Harsco Corporation
Q1 2017 Earnings Call Transcript

Published: 3 May 2017

[Operator:]

Good morning. My name is Samuel, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Harsco Corporation First Quarter Earnings 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 teleconference 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 express written consent of Harsco Corporation. Your participation indicates your agreement. Thank you. Now, I would like to turn the call over to Mr. Dave Martin of Harsco Corporation. Mr. Martin, please go ahead.

[David S. Martin:]

Thank you, Samuel, and welcome to everyone joining us this morning. I am Dave Martin, Director of Investor Relations for Harsco. With me today is Nick Grasberger, our President and Chief Executive Officer; as well as Pete Minan, our Senior Vice President and CFO. This morning, we will discuss our results for the first quarter of 2017, and our outlook for the year. Before our presentation, however, let me take care of a few administrative items. First, a PDF of our earnings release, as well as a slide presentation for this call have been posted to the IR section of our website. Secondly, this call is being recorded and webcast. The replay will be available on our website later this afternoon. Next, 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. Lastly, 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 today as well as the slide presentation. Now, I'll turn the call over to Nick.

[F. Nicholas Grasberger:]

Good morning, everyone thanks for joining us. As noted in our press release, first quarter results were quite strong across the portfolio and we have boosted the full-year outlook for Harsco's financial performance. The combination of supportive markets and solid execution of internal initiatives drove the results in Q1 and we largely expect these trends to continue. Consistent with the past several quarters, Metals & Minerals is leading the way as adjusted profits more than doubled compared to Q1 of last year. M&M is performing ahead of expectations due to higher volumes, improved operational efficiency and contributions from new sites and add-on services at existing sites. We're very pleased with the pipeline of growth opportunity – opportunities as it continues to build beyond levels seen in recent years. We now expect to sign more new contracts over the next year or so than anticipated a few months ago and we've correspondingly increased our capital budget for growth projects. Adjusted full-year profit and M&M should now be up 10% to 15% versus last year, which improved about 40% from 2015. The performance of our Industrial segment was also somewhat better than expected. Although results still lag behind those of last year. Improving demand in the upstream energy and non-residential construction markets is lifting our Air-X-Changer and commercial boiler businesses, while easing competitive tensions are a welcome development in our grating business. So we now expect our Industrial businesses to perform somewhat better for the full year and the segment should resume year-over-year earnings growth and double-digit profit margins this quarter. Earnings in the Rail segment were bit ahead of expectations, largely due to the timing and the outlook for the business is unchanged from our previous view. Although, Rail traffic is beginning to grow again, the capital spending of our major customers for maintenance-of-way equipment will below – will remain below a year-ago levels. Our outlook does assume that we will continue to gain traction with our shorter cycle after market and safety oriented products that should produce double-digit revenue growth this year. So overall, we are very optimistic about the future of each of our segments. The transformation of our M&M business has produced a meaningful and sustainable improvement in our profit margins, cash flow and return on capital and has provided a foundation for future growth as evidenced by our visibility to several new contracts that should yield good returns. And our investments in expanding our Applied Products business to meet the increasing environmental needs of our customers is also yielding results. We expect to make further investments in our product capabilities to provide a better balance against a more capital intensive mill services business. In a similar manner, the future of our Industrial segment is bright due to recovering markets and investments made in both new products and manufacturing efficiency over the past few years. And the signs of recovery in our Rail business are also evident and I'm confident the new management team will produce results in Rail similar to those we have realized in M&M. Finally, a word about our prior announcement to separate M&M from our other businesses. After much consideration and in light of our optimism for future growth and performance, the Board and I have concluded that such a separation is not in the best interest of our shareholders for the foreseeable future. The management team will continue to focus on creating value in each of our businesses, while actively pursuing opportunities to optimize our portfolio. We spent over two years executing a broad based restructuring, navigating very weak end-markets and providing intense focus to cash flow in the balance sheet, while also upgrading our talent and changing our culture. It's now time to leverage all we have accomplished and redefine Harsco as a growth oriented business that generates attractive returns on its invested capital. I'll now turn the call over to Pete.

[Peter Francis Minan:]

So thanks, Nick, and good morning, everyone. So let me start with slide 4. Reported operating income in the first quarter was $28 million, which was above our guidance range of $15 million to $20 million. Each operating segment contributed to the better quarter and as Nick just said Metals & Minerals was the largest contributor and it certainly had a very strong first quarter again reporting double-digit margins. Each of our regions helped versus earlier expectations. The drivers included better steel output and service levels, higher scrap volumes and better metallics pricing. The Rail segment primarily benefited from the acceleration of some shipments and product mix which were supported by the outstanding performance of our Rail operations team. And in Industrial, results were held by stronger demand for heat exchangers as a result of energy market developments and higher grating sales and margins. Compared to the 2016 quarter, our adjusted operating income increased 57%, adjusted operating income in Metals more than doubled as did its operating margin. And this was the first quarter in some time that M&M experienced a meaningful uplift from the external market. Rail's operating income also increased modestly compared with prior year, mainly as a result of higher aftermarket sales. And these positives were only partially offset by lower earnings in Industrial and higher Corporate spending, both of which were anticipated. Harsco's reported diluted earnings per share was $0.11 in the first quarter versus our previous guidance range of between $0.01 loss and earnings per share of $0.04. There are no unusual items in the quarter and this EPS figure compares with a GAAP loss of $0.13 per share and an adjusted earnings per share of $0.03 in the first quarter of 2016. Free cash flow was negative in the quarter as expected and as is traditionally the case in the March quarter. The slight change in our cash flows versus the prior year can mainly be attributed to working capital. We do expect that our free cash flow will improve meaningfully for the remainder of the year. So, let me move to slide 5. In the first quarter, Metals & Minerals generated operating income of $26 million. This represents an increase of $14 million compared with adjusted operating income in the prior year quarter. During the quarter, higher steel production and services and increased profitability of our nickel related or stainless steel sites, led to the year-over-year improvement in earnings. The net impact of new and exited sites was a small positive. We also benefited from lower operating costs. You can see that the year-over-year bridge shows only a modest cost benefit, however, I note that this total is impacted by some offsetting items including the timing of stock-based compensation which exceeded more than $1 million. Customer LSTs increased 11% year-over-year in absolute terms, and increased 8% on a continuing site basis. These changes were a bit better than we've forecasted at the beginning of the year. Now regarding our nickel sites, volumes increased roughly 20% at these sites. Nickel prices increased a similar percentage and we also benefited from a rising chrome and iron prices given the composition of the slag in end product at these locations. Lastly on Metals, free cash flow for the quarter was $10 million, which declined from the prior year quarter as expected. As you know we started a meaningful working capital initiative in M&M at the beginning of 2016. These actions led to some catch-up benefits early last year that were not repeatable this year. Our attention to cash generation has not changed and importantly, we continue to anticipate that M&M will generate a significant amount of cash in 2017. So, turning to Industrial on slide 6. Revenues increased modestly as higher heat exchanger demand was partially offset by lower IKG grading sales. Meanwhile, operating income was $3 million in the first quarter compared with $6 million in the first quarter of 2016. This change can be attributed to a less favorable mix of heat exchangers and the metal cost and competitive pressures we've previously discussed at IKG. Also we experienced an increase in medical costs in the first quarter of this year, which we expect to ease in the coming quarters. Our Industrial results overall were certainly modest relative to historical performance. But, we are incrementally much more positive about where this business and its end markets are heading. As we said before, our energy-linked business likely touched bottom about a year ago and the improvements in capital spending within the U.S. energy market will benefit our Industrial businesses as the year progresses. Our first quarter bookings improved meaningfully versus the fourth quarter and as a result, Industrial backlogs grew more than 30% sequentially. Much of this change is attributable to our heat exchanger business, where the upstream energy demand has increased markedly. In total, our bookings grew year-over-year for the first time in a while and total bookings in the first quarter this year were the highest since late 2014. So, let's talk about Rail on slide 7. Operating income in Rail increased slightly to $6 million from $5 million in the preceding year quarter and its margin rose to 10% in the most recent quarter. These increases were largely the result of a higher proportion of aftermarket sales. Also, as we've discussed in the past, our results continue to be negatively impacted by weak demand for maintenance-of-way or MOW equipment in the domestic market. And these conditions will likely persist for a few more quarters. However, we are encouraged by recent Rail traffic trends and signs of the excess inventory of MOW equipment within the supply chain has started to decline in recent months. Lastly, on our SBB, switch rail (13

[Operator:]

And your first question comes from the line of Rob Brown from Lake Street Capital.

[Robert Brown:]

Good morning.

[F. Nicholas Grasberger:]

Hey Rob.

[Peter Francis Minan:]

Hey Rob.

[Robert Brown:]

On your Industrial business, you talked about improving heat exchangers with a (17

[F. Nicholas Grasberger:]

Yeah, yeah. So the domestic grating business is one that, the competitive landscape is shifting well, I guess it began about six months ago and it's ongoing. And so, as the competitors kind of jockey for position, there's been price pressure and that's beginning to ease somewhat. But I think we'll see over the next year or so is the consolidation in that industry from seven players or eight players to probably three or four and that's ongoing.

[Robert Brown:]

Okay. Good. And then on the bookings number, you talked about in Industrial, sort of being at all-time – or back to kind of prior highs. How long do the bookings take to convert to revenue and you can see that bookings – I guess what's your outlook for the bookings trajectory this year?

[Peter Francis Minan:]

So the bookings have been growing nicely sequentially and certainly year-on-year as I mentioned, they're up and that's manifested in the backlog buildup. So we're starting to see our backlog grow for the first time in quite some time. And here, we're talking mostly about the Air-X-Changers business. Now, we're still at levels that are quite a bit – from a backlog perspective, quite a bit lower than we've seen in the certainly top of the cycle timeframe. So generally, we want to see the – depending on the product mix, of course, the bookings to revenue could be six months to a year. So for that reason, we're going to see the lion share of the benefits from some of these bookings and the build-up of backlog kind of in the fourth quarter and even carrying forward into 2018.

[Robert Brown:]

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

[Operator:]

Next question from the line of Bhupender Bohra from Jefferies.

[Bhupender Bohra:]

Hey, good morning, guys.

[F. Nicholas Grasberger:]

Hi, Bhupender.

[Peter Francis Minan:]

Hey, Bhupender.

[Bhupender Bohra:]

So, just wanted to get a sense of, if I look at the operating income guidance here, if you look at the midpoint, I think you moved the midpoint by like $12.5 million. In the quarter, I think you outperformed by $10 million if I look at my numbers, so you guys talked about like $10 million headwind last year when we came into 2017 from some excess applied materials and excess nickels, I think, inventory you had on hand. So, it seems like you're a little bit more optimistic, I think, that's kind of takes care of the $10 million headwind, which was from last year. Can you just give us a sense, is that the positivity or coming from mostly from M&M or is there something within the Industrial business, especially in the previous question we talked about the bookings here, so just give us some color about like how that operating income guidance plays out for the rest of the year?

[Peter Francis Minan:]

Yeah. So, I can answer that, Bhupender. So, is that definitely take (20

[Bhupender Bohra:]

Okay. Yeah, thanks for the color. On the Industrial operating income, I think if you look at the operating margin up like 660 bps or something and can you give us like how much was healthcare within that materially you cited like materially healthcare costs?

[Peter Francis Minan:]

Yeah. I think the healthcare was in terms of absolute dollars, was about a $1 million year-on-year that might help.

[Bhupender Bohra:]

Okay, got it. And just a last one on the Rail, how much did Swiss contract contribute into – in the quarter in terms of revenue?

[Peter Francis Minan:]

Nothing at all, we don't expect revenue from Swiss Rail until the second half of the year. We're still looking about $50 million of revenue again in the second half of this year.

[Bhupender Bohra:]

Okay. Got it. Thanks a lot.

[Operator:]

Next Jeff Hammond from KeyBanc Capital Market.

[Jeffrey Hammond:]

Hey. Good morning, guys.

[Peter Francis Minan:]

Hi, Jeff.

[F. Nicholas Grasberger:]

Hi, Jeff.

[Jeffrey Hammond:]

Hey. So, Nick, I just wanted to kind of go back to the decision not to separate Metals & Minerals, and I just – I wanted to understand, did we go out and try to sell it and not get the price or kind of what's changed in the thinking. And then as you look forward, just how do you envision the mix of the business. Are we kind of doubling down in Metals or we diversifying into the other, just how should we think about external growth? Thanks.

[F. Nicholas Grasberger:]

Sure. Well, first of all, our thinking with respect to the portfolio has not changed, we certainly acknowledge that we have a portfolio of businesses that's less than ideal, and our strategy hasn't changed either with respect to the different steps we can take to optimize it. We announced 18 months ago that we felt a good step would be a separation of the businesses M&M from the others. And after navigating some tough markets and having poor visibility to where the end-markets were headed over the past 18 months, we simply concluded the timing isn't right to do that. Separation may still well be a value enhancing step that we could take at some point, there are other steps that we can take as well, but the timing for the separation simply has not been ideal and we don't see it being attractive for shareholders for a while. So we felt that after 18 months, it was just important to kind of make that statement that we don't see it happening for a while. Now, there are many other things that we can and should pursue to improve the portfolio going forward and we're very focused on those. So this is a Board and a management team that very proactively discuss and explore options on how to improve the portfolio, but we had a good bit of data upon which we based our judgment on the separation and so we're comfortable with where we are and of course, with the businesses performing quite well and the outlook improving and seeing a lot of traction from things that we've done, we're excited about this going forward and where we are. In terms of the portfolio, I'll acknowledge that 18 months ago, we had not thought about investing in M&M outside of new contracts. And I think at this point, we believe there could well be some very attractive investments we could make on the product side. And so, where 18 months ago the focus was on growing Rail and Industrial through M&A, I think I'd now add M&M to that as well. There may well be some acquisitions that make sense for M&M, but I think that the underlying strategy from a portfolio standpoint and in each of the businesses really hasn't changed with the exception of M&M, which as I indicated, I think we're much more focused on growth now. We like our competitive position. We like the opportunities to grow on the product side, and we want to take advantage of that, and I think you'll see us doing that.

[Jeffrey Hammond:]

Okay. That's helpful. And then, just maybe addressing pipeline, do you have stuff in your pipeline? You mentioned IKG in the grating market consolidating, is that something you'd want to participate in?

[F. Nicholas Grasberger:]

Well, yeah, Jeff. I'm not going to comment on that. That as an industry as I indicated that has been in transition now for the past year or so, and I suspect it will continue to be. I think we're very happy with our competitive position there. And as we discussed, our investment in a high-security fencing product remains very exciting for us.

[Jeffrey Hammond:]

Okay. And then, just back to I guess the outlook, it seems like you really just raised your guidance for your upside in 1Q, I mean, why wouldn't some of this goodness in Metals, whether it would be the LST volumes or the higher nickel prices flow through and support higher numbers throughout the year?

[Peter Francis Minan:]

Yeah. There was actually, as I mentioned just a few second ago, Jeff, its Pete, there was – there's still a couple of headwinds. First of all, yeah, sort of LST, we're anticipating going up on a same-store basis about 3.5% to 4% and 7% in total. But our non-LST related volumes are not anticipated to be at the levels they were prior year, and this would include our Minerals business. And it's for some of the reasons that we just talked about, we had some pretty unusually good quarters last year, particularly in our lead (29

[Jeffrey Hammond:]

Okay. Thanks guys.

[Operator:]

And your next question is from Norfleet from Alembic Global.

[Robert F. Norfleet:]

Good morning guys and congrats on a good quarter.

[F. Nicholas Grasberger:]

Good morning.

[Peter Francis Minan:]

Thanks, Rob.

[F. Nicholas Grasberger:]

Thank you.

[Robert F. Norfleet:]

And just a question on M&M. Given the significant restructuring undertaken over the last three to five years in this business, clearly you've done a great job in reducing the cost structure. But can you give us some thoughts regarding how you seeing incremental margins in this segment, as volumes begin to pickup. And I guess, really, what I'm trying to want to understand is what's a reasonable margin framework for the M&M business going forward? I mean, in the past, it was kind of a 10% to 11% range and we're already there right now. So I guess, what I'm getting to is, is this a business that can be a mid-teen type of margin business?

[F. Nicholas Grasberger:]

I think that will depend in large part, Rob, on mix. Clearly, the product side of the business has higher margins and then higher returns and are focused on improving that balance. I think the margins on the mill services side are quite attractive. We're very pleased with – with where they developed, they basically doubled as had EBITDA minus CapEx margins, which I would argue was a more important metric. So we're very pleased, with where they are. I think the opportunities is more on the product side.

[Peter Francis Minan:]

Well, plus, we also see – I didn't mention this earlier. The contract churn, the – just in mill services the rollover of contracts are having a favorable impact on margins too. So, when we talk about high quality growth investment, which again largely doesn't manifest till 2018, if we spend the capital now that will have a positive impact on the margins as well. So, we do expect just mill services, apples-to-apples margins to be increasing as well.

[F. Nicholas Grasberger:]

But you're right to point out as well. Of course if the industry in that capacity utilization figure, which is up 3 points or 4 points from where it was last year, that continues to increase and our volumes increase we are leveraged to that, of course margins as well as profit, and of course you've got commodity prices, nickel prices remain still quite low, relative to where they've been on average over the past five years or 10 years. So, there's certainly margin potential, the commodity prices would've returned to kind of their historical averages.

[Robert F. Norfleet:]

Great. That's very helpful. Thank you. And then I guess just a quick question on capital allocation, I mean, clearly the balance sheet's in much better shape, all metrics especially EBITDA coverage covenants not even close, and you obviously are seeing a nice improvement in free cash flow. So, what are your priorities outside of internal investment, meaning M&A, debt reduction, potentially reestablishing the dividend, just some thoughts about where you are from that perspective?

[F. Nicholas Grasberger:]

Yeah, yeah I think at this point, Rob, we're focused on growth investments as well as continuing to improve the balance sheet, if we don't find those or can't execute those, we expect to be attractive growth opportunities externally. This is a team that's going to be very disciplined now about how we do that analysis and when and how we pull the trigger. So, I think you're going to see for the rest of the year, the cash flow mostly going to debt reduction.

[Peter Francis Minan:]

That's right. You also appreciate your comment regarding the dividend, you appreciate that our present debt arrangements provide restrictions for dividend and stockholder and repurchase.

[Robert F. Norfleet:]

Great. And my last question, just an update on the – basically how you're seeing – what type of acceptance you're seeing for your new fencing product. Any additional insights into – on your higher demand for that?

[F. Nicholas Grasberger:]

Well, these are like other products in Industrial. This is a longer cycle business. These are large contracts that take some time to kind of incubate. So we obviously have not announced anything of significance yet beyond some, what were very attractive contracts in Mexico, but we are pursuing a number of high profile and very attractive projects in security fencing, mostly here in the U.S., some also outside the U.S.

[Robert F. Norfleet:]

Great. Thanks for your comments.

[Operator:]

There are no further questions at this time; I will turn the call over to Mr. Martin for closing remarks.

[David S. Martin:]

Thank you, Samuel, and to those that listened to this call. We appreciate your interest in Harsco. A replay of this call will be available later today through May 17, and the replay details are included in our earnings release. If you have any follow-up questions also, please contact me. And my contact details' at the top of the earnings release. And again, thanks for joining, and have a great day.

[Operator:]

And this concludes today's conference call. Thank you for your participation. You may now disconnect.