NACCO Industries, Inc. — Q3 2019 Form 10-Q
Business context and reporting period. NACCO is a mining and natural-resources holding company with Coal Mining, North American Mining (NAMining), and Minerals Management segments. This unaudited report covers the quarter and nine months ended September 30, 2019; comparisons are with the corresponding 2018 periods. Segment presentation changed in 2019, and prior-year data were recast.
Key financial results
Amounts below are in millions, except per-share data and percentages.
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Revenue | $32.6 | $31.4 | $114.1 | $96.3 |
| Gross profit | $6.2 | $6.1 | $28.2 | $16.4 |
| Operating profit | $8.7 | $10.5 | $34.2 | $28.1 |
| Net income | $10.3 | $9.2 | $33.3 | $23.8 |
| Diluted EPS | $1.47 | $1.33 | $4.76 | $3.43 |
| Operating cash flow | Not presented by quarter | Not presented by quarter | $47.3 | $38.9 |
| Capital expenditures | Not presented by quarter | Not presented by quarter | $13.3 | $14.6 |
- Revenue increased 3.7% in Q3 and 18.4% year to date. Net income rose 11.6% in Q3 and 39.9% year to date; operating profit fell 17.9% in Q3 but increased 21.8% year to date.
- Calculated consolidated margins: gross margin was 19.0% in Q3 and 24.8% year to date; operating margin was 26.6% and 30.0%, respectively; net margin was 31.5% and 29.2%, respectively.
- At September 30, cash was $115.1 million, versus $85.3 million at year-end 2018. Total debt was $7.7 million, down from $11.0 million; cash exceeded debt by about $107.4 million. Equity was $283.3 million.
- Operating cash flow of $47.3 million and investing cash outflow of $8.8 million produced $38.5 million of cash flow before financing. Financing cash outflow was $8.7 million, including $3.8 million of dividends and $1.4 million of share repurchases.
- Current assets were $180.3 million against current liabilities of $52.8 million. NACoal had no revolver borrowings and $148.6 million of availability under its $150 million facility, after letters of credit. The facility expires in August 2022; NACoal reported compliance with its covenants.
Material changes and segment performance
- Coal Mining: Q3 operating profit declined to $7.3 million from $9.8 million; nine-month profit fell to $19.6 million from $26.4 million. Lower coal deliveries at unconsolidated operations and higher employee-related expenses contributed. Q3 segment revenue was broadly flat; nine-month revenue increased modestly.
- NAMining: Q3 operating loss was $0.4 million versus $0.3 million profit; nine-month loss was $0.8 million versus $1.1 million profit. Higher labor, supplies, repairs, employee, and business-development costs weighed on results, partly offset by stronger earnings from unconsolidated operations and new contracts.
- Minerals Management: Revenue increased to $5.0 million in Q3 from $3.9 million and to $26.0 million year to date from $11.2 million. Segment operating profit rose to $3.9 million and $22.4 million, respectively, primarily as more third-party-operated wells produced natural gas from Ohio reserves.
- Consolidated Q3 operating profit was pressured by Coal Mining and NAMining. Net income nevertheless improved, helped by lower interest expense, higher interest income, and other income. Nine-month results also benefited materially from Minerals Management growth.
Outlook, commentary and risks
- 2019 outlook: Management expected full-year net income to increase significantly from 2018, driven mainly by higher Minerals Management earnings and a $2.7 million pretax customer payment relating to a former India venture, partly offset by weaker Coal Mining and NAMining results. The estimated full-year effective tax rate, excluding discrete items, was about 15%.
- Management expected Q4 2019 operating profit and net income to be significantly below Q4 2018, largely because 2018 included favorable Coal Mining contractual and reclamation items; excluding those items, operating profit was expected to decline moderately. Full-year cash flow before financing was expected to exceed 2018. Estimated 2019 capital expenditures were $28.4 million.
- 2020 outlook: Management expected net income to decrease moderately, mainly in the first half, as Minerals Management earnings declined from unusually high 2019 levels, partly offset by improvement in Coal Mining and NAMining. Estimated capital expenditures were approximately $41 million, including about $30 million for Coal Mining’s new mine area and $10 million for NAMining; cash flow before financing was expected to be a modest use of cash. The projected effective tax rate, excluding discrete items, was 10%–12%.
- Coal Mining deliveries and earnings are sensitive to customer requirements and power-plant outage schedules. The company noted that lower-than-expected demand at MLMC could significantly harm 2020 earnings; elevated MLMC investment will also increase depreciation.
- Natural-gas royalty income may decline with commodity prices, natural well-production declines, operator activity and infrastructure constraints. Management expected a substantial decrease in Minerals Management royalty income in Q4 2019 and 2020 versus high comparison periods.
- In Q3, NACCO agreed to mine the Thacker Pass lithium project under a 20-year contract. The customer reimburses operating and reclamation costs and pays a management fee per metric ton delivered. NACCO had advanced $1.0 million toward a planned $3.5 million development contribution. The project depends on permits and financing; the customer expected major permits by end-2020 and production in 2023. NACCO may acquire up to $50 million of equipment after required permits and financing, with reimbursement over seven years.
- Other notable items: NACCO received $2.7 million from its former India customer ($1.4 million for past invoices and $1.3 million interest income). It adopted lease accounting in 2019, recording $11.7 million of operating-lease right-of-use assets and $12.7 million of operating-lease liabilities; adoption did not materially affect operations, cash flow, liquidity or covenant compliance. A transfer of certain Centennial mine permits reduced reclamation obligations by $5.4 million and resulted in a $0.4 million net loss.
- NACCO reported no legal proceedings in Part II and no material changes to its previously reported risk factors. It disclosed Coyote Creek guarantees that could require a make-whole payment or equipment purchase under specified circumstances; management considered performance remote and recorded no liability. General risks include permitting, reclamation costs, customer demand, commodity prices, regulation, operational disruptions and contract termination.
Important facts for investors to verify
- Whether the forecast improvement in Coal Mining and NAMining in 2020 offsets the expected decline in royalty earnings, and whether the projected $41 million of capital spending is funded as planned.
- Actual customer demand, outage schedules and MLMC cost per ton, including the effect of the new mine-area investment and higher depreciation.
- Natural-gas prices, well declines, third-party drilling and infrastructure developments that determine Minerals Management royalty income.
- Thacker Pass permitting, financing, construction timing, success-fee milestones and NACCO’s eventual equipment commitments and reimbursement terms.
- Cash conversion and the contribution of one-time items, including the India recovery and favorable investment returns, to reported earnings; also monitor lease obligations, reclamation estimates and the Coyote Creek guarantees.