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KOPPERS HOLDINGS INC. filed this Form 10-Q on 11/09/2017
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hardwood lumber for railroad crossties, scrap copper prices, and the cost and amount of coal tar available in global markets, which is negatively affected by reductions in blast furnace steel production; (iii) volatility in oil prices, which impacts the cost of coal tar and certain other raw materials, as well as selling prices and margins for certain of our products including carbon black feedstock, phthalic anhydride, and naphthalene; (iv) competitive conditions in global carbon pitch markets; and (v) changes in foreign exchange rates.

Railroad and Utility Products and Services

The primary end-market for RUPS is the North American railroad industry, which has an installed base of approximately 700 million wood crossties that require periodic replacement. As a result, demand has historically been in the range of 22-25 million wood crossties annually. We sell treated and untreated wood products, rail joint bars and services primarily to the railroad markets in the United States and Canada, and utility poles to the utility sector in Australia. We also operate a railroad services business that conducts engineering, design, repair and inspection services primarily for railroad bridges in the U.S. and Canada.

The supply of untreated crossties can vary at times based upon weather conditions in addition to other factors. We have a nationwide wood procurement team that maintains close working relationships with a network of sawmills. The first component of our revenue stream for many of our largest customers occurs when we procure the untreated crossties, on behalf of our customers, at a nominal markup. This practice provides the railroad customers with an assured level of inventory and minimizes our working capital usage as untreated crossties go through a six- to nine-month air seasoning process before they are ready to be pressure treated. The next phase involves the RUPS segment providing value-added services to customers through treating crossties, switch ties and various types of lumber used for railroad bridges and crossings. The processes include creosote-only treatment and a combined creosote and borate treatment. During any given year, there is a seasonal effect in the winter months on our crosstie business depending on weather conditions for harvesting lumber and installation.

In 2017, the major companies in the rail industry have substantially reduced both operating and capital spending from peak spending levels, which has had a negative short-term impact on sales of various products and services that we provide to that industry. Current year revenues and profitability have reflected a decline year-over-year due to the effects of lower demand caused by continued reductions in capital budgets for most North American Class I railroads. The lower demand has caused the market to reduce raw material purchase prices primarily in the Eastern U.S. which will further reduce our revenues in the near-term and have some impact on our profitability as well. Furthermore, the lower demand has also resulted in price reductions for the products we supply the commercial railroad business as competition to replace the lower Class I demand for crossties has increased. We currently supply all seven of the North American Class I railroads and have long-standing relationships with these customers.  Approximately 70 percent of our North American sales are under long-term contracts and we believe that we are positioned to maintain or grow our current market position.

Overall, the long-term prognosis for the railroad industry and the products and services that we provide to it remains favorable. Currently, the railroad industry is managing the cyclical downturn in the oil and gas industry, while looking to replace demand lost due to a long-term reduction in coal production. At the same time, the railroads are building their revenue base of shipments of non-energy related products. In the near term, railroad customers have scaled back and are focusing on cutting their operating costs and working capital. The Association of American Railroads (“AAR”) reported that the total U.S. rail carload traffic for the nine months ending September 30, 2017 was up 3.8 percent year-over-year and intermodal units were 3.5 percent higher than prior year period. Together, the total combined U.S. traffic for the year-to-date period through September 30, 2017 increased 3.6 percent compared to last year and is expected to continue posting mid-single digit year-over-year growth. While there has been a decline in coal transportation due to low natural gas prices and environmental concerns regarding the burning of coal, all other major categories of freight have exceeded expectations thus far in 2017. According to the AAR, the overall levels of railroad investment are forecast to be $22 billion in 2017, a decline from $25 billion in 2016 and $29 billion in 2015. It is expected that the reduction in coal transport will likely persist; however, the spending by the railroad industry is projected to improve modestly in 2018 as the economy continues to trend favorably and interest rates remain relatively subdued. From a long-term perspective, there remains a need for sustained investment in infrastructure and capacity expansion. We believe that with our vertical integration capabilities in wood treatment and strong customer relationships, we will benefit from increased infrastructure and capacity expansion when it occurs.