Koppers Holdings' (KOP) CEO Walt Turner on Q1 2014 Results - Earnings Call Transcript

| About: Koppers Holdings (KOP)

Koppers Holdings Inc. (NYSE:KOP)

Q1 2014 Results Earnings Conference Call

May 05, 2014, 11:00 AM ET


Michael Snyder - Director, IR

Walter Turner - President and CEO

Leroy Ball - COO & CFO


Laurence Alexander - Jefferies LLC

Liam Burke - Janney Capital Markets

Ivan Marcuse - KeyBanc

David Wodiak - Healy Asset Management

Chris Shaw - Monness, Crespi


Good day, ladies and gentlemen, thank you for standing by. Welcome to the Koppers Holdings Inc. First Quarter 2014 Conference Call. During today’s presentation, all participants will be in a listen-only mode. Following the presentation, the conference will be opened for questions. (Operator Instructions) This conference is being recorded today, Monday, May 5, 2014.

And I would like to turn the conference over to Michael Snyder. Please go ahead, sir.

Michael Snyder

Thanks, Cadia, and good morning, everyone. Welcome to our first 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 financial measures.

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

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

Walter Turner

Thank you, Mike, and welcome everyone to our 2014 first quarter conference call. As Mike indicated in the introductions, I’m very pleased to announce that Leroy has been elected by the Board of Directors as our Chief Operating Officer, a new position here at Koppers.

In addition to his new role, Leroy will continue his CFO responsibility on an interim basis until a replacement is made. Leroy will be responsible for global operations and the financial reporting of the company and report to me. Congratulations are in order for Leroy and I’m looking forward to his continued contributions as we go forward with the growth of this company.

On our financial results for the quarter, we were lower than expected as the availability of hardware lumber for the railroad crossties, which we knew would be a headwind as a result of increased competition from other markets, was made worse by difficult weather conditions in certain regions.

Additionally, our Carbon Materials and Chemicals business was negatively impacted by lower sales prices for phthalic anhydride driven by lower orthoxylene price, combined with lower sales volumes and prices for carbon pitch in North America and the Middle East as market conditions continue to be very challenging.

Our domestic operations were negatively impacted by weather conditions with an estimated impact of about $3 million that includes increased plant costs related to energy usage and plant outages combined with reduced crosstie procurement. We also incurred about $3.5 million of incremental overhead costs for consulting services related to the Osmose acquisition costs, operations improvement projects and the KJCC China plant start-up costs.

Our sales for the quarter were $331 million, down $39 million or 11% from the $370 million in last year’s first quarter and adjusted operating profit was $17.7 million, down $7.6 million or 30% from $25.3 million in the first quarter of 2013. Adjusted EPS was $0.32 compared to $0.54 in last year’s first quarter. Excluding the $6.5 million of additional costs mentioned earlier, our first quarter adjusted EPS would have been about $0.50 per share.

One thing I’d like to point out is that when you look at the reduction in our pitch volume since the 2008 downturn, the main reason for this is the global shift in aluminum production to regions with lower cost energy. In fact, since 2008, aluminum production in North America and Western Europe has declined 15% and 24%, respectively. On the other end of the spectrum, aluminum production in China and the Middle East has increased by 67% and 43%, respectively.

Let me take a few minutes to explain what we have been doing about this paradigm shift in global aluminum production. First of all, we foresaw the increased production in the Middle East and we’re the first country to get a foothold in China in order to access coal tar and export product into the Middle East. That strategy was working very well until the 2008 recession period. And other Western and some Asian competitors became more active in that region as productions in most of their regions were declining.

This competition for market share along with plentiful raw material in China has made the Middle East market a lower-priced market since that time although the situation should improve with the additional capacity from the Ma'aden and EMOS smelters that were recently completed. The other area that we are working on is to address in the global shifting of aluminum production is diversifying more and more pitch away from the aluminum industry. That has been and continues to be the case in our existing Chinese operations where we are converting more of our coal tar into carbon black feedstock material for export into Japan and Korea.

Also, the pitch that we will be producing at our new KJCC plant in China is designed to go to needle coke markets for electrode production. In response to this shift in our aluminum end market, as previously announced, we’re consolidating our distillation facilities in the United States and Europe to right size our operations in these regions and significantly reduce our costs beginning in 2014.

The consolidations include discontinuing distillation at our Uithoorn facility in The Netherlands and curtailing operations at our Follansbee, West Virginia facility. The estimated cost savings for these two facilities alone is $8 million in 2014 and $11 million annually thereafter.

Finally, last month we signed an agreement to acquire the Wood Preservation and Railroad Services businesses from Osmose, which will provide for additional diversification in our products and end markets and further reduce the proportion of our business that relies on aluminum production in the mature markets where we operate.

Having said all that, we continue to remain bullish about the long-term prospect for aluminum and our carbon pitch product. With the production curtailments and the closures over the past several years, we should be getting closer to the point where consumption will outpace production and begin to reduce global inventory levels. If that occurs, it should result in significantly higher aluminum prices, which would help the industry and ultimately be beneficial to our pitch business.

You may have noticed that we recently had a change in management for the Global Carbon Materials and Chemicals business. I believe the promotion of Jim Sullivan to the position of Senior Vice President of Global Carbon Materials and Chemicals will bring a new focus in managing the challenges this business is facing.

Jim has both operations and marketing experience and he has been instrumental in our recent Ashcroft and Osmose transactions from his previous role as Vice President of Business Development. Prior to joining Koppers in June 2013, Jim was a Senior Vice President of the Americas for Calgon Carbon. In that position, Jim had responsibility for all manufacturing facilities in the U.S., as well as all marketing and sales of their products and services in North and South America.

I’ll now turn our call over to Leroy to provide additional detail on the quarter. After his review, I’ll give you an update on the progress we are making with 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 first quarter decreased by 11% or $39 million to $331.4 million, compared to the prior-year quarter, driven mainly by lower sales prices for phthalic anhydride due to lower orthoxylene prices and lower sales for carbon pitch as aluminum production in the mature geographies has been reduced due to lower global aluminum pricing combined with an unfavorable pricing environment in the Middle East.

Additionally, difficulty in procuring crossties due to competing markets of hardwood lumber reduced untreated crosstie sales volumes in the quarter compared to the prior-year quarter.

First quarter adjusted EBITDA was $25.4 million or $7.7 million lower than 2013’s first quarter adjusted EBITDA of $33.1 million with adjusted EBITDA margins of 7.7% compared to adjusted EBITDA margins of 8.9% for the first quarter of 2013. The reduced margins were due mainly to the difficult weather conditions and increased plant costs and reduced revenues, lower sales prices for phthalic anhydride, the dilutive effect of adding $5.1 million in sales from the Ashcroft acquisition with breakeven income and higher overhead related to consulting costs for acquisitions, operations improvement projects and KJCC start-up costs.

Adjusted net income and adjusted earnings per share for the first quarter of 2014 were $6.6 million and $0.32 per share compared to $11.2 million and $0.54 per share for the first quarter of 2013. Items that we excluded from our adjusted results for the quarter included $17.2 million of pre-tax charges related to impairment and plant closure costs. The $17.2 million is comprised of $12 million relating to the ceasing of distillation at our tar plant in the Netherlands and $5.2 million related to impairment charges and accelerated depreciation at our KCCC facility in Tangshan, China.

Our plant in China is expected to cease operations in the third quarter as a result of our joint venture partner being ordered by the local government to close their coke ovens as part of a pollution reduction program in Tangshan. As Walt mentioned, without the $6.5 million of weather-related issues, (indiscernible) costs and KJCC start-up costs, our adjusted EPS would have been about $0.50 per share.

For the first quarter of 2014, we recorded an effective tax rate of approximately 73% compared to 39% in the first quarter of 2013. We expect that our unadjusted effective tax rate for 2014 is going to be unusually high due to the non-deductibility of our restructuring charges in Europe and China that has the effective of lowering our pre-tax income with no corresponding tax benefits. Adjusting for those non-deductible charges will result in a normalized effective tax rate of approximately 42% for 2014 due primarily to a heavier weighted earnings mix in our higher tax rate jurisdictions.

In our Global Carbon Materials and Chemicals business for the first quarter, revenues of $202.6 million were $27.9 million or 12% lower than sales of $230.5 million in the prior-year quarter, due mainly to lower sales volumes and prices for carbon pitch and lower sales prices for phthalic anhydride. Pitch products accounted for an 8% or $16.8 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 very challenging which had a negative impact on sales volumes and pricing compared to the first quarter of last year.

Sales of distillates decreased 4% to $7.5 million due to lower sales volumes for creosote and lower sales prices and volumes for carbon black feedstock compared to the prior-year quarter, driven mainly by lower sales prices and volumes for Chinese operations. The lower volumes for Chinese operations were due in part to the timing of two shipments that were delayed until April.

Sales of cold tar chemicals decreased 1% or $2.9 million as higher sales prices for naphthalene were more than offset by lower sales prices for phthalic anhydride compared to the prior-year quarter. The reduction in sales prices for phthalic anhydride were driven by lower prices of orthoxylene.

The average price for orthoxylene was $0.59 for the first quarter of 2014 compared to $0.71 for the first quarter of 2013, a 17% reduction which correlated to a similar percentage size impact on our phthalic pricing and profitability even though average oil prices were $99 in the first quarter compared to $94 a barrel in the prior-year quarter. Orthoxylene prices were lower at $0.57 a pound in April, down from $0.59 in March with near-term expectations at or below $0.60.

Regarding phthalic imports, while they remain an issue, they appear to be flat to declining compared to last year and we are hopeful this trend will accelerate as Europe economy appears to be slowly recovering.

Carbon Materials and Chemicals adjusted operating profit for the quarter of $8.4 million represented a decrease of $4.7 million from $13.1 million in the first quarter of 2013, which equates to adjusted operating profit margins of 4.1% and 5.7%, respectively. Operating profit and margins were lower mainly as a result of lower profitability from North American operations driven by lower phthalic anhydride pricing and higher plant costs due to difficult winter weather conditions in certain locations.

Turning to our Railroad and Utility Products business, sales decreased by $11.1 million or 8% for the first quarter compared to last year’s first quarter. The sales decline was due to lower sales volumes for untreated crossties mainly due to continued competition in hardwood lumber market and difficult weather conditions in many regions.

Adjusted operating profit for the quarter decreased to $11.1 million from $12.7 million in the prior-year quarter with adjusted operating margins at 8.6% compared to 9.1% in the prior-year quarter. The reduction in margins was driven mainly by consulting costs related to operations improvement projects. If you adjust for those reductions and the effects of the Ashcroft acquisition, the Railroad and Utility Products segment would have generated adjusted operating margins of approximately 9.8%.

Cash used by operations for the first quarter of 2014 amounted to $13.7 million compared to cash provided by operations of $5.7 million for the first quarter of 2013 due mainly to lower net income, $7.2 million non-cash tax benefits compared to the prior-year period and increased working capital as KJCC is getting closer to its start-up date.

Our debt, net of cash on hand at March 31, 2014 increased to $285 million from $221 million at December 31, 2013, mainly due to the Ashcroft acquisition and higher capital expenditures driven by spending for the KJCC joint venture in China. As of March 31, we had $15 million borrowed on our revolver, $28 million of construction loans related to KJCC and we had total estimated liquidity in excess of $350 million.

Our capital expenditures for the first quarter of 2014 were $14.8 million, up from $6.4 million last year, mainly as a result of $8.8 million of expenditures related to our new facility in China.

We’re getting close to beginning the syndication process for the financing we will put in place to acquire Osmose. The new capital structure is expected to include a new $300 million term loan and an increase in our existing revolving credit facility to $500 million from the current $350 million dollar limit and should substantially lower our average borrowing rate.

We expect to have this process completed in June with the funding to occur -- closing sometime during the third quarter. While this additional debt will initially take our net debt to adjusted EBITDA leverage to around 4 times, our goal would be to get this down to 3 times within two years.

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

Walter Turner

Thanks, Leroy. I’d 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 the Railroad and Utility Products business. Our first quarter sales volumes for crossties were down compared to the first quarter of last year and sales volumes for untreated ties were substantially lower due to a difficult lumber market that was made even more difficult by the winter weather.

As we mentioned in previous calls, we expected the headwind that started in the second half of 2013 to continue into 2014 due to increased competition for hardwood lumber from the flooring and crane mat markets. What was somewhat unexpected and made the situation even more difficult was the severity of winter weather in many of the regions where we obtain crossties. As a result of these conditions, untreated crosstie prices have increased more than 10% over the last 12 months.

As a result, we’ve had to draw down our untreated tie inventories this year for both Koppers-owned and Railroad-owned ties to be able to meet our customer commitments. After drawing down our untreated tie inventories by 1 million ties in 2013, our tie inventories were further reduced another 600,000 ties at the end of the first quarter down to 4.6 million ties. We do see the situation as temporary. Our Class I customers have had to increase the price they’re willing to pay for crossties to induce the saw millers to produce crossties as opposed to competing product markets.

While our customers are understandably reluctant to pay increased prices, they understood the importance and the necessity of maintaining their track and we believe they will do what is necessary to insert the level of ties that are anticipated by their insertion programs, as well as begin to restock their inventories.

Capital spending for the Class I railroads for 2014 are estimated to be $17 billion, which represents an increase of 9% from 2013 spending levels. While we aren’t able to relate this number directly to crosstie insertion, it is a positive indication for the financial health of the railroad industry and the expectation is for continued high levels of rail traffic and maintenance spending.

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

We continue to treat a higher proportion of our crossties with the value-added creosote borate process and due to the increased demand from our Class I customers, we are planning to make capital investments at three more of our treating plants this year to add the borate treating process. The addition of borate treatment at these plants should take us from our current proportion of treating ties of about 40% with borate to around 65% in 2015, which should continue to help us achieve higher profit margins in the Railroad and Utility Products and Services segment.

Now, I’d like to talk about the outlook for the Global Carbon Sales and Chemicals business. For the global aluminum industry, a 5% increase in consumption for 2013 is projected to be followed by a 5% to 6% increase in consumption for 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 a driver from aluminum production, the production side is more directly impacting our pitch volumes for us. Our pitch volumes were down globally in the first quarter of 2014 as aluminum prices continue to be depressed and the pricing environment continues to be challenging.

We also had some timing issues regarding shipments especially for our Chinese operations that resulted in reduced pitch volumes in the quarter. Aluminum prices have unfortunately pulled back recently to under $1,800 a ton, but the LME inventory levels have dropped slightly to around 5.3 million tons, down from 5.5 million tons at year end, which is hopefully a good sign.

As mentioned on our last earnings call, with reductions in smelting capacity along with projections of increase aluminum consumption, we are optimistic that the aluminum industry and our pitch business will improve going forward.

The aerospace and automotive industries continue to be use large amounts of aluminum in their products, which along with the emerging market growth, should continue to increase consumption. As mentioned in our last call, the Ford Motor Company recently announced that 97% of truck bodies for the best-selling S150 Ford Model Year 2015 will be made from aluminum to improve fuel efficiency. And there is some thought that other car models will follow suit to achieve the mileage requirements in the U.S.

With regard to capacity increases in the Middle East, I’ll call this Ma'aden smelter in Saudi Arabia and the EMAL expansion in the United Arab Emirates should be at full production levels during the last half of 2014 as capacity continues to grow in this low energy cost region.

We also increased our sales volumes of pitch into the Middle East in 2014 as production at these facilities increased the demand for pitch which should result in a more favorable pricing environment for us. With phthalic anhydride, our sales prices declined by 14% from last year’s first quarter due mainly to lower orthoxylene prices. The impact from the lower pricing resulted in significantly lower profitability for this business in the first quarter compared to the first quarter of 2013.

Looking at the key indicators for phthalic, light vehicle production is expected to increase slightly in 2014 to 16.5 million units, while housing starts are fairly projected to be up by 16% compared to 2013 which should both positively affect our phthalic volumes.

Our carbon black feedstock sales volumes and prices were down in the first quarter compared to last year’s first quarter as we experienced some shipment delays and lower pricing from our Chinese operations. Carbon black feedstock, which is largely driven by the tire demand, should be strong in 2014 as growth rates for global rubber demand are projected to average 3% annually for 2015. This growth has been driven mainly by higher demand from the emerging markets and Asia which are the primary markets that are served by our facilities in China and Australia.

Naphthalene demand, which is driven mainly by its use as a surfactant additive to concrete and as a feedstock for phthalic anhydride, resulted in higher sales volumes and prices for naphthalene in our Chinese operations in 2013 and in the first quarter of 2014 due to 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, with new phthalic anhydride plants currently being built in China, the demand for naphthalene as a feedstock for phthalic production is expected to increase significantly over the next few years.

We did experience a reduction in naphthalene sales volumes from our European operations in the first quarter mainly as a result of the transition of naphthalene production from the Alcorn facility. The naphthalene production from Alcorn will be shifted to our facility in Uithoorn, Denmark which is in the process of expanding its naphthalene distillation capacity to absorb the additional production volumes.

Regarding the outlook for coal tar raw material, the tar supply in the U.S. should be relatively stable and we should receive additional tar from the ArcelorMittal coke plant Monessen, Pennsylvania by mid-2014 when it is expected to produce coke again. This supply should compensate for the closure of two small coke batteries at the Gary, Indiana Coke plant of US Steel late last year. We are now anticipating tar supply issues in our U.S. businesses for 2014.

Outside of North America, we expect to continue purchasing Russian tar to supplement our European supply base. We are in the process of transferring to our Denmark plant the majority of coal tar currently used by our plant in the Netherlands, which recently discontinued operations. Our Australian operations continue to supplement their limited domestic tar supply with soft pitch raw material from both Taiwan and China.

Our North American Carbon Materials and Chemicals business continues to be challenged by the European imports of carbon pitch and phthalic anhydride. Additionally, aluminum LME pricing, which while up from the end of the year, continues to stay well below the global breakeven mark, which has resulted in lower production levels in the mature markets, resulting in a difficult pricing environment for carbon pitch. In addition, reduced electrode production for electric arc furnaces in North America has also put pressure on pitch volumes this year.

In October, we curtailed operations at 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 will be moderately better in 2014 that it was in 2013 due to the benefit of lower cost from the Follansbee curtailment. It appears that the European economy has begun to recover, so we don’t anticipate a meaningful increase in aluminum production in Europe going forward. As a result, we announced in January that we intended to discontinue distillation at our plant in The Netherlands in mid-2014 and the plant stopped distilling tar in late April.

This will lower our overall cost structure in Europe and increase our throughput at our plans in Denmark and the U.K. This consolidation should improve Europe’s profitability compared to 2013 and the Europe’s profitability was up in the first quarter compared to the prior-year quarter excluding the restructuring charges.

For Australia, we mentioned on our last call that Point Henry smelter of Alcoa could be closed, and in fact an announcement to that effect was made in the first quarter. Although this closure will have an impact on sales and profitability for our Australian operations, when the facility closes later this year, we still anticipate that the profitability for this region will be at the same level or better than 2013.

Our Chinese operations got off to a slow start in the first quarter and fixed sales volumes and prices were lower than the first quarter of last year. Excess product availability in the Middle East has continued to keep the pricing environment low, and we are hopeful that this situation will improve as new smelting capacity for Ma'aden and EMAL ramps up throughout the year.

The outlook for China for 2014 will include additional revenues from an expected six months of sales from the new joint venture, but any incremental profitability may be offset by start-up costs. Overall, we expect profitability from China operations to be flat to slightly up compared to 2013.

As mentioned in our last call, Tangshan Iron and Steel, or TISCO, our partner in the 60% owned joint venture in Hebei Province, received notice from the Chinese government requesting TISCO to cease operations for their two coke batteries 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 batteries.

In March, the older of the two batteries were shut down resulting in reduced raw material supply for our plant. Our expectation is that the other coke battery will be closed by the end of June. As a result, we expect to cease production at KCCC in the third quarter.

In order to continue meeting our customer commitments, we currently have a tolling arrangement with (indiscernible) coal chemicals company just outside of Tangshan to produce carbon pitch and carbon black feedstock for us. The plant has as a distillation capacity of 200,000 tons which is about 20% less than the capacity for our KCCC plant, but we will also have product available from our new facility in the Tijo and also from our other joint-venture in the Hebei Province, TKK.

As mentioned in our last call, KCCC contributed $3.3 million to operating profit after minority interest in 2013, most of which will not be realized this year due to the expected closure of our plant. After recoding an impairment charge of $4 million in the fourth quarter, of which $2.4 million represents our ownership interest, we recorded an additional impairment charge of $4.9 million in the first quarter of this year, of which $3.1 million represents our ownership interest.

As of March 31, the remaining net book value of our fixed assets, subject to impairment, was $2.5 million, and this amount will be written off in the form of accelerated depreciation through the end of July, reflecting our estimated useful life of the assets.

Regarding our progress towards the goals supported by our three strategic priorities of growth, margin improvement and capital deployment, I like to start by giving you our growth update. In January, we acquired a crosstie treating business in Canada that should add about $30 million of additional sales this year, while being accretive to the company’s earnings and margins beginning with second half of the year. We’ve recorded approximately $5.1 million of sales related to this acquisition in the first quarter, but profit was only breakeven due to non-cash purchase price amortization for setup in the inventory value.

The same situation will occur in the second quarter before the non-cash inventory purchase price amortization stops. And we’ll begin recognizing normalized profit margins in line with the rest of our crosstie business. This acquisition was in line with our strategy of looking to grow by either expanding our core business or adding near adjacent maintenance of weigh opportunities. This is important. It now gives us a strategic presence in the Canadian and Northwestern U.S. railroad markets, which we believe can open up additional commercial business and procurement opportunity.

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 Province, which should be completed and operational by mid-2014. As mentioned previously, the majority of our production will ultimately be sold to Nippon Steel & Sumikin Chemical, the owner of the adjacent needle coke and carbon black plants when the carbon 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 of this year.

In the meantime, we plan to operate our tar plant at capacity, the 300,000 tons a year capacity, and sell the products into the domestic Chinese market. As mentioned on our last earnings call, the delay in the construction of the needle coke plant and the carbon black plant will extend the timing for maximizing sales and profitability for the project.

That brings us to our most recent announcement indicating that we have signed an agreement to acquire the Wood Preservation and Railroad Services businesses of Osmose. The Wood Preservation business which had revenues of $350 million in 2013, blends and sells wood preservation chemicals used primarily in the residential applications such as decking. This business is adjacent to both of our existing businesses as we produce creosote in our Carbon Materials and Chemicals segment and sell it as a wood preservation chemical to our own Railroad and Utility products segment as well as other wood treaters and distributors.

Our Railroad Services business which had sales of $40 million in 2013 provides engineering, inspection construction and various other services related to railroad bridges for the North American railroad industry. Railroad Services is adjacent to our Railroad and Utility Products business, and in fact fits perfectly with our strategy of growing in the maintenance of weigh space to leverage our existing customer base of Class I and short line railroads.

And just a little more information about the Osmose acquisition, we just received a notification this morning that we’ve been given clearance on our Hart-Scott-Rodino filing to continue on with this acquisition.

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 2015. We have talked extensively on past calls about the success that the Railway and Utility Products business has had since they have improved their EBITDA margin since 2011 by over 420 basis points in that time frame, 180 basis points of which was achieved in 2013.

Even in the first quarter of this year, if you adjust for temporary margin dilution of the Ashcroft acquisition and discretionary consulting expenses, the Railroad and Utility Products business segment would have shown adjusted operating margins of 70 basis points higher than the first quarter of last year.

As mentioned in our last call, we’ve been able to achieve $28 million of cumulative annual margin improvements from 2011 throughout the end of 2013, including the re-pricing of expiring contracts, the introduction of our creosote borate treating process at four of our wood treating facilities, the lower cost substitution of a key raw material in our chemical production process, the closure of our Australian carbon black facility at the end of 2011, the closures of a wood treating facility and a cogeneration facility in the United States in the third quarter of 2012 and ’13, respectively, and a reduction in pension expense which is in line with management’s goal of fully funding our U.S. plants

As for items in process that will continue this year’s margin improvement goals, they include the restructuring of our European operations through the ceasing of distillation activities at our Uithoorn facility in the Netherlands and a movement of those production volumes to other European facilities, also the restructuring of our Follansbee, West Virginia and Portland, Oregon facilities and various operations-focused projects, including productivity capital aimed at reducing plant operating costs and the continuous spillover improvements related to the some of the previously announced projects that have already been generating saving from 2012 and ‘13.

We are expecting generate over $13 million of improvements in 2014 related to the items just mentioned, which will 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 our January 2014 Ashcroft wood treating acquisition, both of which generate above segment margins when absorbed into large network of treating facilities. And finally, the projects just mentioned plus the addition of our creosote borate treating processes at three more of our facilities by the end of 2014 should contribute at least another $15 million of improvement in 2015.

And finally, the acquisition of the Osmose businesses should be accretive to our existing margins in its first full year in 2015 after transaction costs and the initial non-cash inventory purchase pricing (indiscernible) are out of the way and the integration is completed. This acquisition should have a significant impact on our progress towards achieving 12% EBITDA margins on a consolidated basis by the end of next year.

In regards to our progress on our third strategic priority of deploying capital in order to maximize returns, as mentioned on our last call, we have generated approximately $188 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 an average free cash flow generation at 5% of 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% share shares outstanding; $53 million has been used on growth areas such as the $37 million that was spent on our plant currently construction in China; and $16 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 contributions, plant rationalization and business developmental costs. The remaining $12 million resulted in an increase in cash on hand.

In the first quarter of 2014, we spent an additional $30 million for the Ashcroft acquisition and an additional $9 million was invested in the KJCC joint venture new plant in China. As mentioned earlier, the Osmose acquisition has a purchase price of $460 million which will be financed by a $300 million term loans and an upsized revolving credit facility.

While the Osmose acquisition is an amount that exceeds the high end of the range we had anticipated for M&A activity, the expected returns and the strategic fit were really the drivers for our decision to make this significant investment and increase our initial leverage above our long-term comfort level. As mentioned in our call on April 15, it is a priority for us to get our leverage down to the 3 times level within two years after closing.

Although debt pay-downs will become a higher priority for cash deployment, we expect to maintain our basic strategy of deploying cash for productivity projects, pension funding, dividends and share buybacks. We also plan to continue looking for opportunities to grow the business through acquisitions although they would likely be bolt-on type acquisitions of $50 million or less until our leverage gets closer to our target level of 3 times.

I would like to close by summarizing what we are expecting for 2014. As mentioned in our last earnings call, we are expecting a minimum revenue increase of 5% over 2013, excluding the impact of the Osmose acquisition. Contributing to that, will be our new China joint venture coming online mid-year and the addition of our new Canadian wood treating facility acquired in January. Potentially offsetting that would be any net reductions in carbon materials and chemicals volumes as our end markets continue to be challenged in all geographies, and any reductions we might experience in our crosstie business as the industry continues to deal with a shortage of green ties.

We do expect that sales and profitability will be stronger in the second half of the year as we no longer have to deal with the weather-related issues that we dealt with in the first quarter. We also will catch up on our crosstie procurements. The new China joint venture starts up in mid-year and we will begin to realizing profit accretion on the Ashcroft acquisition and move into the net benefit stage of our operational improvements.

From a profitability standpoint, similar to our last earnings call, I’m still not prepared to offer specific guidance, but I will start by reminding you of that $13 million of improvement we expect in the margin initiatives I spoke of earlier. In addition, better than average profit margins should be contributed by our new Canadian wood treatment acquisition.

Depending on the closing date, we could potentially receive a profit contribution from the Osmose acquisition, but it would likely not be significant as we will be incurring transaction costs and an initial non-cash purchase price amortization that will need to be expensed in the second half of this year.

As we are now anticipating an early shutdown of our KCCC facility in China, this will likely have up to a $3 million negative effect on our 2014 results compared to the prior year. 2014 has been and will continue to be very active for Koppers as we work on adjusting our asset footprint to better match our current and future expected businesses through rationalization from the mature geographies that we operate in while we bring up new capacity to serve the growth in the developing markets.

We’ve also been diverting a great deal of energy towards driving margin improvement to identify projects while we continue to look for more areas to reduce costs and enhance our profitability. And finally, we will hopefully be bringing the Osmose Wood Preservation and Railroad Services businesses under the Koppers’ roof sometime in early third quarter, which will meaningfully add to our existing businesses and move us closer to our long-term sales and profitability goals.

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

Question-And-Answer Session


(Operator instructions) Our first question comes from the line of Laurence Alexander with Jefferies LLC. Please go ahead.

Laurence Alexander - Jefferies LLC

Couple of questions. First, on the productivity, can you give us a sense for how much of the productivity falls into the back half compared to the first half?

Leroy Ball

The first half is basically the cost incurrence of implementing the project. So we’re going to have this cost running through in a similar level in the second quarter at which point we’ll start to realize the benefits.

We’ll actually for the year be in a net benefit position, so the back half we would expect to realize approximately $1 million more than the cost that we would have incurred during the first two quarters of this year which is probably in the -- it would probably in, call it, $2.5 million range.

Walter Turner

And just to add on to that, Laurence, as we said in the call, we ceased distillation activities at the Uithoorn facility mid-April and so by the time we get benefits of the added capacity that we have in new (indiscernible) most of it will be in the last (indiscernible).

Laurence Alexander - Jefferies LLC

And then, just secondly, with the Point Henry smelter shutdown, is that having any impact on your operations this year or is that more of an issue for 2015?

Walter Turner

We will, from the announcements that we’ve seen from Alcoa, Point Henry will cease smelting operations at the end of August. We will cease pitch shipments probably sometime end of June, early July, and on an annualized basis that equates to about 10,000 tons of pitch.

And our expectations are that we will be replacing most of that volume both at the other smelter that Alcoa operates in Portland as well as another smelter in Australia, so we’re hoping our expectations are that we can replace a majority of that lost pitch production.

Laurence Alexander - Jefferies LLC

Then just lastly, a quick one on the crosstie business, the lower inventory levels that you have now, how does that impact your incremental margins going forward?

Walter Turner

Using the vulcanizing process, first of all, we’ve not lost -- we’ve committed for all of our customer requirements, so that’s the good news. Vulcanizing obviously takes longer cycle time, almost twice as long, but there are costs built into pricing when we do vulcanize so pretty much we would let’s say breakeven with the vulcanizing process with the additional cost that we charge for that process.


Our next question comes from the line of Liam Burke with Janney Capital Markets. Please go ahead.

Liam Burke - Janney Capital Markets

Leroy, you talked about -- you talked about higher prices for crossties. With a lot of the growth in the crosstie business this year coming from corporate customers, where you actually take inventory of the ties, do you anticipate any kind of negative margin effect with that part of the business contributing a fair amount this year?

Leroy Ball

With where we’ve been out right now, it sort of works a little bit both ways. I mean we had, as a result of the lower purchases of the crossties and that being a kind of lower margin part of that business, we have had a little bit more of a positive mix effect. But on the other hand we’ve been hurt due to the lower throughput as a result of having less crossties come through to the plant.

I would say, yes, as in general -- the point that you bring out with prices moving higher on those untreated crossties, we’ll maintain our margin on that, but the fact that those prices will be going would have a little bit of a dilutive effect on our overall railroad margins. I don’t expect it to be significant and I do expect us to be able to more than offset that with some of the other things that we are doing in that part of the business.

Liam Burke - Janney Capital Markets

And then, Walt, and I apologize for asking this, but you talked about the China joint venture being on time, on budget. The Nippon Steel, half of the project, are they in line to allow you to begin to show some profit potential in 2015?

Walter Turner

Nippon Steel Sumikin Chemical they are about six months late in completing the construction of both their carbon black plant and the needle coke plant, so that’s why I mentioned that we are starting up in June to operate the plant at capacity which will be selling products into the Chinese domestic markets.

You may recall that on the carbon black plant that they are building, those sales will start immediately once they complete their project on that plant. And the needle coke plant the ramping up process, which will start December, January time frame so it’s going to take the six months that was lost for them to ramp up and get the product approval that sort of thing.

So that’s why we are taking advantage of operating our plants and until such time that they are ready to receive product from us for the needle coke production.


Our next question comes from the line of Ivan Marcuse with KeyBanc.

Unidentified Analyst

This is (indiscernible) sitting in for Ivan. I just want to follow up on your guidance and make sure I understand that correct. The second quarter improvements - you are expecting quarter-over-quarter improvements versus year-over-year? For you, year-over-year is also going to be still weaker, is that the correct way to think about?

Leroy Ball

Well, our guidance really has this -- with sales improving by 5% over last year sales, so sales will be just that, we’re projecting 5% higher than last year.

Walter Turner

In terms of profitability, I think you’re right in the context that what we were referring to I think in our scripted comments were that the second quarter would be sequentially better than the first quarter. I think as it relates to the prior-year second quarter, we really didn’t address it specifically within the call and really aren’t prepared to address it at this point.

Unidentified Analyst

And just to follow up on profitability in CMC segment, most of the year-over-year decline in margins was driven by lower phthalic anhydride prices. Is that correct?

Walter Turner

That was a major part for sure and also lower pitch volumes with a more challenging pricing environment in most of the geographies that we are supplying. So it’s a combination of those two primarily.

Unidentified Analyst

Could you provide a little bit more color on your expectations for phthalic anhydride prices going forward? Are you expecting them to stay at around $0.47, I think you said --?

Leroy Ball

Orthoxylene pricing is currently at $0.57 versus like an average of about that for the quarter compared to $0.71 prior quarter. So phthalic pricing is really based off of Ortho pricing, and so it’s difficult to say what’s going to happen.

As far as pricing goes, however, we are pretty optimistic about phthalic volume demand here for ourselves where we’re producing phthalic, but also hopeful in China with our naphthalene sales because of the phthalic demand growing over there.

Walter Turner

If pricing remains in the same general area as it is right now, at least we will be heading for better comparisons in the second, third and fourth quarter when ortho prices average more on the low to mid-$0.60 range. So the costs will be getting better.


Our next question comes from the line of David Wodiak with Healy Asset Management. Please go ahead.

David Wodiak - Healy Asset Management

In the second paragraph of the press release, it refers to the impairment and plant charges -- plant closure charges of $17.2 million pre-tax. Later in the paragraph it seems to say that the after-tax charge was $4.4 million. Could you go over why there is such a large difference between pretax and after-tax?

Leroy Ball

There is a large piece of that that is non-deductible. So we don’t get a tax benefit for a big piece of the charge out of Europe.


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

Chris Shaw - Monness Crespi

Has your ultimate earnings outlook for the -- or potential for the KJCC joint venture changed at all? I guess, over the short-term, maybe you would be less profitable if you are just -- because of delays from Nippon and because you are selling to the Chinese market. But, ultimately it still has the potential that I think you once talked about in the past?

Walter Turner

Ultimately, yes. And if you recall we have a very long-term contract with a specific pricing that will offer us higher margins beyond the normal margins that you’ll see on the China, and so to answer your question, the profitability based on start-up costs improve and we’ll not see much benefit in ‘14 and by the time we get to 2015 we should be getting into what we talked about as far as the kind of margins that we’re expecting there especially once Nippon gets their needle coke plant up and running.

Chris Shaw - Monness Crespi

Because of the delay from Nippon, would you still have been able to achieve the 12% EBITDA margins for ‘15, if you had not been acquiring Osmose?

Walter Turner

On average, our 12% EBITDA margin target?

Chris Shaw - Monness Crespi

I'm just wondering if the delay would have been -- provide Nippon with a net impact relative to that goal.

Walter Turner

No, I would say part of that would, Leroy I can’t --.

Leroy Ball

I still think that we communicated here within again our comments that with all the restructuring and improvement activities that we have going on and there are many in 2014 which is making things little bit complicated, I think we’re still expecting to be able to get to the 12% overall EBITDA margins in 2015 even with the delay in the KJCC, I mean that again is a headwind, but the in the grand big scheme of things, it’s not going to have that big of an overall impact on us being able to get to the 12% EBITDA margins.

Chris Shaw - Monness Crespi

Then, still looking at crossties, I can't remember, historically. When green crossties -- the prices go up and when prices go up, historically have your customers -- I mean, do they sort of budget a number of rail ties, a number for insertions? Or do they budget a dollar amount every year for insertions? And then so I'm just trying to figure out, is there -- do you think -- I mean, you talked about it a little bit, but will there be much of a volume impact do you think, because of the higher prices that they have to pay?

Walter Turner

Really, the railroads for the most part at least the major Class Is really look at their high insertion numbers more so than they do ex-dollars for tie insertions. And so they cost them a little bit more obviously this year for the tie insertions, but based on construction activities, based on making sure that the rails are up to speed, I don’t think we’ll see any reductions in plant insertion programs so it’s based on numbers versus cost.


Thank you. I would like to turn the conference back over to Mr. Turner for any closing remarks. Please go ahead, sir.

Walter Turner

Thank you, Cadia, and again we thank all of you for participating in today’s call and appreciate your continued interest in Koppers. We will continue to do the right things by pursuing growth opportunities that make sense for us as well as looking for ways to improve profitability within our existing businesses.

Despite facing challenges that we have in 2014 due to weather conditions, low aluminum and phthalic prices and crosstie availability issues, we do believe the diversity of our business along with our margin improvement and growth initiatives will continue to provide us with a relative stability in both strong and weak economic climates.

And finally, we remain firmly committed to enhancing shareholder value by maintaining our strategy, providing our customers with the highest quality products and services while continuing to focus on safety, health and the environmental issues with the initiatives that we have. And thank you for being with us today.


Thank you. Ladies and gentlemen, this does conclude our conference for today. Thank you for your participation. You may now disconnect.

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