SunCoke Energy, Inc. (SXC) Q2 2013 Earnings Report, Transcript and Summary

Welcome to SunCoke Energy's Second Quarter 2013 Earnings Conference Call. My name is Adrienne, and I'll be your operator for today's call. [Operator Instructions] Please note that this conference is being recorded. I'll now turn the call over to Ryan Osterholm. Ryan Osterholm, you may begin.

Thank you. Good morning, everyone. Thank you for joining us on SunCoke Energy and SunCoke Energy Partners Second 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 open for Q&A. This conference call is being webcast live on the Investor Relations section of our websites at www.suncoke.com and www.sxcpartners.com. There will be a replay available on our websites. If we don't get to your question during the call, please call our Investor Relations department at (630) 824-1907. Now before I turn the call over 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 applied 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'd like to turn over the call to Fritz.

Thanks, good morning. On Chart 3 is a quick update of our second quarter, called milestones. On the operating side of the business, we had another solid domestic coke quarter in terms of both profitability and EBITDA per ton. We did achieve additional reductions in coal cash cost -- coal cash production costs. So we're hitting our targets -- actually ahead of our targets for coal cash production cost. And then finally, we did file the consent to create related to environmental projects at Haverhill and Granite City in line with our expectation. So a number of things happening in the operating side of the business, which were positive. On the building the core or growing the business, we continued to execute on our Indiana Harbor refurbishment project. The one coke plant that we had in the quarter that was -- actually, was lower production, was Indiana Harbor. Part of that is that we're in the process of refurbishing that plant while we run it. We're about 40% complete with the project. We are seeing improved production in the ovens that are completed in line with our expectations. And we expect the oven repairs, which is, I'll call, it 3 quarters of the project to be complete by the end of the year. There are other parts of that project, which will move into early next year, but that project is right on schedule. And then we are making progress on our contract renewal with ArcelorMittal in Indiana Harbor. Nothing new to report today, but we remain highly confident that we'll reach a reasonable outcome and extend that agreement. So that's what's going on in terms of building our domestic core. And then, finally, in terms of expanding our footprint, we did in the quarter, launch our VISA SunCoke joint…

Thanks, Fritz. As Fritz said, I would characterize this as a solid quarter, which is in line with our full year guidance and expectations. On the revenue front, we were down by about 12.4%, really, reflecting the lower coal price in the pass through on our coal agreements and on slight coke sales. Our coal sales volumes are up quite a bit in the quarter, reflecting higher production in purchased coal but, frankly, this is overwhelmed by a fairly dramatic drop in coal prices, $53 per ton year-over-year, which really is a primary driver of our year-over-year decline in adjusted EBITDA. As Fritz mentioned, our domestic coke business performed well. We do have a small contribution in this quarter from India of India JV, which I'll talk about later. And then, finally, on the EPS front, our EPS declined $0.24 to $0.08 per share, really reflecting the impact of coal on our adjusted EBITDA and the income attributable to SXC unitholders, as well as the accelerated depreciation at Indiana Harbor. I'll talk more about that later. Turning to Chart 6. We have the adjusted EBITDA bridge of $52.4 million in the quarter compared to $66.8 million a year ago. As you see, our coke business is essentially flat with the negative impact of Indiana Harbor being compensated by really strong production and yield at Middletown and Haverhill. We also recorded $0.8 million of adjusted EBITDA related to our India JV, and we'll talk more about India later. Coal is down by $11.9 million, again, primarily reflecting price but, again, as Fritz mentioned, we had fairly strong cash cost improvement in the quarter, and we'll explain more about what we're doing there later. Finally, in corp cost. We're down year-over-year about $3.1 million. I'd say, first off, we're comparing to a…

Thanks, Mark. Page 20. We're sitting here halfway through 2013 outlines the second half priorities for 2013, what we're trying to get accomplished, following the similar structure of -- on operations, domestic growth and expanding our footprint. On operations, much are the same in terms of what we've seen in the first half. I pay particular attention to what we're doing in our mining business to continue to drive down cash cost and position ourselves with the right kind of strategic flexibility as we move into next year and then executing against our environmental project at Haverhill and Granite City remains very high priorities for us. In terms of domestic growth, I've already touched on Indiana Harbor, both for furbishing the plant, as well as reaching a reasonable agreement with our ArcelorMittal on the contract renewal and also receiving a reasonable return on the refurbishment capital we're spending there. As I said before, we're highly confident that that will get done. The work continues in terms of permitting our next U.S. plant. As we've mentioned before, we thought that -- we think that the permit for this plant would likely be received early next year, might be late this year, but much more likely early next year. And that we continue to evaluate coke-making acquisition in the U.S. and Canada. And, finally, in terms of expanding our footprint, our job is to build our presence in India and execute at that venture, continue to evaluate adjacent business lines and business opportunities and work within our 2 capital structures, if you will, to efficiently allocate capital to optimize growth. Speaking of growth, Page 21, our North American growth strategy. We'd separate up between coke making, coke handling and processing and ferrous or iron ore processing. And in coke-making, it's both about looking at opportunities that we -- for customers that might be able to use the coke that we would produce with our new plant, as well as evaluating coke acquisitions of existing byproduct ovens. There's been a number of discussions with a number of different parties, which are in process but nothing new to report, nor would I expect to actually -- that anything here would close in 2013. On coal handling, there are things that can close in 2013. So we've already talked about Lakeshore. We continue to look at opportunities here. We've initiated discussions with potential parties. And then, finally, on iron ore processing, we have as I mentioned, really, a front -- requested a private letter ruling with a qualifying status -- a qualifying income status for certain activities in this area. We are interested in potential greenfield DRI opportunities and evaluating that. And the focus in this area is to engage customers in developing opportunities, which might -- which our preference would be to develop strategies that would put us in the position of deploying capital in a tolling or pass-through business model. With that, we'll wrap it up. Happy to take questions.

[Operator Instructions] And we have Garrett Nelson from BB&T Capital Partners on line with a question. Garrett S. Nelson - BB&T Capital Markets, Research Division: I know you're restricted in terms of what you can talk about regarding your strategic plans following the expiration of the Sunoco tax sharing agreement in January. But can you discuss what some of your options might be, and how you might be able to further unlock value for shareholders of the c corp and MLP.

Garrett, you actually half answered the question to a degree already in terms of the restrictions. Yes we do have certain restrictions. For the benefit of the folks on the phone call, the restrictions are -- it's a 2-year tax sharing agreement. That tax sharing agreement expires January of next year. After that, we could -- we have flexibility to consider additional activities. We've been asked about future drop downs. We have no future plans -- we have no plans for future drop downs, but beyond January of next year, we could consider those. We've received lots of questions about coal, the truth is, today, our focus on coal is to optimize our cost position and do all the things we can do to maximize the strategic flexibility. But again, both that expiration, we are flexible. We are able to do things with the coal business that we think are in the best interest of shareholders. Those would be 2 that we've received a lot of questions on. And so I think as we look at January '14, it's not very far away and January 18, actually -- January of 2014, it's not that far away. So I would say our focus today is, really, on operational excellence, and we'll leave that for 2014. Garrett S. Nelson - BB&T Capital Markets, Research Division: And then I just wanted to clarify that the 2013 guidance for SXCP on Slide 18 does not include the Lakeshore acquisition and that the EBITDA and distributable cash flow numbers would be higher if doing so, all else equal.

Correct and correct.

[Operator Instructions] And we have Lucas Pipes from Brean Capital.

This is Derek Hernandez for Lucas Pipes this morning. First of all, I want to ask about how the contract negotiations with ArcelorMittal are continuing?

They are continuing. The contract expires at the end of the third quarter. There's been dialogue with ArcelorMittal, really, even dating back to the fourth quarter last year. We're, obviously, doing this while refurbishing the plant and while running the plant. I would characterize the dialogue as very constructive. We are highly confident we'll reach an acceptable -- a mutually acceptable outcome. At this point, if you look at it, we are their principal source of coke for their most important asset. They're our entire uptake for an extremely important asset for us. So it's one of -- it's a situation, where I think both sides have an incentive to reach a reasonable outcome. And I fully expect that we will reach that outcome in the third quarter. And it will a reasonable agreement for both parties.

Okay, very good. And then moving over to your coal mining business. Did I see correctly that your full year cost guidance is still $130 per ton?

No, that's not correct. What we said is our full year guidance was $130. We're now running close to -- onto $120, and so I think what we believe is that there's more work that we can do there to further improve that. So I think what we're highlighting is the fact that we're already past our full year guidance that we gave back in December based on actions that we've taken in the first half.

Right. And do you have any update to that guidance yet?

We don't at this point. I think what we are indicating today is based on the improvements that we believe we can achieve in cash cost that even if there are declines in prices -- coal prices going into '14, that we would expect '14 to look very similar to 2013. We're not, at this point, ready to commit to a full year cash cost number.

And we have Nathan Littlewood from Credit Suisse. Nathan Littlewood - Crédit Suisse AG, Research Division: I just had a follow-up question on these coal cash costs. I was hoping to understand a little better how these cost reductions have been achieved. Are you playing with strip ratios, material movements, or what's going on there?

So let me talk about what we've done in the cost side, and then what we've done on the productivity side. On the cost side, you might recall in the first quarter, we took some actions in reduction in force, which reduced our manpower -- underground manpower by 20% and both including contracted employees, as well as full-time employees. Even with that, frankly, our production has increased, and so what we've seen is even with reduced manpower that we've continued to improve our advancement per shift and our productivity per person to a pretty significant degree, so cost-reduction on that side, manpower. We see a pretty significant reduction in cost on maintenance and repair. We embarked on a refurbishment program for our underground equipment about 2 years ago, which was largely, at this point, completed, and what we've seen is a follow through significantly lower maintenance repair costs. So on the numerator side, if you will, in terms of cost, we've seen absolute reductions in costs. We also had lower royalty cost, because prices have been down. We've seen some lower transportation cost, but the big issues have been manpower and maintenance. On the denominator side, what we've seen is continued improvement in advancement and in productivity. We have not seen improvement in yield and part of it is just, because we continue to face challenging geological conditions, but we've seen good productivity in terms of the manpower and, particularly, we had -- 2 years ago, we had a high percentage of our workforce, which are red hats. Today, we have virtually no red hats, and they're fully trained and productive. Last point I'd make is we've made some investments in our prep plant to improve the organic efficiency of the prep plant, including putting in a new circuit. And that's also proven to be beneficial for us. So I would say we made progress in both the numerator and the denominator side. And I would say it's been faster than what we have thought as we entered this year. So we're confident we can do even more. Nathan Littlewood - Crédit Suisse AG, Research Division: Got it, okay. So, mean it sounds like you're managing these assets from margin, and there's more cost that can be taken out in order to protect that margin. Should we assume that those cost reductions would stick? Or if we saw recovering coal prices, are those costs likely to follow them back up?

I would say what we're trying to do with managing our margin -- actually, we have negative margin, so what we're trying to do, obviously, is get ourself back as close to breakeven as possible. We put our guidance out for this year, we said between 0 and negative 15. We're quite confident at being able to operate at that range. I prefer to be 0 than negative 15. But, obviously, year-to-date, we're not there yet. We can continue to do more work, and we do plan on it. If prices were to rise, you would see increases in royalties, but we don't think we'd be given back any of the other factors we've seen in terms of productivity or cost reduction.

And we have Sam Dubinsky from Wells Fargo on line with a question.

I believe Mittal stated publicly that they're closing down their Dofasco coke plant in 2015. Does this have any positive implications for you?

They're closing down one of their batteries at Dofasco. They did confirm that. I think what I would say, Sam, is that we talked a number of times about our ability to grow based upon coke plants from existing customers or new customers wearing out, so I think this is another example of a very old coke plant, where they're decommissioning a portion. It's not all the batteries, but it's a pretty significant battery there. So it's really playing out and what we thought in terms of what might happen with coke plants as they come out of production, which is why we continue to do the work to permit a new plant.

Okay, great. And then just a follow up on iron ore processing. How long does it take to get a tax opinion? And then once you get a tax opinion, how long does it take to build a greenfield plant?

Well, I would say present rulings are generally about 6 months, so -- and we filed earlier. So that gives you some sense of timing. And then in terms of building a plant, a lot of it depends on what kind of plant you're building, but if you're taking a pellet plant, for example, it's -- you're typically 12 to 18 months, I think, not that we've built one.

We can also buy existing assets, too. So, I mean, once we have clearance on the rulings, we can include this in our M&A activity, which we're really not doing today.

Okay, great. But there are assets up for sale somewhat immediately once the tax ruling goes through, if positive?

There's a lot of assets out there involved in either iron ore extraction processing, pelletizing or transporting. So there's no shortage of assets there. What I'd say is until we have a ruling, we're being -- trying not to get ahead of ourselves here.

[Operator Instructions] And we have Mathew Barnett with Jet Capital online with a question.

I just have 2 questions. On your cash flow from operations guidance of $120 million, can you kind of give some color why you're only expecting to generate $30 million in the back half of the year, given that, historically, you've done significantly more than that?

Yes, there are a number of items, Jeff, just looking at Ryan here, just to see if I can remember what they are but the Brazil dividend is certainly one. There are a number of nontraditional fuel tax credit that we pay out in Q3. That's the big one. The 2 are really the Brazilian dividend, as well as the payout of nontraditional fuel tax credits, which we'll pay in Q3 based on timing of Sunoco filing their tax return in September.

And, lastly, you've got the timing of CapEx. So you've got -- there's 3 or 4 factors which affect cash flow. Obviously, CapEx has been in cash flow from operations, but as we think about our normal cash cycle, Mark's already talked about the working capital-related items, and in our view pretty normal. I guess, the last point we'd make is that if we think we did disclose AK, we would have the $20 million effect in the fourth quarter, if we proceed -- when we proceed to offer them terms in the last 50,000 tons.

The 2 item -- the Brazil dividend and the nontraditional fuel tax credit, is that different this year than prior year's?

Yes, well we didn't pay any nontraditional fuel tax credits last year. Again, it all ties off of Sunoco. And so this year, the payments -- so you'll recall that in Q1, we made a payment to AK about $12 million related to this issue. And we actually paid it early. We do have a payment to another customer of about $30 million in Q3. So, basically, the receipts of the dividend in the first half and the payment to a customer of about $30 million on tax credits in the second half results in sort of a poor comparison between first half and second half.

But your point is good. The dividend was the same factor last year. It was not -- well, it is different this year, is the $30 million. Last year, it wasn't paid, this year, it'll be paid.

And then just on the CapEx -- kind of increasing CapEx, seem to be related to environmental remediation. Did those numbers go up in total versus your expectations? Or do you think just some of those numbers got pulled forward from 2014 to 2013?

No, it doesn't go up in total. What we found is we commissioned -- began to commission the project is that we started the project at our Haverhill plant. We had originally thought about actually capping the project module by module in Haverhill. There's 2 modules in Haverhill, and what we found is opportunities to economize and be efficient by taking on more of both modules at the same time. So we're not increasing the total project. What we're just doing is retiming, recall this is also prefunded as part of the MLP but, really, it's all about being efficient in terms of how we do the preparation work at the site across 2 modules.

We have no further questions at this time.

So, we'll wrap up the call. Thanks, again, very much for your involvement and interest and for being a shareholder in SunCoke Energy and SunCoke Energy Partners.

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