Harsco Corporation (HSC) CEO, Nicholas Grasberger on Q2 2018 Results - Earnings Call Transcript
Harsco Corporation (NYSE:HSC) Q2 2018 Earnings Conference Call August 2, 2018 9:00 AM ET
Nicholas Grasberger - President, Chief Executive Officer
Peter Minan - Senior Vice President, Chief Financial Officer
Dave Martin - Director of Investor Relations
Rob Brown - Lake Street Capital Markets
Trish Gorman - Keybanc Capital Markets
Good morning. My name is Deidre 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. If you would like to ask a question during this time, simply press star then the number one on your telephone keypad. If you would like to withdraw your question you may press the pound key on your telephone keypad. Also, this telephone conference, presentation and accompanying webcast made on behalf of Harsco Corporation are subject to copyright by Harsco Corporation and all rights are reserved. Harsco Corporation will be recording this teleconference. No other recordings or redistributions of this telephone conference by any other party are permitted without express written consent of Harsco Corporation. Your participation indicates your agreement.
I would now like to introduce Dave Martin of Harsco Corporation. Mr. Martin, you may begin your call.
Thank you, Deidre, and welcome to everyone joining us this morning. I’m Dave Martin, Director of Investor Relations for Harsco. With me today is Nick Grasberger, our President and Chief Executive Officer, and Pete Minan, our Senior Vice President and Chief Financial Officer.
This morning, we will discuss our results for the second quarter of 2018 and our updated outlook for the year. We’ll then take your questions.
Before our presentation, however, let me highlight a few items. First, a PDF of our earnings release as well as the slide presentation for this call have been posted to our website. Second, this call is being recorded and webcast. A replay will be available on our website later today.
Third, we will make statements today that are considered forward-looking within the meaning of the federal securities laws. These statements are based on our current expectations and knowledge and are subject to certain risks and uncertainties that may cause actual results to differ 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 statement.
Fourth, on this call we will refer to adjusted financial results that are considered non-GAAP for SEC reporting purposes. A reconciliation to GAAP results is included in our earnings release as well as our slide presentation today. Lastly, note that Nick, Pete and I are in different locations today, so please bear with us during any transition and communication challenges.
Now I’ll turn the call over to Nick to begin his remarks.
Thank you, Dave. Good morning everyone and thank you for joining us. I’m very happy to say that we delivered another strong quarter, exceeding our profit guidance and reaching the highest adjusted operating profit margin in over a decade. Each business segment achieved double-digit margin. We have also raised our profit outlook for the full year. Finally and perhaps most importantly, we now expect our return on capital to exceed 15% for 2018 - that’s three times higher than a few years ago and the highest at Harsco in over a decade as well. We believe this reflects smart and disciplined capital allocation, our focus on cost that has yielded more efficient operations, and foundational improvements in a few of our historically challenged businesses.
In short, we enter the second half of the year confident in the prospects of each of our businesses. As our outlook indicates, we anticipate a strong end to 2018 with that momentum continuing through 2019. Through a combination of supportive end markets, a healthy balance sheet, and a stable and talented management team, we are well positioned to execute our strategic growth plans. This includes investing in both internal initiatives [indiscernible] while maintaining the flexibility to return capital to shareholders as and when appropriate.
I’ll make just a few brief comments on each segment and then turn the call over to Pete. Our metals and minerals segment delivered another strong quarter as a result of high steel output and services and new growth contracts, as well as increased applied product sales which, as you know, is a critical component to our growth strategy. Importantly, if you adjust our operating income for the investments we have made this year, our profit growth in M&M is a good bit higher.
I’d like to also provide an update on some of the key initiatives and themes that I discussed last quarter. I mentioned on our last earnings call that M&M is pursuing new relationships at a pace not seen in the past. This year, we have expanded our investments in innovation and added commercial resources to these efforts. As we look towards 2019, we expect a healthy lift in revenues due to these investments and several new contracts across all regions that will commence in the first half of the year.
We also took a strategic look at what skills and experiences would strengthen our M&M team, and as a result we have recently added a talented executive to serve as the Chief Operating Officer of M&M while also adding staff to the business development function.
Finally, I discussed our aspirations to transform M&M into a global leader in providing environmental solutions to basic industries beyond the steel industry. In May, we took the first step with the acquisition of the Altek Group, a U.K.-based manufacturer of market-leading products that help aluminum producers and recyclers better manage their waste streams. This is the first significant investment for M&M in more than a decade, and we are in the process of integrating Altek into our business. It fits perfectly into our strategy of developing a premier environmental solutions platform beyond our core industry.
Our industrial segment reported an excellent second quarter. Revenues increased 25% due to increased demand and higher prices, while operating income increased more than 50% as a result of favorable product mix and improved operational efficiency. All three industrial businesses demonstrated organic growth and operating leverage improvement in Q2 over prior year. Notably, Air-X-Changers upstream and midstream products continue to show considerable strength with revenue up nearly 50% compared to Q2 of last year, and the highest bookings run rate since early 2014. We also continued to gain momentum in capturing market share for our [indiscernible] product line from key competitors that are positioned further downstream. Our industrial backlog is up 60% versus Q2 of 2017 and up 20% versus Q1 of this year. We expect this momentum to continue into Q3 across all three industrial businesses.
In our rail segment, our results and overall market conditions indicate that we have turned the corner and we expect a strong second half and an even stronger 2019. The combination of improving end markets and a strengthened management team that has instituted a much more focused strategy and process orientation have together led to significant growth in our backlog and quoting activities. This is coupled with an exciting pipeline of new products which are truly innovative and will provide compelling value propositions to our customers around the world. Similar to our other two segments, we also anticipate investing in other businesses to broaden our technology and market access in the rail business.
I’d like to as always thank you for your support and your interest in our company, and I will now ask Pete to provide further perspective.
Thanks Nick, and good morning everyone. Let me also echo what Nick just said - we are very pleased with our results this quarter and our revised outlook for the full year. Let me start with Slide 4.
Harsco’s adjusted operating income in the second quarter was $52 million. This result exceeded our guidance range for the quarter of $45 million to $50 million. Among our operating businesses, rail was the largest contributor to our outperformance in the quarter. In North America and Asia, our sales and product mix of rail equipment and aftermarket parts was better than anticipated. Some of these benefits were timing related and we are starting to see some evidence of emerging momentum within the North American rail industry. After a few difficult years in this market, the positive trend is certainly welcome and great to see. This market development coupled with our internal execution led to a healthy growth in our rail backlog in the quarter, which I’ll touch on later.
Secondly, results in our industrial segment were again better than expected and the trends across all of our industrial businesses remain very positive. We experienced some nice margin expansion in our metal grading business, while the strength in Air-X-Changers continues to remain the highlight. Our customer order activity was quite strong through the quarter and our visibility for the next few quarters has improved. Like rail, the backlog in industrial also increased nicely in the quarter with strong bookings. Lastly, relative to guidance for the quarter, our corporate spending was again lower than we forecasted partially due to the timing of some expenditures.
As Nick said, our adjusted operating income of $52 million represents Harsco’s highest profitability in a number of years. The same is true with our adjusted operating margin in the quarter. Our adjusted margin was 11.9% and each segment reported double digit margin in Q2. Revenues in the second quarter total $432 million, an increase of 9% compared with the prior year quarter. Once again, our industrial segment realized the highest year-on-year growth rate.
This top line growth led to a 20% increase in our adjusted operating income, with each segment realizing higher earnings versus the second quarter of 2017. Our adjusted earnings per share was $0.36 compared to our guidance range of $0.30 to $0.35. This EPS figure also represented a 64% increase over the comparable period of 2017. In addition to stronger operating performance, EPS was driven by lower interest costs and a lower effective tax rate.
We did have a few unusual items in the quarter which all told had a net positive impact to our operating income and earnings per share as reported. These included Altek acquisition costs of $1.2 million, expenses to re-price and amend our credit facility of $1 million; a positive deferred tax valuation allowance adjustment also linked to the Altek acquisition of $8 million; and we had some favorable developments resulting in the reversal of an expense accrual in M&M by $3 million. As a result, Harco’s GAAP earnings per share in the second quarter was $0.48.
Free cash flow in the quarter totaled $28 million, which represented a sizeable improvement over the first quarter of this year. Compared with the 2017 quarter, the slight decline can be attributed to higher capital expenditures. Looking forward, we anticipate that our free cash flow will be very strong in the second half of this year, as is traditionally the case each year.
Let me get into the segments, starting on Slide 5. In the second quarter, revenues in the metals segment increased 5%. This growth is actually 10% if you exclude the impact of exited [indiscernible] revenue. Our adjusted operating income increased to $33 million from $31 million in the prior year. These increases are attributable to higher steel output and services demand as well as higher contributions from certain applied products businesses. Steel output at customer sites rose approximately 4% in the quarter. Also, net contract growth had a positive impact on operating income in Q2.
As you are aware, we are now investing for growth and winning new business. The impact of net contract changes turned positive a couple of quarters ago for M&M, and we expect it to remain positive and increase in the future. These positives were partially offset by planned growth-related investments which totaled approximately $2.5 million in the quarter.
Also as you are aware, we acquired Altek Group near the end of May. While its impact on the quarter’s results was not material, the integration process is moving forward smoothly and we are excited about the benefits this acquisition will provide to Harsco as well as our customers.
Lastly, metals adjusted operating margin reached 12.2% in the second quarter.
Turning to industry on Slide 6, revenues increased 25% for the segment versus the comparable period in 2017 while operating income rose over 50% compared with the 2017 quarter. Each of our three product businesses within industrial realized revenue and income growth in the quarter. These changes reflect positive demand trends, higher product prices, and improved margins. As a result, the segment’s operating income margin increased to 15.4% from 12.6% in the prior year period.
Also as mentioned earlier, customer bookings and backlog trends were very positive in Q2. Bookings across the segment rose approximately 40% versus the second quarter of 2017, and our backlogs grew 20% quarter-over-quarter and reached over $130 million, with most of that backlog maintained within our Air-X-Changers business. Air-X-Changers continues to perform well and realized strong margins, illustrating the benefits of the manufacturing improvements we’ve implemented in recent years.
Now for the rail segment on Slide 7. Revenues in the second quarter increased 9% mainly due to the recognition of SBB revenue in the quarter, which as we’ve noted before has zero margin. Beyond the SBB impact, higher revenues from aftermarket sales were offset by lower equipment sales outside North America and lower contract services sales. These trends, along with product mix and lower SG&A, contributed to a slight increase in operating income relative to the prior year quarter. Operating income totaled $9 million versus $8 million in Q2 2017. Rail’s operating margin reached 14% excluding the effect of the zero margin SBB revenues.
Regarding our SBB contracts, we continue to make steady and positive progress against our commitments to this customer. Twelve of the 13 base vehicles have been handed over to SBB under the first contract. The equipment is performing very well and SBB remains pleased with the capabilities of the machines. With respect to the second contract, we expect to lock down the design of the vehicles during the second half of this year.
As I alluded to earlier, customer bookings and backlog growth was positive in Q2. Orders increased over 20% year-on-year and represented our highest quarterly total since early 2014. Our largest wins in the quarter were an equipment order with U.S. Metro and a relatively large equipment sale into Southeast Asia. As a result, our backlog stands at roughly $280 million in rail.
Turning to Slide 8 and our latest 2018 outlook, let me highlight a few key items. First, our full year adjusted operating income guidance has increased to a range of $175 million to $185 million. This compares to $165 million to $180 million previously. Likewise, our forecasted adjusted earnings per share is now expected to be between $1.19 and $1.27 per share as compared to a prior range of $1.11 to $1.24. These outlook changes are being driven primarily by our industrial and rail segments as well as corporate.
For industrial, our visibility and confidence has improved, as mentioned earlier, and as a result operating income for this segment is now projected to increase roughly 45% versus 35% previously. For rail, higher contributions from aftermarket and a more favorable product mix support a better outlook. Net corporate spending for the year is now expected to be similar to the prior year.
Our free cash flow guidance is raised to a range of $90 million to $100 million.
As we mentioned on our last quarterly call, at this point we don’t expect any material impact from input cost inflation as a result of higher commodities and labor costs across our businesses; however, we will continue to monitor this closely.
One item that had somewhat of a negative impact is the movement in FX rates. The stronger U.S. dollar has impacted our expectations for the year’s operating income by a few million dollars versus our expectations a few months ago. Overall, FX is now expected to be neutral to our revenue and earnings for the full year as compared with 2017. Our summary outlook for each of the businesses is included in the presentation appendix.
Let me continue with some comments on the third quarter on Slide 9. In Q3, we expect operating income to be between $50 million and $55 million as compared to adjusted operating income of $39 million in the third quarter of 2017. Also, diluted earnings per share is projected to increase and be between $0.34 and $0.40 per share as compared with adjusted earnings per share of $0.20 in the prior year quarter. As was the case in Q2, each of the company’s segments is projected to realize an improvement in profitability versus the third quarter of 2017.
Rail earnings are expected to increase significantly versus the prior year quarter due to higher contributions from aftermarket, equipment and Protran products. Because of the timing of shipments in rail, we anticipate that rail’s full earnings for the third quarter of this year will look most similar to the fourth quarter of last year. We expect M&M to benefit from higher service levels and applied product contributions as well as new contracts. These positives are expected to offset our growth investments and FX impacts.
Industrial results are anticipated to increase from the prior year quarter due to improved demand. Note that our guidance takes into account a $4 million gain in the third quarter of 2017 that will not be repeated this year.
Lastly before we take your questions, we ended the quarter with a net debt position of approximately $600 million and a leverage ratio of two times after the Altek acquisition. During the quarter, we were pleased to lower the interest rate on our term loan by 75 basis points. This change lowers our annual interest costs by $4 million, which is a nice incremental benefit over the re-pricing benefits we realized in late 2017. We also increased our credit capacity by $100 million, giving us added flexibility as we execute our strategy, including making growth investments across our segments. At the end of the quarter as a result, Harsco’s liquidity exceeded $400 million. We expect to end 2018 at or near a leverage ratio of 1.5 times. We anticipate using our free cash flow in the second half of this year to support our growth objectives, reduce our debt, and return some capital back to shareholders with stock repurchases.
That concludes our prepared remarks, and at this point we’d be happy to take your questions.
Your first question comes from the line of Rob Brown with Lake Street Capital Markets.
Good morning. Nice job on the quarter.
Good morning. Thank you, Rob.
First, I’d like to just go into the acquisition strategy a little bit more. Altek seemed like a nice fit, but maybe just give some more color on your thoughts on additional acquisitions, how Altek fits into that, and what else might you be looking for.
Well, Altek provides us access to a new industry, that being the aluminum industry. That’s our first step, of course, and we intend to build a platform around it to serve the aluminum industry. Of course, Altek also brings a technology that enables us to solve what is widely regarded as the largest issue that aluminum producers and recyclers have, that is processing what’s largely viewed as waste of salt cakes, so we believe that is our initial entry. There’s a lot of opportunity beyond Altek within the aluminum space that we intend to pursue over time.
At the same time, we’re looking at a number of other adjacent markets that all address the same theme of helping industrial companies convert their waste streams or by-products to saleable and higher value products further downstream. There are a number of segments we’re looking at. We’re very excited about the Altek acquisition, but it is just the first step. I think you’ll see us make similar moves over time, whether in the aluminum space, in steel, or other adjacent basic industries.
Okay, that’s a good overview, thank you. On applied products, you talked a bit about market strength or strength in contribution there. I just wanted to clarify - is that market strength, or are there other new products you’ve developed there? What’s happening in applied products?
Well, it’s both. I would say the primary driver of the strength is the investment that we have made in commercial resources, so now we have dedicated applied product leaders and commercial resources in each of our geographic regions. There is a big push on it. We also in our innovation pipeline internally generated a number of new product opportunities within applied products, so I would say it’s driven mostly by internal initiatives; but also of course our customers increasingly are looking for new solutions to address their waste stream within the steel industry.
Okay, good. Then I just wanted to clarify what the nickel price assumption is in the guidance at this point.
Pete, do you have that?
Yes, sure Nick. The nickel price for the first half, we assumed it was about where it is today, frankly - about $6 and change per pound. The assumption is largely going to continue for the rest of the year, and as I said, that’s pretty much exactly where it is today. We don’t really expect any significant change in that, Rob.
Great, thank you. I’ll turn it over.
Your next question comes from the line of Jeff Hammond with Keybanc Capital Markets.
Hey, this is Trish Gorman on for Jeff Hammond. Can you talk a little bit more about that updated guidance, what’s changing the key factors that drive an updated view, and maybe just clarify within rail, it looks like the outlook for revenue, excluding SBB, is slightly lower than last quarter, so maybe just a little bit more color on that.
Okay. Pete, you want to take that as well?
Yes, sure. Let me start with the second part of that question. The outlook for the second half for rail is quite strong, but the second half of the year tends to be strong for rail, so certainly as it relates to the first half, you’ll see a significant uptick both in terms of operating income particularly. As I mentioned in my remarks, the third quarter is where we kind of expect to be the bigger of the two quarters in the second half of this year, which is kind of the reverse of where it was last year. But by and large, all three of the segments, if you look at the second half, are up versus the prior period, and we expect the trends to continue in industrial and rail particularly from what we’ve experienced in the first half of the year.
Okay. Then for the growth investments within M&M, what impact did that have in the quarter and what should we expect going forward?
I think that’s difficult to say. Clearly the investments have been in people and, of course, the Altek acquisition. With respect to the human resource investments, it’s both a business development function which of course is focused on strategy and acquisitions, as well as the resources similar to the ones I mentioned for applied products that have been added to the business. So it’s clear that we’re getting a return on those investments, but I would expect the larger return to really be in 2019. As I mentioned earlier, we’re expecting a nice lift in revenues in M&M in 2019, and we believe that should be around 10% revenue growth next year, if not a little bit higher.
Okay, great. Thank you, that’s helpful.
Again if you would like to ask a question, please press star, one on your telephone keypad. That is star, one to ask a question.
We have a question from Fran Okoniewski with Friess Associates. Fran, your line is open, please state your question. Again Fran, your line is open, please state your question.
There are no further questions.
Thank you, Deidre, and thank you everyone for joining us this morning. We certainly appreciate your interest in Harsco, and we look forward to speaking with you again in a few months. Have a great day, thank you.
This does conclude today’s conference call. You may now disconnect. Thank you for your participation, you may disconnect. Thank you, have a great day.
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