Item 7. Management’s Discussion and Analysis
ITEM 7. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
Overview
See description of the segments in “Item 1 – Business”.
Non-GAAP Financial Measures
We utilize certain financial measures that are not in accordance with U.S. generally accepted accounting principles (U.S. GAAP) to analyze and manage the performance of our business. We believe that adjusted EBITDA provides information useful to investors in understanding the underlying operational performance of the company, our business and performance trends, and facilitates comparisons between periods and with other corporations in similar industries. The exclusion of certain items permits evaluation and a comparison of results for 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.
Adjusted EBITDA is a non-GAAP financial measure defined as net income from continuing operations before interest, income taxes, depreciation and amortization along with other adjustments. These adjustments are items that we believe are not representative of underlying business performance. Adjusted items typically include certain expenses associated with impairment, restructuring and plant closure costs, significant gains and losses on asset disposals or business combinations, LIFO and mark-to-market commodity hedging and other unusual items. Adjusted EBITDA is the primary measure of profitability we use to evaluate our businesses. Refer to “Note 9 – Segment Information” for reconciliations from net income to adjusted EBITDA on a consolidated basis.
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, trends in spending patterns and other factors. During the COVID-19 pandemic, substantially all of our global businesses have continued to operate without significant disruption. In the United States, 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 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, 2021, including those related to COVID-19. Events and changes in circumstances arising after December 31, 2021, including those resulting from the impacts of COVID- 19, will be reflected in our estimates for future periods.
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Koppers Holdings Inc. 2021 Annual Report
Railroad and Utility Products and Services
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 estimated total crosstie installations in 2021 were approximately 18.8 million, of which 14.4 million were for Class I railroads. Throughout the pandemic, some sawmills were operating at 50 percent or less of their production capacity. Sawmills provide raw materials to several industries beyond the wood crosstie market and as demand and pricing for pallet and flooring lumber increased significantly throughout 2021, overall crosstie production output has been lower than forecasted. Crosstie prices increased significantly as a result of limited supply and railroad customers are deferring their purchases. Given continuing economic uncertainties, including those related to COVID-19, the RTA is forecasting a modest increase of 2.2 percent, or 19.2 million crossties, in 2022, primarily from the commercial market while Class I volumes are expected to remain at relatively similar demand levels.
According to the American Association of Railroads (“AAR”), rail traffic in 2021 was substantially higher than in 2020 for most categories. Coal carloads were considerably higher than the prior year due to sharply higher natural gas prices, while carloads of motor vehicles suffered as microchip shortages forced automakers to cut output. For intermodal, a record-setting first-half of 2021 gave way to a lower second half as supply chain challenges persisted. Even so, 2021 ranked as the second-best U.S. intermodal year, behind only 2018. In 2021, total U.S. carload traffic increased 6.6 percent from the prior year, while intermodal units strengthened by 4.9 percent. The combined U.S. traffic for carloads and intermodal units was higher by 5.7 percent than the prior year.
With respect to our utility products business, the installed base for wood distribution poles in the U.S. is approximately 150 million and nearly half are 40 years old. Industry 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 pole 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 portions of the population continue to work remotely due to the COVID-19 pandemic. As long as there are not any extended supply chain disruptions , we anticipate that 2022 demand for pole replacements will be relatively stable to slightly higher, as the overall industry is trending toward expanded and upgraded transmission networks. In addition, there is a developing trend in the industry for utilities to maintain some additional inventory to prepare for potential damaging storms.
With respect to raw materials, we expect the availability of pole supply to be affected as lumber for other uses continue to be in high demand and, consequently, lead to increased costs for pole material. Also, transportation costs, which include fuel costs, are expected to experience some upward pressure and affect the price of pole material delivered to the pole peelers from the forest.
Longer term, we are evaluating opportunities to potentially expand our market presence in the United States as well as certain overseas markets. We believe there remains an overall need for sustained investment in infrastructure and capacity expansion and with our vertical integration capabilities in wood treatment and strong customer relationships, we will ultimately benefit from increased demand.
For the overall segment, a positive development involves t he Infrastructure Investment and Jobs Act, which was signed into law on November 15, 2021, and will usher in more than a trillion dollars in new spending across eight years to improve the nation's roads, bridges, rail, Internet, water systems and more. As a global leader in water- and oil-borne preservatives serving many end markets with our wood-treatment technologies, we are well-positioned to benefit from the new legislation. Our products are used in multiple infrastructure applications, including utility poles, railroad ties, highway and construction concrete, steel, aluminum, and wood for construction projects.
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 our 14 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 January 2022, we began curtailing operations at our Sweetwater, Tennessee plant. During 2021, we exited the Texas Electric Cooperatives’ Jasper, Texas facility and relocated the production of utility products to our Somerville, Texas plant. Separately, in the third quarter of 2020, we permanently closed our Denver, Colorado wood treatment facility. 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 would be primarily funded through proceeds from the sale of non-core assets, including the Denver facility. In October 2021, we sold our closed Denver, Colorado crosstie treating facility and we recorded a gain on sale of $23.4 million. In addition, as part of the sales agreement, we may receive additional contingent post-closing payments secured by a guaranty from the buyer after applicable redevelopment milestones are reached. At this time, we are unable to estimate how much, if any, of these additional funds will ultimately be paid to us.
31
Performance Chemicals
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 from time to time, we enter into forward transactions based upon long-term forecasted needs of copper. Copper prices reached peak levels in mid-2021, boosted by pent-up demand as growth accelerated when pandemic lockdowns were eased and the market faced tight supplies. In 2022, projections for copper prices are mixed and are contingent on supply and demand dynamics as well as the impact of higher interest rates on economic growth.
Product demand for our PC business has historically been closely associated with consumer spending on home repair and remodeling projects in North America, and therefore, trends in existing home sales serve as a leading indicator. Overall, the market for existing homes is showing strong demand. According to the National Association of Realtors® (“NAR”), total existing-home sales increased 8.5 percent in 2021 compared with the prior year, which is the highest annual level since 2006 . The NAR reported, however, total existing home sales in December decreased 4.6 percent from November, and were down 7.1 percent from a year ago. While December sales were softer, the slowdown was more a sign of supply constraints than an indication of a weakened demand for housing.
According to the Leading Indicator of Remodeling Activity (“LIRA”) reported by the Joint Center for Housing Studies of Harvard University, there was 9.4 percent year-over-year growth in home renovation and repair expenditures in the fourth quarter of 2021. The LIRA projects annual growth in renovation and repair spending of 17.3 percent by the third quarter of 2022 . While annual improvement and repair spending is projected to reach $430 billion by the second half of 2022, several headwinds, such as rising costs of labor and construction materials, difficulty retaining contractors, and rising interest rates, may temper growth expectations.
The Conference Board Consumer Confidence Index® increased to 115.2 in December, then declined slightly to 113.8 in January 2022. Consumer confidence moderated somewhat in January, following gains in the final three months of 2021, suggesting the economy finished the year on solid footing; however, the expectations related to near-term growth prospects reflect some moderation during the first quarter of 2022.
Although the market data and projections for home improvements are continually changing, w e anticipate ongoing demand for residential treated wood and in looking at residential renovation markets, businesses are indicating a continued positive outlook. While a global pandemic, an inflationary environment and supply chain delays constitute potential risks, consumers are indicating their continued plans to purchase homes, automobiles, and major appliances over the next six months.
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 realigned 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.
The availability of coal tar, the primary raw material for our CMC business, is linked to levels of metallurgical coke production. As the global steel industry, excluding Asia, has reduced the production of steel using metallurgical coke, the volumes of coal tar have been reduced. Also, coal tar raw material supply remains constrained globally due to reductions in blast furnace steel capacity.
For the external markets served by our CMC business, we anticipate a relative stability in manufacturing overall as well as in the steel, aluminum and carbon black industries. According to IHS Markit Automotive Group (IHS), global light vehicle production in 2021 is projected to be at 75.5 million units, a 1.2 percent improvement from the prior year period. The industry demand levels will likely continue to be constrained as the semiconductor supply chain remains challenged. For 2022, IHS forecasts a rebound in light vehicle production of 9.0 percent, to 82.3 million units.
32
Koppers Holdings Inc. 2021 Annual Report
Results of Operations – Comparison of Years Ended December 31, 2021 and December 31, 2020
Consolidated Results
Net sales for the years ended December 31, 2021 and 2020 are summarized by segment in the following table:
Year Ended December 31,
2021
2020
Net Change
(Dollars in millions)
Railroad and Utility Products and Services
$
729.9
$
759.1
-4
%
Performance Chemicals
503.3
526.3
-4
%
Carbon Materials and Chemicals
445.4
383.7
16
%
$
1,678.6
$
1,669.1
1
%
RUPS net sales for the year ended December 31, 2021 decreased by $29.2 million, or four percent, compared to the prior year. The sales decrease was primarily related to volume decreases in our utility pole business as of result of transitioning production from the Texas Electric Cooperatives’ Jasper, Texas plant to our Somerville, Texas plant along with volume decreases in the commercial crosstie market and volume decreases of untreated crossties for our Class I customers. Increased demand for lumber driven by strong construction markets resulted in decreased purchasing activity of untreated crossties by our customers during the current period. These decreases were offset, in part, by pricing increases in various markets within the segment and volume increases in our maintenance-of-way and crosstie disposal businesses. Foreign currency changes compared to the prior year period had a favorable impact on sales in the current year period of $3.5 million, mainly from our Australian utility pole business.
PC net sales for the year ended December 31, 2021 decreased by $23.0 million, or four percent, compared to the prior year. The sales decrease was primarily due to volume decreases for preservatives in North America as high lumber prices and a return to normal consumer spending habits have tempered customer demand compared to extremely high levels of pandemic-fueled demand in 2020. The decreases were offset, in part, by higher demand for preservatives in our international markets resulting from continued pent-up demand after the lifting of earlier restrictions associated with the pandemic. PC also benefited from pricing increases in the current year period for our copper-based preservatives. Foreign currency changes compared to the prior year period from our international markets had a favorable impact on sales in the current year period of $7.2 million.
CMC net sales for the year ended December 31, 2021 increased by $61.7 million, or 16 percent, compared to the prior year due mainly to higher sales prices for carbon pitch, distillates and chemicals in the current year. Foreign currency translation also had a favorable impact on sales in the current year of $11.3 million, mainly from our Australian and European markets. These increases were offset, in part, by lower sales volumes of carbon pitch and phthalic anhydride in the current year.
Cost of sales as a percentage of net sales was 80 percent for the year ended December 31, 2021, compared to 78 percent in the prior year . Gross margin was unfavorably impacted in the current year period primarily by an increase in raw material costs along with total LIFO expense of $28.2 million compared to the prior year period which was favorably impacted by a LIFO benefit of $13.7 million.
Depreciation and amortization charges for the year ended December 31, 2021 were $3.6 million higher when compared to the prior year period due mainly to an increase in asset retirement obligations at our European CMC operations as well as an increase in capitalized assets in our North American RUPS operations.
Gain on sale of assets for the year ended December 31, 2021 of $31.2 million and is primarily related to the sale of our former RUPS crosstie treating plant located in Denver, Colorado as well as two previously decommissioned CMC plants as described in Note 4 – “Plant Closures and Divestitures”.
Impairment and restructuring charges for the year ended December 31, 2021 were $4.3 million lower when compared to the prior year period . We recorded charges for asset retirement obligations, fixed asset write-offs and severance in the prior year period related to the announced closure of our Denver, Colorado facility. The current year period included residual demolition and other plant closure period costs related to the closure .
Selling, general and administrative expenses for the year ended December 31, 2021 were $5.8 million higher when compared to the prior year period due mainly to an increase of $2.6 million in employee benefit related expenses, $1.9 million for consulting and professional services and $0.7 million in travel and facility related charges.
33
Interest expense for the year ended December 31, 2021 was $8.4 million lower when compared to the prior year primarily as a result of our lower average debt level and lower interest rates due to the significant decrease in underlying 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 tax expense as a percentage of income before income taxes for the years ended December 31, 2021 and 2020 was 29.9 percent and 19.1 percent, respectively. In 2020, we recorded a benefit of $13.3 million due to legislative changes to the interest expense limitation that were a result of the Coronavirus Aid, Relief, and Economic Security Act (the “CARES Act”).
Discontinued operations for the year ended December 31, 2021 resulted in income of $0.1 million compared to a loss of $3.9 million in the prior year period. In the prior year period, the loss was driven by a reduction in net sales and lower end market demand attributable to the economic effects of COVID-19 on our KJCC operations, which was sold in the third quarter of 2020.
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 5 – “Discontinued Operations” for further detail.
Segment Results
Segment adjusted EBITDA and adjusted EBITDA margin for the years ended December 31, 2021 and 2020 are summarized in the following table:
Year Ended December 31,
(amounts in millions)
2021
2020
% Change
Adjusted EBITDA:
Railroad and Utility Products and Services
$
45.4
$
65.3
-30
%
Performance Chemicals
101.8
100.7
1
%
Carbon Materials and Chemicals
76.3
45.0
70
%
Total Adjusted EBITDA
$
223.5
$
211.0
6
%
Adjusted EBITDA margin as a percentage of GAAP sales:
Railroad and Utility Products and Services
6.2
%
8.6
%
-2.4
%
Performance Chemicals
20.2
%
19.1
%
1.1
%
Carbon Materials and Chemicals
17.1
%
11.7
%
5.4
%
Total Adjusted EBITDA margin
13.3
%
12.6
%
0.7
%
RUPS adjusted EBITDA decreased by $19.9 million compared to the prior year period. Adjusted EBITDA as a percentage of net sales decreased to 6.2 percent from 8.6 percent in the prior year period and was unfavorably impacted in our domestic utility pole business by the c osts, loss of throughput and inefficiencies associated with pole treatment preservative conversions at our Vidalia, Georgia and Vance, Alabama plants, a shortage of pole treatment preservative in the fourth quarter of the current year period and higher fuel costs and labor inefficiencies driven by the pandemic. In addition, unfavorability in our railroad crosstie business was driven by lower absorption of fixed costs due to approximately two million less crossties procured than the prior year period as a result of decreased purchasing activity of untreated crossties by our Class I customers driven by the impact higher lumber prices had on the hardwood market. Finally, pandemic-driven costs and inefficiencies in our maintenance-of-way businesses contributed to a reduction in adjusted EBITDA over the prior year period.
PC adjusted EBITDA increased by $1.1 million compared to the prior year. Adjusted EBITDA as a percentage of net sales increased to 20.2 percent from 19.1 percent in the prior year. The current year was favorably impacted by lower realized raw material costs associated with the company’s copper hedging program along with higher demand for preservatives in our international markets. PC benefited from pricing increases in the current year period for our copper-based preservatives in addition to the contribution from our copper-hedging program which mitigated increases in our raw material costs. These favorable drivers were offset, in part, by volume decreases for preservatives in North America.
CMC adjusted EBITDA increased by $31.3 million compared to the prior year. Adjusted EBITDA as a percentage of net sales increased to 17.1 percent from 11.7 percent in the prior year. The current year was favorably impacted by higher sales prices for carbon pitch, distillates and chemicals , a recovery of insurance proceeds. These increases were offset, in part, by an increase in raw material costs and lower sales volumes of carbon pitch and phthalic anhydride in the current year.
34
Koppers Holdings Inc. 2021 Annual Report
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 2020. Sales of crossties increased by $16.8 million in 2020. These increases were offset, in part, by volume decreases in the commercial crosstie market and our maintenance-of-way businesses in 2020.
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 2020 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 2020. Other contributing factors included lower sales volumes of carbon pitch and naphthalene as a result of the economic conditions. These decreases were offset, in part, by volume increases of carbon black feedstock.
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 2020 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. Charges in 2020 consisted of 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 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.
35
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 benefits that significantly influenced income taxes.
For the year ended December 31, 2020, our income tax provision benefited by a total of $13.3 million due to legislative changes to the interest expense limitation that were 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 was 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.
Segment Results
Segment adjusted EBITDA and adjusted EBITDA margin for the years ended December 31, 2020 and 2019 are summarized in the following table:
Year Ended December 31,
(amounts in millions)
2020
2019
% Change
Adjusted EBITDA:
Railroad and Utility Products and Services
$
65.3
$
60.2
8
%
Performance Chemicals
100.7
68.6
47
%
Carbon Materials and Chemicals
45.0
73.5
-39
%
Corporate unallocated
0.0
(1.2
)
-100
%
Total Adjusted EBITDA
$
211.0
$
201.1
5
%
Adjusted EBITDA margin as a percentage of GAAP sales:
Railroad and Utility Products and Services
8.6
%
8.2
%
0.4
%
Performance Chemicals
19.1
%
15.3
%
3.8
%
Carbon Materials and Chemicals
11.7
%
16.1
%
-4.4
%
Total Adjusted EBITDA margin
12.6
%
12.3
%
0.4
%
RUPS adjusted EBITDA increased by $5.1 million compared to the prior year period. Adjusted EBITDA as a percentage of net sales increased to 8.6 percent from 8.2 percent in the prior year period. Adjusted EBITDA 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 and lower selling, general and administrative costs in 2020.
PC adjusted EBITDA increased by $32.1 million compared to the prior year period. Adjusted EBITDA as a percentage of net sales increased to 19.1 percent in 2020 compared to 15.3 percent in the prior year period. Adjusted EBITDA as a percentage of net sales for the year ended December 31, 2020 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 adjusted EBITDA for the year ended December 31, 2020 decreased by $28.5 million, or 39 percent, compared to 2019. Adjusted EBITDA as a percentage of net sales for 2020 decreased to 11.7 percent from 16.1 percent in 2019. Adjusted EBITDA for the year ended December 31, 2020 was negatively affected primarily by lower sales prices for carbon black feedstock, phthalic anhydride and naphthalene as a result of depressed oil prices in 2020. Other contributing factors included lower sales prices and volumes of carbon pitch as a result of economic conditions. These decreases were offset, in part, by volume increases of carbon black feedstock.
36
Koppers Holdings Inc. 2021 Annual Report
Adjusted EBITDA is reconciled to net income, the most directly comparable financial measure determined and reported in accordance with U.S. GAAP.
Year Ended December 31,
(amounts in millions)
2021
2020
2019
Net income
$
84.9
$
121.0
$
67.4
Interest expense
40.5
48.9
61.7
Depreciation and amortization
57.7
54.1
51.4
Depreciation in impairment and restructuring charges
0.7
2.0
3.4
Income taxes
34.5
21.0
0.0
Discontinued operations
0.2
(31.9
)
(3.7
)
Sub-total
218.5
215.1
180.2
Adjustments to arrive at adjusted EBITDA:
Impairment, restructuring and plant closure costs (1)
4.2
15.7
20.4
(Gain) on sale of assets
(31.2
)
0.0
0.0
LIFO expense (benefit)
28.2
(13.7
)
4.5
Mark-to-market commodity hedging losses (gains)
3.8
(9.2
)
(4.0
)
Pension settlement
0.0
0.1
0.0
Discretionary incentive (2)
0.0
3.0
0.0
Total adjustments
5.0
(4.1
)
20.9
Adjusted EBITDA
$
223.5
$
211.0
$
201.1
(1)
Includes costs associated with restructuring, sales and closures of certain RUPS and CMC facilities as described in Note 4 – “Plant Closures and Divestitures”.
(2)
Represents a one-time employee incentive associated with the sale of KJCC as described in Note 5 – “Discontinued Operations”.
Cash Flow
Net cash provided by operating activities was $103.0 million for the year ended December 31, 2021 as compared to net cash provided by operating activities of $127.1 million for the year ended December 31, 2020. The net decrease of $24.1 million was due primarily to higher working capital usage of $28.2 million primarily as a result of higher inventory values from increased raw material prices and inventory levels as well as increased receivables due to higher fourth quarter 2021 sales as compared to the prior year. Operating profit, excluding gain on sale of assets and changes in derivative contracts, was slightly down year-over-year but was offset by a change in other liabilities as a result of lower asset retirement costs.
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 was due primarily to an increase in operating profit partly offset by higher working capital usage of $30.6 million compared to the prior year as a result of timing of payments between periods and an increase in asset retirement costs.
Net cash used in investing activities was $89.5 million for the year ended December 31, 2021 as compared to net cash provided by investing activities of $5.6 million for the year ended December 31, 2020. The net change in cash used in investing activities of $95.1 million is primarily due to an increase in capital expenditures of $55.2 million in the current year period for increased investment in growth projects, primarily the expansion of the RUPS facility in North Little Rock, Arkansas, and net cash of $74.7 million provided by the sale of KJCC in the prior year, partially offset by cash received related to sales of the Denver, Colorado plant and two previously decommissioned CMC plants as well as insurance proceeds in the current year.
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 change 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 across our businesses.
37
Net cash used in financing activities was $4.0 million for the year ended December 31, 2021 as compared to net cash used in financing activities of $128.7 million for the year ended December 31, 2020. The cash used in financing activities in the year ended December 31, 2021 reflected repurchases of common stock of $11.5 million partially offset by net borrowings of debt of $5.1 million. The cash used in financing activities in the prior year period primarily reflected net repayments of debt of $128.0 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 both periods primarily related to repayment of debt.
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, 2021, the basket totaled $271.0 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
The following table summarizes our estimated liquidity as of December 31, 2021 (dollars in millions) :
Cash and cash equivalents (1)
$
43.2
Amount available under credit facility
305.2
Total estimated liquidity
$
348.4
(1)
Cash includes approximately $43.1 million held by foreign subsidiaries and excludes approximately $2.3 million of restricted cash.
Our liquidity was $344.0 million at December 31, 2020.
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 capital expenditures, working capital, and potential return of capital to shareholders. We may also use cash to pursue other potential strategic acquisitions or voluntary pension plan contributions. Capital expenditures in 2022, excluding acquisitions, if any, are expected to total approximately $95 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.
From time to time, we manage our working capital to increase our flexibility to pay down debt. Debt will fluctuate throughout any operating period based upon the timing of receipts from customers and payments to vendors. As of December 31, 2021 and December 31, 2020, approximately 75 percent and 70 percent of accounts payable was current, approximately 20 percent was 1-30 days past due and approximately five percent and ten percent was past due greater than 30 days, respectively.
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Koppers Holdings Inc. 2021 Annual Report
Schedule of Certain Contractual Obligations
The following table details our projected payments for our significant contractual obligations as of December 31, 2021. The table is based upon available information and certain assumptions we believe to be reasonable.
Payments Due by Period
2022
2023-2024
2025-2026
Later years
Total
(in millions)
Long-term debt (1)
$
2.0
$
287.1
$
500.0
$
0.0
$
789.1
Interest on debt
37.2
70.2
15.0
0.0
122.4
Operating leases
28.0
39.5
24.8
25.0
117.3
Federal tax payments (2)
0.8
2.3
0.0
0.0
3.1
Purchase commitments (3)
245.8
308.4
172.2
26.0
752.4
Total contractual cash obligations (4)
$
313.8
$
707.5
$
712.0
$
51.0
$
1,784.3
(1)
Consists primarily of the maturity of the 2025 Notes and the Credit Facility that will mature in 2025.
(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.
(4)
Not included in contractual obligations are commercial commitments associated with standby letters of credit totaling $7.8 million, which expire in 2022.
Pension and other employee benefit plan funding obligations (for defined benefit plans) are not included in the contractual obligation table. We expect defined benefit plan contributions to total approximately $2.0 million in 2022. 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, 2021, there was $2.3 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.
Debt Covenants at December 31, 2021
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, 2021 was 1.50.
◾
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 total secured leverage ratio at December 31, 2021 was 1.23.
◾
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 4.75. The total leverage ratio at December 31, 2021 was 3.34.
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.
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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. Net debt will fluctuate before, after and throughout the related period based upon the timing of receipts from customers and payments to vendors. Refer to “Segment Results” of “Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations” for reconciliation to net income from adjusted EBITDA. The following table summarizes net leverage ratio as calculated by us for the years indicated below:
Year Ended December 31,
(amounts in millions)
2021
2020
Total debt
$
783.5
$
775.9
Less: Cash
45.5
38.5
Net debt
$
738.0
$
737.4
Adjusted EBITDA
$
223.5
$
211.0
Net leverage ratio
3.3
3.5
Our long-term net leverage ratio target continues to be 2.0 to 3.0 times.
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, 2021, 2020 and 2019, exchange rate fluctuations resulted in a decrease to comprehensive income of $16.4 million, an increase of $22.8 million and a decrease of $1.3 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 (losses) gains were $(0.7) million, $2.5 million and $1.0 million for the years ended December 31, 2021, 2020 and 2019, 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.
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. With the exception of the revenue recognition policy, each of the following policies contain critical accounting estimates.
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. To determine the transaction price at the time when revenue is recognized, we evaluate whether the price is subject to adjustments, such as for warranties, discounts or volume rebates, to determine the net consideration to which we expect to be entitled. Shipping and handling costs are included as a component of cost of sales.
For certain contracts, 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.
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Koppers Holdings Inc. 2021 Annual Report
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. We perform an assessment of goodwill at the reporting unit level, utilizing a combination of an income approach, using a discounted cash flow methodology, and a market approach, by comparing the estimated fair value calculations of each reporting unit with its net book value. The discounted cash flow calculations are dependent on several subjective factors including the timing of future forecasted cash flows including future forecasted revenue growth rates, and the discount rate.
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, 2021 was $296.0 million. During the fourth quarter of 2021, we performed an impairment test for goodwill for each of our reporting units using the quantitative approach. Based on our evaluation performed, we determined 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, 2021. We define " headroom " as the percentage difference between the fair value of a reporting unit and its carrying value. For the 2021 impairment test, the headroom for the reporting units ranged between ten percent to 65 percent. Our Railroad Products and Services reporting unit and our Utility Products reporting unit have headroom at the low-end of that range and could experience impairment in the future if we do not achieve our profitability projections, there is a change in key assumptions underlying the valuation or if we experience a substantial decrease in our stock price.
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 $131.5 million as of December 31, 2021. 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.
Deferred Tax Assets . As of December 31, 2021, our balance sheet included $44.2 million of deferred tax assets, which is net of a $44.5 million valuation allowance. We also had $62.6 million of deferred tax liabilities resulting in net deferred tax liabilities of $18.4 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. Item 8. Financial Statements and Supplementary Data – Note 2 includes information on expense recognized during the past two years.
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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, 2021, we used 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 $5.0 million and would increase defined benefit pension expense and other postretirement benefit plan expense by $0.3 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 3.91 percent for 2021 defined benefit pension expense. Decreasing the asset rate of return assumption by 0.25 percent would increase our defined benefit pension expense by $0.5 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.
Environmental Liabilities . As discussed under Environmental Matters in “Item 1 – Business”, 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. 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. The amount accrued is determined through the evaluation of various information, which could include claims, settlement offers, demands by government agencies, estimates performed by independent third parties, identification of other responsible parties and an assessment of their ability to contribute, and our prior experience. Inherent uncertainties exist in such evaluations primarily due to unknown conditions and other circumstances, changing governmental regulations and legal standards regarding liability, and evolving technologies. Item 8. Financial Statements and Supplementary Data – Note 19 includes information about environmental liabilities.
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Koppers Holdings Inc. 2021 Annual Report