NACCO Industries, Inc. — Q2 2018 Form 10-Q
Reporting period: Three and six months ended June 30, 2018. NACCO is the holding company for North American Coal (NACoal), which operates surface mines and provides mining and related services, including limestone-quarry services through North American Mining. Hamilton Beach Brands was spun off in September 2017 and is reported as discontinued operations in prior-period comparisons.
Financial performance
| Metric | Q2 2018 | Q2 2017 | First half 2018 | First half 2017 |
|---|---|---|---|---|
| Revenue | $33.7 million | $28.1 million | $64.9 million | $56.4 million |
| Operating profit | $7.8 million | $9.5 million | $17.5 million | $19.3 million |
| Income from continuing operations | $6.4 million | $7.2 million | $14.6 million | $15.5 million |
| Net income | $6.4 million | $6.8 million | $14.6 million | $11.8 million |
| Diluted EPS from continuing operations | $0.92 | $1.06 | $2.10 | $2.26 |
Revenue growth reflected higher MLMC coal deliveries and reimbursed costs at consolidated North American Mining operations. Earnings of unconsolidated mining operations—accounted for under the equity method—were $15.4 million in Q2 and $31.0 million in the first half; these are a substantial component of reported operating results. NACoal’s operating profit was $9.5 million for Q2 and $20.8 million for the first half, down from $10.9 million and $22.2 million, respectively.
- Margins and cost drivers: Consolidated gross profit was $4.8 million in Q2 and $10.3 million in the first half. Higher MLMC cost per ton, including repair and maintenance costs, weighed on results. Prior-year operating profit benefited from asset-sale gains of $2.6 million in Q2 and $3.0 million in the first half.
- Cash flow: Consolidated operating cash flow was $18.7 million for the first half, versus $14.5 million from continuing operations in the prior-year period. Investing used $8.3 million, including $9.2 million of capital expenditures; financing used $32.1 million, chiefly reflecting debt repayments and dividends. Cash declined $21.6 million to $80.0 million.
- Balance sheet and liquidity: At June 30, cash was $80.0 million, total debt was $28.0 million, and stockholders’ equity was $231.0 million. Current assets were $152.4 million and current liabilities $45.9 million. NACoal reported $20.0 million outstanding under its $150 million revolving facility, with $128.5 million of excess availability after letters of credit. It was in compliance with financial covenants.
- Dividends and repurchases: Dividends were $0.165 per share in Q2, versus $0.2725 a year earlier. A repurchase program authorizes up to $25 million of Class A shares through December 31, 2019; $0.1 million had been repurchased by June 30.
Material changes and notable items
- Despite higher revenue, operating profit and continuing-operations income declined year over year, mainly because prior-year asset-sale gains did not recur and MLMC’s cost per ton increased. Higher unconsolidated-operations earnings, royalties, and improved Centennial results partly offset the declines.
- First-half net income increased year over year because the 2017 period included a $3.7 million after-tax loss from discontinued operations. Continuing-operations income was lower in 2018.
- NACCO adopted ASC 606 on January 1, 2018 using the modified retrospective method. Adoption created a $2.6 million contract liability and reduced opening retained earnings by $2.1 million, net of tax.
- Long-term debt declined substantially from December 31, 2017, and consolidated debt-to-total-capitalization fell from 21% to 11%.
Outlook, risks, and contingencies
- Management expected second-half 2018 continuing-operations pretax income to increase substantially year over year, producing a moderate full-year increase over 2017. Full-year effective tax rate guidance was 9%–12%; continuing-operations income was expected to be modestly lower for the full year, partly due to the higher tax rate.
- Management expected stronger second-half MLMC results as customer demand and deliveries improved and cost per ton declined. A failure of demand to recover as expected could significantly hurt NACoal earnings. Full-year MLMC income was expected to be comparable with 2017.
- Full-year capital expenditures were expected to be up to approximately $31 million; $9.1 million had been spent in the first half. Cash flow before financing activities was expected to decline in the second half and for the full year.
- Management cited uncertainty in royalty income, which depends on third-party extraction activity and market conditions; longer-term risks include low natural-gas prices and renewable-energy growth affecting coal demand, along with customer outages or demand changes, operating and reclamation costs, permitting, regulation, and contract or customer risks.
- NACCO guarantees certain Coyote Creek obligations, including a potential lender make-whole payment in specified circumstances and a future obligation to purchase equipment if the customer terminates the sales agreement on or after January 1, 2024. Management considered performance under the guarantees remote; no liability was recorded. Ordinary-course legal and regulatory matters were disclosed, with no specific material proceeding identified.
- The company expected adoption of the new lease standard in 2019 to materially increase balance-sheet assets and liabilities, but not materially affect cash flows, liquidity, or debt-covenant compliance.
Key facts for investors to verify
- Whether MLMC deliveries and unit costs improve as management anticipated, and the resulting effect on full-year earnings.
- The composition and sustainability of equity-method earnings and royalty income, including exposure to third-party customer and production activity.
- Capital-spending requirements, cash generation, debt reduction, and ongoing availability under NACoal’s credit facility and covenant headroom.
- Potential Coyote Creek guarantee exposure, mine-reclamation obligations, and the eventual balance-sheet effect of lease-standard adoption.
- Comparability of prior-year results, including the HBBHC spin-off, prior-period asset-sale gains, and the 2018 accounting-standard changes.