Ladies and gentlemen, thank you for standing by, and welcome to the NACCO Industries Q1 2020 Earnings Call. I would now like to hand the conference over to your speaker today, Christina Kmetko. Thank you. Please begin.

Thank you. Good morning, everyone, and welcome to our 2020 first quarter earnings call. I am Christina Kmetko, and I am responsible for Investor Relations at NACCO Industries. Thank you for joining us this morning. I hope you and your families are all healthy and safe. I will 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 NACCO and North American Coal, and Elizabeth Loveman, NACCO's Vice President and Controller. Yesterday, we published our first quarter 2020 results and filed our 10-Q. Copies of our earnings release and 10-Q 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 For anyone who is not able to listen to today's entire call, an archived version of this webcast will be on our website later this afternoon and available for approximately 12 months.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. In a moment, I'll discuss our first quarter results, but first let me turn the call over to our President and CEO, J.C. Butler, for some opening remarks. J.C.?

Thank you, Christy. Good morning, everyone. To begin, we want to express our sympathies to all those impacted by the global pandemic and extend our heartfelt thanks to everyone working to keep us safe, especially those in healthcare and first response roles. Their efforts are remarkable, and they deserve our utmost appreciation. I also want to recognize our employees who have been dedicated to delivering coal and limestone to our customers. We are very pleased with how well our workforce and supervisors are navigating this unprecedented situation and adapting to the changes in their work environments. We greatly value our employees' commitment to supporting our customers while working hard to keep everyone safe. Ensuring safety and reducing the spread of the coronavirus has been our top priority, but we also have the responsibility to continue supplying our customers with coal and limestone, as both are essential to infrastructure. Most of our employees have been coming to work in recent weeks. We have put safeguards in place based on regulatory requirements and health authority guidance to protect those on the job and reduce COVID-19 exposure. We're adjusting shift schedules to encourage social distancing, enhancing cleaning and sanitation of work equipment, areas, and common spaces, and promoting hygiene practices while limiting workplace access. Those employees who can work from home are doing so, and we have provided them with the necessary resources and support to ensure productivity. The investments we have made over the past few years to improve our systems and processes, mainly through IT enhancements, are proving to be very beneficial. These upgrades were intended to make our systems more scalable to support our growth, but they are also proving invaluable as we transition to remote work. I am very pleased with the effectiveness of this approach. Business-wise, we are fortunate that we have not been significantly impacted by the pandemic. Customer demand remains steady, and we have not encountered significant issues with suppliers or vendors. However, the future impact of COVID-19 on our company will depend on many unpredictable factors. Before Christy discusses our first-quarter results, I want to address yesterday’s announcement from Great River Energy regarding its plan to retire the Coal Creek Station power plant in the second half of 2020. Our Falkirk Mine is the exclusive supplier of lignite to Coal Creek Station and is our second-largest coal mine. As stated in our release, Falkirk contributed about $16 million to our operating profit in 2019. Although we are understandably disappointed by GRE's decision, we believe Coal Creek Station is an efficient, cost-effective, and valuable generation asset. The long-term operation of this facility is crucial for our employees and the surrounding local and state economy. GRE has expressed openness to considering opportunities to sell Coal Creek Station, and we are actively exploring options that could facilitate the transfer of ownership to one or more third parties. I want to clarify that while we do not have a solution at this time and cannot make any guarantees, we are dedicated to collaborating with all stakeholders to seek a resolution. GRE's announcement indicates that they do not plan to close the plant until the second half of 2022, providing us with time to pursue options that could keep both the power plant and the mine operational.

Thanks, J.C. On a consolidated basis, our first quarter consolidated net income decreased to $6.2 million or $0.88 per share from $15 million or $2.15 per share last year. The largest driver of the decrease was a significant reduction in the earnings of the minerals management segment as 2019 benefited from a large number of new gas wells put into commission during 2018 and early 2019. Because new wells have high initial production rates and follow a natural decline before settling into relatively stable long-term production, earnings in the first quarter of 2020 were substantially lower than the first quarter of 2019. Our Coal segment also contributed to the decline in net income. The Coal Mining segment's operating profit was substantially lower than in the prior year first quarter primarily due to a decrease in results at Mississippi Lignite Mining Company, driven by an increase in the cost per ton delivered, a reduction in tons delivered at the unconsolidated operations as a result of changes in customer demand, and an increase in operating expenses. A significant improvement in operating profit in North American Mining primarily due to new mining contracts, and an increase in tons delivered to existing customers partly offset the reduced operating profit in coal and minerals management. Now let me explain what is happening with income taxes. The CARES Act enacted in response to the COVID-19 pandemic contains temporary changes regarding the utilization of net operating losses. The estimated annual effective income tax rate for 2020 includes the benefit of utilizing provisions of the CARES Act and resulted in a tax benefit for the 2020 first quarter despite having pretax income. For the full year, we anticipate that the effective tax will approximate 0. Those are the significant factors affecting first quarter results. Now let me turn to our outlook. In the Coal Mining segment, we anticipate coal deliveries and operating profit to be comparable to 2019. Excluding a $2.5 million unfavorable adjustment to mine reclamation liabilities last year at Centennial Natural Resources, 2020 operating profit is expected to decrease from the prior year as a result of the lower first quarter results and an expected increase in operating expenses. The decrease in operating profit is expected to be partly offset by an anticipated improvement in Mississippi Lignite Mining Company results. However, the evolving COVID-19 pandemic, historically low natural gas prices and the continued increase in renewable generation, particularly wind, could reduce customer demand, which would unfavorably affect the 2020 outlook for this business. North American Mining expects limestone deliveries to increase and full-year operating results to improve significantly over 2019, primarily from earnings generated by new limestone mining contracts. As I noted previously, 2019 results included significant royalty income generated by a large number of new gas wells put into commission during 2018 and early in 2019. Because new wells have high initial production rates and follow this natural decline curve before settling into stable long-term production, royalty income in 2020 is expected to decrease and be substantially lower than prior year levels, with a significant portion of this decrease expected in the first half of 2020 as comparisons are made to historically high income levels in the first half of 2019. Before I open up the call for questions, let me quickly provide some balance sheet and cash flow information. We ended the quarter with consolidated cash of $93.7 million and debt of $34.6 million. Due to the uncertainty surrounding the COVID-19 pandemic, we suspended our share repurchase activity in March. We expect cash flow before financing activities in 2020 to be a use of cash due to a significant increase in capital expenditures and payments made in the first quarter related to deferred compensation and other payroll liabilities. That concludes our prepared remarks. I will now open up the call for your questions.

Your first question comes from the line of Andrew Kuhn.

So you said in your earnings release that Coal Creek Station, and you reiterated it at the beginning of the call, is an efficient, economic, and attractive generation asset. However, the CEO of Great River Energy in the interview said that, 'We're not talking about selling Coal Creek for a material price. All of our discussions have been basically giving the plant to somebody, and we've had no takers.' So I'm just kind of curious about that, and if you really believe Coal Creek can be economically viable in some other owners' hands? And if so, why do you think Great River Energy is convinced based on a statement that it's effectively worthless?

I don't want to get into a public disagreement with a customer, so let me think about this. I believe we have a very efficient power plant. This power plant has, for several years, been dispatched at over 90% of its capacity, which is extremely high for a power plant. To achieve that level, the plant must be competitive and economical. We think there is past evidence of its ability to compete. There are differing views out there. If you do some research, you can see that in the utility industry, opinions about carbon risk vary. There are also different perspectives on the need for owned dispatchable generation. Renewables are intermittent, while coal, nuclear, and combined cycle natural gas are considered dispatchable, meaning they can be turned on or off as needed. These differing opinions regarding the importance of having dispatchable generation available can significantly vary among utilities, which contributes to the varied views about the value of having a power plant like this in your portfolio. Additionally, there are differing opinions regarding the value of capacity in energy markets. I want to clarify that I'm not an energy expert; we are miners, but we spend considerable time trying to learn as much as we can. In the electricity market, there are both energy and capacity aspects. Generators need access to capacity that exceeds peak demand. There are distinct markets for selling energy and capacity. It appears that there is a growing consensus that the market for capacity is increasing in value and will likely continue to do so as more dispatchable generation is taken offline. We are beginning to see operators like MISO or SPP indicate that they plan to assign less credit for capacity to renewables and more to dispatchable energy due to concerns about the declining amount of dispatchable capacity in the market. This is influencing the varying perspectives among utilities regarding the future value or cost of acquiring capacity in the open market. Does that answer your question?

Got it. Yes, sure. I only have two more questions. One of them is regarding the March investor presentation, where you mentioned that NACCO owns 44,860 gross acres of oil and gas interest. I am curious about the reasoning behind your decision to disclose the exact number of acres.

It's a growing part of our business, as you may have noticed. We've received questions from many people about it. After researching disclosures from other companies that focus solely on owning royalty and mineral interests, we decided it made sense to disclose a figure that gives an indication of what we own. It's important to note that this figure represents gross acres, which is different from our net mineral acreage, as that depends on the royalty percentage we receive and other factors. We chose to share this information in response to inquiries about the size of our reserve base.

Got it. And then my final question is on Catapult Mineral Partners. I'm kind of curious who actually makes the decision to buy stock at Catapult. Is this decision made at the Catapult level, or is the final buy decision made at the parent company level? And then how do you think we should think about a stock investment made by Catapult? Do you think of purchases of stocks in the energy industry as being just another buy and hold sort of way of diversifying NACCO over time? Like will these be long-term, almost permanent stakes? Or will someone at Catapult be actively managing a stock portfolio on a quarter-by-quarter basis?

We are not establishing a trading floor, not at all. Regarding your question on decision-making, differentiating between Catapult and the parent company, I want to clarify that we have a very flat organizational structure. Decisions like these are made collaboratively, and I was actively involved in that process. The Catapult segment of our Minerals Management business is new to us. Their main focus, as we've mentioned, is on managing our existing mineral interests first. We believe there's a viable opportunity to grow this business by acquiring additional minerals, expanding into other basins, and diversifying our oil and gas mix. The main goal is to build a diverse portfolio of mineral interests, not stocks. As for your question about short-term versus long-term, we won’t be operating a trading floor. Our information indicates that we are focused on the long term. This investment represents a small but significant stake in a public company, made during a unique time when many companies’ valuations have dropped significantly. However, these companies possess what Catapult aims to achieve, which is developing a diverse mineral portfolio. Buying a minor stake in this public company enables us to accelerate Catapult's diversification without having to independently acquire those mineral interests. It allows us to diversify our holdings across more basins and oil and gas types through one acquisition. We dedicated considerable time to studying this company, which aligns with our conservative capital structure and long-term outlook. They maintain a disciplined approach to overhead, making them a good fit for us. We became aware of this opportunity through the market changes, which led us to believe this approach would effectively diversify Catapult while also expanding our basins and oil and gas mix.

Yes, it absolutely does.

Your next question comes from the line of Trey Henninger.

I just wanted to ask first about draglines. A lot of the expansion in the limestone business is regarding the acquisition of draglines. So would you be willing to provide some detail about the cost per dragline on average and the expected life of each dragline that you acquire?

Sure. The current situation in North American Mining involves our development of unique expertise in operating draglines to mine lime rock underwater, though the dragline itself is not underwater. Draglines vary significantly in size; smaller models can lift about 5 cubic yards, while those we use in our coal operations can lift up to 125 cubic yards. The price of a dragline typically ranges from several million dollars to over $100 million, but the largest models aren’t commonly used in the lime rock sector. Most draglines fall within the 5 to 35 cubic yard bucket range, which is on the lower end of the scale. In many cases, we don’t own the draglines. We operate several quarries where the customer owns the dragline, and we might have contracts that involve us receiving a management fee for our services, or we might charge a fixed fee covering all costs and profit in a more traditional manner. Ownership can vary; it could be the customer’s dragline or ours. We have been successful in growing our business by having draglines either owned by us, options on draglines, or leads on suitable draglines for customers. Occasionally, we buy draglines and add them to our inventory when we anticipate being able to secure a new contract with them. Our strategy is always to purchase draglines with the intent to contract them for profitable operations that yield a solid return on our invested capital. In terms of pricing, a dragline can cost anywhere from $3 million to $20 million, depending on its size and capability. For larger draglines, a $20 million price could actually be considered quite affordable. However, significant expenses arise from disassembling, transporting, and reassembling these draglines, along with updating their technology. While smaller draglines may be inexpensive to relocate and rebuild, the process can still incur costs that should be factored into the total expense. Would you like me to clarify anything further?

No, that's very helpful. What I’m trying to understand about the limestone business is your long-term focus. I'm looking for clarity on how quickly we need to replace the 20-year draglines, given the information on the cost you provided.

We operate some draglines that have been in use for 40 years in our coal business, which has been established longer than our lime rock business. We believe that any tool we use, whether it's a dragline, a truck, or any excavation equipment, is essential to our operation. Therefore, we are extremely focused on maintenance and follow meticulous practices. Equipment is costly, so it must be properly maintained, which includes preventative maintenance and timely repairs. We are vigilant for any signs of issues, similar to how one would pay attention to a vehicle's brakes when they start to make noise. Draglines can last for decades, and when they are replaced, it is often to upgrade to a larger model to improve capacity rather than because they are worn out. A larger dragline allows for a bigger bucket and higher production rates. Proper maintenance ensures that draglines do not wear out; neglecting them leads to higher costs and may eventually require replacements. Occasionally, we have introduced new draglines to replace those that are indeed worn out. Does that answer your question?

Yes, that's very helpful. One other question. Would you be willing to provide more detail on what seems to be approximately $30 million in cash flow spending on long-term incentive compensation and payroll liabilities? I was able to identify the $13.4 million related to long-term incentive compensation, but I'm unclear about the remaining roughly $17 million when I reviewed the 10-Qs back to around Q1 2019. Could you elaborate on what that accounts payable liability pertains to? Is it related to regular employee compensation, executive compensation, or perhaps pension liability?

Yes. If you don't mind, I'm going to hand that off to Liz. We typically are all sitting at the same table for these calls, but we're in Ohio, which is still on remote work, so we're not together. So I'll pass that to Liz.

Thanks, J.C. The deferred compensation we paid out was approximately $13.5 million. If you check the balance sheet, you'll notice that the accrued payroll decreased from $19.6 million in December to $6.5 million today. The remainder of the changes is just normal cash flow movement. There's not much else significant to discuss. Is that what you were looking for, or do you have another question?

I think really the reason for the question is wondering if this is an expense that we should expect on an annual basis in terms of cash flow? Or is this a cash flow expense that is more one-time? Or does it repeat on a 5-year basis or something along those lines?

No, this would be more one-time. So the deferred compensation was expensed several years ago, and that was just a settlement of that liability.

Understood. So then the payroll...

The payout relates to a long-term plan. There will always be a current component, but most of this was more of a one-time expense.

Yes. It wasn't because we had cash available and decided to distribute it. We terminated some deferred compensation plans around the time of the Hamilton Beach spin-off and created new long-term incentive plans. Some of this was connected to the payout of those plans according to their terms. This was not a decision made because we wanted to pay these out at the beginning of 2020. This was part of the plan termination payouts.

And if you look back, you could see we moved that from long-term to current about 12 months before it was due. So it was planned. It was a planned payment.

Okay. Yes. I've been able to trace that show up in the current, but just missed the transfer. I'll step back into the queue.

There are no further questions at this time. I will turn the call back over to the presenters.

Thank you very much. We do appreciate everybody joining us today. J.C., did you want to make any final comments before we sign off?

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

Yes. Again, thank you. If you do have any follow-up questions, you can reach me at the number that is on our earnings release. Thank you, and have a great day and stay safe.

Ladies and gentlemen, a replay of today's event will be available later today by dialing 855-859-2056 and entering conference ID number 7535388. This replay will be available until midnight 15 May 2020. Ladies and gentlemen, this concludes this conference call. You may now disconnect.