Suncoke Energy, Inc. — Q3 2011 Form 10-Q
Reporting period: Three and nine months ended September 30, 2011. The company was separated from Sunoco on July 18 and completed its IPO on July 26, 2011. Pre-separation figures are combined historical results of Sunoco’s cokemaking and coal-mining operations; post-separation figures are consolidated SunCoke results, so comparisons are not fully like-for-like. Sunoco retained 80.9% of shares after the IPO, and SunCoke received no IPO proceeds.
Financial performance
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Total revenue | $403.5 million | $331.6 million | $1,114.8 million | $1,009.4 million |
| Operating income | $30.1 million | $48.4 million | $55.8 million | $158.5 million |
| Net income | $21.7 million | $40.9 million | $51.4 million | $131.2 million |
| Net income attributable to SunCoke / parent investment | $18.4 million | $37.4 million | $52.6 million | $120.8 million |
| EPS, basic and diluted | $0.26 | $0.53 | $0.75 | $1.73 |
| Operating margin | 7.5% | 14.6% | 5.0% | 15.7% |
- Revenue increased 22% in Q3 and 10% for the nine-month period, primarily from higher coal-cost pass-throughs and fees in Other Domestic Coke, plus acquired coal operations. Operating income and attributable earnings fell substantially as costs rose and Jewell Coke earnings declined following a contract change.
- Nine-month results include an $18.5 million loss on firm coke purchase commitments, recorded in Q1, after anticipated Indiana Harbor production shortfalls required higher-priced third-party coke purchases. A $1.2 million lower-of-cost-or-market inventory adjustment was also recorded in Q2.
- Q3 domestic coke capacity utilization was 104%; domestic production was 964,000 tons versus 953,000 a year earlier. Coal production was 340,000 tons versus 270,000, including HKCC.
- Operating cash flow was $58.7 million for nine months, down from $253.9 million. Investing cash outflow was $221.8 million, including $184.2 million of capital expenditures and $37.6 million for the HKCC acquisition. Financing provided $233.9 million; cash increased $70.8 million to $110.9 million.
- Working capital absorbed cash, notably a $112.8 million inventory increase. Inventory stood at $222.4 million, including coal inventory built partly in response to supplier force majeure events and Middletown start-up needs.
Balance sheet, debt, and liquidity
- At September 30, cash was $110.9 million, current assets $386.5 million, and current liabilities $251.8 million. Total assets were $1.879 billion; total liabilities were $1.275 billion.
- Debt carrying value was approximately $697.8 million: $299.3 million outstanding on the term loan and $400 million principal amount of 7.625% senior notes due 2019, net of discount. The term loan amortizes at 1% of original principal annually, with the balance due at maturity.
- The five-year $150 million revolving facility was undrawn at quarter-end; the credit agreement also allows up to $75 million of uncommitted incremental facilities. Management anticipated using the revolver in Q4 for Middletown completion and start-up.
- The term loan is secured by liens on substantially all company and guarantor assets; the notes are senior unsecured. Debt agreements restrict, among other matters, additional debt, distributions, liens, asset sales, and affiliate transactions. The company reported compliance with covenants at September 30.
- Capital spending was $184.2 million for nine months, including $145.4 million for Middletown. Middletown began operations in October 2011 and was expected to raise U.S. cokemaking capacity to about 4.24 million tons annually.
Material changes, outlook, and risks
- Contract economics and segment trends: Amendments to the ArcelorMittal-Jewell contract effective January 2011 reduced the coke pricing formula’s fixed adjustment factor, weighing on Jewell earnings. Higher internal coal transfer prices shifted earnings toward Coal Mining from Jewell but largely eliminate on consolidation. Other Domestic Coke revenue rose with coal-cost pass-throughs and higher fees, while Q3 segment earnings fell amid weaker operating margins and yields.
- Coal operations: Management slowed the Jewell mine expansion because of tight labor, lower seam yields, and higher regulatory costs. Forecast production was about 1.05 million tons in 2011, 1.15 million in 2012, and 1.45 million in 2013. The expansion plan was expected to require about $30 million, including $10 million in 2011. A planned coal loadout facility was expected to cost about $20 million.
- Indiana Harbor: Management expected approximately $50 million of refurbishment spending during 2011–2013, contingent on commercially acceptable long-term contract terms; the estimate excludes possible NOV-related spending. The existing coke sales and energy-processing agreements expire in October 2013. The company bought an additional 19% partnership interest for $34 million, bringing its ownership to 85%.
- Environmental matters: EPA negotiations regarding Haverhill and Granite City notices of violation may require penalties and capital projects now estimated at $80–$100 million over 2011–2016, versus a prior estimate of $65 million through 2013. Penalty negotiations continued, and the final project cost depends on regulatory discussions. The Indiana Harbor NOV remained unresolved; potential penalties or relief were not yet estimable.
- Other contingencies and unusual items: Management estimated potential black-lung liability could rise by $4–$6 million as it assessed legislative changes and actuarial assumptions. Approximately $112 million of deferred tax benefits might not be realizable under the Sunoco tax-sharing agreement; $98.1 million of deferred tax benefits had already been removed at separation. The HKCC acquisition included contingent consideration with potential undiscounted payments of up to $42 million; its recorded fair value was $8.6 million at quarter-end.
- Separation and taxes: Sunoco’s planned distribution of its remaining shares was expected within one year of the IPO but remained conditional and could be delayed or not occur. SunCoke remained subject to transition services and tax-sharing arrangements with Sunoco.
- Controls: Management concluded disclosure controls were not effective at the reasonable-assurance level because of a material weakness in income-tax accounting controls inherited from Sunoco. Remediation was in progress; the weakness would not be considered remediated until controls operated effectively for a sufficient period.
- Management said cash on hand, operating cash flow, and available borrowing capacity should fund planned operations and capital expenditures. Forward-looking results remain exposed to steel-industry cyclicality, customer and supplier performance, coal availability and quality, mine labor and safety, production reliability, environmental requirements, capital costs, and debt restrictions.
Most important facts for investors to verify
- Whether Middletown reached planned operating levels and how completion costs, ramp-up, and revolver usage affected cash and debt.
- Whether working capital—especially elevated coal and coke inventories—converted to cash as management expected.
- Progress on Indiana Harbor’s customer contract renewal, refurbishment scope, and related energy-processing arrangements.
- Final EPA settlement terms, penalties, timing, and capital requirements at Haverhill, Granite City, and Indiana Harbor.
- Resolution of the income-tax control weakness and the recoverability or allocation of the approximately $112 million in potentially unrealizable deferred tax benefits.
- Whether coal production forecasts and expansion plans were achievable amid labor constraints, seam conditions, safety requirements, and higher costs.
- Whether Sunoco completed its planned share distribution and how the transition and tax-sharing agreements affected SunCoke.