Harsco Corporation
Q1 2018 Earnings Call Transcript

Published: 3 May 2018

[Operator:]

Good morning. My name is Tasha and I'll be your conference facilitator. At this time, I would like to welcome everyone to the Harsco Corporation First 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. 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. I would now like to introduce Mr. Dave Martin of Harsco. Mr. Martin, you may begin your call.

[David S. Martin:]

Thank you, Tasha, and welcome to everyone joining us this morning. I'm Dave Martin, Director of Investor Relations for Harsco. With me today is Nick Grasberger, our President 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 first quarter of 2018 and our updated outlook for the year. We'll then take your questions. Before our presentation, however, let me cover a few administrative items. First, the PDF of our quarterly earnings release as well as a slide presentation for this call have been posted to our website. 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 these 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 statements. Fourth, on this call, we will refer to adjusted financial results that are considered non-GAAP for SEC reporting purposes. A reconciliation to U.S. GAAP results is included in our earnings release as well as the slide presentation. And lastly, note that all prior year operating figures are now restated to reflect the new pension accounting standard. The quarterly impact of these changes for 2017 can be found in the appendix of our earnings release. Now, I'll turn the call over to Nick to begin his remarks.

[F. Nicholas Grasberger:]

Thank you, Dave. Good morning, everyone, and thank you for joining us. Let me start by saying that I am, once again, quite pleased with Harsco's continued strong performance, especially in our Metals & Minerals and Industrial segments. Our positive momentum began two years ago and we fully expect this trend to continue. In fact, we are raising our outlook for the balance of 2018 based on supportive end markets and disciplined execution of our growth and productivity programs. We are also initiating a share repurchase program, the first such program in many years, reflecting the confidence in our outlook and the health of our balance sheet. While we are committed to making investments to grow our business, we believe this should be balanced against returning capital to shareholders when appropriate. I'll make a few brief comments on each segment. M&M delivered yet another strong quarter and we are confident the opportunity for growth has never been greater. The opportunities will continue to be sourced from three areas

[Peter Francis Minan:]

Thanks, Nick, and good morning, everybody. So let me start off on slide 4. Our operating income in the first quarter was $37 million, which exceeded our guidance range for the quarter of $30 million to $35 million. Our Industrial segment was the largest contributor to our better quarterly result. Demand for our heat exchangers continues to accelerate and we benefited from sales mix in this business during the quarter as well. As Nick mentioned, our industrial grating business, IKG, and commercial boiler business, Patterson-Kelley, also had better quarters. In the case of IKG, we benefited from timing related to the acceleration of some customer orders in anticipation of higher product prices. The Metals segment also performed better than anticipated. Higher services demand and commodity prices, along with strong site-level execution, helped us in a few regions including North America, Latin America, and China. Also, our corporate spending was somewhat lower than we forecasted due to the timing of some spending for professional services. Revenues in the first quarter totaled $408 million, an increase of 10% compared with the prior-year quarter. Our growth was led by the Industrial segment where sales increased an impressive 27% and sales in each of our Industrial businesses rose year-on-year. This top-line growth led Harsco to a 28% increase in operating income. Our operating income of $37 million, compared with $29 million in the first quarter of 2017 and again the Industrial and M&M segments, along with lower corporate spending, accounted for this improvement compared with the last year. There were no adjustments for unusual items in either quarter. Diluted earnings per share was $0.22, which was above our guidance range of $0.16 to $0.21. This earnings per share outcome also compares to earnings per share of $0.11 in the first quarter of 2017. And this comparison is helped by a $2 million decrease in interest costs and a lower effective tax rate which was 29% in the first quarter of this year versus 37% in the prior year. Free cash flow was negative in the quarter as expected, traditionally, the case in the March quarter. The change in our cash flows versus the prior year can largely be attributed to higher capital spending including capital expending for growth. Our growth-related CapEx totaled roughly $8 million in the quarter. And as indicated in our updated guidance for the year, we expect that our free cash flow will improve meaningfully for the remainder of the year. Let's move over to slide 5. In the first quarter, revenues in the Metals segment increased 7% and our operating income increased to $28 million from $26 million. This earnings increase is attributable to higher steel output, services demand, new sites and foreign exchange benefits. Steel output or LST at customer sites rose approximately 2% in the quarter. And these positives were then partially offset by growth-related investments which totaled more than $2 million in the quarter. The other offset were lower nickel volumes – sorry, lower volumes at our nickel or stainless steel-related sites which resulted from production schedule changes by our customers mainly in the United States and which have been anticipated. Lastly on Metals, free cash flow for the quarter was a net usage of $7 million. This reflects higher capital spending and some working capital investments which we had expected. Our focus on cash generation is unchanged. And for the balance of the year, as I said earlier, our cash flows in M&M should improve meaningfully as was the case in 2017. Turning to Industrial on slide 6. As mentioned earlier, revenues increased 27% for the Industrial segment versus the comparable period in 2017. This $18 million increase in sales translated to a $9 million increase in operating income, which totaled $12 million in the quarter. Also, our segment operating income margin increased to nearly 15% from 4% in the prior-year period. These changes are the result of higher volumes, manufacturing improvements and a more favorable product mix in the quarter. The manufacturing and efficiency improvements are most directly linked to our Air-X-Changer operations where we are now reaping the benefits of our facility consolidation project, other continuous improvement initiatives, and a continued push for more automation. Also, the momentum in this segment was evident from our customer activity in the quarter. Segment bookings increased nearly 40% quarter-on-quarter and more than 30% year-on-year. As a result, backlogs across our Industrial businesses now exceed $100 million and are 50% higher than a year ago and at levels last seen in early 2015. Most of the order booked in backlog improvements can be attributed to Air-X-Changers where backlogs at the end of the quarter were essentially double our backlogs at the end of the first quarter in 2017. Turning to the Rail segment on slide 7. Revenues in the first quarter were essentially unchanged from the prior-year quarter. Meanwhile, operating income totaled $2 million versus $6 million in Q1 2017. This change resulted primarily from a less favorable equipment mix, lower services contributions and innovation investments which have been expected. These factors fully offset the positive impacts realized in the quarter from our higher contributions from aftermarket parts and continued growth from our safety and diagnostic products. Again, as mentioned earlier, these results in Rail were substantially consistent with our expectations for the quarter, and we anticipate improved results in this segment as the year progresses. Lastly, free cash flow in Rail improved roughly $9 million versus the prior year quarter due to working capital changes. So turning to our updated 2018 outlook on slide 8. Here, let me highlight a few things. First, our full year operating income guidance has increased to a range of $165 million to $180 million. This compares to $150 million to $170 million previously. Likewise, our forecasted earnings per share now will be between $1.11 and $1.24 per share as compared to a prior range of $0.97 to $1.14. These outlook changes are being driven by our Metals and Industrial segments roughly in equal proportions. Our underlying confidence in the demand for mill services and our expectations regarding mix are improved in M&M. Very little of the Metals outlook change can be attributed to recent trade policy actions and discussions in the United States and elsewhere. Also, our assumptions for commodity prices have also increased modestly and foreign exchange is a slight positive versus our original guidance for the year. We are clearly pleased with the momentum within Metals & Minerals. We're pursuing a pipeline of potential growth investments, and we continue to make P&L investments in commercial and innovation linked to our growth strategy. In Industrial, our expectations for each of the underlying businesses have improved although our projections for Air-X-Changers, as you would expect, have increased more than the others. Our sales of heat exchangers are now expected to grow more than 30% for the year. Our outlook for Rail and corporate costs are unchanged. Finally, we don't expect any material impact within our manufacturing businesses from commodity price or input cost inflation. The low end of our free cash flow guidance has increased $5 million, with our capital spending outlook changed. A summary outlook for each of our business units is included in the presentation appendix. And lastly, before I discuss guidance for Q2, let me comment briefly on our other announcement this morning. We are pleased that Harsco's Board authorized the implementation of a $75 million share repurchase program. Our share buyback activity has been very limited during the past few years, and as Nick said, this decision is a positive reflection on our strong balance sheet and our confidence in the business. We plan to be prudent with any repurchase activity and it's important to note that this will not impact our growth plans. Let me conclude with some comments on the second quarter on slide 9. In Q2, we expect operating income to be between $45 million and $50 million as compared to operating income of $43 million in the second quarter of 2017. Also, diluted earnings per share is projected to be between $0.30 and $0.35 as compared with $0.22 in the prior-year quarter. As was the case in the first quarter, the improvement in our financial results year-over-year is projected to be driven by both the Metals and Industrial segments. We expect M&M to benefit from higher service levels and commodities, as well as new contracts. And Industrial results should strengthen from prior-year quarter due to improved demand and a more favorable product mix real. Rail earnings are likely to decline somewhat and corporate costs should be modestly above the year ago period. So that concludes our prepared remarks. And at this point, we'd be happy to take your questions.

[Operator:]

Our first question comes from the line of Jeff Hammond from KeyBanc Capital Markets. Your line is open.

[Jeffrey D. Hammond:]

Hey, good morning, guys.

[F. Nicholas Grasberger:]

Hi, Jeff.

[Jeffrey D. Hammond:]

Hey. So, just on M&M, can you talk – it seems like you have a little more confidence on a go-forward basis in incremental margins. So, can you just talk about that and maybe just speak within that to what you're expecting for Applied Products in the out quarters? Thanks.

[F. Nicholas Grasberger:]

So, in general within M&M, I think the confidence stems from, first of all, what we've accomplished the last couple of years in terms of stabilizing the business and improving its underlying core processes, in large part, how we allocate capital. So you've seen the core metrics around the contracts increased and improved significantly. If you look at the – as we look at the pipeline of new opportunities and we've said the last few quarters that that pipeline is for some time not been as robust as it is now, we think we'll continue to see on the growth, those strong metrics that we see on the existing contracts. So a lot of confidence there also, of course, on existing sites, the ability to add on new services and provide more support around transitioning their waste streams to value. All those things, I think, together, really speak to the opportunity and the confidence that we have in M&M. In terms of Applied Products growth, certainly we expect that to be higher than that in the core services business. Pete, if you have specific figure for the full year on Applied Products?

[Peter Francis Minan:]

No, not broken down specifically but Jeff, I can at least comment a little bit on the margins expectations. So we expect margins to grow in Metals year-on-year, and that's despite the investments that we've been talking about, the P&L related investments that we're making in commercial innovation and all the other things that are linked to our growth strategy. And a good chunk of that, if not most of it, is going to be driven by new contract and contract turnover. As we've talked about before, we expect new revenues from contract changes to be roughly additive by $20 million to $25 million, but the operating income margin associated with that, we're expecting to be in excess of $10 million. So that's part of the reason why we see the margin increase. Plus, as Nick mentioned, the growth in some of these applied products businesses which have, as you know, a better margin portfolio than some of the traditional mill services are expected to increase as well.

[Jeffrey D. Hammond:]

Okay. Great. And then on Rail, it looks like the margin cadence -the margins were weaker and you're anticipating that and still a lot of confidence that op income is up slightly. Can you just walk through any more color you have on margin cadence in Rail into the out quarters and anything we should be aware of on SBB timing that would impact that?

[Peter Francis Minan:]

Well, as you know, a big drag on the margins is the revenue associated with SBB, Jeff, and we're anticipating there to be about $30 million of revenue in 2018 associated with SBB with a zero margin. We had $8 million in this quarter. We may even have a little more than that under the new standard. So that's the biggest draw. Now the offsetting factors to that would be of course, the increase in aftermarket parts, which have a better margin profile. But it's a real big indicator in what's probably going to be driving most of the changes is equipment mix and that's really comparing the nature of what we sold last year compared to this year is going to be a big component of the change. But all in all, I think we expect margins to be, by and large, consistent for the full year in Rail from what we experienced in 2017.

[Jeffrey D. Hammond:]

Okay. Great. And then, just final one. A lot of discussion on other calls about price cost and supply chain issues as things strengthen. Can you maybe just speak to what you're seeing there if anything? It doesn't seem to be showing up in incrementals but in the manufacturing businesses, and then I'll jump back in queue. Thanks.

[Peter Francis Minan:]

So, as I mentioned in my remarks, we're not seeing any material impact from the supply and the input cost inflation, Jeff. It's just not noticeable to us. If anything, we experienced a little bit of acceleration in some sales in our grading business as we saw that some customers were looking to purchase things in anticipation of what they thought would be price increases in the outer period. But overall, very, very immaterial.

[Jeffrey D. Hammond:]

Okay. Thanks, guys.

[Operator:]

Our next question comes from the line of Rob Brown from Lake Street Capital. Your line is open.

[Rob Brown:]

Good morning.

[F. Nicholas Grasberger:]

Hello, Rob.

[Peter Francis Minan:]

Hey, Rob.

[Rob Brown:]

Just on the Industrial business, can you give us a sense of what your capacity utilization is at this point? And then, I guess, generally you talked about the market growth but are those trends continuing into this year and into next year? Just sort of an outlook on how the market is developing.

[F. Nicholas Grasberger:]

I think, in terms of the capacity utilization, and I'll comment just primarily on the Air-X-Changer business. You'll recall that we added significant capacity a few years ago when we consolidated into a much larger facility in Tulsa. So I would estimate now we're kind of at 60%, 60% to 70% of capacity in that business. So we certainly believe we can go well beyond the peak volume of 2014 and 2015 in this new facility. And just a related comment, if you look at the margins in the Air-X-Changer business now, they are well above where they were the previous peak. And in fact, the operating income is above where it was in 2014 and 2015 despite the fact that volume is still only two-thirds to three quarters of what it was. And the outlook continues to be positive. As you know, that's – the lead times are kind of three to six months, so we have good visibility there on the rest of the year. And that really underlies our strong outlook for the Air-X-Changer business.

[Peter Francis Minan:]

Rob, we've got backlog now, as I mentioned in my comments, that are very, very high. We're looking at backlogs in the Air-X-Changer business as $90 million. We're talking six months backlogs. We have really good visibility for the rest of the year. Our bookings continue to accelerate. So we feel pretty confident about the business for Industrial broadly, but Air-X-Changers in particular for the rest of the year.

[Rob Brown:]

Okay. Good. That's a great color. And then, in the M&M business, what nickel price are you modeling into your forecast?

[Peter Francis Minan:]

Yeah. Right now, it's about $6 per pound, which is slightly less than what it is today. But as you've seen, the volatility over the last couple of months certainly seems to center around that $6 per pound number.

[Rob Brown:]

Okay. Good. And then just more of a broader question on the trade impact and some of the tariff discussions, but how's the M&M business impacted by sort of activity in the tariff and trade discussions?

[F. Nicholas Grasberger:]

Our estimate is that it should be a modest net positive, about 25% of the M&M business in North America. Of course, the tariffs and the quotas would support the U.S. steel industry, and therefore, our customers here in the U.S. But we are, as you know, leveraged to the volume not price and even a 1% or so increase in volume globally is about $2 million of operating income and North America is 25% of that. We don't, actually – outside North America, most of our customers do not export to the U.S. So we don't see a negative impact there. So I would say a modest net-net positive.

[Rob Brown:]

Great. Thank you. I'll turn it over.

[Operator:]

There are no further questions at this time. I'd like to turn the call back over to Mr. Martin.

[David S. Martin:]

Thank you for joining us today. A replay of this call will be available later today through May 23 on our website. Also, if you have any follow up questions, please contact me using the contact details provided at the top of our earnings release. Again, we appreciate your interest in Harsco and we look forward to speaking with you in a few months. Have a great day.

[Operator:]

This concludes today's conference. You may now disconnect.