NACCO Industries, Inc. — Q2 2019 Form 10-Q
Business context and period: The filing covers the quarter and six months ended June 30, 2019. NACCO is a holding company for North American Coal, with operating segments in Coal Mining, North American Mining (NAMining) and Minerals Management. In 2019, the company changed its segment reporting; prior-year figures were recast for comparison. Amounts below are in U.S. dollars.
Financial results
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Revenue | $41.4 million | $33.7 million | $81.4 million | $64.9 million |
| Gross profit | $8.7 million | $4.8 million | $22.1 million | $10.3 million |
| Operating profit | $9.2 million | $7.8 million | $25.5 million | $17.5 million |
| Net income | $8.0 million | $6.4 million | $23.0 million | $14.6 million |
| Diluted EPS | $1.14 | $0.92 | $3.29 | $2.10 |
- Revenue rose about 23% in Q2 and 26% for the six-month period. Net income rose about 25% and 58%, respectively.
- Gross margin was about 21.0% in Q2 versus 14.4% a year earlier, and 27.1% for the first half versus 15.8%. Operating margin was about 22.2% in Q2 and 31.3% for the first half; these figures include earnings from unconsolidated operations.
- Earnings of unconsolidated operations were $14.1 million in Q2 and $30.4 million in the first half. These mainly reflect contract-mining operations that NACCO accounts for using the equity method rather than consolidating.
- Operating cash flow was $22.1 million for the first half, up from $18.7 million. Capital expenditures were $6.0 million, compared with $9.2 million. Cash increased to $98.4 million from $85.3 million at year-end 2018.
- At June 30, total debt was approximately $12.0 million, including $4.0 million outstanding on the revolving facility. Cash exceeded debt; the reported debt-to-total-capitalization ratio was 4%. The $150 million NACoal facility had $144.6 million of excess availability, net of letters of credit, and expires in August 2022. NACoal was in compliance with its financial covenants.
- Stockholders’ equity was $272.2 million, versus $250.7 million at December 31, 2018. The company paid $2.5 million in dividends and repurchased $1.4 million of shares during the first half.
Material changes and segment performance
- Coal Mining: First-half revenue increased modestly to $39.3 million, but operating profit fell to $12.3 million from $16.6 million. Lower earnings from unconsolidated mines, fewer deliveries due to customer plant outages, and higher employee-related expenses weighed on results. Q2 operating profit was $4.7 million versus $7.9 million.
- NAMining: First-half revenue increased to $21.5 million, partly due to reimbursed costs, which have offsetting costs and no operating-profit impact. The segment recorded a $0.5 million operating loss versus $0.8 million profit a year earlier, reflecting higher employee, supplies, repair and business-development costs. Two new contracts were signed in Q2.
- Minerals Management: First-half revenue increased to $20.9 million from $7.3 million and operating profit to $18.5 million from $6.2 million, mainly because more third-party-operated wells produced gas from NACCO’s Ohio reserves as infrastructure became available.
- Consolidated results also benefited from lower interest expense, higher interest income on invested cash, and improved results in Minerals Management. The effective tax rate rose to 18.3% for Q2 and 15.2% for the first half, primarily due to the mix of earnings, including increased royalty income.
Outlook, risks and unusual items
- Management expected full-year 2019 consolidated net income to increase significantly from 2018, including or excluding specified favorable prior-year items. The estimated full-year effective tax rate, excluding discrete items, was approximately 15%.
- Coal deliveries were expected to decline in the second half and full year, reflecting customer requirements, power-plant outage timing and comparison with high prior-year deliveries. Excluding specified 2018 favorable items, full-year Coal Mining operating profit was expected to decrease modestly.
- NAMining expected second-half operating profit to improve from the first half and be comparable to the second half of 2018; full-year profit was expected to be significantly below 2018. New contracts were expected to contribute modestly in the second half and moderately from 2020. Management described longer-term growth as dependent on expanding the business and capturing economies of scale.
- Minerals Management royalty income was expected to increase substantially in the second half versus 2018, but at a much lower rate than the first-half increase. Royalties are exposed to well activity, natural-gas prices and production, infrastructure availability, regulation, and lessees’ ability and willingness to fund development.
- 2019 capital expenditures were estimated at approximately $28 million, versus $20.9 million in 2018, primarily for NAMining dragline acquisition and relocation and MLMC mine development. Management expected cash flow before financing activities to increase from 2018.
- In Q2, transfer of certain Centennial mine permits relieved $5.4 million of reclamation obligations. NACCO transferred a $3.4 million escrow account and paid $2.4 million cash, recording a net loss of $0.4 million. The company adopted lease-accounting standard ASC 842 in 2019, recognizing operating lease right-of-use assets of $12.1 million and operating lease liabilities of $13.0 million at June 30; adoption did not materially affect results, liquidity or covenant compliance.
- NACoal has guarantees related to Coyote Creek, including a potential lender make-whole payment under specified circumstances and a potential purchase obligation for equipment if the customer terminates its agreement on or after 2024. Management considered performance under the guarantees remote; no liability was recorded. The company’s maximum stated risk of loss for unconsolidated subsidiaries was its $5.4 million invested capital.
- Key risks include coal demand and plant outages, mine permits and reclamation costs, operating and equipment costs, long-term contract changes or customer default, commodity prices—particularly natural gas and diesel—and delays or shortfalls in third-party well development. Management reported no material change to previously disclosed risk factors and no legal proceedings in the filing.
Important facts for investors to verify
- Whether lower coal deliveries and customer outages persist, and how they affect earnings from unconsolidated mines.
- Whether Minerals Management royalty growth continues, given dependence on gas prices, production, infrastructure and lessee activity.
- Whether NAMining’s new contracts deliver expected contributions while the segment absorbs elevated development and employee costs.
- Whether planned capital spending, particularly at NAMining and MLMC, stays near the forecast and produces expected returns.
- Potential exposure from mine reclamation obligations and the Coyote Creek guarantees, notwithstanding management’s assessment that guarantee performance is remote.