Harsco Corporation
Q3 2015 Earnings Call Transcript

Published: 9 Nov 2015

[Operator:]

Good morning. My name is Joey, and I will be your conference facilitator. At this time, I would like to welcome everyone to the Harsco Corporation Third Quarter Release Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer period. Also, this telephone conference presentation and accompanying webcast made on behalf of Harsco Corporation are subject to copyright by Harsco Corporation and all rights are reserved. Harsco Corporation will be recording this teleconference. No other recordings or redistribution 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 like to now introduce Mr. Dave Martin. Mr. Martin, you may begin your call.

[David S. Martin:]

Thank you, Joey, and welcome to everyone joining us. I'm Dave Martin, Director of Investor Relations for Harsco. With me today is Nick Grasberger, our President and Chief Executive Officer; and also Pete Minan, our Senior Vice President and Chief Financial Officer. This morning, we will discuss our results for the third quarter of 2015 and our outlook, and update you on our strategic priorities. Then, we'll take your questions Before our presentation, however, let me take care of a few administrative items. First, we did issue two news releases this morning. The first was an announcement stating that we are pursuing options for the separation of our Metals & Minerals segment from our other businesses and subsequently, we issued our earnings release for the third quarter. A PDF file of these releases, 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. 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 those forward-looking statements. For a discussion of such risks and uncertainties, see the Risk Factors section in our most recent 10-K and 10-Q, as well as in our other SEC filings. 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 issued today as well as the slide presentation. Now, I'll turn the call over to Nick Grasberger to begin our prepared remarks.

[F. Nicholas Grasberger:]

Thank you, Dave, and good morning, everyone, and thanks for joining our call. Let me start with the announcement concerning the separation of our Metals & Minerals business. Our strategy over the past two years, following the formation of the Brand joint venture, has been fix the Metals & Minerals business, grow the Rail and Industrial businesses, and develop a lean active corporate team, all with a focus on improving return on capital and enhancing shareholder value. Put simply, we are very pleased with the progress we have made against those objectives. While it has been difficult to overcome the precipitous cyclical declines in the steel, energy and commodity sectors, we believe Harsco is much better positioned today to grow and deliver above market returns as these sectors recover. It has also become clear to us that the separation of Metals & Minerals from the Rail and Industrial businesses is the next logical step to unlocking shareholder value and optimizing the returns of the individual businesses. Our efforts in Metals & Minerals to improve core processes, address underperforming contracts, remove excess cost and build a more effective organizational structure have enabled us to now follow this path. So now, we have reached an important milestone and believe the separated businesses would provide more targeted and compelling value propositions for their respective stakeholders. The form of the separation will, of course, take some time to finalize as we explore all options. The Harsco management team and our Board of Directors, supported by Goldman Sachs and other advisors, will pursue the best outcome for all stakeholders. In the meantime, we will continue to navigate the course we have charted and drive towards the financial goals we have set for each of our businesses. Turning to our third quarter results, our key financial metrics were above expectations due to better product mix in Rail and lower cost across each business and at Corporate. And although market conditions are weaker than anticipated in steel, commodities and energy, our earnings guidance is little changed for the full year. You'll note we highlighted a few special items in the quarter related primarily to an M&M site closure in the UK and the resolution of a few longstanding items around environmental and litigation matters in M&M. Pete will cover these in more detail in a few minutes. As we look ahead to 2016, we expect continued core growth in Rail, excluding the FX gain in 2015, but difficult markets to persist in steel, energy and commodities. Although significant cost has been removed in M&M, Industrial and at Corporate, further actions are underway. I have commented before that our deep-dive into M&M's operations through Project Orion has uncovered additional opportunities to streamline our cost structure both in our customer sites and in the support functions. Therefore, we are targeting an additional $20 million to $25 million of cost reduction beyond the $35 million to $40 million already realized. These incremental savings coupled with the year-over-year benefits of the triage efforts related to the underperforming contracts should mitigate the ongoing volume pressure at our customer sites. Before I turn the call over to Pete, I would like to comment on the change in our dividend. It was a very difficult decision for the board, but we believe the responsible action to take, given economic conditions and the weakness in many of our end markets. Harsco is proud of its longstanding practice of returning capital to our investors and remains committed to a healthy balance between the strong capital structure and shareholder returns. I will now turn the call over to Pete.

[Peter Francis Minan:]

Thanks, Nick. And I am on slide five. Adjusted operating income in Q3 of $35 million was above our guidance range of $20 million to $35 million as performance in our Rail and Metals segments were better than anticipated. And also Corporate spending was lower than we had forecasted. In Rail, we benefited from mix and the acceleration of various spare parts and service revenues. In Metals and at Corporate, results were aided by our efforts to control overhead costs. Compared to the 2014 quarter, operating income declined with each business unit reporting lower earnings compared with the prior year quarter as we expected. Revenues in the quarter also declined as expected to $428 million, and this represented a decrease of 19% year-over-year. The impact of a strong U.S. dollar was the primary driver of this change as was the case in preceding quarters. Additionally, revenues were impacted by lower steel production, reduced commodity prices and site exits in Metals along with lower Industrial products demand and a less favorable mix in Rail. Earnings per share was $0.18 in Q3, as compared to our guidance range of $0.05 to $0.09, as a result of the higher adjusted operating income. Compared with the prior year quarter, EPS declined $0.13 and the just completed quarter included equity income from our Brand Energy joint venture of approximately $3 million. This figure translates to an EPS impact of roughly $0.02 after tax and compares to equity income of $5 million in the prior-year quarter. Free cash flow for Harsco for the quarter was $23 million, which was better than we have forecasted internally primarily due to higher cash earnings and the under-spending of capital. Meanwhile, free cash flow declined $42 million versus the third quarter of 2014 as fewer contract advances offset reduced capital spending. Also, as detailed in our earnings release, we recorded a number of unusual items in the quarter. As in the past, a number of these items were connected to Project Orion as we continue to review our sites, including those that are underperforming, to identify opportunities to improve returns and possibly exit sites where we see that as the best outcome. Additionally, there were a few other adjustments in the quarter. One is related to a site, where we have curtailed a portion of our operations after our European customer decided to close its liquid steelmaking operation. As you know, customer site closures have occurred only on a very limited basis to us in the past, but this is a consequence of and, in fact, illustrates the current challenges within the steel industry. With this now behind us, we are generally comfortable with the sustainability of our customer portfolio and are hopeful that similar situations will not develop in the future. We spend considerable time assessing where best to be positioned strategically within the industry. But as you know, steel fundamentals would dictate how much additional right-sizing or restructuring may be required at our customer sites. In total, the unusual items totaled to $27 million or $0.28 per share for the quarter. That includes $14 million for receivables, asset impairments and severance accruals related to the European steel customer that curtailed operations; $11 million of site exit costs and contract resolution charges related to a few underperforming sites; $2 million for external costs incurred to-date for the planned separation of Metals & Minerals; and a $1 million tax true-up adjustment tied to the 2013 infrastructure transaction. Looking forward, we will likely incur additional costs through the M&M's strategic review process and as we implemented additional cost reduction activities. Also, it is possible that we will incur additional costs as we continue to evaluate our underperforming sites. But otherwise, we continue to believe that these types of charges are largely behind us. Can we change to slide six? In the third quarter, Metals & Minerals generated operating income of $21 million, which was better than we had expected due primarily to lower overhead costs. The result compares to operating income of $27 million in the prior-year quarter. Now, during the quarter, lower costs attributable to Project Orion and other factors were offset by lower commodity prices and demand, reduced customer LSTs, site exits and foreign exchange impacts. Customer LSTs in the quarter declined 10% year-over-year in absolute terms. This change reflects the fact that we exited sites in the past year and it also accounts for lower customer production in our three largest operating regions

[Operator:]

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

[Jeffrey D. Hammond:]

Hi, guys. Hey, can you hear me?

[Peter Francis Minan:]

Hey, Jeff.

[F. Nicholas Grasberger:]

Yeah. Good morning, Jeff.

[Jeffrey D. Hammond:]

Okay. So just – can you just talk about the tax dynamics or the tax basis on the Metals & Minerals business? And kind of how you're thinking about timing for when you make a decision on sale or spin or what to do?

[Peter Francis Minan:]

So – hey, Jeff. It's Pete. So, as Nick mentioned, we're just pursuing options now, and all options are being considered. So we haven't reached resolution as to which route we'll take, whether it's a sale or a tax-free spin-off. Naturally, the tax basis and potential for tax leakage will inform that decision, but we're going to ultimately conclude on that in the early part of 2016, and reach a conclusion for whatever we think generates the best value for the shareholders.

[Jeffrey D. Hammond:]

Okay. And then, how does this impact how you are thinking about your balance sheet refinance? And I know you talked – you moved it into the revolver. But how are you thinking about capital strictures going forward? And how you want to have the balance sheet set up from a refinancing standpoint?

[Peter Francis Minan:]

Yeah. Jeff, so for the past several months, we've been, as you know, pursuing options to refinance the bonds that were due in October and we consider market conditions and try to balance that with our need for flexibility financially in an appropriate pricing. So, obviously, in the meantime, we put them on the – put the bonds on the revolver. We're still continuing – notwithstanding that, we're still continuing our plans to refinance that debt on a longer term basis. So really, there is no change in that direction at all. We continue to pursue it and we hope to have clarity on that in next couple of months. As far as the capital structure of the remaining businesses, that's all something that will be considered as we get closer to evaluating the options that we're facing with respect to separation of the business.

[Jeffrey D. Hammond:]

Okay. And then just kind of a housekeeping item. Can you quantify FX headwind and exited contracts headwind on a revenue basis in M&M this quarter?

[Peter Francis Minan:]

Yeah. So let me start with the latter. The impact of lost contracts from a revenue perspective on the quarter, year-on-year comparison, was a decrease of $17 million and the impact of the same on operating income was about $4 million. As far as the FX headwinds, it's about $2 million quarter-on-quarter and it's continuing at the same rate as it was before for the full year, $10 million to $15 million. That's our operating income. I'm sorry, Jeff. You asked about revenue...

[Jeffrey D. Hammond:]

Yeah.

[Peter Francis Minan:]

What's the impact on operating – do you have that number on revenue, Dave? I don't have that handy.

[David S. Martin:]

For?

[Peter Francis Minan:]

FX.

[David S. Martin:]

It would be right around $200 million.

[Jeffrey D. Hammond:]

On a full year basis?

[David S. Martin:]

Yeah.

[Peter Francis Minan:]

Yes.

[Jeffrey D. Hammond:]

Okay. And do you have it in the quarter?

[David S. Martin:]

It was $47 million.

[Jeffrey D. Hammond:]

Okay. Thanks, guys. I'll get back in queue.

[Peter Francis Minan:]

Okay.

[Operator:]

Your next question comes from the line of Bhupender Bohra from Jefferies. Your line is open.

[Bhupender Bohra:]

Hey, good morning, guys.

[F. Nicholas Grasberger:]

Good morning.

[Peter Francis Minan:]

Hey, Bhupender.

[Bhupender Bohra:]

Hey. So I just wanted to talk about Brand Energy here. You guys, took down the guidance. Now, you forecast like less than $1 million. Could you guide us, like talk about, give some color on...?

[F. Nicholas Grasberger:]

Yeah. It's Nick. When the joint venture was formed back in 2013, on a pro forma basis, we were looking at EBITDA, kind of in the 310, 320 range something like that. And it improved based on synergies and some market lift in 2014 up to, say, 360, 365 and the decline back to the 2013 pro forma level was mostly around FX and market conditions. Clearly, there have been other charges and costs related to integrating the businesses, but it's really mostly around FX and energy. Now, you'll recall that the Brand business is more exposed downstream and so the impact of energy CapEx has been somewhat muted in Brand relative to other energy-driven businesses. And also, much of the work they do is associated with long-term contracts, which also tends to dampen any volatility. So that's effectively why the business is where it is. In terms of equity income, we continued to be affected by currency as well off some inter-company loans that they have that are below the operating income line, but affect our equity income.

[Bhupender Bohra:]

And, Nick, how should we think about (26

[David S. Martin:]

Sorry, Joey, we have a lot of noise in the room. So, Bhupender, if you could repeat that question, that would be helpful.

[Bhupender Bohra:]

Sure. Can you hear me now?

[F. Nicholas Grasberger:]

Yes.

[Peter Francis Minan:]

Yeah. That's better.

[Bhupender Bohra:]

Okay. So, yeah, just wanted to get some color on 2016, how should we think about Brand joint venture going into 2016?

[F. Nicholas Grasberger:]

Yeah. I think it's difficult to say at this point. Clearly, we would expect or hope that the FX headwinds would mitigate to some degree and have an easier comp year-over-year both on operating income as well as on the inter-company loans. As you know, the energy markets really began to take a downturn early in 2015, so we'll have a difficult comp at least through the first quarter. What I will say though is that the integration of the businesses is complete. I think the management team there is doing an excellent job. They've taken out a lot of cost both through the integration and since the integration. And we remain very confident in their ability to execute and ultimately in the value that we'll realize when our stake is monetized.

[Bhupender Bohra:]

Okay. Just one more question here. Now, the thinking is, you're going to spin off or do some transaction on M&M business. At the same time, you kind of talk about how you want to grow your Industrial and Rail business, if you can. Just give us some color on your M&A funnel here in those two businesses.

[F. Nicholas Grasberger:]

Yeah. Well, first of all, the plan certainly is to grow M&M and Industrial and Rail, despite what we experienced in M&M, as we've exited contracts, and currency and economic conditions have hurt the business, we do believe that M&M is well positioned to grow as well. In terms of – but largely organically, I'll say. In terms of Industrial and Rail, we do have a fairly sizeable pipeline of M&A. We've done, I guess, three, although somewhat small-ish transactions over the past year or so; two in Rail and one in Industrial. And I would anticipate that we'll do more of the same. But I think it's unlikely that you'll see a very sizeable deal in either one of those sectors in the near-term.

[Bhupender Bohra:]

Okay. Dave, just a question on the LST, what are your expectations for the year now?

[David S. Martin:]

Yeah. We have reduced our LST forecast for the full year. The assumption is that LSTs will contract about 7% in 2015 versus 2014.

[Bhupender Bohra:]

Okay. Thank you, guys.

[F. Nicholas Grasberger:]

Thank you.

[Operator:]

Your next question comes from the line of Jeff Hammond. Your line is open.

[Jeffrey D. Hammond:]

Hey, guys. Just a couple of follow-ups here. One just kind of thinking about 2016, can you talk about some of that additional headwinds that might off some of these savings in M&M into 2016? And it sounds like you're going to get $20 million to $25 million, most of that would be in 2016, but can you quantify maybe total savings in 2016 for M&M?

[Peter Francis Minan:]

So it's still early, Jeff, to provide a whole of detail on 2016, but we are expecting that the headwinds and market pressures that we are experiencing presently will continue. So LST decline, certainly, commodity, steel – nickel and scrap prices will continue to be where they are. So those would be pretty significant headwinds. However, we expect the results to be – those headwinds to be essentially mitigated by those very cost actions you're referring to. So we haven't quantified precisely how much of the $20 million to $25 million will be in 2016, it is substantially – or most of it. So we're still in the process of narrowing that down. But long story short, M&M results should be consistent with 2015 as the improvement initiatives get realized in 2016.

[Jeffrey D. Hammond:]

Okay. And then for Rail, you have the Swiss contract coming on. Is it simple enough to kind of think about the delta of 2015 to 2016 as that Swiss contract coming in?

[Peter Francis Minan:]

Yes. If you look at Rail performance, excluding the impact of that foreign exchange gain we had in Q1, yeah, you should definitely see some improvement there as a result of the full acceleration of the SBB deliveries in 2016.

[Jeffrey D. Hammond:]

Okay. Thanks, guys.

[F. Nicholas Grasberger:]

Thank you.

[Operator:]

There are no further questions at this time. I turn the call back over to the presenters.

[David S. Martin:]

Yeah. Thank you, Joey, and to those that listened to and participated in this call this morning. A replay of this call will be available later today through November 23, and the replay details are included in our earnings release from this morning. Lastly, if you have any follow-up questions, please contact me. And my contact details are included at the top of today's earnings release. Thanks again. We look forward to speaking with you in the future and have a good day.

[Operator:]

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