SunCoke Energy, Inc. (SXC) Q2 2019 Earnings Report, Transcript and Summary

Good morning. My name is Jacqueline and I will be your conference operator today. At this time, I would like to welcome everyone to the Sun Coke Energy, Inc. Q2 2019 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question and answer session. [Operator Instructions]. Thank you. Shantanu Aggarwal, you may begin your conference.

Good morning and thank you for joining us today to discuss Sun Coke Energy's second quarter 2019 earnings. With me today are Mike Rippey, President and Chief Executive Officer, and Fay West, Senior Vice President and Chief Financial Officer. Following management's prepared remarks, we'll open the call for Q&A. This conference call is being webcast live on the Investor Relations section of our website and a replay will be available later today. If we don't get to your questions on the call today, please feel free to reach out to our Investor Relations Team. Before I turn things over to Mike, let me remind you that the various remarks we make on today's call regarding future expectations constitute forward-looking statements. The cautionary language regarding forward looking statements in our SEC filings apply to the remarks we make today. These documents are available on our website as a reconciliation to non-GAAP financial measures discussed on today's call. With that, I will now turn things over to Mike.

Thanks, Shantanu. Good morning. And thank you for joining us on our call this morning. Before we review Q2 results, I wanted to provide a few brief thoughts on the overall market and where we see things for the balance of the year. Since our fourth quarter earnings call, US steel demand has softened somewhat, with domestic capacity utilization recently dropping below 80% for the first time since September of 2018. Additionally, hot rolled benchmark pricing has fallen from $720 per ton in January to a low of $500 per ton before recovering to $580 per ton today. As we look at the futures pricing curve, coupled with price hikes recently announced by major producers, we believe domestic steel prices have bottomed and are entering a period of relative stability. Looking at the current state of the coke market, US Steel announced the temporary idling of two blast furnaces. And while US Steel is one of our key customers, there is no direct impact on SunCoke. We continue to supply US Steel high quality coke from our Granite City facility. Due to the temporary idling of these facilities, we believe the Coke market is slightly oversupplied in the near-term assuming no reduction in supply. On the thermal coal export side, we saw a sharp decline in API 2 and Newcastle prices, resulting in lower-than-expected export volumes in the first half of 2019. Export pricing was impacted by lower demand and supply increases from other regions, in particular Russia. We expect the export volumes will remain subdued for the balance of the year. In summary, while the macro environment has weakened somewhat over the first half of the year, the impact to our 2019 outlook is minimal based on the nature of our long-term take-or-pay contracts. We'll continue to look for opportunities and maximize our operations to serve our customers' current and future needs. Moving on to second quarter highlights. We completed the simplification transaction on June 28 with strong support from SXC shareholders. As we have discussed, this is a very important transaction for our company that creates immediate and long-term value for SunCoke shareholders. The merger creates significant flexibility to allow us to execute against our strategic growth initiatives as well as return capital to shareholders. At the halfway point of the year, we continue to make good progress toward achieving our 2019 objectives. And our second quarter performance and financial results demonstrate this progress. Weather continued to be a factor in the second quarter, affecting coal to coke yields on the coke side and causing high water costs at CMT. We are pleased with the operational performance of our plants as they manage through these adverse conditions, delivering solid second quarter adjusted EBITDA of $63.1 million. Our domestic logistics facilities continue to see solid volumes and delivered results as expected for the second quarter. At Convent, throughput volumes were lower than the prior year, which is reflective of the subdued macroeconomic conditions for thermal coal. Our coke business delivered another consistent quarter and results reflect increases in coke production as well as good cost discipline. The rebuilt ovens at Indiana Harbor are consistently performing at a high level and we can see this favorable impact in our financial results. As mentioned on our first quarter call, the final phase of the Indiana Harbor rebuild campaign is well underway and the first 14 ovens were placed back online in early July. We remain on schedule to complete the oven rebuilds by the end of the year and anticipate achieving Indiana Harbor's 2019 targets. By the end of the year, we'll complete the rebuilds of all 268 ovens and expect the facility to be back at 1.22 million tons of nameplate capacity in 2020. Turning to the balance sheet, we are on pace to achieve our gross leverage target of 3 times by paying down debt through the balance of the year. And lastly, with the year-to-date adjusted EBITDA of approximately $130 million, we're well positioned to achieve our full-year 2019 guidance targets. With that, I'll turn it over to Fay to review our second quarter earnings in details.

Thanks, Mike. And good morning, everyone. Turning to slide four, our second quarter net income attributable to SXC was $0.03 per share. EPS was down $0.03 versus the prior-year period due to lower throughput volumes in our Logistics business, higher depreciation expense on certain coke assets and transaction costs associated with the simplification transaction. Quarter-over-quarter comparisons were also impacted by a $5.4 million loss from the sale of an equity method investment realized in the second quarter of 2018. From an adjusted EBITDA perspective, we finished the second quarter at $63.1million, down $4.2 million versus 2018. The decrease was due to lower throughput volumes at CMT, partially offset by good performance in the Domestic Coke segment. Moving to the detailed adjusted EBITDA bridge on slide five, we are pleased with the overall operating performance of our plant in the second quarter, despite the challenging weather conditions we faced at our facilities. Our Coke segments performed well this quarter and the results reflect strong cost control as well as higher coke volumes, primarily from Indiana Harbor. This benefit was partially offset by the timing and scope of planned outages, which are in line with our full-year expectations. The Coke segment also benefited this quarter from higher met coal prices and favorable coal cost reimbursement at Jewell. As a reminder, while we do pass through the cost of our coal to our customers, we generate incremental adjusted EBITDA from higher coal prices due to improved yield gain calculations. Offsetting these gains were lower coal to coke yields at our Domestic Coke facilities. As we previously mentioned, during periods of heavy rainfall, the moisture content of coal used for coke production increases above normal levels. The elevated coal moisture levels adversely affect our volumes and coal to coke yields. In the Logistics segment, CMT throughput volumes of approximately 2 million tons were slightly lower than the first quarter of 2019 and lower than the second quarter of 2018. Throughput volumes have been impacted by lower API 2 and Newcastle pricing and demand for thermal coal in the export market. Second quarter adjusted EBITDA does not include $5.5 million of deferred revenue, which will be recognized in the fourth quarter of 2019. After adding in the favorable results in Corporate and Other, we finished the second quarter with $63.1 million of adjusted EBITDA. Looking more closely at our Domestic Coke results on slide six, second quarter adjusted EBITDA per ton was $55 on over 1 million tons of production. These results reflect an increase of over 30,000 tons of coke production quarter-over-quarter, mainly from Indiana Harbor rebuilt ovens. EBITDA per ton also benefited from the previously discussed lower operating costs across our fleet. As mentioned before, the lower operating costs were partially offset by the timing and scope of planned outages. We continued to perform normal routine maintenance work and upgrade work on our heat-recovery steam generators and flue gas de-sulfurization systems across our facilities. This work, which will benefit the long-term reliability and operational performance of our assets, was built into our full-year guidance. These improvements will impact quarter-over-quarter comparability for the remainder of the year. As Mike previously mentioned, Indiana Harbor continues to deliver at a sustained level. The 2019 B-battery rebuilds campaign is in full swing and the first set of 14 rebuilt ovens were brought back into service in early July. We are currently rebuilding the remaining 43 B-battery ovens and anticipate the final set of ovens coming back online in late November or early December. Considering the progress to date, we remain positioned to achieve our full-year 2019 Indiana Harbor guidance of approximately $22 million of adjusted EBITDA on 1.025 million tons of coke production. Overall, we are on track to achieve our full-year Domestic Coke adjusted EBITDA per ton and production guidance. Flipping to slide seven to discuss our Logistics business. Our Logistics business generated $11.8 million of adjusted EBITDA during the second quarter as compared to $19.7 million in the prior-year period. The decrease in adjusted EBITDA is primarily due to lower throughput volumes at CMT. Our domestic terminals performed in line with expectations, handling 3.6 million tons during the quarter. Although tons were slightly lower quarter-over-quarter, adjusted EBITDA was higher due to the mix of handling services provided. CMT contributed $8.5 million of adjusted EBITDA on approximately 2 million tons of throughput in the quarter. Volumes remain depressed based on current market conditions. And as we look forward, given the forward pricing curve of the export coal market and expected demand, we now anticipate our customers will not export more than the current run rate. We anticipate that throughput volumes will be approximately 8 million tons in 2019 and this number includes approximately 1 million tons of merchant business. Second quarter adjusted EBITDA does not include $5.5 million of deferred revenue. As a reminder, there is a limited adjusted EBITDA impact from the reduced base volumes due to the nature of our take or pay contracts. Any deferred revenue related to our coal export customers is typically recognized in the fourth quarter if throughput volumes are below the contracted 10 million tons. Based on throughput tons to date, we anticipate recognizing approximately $9.5 million of deferred revenue in the fourth quarter of 2019. Despite the reduced throughput volumes at CMT, we are on track to achieve Logistics adjusted EBITDA at the low end of our guidance range of $73 million to $75 million for the full-year 2019 after considering deferred revenue from the take-or-pay contracts. Turning to slide eight and our liquidity position for Q2. As you can see on the chart, our consolidated cash balance ended the quarter at $102 million. In the quarter, cash flow from operating activities finished at $300.000. Strong operating performance was offset by higher inventory levels, timing of receivables and the timing of interest payments. Weather, specifically flooding on waterways and terminals, affected the timing and procurement of coal in the second quarter. Coal inventories were temporarily increased this quarter to ensure that an adequate coal supply was maintained for the seamless production of coke at our facilities. We anticipate that inventories will revert back to normal levels in the back half of the year. Additionally, coal inventory at the Indiana Harbor facility increased as additional coal will be used for increased coke production as rebuilt ovens come back online. Once again, we anticipate that inventory levels will revert back to normalized levels in the back half of the year. Given the timing aspect of these working capital items, we remain in line with our full-year operating cash flow guidance of $176 million to $191 million dollars. CapEx was $31 million during the quarter, which included approximately $11 million of Indiana Harbor oven rebuild work and approximately $8 million related to the Granite City gas sharing project. The Granite City gas sharing project was completed and put in service at the end of the second quarter. We do not anticipate any further CapEx related to gas sharing. In total, we ended the quarter with a strong liquidity position of over $360 million. With that, I will turn it back over to Mike.

Thanks, Fay. Wrapping up on slide nine, we remain focused on operational execution, maximizing the capability and performance of our coke and logistics assets and ensuring the successful execution of this year's oven rebuild campaign at the Indiana Harbor. Additionally, as mentioned at the start of the call, we delivered on one of our key initiatives, having completed the simplification transaction. This is our strategic transaction for SunCoke, positioning us for success in the future. Also, we continue to pursue our organic and M&A growth strategies, focused on expanding within business verticals that closely align with our core competencies where our knowledge and expertise can create additional value for our shareholders. To this end, we recently signed a long-term take-or-pay contract with an oil refinery to handle pet coke through Convent. And finally, we are continuously focused on executing on our commitments to shareholders by achieving our full-year 2019 financial targets and are well positioned to do so midway through the year. With that, we can open up the call for Q&A.

[Operator Instructions]. Your first question comes from Matthew Fields from Bank of America Merrill Lynch. Your line is open.

Hey, guys. Matt Castellini here on for Matt Fields. Congratulations on the quarter and completing the simplification transaction.

Thank you. Good morning.

Good morning. Now that you guys are a consolidated company, we were wondering what is sort of our priorities for free cash flow moving forward? And also, maybe just any potential you guys see for M&A, specifically in the Logistics space, maybe to add to that portfolio?

Thanks, Matt. As we've indicated before, our first priority is to continue to pay down debt and achieve our leverage target of less than 3 times. So, that's the first priority. We've indicated when we announced simplification that we would intend to begin a common dividend in the first full quarter after simplification is complete. It remains the board's intention. And as we've also indicated, we're going to now look aggressively toward opportunities, both organic and through M&A to grow our business. Having said that we're now looking aggressively, you shouldn't take that to mean that we won't be extremely disciplined. So, while we're working hard, both on organic and inorganic opportunities, we'll remain quite disciplined in that process. So, that's really the priority that we've laid out before and it continues to be our priority now that we've completed simplification.

Okay, got it. Great. Thank you for that. I think you mentioned it earlier. Today, you mentioned that the SXCP bond indenture does, in fact, have a requirement that a full 10-Q be filed later today. So, will that basically be the reporting method going forward for SXCP? Just a Q by itself and no real press release?

We plan on furnishing SXCP standalone financial statements in accordance with the requirements of the indenture on our website later today. So, you should look for full financials on the website later today.

Okay, great. Thanks very much, guys. And congratulations again.

Thank you.

Your next question comes from Daniel Scott from Clarksons. Your line is open.

Hey, good morning. Thanks. Real solid quarter on the coke making side. I want to delve a little more into the Logistics. And, Fay, you were talking about kind of changes in how the full year looked. I think what you said was you're now expecting 8 million tons of throughput, of which 1 million tons is non-coal. So, that kind of ends up being 3 million tons below the take-or-pay levels. Am I thinking it the right way?

No, the take-or-pay levels are 10 million tons. Now, that's kind of the base contracts for our coal customers. So, we're guiding right now to about 8 million tons of throughput. Inclusive in that 8 million tons is 1 million tons of merchant volume, either aggregates or pet coke or other materials. So, that's kind of where we're shaking out based on kind of the current volumes that we're seeing through the facility.

Okay, sure. That's helpful. So, I guess, the run rate year-to-date in your expectations for the back half of the year at current API 2 pricing would indicate that there's going to be another revenue shortfall in the third quarter that will be realized in the first quarter. Is that fair?

That's fair.

Okay. And then, our last question is, and there is some distressed companies in the coal sector right now, including one in the Illinois Basin, have you had any pushback or attempts to renegotiate or anything on your take-or-pays? And if you could help me out also, what are the terms of that for next year and beyond for the take-or-pays?

We fully expect our customers to perform their obligations under any contract, take-or-pay or otherwise, that we have.

Yeah. And the contract – as you know, the expiration of those contracts isn't until 2022. And so, the volume commitments are the same in 2020 as they are in 2019.

Okay, great. Thank you. Very helpful.

Thank you.

And you're next question comes from Lucas Pipes from B. Riley FBR. Your line is open.

Hey, good morning, everyone. I wanted to ask kind of a higher, bigger picture question on the deal-making, coke-making side. Obviously, there's been a lot of talk about new EAF capacity coming online over the next few years. And, Mike, I was curious kind of how do you think this may play out in terms of market share for blast furnaces? And also, how do you think this will impact your business going forward? Very much appreciate your thoughts. Thank you.

Well, Lucas, this is really a better question, I think, for the steel makers to answer. We concern ourselves with the same things you do with regard to capacity additions. Those are announced capacity additions. I believe STI now has more recently confirmed the siting of their 3 million ton facility. But some of those other announcements are just that. Because something is announced doesn't mean it's built. The market for light flat roll continues to grow as it has historically at kind of half the GDP. If infrastructure spending were to increase as it needs over the coming years, there will be greater demand than lesser. So, there's room for demand to continue to grow given the fundamentals of our economy, which would absorb, of course, some of that capacity. Also, as you're aware, during this run up that we saw, rapid run up in hot rolled prices last year, some capacity which had been idled came back online. Some of that capacity, I use the word tertiary, it kind of comes and goes. So, some of that capacity could come back off of line. I'm speculating now. And again, it's a better question for the steel producers in terms of how they intend to defend and grow their market share in a market that's always seen new investment, imports, clear our market. As you're well aware, the US steel market is in structural deficit and is requiring of imports just to balance itself. So, I think you have to think about the presence of imports when you talk about additional capacities. It's not static. It's rather quite elastic. So, imports could be part of that. I think STI has, in fact, said that they're well positioned to defend against imports with their new mill in Texas. So, it's a good question, but there's a lot more in play than simply adding announced capacity and concluding that somehow that has to be surrendered by the existing market. I think our customers are very well-positioned to serve the markets that they do. And again, that's a better question for them. But they've been at it for a long time and I think their customers appreciate the support that they provide with product and innovation and a variety of other services. So, good question. Let's wait and see, but we're not overly concerned at this point in time. We believe our customers can compete well.

That's very helpful. I appreciate that color and that thorough answer. To follow-up on one of the earlier questions, you now have more free cash flow to deploy. And just to backdrop from the prior question, kind of where does – where do investments on the steelmaking side fit in that you kind of rank your priorities, logistics, steelmaking, maybe a new business line altogether. If you could prioritize and order those potential areas of M&A, I would very much appreciate that. Thank you.

Well, we'd rank them on a variety of terms. Most importantly, it would be the risk-adjusted return that's available to us for making an investment. So, if I can make an investment in steel which provided a risk-adjusted return that's higher than logistics, that's what we'd do. Quite similarly, if logistics was offering us a return which was higher on a risk-adjusted basis than steel, that's where we'd put it. Historically, the highest returns have come from organic growth. We're making an investment, as you know, now in the rebuild of the remaining 57 batteries, the B-batteries at the Indiana Harbor works. Our board approved that investment based on its return and the organic opportunities to incrementally grow your business tend to be high returning. So, growing our foundation is something that more traditionally has appealed to us. The further we get from things that we know and understand, our requirement for return would grow quite materially. So, things that are close to home, we understand well. We have technologies. We have operating expertise. We know markets. We know customers. Those are the first places we're going to look because we believe we can add the most value in those areas. So, it's on a return basis. We're not looking at one opportunity. You raise logistics and steel investments more favorably or less than the other. Does that answer your question, Lucas? Did we lose everybody? Hello?

Your next question comes from Nathan Martin [ph]. Your line is open.

Yeah. Thanks for taking my question, guys. Just again, going back to an earlier question – I think it was by Dan – adding to the Logistics question, international thermal prices continue to remain at these depressed levels and export coal needs to fall off, how are you guys thinking about having to back fill or augment that volume and the EBITDA once those take-or-pays do expire at the end of 2022?

So, as you know, we've been actively working on optimizing our CMT facility for over the last year or so. And Mike mentioned the addition of a new contract to move pet coke through the facility. And so, we've been constantly kind of working at getting new volume through the facility. Right now, that facility has the ability to – throughput volumes of up to 15 million tons. And so, we have an opportunity there actually to providing incremental EBITDA. It's something that we are incredibly focused on. And it's taken some time, though, actually, to secure that new business. And so, I think we are working on the diversification of products. We're working on the diversification of customers. And that's something that's top of mind for us.

Got it. I appreciate that, Fay. And then, another question, kind of unrelated, but going back to April 2016, you guys sold some of your coke and coal assets to Revelation Energy. And I believe it's about $10.3 million to assume those mines and some reclamation liabilities, which were around $12 million. I guess just two questions around that. Is Revelation Energy still producing and supplying coal to Jewell Coke? And then, is there any risk that those reclamation liabilities ever returned to SXC if something happens with Revelation? Thank you.

So, you're really testing my memory here going all the way back to 2016, but I'll answer the reclamation liability. First, those reclamation liabilities are the responsibility of Revelation. That was part of the agreement when we divested of those assets. And then, as far as coal supply, we have the opportunity to [indiscernible] coal from a number of vendors in order to supply Jewell coal and we work with our coal procurement department to ensure that we have an adequate supply of the right types of coal to each of our locations to maintain the integrity of our coke-making assets as well as to produce coke and spec for our customers. So, we've got kind of the right coal right now for Jewell and the other facilities.

So, is Revelation part of that blend currently, Fay, no? And does it need to be, I guess, if something were to happen, if those funds went away [ph]?

Like I said, we have a variety of sources that we could procure from. And it doesn't necessarily need to be part of that coal blend in order for the facility to operate as intended.

Would it be more costly to move to a different product?

There's specifics about the kind of coal and transportation costs and the right type of coal. And if you're talking specifically about Jewell, Jewell coal is really kind of earmarked towards our recovery of that. Coal prices earmarked toward what Haverhill coal is procured at. So, there's always a bit of differential. In my prepared comments, I mentioned that we, in the first kind of – and you see this in the first quarter as well as in second quarter that we've had kind of favorable recovery for Jewell coal versus kind of the benchmark price at Haverhill for the first six months.

And you'll remember that one of the benefits of our technology is the ability to change coal blends almost on a continuous basis. And Fay will remind me, but I think we had, in our fleet last year, over 50 blend changes. So, we continue to look at coal pricing, the associated logistics cost of delivering that coal to our facility. So, we're continuously rebalancing and optimizing our coal blends, and we do that in conjunction with our customers. And you'll recall that, most of all of our coal costs are passed directly through to our customers. So, we continuously look at opportunities, again, with our customers in the marketplace to optimize the coal blend. So, change is something that we do and we're pleased that our technology allows us to make these blend changes without jeopardy to the asset itself, and that's not necessarily the case with all coke-making technology.

Got it. I really appreciate the comments, guys. And congratulations again on completing the simplification transaction.

Thank you.

We have no further questions at this time. I'll turn the call back over to the presenters.

Well, thank you, again, everyone, for your participation in this morning's call and your continued interest in SunCoke. We look forward to talking to you in the months and quarters ahead. Thanks again and great day.

This concludes today's conference call. You may now disconnect.