================================================================================
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
--------------------
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 or 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2006
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from _______ to _______
Commission File Number 1-3970
--------------------
HARSCO CORPORATION
(Exact name of registrant as specified in its charter)
Delaware 23-1483991
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(State of incorporation) (I.R.S. Employer Identification No.)
350 Poplar Church Road, Camp Hill, Pennsylvania 17011
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(Address of principal executive offices) (Zip Code)
Registrant's Telephone Number: (717) 763-7064
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Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15 (d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark whether the registrant is a large accelerated filer, an
accelerated filer, or a non-accelerated filer. See definition of "accelerated
filer and large accelerated filer" in Rule 12b-2 of the Exchange Act. (Check
one):
Large accelerated filer [X] Accelerated filer [ ] Non-accelerated filer [ ]
Indicate by check mark whether the registrant is a shell company (as defined in
Rule 12b-2 of the Exchange Act). YES [ ] NO [X]
Indicate the number of shares outstanding of each of the registrant's classes of
common stock, as of the latest practicable date.
Class Outstanding at July 31, 2006
----- ----------------------------
Common stock, par value $1.25 per share 42,011,159
================================================================================
1
HARSCO CORPORATION AND SUBSIDIARY COMPANIES
PART I - FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
----------------------------
CONDENSED CONSOLIDATED STATEMENTS OF INCOME
(Unaudited)
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS) 2006 2005 2006 2005
====================================================================================================================================
REVENUES FROM CONTINUING OPERATIONS:
Service sales $ 636,393 $ 498,787 $ 1,209,024 $ 968,360
Product sales 229,123 197,360 426,045 367,848
------------------------------------------------------------------------------------------------------------------------------------
TOTAL REVENUES 865,516 696,147 1,635,069 1,336,208
====================================================================================================================================
COSTS AND EXPENSES FROM CONTINUING OPERATIONS:
Cost of services sold 457,133 367,401 879,957 719,806
Cost of products sold 184,430 158,914 340,654 300,156
Selling, general and administrative expenses 123,914 95,212 244,484 192,248
Research and development expenses 719 711 1,410 1,370
Other (income) expenses 1,679 (593) 3,546 849
------------------------------------------------------------------------------------------------------------------------------------
TOTAL COSTS AND EXPENSES 767,875 621,645 1,470,051 1,214,429
====================================================================================================================================
OPERATING INCOME FROM CONTINUING OPERATIONS 97,641 74,502 165,018 121,779
Equity in income of unconsolidated entities, net 102 42 163 120
Interest income 918 567 1,808 1,145
Interest expense (14,617) (10,419) (28,707) (20,862)
------------------------------------------------------------------------------------------------------------------------------------
INCOME FROM CONTINUING OPERATIONS BEFORE INCOME
TAXES AND MINORITY INTEREST
84,044 64,692 138,282 102,182
Income tax expense (27,908) (20,647) (45,581) (32,757)
------------------------------------------------------------------------------------------------------------------------------------
INCOME FROM CONTINUING OPERATIONS BEFORE MINORITY INTEREST 56,136 44,045 92,701 69,425
Minority interest in net income (2,078) (2,232) (4,393) (4,560)
------------------------------------------------------------------------------------------------------------------------------------
INCOME FROM CONTINUING OPERATIONS 54,058 41,813 88,308 64,865
------------------------------------------------------------------------------------------------------------------------------------
DISCONTINUED OPERATIONS:
Loss from operations of discontinued business (290) (316) (280) (341)
Gain on disposal of discontinued business -- 204 -- 195
Income/(loss) related to discontinued defense business (6) (6) (12) 32
Income tax expense 112 44 110 43
------------------------------------------------------------------------------------------------------------------------------------
LOSS FROM DISCONTINUED OPERATIONS (184) (74) (182) (71)
------------------------------------------------------------------------------------------------------------------------------------
NET INCOME $ 53,873(A) $ 41,739 $ 88,126 $ 64,794
====================================================================================================================================
Average shares of common stock outstanding 41,961 41,612 41,892 41,558
Basic earnings per common share:
Continuing operations $ 1.29 $ 1.00 $ 2.11 $ 1.56
Discontinued operations -- -- -- --
------------------------------------------------------------------------------------------------------------------------------------
BASIC EARNINGS PER COMMON SHARE $ 1.28(A) $ 1.00 $ 2.10(A) $ 1.56
====================================================================================================================================
Diluted average shares of common stock outstanding 42,222 42,046 42,169 42,012
Diluted earnings per common share:
Continuing operations $ 1.28 $ 0.99 $ 2.09 $ 1.54
Discontinued operations -- -- -- --
------------------------------------------------------------------------------------------------------------------------------------
DILUTED EARNINGS PER COMMON SHARE $ 1.28 $ 0.99 $ 2.09 $ 1.54
====================================================================================================================================
CASH DIVIDENDS DECLARED PER COMMON SHARE $ 0.325 $ 0.30 $ 0.65 $ 0.60
====================================================================================================================================
(a) Does not total due to rounding.
See accompanying notes to unaudited condensed consolidated financial statements.
2
HARSCO CORPORATION AND SUBSIDIARY COMPANIES
PART I - FINANCIAL INFORMATION
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
JUNE 30 DECEMBER 31
(IN THOUSANDS) 2006 2005(A)
====================================================================================================================================
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 88,270 $ 120,929
Accounts receivable, net 706,355 666,252
Inventories, net 269,882 251,080
Other current assets 62,986 60,436
Assets held-for-sale 2,815 2,326
------------------------------------------------------------------------------------------------------------------------------------
TOTAL CURRENT ASSETS 1,130,308 1,101,023
====================================================================================================================================
Property, plant and equipment, net 1,224,883 1,139,808
Goodwill, net 578,357 559,629
Intangible assets, net 80,126 78,839
Other assets 94,670 96,505
------------------------------------------------------------------------------------------------------------------------------------
TOTAL ASSETS $ 3,108,344 $ 2,975,804
====================================================================================================================================
LIABILITIES
CURRENT LIABILITIES:
Short-term borrowings $ 63,378 $ 97,963
Current maturities of long-term debt 12,374 6,066
Accounts payable 251,779 247,179
Accrued compensation 71,316 75,742
Income taxes payable 42,790 42,284
Dividends payable 13,650 13,580
Insurance liabilities 44,601 47,244
Other current liabilities 247,345 218,345
------------------------------------------------------------------------------------------------------------------------------------
TOTAL CURRENT LIABILITIES 747,233 748,403
====================================================================================================================================
Long-term debt 931,293 905,859
Deferred income taxes 118,161 123,334
Insurance liabilities 57,498 55,049
Retirement plan liabilities 103,016 98,946
Other liabilities 51,999 50,319
------------------------------------------------------------------------------------------------------------------------------------
TOTAL LIABILITIES 2,009,200 1,981,910
====================================================================================================================================
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY
Common stock 85,592 85,322
Additional paid-in capital 164,188 152,899
Accumulated other comprehensive loss (134,498) (167,318)
Retained earnings 1,587,067 1,526,216
Treasury stock (603,205) (603,225)
------------------------------------------------------------------------------------------------------------------------------------
TOTAL STOCKHOLDERS' EQUITY 1,099,144 993,894
====================================================================================================================================
TOTAL LIABILITIES AND STOCKHOLDERS' EQUITY $ 3,108,344 $ 2,975,804
====================================================================================================================================
(a) Reclassified for comparative purposes.
See accompanying notes to unaudited condensed consolidated financial statements.
3
HARSCO CORPORATION AND SUBSIDIARY COMPANIES
PART I - FINANCIAL INFORMATION
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)
SIX MONTHS ENDED
JUNE 30
(IN THOUSANDS) 2006 2005
====================================================================================================================================
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 88,126 $ 64,794
Adjustments to reconcile net income to net
cash provided (used) by operating activities:
Depreciation 119,388 97,463
Amortization 3,757 1,270
Equity in income of unconsolidated entities, net (163) (120)
Other, net 5,722 4,578
Changes in assets and liabilities, net of acquisitions
and dispositions of businesses:
Accounts receivable (15,358) (7,280)
Inventories (13,950) (49,476)
Accounts payable (9,572) 2,683
Accrued interest payable 13,098 14,177
Accrued compensation (7,296) (7,689)
Other assets and liabilities 556 14,086
------------------------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED BY OPERATING ACTIVITIES 184,308 134,486
====================================================================================================================================
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment (166,807) (135,777)
Net use of cash associated with the purchases of businesses (935) (8,147)
Proceeds from sale of assets 5,889 14,496
Other investing activities 118 --
------------------------------------------------------------------------------------------------------------------------------------
NET CASH USED BY INVESTING ACTIVITIES (161,735) (129,428)
====================================================================================================================================
CASH FLOWS FROM FINANCING ACTIVITIES:
Short-term borrowings, net (including reclassifications to/from long-term debt) (41,511) 55,223
Current maturities and long-term debt:
Additions 206,181 69,062
Reductions (including reclassifications to/from short-term borrowings) (206,722) (93,351)
Cash dividends paid on common stock (27,204) (24,911)
Common stock issued-options 10,614 6,071
Other financing activities (3,469) (3,503)
------------------------------------------------------------------------------------------------------------------------------------
NET CASH PROVIDED (USED) BY FINANCING ACTIVITIES (62,111) 8,591
====================================================================================================================================
Effect of exchange rate changes on cash 6,879 (8,191)
------------------------------------------------------------------------------------------------------------------------------------
Net increase (decrease) in cash and cash equivalents (32,659) 5,458
Cash and cash equivalents at beginning of period 120,929 94,093
====================================================================================================================================
CASH AND CASH EQUIVALENTS AT END OF PERIOD $ 88,270 $ 99,551
====================================================================================================================================
See accompanying notes to unaudited condensed consolidated financial statements.
4
HARSCO CORPORATION AND SUBSIDIARY COMPANIES
PART I - FINANCIAL INFORMATION
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)
THREE MONTHS ENDED
JUNE 30
(IN THOUSANDS) 2006 2005
====================================================================================================================================
Net income $ 53,873 $ 41,739
------------------------------------------------------------------------------------------------------------------------------------
Other comprehensive income (loss):
Foreign currency translation adjustments 30,531 (24,791)
Net gains (losses) on cash flow hedging instruments, net of deferred income
taxes of ($17) and $44 in 2006 and 2005, respectively 31 (82)
Pension liability adjustments, net of deferred income taxes of $2,597 and
($2,406) in 2006 and 2005, respectively (6,292) 5,609
Reclassification adjustment for gain on cash flow hedging instruments
included in net income, net of deferred income taxes of $0 and $1 in
2006 and 2005, respectively -- (1)
------------------------------------------------------------------------------------------------------------------------------------
Other comprehensive income (loss) 24,270 (19,265)
------------------------------------------------------------------------------------------------------------------------------------
TOTAL COMPREHENSIVE INCOME $ 78,143 $ 22,474
====================================================================================================================================
SIX MONTHS ENDED
JUNE 30
(IN THOUSANDS) 2006 2005
====================================================================================================================================
Net income $ 88,126 $ 64,794
------------------------------------------------------------------------------------------------------------------------------------
Other comprehensive income (loss):
Foreign currency translation adjustments 41,355 (45,677)
Net gains (losses) on cash flow hedging instruments, net of deferred income
taxes of ($11) and $44 in 2006 and
2005, respectively 21 (82)
Pension liability adjustments, net of deferred income taxes of $3,265 and
($3,638) in 2006 and 2005, respectively (8,559) 8,475
Marketable securities, unrealized gain, net of deferred income taxes of $1 and
$0 in 2006 and 2005, respectively 1 --
Reclassification adjustment for (gain) loss on cash flow hedging instruments
included in net income, net of deferred income taxes of ($1) and $1 in 2006
and 2005, respectively 1 (3)
------------------------------------------------------------------------------------------------------------------------------------
Other comprehensive income (loss) 32,819 (37,287)
------------------------------------------------------------------------------------------------------------------------------------
TOTAL COMPREHENSIVE INCOME $ 120,945 $ 27,507
====================================================================================================================================
See accompanying notes to unaudited condensed consolidated financial statements.
5
HARSCO CORPORATION AND SUBSIDIARY COMPANIES
PART I - FINANCIAL INFORMATION
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
----------------------------------------------------------------
A. OPINION OF MANAGEMENT
Financial information furnished herein, which is unaudited, in the opinion of
management reflects all adjustments (all of which are of a normal recurring
nature) that are necessary to present a fair statement of the interim period.
The year-end condensed balance sheet information contained in this Form 10-Q was
derived from 2005 audited financial statements, but does not include all
disclosures required by accounting principals generally accepted in the United
States of America. The unaudited interim information contained herein should
also be read in conjunction with the Company's 2005 Form 10-K filing.
B. RECLASSIFICATIONS
Certain reclassifications have been made to prior years' amounts to conform with
current year classifications. These reclassifications are not material and
relate principally to components of the Consolidated Balance Sheets. As a result
of these reclassifications, certain 2005 amounts presented for comparative
purposes will not individually agree with previously filed Forms 10-K or 10-Q.
C. STOCK-BASED COMPENSATION
Effective January 1, 2006, the Company adopted SFAS No. 123 (revised 2004),
"Share-Based Payments" (SFAS 123R), which replaced SFAS No. 123, "Accounting for
Stock-Based Compensation," and superseded Accounting Principles Board (APB)
Opinion No. 25, "Accounting for Stock Issued to Employees" (APB 25). SFAS 123R
requires the cost of employee services received in exchange for an award of
equity instruments to be based upon the grant-date fair value of the award (with
limited exceptions). Additionally, this cost is to be recognized as expense over
the period during which an employee is required to provide services in exchange
for the award (usually the vesting period). SFAS 123R also requires that the
additional tax benefits the Company receives from stock-based compensation be
recorded as cash inflows from financing activities in the statement of cash
flows. Prior to January 1, 2006, the Company applied the provisions of APB 25 in
accounting for awards made under the Company's stock-based compensation plans.
The Company adopted the provisions of SFAS 123R using the modified-prospective
transition method. Under this method, results from prior periods have not been
restated. During 2003, the Company ceased granting stock options to employees
and non-employee directors. As such, the effect of adopting SFAS 123R was not
material to the Company's income from continuing operations, net income or cash
flows from operating and financing activities for the six months ended June 30,
2006, and the cumulative effect of adoption using the modified-prospective
transition method was not material.
The Company currently grants performance-based restricted stock units as the
long-term equity component of compensation for non-employee directors, officers
and certain key employees. The restricted stock units require no payment from
the recipient and compensation cost is measured based on the market price on the
grant date and is recorded over the vesting period. The vesting period for
restricted stock units granted to non-employee directors is one year; and each
restricted stock unit will be exchanged for a like number of shares of Company
stock following the termination of the participant's service as a director. The
vesting period for restricted stock units granted to officers and certain key
employees is three years, and upon vesting each restricted stock unit will be
exchanged for a like number of shares of the Company stock. Restricted stock
units do not have an option for cash payment.
6
HARSCO CORPORATION AND SUBSIDIARY COMPANIES
PART I - FINANCIAL INFORMATION
The following table summarizes restricted stock units issued and the
compensation expense recorded for the three months and six months ended June 30,
2006 and 2005:
STOCK-BASED COMPENSATION EXPENSE
--------------------------------------------
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30
(IN THOUSANDS) (IN THOUSANDS)
--------------------------------------------------------------------------------------------------
RESTRICTED FAIR VALUE
STOCK UNITS PER UNIT 2006 2005 2006 2005
--------------------------------------------------------------------------------------------------
Directors:
May 1, 2004 3,500 $ 43.42 $ -- $ 13 $ - $ 51
May 1, 2005 6,000 53.75 27 54 108 54
May 1, 2006 8,000 82.59 110 - 110 --
Employees:
January 24, 2005 32,700 50.41 120 156 236 256
January 24, 2006 46,550 67.70 243 - 442 --
--------------------------------------------------------------------------------------------------
Total 96,750 $ 500 $ 223 $ 896 $ 361
==================================================================================================
Restricted stock unit activity for the six months ended June 30, 2006 was as
follows:
RESTRICTED WEIGHTED AVERAGE
STOCK UNITS GRANT-DATE FAIR VALUE
---------------------------------------------------------------------------
Nonvested at January 1, 2006 31,750 $ 50.62
Granted 54,550 69.88
Vested (3,833) 63.34
Forfeited (3,250) 63.71
---------------------------------------------------------------------------
Nonvested at June 30, 2006 79,217 $ 62.73
===========================================================================
As of June 30, 2006, the total unrecognized compensation costs related to
nonvested restricted stock units was $3.8 million which is expected to be
recognized over a weighted-average period of approximately 2.1 years.
The following table summarizes the excess tax benefits, resulting principally
from stock options:
THREE MONTHS ENDED SIX MONTHS ENDED
(IN MILLIONS) JUNE 30 JUNE 30
---------------------------------------------------------------------------
2006 2005 2006 2005
---------------------------------------------------------------------------
Excess tax benefits $ 1.3 $ 0.6 $ 3.3 $ 2.0
No stock options have been granted to officers and employees since February
2002. No stock options have been granted to non-employee directors since May
2003. Prior to these dates, the Company had granted stock options for the
purchase of its common stock to officers, certain key employees and non-employee
directors under two stockholder-approved plans. The exercise price of the stock
options was the fair value on the grant date, which was the date the Board of
Directors approved the respective grants. The 1995 Executive Incentive
Compensation Plan authorizes the issuance of up to 4,000,000 shares of the
Company's common stock for use in paying incentive compensation awards in the
form of stock options or other equity awards such as restricted stock,
restricted stock units or stock appreciation rights. The 1995 Non-Employee
Directors' Stock Plan authorizes the issuance of up to 300,000 shares of the
Company's common stock for equity awards.
When the Company issued stock options, they were granted at fair market value on
the date of grant, which was the date the Board of Directors approved the
respective grants. Options issued in 2002 under the 1995 Executive Incentive
Compensation Plan generally vested and became exercisable two years following
the date of grant. Options issued prior to 2002 under the 1995 Non-Employee
Directors' Stock Plan became exercisable one year following the date of grant
but
7
HARSCO CORPORATION AND SUBSIDIARY COMPANIES
PART I - FINANCIAL INFORMATION
vested immediately. The options under both Plans expire ten years from the date
of grant. At June 30, 2006, there were 1,239,631 and 148,500 shares available
for granting equity awards under the 1995 Executive Incentive Compensation Plan
and the 1995 Non-Employee Directors' Stock Plan, respectively. Generally, new
shares are issued for exercised stock options and treasury shares are issued for
vested restricted stock units.
Stock option activity for the six months ended June 30, 2006 was as follows:
STOCK OPTIONS
---------------------------------------------------------------------
SHARES WEIGHTED AVERAGE AGGREGATE INTRINSIC
UNDER OPTION EXERCISE PRICE VALUE (IN MILLIONS)(B)
-------------------------------------------------------------------------------------------------------
Outstanding, December 31, 2005 749,025(a) $31.93 $26.9
Exercised (215,763) 34.08 --
-------------------------------------------------------------------------------------------------------
OUTSTANDING, JUNE 30, 2006 533,262(a) $31.06 $24.7
=======================================================================================================
(a) Included in options outstanding at June 30, 2006 and December 31, 2005
were 681 options granted to SGB key employees as part of the Company's
acquisition of SGB in 2000. These options are not a part of the 1995
Executive Compensation Plan, or the 1995 Non-Employee Directors' Stock
Plan.
(b) Intrinsic value is defined as the difference between the current
market value and the exercise price.
The total intrinsic value of options exercised during the six months ended June
30, 2006 and 2005 was $10.0 million and $5.8 million, respectively.
Options to purchase 533,262 shares were exercisable at June 30, 2006. The
following table summarizes information concerning outstanding and exercisable
options at June 30, 2006.
STOCK OPTIONS OUTSTANDING AND EXERCISABLE
RANGE OF --------------------------------------------------------------
EXERCISABLE NUMBER OUTSTANDING REMAINING CONTRACTUAL WEIGHTED AVERAGE
PRICES AND EXERCISABLE LIFE IN YEARS EXERCISE PRICE
--------------------------------------------------------------------------------
$25.63 - $29.00 217,108 3.78 $27.46
29.31 - 32.65 247,869 5.50 32.54
32.81 - 46.16 68,285 4.01 37.18
--------------------------------------------------------------------------------
533,262
================================================================================
D. REVIEW OF OPERATIONS BY SEGMENT
THREE MONTHS ENDED THREE MONTHS ENDED
JUNE 30, 2006 JUNE 30, 2005
OPERATING OPERATING
INCOME INCOME
(IN THOUSANDS) SALES (LOSS) SALES (LOSS)
------------------------------------------------------------------------------------------------------------------------------------
Mill Services Segment $ 344,295 $ 38,529 $ 271,286 $ 33,404
Access Services Segment 269,660 36,652 206,597 21,253
Gas Technologies Segment 99,494 1,223 90,034 3,630
------------------------------------------------------------------------------------------------------------------------------------
Segment Totals 713,449 76,404 567,917 58,287
Engineered Products and Services
("all other") Category 152,067 22,001 128,230 18,280
General Corporate - (764) - (2,065)
------------------------------------------------------------------------------------------------------------------------------------
Consolidated Totals $ 865,516 $ 97,641 $ 696,147 $ 74,502
====================================================================================================================================
8
HARSCO CORPORATION AND SUBSIDIARY COMPANIES
PART I - FINANCIAL INFORMATION
SIX MONTHS ENDED SIX MONTHS ENDED
JUNE 30, 2006 JUNE 30, 2005
OPERATING OPERATING
INCOME INCOME
(IN THOUSANDS) SALES (LOSS) SALES (LOSS)
------------------------------------------------------------------------------------------------------------------------------------
Mill Services Segment $ 670,530 $ 72,109 $ 539,921 $ 60,405
Access Services Segment 495,454 53,435 390,174 30,619
Gas Technologies Segment 186,982 3,550 172,168 5,728
------------------------------------------------------------------------------------------------------------------------------------
Segment Totals 1,352,966 129,094 1,102,263 96,752
Engineered Products and Services ("all other") Category 282,103 37,439 233,945 27,311
General Corporate -- (1,515) -- (2,284)
------------------------------------------------------------------------------------------------------------------------------------
Consolidated Totals $ 1,635,069 $ 165,018 $ 1,336,208 $ 121,779
====================================================================================================================================
RECONCILIATION OF SEGMENT OPERATING INCOME TO CONSOLIDATED INCOME
BEFORE INCOME TAXES AND MINORITY INTEREST
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30
(IN THOUSANDS) 2006 2005 2006 2005
------------------------------------------------------------------------------------------------------------------------------------
Segment Operating Income $ 76,404 $ 58,287 $ 129,094 $ 96,752
Engineered Products & Services
("all other") Category 22,001 18,280 37,439 27,311
General Corporate (764) (2,065) (1,515) (2,284)
------------------------------------------------------------------------------------------------------------------------------------
Operating income from continuing operations 97,641 74,502 165,018 121,779
Equity in income of unconsolidated entities, net 102 42 163 120
Interest income 918 567 1,808 1,145
Interest expense (14,617) (10,419) (28,707) (20,862)
------------------------------------------------------------------------------------------------------------------------------------
Income from continuing operations before income taxes and
minority interest $ 84,044 $ 64,692 $ 138,282 $ 102,182
====================================================================================================================================
E. ACCOUNTS RECEIVABLE AND INVENTORIES
At June 30, 2006 and December 31, 2005, accounts receivable of $706.4 million
and $666.3 million, respectively, were net of an allowance for doubtful accounts
of $24.4 million and $24.4 million, respectively. Gross accounts receivable
included trade accounts receivable of $692.1 million and $638.5 million at June
30, 2006 and December 31, 2005, respectively. Also, included in gross
receivables were $19.5 million and $25.2 million of insurance claim receivables
at June 30, 2006 and December 31, 2005, respectively. These insurance claim
receivables were fully offset by current insurance liabilities at June 30, 2006
and December 31, 2005. The provision for doubtful accounts was $2.2 million and
$1.8 million for the three months ended June 30, 2006 and 2005, respectively.
9
HARSCO CORPORATION AND SUBSIDIARY COMPANIES
PART I - FINANCIAL INFORMATION
Inventories consist of the following:
INVENTORIES
---------------------------------
(IN THOUSANDS) JUNE 30 DECEMBER 31
2006 2005
---------------------------------------------------------------------------
Finished goods $ 99,786 $ 85,325
Work-in-process 41,580 43,830
Raw materials and purchased parts 92,740 87,251
Stores and supplies 35,776 34,674
---------------------------------------------------------------------------
Total Inventories $ 269,882 $ 251,080
===========================================================================
Inventories increased $18.8 million from December 31, 2005 due to the following
factors:
o Increased raw materials, finished goods and work-in-process inventories in
the Gas Technologies Segment due to higher material costs and to meet
expected customer demand in 2006.
o Increased finished goods and raw materials in the Engineered Products and
Services Category due to higher material costs and to meet expected
customer demand in 2006.
o Increased finished goods in the international Access Services business to
meet expected customer demand in 2006.
F. PROPERTY, PLANT AND EQUIPMENT
Property, plant and equipment consists of the following:
JUNE 30 DECEMBER 31
(IN THOUSANDS) 2006 2005
---------------------------------------------------------------------------
Land and improvements $ 40,470 $ 39,306
Buildings and improvements 177,097 168,727
Machinery and equipment 2,451,441 2,291,294
Uncompleted construction 86,444 91,186
---------------------------------------------------------------------------
Gross property, plant and equipment 2,755,452 2,590,513
Less accumulated depreciation (1,530,569) (1,450,705)
---------------------------------------------------------------------------
Net property, plant and equipment $ 1,224,883 $ 1,139,808
===========================================================================
10
HARSCO CORPORATION AND SUBSIDIARY COMPANIES
PART I - FINANCIAL INFORMATION
G. GOODWILL AND OTHER INTANGIBLE ASSETS
The following table reflects the changes in carrying amounts of goodwill for the
six months ended June 30, 2006:
GOODWILL BY SEGMENT
------------------------------------------------------------------------------------------------------------------------------------
ENGINEERED
PRODUCTS
MILL ACCESS GAS AND SERVICES
SERVICES SERVICES TECHNOLOGIES ("ALL OTHER") CONSOLIDATED
(IN THOUSANDS) SEGMENT SEGMENT SEGMENT CATEGORY TOTALS
------------------------------------------------------------------------------------------------------------------------------------
Balance as of December 31, 2005, net of accumulated
amortization $ 297,219 $ 217,580 $ 36,693 $ 8,137 $ 559,629
Changes to Goodwill (a) (487) (2,063) -- -- (2,550)
Other (b) -- (3,286) -- -- (3,286)
Foreign currency translation 11,603 12,961 -- -- 24,564
------------------------------------------------------------------------------------------------------------------------------------
BALANCE AS OF JUNE 30, 2006, NET OF ACCUMULATED
AMORTIZATION $ 308,335 $ 225,192 $ 36,693 $ 8,137 $ 578,357
====================================================================================================================================
(a) Relate principally to opening balance sheet adjustments for the BISNH and
Hunnebeck acquisitions.
(b) Reduction of valuation allowance related to realization of tax loss
carryback.
Goodwill is net of accumulated amortization of $106.6 million and $103.0 million
at June 30, 2006 and December 31, 2005, respectively.
The following table reflects intangible assets by major category:
INTANGIBLE ASSETS
-----------------------------------------------------------------------------------------------------
JUNE 30, 2006 DECEMBER 31, 2005
GROSS
CARRYING ACCUMULATED CARRYING ACCUMULATED
(IN THOUSANDS) AMOUNT AMORTIZATION AMOUNT AMORTIZATION
-----------------------------------------------------------------------------------------------------
Customer Relationships $ 77,297 $ 3,972 $ 73,224 $ 1,262
Non-compete agreements 5,343 4,591 5,036 4,402
Patents 4,558 3,781 4,426 3,587
Other 8,339 3,067 7,962 2,558
-----------------------------------------------------------------------------------------------------
Total $ 95,537 $ 15,411 $ 90,648 $ 11,809
=====================================================================================================
During the first six months of 2006, the Company acquired the following
intangible assets (by major class) which are subject to amortization:
ACQUIRED INTANGIBLE ASSETS
-----------------------------------------------------------------------------------------------------
GROSS
CARRYING RESIDUAL WEIGHTED-AVERAGE
(IN THOUSANDS) AMOUNT VALUE AMORTIZATION PERIOD
-----------------------------------------------------------------------------------------------------
Customer relationships $ 309 None 5 years
Non-compete agreements 300 None 5 years
Other 50 None 5 years
---------
Total $ 659
=========
11
HARSCO CORPORATION AND SUBSIDIARY COMPANIES
PART I - FINANCIAL INFORMATION
The above acquisitions were partially offset by the sale of an intangible asset
in the Mill Services Segment.
There were no research and development assets acquired and written off in the
first six months of 2006 or 2005.
Amortization expense for intangible assets was $3.4 million and $1.0 million for
the six months ended June 30, 2006 and 2005, respectively. The following table
shows the estimated amortization expense for the next five fiscal years based on
current intangible assets:
(IN THOUSANDS) 2006 2007 2008 2009 2010
---------------------------------------------------------------------------
Estimated Amortization Expense(a) $6,400 $6,200 $5,900 $5,600 $5,400
(a) These estimated amortization expense amounts do not reflect the
potential effect of future foreign currency exchange rate
fluctuations.
H. ACQUISITIONS AND DISPOSITIONS
ACQUISITIONS
In December 2005, the Company acquired the Northern Hemisphere steel mill
services operations of Brambles Industrial Services (BISNH), a unit of the
Sydney, Australia-based Brambles Industrial Limited, for (pound)136 million
(approximately $234 million), excluding acquisition costs. BISNH is included in
the Company's Mill Services Segment. The Company did not assume debt as part of
this acquisition. BISNH is a provider of on-site, outsourced mill services to
the steel and metals industries, operating at 19 locations in the U.K., France,
Holland and the United States. Goodwill recognized in this transaction (based on
foreign exchange rates at the transaction date) was $92.6 million, of which
$88.1 million is expected to be deductible for U. S. income tax purposes.
Because this acquisition occurred near the end of 2005, the purchase price
allocations and goodwill balance have not been finalized as of June 30, 2006.
In November 2005, the Company acquired the Germany-based Hunnebeck Group GmbH
(Hunnebeck) for (euro)140 million (approximately $164 million), which included
the assumption of debt but excludes acquisition costs. Hunnebeck is included in
the Company's Access Services Segment. Hunnebeck is a provider of highly
engineered formwork and scaffolding equipment with more than 60 branches and
depots in 12 countries and export sales worldwide. Goodwill recognized in this
transaction (based on foreign exchange rates at the transaction date) was $69.1
million, none of which is expected to be deductible for U. S. income tax
purposes. Because this acquisition occurred near the end of 2005, the purchase
price allocations and goodwill balance have not been finalized as of June 30,
2006.
In July 2006, the Company acquired the assets of UK-based Cape PLC's Cleton
industrial maintenance services subsidiaries in Holland, Belgium and Germany
(Cleton). The terms of the transaction provide for an initial cash payment to
Cape PLC of (euro)8.175 million (approximately $10.3 million), which represents
a small premium to the net assets purchased, and is subject to adjustment for
final accounts up to a maximum of (euro)8.85 million (approximately $11.2
million). Cleton posted 2005 revenues in excess of $50 million and employs close
to 400 people. Cleton specializes in providing scaffolding and related
insulation services for the maintenance of large-scale industrial plants, and
serves some of the largest oil refinery, petrochemical, and process plant sites
in the Benelux countries. Cleton will be included in the SGB Division of the
Access Services Segment.
DISPOSITIONS - ASSETS HELD FOR SALE AND DISCONTINUED OPERATIONS
Throughout the past several years, management approved the sale of certain
long-lived assets (primarily land and buildings) of the Gas Technologies
Segment, the Mill Services Segment and the Engineered Products and Services
Category. The major classes of assets "held-for-sale" included in the
Consolidated Balance Sheets are as follows:
ASSETS "HELD-FOR-SALE"
--------------------------------------------------------------------------------
(IN THOUSANDS) JUNE 30 DECEMBER 31
2006 2005
--------------------------------------------------------------------------------
ASSETS
Property, plant and equipment, net $ 2,815 $ 2,326
--------------------------------------------------------------------------------
TOTAL ASSETS "HELD-FOR-SALE" $ 2,815 $ 2,326
================================================================================
12
HARSCO CORPORATION AND SUBSIDIARY COMPANIES
PART I - FINANCIAL INFORMATION
I. COMMITMENTS AND CONTINGENCIES
ENVIRONMENTAL
The Company is involved in a number of environmental remediation investigations
and clean-ups and, along with other companies, has been identified as a
"potentially responsible party" for certain waste disposal sites. While each of
these matters is subject to various uncertainties, it is probable that the
Company will agree to make payments toward funding certain of these activities
and it is possible that some of these matters will be decided unfavorably to the
Company. The Company has evaluated its potential liability, and its financial
exposure is dependent upon such factors as the continuing evolution of
environmental laws and regulatory requirements, the availability and application
of technology, the allocation of cost among potentially responsible parties, the
years of remedial activity required and the remediation methods selected. The
Consolidated Balance Sheets at June 30, 2006 and December 31, 2005 include
accruals of $3.1 million and $2.8 million, respectively, for environmental
matters. The amounts charged against pre-tax income related to environmental
matters totaled $0.5 million for the first six months of 2006 and 2005.
The liability for future remediation costs is evaluated on a quarterly basis.
Actual costs to be incurred at identified sites in future periods may vary from
the estimates, given inherent uncertainties in evaluating environmental
exposures. The Company does not expect that any sum it may have to pay in
connection with environmental matters in excess of the amounts recorded or
disclosed above would have a material adverse effect on its financial position,
results of operations or cash flows.
ROYALTY EXPENSE DISPUTE
The Company is involved in a royalty expense dispute with the Canada Revenue
Agency ("CRA"). The CRA is proposing to disallow certain royalty expense
deductions claimed by the Company's Canadian subsidiary on its 1994-1998 tax
returns. As of June 30, 2006, the maximum assessment from the CRA for the period
1994-1998 is approximately $10.7 million including tax and interest. The Ontario
Ministry of Finance ("Ontario") is also proposing to disallow these same
deductions for the period 1994-1998. As of June 30, 2006, the maximum assessment
from Ontario is approximately $3.4 million, including tax and interest. The
Company has filed administrative appeals and will vigorously contest these
disallowances.
The Company currently anticipates that, ultimately, it may have a liability for
some portion of the assessment in this royalty expense dispute. However, the
Company intends to utilize competent authority proceedings in the U.S. to
recover a portion of any required tax payment amount. The Company believes that
any amount not recovered through these proceedings has been fully reserved as of
June 30, 2006 and, therefore will not have a material adverse impact on the
Company's future results of operations or financial condition. In accordance
with Canadian tax law, the Company made a payment to the CRA in the fourth
quarter of 2005 of $5.0 million, or one-half of the disputed amount.
Additionally, the Company made a payment to the Ontario Ministry of Finance in
the first quarter of 2006 for the entire disputed amount. These payments were
made for tax compliance purposes and to reduce potential interest expense on the
disputed amount. These payments in no way reflect the Company's acknowledgement
as to the validity of the assessed amounts.
OTHER
The Company has been named as one of many defendants (approximately 90 or more
in most cases) in legal actions alleging personal injury from exposure to
airborne asbestos over the past several decades. In their suits, the plaintiffs
have named as defendants, among others, many manufacturers, distributors and
installers of numerous types of equipment or products that allegedly contained
asbestos.
The Company believes that the claims against it are without merit. The Company
has never been a producer, manufacturer or processor of asbestos fibers. Any
component within a Company product which may have contained asbestos would have
been purchased from a supplier. Based on scientific and medical evidence, the
Company believes that any asbestos exposure arising from normal use of any
Company product never presented any harmful levels of airborne asbestos
exposure, and moreover, the type of asbestos contained in any component that was
used in those products was protectively encapsulated in other materials and is
not associated with the types of injuries alleged in the pending suits. Finally,
in most of the depositions taken of plaintiffs to date in the litigation against
the Company, plaintiffs have failed to specifically identify any Company
products as the source of their asbestos exposure.
The majority of the asbestos complaints pending against the Company have been
filed in either New York or Mississippi. Almost all of the New York complaints
contain a standard claim for damages of $20 million or $25 million against the
approximately 90 defendants, regardless of the individual's alleged medical
condition, and without specifically identifying any Company product as the
source of plaintiff's asbestos exposure. With respect to the Mississippi
complaints, most
13
HARSCO CORPORATION AND SUBSIDIARY COMPANIES
PART I - FINANCIAL INFORMATION
contain a standard claim for an unstated amount of damages against the numerous
defendants (typically 240 to 270), without specifically identifying any Company
product as the source of plaintiff's alleged asbestos exposure.
As of June 30, 2006, there are 26,712 pending asbestos personal injury claims
filed against the Company. Of these cases, 26,265 were pending in the New York
Supreme Court for New York County in New York State and 97 of the cases were
pending in state courts of various counties in Mississippi. The other claims,
totaling approximately 350, are filed in various counties in a number of state
courts, and in certain Federal District Courts (including New York), and those
complaints assert lesser amounts of damages than the New York State court cases
or do not state any amount claimed.
As of June 30, 2006, the Company has obtained dismissal by stipulation, or
summary judgment prior to trial, in 16,772 cases.
In view of the persistence of asbestos litigation nationwide, which has not yet
been sufficiently addressed either politically or legally, the Company expects
to continue to receive additional claims. However, there have been developments
during the past several years, both by certain state legislatures and by certain
state courts, which could favorably affect the Company's ability to defend these
asbestos claims in those jurisdictions. These developments include procedural
changes, docketing changes, proof of damage requirements and other changes that
require plaintiffs to follow specific procedures in bringing their claims and to
show proof of damages before they can proceed with their claim. An example is
the action taken by the New York Supreme Court (a trial court), which is
responsible for managing all asbestos cases pending within New York County in
the State of New York. This Court issued an order in December of 2002 that
created a Deferred or Inactive Docket for all pending and future asbestos claims
filed by plaintiffs who cannot demonstrate that they have a malignant condition
or discernable physical impairment, and an Active or In Extremis Docket for
plaintiffs who are able to show such medical condition. As a result of this
order, the majority of the asbestos cases filed against the Company in New York
County have been moved to the Inactive Docket until such time as the plaintiff
can show that they have incurred a physical impairment. As of June 30, 2006, the
Company has been listed as a defendant in 216 Active or In Extremis asbestos
cases in New York County. The Court's Order has been challenged by plaintiffs.
The Company's insurance carrier has paid all legal and settlement costs and
expenses to date. The Company has liability insurance coverage available under
various primary and excess policies that the Company believes will be available,
if necessary, to substantially cover any liability that might ultimately be
incurred on these claims.
The Company intends to continue its practice of vigorously defending these cases
as they are listed for trial. It is not possible to predict the ultimate outcome
of asbestos-related lawsuits, claims and proceedings due to the unpredictable
nature of personal injury litigation. Despite this uncertainty, and although
results of operations and cash flows for a given period could be adversely
affected by asbestos-related lawsuits, claims and proceedings, management
believes that the ultimate outcome of these cases will not have a material
adverse effect on the Company's financial condition, results of operations or
cash flows.
The Company is subject to various other claims and legal proceedings covering a
wide range of matters that arose in the ordinary course of business. In the
opinion of management, all such matters are adequately covered by insurance or
by accruals, and if not so covered, are without merit or are of such kind, or
involve such amounts, as would not have a material adverse effect on the
financial position, results of operations or cash flows of the Company.
Insurance liabilities are recorded in accordance with SFAS 5, "Accounting for
Contingencies." Insurance reserves have been estimated based primarily upon
actuarial calculations and reflect the undiscounted estimated liabilities for
ultimate losses including claims incurred but not reported. Inherent in these
estimates are assumptions which are based on the Company's history of claims and
losses, a detailed analysis of existing claims with respect to potential value,
and current legal and legislative trends. If actual claims differ from those
projected by management, changes (either increases or decreases) to insurance
reserves may be required and would be recorded through income in the period the
change was determined. When a recognized liability is covered by third-party
insurance, the Company records an insurance claim receivable to reflect the
covered liability. See Note 1, "Summary of Significant Accounting Policies," of
the Company's Form 10-K for the year ended December 31, 2005 for additional
information on Accrued Insurance and Loss Reserves.
14
HARSCO CORPORATION AND SUBSIDIARY COMPANIES
PART I - FINANCIAL INFORMATION
J. RECONCILIATION OF BASIC AND DILUTED SHARES
THREE MONTHS ENDED SIX MONTHS ENDED
JUNE 30 JUNE 30
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) 2006 2005 2006 2005
-------------------------------------------------------------------------------------------------------------------------------
Income from continuing operations $ 54,058 $ 41,813 $ 88,308 $ 64,865
===============================================================================================================================
Average shares of common stock outstanding used to compute
basic earnings per common share 41,961 41,612 41,892 41,558
Dilutive effect of stock-based compensation 261 434 277 454
-------------------------------------------------------------------------------------------------------------------------------
Shares used to compute dilutive effect of stock-based compensation 42,222 42,046 42,169 42,012
===============================================================================================================================
Basic earnings per common share from continuing operations $ 1.29 $ 1.00 $ 2.11 $ 1.56
===============================================================================================================================
Diluted earnings per common share from continuing operations $ 1.28 $ 0.99 $ 2.09 $ 1.54
===============================================================================================================================
All outstanding stock options and restricted stock units were included in the
computation of diluted earnings per share at June 30, 2006 and 2005.
K. EMPLOYEE BENEFIT PLANS
THREE MONTHS ENDED
JUNE 30
-----------------------------------------------------
DEFINED BENEFIT PENSION EXPENSE (INCOME) U. S. PLANS INTERNATIONAL PLANS
-------------------------------------------------------------------------------------------------------------------------------
(IN THOUSANDS) 2006 2005 2006 2005
-------------------------------------------------------------------------------------------------------------------------------
Defined benefit plans:
Service cost $ 922 $ 845 $ 2,248 $ 1,684
Interest cost 3,730 3,479 10,755 9,914
Expected return on plan assets (4,985) (4,778) (12,909) (10,962)
Recognized prior service costs 185 192 308 312
Recognized losses 737 904 3,218 3,143
Amortization of transition liability (asset) (91) (364) 9 (6)
Curtailment/settlement loss (gain) 78 -- 248 14
-------------------------------------------------------------------------------------------------------------------------------
Defined benefit plans pension expense $ 576 $ 278 $ 3,877 $ 4,099
===============================================================================================================================
SIX MONTHS ENDED
JUNE 30
-----------------------------------------------------
DEFINED BENEFIT PENSION EXPENSE (INCOME) U. S. PLANS INTERNATIONAL PLANS
-------------------------------------------------------------------------------------------------------------------------------
(IN THOUSANDS) 2006 2005 2006 2005
-------------------------------------------------------------------------------------------------------------------------------
Defined benefit plans:
Service cost $ 1,843 $ 1,690 $ 4,393 $ 3,565
Interest cost 7,460 6,957 21,018 20,254
Expected return on plan assets (9,971) (9,556) (25,227) (22,367)
Recognized prior service costs 371 384 603 635
Recognized losses 1,474 1,809 6,284 6,358
Amortization of transition liability (asset) (181) (728) 18 3
Curtailment/settlement loss (gain) 78 -- 236 27
-------------------------------------------------------------------------------------------------------------------------------
Defined benefit plans pension expense $ 1,074 $ 556 $ 7,325 $ 8,475
===============================================================================================================================
15
HARSCO CORPORATION AND SUBSIDIARY COMPANIES
PART I - FINANCIAL INFORMATION
Defined benefit pension expense in the second quarter of 2006 was slightly
higher than the comparable 2005 period due to increased pension expense for
certain settlement and curtailment losses which were mostly offset by the
increase in the expected return on pension plan assets. For the first half of
2006, the defined benefit pension expense decreased $0.6 million from the
comparable 2005 period. This decrease relates primarily to an increase in the
expected return on plan assets resulting from an increased fair value of plan
assets as of December 31, 2005. The increased fair value of plan assets as of
December 31, 2005 resulted from 2005 actual return on plan assets of 15.6%
(based on beginning of the year fair value of plan assets) as well as Company
cash contributions of $48.8 million, including $16.9 million of voluntary
contributions. The global weighted average expected long-term rate of return on
plan assets was decreased to 7.6% for 2006 compared with 7.8% for 2005, for
reasons disclosed in the 2005 Form 10-K.
Contributions to defined benefit pension plans are as follows:
DEFINED BENEFIT PENSION PLAN CONTRIBUTIONS
---------------------------------------------------------------------------
(IN MILLIONS) U. S. PLANS INTERNATIONAL PLANS
---------------------------------------------------------------------------
First Quarter 2006 $ 0.2 $ 4.7
Second Quarter 2006 0.3 5.8
---------------------------------------------------------------------------
Six Months 2006 0.5 10.5
Projected July - December 2006 0.5 9.5
---------------------------------------------------------------------------
Total Projected Year 2006 $ 1.0 $ 20.0
===========================================================================
Contributions to multiemployer pension plans during the second quarter and six
months ended June 30, 2006 were $4.8 million and $8.7 million, respectively.
Contributions for defined contribution pension plans during the second quarter
and six months ended June 30, 2006 were $3.4 million and $8.4 million,
respectively.
THREE MONTHS ENDED
POSTRETIREMENT BENEFITS EXPENSE (INCOME) JUNE 30
---------------------------------------------------------------------------
(IN THOUSANDS) 2006 2005
---------------------------------------------------------------------------
Service cost $ 2 $ 1
Interest cost 46 48
Recognized prior service costs -- 1
Recognized gains (9) (9)
---------------------------------------------------------------------------
Postretirement benefits expense $ 39 $ 41
===========================================================================
SIX MONTHS ENDED
POSTRETIREMENT BENEFITS EXPENSE (INCOME) JUNE 30
---------------------------------------------------------------------------
(IN THOUSANDS) 2006 2005
---------------------------------------------------------------------------
Service cost $ 3 $ 4
Interest cost 93 103
Recognized prior service costs 1 6
Recognized gains (19) (18)
Curtailment gains - (318)
---------------------------------------------------------------------------
Postretirement benefits expense (income) $ 78 $ (223)
===========================================================================
The curtailment gains of $0.3 million for 2005 were due to the termination of
certain postretirement health care plans.
In the quarter ended June 30, 2006, the Company contributed $66 thousand to the
postretirement plans. For the six months ended June 30, 2006, the Company
contributed $139 thousand to the postretirement plans and anticipates
contributing approximately $186 thousand during the remainder of 2006.
16
HARSCO CORPORATION AND SUBSIDIARY COMPANIES
PART I - FINANCIAL INFORMATION
L. NEW FINANCIAL ACCOUNTING STANDARDS ISSUED
SFAS No. 155, "Accounting for Certain Hybrid Financial Instruments, an Amendment
--------------------------------------------------------------------------------
of FASB Statements No. 133 and 140" (SFAS 155)
----------------------------------------------
In February 2006, the Financial Accounting Standards Board (FASB) issued SFAS
155, which amends SFAS No. 133, "Accounting for Derivative Instruments and
Hedging Activities," and SFAS No. 140, "Accounting for Transfers and Servicing
of Financial Assets and Extinguishments of Liabilities." SFAS 155 addresses
several issues relating to the accounting for financial instruments, including
permitting fair value measurement for any hybrid financial instrument that
contains an embedded derivative, and eliminating the prohibition on a qualifying
special-purpose entity from holding certain derivative instruments. SFAS 155
also provides clarification that concentrations of credit risk in the form of
subordination are not embedded derivatives. SFAS 155 is effective for all
financial instruments issued or acquired after the fiscal year that begins after
September 15, 2006 (January 1, 2007 for the Company), with early adoption
permitted. The Company expects to adopt SFAS 155 effective January 1, 2007, and
has determined that it is not likely to materially impact the Company's
financial position, results of operations or cash flows.
SFAS No. 156, "Accounting for Servicing of Financial Assets, an Amendment of
----------------------------------------------------------------------------
FASB Statement 140" (SFAS 156)
------------------------------
In March 2006, the FASB issued SFAS 156, which amends SFAS No. 140, "Accounting
of Transfers and Servicing of Financial Assets and Extinguishments of
Liabilities." SFAS 156 requires, in certain specified situations, an entity to
recognize a servicing asset or servicing liability when it undertakes an
obligation to service a financial asset by entering into a servicing contract.
SFAS 156 also requires all separately recognized servicing assets and servicing
liabilities to be initially recognized at fair value, if practical, and allows
entities to choose either the amortization method or the fair value measurement
method for subsequent measurement. SFAS 156 is effective for all servicing
transactions occurring on or after the beginning of the first fiscal year that
begins after September 15, 2006 (January 1, 2007 for the Company), with early
adoption permitted. The Company expects to adopt SFAS 156 effective January 1,
2007, and has determined that it is not likely to materially impact the
Company's financial position, results of operations or cash flows.
FASB Interpretation ("FIN") 48, "Accounting for Uncertainty in Income Taxes-an
------------------------------------------------------------------------------
interpretation of FASB Statement No. 109" (FIN 48)
--------------------------------------------------
In July 2006, the FASB issued FIN 48, which clarifies the accounting for
uncertainty in income taxes recognized in an entity's financial statements in
accordance with SFAS No. 109, "Accounting for Income Taxes." It prescribes a
recognition threshold and measurement attribute for financial statement
recognition and disclosure of tax positions taken or expected to be taken on a
tax return. This interpretation is effective for fiscal years beginning after
December 15, 2006. The Company will adopt this interpretation in the first
quarter of 2007. The Company is currently evaluating the requirements of FIN 48
and has not yet determined the impact on the consolidated financial statements.
Proposed Statement of Financial Accounting Standards, "Employer's Accounting for
--------------------------------------------------------------------------------
Defined Benefit Pension and Other Postretirement Plans, an amendment of FASB
----------------------------------------------------------------------------
Statements No. 87, 88, 106, and 132(R)," (the "Exposure Draft")
---------------------------------------------------------------
The FASB is currently reconsidering the accounting for pensions and other
postretirement benefits in a two-phase project. Phase I of this project
primarily addresses the balance sheet recognition of a plan's overfunded or
underfunded status. Phase II will be a comprehensive reconsideration of all
elements of pension accounting, and is expected to take several years to
complete once Phase I is complete. As part of Phase I, the FASB issued the
Exposure Draft in March 2006. Included in this Exposure Draft is a requirement
for an entity to recognize in its balance sheet, the overfunded or underfunded
status of its defined benefit postretirement plans measured as the difference
between the fair value of the plan assets and the benefit obligation. For a
pension plan, this would be the projected benefit obligation; for any other
postretirement plan, the benefit obligation would be the accumulated
postretirement benefit obligation. The Exposure Draft also eliminates early
measurement dates by requiring the pension plan obligations to be measured as of
the date of the entity's balance sheet. It is expected that the final standard
will be issued in the third quarter of 2006, with some of its key provisions
requiring implementation as of December 31, 2006. The Company is currently
evaluating the potential effects of the Exposure Draft on its accounting for its
defined benefit pension plans and other postretirement benefit plans.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
-------------------------------------------------------------------------------
OF OPERATIONS
-------------
The following discussion should be read in conjunction with the accompanying
unaudited financial statements as well as the Company's annual Form 10-K for the
year ended December 31, 2005, which included additional information about the
17
HARSCO CORPORATION AND SUBSIDIARY COMPANIES
PART I - FINANCIAL INFORMATION
Company's critical accounting policies, contractual obligations, practices and
the transactions that support the financial results, and provided a more
comprehensive summary of the Company's outlook, trends and strategies for 2006
and beyond.
FORWARD-LOOKING STATEMENTS
The nature of the Company's business and the many countries in which it operates
subject it to changing economic, competitive, regulatory and technological
conditions, risks and uncertainties. In accordance with the "safe harbor"
provisions of the Private Securities Litigation Reform Act of 1995, the Company
provides the following cautionary remarks regarding important factors which,
among others, could cause future results to differ materially from the
forward-looking statements, expectations and assumptions expressed or implied
herein. Forward-looking statements contained herein could include statements
about our management confidence and strategies for performance; expectations for
new and existing products, technologies, and opportunities; and expectations
regarding growth, sales, cash flows, earnings and Economic Value Added (EVA(R)).
These statements can be identified by the use of such terms as "may," "could,"
"expect," "anticipate," "intend," "believe," or other comparable terms.
Factors which could cause results to differ include, but are not limited to: (1)
changes in the worldwide business environment in which the Company operates,
including general economic conditions; (2) changes in currency exchange rates,
interest rates and capital costs; (3) changes in the performance of stock and
bond markets that could affect the valuation of the assets in the Company's
pension plans and the accounting for pension assets, liabilities and expenses;
(4) changes in governmental laws and regulations, including taxes and import
tariffs; (5) market and competitive changes, including pricing pressures, market
demand and acceptance for new products, services and technologies; (6)
unforeseen business disruptions in one or more of the many countries in which
the Company operates due to political instability, civil disobedience, armed
hostilities or other calamities; and (7) other risk factors listed from time to
time in the Company's SEC reports. A further discussion of these, along with
other potential factors can be found in Part II, Item 1A, "Risk Factors," of
this Form 10-Q. The Company cautions that these factors may not be exhaustive
and that many of these factors are beyond the Company's ability to control or
predict. Accordingly, forward-looking statements should not be relied upon as a
prediction of actual results. The Company undertakes no duty to update
forward-looking statements.
EXECUTIVE OVERVIEW
The Company's performance in the second quarter and first six months of 2006
reflected the execution of the Company's strategy of growth through increasing
internationalization and a focused, industrial services-based portfolio,
augmented by selective strategic acquisitions. Also, during the first half of
2006, the Company was generally able to manage increased commodity and fuel
costs in achieving record results. The outlook for the remainder of 2006 is
positive as the Company continues to focus on its stated strategic objectives.
The Company's second quarter 2006 revenues were a record $865.5 million. This is
an increase of $169.4 million or 24% over the second quarter of 2005. Income
from continuing operations was a record $54.1 million compared with $41.8
million in the second quarter of 2005, an increase of 29%. Diluted earnings per
share from continuing operations were a record $1.28, a 29% increase from the
second quarter of 2005.
Revenues for the first six months of 2006 were a record $1.6 billion. This is an
increase of $298.9 million or 22% over the first six months of 2005. Income from
continuing operations was a record $88.3 million compared with $64.9 million in
the first six months of 2005, an increase of 36%. Diluted earnings per share
from continuing operations were a record $2.09, a 36% increase from the first
half of 2005.
Both the second quarter and first six months 2006 performance benefited from the
Company's November 21, 2005 acquisition of Hunnebeck Group GmbH (Hunnebeck) and
the December 29, 2005 acquisition of the Northern Hemisphere steel mill services
operations of Brambles Industrial Services ("BISNH"). Both of these acquisitions
were accretive in the second quarter and first six months of 2006. Revenues in
the second quarter and first six months of 2006 were reduced by the sale of the
Company's U.K.-based Youngman manufacturing operation on October 1, 2005. The
net effect of business acquisitions and divestitures increased revenues by $98.1
million and $182.9 million for the second quarter and first six months of 2006,
respectively, compared with the same periods last year.
During the second quarter of 2006, the Company had record net cash provided by
operating activities of $114.5 million, a 33% increase over the $86.3 million
achieved in the second quarter of 2005. For the first six months of 2006, the
Company also had record net cash provided by operating activities of $184.3
million compared with $134.5 million for the first six months of 2005, an
increase of 37%. The Company has set a target of $400 million for net cash
provided by operating activities for the full year 2006, a 27% increase over the
2005 level. The Company's cash flows are further discussed in the Liquidity and
Capital Resources section.
18
HARSCO CORPORATION AND SUBSIDIARY COMPANIES
PART I - FINANCIAL INFORMATION
SEGMENT OVERVIEW
Revenues for the second quarter of 2006 for the Mill Services Segment were
$344.3 million compared with $271.3 million in the second quarter of 2005, a 27%
increase. Operating income increased by 15% to $38.5 million, from $33.4 million
in the second quarter of 2005. In comparison with the first six months of 2005,
this Segment achieved period-over-period revenue growth of $130.6 million or 24%
and operating income growth of $11.7 million or 19% for the first six months of
2006. Second quarter operating margins for the Segment decreased by 110 basis
points to 11.2% from 12.3% in the second quarter of 2005. For the first six
months, operating margins decreased by 40 basis points to 10.8% from 11.2% for
the first six months of 2005. The decrease in operating margins was due
principally to certain gains on disposals of non-performing assets in 2005 which
were not repeated. The overall effect of acquisitions increased revenues for the
Segment by $56.2 million and $108.5 million for the second quarter and first six
months of 2006, respectively, compared with the same periods last year. BISNH
was accretive during both the second quarter and first six months of 2006. The
Segment accounted for 40% and 41% of the Company's revenues and 39% and 44% of
the operating income for the second quarter and first six months of 2006,
respectively.
The Access Services Segment's revenues in the second quarter of 2006 were $269.7
million compared with $206.6 million in the second quarter of 2005, a 31%
increase. Operating income increased by 72% to $36.7 million, from $21.3 million
in the second quarter of 2005. Operating margins for the Segment improved by 330
basis points to 13.6% from 10.3% in the second quarter of 2005. In comparison
with the first six months of 2005, this Segment achieved period-over-period
revenue growth of $105.3 million or 27% and operating income growth of $22.8
million or 75%. Operating margins for the first six months of 2006 improved by
300 basis points to 10.8% from 7.8% in the first six months of 2005. These
improvements were broad-based, and were led by the North American, European and
the Middle Eastern operations. The net effect of business acquisitions and
divestitures increased revenues for this Segment by $41.9 million and $74.4
million for the second quarter and first six months of 2006, respectively,
compared with the same periods last year. Hunnebeck was accretive during both
the second quarter and first six months of 2006. The Access Services Segment
accounted for 31% and 30% of the Company's revenues and 38% and 32% of the
operating income for the second quarter and first six months of 2006,
respectively.
The Gas Technologies Segment's revenues in the second quarter of 2006 were $99.5
million compared with $90.0 million in the second quarter of 2005, an 11%
increase. Operating income decreased by 66% to $1.2 million, from $3.6 million
in the second quarter of 2005. In comparison with the first six months of 2005,
this Segment's revenues increased $14.8 million or 9% in the first six months of
2006. Operating income for the first six months of 2006 decreased $2.2 million
or 38% compared with the first six months of 2005. The increased revenues in the
second quarter and first six months of 2006 were led by the valves, industrial
cylinders and cryogenic businesses although higher commodity, energy and
insurance costs negatively impacted operating income for these businesses. These
increased costs reduced operating margins for this Segment by 280 basis points
to 1.2% from 4.0%, and by 140 basis points to 1.9% from 3.3% for the second
quarter and first six months of 2006 compared to the same periods last year,
respectively. This Segment accounted for 11% of the Company's revenues for both
the second quarter and first six months of 2006, and 1% and 2% of the operating
income for the second quarter and the first six months of 2006, respectively.
All five of the businesses in the Engineered Products and Services ("all other")
Category contributed higher revenues in the second quarter of 2006 and first six
months of 2006 compared with the comparable periods in 2005. Additionally, four
of the five businesses contributed higher operating income, with only the
roofing granules and abrasives business showing slightly lower operating income
in the second quarter and first six months of 2006 due to higher transportation
and energy costs. Overall, operating margins for the Category in the second
quarter of 2006 improved by 20 basis points to 14.5% from 14.3% in the second
quarter of 2005. Operating margins for the first six months of 2006 improved by
160 basis points to 13.3% from 11.7% in the first six months of 2005.
In comparison to the second quarter of 2005, the impact of foreign currency
translation for the Company increased second quarter 2006 sales and pre-tax
income by $4.4 million and $0.8 million, respectively. For the first six months
of 2006, the impact of foreign currency translation reduced sales by $12.2
million but increased pre-tax income by $0.8 million, compared to the same
period in 2005.
OUTLOOK OVERVIEW
The Company's operations span several industries and products as more fully
discussed in Part I, Item 1, "Business," of the Company's Form 10-K for the year
ended December 31, 2005. On a macro basis, the Company is affected by worldwide
steel mill production and capacity utilization; non-residential construction and
industrial maintenance activities; industrial production volume; and the general
business trend towards the outsourcing of services. The overall outlook for 2006
continues to be positive for these business drivers.
19
HARSCO CORPORATION AND SUBSIDIARY COMPANIES
PART I - FINANCIAL INFORMATION
The Company's Mill Services Segment expects to benefit from consistent levels of
steel production at mills served by the Company, new contract signings, contract
renewals and a full year of accretion from the December 29, 2005 acquisition of
BISNH. However, the Company also expects to experience continued higher energy
costs that may have a negative impact on operating margins, to the extent these
costs cannot be passed to customers.
Both domestic and international Access Services activity remains strong.
Although the sale of the Youngman light-access manufacturing business in late
2005 will modestly affect 2006 revenues, improvements to operating performance
in 2006 for the Segment are expected to be led by a full year of accretion from
the November 21, 2005 Hunnebeck acquisition; increased non-residential
construction spending and industrial maintenance activity in the Company's major
markets; strategic investments or acquisitions in new markets or expansion of
current product lines; further market penetration from new products; product
cross-selling opportunities among the markets served by the three Access
Services businesses; and cost reduction opportunities through consolidated
procurement initiatives.
In the Gas Technologies Segment for the remainder of 2006, demand for industrial
cylinders and cryogenics equipment is expected to show continued improvement.
The propane business is expected to return to a more normal business cycle in
comparison to the prior two years, and an overall improvement in the valves
business is expected. International operations are expected to continue to
perform well. However, the risk remains that certain commodity cost inflation
and the availability of certain raw materials could continue to adversely affect
this Segment's results.
The outlook for the Engineered Products and Services ("all other") Category is
positive for the remainder of 2006. The Company's railway track maintenance
services and equipment business's income and margins are expected to continue to
benefit from the shift toward contract services, with several major contracts
starting in 2006. The air-cooled heat exchangers business is expected to
continue to benefit from strong energy market demand due to increased natural
gas drilling and transmission. While not expecting a repeat of the same level of
benefits from post-Katrina rebuilding experienced in the second half of 2005,
the industrial grating products business is expected to continue to post
improved results in 2006 due to strong end-markets in energy and non-residential
construction. The boiler and process equipment business is also expected to
continue its strong performance.
The stable or improved market conditions for most of the Company's services and
products and the significant investments made recently for acquisitions and
growth-related capital expenditures provide the base for achieving the Company's
stated objective of growth in diluted earnings per share from continuing
operations for the remainder of 2006. The record performance achieved in the
first six months of 2006 provides a solid foundation towards achieving the
full-year objective.
--------------------------------------------------------------------------------
REVENUES BY REGION
--------------------------------------------------------------------------------
TOTAL REVENUES
THREE MONTHS ENDED PERCENTAGE GROWTH FROM
JUNE 30 2005 TO 2006
--------------------------------------------------------------------------------
(DOLLARS IN MILLIONS) 2006 2005 VOLUME CURRENCY TOTAL
--------------------------------------------------------------------------------
Europe $ 398.8 $ 292.7 35.7% 0.6% 36.3%
North America 351.0 292.1 19.5 0.6 20.1
Latin America 41.3 38.4 3.0 4.5 7.5
Middle East and Africa 38.6 38.3 1.8 -1.0 0.8
Asia/Pacific 35.8 34.6 5.1 -1.6 3.5
--------------------------------------------------------------------------------
Total $ 865.5 $ 696.1 23.7% 0.6% 24.3%
================================================================================
20
HARSCO CORPORATION AND SUBSIDIARY COMPANIES
PART I - FINANCIAL INFORMATION
--------------------------------------------------------------------------------
REVENUES BY REGION
--------------------------------------------------------------------------------
TOTAL REVENUES
SIX MONTHS ENDED PERCENTAGE GROWTH FROM
JUNE 30 2005 TO 2006
--------------------------------------------------------------------------------
(DOLLARS IN MILLIONS) 2006 2005 VOLUME CURRENCY TOTAL
--------------------------------------------------------------------------------
Europe $ 746.7 $ 556.5 37.6% -3.4% 34.2%
North America 659.9 562.4 16.8 0.5 17.3
Latin America 81.5 72.9 3.3 8.4 11.7
Middle East and Africa 79.5 77.7 3.3 -0.9 2.4
Asia/Pacific 67.5 66.7 3.8 -2.6 1.2
--------------------------------------------------------------------------------
Total $1,635.1 $1,336.2 23.4% -0.9% 22.4%
================================================================================
2006 HIGHLIGHTS
The following significant items affected the Company overall during the second
quarter and first six months of 2006 in comparison with the second quarter and
first six months of 2005, respectively:
Company Wide:
-------------
o Strong worldwide economic activity, as well as the accretive performance of
the Hunnebeck and BISNH acquisitions, benefited the Company in the second
quarter and first six months of 2006. This included increased access
equipment services, sales and rentals, especially in North America, Europe
and the Middle East; net increased volume and new business in the Mill
Services Segment; increased global demand for railway track maintenance
services and equipment; and increased demand for air-cooled heat
exchangers, industrial valves, propane equipment, cryogenics equipment,
industrial cylinders and industrial grating products.
o As expected, during the second quarter and first six months of 2006, the
Company experienced higher fuel and energy-related costs, as well as higher
commodity costs for certain manufacturing businesses. To the extent that
such costs cannot be passed to customers in the future, operating income
may be adversely affected.
o Total pension expense for the first six months of 2006 increased $1.8
million from the first six months of 2005. Defined contribution and
multi-employer plan expenses for the first six months of 2006 increased
approximately $2.4 million from the first six months of 2005. This was
partially offset by decreased defined benefit pension expense of
approximately $0.6 million due to improved returns on plan assets. The
Company is currently taking additional actions designed to further mitigate
pension expense volatility. This is more fully discussed in the Outlook,
Trends and Strategies section.
o During the first six months of 2006, international sales and operating
income were 62% and 75%, respectively, of total sales and income. This
compares with the first six months of 2005 levels of 60% of sales and 72%
of operating income. As expected, the international percentages have
increased as a result of the Hunnebeck and BISNH acquisitions.
21
HARSCO CORPORATION AND SUBSIDIARY COMPANIES
PART I - FINANCIAL INFORMATION
MILL SERVICES SEGMENT:
----------------------
THREE MONTHS SIX MONTHS
ENDED JUNE 30 ENDED JUNE 30
--------------------------------------------------------------------------------
(DOLLARS IN MILLIONS) 2006 2005 2006 2005
--------------------------------------------------------------------------------
Revenues $ 344.3 $ 271.3 $ 670.5 $ 539.9
Operating income 38.5 33.4 72.1 60.4
Operating margin percent 11.2% 12.3% 10.8% 11.2%
================================================================================
MILL SERVICES SEGMENT - THREE MONTHS SIX MONTHS
SIGNIFICANT IMPACTS ON REVENUES ENDED JUNE 30 ENDED JUNE 30
--------------------------------------------------------------------------------
(IN MILLIONS)
--------------------------------------------------------------------------------
Revenues - 2005 $ 271.3 $ 539.9
Acquisitions - (BISNH and Evulca SAS) 56.2 108.5
Increased volume and new business 13.2 25.2
Impact of foreign currency translation 3.4 (3.2)
Other 0.2 0.1
--------------------------------------------------------------------------------
Revenues - 2006 $ 344.3 $ 670.5
================================================================================
MILL SERVICES SEGMENT - SIGNIFICANT IMPACTS ON OPERATING INCOME:
o Operating income for the second quarter and first six months of 2006
increased by $5.1 million and $11.7 million, respectively, as a result of
the BISNH acquisition, increased volumes and new business, particularly in
Europe, partially offset by increased operating costs (as noted below).
o Compared with the second quarter and first six months of 2005, the
Segment's operating income and margins in the second quarter and first six
months of 2006 were negatively impacted by increased fuel and
energy-related costs (excluding increased costs due to acquisitions) of
approximately $3 million and $6 million, respectively.
o Foreign currency translation in the second quarter and first six months of
2006 increased operating income for this Segment by $0.9 million and $1.1
million, respectively, compared with the second quarter and first six
months of 2005.
22
HARSCO CORPORATION AND SUBSIDIARY COMPANIES
PART I - FINANCIAL INFORMATION
ACCESS SERVICES SEGMENT:
------------------------
THREE MONTHS SIX MONTHS
ENDED JUNE 30 ENDED JUNE 30
--------------------------------------------------------------------------------
(DOLLARS IN MILLIONS) 2006 2005 2006 2005
--------------------------------------------------------------------------------
Revenues $ 269.7 $ 206.6 $ 495.5 $ 390.2
Operating income 36.7 21.3 53.4 30.6
Operating margin percent 13.6% 10.3% 10.8% 7.8%
================================================================================
ACCESS SERVICES SEGMENT - THREE MONTHS SIX MONTHS
SIGNIFICANT IMPACTS ON REVENUES ENDED JUNE 30 ENDED JUNE 30
--------------------------------------------------------------------------------
(IN MILLIONS)
--------------------------------------------------------------------------------
Revenues - 2005 $ 206.6 $ 390.2
Net effect of acquisitions and divestitures
(Hunnebeck offset by Youngman light-access
manufacturing unit divestiture) 41.9 74.4
Net increased volume and new business 20.2 40.1
Impact of foreign currency translation 1.0 (8.3)
Other - (0.9)
--------------------------------------------------------------------------------
Revenues - 2006 $ 269.7 $ 495.5
================================================================================
ACCESS SERVICES SEGMENT - SIGNIFICANT IMPACTS ON OPERATING INCOME:
o In the first half of 2006, there was a continued strengthening in the North
American non-residential construction markets that started in the latter
half of 2004. This had a positive effect on volume (particularly equipment
rentals) which caused overall margins and operating income in North America
to improve. Equipment rentals, particularly in the construction sector,
provide the highest margins for this Segment.
o The net effect of acquisitions and divestitures had a positive effect on
the second quarter and first six months of 2006 operating income, with the
Hunnebeck business performing well.
o The international access services business continued to improve,
predominantly in Europe and the Middle East, due to increased
non-residential construction spending and industrial maintenance activity
in the Company's major markets, as well as the Hunnebeck acquisition.
During the first six months of 2006, the international operations outside
of the U.K. had $260.6 million in revenues and $38.3 million in operating
income. This compares with $145.0 million in revenues and $19.5 million in
operating income for the first six months of 2005.
o The impact of foreign currency translation in the second quarter and first
six months of 2006 did not have a material impact on operating income for
this Segment when compared with the second quarter and first six months of
2005.
23
HARSCO CORPORATION AND SUBSIDIARY COMPANIES
PART I - FINANCIAL INFORMATION
GAS TECHNOLOGIES SEGMENT:
-------------------------
THREE MONTHS SIX MONTHS
ENDED JUNE 30 ENDED JUNE 30
--------------------------------------------------------------------------------
(IN MILLIONS) 2006 2005 2006 2005
--------------------------------------------------------------------------------
Revenues $ 99.5 $ 90.0 $ 187.0 $ 172.2
Operating income 1.2 3.6 3.6 5.7
Operating margin percent 1.2% 4.0% 1.9% 3.3%
================================================================================
GAS TECHNOLOGIES SEGMENT - THREE MONTHS SIX MONTHS
SIGNIFICANT IMPACTS ON REVENUES ENDED JUNE 30 ENDED JUNE 30
--------------------------------------------------------------------------------
(IN MILLIONS)
--------------------------------------------------------------------------------
Revenues - 2005 $ 90.0 $ 172.2
Increased demand for certain valves and
composite-wrapped cylinders. 4.2 7.5
Increased demand for cryogenics equipment and
industrial cylinders. 2.9 7.6
Increased demand for propane tanks in the
second quarter of 2006. 2.2 (0.1)
Other 0.2 (0.2)
--------------------------------------------------------------------------------
Revenues - 2006 $ 99.5 $ 187.0
================================================================================
GAS TECHNOLOGIES SEGMENT - SIGNIFICANT IMPACTS ON OPERATING INCOME:
o Operational improvements and the effect of increased sales were offset by
increased brass and insurance costs in the valves business in the second
quarter and first six months of 2006 compared with the second quarter and
first six months of 2005. A strategic action plan has been implemented to
improve the results of the valves business. Cost savings as a result of
this plan helped decrease the impact of significantly increased brass
costs. This plan is further discussed in the Outlook, Trends and Strategies
section.
o The international businesses, principally in Europe and, to a lesser
extent, Asia, contributed to the improved performance of the cryogenics
business during the second quarter and first six months of 2006 compared
with the second quarter and first six months of 2005.
o Despite higher demand for industrial cylinders, operating income decreased
due mainly to the effect of equipment repairs and maintenance, product mix
and higher energy-related costs.
o Despite increased demand for propane tanks in the second quarter of 2006,
operating income decreased due to increased commodity and insurance costs.
The negative effect of these items was partially offset by favorable
product mix and process improvement initiatives.
o Slightly lower operating income in the second quarter and first six months
of 2006 for composite-wrapped cylinders was due to unfavorable product mix
and higher raw material costs for aluminum and carbon fiber.
o The impact of foreign currency translation in the second quarter and first
six months of 2006 did not have a material impact on operating income for
this Segment when compared with the second quarter and first six months of
2005.
24
HARSCO CORPORATION AND SUBSIDIARY COMPANIES
PART I - FINANCIAL INFORMATION
ENGINEERED PRODUCTS AND SERVICES ("ALL OTHER") CATEGORY:
THREE MONTHS SIX MONTHS
ENDED JUNE 30 ENDED JUNE 30
--------------------------------------------------------------------------------
(IN MILLIONS) 2006 2005 2006 2005
--------------------------------------------------------------------------------
Revenues $ 152.1 $ 128.2 $ 282.1 $ 233.9
Operating income 22.0 18.3 37.4 27.3
Operating margin percent 14.5% 14.3% 13.3% 11.7%
================================================================================
ENGINEERED PRODUCTS & SERVICES ("ALL OTHER") THREE MONTHS SIX MONTHS
CATEGORY - SIGNIFICANT IMPACTS ON REVENUES ENDED JUNE 30 ENDED JUNE 30
--------------------------------------------------------------------------------
(IN MILLIONS)
--------------------------------------------------------------------------------
Revenues - 2005 $ 128.2 $ 233.9
Air-cooled heat exchangers 10.1 21.8
Railway track maintenance services and equipment 9.0 17.0
Industrial grating products 2.5 3.9
Boiler and process equipment 1.2 2.5
Roofing granules and abrasives 1.2 3.7
Impact of foreign currency translation (0.3) (0.8)
Other 0.2 0.1
--------------------------------------------------------------------------------
Revenues - 2006 $ 152.1 $ 282.1
================================================================================
ENGINEERED PRODUCTS AND SERVICES ("ALL OTHER") CATEGORY - SIGNIFICANT IMPACTS ON
OPERATING INCOME:
o Operating income for the air-cooled heat exchangers business improved in
the second quarter and first six months of 2006 due to increased volume
resulting from an improved natural gas market.
o Higher operating income in the second quarter and first six months of 2006,
in comparison with the same periods last year, for the railway track
maintenance services and equipment business was due principally to
increased repair parts and rail equipment sales. This was partially offset
by reduced contract services income due to higher maintenance and start-up
costs as well as downtime for certain machines.
o Increased second quarter and first six months 2006 operating income for the
industrial grating products business was due principally to higher volume
and an improved product mix.
o The boiler and process equipment business delivered improved second quarter
and first six months 2006 results due to improved revenues from the
new-generation Mach boilers, Thermific boilers and process equipment.
o Strong demand for roofing granules and abrasives again resulted in
profitable results for that business in the second quarter and first six
months of 2006. However, these results were negatively impacted by
increased energy costs in 2006 which reduced operating margins.
o The impact of foreign currency translation in the second quarter and first
six months of 2006 did not have a material impact on operating income for
this Category when compared with the second quarter and first six months of
2005.
OUTLOOK, TRENDS AND STRATEGIES
Looking to the remainder of 2006 and beyond, the following significant items,
trends and strategies are expected to affect the Company:
Company Wide:
-------------
o The Company will continue its focus on expanding the industrial services
businesses, with a particular emphasis on growing the Mill Services Segment
and the Access Services Segment through the provision of additional
services to existing customers, new contracts in both mature and emerging
markets and strategic acquisitions. Additionally, new higher-margin service
opportunities in railway services will be pursued.
25
HARSCO CORPORATION AND SUBSIDIARY COMPANIES
PART I - FINANCIAL INFORMATION
o The Company will continue to invest in strategic acquisitions and growth
capital investments; however, management will be very selective with the
capital investments choosing those with the highest economic value added.
o The armed hostilities in the Middle East could have a significant effect on
the Company's operations in the region. The potential impact of this risk
is currently unknown. This exposure is further discussed in Part II, Item
1A, "Risk Factors."
o A greater focus on corporate-wide expansion into China and other emerging
economies (e.g., Brazil, India, etc.) is expected in 2006 and beyond. More
specifically, within the next three to five years, a focused strategy of
the Company will be to approximately double the presence in the Latin
American, Asia Pacific, Middle East and Africa, and Eastern European
markets to approximately 30% of total revenues.
o The continued growth of the Chinese steel industry, as well as other Asian
emerging economies, could impact the Company in several ways. Increased
steel mill production in China, and in other Asian countries, may provide
additional service opportunities for the Mill Services Segment. However,
increased Asian steel exports could result in lower steel production in
other parts of the world, affecting the Company's customer base.
Additionally, continued increased Chinese economic activity may result in
increased commodity costs in the future, which may adversely affect the
Company's manufacturing businesses. The potential impact of these risks is
currently unknown.
o Increases in energy and commodity costs (e.g., natural gas, steel, brass,
aluminum, etc.) and worldwide demand for these commodities could have an
adverse effect on the Company's raw material costs and ability to obtain
the necessary raw materials. Fuel and energy costs increased approximately
$10 million in the first six months of 2006 compared with the first six
months of 2005 (excluding increased costs due to acquisitions). Should cost
increases continue, it could result in reduced operating income for certain
products to the extent that such costs cannot be passed on to customers.
The effect of the Middle East armed hostilities on the cost of fuel and
commodities is currently unknown, but it could have a significant effect.
Regardless, commodity costs are still anticipated to increase in the second
half of 2006. The potential impact of this risk is currently unknown.
o Foreign currency translation had an overall unfavorable impact on the
Company's sales during the first six months of 2006 compared with the first
six months of 2005, but a positive effect on operating income. As the U.S.
dollar strengthens, particularly in relationship to the euro or British
pound sterling, the impact on the Company would generally be negative in
terms of reduced sales, income and Stockholders' equity.
o An internal target of $400 million in net cash provided by operating
activities has been established for 2006. Currently, this target is
expected to be achieved, helping to support the Company's growth
initiatives.
o Controllable cost reductions and continuous process improvement initiatives
across the Company are targeted to further enhance margins for most
businesses. These initiatives include improved supply chain management;
additional outsourcing in the manufacturing businesses; and an added
emphasis on corporate-wide procurement initiatives. The Company will use
its increased size and leverage due to recent acquisitions to reduce vendor
costs and focus on additional opportunities for cost reductions via
procurement in low-cost countries such as China and India.
o Total pension expense (defined benefit, defined contribution and
multi-employer) for 2006 is expected to approximate or be slightly higher
than the 2005 level. In the U.K., defined benefit pension expense is
expected to decline in 2006 due to the significant level of cash
contributions, including voluntary cash contributions (approximately $16.9
million during 2005), to the defined benefit pension plan as well as the
improved 2005 performance of the plan's assets. Domestically, the majority
of the twenty-year amortization of the transition asset (from the initial
implementation of SFAS No. 87 in 1986) has ceased during 2006. By itself,
the elimination of this benefit is projected to increase domestic
defined-benefit pension expense by approximately $1.0 million when compared
with 2005. The Company's pension task force continues to evaluate
alternative strategies to further mitigate overall pension expense,
including the on-going evaluation of investment fund managers' performance;
the balancing of plan assets and liabilities; the risk assessment of all
multi-employer pension plans; the possible merger of certain plans; the
consideration of incremental cash contributions to certain plans; and other
changes that should mitigate future volatility and expense. On a
comparative basis, total pension expense in the first six months of 2006
was $1.8 million higher than the first six months of 2005.
o Changes in worldwide interest rates, particularly in the U.S. and Europe,
could have a significant effect on the Company's overall interest expense,
as currently approximately 47% of the Company's borrowings are at variable
interest rates (in comparison to approximately 50% at December 31, 2005 and
16% at June 30, 2005).
Mill Services Segment:
----------------------
o To maintain pricing levels, a more disciplined steel industry has been
adjusting production levels to bring inventories in-line with current
demand. However, based on current market conditions and industry reports,
the Company expects global steel production to remain stable in 2006, which
would generally have a favorable effect on this Segment's revenues.
o The increased energy-related costs this Segment experienced during the
first six months of 2006 are expected to persist through the remainder of
2006. In the first six months of 2006, these costs increased approximately
$6 million
26
HARSCO CORPORATION AND SUBSIDIARY COMPANIES
PART I - FINANCIAL INFORMATION
compared with the first six months of 2005 (excluding increased costs due
to acquisitions). Some of these costs were passed on to customers in the
form of selling price increases. Given the volatility of such costs, the
future effect on the Company cannot be quantified.
o The Company has been placing significant emphasis on improving operating
margins of this Segment. Specific plans for 2006 include global procurement
initiatives; process improvement programs; maintenance best practices
programs; and execution of its reorganization plan.
o Further consolidation in the global steel industry is probable. Should
transactions occur involving some of the steel industry's larger companies
that are customers of the Company, it would result in an increase in
concentration of credit risk for the Company. If a large customer were to
experience financial difficulty, or file for bankruptcy protection, it
could adversely impact the Company's income, cash flows and asset
valuations. As part of its credit risk management practices, the Company is
developing strategies to mitigate this increased concentration of credit
risk.
Access Services Segment:
------------------------
o Both the international and domestic Access Services businesses are expected
to show continued improvement during the remainder of 2006. Specifically,
international and North American non-residential construction activity
continued to improve in the first six months of 2006 and the overall market
outlook remains positive. Various industry sources are currently
forecasting continued growth for most non-residential construction markets
served by this Segment during the remainder of 2006. Additionally, new
product line additions should continue to benefit growth in North America.
o In October 2005, the U.K.-based Youngman light-access manufacturing unit
was sold, which has eliminated the associated revenue. For the remainder of
2006, the revenue decrease will be offset by increased sales and income
from the November 2005 Hunnebeck acquisition and the July 2006 Cleton
acquisition, and through the further development of core activities.
Additionally, the sale of the Youngman unit has allowed for greater focus
on the more profitable rental business.
Gas Technologies Segment:
-------------------------
o Worldwide supply and demand for steel, aluminum and the availability of
carbon fiber used to manufacture filament-wound composite cylinders could
have adverse effects on future raw material costs and this Segment's
ability to obtain the necessary raw materials. Additionally, the price of
brass, a raw material used for the production of certain valves, continued
to increase during the first six months of 2006. Should brass prices
continue to increase during the remainder of 2006, this could result in
reduced operating income for certain products to the extent that such costs
cannot be passed on to customers.
o A comprehensive strategic plan to improve the performance of the valves
business was developed during the fourth quarter of 2005 and is currently
being executed. The plan includes the following: a new senior management
team; development and marketing of new products; focus on an expanded
international customer base; consolidating certain manufacturing processes;
process improvements within the manufacturing operations including
outsourcing; and optimization of the organizational structure of the
business. Also, management is currently studying the possibility of
rationalizing certain product lines. If the market conditions encountered
during 2005 persist and raw material costs continue to increase, despite
execution of the strategic action plan, the valuation of this business
could be negatively impacted.
o The industrial cylinder and cryogenics equipment businesses are expected to
show continued improved performance for the remainder of 2006.
Engineered Products and Services ("all other") Category:
--------------------------------------------------------
o International demand for the railway track maintenance services and
equipment business' products and services has been strong and is expected
to remain so in 2006. However, on a comparative basis, second-half 2006
sales are expected to be less than 2005 due to the shipment of several
large machine orders in 2005. Despite this expected decrease in sales,
operating income is expected to be higher in 2006 due to increased volume
of higher-margin industrial services and manufacturing process improvements
and efficiencies that are expected to improve margins on a long-term basis.
Additionally, higher-margin international equipment sales will continue to
be pursued by this business.
o The industrial grating business is expected to sustain improved operating
income for the remainder of 2006.
o Worldwide supply and demand for steel could have an adverse impact on raw
material costs and the ability to obtain the necessary raw materials for
most businesses in this Category. The Company has implemented certain
strategies and plans to help ensure continued product supply to our
customers and mitigate the potentially negative impact rising steel prices
could have on operating income.
o Consistent, sustained profitable results are expected from the roofing
granules and abrasives business, although increased energy costs could
continue to impact margins. This business is pursuing the use of more
energy-efficient equipment to help mitigate the increased energy-related
costs.
27
HARSCO CORPORATION AND SUBSIDIARY COMPANIES
PART I - FINANCIAL INFORMATION
o Due to an improving natural gas market and additional North American
opportunities, demand for air-cooled heat exchangers is expected to remain
strong for the remainder of 2006.
RESULTS OF OPERATIONS
----------------------------------------------------------------------------------------------------
THREE MONTHS SIX MONTHS
(DOLLARS ARE IN MILLIONS, EXCEPT ENDED JUNE 30 ENDED JUNE 30
PER SHARE AND PERCENTAGES) 2006 2005 2006 2005
----------------------------------------------------------------------------------------------------
Revenues from continuing operations $ 865.5 $ 696.1 $ 1,635.1 $ 1,336.2
Cost of services and products sold 641.6 526.3 1,220.6 1,020.0
Selling, general and administrative expenses 123.9 95.2 244.5 192.2
Other (income) expenses 1.7 (0.6) 3.5 0.8
Operating income from continuing operations 97.6 74.5 165.0 121.8
Interest expense 14.6 10.4 28.7 20.9
Income tax expense from continuing operations 27.9 20.6 45.6 32.8
Net income 53.9 41.7 88.1 64.8
Diluted earnings per common share 1.28 0.99 2.09 1.54
Consolidated effective income tax rate 33.2% 31.9% 33.0% 32.1%
----------------------------------------------------------------------------------------------------
COMPARATIVE ANALYSIS OF CONSOLIDATED RESULTS
REVENUES
Revenues for the second quarter of 2006 increased $169.4 million or 24% from the
second quarter of 2005. Revenues for the first six months of 2006 increased
$298.9 million or 22% from the first six months of 2005. These increases were
attributable to the following significant items:
28
HARSCO CORPORATION AND SUBSIDIARY COMPANIES
PART I - FINANCIAL INFORMATION
CHANGES IN REVENUES - 2006 VS. 2005 SECOND QUARTER SIX MONTHS
------------------------------------------------------------------------------------------------------------------------------------
(IN MILLIONS)
------------------------------------------------------------------------------------------------------------------------------------
Net effect of business acquisitions and divestitures in the Mill Services Segment
($56.2 million and $108.5 million, for the second quarter and six months,
respectively) and the Access Services Segment ($41.9 million and $74.4 million
for the second quarter and six months, respectively). $ 98.1 $ 182.9
Net increased revenues in the Access Services Segment due principally to improved
markets in North America and the strength of the international business,
particularly in Europe (excluding the net effect of acquisitions and divestitures). 20.2 39.2
Net increased volume, new contracts and sales price changes in the Mill Services
Segment (excluding acquisitions). 13.4 25.3
Increased revenues of the air-cooled heat exchangers business due to an improved
natural gas market. 10.1 21.8
Increased revenues in the railway track maintenance services and equipment business
due to increased rail equipment sales and contract services. 9.0 17.0
Net increased revenues in the Gas Technologies Segment due principally to increased
demand for certain valves, industrial cylinders, cryogenics equipment and propane
tanks (second quarter only). 9.2 14.8
Increased revenues in the industrial grating products business due to improved volume. 2.5 3.9
Effect of negative foreign currency translation. 4.4 (12.2)
Other (minor changes across the various units not already mentioned). 2.5 6.2
------------------------------------------------------------------------------------------------------------------------------------
Total Change in Revenues - 2006 vs. 2005 $ 169.4 $ 298.9
====================================================================================================================================
COST OF SERVICES AND PRODUCTS SOLD
Cost of services and products sold for the second quarter of 2006 increased
$115.2 million, or 22%, from the second quarter of 2005, a lower rate than the
24% increase in revenues. Cost of services and products sold for the first six
months of 2006 increased $200.6 million, or 20%, from the first six months of
2005, a lower rate than the 22% increase in revenues. These increases were
attributable to the following significant items:
CHANGES IN COST OF SERVICES AND PRODUCTS SOLD - 2006 VS. 2005 SECOND QUARTER SIX MONTHS
------------------------------------------------------------------------------------------------------------------------------------
(IN MILLIONS)
------------------------------------------------------------------------------------------------------------------------------------
Net effect of business acquisitions and divestitures. $ 64.9 $ 124.2
Increased costs due to increased revenues (exclusive of the effect of foreign
currency translation and business acquisitions and including the impact of
increased commodity and energy costs included in selling prices). 49.3 97.0
Effect of foreign currency translation. 3.5 (8.2)
Other (due to product mix; cost controls; process improvements; volume-related
efficiencies and minor changes across the various units not already mentioned;
partially offset by increased fuel and energy-related costs not recovered
through selling prices). (2.5) (12.4)
------------------------------------------------------------------------------------------------------------------------------------
Total Change in Cost of Services and Products Sold - 2006 vs. 2005 $ 115.2 $ 200.6
====================================================================================================================================
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES
Selling, general and administrative (SG&A) expenses for the second quarter of
2006 increased $28.7 million or 30% from the second quarter of 2005, a higher
rate than the 24% increase in revenues. SG&A expenses for the first six months
of 2006 increased $52.2 million or 27% from the first six months of 2005, a
higher rate than the 22% increase in revenues. These higher relative percentage
increases in SG&A expenses as compared with revenues were due principally to the
net effect of acquisitions and divestitures and the nature of the businesses
acquired. The increases in SG&A expenses were attributable to the following
significant items:
29
HARSCO CORPORATION AND SUBSIDIARY COMPANIES
PART I - FINANCIAL INFORMATION
CHANGES IN SELLING, GENERAL AND ADMINISTRATIVE EXPENSES - 2006 VS. 2005 SECOND QUARTER SIX MONTHS
------------------------------------------------------------------------------------------------------------------------------------
(IN MILLIONS)
------------------------------------------------------------------------------------------------------------------------------------
Net effect of business acquisitions and divestitures. $ 17.5 $ 34.5
Higher compensation expense due to salary increases, increased headcount and
employee incentive plan costs due to improved performance. 5.3 9.0
Increased commission expense due to increased revenues. 1.6 2.9
Increased professional fees. 1.4 1.1
Effect of foreign currency translation. 0.5 (2.7)
Other (including increased energy-related costs). 2.4 7.4
------------------------------------------------------------------------------------------------------------------------------------
Total Change in Selling, General and Administrative
Expenses - 2006 vs. 2005 $ 28.7 $ 52.2
====================================================================================================================================
OTHER (INCOME) EXPENSES
This income statement classification includes impaired asset write-downs,
employee termination benefit costs and costs to exit activities, offset by net
gains on the disposal of non-core assets. Net Other expenses were $1.7 million
in the second quarter of 2006, compared with income of $0.6 million in the
comparable 2005 period. Net Other expenses were $3.5 million in the first six
months of 2006, compared with $0.8 million in the first six months of 2005.
These increases in net expenses were attributable to the following significant
items:
CHANGES IN OTHER (INCOME) EXPENSES - 2006 VS. 2005 SECOND QUARTER SIX MONTHS
------------------------------------------------------------------------------------------------------------------------------------
(IN MILLIONS)
------------------------------------------------------------------------------------------------------------------------------------
Decrease in net gains on the disposal of non-core assets. $ 2.3 $ 2.3
Increase in other expenses due principally to certain contract termination
costs in the second quarter of 2006. 0.4 0.7
Increase in costs to exit activities. - 0.5
Decrease in employee termination benefit costs. (0.4) (0.8)
------------------------------------------------------------------------------------------------------------------------------------
Total Change in Other (Income) Expenses - 2006 vs. 2005 $ 2.3 $ 2.7
====================================================================================================================================
INTEREST EXPENSE
Interest expense for the second quarter of 2006 increased $4.2 million or 40%
from the second quarter of 2005. For the first six months of 2006 Interest
expense increased $7.8 million or 38% from the first six months of 2005. These
increases were principally due to increased borrowings to finance business
acquisitions made in the fourth quarter of 2005.
INCOME TAX EXPENSE FROM CONTINUING OPERATIONS
The increase in income tax expense from continuing operations for the second
quarter and first six months of 2006 of $7.3 million or 35% and $12.8 million or
39%, respectively, was primarily due to increased earnings from continuing
operations. The effective income tax rates of 33.2% and 33.0% for the second
quarter and first six months of 2006, respectively, compared with 31.9% and
32.1% for the second quarter and first six months of 2005, respectively.
NET INCOME AND EARNINGS PER SHARE
Net income of $53.9 million and diluted earnings per share of $1.28 in the
second quarter of 2006 exceeded the second quarter of 2005 by $12.1 million and
$0.29, respectively. Net income of $88.1 million and diluted earnings per share
of $2.09 in the first six months of 2006 exceeded the first six months of 2005
by $23.3 million and $0.55, respectively. These increases are primarily due to
strong demand for most of the Company's services and products and the net effect
of business acquisitions and divestitures.
30
HARSCO CORPORATION AND SUBSIDIARY COMPANIES
PART I - FINANCIAL INFORMATION
LIQUIDITY AND CAPITAL RESOURCES
OVERVIEW
Building on 2005's record cash provided by operations of $315.3 million, the
Company continued its momentum by achieving a record $184.3 million in operating
cash in the first six months of 2006, 37% higher than the $134.5 million in the
first six months of 2005. This significant source of cash in the first six
months of 2006 enabled the Company to invest $166.8 million in capital
expenditures (over 46% of which were for revenue-growth projects), in addition
to paying $27.2 million in stockholder dividends.
The Company's management reaffirms its previously stated strategic objectives
for 2006 that include generating $400 million in net cash provided by operating
activities. The Company has also targeted a minimum of $100 million of
discretionary cash flows for debt reduction; however, the amount of debt
reduction will be affected by the timing of growth initiatives (including
acquisitions) and the amount of asset sales. The Company's net cash borrowings
decreased $42.1 million in the first six months of 2006. Balance sheet debt,
which is affected by foreign currency translation rates, decreased slightly from
December 31, 2005 to $1 billion. However, for the same period, the debt to total
capital ratio declined from 50.4% to 47.8%.
The Company's strategy remains to redeploy excess or discretionary cash in new
long-term, high renewal-rate services contracts for the Mill Services business;
for growth in the Access Services; for sensible bolt-on acquisitions in the
industrial services businesses and, to a lesser extent, railway track
maintenance services businesses. The Company also forsees continuing its long
and consistent history of paying dividends to stockholders.
The Company also intends to focus on improved working capital management.
Specifically, accounts receivable in the Access Services Segment and inventory
levels in the manufacturing businesses will continue to be scrutinized and
challenged to improve the Company's use of funds.
SOURCES AND USES OF CASH
The Company's principal sources of liquidity are cash from operations and
short-term borrowings under its various credit agreements, augmented
periodically by cash proceeds from asset sales. The primary drivers of the
Company's cash flow from operations are the Company's sales and income,
particularly in the services businesses. The Company's long-term Mill Services
contracts provide predictable cash flows for several years into the future. (See
"Certainty of Cash Flows" section for additional information on estimated future
revenues of Mill Services contracts and order backlogs for the Company's
manufacturing businesses and railway track maintenance services and equipment
business). Cash returns on capital investments made in prior years, for which no
cash is currently required, are a significant source of operating cash.
Depreciation expense related to these investments is a non-cash charge. The
Company also continues to maintain working capital at a manageable level based
upon the requirements and seasonality of the businesses.
Major uses of operating cash flows and borrowed funds include payroll costs and
related benefits; pension funding payments; raw material purchases for the
manufacturing businesses; income tax payments; interest payments; insurance
premiums and payments of self-insured casualty losses; and machinery, equipment,
automobile and facility rental payments. Other primary uses of cash include
capital investments, principally in the industrial services businesses; debt
payments; and dividend payments. Cash will also be used for bolt-on acquisitions
as the appropriate opportunities arise.
RESOURCES AVAILABLE FOR CASH REQUIREMENTS - The Company has various credit
facilities and commercial paper programs available for use throughout the world.
The following table illustrates the amounts outstanding under credit facilities
and commercial paper programs and available credit at June 30, 2006.
31
HARSCO CORPORATION AND SUBSIDIARY COMPANIES
PART I - FINANCIAL INFORMATION
SUMMARY OF CREDIT FACILITIES AND
COMMERCIAL PAPER PROGRAMS AS OF JUNE 30, 2006
--------------------------------------------------------------------------------
FACILITY OUTSTANDING AVAILABLE
(IN MILLIONS) LIMIT BALANCE CREDIT
--------------------------------------------------------------------------------
U.S. commercial paper program $ 550.0(a) $ 264.7 $ 285.3
Euro commercial paper program 252.9 184.6 68.3
Revolving credit facility (b) 450.0 - 450.0
Supplemental credit facility (b) 100.0 - 100.0
Bilateral credit facility (c) 50.0 - 50.0
--------------------------------------------------------------------------------
TOTALS AT JUNE 30, 2006 $ 1,402.9 $ 449.3 $ 953.6(d)
================================================================================
(a) Increased from $400 million to $550 million in June 2006.
(b) U.S.-based program
(c) International-based program
(d) Although the Company has significant available credit, it is the Company's
policy to limit aggregate commercial paper and credit facility borrowings
at any one time to a maximum of $600 million.
For more information on the Company's credit facilities, see Note 6, "Debt and
Credit Agreements," to the Company's Form 10-K for the year ended December 31,
2005.
CREDIT RATINGS AND OUTLOOK - The following table summarizes the Company's debt
ratings at June 30, 2006:
U.S.-BASED
LONG-TERM NOTES COMMERCIAL PAPER OUTLOOK
---------------------------------------------------------------------------
Standard & Poor's (S&P) A- A-2 Stable
Moody's A3 P-2 Stable
Fitch A- F2 Stable
---------------------------------------------------------------------------
The Company's euro-based commercial paper program has not been rated since the
euro market does not require it. In June 2006, S&P reaffirmed its A- and A-2
ratings for the Company's long-term notes and U.S. commercial paper,
respectively, and its stable outlook. In January 2006, Fitch reaffirmed its A-
and F2 ratings for the Company's long-term notes and U.S. commercial paper,
respectively, and its stable outlook. Moody's reaffirmed their ratings for the
Company in December 2005. A downgrade to the Company's credit ratings would
probably increase the costs to the Company to borrow funds. An improvement in
the Company's credit ratings would probably decrease the costs to the Company to
borrow funds.
32
HARSCO CORPORATION AND SUBSIDIARY COMPANIES
PART I - FINANCIAL INFORMATION
WORKING CAPITAL POSITION - Changes in the Company's working capital are
reflected in the following table:
(DOLLARS ARE IN MILLIONS) JUNE 30 DECEMBER 31 INCREASE
2006 2005 (DECREASE)
--------------------------------------------------------------------------------
CURRENT ASSETS
Cash and cash equivalents $ 88.3 $ 120.9 $ (32.6)
Accounts receivable, net 706.4 666.3 40.1
Inventories 269.9 251.1 18.8
Other current assets 63.0 60.4 2.6
Assets held-for-sale 2.8 2.3 0.5
--------------------------------------------------------------------------------
Total current assets 1,130.3(a) 1,101.0 29.3(a)
--------------------------------------------------------------------------------
CURRENT LIABILITIES
Notes payable and current maturities 75.8 104.0 (28.2)
Accounts payable 251.8 247.2 4.6
Accrued compensation 71.3 75.7 (4.4)
Income taxes payable 42.8 42.3 0.5
Other current liabilities 305.5 279.2 26.3
--------------------------------------------------------------------------------
Total current liabilities 747.2 748.4 (1.2)
--------------------------------------------------------------------------------
WORKING CAPITAL $ 383.1 $ 352.6 $ 30.5
--------------------------------------------------------------------------------
CURRENT RATIO 1.5:1 1.5:1
================================================================================
(a) Does not total due to rounding
Working capital increased approximately 9% in the first six months of 2006 due
principally to the following factors:
o Cash decreased by $32.6 million due to payments made to reduce the
Company's net cash borrowings.
o Net receivables increased by $40.1 million due principally to increases in
receivables in the Mill Services and Access Services Segments which were
largely due to higher sales and foreign currency translation as a result of
the strengthening of the euro and the British pound sterling in relation to
the U.S. dollar. Partially offsetting these increases was the timing of
cash collections of receivables in the railway equipment business.
o Inventories increased $18.8 million from December 31, 2005 due to the
following factors:
- Increased raw materials, finished goods and work-in-process
inventories in the Gas Technologies Segment due to higher material
costs and to meet expected customer demand in 2006.
- Increased finished goods and raw materials in the Engineered Products
and Services Category due to higher material costs and to meet
expected customer demand in 2006.
- Increased finished goods in the international Access Services business
to meet expected customer demand in 2006.
o Notes payable and current maturities decreased $28.2 million based on the
timing of payments.
o Other current liabilities increased $26.3 million principally due to
accrued interest on the Company's borrowings.
CERTAINTY OF CASH FLOWS - The certainty of the Company's future cash flows is
underpinned by the long-term nature of the Company's mill services contracts. At
December 31, 2005, the Company's mill services contracts had estimated future
revenues of $4.3 billion. In addition, as of June 30, 2006, the Company had an
order backlog of $322.9 million for its manufacturing businesses and railway
track maintenance services. This compares with $275.8 million at December 31,
2005 and $269.1 million at June 30, 2005. The increase from December 31, 2005 is
due principally to increased demand for certain products within the Gas
Technologies Segment and industrial grating and heat exchangers within the
Engineered Products and Services ("all other") Category. The railway track
maintenance services and equipment
33
HARSCO CORPORATION AND SUBSIDIARY COMPANIES
PART I - FINANCIAL INFORMATION
business backlog includes a significant portion that will not be realized until
2007 and later due to the long lead time necessary to build certain equipment,
and the long-term nature of certain service contracts. Backlog for scaffolding,
shoring and forming services and for roofing granules and slag abrasives is not
included in the total backlog because it is generally not quantifiable, due to
the nature of the products and services provided.
The types of products and services that the Company provides are not subject to
rapid technological change, which increases the stability of related cash flows.
Additionally, each of the Company's businesses is among the top three companies
(relative to sales) in the industries the Company serves. Due to these factors,
the Company is confident in its future ability to generate positive cash flows
from operations.
CASH FLOW SUMMARY
The Company's cash flows from operating, investing and financing activities, as
reflected in the Condensed Consolidated Statements of Cash Flows, are summarized
in the following table:
SUMMARIZED CASH FLOW INFORMATION
---------------------------------------------------------------------------
SIX MONTHS ENDED
JUNE 30
(IN MILLIONS) 2006 2005
---------------------------------------------------------------------------
Net cash provided by (used in):
Operating activities $ 184.3 $ 134.5
Investing activities (161.7) (129.4)
Financing activities (62.1) 8.6
Effect of exchange rate changes on cash 6.9 (8.2)
---------------------------------------------------------------------------
Net change in cash and cash equivalents $ (32.7)(a) $ 5.5
===========================================================================
(a) Does not total due to rounding
CASH FROM OPERATING ACTIVITIES - Net cash provided by operating activities in
the first six months of 2006 was $184.3 million, an increase of $49.8 million
from the first six months of 2005. The increased cash from operations was a
result of the following factors:
o Increased net income in the first six months of 2006 compared with the
first six months of 2005.
o The use of cash for net inventories in the first six months of 2006
was significantly less than the use of cash for net inventories for
the comparable period in 2005. This was due principally to the timing
of inventory purchases in the Access Services Segment and production
in the Gas Technologies Segment and the railway track maintenance
services and equipment business.
CASH USED IN INVESTING ACTIVITIES - Capital investments for the first six months
of 2006 were $166.8 million. This was an increase of $31.0 million over the
first six months of 2005. Over 46% of the investments were for projects intended
to grow future revenues. Investments were made predominantly in the industrial
services businesses, with 47% in the Mill Services Segment and 37% in the Access
Services Segment. Throughout the remainder of 2006, the Company plans to
continue to invest in high-return projects and bolt-on acquisitions, principally
in the industrial services businesses.
CASH USED IN FINANCING ACTIVITIES - The following table summarizes the Company's
debt and capital positions at June 30, 2006 and December 31, 2005.
JUNE 30 DECEMBER 31
(DOLLARS ARE IN MILLIONS) 2006 2005
---------------------------------------------------------------------------
Notes Payable and Current Maturities $ 75.8 $ 104.0
Long-term Debt 931.3 905.9
---------------------------------------------------------------------------
Total Debt 1,007.1 1,009.9
Total Equity 1,099.1 993.9
---------------------------------------------------------------------------
Total Capital $ 2,106.2 $ 2,003.9(a)
Total Debt to Total Capital 47.8% 50.4%
===========================================================================
(a) Does not total due to rounding
34
HARSCO CORPORATION AND SUBSIDIARY COMPANIES
PART I - FINANCIAL INFORMATION
The Company's debt as a percent of total capital as of June 30, 2006 decreased
from December 31, 2005. Overall debt decreased due to payments made to reduce
the Company's net borrowings, which was partially offset by increases in foreign
currency-denominated debt due to foreign currency translation resulting from the
weakening of the U.S. dollar in comparison with the euro and the British pound
sterling. Additionally, total equity increased due principally to increased net
income for the six months ended June 30, 2006, positive foreign currency
translation, and to a lesser extent, increases in additional paid-in capital
from stock option exercises.
DEBT COVENANTS
The Company's credit facilities and certain notes payable agreements contain
covenants requiring a minimum net worth of $475 million and a maximum debt to
capital ratio of 60%. Based on balances at June 30, 2006, the Company could
increase borrowings by approximately $641.7 million and still be within its debt
covenants. Alternatively, keeping all other factors constant, the Company's
equity could decrease by approximately $427.8 million and the Company would
still be within its covenants. The Company's 7.25% British pound
sterling-denominated notes due October 27, 2010 also include a covenant that
permits the note holders to redeem their notes, at par, in the event of a change
of control of the Company. The Company expects to be compliant with these debt
covenants one year from now.
CASH AND VALUE-BASED MANAGEMENT
The Company plans to continue with its strategy of selective investing for
strategic purposes for the foreseeable future. The goal of this strategy is to
improve the Company's Economic Value Added (EVA(R)) under the program that
commenced January 1, 2002. Under this program, the Company evaluates strategic
investments based upon the investment's economic profit. EVA equals after-tax
operating profits less a charge for the use of the capital employed to create
those profits (only the service cost portion of pension expense is included for
EVA purposes). Therefore, value is created when a project or initiative produces
a return above the cost of capital. Consistent with the second quarter 2006
results, meaningful improvement in EVA was achieved compared with the prior year
second quarter.
The Company is committed to continue paying dividends to stockholders. The
Company has increased the dividend rate for twelve consecutive years, and in May
2006, the Company paid its 224th consecutive quarterly cash dividend. In June
2006, the Company declared its 225th consecutive quarterly cash dividend. The
Company also plans to pay down debt to the extent possible. Additionally, the
Company has authorization to repurchase up to one million of its shares through
January 1, 2007.
The Company's financial position and debt capacity should enable it to meet
current and future requirements. As additional resources are needed, the Company
should be able to obtain funds readily and at competitive costs. The Company is
well-positioned and intends to continue investing strategically in high-return
projects and acquisitions, reducing debt to the extent possible, and paying cash
dividends as a means to enhance stockholder value.
NEW FINANCIAL ACCOUNTING STANDARDS ISSUED
Information on new financial accounting standards issued is included in Note L,
"New Financial Accounting Standards Issued," in Part I, Item 1, Financial
Statements.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
------------------------------------------------------------------
See Part II, Item 1A, "Risk Factors," for quantitative and qualitative
disclosures about market risk.
ITEM 4. CONTROLS AND PROCEDURES
-------------------------------
The Company's management, including the Chief Executive Officer and Chief
Financial Officer, has conducted an evaluation of the effectiveness of
disclosure controls and procedures as of June 30, 2006. Based on that
evaluation, the Chief Executive Officer and Chief Financial Officer concluded
that the disclosure controls and procedures are effective. There have been no
significant changes in internal controls over financial reporting that could
materially affect, or are likely to materially affect, internal control over
financial reporting during the second quarter of 2006.
35
HARSCO CORPORATION AND SUBSIDIARY COMPANIES
PART II - OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
-------------------------
Information on legal proceedings is included under Part I, Item 1, Footnote I
labeled "Commitments and Contingencies."
ITEM 1A. RISK FACTORS
---------------------
MARKET RISK.
In the normal course of business, the Company is routinely subjected to a
variety of risks. In addition to the market risk associated with interest rate
and currency movements on outstanding debt and non-U.S. dollar-denominated
assets and liabilities, other examples of risk include collectibility of
receivables, volatility of the financial markets and their effect on pension
plans, and global economic and political conditions.
CYCLICAL INDUSTRY AND ECONOMIC CONDITIONS MAY ADVERSELY IMPACT THE COMPANY'S
BUSINESSES.
The Company's businesses are subject to general economic slowdowns and cyclical
conditions in the industries served. In particular,
o The Company's Mill Services business may be adversely impacted by slowdowns
in steel mill production, excess capacity, consolidation or bankruptcy of
steel producers or a reversal or slowing of current outsourcing trends in
the steel industry;
o The Company's Access Services business may be adversely impacted by
slowdowns in non-residential construction and annual industrial and
building maintenance cycles;
o The railway track maintenance business may be adversely impacted by
developments in the railroad industry that lead to lower capital spending
or reduced maintenance spending;
o The industrial abrasives and roofing granules business may be adversely
impacted by reduced home resales or economic conditions that slow the rate
of residential roof replacement, or by slowdowns in the industrial and
infrastructure refurbishment industries;
o The industrial grating business may be adversely impacted by slowdowns in
non-residential construction and industrial production;
o The air-cooled heat exchangers business is affected by cyclical conditions
present in the natural gas industry. A high demand for natural gas is
currently creating increased demand for the Company's air-cooled heat
exchangers. However, a slowdown in natural gas production could adversely
affect this business; and
o The Company's Gas Technologies business may be adversely impacted by
reduced industrial production, and lower demand for industrial gases,
slowdowns in demand for medical cylinders, valves and consumer barbecue
grills, or lower demand for natural gas vehicles.
THE COMPANY'S DEFINED BENEFIT PENSION EXPENSE IS DIRECTLY AFFECTED BY THE
EQUITY AND BOND MARKETS AND A DOWNWARD TREND IN THOSE MARKETS COULD
ADVERSELY IMPACT THE COMPANY'S FUTURE EARNINGS. AN UPWARD TREND IN THE
EQUITY AND BOND MARKETS COULD POSITIVELY AFFECT THE COMPANY'S FUTURE
EARNINGS.
In addition to the economic issues that directly affect the Company's
businesses, changes in the performance of equity and bond markets, particularly
in the United Kingdom and the United States, impact actuarial assumptions used
in determining annual pension expense, pension liabilities and the valuation of
the assets in the Company's defined benefit pension plans. The downturn in
financial markets during 2000, 2001 and 2002 negatively impacted the Company's
pension expense and the accounting for pension assets and liabilities. This
resulted in an increase in pre-tax defined benefit pension expense from
continuing operations of approximately $20.8 million for calendar year 2002
compared with 2001 and $17.7 million for calendar year 2003 compared with 2002.
The upturn in certain financial markets beginning in 2003 and certain plan
design changes (discussed below) contributed to a decrease in pre-tax defined
benefit pension expense from continuing operations of approximately $3.8 million
for 2005 compared with 2004, and approximately $5.4 million for 2004 compared
with 2003. Additionally, defined benefit pension expense declined $0.6 million
for the first six
36
HARSCO CORPORATION AND SUBSIDIARY COMPANIES
PART II - OTHER INFORMATION
months of 2006 compared with the first six months of 2005. An upward trend in
capital markets would likely result in a decrease in future unfunded obligations
and pension expense. This could also result in an increase to Stockholders'
Equity and a decrease in the Company's statutory funding requirements. If the
financial markets deteriorate, it would most likely have a negative impact on
the Company's pension expense and the accounting for pension assets and
liabilities. This could result in a decrease to Stockholders' Equity and an
increase in the Company's statutory funding requirements.
In response to the adverse market conditions, during 2002 and 2003 the Company
conducted a comprehensive global review of its pension plans in order to
formulate a plan to make its long-term pension costs more predictable and
affordable. The Company implemented design changes for most of these plans
during 2003. The principal change involved converting future pension benefits
for many of the Company's non-union employees in both the U.K. and U.S. from
defined benefit plans to defined contribution plans as of January 1, 2004. This
conversion is expected to make the Company's pension expense more predictable
and affordable and less sensitive to changes in the financial markets.
The Company's pension committee continues to evaluate alternative strategies to
further reduce overall pension expense including the on-going evaluation of
investment fund managers' performance; the balancing of plan assets and
liabilities; the risk assessment of all multi-employer pension plans; the
possible merger of certain plans; the consideration of incremental cash
contributions to certain plans; and other changes that are likely to reduce
future pension expense volatility and minimize risk.
Changes in the related pension benefit costs may occur in the future due to
changes in the assumptions and due to changes in returns on plan assets
resulting from financial market conditions. Using the expense calculated for
calendar year 2006 and holding all other assumptions constant, a one-half
percent increase or decrease in the discount rate and the expected long-term
rate of return on plan assets would increase or decrease annual pre-tax defined
benefit pension expense as follows:
APPROXIMATE CHANGES IN PRE-TAX DEFINED BENEFIT
----------------------------------------------
PENSION EXPENSE
---------------
U.S. PLANS U.K. PLAN
---------- ---------
Discount rate
-------------
One-half percent increase Decrease of $1.8 million Decrease of $4.8 million
One-half percent decrease Increase of $2.0 million Increase of $5.2 million
Expected long-term rate of return on plan assets
------------------------------------------------
One-half percent increase Decrease of $1.2 million Decrease of $3.0 million
One-half percent decrease Increase of $1.2 million Increase of $3.0 million
Should circumstances change that affect these estimates, changes (either
increases or decreases) to the net pension obligations may be required and would
be recorded in accordance with the provisions of SFAS 87. Additionally, certain
events could result in the pension obligation changing at a time other than the
annual measurement date. This would occur when the benefit plan is amended or
when plan curtailments occur.
THE COMPANY'S GLOBAL PRESENCE SUBJECTS IT TO A VARIETY OF RISKS ARISING FROM
DOING BUSINESS INTERNATIONALLY.
The Company operates in 45 countries, including the United States. The Company's
global footprint exposes it to a variety of risks that may adversely impact
results of operations, cash flows or financial position. These include the
following:
o periodic economic downturns in the countries in which the Company does
business;
o fluctuations in currency exchange rates;
o customs matters and changes in trade policy or tariff regulations;
o imposition of or increases in currency exchange controls and hard
currency shortages;
o changes in regulatory requirements in the countries in which the
Company does business;
37
HARSCO CORPORATION AND SUBSIDIARY COMPANIES
PART II - OTHER INFORMATION
o higher tax rates and potentially adverse tax consequences including
restrictions on repatriating earnings, adverse tax withholding
requirements and "double taxation ";
o longer payment cycles and difficulty in collecting accounts
receivable;
o complications in complying with a variety of international laws and
regulations;
o political, economic and social instability, civil unrest and armed
hostilities in the countries in which the Company does business;
o inflation rates in the countries in which the Company does business;
o laws in various international jurisdictions that limit the right and
ability of subsidiaries to pay dividends and remit earnings to
affiliated companies unless specified conditions are met; and,
o uncertainties arising from local business practices, cultural
considerations and international political and trade tensions.
If the Company is unable to successfully manage the risks associated with its
global business, the Company's financial condition, cash flows and results of
operations may be negatively affected.
The Company has operations in several countries in the Middle East, including
Bahrain, Egypt, Saudi Arabia, United Arab Emirates and Qatar, which are
geographically close to Iraq, Israel, Lebanon and other countries with a
continued high risk of armed hostilities. During the first six months of 2006,
2005 and 2004, these countries contributed approximately $17.9 million, $15.3
million and $10.9 million, respectively, to the Company's operating income.
Additionally, the Company has operations in and sales to countries that have
encountered outbreaks of communicable diseases (e.g., Acquired Immune Deficiency
Syndrome (AIDS) and others). Should these outbreaks worsen or spread to other
countries, the Company may be negatively impacted through reduced sales to and
within those countries and other countries impacted by such diseases.
EXCHANGE RATE FLUCTUATIONS MAY ADVERSELY IMPACT THE COMPANY'S BUSINESS.
Fluctuations in foreign exchange rates between the U.S. dollar and the
approximately 40 other currencies in which the Company conducts business may
adversely impact the Company's operating income and income from continuing
operations in any given fiscal period. Approximately 62% and 60% of the
Company's sales and approximately 75% and 72% of the Company's operating income
from continuing operations for the six months ended June 30, 2006 and 2005,
respectively, were derived from operations outside the United States. More
specifically, during the six months ended June 30, 2006 and 2005, approximately
20% and 21%, respectively, of the Company's revenues were derived from
operations in the U.K. Additionally, approximately 22% and 18% of the Company's
revenues were derived from operations with the euro as their functional currency
during the six months ended June 30, 2006 and June 30, 2005, respectively. Given
the structure of the Company's revenues and expenses, an increase in the value
of the U.S. dollar relative to the foreign currencies in which the Company earns
its revenues generally has a negative impact on operating income, whereas a
decrease in the value of the U.S. dollar tends to have the opposite effect. The
Company's principal foreign currency exposures are to the British pound sterling
and the euro, and the exposure to these currencies, as well as other foreign
currencies, has increased in 2006 due to the acquisitions of Hunnebeck and the
Northern Hemisphere mill services operations of Brambles Industrial Services
("BISNH") in the fourth quarter of 2005.
Compared with the corresponding period in 2005, the average values of major
currencies changed as follows in relation to the U.S. dollar during the second
quarter of 2006, impacting the Company's sales and income:
o British pound sterling Weakened by less than 1%
o euro Strengthened by 2%
o South African rand Weakened by 3%
o Brazilian real Strengthened by 9%
o Australian dollar Weakened by 2%
38
HARSCO CORPORATION AND SUBSIDIARY COMPANIES
PART II - OTHER INFORMATION
Compared with exchange rates at December 31, 2005, the values of major
currencies changed as follows as of June 30, 2006:
o British pound sterling Strengthened by 6%
o euro Strengthened by 6%
o South African rand Weakened by 13%
o Brazilian real Strengthened by 7%
o Australian dollar Strengthened by 1%
The Company's foreign currency exposures increase the risk of income statement,
balance sheet and cash flow volatility. If the above currencies change
materially in relation to the U.S. dollar, the Company's financial position,
results of operations, or cash flows may be materially affected.
To illustrate the effect of foreign currency exchange rate changes in certain
key markets of the Company, in the first six months of 2006, revenues would have
been approximately 0.7% or $12.2 million higher while operating income would
have been approximately 0.9% or $0.81 million lower if the average exchange
rates for the first six months of 2005 were utilized. A similar comparison for
the first six months of 2005 would have decreased revenues approximately 2% or
$29.6 million while operating income would have been approximately 2% or $2.9
million less if the average exchange rates would have remained the same as the
first six months of 2004.
Currency changes result in assets and liabilities denominated in local
currencies being translated into U.S. dollars at different amounts than at the
prior period end. These currency changes resulted in increased net assets of
$41.4 million and decreased net assets of $45.8 million, at June 30, 2006 and
2005, respectively, when compared with December 31, 2005 and 2004, respectively.
The Company seeks to reduce exposures to foreign currency transaction
fluctuations through the use of forward exchange contracts. At June 30, 2006,
the notional amount of these contracts was $122.8 million, and over 98% will
mature in the third quarter of 2006. The Company does not hold or issue
financial instruments for trading purposes, and it is the Company's policy to
prohibit the use of derivatives for speculative purposes.
Although the Company engages in foreign currency forward exchange contracts and
other hedging strategies to mitigate foreign exchange risk, hedging strategies
may not be successful or may fail to offset the risk.
In addition, competitive conditions in the Company's manufacturing businesses
may limit the Company's ability to increase product prices in the face of
adverse currency movements. Sales of products manufactured in the United States
for the domestic and export markets may be affected by the value of the U.S.
dollar relative to other currencies. Any long-term strengthening of the U.S.
dollar could depress demand for these products and reduce sales and may cause
translation gains or losses due to the revaluation of accounts payable, accounts
receivable and other asset and liability accounts. Conversely, any long-term
weakening of the U.S. dollar could improve demand for these products and
increase sales and may cause translation gains or losses due to the revaluation
of accounts payable, accounts receivable and other asset and liability accounts.
NEGATIVE ECONOMIC CONDITIONS MAY ADVERSELY IMPACT THE ABILITY OF THE COMPANY'S
CUSTOMERS TO MEET THEIR OBLIGATIONS TO THE COMPANY ON A TIMELY BASIS AND IMPACT
THE VALUATION OF THE COMPANY'S ASSETS.
If a downturn in the economy occurs, it may adversely impact the ability of the
Company's customers to meet their obligations to the Company on a timely basis
and could result in bankruptcy filings by them. If customers are unable to meet
their obligations on a timely basis, it could adversely impact the realizability
of receivables, the valuation of inventories and the valuation of long-lived
assets across the Company's businesses, as well as negatively affect the
forecasts used in performing the Company's goodwill impairment testing under
SFAS No. 142, "Goodwill and Other Intangible Assets" (SFAS 142). If management
determines that goodwill or assets are impaired or that inventories or
receivables cannot be realized at recorded amounts, the Company will be required
to record a write-down in the period of determination, which will reduce net
income for that period. Additionally, the risk remains that certain Mill
Services customers may file for bankruptcy protection, be acquired or
consolidate in the future, which could have an adverse impact on the Company's
income and cash flows. The potential financial impact of this risk has increased
with the Company's acquisition of BISNH in December 2005. Conversely, such
consolidation may provide additional service opportunities for the Company.
39
HARSCO CORPORATION AND SUBSIDIARY COMPANIES
PART II - OTHER INFORMATION
A NEGATIVE OUTCOME ON PERSONAL INJURY CLAIMS AGAINST THE COMPANY MAY ADVERSELY
IMPACT RESULTS OF OPERATIONS AND FINANCIAL CONDITION.
The Company has been named as one of many defendants (approximately 90 or more
in most cases) in legal actions alleging personal injury from exposure to
airborne asbestos. In their suits, the plaintiffs have named as defendants many
manufacturers, distributors and repairers of numerous types of equipment or
products that may contain asbestos. Most of these complaints contain a standard
claim for damages of $20 million or more against the named defendants. If the
Company was found to be liable in any of these actions and the liability was to
exceed the Company's insurance coverage, results of operations, cash flows and
financial condition could be adversely affected. For more information concerning
this litigation, see Note I, "Commitments and Contingencies," in Part 1, Item 1,
Financial Statements.
THE COMPANY MAY LOSE CUSTOMERS OR BE REQUIRED TO REDUCE PRICES AS A RESULT OF
COMPETITION.
The industries in which the Company operates are highly competitive.
o The Company's Mill Services business is sustained mainly through contract
renewals. Historically, the Company's contract renewal rate has averaged
approximately 95%. If the Company is unable to renew its contracts at the
historical rates or renewals are at reduced prices, revenue may decline.
o The Company's Access Services business rents and sells equipment and
provides erection and dismantling services to principally the
non-residential construction and industrial plant maintenance markets.
Contracts are awarded based upon the Company's engineering capabilities,
product availability, safety record, and the ability to competitively price
its rentals and services. Commencing in 2000, due to economic downturns in
their home markets, certain international competitors exported significant
quantities of rental equipment to the markets the Company serves,
particularly the U.S. This resulted in an oversupply of certain equipment
and a consequential reduction in product and rental pricing in the markets
receiving the excess equipment. The effect of these actions was mitigated,
to some extent, in 2005 and the first six months of 2006 due to a buoyant
U.S. non-residential construction market. However, if the Company is unable
to consistently provide high-quality products and services at competitive
prices, it may lose customers or operating margins may decline due to
reduced selling prices.
o The Company's manufacturing businesses compete with companies that
manufacture similar products both internationally and domestically. Certain
international competitors export their products into the United States and
sell them at lower prices due to lower labor costs and government subsidies
for exports. Such practices may limit the prices the Company can charge for
its products and services. Additionally, unfavorable foreign exchange rates
can adversely impact the Company's ability to match the prices charged by
international competitors. If the Company is unable to match the prices
charged by international competitors, it may lose customers.
The Company's strategy to overcome this competition includes continuous process
improvement and cost reduction programs, international customer focus and the
diversification, streamlining and consolidation of operations.
INCREASED CUSTOMER CONCENTRATION AND CREDIT RISK IN THE MILL SERVICES SEGMENT
MAY ADVERSELY AFFECT THE COMPANY'S FUTURE EARNINGS AND CASH FLOWS.
Concentrations of credit risk with respect to accounts receivable are generally
limited due to the Company's large number of customers and their dispersion
across different industries and geographies. However, the Company's Mill
Services Segment has several large customers throughout the world with
significant accounts receivable balances. In December 2005, the Company acquired
BISNH. This acquisition has increased the Company's corresponding concentration
of credit risk to customers in the steel industry.
Additionally, further consolidation in the global steel industry is probable.
Should transactions occur involving some of the steel industry's larger
companies, which are customers of the Company, it would result in an increase in
concentration of credit risk for the Company. If a large customer were to
experience financial difficulty, or file for bankruptcy protection, it could
adversely impact the Company's income, cash flows and asset valuations. As part
of its credit risk management practices, the Company is developing strategies to
mitigate this increased concentration of credit risk.
INCREASES IN ENERGY PRICES COULD INCREASE THE COMPANY'S OPERATING COSTS AND
REDUCE ITS PROFITABILITY.
Worldwide political and economic conditions, extreme weather conditions, armed
hostilities in oil-producing regions, among other factors, may result in an
increase in the volatility of energy costs, both on a macro basis and for the
Company specifically. In the first six months of 2006 and 2005, energy costs
have approximated 4.2% and 3.8% of the Company's revenue, respectively. To the
extent that such costs cannot be passed to customers in the future, operating
income and results of operations may be adversely affected.
40
HARSCO CORPORATION AND SUBSIDIARY COMPANIES
PART II - OTHER INFORMATION
INCREASES OR DECREASES IN PURCHASE PRICES OR AVAILABILITY OF STEEL OR OTHER
MATERIALS AND COMMODITIES MAY AFFECT THE COMPANY'S PROFITABILITY.
The profitability of the Company's manufactured products is affected by changing
purchase prices of steel and other materials and commodities. Beginning in 2004,
the price paid for steel and certain other commodities increased significantly
compared with prior years. Although these costs moderated in 2005, the current
outlook for 2006 indicates that there will be increases in the prices of such
commodities. If raw material costs associated with the Company's manufactured
products increase and the costs cannot be passed on to the Company's customers,
operating income would be adversely affected. Additionally, decreased
availability of steel or other materials, such as carbon fiber used to
manufacture filament-wound composite cylinders, could affect the Company's
ability to produce manufactured products in a timely manner. If the Company
cannot obtain the necessary raw materials for its manufactured products, then
revenues, operating income and cash flows will be adversely affected.
THE COMPANY IS SUBJECT TO VARIOUS ENVIRONMENTAL LAWS AND THE SUCCESS OF EXISTING
OR FUTURE ENVIRONMENTAL CLAIMS AGAINST IT COULD ADVERSELY IMPACT THE COMPANY'S
RESULTS OF OPERATIONS AND CASH FLOWS.
The Company's operations are subject to various federal, state, local and
foreign laws, regulations and ordinances relating to the protection of health,
safety and the environment, including those governing discharges to air and
water, handling and disposal practices for solid and hazardous wastes, the
remediation of contaminated sites and the maintenance of a safe work place.
These laws impose penalties, fines and other sanctions for non-compliance and
liability for response costs, property damages and personal injury resulting
from past and current spills, disposals or other releases of, or exposure to,
hazardous materials. The Company could incur substantial costs as a result of
non-compliance with or liability for remediation or other costs or damages under
these laws. The Company may be subject to more stringent environmental laws in
the future, and compliance with more stringent environmental requirements may
require the Company to make material expenditures or subject it to liabilities
that the Company currently does not anticipate.
The Company is currently involved in a number of environmental remediation
investigations and clean-ups and, along with other companies, has been
identified as a "potentially responsible party" for certain waste disposal sites
under the federal "Superfund" law. At several sites, the Company is currently
conducting environmental remediation, and it is probable that the Company will
agree to make payments toward funding certain other of these remediation
activities. It also is possible that some of these matters will be decided
unfavorably to the Company and that other sites requiring remediation will be
identified. Each of these matters is subject to various uncertainties and
financial exposure is dependent upon such factors as the continuing evolution of
environmental laws and regulatory requirements, the availability and application
of technology, the allocation of cost among potentially responsible parties, the
years of remedial activity required and the remediation methods selected. The
Company has evaluated its potential liability and the Consolidated Balance
Sheets for June 30, 2006 and December 31, 2005 include an accrual of $3.1
million and $2.8 million for environmental matters, respectively. The amounts
charged against pre-tax earnings related to environmental matters totaled $0.5
million for the six months ended June 30, 2006 and 2005. The liability for
future remediation costs is evaluated on a quarterly basis. Actual costs to be
incurred at identified sites in future periods may be greater than the
estimates, given inherent uncertainties in evaluating environmental exposures.
RESTRICTIONS IMPOSED BY THE COMPANY'S CREDIT FACILITIES AND OUTSTANDING NOTES
MAY LIMIT THE COMPANY'S ABILITY TO OBTAIN ADDITIONAL FINANCING OR TO PURSUE
BUSINESS OPPORTUNITIES.
The Company's credit facilities and certain notes payable agreements contain a
covenant requiring a maximum debt to capital ratio of 60%. In addition, certain
notes payable agreements also contain a covenant requiring a minimum net worth
of $475 million. These covenants limit the amount of debt the Company may incur,
which could limit its ability to obtain additional financing or to pursue
business opportunities. In addition, the Company's ability to comply with these
ratios may be affected by events beyond its control. A breach of any of these
covenants or the inability to comply with the required financial ratios could
result in a default under these credit facilities. In the event of any default
under these credit facilities, the lenders under those facilities could elect to
declare all borrowings outstanding, together with accrued and unpaid interest
and other fees, to be due and payable, which would cause an event of default
under the notes. This could, in turn, trigger an event of default under the
cross-default provisions of the Company's other outstanding indebtedness. At
June 30, 2006, the Company was in compliance with a debt to capital ratio of
47.8% and a net worth of $1,099.1 million. The company had $368.9 million in
outstanding indebtedness containing these covenants at June 30, 2006.
41
HARSCO CORPORATION AND SUBSIDIARY COMPANIES
PART II - OTHER INFORMATION
HIGHER THAN EXPECTED CLAIMS UNDER INSURANCE POLICIES, UNDER WHICH THE COMPANY
RETAINS A PORTION OF RISK, COULD ADVERSELY IMPACT RESULTS OF OPERATIONS AND CASH
FLOWS.
The Company retains a significant portion of the risk for property, workers'
compensation, U.K. employers' liability, automobile, general and product
liability losses. Reserves have been recorded which reflect the undiscounted
estimated liabilities for ultimate losses including claims incurred but not
reported. Inherent in these estimates are assumptions that are based on the
Company's history of claims and losses, a detailed analysis of existing claims
with respect to potential value, and current legal and legislative trends. At
June 30, 2006 and December 31, 2005, the Company had recorded liabilities of
$102.1 million and $102.3 million, respectively, related to both asserted and
unasserted insurance claims. Included in the balances at June 30, 2006 and
December 31, 2005 were $19.5 million and $25.2 million, respectively, of
recognized liabilities covered by insurance carriers. If actual claims are
higher than those projected by management, an increase to the Company's
insurance reserves may be required and would be recorded as a charge to income
in the period the need for the change was determined. Conversely, if actual
claims are lower than those projected by management, a decrease to the Company's
insurance reserves may be required and would be recorded as a reduction to
expense in the period the need for the change was determined.
THE SEASONALITY OF THE COMPANY'S BUSINESS MAY CAUSE ITS QUARTERLY RESULTS TO
FLUCTUATE.
The Company has historically generated the majority of its cash flows in the
third and fourth quarters (periods ending September 30 and December 31). This is
a direct result of normally higher sales and income during the latter part of
the year, as the Company's business tends to follow seasonal patterns. If the
Company is unable to successfully manage the cash flow and other effects of
seasonality on the business, its results of operations may suffer.
HISTORICAL REVENUE PATTERNS
(IN MILLIONS) 2006 2005 2004 2003 2002 2001
------------------------------------------------------------------------------------------------------------------------------------
First Quarter Ended
March 31 $ 769.6 $ 640.1 $ 556.3 $ 487.9 $ 458.6 $ 505.0
Second Quarter Ended June 30 865.5 696.1 617.6 536.4 510.3 510.1
Third Quarter Ended September 30 - 697.5 617.3 530.2 510.5 510.3
Fourth Quarter Ended December 31 - 732.5 710.9 564.0 497.3 499.7
------------------------------------------------------------------------------------------------------------------------------------
Totals $ - $ 2,766.2 $ 2,502.1 $ 2,118.5 $ 1,976.7 $ 2,025.2(a)
====================================================================================================================================
(a) Does not total due to rounding.
42
HARSCO CORPORATION AND SUBSIDIARY COMPANIES
PART II - OTHER INFORMATION
HISTORICAL CASH PROVIDED BY OPERATIONS
(IN MILLIONS) 2006 2005 2004 2003 2002 2001
------------------------------------------------------------------------------------------------------------------------------------
First Quarter Ended
March 31 $ 69.8 $ 48.1 $ 32.4 $ 31.2 $ 9.0 $ 2.6
Second Quarter Ended June 30 114.2 86.3 64.6 59.2 71.4 65.1
Third Quarter Ended September 30 -- 98.1 68.9 64.1 83.3 66.1
Fourth Quarter Ended December 31 -- 82.7 104.6 108.4 90.1 106.9
------------------------------------------------------------------------------------------------------------------------------------
Totals $ -- $ 315.3(a) $ 270.5 $ 262.8(a) $ 253.8 $ 240.6(a)
====================================================================================================================================
(a) Does not total due to rounding.
THE COMPANY'S CASH FLOWS AND EARNINGS ARE SUBJECT TO CHANGES IN INTEREST RATES.
The Company's total debt as of June 30, 2006 was $1,007 million. Of this amount,
approximately 47.4% had variable rates of interest and 52.6% had fixed rates of
interest. The weighted average interest rate of total debt was approximately
5.6%. At current debt levels, a one-percentage increase/decrease in variable
interest rates would increase/decrease interest expense by approximately $4.8
million per year.
The future financial impact on the Company associated with the above risks
cannot be estimated.
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
-------------------------------------------------------------------
(c). Issuer Purchases of Equity Securities
MAXIMUM NUMBER OF
TOTAL NUMBER OF AVERAGE PRICE TOTAL NUMBER OF SHARES PURCHASED SHARES THAT MAY
SHARES PAID AS PART OF PUBLICLY ANNOUNCED YET BE PURCHASED UNDER
PERIOD PURCHASED PER SHARE PLANS OR PROGRAMS THE PLANS OR PROGRAMS
------------------------------------------------------------------------------------------------------------------------------------
April 1, 2006 - April 30, 2006 -- -- -- 1,000,000
May 1, 2006 - May 31, 2006 -- -- -- 1,000,000
June 1, 2006 - June 30, 2006 -- -- -- 1,000,000
--------------------------------------------------------------------------------------------------------
Total -- -- --
--------------------------------------------------------------------------------------------------------
The Company's share repurchase program was extended by Board of Directors in
November 2005. The program authorizes the repurchase of up to 1,000,000 shares
of the Company's common stock and expires January 31, 2007.
ITEM 5. OTHER INFORMATION
-------------------------
DIVIDEND INFORMATION
--------------------
On June 20, 2006, the Board of Directors declared a quarterly cash dividend of
$0.325 per share, payable August 15, 2006, to stockholders of record as of July
14, 2006.
43
HARSCO CORPORATION AND SUBSIDIARY COMPANIES
PART II - OTHER INFORMATION
10b5-1 Plan
-----------
The Chief Executive Officer (CEO) of the Company adopted in the First Quarter of
2006, a personal trading plan, as part of a long-term strategy for asset
diversification and liquidity, in accordance with the Securities and Exchange
Commission's Rule 10b5-1. Under the plan, which expired in July 2006, the CEO
exercised, under pre-arranged terms, 100,000 options in open market
transactions. All 100,000 shares have been sold under the trading plan.
The President and Chief Financial Officer (CFO) of the Company adopted in the
First Quarter of 2006, a personal trading plan, as part of a long-term strategy
for asset diversification and liquidity, in accordance with the Securities and
Exchange Commission's Rule 10b5-1. Under the plan, which was to expire in August
2006, the President and CFO exercised, under pre-arranged terms, 28,000 options
in open market transactions. As of July 20, 2006, all 28,000 shares have been
sold under the trading plan.
Rule 10b5-1 allows officers and directors, at a time when they are not in
possession of material non-public information, to adopt written plans to sell
shares on a regular basis under pre-arranged terms, regardless of any subsequent
non-public information they may receive. Exercises of stock options by the CEO
or President and CFO pursuant to the terms of their respective plans will be
disclosed publicly through Form 144 and Form 4 filings with the Securities and
Exchange Commission.
ITEM 6. EXHIBITS
Listing of Exhibits filed with Form 10-Q:
Exhibit
Number Data Required Location
------ ------------- --------
31 (a) Certification Pursuant to Rule 13a-14(a) and 15d-14(a),
as Adopted Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002 Exhibit
31 (b) Certification Pursuant to Rule 13a-14(a) and 15d-14(a),
as Adopted Pursuant to Section 302 of the Sarbanes-Oxley
Act of 2002 Exhibit
32 (a) Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 Exhibit
32 (b) Certification Pursuant to 18 U.S.C. Section 1350, as
Adopted Pursuant to Section 906 of the Sarbanes-Oxley
Act of 2002 Exhibit
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
HARSCO CORPORATION
(Registrant)
DATE August 7, 2006 /S/ Salvatore D. Fazzolari
------------------- -------------------------------
Salvatore D. Fazzolari
President, Chief Financial
Officer and Treasurer
DATE August 7, 2006 /S/ Stephen J. Schnoor
------------------- -------------------------------
Stephen J. Schnoor
Vice President and Controller
44