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SXC > SEC Filings for SXC > Form 10-Q on 1-Nov-2012All Recent SEC Filings

Show all filings for SUNCOKE ENERGY, INC. | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for SUNCOKE ENERGY, INC.


1-Nov-2012

Quarterly Report


Item 2. Management's Discussion and Analysis of Financial Condition and Results of Operations

This Quarterly Report on Form 10-Q contains certain forward-looking statements of expected future developments, as defined in the Private Securities Litigation Reform Act of 1995. This discussion contains forward-looking statements about our business, operations and industry that involve risks and uncertainties, such as statements regarding our plans, objectives, expectations and intentions. Our future results and financial condition may differ materially from those we currently anticipate as a result of the factors we describe under "Cautionary Statement Concerning Forward-Looking Statements."

Unless the context otherwise requires, references in this report to "the Company," "we," "our," "us," or like terms, when used in a historical context (periods prior to July 18, 2011), refer to the cokemaking and coal mining operations of Sunoco prior to their transfer to the Company in connection with our separation from Sunoco (the "Separation"). References when used in the present tense or prospectively (after July 18, 2011) refer to SunCoke Energy, Inc. and its subsidiaries.

This "Management's Discussion and Analysis of Financial Condition and Results of Operations" is based on financial data derived from the financial statements prepared in accordance with U.S. generally accepted accounting principles ("GAAP") and certain other financial data that is prepared using non-GAAP measures. For a reconciliation of these non-GAAP measures to the most comparable GAAP components, see "Non-GAAP Financial Measures" at the end of this Item.

Overview

We are the largest independent producer of coke in the Americas, as measured by tons of coke produced each year, and have 50 years of coke production experience. Coke is a principal raw material in the integrated steelmaking process. We have designed, developed and built, and own and operate five cokemaking facilities in the United States ("U.S."). Our fifth U.S. cokemaking facility in Middletown, Ohio was recently completed and commenced operations in October 2011.

During 2011, we sold approximately 3.8 million tons of coke to our three primary customers in the U.S.: ArcelorMittal, U.S. Steel, and AK Steel. With the completion of our Middletown facility, our total U.S. cokemaking capacity has increased to approximately 4.2 million tons of coke per year. We also operate a cokemaking facility in Brazil under licensing and operating agreements on behalf of a Brazilian subsidiary of ArcelorMittal. The Brazilian facility is the largest cokemaking facility that we operate, with production capacity of approximately 1.7 million tons of coke per year.

All of our U.S. coke sales are made pursuant to long-term take-or-pay agreements. These coke sales agreements have an average remaining term of approximately 10 years and contain pass-through provisions for costs we incur in the cokemaking process, including coal procurement costs, subject to meeting contractual coal-to-coke yields, operating and maintenance expenses, costs related to the transportation of coke to our customers, taxes (other than income taxes) and costs associated with changes in regulation. The coke sales agreement and energy sales agreement with AK Steel at our Haverhill facility are subject to early termination by AK Steel beginning in January 2014 under limited circumstances and provided that AK Steel has given at least two years prior notice of its intention to terminate the agreements and certain other conditions are met. In addition, AK Steel is required to pay a significant termination payment to us if it exercises its termination right prior to 2018. No other coke sales contract has an early termination clause.


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The following table sets forth information about our cokemaking facilities:

                                                                                                                      Cokemaking
                                                                          Year of      Contract     Number of          Capacity
Facility                              Location             Customer       Start Up    Expiration    Coke Ovens    (thousands of tons)     Use of Waste Heat
Owned and Operated:
Jewell                         Vansant, Virginia         ArcelorMittal      1962         2020          142                720            Partially used for
                                                                                                                                         thermal coal drying
Indiana Harbor                 East Chicago, Indiana     ArcelorMittal      1998         2013          268               1,220           Heat for power
                                                                                                                                         generation
Haverhill Phase I              Franklin Furnace, Ohio    ArcelorMittal      2005         2020          100                550            Process steam
Phase II                       Franklin Furnace, Ohio    AK Steel           2008         2022          100                550            Power generation
Granite City                   Granite City, Illinois    U.S. Steel         2009         2025          120                650            Steam for power
                                                                                                                                         generation
Middletown(1)                  Middletown, Ohio          AK Steel           2011         2032          100                550            Power generation

Total                                                                                                  830               4,240

Operated:
Vitσria                        Vitσria, Brazil           ArcelorMittal      2007         2023          320               1,700           Steam for power
                                                                                                                                         generation

Total                                                                                                 1,150              5,940

(1) Cokemaking capacity represents stated capacity for production of blast furnace coke. Middletown production and sales volumes are based on "run of oven" capacity, which include both blast furnace coke and small coke. Middletown capacity on a "run of oven" basis is 578 thousand tons per year.

We also own and operate coal mining operations in Virginia and West Virginia that sold approximately 1.4 million tons of metallurgical coal (including internal sales to our cokemaking operations) in 2011. In January 2011, we acquired the Harold Keene Coal Co., Inc. and its affiliated companies ("HKCC") whose results are included in the Coal Mining segment from the date of acquisition. Our mining area consists of 14 active underground mines, two active surface mines and two active highwall mines, as well as three preparation plants and four load-out facilities in Russell and Buchanan Counties in Virginia and McDowell County, West Virginia.

Our Separation from Sunoco

On January 17, 2012 (the "Distribution Date"), we became an independent, publicly-traded company following our separation from Sunoco, Inc. ("Sunoco"). The Separation occurred in two steps (the "Separation"):

• We were formed as a wholly-owned subsidiary of Sunoco in 2010. On July 18, 2011 (the "Separation Date"), Sunoco contributed the subsidiaries, assets and liabilities that were primarily related to its cokemaking and coal mining operations to us in exchange for shares of our common stock. As of such date, Sunoco owned 100 percent of our common stock. On July 26, 2011, we completed an initial public offering ("IPO") of 13,340,000 shares of our common stock, or 19.1 percent of our outstanding common stock. Following the IPO, Sunoco continued to own 56,660,000 shares of our common stock, or 80.9 percent of our outstanding common stock.

• On the Distribution Date, Sunoco made a pro-rata, tax free distribution (the "Distribution") of the remaining shares of our common stock that it owned in the form of a special stock dividend to Sunoco shareholders. Sunoco shareholders received 0.53046456 of a share of common stock for every share of Sunoco common stock held as of the close of business on January 5, 2012, the record date for the Distribution. After the Distribution, Sunoco ceased to own any shares of our common stock.


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Third Quarter Key Financial Results

• Revenues increased 19.1 percent in the three months ended September 30, 2012 to $480.5 million primarily due to higher sales in our Other Domestic Coke segment driven by contributions from our Middletown facility.

• Net income attributable to stockholders increased $13.4 million for the three months ended September 30, 2012, to $31.6 million, or $0.45 per share, compared with the three months ended September 30, 2011. This increase is due to the contribution of our Middletown facility and the strong performance of our cokemaking operations, offset by an increase in our interest cost as a stand-alone company.

• Adjusted EBITDA was $72.4 million in the three months ended September 30, 2012 compared to $44.8 million in the same period prior year, an increase of $27.6 million. This increase was driven by the successful ramp up of production at our Middletown facility and reduced corporate expenses.

Recent Developments and Outlook

• Indiana Harbor refurbishment. The initial term of our Indiana Harbor coke sales agreement ends on September 30, 2013. In preparation for negotiation of a new long-term contract, we conducted an engineering study to identify major maintenance projects necessary to preserve the production capacity of the facility. In accordance with the findings of this engineering study, we expect to spend approximately $50 million in the 2012 through 2014 timeframe to improve the reliability of the facility, of which approximately $10 million will be spent in 2012. This estimate includes anticipated spending that may be required in connection with the settlement of the Notices of Violation ("NOV") at our Indiana Harbor facility. While we believe that there is a reasonable likelihood that we will reach agreement with our customer for a new long-term contract, such an agreement may not be reached. The actual level of capital expenditures may depend upon the terms of an eventual agreement with our customer.

• Timing of potential new U.S. plant. We are currently discussing opportunities for developing new heat recovery cokemaking facilities with domestic and international steel companies. Such cokemaking facilities could be either wholly-owned or developed through other business structures. As applicable, the steel company customers would be expected to purchase coke production under long-term contracts. The facilities would also generate steam or electricity for sale. We originally estimated that this plant could have a capacity of up to 1.1 million tons, but now believe a smaller facility size with 120 ovens and 660 thousand tons of capacity would be more closely aligned with near-term U.S. market demand. This potential new facility could serve multiple customers and may have a portion of its capacity reserved for coke sales in the spot market. We are in the early stages of permitting for this potential facility in Kentucky, but are also assessing alternative sites in other states. In light of the current economic and business outlook, we expect to defer seeking customer commitments for this potential facility until we make further progress on obtaining permits, which we anticipate receiving in 2013. Our ability to construct a new facility and to enter into new commercial arrangements is dependent upon market conditions in the steel industry.

• Expansion of growth strategy. We are exploring opportunities to enter into business relationships or other transactions with respect to existing cokemaking facilities in order to opportunistically capture market share in the United States and Canada. We believe that the efficiencies we have developed from our experience as the leading independent U.S. coke producer and our proven ability to provide a reliable supply of coke make us well suited to purchase or operate facilities, including by-product cokemaking facilities, currently operated by steelmakers or others that would prefer to utilize the capital committed to such equipment for other purposes. In addition, the Company continues to pursue investment opportunities to grow our international footprint in India.

• Coal operations. Coal market conditions deteriorated throughout 2012 and are expected to remain weak in 2013. In view of this, we have and will continue to take several actions to reduce costs and increase productivity including idling certain high-cost mines; consolidating our labor force and equipment into more productive, lower cost mines; relocating mine sections in our largest mine and implementing deep cut mining plans as permits are received. In addition, we have deferred previously announced expansion plans for our Jewell underground mines, and substantially all the capital expenditures associated with the expansion plan. We expect Jewell coal mining production to be 1.10 million tons in 2012, and do not anticipate increasing production in 2013 to 1.45 million tons as previously planned. In the fourth quarter 2012, we expect to be negotiating coal sale contracts for 2013 and anticipate pricing will be significantly below the price in 2012. As a result, we expect our coal mining segment will contribute minimally to 2013 results.


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In June 2011, we entered into a series of coal transactions with Revelation Energy, LLC ("Revelation"). Under a contract mining agreement, Revelation mines certain coal reserves at our Jewell coal mining operations that are included in our current proven and probable reserve estimates. This coal will be mined, subject to the satisfaction of certain conditions, over a four-year period. Although mining began in the first quarter of 2012, permitting delays for a portion of the reserves resulted in lower than expected production levels. We expect approximately 1.2 million tons of coal in the aggregate to be mined in the four year period from 2012 to 2015 with a larger percentage being mined in the last three years. The construction of a rapid train coal loading facility has also been delayed and the majority of the approximate $15 million cost is now expected to occur in 2013.

• Black lung obligation. We are currently evaluating our obligation relating to black lung benefits which is estimated based on various assumptions, including actuarial estimates and discount rates. Our current obligation at September 30, 2012 is $33.5 million. For each 25 basis point decrease in the discount rate our liability is estimated to increase approximately $1.0 million and we estimate our liability may increase $4 million to $5 million based on current assumptions. We anticipate that we will complete our evaluation in the fourth quarter of 2012.

• Formation of a master limited partnership. On July 19, 2012, we announced that our Board of Directors approved the formation of a master limited partnership ("MLP") and the filing of a registration statement to effect the initial public offering of common units representing limited partner interests in the MLP. The key assets of the MLP are expected to be 65 percent of our interests in each of our Haverhill and Middletown cokemaking facilities.

If an initial public offering of the MLP is completed, we would own the general partner of the MLP, as well as all of the MLP's incentive distribution rights and a portion of the common units representing limited partner interests in the MLP. We expect to close the initial public offering of the MLP in the fourth quarter of 2012, subject to prevailing market conditions. We would also be party to an omnibus agreement pursuant to which we would provide remarketing efforts to the MLP upon the occurrence of certain potential adverse events under our coke sales agreements, indemnification of certain environmental costs and preferential rights for growth opportunities. In connection with the closing of the MLP transaction, we expect to enter into an amendment to our Credit Agreement.

• Outlook. We expect diluted earnings per share attributable to our stockholders to be in the range of $1.30 to $1.40 and Adjusted EBITDA to be in the range of $255 million to $270 million for 2012. We expect that the strong performance in our domestic coke operations will offset the impact of market and operational challenges in our Coal Mining segment. Domestic coke production in 2012 is expected to be in excess of 4.3 million tons, which would exceed 100 percent capacity utilization. Coal production in 2012 is expected to be approximately 1.4 million tons. We expect free cash flow in 2012 to exceed $100 million, compared to our original 2012 guidance of free cash flow in excess of $50 million. The expected increase in free cash flow is due to the deferral of capital expenditures associated with our Coal Mining segment, the anticipated timing of potential international investment opportunities and decreases in working capital. See "Non-GAAP Financial Measures" at the end of this Item.

Items Impacting Comparability

• Indiana Harbor Cokemaking Operations. On September 30, 2011, we acquired the 19 percent interest held by an affiliate of GE Capital in the partnership that owns the Indiana Harbor facility. As a result of this transaction, we now hold an 85 percent interest in the partnership. The remaining 15 percent interest in the partnership is owned by an affiliate of DTE Energy Company. The change in ownership percentage of our Indiana Harbor facility contributed $1.6 million and $5.3 million to Adjusted EBITDA for the three and nine months ended September 30, 2012, respectively.

In the fourth quarter of 2011, we clarified the interpretation of certain contract and billing items with our customer. As a result, coal spilled during the coke oven charging process ("Pad Coal") may not be subsequently reused for making coke for this customer, unless it is included in the coal blend at zero cost.


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In the three and nine months ended September 30, 2012, the Company recorded approximately $0.4 million and $2.4 million in lower of cost or market adjustments on existing Pad Coal inventory, respectively, and is currently remarketing this Pad Coal to other customers. Additionally, in conjunction with the work performed to address the contract and billing issues, the Company recorded a $2.8 million charge for a reduction in coke inventory in the first quarter of 2012.

• Middletown Cokemaking Operations. We commenced operations at our Middletown, Ohio cokemaking facility in October 2011 and reached full production in the first quarter of 2012, ahead of previous expectations. In the three months ended September 30, 2012, the Middletown cokemaking facility produced 154 thousand tons of coke and contributed $76.7 million and $16.9 million to revenues and Adjusted EBITDA, respectively. In the nine months ended September 30, 2012, the Middletown cokemaking facility produced 449 thousand tons of coke and contributed $217.2 million and $42.3 million to revenues and Adjusted EBITDA, respectively. Unreimbursed costs and lower than expected coal-to-coke yield performance of $7.0 million ($4.0 million related to start-up activities) are included in the results for the nine months ended September 30, 2012. Beginning in 2013, we expect an increase in the recovery of operating costs at Middletown as the operating fee transitions from a fixed amount per ton to a budgeted amount per ton based on the full recovery of expected operating maintenance costs.

• Corporate Separation Transactions. Historically, our operating expenses have included allocations of certain general and administrative costs of Sunoco for services provided to us by Sunoco. During 2011, we replaced most services provided by Sunoco prior to the Distribution Date and have developed the internal functions, such as financial reporting, tax, regulatory compliance, legal, corporate governance, treasury, internal audit and investor relations, necessary to fulfill our responsibilities as a stand-alone public company. Allocations from Sunoco were zero and $1.9 million for the three months ended September 30, 2012 and 2011, respectively, and $0.5 million and $5.8 million for the nine months ended September 30, 2012 and 2011, respectively.

• Loss on Firm Purchase Commitments. During the first quarter of 2011, we estimated that Indiana Harbor would fall short of its 2011 annual minimum coke production requirements by approximately 122 thousand tons. Accordingly, we entered into contracts to procure approximately 133 thousand tons of coke from third parties. However, the coke prices in the purchase agreements exceeded the sales price in our contract with ArcelorMittal. This pricing difference resulted in an estimated loss on firm purchase commitments of $18.5 million ($12.2 million attributable to net parent investment and $6.3 million attributable to noncontrolling interests), which was recorded during the first quarter of 2011. In the second quarter of 2011, the Company recorded lower of cost or market adjustments of $1.2 million ($0.8 million attributable to SunCoke Energy, Inc./net parent investment and $0.4 million attributable to noncontrolling interests) on this purchased coke. In the fourth quarter of 2011, we recorded lower of cost or market adjustments of $0.7 million ($0.6 million attributable to SunCoke Energy, Inc. /net parent investment and $0.1 million attributable to noncontrolling interests) on this purchased coke. In the second quarter of 2011, the Company sold 38 thousand tons of this coke to ArcelorMittal. Operational improvements at Indiana Harbor subsequent to the first quarter of 2011 increased coke production for the balance of 2011 and Indiana Harbor was able to meet its 2011 contractual requirements with ArcelorMittal.

In the third quarter of 2011, the Company entered into an agreement to sell approximately 95 thousand tons of this purchased coke to a customer on a consignment basis that will expire, as amended, on the earlier of December 31, 2012 or full consumption of, and payment for, the coke. If, after December 31, 2012, the customer has not consumed all of the consigned coke and the Company chooses to remove any of the remaining coke from the customer's facility, the Company will be entitled to collect a commitment removal fee. The customer did not consume any coke in fiscal 2011. In the three and nine months ended September 30, 2012, the customer consumed approximately 15 thousand tons and 42 thousand tons of consigned coke, respectively.

• Financing Activities. Prior to the IPO, our primary source of liquidity was cash from operations and borrowings from Sunoco. Our funding from Sunoco was through floating-rate borrowings from Sunoco, Inc. (R&M), a wholly-owned subsidiary of Sunoco. The agreements between Sunoco and the Company related to these borrowings terminated concurrent with the IPO and all outstanding advances were settled. Prior to the Separation Date, we also earned interest income on $289.0 million in notes receivable from The Claymont Investment Company ("Claymont"), a then wholly-owned subsidiary of Sunoco. In connection with the Separation, Sunoco contributed Claymont to SunCoke Energy. As a


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result, we no longer earn interest income for these notes, as the balances and related interest are eliminated in our consolidated results. For periods prior to the Separation Date, interest income exceeded interest expense.

Since July 26, 2011, we have issued $730.0 million in debt. For periods subsequent to the Separation Date, interest expense has exceeded interest income.

Results of Operations

The following table sets forth amounts from the Combined and Consolidated
Statements of Income for the three and nine months ended September 30, 2012 and
2011:



                                              Three Months Ended September 30,                Nine Months Ended September 30,
                                               2012                      2011                  2012                    2011
                                                                           (Dollars in millions)
Revenues
Sales and other operating revenue         $         480.1           $         403.1       $       1,421.4         $       1,113.7
Other income, net                                     0.4                       0.4                   1.3                     1.1

Total revenues                                      480.5                     403.5               1,422.7                 1,114.8

Costs and Operating Expenses
Cost of products sold and operating
expenses                                            388.9                     332.8               1,174.6                   933.3
Loss on firm purchase commitments                      -                         -                     -                     18.5
Selling, general and administrative
expenses                                             20.0                      26.0                  61.2                    64.8
Depreciation, depletion and
amortization                                         18.9                      14.7                  57.5                    42.4

Total costs and operating expenses                  427.8                     373.5               1,293.3                 1,059.0

Operating income                                     52.7                      30.0                 129.4                    55.8

Interest income - affiliate                            -                        1.1                    -                     12.5
Interest income                                       0.1                       0.2                   0.4                     0.3
Interest cost - affiliate                              -                       (0.4 )                  -                     (3.6 )
Interest cost                                       (12.3 )                    (8.8 )               (36.4 )                  (8.8 )
Capitalized interest                                   -                        4.6                    -                      5.3

Total financing (expense) income, net               (12.2 )                    (3.3 )               (36.0 )                   5.7

Income before income tax expense                     40.5                      26.7                  93.4                    61.5
Income tax expense                                    7.6                       5.1                  19.9                    10.1

Net income                                           32.9                      21.6                  73.5                    51.4
Less: Net income (loss) attributable
to noncontrolling interests                           1.3                       3.4                   2.3                    (1.2 )

Net income attributable to SunCoke
Energy, Inc./net parent investment        $          31.6           $          18.2       $          71.2         $          52.6

Three Months Ended September 30, 2012 compared to Three Months Ended September 30, 2011

Revenues. Our total revenues, net of sales discounts, were $480.5 million for the three months ended September 30, 2012 compared to $403.5 million for the corresponding period of 2011. Our Middletown facility contributed $76.7 million to the increase in revenues. The remainder of the increase was driven by a . . .

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