[Logo] NACCO INDUSTRIES, INC.
CEO
PERSPECTIVES
Alfred M. Rankin, Jr.
Chairman, President and Chief Executive Officer
NACCO Industries, Inc.
CEO Perspectives
INTRODUCTION
Dear Stockholder:
From 1991 through 1995, NACCO's annual reports included a CEO Perspective
section. Each of those CEO Perspectives dealt with aspects of corporate
governance and management structure and approach, which I considered important
to NACCO's effective operation. The topics covered were Corporate Governance,
Executive Compensation, Generating Constructive Change, Financial Performance
Measurement, and NACCO's Strategy for Long-Term Wealth Creation. I believe that
the principles outlined in these CEO Perspectives present a cohesive structure
for governance, oversight and corporate direction that has worked well for
NACCO. Given the recent public focus on these matters, we have decided to
republish these articles in a single document to reconfirm to our stockholders
the approach our company is following in these important areas.
Limited editing of the original articles has been made to eliminate
duplication unnecessary in a single publication and to remove material that was
specific to particular years but which is no longer relevant. In addition, I
have added a new Part 2 to the CEO Perspective on Corporate Governance to
address aspects of Board of Directors operation which were not covered in the
1992 CEO Perspective, but which have always been very important and are
currently very topical.
Your Board and management take our duty to our stockholders very seriously.
Over an extended period, we have made a concerted effort to think through these
important governance, oversight and corporate direction matters to ensure that
the highest standards of fiduciary responsibility and corporate effectiveness
are being met. We believe our approach has provided additional safeguards to
ensure that NACCO has minimized the risk of corporate abuses, including the
kinds of abuses which have been publicized in the media in recent years. While
our proactive approach does not guarantee satisfactory financial performance and
growth (we have a significant execution task ahead of us in this area, as
outlined in our 2003 Annual Report), we firmly believe that maintaining the
highest level of integrity in these matters is a critically important component
of our responsibility to our stockholders.
/s/Alfred M. Rankin, Jr.
ALFRED M. RANKIN, JR.
Chairman, President and Chief Executive Officer
NACCO Industries, Inc.
CEO Perspectives
CONTENTS
Corporate Governance 1
Corporate Governance (Part 2) 4
Executive Compensation 7
Generating Constructive Change 10
Financial Performance Measurement 14
NACCO's Strategy for Long-Term Wealth Creation 16
CEO Perspectives
CORPORATE GOVERNANCE*
At NACCO Industries, Inc., a disciplined analysis of corporate governance
has brought us to what we believe is a more effective way of managing the
relationships between stockholders, the Board, the Chief Executive Officer, the
strategic business units, and any management levels above the strategic business
level.
Our first step was to clearly identify NACCO's strategic business units,
the baseline elements on which corporate governance must be imposed, since they
are by definition entities without significant synergy opportunities with other
units. NACCO is made up of four such strategic business units: coal mining,
forklift trucks, electric housewares, and a kitchen goods retail store chain.
Against this backdrop, the governance approach we have adopted at NACCO is
rooted in the following four key elements:
BUSINESS UNITS TRULY STAND ALONE
We have organized our individual strategic business units as truly
stand-alone businesses. Each operates essentially as a full-service subsidiary
company with a complete income statement and balance sheet, a Chief Executive
Officer with full responsibility, and pay-for-performance compensation tailored
to its needs.
BOARD OF DIRECTORS RESTRUCTURED
In a step which I believe is relatively unique, we have established
separate, real Boards of Directors and have all of the usual Board committees
for each strategic business unit. This approach provides Board oversight at the
strategic business unit level, where strategy and operational activity occur
and, therefore, where oversight is really needed. Strategic business unit Boards
are integrated with the corporate Board through a core Board concept, in which
all 12 members of the parent company Board are also core Board members of each
unit. This structure enables us to maintain a cohesive overall view and meet our
fiduciary responsibilities to our corporate stockholders.
BOARD OVERSIGHT ROLE GIVEN REAL TEETH
To make this subsidiary Board approach work effectively, we believe four
key elements are required. First, the parent company Chief Executive Officer
acts as the representative of the core Board in the capacity, in effect, of
*Originally published in NACCO's 1992 Annual Report
1
non-executive chairman of each strategic business unit. This full-time position,
assisted by the few others with oversight functions at the corporate center,
gives the subsidiary Board the independent, informed basis for exercising
effective oversight. The business unit Chief Executive, who reports directly to
his Board, is responsible for his business. As a result, the role of the
corporate center is to exercise oversight as representatives of the NACCO Board
and its stockholders, as opposed to being intervening layers of management.
Second, each business provides an extremely full and free flow of in-depth
financial and management information so that the key drivers of the business
always can be monitored effectively. Nothing is hidden. We believe this practice
not only informs the Boards, but enhances the sense of accountability and
responsibility within the strategic business unit.
Third, the corporate center and the Board exercise, in large measure,
control of strategic business unit compensation and senior personnel matters.
Finally, the Board and the corporate center instill a sense of urgency and
a focus on disciplined thinking in strategic and operating matters. We help
ensure that each unit's strategic vision is satisfactorily defined, not so much
in terms of financial targets and results, but in terms of driving concepts that
will help ensure strategically sustainable competitive advantage over the long
term. Each unit must present to its Board its strategies against the competition
in the areas that drive success, such as product design cost and performance
positioning, product price-value positioning, product manufacturing cost
strategy, and distribution and sales force strategy. We also monitor execution
of key projects and help assure that significant operating issues are brought to
each Board's attention and are soundly addressed by management.
ADDITIONAL CORPORATE CENTER ROLES
Properly addressing governance and oversight does not preclude other roles
for the corporate center provided they truly add value. However, a skeptical
view is important since such roles can easily lead to layering which does not
add value. At NACCO, the holding company's small staff of about 40 people adds
value in three additional ways.
First, it carries out public company responsibilities for the group.
Second, it performs those few services which we believe are better provided
centrally, including internal audit for control reasons, as well as some
acquisition and divestiture and bank loan negotiation, because these are
specialized skills not frequently needed by the units.
2
Third, we provide limited consulting on a few key strategic, operational
and financial issues with a small staff who work together with strategic
business unit personnel. This staff applies its analytical expertise to targeted
studies approved by the strategic business unit Chief Executive Officer, and its
efforts are proving to be instrumental in generating constructive change in the
strategic business units, which typically have excellent business knowledge but
lack time, experience and skills in analytical work.
###
In summary, we believe our approach to corporate governance - stand-alone
strategic business units, a restructured Board, oversight with real teeth, and
value-adding corporate center roles - revitalizes the concept of a public
company board. It binds the Chief Executive Officer of the parent company, armed
with a small staff, to the Board members in the common interests of the
stockholders. The key relationship in this structure is the separation of
strategic business unit management from control of the Board. We strive for a
professional but independent relationship between each strategic business unit
Chief Executive Officer and his Board. Cozy relationships do not develop.
This approach leads to a strengthened ability of the Board to act
aggressively in support of stockholder interests and to force needed changes
which would not otherwise occur. It restores a check and balance system, which
was the cornerstone of the original independent Board concept, and adds back, in
a new form, the linkage between ownership and effective oversight. Further, it
recognizes that, while multiple strategic business unit companies may not need
centralized management, they need effective oversight at the strategic unit
level.
We believe that governing our company in this way positions the parent
company to, as Peter Drucker has put it, maximize the long-term wealth-producing
capacity of our strategic business units in terms of market standing,
innovation, productivity, and people and their development.
It is not our objective to act as a trustee for the best-balanced interest
of various stakeholders nor to maximize stockholder value (stock price) on a
short-term basis, neither of which seems to us to provide a sound basis for
actually managing strategic business units. In turn, we hope this approach to
governance will increase the likelihood of long-term, as opposed to trader,
ownership of our shares; in this environment, we can focus more effectively on
long-range business results and not on stock market levels driven by interest
rates and short-term business conditions. That is, I believe, how stockholder
wealth-producing capacity can be maximized and how investors really make money.
###
3
CEO Perspectives
CORPORATE GOVERNANCE (PART 2)*
I believe that the principles outlined in the 1992 CEO Perspective on
Corporate Governance have stood the test of time and remain a sound framework
for NACCO. That CEO Perspective, however, was focused primarily on managing the
relationships between stockholders, the Board, the parent company CEO, senior
managers, and NACCO's operating subsidiaries. Given the intense scrutiny of
governance matters which has grown out of recent well-publicized corporate
abuses, I believe this is an appropriate time to elaborate on other aspects of
governance that NACCO has followed to avoid issues in three key potential
problem areas: accounting integrity; management self-dealing and undue
enrichment in compensation matters; and Board oversight of management. I believe
that most of the abuses of recent years can be traced back to shortcomings in
these three interrelated areas, and that properly addressing four key elements
of corporate governance can help significantly in preventing these kinds of
corporate abuses. I believe that NACCO has effectively addressed each of these
four key elements.
A STRONG AUDIT COMMITTEE
First, NACCO has in place a strong audit committee to help ensure
accounting integrity. The members of NACCO's Audit Review Committee are
independent of management and have a breadth of experience and range of
qualifications, which permit them to exercise their duties very effectively.
Their responsibilities include selection of the Company's outside auditor,
active review of key accounting technical and judgment matters, review of public
financial filings and press releases, review of corporate public reporting
policies on such matters as earnings guidance policy (we do not give earnings
guidance) and the use of proforma earnings (we do not use them), and oversight
of the Company's corporate compliance program. Finally, the Committee's
procedures are designed to ensure active involvement through periodic, regularly
scheduled private meetings with our outside auditors and our internal auditors,
and through independent access to the Company's internal and external legal
counsel as needed. In addition, the Committee Chairman has regular private
discussions with the outside auditor, generally prior to each meeting of our
Audit Review Committee.
* May 2003
4
A STRONG COMPENSATION COMMITTEE
Second, NACCO has a strong Compensation Committee to help ensure that there
is no management self-dealing and no undue enrichment of management or Directors
in compensation matters. All of the members of NACCO's Compensation Committee
are independent of management, and the Committee meets regularly in private,
without management. The Committee's responsibilities include engaging one, and
periodically more, independent outside consultants of its own choosing, and
administering the compensation system along the lines of the principles outlined
in the 1991 CEO Perspective on Executive Compensation. In particular, the
Committee establishes clearly and comprehensively defined total target
compensation levels for each management position, including salary, and
short-term and long-term incentive compensation targets.
The Committee also plays a key role in ensuring that well thought through,
very disciplined, performance-based, incentive compensation mechanisms are
utilized to deliver incentive compensation which is closely linked to specific
business objectives of each of our companies, and which is aligned with our
stockholders' long-term interests. For example, at the parent company, our
long-term incentive compensation plan provides for payments to be made in fully
vested but restricted stock, which must be held for 10 years. Restricted stock
is used rather than stock options because we believe that stock grants provide a
clearer statement of compensation value received in relation to company
performance and better links future value to long-term stockholder returns.
Similarly, long-term incentive compensation plans at our subsidiary companies
generally use awards based on subsidiary book value appreciation programs linked
to subsidiary performance, for which future value is determined by compounding
over an extended period.
A STRONG ROLE FOR THE BOARD OF DIRECTORS
Third, NACCO's organization structure creates a strong role for its Board
of Directors in providing effective oversight of management. Further, I believe
that this organization structure, which includes truly stand alone strategic
subsidiaries, separate, real Boards of Directors for each strategic subsidiary,
and the close integration of the subsidiary company Boards with the parent
company Board through a core Board concept, has stood the test of time and works
very effectively for us.
All Directors, except for the parent company CEO, are independent of
management, and only one other Director maintains a professional relationship
with the Company. We strive to have experienced, strong, independent-minded,
5
outspoken Board members. All Directors have long-term equity positions in the
Company. A minimum of 50 percent of Board members' annual retainers is paid in
restricted shares of Company stock, which generally cannot be sold for 10 years.
The parent company Chief Executive is, in effect, the non-executive
chairman of each of the subsidiary company Boards. This helps ensure that each
company's business agenda is focused on key strategic and operating issues.
Further, subsidiary Board meetings are supplemented by quarterly parent company
Board meetings which, in effect, constitute regular executive sessions for each
of the operating subsidiaries, since the subsidiary CEOs are not present. Active
Board discussions, which occur against the backdrop of the governance structure
outlined in the 1992 CEO Perspective on Corporate Governance, are key features
of the separate Board meetings that are held for NACCO as well as for each of
its subsidiaries. In sum, I believe that our organization structure ensures
thoughtful, arm's length oversight of operating management, including the CEOs
of the subsidiary companies and of the parent company.
A STRONG NOMINATING AND GOVERNANCE COMMITTEE
Fourth, the strong Board role outlined above is brought to life by a strong
nominating and governance committee function. At NACCO, this is carried out by
the Nominating, Organization and Compensation Committee. At its core, this
Committee is responsible for identifying and recruiting Directors who meet
NACCO's rigorous qualification standards. Without strong, independent, outspoken
Board members, our organizational structure would not be as effective as it is.
In addition, the Committee is ultimately responsible for the selection, review
and compensation of the Chief Executive Officers and senior managers of NACCO
and each of its subsidiaries who ultimately run our operations.
###
Overall, I believe that NACCO's corporate governance structure serves
NACCO's stockholders extremely well. It creates a fabric of active
responsibility throughout its Boards and Board committees that results in
diligent oversight to help ensure the integrity of its accounting, to help
ensure that there is no self-dealing or undue enrichment of management, and to
help ensure the quality of management's business judgments as the basis for
sound decision-making.
###
6
CEO Perspectives
EXECUTIVE COMPENSATION*
At NACCO, in the early 1990s, we radically restructured our managerial pay
program in ways I believe more effectively support our stockholders' interests.
At the core of this restructuring is a strong link between an executive's target
total compensation and individual and company performance. Following rigorous
job evaluation to ensure internal equity, we have comprehensively defined target
total compensation for solid performance for each position explicitly in dollar
terms as the sum of salary and perquisites; short-term and long-term incentives,
each as a percentage of salary midpoint; insurance benefits; and retirement
contributions. Further, we offer opportunities for executives to earn truly
superior pay for outstanding results, but link this with significantly reduced
pay for weak results. While our objective is to provide competitive compensation
at target, we tend to be skeptical about uncritical use of competitive surveys
which can often result in chasing compensation to higher and higher levels. This
problem is especially prevalent in good times when surveys tend to report higher
average compensation, establishing new norms for all times - good and bad.
The five elements of our pay program, tailored to each strategic business
unit's individual needs, are familiar, but our approach overall is far from
standard.
BASE SALARY AND PERQUISITES. Our base salaries take into account
competitive surveys. However, we convert target levels of perquisites
for senior executives into fixed dollar amounts - and pay this in
cash. This clean approach recognizes that perquisites are largely just
another form of compensation, reduces the criticism which can be aimed
at perquisites such as country clubs and cars, and minimizes record
keeping and tax concerns.
SHORT-TERM INCENTIVES. Our annual incentive plans at target
performance provide a target percent of salary midpoint depending on
the position. Roughly 60 percent of the target award is tied to the
annual plan's operating and financial objectives, with the other 40
percent typically based on return on capital performance to ensure
stockholder protection.
* Originally published in NACCO's 1991 Annual Report
7
LONG-TERM INCENTIVES. Our long-term incentive plans at target
performance provide a target percent of salary midpoint, unless the
amount is currently taxable, in which case the targets are somewhat
higher. We make specific dollar denominated awards each year based on
performance against long-term objectives. We do not grant stock
options because we believe the likely payment is unclear both in
amount and in its relationship to performance, and stockholders
usually suffer dilution upon exercise. At the parent company, the cash
award, based on the level of return on equity performance, will be
converted into a grant of restricted but vested stock. At our
subsidiaries, we have increasingly used book value appreciation
programs; however, multi-year target plans tailored to individual unit
needs and achievement of enhanced stockholder value also have been
used. All of these plans, however, require truly long-term commitment.
Cash withdrawals or stock sales are generally not permitted for 10
years. In effect, the award amount is invested in the enterprise for
an extended period to strengthen the tie between stockholders' and
managers' long-term interests. I believe the purpose of long-term
incentive programs should be to accumulate capital through the success
of our businesses. To the same end, half of our Directors' fees also
are paid in the form of restricted stock.
INSURANCE BENEFITS. In both health and life insurance benefits our
watchword is affordability. In health insurance, we provide the same
plans for all employees, both salaried and hourly. While our programs
are competitive with other appropriate industries, we have phased out
early retirement medical subsidies and facilitate (but do not pay for)
purchase of retiree medical insurance to supplement medicare. Life and
disability insurance are generally tied to a competitive multiple of
pay. In both areas, an increasing number of plans permit flexible
selection of benefits by the employee.
8
RETIREMENT. We have moved from defined benefit programs to defined
contribution programs and generally augment these with 401(k) plans,
sometimes with a match to encourage employee saving. The total company
contribution is targeted at a competitive level as a percentage of
salary, and increasingly all employees, both salaried and hourly, are
in the same plans. These new plans are distinctive in two other key
ways: (1) we are making annual contributions based on age to provide
equal benefits as a percentage of pay at age 65 for each year worked,
and (2) we use a benefits-for-performance concept, which ties a
portion of the contributions to individual business results.
Generally, each business unit's return on equity performance against
target determines the contribution amount. I believe this approach,
properly communicated, is very effective in helping to motivate our
employees to work toward the common interest of building each
company's financial and strategic health, as well as stockholder
value.
###
By providing a well thought-out, total pay-for-performance package, I
believe we are able to reward our key managers with competitive total
compensation awards for achievement of specific goals, while at the same time
making them long-term stakeholders in the company. In difficult times, payouts
under key elements of these plans are very low. Over the years, of course, we as
managers are determined to earn incentive pay significantly greater than 100
percent of target by delivering outstanding performance. I expect that
stockholders' confidence in us will be reinforced by the clear connection
between their interests and our executive pay levels.
###
9
CEO Perspectives
GENERATING CONSTRUCTIVE CHANGE*
I believe that over the last few years our Company has established a
successful mechanism for generating constructive change. In earlier annual
reports, I have outlined in the CEO Perspective our thoughts on corporate
governance and executive compensation as they should apply to our Company. While
this structure appears to be serving the Company well and has begun to withstand
the test of time, the structure itself does not inherently drive constructive
change. Rather, the structure is only a vehicle for reinforcing the process of
constructive change which is necessary to accomplishing our goals.
GENERATING CONSTRUCTIVE CHANGE
We believe our success in driving constructive change results from a focus
of the oversight process on encouraging constructive change, rigorous and
comprehensive identification of what needs to change, sound project execution
management, the high impact use of our parent company internal consulting group,
and a role for the parent company Chief Executive Officer which is clearly
focused on generating constructive change.
ENCOURAGING CONSTRUCTIVE CHANGE
The oversight approach we follow is one which focuses on encouraging
constructive change. We do not focus on reviewing and approving strategic and
operating decisions proposed by the business units. We believe that the business
unit managers must ultimately make these business judgments, since they should
be most knowledgeable about the business. At the parent company level, on the
other hand, we can help ensure disciplined thinking on key operational matters
by requiring excellence and rigor in the decision-making process and a clear
focus on aspects of the business in which change is of long-term importance. We
constantly encourage the search for change which enhances long-term competitive
advantage, rather than focus on disciplined achievement of budgets or long-term
financial objectives. We are convinced that properly executed constructive
change programs built on a concept for competitive advantage will lead to sound
market share and financial results. This environment of encouraging constructive
change, however, must be followed by a rigorous process for identification of
where that change is needed.
* Originally published in NACCO's 1994 Annual Report
10
IDENTIFICATION OF NEEDED CHANGE
Each business unit provides as a baseline an extremely full and free flow
of in-depth financial and management information on strategic and operating
matters. Nothing is hidden. We believe this practice not only informs Board and
parent company oversight but also enhances the sense of accountability and
responsibility within the strategic business unit.
Against this backdrop we try to ensure that over time essentially every
strategic and operating area of each strategic business unit is reviewed against
a test of excellence. In strategic matters we expect the vision for sustainable
competitive advantage to be clear, and that the driving concepts for attaining
it to have change programs identified where they are needed. If rigorous
assessment of what to do in relation to the competition in key business area
drivers is not available, we undertake sufficient analysis to determine whether
change is needed. Essentially, every time rigorous analysis is not available, a
change opportunity of significance has been identified. Examples of areas where
analysis has been undertaken are: product design cost and performance
positioning, price-value positioning for each of our products, product
manufacturing cost strategy, distribution strategy, and sales force
effectiveness strategy.
In operating matters we assess key generic operating activities and key
functional capabilities to identify areas where constructive change is needed.
These operating matters range broadly and could include, as examples, human
resource policies, sales force effectiveness procedures, and value improvement
programs.
PROJECT EXECUTION MANAGEMENT
Over time, a list of key projects in both strategic and operating areas of
each business evolves out of this process of identification of major change
requirements, or the need, in some cases, for continued project oversight to
ensure excellence. The list is constantly updated to reflect completion of
projects and identification of new projects. The list of projects also leads
directly to a formal disciplined assessment by the subsidiary Chief Executive
Officer, in concert with the parent company Chief Executive Officer, on how best
and over what time frame to accomplish each project. Some are straight-forward
functional projects. Others require multifunctional teams. For all projects, we
develop hypotheses, conclusions and action steps for implementation based on
rigorous fact-based analysis. Project plans and conclusions are then often
reviewed with the subsidiary's Board of Directors.
11
Recent projects managed in this way have included: at North American Coal
Corporation an assessment of our coal reserve position strategy and an
administrative cost reduction study; at Kitchen Collection a detailed assessment
of an alternative market channel growth strategy; at Hamilton
Beach/Proctor-Silex a manufacturing location and production consolidation plan,
a brand name strategy, channel and customer strategies, and a sales force
effectiveness study; at NACCO Materials Handling Group a component commonality
strategy, a worldwide assembly and component sourcing strategy, a product
performance and feature, cost, and price-positioning strategy, and a dealer
structure and operations improvement strategy.
PARENT COMPANY INTERNAL CONSULTING CAPABILITY
The NACCO parent company consulting group, provided by the parent company
as one of the few services to our subsidiary companies, has become a critical
element in driving to successful completion important, complex change programs
in our strategic business units. For some projects the strategic business units
have the full set of skills required to carry out their programs resident in the
units. For others, this has not been the case, particularly when highly
disciplined, trained, analytical skills are critical to creative solutions to
projects. Further, often those business unit managers who might develop the
needed approaches simply do not have the time to do so in light of day-to-day
operational responsibilities. As a result, our small consulting staff, with its
strong analytical skills, working together with business unit personnel who have
excellent business knowledge, undertakes targeted studies approved by the
subsidiary and parent company Chief Executive Officers. Often, the leadership of
these team efforts is provided by the consulting unit, which over time has come
to know our businesses well because of the staff's continuity of involvement. We
believe this consulting capability has greatly enhanced our problem-solving
capability.
ROLE OF PARENT COMPANY CHIEF EXECUTIVE OFFICER
In my view, the role of the parent company Chief Executive Officer is
critical to making sure this process of generating constructive change is
accomplished as effectively as possible. With stand-alone Chief Executive
Officers responsible for day-to-day decisions of full-service subsidiaries
reporting to their own Boards, the parent company Chief Executive Officer is
positioned to act independently as the full-time representative of the parent
12
company Board. This structure provides the basis for informed, in-depth
oversight by the parent company Chief Executive Officer to ensure that
constructive change is driven forcefully in both change program identification
and in execution monitoring, all with a high standard of excellence.
This focus of the parent company Chief Executive Officer on forcing
constructive change is reinforced by independence from the business units, and
backed up by the responsibility, ultimately, to change senior business unit
leadership which is unable to carry out this kind of change process. On the
other hand, the effective interplay between parent company oversight and key
executives of the business unit is pivotal, since mutual agreement must be
achieved on the change programs needed, the level of excellence of the process
of developing recommendations, and of project implementation effectiveness, all
without making the decisions themselves at the parent company level.
This approach tends to require somewhat different Chief Executive Officer
managerial skills at the parent company level from those critical to managing a
single strategic business unit. While this approach demands real understanding
and familiarity with the requirements of leading a strategic business unit, the
skills used are often closer to those of a consultant than to those of a
strategic business unit Chief Executive Officer. This is true both in general
oversight, in which the emphasis is on problem identification and problem
solving rather than on review and approval activities, as well as in supervising
the consulting group.
###
We believe that this overall process of management is helping to ensure a
high level of constructive change with an appropriate sense of urgency in our
Company. This change is focused on ensuring long-term competitive advantage by
trying to maximize the wealth-producing capacity of our strategic business units
in terms of market standing, innovation, productivity, and people and their
development. In a broad sense, we believe it is this process of generating
constructive change which will allow us to achieve our aspirations of earning
outstanding returns on the capital invested in our businesses while still
permitting attainment of long-term competitive advantage.
###
13
CEO Perspectives
FINANCIAL PERFORMANCE MEASUREMENT*
We believe that return on equity is a key determinant of long-term value
generation for our stockholders, but one which must be put in thoughtful
perspective to ensure that it is used appropriately as a measuring stick for the
Company's current and future performance.
We believe that the first step in analyzing our relative return on equity
is to recognize that the return on equity of our Company and that of the S&P
market composite contain two very different elements. On the one hand is return
on tangible assets committed to the business, and on the other is the impact on
returns of goodwill financed within the business.
Return on tangible assets is the basis for direct competition between
companies. It represents the deployment of capital into working
business assets to provide a return to the stockholders of the
business. Further, we have found that since this is the basis for
direct competition between companies, this measure is useful in
determining the performance of our business units relative to other
companies.
On the other hand, return on equity in total assets measures our
performance not only on tangible assets, but also on our investment in
goodwill. Goodwill, in a broad sense, represents the additional value
necessary to bring the value of the return on the tangible assets
committed to the business to market value. This goodwill value in most
companies is located largely outside the business enterprise and is
represented by the difference between the publicly traded market value
of the Company's shares and the recorded book value of its shares.
However, when the Company has purchased assets at a price greater than
book value, the goodwill is placed on the internal books of the
Company. The greater the internal investment of goodwill as a
percentage of tangible assets, the higher the return on tangible
assets required to achieve a market return on total assets. This
measurement provides, we believe, a useful perspective to our
stockholders on how our business units are performing in terms of
market-based returns in light of our investment in goodwill.
* Originally published in NACCO's 1993 Annual Report
14
NACCO Industries has substantial unamortized goodwill, compared to the
tangible assets on its books, as a result of several acquisitions at market
prices considerably higher than historical book values. Three acquisitions
(Yale, Proctor-Silex and Kitchen Collection) used company funds to acquire
investment opportunities for our stockholders. Two other acquisitions were made
for internal strategic reasons: adding Hamilton Beach to Proctor-Silex and
Hyster to Yale in order to make stronger strategic business units.
We believe that all of these acquisitions have been consistent with our
objective that taxable stockholders maximize their after-tax returns from
long-term ownership of the shares of our company. This objective recognizes that
dividends in the hands of taxable stockholders would (otherwise) be taxed before
stockholders could invest the funds for themselves. Further, we believe it
follows from the distinction between tangible assets and goodwill that we must
also meet the joint financial objectives of having a fully competitive return on
tangible assets consistently over time, and at least a market return over time
on any invested goodwill and its associated tangible assets.
###
In summary, we believe that the returns on tangible assets of our
businesses generally have been quite sound. We also believe that improvements
can be achieved. These improvements should, at a minimum, make demanding market
returns on tangible assets and their associated goodwill a reasonable
possibility for NACCO in total. Further, these returns should be especially
attractive to taxable long-term stockholders. They will be tax advantaged
because the market price acquisitions of our businesses used internal company
funds, not subject to a dividend tax, and because of the use of significant
internal borrowing leverage as well. Overall, as cash flow is generated which is
not needed for growth in tangible equity in our existing businesses, debt in
excess of our target can be converted to equity. Additional cash generated can
then be deployed in acquisitions related to existing businesses, in new business
opportunities or in dividends. These decisions will be made in light of our
objective of maximizing long-term, after-tax returns for our stockholders.
###
15
CEO Perspectives
NACCO's STRATEGY FOR LONG-TERM WEALTH CREATION*
In our annual reports and other communications, we have emphasized that
NACCO's core objective is to maximize long-term wealth creation for our
stockholders.
WEALTH-CREATION PROSPECTS OF NACCO'S BUSINESSES
We believe that the wealth-creation potential of NACCO's businesses is
excellent. Performance at each of our businesses is on track, with each at, or
moving toward, target profitability levels. All of our businesses have
significant growth potential, and we anticipate significant free cash flow from
each over time.
In short, we believe that the engine of wealth-creation - the performance
of our existing businesses - can perform very well, and we intend to try to keep
it operating well into the future through our improvement and growth programs.
REINVESTMENT OF CASH
As free cash flow is generated by our businesses, our objective is to
invest that cash in opportunities with the potential to achieve sound returns.
Our first priority is to invest wisely in the businesses we have. In recent
years, we have invested both in capital equipment and annual expenses for new
product development, manufacturing productivity improvement, marketing position
enhancement and capacity additions.
In addition to these internal investments, we are actively looking for
acquisition prospects which mesh synergistically with the businesses we have
today. An example is the acquisitions of DECA and ORMIC in Europe, which
expanded NACCO Material Handling Group's European product line offered to our
dealers and to our ultimate customers to a full line by adding warehousing
products.
Given current high market prices, we believe that attractive new strategic
business unit acquisitions are currently unlikely, but we would expect to
consider this approach if more moderate valuations occur. We would want an
acquired company to earn a minimum of 12 percent return on our investment and 15
percent return on equity in properly capitalized tangible assets.
* Originally published in NACCO's 1995 Annual Report
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Our broad preference continues to be to find sound investments rather than
to increase NACCO's dividends substantially. We believe this approach is
advantageous for stockholders because of the potentially substantial benefit of
allowing internally generated cash to compound at attractive return rates over
time. Further, to meet stockholder cash objectives, stock can be sold. For
taxable stockholders, capital gains income from the sale of stock has a clear
tax advantage over ordinary income from dividends, a benefit which is higher if
the tax basis in the stock is high. Indeed, a voluntary decision to be taxed
rather than the imposition of tax as a result of dividends provides our
stockholders, a substantial majority of whom are taxable, both the flexibility
to compound returns on a pre-tax basis and a lower tax rate when any sales are
made.
In summary, our perspective at this time on using cash is to meet the needs
of our existing businesses by investing to enhance their profitability and to
take advantage of growth opportunities; to invest in synergistic acquisitions
for our existing businesses; and to bring our businesses to target debt-to-total
capitalization ratios of 35 percent. We will then consider various options for
investing any additional cash, but will not invest in new strategic business
units unless valuations allow us to achieve our target returns, which seems
unlikely in the current market environment.
RETURNS TO THE STOCKHOLDERS
One of our key objectives is to achieve consistently high levels of
financial performance in the years ahead. To encourage recognition of our
prospects in the market, we will continue to provide in-depth information on our
Company and its prospects so that investors can understand and appreciate our
current businesses and their prospects. Our hope is that stockholders who
understand the programs and investments we have put in place, the substantial
achievements and market position of our businesses, and the returns on NACCO's
equity and on equity in properly capitalized tangible assets of each of our
businesses will be rewarded substantially over the long term in the market for
NACCO's stock.
NACCO's low multiple relative to the market exists even though our
companies have excellent positions in their respective industries. NACCO
Materials Handling Group, for example, has a world leadership position in the
lift truck industry. Hamilton Beach/Proctor-Silex has a North American
leadership position
17
in the small electric appliance industry. Kitchen Collection has the leadership
position in its factory outlet mall niche. North American Coal is an outstanding
service-oriented coal miner.
Our hope is that enhanced future earnings prospects and what we believe is
a new underlying base earnings level, especially for the historically cyclical
lift truck business, will increasingly be recognized in the marketplace in the
years ahead, and that this will cause the total return gap relative to the S&P
500 to begin to close. Further, over time, increased understanding in the
marketplace of our complex capital structure and of our several distinct
businesses, as well as a larger market capitalization which could attract more
interest from both analysts and investors, could reinforce this process.
###
We believe that reinvesting internally generated cash at sound returns
through NACCO and a modest dividend policy will maximize investors' long-term
total returns. Needless to say, if we can earn at least a 14 percent return on
equity (our internal objective) over time by managing our existing businesses
well and generating and investing free cash flow wisely, the growth of our
equity through compounding should reward our stockholders well, even at a low
price-earnings ratio relative to the market. Ultimately, NACCO could be
recognized in the marketplace with an enhanced price-earning ratio. In short, we
believe we are following a sound long-term strategy for achieving our core
objective of maximizing long-term wealth creation for our stockholders.
###
18
CORPORATE OFFICE
NACCO Industries, Inc.
5875 Landerbrook Drive
Mayfield Heights, Ohio 44124
(440) 449-9600
STOCK LISTING
The New York Stock Exchange
Symbol: NC
NACCO INDUSTRIES WEB SITE
www.nacco.com
[Logo]
NACCO INDUSTRIES, INC.
5875 LANDERBROOK DRIVE
MAYFIELD HEIGHTS, OHIO 44124