NACCO Industries, Inc. — Q3 2018 Form 10-Q
Reporting period: Three and nine months ended September 30, 2018. NACCO is a holding company for North American Coal (NACoal), which operates surface mines and provides mining and related services, including through North American Mining (NAM). Most coal operations are unconsolidated and contribute earnings through equity-method income. Hamilton Beach Brands was spun off in September 2017; prior-period results include discontinued operations.
Financial performance
| Metric | Q3 2018 | Q3 2017 | Nine months 2018 | Nine months 2017 |
|---|---|---|---|---|
| Revenue | $31.4m | $21.9m | $96.3m | $78.3m |
| Operating profit | $10.5m | $7.0m | $28.1m | $26.3m |
| Income from continuing operations | $9.2m | $3.3m | $23.8m | $18.8m |
| Net income | $9.2m | $8.4m | $23.8m | $20.2m |
| Diluted EPS from continuing operations | $1.33 | $0.49 | $3.43 | $2.74 |
Revenue rose 43% in Q3 and 23% year to date. Consolidated gross margin was approximately 19.4% in Q3 versus 11.3%, and 17.0% year to date versus 14.8%. Growth reflected higher customer requirements and deliveries at consolidated operations, higher reimbursed costs, and increased royalty revenue. Reimbursed costs generally have offsetting cost of sales and do not add operating profit. Q3 operating profit benefited from stronger consolidated mine results, royalties and unconsolidated-operation earnings; year-to-date profit also reflected higher equity earnings and royalties, partly offset by the absence of prior-year asset-sale gains and increased expenses.
Cash from continuing operating activities was $38.9m for the first nine months, versus $34.8m; capital expenditures were $14.6m versus $9.2m. Cash declined to $83.1m from $101.6m. Total debt was $17.5m, down from $58.1m; debt-to-total-capitalization fell to 7% from 21%. NACoal had $10.0m outstanding on its $150m revolving facility and $138.5m of excess availability; it was in compliance with covenants. The company reported sufficient liquidity for operating needs and commitments. Nine-month dividends were $0.495 per share, compared with $0.8125.
Outlook, risks and notable items
- Q4 and 2018: Management expected Q4 continuing pretax income to increase substantially year over year, but continuing-operations income after tax to decline substantially, primarily because of a higher expected tax rate and absence of 2017 tax benefits. Full-year continuing pretax income was expected to increase, with an 11%–14% effective tax rate. 2018 capital expenditures were projected at approximately $27m.
- 2019: Management expected pretax income to increase versus 2018, driven by higher royalty income and improved consolidated coal operations, particularly anticipated higher MLMC demand and volumes. Cash flow before financing was expected to increase; capital expenditures were projected at approximately $19m.
- Execution and market risks: The outlook depends on customer demand, power-plant operating conditions, commodity prices and infrastructure development for oil and gas royalties. Lower natural-gas prices and growth in renewable generation may pressure coal demand over time. Other disclosed risks include permitting and regulatory changes, reclamation costs, weather, equipment issues, contract changes and customer defaults.
- Contingencies: NACoal has guarantees tied to Coyote Creek, including a potential lender make-whole payment under specified default or termination circumstances and an obligation, in certain circumstances after 2024, to purchase equipment at net book value. Management considered performance under the guarantees remote; no liability was recorded. Ordinary-course legal and regulatory matters were disclosed, with no specific material case identified.
- Accounting and capital allocation: ASC 606 adoption reduced opening retained earnings by $2.1m after tax and established contract liabilities. Adoption of lease accounting was planned for January 2019 and expected to materially increase recorded assets and liabilities, but not materially affect cash flows, liquidity or covenant compliance. A $25m share repurchase authorization runs through December 2019; $0.3m had been repurchased through September.
Most important facts to verify
- Whether MLMC customer demand and deliveries meet the assumptions underpinning the 2018 and 2019 forecasts.
- Whether projected increases in 2019 royalty income materialize given commodity prices, infrastructure and lessee investment.
- Actual capital spending, cash generation and debt reduction versus management’s outlook.
- Potential exposure under the Coyote Creek guarantees and ongoing mine-reclamation obligations.
- The final balance-sheet impact of adopting the lease standard and any resulting changes to reported leverage.