, 2020 and 2019 was 19.1 percent and zero percent, respectively. The increase is partially due to income before income taxes being $46.4 million higher when compared to the prior year period and the benefits from a Dutch legal entity restructuring recorded for the year ended December 31, 2019.
Discontinued operations for the year ended December 31, 2020 resulted in a loss of $3.9 million compared to income of $3.7 million in the prior year period due primarily to a year-over-year reduction in net sales of $104.2 million attributable to lower end market demand on our KJCC operations and only nine months of operations in 2020 due to the sale of the company.
Gain on sale of discontinued operations for the year ended December 31, 2020 is related to the sale of our KJCC business in China in September 2020. See Note 4 – “Plant Closures and Discontinued Operations” for further detail.
Segment Results
Segment operating profit for the years ended December 31, 2020 and 2019 is summarized in the following table:
Year Ended December 31,
2020
2019
% Change
(Dollars in millions)
Operating profit (loss):
Railroad and Utility Products and Services
$
46.7
$
35.8
30
%
Performance Chemicals
88.6
52.1
70
%
Carbon Materials and Chemicals
23.4
39.2
-40
%
Corporate
(2.0
)
(2.1
)
5
%
$
156.7
$
125.0
25
%
Operating profit as a percentage of net sales:
Railroad and Utility Products and Services
6.2
%
4.9
%
1.3
%
Performance Chemicals
16.8
%
11.6
%
5.2
%
Carbon Materials and Chemicals
6.1
%
8.6
%
-2.5
%
9.4
%
7.6
%
1.8
%
RUPS operating profit increased by $10.9 million compared to the prior year period. Operating profit as a percentage of net sales increased to 6.2 percent from 4.9 percent in the prior year period. Operating profit as a percentage of net sales for the year ended December 31, 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, a favorable adjustment to our LIFO inventory reserve and lower selling, general and administrative costs in the current year period.
PC operating profit increased by $36.5 million compared to the prior year period. Operating profit as a percentage of net sales increased to 16.8 percent from 11.6 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.
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CMC operating profit decreased by $15.8 million compared to the prior year period. Operating profit as a percentage of net sales decreased to 6.1 percent from 8.6 percent in the prior year period. Operating profit for the year ended December 31, 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 in North America as a result of economic conditions. These decreases were offset, in part, by volume increases of carbon pitch and carbon black feedstock in Australia.
Results of Operations – Comparison of Years Ended December 31, 2019 and December 31, 2018
Consolidated Results
Net sales for the years ended December 31, 2019 and 2018 are summarized by segment in the following table:
Year Ended December 31,
2019
2018
Net Change
(Dollars in millions)
Railroad and Utility Products and Services
$
733.5
$
634.8
16
%
Performance Chemicals
448.3
420.0
7
%
Carbon Materials and Chemicals
455.2
507.9
-10
%
$
1,637.0
$
1,562.7
5
%
RUPS net sales for the year ended December 31, 2019 increased by $98.7 million, or 16 percent, compared to the prior year. The sales increase was primarily due to volume increases in the Class I and commercial crosstie markets, as well as a full year of results from UIP which was acquired in the second quarter of the prior year, along with price increases across the segment in 2019. Sales of crossties increased by $61.1 million in 2019. These increases were offset, in part, by volume decreases in the rail joints market and an unfavorable impact from foreign currency translation in 2019 of $2.5 million from our Australian pole business.
PC net sales for the year ended December 31, 2019 increased by $28.3 million, or seven percent, compared to the prior year. The sales increase was due primarily to new customer wins, new product sales, higher organic volumes and price increases for copper-based preservatives in North America. Sales of non-copper based preservatives in Europe realized a more favorable pricing mix in 2019 as well. These increases were partially offset by an unfavorable impact from foreign currency translation in 2019 of $3.0 million.
CMC net sales for the year ended December 31, 2019 decreased by $52.7 million, or ten percent, compared to the prior year due mainly to lower sales prices for carbon pitch and naphthalene in Europe, along with lower sales volumes of carbon pitch in Australia and carbon black feedstock globally. F oreign currency translation also had an unfavorable impact on sales in 2019 over the prior year period. These decreases were partially offset by increased volumes for carbon pitch in North America. In Australia, higher sales prices for carbon pitch were driven primarily by higher raw material cost and increases in global oil pricing.
Cost of sales as a percentage of net sales was 80 percent for the year ended December 31, 2019, compared to 81 percent in the prior year. Lower gross margins for PC in 2019 were primarily due to higher year-over-year raw material costs . These were offset by higher gross margins for RUPS due to increased sales volumes of crossties coupled with commercial crosstie market price increases .
Depreciation and amortization charges for the year ended December 31, 2019 were $4.5 million higher when compared to the prior year period due mainly to assets placed in service during 2019 related to our new naphthalene unit at our CMC plant in Stickney, Illinois along with a full year of depreciation and amortization from our acquisition of UIP which occurred in the second quarter of 2018.
Loss on sale of assets of $8.3 million for the year ended December 31, 2018 reflects sales of our coal tar distillation facility in Clairton, Pennsylvania and our specialty chemicals business in the United Kingdom within our CMC segment and the sale of assets in the United Kingdom within our PC segment.
Impairment and restructuring charges were $2.0 million higher when compared to the prior year period. In the third quarter of 2019, we discontinued remaining production activities at our Follansbee, West Virginia facility and, as such, we recorded associated charges of approximately $3 million for asset retirement obligations and inventory and fixed asset write-offs in 2019. Prior year charges consisted of storage tank decommissioning costs and accelerated depreciation for the remaining fixed assets at our coal tar distillation facilities in Clairton, Pennsylvania and Follansbee, West Virginia.
Selling, general and administrative expenses for the year ended December 31, 2019 were $9.9 million lower when compared to the prior year period due primarily to a decrease of $9.4 million for travel, consulting and professional service expenses mostly related to our prior year acquisitions. This decrease was partially offset by an increase in legal costs.
Interest expense for the year ended December 31, 2019 was $7.6 million higher when compared to the prior year period primarily due to the higher average debt level related to our acquisitions of UIP and KRR in 2018 as well as cash used to fund our stock buybacks and capital expenditures in the second half of 2018.
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Koppers Holdings Inc. 2020 Annual Report
Income taxes for the year ended December 31, 2019 were $25.7 million lower when compared to the prior year period. Both periods included various tax costs or benefits that significantly influenced income taxes.
For the year ended December 31, 2019, we completed a Dutch legal entity restructuring project, which resulted in an intra-entity transfer of certain intangible assets and intellectual property. This transaction resulted in the recognition of a deferred tax asset of $14.9 million. We also recorded a favorable tax benefit of $4.3 million in the year ended December 31, 2019 for the reversal of various unrecognized tax benefits due to the closure of a U.S. tax audit.
For the year ended December 31, 2018 , income taxes included a tax cost of $4.8 million related to the completion of the analysis of the final impact of the Tax Cuts and Jobs Act of 2017 (the “Tax Act”) and a tax cost of $6.6 million related to the impact of the global intangible low taxed income (“GILTI”) provision in our 2018 U.S. tax provision.
Income tax expense as a percentage of income before income taxes for the years ended December 31, 2019 and 2018 was zero percent and 82.4 percent, respectively. The decrease in this percentage is largely due to the factors that are described in the above paragraph. Additionally, the annual effective income tax rate is lower when compared to the prior period due to a decrease in unfavorable U.S. tax adjustments for the limitation on our U.S. interest expense deduction and the GILTI inclusion.
Discontinued operations for the year ended December 31, 2019 resulted in income of $3.7 million compared to income of $23.7 million in the prior year period due primarily to higher sales prices in China in 2018 based on higher market prices, particularly in the first quarter .
Segment Results
Segment operating profit for the years ended December 31, 2019 and 2018 is summarized by segment in the following table:
Year Ended December 31,
2019
2018
% Change
(Dollars in millions)
Operating profit (loss):
Railroad and Utility Products and Services
$
35.8
$
5.9
507
%
Performance Chemicals
52.1
36.2
44
%
Carbon Materials and Chemicals
39.2
44.7
-12
%
Corporate
(2.1
)
(2.4
)
13
%
$
125.0
$
84.4
48
%
Operating profit as a percentage of net sales:
Railroad and Utility Products and Services
4.9
%
0.9
%
4.0
%
Performance Chemicals
11.6
%
8.6
%
3.0
%
Carbon Materials and Chemicals
8.6
%
8.8
%
-0.2
%
7.6
%
5.4
%
2.2
%
RUPS operating profit increased by $29.9 million compared to the prior year period. Operating profit as a percentage of net sales increased to 4.9 percent in 2019. Operating profit as a percentage of net sales for the year ended December 31, 2019 was impacted by increased sales volumes of crossties to Class I customers coupled with commercial crosstie market price increases and higher overall demand along with benefits in 2019 from our 2018 acquisition of UIP. The prior year period also included acquisition-related costs not present in 2019.
PC operating profit increased by $15.9 million compared to the prior year period. Operating profit as a percentage of net sales increased to 11.6 percent from 8.6 percent in the prior year period. The year ended December 31, 2019 was favorably impacted by sales increases due primarily to new customer wins, new product sales, higher organic volumes and price increases for copper-based preservatives in North America. Sales of non-copper based preservatives in Europe realized a more favorable pricing mix in 2019 as well. Higher year-over-year raw material prices partially offset our increase in sales for the year ended December 31, 2019.
35
CMC operating profit for the year ended December 31, 2019 decreased by $5.5 million, or 12 percent, compared to the prior year. Operating profit as a percentage of net sales decreased to 7.6 percent from 10.8 percent in the prior year period. Operating profit for the year ended December 31, 2019 was negatively affected primarily by lower sales prices for carbon pitch and naphthalene in Europe, along with lower sales volumes of carbon pitch in Australia and carbon black feedstock globally and an unfavorable impact from foreign currency translation. Additionally, we recognized restructuring and related charges to earnings of approximately $3 million in the current year resulting from our cessation of remaining production activities at our Follansbee, West Virginia facility in the third quarter of 2019. These unfavorable drivers were partially offset by increased volumes for carbon pitch in North America coupled with a more streamlined and efficient cost structure across the entire segment.
Cash Flow
Net cash provided by operating activities was $127.1 million for the year ended December 31, 2020 as compared to net cash provided by operating activities of $115.3 million for the year ended December 31, 2019. The net increase of $11.8 million in cash provided by operations was due primarily to an increase in net income and certain other operating activities of $42.4 million from the prior year period, which includes the gain on the sale of KJCC of $35.6 million in the current year period. These drivers were partly offset by higher working capital usage of $30.6 million compared to the prior year period, mainly due to an increase in accounts receivable and a reduction in accounts payable in the current year period.
Net cash provided by operating activities was $115.3 million for the year ended December 31, 2019 as compared to net cash provided by operating activities of $78.3 million for the year ended December 31, 2018. The net increase of $37.0 million in cash provided by operations was due primarily to lower working capital usage of $30.7 million compared to the prior year period, mainly due to favorable timing of accounts receivable collections in 2019. In addition, the change in income and certain operating activities of $6.3 million from the prior year period had a favorable result on cash provided by operations in 2019. These positive impacts were partially offset by a net unfavorable impact on cash from a reduction in outstanding payables in 2019 relative to the prior year end.
Net cash provided by investing activities was $5.6 million for the year ended December 31, 2020 as compared to net cash used in investing activities of $33.8 million for the year ended December 31, 2019. The net increase in cash provided by investing activities of $39.4 million is primarily due to net cash of $74.7 million provided by the sale of KJCC partly offset by an increase in capital expenditures of $32.6 million used mainly for production expansion and modernization at our RUPS plant in North Little Rock, Arkansas.
Net cash used in investing activities was $33.8 million for the year ended December 31, 2019 as compared to net cash used in investing activities of $376.4 million for the year ended December 31, 2018. The decrease in cash used for investing activities of $342.6 million is primarily due to $264.0 million of net cash used for acquisitions in the prior year period as well as prior year capital expenditures used mainly to expand production capacity at PC in the United States and continued spending on the new naphthalene unit at our CMC plant in Stickney, Illinois. Both of these projects were substantially completed by the end of 2018. The net decrease in cash used for capital expenditures in 2019 from the prior year period was $72.5 million.
Net cash used in financing activities was $128.7 million for the year ended December 31, 2020 as compared to net cash used in financing activities of $88.7 million for the year ended December 31, 2019. The cash used in financing activities in the year ended December 31, 2020 reflected net repayments of debt of $128.0 million and repurchases of common stock of $1.6 million related to long-term incentive compensation plans. The cash used in financing activities in the prior year period, reflected net repayments of debt of $90.8 million and repurchases of common stock of $0.9 million.
Net cash used in financing activities was $88.7 million for the year ended December 31, 2019 as compared to net cash provided by financing activities of $282.8 million for the year ended December 31, 2018. The cash used in financing activities in 2019 reflected net repayments of debt of $90.8 million partially offset by issuances of common stock of $4.0 million. The cash provided by financing activities in the prior year period reflected net borrowings of $314.6 million to primarily fund acquisitions and capital expenditures and repurchases of common stock of $31.8 million.
36
Koppers Holdings Inc. 2020 Annual Report
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 described in Note 15 of the Notes to Consolidated Financial Statements.
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 December 31, 2020, the basket totaled $226.9 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.
Liquidity
In the third quarter of 2020, we used the net proceeds of the KJCC sale to reduce our borrowings under the 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 repaid approximately $63 million of the term loan in the fourth quarter of 2020, inclusive of the normal quarterly principal payment of $2.5 million. In addition, effective as of December 31, 2020, our total secured leverage ratio is not permitted to exceed 2.75 times and our total leverage ratio is not permitted to exceed 5.0 times due to the scheduled reduction of these ratios under our credit agreement. However, the step down of these covenant ratios did not have a substantial effect on our liquidity as of December 31, 2020.
The following table summarizes our estimated liquidity as of December 31, 2020 (dollars in millions) :
Cash and cash equivalents (1)
$
36.2
Amount available under credit facility
307.8
Total estimated liquidity
$
344.0
(1)
Cash includes approximately $35.4 million held by foreign subsidiaries and excludes approximately $2.3 million of restricted cash.
Our liquidity was $254.6 million at December 31, 2019.
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 2021, excluding acquisitions, if any, are expected to total approximately $105 to $115 million and are expected to be funded by cash from operations. We anticipate that our estimated liquidity will continue to be adequate to fund our cash requirements for the next twelve months.
37
Schedule of Certain Contractual Obligations
The following table details our projected payments for our significant contractual obligations as of December 31, 2020. The table is based upon available information and certain assumptions we believe to be reasonable.
Payments Due by Period
2021
2022-2023
2024-2025
Later years
Total
(in millions)
Long-term debt (1)
$
10.1
$
2.1
$
772.0
$
0.0
$
784.2
Interest on debt
37.5
74.6
48.0
0.0
160.2
Operating leases
28.4
43.8
27.8
33.5
133.5
Federal tax payments (2)
0.4
1.8
1.3
0.0
3.4
Purchase commitments (3)
224.9
218.5
167.1
65.6
676.1
Total contractual cash obligations
$
301.3
$
340.8
$
1,016.2
$
99.1
$
1,757.5
(1)
Consists primarily of the maturity of the 2025 Notes and the Credit Facility that will mature in 2024.
(2)
Relates to the transition tax in accordance with the Tax Act.
(3)
Consists primarily of raw materials purchase contracts. These are typically not fixed price arrangements; the prices are based on the prevailing market prices. As a result, we generally expect to be able to hedge the purchases with sales at those future prices.
Pension and other employee benefit plan funding obligations (for defined benefit plans) are not included in the table above. We expect defined benefit plan contributions to total approximately $1.7 million in 2021. Estimated funding obligations are determined by asset performance, workforce and retiree demographics, tax and employment laws and other actuarial assumptions which may change the annual funding obligations in addition to decisions to fund in excess of statutorily required amounts. The funded status of our defined benefit plans is disclosed in Note 14 in our consolidated financial statements.
As of December 31, 2020, there was $2.5 million of tax liabilities related to unrecognized tax benefits. Because of the high degree of uncertainty regarding the timing of future cash outflows associated with these liabilities, we are unable to estimate the years in which settlement will occur with the respective taxing authorities. See Note 10 in our consolidated financial statements for further information.
Schedule of Certain Other Commercial Commitments
The following table details our projected payments for other significant commercial commitments as of December 31, 2020. The table is based upon available information and certain assumptions we believe to be reasonable.
Amount of Commitment Expiration Per Period
Total
Amounts
2021
2022-2023
2024-2025
Later years
Committed
(in millions)
Lines of credit (unused)
$
0.0
$
0.0
$
272.0
$
0.0
$
272.0
Term Loan
10.0
2.0
0.0
0.0
12.0
Standby letters of credit
0.0
0.0
7.7
0.0
7.7
Total other commercial commitments
$
10.0
$
2.0
$
279.7
$
0.0
$
291.7
Debt Covenants at December 31, 2020
The 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 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 December 31, 2020 was 2.29.
◾
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 2.75. The leverage ratio at December 31, 2020 was 1.32.
◾
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 5.00. The leverage ratio at December 31, 2020 was 3.59.
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.
38
Koppers Holdings Inc. 2020 Annual Report
Effects of COVID-19 on our Liquidity
As of December 31, 2020, we are in compliance with our debt covenants under the Credit Facility and had $344.0 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.
Non-GAAP Financial Measures
We utilize certain financial measures that are not in accordance with U.S. generally accepted accounting principles (US GAAP) to analyze and manage the performance of the business. We believe that EBITDA (as defined below), adjusted EBITDA, adjusted EBITDA margin, and net leverage ratio provide information useful to investors in understanding the underlying operational performance of the company, our business and performance trends, and facilitate comparisons between periods and with other corporations in similar industries. The exclusion of certain items permits evaluation and a comparison of results for ongoing business operations, and it is on this basis that our management internally assesses our performance. In addition, our board of directors and executive management team use adjusted EBITDA as a performance measure under the company’s annual incentive plans.
Although we believe that these non-GAAP financial measures enhance investors’ understanding of its business and performance, these non-GAAP financial measures should not be considered an alternative to GAAP basis 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.
EBITDA is a non-GAAP financial measure defined as net income from continuing operations before income taxes and interest, depreciation and amortization. The adjustments to arrive at adjusted EBITDA 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, other one-time or unusual items or recurring non-cash income or expense items such as LIFO and mark-to-market commodity hedging.
The following tables summarize EBITDA and adjusted EBITDA on a consolidated and segment basis as calculated by us for the years indicated below:
Year Ended December 31,
(amounts in millions)
2020
2019
Net income
$
121.0
$
67.4
Interest expense
48.9
61.7
Depreciation and amortization
54.1
51.4
Depreciation in impairment and restructuring charges
2.0
3.4
Income taxes
21.0
0.0
Discontinued operations
(31.9
)
(3.7
)
EBITDA with noncontrolling interests
215.1
180.2
Adjustments to arrive at adjusted EBITDA:
Impairment, restructuring and plant closure costs
15.7
20.4
Non-cash LIFO (benefit) expense
(13.7
)
4.5
Mark-to-market commodity hedging
(9.2
)
(4.0
)
Pension settlement
0.1
0.0
Discretionary incentive
3.0
0.0
Total adjustments
(4.1
)
20.9
Adjusted EBITDA
$
211.0
$
201.1
39
Year Ended December 31,
(amounts in millions)
2020
2019
EBITDA with noncontrolling interests:
Railroad and Utility Products and Services
$
68.8
$
54.0
Performance Chemicals
109.9
72.6
Carbon Materials and Chemicals
39.6
54.8
Corporate unallocated
(3.2
)
(1.2
)
Total EBITDA
$
215.1
$
180.2
Adjusted EBITDA:
Railroad and Utility Products and Services
$
65.4
$
60.2
Performance Chemicals
100.7
68.6
Carbon Materials and Chemicals
45.0
73.5
Corporate unallocated
(0.1
)
(1.2
)
Total Adjusted EBITDA
$
211.0
$
201.1
Adjusted EBITDA margin as a percentage of GAAP sales:
Railroad and Utility Products and Services
8.6
%
8.2
%
Performance Chemicals
19.1
%
15.3
%
Carbon Materials and Chemicals
11.7
%
16.1
%
Total Adjusted EBITDA margin
12.6
%
12.3
%
The increase in adjusted EBITDA of $9.9 million from 2019 is primarily due to higher sales volume, favorable product mix and improved cost absorption from our PC segment which was driven by the demand for copper-based preservatives in the U.S. from strong housing, repair and remodeling markets. As an effect of the pandemic on the consumer markets, this strong market was driven by the diversion of discretionary spending from leisure and entertainment categories to home repair and beautification projects. Our RUPS segment also experienced improved adjusted EBITDA from higher margins in our domestic utility pole and maintenance-of-way markets and a favorable sales mix in our Class I crosstie market. This increase was partially offset by lower adjusted EBITDA from our CMC segment as a result of a weakness and lower pricing in key markets, particularly in the first half of the year, due to the economic effects of the pandemic.
Net leverage ratio is a non-GAAP financial measure defined as net debt (total debt less cash) divided by adjusted EBITDA for the latest twelve months and is a financial measure used by us to assess our borrowing capacity and ability to service our debt. The following table summarizes net leverage ratio as calculated by us for the years indicated below:
Year Ended December 31,
(amounts in millions)
2020
2019
Total Debt
$
775.9
$
901.2
Less: Cash
38.5
32.3
Net Debt
$
737.4
$
868.9
Adjusted EBITDA
$
211.0
$
201.1
Net Leverage Ratio
3.5
4.3
Our net leverage ratio decreased in 2020 primarily due to the $131.5 million decrease in net debt, principally due to cash generated from operating activities in excess of capital expenditures totaling $57.3 million and the net proceeds from the divestiture of KJCC totaling $74.7 million.
Other Matters
Foreign Operations and Foreign Currency Transactions
We are subject to foreign currency translation fluctuations due to our foreign operations. For the years ended December 31, 2020, 2019 and 2018, exchange rate fluctuations resulted in an increase to comprehensive income of $22.8 million, a decrease of $1.3 million and a decrease of $25.6 million, respectively. Foreign currency transaction gains and losses result from transactions denominated in a currency which is different from the currency used by the entity to prepare its financial statements. Foreign currency transaction gains were $2.5 million, $1.0 million and $0.6 million for the years ended December 31, 2020, 2019 and 2018, respectively.
Recently Issued Accounting Guidance
Information regarding recently issued accounting guidance is contained in Note 3 “New Accounting Pronouncements” of the Notes to Consolidated Financial Statements.
40
Koppers Holdings Inc. 2020 Annual Report
Critical Accounting Policies
The preparation of financial statements in conformity with generally accepted accounting principles in the United States requires management to use judgment in making estimates and assumptions that affect the reported amounts of revenues and expenses, assets and liabilities, and the disclosure of contingent liabilities. The following accounting policies are based on, among other things, judgments and assumptions made by management that include inherent risks and uncertainties. Our management’s estimates are based on the relevant information available at the end of each period.
Revenue Recognition. We recognize revenue upon the completion of performance obligations under contracts with our customers and when control of a good or service is transferred to the customer. Substantially all of our contracts with our customers are ship and invoice arrangements where revenue is recognized when we complete our performance obligations and transfer control to the customer . We also have certain arrangements where revenue is recognized under the contract where control of the goods or services had been transferred to the customer prior to shipment. Revenue recognition generally occurs at the point of shipment; however in certain circumstances as shipping terms dictate, we transfer control and revenue is recognized at the point of destination. Shipping and handling costs are included as a component of cost of sales.
We also recognize revenue related to the procurement of certain untreated railroad crossties upon delivery to our plant and acceptance by the customer. Service revenue, consisting primarily of wood treating services, is recognized at the time the service is provided and the performance obligation is satisfied.
Goodwill and Intangible Assets . Goodwill is not amortized but is assessed for impairment annually, using a quantitative goodwill impairment test, or more frequently if a change in circumstances or the occurrence of events indicate the carrying value may not be recoverable. In making this assessment, management may first consider qualitative factors to determine whether it is more likely than not that the fair value of a reporting unit is less than its carrying amount. Examples of qualitative factors include macroeconomic conditions, industry and market considerations, cost factors, overall financial performance, entity-specific events, events affecting reporting units, and sustained changes in our stock price. If results of the qualitative assessment indicate a more likely than not determination or if a qualitative assessment is not performed, a quantitative test is performed utilizing a combination of an income approach, using a discounted cash flow methodology, and a market approach, by comparing the estimated fair value of each reporting unit with its book value. The discounted cash flow calculations are dependent on several subjective factors including the timing of future forecasted cash flows, including forecasted future growth rates such as revenue and the discount rate. Because management’s judgment is involved in performing goodwill impairment analyses, there is risk that the carrying value of goodwill is overstated. If our assumptions or estimates in our fair value calculations change or if future cash flows or future growth rates vary from what was planned, this may impact our impairment analysis.
We have three reporting units for purposes of goodwill evaluation. These units consist of our PC operating segment, our Railroad Products and Services reporting unit and our Utility Products reporting unit. Railroad Products and Services and Utility Products are one level below our RUPS operating segment. The Railroad Products and Services reporting unit primarily serves the rail industry in North America and the Utility Products reporting unit serves the utility industries in the United States and Australia.
Goodwill remaining on our consolidated balance sheet at December 31, 2020 was $297.8 million. During the fourth quarter of 2020, we performed an impairment test for goodwill for each of our reporting units using the quantitative approach. Based on our evaluation performed, we determined that it was more likely than not that the fair value of each of the reporting units exceeded its respective carrying amount, and therefore, we determined that goodwill was not impaired at any of our reporting units as of December 31, 2020.
Identifiable intangible assets are valued at fair value upon the acquisition of a business. Identifiable intangible assets are amortized on a straight-line basis over their estimated useful lives. We have identifiable intangible assets of $149.8 million as of December 31, 2020. We annually evaluate the remaining useful life of the intangible asset being amortized to determine whether events or circumstances warrant a revision to the remaining period of amortization. If the estimate of an intangible asset’s remaining useful life is changed, the remaining carrying amount of the intangible asset will be amortized prospectively over that revised remaining useful life. Identifiable intangible assets are also subject to testing for recoverability whenever events or changes indicate that its carrying value may not be recoverable.
Changes in economic and operating conditions impacting these assumptions could result in goodwill and intangible asset impairments in future periods. Additionally, disruptions to our business such as prolonged recessionary periods or unexpected significant declines in operating results of the relevant reporting units could result in charges for goodwill and other asset impairments in future periods.
41
Deferred Tax Assets . At December 31, 2020, our balance sheet included $18.4 million of deferred tax assets, which is net of a $44.6 million valuation allowance. We also had $21.3 million of deferred tax liabilities resulting in net deferred tax liabilities of $2.9 million, which are predominantly related to our domestic entities. In assessing the realizability of deferred tax assets, management considers whether it is more likely than not that some portion or all of the deferred tax assets will be realized. In evaluating the need for a valuation allowance, management considers various factors, including the expected level of future taxable income, available tax planning strategies and reversals of existing taxable temporary differences.
The realization of a majority of our deferred tax assets is not subject to any expiration and is dependent upon the reversal of the underlying temporary differences. To the extent future taxable income projections are not achieved, we could be required to record a valuation allowance against certain deferred tax assets. Item 8. Financial Statements and Supplementary Data – Note 10 includes information on deferred tax activity during the past two years.
Asset Retirement Obligations . We measure asset retirement obligations based upon the applicable accounting guidance, using certain assumptions including estimates regarding the recovery of residues in storage tanks. In the event that operational or regulatory issues vary from our estimates, we could incur additional significant charges to income and increases in cash expenditures related to the disposal of those residues. Certain conditional asset retirement obligations related to facilities have not been recorded in the consolidated financial statements due to uncertainties surrounding the ultimate settlement date and estimate of fair value related to a legal obligation to perform an asset retirement activity. At the date a reasonable estimate of the ultimate settlement can be made, we will record an asset retirement obligation and such amounts may be material to the consolidated financial statements in the period in which they are recorded. In 2020, we recorded additional asset retirement obligations of $4.6 million principally related to storage tank and drip pad cleaning costs within our RUPS segment in the United States. Item 8. Financial Statements and Supplementary Data – Note 2 includes information on expense recognized during the past two years.
Pension and Postretirement Benefits . Accounting for pension and other postretirement benefit obligations involves numerous assumptions, the most significant of which relate to the following:
◾
the discount rate for measuring the present value of future plan obligations; and
◾
the expected long-term return on plan assets.
We develop our demographics and utilize the work of third-party actuaries to assist in the measurement of these obligations. We have selected different discount rates for our pension plans and our other post-retirement benefit plans due to the different projected benefit payment patterns. In determining the assumed discount rates at December 31, 2020, we use our third-party actuary’s discount rate model. This model calculates an equivalent single discount rate for the projected benefit plan cash flows using a hypothetical bond portfolio to match expected cash flows under our benefit plans. The bonds used are rated AA or higher by a recognized rating agency and only non-callable bonds are included with the exception of those with a “make-whole call” feature. The actuary limited the selection to those bonds with a minimum of 100,000 outstanding issues. Outlier bonds whose yields exceeded two standard deviations from the yield curve derived from similar quality bonds were excluded.
Of the assumptions used to measure the year-end obligations and estimated annual net periodic benefit cost, the discount rate has the most significant effect on the periodic benefit cost reported for the plans. Decreasing the discount rates by 0.25 percent for our pension plans and 0.25 percent for our other postretirement benefit plans would increase pension obligations and other postretirement benefit plan obligations by $7.6 million and would increase defined benefit pension expense and other postretirement benefit plan expense by $0.1 million.
The asset rate of return assumption considers the asset mix of the plans (currently targeted at approximately 30 to 40 percent equity securities and 60 to 70 percent fixed income securities for the funded pension plans), past performance and other factors, including expected re-allocations of asset mix occurring within a reasonable period of time. Our asset rate of return assumption is 3.67 percent for 2020 defined benefit pension expense. Decreasing the asset rate of return assumption by 0.25 percent would increase our defined benefit pension expense by $0.4 million.
Item 8. Financial Statements and Supplementary Data – Note 14 includes detailed information about the assumptions used to calculate the components of our annual defined benefit pension and other postretirement plan expense, as well as the obligations and accumulated other comprehensive loss reported on the year-end balance sheets.
42
Koppers Holdings Inc. 2020 Annual Report
Environmental Liabilities . We are subject to federal, state, local and foreign laws and regulations and potential liabilities relating to the protection of the environment and human health and safety, including, among other things, the cleanup of contaminated sites, the treatment, storage and disposal of wastes, the discharge of effluent into waterways, the emission of substances into the air and various health and safety matters. We expect to incur substantial costs for ongoing compliance with such laws and regulations. We may also incur costs as a result of governmental or third-party claims, or otherwise incur costs, relating to cleanup of, or for injuries resulting from, contamination at sites associated with past and present operations. We accrue for environmental liabilities when a determination can be made that they are probable and reasonably estimable. Item 8. Financial Statements and Supplementary Data – Note 19 includes information about environmental liabilities.