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SXC > SEC Filings for SXC > Form 10-K on 28-Feb-2014All Recent SEC Filings

Show all filings for SUNCOKE ENERGY, INC.

Form 10-K for SUNCOKE ENERGY, INC.


28-Feb-2014

Annual Report


Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations

This Annual Report on Form 10-K 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" and "Risk Factors." Unless the context otherwise requires, references in this report to "the Company," "we," "our," "us," or like terms, when used in describing periods prior to July 18, 2011, refer to the cokemaking and coal mining operations of Sunoco, Inc. and its subsidiaries prior to the transfer of these operations to SunCoke Energy, Inc. in connection with the Separation. Such references when used in describing periods 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 accounting principles generally accepted in the United States ("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
SunCoke Energy, Inc. ("SunCoke Energy", "Company", "we", "our" and "us") is the largest independent producer of high-quality coke in the Americas, as measured by tons of coke produced each year, and has 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."). Additionally, we have designed and operate one cokemaking facility in Brazil under licensing and operating agreements on behalf of our customer and have a joint venture interest in the operations of one cokemaking facility in India. The capacity of our five U.S. cokemaking facilities is approximately 4.2 million tons of coke per year. The cokemaking facility that we operate in Brazil has cokemaking capacity of approximately 1.7 million tons of coke per year. We also have a preferred stock investment in the project company that owns the Brazil facility. In March 2013, we formed a cokemaking joint venture with VISA Steel Limited ("VISA Steel") in India called VISA SunCoke Limited ("VISA SunCoke"). VISA SunCoke has a cokemaking capacity of 440 thousand tons of coke per year.
Our cokemaking ovens utilize efficient, modern heat recovery technology designed to combust the coal's volatile components liberated during the cokemaking process and use the resulting heat to create steam or electricity for sale. This differs from by-product cokemaking which seeks to repurpose the coal's liberated volatile components for other uses. We have constructed the only greenfield cokemaking facilities in the U.S. in the last 25 years and are the only North American coke producer that utilizes heat recovery technology in the cokemaking process. We believe that heat recovery technology has several advantages over the alternative by-product cokemaking process, including producing higher quality coke, using waste heat to generate steam or electricity for sale and reducing environmental impact.
Our Granite City facility, the first phase of our Haverhill facility, or Haverhill 1, and our VISA SunCoke joint venture include steam generation facilities which use hot flue gas from the cokemaking process to produce steam. Pursuant to steam supply and purchase agreements, Granite City and Haverhill facilities' steam is sold to third-parties and VISA SunCoke's steam is sold to our partner, VISA Steel. Our Middletown facility and the second phase of our Haverhill facility, or Haverhill 2, include cogeneration plants that use the hot flue gas created by the cokemaking process to generate electricity. The electricity is either sold into the regional power market or to AK Steel pursuant to energy sales agreements.
We own and operate coal mining operations in Virginia and West Virginia with more than 111 million tons of proven and probable reserves at December 31, 2013. In 2013, we sold approximately 1.5 million tons of metallurgical coal (including internal sales to our cokemaking operations) and 0.1 million tons of thermal coal.
Our business strategy has evolved to include the expansion of our operations into adjacent business lines within the steel value chain. During 2013, through our master limited partnership, we expanded our operations into coal handling and blending services through two acquisitions. On August 30, 2013, our master limited partnership completed the acquisition of Lakeshore Coal Handling Corporation ("Lake Terminal"). Located in East Chicago, Indiana, Lake Terminal provides coal handling and blending services to our Indiana Harbor cokemaking operations. On October 1, 2013, our master limited partnership completed the acquisition of Kanawha River Terminals ("KRT"). KRT is a leading metallurgical and thermal coal


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blending and handling service provider with collective capacity to blend and transload more than 30 million tons of coal annually through its operations in West Virginia and Kentucky.
Further, we are exploring opportunities for entry into the ferrous segments of the steel value chain, such as iron ore concentration and pelletizing and direct reduced iron production ("DRI"). Concentrating and pelletizing are processes that prepare iron ore for use in a blast furnace as part of the integrated steelmaking process and result in a more efficient blast furnace steelmaking process. The current capacity for both concentrating and pelletizing of iron ore in the U.S. and Canada is in excess of 230 million tons and we believe acquisitions of existing facilities could potentially provide an attractive avenue for growth. DRI, an alternative method of ironmaking is used today in conventional blast furnaces and electric arc furnaces ("EAF"). The capital investment required to build DRI plants is low compared to integrated steel plants and operating costs can be favorable if low cost energy supplies are available. DRI is successfully manufactured in various parts of the world through either natural gas or coal-based technology. Currently, there is only one DRI operation in the U.S., but we believe demand for additional DRI capacity in the U.S. may grow by approximately 5 million tons, driven in part by the available supply of low cost natural gas as a reducing agent.
Incorporated in Delaware in 2010 and headquartered in Lisle, Illinois, we became a publicly-traded company in 2011 and our stock is listed on the New York Stock Exchange ("NYSE") under the symbol "SXC." As discussed below, our separation ("Separation") from Sunoco, Inc. ("Sunoco") was completed in 2012. Our Separation from Sunoco
On January 17, 2012 (the "Distribution Date"), we became an independent, publicly-traded company following our separation from Sunoco. Our separation from Sunoco occurred in two steps:

         We were formed as a wholly-owned subsidiary of Sunoco. 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.

Formation of a Master Limited Partnership On January 24, 2013, we completed the initial public offering of SunCoke Energy Partners, L.P., 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 percent 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 is reflected as noncontrolling interest on our Consolidated Statement of Income and Consolidated Balance Sheet beginning in the first quarter of 2013. Income attributable to the noncontrolling interest in the Partnership was approximately $24.6 million for the year ended December 31, 2013. The key assets of the Partnership at the time of formation were a 65 percent interest in each of our Haverhill and Middletown cokemaking and heat recovery facilities. The Partnership continues to hold this 65 percent interest in these facilities and now also owns the coal blending and handling facilities acquired during 2013. We are also party to an omnibus agreement pursuant to which we will provide remarketing efforts to the Partnership 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 Partnership offering, we entered into an amendment to our Credit Agreement and the Partnership issued $150.0 million of senior notes ("Partnership Notes") and repaid $225.0 million of our Term Loan. For a more detailed discussion see "Liquidity and Capital Resources."


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2013 Key Financial Results
         Total revenues in 2013 decreased 13.9 percent to $1,647.7 million
          primarily due to the lower coal prices, resulting in the pass-through
          of lower coal prices within our Domestic Coke segment as well as an
          approximately $49 per ton decrease in coal sales prices in our Coal
          Mining segment. Lower volumes at our Indiana Harbor facility also
          reduced revenues. These decreases were partially offset by increased
          operating expense recovery in our Domestic Coke segment as well as
          revenues from our new Coal Logistics segment.


         Net income attributable to stockholders was $25.0 million in 2013
          compared to $98.8 million in 2012. The decrease was the result of the
          overall weakness in the coal mining industry as well as the impact of
          the refurbishment at Indiana Harbor, which temporarily increased costs
          and driven down volumes at this facility. Our continued strong
          operating performance at our other domestic cokemaking facilities
          partially offset these decreases.


         Adjusted EBITDA was $215.1 million in 2013 compared to $265.7 million
          in 2012 due primarily to the factors driving the decrease in revenues
          and net income discussed above. Adjusted EBITDA from our Coal Mining
          operations decreased $52.1 million compared to the prior year. While
          overall Adjusted EBITDA decreased, Adjusted EBITDA per ton in our
          Domestic Coke operations remained consistent with the prior year at
          approximately $57.


         Cash generated from operating activities was $151.3 million in 2013
          compared to $206.1 million in 2012. The decrease was driven primarily
          by the contribution of lower earnings discussed above.

Our Focus in 2013
For the Company, 2013 was a year of solid execution. Our 2013 strategies and
accomplishments were as follows:
         Sustained momentum established at our cokemaking facilities through
          continued focus on operational excellence, including safety and
          environmental stewardship, at all facilities

Completed an initial public offering of a master limited partnership

         Achieved domestic and international growth through acquisitions and
          investments


         Executed initiatives at Indiana Harbor and initiated the environmental
          remediation project related to the Haverhill and Granite City consent
          decree


         Improved productivity and reduced production costs in our coal
          operations to enhance long-term strategic flexibility

Sustained momentum established at our cokemaking facilities through continued focus on operational excellence, including safety and environmental stewardship, at all facilities.
During 2013, our cokemaking business maintained its momentum, again exceeding 100 percent capacity utilization. Adjusted EBITDA from our cokemaking operations declined $6.2 million to $243.2 million in 2013 primarily due to lower performance at our Indiana Harbor facility, which incurred higher costs and produced lower volumes as a result of its ongoing refurbishment efforts. Operating our cokemaking facilities reliably and at low cost, while producing consistently high quality coke, is critical to maintaining the satisfaction of existing customers and our ability to grow with new and existing customers. We have continued to achieve reliable and cost-efficient operation of our facilities through the SunCoke Way, a standardized processes, procedures and management system incorporating best practices. Consistent implementation of the SunCoke Way as well as a better understanding of cokemaking sciences have improved our efficiencies, resulting in better yields and enabling us to achieve the flexibility required to execute opportunistic spot sales of approximately 40 thousand tons to a fourth customer during 2013. We also remained committed to maintaining a safe work environment and ensuring strict compliance with applicable laws and regulations.
Completed an initial public offering of a master limited partnership On January 24, 2013, we completed the initial public offering of 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 was formed to enhance the value of the Company, potentially help lower our cost of capital and provide greater financial flexibility. See previous discussion in the "Formation of a Master Limited Partnership."


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Achieved domestic and international growth through acquisitions Domestic
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. Adjusted EBITDA from Lake Terminal subsequent to the acquisition date was approximately $2.5 million. Located in East Chicago, Indiana, 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.
On October 1, 2013, the Partnership completed its acquisition of Kanawha River Terminals LLC ("KRT") for $84.7 million, utilizing $44.7 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 in West Virginia and Kentucky with the collective capacity to blend and transload more than 30 million tons of coal annually. Adjusted EBITDA from KRT subsequent to the acquisition date was approximately $2.2 million.
Lake Terminal and KRT do not take possession of coal but instead generate revenues by providing coal handling and blending services to their customers on a fee per ton basis. The results of these acquisitions have been included in the Consolidated Financial Statements and Coal Logistics segment since the acquisition dates.
During 2013, we made substantial progress permitting our next potential domestic facility and expect to receive final permits in early 2014. This potential new facility is planned to be constructed in Kentucky and will include 120 ovens and approximately 660 thousand tons of capacity. We expect this new facility to serve multiple customers while also reserving a portion of its capacity for opportunistic spot market coke sales. Our ability to construct a new facility and to enter into new commercial arrangements is dependent upon market conditions in the steel industry. The Partnership has preferential rights to purchase our interest in this potential facility upon the completion of construction at a price sufficient to provide us with a return on our invested capital equal to our weighted average cost of capital plus six percent. International
On March 18, 2013, we formed 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 VISA SunCoke sells all of its steam production and approximately one-third of its coke production to VISA Steel, with the remaining coke sold in the spot market. 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. During 2013, VISA SunCoke generated $0.9 million of Adjusted EBITDA reflecting market conditions as well as trade financing challenges related to securing our coal supply. Our focus in 2014 will be to stabilize the business, increase profitability, and maximize cash flow.
Executed initiatives at Indiana Harbor and initiated the environmental remediation project related to the Haverhill and Granite City consent decree 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. In connection with the renewal of this long-term contract, we identified capital refurbishment projects to preserve the production capacity of the facility. As a result of higher than anticipated costs to refurbish the ovens as well as the incremental cost of managing the refurbishment to minimize disruptions to ongoing operations, we now estimate costs related to the project will be approximately $100 million, compared to our previous estimate of $85 million. During 2013 and 2012, we spent $66 million and $14 million, respectively, on these capital projects and estimate spending an additional $20 million in 2014. In addition, we believe the project scope will address items that may be required in connection with the settlement of the Notices of Violations ("NOVs") at our Indiana Harbor facility. See the section entitled "Business - Legal and Regulatory Requirements - Environmental Matters and Compliance." The contract renewal included an increased fixed fee per ton of coke produced to provide a return on refurbishment capital expenditures. Other key provisions of the extension agreement are substantially similar to the existing agreement, including continuing the pass-through of coal costs and reimbursement of operating and maintenance expenses subject to certain metrics. We have undertaken capital projects to improve the reliability of the energy recovery systems and enhance environmental performance at our Haverhill and Granite City cokemaking facilities in response to NOVs received from the EPA. We anticipate these capital projects will cost approximately $120 million over the 2012 to 2016 time period, an increase from our previous estimate of $100 million, for which we have spent $33 million to date. During 2013, we finalized negotiations with regulators who have lodged a consent decree in federal district court which is undergoing review. We estimate our probable loss to be approximately $2.2 million. For more information, see the section entitled "Business-Legal and Regulatory Requirements-Environmental Matters and Compliance."


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Improved productivity and reduced production costs in our coal operations to enhance long-term strategic flexibility
During 2013, coal market conditions remained challenging. We continued with our plan to address near-term market weakness and enhance long-term strategic flexibility, reducing costs and increasing productivity by idling certain high-cost mines; consolidating our labor force and equipment into more productive, lower cost mines as well as mines producing higher royalty rates; relocating mine sections in our largest mine and implementing deep cut mining plans as permits are received. As a result, we improved productivity and reduced cash costs per ton by $19 during the year which partially mitigated the impact of the $49 per ton decline in price. This decline in coal sales price per ton, partially offset by an increase in volume of 152 thousand tons, resulted in an Adjusted EBITDA loss of $18.7 million for 2013. Our Focus and Outlook for 2014
In 2014, our primary focus will be to:

            Sustain high-level of operating performance in our Domestic Coke
             operations, continue to drive coal mining efficiencies and stabilize
             our India joint venture


            Pursue growth opportunities in cokemaking, coal logistics and a
             potential entry into the ferrous value chain


            Evaluate opportunities to enhance value of our coke and coal assets
             and assess optimal capital structure

Sustain high-level of operating performance in our Domestic Coke operations, continue to drive coal mining efficiencies and stabilize our India joint venture Given our strong operating performance in 2013, we expect our cokemaking operations to maintain their positive momentum and produce approximately 4.3 million tons of coke. We expect to achieve Adjusted EBITDA per ton of $60 to $65 at our cokemaking operations in 2014.
We expect performance at our Indiana Harbor facility will normalize in the latter half of the year after the completion of the refurbishment project and the anticipated blast furnace outage at ArcelorMittal, both of which we anticipate to occur during the first half of the year. We will also benefit from the 10-year contract renewal, which provides a return on our refurbishment capital. We also expect to renew the Indiana Harbor flue gas supply and processing agreement with Cokenergy, Inc. ("Cokenergy"), which expired on September 30, 2013. Operations have continued under the terms of the previous agreement without disruption, and we expect to renew this agreement in 2014. See further discussion of these operations in Part I.
In 2014, we will continue our work to improve the reliability of the energy recovery systems and enhance environmental performance at our Haverhill cokemaking facilities. We expect to successfully complete the execution of the environmental remediation project at Haverhill 2 during 2014 and Haverhill 1 during 2015.
In our Coal Mining business, we will continue driving mining efficiency gains to help mitigate the coal pricing headwinds. We will continue to focus on reducing costs and increasing productivity in our coal operations by idling certain high-cost mines and utilizing mines with lower royalty rates. We anticipate continued difficulties at VISA Steel due to iron ore mining restrictions in India, which will limit steel production, and a weak coke pricing environment due to increased Chinese coke imports. Together with our joint venture partner, we will continue to focus on stabilizing coal supply, mitigating foreign currency risk and managing the operations at VISA SunCoke to achieve improved Adjusted EBITDA and positive cash flows, despite these anticipated challenges in 2014. We plan to pursue additional investment opportunities to grow our international footprint in India by utilizing cash flows and reinvesting our earnings once our existing operations have stabilized. Pursue growth opportunities in cokemaking, coal logistics and a potential entry into the ferrous value chain
During 2014, we will continue to explore selective opportunities to acquire existing cokemaking assets in the U.S. and Canada. In addition, we expect to finalize the permitting of a potential new coke facility in Kentucky and will seek long-term customer commitments for a majority of the facility's capacity prior to commencing construction.
We also plan to actively pursue opportunities to expand our coal logistics business, leveraging the management and operations expertise acquired with these businesses. Our coal logistics facilities are operating below capacity, and we will seek to secure additional volumes from existing and new customers to fully utilize these facilities. In addition, we will pursue acquisitions of third-party assets that can expand our footprint in attractive and complementary segments of the coal logistics market.
In 2013, we received a favorable IRS private letter ruling for the concentrating and pelletizing of iron ore, and we will continue to pursue opportunities for entry into the ferrous market in 2014. In iron ore concentrating, various crushing, grinding and enriching processes separate iron-bearing particles from waste material to produce a concentrate of specific iron content. In pelletizing, a thermal treatment process forms iron ore concentrate into pellets which are then used in a blast furnace as part


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of the integrated steelmaking process. Iron ore pellets allow air to flow between the pellets, resulting in a more efficient blast furnace steelmaking process. The current capacity for both concentrating and pelletizing of iron ore in the U.S. and Canada is in excess of 230 million tons and we believe acquisitions of existing facilities could potentially provide an attractive avenue for growth.
DRI, an alternative method of ironmaking, has been developed to overcome some of the economic and operating challenges of conventional blast furnaces. DRI is predominantly used as a replacement for steel scrap or pig iron in the electric . . .

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