TMCnet News
NACCO INDUSTRIES INC - 10-Q - Management's Discussion and Analysis of Financial Condition and Results of Operations (Dollars in thousands, except as noted and per share data)(Edgar Glimpses Via Acquire Media NewsEdge) NACCO Industries, Inc. (the "parent company" or "NACCO") and its wholly owned subsidiaries (collectively, the "Company") operate in the following principal industries: mining, small appliances and specialty retail. Results of operations and financial condition are discussed separately by subsidiary, which corresponds with the industry groupings. The North American Coal Corporation and its affiliated coal companies (collectively, "NACoal") mine and market steam and metallurgical coal for use in power generation and steel production and provide selected value-added mining services for other natural resources companies. Hamilton Beach Brands, Inc. ("HBB") is a leading designer, marketer and distributor of small electric household appliances, as well as commercial products for restaurants, bars and hotels. The Kitchen Collection, LLC ("KC") is a national specialty retailer of kitchenware and gourmet foods operating under the Kitchen Collection® and Le Gourmet Chef® store names in outlet and traditional malls throughout the United States. CRITICAL ACCOUNTING POLICIES AND ESTIMATES Please refer to the discussion of the Company's Critical Accounting Policies and Estimates as disclosed on pages 34 through 37 in the Company's Annual Report on Form 10-K for the year ended December 31, 2013. The Company's Critical Accounting Policies and Estimates have not materially changed since December 31, 2013. THE NORTH AMERICAN COAL CORPORATION NACoal mines and markets steam and metallurgical coal for use in power generation and steel production and provides selected value-added mining services for other natural resources companies. Coal is surface mined from NACoal's developed mines in North Dakota, Texas, Mississippi, Louisiana and Alabama. Total coal reserves approximate 2.2 billion tons with approximately 1.1 billion tons committed to customers pursuant to long-term contracts. NACoal has two consolidated mining operations: Mississippi Lignite Mining Company ("MLMC") and Reed Minerals, and provides dragline mining services for independently owned limerock quarries in Florida. NACoal also has the following wholly owned unconsolidated subsidiaries that each meet the definition of a variable interest entity and are accounted for using the equity method: The Coteau Properties Company ("Coteau") The Falkirk Mining Company ("Falkirk") The Sabine Mining Company ("Sabine") Demery Resources Company, LLC ("Demery") Caddo Creek Resources Company, LLC ("Caddo Creek") Coyote Creek Mining Company, LLC ("Coyote Creek") Camino Real Fuels, LLC ("Camino Real") Liberty Fuels Company, LLC ("Liberty") NoDak Energy Services, LLC ("NoDak") Coteau, Falkirk and Sabine were developed between 1974 and 1981 and operate lignite coal mines under long-term contracts with various utility customers. Coteau, Falkirk and Sabine are capitalized primarily with debt financing, which the utility customers have arranged and guaranteed, and are without recourse to NACCO and NACoal. Demery, Caddo Creek, Coyote Creek, Camino Real and Liberty (collectively with Coteau, Falkirk and Sabine, the "Unconsolidated Mines") were formed to develop, construct and operate surface mines under long-term contracts. Demery commenced delivering coal to its customer in 2012 and is expected to reach full production levels in 2016. Liberty commenced production in 2013 but is not expected to produce tons for Mississippi Power Company's new Kemper County Energy Facility for the remainder of 2014. Production levels are expected to increase gradually beginning in 2015 to full production of approximately 4.3 million tons of coal annually beginning in 2019. Construction of the Kemper County Energy Facility is still ongoing which may affect the pace of the increase in deliveries. Mining permits needed to commence mining operations were issued in 2013 for Caddo Creek and Camino Real. Caddo Creek expects to begin making initial coal deliveries in late 2014. Camino Real expects initial deliveries in the second half of 2015, and expects to mine approximately 2.5 million to 3.0 million tons of coal annually when at full production. Coyote Creek received its mining permit in October 2014 and is developing a mine in Mercer County, North Dakota, from which it expects to deliver approximately 2.5 million tons of coal annually beginning in mid-2016. NoDak was formed to operate and maintain a coal processing facility. 18 -------------------------------------------------------------------------------- Table of Contents The contracts with the customers of the Unconsolidated Mines provide for reimbursement at a price based on actual costs plus an agreed pre-tax profit per ton of coal sold or actual costs plus a management fee. North American Coal Corporation India Private Limited ("NACC India") was formed to provide technical business advisory services to the third-party owners of a coal mine in India. During the first nine months of 2014, NACoal recognized a $1.1 million after-tax charge to establish an allowance against the receivable from NACC India's customer. During the third quarter of 2014, NACC India's customer defaulted on its contractual payment obligations and as a result of this default, NACC India has terminated its contract with the customer and intends to pursue contractual remedies. Coal-fired power plants produce carbon dioxide and other greenhouse gases ("GHGs") as a by-product of their operations. GHG emissions have received increasing scrutiny from local, state, federal and international government bodies. The Environmental Protection Agency (the "EPA") and other regulators are using existing laws, including the Clean Air Act ("CAA"), to limit emissions of carbon dioxide and other GHGs from major sources, including coal-fired power plants. On June 2, 2014, the EPA proposed new regulations limiting carbon dioxide emissions from existing power plants. Under this proposal, nationwide carbon dioxide emissions would be reduced by 30% from 2005 levels by 2030, with a focus on emissions from coal-fired generation. The final rule is expected to be issued in June 2015 with state implementation plans ("SIPs") due by June 2016 and emissions reductions scheduled to be phased in between 2020 and 2030. The proposed rule would give states a variety of approaches, including "cap-and-trade" programs, to meet proposed carbon dioxide emission standards. On June 18, 2014, the EPA also issued a carbon dioxide emission regulation for reconstructed and modified power plants, which addresses carbon dioxide emissions limits for power plants subsequent to modification. Enactment of laws and passage of regulations regarding GHG emissions by the United States or some of its states, or other actions to limit carbon dioxide emissions, such as opposition by environmental groups to expansion or modification of coal-fired power plants, could result in electric generators switching from coal to other fuel sources and could have a materially adverse effect on NACoal's business, financial condition and results of operations. FINANCIAL REVIEW Tons of coal sold by NACoal's operating mines were as follows for the three and nine months ended September 30: THREE MONTHS NINE MONTHS 2014 2013 2014 2013 (In millions) Coteau 3.4 3.5 10.8 10.2 Falkirk 2.0 2.0 5.6 5.6 Sabine 1.2 1.2 3.5 3.5 Unconsolidated mines 6.6 6.7 19.9 19.3 MLMC 0.8 1.0 2.3 2.3 Reed Minerals 0.3 0.2 0.7 0.7 Consolidated mines 1.1 1.2 3.0 3.0 Total tons sold 7.7 7.9 22.9 22.3 The limerock dragline mining operations sold 5.2 million and 16.5 million cubic yards of limerock in the three and nine months ended September 30, 2014, respectively. This compares with 4.9 million and 16.5 million cubic yards of limerock in the three and nine months ended September 30, 2013, respectively. 19 -------------------------------------------------------------------------------- Table of Contents The results of operations for NACoal were as follows for the three and nine months ended September 30: THREE MONTHS NINE MONTHS 2014 2013 2014 2013 Revenue - consolidated mines $ 48,209 $ 49,045 $ 131,513 $ 131,475 Royalty and other 1,631 3,825 7,979 16,109 Total revenues 49,840 52,870 139,492 147,584 Cost of sales - consolidated mines 47,403 48,222 134,941 125,792 Cost of sales - royalty and other 503 623 1,619 1,193 Total cost of sales 47,906 48,845 136,560 126,985 Gross profit 1,934 4,025 2,932 20,599 Earnings of unconsolidated mines (a) 12,064 11,808 36,069 34,187 Selling, general and administrative expenses 8,725 5,017 25,136 19,329 Amortization of intangible assets 911 1,076 2,667 2,736 Operating profit 4,362 9,740 11,198 32,721 Interest expense 1,721 788 4,298 2,200 Other (income) or loss, including (income) loss from other unconsolidated affiliates (367 ) 12 (550 ) (645 ) Income before income tax provision (benefit) 3,008 8,940 7,450 31,166 Income tax provision (benefit) (177 ) 1,146 (1,365 ) 4,829 Net income $ 3,185 $ 7,794 $ 8,815 $ 26,337 Effective income tax rate (b)(c) n/m 12.8 % n/m 15.5 % (a) See Note 6 to Unaudited Condensed Consolidated Financial Statements for a discussion of the Company's unconsolidated subsidiaries, including summarized financial information. (b) The NACoal effective tax rate is affected by the benefit of percentage depletion. (c) The effective income tax rate is not meaningful in 2014 as the income tax benefit amounts are not directly correlated to the pre-tax income for the three and nine months ended September 30, 2014. See further information regarding the consolidated effective income tax rate in Note 9 to Unaudited Condensed Consolidated Financial Statements. Third Quarter of 2014 Compared with Third Quarter of 2013 The following table identifies the components of change in revenues for the third quarter of 2014 compared with the third quarter of 2013: Revenues 2013 $ 52,870 Increase (decrease) from: Royalty and other income (2,195 ) Consolidated mining operations (835 ) 2014 $ 49,840 Revenues decreased in the third quarter of 2014 compared with the third quarter of 2013 due to significantly lower royalty and other income as well as a decrease in revenues at the consolidated mining operations. The decrease in revenues at the consolidated mining operations was primarily the result of fewer tons sold at MLMC due to an increase in the number of planned and unplanned outage days at the customer's power plant in the third quarter of 2014 compared with the third quarter of 2013. The decrease in revenues at MLMC was largely offset by an increase in revenues at Reed Minerals. Revenues at Reed Minerals improved due to an increase in tons sold partially offset by lower average selling prices in the third quarter of 2014 compared with the third quarter of 2013. 20 -------------------------------------------------------------------------------- Table of Contents The following table identifies the components of change in operating profit for the third quarter of 2014 compared with the third quarter of 2013: Operating Profit 2013 $ 9,740 Increase (decrease) from: Selling, general and administrative expenses (3,195 ) Royalty and other income (2,422 ) Consolidated mining operations (17 ) Earnings of unconsolidated mines 256 2014 $ 4,362 Operating profit decreased substantially in the third quarter of 2014 from the third quarter of 2013 primarily as a result of significantly higher selling, general and administrative expenses, mainly attributable to the absence of a $1.6 million pension curtailment gain recognized in the third quarter of 2013 that did not recur in 2014 and higher professional service fees. Substantially reduced royalty and other income also contributed to the decrease in operating profit. Operating results at the consolidated mining operations were comparable with the prior year quarter as the unfavorable effect of reduced tons sold at MLMC was largely offset by improved operating results at Reed Minerals. The increase in tons sold at Reed Minerals, combined with operating and productivity improvements implemented earlier in 2014, efficiencies and productivity improvements resulting from personnel changes in the second quarter of 2014 and investments in equipment and reserves made in late 2013 and early 2014 contributed to Reed Minerals' improved results. NACoal recognized net income of $3.2 million in the third quarter of 2014 compared with net income of $7.8 million in the third quarter of 2013 primarily due to the factors affecting operating profit and a favorable return to provision adjustment recognized in the third quarter of 2014. First Nine Months of 2014 Compared with First Nine Months of 2013 The following table identifies the components of change in revenues for the first nine months of 2014 compared with the first nine months of 2013: Revenues 2013 $ 147,584 Increase (decrease) from: Royalty and other income (8,130 ) Consolidated mining operations 38 2014 $ 139,492 Revenues decreased in the first nine months of 2014 compared with the first nine months of 2013 primarily as a result of a decrease in royalty and other income. Overall revenues at the consolidated mining operations in the first nine months of 2014 were comparable to the prior year period as an increase in revenue at Reed Minerals and the limerock dragline mining operations was almost fully offset by reduced revenue at MLMC. The increase in Reed Minerals revenues was due to an increase in tons sold , partially offset by lower selling prices in the first nine months of 2014 compared with the first nine months of 2013 resulting from unfavorable metallurgical coal market conditions. Revenues at the the limerock dragline mining operations increased as a result of an increase in reimbursed costs. Reduced revenues at MLMC was primarily due to an increase in the number of planned and unplanned outage days at the customer's power plant in first nine months of 2014 compared with the first nine months of 2013. 21 -------------------------------------------------------------------------------- Table of Contents The following table identifies the components of change in operating profit for the first nine months of 2014 compared with the first nine months of 2013: Operating Profit 2013 $ 32,721 Increase (decrease) from: Royalty and other income (9,814 ) Consolidated mining operations (7,935 ) Selling, general and administrative expenses (4,480 ) Reimbursement of damage to customer-owned equipment (1,176 ) Earnings of unconsolidated mines 1,882 2014 $ 11,198 Operating profit decreased substantially in the first nine months of 2014 from the first nine months of 2013 primarily due to significantly reduced royalty and other income, a significant decline in operating results at the consolidated mining operations, an increase in selling, general and administrative expenses and a $1.2 million charge to reimburse a customer for damage to certain customer-owned equipment at the limerock dragline mining operations. The increase in selling, general and administrative expenses was primarily due to the absence of a $1.6 million pre-tax pension curtailment gain, higher professional fees and higher management fees. These decreases were partially offset by an increase in earnings of unconsolidated mines mainly resulting from an increase in tons sold in the first nine months of 2014 compared with the first nine months of 2013. The substantial decline in operating profit at the consolidated mining operations was largely due to a significantly larger loss at Reed Minerals than in the first nine months of 2013 and fewer tons sold at MLMC. Operating and productivity improvements at Reed Minerals were implemented later than anticipated in 2014, primarily related to a delay in the startup of a new dragline. As a result of the delay, Reed Minerals experienced production shortfalls, which caused a decrease in inventory levels. In addition, Reed Minerals' results were unfavorably affected by an increase in depreciation expense on equipment acquired during 2013 and in 2014 to improve efficiencies and productivity. These additional expenses were partially offset by favorable equipment rental expense, fuel and labor. Net income decreased to $8.8 million in the first nine months of 2014 from $26.3 million in the first nine months of 2013 primarily due to the factors affecting operating profit, increased interest expense as a result of higher debt outstanding during 2014 and a $1.1 million after-tax charge to establish an allowance against the receivable from NACC India's customer. The decrease in net income was partially offset by an income tax benefit mainly attributable to a $1.4 million discrete tax benefit resulting from the conclusion of the 2011 and 2012 U.S. federal tax return examinations and a favorable return to provision adjustment in the first nine months of 2014. 22 -------------------------------------------------------------------------------- Table of Contents LIQUIDITY AND CAPITAL RESOURCES Cash Flows The following tables detail the changes in cash flow for the nine months ended September 30: 2014 2013 Change Operating activities: Net income $ 8,815 $ 26,337 $ (17,522 ) Depreciation, depletion and amortization 16,063 11,872 4,191 Other 6,430 (19,405 ) 25,835 Working capital changes (16,804 ) 5,588 (22,392 ) Net cash provided by operating activities 14,504 24,392 (9,888 ) Investing activities: Expenditures for property, plant and equipment (43,321 ) (21,588 ) (21,733 ) Cash in escrow for investment - (5,000 ) 5,000 Other (82 ) 924 (1,006 ) Net cash used for investing activities (43,403 ) (25,664 ) (17,739 ) Cash flow before financing activities $ (28,899 ) $ (1,272 ) $ (27,627 ) The decrease in net cash provided by operating activities was primarily the result of working capital changes and the decline in net income, partially offset by the change in other operating activities during the first nine months of 2014 compared with the first nine months of 2013. The change in working capital and other operating activities was mainly the result of changes in intercompany taxes and accounts receivable from unconsolidated mines in the first nine months of 2014 compared with the comparable 2013 period. The increase in net cash used for investing activities was primarily attributable to expenditures for property, plant and equipment, mainly for the refurbishment of a dragline and purchase of equipment at Reed Minerals in the first nine months of 2014. 2014 2013 Change Financing activities: Net additions (reductions) to long-term debt and revolving credit agreements $ 18,000 $ (2,959 ) $ 20,959 Capital contribution from NACCO 11,300 - 11,300 Net cash provided by (used for) financing activities $ 29,300 $ (2,959 ) $ 32,259 The change in net cash provided by (used for) financing activities was primarily due to an increase in borrowings and a capital contribution from NACCO during the first nine months of 2014 to fund operations and expenditures for property, plant and equipment as opposed to a reduction in borrowings in the first nine months of 2013. Financing Activities NACoal has an unsecured revolving line of credit of up to $225.0 million (the "NACoal Facility") that expires in November 2018. Borrowings outstanding under the NACoal Facility were $160.0 million at September 30, 2014. At September 30, 2014, the excess availability under the NACoal Facility was $64.0 million, which reflects a reduction for outstanding letters of credit of $1.0 million. The NACoal Facility has performance-based pricing, which sets interest rates based upon achieving various levels of debt to EBITDA ratios, as defined in the NACoal Facility. Borrowings bear interest at a floating rate plus a margin based on the level of debt to EBITDA ratio achieved. The applicable margins, effective September 30, 2014, for base rate and LIBOR loans were 1.25% and 2.25%, respectively. The NACoal Facility has a commitment fee which is based upon achieving various levels of debt to EBITDA ratios. The commitment fee was 0.40% on the unused commitment at September 30, 2014. The weighted average interest rate applicable to the NACoal Facility at September 30, 2014 was 3.20% including the floating rate margin and the effect of the interest rate swap agreement. 23 -------------------------------------------------------------------------------- Table of Contents To reduce the exposure to changes in the market rate of interest, NACoal has entered into an interest rate swap agreement for a portion of the NACoal Facility. Terms of the interest rate swap agreement require NACoal to receive a variable interest rate and pay a fixed interest rate. NACoal has interest rate swaps with notional values totaling $100.0 million at September 30, 2014 at an average fixed rate of 1.4%. The NACoal Facility contains restrictive covenants, which require, among other things, NACoal to maintain a maximum debt to EBITDA ratio of 3.50 to 1.00 and an interest coverage ratio of not less than 4.00 to 1.00. The NACoal Facility provides the ability to make loans, dividends and advances to NACCO, with some restrictions based on maintaining a maximum debt to EBITDA ratio of 3.00 to 1.00 in conjunction with maintaining unused availability thresholds of borrowing capacity, as defined in the NACoal Facility, of $15.0 million. At September 30, 2014, NACoal was in compliance with all financial covenants in the NACoal Facility. NACoal has a demand note payable to Coteau which bears interest based on the applicable quarterly federal short-term interest rate as announced from time to time by the Internal Revenue Service. At September 30, 2014, the balance of the note was $3.4 million and the interest rate was 0.31%. NACoal believes funds available from cash on hand at the Company, the NACoal Facility and operating cash flows will provide sufficient liquidity to meet its operating needs and commitments arising during the next twelve months and until the expiration of the NACoal Facility in November 2018. Contractual Obligations, Contingent Liabilities and Commitments Since December 31, 2013, there have been no significant changes in the total amount of NACoal's contractual obligations, contingent liabilities or commercial commitments, or the timing of cash flows in accordance with those obligations as reported on page 46 in the Company's Annual Report on Form 10-K for the year ended December 31, 2013. Capital Expenditures Expenditures for property, plant and equipment were $43.3 million during the first nine months of 2014. NACoal estimates that its capital expenditures for the remainder of 2014 will be an additional $13.2 million, primarily for mine equipment and development at its mines. These expenditures are expected to be funded from internally generated funds and bank borrowings. Capital Structure NACoal's capital structure is presented below: SEPTEMBER 30 DECEMBER 31 2014 2013 Change Cash and cash equivalents $ 428 $ 27 $ 401 Other net tangible assets 283,016 242,486 40,530 Coal supply agreements and other intangibles, net 57,017 59,685 (2,668 ) Net assets 340,461 302,198 38,263 Total debt (181,844 ) (163,843 ) (18,001 ) Total equity $ 158,617 $ 138,355 $ 20,262 Debt to total capitalization 53% 54% (1)% The increase in other net tangible assets during the first nine months of 2014 was primarily due to an increase in property, plant and equipment. The increase in property, plant and equipment was mainly attributable to the refurbishment of a dragline and purchase of equipment at Reed Minerals and the National Coal of Alabama, Inc. ("NCOA") acquisition. Total debt increased mainly to fund operations and the increase in property, plant and equipment. Total equity increased primarily as a result of $11.3 million of capital contributions from NACCO during the first nine months of 2014. 24 -------------------------------------------------------------------------------- Table of Contents OUTLOOK NACoal expects overall improved operating performance at its coal mining operations in the fourth quarter of 2014 compared with the fourth quarter of 2013. At the consolidated coal mining operations, tons sold at Reed Minerals are expected to increase in the fourth quarter of 2014 over the fourth quarter of 2013. The company installed key management from NACoal legacy operations in the Reed Minerals operations late in the second quarter of 2014. These personnel changes contributed to operating and productivity improvements in the third quarter and are expected to help Reed Minerals achieve additional planned operating and productivity improvements in the remainder of 2014. In addition, a higher-cost Reed Minerals mining area was temporarily idled at the beginning of the 2014 second quarter and will remain idled while a revised mining permit for the area is reviewed by state regulators and selling prices for the coal produced from this mine area are assessed against anticipated production costs. If selling prices remain low, Reed Minerals expects to continue to shift the production of tons to lower cost mine areas. Productivity improvements and increased mining efficiencies are expected to contribute to a reduced operating loss at Reed Minerals in the fourth quarter of 2014 compared with the fourth quarter of 2013, excluding the effect of the $4.0 million impairment charge recognized in 2013. The improved performance at Reed Minerals in the fourth quarter of 2014 is expected to be somewhat offset by reduced income at MLMC resulting from fewer deliveries compared with the fourth quarter 2013 because of a significant planned outage at the customer's power plant that began late in the third quarter and will continue into the fourth quarter of 2014. No significant outages are anticipated at the customer's power plant in 2015. At the unconsolidated mining operations, steam coal tons delivered in the fourth quarter of 2014 are expected to increase slightly from the same period in 2013. Demery commenced delivering coal to its customer in 2012 and full production levels are expected to be reached in 2016. Liberty commenced production in 2013 but is not expected to produce tons for Mississippi Power Company's new Kemper County Energy Facility for the remainder of 2014. Production levels are expected to increase gradually beginning in 2015 to full production of approximately 4.3 million tons of coal annually beginning in 2019. Construction of the Kemper County Energy Facility is still ongoing which may affect the pace of the increase in deliveries. Unconsolidated mines currently in development are expected to continue to generate modest income during the remainder of 2014. Mining permits needed to commence mining operations were issued in 2013 for the Caddo Creek and the Camino Real projects in Texas. Caddo Creek expects to begin making initial coal deliveries in late 2014. Camino Real expects initial deliveries in the second half of 2015, and expects to mine approximately 2.5 million to 3.0 million tons of coal annually when at full production. Coyote Creek received its mining permit in October 2014 and is developing a mine in Mercer County, North Dakota, from which it expects to deliver approximately 2.5 million tons of coal annually beginning in mid-2016. Limerock deliveries in the fourth quarter of 2014 are expected to be lower than in the fourth quarter of 2013 as a result of reduced customer requirements. Declines in royalty and other income are also expected in the fourth quarter of 2014 from the higher levels realized in the prior year period. Overall, NACoal expects net income in the fourth quarter of 2014 to increase significantly over the fourth quarter of 2013. Improvements at Reed Minerals and a $3.5 million gain on sale of assets sold to Mississippi Power in early October 2014 are expected to be partially offset by significantly reduced deliveries at MLMC and lower royalty and other income than in the prior year fourth quarter. Net income in 2015 is expected to increase significantly compared with 2014 as improvements at Reed Minerals are expected to continue. In addition, deliveries are expected to increase at MLMC and at the unconsolidated mines, based on the customers' currently planned power plant operating levels and as production increases at the newer mines. Cash flow before financing activities in 2014 is expected to be positive as compared with negative cash flow before financing activities in 2013, and is expected to increase substantially in 2015 over 2014. Over the longer term, NACoal's goal is to increase earnings of its unconsolidated mines by approximately 50% by 2017 from 2012 levels through the development and maturation of its new mines and normal escalation of contractual compensation at its existing mines. Also, NACoal has a goal of at least doubling the earnings contribution from its consolidated mining operations by 2017 from 2012 levels due to benefits from operational improvements at MLMC's customer's power plant and from the company's execution of its long-term plan at the Reed Minerals operations. The company views its acquisition of Reed Minerals and related acquisitions of coal reserves and mining equipment in Alabama as a metallurgical coal strategic initiative which includes increased volume and profitability for the company over the long term. Achieving the goal for the consolidated 25 -------------------------------------------------------------------------------- Table of Contents mining operations will be dependent on improved market conditions for Reed Minerals' metallurgical coal, the demand for and selling price of which have declined substantially since 2012, and steam coal. NACoal also expects to continue its efforts to develop new mining projects. The company is actively pursuing domestic opportunities for new or expanded coal mining projects, which include various clean coal technologies. NACoal also continues to pursue additional non-coal mining opportunities, principally in aggregates, and international value-added mining services projects. HAMILTON BEACH BRANDS, INC. HBB is a leading designer, marketer and distributor of small electric household appliances, as well as commercial products for restaurants, bars and hotels. HBB's products are marketed primarily to retail merchants and wholesale distributors. HBB's business is seasonal, and a majority of its revenues and operating profit typically occurs in the second half of the year when sales of small electric appliances to retailers and consumers increase significantly for the fall holiday selling season. FINANCIAL REVIEW The results of operations for HBB were as follows for the three and nine months ended September 30: THREE MONTHS NINE MONTHS 2014 2013 2014 2013 Revenues $ 135,155 $ 134,099 $ 354,865 $ 354,901 Operating profit $ 9,531 $ 11,788 $ 12,719 $ 18,461 Interest expense $ 236 $ 169 $ 855 $ 1,078 Other expense (income) $ 345 $ (60 ) $ 478 $ 182 Net income $ 6,008 $ 7,427 $ 7,717 $ 10,913 Effective income tax rate 32.9 % 36.4 % 32.2 % 36.6 % Third Quarter of 2014 Compared with Third Quarter of 2013 The following table identifies the components of change in revenues for the third quarter of 2014 compared with the third quarter of 2013: Revenues 2013 $ 134,099 Increase (decrease) from: Unit volume and product mix 1,859 Foreign currency (753 ) Other (50 ) 2014 $ 135,155 Revenues for the third quarter of 2014 increased slightly compared with the third quarter of 2013 mainly in the commercial and international consumer markets. The increase was partially offset by unfavorable foreign currency movements as both the Canadian dollar and Mexican peso weakened against the U.S. dollar in the third quarter of 2014 compared with the comparable 2013 period. 26 -------------------------------------------------------------------------------- Table of Contents The following table identifies the components of change in operating profit for the third quarter of 2014 compared with the third quarter of 2013: Operating Profit 2013 $ 11,788 Increase (decrease) from: Selling, general and administrative expenses (2,921 ) Foreign currency (378 ) Gross profit 1,042 2014 $ 9,531 HBB's operating profit decreased in the third quarter of 2014 from the third quarter of 2013 due to increased selling, general and administrative expenses and unfavorable foreign currency movements partially offset by higher gross profit. Selling, general and administrative expenses increased primarily because the third quarter of 2013 included a $1.6 million benefit that did not recur in the third quarter of 2014, related to a third party's commitment to share in environmental liabilities at HBB's Southern Pines and Mt. Airy locations which reduced the third quarter 2013 selling, general and administrative expenses. Selling, general and administrative expenses also increased as a result of higher outside service fees and advertising expenses incurred to execute HBB's five strategic initiatives. The increase in gross profit was mainly attributable to an increase in sales of products with higher price points and higher margins partially offset by decreased sales volumes. HBB recognized net income of $6.0 million in the third quarter of 2014 compared with $7.4 million in the third quarter of 2013 primarily due to the factors affecting operating profit. First Nine Months of 2014 Compared with First Nine Months of 2013 The following table identifies the components of change in revenues for the first nine months of 2014 compared with the first nine months of 2013: Revenues 2013 $ 354,901 Increase (decrease) from: Unit volume and product mix 4,083 Foreign currency (2,769 ) Other (1,350 ) 2014 $ 354,865 Revenues for the first nine months of 2014 were comparable to the first nine months of 2013. An increase in sales mainly in the commercial market and Canadian consumer market, was largely offset by decreased sales in the U.S. consumer market, and unfavorable foreign currency movements as both the Canadian dollar and Mexican peso weakened against the U.S. dollar. The following table identifies the components of change in operating profit for the first nine months of 2014 compared with the first nine months of 2013: Operating Profit 2013 $ 18,461 Increase (decrease) from: Selling, general and administrative expenses (5,862 ) Foreign currency (1,933 ) Gross profit 2,053 2014 $ 12,719 HBB's operating profit decreased in the first nine months of 2014 compared with the first nine months of 2013 as a result of an increase in selling, general and administrative expenses and unfavorable foreign currency movements partially offset by an increase in gross profit. Selling, general and administrative expenses increased primarily due to an increase in environmental expense, higher professional and outside service fees and advertising expenses incurred to execute HBB's five strategic initiatives and higher employee-related expenses. The increase in gross profit primarily resulted from more sales of products 27 -------------------------------------------------------------------------------- Table of Contents with higher price points and higher margins, partially offset by the absence of a favorable product liability adjustment recognized during the first nine months of 2013 as a result of a change in estimate. HBB recognized net income of $7.7 million in the first nine months of 2014 compared with $10.9 million in the first nine months of 2013 primarily due to the factors affecting operating profit. LIQUIDITY AND CAPITAL RESOURCES Cash Flows The following tables detail the changes in cash flow for the nine months ended September 30: 2014 2013 Change Operating activities: Net income $ 7,717 $ 10,913 $ (3,196 ) Depreciation and amortization 1,587 2,077 (490 ) Other 3,168 (4,150 ) 7,318 Working capital changes (7,741 ) 7,780 (15,521 ) Net cash provided by operating activities 4,731 16,620 (11,889 ) Investing activities: Expenditures for property, plant and equipment (2,751 ) (1,271 ) (1,480 ) Other - 35 (35 ) Net cash used for investing activities (2,751 ) (1,236 ) (1,515 ) Cash flow before financing activities $ 1,980 $ 15,384 $ (13,404 ) Net cash provided by operating activities decreased by $11.9 million in the first nine months of 2014 compared with the first nine months of 2013 primarily as a result of the change in working capital. The change in working capital was mainly due to a larger increase in inventory in the first nine months of 2014, a decrease in accrued payroll from increased payments in the 2014 period and the change in intercompany taxes payable compared with the 2013 comparable period. These items were partially offset by a larger decrease in accounts receivable in the first nine months of 2014 compared with the 2013 comparable period primarily due to timing. The increase in inventory purchases mainly resulted from higher expected demand in the 2014 holiday selling season. 2014 2013 Change Financing activities: Net additions (reductions) to revolving credit agreement $ 4,094 $ (16,860 ) $ 20,954 Net cash provided by (used for) financing activities $ 4,094 $ (16,860 ) $ 20,954 The change in net cash provided by (used for) financing activities was primarily due to an increase in borrowings as HBB required more cash for working capital during the first nine months of 2014 compared with a decrease in borrowings in the first nine months of 2013. Financing Activities HBB has a $115.0 million senior secured floating-rate revolving credit facility (the "HBB Facility") that expires in July 2019. The obligations under the HBB Facility are secured by substantially all of HBB's assets. The approximate book value of HBB's assets held as collateral under the HBB Facility was $254.3 million as of September 30, 2014. At September 30, 2014, the borrowing base under the HBB Facility was $110.5 million and borrowings outstanding under the HBB Facility were $22.8 million. At September 30, 2014, the excess availability under the HBB Facility was $87.7 million. The maximum availability under the HBB Facility is governed by a borrowing base derived from advance rates against eligible accounts receivable, inventory and trademarks of the borrowers, as defined in the HBB Facility. Adjustments to reserves booked against these assets, including inventory reserves, will change the eligible borrowing base and thereby impact the 28 -------------------------------------------------------------------------------- Table of Contents liquidity provided by the HBB Facility. A portion of the availability is denominated in Canadian dollars to provide funding to HBB's Canadian subsidiary. Borrowings bear interest at a floating rate, which can be a base rate or LIBOR, as defined in the HBB Facility, plus an applicable margin. The applicable margins, effective September 30, 2014, for base rate loans and LIBOR loans denominated in U.S. dollars were 0.00% and 1.50%, respectively. The applicable margins, effective September 30, 2014, for base rate loans and bankers' acceptance loans denominated in Canadian dollars were 0.00% and 1.50%, respectively. The HBB Facility also required a fee of 0.25% per annum on the unused commitment. The margins under the HBB Facility are subject to quarterly adjustment based on average excess availability. The weighted average interest rate applicable to the HBB Facility at September 30, 2014 was 2.87% including the floating rate margin and the effect of interest rate swap agreements. To reduce the exposure to changes in the market rate of interest, HBB has entered into interest rate swap agreements for a portion of the HBB Facility. Terms of the interest rate swap agreements require HBB to receive a variable interest rate and pay a fixed interest rate. HBB has interest rate swaps with notional values totaling $20.0 million at September 30, 2014 at an average fixed rate of 1.4%. The HBB Facility includes restrictive covenants, which, among other things, limit the payment of dividends to NACCO, subject to achieving availability thresholds. Dividends are discretionary to the extent that for the thirty days prior to the dividend payment date, and after giving effect to the dividend payment, HBB maintains Excess Availability of not less than $25.0 million. The HBB Facility also requires HBB to achieve a minimum fixed charge coverage ratio in certain circumstances, as defined in the HBB Facility. At September 30, 2014, HBB was in compliance with all financial covenants in the HBB Facility. HBB believes funds available from cash on hand at the Company, the HBB Facility and operating cash flows will provide sufficient liquidity to meet its operating needs and commitments arising during the next twelve months and until the expiration of the HBB Facility. Contractual Obligations, Contingent Liabilities and Commitments In the nine months ended September 30, 2014, there were no significant changes in the total amount of HBB's contractual obligations, contingent liabilities or commercial commitments, or the timing of cash flows in accordance with those obligations as reported on page 52 in the Company's Annual Report on Form 10-K for the year ended December 31, 2013. On July 29, 2014, HBB amended its $115.0 million secured, floating-rate revolving credit facility, extending the term through July 2019. The terms of the amended HBB Facility are similar to the terms under the previous HBB Facility. Capital Expenditures Expenditures for property, plant and equipment were $2.8 million for the first nine months of 2014 and are estimated to be an additional $2.1 million for the remainder of 2014. These planned capital expenditures are primarily for tooling for new products and improvements to HBB's information technology infrastructure. These expenditures are expected to be funded from internally generated funds and bank borrowings. Capital Structure Working capital is significantly affected by the seasonality of HBB's business. The following is a discussion of the changes in HBB's capital structure at September 30, 2014 compared with both September 30, 2013 and December 31, 2013. September 30, 2014 Compared with September 30, 2013 SEPTEMBER 30 SEPTEMBER 30 2014 2013 Change Cash and cash equivalents $ 6,060 $ 1,302 $ 4,758 Other net tangible assets 76,099 76,616 (517 ) Net assets 82,159 77,918 4,241 Total debt (22,781 ) (22,816 ) 35 Total equity $ 59,378 $ 55,102 $ 4,276 Debt to total capitalization 28 % 29 % (1 )% Other net tangible assets decreased $0.5 million from September 30, 2013 primarily due to a decrease in accounts receivable, an increase in accounts payable and a change in deferred income taxes, partially offset by an increase in inventory and a change 29 -------------------------------------------------------------------------------- Table of Contents in HBB's pension liability. The decrease in accounts receivable was primarily attributable to timing and the increase in accounts payable was mainly the result of the timing of inventory purchases. The increase in inventory was driven by higher expected demand in the 2014 holiday selling season. September 30, 2014 Compared with December 31, 2013 SEPTEMBER 30 DECEMBER 31 2014 2013 Change Cash and cash equivalents $ 6,060 $ 11 $ 6,049 Other net tangible assets 76,099 70,700 5,399 Net assets 82,159 70,711 11,448 Total debt (22,781 ) (18,447 ) (4,334 ) Total equity $ 59,378 $ 52,264 $ 7,114 Debt to total capitalization 28 % 26 % 2 % Other net tangible assets increased $5.4 million from December 31, 2013 primarily due to an increase in inventory and a decrease in payroll-related accruals, partially offset by a decrease in accounts receivable and an increase in accounts payable during the first nine months of 2014. The changes in inventory, accounts receivable and accounts payable were attributable to the seasonality of the business. Total debt increased $4.3 million mainly as a result of the seasonality of the business and the required funding of operations during the first nine months of 2014. OUTLOOK HBB's target consumer, the middle-market mass consumer, continues to struggle with financial and economic concerns. These conditions, as well as weakened consumer traffic to retail locations, are creating continued uncertainty about the strength of the retail market. As a result, sales volumes in the middle-market portion of the U.S. small kitchen appliance market in which HBB participates are projected to grow only moderately in the remainder of 2014. The Canadian retail market is expected to follow U.S. trends, while other international and commercial product markets in which HBB participates are also anticipated to grow moderately in the remainder of 2014 compared with the fourth quarter of 2013. Nevertheless, HBB expects its sales volumes to grow more favorably than the market due to increased promotions and placements of products in the fourth quarter of 2014 compared with the fourth quarter of 2013. HBB's sales volumes in the international and commercial product markets are anticipated to grow in the remainder of 2014 compared with the same period in the prior year as a result of HBB's strategic initiatives. HBB continues to focus on strengthening its North American consumer market position through product innovation, promotions, increased placements and branding programs, together with appropriate levels of advertising for HBB's highly successful and innovative product lines. HBB expects the FlexBrewTM coffee maker, launched in late 2012, and the Hamilton Beach® Breakfast Sandwich Maker line, launched in early 2013 to continue to gain market position. In addition, during 2015, HBB expects to expand both product lines with products offering a broader range of features. HBB is continuing to introduce other innovative products and upgrades to certain products in several small appliance categories, as well as in its growing global commercial business. HBB expects the commercial business to benefit from several new products, including the FuryTM and EclipseTM high-performance blenders and the Blend-in-Cup mixer and PrimePour "cocktails-on-tap" machine. Finally, HBB's new Jamba® blenders and juicing products and Wolf Gourmet® brand products are expected to enter the market in the first half of 2015 and expand and gain market position during the remainder of 2015. These products, as well as other new product introductions in the pipeline for the fourth quarter of 2014 and for 2015, are expected to affect both revenues and operating profit positively. As a result of these new products and execution of HBB's strategic initiatives, both domestically and internationally, HBB expects an increase in revenues in the fourth quarter of 2014 compared with the fourth quarter of 2013, provided consumer spending is at expected fourth quarter levels. Overall, HBB expects fourth quarter 2014 net income to be moderately higher than the fourth quarter of 2013, although full year 2014 net income is expected to be lower than full year 2013 as the second half improvements are not expected to offset the declines from the first half of 2014. In the near-term, the anticipated increase in sales volumes attributable to the continued implementation and execution of HBB's strategic initiatives is expected to be partially offset by the planned costs of implementing those initiatives and by increased advertising and promotional costs and outside services fees. Product and transportation costs are expected to increase modestly in the fourth quarter of 2014 compared with 2013. HBB continues to monitor both currency effects and commodity costs closely and intends to adjust product prices and product placements appropr 30 -------------------------------------------------------------------------------- Table of Contents iately in response to cost increases. HBB expects cash flow before financing activities in 2014 to be substantial but down significantly from 2013. Revenues and net income are expected to increase in 2015 compared with 2014 due to increased product placements and sales volumes resulting from the execution of HBB's strategic initiatives, partially offset by the costs to implement these initiatives, modest increases in product and transportation costs and unfavorable foreign currency translation. Cash flow before financing activities in 2015 is expected to be slightly higher than 2014. Longer term, HBB will work to take advantage of the potential to improve return on sales through economies of scale derived from market growth and a focus on its five strategic volume growth initiatives: (1) enhancing its placements in the North America consumer business through consumer-driven innovative products and strong sales and marketing support, (2) enhancing internet sales by providing best-in-class retailer support and increased consumer content and engagement, (3) participating in the "only-the-best" market with a strong brand and broad product line, including investing in new products to be sold under the Jamba® and Wolf Gourmet® brand names, (4) expanding internationally in the emerging Asian and Latin American markets by increasing product offerings and expanding its distribution channels and sales and marketing capabilities and (5) achieving global Commercial market leadership through a commitment to an enhanced global product line for chains and distributors serving the global food service and hospitality markets. HBB continues to make strides in the execution of its strategic initiatives and expects to continue to do so over the remainder of 2014 and in 2015. THE KITCHEN COLLECTION, LLC KC is a national specialty retailer of kitchenware and gourmet foods operating under the Kitchen Collection® and Le Gourmet Chef® ("LGC") store names in outlet and traditional malls throughout the United States. KC's business is seasonal, and a majority of its revenues and operating profit typically occurs in the second half of the year when sales of kitchenware to consumers increase significantly for the fall holiday selling season. FINANCIAL REVIEW The results of operations for KC were as follows for the three and nine months ended September 30: THREE MONTHS NINE MONTHS 2014 2013 2014 2013 Revenues $ 37,551 $ 42,618 $ 107,231 $ 120,709 Operating loss $ (1,429 ) $ (3,658 ) $ (12,198 ) $ (14,045 ) Interest expense $ 90 $ 87 $ 270 $ 217 Other expense, net $ 16 $ 17 $ 50 $ 59 Net loss $ (966 ) $ (2,822 ) $ (7,656 ) $ (8,492 ) Effective income tax rate 37.1 % 25.0 % 38.8 % 40.7 % Third Quarter of 2014 Compared with Third Quarter of 2013 The following table identifies the components of change in revenues for the third quarter of 2014 compared with the third quarter of 2013: Revenues 2013 $ 42,618 Increase (decrease) from: Closed stores (6,731 ) KC comparable store sales (918 ) LGC comparable store sales (572 ) New store sales 3,057 Other 97 2014 $ 37,551 Revenues for the third quarter of 2014 decreased compared with the third quarter of 2013. The decrease was primarily the result of the loss of sales from closing unprofitable KC and LGC stores since September 30, 2013 and a decline in comparable store sales at both KC and LGC. The decrease in comparable store sales was mainly due to fewer customer visits and a decrease in the average sales transaction value at both store formats from a shift in sales mix to lower-priced but higher-margin products, as well as a reduction in store transactions at LGC store formats in the third quarter of 2014 compared with the third q uarter of 2013. These decreases were partially offset by an increase in store transactions at KC and sales at newly opened KC stores. At September 30, 2014, KC operated 239 stores compared with 258 stores at September 30, 2013 and 272 stores at December 31, 2013. At September 30, 2014, LGC operated 14 stores compared with 36 stores at September 30, 2013 and 32 stores at December 31, 2013. The following table identifies the components of change in operating loss for the third quarter of 2014 compared with the third quarter of 2013: Operating Loss 2013 $ (3,658 ) (Increase) decrease from: Closed stores 923 Selling, general and administrative expenses 659 Comparable stores 508 Other 85 New stores 54 2014 $ (1,429 ) KC recognized a decreased operating loss in the third quarter of 2014 compared with the third quarter of 2013 primarily as a result of closing unprofitable KC and LGC stores since September 30, 2013 and reduced selling, general and administrative expenses, primarily due to lower employee-related costs. In addition, comparable store operating margins improved at the KC store formats due to a shift in mix to higher-margin products, fewer promotional sales and a reduction in store expenses. KC reported a net loss of $1.0 million in the third quarter of 2014 compared with a net loss of $2.8 million in the third quarter of 2013 primarily due to the factors affecting operating loss and a higher estimated effective income tax rate in the third quarter of 2014 compared with the third quarter of 2013 resulting in a greater tax benefit on the 2014 operating loss. First Nine Months of 2014 Compared with First Nine Months of 2013 The following table identifies the components of change in revenues for the first nine months of 2014 compared with the first nine months of 2013: Revenues 2013 $ 120,709 Increase (decrease) from: Closed stores (15,945 ) KC comparable store sales (3,937 ) LGC comparable store sales (1,219 ) New store sales 7,277 Other 346 2014 $ 107,231 Revenues decreased for the first nine months of 2014 compared with the first nine months of 2013 primarily due to closing unprofitable KC and LGC stores since September 30, 2013 and a decline in comparable store sales at both KC and LGC. The decrease in comparable store sales resulted from fewer customer visits, a reduction in store transactions and a decrease in the average sales transaction value at both store formats for the first nine months of 2014 compared with the first nine months of 2013. These decreases were partially offset by sales at newly opened KC stores. 31 -------------------------------------------------------------------------------- Table of Contents The following table identifies the components of change in operating loss for the first nine months of 2014 compared with the first nine months of 2013: Operating Loss 2013 $ (14,045 ) (Increase) decrease from: Closed stores 1,775 Selling, general and administrative expenses 1,414 Comparable stores (865 ) New stores (433 ) Other (44 ) 2014 $ (12,198 ) KC recognized a decreased operating loss in the first nine months of 2014 compared with the first nine months of 2013 primarily as a result of closing unprofitable KC and LGC stores during the last 12 months and lower selling, general and administrative expenses, mainly from a decrease in employee-related expenses. The decrease in the operating loss was partially offset by reduced sales and unfavorable inventory adjustments at comparable stores, as well as seasonal losses at newly opened KC stores. KC reported a net loss of $7.7 million in the first nine months of 2014 compared with a net loss of $8.5 million in the first nine months of 2013 primarily due to the factors affecting the operating loss and a lower estimated effective income tax rate in 2014 resulting in less of a tax benefit on the 2014 operating loss. LIQUIDITY AND CAPITAL RESOURCES Cash Flows The following tables detail the changes in cash flow for the nine months ended September 30: 2014 2013 Change Operating activities: Net loss $ (7,656 ) $ (8,492 ) $ 836 Depreciation and amortization 1,561 2,170 (609 ) Other (509 ) 300 (809 ) Working capital changes (3,303 ) (17,426 ) 14,123 Net cash used for operating activities (9,907 ) (23,448 ) 13,541 Investing activities: Expenditures for property, plant and equipment (1,038 ) (1,826 ) 788 Other 388 36 352 Net cash used for investing activities (650 ) (1,790 ) 1,140 Cash flow before financing activities $ (10,557 ) $ (25,238 ) $ 14,681 Net cash used for operating activities decreased $13.5 million in the first nine months of 2014 compared with the first nine months of 2013 primarily due to the change in working capital. The change in working capital was mainly the result of a large decrease in inventory levels in the first nine months of 2014 compared with a large increase in inventory levels in the first nine months of 2013, primarily attributable to the reduction in the number of stores. Expenditures for property, plant and equipment decreased mainly as a result of the reduction in the number of stores. 2014 2013 Change Financing activities: Net additions to revolving credit agreement $ 10,564 $ 14,704 $ (4,140 ) Other (15 ) (17 ) 2 Net cash provided by financing activities $ 10,549 $ 14,687 $ (4,138 ) The change in net cash provided by financing activities was the result of a decrease in borrowings as KC required less cash for both working capital and capital expenditures during the first nine months of 2014 compared with the first nine months of 2013. Financing Activities KC has a $30.0 million secured revolving line of credit that expires in September 2019 (the "KC Facility"). The obligations under the KC Facility are secured by substantially all of the assets of KC. The approximate book value of KC's assets collateralized under the KC Facility was $56.9 million as of September 30, 2014. The maximum availability under the KC Facility is derived from a borrowing base formula using KC's eligible inventory and eligible credit card accounts receivable, as defined in the KC Facility. Borrowings bear interest at a floating rate plus a margin based on the excess availability under the agreement, as defined in the KC Facility, which can be either a base rate plus a margin of 1.00% or LIBOR plus a margin of 2.00% as of September 30, 2014. The KC Facility also requires a commitment fee of 0.32% per annum on the unused commitment. The floating rate of interest applicable to the KC Facility at September 30, 2014 was 2.16% including the floating rate margin. At September 30, 2014, the borrowing base under the KC Facility was $26.7 million and borrowings outstanding under the KC Facility were $12.0 million. At September 30, 2014, the excess availability under the KC Facility was $14.7 million. 32 -------------------------------------------------------------------------------- Table of Contents The KC Facility allows for the payment of dividends to NACCO, subject to certain restrictions based on availability and meeting a fixed charge coverage ratio as described in the KC Facility. Dividends are limited to (i) $6.0 million in any twelve-month period, so long as KC has excess availability, as defined in the KC Facility, of at least $7.5 million after giving effect to such payment and maintaining a minimum fixed charge coverage ratio of 1.1 to 1.0, as defined in the KC Facility; (ii) $2.0 million in any twelve-month period, so long as KC has excess availability, as defined in the KC Facility, of at least $7.5 million after giving effect to such payment and (iii) in such amounts as determined by KC, so long as KC has excess availability under the KC Facility of $15.0 million after giving effect to such payment. At September 30, 2014, KC was in compliance with all financial covenants in the KC Facility. KC believes funds available from cash on hand at KC and the Company, the KC Facility and operating cash flows will provide sufficient liquidity to meet its operating needs and commitments arising during the next twelve months and until the expiration of the KC Facility. Contractual Obligations, Contingent Liabilities and Commitments Since December 31, 2013, there have been no significant changes in the total amount of KC's contractual obligations, contingent liabilities or commercial commitments, or the timing of cash flows in accordance with those obligations as reported on page 58 in the Company's Annual Report on Form 10-K for the year ended December 31, 2013. On September 19, 2014, KC amended its $30.0 million secured revolving line of credit, extending the term through September 2019. The terms of the amended KC Facility are similar to the terms under the previous KC Facility. Capital Expenditures Expenditures for property, plant and equipment were $1.0 million for the first nine months of 2014 and are estimated to be an additional $0.2 million for the remainder of 2014. These planned capital expenditures are primarily for fixtures and equipment at new or existing stores and improvements to KC's information technology infrastructure. These expenditures are expected to be funded from internally generated funds and bank borrowings. Capital Structure Working capital is significantly affected by the seasonality of KC's business. The following is a discussion of the changes in KC's capital structure at September 30, 2014 compared with both September 30, 2013 and December 31, 2013. September 30, 2014 Compared with September 30, 2013 SEPTEMBER 30 SEPTEMBER 30 2014 2013 Change Cash and cash equivalents $ 773 $ 971 $ (198 ) Other net tangible assets 40,367 48,897 (8,530 ) Net assets 41,140 49,868 (8,728 ) Total debt (12,024 ) (14,704 ) 2,680 Total equity $ 29,116 $ 35,164 $ (6,048 ) Debt to total capitalization 29 % 29 % - % The $8.5 million decrease in other net tangible assets at September 30, 2014 compared with September 30, 2013 was mainly due to a reduction in inventory and property, plant and equipment, partially offset by a decrease in accounts payable, all primarily from the decrease in the number of stores open at September 30, 2014 compared with September 30, 2013. The decrease in borrowings during the first nine months of 2014 compared with the first nine months of 2013 was mainly due to the required funding of operations. Total equity decreased as a result of KC's net loss during the last 12 months. 33 -------------------------------------------------------------------------------- Table of Contents September 30, 2014 Compared with December 31, 2013 SEPTEMBER 30 DECEMBER 31 2014 2013 Change Cash and cash equivalents $ 773 $ 781 $ (8 ) Other net tangible assets 40,367 37,451 2,916 Net assets 41,140 38,232 2,908 Total debt (12,024 ) (1,460 ) (10,564 ) Total equity $ 29,116 $ 36,772 $ (7,656 ) Debt to total capitalization 29 % 4 % 25 % Other net tangible assets increased $2.9 million at September 30, 2014 compared with December 31, 2013 primarily from decreases in accounts payable, sales tax payable and accrued payroll partially offset by a decrease in inventory, all due to the seasonality of the business. Total debt increased as a result of the seasonality of the business and the required funding of operations during the first nine months of 2014. Total equity decreased as a result of KC's net loss during the first nine months of 2014. OUTLOOK Consumer traffic to all mall locations, and particularly outlet malls, remained weak in the third quarter of 2014 and prospects for the remainder of 2014 and 2015 remain uncertain. The trend of fewer households being established appears to be continuing and the middle-market consumer remains under pressure as a result of financial and economic concerns. These concerns are expected to continue to dampen consumer sentiment and limit consumer spending levels for KC's target customer over the remainder of 2014 and in 2015. KC expects to continue to refine its business plan on the assumption of continued market softness. In this context, KC closed 62 stores in the first nine months of 2014 and only opened five new stores as part of a program to close underperforming stores and realign the business around core stores which perform with acceptable profitability. KC also expects to maintain a lower number of stores during 2015 compared with 2014 as a result of closing a number of additional stores during the first quarter of 2015. As a result, KC expects revenues in the fourth quarter of 2014 and in 2015 to decrease substantially compared with the comparable prior year periods. However, KC believes it is well-positioned to take advantage of any market rebound. Overall, KC expects a substantial increase in fourth quarter 2014 net income compared with the fourth quarter of 2013. This improvement is expected primarily due to the closure of stores with operating losses and reduced operating expenses at both the stores and headquarters resulting from KC's business realignment and cost reduction programs implemented during the first half of 2014, as well as the absence of charges totaling $2.0 million pre-tax recorded in 2013 related to the 2014 store closures and business realignment. In addition, during the first quarter of 2014, KC executed revisions to its store layouts designed to focus customers on higher-margin products. These changes appear to be taking hold as margins have improved since late in the first quarter of 2014 and are expected to continue to improve during the remainder of 2014 and in 2015. These improvements, while positive, are not expected to offset the losses from the first nine months of the year. As a result, KC expects a loss for the 2014 full year. The net effect of closing additional stores early in 2015 and the anticipated opening of new stores during the second half of 2015, as well as the ongoing evaluation of KC's expense structure, is expected to contribute to improved results of near break-even in 2015. KC expects to generate positive cash flow before financing activities in 2014 compared with negative cash flow before financing activities in 2013 and to continue to improve in 2015 compared with 2014. Longer term, KC plans to focus on comparable store sales growth around a solid core store portfolio. KC expects to accomplish this by enhancing sales volume and profitability through continued refinement of its formats and ongoing review of specific product offerings, merchandise mix, store displays and appearance, while improving inventory efficiency and store inventory controls. Increasing sales of higher-margin products will continue to be a key focus. KC will also continue to evaluate and, as lease contracts permit, close or restructure leases for underperforming and loss-generating stores. In the near term, KC expects to add stores cautiously and focus its growth on its core Kitchen Collection® stores, with new stores expected to be located in sound positions in strong outlet malls. 34 -------------------------------------------------------------------------------- Table of Contents NACCO AND OTHER NACCO and Other includes the parent company operations and Bellaire. FINANCIAL REVIEW Operating Results The results of operations at NACCO and Other were as follows for the three and nine months ended September 30: THREE MONTHS NINE MONTHS 2014 2013 2014 2013 Revenues $ - $ - $ - $ - Operating loss $ (1,073 ) $ (1,155 ) $ (4,429 ) $ (4,690 ) Other expense $ 216 $ 185 $ 765 $ 851 Net loss $ (906 ) $ (1,137 ) $ (3,776 ) $ (4,188 ) Third Quarter of 2014 Compared with Third Quarter of 2013 and First Nine Months of 2014 Compared with First Nine Months of 2013 The decrease in the operating loss in the third quarter of 2014 compared with the third quarter of 2013 was primarily due to an increase in management fees charged to the subsidiaries partially offset by an increase in employee-related costs. The decrease in the operating loss in the first nine months of 2014 compared with the first nine months of 2013 was primarily due to an increase in management fees charged to the subsidiaries and a reduction in professional fees partially offset by a $1.1 million charge for the correction of an error recorded during the first nine months of 2014. During the second quarter of 2014, the Company detected a prior period accounting error and recorded the $1.1 million charge included in Selling, general and administrative expenses in NACCO and Other related to an increase in the estimated liability for certain frozen deferred compensation plans. See Note 11 to the Unaudited Condensed Consolidated Financial Statements in this Form 10-Q for further discussion of this error. The change in net loss for both the three and nine months ended September 30, 2014 compared with the 2013 comparable periods was primarily due to the factors affecting operating loss. Management Fees The management fees charged to the operating subsidiaries represent an allocation of corporate overhead of the parent company. Management fees are allocated among all subsidiaries based upon the relative size and complexity of each subsidiary. The Company believes the allocation method is consistently applied and reasonable. Following are the parent company management fees included in each subsidiary's selling, general and administrative expenses for the three and nine months ended September 30: THREE MONTHS NINE MONTHS 2014 2013 2014 2013 NACoal $ 1,104 $ 739 $ 3,103 $ 2,219 HBB $ 914 $ 824 $ 2,742 $ 2,471 KC $ 65 $ 62 $ 195 $ 187 Stock Repurchase Programs See Item 2 and Note 4 to the Unaudited Condensed Consolidated Financial Statements in this Form 10-Q for a discussion of the Company's stock repurchase programs. LIQUIDITY AND CAPITAL RESOURCES Although NACCO's subsidiaries have entered into substantial borrowing agreements, NACCO has not guaranteed any borrowings of its subsidiaries. The borrowing agreements at NACoal, HBB and KC allow for the payment to NACCO of dividends and advances under certain circumstances. Dividends (to the extent permitted by its subsidiaries' borrowing agreements), advances and management fees from its subsidiaries are the primary sources of cash for NACCO. The Company believes funds available from cash on hand, its subsidiaries' credit facilities and anticipated funds generated from operations are sufficient to finance all of the subsidiaries scheduled principal repayments, and its operating needs and commitments arising during the next twelve months and until the expiration of its subsidiaries' credit facilities. Contractual Obligations, Contingent Liabilities and Commitments Since December 31, 2013, there have been no significant changes in the total amount of NACCO and Other contractual obligations, contingent liabilities or commercial commitments, or the timing of cash flows in accordance with those obligations as reported on page 62 in the Company's Annual Report on Form 10-K for the year ended December 31, 2013. Capital Structure NACCO's consolidated capital structure is presented below: SEPTEMBER 30 DECEMBER 31 2014 2013 Change Cash and cash equivalents $ 50,598 $ 95,390 $ (44,792 ) Other net tangible assets 392,837 341,230 51,607 Coal supply agreement and other intangibles, net 57,017 59,685 (2,668 ) Net assets 500,452 496,305 4,147 Total debt (216,649 ) (183,750 ) (32,899 ) Bellaire closed mine obligations, net of tax (14,561 ) (14,775 ) 214 Total equity $ 269,242 $ 297,780 $ (28,538 ) Debt to total capitalization 45% 38% 7% 35-------------------------------------------------------------------------------- Table of Contents EFFECTS OF FOREIGN CURRENCY HBB operates internationally and enters into transactions denominated in foreign currencies. As a result, the Company is subject to the variability that arises from exchange rate movements. The effects of foreign currency fluctuations on revenues, operating profit and net income at HBB are addressed in the previous discussions of operating results. See also Item 3, "Quantitative and Qualitative Disclosures About Market Risk," in Part I of this Form 10-Q. FORWARD-LOOKING STATEMENTS The statements contained in this Form 10-Q that are not historical facts are "forward-looking statements" within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934. These forward-looking statements are made subject to certain risks and uncertainties, which could cause actual results to differ materially from those presented. Readers are cautioned not to place undue reliance on these forward-looking statements, which speak only as of the date hereof. The Company undertakes no obligation to publicly revise these forward-looking statements to reflect events or circumstances that arise after the date hereof. Such risks and uncertainties with respect to each subsidiary's operations include, without limitation: NACoal: (1) changes in tax laws or regulatory requirements, including changes in mining or power plant emission regulations and health, safety or environmental legislation, (2) changes in the demand for and market prices of metallurgical and steam coal produced at the Reed Minerals operations, (3) changes in costs related to geological conditions, repairs and maintenance, new equipment and replacement parts, fuel or other similar items, (4) regulatory actions, changes in mining permit requirements or delays in obtaining mining permits that could affect deliveries to customers, (5) weather conditions, extended power plant outages or other events that would change the level of customers' coal or limerock requirements, which would have an adverse effect on results of operations, (6) weather or equipment problems that could affect deliveries to customers, (7) changes in the power industry that would affect demand for NACoal's reserves, (8) changes in the costs to reclaim current NACoal mining areas, (9) costs to pursue and develop new mining opportunities, (10) changes or termination of a long-term mining contract, or a customer default under a contract and (11) increased competition, including consolidation within the industry. HBB: (1) changes in the sales prices, product mix or levels of consumer purchases of small electric appliances, (2) changes in consumer retail and credit markets, (3) bankruptcy of or loss of major retail customers or suppliers, (4) changes in costs, including transportation costs, of sourced products, (5) delays in delivery of sourced products, (6) changes in or unavailability of quality or cost effective suppliers, (7) exchange rate fluctuations, changes in the foreign import tariffs and monetary policies and other changes in the regulatory climate in the foreign countries in which HBB buys, operates and/or sells products, (8) product liability, regulatory actions or other litigation, warranty claims or returns of products, (9) customer acceptance of, changes in costs of, or delays in the development of new products, (10) increased competition, including consolidation within the industry and (11) changes mandated by federal, state and other regulation, including health, safety or environmental legislation. KC: (1) changes in gasoline prices, weather conditions, the level of consumer confidence and disposable income as a result of economic conditions, unemployment rates or other events or conditions that may adversely affect the number of customers visiting Kitchen Collection® and Le Gourmet Chef® stores, (2) changes in the sales prices, product mix or levels of consumer purchases of kitchenware, small electric appliances and gourmet foods, (3) changes in costs, including transportation costs, of inventory, (4) delays in delivery or the unavailability of inventory, (5) customer acceptance of new products, (6) the anticipated impact of the opening of new stores, the ability to renegotiate existing leases and effectively and efficiently close under-performing stores, (7) increased competition and (8) the impact of tax penalties under health care reform legislation beginning in 2015. 36-------------------------------------------------------------------------------- Table of Contents |