Harsco Corporation
Q2 2015 Earnings Call Transcript

Published: 5 Aug 2015

[Operator:]

Good morning. My name is Samuel, and I will be your conference facilitator. At this time, I would like to welcome everyone to the Harsco Corporation Second 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. [Operator Instructions] . 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 re-distributions of this telephone conference by any other party are permitted without the expressed written consent of Harsco Corporation. Your participation indicates your agreement. Thank you I would now like to turn call over to Mr. Dave Martin. Please go ahead.

[Dave Martin:]

Thank you, Samuel to 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, our Senior Vice President and Chief Financial Officer. This morning, we will discuss our results for the second quarter, our outlook for the year, and update you on our key initiatives. Then we will take your questions. Before our presentation, however, let me take care of a few administrative items. First our earnings release was issued this morning. A PDF file of the news release, as well as a slide presentation for this call have been posted to our website. Secondly, this call is being recorded and webcast. A replay will be available on our website later today. 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. A replay will be available on our website later this afternoon. Next, we will make statements today that are considered forward-looking. 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 our risks and uncertainties, see the Risk Factors section in our most recent 10-K and 10-Q, as well as in certain of our other SEC filings. The company undertakes no obligation to revise or update any forward-looking statements. Lastly, on the 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 press release issued today as well in our slide presentation. With that being said, I'll turn the call over to Nick Grasberger to begin our prepared remarks.

[Nicholas Grasberger:]

Thank you, Dave, good morning, everyone and thanks for joining our call. I was satisfied with our ability to deliver profit above our expectations in the second quarter, it also important to note that there were no special items in the quarter. Lower SG&A costs across each business and at corporate offset the negative effects of reduced demand in M&M and industrial due to weak steel and energy markets. Our revised outlook for the remainder of 2015 assumes these markets remained very weak and continue to obscure the operational improvements we've made in both M&M and Industrial. In addition a handful of difficult contracts in South America continues to weigh on M&M and therefore we have reduced the midpoint of our operating income guidance for the full year by about 15%. I'll offer just a few brief comments on each division. M&M continues to execute on the initiatives outlined over a year ago to transform the business into a leaner more disciplined and data driven organization focused on boosting its return on capital. And now with the full corporate team actively engaged with the M&M team I expect streamline decision making to complete support of our organization and full alignment around our strategic plan moving forward. We expect to realize $35 million to $40 million of benefits by the end of next year through the simplification component of Project Orion which is a bit higher than original projection. We're also beginning a program targeting additional reductions and cost of sales at our sites in a global basis. It's another out growth of our deep dive into site operations over the past several months. Our triage teams are aggressively pursuing the best possible commercial outcomes on our underperforming contracts while also driving operations improvements at these sites. We expect over $10 million of annualized earnings improvement from the underperforming contracts that we've successfully addressed or finalized this year and this figure should grow in 2016 as the remaining underperforming contracts are finalized. Finally the fundamental process changes in our Bid & Contract Management function and the implementation of the global operational standards are creating a more uniform business with stronger controls. Put simply we're very excited about the upside opportunity in M&M when markets recover. We've also reduced the outlook for our Industrial division which is heavily exposed to the energy sector as you know. Previously, we assumed a modest recovery in energy prices in the second half of this year, but that is currently not happened. Nonetheless, our Industrial leadership team moved quickly and skillfully earlier in the year to mitigate the impact of a lower demand and we expect the year-over-year decline in earnings to be quite modest relative to the decline in revenue. Moreover we continue to feel confident in the impact of our operational initiatives and new product offerings will have in 2016 and beyond. The operating leverage of our industrial group has never been higher and we look forward to generating significant earnings growth as markets recover. The outlook for our Rail division is unchanged and certainly quite positive. We fully expect Rail to be a $500 million business with continued attracted margins and returns within a few years based largely on existing backlog. And we're optimistic that backlog will continue to grow over the next year as additional long-term contracts are awarded. We are also excited about the pipeline of possible acquisitions we've identified and our Rail leadership team is talented, disciplined and focused and has proven its ability to execute at a high level. Overall, we remain steadfast in our focus on driving three key financial metrics and creating a more balanced portfolio of businesses. We expect to improve free cash flow and EBITDA minus CapEx margins this year despite a $50 million negative effect on profit for market conditions, FX rates and commodity prices. And ROIC would be about level with last year if not for a higher tax rate. In term of portfolio balance we have committed much more growth capital over the past year to Rail and Industrial and to M&M and our acquisition focus remains fixed on our manufacturing businesses. At the same time, we have removed a great deal of risk from the M&M business to implementing tighter processes and controls in addressing legacy risk items such as poor contracts. No one is more disappointed in Harsco's earnings and share price performance than I am, but I'm confident we're building a better company for the future. I'll now turn the call over to Pete.

[Peter Minan:]

Thanks, Nick. Let's me start on the slide four of the presentation. So operating income in second quarter of $36 million was above our guidance range of $30 million to $35 million as performance in our Rail segment was better than anticipated and also corporate spending was slightly lower than we had forecasted. These positive offsets the results in metals where the performance was impacted by a lower steel output or LSTs in North America and Brazil, weaker nickel demand and higher maintenance cost in certain locations as well. We were also impacted by the bankruptcy of a customer in South Africa. Compared to the 2014 quarter, operating income declined as we expected. With each business unit reporting lower earnings compared with the prior year quarter and these changes were only partially offset by lower cost at corporate from reduced consulting fees and other areas where we are focused on controlling our expenditures. Revenues in the quarter also declined as expected to $456 million and this represented a decrease of 15% year-over-year. This change resulted mainly from the impact of a stronger U.S. dollar, site exits and lower nickel related sales within our Metals & Minerals segment revenues also fell in our Industrial business as a result of weaker demand for its products which was mostly tied to trends in U.S. energy spending. As a result, our operating margin was essentially unchanged at 8.6% compared with the prior period. Earnings per share, was $0.08 in Q2 as compared to our guidance range of $0.06 to $0.12. Compared with our outlook, higher operating income was offset by taxes, brand joint venture contributions each of which negatively impacted EPS by $0.02 to $0.03. Compared with the prior year quarter, EPS decreased $0.11 and a just completed quarter included an equity loss contribution from our brand JV of approximately $8 million. This figure translates to an EPS impact of roughly $0.06 after-tax and compares to a loss of $3 million in the prior year quarter. Now regarding brand, it's important to emphasize and highlight that we reported a seasonally weak period for this business during our Q2 and also that the Brand P&L impact to Harsco was again impacted by non-cash foreign exchange losses in the second quarter. These foreign exchanges losses totaled $23 million for Brand in the quarter and impacted our EPS by approximately $0.05. Also on Brand the JV ended the relevant quarter with net debt of $1.7 billion which was essentially unchanged from the prior quarter. Free cash flow for Harsco in the quarter was $10 million which was better than we had forecasted internally primarily due to the under spending of capital. Meanwhile, free cash flow declined $10 million versus the second quarter of 2014 as lower CapEx was offset by the change in cash earnings and the fact that our prior year quarter included additional cash proceeds from the sale of our infrastructure business. And lastly, return on invested capital improved to 6.8% from 6.1% in 2014. Let me talk about the businesses and moving to slide five. In the second quarter, Metals & Minerals generated operating income of $19 million as compared to $24 million in the prior year quarter. During the quarter, the organizational savings in the Project Orion and lower bad debt cost were than offset by foreign exchange impacts, site exists and lower nickel prices and shipments. Customer LSTs in the quarter declined 4% year-over-year in absolute terms. This change reflects the fact that we have exited sites in the past year and it also accounts for lower customer production in certain locations such as North America and South America that impacted our Q2 results. Free cash flow year-to-date in metals totaled $22 million as compared to $5 million in the prior year with this improvement attributable to both lower capital spending and working capital. Let me move on to slide six. Our Industrial business generated operating income of $14 million in Q2 as compared to $17 million in the second quarter of 2014. This change resulted from lower demand across the business along with facility moving costs related to our new CenterPoint facility in Tulsa that total approximately $1 million in the quarter. As a result of these income and revenue changes operating margin declined just over 100 basis points year-over-year. In the face of meaningful headwinds, we continue to reduce our overhead structure within the Industrial businesses. These costs reduction initiatives to-date offset a large portion of these headwinds in Q2 and we anticipated an additional workforce changes will be completed in the coming months. Free cash flow year-to-date totaled $21 million versus $29 million in 2014 and this change is attributable to our capital expenditures to CenterPoint. Lastly, our backlogs declined 8% sequentially during the quarter as can be expected. It's important to note that these backlogs which represents more than three months of segment revenues are little changed versus the year ago period and we'll continue to support the business for the balance of the year. Moving to slide seven, operating income in Rail was $11 million as compared to $14 million in the prior year period. This result was ahead of internal plans as a result of better parts and service mix and lower administrative costs. Compared with the 2014 quarter however, income and margins fell due to a less favorable sales mix. Free cash flow in Rail totaled $14 million year-to-date versus $33 million last year and this change is due to fewer customer advances on certain large contracts within our backlog. Our current Rail backlog as you know includes two sizeable contracts with the Swiss National Railroad, SBB. We are very pleased with the progress of our Rail team against these contracts and as expected we are poised to begin delivering equipment and recognizing revenue under these contracts in the fourth quarter of this year. As in the past, we highlighted strength of our Rail business and our growth opportunities within the global maintenance and weigh market. These opportunities remain unchanged and the large equipment tenders that we referred to in the past remain outstanding. We continue to remain very encouraged by the opportunities and confident and our ability to win some of these contracts in the forthcoming quarters. Now before I walk through the changes to our 2015 outlook on slide eight. Let me again highlight that the majority of the guidance change is result from the external pressures on our businesses that we've discussed in the past. These pressures as you know are most pronounced within our Metals & Minerals business and our Industrial business. At the time of our last conference call in May, we were encouraged that a number of indicators within the metal and energy markets suggested that the fundamentals may have bottomed and maybe the worst was behind us. This improvement was short lived as evidenced by significant fall in nickel and oil prices. And as the strengthening in scrap demand and steel production fails to materialize. In Metals & Minerals these factors have an incremental earnings impact in excess of $10 million versus our prior outlook and when combined with other external challenges such as a stronger U.S. dollar, we are now expected to impact the businesses earnings by more than $40 million as compared to 2014. Also in metals our updated outlook now incorporates additional site exit and contract termination costs in underperforming regions that we had not anticipated earlier as well as additional maintenance and operating costs at a small number of underperforming sites in Latin America. In Industrial, we now anticipate that our cost reduction initiatives within the business will not fully offset the impact from reduced energy related demand for our heat exchanger and grating products in 2015. This growth impacts are now estimated at $10 million to $15 million versus $5 million to $10 million previously. Overall, we're pleased with how our businesses are managing through a difficult environment and executing upon key priorities and strategies. Although as Nick mentioned and as you would expect we're clearly disappointed with the changes to our guidance. In Metals & Minerals, the transformation has clearly improved the business but there's certainly much more work to do. The cost challenges in metals that I referred to you earlier are limited to a small number of sites and these have and will continue to get more attention in the forthcoming quarters. Also as I mentioned in the past, we continue to explore other cost reduction initiatives and business levers in Metals & Minerals to create value. I'll comment more on these in a few minutes. So turning back to our outlook, we now expect 2015 operating income of $120 million to $135 million as a result of our updated expectations from Metals and Industrial. Our underline forecast for our Rail - business are essentially unchanged versus our prior guidance. Meanwhile, our EBITDA minus CapEx guidance a very important metric for us is maintained at $135 million to $150 million for the year as we have reduced our capital spending plans across the company and it's important again to highlight that we still expect year-over-year improvement in this key financial metric. Our capital budget for 2015 is now $135 million to $145 million as compared with the $165 million to $170 million previously. Most of this change is attributable to the metals unit although our spending plans have declined also in our other businesses. Next our free cash flow forecast for the year is now $60 million to $ 80 million which incorporates our latest working capital forecasts. And lastly, earnings per share is now expected to be between $0.41 to $0.55 and this range now assumes the tax rate of 42% to 44% and this tax rate change is driven by the geographic distribution of our anticipated profits. Also note that the expected equity contributions from our Brand Joint venture are unchanged at $4 million to $6 million for the year. Before I turn to slide nine and discuss our third quarter, let me comment on our financial position. As you know, we issued a bond offering in early June given timing and market conditions. At that time, we simply found the financing options unattractive as have a number of companies in recent months. We continue to evaluate the options to refinance our $250 million of notes due in October. We are evaluating various alternatives and are confident in our ability to complete the refinancing prior to maturity. At this point, we can't say much more about our efforts here although I will highlight that we remain very comfortable with our financial position and flexibility. At the end of the quarter, our net debt stood at $876 million. In addition, subsequent to the quarter end we monetized our year denominated cross currency interest rates swap agreement and the cash proceeds from this transaction of approximately $75 million provide us additional liquidity and financial flexibility. Now regarding our third quarter, we expect operating income to be between $20 million and $25 million and earnings per share of $0.05 to $0.09. In Metals & Minerals, operating income will decline versus the prior year as cost reductions will be offset by lower - LSTs site exits, weaker nickel and scarp demand and foreign exchange impact. For Industrial, operating income is expected to decrease given that reduced demand will offset lower SG&A costs. In Rail, earnings will decline meaningfully from a very strong third quarter 2014, as a result of lower parts and service contribution and a weaker mix. And lastly on Brand, we were expected to record equity income of approximately $4 million in Q3. Now, turning to Project Orion in slide 10, the major works streams of Project Orion continue to progress according to our expectations and we are in the later stages of these initial steps to improve the capital returns in this business. Regarding our simplification efforts, 90% of the anticipated workforce changes have been completed. We realized roughly $5 million dollars of savings in the quarter and we still expect $20 million of savings this year related to these workforce and operational improvements. Also the run rate of the improvements to-date now approximates $35 million as compared to our yearend target of $35 million to $40 million, we are on track. Regarding underperforming contracts or sites, we have finalized solutions at 56% of the original underperforming contracts or UPCs, as of the end of the quarter. This means four were finalized since our last call in May. The financial performance at our finalized site continues to improve despite external market headwinds and additional benefits will accrue as outcomes become effective. Overall, we are very pleased with the efforts of our triage team to-date and as we discussed addressing these underperforming contracts is difficult work and involves prolonged discussions with our customers. Of the remaining 30 underperforming sites, 19 are in progress and despite numerous challenges our triage efforts are expected to accelerate in the coming months. We still anticipate addressing our remaining UPCs by early 2016. And lastly, let me comment on the other improving initiatives underway within metals that I referred to earlier. To start we are in the midst of a comprehensive review of our M&M costs and these efforts included an analysis of all costs of sale items SG&A and procurement expenditures. Our metals cost of sales totaled nearly $1 billion and we see further opportunities to reduce our operating costs building on the success of Project Orion. Key focus items for us include labor efficiency, productivity, equipment utilization and maintenance, fuel and tire costs to name a few. In the coming months, we plan to identify a number of key operating priorities with each of our site level operating and maintenance supervisors to achieve significant improvement. Also we anticipated these actions will be implemented starting in the fourth quarter of this year. Now at this point it's too early to quantify the expected benefits and state when these savings maybe realized, but we believe the value potential from these initial initiatives is meaningful at this point. Lastly as we've stated before, we expect that these initiatives will offset a significant portion of the macroeconomic headwinds evident in the business today. Now that concludes my prepared remarks and at this point we'd be happy to take your questions.

[Operator:]

[Operator Instructions] And the first question comes from the line of Jeff Hammond from KeyBanc Capital Markets.

[Jeff Hammond:]

Hey, good morning guys.

[Nicholas Grasberger:]

Hey, Jeff.

[Peter Minan:]

Hey, Jeff.

[Jeff Hammond:]

Hey Pete, just on your last comment about additional things that can be done. So I don't know if there's a better way to quantify or maybe just talk about did you need to get Project Orion done first before really attacking this or is it just a function of weaker environment, just a little more color there?

[Nicholas Grasberger:]

I think it's more of the former Jeff, we have new experience success with Project Orion, we got a lot then we want to build on that by really in essence expanding the initiative that we stared with Project Orion into these other areas. So they're not entirely sequential, there is a fair amount of overlap, but it's really building on the success that we got with Orion which we expect to do with the broader project on cost of sales and remaining SG&A.

[Peter Minan:]

And I would add that that's really been facilitated by having a global operational organization that really has been able to understand as they have worked with each region, where the opportunities lie across those regions. So it is kind of the next logical step here after having taken out the cost kind of above the site that now we're looking much more closely at the operational performance at each site and where the opportunities lie.

[Jeff Hammond:]

Okay. And then can you quantify I guess it sounds like you didn't have any charges this quarter, but it seems like there is in the back half guidance some one-time exit cost. And then some short-term maintenance issues, so where to quantify that did those - I guess when we're all done with the exits, how much of a headwind kind of goes away into 2016?

[Peter Minan:]

Yeah, in the quarter just focus on the exits for now and it's a little bit of mix bag here because it's not only just the year-on-your exits, but it’s also some additional costs we are incurring in existing contracts or sites that have been sighted for exit, particularly in South America. But the net impact on revenues from contract exit in the quarter is about $13 million. And the net churn, the operating income level is just under $4 million and then when you separate that out for the full year we're talking about revenue impact of say $58 million or so and net churn impact of negative $7 million. So the impact that we're experiencing during the quarter though is affected by some additional really closing costs that we probably underestimated a bit when we identified this - surely one or two specific sites one in South Africa and one in South America. We're incurring more costs then we had planned. We still expect to on track to exit the site completely by the end of this year so that should go away completely for next year.

[Jeff Hammond:]

Okay. But the $7 million is that profit associated with this $58 million of revenues exited or is that - or is there a portion of that that's one-time cost?

[Peter Minan:]

Its year-on-year impact of the contracts that are exited and are in process of being exited.

[Jeff Hammond:]

Okay. And then can you just quickly quantify the FX impact by business?

[Peter Minan:]

Yeah. So year-on-year impact for FX is about $10 million for metals which is the vast majority of the impact. There's some minor impact in Industrial and the Rail business but it's not consequential. And that's...

[Jeff Hammond:]

Okay.

[Peter Minan:]

At the OI level. The impact on the revenue levels is about $160 million year-on-year.

[Nicholas Grasberger:]

And Jeff, were you asking about the second quarter specifically or the full year?

[Jeff Hammond:]

Yeah, second quarter?

[Nicholas Grasberger:]

Oh, sorry second yeah.

[Peter Minan:]

I'll give you the detail. So its $45 million of revenue in the second quarter, $43 million plus of that was in metals and then at the OI level it was $2.2 million and all of that with that metals.

[Jeff Hammond:]

Okay. Thanks, guys.

[Peter Minan:]

Okay.

[Operator:]

Next question from the line of Scott Graham from Jefferies.

[Scott Graham:]

Hey, good morning.

[Nicholas Grasberger:]

Hi, Scott.

[Peter Minan:]

Hi, Scott.

[Scott Graham:]

So as I look at the adjusted operating income bridge on slide five for M&M. I'm seeing a much different picture with the $5.4 million up that we saw last quarter which was $4.1 million down. Is that all Project Orion and improved operating improvements.

[Peter Minan:]

So it's probably best if I just walk you through it if I could Scott. So the Project Orion benefits that we experienced during the quarter were about $5 million and that's the bulk of that is in. There's also the favorable comp on bad debt expense that also included in that figure. But if you're just focusing on the Project Orion benefits from the simplification efforts is $4 million to $5 million.

[Scott Graham:]

Got you. Now if we look at this, the nickel and t applied products hit I'm sure that's a lot worse than what you thought. If you were to look at this from a let's say a nickel versus applied products. Because I know that you're more in control of applied sort of what is the split there on the $5.8 million between nickel versus the applied?

[Nicholas Grasberger:]

Scott it's a 100% nickel related sites. Nickel prices were down roughly 30% year-over-year in the quarter. Our volumes were down the same percentage. So that entire $6 million is nickel

[Scott Graham:]

So on a go forward basis I mean obviously you don't want to hedge now at the low but is this something where we could mitigate this because this is just sort of such an uncontrollable - price, what's the plan there?

[Nicholas Grasberger:]

Yeah we've, obviously we've considered now is not the right time as you said. But we have considered whether or not we could find ways to hedge our exposure here. It's a little bit more complicated than it would appear it's not just price there is demand and volume issues. But the accounting as you could imagine the accounting for this is very difficult to achieve the financial accounting benefits you end up having some unfavorable volatility in the earnings even if you're able to hedge it economically. But that being said we do continue to evaluate whether there's way to deal with this Scott.

[Scott Graham:]

Okay. And here's my last one on M&M and I'll get back in the queue. The net contract churn Pete is that the cost to exit?

[Nicholas Grasberger:]

It's a combination of factors, it's mostly the year-on-year comparison of operating income from exited contracts. In the current year though it does include an element of increased cost to exit for a couple of sites.

[Scott Graham:]

Okay. Because that went up versus last quarter, does that mean that you're - not that we're cutting into the media I don't mean it that way but the - in some way is that maybe a good thing that your, the bar as it goes higher actually shows that you're more focused on the ROIC is that - there's a I think a relationship there yes?

[Nicholas Grasberger:]

There's a relationship although I think this is the increase that we're talking about is probably just additional cost from an underestimation frankly of what it would to take to get out. It shows that we're getting out of the bridge contracts that's consistent with the objective of Project Orion, we continue to do that and so in that sense it's a fair statement, Scott, but I just - the impact this quarter and for the full year has an impact of additional cost to exit at couple of sites.

[Scott Graham:]

Was the $3.7 million higher than your total would be Pete?

[Peter Minan:]

Yeah. It was probably $1 million or so higher than we thought.

[Scott Graham:]

Very good. Thanks.

[Operator:]

[Operator Instruction] And your next question comes from the line Rich Glass from Deutsche Bank.

[Rich Glass:]

Hey, guys.

[Nicholas Grasberger:]

Hi, Rich.

[Peter Minan:]

Hi, Rich.

[Rich Glass:]

Can you guys give us little insight into how you do your forecasting I mean it seems to be you've been congenitally too optimistic on some of the pricing and some of the macro particularly commodity related pricing I mean side of things and this beaten lower thing has gotten old. I would think you guys would be conservative as held quite honestly at this point and it's a little more and a little frustrating to have to go through this Chinese word for what you living through here. So maybe you can help us understand how you do that?

[Nicholas Grasberger:]

Yeah, so it's obviously frustrating for everybody involved Rich, but - the forecasting process and really let's focus on metal to that's we were talking about. It's done at the site level I mean we have 175 sites that's where it all starts. It's getting an understanding of what the volumes will be at those particular sites, but as you know from the industry there is not a whole lot of future visibility in terms of volumes even - by the customers at the site but it starts there. As far as the macroeconomic factors, I mean let's just go backwards to where we were in this conference call in the first quarter when we said that - we're starting to see some indications and maybe things were bottoming out. Nickel price was over $6 and was creeping upwards, steel productions seems to be leveling out in North America and South America, we had foreign exchange, the dollar was starting to weaken and we had oil that was selling around $60 a barrel. We felt pretty confident there. I think we clearly - we don't think we were being overly optimistic there, we thought we were just reacting to the market conditions as we saw them. Unfortunately as I said earlier, those perceptions were short lived.

[Peter Minan:]

The other variable here Rich of course is the whole triage process and underperforming contracts. So we make assumptions on what the outcome of those negotiations will be with the customer and whether we'll exit or stay at the course. And so of course we don't control the timing of that and also sometimes we'll exit as opposed to continue and there are costs associated with exiting that are difficult to forecast. So I think that that volatility or that high variance to forecast is going to come down over time as we navigate through all these underperforming contracts. That's been a real wild card for us and frankly difficult to forecast.

[Rich Glass:]

Okay. It's get I mean maybe my question revolves around how much of a haircut you gave the site level forecast I mean it seems that a lot of the problems with the Metals & Minerals performance is that it was decentralized that there were no best practices that there were no standard operating procedures, that there was no central purchasing, that there was a very large degree of ownership at the local level. So how conservative, how much of a haircut you're giving and how do you, how can you much faith in that number that they're sending to you will that be...?

[Nicholas Grasberger:]

Yeah, look as Pete mentioned we're extraordinarily frustrated about this ourselves. We have a new CFO in the business. We're looking for a new head of the business as you know. The corporate team is leaning in much, much more actively. Pete himself went into the forecasting process with our new CFO in that business who we know well from our past. So this is clearly top on our agenda with the business right now and there is a lot of resource being applied to it.

[Rich Glass:]

Okay. So moving out from there, what is the number on the full year cost to exit for that business. How big is that number, at times it gets pretty sizeable?

[Nicholas Grasberger:]

In terms of exit costs?

[Rich Glass:]

Exit costs from the Metals & Minerals because you're moving out - a fair amount of sites it sounds like between year and - or beginning this year and the beginning of next year?

[Nicholas Grasberger:]

Right. So the vast majority of the cost that we anticipated from exiting sites from Project Orion and triage efforts were taken last year. Those were - almost $90 million were the charges that were taken would largely relate to exit costs. We don't expect anything in the neighborhood of that anywhere close to that this year Rich. The exit costs we're talking about is where we identified a contract site for exit and we anticipated exiting within say six months it may have taken nine months or a little longer than that and the actual cost incurred and that leaning period may have been more. So when I was referring to you exit costs being greater than expected earlier in this call that's what I was referring to. We're not expecting...

[Rich Glass:]

What I'm trying to get at - is what comes back next year, what do you not incur next year because you did this year?

[Peter Minan:]

Yeah. You certainly have a loss making contracts, right that are going away. I made a comment earlier that of the sites that we've exited or addressed that we're underperforming we expect to have $10 million of incremental earnings from that set of contracts this year and that number will grow significantly next year as we exit more contracts that are underperforming and in many cases loss making. So there are three or four contracts in particular in South America that are loss making that we expect will either exit or not have losses next year.

[Rich Glass:]

And are you talking to people about new business in the Metals & Minerals has been any?

[Peter Minan:]

We are, we have a pipeline of new opportunities as well, but honestly we're focused on renewing the best contracts and resolving the worst contracts. This is not about growth you've seen our CapEx numbers come down, the CapEx that we are spending is mostly on renewals and on maintenance, not on new opportunities. Now that's different in India and China, obviously we're very focused on growth in those markets and we've announced some sizable new growth oriented projects in India and China over the past year and that's our focus.

[Rich Glass:]

Right, so there are growth opportunities though in this business, once we...?

[Peter Minan:]

No question.

[Rich Glass:]

Turn the corner which seems to be a pretty slow process. So...?

[Peter Minan:]

Well is that and it's also the applied products business that we talk about.

[Rich Glass:]

Right.

[Peter Minan:]

We feel that shining a light on that business globally which really has not been done before as you know that's not a capital intensive business and we have good technology there, we think that's the other growth opportunity in M&M.

[Rich Glass:]

Okay, switching to the Rail business, can you talk about the negatives on the spare parts in contract services. It seems like these are two business that you guys had a lot of white space in because you hadn't pursued in the past and there should be lot of upside in spare parts and contract services and as you move to capturing more of the aftermarket was what I thought the plan was here?

[Nicholas Grasberger:]

No question, I think you have to distinguish between aftermarket contract services, aftermarket is where the real opportunity is but the reality is as we grow that business it is lumpy. So as you compare quarter-to-quarter sequentially or year-over-year you're going to have product mix effects from equipment versus aftermarket. And so while we've tripled the size of the aftermarket business over the last couple of years, it's not linear quarter-to-quarter right, it remains a bit lumpy and a bit opportunistic and that's part of building out the new business model to make it more systematic and more predictable.

[Rich Glass:]

The aftermarket for Rail are as lumpy as in the original equipment sort of end of things or worse?

[Nicholas Grasberger:]

I think the backlog and equipment is more consistent and more predictable in terms of how that's going to turn into revenue and profit. The aftermarket business tends not to have much of a backlog and it tends to be more difficult to predict kind of quarter-to-quarter, because of remains to some degree opportunistic.

[Rich Glass:]

I, see and how much? What is the number for aftermarket? I mean you said you've tripled it which is?

[Nicholas Grasberger:]

Yeah, it's about $90 million of annual revenue with margins that are kind of 2x, the margins on equipment.

[Rich Glass:]

And what's the potential for that business if we were looking out three to five years and how big can that be?

[Nicholas Grasberger:]

We're actually underrepresented in aftermarket relative to equipment. So we have a very small percentage of the market in aftermarket and so the potential is sizeable.

[Rich Glass:]

Okay. Is your guidance include an accrual for incentive comps for this year?

[Nicholas Grasberger:]

Yes.

[Rich Glass:]

And how does that compare to year-over-year?

[Nicholas Grasberger:]

It's down.

[Rich Glass:]

A lot, a little I mean as a shareholder it's a little hard to understand with targets that are only moving in one direction unfortunately. Why much of anything is deserved above a base salary that's supposed to be incentive comp meaning you make your incentives and level of performance and then you get paid?

[Nicholas Grasberger:]

Yeah, that's certainly true. Our comp program for executive is very much aligned with pay for performance. So we have a very high percentage of our compensation that varies with performance. And so that accrual as you might imagine has come down throughout the year as we've reduced our earnings outlook.

[Rich Glass:]

Okay, is that accrued into corporate costs or where does that get lumped?

[Nicholas Grasberger:]

Well the corporate accrual for the executive is that corporate, but the business units have the accrual for their incentive comp.

[Rich Glass:]

Okay. So can you explain to me why corporate costs being flattish you guys, didn't give exact numbers that I saw, but why is that a good thing I mean it seems like your revenues are down 15%. You guys to be burned in the furniture over there quite honestly and I don't know what the opportunities are, but you would think with the business that's been constantly shrinking that the overhead structure needs to shrink relatively as well?

[Nicholas Grasberger:]

Yeah, so corporate costs are down a little bit year-on-year Rich and we are looking at opportunities to obviously reduce that further naturally. It's combined with the efforts that I referred to on my call earlier so.

[Rich Glass:]

All right, thanks guys, good luck.

[Operator:]

Next question from the line of Robert Norfleet from Alembic Global Advisors.

[Robert Norfleet:]

Hi, good morning guys.

[Nicholas Grasberger:]

Hey Rob.

[Peter Minan:]

Hey.

[Robert Norfleet:]

Hey, a just a couple of quick questions most of mine have been answered, but can you give us a little bit of an update on brand clearly I know the energy markets are challenged we knew that on a daily basis. But I'm referring more to the legacy Harsco Infrastructure business we've obviously had gotten a couple of glimpses that European non-resi demand had at least stabilized a little bit. So maybe you could just discuss how you're seeing that business trend. And then secondly on that any update on just from your perspective timing of the monetization of that asset, whether you still think it's a 2017 event or whether it could potentially be 2016 event?

[Peter Minan:]

Yeah well, the outlook is not changed for brands, EBITDA and cash flow over the past several months. As we've indicated before given their exposure to energy or be it mostly downstream. We expect - the EBITDA to be down 5% to 10% year-over-year that has not changed. But you're right to point out the legacy Harsco business which is relatively larger outside North America than the brand business is doing well. They have seen a better performance say in Europe from the legacy Harsco businesses since the transaction than in the North American business.

[Nicholas Grasberger:]

In terms of the monetization it's just difficult to say, obviously that's the decision we'll be taken along with our partner and with the downturn in the energy market. I think it’s fair to assume that the exit has been pushed out a bit but it's a, we're still targeting a hold period that's good bit less than what you would typically associate with a private equity owned business.

[Robert Norfleet:]

Okay, that's fair thanks. And then just lastly question to Pete you obviously talked about some additional cost savings actions at M&M on the cost of goods sold. The COGS line, I know you're not, you gave some variables as to how that could happen and I know you're not going to get overly specific. But without cutting into the burn I mean what type of savings could we potentially realize I mean is this a 3% to 5% savings, is it potentially 5% to 10% I'm just trying to get some idea of the cost out opportunity there?

[Peter Minan:]

I think we're going to be looking at magnitude of 5% to be 3% or 4% here with 10s of millions of dollar what we're targeting - like I said we haven't quantified it we haven't - we're not in the point where we can really crystalize that yet, but that's what we're trying to target.

[Robert Norfleet:]

Okay, great. That's all for me and thanks.

[Peter Minan:]

Thank you.

[Operator:]

Next question from the line Scott Graham from Jefferies.

[Scott Graham:]

Hey, good morning. I just want a couple of follow-ups here, Nick at the outset I think you mentioned that the renegotiated contracts to-date that you'll get a $10 million operating income benefit from that and I was just wondering over what period are you looking for, for that?

[Nicholas Grasberger:]

Yeah to be clear what that is, that's the universe of underperforming contracts that have been finalized. So either they've been renegotiated or we've exited them or in some cases they've been significant operational improvements as part of the triage effort, okay. So that universe of contracts if you look at the expected gross profits from those contracts for a full year of 2015 versus a full year of 2014 that's about $10 million.

[Scott Graham:]

Okay.

[Nicholas Grasberger:]

Positive incremental gross profits and if you then extrapolates into 2016 and make assumptions around within that same universe of contracts it's growing because we're exiting or addressing more of those underperforming contracts that $10 million should grow significantly in 2016. We've not yet quantified that, but if you look at the trend and you look at the trend and you look at where some of the loss making contracts are in the process of being exited. You start to feel pretty good about the impact that could have in 2016.

[Scott Graham:]

Got you. Your assumption for second half steel production in North America and Europe?

[Nicholas Grasberger:]

The steel production in Europe second half moderate to flat, moderate increase to flat in Europe. And across in North America and South America it's declining.

[Peter Minan:]

So Scott for the full year we're assuming our LSTs are down 5.5%. So year-to-date we're down 4% so you can extrapolate our assumptions for the second half it's basically pointing to no improvement.

[Nicholas Grasberger:]

And one thing we should probably highlight as well is the geographic diversity of the performance in M&M right. Europe, China, India, Middle East have all been performing quite well and according to their plan largely. The challenge has been North America mostly due to LST and nickel price. And South America where it's a combination of bad contracts, poor execution on our part in terms of maintenance spending and in some cases also a weakening customer base. So we really can't paint the entire M&M portfolio with the same brush. They're very different levels of performance across the regions and that's why we are stored nearly focused on South America right now. There's not a lot we can do about the nickel price in the short-term and its impact on North America. But we feel that we're focused in the right places that the European business and again we're very encouraged by China and India. We've put an awful lot of money in those two countries over the past few years and they're performing well.

[Scott Graham:]

Right. But I guess just to my question Nick was that, I'm looking at the U.S. and Europe totaling up to close to 70% of your sales.

[Nicholas Grasberger:]

Correct.

[Nicholas Grasberger:]

And you're expecting flat, maybe up slightly in North America but you're expecting - I'm sorry in Europe, but you're expecting down in North America. Is that what I'm hearing you say?

[Peter Minan:]

That's right.

[Nicholas Grasberger:]

Yes.

[Scott Graham:]

Okay, very good. Last question is on Brand. The guidance for the full year versus kind of where we are now. Why are we - I mean that was pretty big hit we took in the second quarter on the negative side. So you're expecting some pretty good equity income out of the third and fourth quarter. A) Am I calculating this wrong I don't think I am but maybe. B) Why would we expect that?

[Peter Minan:]

Well partly because - largely because of the fact that there was a very large foreign exchange non-cash loss in Q2, which of course impacts us significantly. That was $23 million. That will - there is actually and as planned how that go to the opposite direction in the next quarter. So we'll be benefiting from it. So year-to-year we're going to still get the $4 million to $6 million that we're anticipating even though we had a loss this quarter.

[Scott Graham:]

So you're saying that's going to reverse this quarter as in 3Q?

[Peter Minan:]

Yeah that's fine.

[Scott Graham:]

Or in the second half?

[Peter Minan:]

Second half. Scott, the other thing to consider is just the seasonality of that business.

[Scott Graham:]

Yeah, okay got you. That's all I had thanks.

[Peter Minan:]

Thank you Scott.

[Operator:]

Next question from the line of David [indiscernible].

[Unidentified Analyst:]

Hi, I wanted to part a little bit from the quantitative aspect of the call and a talk a little bit qualitatively if you can. At the KeyBanc Conference, Nick you talked about the portfolio and the composition of the portfolio and your thoughts on how the portfolio might evolve. If you might share that again with this audience in terms of where you headed in terms of the business that you own, the opportunity set for those businesses and look at sort of over cycle earnings potential of the company as opposed to focusing on one of two poor quarters this year?

[Nicholas Grasberger:]

Yeah, yeah thanks for the question David. As we have indicated at KeyBanc that conference and elsewhere, we are as you would expect us to do looking at the portfolio quite actively and what fits and what doesn't and why and what the issues are that arise from that question and the answer to it. And honestly everything is on the table right now. As we've been fairly clear, the focus over the past 15 months has been on transforming and turning around the metals business and on investing in growth and Industrial and Rail and we feel about exactly what we've been doing in the past 15 months. We also laid out 15 months ago what we thought we could achieve financially over three years from that focus. And honestly we've not backed off of those targets. I mean the components of getting from here to there have changed a bit but the focus remains very much on growing Industrial and Rail and continuing to execute the initiative in M&M which is largely around dealing with risk items right, improving controls before we grow again. And of course the frustrating thing has been that they, in my view the very good progress we've made against that in M&M has really been hidden by very, very poor markets and continued poor performance in handful of contracts mostly in South America. But there's no question David - the core of your question we're very focused on the portfolio and of course the Board is very actively engaged in those discussions with us and we recognize that this portfolio is not profitable.

[Peter Minan:]

Samuel any...?

[Operator:]

Next question from the line of Jeff Hammond from KeyBanc Capital Markets.

[Jeff Hammond:]

Hey guys just couple quick follow-ups. So on the earlier question I think you talked about $10 million improvement from these exited contracts and that improvement from there is that separate and distinct from Project Orion and what's the incremental savings into 2016 on Project Orion?

[Peter Minan:]

That's - going back to the various components of Orion, right there what we call the simplification or the cost out initiative both at the site and above the site. Then there was the change in the Bid & Contract Management function to a very centralized much more quantitative function with better controls. And then the third one was this triage component of addressing underperforming contracts okay. So the $10 million that I mentioned is really from the triage activities and that's distinct from the $35 million to $40 million that we expect to realize from cost out in that first component. So it is incremental.

[Jeff Hammond:]

Okay. And then what's the incremental savings Orion because I guess you're going to get what $15 million to $20 million this year and then you'll get the balance in 2016?

[Peter Minan:]

Yeah, another $10 million or so next year.

[Nicholas Grasberger:]

Yeah, it should be $21 million this year right.

[Peter Minan:]

Plus the incremental benefits from exiting poor contracts. Now obviously you have to keep in mind there are some offsets to that right. There have been exits of contracts that were profitable they may have had poor returns, but they were profitable. So you really need to look at again over time what's happening with return on capital and also EBITDA minus CapEx margin. If you just simply look at EBITDA or earning there is an offsets because of those contracts that are underperforming but still profitable.

[Jeff Hammond:]

Right.

[Peter Minan:]

And - as you likely know there also have been some contracts that we liked that were profitable that we didn't want to exit that have either been lost or upon renewal the terms - we can do still good contracts but not to the extent that they were. So there are a lot of moving parts.

[Jeff Hammond:]

Okay. And then the South America issues, I means what's how - I mean I guess as you were kind of going through the portfolio and the contracts and everything and there has been kind of multiyear discussion on kind of better maintenance practices. So how did that get missed?

[Peter Minan:]

Well. If you go back to the origin of many of those contracts we were the first mover in South America for mill services right so there was a very aggressive push to very quickly penetrate that market and not surprisingly when that's your approach you're going to make some mistakes and there were some poorly written contracts we build out some teams that were not up to the job honestly. We're replacing an awful lot of people there both at the sites and also - the people that run the business above the sites. And so, it's been frustratingly sticky I'll say to improve the operations, but we're confident in the new people that we brought in, we're confident in the new leadership there and but again these things take time. We talked about this Harsco way of operational standards that we're rolling out globally and the first geography or focus is South America. And so, we have a disproportionate amount of resource being applied to fixing these issues in South America.

[Nicholas Grasberger:]

I guess I just want to reemphasize that we're talking about a handful of sites here. So we have 20 plus sites in Brazil for example and the ones that we're talking about that are causing some concerns are the under performers are two or three, four of them. So it's not a pervasive issue across the country or even the region, it's really isolated to those underperforming sites that we knew we're trouble to start with.

[Peter Minan:]

Yeah.

[Jeff Hammond:]

Right, okay. And then as you consider the financing how are you thinking about the dividend same or differently?

[Peter Minan:]

I think we're - we remain committed to the dividend Jeff. We really don't have concerns about our ability to execute the refinancing in the fall. So our liquidity position is strong and will be strengthened further as a result of the refinancing the $75 million of proceeds from unwinding the swap also of course helps that. So we continue to believe we've adequate liquidity and visibility to cash flow going forward to maintain the dividend.

[Jeff Hammond:]

Okay, great thanks guys.

[Peter Minan:]

Sure.

[Operator:]

And there are no further questions at this time.

[Dave Martin:]

Thank you, Samuel. And to those that participated in the call today. We appreciate your interest in Harsco. A replay of this call will be available later today through August 19. And the replay details are included in our press release this morning. Lastly, if anyone has any follow-up questions, please call me. And we look forward to speaking with you in the future. Thanks.

[Operator:]

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