Harsco Corporation
Q3 2020 Earnings Call Transcript

Published: 3 Nov 2020

[Operator:]

Good morning. My name is Shelby, and I will be your conference facilitator. At this time, I would like to welcome everyone to the Harsco Corporation Third Quarter Release Conference Call. All lines have been placed on mute to avoid 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. The recordings or we distributions of this telephone conference by any party are permitted without the express written consent of Harsco Corporation. Your participation indicates your agreement.

[Dave Martin:]

Thank you, Shelby. Welcome to everyone joining us this morning, and I hope you’re well. I’m Dave Martin for Harsco. With me today is Nick Grasberger, our Chairman and Chief Executive Officer and Pete Minan, Harsco’s Senior Vice President and Chief Financial Officer. This morning, we will discuss our results for the third quarter and our outlook for Q4, as well as Harsco’s key initiatives. We’ll then take your questions. Before our presentation, however, let me mention a few additional items. First, our quarterly earnings release as well as the slide presentation for the call, are available on our Web site. Second, 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 and 10-Q. 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 as well as the slide presentation. Now I’ll turn the call to Nick.

[Nick Grasberger:]

Thank you, Dave, and good morning, everyone. Thanks for joining us today. The third quarter developed largely as we anticipated on a consolidated basis with our environmental businesses improving sequentially. While our rail business, which did not see a significant impact from COVID through Q2, was affected by weak demand and an unfavorable product mix. Overall, EBITDA was consistent with our expectations while cash flow was better. Revenues in our environmental businesses, which represent more than 80% of total Harsco revenue, were up 15% versus the second quarter. Volumes were up in all waste categories led by hazardous medical waste. Retail and industrial waste volumes were also up by double digits, while steel waste or LST was up high single digits. Revenue was also up in the contaminated materials segment with strength in the dredge business offsetting weakness in our high margin soils business, which has been affected by softness in large non-residential construction projects in the Mid-Atlantic and Northeast regions.

[Pete Minan:]

Well, thanks for the kind words Nick and good morning everybody. So please turn to Slide 4 in our consolidated financial summary for the third quarter. In the third quarter, Harsco's revenues totaled $509 million and adjusted EBITDA totaled $59 million. Our revenues increased 14% over the second quarter of this year, with each of our businesses realizing a nice improvement in revenues from the second quarter when we believe the impacts of the pandemic peaks for most of our end markets. The sequential improvement in revenue ranged from 20% increase at Clean Earth to 9% increase at Harsco Environmental. Our third quarter adjusted EBITDA of $59 million is consistent with our expectations in August and is comparable to our adjusted EBITDA result in Q2, despite the unfavorable timing impact of certain expenditures we discussed on our earnings call last quarter. These incremental items consisting largely of the timing of insurance and compensation related amounts, negatively affected the quarter-on-quarter comps by approximately $10 million. Otherwise, underlying performance improved compared with Q2 as a result of volume growth driven by the ongoing economic recovery and strong underlying operating performance within our businesses, including at ESOL where margins improved considerably as our integration and operational improvement actions began to take hold. And as you may recall, Q3 was our first full quarter of owning ESOL after we acquired it in April. Relative to our expectations at the beginning of the quarter, our results were aided by better top line and margin performance in Harsco Environmental and lower corporate spending as a result of our ongoing focus on managing costs. Our EBITDA in the third quarter of 2019 totaled $87 million. The change year-on-year clearly reflects the ongoing impact of the pandemic on end market demand, as well as the fact that the prior year quarter was particularly strong due to a favorable mix in both Rail and the Clean Earth. Harsco’s adjusted earnings per share from continuing operations for the third quarter was $0.08. And lastly, our free cash flow totaled $18 million in Q3, a strong performance considering that this figure is net of approximately $14 million of cash related outflows that we had deferred from the second quarter. This figure compares with free cash flow of $5 million in the third quarter of 2019. And year-to-date, our free cash flow is now $10 million positive, significantly improved from 2019. Capital spending discipline and improved working capital performance have been the main drivers of the improvement this year, and should continue to be so for the foreseeable future. Generating positive free cash flow is clearly an important focus for us and we expect to generate positive free cash flow in Q4 as well.

[Operator:]

First question comes from Larry Solow of CJS Securities.

[Larry Solow:]

Maybe just on the environmental piece. Can you maybe discuss sort of sequentially through the quarter what your customers see in terms of production, utilization and obviously it remains down, but does it still continue to steadily improve? And how about -- I mean on the cost side, do you have any more anticipated cost cutting measures or other offsetting things to offset some of this impact?

[Nick Grasberger:]

So overall, I think we did see a fairly steady improvement in production levels at our steel companies really around the world, some regions, of course stronger than others. Capacity utilization, which was down around 60%, earlier in the year, I think is probably up around 70% or so at this point. And that was a bit better than we anticipated in the third quarter. We don't expect that type of lift, that magnitude in Q4 but nonetheless, a continued improvement. In terms of cost reduction, Larry, we do actually in environmental expect to continue to take out costs. And we'll be talking about that more as we provide full guidance for 2021. But we believe there's further opportunity, both in terms of at the site cost as well as SG&A.

[Larry Solow:]

And then just switching gears real quick on the rail side, I know directionally not a surprise in terms of where the impact is coming from on North American side, just a little bit surprised on the magnitude or less improvement year-over-year, with the SCOR program advancing and seemingly international piece of the business remaining pretty much intact. So I'm just trying to -- it sounds like we're not going to get much improvement in Q4. So is the drag on that, is it purely North American side, or have some of the deliveries that were scheduled in the back half of this year on the international side also been delayed a little bit?

[Nick Grasberger:]

Yes. It's both, Larry. Clearly, the core US market is down for our higher-margin equipment and also some of the shorter-cycle aftermarket type opportunities. But we've been tracking and assuming throughout the year that some high-margin technology transactions would take place outside the U.S. and this looking as though those will be deferred into 2021. With respect to SCOR, I think the big negative impact from a manufacturing standpoint, last year was in Q4. And we certainly expect to see in Q4 an EBITDA on a level consistent with Q3 and much above Q4 of last year.

[Larry Solow:]

And then just switching gears real quick. Just on the ESOL. It sounds like on Clean Earth, ESOL, it sounds like maybe a little bit, at least from my expectations, maybe integration a little bit faster than expected. Just to confirm, did you say that actually we are above the pre-pandemic level. So in other words, we're sort of pacing, I don't know, $10 million a quarter in EBITDA, $9, $10 million a quarter, is that correct already on ESOL?

[Nick Grasberger:]

Yes, that's correct. I mean that's the run rate. We're actually doing better than the pre COVID levels at the EBITDA level, and that's the appropriate run rate there, Larry.

[Operator:]

Your next question is from Jeff Hammond of KeyBanc.

[Jeff Hammond:]

So just on Clean Earth, I think you said you ESOL was $130 million in revenue contribution. Is that right?

[Nick Grasberger:]

Yes, that's correct.

[Jeff Hammond:]

So if I look at the base business, it looks like it was still down like mid-20s, the base Clean Earth. I'm just wondering what the big drags are? Is it simply the soil business? Or what's going on with the hazardous side of Clean Earth?

[Pete Minan:]

Well, it's a combination of both. By far, the biggest piece is the soil business, Jeff, and it's related to the construction starts and delays that we experienced from the pandemic. But certainly, to some degree, the haz waste business, which is largely equivalent to the ESOL manufacturing and industrial businesses had felt, particularly during the second quarter, the headwinds associated with the pandemic.

[Jeff Hammond:]

And then what's the trend in the Clean Earth hazardous business kind of into fourth quarter?

[Pete Minan:]

Trending upward, just consistent with the rest of the ESOL business and all lines of businesses are trending steadily upward from where they were in Q2. This soil business, albeit much slower, but the haz waste business more robust, more pronounced.

[Jeff Hammond:]

So as we kind of frame 4Q, it seems like Environmental gets a little bit better sequentially. You're kind of flattish on EBITDA for Rail? And then how should we think about Clean Earth sequentially?

[Pete Minan:]

Should be modestly better as well. The combined Clean Earth ESOL businesses will be modestly improving in Q4 versus Q3.

[Jeff Hammond:]

And so just back on the Rail margins, it sounds like you're happy with the SCOR progress. It's just more a parts and service mix issue in the near term?

[Nick Grasberger:]

I mean, clearly, as I highlighted in my remarks that the follow-on to the SCOR program will be building that lean operating model that will serve to sustain the improvements made in the SCOR program. And that's where, in my view, the Rail business operationally has fallen down in the past, where we've made improvements, but they've not been sustained. So I think we're very happy with the SCOR program. But at this point, shifting our focus more to how best to sustain those improvements that we've made.

[Operator:]

Your next question is from Rob Brown of Lake Street Capital.

[Rob Brown:]

First question is on the Rail business. I think you talked about aftermarket being a little weaker. How does that business perform typically in downturns. Does that shut off kind of quickly and then turn on quickly? Or what have you seen in the past about how quickly that can come back?

[Nick Grasberger:]

Yes. Certainly not to the extent that the equipment business does. The aftermarket challenge now is actually, I'll say, somewhat less than it is in our technology business, which is another short-cycle segment within the Rail business and tends to be quite high-margin as well. So while aftermarket is a bit softer, the change relative to previous expectations has really been the pushout of some of these higher-margin technology projects that we expected in Q3 and Q4.

[Rob Brown:]

And then on the ESOL business, you talked about kind of tracking -- you're starting on your early in your journey, but tracking to that 2x the margin in a few years. Could you just summarize again kind of what you think that margin can get to in the, I guess, overall Clean Earth business? And kind of what are the -- how does that ramp? Is it sort of an even ramp? Or is it in the back-end loaded in terms of seeing results from these efforts?

[Pete Minan:]

Yes. I think we're going to see a fairly accelerated rate in terms of margin improvements. I mean, we were very pleased with the results this quarter just in one quarter's worth of activities in terms of the margin lift. But we expect to see that continue on through 2021. And when we talk about doubling the EBITDA in the three years, we're really talking about getting to that run rate by the end of the second year, which would imply margins 300, 400 basis points higher than what we've experienced this year.

[Operator:]

Your next question is from Chris Howe of Barrington Research.

[Chris Howe:]

Most of my questions have been taken here, but just following up on some of the comments regarding the ESOL integration. Things are going very well to plan, ahead of plan. As we look at the performance to date, what is attributable to perhaps a pull forward of expectations versus an acceleration? You mentioned an accelerating rate of margin improvement here. What specifically is tracking ahead of plan in regard to this integration?

[Nick Grasberger:]

Yes. I think it's both an acceleration as well as, as we've commented on before, a view that the opportunities might be somewhat greater than we felt originally. What we've seen thus far is probably more of an acceleration. But I think as we look out for the next 2 or 3 years, our expectation on the benefits of the transaction, if anything, improved.

[Chris Howe:]

It seems that at the time of the ESOL acquisition, there were some concerns over some of the different parts of the business in regard to cyclicality, but it's held up well in this environment, tracking ahead of plan. As we look outside of that to the legacy business, which has been more impacted by this pandemic environment, how do you anticipate that mix being sustained? Who knows with this virus. But as we look into the early part of next year, how this could change eventually to your benefits as we move into the latter part of fiscal year '21.

[Nick Grasberger:]

I think as Pete commented, the portion of the legacy Clean Earth business that is really most concerning now is the soils or contaminated materials business, which includes dredging. Dredging is improving at a pretty fast pace. Those projects have been approved. And I think the backlog there for us is very attractive. But much less so on the soil side. And we have a kind of a baseload of volume that we process in each plant. But above that, we typically see good volumes from large non-res kind of infrastructure projects in our core markets of Mid-Atlantic and Northeast. And those generally are publicly funded, and many of those have just been put on hold. And so that's, that's been the most concerning component of the Clean Earth business. But we would expect those to come back online, moving into 2021.

[Chris Howe:]

Understanding now that the priorities, debt reduction, maintaining your cash flow generation levels. As we look in the Clean Earth markets, anything there as far as the fragmentation within the market that could be a near-term opportunity, understanding capital allocation and priorities are the utmost importance now. But is there anything on the M&A side where you can pick up a little tuck-in here in this kind of environment that's impacting the legacy Clean Earth?

[Nick Grasberger:]

Well, certainly, one of the many factors that attracted us to the hazardous waste segment and the purchase of Clean Earth and ESOL was the fragmentation in the market and the opportunity to continue to scale a platform to some size over time, certainly well over $1 billion. And that's still very much our intent. We think it's the availability of such businesses will be there when we're ready. But again, if you look at our capital allocation priorities, and I think the need to see some of these markets bounce back. I think it's unlikely in 2021 that we would execute anything of size. Could there be a tuck-in or 2 that might be attractive and actionable? Perhaps. But I think generally, our mindset is 2021 is another year of executing on the internal programs. And reducing debt.

[Operator:]

Your final question is from Michael Hoffman of Stifel.

[Michael Hoffman:]

Nick, Pete, Dave, I hope everybody is well. Nice leverage for the -- based on the EBITDA you've given us, how do you -- how would you frame what your leverage would land if we're at the midpoint of your EBITDA, by inference, you basically have given us of FY '20 because it just picked the first 9 months and had the fourth quarter?

[Pete Minan:]

We'll be about the same level we are at the end of this Q3, Michael, which is about 4.5x. I think we've talked about that just because -- well below the covenants, right. But the expectation is to move that steadily downward, as you know, over the next years, right.

[Michael Hoffman:]

And then, Nick, one of your strategic objectives in the steel side is to eventually wean your business from the logistics revenues, and with a variety of strategies approaching that. How is that progressing as far as your efforts to engage both your customer and potential outsourcing of that work?

[Nick Grasberger:]

Well, I think we're still very early in that, Michael. It's difficult to execute on individual contracts in advance of them -- in advance of the renewal process. So it's -- but it's early. I think the most important accomplishments on that front is the changing mindset amongst our leaders in that business and the commitment to the business generating a cash flow margin every year that is much more akin to a true environmental business. That's the focus. And there are different paths to get there. One of them is what you mentioned, shifting our focus over time more to the less capital intensive, truly environmental services for our steel customers.

[Michael Hoffman:]

So if I followed up on that, what do you think that target margin, say, as a percentage of revenue should be?

[Nick Grasberger:]

Well, so today, it's about 70% environmental, 30% not environmental. I think our long-range plan would get that to 85% or 90% in the next few years.

[Michael Hoffman:]

And then regarding steel, in 2Q, you thought the year ex-China would be down about 12%, 15%. Do we still think that, that's sort of a path?

[Nick Grasberger:]

It's about right. I think it's down about 10%.

[Pete Minan:]

Yes. A little less than what we thought about at that time, Michael. It's probably 10% to 12%.

[Michael Hoffman:]

So clearly, the environment is being held by the return of auto production and some global level of construction activity and what have you.

[Nick Grasberger:]

Right.

[Michael Hoffman:]

And on Clean Earth, if I take soils out and I get that you need these infrastructure projects to start back up. But if I take soils out of this conversation and focus on industrial waste, hazardous waste, both the retail medical side as well as the industrial side. Does the plan, as you've laid out your EBITDA, suggest you're back to -- I'm saying this very badly. Would 4Qx soils be back to pre-COVID levels of activity given the level of improvement in industrial production that's going on in the economy?

[Pete Minan:]

Yes, not quite, Michael. It's certainly working towards that, but we're not quite there in Q4. I think it's going to -- we won't see that probably until maybe the end of the first quarter in '21 or second quarter.

[Michael Hoffman:]

And then your free cash flow year-to-date of the segments is about $80 million, but the guidance -- or the year-to-date actual report is about $10 million. So I'm looking at about $70 million of corporate is the sort of cash spend and curious about sort of opportunities to improve that number?

[Pete Minan:]

Well, it's interest in taxes, of course, and corporate costs. But we're looking at all opportunities. In fact, we have some opportunities that we're looking now in terms of pension payments that we have the opportunity to defer into future periods. So there's a number of things that we're pursuing to help with that, Michael.

[Michael Hoffman:]

And then lastly, on the soil side. So some of the things like the ABI data are starting to improve, which suggests that non-res construction may have found a floor is -- are you getting any sense of that even from your customers from a standpoint of at least talking about the possibilities of schedules?

[Nick Grasberger:]

Yes, I think so. I think that's absolutely the case, Michael, that the worst is behind us here and that the restart of some of those projects is just around the corner.

[Operator:]

There are no further questions in queue. Mr. Martin, do you have any closing remarks?

[Dave Martin:]

Thanks, Shelby, and thank you for everyone for joining this call. Feel free to contact me with any follow-up questions that you may have using the contact details provided at the top of today's earnings release. And lastly, again, we appreciate your interest in Harsco and look forward to speaking with you in the future. Have a great day.

[Operator:]

Ladies and gentlemen, this concludes today's conference call. Thank you for your participation. You may now disconnect.