SunCoke Energy, Inc.
Q4 2013 Earnings Call Transcript

Published: 30 Jan 2014

[Operator:]

Welcome to the SXC Earnings Call. My name is Adrienne, and I'll be your operator for today's call. [Operator Instructions] Please note, this conference is being recorded. I'll now turn the call over to Ryan Osterholm. Ryan Osterholm, you may begin.

[Ryan Osterholm:]

Thank you, Adrienne. Good morning, everyone. Thank you for joining us on the SunCoke Energy fourth quarter 2013 earnings conference call. With me are Fritz Henderson, our Chairman and Chief Executive Officer; and Mark Newman, our Senior Vice President and Chief Financial Officer. Following the remarks made by management, the call will be opened for Q&A. This conference call is being webcast live on the Investor Relations section of our website at www.suncoke.com. There will be a replay available on our website. If we don't get to your question during the call, please call our Investor Relations Department at [phone]. Before I turn over the call to Fritz, let me remind you that the various remarks we make about future expectations constitute forward-looking statements, and the cautionary language regarding forward-looking statements in our SEC filings apply to the remarks on our call today. These documents are available on our website as are reconciliations of any non-GAAP measures discussed on this call. Now I'll turn it over to Fritz.

[Frederick A. Henderson:]

Thanks. Good morning. Thank you, Ryan. A quick look at our fourth quarter and fiscal year '13 earnings. We delivered -- SunCoke Energy delivered on the '13 adjusted EBITDA guidance, albeit at the lower end of the revised range. Well, the fourth quarter was weak. And I wanted to talk a little bit about why. They were impacted by 3 -- really 3 things

[Mark E. Newman:]

Thanks, Fritz, and good morning. As Fritz indicated, Q4 was a weak ending to an otherwise good year. Focusing in our -- on our adjusted EBITDA results in the quarter, we reported adjusted EBITDA of $59.7 million versus $69.7 million in the prior year. With really weakness coming in a couple of key areas. First, as Fritz indicated, Indiana Harbor was the lower expectation, and I'll cover the year-over-year comparison in a minute. Additionally, we did have an accrual in the quarter of $2.5 million related to some quality issues at our Jewell Coke facility. And then finally, coal, sequentially to Q3 and year-over-year, was weaker, but the results there were also impacted by some adjustments, namely a $2.3 million mark-to-market on coal inventory and then unfavorable $1 million Black Lung liability adjustment in the quarter. On a full year basis, we reported adjusted EBITDA of $215 million versus $265.7 million. In the prior year and as you'll notice in the chart, the year-over-year deterioration is more than accounted for by our Coal Mining segment with coke and corporate costs being relatively flat and Coal Logistics being additive, a new business for us, in calendar year 2013. Turning to Chart 5. Cover the adjusted EBITDA bridge for the quarter. Again, $59.7 million versus $69.7 million, $10 million lower in the prior year. If you look at our Domestic Coke business, excluding Indiana Harbor, it was actually up slightly and the $3.1 million is inclusive of the unfavorable accrual related to the quality claim at our Jewell Coke facility. Indiana Harbor, on a year-over-year basis, was down relative to its performance by around $8 million. We have shown here the impact of the contract renewal relative to the volumes we've produced in the quarter, which is favorable by $3.3 million. And then I'll just remind the group that last year in Q4, we had a favorable billing adjustment of $4.2 million, so that results in an unfavorable year-over-year comparison. International coke was up $3.4 million in the quarter. In part, due to the results at our Indian Joint Venture, VISA SunCoke, where we had both favorable operating performance, as well as foreign exchange activity that resulted in a $2.2 million uplift. As I said earlier, Coal Logistics, is a new business for us and is performing in line with the expectations at the time of the acquisition. Coal Mining unfavorable $14.9 million, again, is inclusive of the $2.3 million mark-to-market on coal inventories and the $1 million Black Lung adjustment, and, again, really reflects the significant year-over-year price, which was somewhat mitigated by the work that we've done on coal cash cost. Finally, Corporate is favorable, in part driven by $4.4 million favorable Black Lung adjustment. Maybe I'll just explain that we have 2 populations within our Black Lung. We have some legacy mines that were closed a long time ago in Kentucky, and this population we have had favorable actuarial adjustments and, obviously, a higher discount rate, whereas in our Jewell Coal Mining segment, where we have an active mine population, we've actually had higher claims. So in spite of the higher interest rate, we actually had a negative Black Lung adjustment in Coal Mining and a favorable adjustment in our Corporate segment. Turning to our full year comparison on Chart 6. We ended the year at $215.1 million of adjusted EBITDA, down from $265.7 million in the prior year. Again, if you look at our coke business, excluding -- our Domestic Coke business excluding Indiana Harbor, we were favorable $9.6 million inclusive of the unfavorable accrual. Most of this favorability comes from Middletown and Haverhill, which, as you know, are inside of the MLP, 65% is owned by the MLP. And this explains the relatively favorable SXCP results, which we reported earlier. Indiana Harbor, on a full year, is down roughly $15 million. Again, we noted here the contract renewal impact, which only impacted Q4 and the Q4 billing adjustment. Looking at International Coke, for the full year, primarily better results from our Brazilian operations with India, essentially a breakeven on a full year basis. Coal Logistics, again, favorable $4.7 million. And then, finally, the big negative on this chart, which I'll cover in more detail later, really relates to our Coal Mining business, where our realized coal prices for the full year were down about $49. That's $167 in '12 versus $118 in '13. And then finally, we did improve cash costs by about $19 a ton, on a full year basis where our full year cash cost in '12 were $145 versus $126 in calendar year '13. Corporate costs were slightly unfavorable and really reflects a number of puts and takes. I will just remind the group that we have the cost related to running the MLP in the full year results, inclusive of the $1.8 million payment to DTE, related to the Lake Terminal acquisition. Chart 7 is a chart that we added to compare the guidance that we provided, the EBITDA guidance, at the beginning of the year versus where we ended up. So again, if we took --if we take, starting from the left of the chart, our full year guidance adjusted EBITDA of $205 million to $230 million. And we simply take the midpoint of that range, which would be $217.5 million. We would then walk across to our full year results of $215.1 million. Again, Domestic Coke, excluding Indiana Harbor, quite favorable versus our full year expectations at the time we provided guidance. Indiana Harbor, which really earned $3 million in adjusted EBITDA for the full year, is down versus our expectations and, obviously, we had curtailed our expectations based on the refurbishment project, which was underway. But quite frankly, the project is proving more difficult and its impact on operating results more severe than we expected at the beginning of the year. International Coke is in line with expectations with Brazil doing better and India doing worse, and then Coal Logistics was not included at the time we provided guidance. Finally, Coal Mining, we provided a guidance range of $0 to minus $15 million on an adjusted EBITDA basis. So if assume a midpoint of that of $7.5 million, our results of $18.7 million negative are down roughly $11 million versus the initial guidance. And then finally, Corporate costs ended up being slightly favorable in part due to some of the adjustments we took in Q4, primarily related to black lung, but somewhat offset by higher acquisition cost and the cost of running the MLP. Turning to Chart 8. The EPS walk. First for the quarter, the results -- the EPS deterioration from our prior year where we reported $0.39 versus $0.16 in the quarter, is primarily driven by the lower EBITDA and the equity income losses related to our Indian joint venture. Indiana Harbor depreciation, which we've been calling out all year, was $0.02 in the quarter, with roughly a $0.01 attributable to accelerated depreciation. We are picking up also depreciation related to our newly acquired Coal Logistics business. Taxes, they are favorable, really based on the lower earnings, as well as the income that is attributable to our SXCP public unitholders. On a full year basis, we reported EPS of $0.36 versus $1.40 in the prior year, again, driven by lower EBITDA performance, higher depreciation at Indiana Harbor where the accelerated depreciation is $0.14 for the full year. And again, taxes being favorable on the basis of lower earnings and earnings attributable to SXCP. We also had slightly higher interest expense as a result of the transactions that we took on in the year, namely, the IPO and the debt issuance at the MLP, as well as the repayment of debt at the parent. When I look at our full year tax rate, we came in for 2013 at approximately 11.4%. Which was a little lower than our guidance based on the lower earnings. Our cash tax rate for the full year was higher than our guidance of 25.9%. We actually made some estimated payments that in retrospect we didn't need to make and will result in refunds in early next year. So our cash tax rate for next year, we actually, expect to be lower than the guidance that we provided in December. And we'll cover that later. Turning to Chart 9, our Domestic Coke business summary. Again, production in the quarter of 1.056 million tons was low, really, related to Indiana Harbor. Our EBITDA per ton in the quarter was approximately $54. I think for the full year, we are at $57, in line with our guidance. Obviously, the EBITDA per ton in Q4 impacted by both Indiana Harbor, as well as the $2.5 million quality accrual that I spoke about earlier. Finally, we've added a chart here that shows our coke sales by customer, and we were able to sell roughly 38,000 tons on the spot market to a fourth customer, which really allowed us, in Q3 and Q4, to run above contract maximums for the full year at Haverhill and our Jewell Coke facilities. Turning to our India coke chart on Chart 10. Again, we reported $2.2 million of adjusted EBITDA in Q4. You'll see the improvement in capacity utilization from the prior quarter. So at this point, we have relatively stable operations. We have high-capacity utilization and we've seen some reversal in terms of the strengthening of the rupee from where we were earlier in the year, which impacted us favorably in the quarter. I'm pleased to report that we now have our FX hedging program in place, and we have also completed our trade credit facilities of approximately $50 million equivalent, which will allow us to run the plant at the optimum levels of inventory. The market in India, the coke market remains weak. We really do not expect significant change in the first half. Our Indian colleagues tell us that until after the general election in April, we should expect the market to remain weak. With the FX hedging and trade credit facilities now in place, our focus really is on running the business for profitability and cash flow going forward. Turning to Coal Mining on Chart 11. Again, our EBITDA results were down approximately $15 million in the quarter on a year-over-year basis, driven, again, by weak coal prices, down roughly $48 on a year-over-year basis and, partially offset by lower cash costs. We're down only $11 in Q4, which was not a strong quarter for us, but on a year-over-year basis, we're down approximately $19 to the average of $126 per ton. Again, our results in the quarter were impacted by the $2.3 million mark-to-market inventory adjustment and the Black Lung, the increase in our Black Lung liability. Additionally, I'd say from an operating perspective, we had some geology challenges in the quarter, and we had 9 fewer working days. Our full year adjusted EBITDA of $18.7 million came in somewhat below the lower end of our range. Again, if I look at the $3 million related to both Black Lung and the mark-to-market in Q4, we feel like we were somewhat close to the range for the full year and we continue to expect for 2014, an adjusted EBITDA range of a loss of $20 million to $30 million on an adjusted EBITDA basis. Turning to SXC liquidity. We ended the quarter with our cash balance on a consolidated basis at $233.6 million. If you look at the change in cash, what you'll notice is that most of their reduction in cash occurred at the MLP, at SXCP, where effectively we drew down our cash balances and did a $40 million draw on the revolver to fund the $84.7 million acquisition of KRT. So this was a planned use of excess cash and the revolver to fund what was a very good acquisition. If you look at the operating performance, the operating cash flows in the business, in addition, to the earnings and depreciation, we had favorable working capital of $19.5 million in the quarter. This is even in spite of the extension of payment terms of approximately $21 million, which we provided to AK Steel, related to shipments from Middletown in December. We also had a buildup of our interest payable, which is paid twice a year in February and August in the quarter. For the full year, as Fritz mentioned at the outset, we achieved cash flow from operations of approximately $151 million, even after taking into account the $21 million of extended payment terms to AK, as well as the payment of $30 million in sales discount throughout the year. And I'd say, in addition to our strong focus on operating performance, we have really sharpened our focus on both inventories and all other forms of working capital at our plants, and it paid big dividends this year. So with that, I'll turn the call back to Fritz.

[Frederick A. Henderson:]

Thanks, Mark. Just looking again at 2014 consolidated guidance. Today, we are affirming our 2014 earnings guidance, although, as I mentioned earlier, we do expect the first quarter to be challenged by the impact of severe weather, particularly in January. We have to see what the weather is in February. The impact in January in production, about 45,000 tons in total across all of our coke fleet, about half of that felt at Indiana Harbor. So I'd just give you some sense over all. In looking at the individual components, the 2 things that we would modify today, CapEx up from $110 million to $117 million, that's largely because of Indiana Harbor spending more, as I mentioned earlier, than we originally thought. And then, our cash tax rate being down from the prior guidance, 16% to 22% to 10% to 18%, largely, as Mark mentioned, as a result of the refund we expect to receive. So nothing of significant note here. Let's turn to the next chart, Strategic Considerations. Those of you who have followed us, which just about everybody in this call has, since SunCoke Energy was born in July of '11, knows that we were born from a tax-free spin from Sunoco. As part of that spin, we made certain representations to Sunoco and signed a tax sharing agreement that contained a number of provisions and limitations. Important ones that had to do with restructuring of the business really had a 2-year tail after the distribution date. The distribution date took place in January of '12. January 18 saw the conclusion of those limitation, and which does provide and expands both our strategic and our restructuring flexibility going forward. So what we plan to do is the following

[Operator:]

[Operator Instructions] And we have Neil Mehta from Goldman Sachs on the line with a question.

[Neil Mehta:]

This might be premature, but can you talk about what you mean in the press release and in the slides about exploring Coal Mining strategic alternatives? Is exiting the business altogether one of the options on the table? And if so, what are the gating factors that may exist to actually practically achieving that?

[Frederick A. Henderson:]

I'd say all options are on the table today, Neil, so this is premature question, but all options are on the table, which could include that, which could include exiting. But that's 1 of the number. I think the 1 option that I don't have on the table is the status quo. We think we need to do something different from where we are today. So gating factors, obviously, are first and foremost, for us, the supply of coal on a cost-effective basis to our coke plant. We can buy coke -- excuse me coal. We do that obviously, on our other coke plants. We actually do that in Jewell, as well, but we want to make sure that we have a good source of supply, longer term, for this very important Jewell Coke asset. The second is, my view is any transaction, I would want to have the ability to make the coal business more competitive. We lack scale in this business. We are small, obviously, in a world of much larger miners. And I'd like to have a transaction to improve the competitiveness of the mining operations in Jewell. Third, we wouldn't look for something -- if we were to do a transaction, obviously, one question sometimes asked in these sorts of matters is do you have a price in mind? We actually -- we're very flexible on structuring, as to how we would look at coal. Because we have the flexibility to consider alternative structures that might, for example, allow us to preserve upside going forward, while potentially moving the operating responsibility to another party. So we are pretty flexible on structuring, actually, is what I would say, and which is why we need to take time now with our Board to consider our strategic option.

[Neil Mehta:]

Got it. And then the second question is, you think about the suite of opportunities for you from a tuck-in M&A perspective, can you talk about, which verticals do you see the most right for opportunity for potential acquisition?

[Frederick A. Henderson:]

So obviously, this is an area where prognostication is reckless risk, but let me at least take a shot at it. I think Coal Logistics actually is a big area out there. There's a lot of activity. We now have a management team in place that came with us with KRT. And in scenarios, I think of 2014, that we're going to continue to plum this because we think we have some interesting opportunities. The deals can be smaller, but given the size of our MLP, even small deals can be accretive and nicely accretive. So we're going to work on that. We've done a lot of work on coke plants. We know what coke plants might be of interest to us in terms of acquiring existing coke plants. I think in this one, we're going to be patient actually, because you've got to have 2 parties that are interested in doing a deal. And so we've done the work, we've done all the diligence, and I would say, we would be open to do this in a number of certain coke plants. But we're going to be patient, we're going to see whether or not counter-parties might have an interest. It's not like there's hundreds of coke companies out there. So that will be second. Third, in terms of our greenfield projects, this would not generate adjusted EBITDA until 2017. So this is more about working with customers to address their longer-term coke needs, and if we're successful, beginning a project later this year. So I would say, in terms of tuck-ins or bolt-ons or whatever we want to call it, Coal Logistics is the area where we see the most fertile ground in 2013.

[Operator:]

And we have Nathan Littlewood from Crédit Suisse on line with a question.

[Nathan Littlewood:]

Just wondering, in relation to this whole dropdown scenario, I appreciate it may be a little bit too early here. But is there any metrics or guides that you could perhaps give us for thinking about the rate at which that might occur, are there some sort of target multiples that you would want to keep in mind or within?

[Frederick A. Henderson:]

Nathan, no and no. Because I think this is really an area where we want to engage with the Board. We also need to engage not only with the Board at SunCoke Energy, we need to engage with the 3 independent Directors of SunCoke Energy Partners, which constitute the complex committee. So we have work ahead of us. Obviously, these are key things. I mean, the multiple of which a transaction would be done as a dropdown is a critical item. But at this point, we don't have any parameters we could share with you.

[Nathan Littlewood:]

Got it. You guys might have to sell tickets to this thing in March. It sounds like a popular event.

[Operator:]

And we have Brett Levy from Jefferies in line with the question.

[Brett M. Levy:]

As you look at strategic alternatives, I mean, it's not a gigantic met coal mine. What are the approximate costs of sort of shutting this down for a period of time and then opening it back up again, when prices return to more normal levels? I mean, is there a ballpark size of that, have you guys figured that out yet?

[Frederick A. Henderson:]

No. Actually, we haven't figured that out yet. It's obviously, you need to consider all alternatives which could include that. We haven't done any real work on that yet. But that's something that we're going to evaluate here as we consider what our fallback alternatives are. So that would not be our preference, but you have to consider what your alternatives are. We have idle mines, we know what it costs to hot idle a mine, and it's not inconsiderable but it's also not -- it doesn't break the bank. So I think our preference is to figure out how we structure the mine and how we work with potential partners in the mine. At the same time, we'll be quantifying what the impact might be of hot idling mines or even coal idling mines, if we need to.

[Brett M. Levy:]

And then as AK is basically sort of suspended their investment in AK coal, does that have any impact on the amount of business you guys do with them at Middletown or Ashland or anything like that kind of in the out years?

[Frederick A. Henderson:]

No. And in mining, it's really contracted for an annual basis. We don't have anything that goes beyond 1 year. So we haven't seen the impact now and -- but I don't really know how to think about it beyond 1 year.

[Operator:]

We have Lucas Pipes from Brean Capital online with a question.

[Lucas Pipes:]

My first question is on Indiana Harbor. Could you maybe give us a quick update on where you stand in the refurbishment today, how much more work do you think needs to be done? And then, I'm kind of thinking about a quarter-over-quarter throughout the year improvement at this oven. Is this the right way to think about it or are there kind of inflection points where it's then going to be fixed and earnings could -- and the profitability at that plant could maybe increase a little bit more quickly in any particular period?

[Frederick A. Henderson:]

Okay. So status of oven refurbishment, which is the, I'll call it, the main body of work that we're taking on Indiana Harbor. There are 4 coke batteries in Indiana Harbor, 3 of which are done. The fourth of which is part done. And we had been making good progress on it until the weather has hit us pretty hard, actually, hit us very hard. But I would say that we feel like we -- at one point, had the weather been, I'll call it more reasonable, and going into the fourth quarter, we thought we might be able to finish that fourth battery by about now, or early February and it's, frankly, taken us a little longer given all the other issues we've had. So it gives you a sense on the ovens, on cleaning tunnels, which is more expense money actually than it is capital. We've gotten good progress in that. But again, that's been slowed by both production, as well as the weather. Equipment itself is on order. We anticipate to push the charging machine, which is a principal equipment we've ordered was going to come into the second quarter anyway. I think the real issues has been -- on, particularly, on upsizing the size of the project has been the inability to -- we have the trades, we're just not able to complete the work as quickly as we would like. But we're well along. But it's just not done and we would've liked to have been pretty much done at this point. In terms of your second question on quarter-over-quarter improvement, we mentioned when we provided the guidance and we had a chart on journey of Indiana Harbor that we anticipated the Indiana Harbor would accelerate pretty much in the second half of this year. We thought the second quarter would -- the customer has expected planned outage for their major blast furnace there. So we anticipated production to be restrained in the second quarter, obviously, the impact in the first quarter -- has been impacted more by weather than it has been by the -- any outage per se. But as I look at Indiana Harbor in terms of its rate of improvement, we certainly think the rate of improvement will be back-end loaded in 2014.

[Lucas Pipes:]

Okay. That's very helpful. And then, as a follow-up from what I understand, you've made great progress on the permitting of the new Kentucky facility. Is it fair to say that the previous timetable still holds that in the May or so we should have -- you should have a final permit for this facility? And in anticipation of that, when do you expect to increase your negotiations with potential off-takers for this facility? And how do you expect those to evolve?

[Frederick A. Henderson:]

One step at a time. So we got the draft permit in December. We go through a 1-month public comment period, I think, that's just about ended actually and we're collecting the comments now, we'll analyze them to figure out what changes, if any, need to be made. You then submit your proposed modifications. We anticipated a final permit to be issued in the first quarter of this year [indiscernible] and still think that's a reasonable estimate. So I don't think there's any change in timing there. Obviously, we need to evaluate the comments that have been provided to see whether or not -- we haven't done that yet. So let me kind of go to the -- in my mind, the more gating item, which is customer commitment. As we look out at their market today with this permit, we've had preliminary dialogue with customers on this. We'll now have a permit with a plant, with the size, with the capital cost, with the various things that we need to be able to provide more firm quotes, if you will, to customers, as we get into the spring and summer. I anticipate, as I mentioned before, if this plant is built, it will be likely built as a multi-customer plant. Haverhill today is a multi-customer plant. But it's, interestingly, was not built that way. It was built in 2 modules, each with 1 customer. This is a plant that will be built for multi-customer. So I don't think that any single customer would take on the 660,000 tons of capacity that we've tied to that, #1. #2, I don't -- I think that contract terms of this plant would be more flexible. Given our size, I think we can be more flexible now, but the traditional 15-year long-term take-or-pay for the entire plant will likely to have more flexibility required around that than we've historically done. And we can manage that within our overall coke fleet capacity. And then, third, interestingly, a multi-customer plant, you need to have some agreement with who those customers are as to coal blend and coal blending, because you're going to have to have more consistency across the plant and, historically, we've done coal blend in -- that are specific to a customer and specific to a plant. You're going to run a multi-customer plant, you're going to have something which is more generic. But you certainly going to have to want to manage a more consistent blend across customers. All of that, I kind of dived into the weeds, let me come back out, and we're going to be in dialogue with customers spring and summer of this year, I think. And if we're successful, we'd break ground later this year. And we'll start producing coke EBITDA in the first quarter of '17. But we're not going to break ground on this plant without having some reasonable proportion of this plant capacity spoken for on a committed basis. We're not going to build the plant on spec.

[Lucas Pipes:]

Okay. And reasonable, is that 70%, 80%. What do you -- what do you think is the cut off?

[Frederick A. Henderson:]

Interestingly there, that's a very good question, and I've asked myself that question before. I would say 70% is probably a reasonable number. If you had -- if you were 65% and you had -- you knew you had high confidence about something else, you would probably do that. So I don't think it's a hard and fast number, but I certainly think 70% is a good reasonable number because then we'd be talking about a couple of hundred thousand tons within the 660,000 be available for merchant. It's not a bad mix, actually. That would be a pretty good basis for us.

[Operator:]

[Operator Instructions]

[Frederick A. Henderson:]

I think, at this point, we -- I'm advised by Lisa that we don't have any other questions. Again, I want to thank everybody for your time this morning, for your interest in SunCoke Energy. And a lot of good work to do. I'm not sure we'll be selling tickets to our Analyst Meeting in March. But I really appreciate your interest in the company and look forward to the future discussion. Thanks very much.

[Operator:]

Thank you, ladies and gentlemen. This concludes today's conference. Thank you for participating. And you may now disconnect.