NACCO Industries, Inc. (NC) Q4 2015 Earnings Report, Transcript and Summary

Good morning. My name is Keith and I will be your conference operator today. At this time, I'd like to welcome everyone to the NACCO Industries Inc. 2015 Fourth Quarter Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, we will have a question-and-answer session. [Operator Instructions] Thank you. Christina Kmetko, Investor Relations, you may begin your conference.

Thank you. Good morning, everyone, and welcome to our 2015 fourth quarter earnings call. I am Christina Kmetko and I'm responsible for Investor Relations at NACCO Industries. I will be providing a brief overview of our quarterly results and business outlook, and then I will open up the call for your questions. Joining me on today's call are Al Rankin, Chairman, President, Chief Executive Officer; J.C. Butler, our Senior Vice President Finance, Treasurer, and Chief Administrative Officer, as well as the President and Chief Executive Officer of our North American coal subsidiary; and Elizabeth Loveman, NACCO's Vice President and Controller. Yesterday, we published our fourth quarter and full-year 2015 results and filed our 10-K for the year ended December 31, 2015. Copies of our earnings release and 10-K are available on our website at nacco.com. For anyone who is not able to listen to today's entire call, an archived version of this webcast will be on our website later this afternoon and available for approximately 12 months. As we begin, I would like to remind participants that this conference call may contain certain forward-looking statements. These statements are subject to a matter of risks and uncertainties that could cause actual results to differ materially from those expressed in the forward-looking statements made here today in either our prepared remarks or during the following question-and-answer session. We disclaim any obligation to update these forward-looking statements, which may not be updated until our next quarterly conference call, if at all. Additional information regarding these risks and uncertainties were set forth in our earnings release and in our 10-K. Also, certain amounts discussed during today's call are considered non-GAAP. The non-GAAP reconciliations of these amounts are included in our 2014 fourth quarter earnings release available on our website. Before I discuss our results, I want to talk a bit about Centennial. As we previously announced, mining operations at Centennial ceased during the fourth quarter. This eliminated North American Coal's only direct exposure to coal market price volatility. Because of this cessation, some of you have asked us to provide our financial results excluding Centennial so you can better understand and analyze the underlying operations. However, since the Centennial shutdown is not treated as a discontinued operation under U.S. GAAP, we were unable to completely break out Centennial in the financial statements. Accordingly, we have provided as much information as we can. You can analyze both our consolidated results and North American Coal's results without Centennial. Further, while Centennial has ceased mining, there are still asset disposal and reclamation activities that will continue for some time. Centennial will continue to affect our results in future periods, but to a much smaller extent than it did in 2015. Centennial still has assets valued at $45.5 million as of December 31, of which approximately $11 million of equipment is expected to be transferred to Mississippi Lignite Mining Company during the first quarter of 2016. North American Coal is evaluating opportunities to dispose of the remaining assets in a manner that maximizes cash flow. Of course, actual amounts realized may be different than the carried amount of these remaining assets. Also, cash expenditures related to mine reclamation will continue until reclamation is complete or ownership of the mines is transferred. Now let's discuss our results for the fourth quarter. Our consolidated revenues were $286.5 million compared with $297.3 million in the fourth quarter of 2015. Revenues declined primarily as a result of fewer sales at Centennial and a reduction in the number of stores at our Kitchen Collection subsidiary. Net income, on the other hand, increased to $18.1 million or $2.63 per share from a net loss of $40.7 million or $5.57 per share last year. Last year's results were affected significantly by the $66.4 million after-tax asset impairment charge taken at Centennial, and both years were also affected by substantial operating losses at Centennial. Adjusting the financial results to exclude Centennial provides a clear look at the performance of the remaining operations. On an adjusted basis, our fourth-quarter consolidated revenues were comparable to the prior-year quarter and consolidated adjusted income decreased to $22.8 million, or $3.32 per share, from $29.9 million or $4.08 per share in the fourth quarter of 2014. While our Kitchen Collection business reported an improvement in results this quarter compared with last year, the decline in our consolidated adjusted income was driven by lower results at our Hamilton Beach and North American Coal businesses. North American Coal, including Centennial, had net income of $2.2 million and revenues of $26 million in the fourth quarter of 2015, compared with a net loss of $59.8 million and revenues of $33.2 million in the fourth quarter of 2014. However, if you exclude Centennial, North American Coal’s revenues improved over the prior-year fourth quarter because of an increase in tons sold at Mississippi Lignite Mining Company. You may recall that, last year, Mississippi Lignite Mining Company's customer had an extended power plant outage in the fourth quarter. This year, there were fewer outage days at that plant. And the increase in revenues at Mississippi Lignite was more than offset by a $5.9 million reduction in gains on sales of assets in the fourth quarter of 2015, compared with last year, and reduced royalty and other income as well as higher selling, general and administrative expenses. North American Coal reported a decrease in adjusted income before income taxes from $12.1 million in the fourth quarter of 2014 to $3.7 million this quarter. Looking forward to 2016, we expect an increase in tons sold in North American Coal's coal mining operations compared with 2015. Despite this increase in tons and excluding Centennial results, we expect a substantial decrease in income before income taxes primarily because of an expected decrease in income at Mississippi Lignite Mining Company. Mississippi Lignite sells lignite at contractually agreed-upon coal prices which are subject to changes in the level of established indices over time. The price of diesel fuel is heavily weighted among these indices. We expect the recent substantial decline in diesel prices to reduce earnings because the decline in revenue is expected to be only partially offset by a moderate increase in tons sold and the beneficial effect of the lower diesel prices on production costs. We also expect royalty and other income to decrease significantly in 2016 and we expect deliveries and operating results at the limerock mining operations to be modestly lower than 2015 due to reduced customer requirements. These decreases are expected to be partially offset by additional income from the unconsolidated mining operations as newer mines begin or increase production in 2016. On an important positive note, in December 2015, we announced that North American Coal's wholly-owned subsidiary, Bisti Fuels Company, entered into a 15-year cost plus contract mining agreement with the Navajo Transitional Energy Company, or NTEC. Bisti Fuels will become the contract miner at NTEC's Navajo mine, which is within the Navajo Nation near Fruitland, New Mexico. Production is expected to be approximately 5 to 6 million tons of coal per year. North American Coal expects to transition into a contract miner role once NTEC completes a pending commercial transaction with the existing contract miner which is expected to occur during the second half of 2016. Finally, we expect North American Coal's cash flow before financing activities to decrease substantially in 2016 compared with last year, primarily as a result of the 2015 repayment of a large receivable from Coyote Creek and an increase in capital expenditures in 2016. Capital expenditures are expected to be approximately $16 million this year compared with $4.1 million last year. Now let me turn to Hamilton Beach. Hamilton Beach's fourth quarter results were strong but lower than the prior-year fourth quarter. An increase in revenues from the favorable effect of sales in new and higher-priced products, as well as the recognition of a full quarter of Weston sales, was almost fully offset by substantially lower volumes in the U.S. consumer market and unfavorable currency movements. Currency movements also significantly affected operating results and was primarily the significant driver of the decrease in net income from $15.4 million in 2014 to $11.1 million in 2015. Substantially lower unit volumes, excluding the effect of Weston, the absence of a tax benefit recognized in 2014 that did not recur this year, and the recognition of a $1.5 million pretax charge in the fourth quarter of 2015 related to an increase in the estimate of environmental liabilities at Hamilton Beach's Picton, Ontario facility also contributed to the decline in net income. However, lower employee related costs, incremental operating profits from Weston, and moderately favorable product costs partially offset the decrease. Looking forward to 2016, we want to note that consumer habits appear to be changing, which affects both our Hamilton Beach and Kitchen Collection businesses. Consumer traffic to physical retail store locations has been declining as consumers buy more over the Internet or utilize the Internet for comparison shopping. This trend is creating uncertainty in the growth prospects for the U.S. retail market for small appliances, including growth prospects for both in-store and Internet sales. As a result, volumes in 2016 in the market in which our core Hamilton Beach brands participate are projected to be comparable with 2015. The Canadian retail market is also expected to be difficult since the Canadian economy continues to struggle. However, the hunting, gardening, and food enthusiast markets where Weston participates as well as the international and commercial markets in which Hamilton Beach participates are expected to grow moderately. In spite of these market conditions, we expect Hamilton Beach's 2016 consolidated sales volumes to increase moderately compared with last year as a result of enhanced distribution and increased placement of higher margin products in the core small kitchen appliance business. We also expect international and commercial product sales volumes to increase as a result of Hamilton Beach's strategic initiatives. With a number of new products in the pipeline and execution of these strategic initiatives, both domestically and internationally, we expect a moderate increase in revenues at Hamilton Beach in 2016 compared with last year provided consumer spending is at expected level. We also expect an increase in Hamilton Beach's full-year 2016 net income. However, the anticipated increase in sales volumes and revenues are expected to be partially offset by unfavorable currency relationships based on currency rates in effect at the end of 2015. Cash flow before financing activities is expected to be substantially higher in 2016. Finally, our Kitchen Collection business reported fourth quarter net income of $3.9 million, an improvement over net income of $3.1 million reported last year. However, this improvement was largely due to the absence of realignment charges of $2.8 million pretax taken in 2014. Excluding these realignment charges, overall fourth quarter 2015 results decreased moderately, primarily as a result of the strategic decision to close a significant number of stores since the fourth quarter of 2014, which resulted in fewer stores being open during the peak holiday selling season and as a result of the recognition of nondeductible employee related expenses. As a result of the changing consumer trends previously discussed, and the ongoing market weakness, Kitchen Collection realigned its business by closing nearly 100 underperforming stores during 2014 and 2015 while only opening 24 new stores this year, thus leaving a smaller number of core Kitchen Collection outlet stores. With this realignment and in the context of the current market environment, we expect Kitchen Collection's 2016 revenues and results to be comparable with 2015. Kitchen Collection believe its remaining stores are well-positioned to allow the Company to perform at close to break-even in the current challenging environment and to take advantage of any future market rebound. Cash flow before financing activities is expected to be positive in 2016, but substantially lower than last year. That concludes our prepared remarks. I will now open up the call for your questions.

[Operator Instructions] Your first question comes from the line of John Choi from Medina

It's actually John Choi. Congrats on the Bisti deal. I wanted to know if there are many contract mining deals of the size available in the marketplace, and also when are you expecting to achieve full production here?

Al, do you want me to take that?

J.C., why don't you take that one?

Yes, so your question, two-part question. One was do you expect – how many of these are available in the market. It's hard to say. Clearly, the coal industry is in a tremendous amount of turmoil right now. My own view is an industry in turmoil may create opportunities, and it's hard to tell where those opportunities might be. This is an instance where there's an existing mine and a miner is leaving, actually exiting the United States at this point. And so an opportunity was created, an RFP was run, and we were successful. There may be all sorts of other opportunities that spring up across the United States for surface mining opportunities in the future, but right now it's hard to tell. The number of coal miners – coal mining companies that are in bankruptcy and even some utilities that are struggling may create opportunities for us. But to specifically say how many are available, it's a hard number to state precisely. Your question about full production, you know, this is an existing mine serving an existing power plant. Once we take over as the contract miner, it will be at its regular run rate of 5 million to 6 million tons per year, and it really just depends on when we step into that position. It’s going to be – we believe it’s going to be sometime later this year. That’s what we’re told by our customer. And once we get there, we’ll pick up steady run rate production.

Okay. That’s really helpful. Thank you. I guess my next question, so we’re going to generate substantial free cash flow as you ramp production for unconsolidated mines and approach our 2017 targets. What are priorities of cash going to be then?

Well, you mean within the coal company? I think, at this point, we think that the first priority of course is to put capital back into our existing mines, and that is particularly our consolidated mine, the Mississippi Lignite Mining Company. But other than that, there are not a lot of capital uses within the coal business that we anticipate. We’ve got a fair amount of debt, and over time, we expect to see that reduced to some degree, but that’s where our thinking is right at the moment. We haven’t developed our thinking any further than that.

Okay. And on MLMC, we faced a similar dynamic about five years ago when diesel had fallen sharply. Is the fuel impact for 2016 versus 2015 kind of comparable to what we saw in 2010 versus 2009?

J.C., I don’t really have that number in mind. It’s the mechanical formula is the main thing I would say.

Yes, I mean Al, I think that’s correct. It was a similar dynamic because we had the big drop in diesel fuel in 2008 and 2009 that created a similar situation, but I don don’t actually have numbers going back that far to give you a comparison.

Okay, maybe I think the important point is if those numbers turnaround, which is something that we can’t predict, then the profit prospects will improve. And if they go up significantly, then the profit prospects would improve significantly.

Okay. And if you could backtrack one step, I think you guys had given us kind of priorities of cash just for the coal company. But kind of on a consolidated basis, on an overall basis, can you kind of go through your priorities of cash?

Yes, and at this point, what we’ve said is our first focus would be to look for opportunities inside the businesses that we have, and – but I think, as a practical matter, we expect those to be reasonably limited. We would then look for adjacent businesses, particularly at Hamilton Beach. We were fortunate enough to have the Weston opportunity come along. It was a very good fit. There are not many of those and we would be very, very careful. But we certainly do have an open mind about that. And then of course we would plan to continue to return cash to our shareholders. We have had obviously our dividend policy, and secondly, we have share repurchase programs from time to time.

Okay. My last question is one on HVB. I’m wondering how the M&A environment and the small kitchen appliance space kind of improvens or weakens our competitive positioning?

Maybe you’d say a little bit more about your question in terms of what you mean by the M&A environment and how it affects our business.

Yes, there’s been some consolidation within the space, and I’m wondering how you guys view that and how that either improves or weakens our competitive positioning. It could be in terms of…

Well, the consolidation that has taken place in recent times has been more a consolidation of competitors in the small appliance business with businesses that do a large amount of business with similar kinds of companies that the small appliance business deals with large retailers and so on. And so it isn’t – there hasn’t been a huge amount of direct change in recent years as a result of the M&A environment. It’s really been quite some time since there’s been a really significant acquisition that affected the direct competitive position of the participants in the industry by having one appliance business come together with another. I think that would be the main comment that I would have for you at this point.

Okay, thank you.

Your next question comes from the line of Brian Leonard with Keeley Asset Management. Your line is open.

Good morning.

Good morning.

Good morning.

Bear with me. I have a handful of questions on each subsidiary. So, I’ll start out with North American Coal. Why was SG&A up so much? It looked like both professional fees and employee costs were high. Kind of walk through that and when do you expect that to normalize?

I think the best answer to that is to say that we have an incentive compensation program which takes into account the opportunity that’s achieved for the Company through new arrangement such as the Bisti Fuels deal. And so there is a charge for that which, in comparison to previous years, comes off the back of low incentive compensation payments significantly because of the Centennial situation. So, I would expect that SG&A would normalize in 2016. J.C., do you have anything you want add to that?

No. I think that’s correct. The other part of the question was about professional services fees. We did incur some professional service fees in order to get the Bisti deal put in place, which helps. And we also have this ongoing legal situation in India that we are working through that’s causing some professional costs there as well.

So, there may be some outside service charges that are a little higher than normal.

Okay, makes sense. The decline in equity earnings of the unconsolidated mines this quarter, is that similar to what’s going on at Mississippi mining? Is there index pricing there as well?

So, at the unconsolidated mines, the way those contracts works is the customer reimburses 100% of our costs for running each one of those mines, and we collect a fee per ton, or per heating unit, typically measured by BTUs that we deliver. That the escalation, contractual escalation, on each of those fees that we receive is determined by general inflation indicators – CPI, PPI, GDP, things like that. So as goes inflation in the United States in general, that affects our fees over time.

Does that reset annually or is there certain other kind of…

It varies. Some reset annually, some reset monthly. Some reset quarterly. Some have a mechanism that uses a fixed number for 11 months and then has a true up in the 12th month. I mean it really just depends on the individual contract. Generally, over time, they all grow with inflation.

Okay. Moving to Hamilton Beach, what was the main driver for the gross profit decline? Was it more FX or was it more mix?

We had a significant decline in volume in the fourth quarter compared to previous years. Elizabeth, do you want to comment on that? Are you there?

Yes. That is the case, and FX was the other main driver.

And then where does the $1.5 million pretax charge for the environmental liability fall in the operating line?

That would be a component of SG&A.

So, it would be a component, okay.

Yes.

The working capital within Hamilton Beach was up on a dollar basis as well as percent of sales. What was the driver in that? Is it higher inventory balances? Is it more AR, AP?

It’s more AR and less AP. Inventories aren’t so bad, but it’s always a question as to how quickly the receivables come in. But I think we had some declines in AP. Do you want at anything to that Elizabeth?

No, I think that’s pretty much the story. And then there is just some timing always that impacts working capital.

Our – I think that’s probably about the best way to think about it. It’s really in the payables. I would expect that to come right back in line very quickly. So, it’s very short term.

Okay. What currency are you guys most exposed to? Is it the fall in the – because both Canadian dollars and Mexican pesos called out. Is one higher impact versus the other is your exposure, or is it just the decline?

Elizabeth, do you want to comment on that?

The peso and the Canadian dollar, I don’t have the split of the impacts between those readily available.

Okay. I can follow-up on that. Then lastly, is there any update on Wolf? I haven’t really heard you guys talk much about it. And then there was a press release this morning about some kind of commercial launch of Hamilton Beach. So, I don’t know if you want to talk about new products or not.

We are very pleased with the way the Wolf program is coming along. As you know, it was launched in 2015. I think the sales are at a level we’ve been very pleased with, and we expect further improvement in 2016. So that’s very much in line with our expectations, if not a little bit better. And the Hamilton Beach commercial, which I think is what you are referring to, is it not?

Yes, that’s correct.

Hamilton Beach Professional, rather, is another of our programs to provide offerings under different brands at the higher price points. And so to the extent that we can put things into the general retail market that have a commercial character to them, we would use a brand name like Hamilton Beach Professional. We think that’s another element of our effort to meet the objectives and the strategic initiative which involves establishing a significant position in only the best marketplace, which I believe is called out in the earnings release as one of our initiatives.

Okay. And then lastly, on Kitchen Collection, the tax rate was much higher this quarter than I would have thought or anticipated. Any drivers behind that?

Elizabeth, do you want to handle that to the degree that – we called it out as a nondeductible expense I believe.

Correct. The penalty that we are paying under the Affordable Care Act is nondeductible for tax purposes. It’s skewing our tax rate.

Got it. Is that something that you anticipate to continue? It appears to be the case.

That’s the law.

Yes, got it. All right. That does it for me. Thank you very much.

Thank you.

There are no further questions at this time. I’ll turn the call back over to the presenters. We did have a last-minute question queue up from Rob Wallendorf with Western Standard. Your line is open.

Good morning

Good morning.

Good morning.

Yes, I was just curious if you guys could help quantify what you mean with respect to a substantial decline in the North American Coal business year-over-year in 2016 to 2015? How would you define substantial?

I think we aren’t going to go any further than we went in our earnings release. First of all, you have to take out the effect of Centennial. And then we have, as we have indicated, a significant reduction in the Mississippi Lignite Mining Company at current diesel prices. And so that is an impact of substance. And finally, I believe that we called out royalty, did we not, Elizabeth?

Yes. We did.

Yes.

Okay. And then earnings from unconsolidated will actually be up year-over-year in 2015, right? So, it’s really MLMC and lower royalties than maybe lower limerock.

That’s correct.

Okay.

That’s essentially – MLMC royalty and limerock are essentially what makes up the consolidated operations. So you’ve got that right.

Okay. So everything in consolidated will be down. Unconsolidated will be up. And the base you are comparing 2016 to is the $32.634 million in kind of adjusted North American Coal income before income tax?

Yes. The adjusted number.

The results would decline substantially from that number.

Yes.

Okay. And then the last question was with respect to the share repurchase program. I was just curious given some of the commentary you guys have had already provided on the call about not necessarily having that much use or need for cash particularly over the next couple of years within coal and within some of the other businesses. Why not authorize a new share repurchase program?

Our board looks at this periodically. We’ve demonstrated through our past actions that we are quite prepared to do that when we believe that the circumstances in total for the Company make that the appropriate action. And I just leave it at that. We have an open mind and we have a record of looking at returning cash to our shareholders in a variety of ways, and we will continue to do that.

Okay, great. All my other questions were answered. Thank you for your time.

Okay. Thanks a lot.

There are no further questions at this time. I’ll turn the call back over to the presenters.

Al, did you have any final comments?

No. I don’t, Christie. Thank you.

Okay. Thank you, everybody, for joining us today. We appreciate your interest. And if you do have any additional questions, please contact me. My phone is 440-229-5130.

Thank you for joining us today. As a reminder, this call is available for replay by dialing 855-859-2056 and also 404-537-3406, and entering the conference ID number 5970777. This concludes today’s conference call. You may now disconnect.