Suncoke Energy, Inc. — Q2 2011 Form 10-Q
Reporting period: Three and six months ended June 30, 2011; filed August 3, 2011. Unless noted otherwise, financial figures below are in millions of dollars. The statements are unaudited combined historical results of Sunoco’s cokemaking and coal-mining operations before SunCoke’s July 26, 2011 IPO and separation; they may not represent SunCoke’s post-separation results.
Business context
SunCoke operates four U.S. metallurgical coke facilities, a coke facility in Brazil, and coal mines in Virginia and West Virginia. It sells coke primarily under long-term contracts with take-or-pay provisions. The company acquired the HKCC coal businesses in January 2011 and was building a new 550,000-ton annual-capacity coke facility in Middletown, Ohio.
Financial performance
| Metric | Q2 2011 | Q2 2010 | First half 2011 | First half 2010 |
|---|---|---|---|---|
| Total revenue | $378.0 | $349.3 | $711.3 | $677.7 |
| Operating income | $21.4 | $57.9 | $25.7 | $110.1 |
| Net income | $24.0 | $47.6 | $29.6 | $90.3 |
| Net income attributable to net parent investment | $22.4 | $44.3 | $34.2 | $83.3 |
- Revenue increased 8% in Q2 and 5% in the first half, largely from higher coal-cost pass-throughs, operating-fee reimbursements, higher coke volumes at domestic facilities, and HKCC.
- Operating margin fell to about 5.7% from 16.6% in Q2 and 3.6% from 16.2% for the first half. Lower Jewell Coke pricing after an amended ArcelorMittal contract, higher costs, corporate expenses, and an $18.5 million firm-purchase-commitment loss weighed on results.
- Q2 operating income and net income attributable to parent were down year over year; first-half net income attributable to parent also declined materially. The first-half $18.5 million purchase-commitment loss was recorded in Q1, not Q2.
- Cash from operations was $16.4 million in the first half, versus $184.4 million in 2010. Investing used $165.5 million, including $128.0 million of capital expenditures and $37.6 million for HKCC. Financing provided $139.5 million, principally through increased Sunoco-affiliate advances. Cash declined $9.6 million to $30.5 million.
Balance sheet, liquidity and debt
- At June 30, 2011, total assets were $1.973 billion, total liabilities $1.515 billion, and equity $457.3 million. Cash was $30.5 million and current assets $250.5 million versus current liabilities of $1.221 billion; current liabilities included $1.033 billion of advances from an affiliate.
- These June balances are pre-separation. After the IPO, the company had $300 million outstanding under a seven-year term loan, a $150 million five-year revolving facility with no borrowings, and $400 million of 7.625% senior notes due 2019. The debt proceeds were used to repay $575 million of intercompany debt, pay fees, and for general purposes. The filing states the IPO sale proceeds went to the selling debt exchange party, not SunCoke.
- The term loan has quarterly amortization equal to 1% of original principal per year, with the remaining balance due at maturity. Debt agreements impose leverage, interest-coverage, and other covenants; substantially all assets secure the credit facilities.
Material changes, outlook and risks
- Jewell Coke revenue and segment earnings fell sharply after the ArcelorMittal contract amendment effective January 1, 2011, which changed coke pricing and reduced the effect of coal prices on Jewell’s results. The change shifted some earnings between Jewell and Coal Mining through internal coal-transfer pricing.
- Other Domestic Coke benefited from improved Indiana Harbor, Haverhill, and Granite City utilization and higher cost recovery, but Indiana Harbor incurred reliability-related repair costs and a $1.2 million inventory valuation adjustment on purchased coke. Management said second-quarter operating improvements should allow Indiana Harbor to meet its contractual production requirements.
- The Middletown facility was expected to be completed in Q4 2011. Management expected coal output to increase by about 350,000 tons annualized in 2012 and by 500,000 tons by mid-2013, reaching a two-million-ton annualized sales rate; planned project spending was about $25 million, including $10 million in 2011. These are expectations, not guarantees.
- Management said cash on hand, operating cash flow, and available debt financing should fund planned operations and capital spending. First-half capital expenditures were $128.0 million, including $103.9 million for Middletown.
- The HKCC acquisition cost approximately $52.0 million including contingent consideration, added 21 million tons of proven and probable reserves, and carries potential future contingent payments of up to $42 million undiscounted.
- Sunoco retained 80.9% immediately after the IPO and planned a shareholder distribution within 12 months, subject to conditions; Sunoco could terminate that plan. SunCoke also entered transition, tax-sharing, indemnity, and other separation agreements with Sunoco.
- An EPA demand sought civil penalties for alleged Clean Air Act violations at Haverhill and Granite City. Negotiations were ongoing and the company could not estimate a reasonably possible loss range; management did not expect a probable loss to be material. Separate tax indemnities had a stated maximum potential payment of about $20 million, though management considered the likelihood remote.
- Disclosure controls were found ineffective at the reasonable-assurance level due to a material weakness in income-tax accounting inherited from Sunoco. Remediation was underway, but the weakness was not yet considered remediated.
Most important facts for investors to verify
- Whether Indiana Harbor sustains improved production and fulfills contractual minimums without further costly coke purchases, and how repair costs affect margins.
- Actual completion, spending, commissioning, and operating performance of the Middletown project, plus progress and cost of the planned coal expansion.
- Post-separation cash generation, working-capital needs, debt covenant headroom, interest burden, and repayment capacity.
- Resolution and potential financial exposure from the EPA matter and other contingencies, including HKCC contingent payments and tax indemnities.
- Completion of tax-control remediation and the timing and conditions of Sunoco’s planned share distribution.