Harsco Corporation

David S. Martin - Harsco Corp.

F. Nicholas Grasberger - Harsco Corp.

Peter Francis Minan - Harsco Corp.

Jeffrey Hammond - KeyBanc Capital Markets, Inc. Rob Brown - Lake Street Capital Markets LLC Bhupender Bohra - Jefferies LLC Robert F.

Norfleet - Alembic Global Advisors LLC

Thank you, Bridgett, and welcome to everyone joining us today. I'm Dave Martin, Director of Investor Relations for Harsco.

With me today is Nick Grasberger, our President and Chief Executive Officer; as well as Pete Minan, our Senior Vice President and Chief Financial Officer. This morning, we will discuss our results for the third quarter of 2016, our outlook for the fourth quarter, and we'll also take your questions.

Before our presentation, however, let me take care of a few administrative items. First, our Q3 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 the IR section of our website.

Secondly, this call is being recorded and webcast. A replay will be available on our website later today.

Thirdly, we will make statements today that are considered forward-looking within the meaning of the Federal Securities Laws. These statements are based on our current knowledge and expectations and are subject to certain risks and uncertainties that may cause actual results to differ materially from these forward-looking statements.

For a discussion of such risks and uncertainties, see the Risk Factors section in our most recent 10-K as well as in our 10-Q for the period ended June 30, 2016. The company undertakes no obligation to revise or update any forward-looking statements.

Lastly, on this call, we will refer to adjusted financial results that are considered non-GAAP for SEC reporting purposes. A reconciliation to U.S.

GAAP results is included in our earnings release today, as well as the slide presentation. Now, I'll now turn the call over to Nick to begin our prepared remarks.

Good morning, everyone, and thanks for joining us. The market trends that we experienced in the first half of the year largely continued this past quarter and our financial results were consistent with expectations.

The exception was cash flow, which was stronger than expected, I'm very pleased to say that we've raised our cash flow guidance for the year. Over the past few months, we've also taken significant steps to improve our balance sheet and liquidity positions, further upgrade our executive leadership team, and also boost our operating leverage.

The highlight within Harsco continues to be Metals & Minerals. Despite weak steel production and low commodity prices, M&M margins have stabilized that their highest levels in over 10 years due to cost reduction and a much improved mix of contracts.

Underperforming contracts have declined from about one-third of the portfolio two years ago to well under 10%. At the same time, working capital and capital spending efficiency are much improved driving cash flow this year to a level 2 times to 3 times the average generated over the past five years.

As we look ahead to 2017, we're hopeful some improvement in market conditions will fuel continued the earnings growth. But in any case, we are excited about the growth opportunities in new contracts, add-on services at existing sites, and in applied products.

And in terms of operational excellence, we continue to implement best practices across our sites to both reduce costs and boost our competitive position. The Industrial segment continues to demonstrate its resilience at the bottom of its industry cycles.

I've been very pleased with the cost reduction and working capital improvements that have enabled the segment to maintain a double-digit operating margin and solid cash flow despite the sizable drop in revenues. We believe we have seen the trough of these markets and look forward to some recovery in 2017, however modest it might be.

The pipeline of project opportunities in heat exchangers, commercial boilers and high security fencing for next year is also encouraging. Volumes in our Rail business are at their lowest level since 2009, consistent with the reduction in capital spending for maintenance equipment by the Class I railways here in North America.

In addition, the delivery dates on our equipment orders have been deferred to next year by our customer. Overall equipment sales in the core North American market are expected to be 30% to 40% lower this year than the average annual shipments over the past five years.

However, aftermarket sales have held up much better and are up about 10% compared to last year. In terms of our contracts with the Swiss National Railway, the initial delivery of vehicles occurred during the quarter and the early test results are quite good.

I met with a customer last week, and they are very pleased with the quality of the vehicles. So despite the recent challenges with the contract, I'm confident that our relationship with SBB will be both long lived and profitable.

Finally and most importantly, Jeswant Gill joined us few days ago as the new President of Harsco Rail. Jeswant brings the leadership, energy, and experience that we need to capture the opportunities available to us in the global maintenance-of-way market.

So in summary, as we navigate the final few months of 2016 we look ahead to next year with a great deal of optimism. Each of our three principal end markets, steel, energy and rail, likely touched bottom this year, and yet cash flow and EBITDA minus CapEx margins will be at their highest levels in several years, while operating margins remain in the high single-digits.

The balance sheet is also the healthiest in many years. Financial leverage is nearing two times, and yesterday we secured committed financing for the next five years to seven years.

And with the recent appointment of new leadership in Metals & Minerals and Rail, we have a very strong committed executive team anxious to turn its focus to rowing our company. Before I turn the call over to Pete, I want to take a moment to publicly thank our employees who work so hard and effectively in helping Harsco turn the corner.

To be sure, we have more to accomplish, but I also know how far we have come. So I could not be more proud of the Harsco organization.

I'll now turn the call over to Pete.

Thanks, Nick, and good morning, everyone. So let me start on slide four of the materials.

Operating income in the third quarter was $29 million, and this result was within our guidance range of $27 million to $32 million. As Nick said our Metals & Minerals segment had another strong quarter due to a variety of positive factors.

The regions that contributed to a better result included our Europe, Latin America, Middle East, and North American regions. The contributing factors in these regions are varied, and included drivers such as higher nickel volumes in the U.S., service volumes and mix in Europe and the Middle East, steel output in Latin America and lower operating costs at some sites.

But again, no single variable helped the quarter given the diversity of our M&M business. Also corporate costs were a bit lower than forecasted due to our continued reduction in staffing and other expenditures.

Compared to the 2015 quarter, as was the case in recent quarters, Metals & Minerals realized an increase in operating income as a result of our internal initiatives or improvements despite limited to mill (08:36) uplift from the external market. M&M's operating margin in Q3 was 9.7% compared with 7.7% in the prior year quarter, which is certainly worth highlighting and as a result of our internal cost in operating improvement initiatives.

Also compared with the prior year corporate spending was lower. And these positive factors were offset by lower profitability in our Industrial and Rail segments as a result of cycle pressures, which we believe either have bottomed or are nearing bottom.

Revenues in the quarter declined as expected to $368 million, which represented a decrease of 14% year-over-year. Lower demand in Industrial for heat exchangers and site exits in Metals accounted for the majority of this change.

Harsco's reported diluted loss per share was $0.41 in Q3, which included non-cash accounting items of $44 million related to the sale of our interest in Brand, and the write-off of a portion of deferred financing costs related to our debt reduction. Excluding these items earnings per share would have been $0.14 in Q3, which was also within our guidance.

These figures compare to a prior year GAAP loss of $0.10 and adjusted earnings per share of $0.18. Our equity income from our Brand Energy joint venture was $3 million or $0.03 per share in the quarter, which was comparable to the 2015 quarter and was modestly above the guidance range we provided for the quarter.

Also as you know starting in the current quarter we will no longer report any equity income from Brand. As Nick mentioned free cash flow for Harsco in the third quarter was very strong totaling approximately $60 million compared with $23 million in the prior year quarter.

As discussed in the past, free cash flow was a key financial metric for Harsco, and we've been keenly focused on a number of initiatives to strengthen our cash generation. Our progress here showed in the quarter and in the year-over-year growth in free cash flow was driven by working capital as well as lower capital expenditures.

Year-to-date free cash flow is now $62 million. This total has surpassed our internal forecasts principally due to actions within M&M and as a result we have raised our free cash flow outlook for the year.

Let's move to slide five, in the third quarter Metals & Minerals generated operating income of $24 million, which compares to adjusted operating income of $21 million in the prior year quarter. During the quarter, improved performance at previously underperforming sites and cost reductions were the primary drivers of the year-over-year improvement in adjusted operating income, and these benefits were partially offset by site exits.

The year-on-year negative impact of net site exits or a contract churn on operating income was approximately $1.5 million for the quarter. This amount was consistent with our expectations.

It is also lower than recent quarters and these impacts should continue to diminish in future quarters. Customer liquid steel tonnage or LST declined 7% year-over-year in absolute terms and it was unchanged on continuing site basis, which was consistent with our expectation.

I've noted this quarter was the first quarter in over a year in which our LSTs at our continuing sites did not contract on a year-over-year basis. Also the change in our LSTs in Q3 was slightly better than steel industry trends in the major regions where we operate.

Also nickel prices were little changed compared with the 2015 quarter. Free cash flow year-to-date in Metals has more than doubled to $108 million as compared to $47 million in the prior year.

With this improvement mainly attributable to changes in working capital and capital spending. Slide six, the story line in Industrial is similar to recent quarters in that we've experienced a year-over-year decrease in revenues and operating income as a result of lower demand for heat exchangers from U.S.

energy customers. We also experienced a decline in demand for industrial grating compared with the prior year, which is also partially attributable to the energy market.

Operating income was $6 million in Q3 compared with operating income of $14 million in the third quarter of 2015. And despite a 30% revenue decline Industrial was able to maintain 10% margin in the quarter, as a result of prior cost reduction efforts.

Looking forward, we expect the weakness in our industrial grating business to persist, but we are encouraged by the recent customer activity within our Air-X-Changers business. The stability within Air-X has likely resulted from a stability and energy prices.

Here our orders and bookings appeared to have bottomed in the early part of Q2 and we've since seen steady improvement. Absolute volumes remain at a low level certainly, but our bookings improved quarter-over-quarter, and also modestly, year-over-year and as a result our Air-X backlogs grew slightly against the sequential quarter for the first time in seven quarters.

Let's move to slide seven, operating income in Rail was $5 million in the third quarter versus $8 million in the prior year quarter. This change was mainly attributable to lower contributions from contract services, and overall our Rail results in the quarter were a bit disappointing.

Some of this was timing and the remainder was largely driven by continued demand weakness in the domestic market for maintenance-of-way equipment. Meanwhile, a positive in Rail's quarter was free cash flow.

Despite remaining negative for the year, free cash flow was positive in the third quarter with much of the year-over-year and quarter-over-quarter improvement attributable to working capital including contract advances. On our August call, we stated that Rail free cash flow was to improve considerably in the second half of this year and we expect Rail free cash flow to be also positive in the fourth quarter.

Lastly, on our SBB contracts as Nick mentioned, recent developments have been positive. We did receive cash advances from SBB in the third quarter and we delivered our first base vehicle to the customer during the quarter for testing and commissioning.

Also as Nick mentioned feedback from the customer on product quality and our service are very positive, and we remain optimistic that we can profitably grow our relationship with SBB over time. Moving to slide eight, which includes our key outlook items for the remainder of the year.

Many of these variables were narrowed around the midpoint of our previous ranges. The exception is free cash flow where we raised our outlook as mentioned earlier.

Reported or GAAP operating income is expected to be within a range of $60 million to $69 million including the unusual items recorded year-to-date. Excluding these unusual items adjusted operating income is now projected to be between $108 million and $117 million, as compared with $105 million to $120 million previously.

Also we now expect adjusted earnings per share to be within a range of $0.36 and $0.45. This outlook reflects that our expectations for Industrial are unchanged while we've trimmed our earnings view in Rail in the short-term due to continued pressures within the domestic market.

And this impact is partially offset by the M&M outlook and lower corporate spending. Moving on to free cash flow, our guidance for free cash flow was increased to a current range of $75 million to $85 million for the year, versus the prior range of $65 million to $80 million.

Working capital improvements and lower capital expenditures within M&M are driving this higher range. And this range now includes net capital investments of approximately $70 million in 2016.

Before I turn to the fourth quarter, let me comment briefly on our financial position including our recent refinancing. As we announced yesterday, we've just completed a very successful refinancing of our entire capital structure.

Our term loan offering was well oversubscribed and the final terms of this facility are more favorable than our original expectations as a result. We're also very pleased with and grateful for the continued support from our relationship banks.

Our pending maturity has arguably been an overhang of Harsco for some time. And as you know we've been keenly focused on our balance sheet over the past year.

This transaction extends the maturity profile of our debt obligations and significantly strengthens our financial flexibility. So clearly we're pleased to complete this refinancing and also with the progress we've had to-date in reducing debt.

During the quarter, our net debt position declined more than $200 million to less than $600 million and we have now surpassed our stated debt reduction goal for the year. Strong free cash flow and the sale of our Brand interest drove this change in the quarter.

Also our net leverage position declined to 2.2 times and we ended the quarter with more than $340 million of liquidity. So moving to slide nine, regarding our fourth quarter outlook, we expect operating income to be between $20 million and $29 million, as compared to adjusted operating income of $26 million in the fourth quarter of 2015.

Operating income in Metals is expected to increase over the prior year as cost improvements will offset site exits. Industrial operating income is forecasted to fall on lower demand for heat exchangers and industrial grating as well as mix.

Rail income will be similar to the fourth quarter of 2015, as higher international equipment sales will be offset by lower contract services work and continued softening of North America equipment market. And corporate costs are anticipated to be slightly lower than prior year levels.

Compared with the just completed quarter, you should expect some seasonal impact with our M&M and industrial grating businesses, and an improvement in Rail earnings. So that concludes our prepared remarks.

And at this point we'll be happy to take your questions.

Hey, good morning, guys.

Hey, Jeff.

Hey, how are you doing?

Doing well. So I guess with the financing in the balance sheet certainly in solid shape, M&M performing well and looks very stable and encouraging.

Just maybe update us on how you're thinking about the portfolio discussion in your announcement a little while back about splitting the businesses or looking at strategic alternatives?

Sure, Jeff, good question. Well, we certainly are as committed to a separation process as we were about a year ago when we announced our intent to do so.

Of course, though we're very focused on getting the highest value per shareholder as possible, and therefore with the markets remaining quite weak, we simply don't believe that the timing has been ideal to do that. So we're still focused on it, we're still watching the markets of course very, very carefully, but it's really a matter of timing.

Okay, and then just as we – can you hear me?

Yes.

Okay, just as we kind of peek into 2017, can you just talk about what you're seeing from a visibility standpoint in Rail outside SBB, and just kind of the confidence level with kind of stable M&M markets kind of how you're feeling about sustaining these margins that have been much better in 2Q, 3Q? Thanks.

Yeah, yeah. Yeah, I'll start with that Jeff.

With M&M I think we're all quite confident that these margins that we've achieved over the last few quarters in M&M are sustainable. As you know, we have long-term contracts.

We're quite confident that the contracts that are maturing next year will be renewed. And so I think we feel quite good about the cost structure, and also the ongoing opportunities to boost operational excellence, there are still many, many things that we're doing.

As part of the former Orion Project which are now, I'll say part of our business system, that will continue to yield benefits to us. So quite confident in M&M, less confident of course in where the industry is going, and whether or not we'll see higher production levels that would lead to further earnings growth for us.

But margins I think are stable at this high level and if anything there's probably some more upside opportunity even without the lift in the market. In terms of Rail, the visibility into 2017 is not good.

As you know, it's a long cycle business. So we look back at the previous trough in 2009, it was followed by a reasonable recovery in 2010.

We see no evidence that this cycle will be similar to that. We're of course hopeful, and perhaps a bit optimistic, but we've not really seen any data that would suggest that the Rail market will improve next year.

On the short cycle end of the business that being aftermarket, we continue to take share in aftermarket as we further penetrate that market. So I would expect further growth in aftermarket next year, even without a recovery on the equipment side.

Okay. Thanks, guys.

Yeah.

Good morning. Thanks for taking my call.

Yeah. Hi.

Hey, Rob.

Hi, on the Industrial segment you talked about some signs of recovery, and maybe the first kind of backlog stability and growth in a number of quarters. How does that sort of line you up for 2017.

Should that be a – could that be a growth year or how does 2017 look in Industrial?

It could be, but I think if it is, it's going to be fairly modest at least based on what we're seeing at the moment. So yes, backlogs are increasing, order rates have improved, but not at dramatic (24:20).

So, yes, we're optimistic, and I think we have good reason to expect some growth next year in the Air-X-Changer business.

Rob, it's Pete, to give you a little color on the backlog figures for Air-X-Changers, I mean, there – we're seeing a modest increase quarter-on-quarter, but they're still down 30% plus year-on-year in terms of backlog. So we're cautiously optimistic, we're moving in the right direction.

But it's not going to get back to the 2014 levels quickly.

Okay. And then in terms of margins, can you still see margin expansion in a stabilized environment or just sort of where you are at (24:59)?

You're speaking about Industrial?

Yes, correct.

Yeah, I think that there's margin opportunity in next year in Industrial for sure.

All right. Thank you.

I'll turn over.

Good morning, guys.

Good morning.

Hey, Bhupender.

Hey, just a question on M&M here on the exit revenue, I think, Pete, you mentioned about you gave the number on exit – the impact of exit revenue on operating income. Can I have the exit revenue?

Yes, for the quarter Bhupender it's about $20 million year-on-year, which it translates to the $1.5 million of the operating income level and for the full year we're looking about $80 million of revenue, which is consistent with our $10 million of operating income effect.

And how should we think about that number going into 2017 – I think Nick talked about like some of the contracts coming up for renewal next year. Can you give us some color in terms of like any contracts, which will not be renewed or the risk is higher or lower?.

As we've looked at each of those contracts, we are fairly confident that each will be renewed. So I do not see any significant impact of site exits on revenue next year.

Yes, this impact has been diminishing, ebbing in the last couple of quarters Bhupender, and next year we're not expecting it to be any real significant effect of contract churn.

Okay, got it. And that the second question on Industrial, I think Nick you mentioned about some opportunities over there, as you are looking at heat exchanger business, the Hammco business.

If you can give us how that business is doing and from the fencing side, I think that was one of the opportunities we have talked in the prior calls to if you can update us on that? Thank you.

Well, in terms of Air-X-Changers the team there has done a tremendous job continuing to take cost out of the product and find additional operating cost reduction opportunities. So I think and I alluded to it in my prepared remarks the operating leverage in Air-X-Changers has really never been higher, the new facility that we're in, and its ability to really produce much higher volumes is something that's really going to benefit the business over the next couple of years as the market recovers.

So very optimistic about, about the Air-X-Changer business. In terms of security fencing we've had an awful lot of both positive press and potential customer increase into the product and received very high praise for its uniqueness and its value proposition, it's just a matter of now that budgets for 2017 for these large projects are being constructed.

As we look into 2017, we certainly are optimistic that some of these projects similar to the one in Mexico at the Mexican City – Mexico City airport, which we were awarded this year.

Okay. And lastly on the Rail side I mean you guys have talked about some decent opportunity like SBB, which you are bidding for, any updates on those like in the Europe, Asia and some of the geographies you've been bidding for those contracts?

Yeah, none of those opportunities have been awarded. They continue to be pushed out, but they remain active.

And we're very involved whether it's in Europe or in Asia. So I think given the learnings of the SBB contract, and the much stronger team that we have in place, we look forward to future opportunities like SBB.

Okay, and lastly on the Hammco, do you have that number like how much that business grew in this quarter?

It was double-digits for sure. I'm going to say it was 20%-plus.

Okay, got it. Thanks a lot.

(29:43) How are you all doing this morning?

How are you doing?

I'm fine. So just question for I guess for Pete and Nick, with the recent refinancing of the balance sheet and the debt reduction, as well as improving free cash flow, how should we look at capital allocation priorities in 2017?

I mean, you guys have been clearly plain decent with debt maturities being an issue now, clearly you've gotten flexibility to do some other things. I mean, should we expect you guys to look at M&A and buybacks with a little more enthusiasm as we move into 2017 or is it still about debt reduction?

Well, I think it's primarily debt reduction. We certainly do have the ability now to focus on both on M&A and also putting some growth capital back into M&M.

And as we look at growth opportunities in M&M, there are some that are quite compelling. So I think you will see us invest in growth, in M&M, and new contracts next year.

In terms of M&A, any M&A would be similar to a Hammco or Protran, two acquisitions we've made in the past few years that have been highly successful, very much bolt-on type opportunities and kind of below $100 million type probably price tags.

So, Rob, it's Pete. So the pro forma leverage ratio for after the refinancing, is just maybe in the 2.2 times to 2.3 times range and we feel pretty comfortable operating at that debt level – at that leverage ratio.

So anything that – Nick was referring to in terms of growth whether it's in investment in additional capital in Metals or bolt-on acquisitions, we'll still be targeting to be in that leverage range.

Okay. Perfect.

And that goes to Pete in terms of the free cash flow, obviously, great improvements this year. As we look into next year, looking at working capital, or your CapEx (32:04) supposed to be.

Any reason, we should assume a similar conversion of net income to free cash flow?

Yes, I think there is – that's a reasonable assumption and certainly we are keeping eyes on, but the initiatives that we put in place in terms of working capital and the discipline we put around capital spend certainly are going to sustain in the future.

Okay, great. My last question just on the M&M, I know you all talked about some of the exit revenues and the impact on operating income.

Based on what you said Pete, should I – should we assume that there are no longer any contracts in a loss position or are there still some exits which we should expect going into 2017?

Yeah, we're not anticipating any exits of any magnitude in 2017.

Great. That's all I have.

Thanks.

Thank you.

Hey guys, just a couple of housekeeping items. So, versus the $50 million to $51 million interest expense, how are you thinking about that in 2017 with the new financing, and just with the JV gone, what's kind of the normal ongoing tax rate?

Yes. So the first question in terms of interest with the average debt levels coming down significantly and with the terms we've gotten on the financing.

We should expect a modest decline in interest expense year-on-year. As far as the – what's the other question...?

The tax rate.

Yeah cash taxes should be under 20% and the other tax rate should 40%-plus, roughly consistent with the current year.

Okay. Thanks, guys.

Thank you, Bridgett, and to those that joined the call this morning. A replay of this call will be available later today through November 17, and the replay details are included at the top of our earnings release – I'm sorry, at the back of our earnings release.

If you have any follow-up questions, please do contact me, my details are also on the release. And again, thank you for joining and have a great day.