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Koppers Holdings Inc. (NYSE:KOP)

Q4 2013 Earnings Conference Call

February 13, 2014 11:00 AM ET

Executives

Michael Snyder – Director, IR

Walter Turner – President and CEO

Leroy Ball – VP and CFO

Analysts

Laurence Alexander – Jefferies & Co.

Christopher Shaw – Monness, Crespi Hardt

Liam Burke – Janney Montgomery Scott LLC

Steven Schwartz – First Analysis

Operator

Good morning, ladies and gentlemen and thank you for standing by. Welcome to the Koppers Holdings, Inc. Fourth Quarter Conference Call. At this time all participants are in a listen-only mode. Following the presentation we will conduct a question-and-answer session. Instructions will be provided at that time. (Operator Instructions). I would like to remind everyone that this conference call is being recorded today February 13, 2014.

I will now turn the conference over to Mr. Michael Snyder, Director of Investor Relations. Please go ahead.

Michael Snyder

Thanks, Sarah and good morning everyone. Welcome to our fourth quarter earnings conference call. My name is Mike Snyder and I’m the Director of Investor Relations for Koppers.

At this time each of you should have received a copy of our press release. If you haven’t one is available on our website or you can call Rose Helenski at 412-227-2444 and we can either fax or email you a copy.

Before we get started I’d like to remind all of you that certain comments made during this conference call may be characterized as forward-looking under the Private Securities Litigation Reform Act of 1995. These forward-looking statements may be affected by certain risks and uncertainties, including risks described in the cautionary statement included in our Press Release and in the company’s filings with the Securities and Exchange Commission.

In light of the significant uncertainties inherent in the forward-looking statements included in the company’s comments you should not regard the inclusion of such information as a representation that its objectives, plans and projected results will be achieved. The company’s actual results could differ materially from such forward-looking statements.

The company assumes no obligation to update any forward-looking statements made during this call. References may also be made today to certain non-GAAP financial measures. The company has provided with its press release, which is available on our website, reconciliations of these non-GAAP financial measures to the most directly comparable GAAP financials measures.

I’m joined on this morning’s call by Walt Turner, President and CEO of Koppers; and Leroy Ball, our Chief Financial Officer.

At this time I’d like to turn over the call to Walt Turner. Walt?

Walter Turner

Good morning and thank you Mike and welcome everyone to our 2013 fourth quarter conference call.

I would like to start the call by talking about the full year’s results. On the surface 2013 shaped up to be a disappointing year as we saw both sales and earnings decline from our record 2012 results. Like most years there are a number of positives and negatives and I’ll review some of those later in the call. But if I had to bore right down to the primary reason for the decline in 2013 I would clearly place the blame on the deterioration of the European end markets.

We did experience volume shortfalls in other regions and pricing was a challenge but the Railroad and Utility products market continued to be very strong for us. However, we were able to more than offset any negative impact from those lower volumes in a challenging price environment with numerous positive impacts realized in both businesses.

But first, let me put into perspective the impact that Europe had on our consolidated results in 2013. For the year we finished with an adjusted operating profit of $118.3 million, compared to $130 million in 2012, an $11.7 million decline. Europe’s adjusted operating profit alone fell by $17.8 million year-over-year, which puts a net improvement on the rest of our businesses at $6.1 million for the year.

The European impact gets even wider when you look at the effect that Europe had on our effective tax rate and adjusted EPS during the underutilizing of the [tolling] tax structure we put into place at the end of 2011. Our estimate for the overall impact that Europe had on our consolidated results, including the higher tax rate, was just under $1 per share. Just to make this point even more clear, while our European business posted flat results in 2013 compared to 2012, we would have recorded an adjusted EPS of just under $3.60 per share. That represents about $0.30 per share or 10% of earnings improvement in the other businesses for the year.

Also in 2013, we realized approximately $9 million of real sustainable profit improvement to add to the $18 million we generated in 2012. As we head into 2014, that puts us well on track to exceed our 2015 target of $40 million in annualized savings a year ahead of schedule. I will provide more detail later that will give you a better understanding of where those savings are coming from.

Our financial results for the fourth quarter were a continuation of what we experienced in the first three quarters of this year. Adjusted operating profit was $24.8 million, compared to $26.3 million in the fourth quarter of 2012. Europe alone had a $6.6 million negative impact on the comparison, which means the other businesses did better by $5.1 million in the quarter compared to the prior year.

The primary reason for the significant difference in comparison for Europe was a large customer order for carbon pitch in the fourth quarter of 2012 that did not repeat in the fourth quarter of 2013. The effect of Europe on adjusted EPS for the quarter, due to its lower operating profit and subsequent impact on the consolidated tax rate was approximately $0.36, which more than accounts for the $0.22 reduction in 2013 compared to 2012.

I will now turn it over to Leroy to provide some additional detail on the quarter. After his review, I will give you an update on the progress we are making in several of our strategic initiatives and provide more insight into the status of our end markets. Leroy?

Leroy Ball

Thanks, Walt. On a consolidated basis, sales for the fourth quarter decreased by 9% or $33.1 million to $341.8 million compared to the prior year quarter, driven mainly by lower sales of carbon pitch as aluminum production in the mature geographies has been reduced due to lower global aluminum prices combined with an unfavorable pricing environment. Additionally, difficulty in procuring crossties due to competing markets of hardwood lumber reduced crosstie sales for the fourth quarter compared to the prior year.

Fourth quarter adjusted EBITDA was $33 million or $0.6 million lower than 2012 fourth quarter adjusted EBITDA of $33.6 million, but adjusted EBITDA margins of 9.7% for the fourth quarter 2013 were above adjusted EBITDA margins of 9% for the fourth quarter of 2012. Excluding the effect of the non-deductible impairment and restructuring charges for our plants in China and in the Netherlands, our tax expense as a percent of pretax earnings this quarter was [$0.06] compared to 25% in the prior year quarter with the increase due mainly to the unfavorable impact of lower European earnings in the fourth quarter of 2013.

The negative impact of the higher tax rate on fourth quarter results amounted to about $0.20 a share. We anticipate an overall tax rate for 2014, excluding discrete items and European restructuring charges of around 40% compared to our 2013 rates excluding restructuring charges and discrete items of approximately 46%. Adjusted net income and adjusted earnings per share for the fourth quarter of 2013 were $9 million and $0.44 a share compared to $13.9 million and $0.66 per share for the fourth quarter of 2012.

Items excluded from the adjusted results for the quarter included pretax charges of $14.1 million related to plant closures and rationalization, and $2.9 million related to our tank and tank car cleaning program due to our decision to accelerate the cleaning and dismantling of certain tanks as a result of our recently completed global study of our storage tanks that was initiated because of the Australian pitch tank leak that occurred in 2012.

Turning to Carbon Materials and Chemicals, for the fourth quarter revenues of $213.7 million were $28.7 million or 12% lower than sales of $242.4 million in the prior year quarter, due mainly to lower sales volumes and prices for carbon pitch. Pitch products accounted for 9% or $22.8 million decrease in sales compared to the prior year quarter as sales volumes and prices for carbon pitch declined.

As mentioned earlier, the global carbon pitch markets have been challenged as a result of the difficult aluminum end-market, which has had a negative impact on sales volumes and pricing compared to the fourth quarter of last year.

Sales of distillates decreased 1% to $3.9 million as lower sales volumes for creosote, lower sales prices for carbon black feedstock sales were partially offset by higher sales volumes for carbon black feedstock compared to the prior year quarter. Sales of cold tar chemicals were flat as higher sales prices for naphthalene were offset by lower sales volumes for phthalic anhydride compared to the prior year quarter. Phthalic anhydride sales volumes were negatively affected by a customer plant closure, reduced demands from the plasticizer markets and European imports.

The average price for orthoxylene was $0.61 for the fourth quarter of 2013 compared to $0.66 for fourth quarter 2012 despite the fact that average oil prices were $97 a barrel in the fourth quarter compared to $88 a barrel in the prior year’s quarter. Orthoxylene prices were flat at $0.60 a pound in January, the same as in December, and dropped to $0.585 a pound in February as lower seasonal demand had a negative impact on spot xylene prices.

Carbon Materials and Chemicals adjusted operating profit for the quarter of $13 million represented a decrease of $5 million from $18 million in the fourth quarter of 2012, which equates to adjusted operating profit margins of 6.1% and 7.4% respectively. Operating profit and margins were lower mainly as a result of lower profitability from European operations.

For the year, sales of carbon materials and chemicals of $906.1 million decreased by $93.6 million or 9% from sales of $999.7 million in the prior year. Sales of carbon materials were down 6% or $61.5 million mainly due to lower sales volumes for carbon pitch. Sales of distillates were flat as lower sales volume for creosote in North America and lower sales prices of carbon black feedstock in Europe were partially offset by higher sales volumes for carbon black feedstock

Sales of cold tar chemicals for the year were 2% or $17.7 million lower than the prior year with lower sales volume for phthalic anhydride and naphthalene were partially offset by higher sales prices of naphtha.

Adjusted operating profit for the year amounted to $60.4 million, 27% or $22.7 million lower than adjusted operating profit of $83.1 million in 2012 due mainly to lower profitability from European and US operations. The reduction in profitability for European operations was due to lower sales volumes of pitch and naphthalene and lower sales prices for pitch and carbon feedstock, carbon black feedstock and the reduction in profitability for US operations was due mainly to lower sales volume for phthalic anhydride.

For our global Railroad and Utility Products business, sales decreased by $4.4 million or 3% for the fourth quarter compared to last year’s fourth quarter. Sales decline was due to lower sales volume for crossties mainly due to the timing of order and continued competition in the hardwood lumber market. Reduction in sales volume for crossties was partially offset by incremental sales from our November, 2012 utility pole business acquisition in Australia.

Adjusted operating profit for the quarter increased to $12.2 million from $8.6 million in the prior year quarter with adjusted operating margins at 9.5% compared to 6.5% in the prior year quarter. Profits from the Australian pole business acquisitions, and favorable product mix for the U.S. railroad business and lower pension expense contributed to the improved results for the quarter.

For the year sales of railroad and utility products [dropped] 3% or $16.9 million to $572.2 million mainly due to the acquisition of the western pole business in Australia in November 2012 as lower sales volume for untreated crossties were largely offset by higher sales volume for treated crossties.

Adjusted operating profit increased by 23% or about $11.3 million to $59.8 million from $48.5 million in 2012 due mainly to a favorable product mix that included higher sales volumes for borate-treated crossties, cost savings from the closure of Grenada plant in mid-2012 and incremental profitability from the acquisition of the Western Poles business in Australia in November 2012.

Cash provided by operations for the year 2013 amounted to a $117.6 million compared to cash provided by operations of $77.8 million for 2012, as working capital decreases in 2013 more than offset lower net income compared to the prior year period.

Our debt, net of cash on hand at September 31, 2013 decreased to $221 million from $229 million at December 31, 2012. As of December 31, we had $6.6 million borrowed on our revolver and total estimated liquidity in excess of $400 million.

During the fourth quarter we increased the size of our revolving credit facility to $350 million and added to it a $100 million of [flooring] to give us additional borrowing capacity if needed. Our 7.875 notes are inching to the first call date in December this year and we are keeping a close eye on when might be the right chance for refinance them. To give you a sense of the cost of refinancing the notes today it would cost us approximately $27 million to do an early tender while if we wait till its call date in December it will cost us approximately $12 million.

If we continue to move towards the call date $27 million will continue to drop which would reduce the cost of the refinancing. However if interest rates make a significant moves upward between now and then it could wipe out any savings generated by trying to wait till the last possible moment. Based upon where things stand today we could probably save at least $6 million per year in interest cost through no refinancing. So we will continue to keep our eye on this situation and act when feel it’s most appropriate.

Our capital expenditures for the year 2013 were $73 million, up from $29 million last year, mainly as a result of $37 million of expenditures related to our new coal tar distillation facility that is being constructed in the Jiangsu Province in China.

One final note that I’d like to update everyone on is our progress towards fully funding our U.S. pension obligations. As of year-end 2013 we stood at a funding status of 92% which equates to a $12.9 million shortfall. As we’ve increased our funding status we’ve changed our asset allocation towards more longer term fixed income products in order to hedge our risk against the funding gap widening again.

According to our assumption which include another $7 million contributions this year we would be at a 105% funding level by the end of 2014 which would allow us to consider a plan termination which would effectively transfer our pension obligations from our balance sheet.

At this time I’d like to turn it back over to Walt.

Walter Turner

Thanks, Leroy. Now I would like to give you an update on the status of our key end markets and how we see these markets impacting our results for 2014. First, I’d like to talk about our Railroad and Utility products business. Our fourth quarter sales volumes for crossties were down compared to the fourth quarter of last year as sales volumes for untreated ties were lower due to a difficult lumber market.

Our sales volumes for treated ties were also lower mainly due to the timing related to the completion of annual insertion programs through some of the Class I customers. As we mentioned in the previous calls we expected a headwind from the second half of the year and into 2014, due to the increased competition for hardwood lumber from the flooring and [crane net] markets that would provide a challenge in obtaining adequate supplies of raw material. We have had to draw down on our untreated tie inventories this year for both Koppers owned and Railroad owned ties to be able to meet our customer commitments. As a result our untreated tie inventories were reduced from 6.2 million ties at the end of 2012 to 5.2 million ties at the end of 2013.

While we see continued challenges for crosstie procurement, we expect to be able to manage through this temporary shortage and we believe we are in a stronger position than our competitors due to the size of our procurement buying network. The shortage we are currently experiencing will likely result in fewer air seasoned crossties available for treatment next year, but fortunately we have the option of using an accelerated drying process referred to as boltonizing that should help mitigate most if not all of the shortfall.

The commercial crosstie business in 2014 is expected to have another strong year as the short line railroads continue to upgrade their rail lines to accommodate the heavier carloads from the Class I railroads. While the Section 45 tax credits expired at the end of 2013 there appears to be strong support in Congress to extend this credit for at least a few more years.

On the M&A front we completed the acquisition of Tolko’s Ashcroft crosstie treating business in Canada in early January. This addition to our network of treating plants gives us a broader footprint in Canada as-well-as the northwest region of the U.S. We expect this business to add about $30 million in revenues and be accretive to earnings in 2014 as-well-as providing synergies that should further enhance our profitability.

On the utility side, our Australian utility pole business showed significant improvement over its strong 2012 results due primarily to the acquisition of the Western Poles business that was completed in last year’s fourth quarter. This acquisition generated over $25 million in revenue and was a strong contributor to the margins and profitability for this segment.

The Creosote borate treated tie volumes continue to increase in terms of the percentage of total ties treated. And this ratio should continue to grow in 2014 enhancing revenues and profitability for the Railroad business. The three year contract extension with the Norfolk Southern that we recently announced also provides additional volumes of Creosote- borate treated ties.

During the fourth quarter we discontinued operations at our co-gen operation facility in Muncy, Pennsylvania and I will talk more about that in our margin improvement discussion.

Now I’d like to talk about the outlook for our global carbon materials and chemical business. For the global aluminum industry, an estimated 5% increase in consumption for 2013 is projected to be followed by a 5% to 6% increase in consumption in 2014 and 2015. Excluding China, which produces and consumes nearly half of the world’s aluminum, both consumption and production are projected to increase by 3% in 2014.

While aluminum consumption is ultimately the driver for aluminum production, the production side more directly impacts pitch volumes for us. Our pitch volumes were down globally in 2013 as aluminum production in the U.S. was down 6% for the year and we also had continuously depressed pricing environments in Europe and Middle East. Additionally there were smelter closures in Europe and Australia in 2012 that had a full year’s impact in 2013.

Aluminum prices continued to be depressed at under $1,700 a ton and the LME inventory levels continue to be around 5.5 million tons. However with the reduction from smelting capacity along with the projections for increase aluminum consumption we are hopeful that the aluminum industry and our pitch business will improve going forward.

The aerospace and automobile industries continue to use large amounts of aluminum in their products which along with the emerging market growth should continue to increase consumption. For example the Ford Motor Company recently announced that 97% on their truck bodies, for the best-selling S150 Ford Model Year 2015 will be made from aluminum to improve fuel efficiencies. And a recent forecast is projecting aluminum demand will outpace production in 2015 which is the first time this has happened since 2006 and should be beneficial to the aluminum pricing and the industry as a whole.

With regard to capacity increases in the Middle East, Alcoa’s Ma’aden smelter in Saudi Arabia and the Emal expansion in the United Arab Emirates could be at full production levels by the last half of 2014 as capacity continues to grow in this low energy cost region. We hope to increase our sales volumes of pitch into the Middle East in 2014, as production at these facilities increases the demand for pitch which will hopefully result in a more favorable pricing environment for us.

2013 was a tough year for phthalic anhydride volumes as we experienced pressure from a closure of a customer’s facility, lower demand from the plasticizer markets and increased competition from the European imports. However due to a contract extension with one of our major customers that includes increase volumes and positive signals from some key leading indicators like auto production and housing starts we anticipate a moderate increase in phthalic anhydride sales volume in 2014.

Looking at those key indicators light vehicle production is expected to increase slightly in 2014 to just over 60 million units while housing starts are currently projected to be up by 24% compared to 2013 which should both positively affect our phthalic volumes.

Our carbon black feedstock sales volumes were up in the fourth quarter and for the year on a comparative basis, although sales prices were lower mainly as a result of depressed market we have in the Europe. Carbon black feedstock, which is largely driven by the tire demand could be strong in 2013 as growth rates for global rubber demand are projected to average 3% annually through 2015.

This growth is being driven mainly by higher demand from the emerging markets in Asia which are the primary markets that are served by from our facilities in China and Australia. Naphthalene demand, which is driven mainly by its use as a surfactant catalyst in concrete resulted in higher sales volumes for our Chinese operations in 2013 due to the infrastructure expansions and stimulus programs of the emerging economies.

Global surfactant markets are projecting a 4% annual growth rate through 2016 with higher growth levels in China and other emerging market economies. Additionally new phthalic anhydride plants currently being built in China, demand for naphthalene as a feedstock for phthalic production is expected to increase significantly over the next few years. This increased level of demand in China result in higher sales prices and volumes for naphthalene for Chinese operations in 2013 as selling prices for naphthalene for the year were up over 30% compared to a year ago.

Regarding the outlook for our coal tar raw material, the tar supply in the U.S. would be relatively stable and we should receive additional tar from the ArcelorMittal Coke Plant in Monessen, Pennsylvania by Mid-2014 where it is expected to be producing coke again.

Outside of North America we expect to continue supplementing our tar supply in the Europe, by bringing tar in from Russia and the Ukraine to supplement our European supply base. We will also continue to have access to the majority of coal tar currently used by our plants in the Netherlands after it discontinues operations. Raw material cost in China increased in 2013 due mainly to a higher demand from the naphthalene market and there will likely continue to be an upward pressure on tar prices in 2014.

Our Australian operations will continue to supplement very limited domestic tar supply with stock pitch raw material from both Taiwan and China. Our North American Carbon Materials and chemicals business continued to be challenged by the European imports of carbon pitch and phthalic anhydride. Additionally, Aluminum LME pricing continues to stay below the $1,700 mark which has resulted in lower production levels in the mature markets resulting in difficult pricing environment for the pitch.

In addition, reduced electrode production for electric arc furnaces in North America has also put pressure on pitch volumes for this year. In October we curtailed operations on our tar distillation facility located in Follansbee, West Virginia to lower our overall cost structure and I’ll talk more about that shortly as a part of our margin improvement discussion.

We anticipate that this business would be moderately better than 2013 due to the benefit of lower cost from the Follansbee curtailment. It appears that the European economy has begun to recover but we don’t anticipate an increase in aluminum production in Europe going forward. As a result we announced in January that we are discontinuing distillation at our plant in the Netherlands in Mid-2014 which will lower our overall cost structure in Europe and increase our throughputs and our plans in Denmark and UK.

This consolidation should improve Europe’s profitability compared to 2013. For Australia we expect 2014 results to be similar to 2013 with some downside risk in the event that the point Henry Aluminum smelter closes.

The outlook for China for 2014 will include additional revenues from an expected fixed [license] sales from the new joint venture but then any incremental cost ability maybe offset by start-up costs. Overall we expect profitability from the Chinese operations to be flat slightly up compared to 2013.

As mentioned in our last call Tangshan Iron and Steel Company, or TISCO, our partner in our 60% owned joint venture in the Hebei Province we received notice from the Chinese government requesting TISCO to cease operations for their two coke factories as a part of the government’s air quality improvement efforts. Our adjacent tar distillation plant known as KCCC, receives most of its utilities and raw material from the two coke factories.

So we will need to find alternate sources if the pulp operations too cease production. As a result we continue to look into the various alternatives including relocations as well as alternative power and raw material sources but it is possible we could ultimately decide to close this plant. We are currently in discussions with our joint venture partner and as well as the local Chinese government authorities requesting a delay of the closure as well as financial and other assistance.

KCCC contributed about $3 million to operating profit after minority interest in 2013. After recording an impairment charge of $4 million in the fourth quarter of which $2.4 million represents our ownership interest Kopper’s share of the book value of the fixed asset is approximately $6 million. Of the $6 million about $5 million relates directly to the plant and will be depreciated over 36 months in anticipation of a closure.

In the event that we have to close the facility we expect to fully meet our customer commitments both in the domestic and export markets by utilizing other tar distillation facility that we have in the Hebei province as well as our new facility that is being built in Jiangsu Province that will begin operations in mid-2014.

Regarding our progress towards the goals supported by our three strategic priorities of growth, the margin improvement and capital deployment. I like to start by giving you a broad update. As mentioned earlier in January we acquired a crosstie trading business in Canada that should add about $30 million of additional sales in 2013, while being accretive to the company earnings and margins. This acquisition was in line with our strategy of looking to grow by either expanding our core business or adding near adjacent [maintenance of] opportunities. This is important, it now gives us a strategic presence in the Canadian and North Western U.S. railroad markets which we believe can open up additional commercial business and procurement opportunities.

Regarding the new joint venture in China construction continues to be on time and on budget for our new coal tar distillation facility in Jiangsu which should be completed and operational by mid-2014. As mentioned previously the majority of our production will ultimately be solid to Nippon Steel & Sumikin Chemical the owner of the adjacent needle coke and carbon black plants when the carbon black complex is completed.

We continue to anticipate that the completion of construction for the needle coke and carbon black facilities will be in the fourth quarter 2014. In the interim we plan to operate our tar distillation plant at capacity and sell these products into the domestic Chinese markets. As a reminder the delay in construction of the needle coke and carbon black plants will extend timing for maximum sales and profitability for the project.

The Australian utility pole business that we acquired in late 2012 has exceeded our expectations and added over $25million in sales this year while generating margins that are in line with our legacy Australian utility pole business that happen to be the highest of any segment or geography in the entire company. We continue to work diligently on evaluating M&A opportunities that sit within our targeted growth areas and have devoted much time to this aspect over the past year.

Unfortunately most opportunities that are going through a formal auction process like the three we are currently evaluating, take time to develop that is why – and that is what we are experiencing at the moment. We are currently engaged in various stages of negotiation and due diligence for each of these three companies and we hope to be successful at closing at least one of these additional opportunities during the year.

Moving on to our second strategic priority of margin improvement there are several areas I can point to that are currently contributing towards reaching our 12% EBITDA margin target by 2013. Before I get into the specifics of the progress that we’ve made from various margin improvement initiatives I think it’s important to highlight the European performance how much it has masked the success that we have had today.

As we’ve made clear for some time now we are working toward achieving an increase in our EBITDA margins that will take us from the 9.6% that we achieved in our base year of 2011 to a 12% margin by the end of 2015. If you look at the raw adjusted numbers we have essentially improved upon the 9.6% base EBITDA margin by only 60 basis points so far as we finished 2013 at 10.2%.

Not only that but the raw numbers would also show a 10 basis point decline from 2012 to 2013. That certainly is not reflective of the approximate $27 million of sustainable cost reductions of profit enhancers that we have achieved over the last two years. Once again Europe is the prime reason. If we look at the non-European CMC business in isolation they would show a 140 basis points EBITDA margin improvement from 2011 to 2012 and an additional 50 basis points improvement from 2012 to 2013 for a total of 190 basis points improvement over this last two year period.

We have talked extensively on past calls about the success that the Railroad and Utility Products business has had and they improved their EBITDA margins since 2011 by 420 basis points over that time point, 180 of which was achieved in 2013. If you remove Europe from the consolidated results we would show 11.8% EBITDA margin in 2013 which would have had us more or less reaching our goal two years earlier. It’s not my intent to try to divert any attention away from what was a disappointing year, only to make sure that everyone understands that a lot of – that has already been done to mitigate most of the damage caused by the end markets that are in turmoil.

As I have also indicated on prior calls we only scratched the surface and I believe that we still have considerably more potential to both reducing cost and enhancing profits through various initiatives. With that as a backdrop I’ll now give you a little more color on some of the items both completed and new projects.

In the category of items completed that have contributed to the $27 million of cumulative annual margin improvements, by the replacing of expiring contracts, the introduction of our creosote borate treating process at four of our owned treating facilities, the low cost substitution of key raw materials in our chemical production process, the closure of our Australian Carbon Black facility at the end of 2011, the closure of a wood treating facility and a co-generation facility in the United States in the third quarter of 2012 and 2013 respectively, the restructuring of our Australian administrative office and a reduction in pension expense in-line with management’s goal of fully funding U.S plans.

As for the items in progress that will contribute to next year’s margin improvement goals, they are through the restructuring of our European operation, through the ceasing of distillation activity at our Uithoorn, The Netherlands facility, a movement of those production volumes to our other European facilities, the restructuring of our Follansbee, West Virginia and Portland, Oregon facility, various operations focused projects including productivity capital aimed at reducing plant operating costs and the continued spillover improvements related to some of the previously mentioned projects that have already generated savings in 2012 and 2013.

We are expecting to generate over $20 million of improvements in 2013 related to the items just mentioned which would bring our three year annualized total to just over $40 million. That does not include the margin benefit added by our 2012 Australian Pole acquisition and the ALE 2014 Canadian Wood treating acquisition both of which generate above margins being absorbed in your larger network of treating facilities.

And finally the projects just mentioned, plus the addition of our Creosote-borate treating process at two or three at our facilities by the end of 2014 should contribute at least $11 million to $15 million of improvement in 2015.

Now to summarize our progress on our third strategic priority of deploying capital, in order to maximize returns we have generated approximately $180 million of free cash flow over the past two years which equates to about 6.2% of sales generated over that time period. As a reminder we have targeted average free cash flow generation at 5% in sales over our planning period so we are tracking ahead of that goal as it stands today.

The $188 million has been deployed as follows: $66 million has been returned to shareholders through a combination of $40 million of dividends and $26 million of share repurchases equal to about 3% of shares outstanding. $53 million has been used on growth areas such as the $37 million that has been spent on our plant currently under construction in China and the $60 million on our Australian utility pole business acquisition and finally $57 million has been spent on margin improvement initiatives such as productivity capital, excess pension contribution, plant rationalization and business development costs.

That leaves a balance of $11 million of excess cash that combined with $17 million of net average non-operating cash generated over the past few years equates to a $27 million increase in our cash balance over that same time period. Our debt has been flat over that same period as we repaid $6 million in 2012 and borrowed $6 million in 2013.

To summarize, while 2013 has been a challenging year in many respects there are still several positive areas that we can point to for the future of our businesses. We have improved the railroad utility products business adding another banner year while continuing to show further upside implementing several margin improvement initiatives that contributed $9 million to operating profit and helping to offset some of the European decline and successfully integrating our Australian pole acquisition while doing the work that allowed us to be successful in landing another tuck-in acquisition in the Railroad and Utility products segment in early 2014.

I’d like to close by summarizing on a high level my earlier comments about what we are expecting as we enter 2014. Let me start with the top line, here we are expecting a minimum revenue increase of 5% over 2013. Contributing to that, will be our new China joint venture coming online in mid-year and the addition to our new Canadian wood treating facility acquired in January. Potentially offsetting that there will be any net reductions in the carbon sales and chemicals volumes in Europe and Australia as end markets continue to be challenged in those geographies and any reductions we might experience in our crosstie as industry continues to deal with a shortage of ties.

From a profitability standpoint I am not prepared to offer specific guidance and I will start by reminding you of the $13 million of improvements we expect from the margin initiatives I spoke of earlier. In addition, better than average profit margin should be contributed by our new Canadian wood treatment acquisition. Also from an EPS standpoint we can also see a benefit from new financing bonds at some point between now and the December first call date. Partially offsetting those positive items would be a potential increase in incentive compensation expense above the considerably lower number recognized in 2013 due to most of our business regions not meeting expectation.

As I previously mentioned, in the interest of conservatism we are not expecting much contribution from the new China operation in 2014 as they will incur an increasing amount of startup cost as they get closer to startup time by mid-year, but that could provide some upside compared to our current expectation. None of what I mentioned compensates the impact from the early shutdown of our KCCC facility in China which could have up to a $3 million negative effect on our 2014 results and it doesn’t include any assumptions related to the acquisitions which I am hopeful to be successful at least one within the first half of 2014.

The bottom line is that 2014 will continue to be a very active year for Kopper as we work diligently on adjusting our asset footprint to better manage our current and future expected business, the rationalization in metro geographies that we operate in while we bring up new capacity to serve the growth in the developing markets.

While that is going on there we will also be diverting a great deal of energy towards driving margin improvement through identified projects while we continue to look for even more ways to reduce cost and enhance profitability. And finally as we are doing work throughout the year to integrate our new wood-treating acquisition we will continue to search for other pieces that make sense and meaningfully add to the existing businesses and leave us closer to our long-term sales and profitability goals.

As most of you on the call know we have spent a lot of time over the past couple of years reviewing our plans and our goals through 2015. Now that we are half way through that full year planning period we are in the process of updating our score card and investor communication to revise and expand our expectations out another two years through 2017. As of now it is our intention to disclose and begin discussing that in the late first quarter-early second quarter time span.

At this time I would like to open up the conference call to any questions you may have.

Question-and-Answer Session

Operator

Thank you. Ladies and gentlemen we will now conduct the question-and-answer session. (Operator Instructions). Your first question comes from the line of [Ivan Matthews] of KeyBanc Capital Market. Please go ahead.

Unidentified Analyst

Hi guys. Thanks for taking my questions. Real quick to your last comment and your extending the goals up to 2017, that is the 12% EBITDA margin goal that you’re referring to?

Walter Turner

Ivan, no what we mean is the 12% EBITDA margin goal is still a 2015 goal and we think it’s still realistically achievable. I think what we’re just trying to say is we’re halfway through that it’s time to refresh the numbers and extend it out another couple of years.

Unidentified Analyst

Got you. And if you look at all the detail you gave so, I understand you are having about $13 million dollars in cost savings and profitability and everything you just went through, but if the environment in the carbon pitch business continues as it is and phthalic continues to be pressured are you going to be able to grow earnings next year?

Walter Turner

Yes, very frankly, that’s what with we’re saying with all the things we’re doing Ivan, we definitely increase our earnings in 2014 and 2015 for sure.

Leroy Ball

Yeah the expectation is I think even in the challenged markets that with the initiatives that are in progress and that we’ve been pretty successful on getting results on so far that we were able to offset any reductions that would come from those challenged markets.

Unidentified Analyst

Great, and two more quick questions, one which is sort of tax – what’s your tax rate expectations for 2014 and then if you look at your…?

Leroy Ball

Tax rate expectation for 2014 is 40% excluding the restructuring items and any discrete items that might be there.

Unidentified Analyst

Got you, but for modeling expectations you’d put it at 40%?

Leroy Ball

Yes.

Unidentified Analyst

Got you. And then the last question on acquisition you talked about three, were they – these were all very similar in the railroad business or are they both in the carbon – the chemical business or how would you split up?

Walter Turner

Well, actually they reflect both core businesses, Ivan.

Unidentified Analyst

Okay great. Thanks for taking my questions.

Operator

Your next question comes from the line of Laurence Alexander of Jeffries. Please go ahead.

Laurence Alexander – Jefferies & Co.

Good morning.

Walter Turner

Good morning, Laurence.

Laurence Alexander – Jefferies & Co.

Couple of quick questions, how much of a headwind if any was the inventory reduction in Q4? And as I think about the bridge into 2014 if we do see better volumes in either the crosstie business later in the year or CMC, how would you think about incremental margins, they are probably a little bit stronger than historically is that fair?

Leroy Ball

Well, on the railroad ties as you heard we reduced our inventory on the sort of the seasoned ties by a 1 million ties and we continue to struggle a little bit, it’s a challenge out there with the flooring and the train mats competing with as lumber but we still expect shortly the class ones to be raising prices here and sort of get this turned around a little bit. But at the moment we have to as I mentioned if we have to use vulcanizing as the way to dry the ties that’s what we’ll do.

But going forward, yeah at this time I think we’re going to be all right with –

Walter Turner

Not all right, but it will be a challenge, but we’re going to be looking at sort of increase in procurement through higher prices. At the moment the difference between the tie and what the flooring and crane mat are paying is almost $5 a tie. So the railroads have got to catch up with what that equivalent is from a cost side contribution.

On the carbon and chemicals inventory we’re sort of status quo, I guess, we’ve not see much reductions of our raw materials. We’ve been managing that pretty well throughout the region. As I also mentioned the coal tar supplies I think we’re pretty stable in the U.S. and we continue to bring coal tar in from Russia and Ukraine and then once we close distillation and release the Netherland plant we’ll continue to have that coal tar that we are using here into both Denmark and the UK.

Laurence Alexander – Jefferies & Co.

And then speaking of pricing are you seeing any shift in your carbon pitch customers to tie-in contracts to coal tar pass-through?

Walter Turner

No, none at this point. When you’ve got sort of the mature markets still operating at fairly low rate in regards to aluminum smelting it’s a been challenge from a very weak pricing environment.

Laurence Alexander – Jefferies & Co.

And then lastly how much of a headwind do you think you have on the incentive comp and just overall cost inflation that’s here?

Walter Turner

Well we had a reduction this year from the prior year Laurence of close to $5 million overall….

Laurence Alexander – Jefferies & Co.

Thank you.

Operator

Your next question comes from the line of Chris Shaw of Monness, Crespi Hardt. Please go ahead.

Christopher Shaw – Monness, Crespi Hardt

Hey good morning guys. How are you doing?

Walter Turner

Hey good morning Chris.

Christopher Shaw – Monness, Crespi Hardt

I want to just talk about I guess Europe and carbon [materials] specifically and with shutdown or the planned shutdown of your Dutch plant now, how do you think that’s going to change, I guess the overall industry utilization rates, I mean how’s the change for, with the utilization rates that you’ve seen at your other two plants and what do you think that, that market can – how much more rationalization should we think there is required to get better pricing or stable pricing, your thoughts maybe on sort European I guess probably pitch market?

Walter Turner

Well, there are a couple of things there. First of all, when we were operating the three plants we were probably operating about 60% of capacity. Now we’re going from three plants to two plants now we are going to do 85 plus percent of operating capacity so that will obviously incrementally help our cost side. What others are doing in the industry I really don’t know but when you see over high cost aluminum smelters closing and not returning the industry which includes us as well as others industry must adapt to these markets, so we had no choice but to rationalize our capacity and focus on two plants which will give us much higher rates. But beyond that I really don’t know what others might be doing?

Christopher Shaw – Monness, Crespi Hardt

I mean I see like even in the past when conditions were – margins were better in Europe even then I thought some of smaller plans that are operating there might be losing or not be making much money, probably going to be shut down but is there any sign, I know there are lot of small like one in Czechoslovakia, one in Spain, I mean is there any signs from those or any other every big guy, [Rain or Ruetgers] those plants they might be taking some capacity off?

Walter Turner

Well actually as you say that based on the Czech Republic and you got one other in Spain, I thought by now that there would something that would happen. They are definitely operating at very low rates. If you do the math, we keep knocking on the doors but they want to continue to operate these facilities even low rates and as you say even I think losing money as well but nothing has really happened there and then you got [Rain] operating those two plans one in Belgium, one in Germany and I have not seen any signs of any cut backs there.

Christopher Shaw – Monness, Crespi Hardt

Thanks. And I was curious on the on the Norfolk Southern contract renewal is there any pricing indication you give there in terms of they are up significantly or is it sort of a normal increase that you would see for a class one contract?

Walter Turner

I mean as you’ve heard us talk in the past, that when we renew contracts there’s always adjustments on pricing and so forth and so there is about three year extension of those contracts and then also includes us having capability to also have the creosote-borate treatment. So it was a good contract for us to extend out three years.

Christopher Shaw – Monness, Crespi Hardt

Okay, thank you.

Operator

Your next question comes from the line of Liam Burke of Janney Capital. Please go ahead.

Liam Burke – Janney Montgomery Scott LLC

Thank you, good morning. Walt, good morning, Leroy.

Walter Turner

Good morning.

Liam Burke – Janney Montgomery Scott LLC

Walt I apologize for asking this question again you stated that you are going to hold the line on the 12% EBITDA margin for your goals of ‘15 have your EPS targets changed?

Leroy Ball

EPS targets – Liam, that right now will be part of the revision that we would be preparing to take out at the end of the first quarter beginning the second quarter. So it’s a little premature for us to say anything on that at this point.

Liam Burke – Janney Montgomery Scott LLC

Okay. Thanks Leroy. And then I understand in the U.S. plasticizers they’re using less phthalic anhydride and using different processes. Do you anticipate that to affect the overall long-term demand for naphthalene?

Walter Turner

Naphthalene would only impact on us Liam, that will be only of the three phthalic producers we were only producers using Naphthalene versus Orthoxylene. There is some decline in plasticizers using phthalic anhydride but the most we can get is looking at may be a 5% per year decline on net – but we do see sort of offsets on the [inaudible]. So there is a decline as you say but no more than may be 5% annually for the next three or four years but most of that if not all is being offset by the resins and the paints.

Liam Burke – Janney Montgomery Scott LLC

Great and then Leroy could you give a split on CapEx for 2015 between the joint venture and just the normal maintenance?

Leroy Ball

For which year?

Liam Burke – Janney Montgomery Scott LLC

For 2014.

Leroy Ball

2014, I think we are expecting something in range of probably about $48 million.

Liam Burke – Janney Montgomery Scott LLC

Okay, and with that would there be any spill over from the JV.

Leroy Ball

There would be spill over from the JV. And that would be something actually in probably the $25 million range. So the 23 as I said so the difference between that 48 and 25 would essentially be more along the line of maintenance and [inaudible] capital and we would have some sort of extrapolation over that.

Liam Burke – Janney Montgomery Scott LLC

And then lastly Walt are you going to be able to revive the export program that you had on the rail tie business in Latin America?

Walter Turner

Yes, I mean that’s something that’s definitely a growth area for us Liam we have people on the ground there and actually getting some RFQs in the last two weeks. So yes it’s definitely a market that we plan to extend our tie treating business.

Liam Burke – Janney Montgomery Scott LLC

Great thank you very much.

Walter Turner

Welcome.

Operator

Your next question comes from the line of Steve Schwartz of First Analysis. Please go head.

Steven Schwartz – First Analysis

Hi, good morning guys.

Walter Turner

Good morning Steve.

Steven Schwartz – First Analysis

If we could go back Walt in your response to Chris’ question about Europe so one time you had an acquisition strategy that revolved around consolidation in that market, but given that demand is so weak you mentioned you are still knocking on some doors there but so you are in fact still think of acquiring to consolidate there or are you now starting to think that it’s better just to walk away from that region altogether?

Walter Turner

No, we are definitely not walking away from that region at all, Steve. But if we have the opportunity to take out capacity what we are still [someone will be] taking out we would definitely take a hard look at.

Steven Schwartz – First Analysis

Okay. So there is an opportunity to still do some good business in Europe?

Walter Turner

I think so. It’s not going to be what it was two years ago, three years ago but this is an important region for us. We’re not by closing – we’re not walking away from that region. We’re just trying to adapt to what’s happened in the past two years and make it more profitable for us.

Steven Schwartz – First Analysis

If we could expand this discussion to the global perspective I mean certainly in the Middle East you are getting pressure from Asian pitch suppliers and so as you think about what you are doing with your capacity how do you think that compares to what global pitch capacity is doing?

Walter Turner

Well it’s still a bit of a difficult market but when you look at production from ‘12 to ‘13 increased by about 5.5%-6% but 65%, 70% of that increase was in China and the rest of it was in Middle East. Meanwhile you have got the mature markets U.S., Europe even few other places in Australia even, it’s actually reduced. So here we’re shooting in the wrong geographies with these higher cost smelters and as you know in China it’s increased the smelters an area that we just have not been able to supply because of logistics.

So now with our third plant that we are building in China which we can add on to eventually we are much, much closer to the aluminum industry there. It’s been a – we’re adapting it’s just unfortunate it takes time to adapt to these mature market conditions that we’re seeing.

Steven Schwartz – First Analysis

Okay and then just on my last question Walt did you mention that there was a capacity built out in the industry for naphthalene in China?

Walter Turner

That continues to get – the market continues to grow because of the phthalic plants that are being built and even construction, even though GDP might be in the 7% range now China there’s still a fair amount of naphthalene consumed in the surfactant for concrete but also as you correctly say naphthalene pricing was up 30% from last year again because of the demand for the product throughout China.

Steven Schwartz – First Analysis

So Chinese producers generally have been known to sometimes be over zealous and over build capacity and then they get irrational with dumping that globally. It doesn’t sound like you see that those – built outs as a risk to the currently strong pricing and may be even volume?

Walter Turner

Seriously not over the next – let’s say next three years or even longer perhaps that you’ll see that. But you are right though it seems like they do have a tendency to overbuild in certain markets but phthalic continues to grow in China and what’s happening now with construction of phthalic plants there is a market there internally for us.

Steven Schwartz – First Analysis

Okay. Thank you, Walt.

Walter Turner

Sure, Sarah?

Operator

Sorry, Mr. Turner there are no further questions at this time.

Walter Turner

Okay. Thank you very much everyone for participating in today’s call. And we appreciate your continued interest in Koppers. So we continue to do the right things by pursuing growth opportunities that we talked at length about today that makes sense for us as well as looking for ways to improve our profitability within our existing businesses. Despite facing challenges in 2013 and ‘14 due to the European economy and lower aluminum pricing we do believe the diversity of our business along with our margin improvement and growth initiatives will continue to provide us with relative stability in both strong and weak economic climates.

And finally we remain firmly committed to enhancing our shareholder value while maintaining our strategy of providing our customers with the highest quality products and services while continuing to focus on our safety health and [inaudible] initiatives. Thank you.

Operator

Ladies and gentlemen, this concludes the conference call for today. Thank you for participating. Please disconnect your lines.

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