NACCO Industries, Inc. — FY 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018; this is an annual filing, not a standalone fourth-quarter report. Comparisons are primarily with FY 2017. NACCO is a holding company whose principal business, NACoal, operates surface mines and provides mining services. Most coal operations are conducted through unconsolidated, customer-supported entities; North American Mining (NAM) serves aggregates customers. Hamilton Beach Brands was spun off in September 2017, and its results are presented as discontinued operations through the spin-off date.
Financial performance and position
| Metric | FY 2018 | FY 2017 |
|---|---|---|
| Revenue | $135.4 million | $104.8 million |
| Operating profit | $43.6 million | $32.8 million |
| Income before tax | $42.2 million | $29.1 million |
| Income from continuing operations | $34.8 million | $28.5 million |
| Net income | $34.8 million | $30.3 million, including discontinued operations |
| Diluted EPS | $5.00 | $4.41, including discontinued operations |
| Operating cash flow, continuing operations | $54.6 million | $49.0 million |
| Capital expenditures | $20.9 million | $15.7 million |
- Revenue rose 29.2%, primarily reflecting higher MLMC customer requirements and reimbursable costs at consolidated NAM operations, as well as higher royalty revenue. Reimbursed costs generally have offsetting expenses and do not increase operating profit.
- Operating profit increased $10.8 million. Approximate consolidated gross margin was 22.1% versus 16.1%; operating margin was 32.2% versus 31.3%.
- The continuing-operations effective tax rate was 17.5%, compared with 2.2% in 2017. The 2018 rate benefited from percentage depletion and was adversely affected by $1.2 million of discrete tax items. The 2017 comparison included a $3.1 million TCJA-related tax benefit and spin-off-related tax allocation effects.
- Cash and cash equivalents were $85.3 million at year-end, down from $101.6 million. Total debt fell to $11.0 million from $58.1 million; debt to total capitalization declined to 4% from 21%. Approximate cash less total debt was $74.2 million.
- NACoal’s $150 million revolving facility had $4.0 million drawn and $144.5 million of excess availability at year-end, including the effect of letters of credit. NACoal was in compliance with its financial covenants.
- Current assets were $164.2 million and current liabilities $42.2 million at year-end. The filing reports $37.7 million of asset retirement obligations, including $35.9 million long-term.
Material changes and notable items
- Coal deliveries increased to 38.5 million tons from 37.2 million; limestone deliveries increased to 35.4 million cubic yards from 30.0 million.
- NACoal operating profit improved to $50.3 million from $39.7 million. Drivers included stronger royalty income, higher earnings from unconsolidated operations, improved MLMC results and $3.0 million of MLMC contractual settlements. Higher SG&A and lower gains on asset sales partly offset the increase.
- Royalty income benefited from increased third-party development and operation of wells on NACCO’s Ohio Utica assets. Earnings of unconsolidated operations also benefited from Bisti business-interruption insurance proceeds and Liberty reclamation-period compensation.
- 2018 income before tax included approximately $3.0 million of MLMC contractual settlements and $2.8 million of favorable Centennial reclamation-liability adjustments. These items affect comparison with 2019 expectations.
- Cash flow from operations exceeded capital expenditures, while financing cash use included $47.1 million of net debt reductions, $4.6 million of dividends paid and $1.3 million of share repurchases. The 2017 comparison included $38.0 million of HBBHC dividends received, including a one-time $35.0 million payment before the spin-off.
- Adoption of ASC 606 in 2018 created a $2.6 million contract liability and a $2.0 million after-tax reduction to opening retained earnings, principally related to accounting for royalty lease bonuses. Prior-year amounts were not recast.
Outlook, risks and contingencies
- Management expected FY 2019 consolidated income before tax to increase versus 2018 and forecast an effective tax rate of 13%–15%. Excluding the cited favorable 2018 items, management expected a significant increase, mainly from MLMC and royalty income.
- Management anticipated higher MLMC revenue from contractual index adjustments and lower diesel costs per ton, and higher royalty income based on wells in development or operation. These expectations depend on customer demand, indices, fuel prices, commodity prices and third-party drilling activity.
- Income from unconsolidated operations was expected to be comparable to 2018: anticipated gains at Bisti and NAM were expected to be offset by lower deliveries at Falkirk, Sabine and Coyote Creek. Planned 2019 capital expenditures were approximately $23 million, primarily for MLMC and NAM; management expected cash flow before financing to increase significantly.
- Key risks include heavy customer concentration (over 75% of consolidated revenue from two customers), dependence on long-term mining contracts, declining coal demand from competing fuels and environmental or emissions regulation, operational and weather disruptions, reclamation-cost estimation, and volatility in third-party oil and gas development and royalties. One customer accounted for approximately 60% of NACoal revenue; Cemex accounted for approximately 20%.
- NACoal had guarantees related to Coyote Creek, including potential make-whole and equipment-purchase obligations upon specified events. Management considered performance remote and recorded no liability. Bellaire’s legacy mine-water treatment and environmental obligations continue; its restricted Mine Water Treatment Trust had a fair value of $8.7 million.
- The company expected adoption of lease accounting in 2019 to recognize approximately $13 million of right-of-use assets and lease liabilities; management did not expect a material effect on cash flows, liquidity or covenant compliance. The board also approved termination of certain deferred-compensation plans, with $12.9 million of balances expected to be distributed in 2020.
- Ernst & Young issued unqualified opinions on the financial statements and internal control over financial reporting. Management reported effective disclosure controls and internal controls at year-end.
Investor verification priorities
- Review the customer concentration, contract terms and delivery assumptions underlying the 2019 outlook, particularly at MLMC and the largest customers.
- Assess the recurring earnings base by separating contractual settlements, reclamation adjustments, insurance proceeds and asset-sale gains from ongoing operating results.
- Verify the sustainability and sensitivity of royalty growth to gas prices, well activity, infrastructure and third-party operator decisions.
- Review reclamation obligations, Coyote Creek guarantees, legacy Bellaire liabilities and the assumptions used to estimate their timing and cost.
- Track planned 2019–2020 capital spending, debt repayment and liquidity, including the effects of lease-accounting adoption and the 2020 deferred-compensation distribution.