Harsco Corp. Q4 2007 Earnings Call Transcript

| About: Harsco Corporation (HSC)

Harsco Corporation (NYSE:HSC)

Q4 2007 Earnings Call

January 31, 20082:00 pm


Derek Hathaway - Chairmanand Chairman of Exec. Committee

Sal Fazzolari - CEO

Mark Kimmel -Sr. VP, Gen. Counsel and Corp. Sec.


Curtis Woodworth - J.P. Morgan

Jeffrey Hammond - Keybanc Capital Mkts

William Fisher - Raymond James


I would like to welcome everyone to the Harsco CorporationFourth Quarter Release Conference call.

(Operator Instructions)

This telephone conference presentation and accompanyingwebcast made on behalf of Harsco Corporation are subject to copyright by HarscoCorporation and all rights are reserved.

I would now like to introduce Mr. Derek Hathaway, Chairmanof Harsco Corporation.  Mr. Hathaway, youmay begin your call.

Derek Hathaway

Thank you very much. Good afternoon, ladies and gentlemen, and welcome to this conferencecall which principally will be dealing with the year 2007 and its fourth quarter.  With me in the room today are Gene Truett whois the Investor Relations principal and also Chief of Credit Control for HarscoCorporation, Ken Julian who is our Director of Communications, Stephen Schnoorwho is the Chief Financial Officer, formerly Controller, who became the ChiefFinancial Officer on January 1, 2008.  He was present at the last conference calland is present with us here today.  MarkKimmel who is Chief Counsel and Board Secretary and Sal Fazzolari who is ournew Chief Executive Officer, formerly our Chief Financial Officer as you areaware.

It is a very considerable pleasure obviously for me toconduct what will be my last conference call. In the long career that I have had with Harsco Corporation and most ofthe meeting will be I guess led by Sal, our new CEO and the gentleman who weanticipate will become the Chairman immediately following the annual meeting onApril 22, 2008.

You will understand the particular pleasure that it gives mepersonally to account for the results of the year and the fourth quarter.  They’re quite self-explanatory in the pressrelease and all I can say is, as a summary for the year, we did what we said wewere going to do and more and that all of the principal objectives that we laidout in 2006 relating to 2007 were accomplished plus a little bit.  So without any further ado, I am going tohand the call over now to Mr. Fazzolari who will give us a lot more detail onthe results.

Sal Fazzolari

I do need to haveMark just briefly read the Safe Harbor Statement before the commencement ofcomments.

Mark Kimmel

As we do at the beginning of all of our calls we just wantto let you know that we will be having forward-looking statements in ourdiscussion with you today.  Thestatements relate to the future of our business, our operations, our results,economic expectations and other aspects relating to and affecting ourbusiness.  While what we say today isbased on the best information we have available, it is possible that theresults 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 anydifference that could occur.  We inviteyou to you review the SEC filings at your convenience.

We would also like to remind you that replays of this calland related information are available at our website.  Please take the time to access that at yourconvenience and you can also access replays at that website.

Sal Fazzolari

Thanks, Mark.  Goodafternoon everyone.  It is certainly apleasure to be here with you today.  Wewere obviously very pleased with the fourth quarter 2007 performance from continuingoperations.  Sales, income, dilutedearnings per share and operating margins were all records, underpinning exactlywhat Derek just said.  Also, the overallfourth quarter operating margin for the company was quite pleasing to us aswell where we hit a record 11.4% and that is an 80-basis point improvement overlast year’s 10.6%.

Additionally, we are very pleased with the improvement onthe return on invested capital for 2007. The return on invested capital for continuing operations improved byapproximately 120-basis points to 11.8%. Margin expansion and improvement in the return on invested capital ofcourse all translates to value creation. This value creation is captured in what we call the measurement of EVAor EVA performance.  For 2007, our EVAperformance exceeded the target by nearly 400%. I would also like to remind you that the annual EVA target of Harsco isset independently by Stern Stewart, our EVA consultant, and the ManagementDevelopment Compensation Committee of the Board of Directors.  We do not set or control the EVA target, wejust simply try to exceed it.

Staying with the full year results, there are some othersalient points that I would like to make regarding the overall exceptionalperformance of 2007.  Operating marginsfor the company overall for the year, a record 12.4%.  That is a 100-basis point improvement overlast year’s 11.4%.  Our strongperformance, we believe, was underpinned by a well constructed andwell-balanced global portfolio of substantial industrial service businessesthat we believe are well positioned both geographically and operationally tocontinue their forward momentum in 2008.

This balance was manifested well in 2007 in the overalloperating income of the company.  Thefull year operating income was $458 million with Access Services accounting for40% of the total, Minerals and Rail accounting for 31% and Mill Servicesaccounting for the remaining 29%.  Webelieve that is balanced.

Sales increased 22% in 2007 to a record $3.7 billion.  Organic growth contributed about 9% whileacquisitions contributed 7% and foreign currency translation accounted for theremaining 6% of the growth in sales. This performance again exemplifies Harsco’s balance.

We are also pleased with our business profile at the end of2007.  For the year, our industrialservices portfolio accounted for 86% of total sales while international salesaccounted for almost 70% of total sales.

Our sales for the year were geographically balanced asfollows:  19% of total sales in emergingeconomies such as the Middle East and Latin America with 34% in North America and theremaining 47% in Western Europe.  To remind you, our goal for the next threeyears is to increase sales outside North America and Western Europe from about 19% to about 30% of total sales, off of course amuch larger base.

Noteworthy for the year was the sales growth of our Access ServicesSegment.  Sales grew by a very healthy31% with approximately 19% coming from organic growth, only 5% fromacquisitions and 7% from foreign currency translation.  The sales growth in Access Services was wellbalanced throughout the world.  We wereparticularly pleased to see that the key emerging economies such as the Middle East and Eastern Europe contributedsignificantly to the overall sales growth of the group, as these economiescontinue to make significant investments as you all know in new constructionand infrastructure modernization initiatives.

Also, noteworthy for 2007 is that we did exceed our cashflow target of $445 million that -- is cash flow from operations.  That was exceeded by $27 million.  So for the year we ended up with $472million, which is a 15% increase year-over-year.

Consistent with our growth initiatives, our substantial cashflows enabled us to invest a record of $444 million in capex in 2007.  This is an increase of approximately 30% overlast year’s $340 million.  Importantly,over 55% of this year’s capex or about $246 million has been invested instrategic growth initiatives with the remaining 45% allocated to what we callsustaining the current revenue stream, what you may call it maintenance capex.  The $246 million in growth capex is inaddition to, you may recall, the $148 million we invested last year in growthcapex, so that is quite a substantial amount of capital that we have invested.  Again that is manifesting itself in thefinancials through organic growth, particularly what we have just outlined foryou on Access Services.

So based on this organic growth rate for 2007, as you wouldexpect, approximately 68% or $168 million of the growth capital for 2007 wasinvested in fact in our rapidly growing Access Services Segment.  The remained of the growth capex for 2007 orapproximately $77 million was invested mainly in the Mill Servicesbusiness.  So again, good balance there.

I am also very pleased to report that our debt to capitalratio decreased 760-basis points during the quarter to 40.8% from 48.4% of September 30, 2007 and 730-basispoints from 48.1% at December 31, 2006.  This substantialdecrease is due to the cash proceeds from the sale of the Gas business, as wellas our strong internally generated cash flows from operations.

In fact, if you look at the net debt, if you backed out thecash, it has a three in front of it.  Weare well below the 40, I believe it is around 38-something percent, so we arequite pleased with where we are with our debt to cap ratio.  So in a nutshell, we ended the year with avery strong, very healthy and a re-armed balance sheet.

Now, let us turn and look at the fourth quarter performanceboth from an overall perspective and talk a little bit about each of thebusiness groups.

Overall sales for the fourth quarter for the company grew byagain, 21%, very strong.  Organic growthcontributed over 8%, while acquisitions contributed approximately 6% andforeign currency translation accounted for the remaining 7%.  We are certainly pleased with our strongorganic growth rate, again as it underpins our continued confidence in ourfuture organic growth investment opportunity that we see throughout the globe.

Cash flow from operating activities for the fourth quartercame in at about $99 million.  That is$31 million lower than last year’s record $130 million, but this wasexpected.  The main reason for thedecrease are two things; one is we expect a much higher tax payments in thefourth quarter year-over-year and, also, we have had a little bit of inventoryor working capital build up to meet the extremely strong backlog that we havein some of our businesses, particularly at HTT as we get geared up for theChina order.

Now, looking at the segments in a little more detail, as ithas done all year long, our global Access Services business led Harsco’s growthsetting new quarterly records for sales, operating income and margins.  The fourth quarter was well balanced andbroad based.  Again, we are especiallypleased with the excellent 18% organic growth for the business in the fourthquarter.  Also, noteworthy in the fourthquarter is the fact that operating margins in Access Services improved by300-basis points, so a record 13.3%.

Reflecting on the year, operating margins improved 190-basispoints from 11.1% to 13% and we are obviously very pleased with thisperformance.

The outlook for Access across our large and expanding globalfootprint is pretty much the same.  We remainvery positive.  We see significant growthopportunities and you should see similar investments in 2008 as you saw onaverage for the last couple of years.

On the Mill Services side, again, as pointed out in thepress release, the Mill Services performance for the fourth quarter, againinternally as expected, it was down due principally to a $4.7 million pre-taxcharge, as well as $2.9 million in additional expenses as part of our overallinitiative to optimize the organization. As you may recall, we spent quite a bit of time in December talking toyou about how we are investing money in the business overall and particularlyon the Mill Services side as well, on better optimizing the organization.  And we would be happy to expand on that moreif you like.

These actions in the fourth quarter were of course part ofthe plan that we outlined to you both during the third quarter conference callas you may recall at the December analyst meeting and with the single objectiveto restore margins to more historical levels.

And as we stated during our conference call and as well asin December, we clearly were not satisfied with the overall performance of the MillServices business, but we do believe that the act that we have taken now willshow year-over-year improvement, so we are confident that we will improvemargins in 2008.

Our optimism is underpinned by the actions that we havetaken to date and where we are in our overall improvement plan.  So I think it would be helpful to give you alittle more color on that as to where we stand, particularly the points that weoutlined to you back in December.

Again, you will recall that the main objective is to restoremargins to normalized levels in 2008, back to somewhere in the annualized rateof about 10.5%.  If you examine the priorthree years operating margins for Mill Services, say from 2004 to 2006, theannualized operating margins for Mill Services is really in a very tight rangeat 10.6%, 10.3%, 10.8% respectively.

Some of the key components of our margin improvement plan inno particular order include the following: one, you will recall, we said that we are in the process ofre-negotiation and if unsuccessful, the exit from several older underperformingcontracts principally in North America, this is still an ongoing process, butwe did exit one such contract in the fourth quarter.  Our intention, is to divest that low margintransport business in the UK;that sale process will be underway in the first quarter here and we do expectcompletion in either the second or third quarter.

The execution of our geographic expansion strategyparticularly in Eastern Europe and Middle East and Africa, Latin America andAsia Pacific, where we generally do much better from our returns standpointthan we do in North America and Western Europe. We believe we are making very good progress in this area and you shouldsee additional press releases underpinning this throughout the year.  We are also continuing to closely examine ourglobal cost optimization initiatives as well as site optimization efforts.  As you will recall, site optimizationincludes among other things, reducing equipment, maintenance cost and improvingthe overall efficiency of the site.

We are optimistic that these actions will provide theappropriate momentum to restore the Mill Services margins to more historicallevels.  Also, underpinning this and givingus more optimism are the recently published numbers on global steelproduction.  You may have seen this, butthe International Iron Steel Institute reported that global steel productionfor 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 fifthconsecutive 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 andother one time costs, margins in 2007 would have been approximately 9.7%.  That compares with margins of about 10.8% in2006.  We believe that the gap of some100-basis points can be closed in 2008 based on the plan that we just outlinedfor you.

Briefly on the Minerals and Rail Services Group, the groupposed exceptional fourth quarter performance with all business units, postinghigher income and higher margins.  As aresult, the Minerals and Rail Group as a whole achieved record operatingmargins of 16.4%, a 640-basis point improvement over last year.  Both the short and long term outlook for thisGroup 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, numerousinternational organic growth opportunities that we see and our enterprisebusiness optimization initiatives, we are confident that we will perform wellin 2008.  Our current expectations andoutlook are for another record year.  Asa result, we are raising our EPS guidance from continuing operations for 2008from a range of $3.35 to $3.45 to a new range of $3.40 to $3.50.  Using a midpoint of this guidance, ourexpected 2008 results will represent a year-over-year improvement in dilutedearnings per share of 15%.  This will representthe fifth consecutive year of significant EPS growth for the company and we arequite proud of that record.

Similarly, our outlook for the first quarter of 2008 fromcontinuing operation is for another record quarter.  Using the midpoint of our guidance for 2008to calculate the first quarter, diluted earnings per share from continuingoperations in the first quarter are forecast to be in a range of $0.60 to$0.62.  That compares with $0.54 in thefirst quarter of 2007.  Using a midpointof the range, this will represent increase of about 13%.

I would like to make one further point on our guidance forthe first quarter of 2008.  Severalinitial research reports issued earlier this morning noted that this guidancewas below current first quarter 2008 consensus estimates.  I would like to point out that there wereonly two such estimates.  That is onlytwo out of eight analysts that report to First Call.  One of the estimates was at $0.63 whichgenerally is in line with our guidance and the other estimate is an outlier at$0.77.  I would strongly suggest thatwhen only two such divergent data points are averaged, they tend to make thecomparison to a consensus estimate much less reliable.

Furthermore, I believe that when only two out of eight analystsprovide estimates that it does not truly reflect a consensus estimate.  I would also like to remind you that thecompany never gave guidance for the first quarter of 2008 until now.

That completes my comments, and now we would be very pleasedto take your questions.

Question and AnswerSession


(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 areyou essentially saying that you think you can continue to grow organic growthin sort of that mid-teens level?  Is thatkind of embedded in your guidance for 2008?

Sal Fazzolari

No, we never gave specific percentages.  What we said is that the business willcontinue to grow at a healthy rate.  Wecertainly see that business can grow at high single digits or better and it isgoing to depend on the amount of capital investments we make this year.  Right now, I can tell you, we are pretty muchtracking where we were last year, so if that continues for the year, I couldcertainly 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 itis possible, but how do you think about it in terms of actual end market demandrelative to your ability to penetrate new markets, gain market share; just totry 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 theworld, number one.  Number two is, we’remaking a lot of progress in some very key markets like the Middle East, Eastern Europe.  We are also looking at parts of Asialike India forexample.  We are looking at many otherparts of the world where we are starting to get a footprint in and we areexpanding in other geographies as well and in addition to that, in some of themarkets 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 havethe best people and the best engineers and so forth, so we think we can bring alot of value and so that is why we are so optimistic.  We think this business has a lot ofmomentum.  It is very focused and theopportunities are there.

Curtis Woodworth -J.P. Morgan

In terms of just resources for this industry globally orwhere you operate, are you seeing any shortages, any inability to meet demandwhich would essentially lead to a better pricing scenario next year?

Sal Fazzolari

There are pockets we see, but historically, what happens inthese markets is actually, competitors rent equipment with each other insteadof -- if there is a shortage of equipment, it is not uncommon for actuallycompetitors that rent equipment with each other and we call it rent forre-rent, and that happens, but it is not a major thing, but that is one way youcompensate if there is a shortage somewhere.

Curtis Woodworth -J.P. Morgan

And can you comment on the acquisition pipeline or strategynow 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 are-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 goingto do anything silly like overpay for an acquisition, so it is going to reallydepend on valuations.  There arecertainly numerous opportunities out there, but it always comes down tovaluation and EVA and value creation and we have an internal house rule and thehouse 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 thedividend as well.  We have done, I think,12, 13, 14 consecutive years, so we are a balanced company and that is how theway we run the business and that is the way we run the company and we look atwhere the best place.

If you look at the projected cash flows for the year and thestrong balance sheet, we should be able to fund all the growth without addingany kind of leverage at all, unless there are numerous opportunities thencertainly we are willing to leverage up a little bit.

Curtis Woodworth -J.P. Morgan

And from the seller’s perspective, has there been any changein kind of valuation parameters that some of these companies are stillexpecting 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 ofan adjustment which is, believe, it was needed because the market has gottenway ahead of itself.  Some of the EBITDAmodels we saw in some transactions that we were bidding in were just ridiculousand so, we are very pleased and we welcome this change.


Your next question comes from Jeff Hammond with KeybancCapital.

Jeffrey Hammond - KeybancCapital Mkts

Sal, you did a good job articulating the progress on the Millside.  I just want to get a better senseof what do you think the timing is for an inflection point where you start tosee that notably improve.  What are someof 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 themaintenance cost issues, which is good. Fuel prices have kind of moderated, if you will, relativelyspeaking.  So all of those things arevery good signs.  We have taken someactions in some contracts.  So it isgoing 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-resconstruction in the US, Western Europe in general, I mean, it does not seem tobe showing up in your business as you go out and quote projects, are you seeingany pockets of weakness anywhere?

Sal Fazzolari

We are not seeing a drop and the thing is, you have got tobe careful.  People say Western Europe and then they say the US,what does that mean?  You have got tolook and see what markets we are in.  Donot forget, we are very diversified.  Weprovide forming, that is shoring, scaffolding, the whole thing.  We provide industrial maintenance.  We are in concrete forming and we are a verydiverse market-wise.  And then you’ve gotto look to see what areas are being impacted. In Europe for example, you are seeing maybe a little bit more impact onthe residential side like you are seeing here in the US, but the majorinfrastructure projects and the industrial maintenance, we are not seeing anyslow down, in fact, we are seeing a pick up in some markets in some of thosekey areas.

Jeffrey Hammond -Keybanc Capital Mkts

Can you just give us a better sense with Excell being anewer 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 youhave a little bit of January and December are not the two best months, they arethe two worst months, but other than that, it is not too bad.


Your next question comes from Bill Fisher with RaymondJames.

William Fisher -Raymond James

Just following up on Jeff’s question, looking at the growthcapex, I think you said roughly 70% of it was in Access, do you have any senseif well over half of that was in more to your emerging markets, if you couldput some color there?

Sal Fazzolari

Believe it or not, actually it was pretty welldispersed.  We are making some very good headwayin Canada andthe US, we aremaking good progress.  Eastern Europe, alot in the Middle East and a little bit in Western Europe and a little bit inthe 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 oneparticular part.

William Fisher - RaymondJames

You touched on some of the global production on the steelside, but supposing that the Chinese government puts some export reduction orrestrictions on steel I think in their Q4 and it seemed to help some of thevolumes outside China in the fourth quarter, is that something your customerssee 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 winterthat 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, sothat 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 inthe fourth quarter and you said the record backlogs, but do you have apercentage on what that overall backlog on the mineral side was up in thequarter?

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, andevery one of them has a very, very strong backlog.  It is another reason we feel confident about’08.


(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 anindication that people areat least pleased with thedetail that has beengiven.  That is what particularlyimpressed me as nowsomewhat a littleremoved now from theleadership and now we have anew Chief Executive Officer, but these things can belistened to again and thething that impresses meabout our new CEO and theteam’s report today is thedetail that we have given and, more importantly, I think, thecarefully chosen words regarding optimism for thefuture.  There is aplan in place; I dobelieve that it will beexecuted and that arewelcome listening to theQuarter 1 report obviously some time inApril.  That being said, on apersonal note, I want to thank you allfor the support thatyou have given this company and I use theword Company, this is not apersonality cult organization.  We havealways worked as ateam, but thank you for thesupport of the team.  I hope that that will continue under thenew leadership as you play your part inassisting this corporation to achieve its goals and objectives.  And finally, I would, knowing that many of themanagers around this company arelistening to this and to thegentleman that share this board room with meat themoment, I just want to saythank you to the teamfor all of theirsupport and to saypublicly, I said this inDecember, I am taking theopportunity again, this is agreat corporation, which I have been privileged to lead for many years and I amvery, very proud and I hope that people will regard thelegacy that I will leave, theprincipal legacy is not somuch the presentperformance, but ateam that will even improve theperformance in theupcoming years.

So thank you.  We lookforward again to talking with you in April and in the meantime, wish you allwell.  Thank you very much.


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

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