Item 1A. Risk Factors
Item 1A Risk Factors
During the quarter ended September 30, 2022, there have been no material changes to the risk factors previously disclosed in the Company's Annual Report on Form 10-K for the year ended December 31, 2021, except as follows:
The value of our investment in a private company involved in the ethanol industry could decline, could be illiquid and could be volatile in terms of value and returns, which could adversely affect our financial condition and results of operations.
As of September 30, 2022, we held a $20.0 million investment in Midwest AgEnergy, a North Dakota-based ethanol business. Financial returns on ethanol investments are highly dependent on commodity prices, which are subject to significant volatility, uncertainty and regional supply shortages. The valuation for this investment is based, in part, on an assumption that the private company will implement carbon capture and storage to capture carbon dioxide generated in the ethanol production process. This process increases the value of the ethanol produced by the private company. Should this capture process be delayed or not implemented, the value of this investment may be impaired.
On October 26, 2022, Midwest AgEnergy announced that it has finalized an agreement, under which the equity holders of Midwest AgEnergy, including NACCO, would sell their equity interests. The transaction is expected to close before the end of 2022, however there can be no assurance that the transaction will be finalized in the anticipated timeframe or at all. The amount and timing of NACCO’s cash proceeds will be dependent on the terms of the transaction. The transaction is not expected to have a material impact on 2022 results of operations based on current estimates.
If for any reason the proposed merger is not completed, this investment will continue to be accounted for under the equity method under which we report our proportionate share of the net earnings or losses of this private company as a component of Income before income tax provision. If the earnings or losses of and distributions from this investment is material in any year, those earnings or losses may have a material effect on our net income, cash flows, financial condition and liquidity. We do not control the day-to-day operations of this investment; however, how the company is managed could impact our results of operations and cash flows. Additionally, this business is subject to laws, regulations, market conditions and other risks inherent in its operations.
If the announced transaction is not finalized, this investment is non-marketable and we may not be able to achieve a return on our investment in a timely manner, if at all. Midwest Ag Energy’s operating agreement restricts the Company's ability to transfer the membership units, resulting in a liquidity discount. Since there is no active market for the exchange of these securities, our ability to liquidate this investment will likely be dependent on a liquidity event. Valuations of privately-held companies are inherently complex and uncertain due to the lack of readily available market data for such securities. If we determine that this investment has experienced a decline in value, we will be required to recognize an impairment charge in net income. Any of these factors could adversely impact our results of operations, our cash flows and the value of our investment.
MLMC is subject to risks associated with its capital investment, operating and equipment costs, growing use of alternative generation that competes with coal fired generation, changes in customer demand and inflationary adjustments.
The profitability of MLMC is subject to the risk of loss of investment in this operation, increases in the cost of mining, changes in customer demand, growing competition from alternative power generation that competes with coal-fired generation and the emergence of adverse mining conditions. At MLMC, the costs of mining operations are not reimbursed by MLMC's customer. As such, increased costs at MLMC or decreased revenues could materially reduce the Company's profitability. Any reduction in customer demand at MLMC, including reductions related to reduced mechanical availability of the customer’s power plant, would adversely affect the Company's operating results and could result in significant impairments. MLMC has approximately $135 million of long-lived assets, including property, plant and equipment and a coal supply agreement intangible asset, which are subject to periodic impairment analysis and review. Identifying and assessing whether impairment indicators exist, or if events or changes in circumstances have occurred, including assumptions about future power plant dispatch levels, changes in operating
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costs and other factors that impact anticipated revenue and customer demand, requires significant judgment. Actual future operating results could differ significantly from these estimates, which may result in an impairment charge in a future period, which could have a substantial impact on the Company’s results of operations.
MLMC sells lignite at contractually agreed upon prices which are subject to changes in the level of established indices over time. As diesel fuel is heavily weighted among the indices used to determine the coal sales price, fluctuations in diesel fuel prices can result in significant fluctuations in earnings at MLMC.
MLMC delivers coal to the Red Hills Power Plant in Ackerman, Mississippi. The Red Hills Power Plant supplies electricity to TVA under a long-term power purchase agreement. MLMC’s contract with its customer runs through 2032. TVA’s power portfolio includes coal, nuclear, hydroelectric, natural gas and renewables. In 2019, TVA published its updated Integrated Resource Plan, which indicates plans to increase its reliance on solar power. A decrease in the number of days TVA dispatches the Red Hills Power Plant would reduce MLMC's customer's demand for coal. The decision of which power plants to dispatch is determined by TVA.
Choctaw Generation Limited Partnership ("CGLP") leases the Red Hills Power Plant from a Southern Company subsidiary pursuant to a leveraged lease arrangement. CGLP's ability to make required payments to the Southern Company subsidiary is dependent on the operational performance of the Red Hills Power Plant. During 2020, Southern Company revised the estimated cash flows to be received under the leveraged lease which resulted in a full impairment of the lease investment. If any future lease payment is not paid in full, the Southern Company subsidiary may be unable to make its corresponding payment to the holders of the underlying non-recourse debt related to the Red Hills Power Plant. Failure to make the required payment to the debtholders could represent an event of default that would give the debtholders the right to foreclose on, and take ownership of, the Red Hills Power Plant from the Southern Company subsidiary. A foreclosure of the Red Hills Power Plant could have a material adverse effect on MLMC's financial condition, results of operations and cash flows. Southern Company publicly disclosed that all required lease payments have been paid in full through December 31, 2021. On October 27, 2022, Southern Company disclosed in its Form 10-Q, that it provided notice to the lessee, CGLP, to terminate the related operating and maintenance agreement effective June 30, 2023. The parties to the lease agreement are currently negotiating a potential restructuring, which could result in rescission of the termination notice. The ultimate outcome of this matter cannot be determined at this time but could have a material impact on the Company's financial statements if the operating and maintenance agreement is terminated.
Similar to the Company's unconsolidated mines, all production costs at MLMC are capitalized into inventory and recognized in cost of sales as tons are delivered. In periods of limited or no deliveries, MLMC may be required to reduce its inventory carrying value using the lower of cost and net realizable value approach, which could adversely affect MLMC’s results of operations.
Changes in customer demand for any reason, including, but not limited to, reduced mechanical availability of the customer’s power plant, dispatch of power generated by other energy sources ahead of coal, fluctuations in demand due to unanticipated weather conditions, regulations or comparable policies which may promote planned and unplanned outages at the Red Hills Power Plant, economic conditions, including an economic slowdown and a corresponding decline in the use of electricity, governmental regulations and inflationary adjustments could have a material adverse effect on MLMC's financial condition, results of operations and cash flows.
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Text extracted from the filing as submitted to EDGAR. Formatting, tables and exhibits are simplified for reading; the original document is authoritative for anything you rely on.