NACCO Industries, Inc. — Q2 2020 Form 10-Q
Business context and period: The filing covers the quarter and six months ended June 30, 2020. NACCO is a holding company operating in Coal Mining, North American Mining (NAMining) and Minerals Management. Its coal mining model is largely based on long-term, service-fee contracts; NAMining provides contract mining services, and Minerals Management earns primarily royalties.
Financial performance
| Metric | Q2 2020 | Q2 2019 | Six months 2020 | Six months 2019 |
|---|---|---|---|---|
| Revenue | $35.4 million | $41.4 million | $73.0 million | $81.4 million |
| Gross profit | $3.8 million | $8.7 million | $8.9 million | $22.1 million |
| Operating profit | $4.5 million | $9.2 million | $12.1 million | $25.5 million |
| Net income | $6.1 million | $8.0 million | $12.2 million | $23.0 million |
| Diluted EPS | $0.86 | $1.14 | $1.74 | $3.29 |
- Segment results: Coal Mining operating profit was $7.5 million in Q2 and $14.7 million for the half, versus $7.3 million and $17.3 million, respectively, in 2019. NAMining returned to profit: $0.5 million in Q2 and $1.3 million for the half, compared with losses in the 2019 periods. Minerals Management operating profit declined to $0.5 million in Q2 and $4.8 million for the half, from $6.8 million and $18.5 million.
- Cash flow: Six-month operating cash flow was a use of $12.5 million, versus a source of $22.1 million in 2019. Investing activities used $14.6 million, including $12.8 million of capital expenditures; financing activities used $0.2 million. Cash declined $27.3 million to $95.5 million.
- Liquidity and debt: At June 30, cash was $95.5 million and total debt was $28.4 million; debt to total capitalization was 9%. NACoal’s $150 million revolving facility had $14 million drawn and $133 million of excess availability, after letters of credit. NACoal was in compliance with its financial covenants. Management said available cash, facility capacity and operating cash flows should meet needs for the next 12 months.
- Other balance-sheet items: Total assets were $443.0 million and equity was $299.3 million. Current assets were $190.7 million and current liabilities $39.3 million.
Material changes and unusual items
- Revenue and profit fell year over year, particularly in the first half, as Minerals Management royalties declined from unusually strong 2019 gas-well production and Coal Mining earnings from unconsolidated operations weakened.
- Minerals Management’s 2019 results benefited from new Ohio Utica gas wells placed in service in 2018 and early 2019; production declines and lower expected natural gas prices pressured 2020 results. A $0.5 million Q2 charge related to writing off leasehold interests also reduced segment profit.
- Q2 included a $1.5 million gain on equity securities, primarily reflecting market-price changes. NACCO also invested $2.0 million in a publicly traded company with royalty-producing mineral interests.
- Operating cash flow was affected by payments for deferred compensation and long-term incentive plans, lower net income and working-capital movements. Capital spending increased significantly from the prior-year first half.
- The 2020 tax benefit reflects, in part, the expected use of tax losses under CARES Act provisions. The company expected a 2020 tax-basis net operating loss and was assessing its ability to use the expanded carryback rules.
Guidance, risks and management commentary
- Management expected a significant decrease in full-year 2020 consolidated net income versus 2019, driven mainly by lower Minerals Management operating profit, anticipated reduced Coal Mining earnings and the absence of $2.7 million of pre-tax income from a prior India venture recognized in Q3 2019. Expected tax benefits and NAMining improvement were partial offsets.
- For 2020, the company expected approximately $47 million in consolidated capital expenditures and cash flow before financing activities to be a use of cash. High spending in Coal Mining includes development of a new MLMC mine area; these investments are expected to increase future depreciation.
- Coal Mining deliveries and operating profit were expected to decline in the second half and full year. Lower customer requirements and higher expenses were key concerns; dispatch changes tied to low natural-gas prices and renewable generation could further weaken demand.
- GRE announced its intention to retire Coal Creek Station in the second half of 2022 and convert Spiritwood Station to natural gas. Falkirk is the sole coal supplier to Coal Creek. NACCO said a closure would materially harm long-term earnings, though GRE is contractually responsible for specified mine-closure costs. NACCO was exploring a potential sale of the plant.
- The Camino Real contract ended effective July 1, 2020 after the customer’s coal supply contract was terminated. The mine closed July 9. NACCO received inventory and a securitized note in Q3 to settle the June receivable and certain closure-date costs. Management said closure did not materially affect its 2020 outlook; reclamation remained the customer’s responsibility, though NACCO was discussing a possible new arrangement.
- NAMining expected modestly higher second-half and full-year deliveries and higher full-year operating profit than 2019, while second-half profit was expected to be below first-half 2020. The Thacker Pass lithium project was then expected to begin construction in 2021 and production in 2023, subject to permitting and development.
- COVID-19 had not materially affected operations to date, which continued as an essential business, but future effects on operations, employees, customers and supply chains were uncertain and could be material. Natural-gas prices and well development, coal-plant dispatch, environmental regulation, mine costs and long-term contract changes were additional risks.
- Other exposures include Coyote Creek guarantees under specified default or termination circumstances; management considered performance remote and recorded no liability. The filing reported no legal proceedings and no material change to previously disclosed risks other than the COVID-19 risk and specified customer/plant risks.
Important facts for investors to verify
- Developments in GRE’s Coal Creek Station retirement or sale plans and the resulting outlook for Falkirk.
- Collection and recoverability of the Camino Real securitized note and any further reclamation arrangement.
- Coal dispatch and customer requirements, including MLMC demand and cost trends.
- Natural-gas prices, new well activity and the pace of royalty-income decline in Minerals Management.
- Actual capital spending, operating cash generation, facility availability and covenant compliance as 2020 progresses.
- Realization and timing of expected CARES Act tax benefits, and permitting and execution milestones for Thacker Pass.
Management reported that disclosure controls were effective at June 30, 2020 and that there were no material changes in internal control over financial reporting during the quarter.