Enviri Corp (NVRI) 2011 Q2 法說會逐字稿

Good morning, my name is Michelle, and I will be your conference facilitator. At this time, I would like to welcome everyone to the Harsco Corporation Second Quarter Earnings Release Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers remarks there will be a question-and-answer period.

(Operator Instructions)

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 we recording this teleconference, no other recordings or redistributions of this telephone conference by any other party are prohibited without the express written consent of Harsco Corporation. Your participation indicates your agreement.

I would now like to introduce Mr. Salvatore Fazzolari, Chairman and CEO of Harsco Corporation. Mr. Fazzolari, you may begin your call.

Thank you, and good morning. I would like to welcome everyone to Harsco's Second Quarter 2011 Conference Call. I have here with me today Gene Truett and Stephen Schnoor. So before we begin, I want to ask Gene to read the Safe Harbor statement. Gene, please?

Good morning everyone.

As we do at the beginning of all of our calls we want to let you know that we will be having forward-looking statements in our discussions with you today. These statements relate to the future of our business, our operations, our results, economic expectations, and other aspects related to and affecting our business. What we say today is based on our best information available. It is possible the results could differ from what we tell you today. We have listed in our SEC statements reasons and risk factors that affect our businesses and these could be the reasons for any difference that could occur. We invite you to review the SEC filings at your convenience.

I would like to remind you that replays of this call and related information are available on our website. Please take the time to access this information at your convenience. Sal?

Thank you, Gene.

I will commence this morning with some brief comments and then turn the call over to Steve so he can give you some further color on the second quarter performance. Then, of course, we'll comment on the outlook and take your questions. So let's start with a few opening comments.

We continue to be pleased with the overall performance of our operations. In addition to achieving results above the upper end of our previous guidance for the quarter, our results as noted in the press release also benefited by an additional $8 million, or $0.07 per share, for the reduction of estimated costs related to the first phase of our large rail order to Ministry of Rail in China. I may add that the performance of our rail group on the first phase and this order has been truly exemplary.

Also, we were pleased with our overall revenue growth of 11%, which benefited from our broad international footprint and the positive effects of foreign currency translation. We've completed the first half of 2011 on a positive note, and for the second time this year I am pleased to say we have incrementally raised our earnings guidance.

I am very pleased with the landmark agreement that we announced this morning. After almost three years of a tremendous effort by the Harsco team, we signed a 25-year environmental solutions contract with China's TISCO, which marks the largest single contract in Harsco's history. TISCO, who is also our joint venture partner, is one of the world's premier and largest and best-managed steel companies.

The culmination of this important relationship establishes a major new platform for our continuing global advancement as a knowledge-based environmental solutions company. We are truly honored to join with TISCO as long-term partners on such a far-reaching and environmentally beneficial enterprise.

There are two phases to this agreement. The first phase, and the most immediate, is the metal recovery portion of the contract that is estimated in excess $500 million over its 25-year period. This first phase paves the way for the second phase, where the joint venture will commercialize select co-products in China for a range of projected agricultural and industrial uses.

I will now turn the call over to Steve, our CFO, who will give you more details on our performance for the second quarter. Steve?

Thank you Sal, and good morning everyone. As we reported in this morning's press release, we recorded earnings per share from continuing operations of $0.47 for the second quarter. The results exceeded second quarter 2010 earnings per share of $0.40 by 18%.

Harsco Infrastructure and Harsco Rail improved upon prior-year earnings, while Harsco Industrial's earnings approximated last year's results. As expected, Harsco Metals and Minerals operating income was below prior-year results, principally due to asset gains recorded in the second quarter of last year.

Overall results for the quarter included a change in estimated costs for completion of the first phase of the Ministry of Railways, China, rail order that Sal just mentioned. We do not anticipate any further significant changes in estimated costs as the first phase of the China rail order is now completed.

Second-quarter consolidated sales of $875 million were 11% higher than last year, with all business segments exceeding last year's sales except Harsco Rail, which was expected due to the timing of shipments.

Harsco Rail's shipments in 2011 will be weighted to the second half of the year, particularly the fourth quarter. Additionally, a China shipment originally planned for late in the fourth quarter is now expected to ship early in the first quarter of 2012. Conversely in 2010, shipments were much greater in the first half of the year. Still, first-year 2011 sales of Harsco Rail are expected to exceed that of 2010, and operating income should approach that of 2010.

With the exception of some commodity pricing and volume weakness in the US market of the Minerals business, second-quarter results reflect overall stable market conditions for the Metals and Minerals segment, the Rails segment, and the Harsco Industrial segment. The results also reflect continued weak global market conditions in our residential construction affecting our Infrastructure business.

The second quarter effective income tax rate was slightly lower than expected. The full year 2011 effective income tax rate is now expected to be in a range of 24% to 25%, as we expect tax rates in the second half of 2011 to be lower than we had originally planned.

I will now review our cash flow and our liquidity position and then discuss performance of each business segment in more detail. The first half of the year is the most seasonally slow for cash flows. Historically, most of our cash from operations is generated in the second half of the year, particularly in the fourth quarter. This year is expected to be no exception.

First half cash from operations was $67 million, which was impacted by $16 million of cash disbursed for the Infrastructure group's 2010 restructuring actions. Additionally over $40 million of cash was collected during the first couple of days of July but was expected to be received by June 30.

Capital expenditures increased due to required funding for renewal contracts and previously announced incremental growth projects in our metals and minerals business. Our debt-to-capital ratio as of June 30 was 38%, the same as March 31 of this year and only slightly higher than the 37.6% at year-end, which is the lowest debt-to-capital ratio in at least 12 years. The second quarter 2011 debt-to-capital ratio was significantly lower than the 40% for the second quarter of last year. So our balance sheet remains in great shape providing us with substantial financial flexibility.

Let's now review the second-quarter performance of each of the business groups. Second-quarter sales of the Harsco Metals and Minerals segment exceeded last year by 13%, while operating income and operating margins were lower than last year, principally due to $3 million of asset gains recorded in last year's second quarter. Foreign currency translation increased sales in the quarter by approximately $34 million, or 9%, and operating income by approximately $3 million.

In the second quarter of this year, steel production of our mill site customers was higher than both the second quarter of last year as well as sequentially higher than the first quarter of 2011. This had a positive effect on sales and income during the quarter. The effect of tighter volume by our mill site customers was somewhat offset with lower stainless steel scrap pricing as well as lower volume in the US Minerals business. Higher fuel cost also impacted the business.

We expect stable customer steel production for the remainder of 2011 although stainless steel scrap pricing is not expected to improve in the near term. The outlook for the full year 2011 for Metals and Minerals is positive, resulting from new contract startups and contract renewals with increased volumes. Increased fuel costs are expected to be somewhat mitigate the benefits of higher volume.

Although the continued difficult environment for global non-residential construction activity continued to impact the performance of our Infrastructure group in the second quarter, the overall performance of the business was consistent with our expectations. The $5.1 million operating loss in the quarter was substantially lower than the $13.6 million operating loss in last year's second quarter, and the $17.5 million operating loss in the first quarter of 2011. The cost savings from the fourth quarter 2010 restructuring actions that we took are being realized as expected.

Foreign currency translation increased sales by approximately $26 million, or 10%, in the quarter, when compared with the second quarter of last year, but had a negative impact on operating income of approximately $1 million.

The rental equipment utilization rate in the second quarter was 57.5% compared with 54.1% in the second quarter of last year. As expected due to seasonal effects, the second-quarter utilization rate increased from the 54% experienced the first quarter of this year. Rental rates in the second quarter were 7% lower than last year's second quarter, when the end market conditions were still declining. However, second-quarter rental rates were equal to the first quarter of 2011, and the third and fourth quarters of last year, 2010, again remaining stable in consecutive quarters. Rental rates have now remained stable for three consecutive quarters.

Harsco Rail reported strong results, which benefited by reduced costs of the China order that I mentioned earlier. We expect the Rail business to continue to perform well for the full year 2011, as backlog and quoting activity remained strong. However the fourth-quarter results are expected to exceed the third-quarter results.

Harsco Industrial sales are higher than the second quarter of 2010, and operating income approximated last year. Operating margins were lower than last year due to higher commodity prices, which also affected LIFO costs.

That completes my comments and I would now like to turn the call back to Sal.

Thanks Steve, let me summarize for you the outlook for the third quarter and for the full year. While we are obviously encouraged by the first-half results, it remains prudent for us to presently view the outlook for the remainder of the year with a degree of caution, particularly due to the continuing global uncertainty in key markets, and because we have yet to seen any measurable improvement in our Infrastructure Segment's principal end markets.

More specifically though, with respect to the third quarter outlook, we do expect the Harsco Infrastructure business, as previously noted, to continue to show notable year-over-year improvement compared with last year's third quarter, moreover, as we also expect the infrastructure business to show sequential improvement as well from the second quarter to the third quarter.

So overall, as Steve indicated, we've continued to execute on our strategy, underpinned by the restructuring actions of late last year. As you look forward to the other initiatives we're taking in this business, we've continued to implement cost reduction actions. And so you'll see that for the year-over-year improvement, that we are on target to achieve approximately $40 million as we again I think articulated in the last conference call, as well as last year, that we are expecting approximately that kind of improvement in 2011.

And then when we get the full annualized cost savings of about $60 million, that will take effect in 2012 which means that we expect the business in 2012 to at least break even or better.

Our Harsco Metals and Minerals business is expected to continue to perform well in the second half of the year. However, just like the second quarter, the Minerals business, which is isolated to one item, will continue to negatively impact margins and operating income due to, again as Steve indicated, and as we have articulated in the press release, the pricing of stainless steel scrap is the key driver there. But overall, the Metals portion, the on-site services, continues to do very well.

We look for the Harsco Rail business to again perform relatively well, but as we've noted the timing of shipments to China and the second phase of the contract is resulting in a shift in sales. More specifically, the remainder of the year for rail will be negatively impacted by delivery that was planned for late in the fourth quarter, but has shifted to early in the first quarter of 2012.

So in summary, the third quarter is expected to be a well-balanced and solid quarter given our current expectations. Our present outlook is for the third quarter diluted EPS from continuing ops to be in the range of $0.37 to $0.42, and that compares with $0.26 last year. And with respect to the full year, we are again increasing slightly our previously communicated 2011 diluted EPS guidance from continuing ops from $1.30 to $1.40 per share, to a new annual number of $1.35 to $1.45.

The increased guidance for 2011 is based on the following factors. On the positive side, the expected 2011 results factor in the lower cost of sales benefit that we mentioned related to Rail that was realized in the second quarter, and also, as Steve indicated, an expected lower effective tax rate for the second half of the year as well.

However there are other factors that went into developing our guidance for the year and that includes the lower results in Minerals as I just mentioned for both the third quarter as well as the fourth quarter, and that's principally due to stainless steel scrap pricing and volume.

Acquisition due diligence costs in the second half of the year, a further deterioration of the UK economy and construction market for Infrastructure, and the timing of a rail machine delivery, as we just indicated, to China, which had been expected to ship late in the fourth quarter, but now is highly probable to ship in early 2012.

That completes my comments because I'm sure you have a lot of questions given all the announcements this morning. So we would be pleased to take your questions at this time.

(Operator Instructions)

Jim Lucas, Janney Capital Markets

First question, I just wanted to follow up on one of your last comments, Sal, when you're talking about second half expectations. You mentioned in the costs -- acquisition due diligence costs. Can you expand upon that comment, please?

Yes, sure. I have got to be careful what I say because of confidentiality agreement. But right now we are doing due diligence on principally in the Rail area. As we indicated and have articulated since I think last year that one of our clear focuses, other than growing obviously in the emerging markets, is to grow our rail business. We've been working that for quite a bit of time. Actually we started about 18 months ago. We are now in due diligence for one transaction of a modest size, and we expect to incur approximately $3 million in due diligence costs in the second half of the year. That's probably all I can say, Jim.

Okay I just wanted to flesh out, because clearly there's some activity there and just wanted to get as much color as we could as to what those costs were relating to. And could you give us an update on CapEx for the second half of the year, as you've got a number of projects? You had talked about it last quarter, but any update you can give us there on capital spending in the back half?

Yes, I will let Steve give you some numbers, but I will start off by saying that I'm sure you've seen a significant number of announcements this year. I'll take you back. We had a major contract in Mexico for Metals and Minerals. We had a major contract in India, another one in Brazil. And obviously now TISCO, the largest of all contracts in our history.

What's special about all these contracts is a common theme here -- they're all what we call hybrid services, which includes a lot of environmental solutions. As we continue -- as you'll recall, one of my key strategies when I was appointed CEO four years ago was to transform this Company to a knowledge-based solutions Company, as opposed to just providing basic services and products. Because you know what that lends, that leads to commoditization.

So as we embarked on this transformation, and one of the key things in our Metals and Minerals business, what -- to develop what we call this hybrid solutions business, which really focuses a lot on environmental solutions. Every one of these contracts addresses that issue. So maybe we have not talked enough about that in the past, so that requires we're spending a lot of money.

The other thing that -- I'll get to Steve on the CapEx here in a second, but just to emphasize -- one of the things that we have not talked about that's been impacting the margins of Metals and Minerals as well is the ongoing investment that we're making in technology and business development.

I mean, you're talking about millions and millions and millions of dollars and we have not talked about that, because that's just part of the business model now. But as compared with the past, it is relevant. So again, it wasn't just simply the issue we had with the stainless steel scrap pricing in the quarter. There's also quite a bit of incremental spend on our part on technology, development, as well as business development. Because as you can appreciate, like TISCO for example, it's taken us three years to land that contract. We've probably invested a couple million dollars in costs to get that done.

So that's just one example. So I just wanted to give you a little more color. Now I will have Steve talk to you more specifically about CapEx for the year.

Yes, Jim. Right now we presently estimate our net CapEx for the year to be around $300 million for the projects that Sal mentioned. Many of those projects we're spending the money on. But I'd also point out that approximately 10% of this spend will be for the TISCO contract which is out this morning. So 10% for TISCO, and of course the timing could change, somewhat, and some could slip into 2012 as well. But the net amount of CapEx will be approximately $300 million.

Okay, and the final question. Just going back to your very helpful commentary, Sal. With regards to the ongoing investments in technology and business development -- that incremental spend that you talked about that have had somewhat of an impact on the Metals and Minerals margins. To the extent you can, can you quantify what kind of headwind that has been? Are we talking tens of basis points, or is that more like 100 basis points headwind?

Yes, I mean, Jim, as you can appreciate, I don't want to use it as an excuse, if you will, but suffice it to say that it's in the millions of dollars. I mean, we are taking obviously this technology thing very seriously. The only thing I'll stay to you is stay tuned. You will see more announcements this year that will continue to underpin what I'm saying. I think the TISCO thing clearly shows that we're changing this Company. There will be more coming down the pike that will even continue to underpin this and show you that this investment that we're making in technology is going to pay off, and we are becoming a very different Company.

Perfect, thank you very much.

Jeff Hammond - KeyBanc Capital Markets

Just on Sal, on the moving pieces of guidance. You quantified the acquisition due diligence costs. But is there a way to quantify other, individually, each of these headwinds, or kind of order of magnitude, biggest impact to the smallest? Just in terms of the timing of the Rail contract that the steel scrap pricing issue --?

Yes, for the second quarter for example, the pricing issue and the volume issue, on the stainless steel scrap, specifically, cost us about $4 million or $5 million, so we anticipate a similar impact to the second half of the year. And that was more pronounced in the second and third quarter. We expect a little less in the fourth quarter but in total it was about $4 million or $5 million. Similar numbers, say, for the -- I'm just giving you some broad members, Jeff.

On the Rail thing, it's kind of sensitive, given the customer thing. So again, suffice it to say, it's millions of dollars and you can just leave it at that. I think I covered all of them.

On the Infrastructure thing that we talked about, we're just saying, we're not quantifying that at all. What we're saying there is that there is just no improvement in the market, Jeff. So it's more of an explanation point from the standpoint that the benefits you're seeing or the improvement I should say that you're seeing in Infrastructure is due solely to the restructuring actions, the ongoing restructuring actions, because there's no market improvement whatsoever.

Okay, great. Overall for the year, do you expect margins to be up in Metals and Minerals?

I think for the year, Jeff, certainly the income is going to be up for the year. I think the overall margins compared to 2010, yes, I think we are still expecting that on a year-over-year basis, that the margins will improve. That's correct.

Okay, great, and then can you update us on restructuring? I think you eventually get to kind of a $15 million a quarter run rate on Infrastructure. Are we there yet, or do we get there in 3Q?

We are getting close, Jeff. We're getting close. I think last year I did say that we expect -- I think we're running about $12 million right now for the second quarter, I think it was. We are expecting, as I mentioned in my comments a loss in both the third quarter and fourth quarter, albeit they're going to be small losses. So you will see something close to the $12 million, $13 million per quarter improvement. And, as we get towards the later part of the year, obviously we will start getting closer to that $15 million.

So the difference 2Q to 3Q is really a little more cost savings and the business kind of otherwise flat?

Yes, Jeff, just one thing to keep in mind that Q3 and Q4 you do have the possibility of a bit of seasonality as you exit the typical building season. So keep that in mind.

Okay. And then, just on this TISCO JV, can you give us a sense of how the project kind of winds up with your historical view on return on capital, and particularly risk adjusted return on capital, given emerging markets?

Yes. Jeff, suffice it to say if you look at the cost of capital for China, it's certainly higher than it is for Europe and the United States and other developed economies. The only thing I'll say is that it is above the cost of capital for China and also if you look at the -- there's two components to this. Now I'm just talking about the Metals piece.

On the second piece, which is the commercialization of the co-products, which is principally agricultural and, to a lesser extent, industrial products, that certainly should have different characteristics as well, but that doesn't kick in until much later. We expect that to start kicking in slowly in 2014. But the metal recovery part will commence operation sometime next year, and full run rate in 2013, but all of it though, above the cost of capital for China.

Okay, great. And then just last question. On the pieces of free cash flow, can you give us what the expectation is for the year for cash flow from operations -- and then that $300 million CapEx is split between maintenance and growth CapEx?

Yes, it's about a 50-50 split between maintenance and growth, Jeff. And as far as cash from operations, historically, we've been $400 million or above, and I would expect that for this year, we would approach that as well.

Okay, thanks guys.

(Operator Instructions) Scott Graham, Jefferies & Co.

A couple of questions for you all. The Metals and Minerals margin deterioration -- didn't really talk much about that in the first quarter. Was that an accelerating situation in the second quarter that you saw hit a little bit harder and are kind of expecting the same, or do we start to see that in the first quarter? It just looks like that margin is running at a level that I would not have expected given what I saw in the first quarter. Understanding, of course, that scrap prices are down, I think we know that. But, the impact on the margin, I thought, was a lot more than what I expected, and I think more than perhaps what you guys talked about in the first quarter.

Yes. Again, Scott, remember the asset sale last year, so you've got to keep that in mind as well. But clearly the issue did not occur until the second quarter, and that is, there was a significant slowdown in production of stainless steel, and it was quite a significant change in the pricing of the scrap, to the level that we had not seen for quite a long time. So it was that sudden and that significant. As I mentioned earlier in my comments, that resulted in about a $4 million to $5 million impact to the operating income in the second quarter, which we did not have in the first quarter.

So we would essentially, since it happened and accelerated in the second quarter is that $4 million to $5 million the type of number we should see in the second half, or will it in fact maybe be a little higher than that?

It should be about the same number for the second half roughly, Scott. That's what we're expecting.

Right, so now turning to cash flow. I understand that the $200 million goal is sort of an average for the five-year period that you guys talked about last December. But obviously with capital expenditures looking pretty large, which was kind of the same situation that we had last cycle, and the working capital investments very large as well, it doesn't look like we're going to come anywhere near that number for 2011.

I was just wondering how -- why we're - I understand that we're managing the business for growth with both of those components in mind, CapEx and working capital. But I guess maybe what has changed versus the December analyst meeting, where the cash flow is so significantly different trendline-wise?

Well, first of all, Scott, you have got to remember different dynamics here. All of this investment is underpinned by long-term contracts. As opposed to last cycle, a lot of it was -- or the majority of the spend was in our Infrastructure business, which was not underpinned by long-term contracts. It was underpinned by short-term orders. So that's a huge difference in the profile, the returns and the long-term horizon of that investment, number one.

Number two, as I indicated before, we still obviously are very focused on free cash flow. You're going to have years where we're just not going to hit that number. Clearly this is going to be one of those years. We have ongoing programs right now that we think long-term will benefit us from a lower CapEx spend. That is our global supply chain initiative, our lean initiative, as well as what we call our clean sheet assessment where we re-engineer our sites to invest, which requires less investment of capital.

Those things take time, though, to have effect. But we believe those mechanisms that we be put in place, will over a longer period of time, reduce the CapEx.

We still have old lot of work to do on improving our cash from operations. Obviously the best way to do that is have higher earnings and improve working capital. We're tackling those issues very hard as well. So, you've just got to be a little more flexible.

The final point I'll make is that we're not your typical company. I still think -- we used to do this many years ago and I think it's probably a better way to view Harsco. You really need to view Harsco from what we call discretionary cash flow. That is cash from ops, less maintenance CapEx. Because that's the CapEx you need to sustain the current revenue stream. I mean, you have got to invest for growth, and when you invest for growth, it requires either acquisitions -- most companies spend on acquisitions -- we have the luxury of using free cash flow for both acquisitions, as well as growth CapEx. We still think the better definition for Harsco for free cash is really cash from ops minus maintenance CapEx, as opposed to full CapEx.

Scott, if I could add two things here. The biggest change from December is probably the simple fact that we are clearly seeing more success in winning within the Metals and Minerals business contract signings and bidding activity, which then requires the funding, because again we only fund those contracts once we have a contract. We don't spec buy equipment.

And as Sal said, it's funded under a seven-year contract. The other thing, keep in mind, when you use the term working capital is that our principle of working capital is really receivables, and our growth in receivables right now is to a large degree because of higher revenues. Partly from currency, but be that as it may, we're not the typical Company that manufactures, and we have raw materials, work process, finished goods, that's only 15% of the Company. So if I could just qualify those two, the primary delta from December, which again, we put the data together more in November, was that we are seeing good success in the Metals or Minerals business. The solutions-based marketing of our services is really resonating.

Okay. Last question is along the lines of the, apologies, I'm sorry, in Infrastructure. So I guess we're looking at a weaker UK environment and I know that Europe in total is the largest part of Infrastructure. Can you give us an idea of what the UK is to that business percent of sales?

I think it is about 15%. I think it is about 15% of the total business.

Yes, our largest country actually in Europe, Scott, you might recall -- I think we went through this last time -- is actually Holland, and that's because we're successful there with our -- under contract mostly industrial maintenance services.

Yes, Holland, France, and Germany are the other three large part countries in Europe and Poland, those four countries are actually doing okay. It's just the UK that is really very depressed.

Actually, there is one other question. Unfortunately I got onto the call a couple minutes late. Did you indicate what the second-half tax rate would be?

Yes we did, Scott, it is 24% to 25%.

That's helpful, thanks very much.

I have no further questions at this time. I'll turn the call back over to the presenters.

Thank you. In closing, obviously we're pleased with the progress so far this year. As we stated, our objectives are clear. We are committed to executing our strategic plan. As we stated last December and again during the first quarter conference call and I will repeat it again this conference call, 2011 is clearly a transition year for Harsco as we regain our earnings momentum. We are committed to delivering consistent double-digit earnings growth in the next five years and beyond. We are excited about the future of Harsco as we embark on this new growth era. Again, I'd like to thank you for your ongoing support, and thanks for joining our call today.

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