Executives
Derek Hathaway - Chairman and Chairman of Exec. Committee
Sal Fazzolari - CEO
Mark Kimmel - Sr. VP, Gen. Counsel and Corp. Sec.
Analysts
Curtis Woodworth - J.P. Morgan
Jeffrey Hammond - Keybanc Capital Mkts
William Fisher - Raymond James
Harsco Corporation (HSC) Q4 2007 Earnings Call January 31, 1969 6:00 PM ET
Operator
I would like to welcome everyone to the Harsco Corporation Fourth Quarter Release Conference call.
(Operator Instructions)
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.
I would now like to introduce Mr. Derek Hathaway, Chairman of Harsco Corporation. Mr. Hathaway, you may begin your call.
Derek Hathaway
Thank you very much. Good afternoon, ladies and gentlemen, and welcome to this conference call which principally will be dealing with the year 2007 and its fourth quarter. With me in the room today are Gene Truett who is the Investor Relations principal and also Chief of Credit Control for Harsco Corporation, Ken Julian who is our Director of Communications, Stephen Schnoor who is the Chief Financial Officer, formerly Controller, who became the Chief Financial Officer on January 1, 2008. He was present at the last conference call and is present with us here today. Mark Kimmel who is Chief Counsel and Board Secretary and Sal Fazzolari who is our new Chief Executive Officer, formerly our Chief Financial Officer as you are aware.
It is a very considerable pleasure obviously for me to conduct what will be my last conference call. In the long career that I have had with Harsco Corporation and most of the meeting will be I guess led by Sal, our new CEO and the gentleman who we anticipate will become the Chairman immediately following the annual meeting on April 22, 2008.
You will understand the particular pleasure that it gives me personally to account for the results of the year and the fourth quarter. They’re quite self-explanatory in the press release and all I can say is, as a summary for the year, we did what we said we were going to do and more and that all of the principal objectives that we laid out in 2006 relating to 2007 were accomplished plus a little bit. So without any further ado, I am going to hand the call over now to Mr. Fazzolari who will give us a lot more detail on the results.
Sal Fazzolari
I do need to have Mark just briefly read the Safe Harbor Statement before the commencement of comments.
Mark Kimmel
As we do at the beginning of all of our calls we just want to let you know that we will be having forward-looking statements in our discussion with you today. The statements relate to the future of our business, our operations, our results, economic expectations and other aspects relating to and affecting our business. While what we say today is based on the best information we have available, it is possible that the results could differ from what we tell you today. We have listed in our SEC statements reasons, risk factors that affect our business and these could be the reasons for any difference that could occur. We invite you to you review the SEC filings at your convenience.
We would also like to remind you that replays of this call and related information are available at our website. Please take the time to access that at your convenience and you can also access replays at that website.
Sal Fazzolari
Thanks, Mark. Good afternoon everyone. It is certainly a pleasure to be here with you today. We were obviously very pleased with the fourth quarter 2007 performance from continuing operations. Sales, income, diluted earnings per share and operating margins were all records, underpinning exactly what Derek just said. Also, the overall fourth quarter operating margin for the company was quite pleasing to us as well where we hit a record 11.4% and that is an 80-basis point improvement over last year’s 10.6%.
Additionally, we are very pleased with the improvement on the return on invested capital for 2007. The return on invested capital for continuing operations improved by approximately 120-basis points to 11.8%. Margin expansion and improvement in the return on invested capital of course all translates to value creation. This value creation is captured in what we call the measurement of EVA or EVA performance. For 2007, our EVA performance exceeded the target by nearly 400%. I would also like to remind you that the annual EVA target of Harsco is set independently by Stern Stewart, our EVA consultant, and the Management Development Compensation Committee of the Board of Directors. We do not set or control the EVA target, we just simply try to exceed it.
Staying with the full year results, there are some other salient points that I would like to make regarding the overall exceptional performance of 2007. Operating margins for the company overall for the year, a record 12.4%. That is a 100-basis point improvement over last year’s 11.4%. Our strong performance, we believe, was underpinned by a well constructed and well-balanced global portfolio of substantial industrial service businesses that we believe are well positioned both geographically and operationally to continue their forward momentum in 2008.
This balance was manifested well in 2007 in the overall operating income of the company. The full year operating income was $458 million with Access Services accounting for 40% of the total, Minerals and Rail accounting for 31% and Mill Services accounting for the remaining 29%. We believe that is balanced.
Sales increased 22% in 2007 to a record $3.7 billion. Organic growth contributed about 9% while acquisitions contributed 7% and foreign currency translation accounted for the remaining 6% of the growth in sales. This performance again exemplifies Harsco’s balance.
We are also pleased with our business profile at the end of 2007. For the year, our industrial services portfolio accounted for 86% of total sales while international sales accounted for almost 70% of total sales.
Our sales for the year were geographically balanced as follows: 19% of total sales in emerging economies such as the Middle East and Latin America with 34% in North America and the remaining 47% in Western Europe. To remind you, our goal for the next three years is to increase sales outside North America and Western Europe from about 19% to about 30% of total sales, off of course a much larger base.
Noteworthy for the year was the sales growth of our Access Services Segment. Sales grew by a very healthy 31% with approximately 19% coming from organic growth, only 5% from acquisitions and 7% from foreign currency translation. The sales growth in Access Services was well balanced throughout the world. We were particularly pleased to see that the key emerging economies such as the Middle East and Eastern Europe contributed significantly to the overall sales growth of the group, as these economies continue to make significant investments as you all know in new construction and infrastructure modernization initiatives.
Also, noteworthy for 2007 is that we did exceed our cash flow target of $445 million that -- is cash flow from operations. That was exceeded by $27 million. So for the year we ended up with $472 million, which is a 15% increase year-over-year.
Consistent with our growth initiatives, our substantial cash flows enabled us to invest a record of $444 million in capex in 2007. This is an increase of approximately 30% over last year’s $340 million. Importantly, over 55% of this year’s capex or about $246 million has been invested in strategic growth initiatives with the remaining 45% allocated to what we call sustaining the current revenue stream, what you may call it maintenance capex. The $246 million in growth capex is in addition to, you may recall, the $148 million we invested last year in growth capex, so that is quite a substantial amount of capital that we have invested. Again that is manifesting itself in the financials through organic growth, particularly what we have just outlined for you on Access Services.
So based on this organic growth rate for 2007, as you would expect, approximately 68% or $168 million of the growth capital for 2007 was invested in fact in our rapidly growing Access Services Segment. The remained of the growth capex for 2007 or approximately $77 million was invested mainly in the Mill Services business. So again, good balance there.
I am also very pleased to report that our debt to capital ratio decreased 760-basis points during the quarter to 40.8% from 48.4% of September 30, 2007 and 730-basis points from 48.1% at December 31, 2006. This substantial decrease is due to the cash proceeds from the sale of the Gas business, as well as our strong internally generated cash flows from operations.
In fact, if you look at the net debt, if you backed out the cash, it has a three in front of it. We are well below the 40, I believe it is around 38-something percent, so we are quite pleased with where we are with our debt to cap ratio. So in a nutshell, we ended the year with a very strong, very healthy and a re-armed balance sheet.
Now, let us turn and look at the fourth quarter performance both from an overall perspective and talk a little bit about each of the business groups.
Overall sales for the fourth quarter for the company grew by again, 21%, very strong. Organic growth contributed over 8%, while acquisitions contributed approximately 6% and foreign currency translation accounted for the remaining 7%. We are certainly pleased with our strong organic growth rate, again as it underpins our continued confidence in our future organic growth investment opportunity that we see throughout the globe.
Cash flow from operating activities for the fourth quarter came in at about $99 million. That is $31 million lower than last year’s record $130 million, but this was expected. The main reason for the decrease are two things; one is we expect a much higher tax payments in the fourth quarter year-over-year and, also, we have had a little bit of inventory or working capital build up to meet the extremely strong backlog that we have in some of our businesses, particularly at HTT as we get geared up for the China order.
Now, looking at the segments in a little more detail, as it has done all year long, our global Access Services business led Harsco’s growth setting new quarterly records for sales, operating income and margins. The fourth quarter was well balanced and broad based. Again, we are especially pleased with the excellent 18% organic growth for the business in the fourth quarter. Also, noteworthy in the fourth quarter is the fact that operating margins in Access Services improved by 300-basis points, so a record 13.3%.
Reflecting on the year, operating margins improved 190-basis points from 11.1% to 13% and we are obviously very pleased with this performance.
The outlook for Access across our large and expanding global footprint is pretty much the same. We remain very positive. We see significant growth opportunities and you should see similar investments in 2008 as you saw on average for the last couple of years.
On the Mill Services side, again, as pointed out in the press release, the Mill Services performance for the fourth quarter, again internally as expected, it was down due principally to a $4.7 million pre-tax charge, as well as $2.9 million in additional expenses as part of our overall initiative to optimize the organization. As you may recall, we spent quite a bit of time in December talking to you about how we are investing money in the business overall and particularly on the Mill Services side as well, on better optimizing the organization. And we would be happy to expand on that more if you like.
These actions in the fourth quarter were of course part of the plan that we outlined to you both during the third quarter conference call as you may recall at the December analyst meeting and with the single objective to restore margins to more historical levels.
And as we stated during our conference call and as well as in December, we clearly were not satisfied with the overall performance of the Mill Services business, but we do believe that the act that we have taken now will show year-over-year improvement, so we are confident that we will improve margins in 2008.
Our optimism is underpinned by the actions that we have taken to date and where we are in our overall improvement plan. So I think it would be helpful to give you a little more color on that as to where we stand, particularly the points that we outlined to you back in December.
Again, you will recall that the main objective is to restore margins to normalized levels in 2008, back to somewhere in the annualized rate of about 10.5%. If you examine the prior three years operating margins for Mill Services, say from 2004 to 2006, the annualized operating margins for Mill Services is really in a very tight range at 10.6%, 10.3%, 10.8% respectively.
Some of the key components of our margin improvement plan in no particular order include the following: one, you will recall, we said that we are in the process of re-negotiation and if unsuccessful, the exit from several older underperforming contracts principally in North America, this is still an ongoing process, but we did exit one such contract in the fourth quarter. Our intention, is to divest that low margin transport business in the UK; that sale process will be underway in the first quarter here and we do expect completion in either the second or third quarter.
The execution of our geographic expansion strategy particularly in Eastern Europe and Middle East and Africa, Latin America and Asia Pacific, where we generally do much better from our returns standpoint than we do in North America and Western Europe. We believe we are making very good progress in this area and you should see additional press releases underpinning this throughout the year. We are also continuing to closely examine our global cost optimization initiatives as well as site optimization efforts. As you will recall, site optimization includes among other things, reducing equipment, maintenance cost and improving the overall efficiency of the site.
We are optimistic that these actions will provide the appropriate momentum to restore the Mill Services margins to more historical levels. Also, underpinning this and giving us more optimism are the recently published numbers on global steel production. You may have seen this, but the International Iron Steel Institute reported that global steel production for 2007 increased 7.5%, or 3.3% if you exclude China. So still a very good growth. You might further note that 2007 was the fifth consecutive year that world steel production grew by more than 7%.
One final comment on Mill Services margins for 2007. If you adjust for the reorganization and other one time costs, margins in 2007 would have been approximately 9.7%. That compares with margins of about 10.8% in 2006. We believe that the gap of some 100-basis points can be closed in 2008 based on the plan that we just outlined for you.
Briefly on the Minerals and Rail Services Group, the group posed exceptional fourth quarter performance with all business units, posting higher income and higher margins. As a result, the Minerals and Rail Group as a whole achieved record operating margins of 16.4%, a 640-basis point improvement over last year. Both the short and long term outlook for this Group is very favorable and we expect another strong year in 2008.
Let me now summarize our current outlook for you.
Based on our continuing strong end-markets, numerous international organic growth opportunities that we see and our enterprise business optimization initiatives, we are confident that we will perform well in 2008. Our current expectations and outlook are for another record year. As a result, we are raising our EPS guidance from continuing operations for 2008 from a range of $3.35 to $3.45 to a new range of $3.40 to $3.50. Using a midpoint of this guidance, our expected 2008 results will represent a year-over-year improvement in diluted earnings per share of 15%. This will represent the fifth consecutive year of significant EPS growth for the company and we are quite proud of that record.
Similarly, our outlook for the first quarter of 2008 from continuing operation is for another record quarter. Using the midpoint of our guidance for 2008 to calculate the first quarter, diluted earnings per share from continuing operations in the first quarter are forecast to be in a range of $0.60 to $0.62. That compares with $0.54 in the first quarter of 2007. Using a midpoint of the range, this will represent increase of about 13%.
I would like to make one further point on our guidance for the first quarter of 2008. Several initial research reports issued earlier this morning noted that this guidance was below current first quarter 2008 consensus estimates. I would like to point out that there were only two such estimates. That is only two out of eight analysts that report to First Call. One of the estimates was at $0.63 which generally is in line with our guidance and the other estimate is an outlier at $0.77. I would strongly suggest that when only two such divergent data points are averaged, they tend to make the comparison to a consensus estimate much less reliable.
Furthermore, I believe that when only two out of eight analysts provide estimates that it does not truly reflect a consensus estimate. I would also like to remind you that the company never gave guidance for the first quarter of 2008 until now.
That completes my comments, and now we would be very pleased to take your questions.
Question and Answer Session
Operator
(Operator Instructions)
Your first question comes from Curtis Woodworth with J.P. Morgan.
Curtis Woodworth - J.P. Morgan
In terms of your comments around Access on the outlook, based on what you are saying that you expect to see more of the same, so are you essentially saying that you think you can continue to grow organic growth in sort of that mid-teens level? Is that kind of embedded in your guidance for 2008?
Sal Fazzolari
No, we never gave specific percentages. What we said is that the business will continue to grow at a healthy rate. We certainly see that business can grow at high single digits or better and it is going to depend on the amount of capital investments we make this year. Right now, I can tell you, we are pretty much tracking where we were last year, so if that continues for the year, I could certainly a scenario where that business can grow in double digit rates revenuewise.
Curtis Woodworth - J.P. Morgan
In terms of disaggregating the growth, I do not know if it is possible, but how do you think about it in terms of actual end market demand relative to your ability to penetrate new markets, gain market share; just to try to get a sense of how we think the market is growing high single digits?
Sal Fazzolari
We have got a lot of things going for us. First of all, we think we are the best in the world, number one. Number two is, we’re making a lot of progress in some very key markets like the Middle East, Eastern Europe. We are also looking at parts of Asia like India for example. We are looking at many other parts of the world where we are starting to get a footprint in and we are expanding in other geographies as well and in addition to that, in some of the markets that we are in, we are gaining market share because of what we bring, the value we bring; we have, we believe the most modern equipment and we have the best people and the best engineers and so forth, so we think we can bring a lot of value and so that is why we are so optimistic. We think this business has a lot of momentum. It is very focused and the opportunities are there.
Curtis Woodworth - J.P. Morgan
In terms of just resources for this industry globally or where you operate, are you seeing any shortages, any inability to meet demand which would essentially lead to a better pricing scenario next year?
Sal Fazzolari
There are pockets we see, but historically, what happens in these markets is actually, competitors rent equipment with each other instead of -- if there is a shortage of equipment, it is not uncommon for actually competitors that rent equipment with each other and we call it rent for re-rent, and that happens, but it is not a major thing, but that is one way you compensate if there is a shortage somewhere.
Curtis Woodworth - J.P. Morgan
And can you comment on the acquisition pipeline or strategy now that the balance sheet is re-geared a little lower?
Sal Fazzolari
Well, certainly, we are very pleased where we are. Like what we said in the comments, we have a re-armed balance sheet and we are looking at everything like we always do. We look at share repurchases. We look at growth capex. We look at acquisitions and we are not going to do anything silly like overpay for an acquisition, so it is going to really depend on valuations. There are certainly numerous opportunities out there, but it always comes down to valuation and EVA and value creation and we have an internal house rule and the house rule is that if it is not EVA and EPS accretive, we do not do that. And the final thing we look at is raising the dividend as well. We have done, I think, 12, 13, 14 consecutive years, so we are a balanced company and that is how the way we run the business and that is the way we run the company and we look at where the best place.
If you look at the projected cash flows for the year and the strong balance sheet, we should be able to fund all the growth without adding any kind of leverage at all, unless there are numerous opportunities then certainly we are willing to leverage up a little bit.
Curtis Woodworth - J.P. Morgan
And from the seller’s perspective, has there been any change in kind of valuation parameters that some of these companies are still expecting as part when you re-set a little bit lower post the credit issue?
Sal Fazzolari
We are just starting to see that. Just recently, there has been a little bit of an adjustment which is, believe, it was needed because the market has gotten way ahead of itself. Some of the EBITDA models we saw in some transactions that we were bidding in were just ridiculous and so, we are very pleased and we welcome this change.
Operator
Your next question comes from Jeff Hammond with Keybanc Capital.
Jeffrey Hammond - Keybanc Capital Mkts
Sal, you did a good job articulating the progress on the Mill side. I just want to get a better sense of what do you think the timing is for an inflection point where you start to see that notably improve. What are some of the swing factors therein?
Sal Fazzolari
That is a good question. Production seems to be holding up well, which is good. We are starting to make some in-roads on the maintenance cost issues, which is good. Fuel prices have kind of moderated, if you will, relatively speaking. So all of those things are very good signs. We have taken some actions in some contracts. So it is going to be a nice, even progression as the year goes on, Jeff.
Jeffrey Hammond - Keybanc Capital Mkts
There seems to be emerging concerns about non-res construction in the US, Western Europe in general, I mean, it does not seem to be showing up in your business as you go out and quote projects, are you seeing any pockets of weakness anywhere?
Sal Fazzolari
We are not seeing a drop and the thing is, you have got to be careful. People say Western Europe and then they say the US, what does that mean? You have got to look and see what markets we are in. Do not forget, we are very diversified. We provide forming, that is shoring, scaffolding, the whole thing. We provide industrial maintenance. We are in concrete forming and we are a very diverse market-wise. And then you’ve got to look to see what areas are being impacted. In Europe for example, you are seeing maybe a little bit more impact on the residential side like you are seeing here in the US, but the major infrastructure projects and the industrial maintenance, we are not seeing any slow down, in fact, we are seeing a pick up in some markets in some of those key areas.
Jeffrey Hammond - Keybanc Capital Mkts
Can you just give us a better sense with Excell being a newer business how that business is from a seasonality standpoint? Is there much in the way of seasonality?
Sal Fazzolari
No, it is a little bit like MultiServ in the sense that you have a little bit of January and December are not the two best months, they are the two worst months, but other than that, it is not too bad.
Operator
Your next question comes from Bill Fisher with Raymond James.
William Fisher - Raymond James
Just following up on Jeff’s question, looking at the growth capex, I think you said roughly 70% of it was in Access, do you have any sense if well over half of that was in more to your emerging markets, if you could put some color there?
Sal Fazzolari
Believe it or not, actually it was pretty well dispersed. We are making some very good headway in Canada and the US, we are making good progress. Eastern Europe, a lot in the Middle East and a little bit in Western Europe and a little bit in the South America, with Chile and so forth, so it is pretty evenly dispersed, so we do not have a concentration where all the capital is going in one particular part.
William Fisher - Raymond James
You touched on some of the global production on the steel side, but supposing that the Chinese government puts some export reduction or restrictions on steel I think in their Q4 and it seemed to help some of the volumes outside China in the fourth quarter, is that something your customers see a benefit from since you are more weighted outside China.
Sal Fazzolari
That is why we think production is holding up well. I mean, the Chinese had a very severe winter that will slow production as well, and you see steel prices are really held up, in fact, they keep coming up with higher prices everyday, it seems like, so that seems to be working well for our customers outside of China, yes.
William Fisher - Raymond James
You mentioned the rail sales are down due to the timing in the fourth quarter and you said the record backlogs, but do you have a percentage on what that overall backlog on the mineral side was up in the quarter?
Sal Fazzolari
If our exchangers have record backlogs, HTT has record backlogs, IKG’s backlog is very strong, so you go through each of the businesses, and every one of them has a very, very strong backlog. It is another reason we feel confident about ’08.
Operator
(Operator Instructions)
At this time, there are no further questions.
Derek Hathaway
Well thank you very much. Brevity is better than anything else, we think, because that maybe an indication that people areat least pleased with the detail that has been given. That is what particularly impressed me as now somewhat a little removed now from the leadership and now we have a new Chief Executive Officer, but these things can be listened to again and the thing that impresses me about our new CEO and the team’s report today is the detail that we have given and, more importantly, I think, the carefully chosen words regarding optimism for the future. There is a plan in place; I do believe that it will be executed and that are welcome listening to the Quarter 1 report obviously some time in April. That being said, on a personal note, I want to thank you all for the support that you have given this company and I use the word Company, this is not a personality cult organization. We have always worked as a team, but thank you for the support of the team. I hope that that will continue under the new leadership as you play your part in assisting this corporation to achieve its goals and objectives. And finally, I would, knowing that many of the managers around this company are listening to this and to the gentleman that share this board room with meat the moment, I just want to say thank you to the team for all of their support and to say publicly, I said this in December, I am taking the opportunity again, this is a great corporation, which I have been privileged to lead for many years and I am very, very proud and I hope that people will regard the legacy that I will leave, the principal legacy is not so much the present performance, but a team that will even improve the performance in the upcoming years.
So thank you. We look forward again to talking with you in April and in the meantime, wish you all well. Thank you very much.
Operator
This concludes today’s conference call. You may now disconnect.
Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.
THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.
If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!