SunCoke Energy Partners' (SXCP) CEO Fritz Henderson on Q2 2016 Results - Earnings Call Transcript

| About: SunCoke Energy (SXCP)

SunCoke Energy Partners, L.P. (NYSE:SXCP)

Q2 2016 Earnings Conference Call

July 28, 2016 10:00 a.m. ET

Executives

Kyle Bland - Director of IR

Fritz Henderson - Chairman, President, and CEO

Fay West - SVP and CFO

Analysts

Lucas Pipes - FBR

Neil Weiner - Foxhill Capital Partners

Matt Vittorioso - GoldenTree

Operator

Good morning. My name is Erin, and I will be your conference operator today. At this time, I would like to welcome everyone to the SXCP Second Quarter 2016 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speaker's remarks, there will be a question-and-answer session. [Operator Instructions] Thank you.

Kyle Bland, Director of Investor Relations, you may begin your conference.

Kyle Bland

Thanks, Erin, and good morning and thank you all for joining us to discuss SunCoke Energy's second quarter 2016 earnings. With me are, Fritz Henderson, our Chairman, President and Chief Executive Officer; and Fay West, our Senior Vice President and Chief Financial Officer.

Following the remarks made by management, we will open the call for Q&A. This conference call is being webcast live on the Investor Relations section of our Web site, and a replay will be available for a few weeks. 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 the call over to Fritz, let me remind you that the various remarks we make on today regarding future expectations constitute forward-looking statements, and the cautionary language regarding forward-looking statements in our SEC filings apply to the remarks we make today. These documents are on our Web site, as are reconciliations to any non-GAAP measures discussed on today's call.

With that, I'll turn it over to Fritz.

Fritz Henderson

Thanks, Kyle. Thank you all for joining us this morning. Starting off on slide two, wanted to share our perspective on the quarter, as well as provide a few comments about the first half of the year. We continue to be pleased by the stability and the strong performance of our cokemaking business SXCP. Particularly at Middletown which is on track for a record year. On the logistics front, the industry challenges in the coal business both domestic as well as international in the first half drove lower volumes across all of our terminal locations. But we're recently seeing, coming into the third quarter, some stabilization of that business. And I'll have more to say about that a little bit later.

From a capital allocation perspective we repurchased 17 million of senior notes in the quarter using $13 million of cash, now retired over 117 million of our senior notes over the last three quarter. We remain well on track to achieve our 2016 goal of allocating at least $60 million of cash toward de-levering the business at SXCP. On the distribution font, we declared and maintained our second quarter distribution at $0.594 [ph] per unit. And finally, with the second quarter in the books we're reaffirming today our 2016 adjusted EBITDA guidance, which as we outlined at the beginning of the year when we set the guidance, assumes continued customer performance under our agreement.

Turning to slide three, just some perspectives on what we've seen unfold in the first half of the year. Since the start of the year we're received clarity on several items where were previously top-of-mind for investors at our December investor day. But I'll just go through them notably. First, at the beginning of the year, there was some discussion within the investment community that one of our customers, AK Steel which has a cancellation right in our Haverhill 2 contract might send that notice to us. It hasn't happened. We reached a reasonable accommodation with AK Steel earlier in the year which was a positive. But on the labor front we came into the year two of our customers, both with outstanding labor agreements, U.S. Steel and ArcelorMittal. And those agreements were reached and ratified most recently -- or ratified. So that was good.

From our perspective that was a liquidity issue more than anything else. But nonetheless it was good to see it - progress with our customers with the steel workers, and that risk being taken off the table. And we continue to work side-by-side with our customers to help them manage their coke requirements. In the first quarter, for example, we talked about the changes we made with respect to AK, which involved both lowering production as well as adjusting our reimbursement rate in fixed fees in order to be whole relative to what we would have done had we run at contract max. At the same time we saved both coal cost as well as working capital.

We've timed our production, for example, at Granite City, through the year to work with U.S. Steel to allow them to draw down inventories and manage their working capital. And we remain working closely with our customers -- cokemaking customers -- excuse me, coke receiving customers in order to meet their needs as they navigate the environment in 2016. The same time we've also seen an improvement in the steel industry through the first half of the year. And we as -- I'll make a couple of comments a little bit later about the stabilization we're seeing in coal as well. On the steel side, we've seen all three of our customers access the capital markets, both debt and equity. There are two in the case -- two of our customers access the equity markets. One of them access both debt and equity. And the third accessed the debt markets, which pushed out debt maturities and strengthened the balance sheets and liquidity position.

The overall domestic steel market supply-demand balance has improved. You've imports for the first half of the year falling approximately 28%, in part driven by favorable trade case resolutions. Inventory restocking at reasonable levels continues. And domestic steel makers remain disciplined in their approach to supply optimization. If you look at the level of blast furnace capacity that's been taken offline either permanently or temporarily, about 8 million tons of blast furnace capacity, so a reasonable sized chunk of blast furnace capacity has remained out of the marketplace. And with that stability, and with what we've seen on imports you've seen a pretty significant -- a recovery of prices.

For example, hot-rolled coal prices have increased significantly. Today, they hover at approximately $600 per ton, compared with the sub-$400 per ton pricing at the end of 2015. I remember at one point seeing that Platts was comparing the price of hot-rolled coil to the price of cabbage in steel, for example. And what you've seen is a pretty significant recovery. Not only U.S., but also on a global basis, so encouraging signs.

On the coal side the market fundamentals have -- interestingly they've stabilized. If you look at the export market, obviously a large part of our business prospectively in the current environment relates to our CMT export terminal. You've see API2 prices sharply higher. At one point earlier this year, they were in the low 40s. And the curve was backward dated. So you had the long-dated API2 was even lower. What we've seen is API2 prices recover to around $60 yesterday, where they're slightly over. And you've seen the current flatten out. So you have seen recovery in API2, which as we move into the second half of year we think is an encouraging sign, in part driven by just supply-demand dynamics. And what's happening on a global basis. We're also seeing very hot weather in the U.S., which I think as we look at volumes in the thermal coal side of our River Terminal business. We think we'll stability -- at least stability in the second half of the year.

So as we look in the second half, we're encouraged by those signs. We continue to monitor customer developments. One important announcement made earlier this week was by Foresight, for example. And what we've seen is they've made progress with their bottler negotiations. Through the month of August we'll monitor that. But I think an important step for Foresight. And finally, we're continuing to watch Murray Energy's progress as they engage in dialogue with customers, labor, and their creditors for the balance of the year. With this as a backdrop and we look into 2016, the port remains flexible and responsive. We've done that in the first half. We're going to remain flexible and responsive in the second half.

And at this point I'd like to turn it over to Fay.

Fay West

Thanks, Fritz. Looking at slide four, in terms of performance for the quarter total adjusted EBITDA $41.7 million was down $3 million from the prior year, reflecting comparable operating performance for our cokemaking fleet, and below-target volumes across our Coal Logistics business as compared to the prior year period. Before moving forward, and as a reminder, our adjusted EBITDA results now exclude Coal Logistics deferred revenue, which in response to the new SEC guidelines is now recognized in adjusted EBITDA when it is recorded as revenue under GAAP accounting. In this case it's typically by December 31 of each year. We continue to include deferred revenue in distributable cash flow as amounts due our bill to the customers each quarter.

Moving on, distributable cash flow for the quarter of $39.1 million includes the $7 million benefit of SXC's corporate cost deferral, as well as $9.1 million in deferred revenue from our Coal Logistics take-or-pay contracts. We ended the quarter with a cash coverage ratio of 1.33 times, which includes our second quarter distribution of $0.594 per unit. Lastly, from a net income perspective, second quarter results also reflect higher depreciation due to the addition of Convent, as well as a $3.5 million gain on debt extinguished when driven by our de-levering activity.

Looking at slide five, we ended the second quarter with adjusted EBITDA of $41.7 million, down $3 million versus the prior year period. In the coke segment, we were down about $1.1 million as several small operating items netted, and we were impacted by the complete write-off of a $1.4 million receivable from Essar Algoma, which was related to 2015 spot coke sales.

At coal logistics, the $4.2 million contribution from our content facility was almost entirely offset by lower volumes at KRT in late terminals. Volumes across all terminals remain below expectations as challenges in both met and thermal coal markets continued to way on our customers.

And finally our corporate segment was impacted by higher allocation from SXC, higher direct professional services spend and higher stock compensation cost which drove a $2.2 million variance to the prior year. Such in briefly on our Coke segment on slide 6 we delivered solid second quarter adjusted EBITDA per ton of $71 and 583,000 tons of production.

Our quarterly results were impacted by several factors including the complete right off of the Essar Algoma receivable which I mentioned earlier and customer volume adjustments which as we outlined on the first quarter call lower production but do not impact adjusted EBITDA results since we are made economically hold by the customer. Focusing on our coal logistics segment on the next slide in the quarter we saw below target volumes across all facilities due to industry challenges in the coal space.

While we continued to tightly manage staffing and spending these volume declines more than offset our cost discipline. On the domestic coal logistics side low natural gas prices and higher inventory cost lower burn rate in the thermal coal space to the first half of the year but with favorable natural gas price movement and hot summer weather we've seen increased volumes to start off the third quarter.

On the met coal side higher inventories are driving lower than expected volumes but again we are seeing science of things picking here in July. At Convent we earned $4.2 million of adjusted EBITDA in the period and 976,000 in bound tons. Again as I mentioned earlier these results do not include the $9.1 million of deferred revenue earned for pay tons in the quarter while we saw below target volumes at CMT we are hopeful that the recent horizon API2 prices about $60 per ton threshold will help increase throughput in the second half of the year.

Moving to the liquidity bridge on slide eight, we ended the quarter with more than $120 million in total liquidity including cash of $54 million and remaining revolver capacity of $67 million. In the quarter, we generated significant operating cash flow and paid out over $28 million in distributions to our unit holders. And as previously mentioned, we continue to make progress on de-levering our balance sheet by retiring $17 million of face value debt for $14 million in cash.

Moving out to the next slide, as mentioned at the start of the call, we declared our second quarter distribution of $0.594 per unit, marking our 14th consecutive distribution since our IPO. Through the first half of the year, we repurchased roughly $70 million of face value debt for approximately $47 million in cash or $0.66 on the dollar.

With this progress, we are ahead of pace and well on track for our goal of allocating approximately $60 million of cash to de-lever the balance sheet and expect to continue executing against our de-levering initiatives for the balance of 2016.

With our progress to-date in de-levering, our strong operating performance through the first half of the year as well as improving and stabilizing market conditions in steel, SXC will forego sponsor support for the third quarter as before we will continue to work with our sponsor on further support arrangements and we will evaluate our capital allocation and distribution priorities each quarter.

Flipping to the 2016 outlook, as mentioned earlier, we are reaffirming our adjusted EBITDA guidance for 2016 of $207 million to $217 million. However, with the modified outlook for SXC sponsor support we have revised our distributable cash flow guidance range and associated cash coverage which is expected to remain strong at 1.28 to 1.4 times.

With that I will turn it over to Fritz.

Fritz Henderson

All right. Just wrapping up, thanks, Fay. Turning to slide 11, we do continue to adapt and respond to the headwinds of our industry and the customers that we both - we and our customers face, we did in the first half of the year and we intend to remain flexible on moving forward.

As I discussed earlier, underlying market conditions have continued to improve in the second quarter, I already made some comments about what we see in the second half of the year but I think particularly if domestic steel industry and for our steel customers we feel encouraged by the progress that is made.

From an operations perspective, we will continue to pursue new business across a variety of industrial products at Convent. And we remain focused on driving strong operational, safety, environmental performance across our coke and our coal logistics fleet.

Lastly, we are working to achieve our consolidated 2016 financial guidance, and our de-levering targets remain focused on delivering these commitments to unitholders.

With that, I would like to turn it over to you for Q&A.

Question-and-Answer Session

Operator

[Operator Instructions] And your first question comes from the line of Lucas Pipes with FBR & Co. Your line is open.

Lucas Pipes

Hey, good morning.

Fritz Henderson

Good morning, Lucas.

Fay West

Hi, Lucas.

Lucas Pipes

Fay, first question for you just because it maybe wasn't fully captured here in consensus estimates and such, but is it fair to say that if there had not been the change in the accounting treatment of deferred revenue and adjusted EBITDA, your adjusted EBITDA in the second quarter would have been $9.1 million higher. Is that right?

Fay West

That's absolutely correct.

Lucas Pipes

Great, thank you.

Fay West

Yes, we are trying to get ahead of kind of the new definition and put out a press release earlier in July trying to just let folks know that there is a change in the definition, but you're right, Lucas, if we hadn't changed it would be $9.1 million higher for the quarter.

Lucas Pipes

And in terms of the realization of that, essentially all of that is going to be backend loaded in Q4, is that the right way to think about that?

Fay West

That's exactly correct. You'll see kind of a more bumpy kind of recognition and most of that will come -- all the take or pays -- all the pay volume will come through in the fourth quarter.

Lucas Pipes

So similarly Q3 is going to be affected, but then in Q4 you are going to have that big bump?

Fay West

You're absolutely right. Yes, on a full-year basis it will have no impact, but you'll see it kind of impacting on a quarter-to-quarter basis.

Lucas Pipes

Perfect, great. Thank you. And then, Fritz, maybe to turn to the broader market dynamics, you alluded to it in your prepared remarks. But, I was curious have you seen an impact on just a stronger kind of steel pricing on your business? How are your conversations with steel customers at this time? And how do you think it's ultimately going to impact your bottom line? Thank you.

Fritz Henderson

Lucas, thanks. As I said, we were in constant touch with our steel makers. We haven't seen it affect our business directly mainly because earlier in the year when the adjustments were made between what the U.S. Steel was doing, what AK doing. We adjusted our business for example with AK for production in Haverhill. We've maintained that through quarter. I anticipate we're going to maintain that for the second half of the year although obviously that's a function of what the customer wants. As I said, the blast furnace capacity coming out of the system both temporarily as well as permanent, I think has had some role to play in the stability of the business. And Lucas, I can't speak for my customers, but I think they are pretty focused on hitting their financial goals, de-leveraging themselves, improving their financial conditions. And I think discipline has been a factor in this.

Lucas Pipes

That's helpful. Thank you. And then, may be to turn to your own de-leveraging plans, if I understood correctly, there were more bond repurchases during the quarter. Could you update us on your goals for the full year and where you would ultimately like to take that leverage ratio and the total debt outstanding?

Fay West

Sure. So, through the first half of the year, we repurchased roughly $70 million of face value debt with approximately $47 million in cash, that with an average price of $0.66.

When you look at what we've done since we initiated the program back in the fourth quarter, we've purchased a total of a $117 million for an average price of $0.69. So, we are progressing as we anticipated. Actually, we are ahead of schedule. Our goal was to use $60 million of cash this year to de-lever the balance sheet, and we're at $47 million into the goal for 2016. So, we anticipate that we are going to continue executing against that initiative through the balance of the year.

Fritz Henderson

And then what I would say to your point I mean our target is to bring ourselves within the 3.5 to 4 debt-to-EBITDA range that was what was -- that is the goal that we've been driving towards. And obviously, first thing first, de-lever EBITDA because that's the denominator. And then as we continue to de-lever, we feel like we're moving well towards being in that range.

Lucas Pipes

Perfect, great. Well, appreciate the update and good luck.

Fritz Henderson

Thank you.

Fay West

Thank you.

Operator

[Operator Instructions] Your next question comes from the line of Neil Weiner with Foxhill Capital Partners. Your line is open.

Neil Weiner

Good morning, everybody.

Fritz Henderson

Hi, Neil.

Fay West

Hi, Neil.

Neil Weiner

A couple of questions, on AK Steel's conference call, they reiterated they expect Ashland to remain closed even though there's been some improvement. What's your plan, I guess, longer term if that continues to stay closed? And then have you spoken to them about that?

Fritz Henderson

So as I said before, when I talked about supply discipline, Neil, $8 million obviously Ashland is part of that. And what we've done, we reviewed this in the first quarter, the coke that we produce for them from Haverhill 2 goes to Dearborn.

Neil Weiner

Correct.

Fritz Henderson

And I anticipate that continuing. Interestingly, the original Haverhill 2 project going back years was originally for Severstal and Dearborn. So, some ways it's back to the future, and I don't anticipate that changing for the foreseeable future. Obviously, they'll have to decide what they want to do with Ashland. But in the meantime, we reduced our production for them. We made the adjustments in both fees and cost reimbursement. And we anticipate continuing to do that.

Neil Weiner

Thanks. Also, what kind of contingency plans have you made in case of Murray, either files or they need to -- I know it's take or pay, but they need to come to you to renegotiate their Convent Terminal both volumes and/or price?

Fritz Henderson

So as you would expect, we do continue to do planning. Obviously, the contract is a take or pay contract. Its terms have not been changed. If that would happen, my experience is bankruptcy is a large negotiation. And our contracts could be rejected. Our contracts excuse me could be rejected and bankruptcy we don't know, one way or the other. So what we've done is we've looked at the level of EBITDA and cash flow. And frankly to look at Convent again, it's a little bit confusing to follow given the changes we have made in adjusted -- in how we determine adjusted EBITDA. But if you start off with the guidance we have for Convent which is 50 to $55 million for the year, you should think of half of that being from Murray roughly. And so we've modeled in what the impact might be of that sought of diminishing in EBITDA. And what we would do in terms of continue to de-lever, we have tools available to us that allows us to continue to de-lever and stay within all of our financial covenants and frankly continue to run the business if that would happen. And now we'll just monitor it.

So, we do a lot of contingency planning. Frankly earlier in this year, we had lots of contingency planning about lots of contingencies. But, as we look it at today, number of the risk that we saw in the environment early in the year have diminished. And now, this is the one that's in front of us today.

Neil Weiner

And one last question, I guess at what level or sustained level, would you obtain API2? Would you expect coal exports to increase materially and volumes to pick up through the terminal?

Fritz Henderson

It's excellent question. One, probably best lodged with our customers, but if you look at the only low 60s, it's a reasonable level when you look at net back. So we did a million tons basically roughly in the both the first and the second quarter. As I look out with API2 in the low 60s, it feels to me like you can start to see volume pick up. We don't determine what our customers do, but it's -- you look at net backs, you take out the transportation, you take out ocean freight. You look at it and you say that's a reasonable level. Obviously, the prefer it to be higher, but interestingly it's coming back to. It's where API2 was when we originally did the deal year ago. So, it has been an encouraging sign and we'll just have to see what our customer do.

Neil Weiner

And I am sorry, one question for Fay. Fay, assuming that you are essentially repurchasing debt as your cash flow comes in to execute against that $60 million number, is that correct, and that's why you haven't been more aggressive earlier in the year?

Fay West

That's correct.

Neil Weiner

Okay. Thank you everybody.

Fritz Henderson

You're welcome.

Fay West

Thank you.

Fritz Henderson

Thank you.

Operator

Your next question comes from the line of Matt Vittorioso with GoldenTree. Your line is open.

Matt Vittorioso

Yes, thanks for taking my question. Just along those same lines when you're talking about the risk around Murray, maybe if you could put a little bit more detail around what you're pursuing on the other industrial materials for Convent. It seems to me that that would be a good risk mitigant if you were able to announce some sort of actual contract or some progress towards new materials being moved through that terminal. So is there any other detail you can provide on that, or how real is that opportunity?

Fritz Henderson

Matt, I would say I think we covered this in the first quarter, but I will repeat it. So, works continues, if and when we actually have additional business, we will let people know. I think that the focus has been on pet coke, and we've been in dialog with a number of refineries. And I'm not going to mention which ones, but we are actually in a good location with respect to refineries and pet coke exports.

And then the second thing is coal actually. And we have been looking at ways with potential customers -- with customers where we either might export for them or actually be a stopping point for coal that might be supplied back into the U.S. So, all of our focus has been on either coal or pet coke. We haven't spent a lot of time on product that would require change in the different color products basically because it does drive a lot of complexities in the terminals.

In the event we were to do something with the lighter product than we would need to be reasonable volumes, we could actually justify the expense associated with cleaning and investment associated with the different belt. But the focus has really been on pet coke and coal. And what I would say is the dialog has continued through the second quarter, and some of these things by the way are longer sale processes. I mean we have customers who are -- their needs are met today by other companies. And so, what we are trying to do is get a piece of that business. It takes some time.

Matt Vittorioso

Okay. That's helpful. And then, on your balance sheet I don't know what you can say about this, but before talking about risk around Foresight and Murray, I guess the Kline group has extended financing for you to purchase that Convent Terminal. Is that financing at all contingent upon those customers continuing to perform on their contract or is it completely separate?

Fritz Henderson

No, completely separate. It's not linked to the supply agreement.

Matt Vittorioso

Okay, so if Murray/Foresight/Kline, whatever entity filed you would continue to owe that debt?

Fritz Henderson

Yes.

Matt Vittorioso

Yes, okay. One last housekeeping on working capital, just as we think about your ability to de-lever and generate cash and continue to do so over the back half of the year. Working capital was a nice source of cash in the second quarter. What's your expectation for the full year?

Fay West

I think that we will continue to see favorable working capital trend through the balance of the year.

Matt Vittorioso

So you can squeeze some more cash out of working capital in the third and fourth quarter, yes?

Fay West

I think we will do some.

Matt Vittorioso

Yes, okay. All right, thank you.

Operator

There are no further questions at this time. I will turn the call back over to the presenters.

Fritz Henderson

All right. Well, again, thanks very much for joining this morning and for your interest in investing in us and SunCoke Energy Partners. Later this morning, SunCoke Energy will host the earnings call for the sponsor and the parent. Thank you very much.

Operator

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

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