NACCO Industries, Inc.

Thank you. Thank you. Ladies and gentlemen, thank you for standing by, and welcome to the NACO Industries Third Quarter Earnings Conference Call. At this time, all participants are in a listen-only mode. After the speaker's presentation, there will be a question-and-answer session. To ask a question during the session, you'll need to press star 1 on your telephone. Please be advised that today's conference is being recorded. If you require any further assistance, please press star 0. I'd now like to turn the call over to Ms. Christina Kmitko. Please go ahead.

Thank you. Good morning, everyone, and welcome to our 2020 Third Quarter Earnings Call. I am Christina Kometko, and I am responsible for Investor Relations at NACO Industries. Thank you for joining us this morning. I'll be providing a brief overview of our quarterly results and business outlook, and then I will open up the call for your questions. Joining me today are J.C. Butler, President and Chief Executive Officer of both NACO and North American Coal, and Elizabeth Lovman, NACO's Vice President and Controller. Yesterday, we published Our third quarter 2020 results installed our 10Q. Copies of our earnings release and 10Q are available on our website. For anyone who is not able to listen to today's entire call, an archived version of this webcast will be on our website later this afternoon and available for approximately 12 months. Our remarks that follow, including answers to your questions, contain forward-looking statements. These statements are subject to a number of risks and uncertainties that could cause actual results to differ materially from those expressed in the forward-looking statements made here today. These risks include, among others, matters that we have described in our earnings release issued last night and in our 10-Q and other filings with the SEC. We disclaim any obligation to update these forward-looking statements, which may not be updated until our next quarterly earnings conference call, if at all. Now let me discuss our 2020 third quarter. I will cover our consolidated results first and then provide the highlights for each segment. On a consolidated basis, our third quarter consolidated operating profit improved 8.5% to $9.4 million, up from $8.7 million in 2019. This improvement was driven by a number of factors, the largest being a reduction in our unallocated employee-related costs. higher earnings at both our coal mining and North American mining segments also contributed to this improvement, that those segments' earnings were more than offset by a significant reduction in the earnings of the minerals management segment. Despite the improvement in our operating profit, our consolidated net income decreased to $8 million or $1.14 per share from $10.3 million or $1.47 per share last year. In the third quarter of 2019, we received an initial $2.7 million settlement award associated with a former India venture. In 2020, we received a final settlement of $1 million. The $1.7 million difference in these award amounts combined with a higher effective income tax rate more than offset the improved operating profit discussed previously. Turning to our segments, the coal mining segments operating profit increased moderately over the prior year driven by improved earnings at Mississippi Lignite Mining Company and lower employee-related costs partially offset by reduced earnings of unconsolidated coal mining operations from lower customer demand and the termination of the Camino Real Fuels contract on July 1, 2020 that we discussed last quarter. At North American Mining, revenues and operating profit improved due to more times delivered and favorable changes in the mix of customer requirements. At our Minerals Management segment, similar to the first half of the year, earnings were down substantially as the prior year benefited from a large number of new gas wells put into commission during 2018 and early 2019. This decrease was expected because of the natural decline wells go through before settling into relatively stable long-term production. Lower commodity prices this year have also contributed to the reduction in the minerals management operating profit. Those are the significant factors affecting the third quarter results. Now let me turn to our outlook. I'll provide some insight on our expectations for the fourth quarter and full year 2020, as well as provide a high-level overview of our current expectations for 2021. While we are providing this first look at 2021, more color will be provided with the fourth quarter and full year 2020 earnings release once we have finalized our 2020 annual operating plan. At our coal mining segment, we expect the fourth quarter 2020 coal deliveries to become comparable to the prior year fourth quarter. Operating profit, on the other hand, is expected to decrease mainly due to an anticipated reduction in results at Mississippi Lignite Mining Company from an expected increase in the cost per ton delivered and a reduction in earnings at the unconsolidated mining operations. For the full year, coal deliveries and operating profit are expected to be lower than 2019, mainly because earnings at our unconsolidated mining operations are expected to decline as a result of the termination of the Camino Real Fuels contract agreement and reduced customer requirements. Changes in power plant dispatch contributed to the reduction in customer requirements. The power plant served by our Sabine Mine has been dispatched at a much lower rate this year than in 2019. During the third quarter, Sabine Mine's customer reduced its ligament coal requirements to be between 1.4 million and 1.7 million tons annually, compared with 2.6 million tons delivered in 2019. Also, on September 30, 2020, our Caddo Creek Resources customer entered into an agreement for the sale of their activated carbon manufacturing business, including the Marshall Mine, which is operated by Caddo Creek. The buyer announced its intent to close the mine, which delivered 200,000 tons in 2019. Caddo Creek has been contracted to perform the mine reclamation. Looking into 2021, we expect coal deliveries to be comparable to 2020 based on current expectations of customer requirements. But despite this, operating profit for this segment is expected to decrease compared with 2020. An expected increase in operating expenses and an anticipated reduction in earnings at the unconsolidated coal mining operations are the primary drivers of this decrease. The lower earnings at the unconsolidated operations are mainly because of a reduction in fee-based earnings at the closed Liberty Mine as our mine reclamation activities have been reduced. At our consolidated mining operations, 2021 results are expected to be comparable between years. An anticipated decrease in earnings at Mississippi Lignite Mining Company due to an increase in the cost per ton of coal delivered in 2021 versus 2020 is expected to be offset by a lower operating loss at Centennial. At our North American mining segment, we expect fourth quarter 2020 limestone deliveries to increase moderately over the fourth quarter of 2019, resulting in an overall modest increase in tons delivered for the full year compared to last year. Fourth quarter operating profit is expected to improve substantially over last year's fourth quarter as a result of favorable changes in the mix of customer requirements. But this improvement is expected to be less significant than what we saw in the first three quarters of this year. As a result, a significant increase is already realized in the first part of the year compared with last year, full year 2020 operating profit is expected to increase significantly over 2019. In 2021, we expect North American mining's operating profit to be comparable to this year with its existing customer contracts. However, we are pursuing a number of growth initiatives that, if successful, would be accretive to future earnings. As I noted previously, Last year's mineral management results included significant royalty income, particularly in the first half of the year, generated by a large number of new gas wells put into commission during 2018 and early in 2019. Given expected lower natural gas prices, fewer expected new wells, lower commodity prices, and the natural production decline that occurs early in the life of a well, we expect fourth quarter and full year 2020 royalty income to be substantially lower than 2019 levels. Given these factors, royalty income from existing assets is also expected to be down substantially in 2021 compared with this year. While you can get the capital expenditure numbers from our 10-Q for the other two segments, let me spend a minute talking about our investment plans for minerals management. We are targeting investments in mineral and royalty interest of approximately $15 million in the fourth quarter of 2020 and approximately $10 million next year. although the timing of the fourth quarter investments could slip into 2021. While we expect these investments to be accretive to earnings, each investment's contribution will be dependent on the timing, size, and stage of mineral development of the reserves acquired. To summarize, overall, we expect both consolidated operating profit and consolidated net income in the fourth quarter of 2020 to decrease significantly compared with the prior year period, Once you exclude the impact of a $2 million unfavorable mine reclamation adjustment taken in last year's fourth quarter. Lower results in our coal mining segment and an increase in income tax expense partially offset by lower unallocated employee related costs are driving this decrease. We also expect a significant decrease in the full year 2020 consolidated operating profit in net income. primarily due to the substantial decrease in operating profit at minerals management in the first nine months of this year and the anticipated reduction in full-year earnings at the coal mining segment. We are forecasting an effective income tax rate in the range of 5 to 7 percent. Finally, we expect 2021 consolidated net income to decrease significantly from this year because of the decrease in the coal mining segment's operating profit and a reduction in earnings at the minerals management segment excluding any benefit from future acquisitions of additional royalty or mineral interest. The full year 2021 effective income tax rate is expected to be negative 5% to negative 7% based on the current forecasted mix of earnings. Moving away from results expectations, let me briefly provide some cash flow information. We ended the third quarter with consolidated cash of $97.6 million and debt of $23.1 million, compared with consolidated cash of $95.5 million and debt of $28.4 million at the end of the second quarter. In addition, at the end of this quarter, we had availability of $138 million under our $150 million revolving credit facility. We believe that a conservative capital structure and liquidity are important given our strategic initiatives to grow and diversify, as well as the changing trends occurring in energy markets. We expect cash flow before financing activities to be significant use of cash due to substantial capital expenditures and payments made in the first half of 2020 related to deferred compensation and other payroll liabilities. However, in 2021, we expect cash flow before financing activities to improve and provide a solid generation of cash versus the use of cash this year. But 2021 is still not expected to reach the level the levels realized in 2019. That concludes my specific outlook remarks. But before I open up the call for questions, let me mention a couple of other items that could affect the company going forward. As we mentioned in our earnings release, we commenced the voluntary retirement program for certain corporate employees in the fourth quarter. We expect the program to be substantially completed by December 31, 2020. But until the program is complete and we understand the level of participation, the amount of savings and related one-time separation costs cannot be determined. Lastly, let me take a minute to discuss the pandemic. It is still very much a part of our daily lives and may become more so as we see cases increasing again in the United States. Our mining operations have not been directly affected by the pandemic to date. The extent to which we are impacted going forward will depend on numerous factors in future developments which are highly uncertain and unpredictable and could cause a significant and rapid deterioration in our results, our supply chain channels, and customer demand. Until proven treatments and vaccines for COVID-19 are available, we will work diligently to limit the exposure of our employees to COVID-19. We would also like to thank our workforce for their commitment to supporting our customers while also working diligently to keep one another safe. Now let me open up the call for your questions.

If you'd like to ask a question at this time, please press star, then the number one on your telephone keypad. If you would like to withdraw your question, press the pound key. First question comes from Andrew Kuhn with Focus Compounding.

Hey, everyone. Thank you. for taking my call. I want to start with the voluntary retirement program. I was wondering if you could talk a little bit about that. How long have you been considering a program like this? And were there any specific events that led to this decision? Or is this more of a response to the shift in public opinion towards coal? Is it changes in the economics of wind versus coal? Is it future regulations you think or might be expecting. Maybe if you could talk a little bit about that, that would be great.

Sure. Thanks for calling in. Thanks for the question. I guess I would say that, you know, we're always paying a lot of attention to our overhead costs. You know, I generally think it's a good rule to live by, whether it's a business or your personal life, anybody's personal life. So it's something that we watch pretty carefully. We measure it. We look at it. We study it, think about it. And I would say that it's, you know, it certainly is partly related to challenges that we see in the coal segment. You know, we earlier in the year lost Camino Real because of a a termination event between our customer and their customer. And to a much lesser extent, Caddo has now gone into reclamation, but that's kind of immaterial. And we've got lower production levels at Sabine. I mean, there's no question that there are challenges in the coal segment. But I'd also point out, I'm sure you've noticed the changing nature of our business, right? We've had a lot of growth over the last several years in our newer businesses. North American mining is growing very rapidly. We're seeing initial growth in our minerals management business. We certainly anticipate more of that, and we've started this new minerals management business called – I'm sorry, mitigation business called Mitigation Resources of North America. You know, the growth in those businesses will change the needs that we have from an overhead, you know, G&A kind of standpoint. And so as we think about those dynamics, we also look at the investments that we've made over the last several years in new tools and seeing, you know, the better utilization that we get out of these new software platforms. And it sort of is providing us with an opportunity to, you know, see that we can operate from an overhead standpoint more efficiently, lower cost. I always think that's, you know, that's a good thing to do. So I would say, your question started with, have we been thinking about it for a long time? I'd say we're sort of always thinking about our overhead structure. And so this, you know, seemed like now was a confluence of factors that said, you know, now's probably a pretty good time to think about doing that.

Got it. Great. My next question would be, you're planning to invest $25 million in mineral and royalty interest during 2020 and 2021. Are these most likely to be U.S. oil rights as opposed to anything foreign or anything that's mainly natural gas? And is your reason for making these kinds of investments purely about diversifying away from being just Utica natural gas? Or would you say the price decline in oil over the last year played a part in where you've chosen to focus your investments?

This is one of our core growth platforms, our minerals management business. We, as you know, have a vast majority of our legacy investments are minerals. you know, were made decades ago, really, in Marcellus and Utica. It's largely natural gas. And I think, as we've stated publicly, but I certainly have said, you know, we're looking to diversify what we own in the mineral space. So that will... We're heavily weighted towards natural gas now, so that means we will probably be investing in oil as opposed to natural gas. I will tell you that we're focused in the United States, not offshore at all. And we view this as a core part of diversification. I think one of the things you mentioned was diversification away from coal. I wouldn't say it's away from coal. I just look at our company and say, gosh, you know, any business does better when it's got a diversified portfolio of customers and suppliers and business models and skill sets and sources of income. And so the activities that we've been pursuing pretty aggressively over the last several years, and we intend to continue to pursue, reflect that desire to grow and diversify. create additional platforms that we think can be successful contributors to our business.

Got it. And then finally, I guess. Maybe the question is, how do you want investors to think of NACO? Are you a mining services company? Are you an energy stock? Are you a coal company? Basically, what industry would you tell an investor they're buying into when they purchase NACO shares? And I'll jump back in the queue. Thank you so much.

Yeah, thank you for the question. I will tell you that it's a question that we are spending some time on right now, thinking about how to do a better job of describing who and what we are. You know, I mean, historically, we've said NACO Industries is the parent, well, we all know historically NACO Industries was the parent company for North American Coal and High Street Yale and Hamilton Beach. High Steel and Hamilton Beach are now separate companies. So today, NACO Industries is the public parent of North American Coal, and North American Coal has a group of growing businesses inside it, including its legacy coal operations. Those businesses that we're growing are becoming more like siblings than children, if you think of typical org chart kind of structure, and we're thinking about what all that means with respect to how to think about NACo short of an eloquent way to describe it that we'll hopefully be able to produce here in the next several months. The way I describe it is we're a very strong legacy coal business. We're really in the mining services business because the nature of our management fee contracts, which are all but one of our coal mining contracts, really are structured in a way where we're providing mining services. We only have one mine where we're actually in the business of selling coal and making our profits off the margin. The Lime Rock business started as a very small business helping people with their maintenance and operation of drag lines. It's now turned into a very sizable business. We're now the largest operator of drag lines for any purpose in the United States. And, you know, it's turned into a kind of a really nice growth platform where we're providing mining services, not only in aggregates, but we're doing some sand work. And as you know, we're going to be developing a lithium mine with a management fee approach. So, again, in mining services. And then we have our other two businesses that are, you know, the minerals management space, which is really a royalty business. Invest in minerals, collect royalties. It's a very low overhead investment kind of business. And we've got our mitigation business that grew out of our strength in our reclamation work and environmental work and our coal mining operations, but we've turned that into a business. So I'd say, you know, in some ways we're headed back towards having a portfolio of businesses in the natural resources and mining services industries. But how exactly to describe that in a succinct, eloquent way, I mean, that's something we're trying to figure out. And, Andrew, that's going to include rethinking, you know, everything from, you know, how we – think about marketing materials when we go talk about potential new partners to how our websites are designed. But it's a very topical question that you've identified, and hopefully I've helped describe at least what our thinking is at the moment.

And once again, to ask a question, please press star 1. And we have a question from Trey Henninger with DIY Investing.

Hi. Thank you for... the opportunity to ask a question. I wanted to ask my first question about North American mining. Now that the North American mining division has positive operating earnings, do you expect to see operating leverage from the future revenue growth opportunities that you're pursuing, or do you expect earnings to grow linearly with future revenue growth?

Well, of course, the answer is always it depends. It depends on the mix of new business that we bring in and the profit growth profile of any new project. But I would say in general, we believe that we have made – the investments that we need to make in the administrative platform, kind of the backbone of the North American mining business. I think the largest of those investments have probably already been made, and we have the infrastructure that we need to continue to drive that business forward. So I would expect that we're going to see, in general, probably pretty good operating leverage as we continue to grow that business. We think we can add quite a bit without meaningful additional overhead costs. I will say, you know, we've got a headquarters in the Miami area. We have a secondary, you know, warehouse and service center in Central Florida. I mean, if we find that we are establishing another pocket of business somewhere in the United States, we may end up putting another satellite facility to serve a number of customers. But that, you know, that really would be that would probably come after we were establishing, you know, a toehold in another part of the U.S. It wouldn't be investment that we'd make ahead of time. So I think, yeah, I think there's pretty, I think there are good opportunities for the operating leverage that you mentioned in that business, albeit there may be some stair steps along the way.

Understood. Thank you. My next question is about the minerals mining or minerals management investments that you're talking about making. So you mentioned making somewhere in the range of $25 million in investments over the next year. Can you speak at all to the types of return on investment that you're seeking from those sorts of investments, either in terms of ROI or payback period?

We have not disclosed our specific targets. And, you know, as we look at each type of mineral that we might acquire, and that's with regards to whether it's gas or oil, which basin is it in, but I would also what stage of development. You know, we may invest in some undeveloped mineral reserves that we think have a reasonable likelihood of future development. We may invest in some recently drilled wells that are yet to be completed. We may invest in some that were drilled and completed several years ago and they're further out in their decline curve. So each of those is going to have its own return profile. But I would say that the business model that we are trying to build and we think that we're going to be successful in building is one that's going to deliver – returns on capital that'll be certainly in the teens. But that's going to take some time to build. Our legacy operations, we have very, very little invested in them because the investments were made a long time ago. We've recently added, we now have three people in this business that are really driving us forward. We've made some investments in some technology and software tools to help them, and it's really now building out the platform that eventually will get us to a business where we've got, we think, very nice returns.

So are those direct investments in minerals, or is it more similar to the $2 million investment where you purchased public securities?

Yeah, the $2 million purchase of public securities, you know, was a unique point in time when certainly public company stocks in the royalty space had been beaten up. So we feel that we were able to get a jump start in our diversification efforts by making that investment. But that is not our primary interest. Our intent is to buy mineral interests or royalty interests, which is really very similar to a mineral interest. It's just one step removed. We intend to do that directly as opposed to doing that through investments in public companies that are doing exactly the same thing that we're thinking about doing. That first investment was really an opportunistic jumpstart as we saw it.

Okay. And so, just to be clear, the minerals management segment, if you were to invest in, say, oil reserves, you don't have any plans to develop those reserves yourself, but simply to earn the royalties on them when partnering with another developer?

That's correct.

Is it becoming an oil company or is it just the reserves?

I'm sorry, can you just say that last part again?

So the question is more structured like are you becoming like an oil E&P company or are you just holding the reserves to seek the royalties basically?

We are owning the reserves to seek the royalties. All right. In some instances, those will already be leased. In some instances, they'll already be leased and developed. In some instances, they might not be leased yet. Understood. Thank you. Yeah, thank you for the questions.

Once again, to ask a question, please press star, then the number 1 on your telephone keypad. And we do not have any telephone questions at this time. I will turn the call over to the presenters.

Thank you very much for joining us. JC, did you have any follow-up concluding remarks you wanted to make?

No, Christy. I just want to thank the callers for their questions.

Great. Thank you again for joining us today. We do appreciate your interest, and if you have any follow-up questions, my information is available on our earnings release. Please feel free to give me a call. Thanks so much, and have a great day.

Thank you for participating in today's conference call. This call will be available for replay beginning at 11.30 a.m. Eastern Time today, November 3rd through 11.59 Eastern Time, November 10th, 2020. The conference ID for the replay is 1574089. Once again, the conference ID for the replay is 1574089. The number to dial for the replay is 800-585-8367. Once again, the number is 800-585-8367. This concludes today's conference call. You may now disconnect.