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NACCO Industries, Inc. (NYSE:NC)

Q2 2010 Earnings Call

August 05, 2010 11:00 a.m. ET

Executives

Christina Kmetko - IR

Al Rankin - President & CEO

Analysts

Schon Williams - BB&T Capital Markets

Operator

Good day ladies and gentlemen and welcome to the Second Quarter 2010 NACCO Industries Earnings Conference Call. My name is Brandy and I will be your operator for today. At this time all attendees are in listen-only mode. (Operator Instructions).

And I will turn the call over to your host for today, Ms. Christina Kmetko. Please proceed, ma'am.

Christina Kmetko

Thank you. Good morning everyone and thank you for joining us today. Yesterday, a press release was distributed outlining NACCO's 2010 second quarter results. If anyone has not received a copy of this earnings release or would like a copy of the 10-Q, please call me at 440-449-9669 and I will be happy to send you this information. You may also obtain copies of these items on the NACCO website at nacco.com.

The conference call today will be hosted by Al Rankin, Chairman, President, and Chief Executive Officer of NACCO Industries. Also in attendance representing NACCO Industries is Ken Schilling, Vice President and Controller.

Al will provide an overview of the quarter and full year and then open up the call to your questions.

Before we begin, I would like to remind participants that this conference call may contain certain forward-looking statements. These statements are subject to a number of risks and uncertainties that could cause actual results to differ materially from those expressed in the forward-looking statements made here today. Additional information regarding these risks and uncertainties was set forth in the earnings release and in the 10-Q.

I'll now turn the call over to Mr. Al Rankin.

Al Rankin

Good morning to all of you. As I think you all are probably aware of NACCO announced its earnings last evening. Net income was $15.9 million or $1.91 per share in the second quarter on revenues of about $599 million that compares with net income of 1.6 million or $0.19 a share on revenues of about 540 million in the year ago second quarter.

At NACCO materials Handling Group net income was $7.3 million, revenues 413 million compared with a net loss in the second quarter of $3.1 million and revenues of 362 million.

Operating profit improved substantially to 9.8 million from a loss of 1.7 million in the year ago quarter. Revenue increase 14% compared with the 2009 quarter primarily as a result of an increase in units and parts volume in the America and in our EMEA, Europe, Middle-East and Africa markets.

Shipments in the second quarter increased to 13,800 units from 11,100 in the first quarter and 9900 units in the year ago second quarter. The backlog was approximately 21,700 units at June compared with 16,900 a quarter ago March 31 and 13,200 at the end of last year and 12.,300 at the end of the year ago second quarter of June 30.

The second quarter net income increased significantly compared with 2009 primarily as a result of a substantial increase in operating and a change in effective income tax rates. Operating profit increased 11.5 million, primarily due to improved gross profit attributable to higher sales volumes and margins of both units and parts and lower manufacturing variances which resulted from higher production levels in 2010.

The improvement in operating profit was partially offset by an increase in employee related expenses which resulted from the partial restoration of compensation and benefits which were reduced in 2009 and higher product liability expense, primarily due to a smaller favorable adjustment in 2010 compared with the amount in 2009.

Finally, in the second quarter, the company had a reduction in the blended income tax rate compared with the second quarter 2009, primarily as a result of a shift in the mix of jurisdictions where pre-tax results are projected for 2010 compared with 2009.

Looking forward, NACCO Materials Handling Group expenses global market levels for units and parch volumes to improve significantly in the second half of 2010 compared with the second half of 2009. The Chinese market in which NACCO Materials Handling Group is not a significant participant has recovered to prerecession levels and is expected to continue to grow and the company's largest market, the America's, the Brazilian market also appears to be more robust than originally anticipated and Latin America and the critical North American markets appear to be improving with moderate growth expensed in these markets over the second half of 2010.

Recoveries are also expected to be stronger in Eastern Europe, Middle East and Asia than in Western Europe which is expected to be relatively flat in comparison with 2010. As a result, the company expects substantial increases in bookings, unit shipment levels, backlog and parch sales in 2010 compared with 2009 with significant comparative increases each quarter over the prior year quarter.

NMHG anticipates further increases in material cost, particularly steel in the second half of 2010 as a result of price increases. As a result price increases were announced during the second quarter of 2010, which in combination with additional increases if necessary are expected over time to offset the effective increase of commodity costs.

NMHG's new electric-rider lift truck program and warehouse, internal combustion engine and big truck product development programs are progressing as planned. The new electric-rider lift truck program is bringing a full line of newly designed products to market and NMHG introduced the 2 and 3-ton four-wheel electric lift trucks in Europe in early 2010 and a 1 to 2-ton three-wheel electric cushion-tire truck and a 1 to 2-ton four-wheel electric pneumatic lift truck in the Americas during the second quarter of 2010.

The company expects to launch three additional series of electric-rider lift trucks in 2011, two in the Americas and one in Europe and NMHG also introduced a new 5,000 pound base-model lower-cost internal combustion engine lift trucks aimed at the medium duty segment of the market in the Americas in July of this year.

The remaining trucks in this series are expected to be rolled out in 2012 or by 2012 in both the Americas and Europe. Overall market improvements anticipated in the remainder of 2010 are expected to generate increased profitability in the second half of 2010.

However, the third quarter is expected to be significantly lower than the second quarter due to scheduled plant shut downs in the sale of NMHG's remaining European and Australian retail dealerships in July.

Cash flow before financing activities for 2010 is expected to be significant, but substantially lower than 2009 because the working capital reductions in 2009 related to lower business activity obviously won't be repeated in 2010.

And what we can expect overall is that shipment volume will be increasing but considerably more slowly than the bookings levels in order to ensure continuity of supply and also to make sure that none of this increase in bookings is strictly related to replenishment of inventories

Turning to Hamilton Beach, net income was $3.8 million in the second quarter, revenues $103 million and that compares to $4.7 million in the second quarter revenues of $107 million in 2009. Operating profit was 7.8 million that compared with 9.8 million a year ago.

Revenues decreased 4% compared with 2009 primarily due to lower average selling prices and lower unit sales volumes attributable to lower volumes in the U.S. and Canadian consumer markets, partially offset by increased unit sales volumes in the Mexican and Latin American consumer retail markets, as well as commercial markets. Favorable foreign currency movements caused by a strengthening Canadian dollar and Mexican peso also partially offset the decline in revenue.

Net income and operating profit declined compared with the 2009 second quarter primarily due to higher employee-related expenses which resulted from full restoration of compensation and benefits that were suspended in the first half of 2009. The increase in selling, general and administrative expenses was partially offset by improved gross profit and gross profit improved primarily due to lower product costs and sales of higher margin products, partially offset by lower average selling prices.

The small kitchen appliance market in for Hamilton Beach continues to recover and the company is moderately optimistic that markets for its consumer products will strengthen further in the second half of 2010. Accordingly, revenues for the second half of 2010 are expected to be higher than the second half of 2009, resulting in a moderate increase in revenues for the full year compared with the year ago.

However, while the market has shown improvement compared with 2009, the pace and sustainability of the upturn remains uncertain because consumers continue to struggle with financial concerns and high unemployment rates and if the company's markets begin to deteriorate, obviously revenues could be adversely affected.

Overall, full-year 2010 net income and cash flow before financing activities are expected to be strong but lower than 2009. Employee-related costs are expected to be higher in 2010 because compensation and benefit programs, which were partially suspended during 2009, have been fully restored.

In addition, Hamilton Beach continues to monitor commodity costs and relative foreign currency relationships very closely and the company expects increased transportation and product costs in the second half of 2010 and will be working to mitigate those increased costs through optimizing product assortments and selective price increases when appropriate.

Kitchen Collection reported a net loss of 1.8 million on revenues of 40.9 million a year ago compared with a net loss for the second quarter, compared with a net loss of $1.7 million on revenues of $40.6 million for the year ago second quarter..

The second quarter revenue was comparable to the second quarter of the year earlier and an increase in comparable store sales and sales at newly opened Kitchen Collection and Le Gourmet Chef stores was almost completely offset by the effect of closing primarily unprofitable Gourmet Chef stores since June 30, 2009.

The increase at store sales was a the result of an increase in the average sales transaction value at both the Kitchen Collection and Le Gourmet Chef as a result of improved product assortment and more effective merchandising. At June 30, Kitchen Collection operated 224 stores and Gourmet Chef 66, compared with 211 and 78.

Consumer sentiment and spending levels in Kitchen Collection's market continue to reflect financial concerns and high unemployment rates and result in a challenging retail environment. However, the outlet mall retail market is less volatile than in early 2009 and the company expects to take advantage of opportunities to increase the number of temporary and seasonal stores in the second half of 2010. As a result, Kitchen Collection expects full year revenue to increase compared with 2009.

The favorable sales trends that occurred in the reformatted Gourmet Chef stores in the second half of 2009 and early 2010 are expected to continue in the second half of the year. In addition, the company plans to refine its promotional efforts and merchandise mix in the Gourmet Chef stores to improve sales and margins.

The opening of new stores, the renegotiation of leases and the company's continuing program of closing underperforming stores are also expected to provide improved results this year. However the company expects increased transportation costs in the second half and is going to be working to offset these costs through pricing and other actions that are appropriate.

Overall, Kitchen Collection anticipates a significant percentage increase in full-year net income for 2010 compared with 2009, primarily due to the results in the first half and the current expected improvement in the market through the holiday season. Cash flows before financing activities are expected to be higher in 2010 than in 2009. At North American Coal net income in the second quarter was $11.3 million, on revenues at $42 million compared with $6.8 million on revenues of $31 million.

Revenue increased in the second quarter primarily due to revenue of $7.6 million related to reimbursement from Mississippi Power Company for previously recognized costs of pre-development activities. Also increased deliveries at the Florida dragline mining operations and an increase in royalty income also contributed to the increase in revenues.

The improvement in net income compared is mainly due to income of 7.4 million, or 4.4 million after tax of 3.0 million, related to the reimbursement from Mississippi Power Company. Excluding this income, second quarter net income was comparable to the second quarter of 2009, with lower income from the Mississippi Lignite Mining Companies and the unconsolidated mines offset by an increase in income from the limerock mining operations.

North American Coal expects steady performance at its coal mining operations in 2010 provided that customers achieve currently planned power plant operating levels. Overall, tons delivered at the coal mines are expected to be comparable to the year earlier.

Limerock deliveries as you would expect will be significantly higher in 2010 than in 2009. In early 2010, the Army Corps of Engineers issued new mining permits for North American Coal's limerock customers in the Florida lake belt region where an unfavorable legal ruling set aside the customers' previous mining permits. Although these quarries are back in production, production levels are expected to continue at moderate rates through the remainder of 2010 because of the continued depressed levels of the Southern Florida housing and construction markets and delivery levels are not expected to achieve the previously high levels of 2008 and 2010.

The company also provides mining services to four new mines that are expected to generate modest income during the second half of 2010. These mines, which are not consolidated are in the development stage and will not be in full production for several years. During the second quarter, North American Coal did finalize an agreement with Mississippi Power Company to provide approximately 4.2 million tons of lignite annually from its new Liberty Mine to the new Kemper County lignite coal-fired Integrated Gasification Combined Cycle power plant that's currently underway in Mississippi.

The building of the power plant is still contingent I would note on satisfying legal challenges to recent and future regulatory approvals. Initial deliveries are expected to commence in late 2013 and North American Coal also has new project opportunities for which it expects to continue to incur additional expenses in 2010.

In particular, the company continues to move forward to gain a permit for its Otter Creek reserve in North Dakota in preparation for the expected construction of a new mine and the permit is expected to be issued late in the second half of 2010.

Overall, North American Coal expects full year 2010 income from continuing operations to increase over 200. Cash flow before financing activities is expected to be significant, but down from 2009, when North American Coal sold the Red River Mining Company.

North American Coal's contract at San Miguel expires at the end of 2010 and during the second quarter, the company responded to the San Miguel Electric's "Request for Proposal" to operate that mine beyond 2010 but the company was not selected in that process.

Beginning in the third quarter the company will start planning for the transition of mining operations to a new mining company. North American Coal does not expect to incur significant costs as a part of the wind-down of this contract and under the current contract, revenues generated by San Miguel were 30 to $50 million a year and were primarily for contractual reimbursable costs. Net income generated by San Miguel has been less than $1 million a year under the current contract.

Over the longer term, North American Coal expects to continue its efforts to develop new mining projects. They're actively pursuing domestic opportunities for new coal mining projects and the company is also encouraged that new international mining services projects for coal may become available in addition to North American Coal's current agreement to provide mining services in India.

That concludes our prepared remarks and I would be happy to take any questions that you may have.

Question-and-Answer Session

Operator

(Operator Instructions). And the first question comes from Schon Williams at BB&T Capital Markets. Please proceed.

Schon Williams - BB&T Capital Markets

Hi, good morning. It's Schon Williams.

Al Rankin

Good morning.

Schon Williams - BB&T Capital Markets

Let's start with the star that showed this quarter's material handling. Order activity has been very robust in the first half of the year. I just wanted to kind of circle back on the issue of shipments. Certainly the backlog has been building fairly dramatically the last two quarters and it sounds like you're kind of expecting normal seasonal slowdown in terms of shipments in Q3 and I'd expect that to kind of ramp back up in Q4 but do you expect that you can clear some of this backlog in Q4 or are you going to carry a lot of that into 2011. I'm just wondering how long can you keep customer orders in that backlog maybe before there is some risk that they get cancelled.

Al Rankin

Well we would hope to manage the backlog in a way that there wouldn't be any cancellations. However there are a clear limitations to our ability to ramp up the shipment schedule from a supplier point of view. In addition we want to be very careful that we don't get out ahead of the market. But the bookings performance has been very encouraging and as you say, it's seasonal in a sense in the summer but it's seasonal in the sense that we have factory vacations and those will proceed on a normal basis.

So, shipments will ramp up at a much lower rate than the bookings at this point. And then as we go into 2011 I certainly think we will look forward and my hope would be that we will have a supply chain level of support that can sustain throughout 2011 higher levels of shipments than 2010.

Schon Williams - BB&T Capital Markets

Are there specific components that are critically short at this point or is it kind of across the Board.

Al Rankin

It's just spotty and the suppliers are all ramping up too and I think these are the normal issues -- at this point we haven't seen any problem areas that are of significant concern. It's just a question of working closely with suppliers to ensure that they are ramping at the same speed that we are.

The last thing we want to do is end up with a lot of inventory that we can't shipment.

Schon Williams - BB&T Capital Markets

Certainly, Al can you talk a little bit about pricing, it sounds like you have got some new rounds of pricing I guess coming in Q3. How much are you looking for there?

Al Rankin

Well we have put some modest price increases out and we will really gear those around cost increases and in the main that will be the driver and we see the same thing going on with our competitors. Some of them are experiencing the same forces of course that we are and reacting in a similar way. But they are going to be moderate and reflective of tight conditions. They are going to be reflective of input cost increases.

Schon Williams - BB&T Capital Markets

Is there any concern that there was some customer pre-buy ahead of that price increase? Have you seen that historically?

Al Rankin

We see some booking activity but we have been a little surprised at how little that seems to have affected the bookings since the time that price increase was announced but you are right there is usually is that kind of behavior we haven't seen at this point but again I just want to say that on the one hand I am very encouraged by the bookings increases and in the other hand we are going to make sure they are real and that they are going to continue over a period of time. I think I noted in my comments that there is some element of rebuilding of inventories and depleted inventory situations around the world and we want to make sure that and we have had some new dealers that have come onboard in certain areas and we just want to make sure that the underlying levels of demand continue to support our factory schedules.

We don't want them to get out ahead and as you will know future economic conditions are not crystal clear. We are still in the camp of thinking that there is going to be slow and steady improvement in the economy not a snap back but we're going to watch it very carefully.

Schon Williams - BB&T Capital Markets

Okay, and then as a follow-up, can you talk a little bit about some of your market expansion opportunities. It sounds like you got -- captured a dealer in the UK and with a new agreement in Russia that was recently signed. Can you talk about where you see the most opportunity right now and how that plays into the market share expansion?

Al Rankin

Well, we're always on the lookout for opportunities to strengthen our existing dealer base and I believe that we have been able to do that in Russia. I believe we've been able to do that in our Yale UK operations where we had a much more limited position through the Yale distribution which we owned and which has now been brought by that dealer as a part of the overall program in the UK. There are other areas where we see those opportunities. We see other situations where dealers have depleted excess stocks and are now ordering in line with the market.

All of those things are helping. We were very aggressive last year and in the end of 2008 and helping our dealers to deplete their stocks and in running off our own, as opposed to trying to moderate the downturn and now that's coming around to help us on the other side of the equation and we've got a healthy distribution system.

But we'll continue to look for opportunities to strengthen it. So the distribution dealers are one aspect of it. We are very reliant, very confident about our dealer network. The other is individual market areas and certainly, as I indicated in areas where we participate and indeed participate significantly, such as Brazil and in developing markets such as Brazil, Eastern Europe, Russia.

Those markets have come back relatively quickly compared to the European, the Western European and North American markets and the only major developing country where we're really quite a modest player is China and on the other hand the margins in that business are very, very thin. So from a profit point of view that's not a major consideration.

So think we have both certain markets and strengthened distribution, something we've been working very hard on over the last few years coming to bear at this point and you put that together with the up to date product line I described, the cost impact of the closure of the urban facility and the Modena facility in Europe and the restructuring of some of our U.S operations and the amount of effort we put into insuring that our supply chain has low cost sourcing from maximum amount of its components. All that's really coming together at this point and it's the stronger, if you give the distribution of right product at the right cost with the right quality then I think the dealers can pull that through with their customer base and certainly that's what we are hopeful of in our bookings performance in the remainder of this area and on out over the next few years.

Schon Williams - BB&T Capital Markets

Okay. Thank you. Let me move on to Hamilton Beach and Kitchen Collection, it looks like sequential revenues kind of Q2 versus Q1 or unusually weak there and both of those units. You sound immoderately bullish kind of in the second half of the year. Are you concerned about any weakness in the consumer markets or are there other kind of factors playing out there?

Al Rankin

There is a lot to do with promotional activity and when we get it in comparison to previous years and we are very hopeful that the promotional activity in the third and fourth quarter have been quite encouraging for Hamilton Beach. There are signs that consumer behavior is uncertain. In the last month or so there are some indications that traffic and factory outlet malls has been down a little bit.

I think our views are not based at this point on a really strong upturn in consumer buying. We are taking a pretty moderate point of view but an awful lot of depends on how our retailers do particularly in the mass marketing people and how their relative positions are in terms of comparisons to other. So there is a lot of issues in terms of the mix of the customer base.

There is some in terms of the mix of products but these happen every year and we are feeling reasonably good unless this consumer gets more stressed in that second half, in Hamilton Beach. I think the biggest driver for improvement in Kitchen Collection is the enhanced formats really in both businesses but particularly in Gourmet Chef.

I think what is less clear is just how quickly we will get the full benefit of that. It takes a while for consumers to get in a regular pattern on coming back to our stores and making kinds of repeat purchases that we would hope to overtime but we feel we are very well positioned over the next couple of years there.

Schon Williams - BB&T Capital Markets

Okay and then it looks like Hamilton Beach is moving a distribution center in the quarter. Do you expect – are there going to be any significant cost associated with that move?

Al Rankin

No I think that, I am not sure where that comes from, we are not moving any distribution centers at all. What we are…

Schon Williams - BB&T Capital Markets

Not, not in the quarter. The lease in Memphis...

Al Rankin

That really is a very marginal move. There's no material expense moved. It's just moving from one building to a nearby building and we have better rental rates. But it's not a significant matter.

Schon Williams - BB&T Capital Markets

Okay, and then let me just move on to coal. Can you just talk about the, your expecting some modest increases from some of the new mines coming online. Are we -- over the next four quarters, kind of Q3 through Q2 of next year, Q2 of this year through Q2 of next year, are we talking about maybe tens of thousands of tones coming online, maybe a 200,000 tones coming online, very modest numbers really kind of over the next 12 months. Is that what we should expect?

Al Rankin

It's pretty modest though '10 and '11 and you're not going to see much till '12, '13.

Schon Williams - BB&T Capital Markets

Okay, okay. And then last question here, we discussed this last time but it looks like the litigation cost ballooned significantly in Q2 versus Q1. I understand that this is kind of a moving target but at $4.5 million a quarter, that's very material to earnings. Do you have a sense of whether that going to be the run rate for the next couple of quarters, 4.5 million a quarter or just was there a tremendous amount of activity this quarter that just happened to hit because of timing.

Al Rankin

Well, we're in a very active stage of the litigation process right now. Many depositions are being taken in preparation for depositions and preparation of legal case. Certainly that process is going to continue at a high level for a while. Then we'll have to see where things go as we get further down the track but there will be some ebbs and flows. We're certainly at a higher level now but litigation is a very expense process and very time consuming, very people intensive, not just of lawyer's time but also of management's time. But the case is moving forward and there will be substantial expenses through the remainder of this year and I can't really say just exactly what the level would be but certainly the second quarter was a very active period.

Schon Williams - BB&T Capital Markets

Okay, that's all I have for now. Thank you for your time.

Al Rankin

Okay, are there other questions?

Operator

(Operator Instructions).

Al Rankin

Okay, if there are no more questions, thank you all for listening to our earnings call. Cristi?

Christina Kmetko

Thank you for joining us. We do appreciate your interest and if you do have any additional questions, you can call me. Again the phone number is 440-449-9669. Thanks and have a great day.

Al Rankin

Bye-bye.

Operator

Thank you for joining today's conference. That concludes the presentation. To access the replay of the call please dial 1-888-286-8010 and passcode is 28666167. Again, its 28666167. Have a great day.

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