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SXC > SEC Filings for SXC > Form 10-Q on 30-Oct-2013All Recent SEC Filings

Show all filings for SUNCOKE ENERGY, INC.

Form 10-Q for SUNCOKE ENERGY, INC.


30-Oct-2013

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." 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 high-quality coke in the Americas, as measured by tons of coke produced each year, and have more than 50 years of coke production experience. Coke is a principal raw material in the blast furnace steelmaking process. Coke is generally produced by heating metallurgical coal in a refractory oven, which releases certain volatile components from the coal, thus transforming the coal into coke. We have designed, developed and built, and own and operate five cokemaking facilities in the United States ("U.S."). During 2012, we sold approximately 4.4 million tons of coke to our three primary customers in the U.S.: ArcelorMittal, AK Steel and U.S. Steel. Our total U.S. cokemaking stated capacity is approximately 4.2 million tons of coke per year. We 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. On March 18, 2013, we completed the transaction to form a cokemaking joint venture with VISA Steel Limited ("VISA Steel") in India called VISA SunCoke Limited ("VISA SunCoke"). VISA SunCoke is comprised of a 440 thousand ton heat recovery cokemaking facility and the facility's associated steam generation units in Odisha, India. VISA SunCoke will sell approximately one-third of its coke production and all of its steam production to VISA Steel with the remainder of the coke production being sold on the spot market.
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 11 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        2023         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
                                                                                       830              4,240
Operated:
Vitσria            Vitσria, Brazil          ArcelorMittal     2007        2023         320              1,700          Steam for power
                                                                                                                       generation
                                                                                      1,150             5,940
Equity Method Investment:
VISA Suncoke(2)    Odisha, India            Various           2013         NA           88               440           Steam for power
                                                                                                                       generation
Total                                                                                 1,238             6,380

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

(2) Cokemaking capacity respresents 100 percent of VISA SunCoke, our 49 percent joint venture with VISA Steel.

We also own and operate coal mining operations in Virginia and West Virginia that sold approximately 1.5 million tons of metallurgical coal (including internal sales to our cokemaking operations) in 2012. Our mining area consists of nine active underground mines, one active surface mines and one active highwall mine, as well as three preparation plants and three 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.

Recent Developments
• Formation of a Master Limited Partnership. On January 24, 2013, we completed the initial public offering of a master limited partnership ("the Partnership") through the sale of 13,500,000 common units of limited partner interests in the Partnership in exchange for $231.8 million of net proceeds (the "Partnership offering"). Upon the closing of the Partnership offering, we own the general partner of the Partnership, which consists of a 2.0 percent


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ownership interest and incentive distribution rights, and own a 55.9 percent limited partner interest in the Partnership. The remaining 42.1 percent interest in the Partnership is held by public unitholders and reflected in noncontrolling interest on our Consolidated Statement of Income and Consolidated Balance Sheet beginning with the first quarter of 2013. The key assets of the Partnership are a 65 percent interest in each of our Haverhill and Middletown cokemaking and heat recovery facilities. As the general partner of the Partnership, we have the sole ability to direct the activities of the Partnership that most significantly impact its economic performance. We are also considered to be the primary beneficiary of the Partnership for accounting purposes and consolidate the results of the Partnership in our results. Income attributable to the noncontrolling interest in the Partnership was approximately $5.8 million and $17.4 million for the three and nine months ended September 30, 2013, respectively.
• International growth strategy. On March 18, 2013, we completed the transaction to form a joint venture with VISA Steel in India. VISA SunCoke is comprised of a 440 thousand ton heat recovery cokemaking facility and the facility's associated steam generation units in Odisha, India. We invested $67.7 million to acquire a 49 percent interest in VISA SunCoke, with VISA Steel holding the remaining 51 percent. The investment is accounted for under the equity method under which investments are initially recorded at cost. We recognize our share of earnings in VISA SunCoke on a one-month lag. VISA SunCoke will sell approximately one-third of its production to VISA Steel with the remainder being sold on the spot market. The Company continues to pursue additional investment opportunities to grow our international footprint in India.

• Coal handling transactions. On August 30, 2013, the Partnership completed its acquisition of the assets and business operations of Lakeshore Coal Handling Corporation ("Lakeshore"), now called SunCoke Lake Terminal LLC ("Lake Terminal") for $28.6 million. Prior to the acquisition, the entity that owns SunCoke's Indiana Harbor cokemaking operations was a customer of Lakeshore and held the purchase rights to Lakeshore. Concurrent with the closing of the transaction, the Partnership paid $1.8 million to DTE Energy Company, the third party investor owning a 15 percent interest in the entity that owns Indiana Harbor in consideration for assigning its share of the Lake Terminal buyout rights to the Partnership. The Partnership recognized this payment in selling, general, and administrative expenses on the Consolidated Statement of Income during the period. We expect Adjusted EBITDA of approximately $1.3 million from Lake Terminal during the balance of 2013.

Located in East Chicago, Indiana, Lake Terminal does not take possession of coal but instead derives its revenue by providing coal handling and blending services to its customers on a per ton basis. Lake Terminal has and will continue to provide coal handling and blending services to the Company's Indiana Harbor cokemaking operations. In September 2013, Lake Terminal and Indiana Harbor entered into a new 10-year contract with terms equivalent to those of an arm's-length transaction. The Partnership intends to maintain Lake Terminal's current operations and retain existing staff. The results of Lake Terminal have been included in the Consolidated Financial Statements since the acquisition date and are included in the new Coal Logistics segment.
On October 1, 2013, the Partnership completed its acquisition of 100 percent of the ownership interest in Kanawha River Terminals LLC ("KRT") for $86.0 million utilizing $46.0 million of available cash and $40.0 million of borrowings under its existing revolving credit facility. KRT is a leading metallurgical and thermal coal blending and handling terminal service provider with the collective capacity to blend and transload more than 30 million tons of coal annually. We expect Adjusted EBITDA of approximately $2.9 million from KRT during the balance of 2013. Beginning in the fourth quarter, the results of the Partnership's acquisition of KRT will be included in the new Coal Logistics segment.
• ArcelorMittal contract extension. Effective October 1, 2013, the Company entered into a 10-year extension of its existing Indiana Harbor coke sales agreement to provide 1.22 million tons of coke annually to ArcelorMittal. Key provisions of the extension agreement are substantially similar to the existing agreement, including continuing the pass-through of coal costs, reimbursement of operating and maintenance expenses subject to certain metrics, and an increased fixed fee per ton of coke produced to recognize the approximately $85 million in new capital being deployed to refurbish and upgrade the Company's Indiana Harbor cokemaking facility. We expect an increase in Adjusted EBITDA of approximately $4 million in the balance of 2013 related to the change in terms.

• AK Steel Middletown outage. We cooperated with AK Steel on its projected second half of 2013 coke needs after a blast furnace outage at their Middletown plant in the second quarter of 2013. Specifically, due to this outage, we agreed to manage production at our Haverhill cokemaking facility to be consistent with annual contract maximums and to temporarily scale back coke production at our Middletown facility to name plate capacity levels in the second half of 2013. In addition, we plan to provide AK Steel extended payment terms on December 2013 coke production of 50 thousand tons, resulting in a shift of approximately $20 million in expected operating cash flow from 2013 to early 2014. The scale back in production had an estimated $0.9 million effect on Adjusted EBITDA during the third quarter of 2013, and we expect a $0.6 million effect on Adjusted EBITDA in the fourth quarter 2013.


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Third Quarter Key Financial Results
• Revenues decreased 18.7 percent in the three months ended September 30, 2013 to $390.5 million primarily due to the pass-through of lower coal prices in our cokemaking business and an approximate $46 per ton decline in average coal sales price partly offset by higher coal sales volume.

• Net income attributable to stockholders decreased $25.4 million for the three months ended September 30, 2013, to $6.2 million, or $0.09 per share, compared with the three months ended September 30, 2012. This decrease is due to the following items:

• weakness in our Coal Mining segment;

•           increased income attributable to noncontrolling interest due to the
            creation of the Partnership;


•           higher depreciation related to capital expenditures as well as
            accelerated depreciation taken on certain assets at our Indiana
            Harbor facility due to a change in their estimated useful lives as a
            major refurbishment is underway; and


•           increased corporate expenses reflecting higher legal expenses and
            higher incentive stock compensation and public company costs
            associated with the Partnership.


•     Adjusted EBITDA was $50.7 million in the three months ended September 30,
      2013 compared to $73.7 million in the same period prior year, a decrease of
      $23.0 million. This decrease was driven primarily by weakness in our Coal
      Mining segment.

Items Impacting Comparability
• Middletown Cokemaking Operations. We commenced operations at our Middletown, Ohio cokemaking facility in October 2011 and reached full production during the first quarter of 2012. In the nine months ended September 30, 2013, the Middletown cokemaking facility produced 463 thousand tons of coke and contributed $198.9 million and $58.3 million to revenues and Adjusted EBITDA, respectively. This compares to production of 449 thousand tons of coke and contributions of $217.2 million and $42.3 million to revenues and Adjusted EBITDA, respectively, in the nine months ended September 30, 2012. Middletown revenue and Adjusted EBITDA for the nine months ended September 30, 2013 benefited from increased operating cost recovery of $4.9 million due to the change from a fixed operating fee per ton to a budgeted amount per ton based on the expected full recovery of operational and maintenance costs. Middletown Adjusted EBITDA for the nine months ended September 30, 2012 included higher costs and lower than expected coal-to-coke yield performance of $7.0 million, of which $4.0 million related to start up activities.

• Interest Expense, net. In connection with the closing of the Partnership offering in the first quarter of 2013, the Partnership repaid $225.0 million of our seven-year term loan ("Term Loan") and we entered into an amendment to our credit agreement ("Credit Agreement"). The weighted average interest rate for borrowings outstanding under the Term Loan during 2013 and 2012 was 4.07 percent. In conjunction with the repayment, we incurred a charge of approximately $2.9 million representing the write-off of unamortized debt issuance costs and original issue discount related to the portion of the Term Loan that was extinguished.

In addition, with the closing of the Partnership offering, the Partnership issued $150.0 million of senior notes ("Partnership Notes") that have an interest rate of 7.375 percent. The Partnership incurred costs of $3.7 million related to the issuance of the Partnership Notes relating to fees paid to lenders and certain third parties, of which $0.8 million were recognized immediately. Comparability of interest expense between periods was affected by higher interest rates partially offset by lower debt balances after the closing of the Partnership offering and related transactions.
• Indiana Harbor Cokemaking Operations. In the fourth quarter of 2011, we clarified the interpretation of certain contract and billing items with our customer. In the nine months ended September 30, 2012, the Company recorded a $2.8 million charge for a reduction in coke inventory in conjunction with work performed to address the contract and billing issues.

During 2011, in preparation for negotiation of the extension of the Company's existing coke sales agreement, we conducted an engineering study to identify major maintenance projects necessary to preserve the production capacity of the facility. We began the project work in July 2012 and spent approximately $14 million in 2012. We expect to spend another $58 million in 2013 and anticipate spending up to $85 million in total on the project. Effective October 1, 2013, the Company entered into a 10-year extension of its existing Indiana Harbor coke sales agreement, which contains an increased fixed fee per ton of coke produced to recognize the additional capital being deployed. Additionally, we revised the estimated useful life of certain assets being replaced as part of the project, which resulted in additional depreciation of $2.5 million in 2012, or $0.04 per common share. The full year impact on 2013 is estimated to be approximately $10.9 million, or $0.16 per common share, of which we recorded accelerated depreciation of approximately $1.7 million and $9.0 million in the three and nine months ended September 30, 2013, respectively. While we expect to be substantially complete with oven repairs by the end of 2013, the installation of


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new equipment will be completed in the second half of 2014. Our customer has also notified us of a potential blast furnace outage in the first half of 2014. Accordingly, we expect to begin realizing the full benefits of the refurbishment in 2015.
• Income Taxes. During the nine months ended September 30, 2013, we recorded a benefit of $1.7 million in provision-to-return adjustments as well as recorded a charge of $0.4 million associated with local income taxes due for our Middletown operations. We also recorded tax expense of $1.4 million for an adjustment to our valuation allowance associated with deferred tax assets related to state and local taxes. Additionally, as part of provisions of our tax sharing agreement with Sunoco, we recognized $1.7 million of income tax expense to settle potential obligations. We will continue to monitor obligations under the provisions of the tax sharing agreement with Sunoco and will record adjustments as an income tax expense with a corresponding payable due to Sunoco. Prior to December 31, 2012, amounts due to Sunoco were reflected as a reduction to SunCoke Energy's equity accounts. We previously estimated our effective tax rate for 2013 to be between 7 percent and 14 percent. As a result of these items, we estimate our full-year effective tax rate to be in the range of 14 percent to 20 percent.

Results of Operations
The following table sets forth amounts from the Consolidated Statements of
Income for the three and nine months ended September 30, 2013 and 2012:
                                        Three Months Ended September 30,     Nine Months Ended September 30
                                              2013               2012              2013             2012
                                                               (Dollars in millions)
Revenues
Sales and other operating revenue      $           389.9     $    480.1     $        1,245.0     $ 1,421.4
Other income, net                                    0.6            0.4                  3.1           1.3
Total revenues                                     390.5          480.5              1,248.1       1,422.7
Costs and operating expenses
Cost of products sold and operating
expenses                                           316.5          388.9              1,031.3       1,174.6
Selling, general and administrative
expenses                                            23.5           20.0                 65.9          61.2
Depreciation, depletion and
amortization                                        23.2           18.9                 70.5          57.5
Total costs and operating expenses                 363.2          427.8              1,167.7       1,293.3
Operating income                                    27.3           52.7                 80.4         129.4
Interest expense, net                               12.1           12.2                 40.0          36.0
Income before income tax expense and
loss from equity method investment                  15.2           40.5                 40.4          93.4
Income tax expense                                   0.6            7.6                  6.5          19.9
Loss from equity method investment                   2.3              -                  2.5             -
Net income                                          12.3           32.9                 31.4          73.5
Less: Net income attributable to
noncontrolling interests                             6.1            1.3                 17.4           2.3
Net income attributable to SunCoke
Energy, Inc.                           $             6.2     $     31.6     $           14.0     $    71.2

Revenues. Our total revenues, net of sales discounts, were $390.5 million and $480.5 million for the three months ended September 30, 2013 and 2012, respectively and $1,248.1 million and $1,422.7 million for the nine months ended September 30, 2013 and 2012, respectively. The decreases were due primarily to the pass-through of lower coal prices within our Domestic Coke segment as well as an approximately $46 per ton decrease in coal sales prices in our Coal Mining segment and lower volumes at Indiana Harbor. These decreases were partially offset by increased operating expense recovery in our Domestic Coke segment, specifically at our Middletown facility.
Costs and Operating Expenses. Total operating expenses were $363.2 million and $427.8 million for the three months ended September 30, 2013 and 2012, respectively and were $1,167.7 million and $1,293.3 million for the nine months ended September 30, 2013 and 2012, respectively. The decreases in cost of products sold and operating expenses were driven primarily by reduced coal costs in our Domestic Coke segment and reduced mining costs in our Coal Mining segment due to the benefit of prior years investment in mine planning, equipment, training, idling of certain mines and cost containment initiatives. These decreases were partially offset by public company costs of the Partnership and acquisition costs. Additionally, depreciation, depletion and amortization expense increased due primarily to increased capital expenditures as well as accelerated deprecation recorded in connection with the refurbishment of our Indiana Harbor facility.


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Interest Expense, Net. Interest expense, net was $12.1 million and $12.2 million for the three months ended September 30, 2013 and 2012, respectively and $40.0 million and $36.0 million for the nine months ended September 30, 2013 and 2012, respectively. Concurrent with the IPO of the Parternship, we issued $150.0 million in Partnership Notes with an interest rate of 7.375 percent and repaid $225.0 million of the Term Loan. The weighted average interest rate for borrowings outstanding under the Term Loan was 4.07 percent during 2013 and 2012.
The increase of $4.0 million for the nine months ended September 30, 2013 was due primarily to a $2.9 million charge incurred in the nine months ended September 30, 2013 for the write-off of unamortized debt issuance costs and original issue discount related to the portion of the term loan extinguished in conjunction with the Partnership offering as well as $0.8 million of debt issuance costs recognized immediately related to the issuance of $150.0 million of Partnership Notes. The remaining increase of $0.3 million was primarily due to higher interest rates partially offset by lower debt balances after the closing of the Partnership offering and related transactions.
Income Taxes. Income tax expense decreased $7.0 million to $0.6 million for the three months ended September 30, 2013 compared to $7.6 million for the corresponding period of 2012, and decreased $13.4 million to $6.5 million for the nine months ended September 30, 2013 compared to $19.9 million for the corresponding period of 2012. The decrease was due primarily to lower overall earnings as well as higher earnings attributable to noncontrolling interests resulting from the Partnership offering in January 2013, partially offset by lower nonconventional fuel tax credits due to the expiration of the Haverhill credits. Also, for the three months ended September 30, 2013, we finalized our . . .

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