Harsco Corporation
Q1 2019 Earnings Call Transcript

Published: 11 May 2019

[Operator:]

Welcome everyone to the Harsco Corporation First Quarter Release Conference Call. All lines have placed on mute to prevent any background noise. After the speakers’ remarks, there will be a question-and-answer period. Also, this telephone conference presentation and accompanying webcast made on behalf of Harsco Corporation are subject to copyright by Harsco Corporation and all rights are reserved. Harsco Corporation will be recording this teleconference. No other recordings or redistributions of this telephone conference by any other party are permitted without the expressed written consent of Harsco Corporation. Your participation indicates your agreement.

[David Martin:]

Thank you, Shelby, and welcome to everyone joining us this morning. I’m Dave Martin of Harsco. With me today is Nick Grasberger, our Chairman and Chief Executive Officer; as well as Pete Minan, Harsco’s Senior Vice President and Chief Financial Officer. We appreciate you joining us a bit earlier than normal today on this very exciting day for Harsco. This morning, we will discuss our two transactions, our results for the first quarter of 2019 and our outlook for the remainder of the year. We’ll then take your questions. Before our presentation, however, let me mention a few items. First, our three press releases that we issued this morning are available on our website. A slide presentation that we will be referencing on this call is also available on our website, and on Page 3 of that slide deck, you will see the agenda for today’s call. Nick will provide a brief overview of earnings and then focus his remarks on the rationale of today’s strategic announcements. He will also provide an overview of Clean Earth and its growth levers as well as discuss the attractiveness of its markets and its fits with Harsco. Pete will follow with comments on the synergy opportunities we see with the Clean Earth acquisition, some additional detail on the sale of Air-X-Changers, our pro forma financial overview and then conclude with a review of our earnings and our 2019 outlook. Second, this call is being recorded and webcast. A replay will be available on our website later today. Third, we will make statements today that are considered forward-looking within the meaning of the federal securities laws. These statements are based on our current knowledge and expectations and are subject to certain risks and uncertainties that may cause actual results to differ materially from those forward-looking statements. For a discussion of such risks and uncertainties, see the Risk Factors section in our most recent 10-K. The company undertakes no obligation to revise or update any forward-looking statement. Lastly, on this call, we will refer to adjusted financial results that are considered non-GAAP for SEC reporting purposes. A reconciliation to GAAP results is included in our earnings release today as well as the slide presentation. With that being said, I’ll turn the call over to Nick to begin his remarks.

[Nick Grasberger:]

Thanks, everyone, for joining us a bit earlier on short notice. I think it’s fair to say that today is a transformational day for Harsco. So, I will start with a few brief comments on our first quarter and improved outlook and spend somewhat more time discussing the transactions we announced earlier this morning.

[Pete Minan:]

Thanks, Nick, and good morning, everyone. Let me start by echoing what Nick and Dave said. This is an exciting day for Harsco. So, I’ll provide a bit more color about our two transactions and then hit the highlights of our first quarter results and outlook for the remainder of the year. So, let me start with the financial impact of our acquisition of Clean Earth.

[Nick Grasberger:]

Thank you, Pete. Before I open the call for questions, I’d simply like to thank the 11,000 Harsco employees for helping us arrive at this transformative inflection point in our company’s history. We have a clear direction, a strong sense of purpose and are excited about expanding our contributions to the global environment. The Harsco leadership team has never been more enthusiastic about Harsco’s mission or confident in this future. I’ll now open the line for questions.

[Operator:]

Your first question comes from Rob Brown of Lake Street Capital.

[Rob Brown:]

Good morning. Congratulations on a good quarter and a nice set of transactions. First, just wanted to maybe dive into the Clean Earth business a little bit. What’s your view on the environmental services market? How sort of fragmented is it? What’s the share of the Clean Earth business? And what sort of your – I think you said organic growth of 7%, but how does that market look in terms of growth rates going forward?

[Nick Grasberger:]

Well, it’s a sizable market. It’s about $4 billion – or $5 billion in the U.S. Clean Earth has a quite good position in the Northeast and Mid-Atlantic and some facilities in other geographies as well. We believe that there are a few larger players, but there are many midsized to smaller businesses as well that are more regionally based. Clean Earth over time, over the last 4 or 5 years, has executed a number of smaller transactions and integrated them quite well and certainly received significant benefits from doing so. The organic growth rate that they realized of 7% or so, we think, is the appropriate rate to assume going forward. In fact, the higher rate of 14% overall, including acquisitions, we think, is also reasonable, perhaps even slightly higher. So, we are quite bullish on this space. We’re very confident that the combination of the Harsco team and the Clean Earth team will continue to drive growth above what we generally see in the U.S. economy, and we’re actually going to get going.

[Rob Brown:]

Okay. Great. And then maybe just the cyclicality of that business, what sort of the main drivers there. I would assume it’s not very cyclical, but maybe just cover the cyclicality of Clean Earth and environmental services?

[Nick Grasberger:]

Yes. That’s certainly was one of the areas of attraction for us. As we looked at the business through the past few U.S. economic downturns, the Clean Earth business held up really quite well, both a volume and a margin standpoint. So relative to Air-X-Changers, it’s quite less cyclical. And again, that was one of our key criteria looking at businesses in this space.

[Rob Brown:]

Yes. Okay. And then switching to the Rail business, you’re seeing some nice growth there and you gave some pretty nice long-term targets. But maybe some depth on what’s driving that growth, how you kind of see it playing out in the next few years and maybe kind of the international piece of that as well.

[Nick Grasberger:]

Well, much of that growth that we’re anticipating moving forward is based on initiatives that we’ve undertaken in terms of new innovation, new geographies. I mentioned the metro rail space, which historically we’ve really not been a player, and that’s changing quickly. We also, this year, have seen some pent-up demand in North America. Many of the Class 1s had not been spending on maintenance equipment for some time, so we’re seeing a nice bounce back in our North American business this year. And also, aftermarket and our technology businesses are both growing at a very healthy double-digit rate. And so, our outlook is more linked to initiatives that we’ve taken as opposed to the underlying growth rate in the market.

[Rob Brown:]

Okay. Great. And then lastly, on Air-X, the business improved nicely. What’s sort of the backlog picture there at this point? I know you’re selling it, but what’s the backlog picture there? And then maybe what was sort of the peak revenue in the past in that business?

[Nick Grasberger:]

Well, the backlog is still quite strong year-over-year. It’s declined a little bit quarter-over-quarter as we reached a new point in the cycle, but it’s still close to its record-high backlog, a little bit less. Yes, in terms of peak revenues, I believe they are $25 million to $50 million below kind of previous peak revenues. The margins are above where they were with peak revenues, but yes, I think we’re still about $25 million, $50 million away.

[Rob Brown:]

Okay, great. Thank you, I’ll turn it over.

[Operator:]

Your next question comes from Jeff Hammond of KeyBanc.

[Jeff Hammond:]

Hey, good morning, guys. Congrats on all these moves. It really looks positive for the portfolio. Can you just talk about the timing of the deals for when Air-X closes, when Clean Earth closes, when do you think IKG and Patterson-Kelley would come out?

[Nick Grasberger:]

We expect both transactions, Clean Earth and Air-X-Changers, to close in the next few months. We don’t see any regulatory hurdles, and we see a very clear path to closing in that time frame. In terms of IKG and PK, I think a reasonable estimate of closing those transactions would be late this year or early in 2020.

[Jeff Hammond:]

Okay. And then just on M&M, a little bit softer, I know there’s been some production slowdown. How much of the softness you’ve seen is production-related versus kind of Applied Products and pricing? And then just what gives you confidence given some of the production slowdown that you start to see steel output improve into the second half?

[Nick Grasberger:]

Yes. We really haven’t, Jeff, been all that affected by production slowdowns at our customers. As Pete mentioned, the year-over-year challenge in Q1 for M&M was really linked to currency and SG&A investments. And I think we simply look at our backlogs for the remainder of the year. And our, as you know, existing longer-term contracts, I think, gives us pretty good visibility to the performance over the balance of the year. So, we certainly do expect quarters 2, 3 and 4 on a year-over-year basis to be a good bit better than they were in Q1.

[Jeff Hammond:]

Is the SG&A investment front-end loaded and that steps down into the second half?

[Pete Minan:]

Yes, Jeff, this is Pete. The SG&A investment is to some degree front-end loaded, and more importantly, we’re going to start seeing the benefits from ramp-ups of contracts and other growth that are benefiting from that investment. So, it’s a combination of the two factors. But I should point out that the second half, we anticipate some easing of some of the headwinds we face in terms of currency and commodity prices, which have been, as you saw and as I mentioned earlier, a big component of the year-on-year change for Metals in Q1. So, all those factors together kind of gives us a pretty good feel for our ability to kind of hit the guidance for Metals through the rest of this year.

[Jeff Hammond:]

Okay. Great. And then just a couple of questions on Rail. One, there’s been a lot of discussion about PSR, precision scheduling railroading. Just talk about – and it’s created some consternation on kind of the outlook for other rail companies. But just talk about how that does or does not impact you. And then I think you mentioned the $500 million revenue target, does that include all core growth or does that include some M&A?

[Nick Grasberger:]

Yes. On the first question, Jeff, many of the new products that we’re introducing really address the trends in the rail industry in a very positive way. So, we believe that our product portfolio is shifting in a way that is really in line with what our customers are looking for to address those industry trends. And those products, by the way, as they’ve been introduced in the last quarter or so, have been very well received and certainly are a component of our attractive long-term outlook on the equipment side in Rail.

[Pete Minan:]

With respect to long-term outlook, the $500 million that we mentioned earlier and that we published, that’s all organic, Jeff. That does not anticipate any M&A growth.

[Jeff Hammond:]

Okay. Great. And then just last one. Maybe – I know you had some long-term targets out there and maybe those have changed with the change in complexion of the portfolio, but just talk about as you look forward long term what you think the core growth rate of the new coke could be, where you think ROIC targets could be three years out when you get some of the synergies. That would be helpful.

[Nick Grasberger:]

Yes. Well, first of all, our long-term view on M&M and Rail has not changed. That is consistent with what we discussed recently. We also noted that the underlying growth rates in Clean Earth and in the industrial waste industry are certainly higher than what we see in our businesses in the Industrial segment. So clearly, over time, we would expect organic growth rates to outperform those of what we’re divesting. We also believe that there’s more runway for bolt-on acquisitions or even moderate-size acquisitions in the industrial waste space. So, I think you’re going to see pretty high total growth rates from us in this new segment over time. In terms of ROIC, I kind of hesitate to put a target out there at this point. I think as Pete noted, when these transactions close within a few months, we will update our long-range targets, including that for ROIC.

[Pete Minan:]

The only thing I’d add to that, Jeff, is when you look at the Clean Earth business and compare it to what we’re exiting, I mentioned in my script that it was – it’s a very capital-wide, high-margin business. We’re talking margins that are going to be – the EBITDA margins are going to be mid- to high 20s. So, we’re looking at a profile that has the potential to generate the kinds of ROIC that kind of incrementally would be favorable to what we had published before. Now you got to weigh that against the investment so it’ll take time to get there, but that’s how we’re looking at it.

[Jeff Hammond:]

If I can just sneak one more in, just on Clean Earth around cyclicality. Can you just maybe enhance the discussion on that? What produces the cyclicality of that? If you look at kind of past slowdowns or recessions, how did it perform?

[Nick Grasberger:]

Well, first of all, as we discussed, it’s actually a quite diverse business in terms of the industries that it serves and the different processes that they undertake. And so there’s a tremendous amount of backlog of contaminated material and hazardous waste. So, we believe that even in an economic downturn and this has been demonstrated by Clean Earth over the past few downturns, their volumes have been quite steady, and obviously, over time, they’ve been growing quite nicely. So, I certainly wouldn’t say it’s recession proof, but it’s recession resistant.

[Pete Minan:]

Yes. The only thing I’d add to that, Jeff, is that the business is roughly split between kind of hazardous waste, which is the regulatory and the waste that’s regulatory required to be disposed of in a certain manner. So that really is kind of not cyclical at all. It needs to be dealt with and is pretty consistent regardless of where we are in the cycle. The other half of their business is actually largely tied to long-term infrastructure spend. So, it’s actually, we’re providing the disposal processing for major government-sponsored infrastructure projects, which, again, while not totally immune to the cycle, certainly react much less volatile-y against that. So that’s really what the 2 major drivers for Clean Earth in terms of the cycle.

[Jeff Hammond:]

Okay. Great to hear. Thanks, guys, congrats again.

[Operator:]

Your next question comes from Chris Sakai of Singular Research.

[Chris Sakai:]

I just wanted to ask about – I guess what are some competitors of Clean Earth?

[Nick Grasberger:]

Well, there are a few public companies, US Ecology would be one, Clean Harbors to some degree, Waste Management to a lesser degree. There are a number of medium to smaller-sized privately held businesses that tend to have more regional footprints.

[Chris Sakai:]

Okay. And then does Clean Earth operate outside the U.S.?

[Nick Grasberger:]

It does not.

[Chris Sakai:]

Can you disclose, I guess, in the future, for the rest in 2019 and beyond, will Harsco look to make acquisitions similar to this that operate globally?

[Nick Grasberger:]

That certainly is quite possible. It’s an industry generally that does not cross borders well because of the quite different regulatory issues on a country-by-country basis. But yes, given our global footprint and our Metals & Minerals business operating in 35 countries, we certainly expect over time, whether through acquisition or just expanding organically and leveraging M&M’s footprint, we would expect to have more of a presence managing industrial waste outside the U.S.

[Chris Sakai:]

Okay, thanks.

[Operator:]

Scott Blumenthal of Emerald Advisers has a question.

[Scott Blumenthal:]

Yes, congratulations on the quarter. Thank you for taking my question. Nick, can you talk a little bit about the Clean Earth facilities? I know the press release talked about treating and documenting and recycling. Are they landfills? Are they incinerators? Are they neither?

[Nick Grasberger:]

They are neither. Their processing facilities tend to be a chemical or a physical process to change the nature of the hazardous or contaminated material for it to be reused or ultimately disposed of.

[Scott Blumenthal:]

Okay. And I believe you did mention that it’s a very, very low CapEx business. So, I guess the costs associated with operating the business are the purchase of chemicals and things like that in order to, I guess, do this processing on the materials.

[Nick Grasberger:]

Yes. That’s correct.

[Scott Blumenthal:]

Is there a contractual relationship with many or most of the customers? And then I guess on the other side, you may need relationships with incinerators or landfills. Or am I mistaken there?

[Nick Grasberger:]

No. You’re correct on both cases. The contracts, though, tend not to be as long in duration as you might imagine as they are in the M&M business.

[Scott Blumenthal:]

Okay. Do you have any statistics as to the duration of the contract? Or are we still a little bit too early for that?

[Nick Grasberger:]

I don’t have that at my fingertips, Scott.

[Operator:]

There are no other questions in queue. I’ll turn it back over to Dave Martin for any closing remarks.

[David Martin:]

Thank you for joining us this morning. A replay of this call will be available later today through May 23, and the replay details are included in our earnings release. Also, please contact me with any follow-up questions using the contact details at the top of today’s releases. Again, we appreciate your interest in Harsco and look forward to speaking with you in the future. Have a great day.

[Operator:]

This concludes today’s conference call. You may now disconnect.