SunCoke Energy (NYSE:SXC)
Q2 2016 Earnings Conference Call
July 28, 2016, 11:00 AM ET
Kyle Bland - IR
Fritz Henderson - Chairman, President and CEO
Fay West - SVP and CFO
Lucas Pipes - FBR Capital Markets
Neil Weiner - Foxhill Capital Partners
Matt Vittorioso - GoldenTree Asset Management
Good morning. My name is Sylvie, and I will be your conference operator today. At this time, I would like to welcome everyone to the SXC second quarter 2016 earnings 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.
Thanks Sylvie. Good morning and thank you 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’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 for a few weeks. If we don’t get to your call today, 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’s call, 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 available on our website as the reconciliations to any non-GAAP measures discussed on today’s call.
Now with that, I’ll turn it over to Fritz.
Thanks, Kyle and thank you all for joining the call this morning.
I'll start off with Slide 2, I want to share our perspectives on the quarter. During the first half of the year as well, we'll talk a bit more about that in the next chart, but we remain on track to achieve our full year consolidated adjusted EBITDA guidance, driven by the solid performance of our coal fleet, particularly at Middletown, which is on track for a record year.
In Indiana Harbor, we continue to see strong cost performance and improvement and tend to expand our rebuild initiative to address production challenges. Again I'll cover that a little bit later. In the first quarter, we were improved year-over-year, but nonetheless we still have significant amount of work ahead of us.
In Indiana Harbor, on the logistics front, coal industry challenges in both this quarter, the second quarter and the first half drove lower volumes across our thermal operations, both export as well as domestic, but we've seen some recent stabilization in the market fundamentals as we enter the third quarter.
Additionally in the quarter, we completed the divestiture of our coal mining business, which helped contribute -- help contribute to the year-over-year adjusted EBITDA improvement and we've already achieved our run rate go-forward cost target for that segment.
From a capital allocation perspective, we continued our deleveraging efforts and reduced debt outstanding by over $57 million in the quarter on a consolidated basis, including $17 million in repurchases at SunCoke Energy Partners. We're pleased with the progress we made to date and remain ahead of schedule toward achieving our 2016 deleveraging objective.
Finally as I mentioned we're reaffirming today our 2016 adjusted EBITDA guidance of between $210 million to $235 million, which assumes as it did when we set that guidance earlier this year -- late last year, excuse me, continued customer performance under our take or pay contracts.
Few words about the current environment on Page 3, both what we saw in the first half of the year as well as what we see looking out into the next six months, but we reflect first on development through the first half of the year.
We came into the year, we faced a number of risks in our business. A number of those risks have been resolved or at least mitigated to a degree. With respect to our Coke making customers for example in Steel, we've adjusted our production to lower production rates for example with AK Steel something we announced earlier this year, where we reduced production, lowered both our Coke office as well as working capital requirements.
We adjusted our fixed season reimbursement rates and it was an agreement that was I think reasonable for both parties. The production from our Haverhill facility is going to their blast furnace and the cancellation notice that the Haverhill 2 contract does have a two-year cancellation notice that there were lot of questions about that late last year early this year.
We've not received that notice and we think we've reached a reasonable position with AK Steel. We continue to work with them as well as all of our customers. With respect to US Steel, we did -- we timed our production at Granite City through the year and we slowly ramped it up, so that over the course of the year, we think we worked to help support our customer US Steel in terms of their objectives to reduce working capital without prejudicing our own business.
Relative to labor, we came into the year with both US Steel and ours middle without ratified labor agreement. Those are now both ratified and while that was a liquidity risk rather than a broad business risk for us, we would nonetheless with liquidity risk that we had to be mindful of and that didn’t materialize.
And as we continue to work side by side with our customers to help manage their coke requirements, we do invest within the bounds of our take or pay agreement.
At the same time I think it's important to look back and see the improvement in the steel industry through the first half of the year and the second point, I'll make some comments about coal, but we're beginning to see as we come into the third quarter some signs of stabilization in coal both domestic as well as the export market.
On the steel side, we've seen all three of our customers access the capital markets helping to push out debt maturities, improve liquidity, strengthen balance sheet. Two of our customers raised equity count. Two of them raised debt and again these were important initiatives from their perspective from both liquidity as well as capital structure to move up maturities.
At the same time, the overall domestic steel market supply demand balances improved. Imports through the first half of the year fallen 28% driven in part by favorable trade case rulings. The inventory levels across the industry is a significant amount of destocking last year and you’ve seen is I think inventory levels being reasonable today with some restocking across the industry.
And importantly the domestic steel makers remain disciplined in their approach to supply optimization and here with respect to the blast furnace steel making, when you step back eight million tons of blast furnace steel making that’s either been temporarily or permanently idled across the industry, which I think is in part contributed to that supply discipline through the first half.
With these items what you’ve seen is hot rolled coil prices, which today hover around $600 per ton, compared with a sub $400 per ton that we saw at the end of 2015, which is I think an encouraging sign for our customers.
On the coal side, we've seen some stabilization and in fact we've seen number of signs that we might see better volumes for example in the second half. Let's start on the export side.
API 2 prices have moved sharply higher. They were as low as $40 -- in the low $40s earlier this year. The forward curves were backward dated, so you had even lower prices in the out year periods. What you now see is API 2 prices in the low 60s, right around $60. You’ve seen those curves flatten out and they’ve been mildly in contango actually more recently, but they're relatively flat and with the difference between the low 40s of API 2 and 60-60 the low 60s, I think a good fact for our export customers going forward on the thermal side.
On the domestic side what you’ve seen is very hot weather and while you saw significant inventory dry down from the mild winter through the first half of the year, I think we're starting to see some signs of at least stability in volume in terms of our thermal coal domestic customers and on the met side, again this runs through our KRT terminal.
We saw significant destocking of inventories in the first half and we think we've seen some stability there as well if you go into the second half. So I think the important word here that I would use is stability as we get into the second half.
With respect to our customers, we continue to closely monitor developments at our customers at the Convent Marine Terminal. We're encouraged by the recent -- to see the progress. The foresight is made with its bondholder and creditor negotiation and I think we'll see some more -- we should see some more developments in that regard next week and so we'll continue to monitor that.
And we're continuing to watch the situation with our other customer at Convent Marine Energy as they engage in dialogue with both their creditors and their labor force through the balance of the year.
With this as a backdrop as we look in to the second half of '16, I think it's important that we remain both vigilant, flexible and responsive as we have been in the first half of the evolving market landscape and that’s what we plan to do.
At this point, I would like to turn it over to Fay.
Thanks Fritz. For the second quarter, consolidated adjusted EBITDA of $46.5 million was up $13.1 million versus the prior year period and this was driven primarily by the lapping of a $12.6 million non-cash pension termination charge, the benefit of CMT acquisition and improved costs performance at Indiana Harbor.
Before moving forward and as a reminder, our adjusted EBITDA results now exclude Coal Logistics deferred revenue. This change in definition is in response to the new SEC guidelines and deferred revenue is now recognized in adjusted EBITDA when it is recorded as revenue under GAAP accounting, in this case typically by December of each year.
This change in definition has not been contemplated in the consensus guidance and analysts reports. Good to note that if there was no change in adjusted EBITDA in the definition, adjusted EBITDA would have been $9 million higher.
From an EPS perspective, the loss of $0.07 per share reflects improved operating income and includes a $5.1 million loss associated with the coal mining divestiture and a $3.5 million gain on debt extinguishment from our de-levering activities.
Turning to Slide 5 and driving further into adjusted EBITDA results, you can see the $1.1 million performance improvement at Indiana Harbor was driven by disciplined cost management, but was partially offset by lower volumes and yields.
While we're encouraged by the significant progress that we've made on cost control and by the performance of the oven rebuild, we continue to experience production challenges, which Fritz will go through in more detail later on the call.
Excluding Indiana Harbor, the remainder of the coke business was impacted by several items including the timing of shipments at Jewell Coke, $1.3 million of coal transportation cost that were shifted from the coal mining business to Jewell Coke and the complete write off of a $1.4 million receivable from Essar Algoma which was related 2015 spot coke sales.
Moving on from coke, improvement at our corporate segment benefited from lower headcount and the lapping of a $12.6 million non-cash pension termination charge, which we incurred in the Q2 of 2015. At coal logistics the $4.2 million contribution from our Convent facility was almost entirely offset by lower volumes at KRT and Lake Terminal.
Volumes across all terminals remain below expectations as challenges in both met and thermal coal markets continue to weigh on our customers. And finally our coal mining divestiture which was completed in April helped drive favorable year-over-year results and we had a seamless transition to a 100% third party purchase coal at our Jewel Coke facility.
Furthermore we have already reduced ongoing cost to our targeted $2 million annual run rate going forward.
Turning to our domestic coke results on Slide 6, we delivered solid second quarter adjusted EBITDA per ton of $51 about 998,000 tons of production. Our quarterly results were impacted by several factors some of which I've already discussed including the shift of coal transporation cost from coal mining to Jewel coke, the complete write-off of the Essar Algoma receivable, below target Indiana Harbor performance 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 whole by the customer.
Moving to our Coal Logistics performance on Slide 7, in the quarter, we saw below-targeted volumes across all facilities due to industry challenges in the coal space. And while we continue 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 inventories have caused lower burn rates in the thermal coal space through the first half of the year. But with favorable natural gas prices and hot summer weather, we have seen increased volume to start off the third quarter.
On the met coal side, higher inventories are driving lower-than-expected volumes. But again, we are seeing signs of things picking up here in July. At Convent, we earned $4.2 million of adjusted EBITDA in the period on 976,000 inbound tons. And 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're hopeful that the recent rise in API2 prices above the $60 per ton thresholds will help increase throughput in the second half of the year.
Moving to the liquidity bridge on Slide 8, we ended the quarter with approximately $108 million of cash and $167 million of combined revolver availability. In the quarter, very strong operating cash flow was due to significantly deliver the balance sheet. We used nearly $55 million to reduce both SXC revolver borrowings and repurchase senior notes at SXCP.
We have now reduced consolidated debt outstanding by over $157 million in the last 3 quarters and remain well positioned with approximately $275 million of total combined liquidity.
I will now turn it back over to Fritz to walk through an update on Indiana Harbor.
Thanks Fay. Turning to Chart 9, as you can see in the second quarter, we once again achieved strong cost savings, resulting in $4.6 million in O&M savings versus the second quarter of ‘15. These savings are a result of a holistic and disciplined approach to cost management through the plant. We've netted approximately $10 million in savings through the first 6 months of the year.
Late last year, as we were confronting the challenges in Indiana Harbor, one of the things I talked about was the importance of having a holistic approach to the plant, not only production but also cost capital and also environmental and health and safety performance. And we've approached Indiana Harbor in a holistic way as we've proceeded in 2016. Now the progress has been good on the cost side. The progress has not been satisfactory on the production side.
But let me talk about the oven rebuild because the ovens that we've rebuilt -- we've evaluated another quarter of data from the 48 ovens we rebuilt last year. We remain encouraged by the sustained performance across those 48 ovens. We continue to analyze and monitor the results in order to optimize the design for future rebuilds that we expect to complete in 2016 and beyond. I'm going to talk about that more in a moment.
But you can see the average charge weights of 39.8 tons in the second quarter -- excuse me, year-to-date ‘16 relative to a 39 ton average -- excuse me, target. You see coking rates, again -- charge weight, coking time. And on coking times, 45.1 hours average coking time versus a 46.5 target. So as we step back and look at the ovens that we've rebuilt, we're encouraged by their performance.
But we also see areas where we can improve further as we tackle the approximately 40 ovens that we're going to rebuild late this year. This is one of the advantages of actually going slower on certain things because it gives you the ability to step back, monitor and adjust. And in this case, we're -- I think we're going to benefit from having taking a more deliberate approach to the next round of ovens that we're going to rebuild.
The operational challenges at the plant are considerable. I would say a couple of things. One, as we get our arms around what we need to do with the ovens, we are expanding our focus on how do we improve the mechanical reliability across the plant associated with the moving equipment and the various other parts of the plant that support the ovens in trying to minimize operating disruptions.
I want to talk more about that a little bit in a couple of charts. What we've also seen is accelerated oven health degradation across the non-rebuilt oven, which is the imperative as we look at what do we want to get accomplished rebuilding ovens both this year and then going into next year.
Turn to Slide 10. First on oven health. The point is we have seen higher-than-expected degradation across the non-rebuilt ovens. So what is oven degradation and what does it mean?
Structurally, oven degradation is evidenced by wall cracks, floor cracks and blockages across the sole flues in the bottoms of the ovens, which is the area where the gas moves under the ovens. These issues reduce oven temperature, which from an operations perspective results in longer and, importantly, more inconsistent coking time, and therefore, require lower charge weights.
In the first half of the year, we have seen these two metrics deviate from our normalized oven degradation curves in the non-rebuilt ovens, driving lower production and also impacting our yield in a negative way.
As mentioned in our December Investor Day, a task Dovie Majors, our VP of Coke Operation, was executing a more analytical and methodological -- methodical, excuse me, approach to addressing challenges at the harbor. On oven degradation specifically, we've expanded scope of our rebuild for 2016. We're going to rebuild approximately 40 total ovens, up from our original estimate of 19.
We'll continue to monitor performance of the ovens that we rebuilt last year and the ovens that we'll rebuild later this year, so that future rebuild decisions will be based upon sound economic returns and again, not necessarily focused on achieving 1.22 million tons across the plant.
We expect to begin the next wave of oven rebuilds in the back half of this year, specifically in the fourth quarter, to ensure a full understanding of the degradation problems and to incorporate lessons learned from the initial 48 ovens that we rebuilt last year.
As you know, for the last few quarters, we have focused on oven health and executing this more holistic approach to oven rebuilds, with those results beginning to deliver to our expectations and performing our rebuild plans going forward allows us to focus on other areas where we can also continue to improve. In that regard, focusing on mechanical reliability as well as workforce performance, we are very focused on both of these areas and not only at the harbor but benchmarking the harbor relative to our other operations.
From a plant performance perspective, these items are responsible for inefficiencies within our daily operating cycle, driving increased coking times. So it's interrelated. It's not just simply a function of mechanical reliability, an operating performance and an oven performance, all three of those things relate.
To address these issues, like our other facilities, we're using a strict maintenance window in order to ensure mechanical uptime, in order to ensure that we can actually make the improvements and make the necessary maintenance changes to our equipment to improve mechanical uptime during our daily operating cycle.
This is a difficult process, a transition process. It means we'll have a shorter push window in order to implement the changes. That being said, it's the right thing to do and it's a step that we've taken.
Finally, we have begun labor negotiations with the steelworkers at the site, with the expectation that we, with our workforce, will work on activities that can align and produce better performance going forward.
Looking at the outlook for Indiana Harbor. With the continued production challenges as well as the changes to our 2016 oven rebuild initiative; we're revising our adjusted EBITDA guidance at Indiana Harbor to be approximately breakeven in 2016. When we started the year, we anticipated that number would be between $3 million and $13 million.
This compares with the actual adjusted EBITDA that we've earned through the first half the year of $3.8 million. So as you look out in the second half, obviously, this is impacted both by the increased number of ovens that we'll rebuild and the later timing of those rebuilds.
While this will impact our production in the short term, i.e. taking out more ovens than we originally anticipated, we think this is the right approach going forward. While our near-term performance is not where we want it to be, we feel the areas we're focused on and the methodical approach we're taking to address them is the right thing to do to drive the long-term profitability and cash flows at this plant.
Wrapping it up, we continue to adapt and respond to the headwinds and the challenges that our industry and our customers face. We did it in the first half of the year, and we intend to remain flexible as we move into the second half of the year. As I discussed earlier, some of the underlying market conditions have improved through the second quarter and as we approach the third and fourth quarter of this year, especially within the domestic steel industry and with respect to our three specific customers in the domestic steel industry.
From an operations perspective, we remain focused on cost control, oven health and reliability to drive long-term performance in Indiana Harbor while we look to continue delivering on a track record of strong operational, safety, environmental performance across the rest of our coke making fleet.
We already made the comments on what we're doing on Coal Logistics. Fay made a couple comments. We've adjusted our cost position in those terminals to the maximum extent possible, and we'll work with our customers as we look at the outlook for volume in the second half of the year.
And finally, we're positioned to achieve our consolidated 2016 financial guidance and our deleveraging targets, and we remain focused on delivering at those commitments for shareholders in 2016.
With that, I'd like to turn it over for Q&A.
[Operator Instructions] You do have a question.
Excellent. Thank you.
Your first question comes from the line of Chad Caywood [ph].
My question is concerning the dividend, if the dividend is $0.59 and the units earned $0.23, where does -- you probably have covered this, and I apologies if you have, but how is the dividend to be paid?
Chad, the distribution, you were talking -- the $0.594 is at the MLP. So there's no dividend on the SXC shares. The dividend at SXCP or the MLP is a carryover from what it has been, and it's $0.594. And was that where you were getting that?
Yes. My question is if the units earned $0.23 and you're paying out $0.59, where does the rest of the money come from?
Okay. Did you -- were you on the call earlier this morning, Chad on the SunCoke Energy Partners call, where we went through distributable cash flow and coverage?
Clearly, I'm on the wrong call.
No problem. Tell you what, we'll follow-up with you directly because what we'd do is we'll take you through the metrics that show -- I mean, the coverage levels that we maintain at SunCoke Energy Partners are quite robust and support that distribution. We'll just follow up with you directly.
Thank you very much.
There are no further questions at this time. I will turn the call back over to the presenters.
Great. Again, thank you very much for joining us this morning, for your interest and your investment in SunCoke Energy. Thank you.
This concludes today's conference call. You may now disconnect.
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