# Koppers Holdings Inc. (KOP) FY 2022 MD&A

Verbatim Item 7 Management's Discussion and Analysis from Koppers Holdings Inc.'s 10-K for fiscal year 2022.

SEC filing source: https://www.sec.gov/Archives/edgar/data/1315257/000095017023004546/kop-20221231.htm
Accession: 0000950170-23-004546
Filing date: 2023-02-27
Report date: 2022-12-31
Extracted structurally from real Item 7 body heading to real Item 7A/8 boundary.
Confidence: high

Company profile: /company/KOP/
All MD&A years: /company/KOP/mda/
Previous year: /company/KOP/mda/fy2021/ (FY 2021)
Next year: /company/KOP/mda/fy2023/ (FY 2023)

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.

Railroad and Utility Products and Services

Historically, North American demand for crossties had been in the range of 18 million to 22 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 2022 were approximately 18.6 million, of which 14.3 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 during the beginning of 2021, overall crosstie production output was lower than forecasted. Crosstie prices increased significantly as a result of limited supply and railroad customers were deferring their purchases. Given continuing economic uncertainties, the RTA is forecasting a modest increase of 1.1 percent, or 18.8 million crossties, in 2023, primarily from the commercial market while Class I volumes are expected to remain at relatively similar demand levels.

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Koppers Holdings Inc. 2022 Annual Report

According to the Association of American Railroads (“AAR”), rail traffic in 2022 was lower than in 2021 for most categories. Compared to prior year, total U.S. carload traffic for 2022 was down 0.3 percent, and intermodal units were down 4.9 percent. For 2022, total combined U.S. traffic decreased by 2.8 percent compared to last year. According to the AAR, rail markets are ever evolving. There was solid growth in coal carloads in 2022, largely because higher natural gas prices made coal-fired electricity generation more competitive. However, higher natural gas prices, along with other market disruptors, negatively impacted rail chemical volumes since natural gas is a key raw material for chemical manufacturing. Also, grain carloads were slightly higher in 2022 than the annual average over the past decade, but decreased year-over-year from 2021, which was the best year for grain carloads since 2008. Meanwhile, intermodal volumes in 2022 were relatively strong, but down from an even stronger 2021.

With respect to our utility products business, the installed base for wood distribution poles in the United States is approximately 150 million and nearly half are 40 years old. Industry demand has historically been in the range of approximately two to four 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 work remotely. As long as there are not any extended supply chain disruptions, we anticipate that 2023 demand for pole replacements will be 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 potentially damaging storms.

With respect to raw materials, we expect the availability of pole supply to be affected as lumber continues to be in high demand for other uses and, consequently, leads 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 the 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. Actions we have taken over the past three years include the sale of our Sweetwater, Tennessee plant, exiting the Texas Electric Cooperatives’ Jasper, Texas facility and relocating the production of utility products to our existing Somerville, Texas plant and the permanent closure of 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.

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.

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Koppers Holdings Inc. 2022 Annual Report

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. According to the National Association of Realtors® (“NAR”), total existing-home sales in December were 1.5 percent lower than November, representing the eleventh consecutive month of decline. Three of the four major U.S. regions recorded month-over-month decreases, while sales in the West were unchanged. On a year-over-year basis, December existing home sales were lower by 34 percent, with all regions reporting declines. While December was another difficult month for home buyers due to limited inventory and high mortgage rates, the NAR expects that sales will begin to show improvements as recent declines in rates should help to stabilize the market. This sentiment is supported by December’s pending home sales data, a forward-looking indicator of home sales based on contract signings, which increased month-over-month for the first time since May 2022, following six consecutive months of declines.

According to the Leading Indicator of Remodeling Activity (“LIRA”) reported by the Joint Center for Housing Studies of Harvard University, there was 16.3 percent year-over-year growth in home renovation and repair expenditures in the fourth quarter of 2022. According to LIRA, expenditures for home improvements and repairs are forecasted to decelerate throughout 2023, going from 14.1 percent in the first quarter to 2.6 percent by the end of the year. Generally, homeowners are likely to pull back on high-end discretionary projects and instead focus their spending on necessary replacements and smaller projects in the immediate future. Although the pace of expenditures is expected to slow substantially this year, new benchmark data from the American Housing Survey has recalibrated the overall market size. As a result, the remodeling market is expected to increase in 2023 by approximately $45 billion, or 10.2 percent, to $485 billion.

The Conference Board Consumer Confidence Index® increased to 108.3 in December, significantly higher than 101.4 in November. Consumer confidence rebounded in December, reversing consecutive declines in October and November to reach its highest level since April 2022. Consumers are indicating a more favorable view regarding the economy and jobs, and inflation expectations in December were at their lowest level since September 2021, primarily due to recent declines in gas prices.

Although the market data and projections for home improvements are continually changing, we anticipate ongoing demand for residential treated wood and businesses in the residential renovation market indicate a positive outlook.

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 relative stability in manufacturing overall as well as in the steel, aluminum and carbon black industries. According to IHS Markit Automotive Group (IHS), U.S. light vehicle production levels are forecasted to increase even as economic conditions are expected to deteriorate. The advancing production levels, along with reports of sustained retail order books, recovering stock of vehicles, and a fleet sector that remains low on product should provide some benefits to automotive demand levels. For 2023, IHS projects U.S. production volumes of 14.8 million units, a seven percent increase from the estimated 2022 production level.

Globally, the auto industry continues to navigate supply chain challenges while impacted by several markets facing deteriorating economic conditions and fading pent-up demand. As the ongoing issue of semiconductor availability continues to be addressed, the global light vehicle market is expected to cautiously recover and vehicle sales are anticipated to reach nearly 83.6 million units in 2023, a 5.6 percent increase year-over-year.

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Koppers Holdings Inc. 2022 Annual Report

Results of Operations – Comparison of Years Ended December 31, 2022 and December 31, 2021

Consolidated Results

Net sales for the years ended December 31, 2022 and 2021 are summarized by segment in the following table:

[[GREPCENT_TABLE]]
[["","","Year Ended December 31,"],["","","2022","","","2021","","","Net Change"],["(Dollars in millions)"],["Railroad and Utility Products and Services","","$","788.3","","","$","729.9","","","","8","%"],["Performance Chemicals","","","579.9","","","","503.3","","","","15","%"],["Carbon Materials and Chemicals","","","612.3","","","","445.4","","","","37","%"],["","","$","1,980.5","","","$","1,678.6","","","","18","%"]]
[[/GREPCENT_TABLE]]

RUPS net sales for the year ended December 31, 2022 increased by $58.4 million, or eight percent, compared to the prior year. The increase was primarily a result of pricing increases across multiple markets, particularly crossties and utility poles, volume increases in our commercial crosstie business and activity increases in our railroad bridge services business. These increases were offset by volume decreases in our utility pole business due to transitioning production from the Texas Electric Cooperatives’ Jasper, Texas plant to our Somerville, Texas plant. In addition, a decrease in purchasing activity of untreated crossties by our customers during the first half of the year was a result of decreased supply due to increased demand for lumber driven by strong construction markets. Foreign currency changes compared to the prior year period had an unfavorable impact on sales in the current year period of $3.3 million, mainly from our Australian utility pole business.

PC net sales for the year ended December 31, 2022 increased by $76.6 million, or 15 percent, compared to the prior year. The sales increase was primarily due to global price increases in the current year for most preservatives in our portfolio of products and an 11.3 percent volume increase in the Americas. In the prior year period, volumes in the Americas decreased as high lumber prices and a temporary change in consumer spending habits tempered customer demand for treated wood products. The increases were offset, in part, by volume decreases for preservatives within our European markets. Foreign currency changes compared to the prior year period had an unfavorable impact on sales in the current year period of $10.1 million.

CMC net sales for the year ended December 31, 2022 increased by $166.9 million, or 37 percent, compared to the prior year due mainly to higher sales prices for carbon pitch, chemicals and distillates driven by strong demand for our products coupled with limited supply in the current year. Foreign currency changes from our international markets had an unfavorable impact on sales in the current year of $38.2 million and, while demand was strong, sales volumes, primarily in pitch and distillates, had an unfavorable impact in the current year of $18.2 million compared to the prior year.

Cost of sales as a percentage of net sales was 83 percent for the year ended December 31, 2022, compared to 80 percent in the prior year. Gross margin was unfavorably impacted in the current year period primarily by an increase in raw material costs, fuel costs, shipping costs and other operating expenses across our businesses as a result of inflationary pressures in the current year period that outpaced price increases to our customers especially earlier in the year.

Depreciation and amortization charges for the year ended December 31, 2022 were consistent with the prior year period.

Gain on sale of assets for the year ended December 31, 2022 was related to the sale of our utility pole treating facility in Sweetwater, Tennessee while the gain on sale of assets for the prior year period was related to the sales of two previously decommissioned plants as described in Note 4 – “Plant Closures and Divestitures”.

Impairment and restructuring charges for the year ended December 31, 2021 included demolition and other plant closure period costs related to the closure of our Denver, Colorado facility.

Selling, general and administrative expenses for the year ended December 31, 2022 were $4.4 million higher when compared to the prior year period due mainly to an increase of $5.8 million in travel, entertainment and advertising expenses and $1.9 million for consulting and other professional services, partially offset by favorable insurance claims and compensation related costs during the current year. Selling, general and administrative expenses as a percentage of sales decreased to 7.7 percent from 8.9 percent in the prior year.

Interest expense for the year ended December 31, 2022 was $4.3 million higher when compared to the prior year period due to higher interest rates.

Income tax expense as a percentage of income before income taxes for the years ended December 31, 2022 and 2021 was 33.1 percent and 28.8 percent, respectively. This increase in the estimated annual effective income tax rate is attributable to a shift in the geographical mix of earnings from domestic to foreign sources in 2022.

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Koppers Holdings Inc. 2022 Annual Report

Segment Results

Segment adjusted EBITDA and adjusted EBITDA margin for the years ended December 31, 2022 and 2021 are summarized in the following table:

[[GREPCENT_TABLE]]
[["","","Year Ended December 31,"],["(amounts in millions)","","2022","","","2021","","","% Change"],["Adjusted EBITDA:"],["Railroad and Utility Products and Services","","$","53.6","","","$","45.4","","","","18","%"],["Performance Chemicals","","","75.5","","","","101.8","","","","-26","%"],["Carbon Materials and Chemicals","","","99.0","","","","76.3","","","","30","%"],["Total Adjusted EBITDA","","$","228.1","","","$","223.5","","","","2","%"],["Adjusted EBITDA margin as a percentage of GAAP sales:"],["Railroad and Utility Products and Services","","","6.8","%","","","6.2","%","","","0.6","%"],["Performance Chemicals","","","13.0","%","","","20.2","%","","","-7.2","%"],["Carbon Materials and Chemicals","","","16.2","%","","","17.1","%","","","-1.0","%"],["Total Adjusted EBITDA margin","","","11.5","%","","","13.3","%","","","-1.8","%"]]
[[/GREPCENT_TABLE]]

RUPS adjusted EBITDA increased by $8.2 million compared to the prior year period. Adjusted EBITDA as a percentage of net sales increased to 6.8 percent from 6.2 percent in the prior year period due to price increases and favorable absorption in our utility pole business and improvements in our maintenance of way businesses, partially offset by higher raw material and operating costs across the segment as a result of rising inflation in the current year period.

PC adjusted EBITDA decreased by $26.3 million compared to the prior year. Adjusted EBITDA as a percentage of net sales decreased to 13.0 percent from 20.2 percent in the prior year period. Higher overall raw material costs, which were exacerbated by working through higher cost inventory in a falling copper price environment, more than offset global price increases and higher volumes in the Americas.

CMC adjusted EBITDA increased by $22.7 million compared to the prior year. Adjusted EBITDA as a percentage of net sales decreased to 16.2 percent from 17.1 percent in the prior year period due to an increase in raw material and other operating costs partly offset by a favorable pricing environment compared to the prior year period. Foreign currency changes from our international markets had an unfavorable impact on profitability in the current year period of $10.0 million. In addition, the prior year period margin was favorably impacted by a $2.9 million insurance recovery.

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:

[[GREPCENT_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","%"]]
[[/GREPCENT_TABLE]]

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 2021. 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 2021 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 2021 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 2021 of $7.2 million.

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Koppers Holdings Inc. 2022 Annual Report

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 2021. Foreign currency translation also had a favorable impact on sales in 2021 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.

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 2021 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 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. Residual demolition and other plant closure period costs related to the closure were included in 2021.

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.

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 28.8 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.

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 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:

[[GREPCENT_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","%"]]
[[/GREPCENT_TABLE]]

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Koppers Holdings Inc. 2022 Annual Report

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 costs, 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 2021 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 year ended 2021 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 2021 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 year ended 2021 was favorably impacted by higher sales prices for carbon pitch, distillates and chemicals and 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.

Adjusted EBITDA is reconciled to net income on a consolidated basis, the most directly comparable financial measure determined and reported in accordance with U.S. GAAP.

[[GREPCENT_TABLE]]
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[[/GREPCENT_TABLE]]

(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 fair value step-up on inventory acquired in a business acquisition as described in Note 3 – "Acquisitions".

(3)
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 $102.3 million for the year ended December 31, 2022 as compared to net cash provided by operating activities of $103.0 million for the year ended December 31, 2021. The decrease is primarily the result of higher working capital usage of $0.4 million in the current year period.

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.

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Koppers Holdings Inc. 2022 Annual Report

Net cash used in investing activities was $114.8 million for the year ended December 31, 2022 as compared to net cash used in investing activities of $89.5 million for the year ended December 31, 2021. Capital expenditures for both periods include maintenance projects and increased investment in growth projects, primarily in our crosstie business, such as the expansion of our RUPS facility in North Little Rock, Arkansas.

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 2021 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 2021.

Net cash provided by financing activities was $4.8 million for the year ended December 31, 2022 as compared to net cash used in financing activities of $4.0 million for the year ended December 31, 2021. The cash provided by financing activities in the year ended December 31, 2022 reflected net borrowings of $36.3 million partly offset by repurchases of common stock, dividends paid and payments of debt issuance costs. The cash used in financing activities in the prior year period primarily reflected repurchases of common stock of $11.5 million partially offset by net borrowings of debt of $5.1 million.

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.

Liquidity and Capital Resources

Our Credit Facility is described in Note 15 – “Debt.”

Restrictions on Dividends to Koppers Holdings

Koppers Holdings depends on the dividends from the earnings of Koppers Inc. and its subsidiaries to generate the funds necessary to meet its financial obligations, including the payment of any declared dividend of Koppers Holdings. The Credit Facility permits Koppers Inc. to make dividend payments to Koppers Holdings if certain conditions are met, including, among other permitted dividend payments, the ability to fund the payment of regularly scheduled dividends on and repurchases of Koppers Holdings common stock, in an aggregate amount per fiscal year not to exceed the greater of $50.0 million, with unused amounts in any fiscal year being carried over to the succeeding fiscal year, and 6.0 percent of market capitalization. The indenture governing the 2025 Notes restricts Koppers Inc.’s ability to finance our payment of dividends if a default has occurred or would result from such financing, Koppers Inc. is not able to incur additional indebtedness (as defined in the indenture), or the sum of all restricted payments (as defined in the indenture) has exceeded the permitted amount (which we refer to as the “basket”) at such point in time.

At December 31, 2022, the basket totaled $301.6 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.

Liquidity

As of December 31, 2022, the maximum amount available under the Credit Facility considering restrictions from debt covenants was approximately $412 million. The maximum amount available under the Credit Facility is increased by the amount of cash held by certain subsidiaries as defined by the Credit Facility. At December 31, 2021, the maximum amount available under the previous credit agreement which contained different covenants was approximately $300 million.

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Koppers Holdings Inc. 2022 Annual Report

Our need for cash in the next twelve months relates primarily to contractual obligations which include potential acquisitions, debt service, pension plan funding, purchase commitments and operating leases, as well as working capital, capital programs, the funding of plant consolidation and rationalizations, dividends and share repurchases. We may also use cash to pursue other potential strategic acquisitions or voluntary pension plan contributions. In addition, we continually monitor debt and capital markets. We may, from time to time, pursue one or more transactions to refinance all or a portion of the 2025 Notes, which may include, among other things, the redemption of the 2025 Notes or the purchase of 2025 Notes in the open market. We would expect to cancel any 2025 Notes which are purchased. Capital expenditures in 2023, excluding acquisitions, if any, are expected to total approximately $105 million and are expected to be funded by cash from operations. We anticipate that our liquidity will continue to be adequate to fund our cash requirements for the next twelve months.

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, 2022, approximately 80 percent of accounts payable was current and 20 percent was 1-30 days past due. As of December 31, 2021, approximately 75 percent of accounts payable was current, 20 percent was 1-30 days past due and five percent was greater than 30 days past due.

Schedule of Certain Contractual Obligations

The following table details our projected payments for our significant contractual obligations as of December 31, 2022. The table is based upon available information and certain assumptions we believe to be reasonable.

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(1)
Consists primarily of the maturity of the 2025 Notes and the Credit Facility that will mature in 2027. See Note 15 - "Debt" regarding the springing maturity on our Credit Facility in the event our 2025 Notes are not repurchased, redeemed or refinanced prior to November 15, 2024.

(2)
Relates to the transition tax in accordance with the Tax Cuts and Jobs Act of 2017 (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 2023.

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 $7.0 million in 2023. 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 – "Pensions and Post-Retirement Benefit Plans."

As of December 31, 2022, there was $1.4 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 – "Income Taxes."

Debt Covenants at December 31, 2022

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 total net leverage ratio, calculated as of the last day of each fiscal quarter, is not permitted to exceed 5.0. The total net leverage ratio as of December 31, 2022 was 3.3.

▪
The cash interest coverage ratio, calculated as of the last day of each fiscal quarter, is not permitted to be less than 2.0. The cash interest coverage ratio as of December 31, 2022 was 5.5.

We are currently in compliance with all covenants governing the Credit Facility. Our continued ability to meet these financial covenants can be affected by events beyond our control; however, 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.

35

Koppers Holdings Inc. 2022 Annual Report

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, 2022, 2021 and 2020, exchange rate fluctuations resulted in a decrease to comprehensive income of $21.6 million, a decrease of $16.4 million and an increase of $22.8 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 $(0.8) million, $(0.7) million and $2.5 million for the years ended December 31, 2022, 2021 and 2020, respectively.

Recently Issued Accounting Guidance

Information regarding recently issued accounting guidance is contained in Note 2 – “Summary of Significant Accounting Policies.”

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.

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.

36

Koppers Holdings Inc. 2022 Annual Report

Goodwill remaining on our consolidated balance sheet at December 31, 2022 was $294.0 million. During the fourth quarter of 2022, 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, 2022. We define "headroom" as the percentage difference between the fair value of a reporting unit and its carrying value. For the 2022 impairment test, the headroom for the reporting units ranged between six percent and 84 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 $116.1 million as of December 31, 2022. 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, 2022, our balance sheet included $47.7 million of deferred tax assets, which is net of a $43.8 million valuation allowance. We also had $57.5 million of deferred tax liabilities resulting in net deferred tax liabilities of $9.8 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.

Pension and Post-retirement Benefits. Accounting for pension and other post-retirement 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, 2022, 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.

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Koppers Holdings Inc. 2022 Annual Report

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 post-retirement benefit plans would increase pension obligations and other post-retirement benefit plan obligations by $4.0 million. Increasing the discount rates would decrease defined benefit pension expense and other post-retirement 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 U.S. pension plan), 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 4.65 percent for 2022 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.