Crane Co (CR) 2002 Q4 法說會逐字稿

Good day, and welcome everything to the Crane Company fourth quarter 2002 earnings analyst conference call. Today ace call is being recorded. At this time, I would like to turn the call over to the director of investors relations, Ms. Pamela Styles.

Thank you, Lisa, and good morning, everyone. Welcome to our Crane Company 2002 fourth quarter earnings release conference call.

I'm director of investors relations and strategic planning. We have Eric Fast, President and CEO this morning on the call.

Let me remind you that the comments we make on this call may include forward-looking statements. We would ask you to look to the disclaimer statement, and also our annual report and Form 10-K containing forward-looking statements. Let me turn this call over to Eric.

Good morning, from my perspective, the fourth quarter was fine operationally, but obviously difficult reflecting increased asbestos claims,[MSOffice1]and the 73 million after-tax, non-cash charge for future and existing asbestos claims. I will cover this in detail in a moment. Operationally pre-asbestos charged we earned 37 cents in the fourth quarter, in line with our previous guidance of 34 to 36 cents. Segment operating results were higher in forward handling reflecting the prior year acquisition activity, and engineered materials where the RV market demand remains strong. Most of our businesses continued to experience difficult or depressed markets, particularly aerospace and chemical processing. On the M & A front we had 125 million acquisition in the quarter, General Technology Corporation, a manufacturer of custom electronic components, which would be combined with Interpoint, expanding our air other space business.

We are actively pursuing additional strategic acquisitions and have seen pickup in activities.

The non-cash after-tax charge for asbestos in the fourth quarter totaled $73.3 million or $1.03 per share. The charge reflects the recent significant increase in the array of new claims filed, particularly in the last few months of 2002, and the estimated settlement and defense cost of pending and future asbestos claims through 2007, net of estimated insurance recovery. Our history of outstanding asbestos claims, which we have disclosed since 1995, is as follows. At year-end '95, 1,000 claims, year end 2000, 5,000 claims. Year he end 2001, 16,000 claims. At the quarter end basis in 2002 those claims were March, 21,000, June 25,000, September 43,000, and December 54,000. As you can see, there has been an escalation of the claims in the last few months of this year.

I'd like now to anticipate some of your questions. The first one being, why now? The company's practice has been to evaluate on a quarterly basis its estimated asbestos claims liability, including estimated future costs based on the company's historical experience with asbestos claims. The rate of new claims filed and the cost of settling claims and defense costs increased significantly, particularly during the last few months of 2002,. when the company increased the liability to reflect the more recent claims and cost data. The calculation of the liability is as follows. The $200 million gross liability, less $80 million in estimated insurance recovery, so $120 million after insurance. We had a $12 million reserve already recorded on the September balance sheet, so the pretax charge totaled $108 million, and therefore, $73.3 million in after-tax. The asbestos liability, the best estimate of these costs net anticipated insurance recoveries through 2007. The company does not expect additional charges on these estimated claims, unless experiences inconsistent with the claim and cost assumptions used.

For all of 2002, gross settlement costs associated with asbestos before insurance were $7.3 million and associated legal costs were $4.8 million. The actual cash payments on asbestos claims by Crane were $1.4 million in 2002, $800,000 in 2001, and $270,000 in 2000. As you know, we have a solid investment-grade debt rating of BAA1from Moody's and BBB+ from Standard and Poor's. We expect S&P to affirm our current debt ratings while we expect that while Moody's will take no immediate action, it will need more time to consider the impact of this charge before making a determination. We expect our senior bank group to remain supportive and that our access to the bank and public debt markets will not be limited by this asbestos charge. Please remember Crain never manufactured any asbestos product or any asbestos-containing materials. We are equipment manufacturer, and certain of our valves, pumps and long-ago boilers contained encapsulated gasket, pickings and seals manufactured by others with asbestos material. Accurate product identification is critical in any claim, and our normal practice is to vigorously challenge each claim in terms of product identification.

However, given the state of the judicial system, particularly in certain jurisdictions, we are forced to settle far more cases than we would like. We have insurance coverage for asbestos claims that is estimated to cover 40 to 50 percent of our costs. I want to emphasize that we are working actively on all means to defend against this liability, whether it's defend each claim one by one. We are ready for trial, if necessary, and we will, of course, explore any feasible alternative solution. In wrapping up on the asbestos topic, I hope you all understand and will be sensitive that any further elaboration or details could compromise our position on defending claims.

Turning to the business. We continue to produce strong free cash flow in the quarter with debt as a percent of capital at a conservative 25%. At year-end versus 24% at September 30. Operating activities generated a cash flow of $59 million in the fourth quarter, and $100 --net 97—million (ph) for the full year. Free cash flow for the full year after dividends and capital expenditures was $148 million or $2.47 per share, substantially exceeding our target of $120 million. Our balance sheet remains strong. To help you with the impact on the balance sheet of the asbestos charge, I would note that the total gross estimated liability of $200 million is included in other liabilities, and the estimated insurance recoveries is included in other assets.

We expect first quarter 2003 earnings per share to be 27 to 29 cents, including an approximately $4 million or 5 cents per share impact on anticipated severance charges. We continue to expect 2003 earnings per share to be $1.65 to $1.75 reflecting continuing challenging operating environments.

Now I'll give some brief remarks on operations, and these will exclude the goodwill amortization and the asbestos. Total company sales in the fourth quarter were $367 million down 1.5% from prior year. Operating profits were $35 million, down 6% from last year. Margins were -- operating margins- were 9.7% v. 10.1% last year. In the quarter, aerospace sales were down 8.7%, operating profit down 7%, but we were able to hold margins at 22.9%, slightly above prior-year levels. In our traditional commercial aerospace business, the aftermarket was relatively stable with orders and shipments modestly up. OEM shipments, however, continue to decline. We expect the after-market business to be relatively stable in 2003 as a result of our globally diverse customer base and the fact that no individual commercial carrier represents more than 1.5% of our total after-market revenue. While the U.S. domestic market has been hardest hit, it's important to remember that Asia is growing and Europe is stable or static. Interpoint acquired General Technology corporation during the quarter. Performance was very satisfactory and we think this acquisition looks to be an excellent start on the expansion of our electronics activity.

Our guidance remains unchanged in this segment. We expect the aerospace market to remain weak in '03, and assuming current OEM production levels and after-market maintenance activity, we continue to expect a further 10% reduction in operating profit from 2002 levels. Crane's aerospace group will be reorganizing its five business units into two larger units serving traditional aerospace and electronics markets. Consolidation of the aerospace activities will result in head count reductions this quarter. At engineer materials, sales were $64.9 million, up 12.6%, and operating profit was up 20.5%, and margins improved slightly from 13.3 %. to 12.4%. Chemline ‘s (ph) demand remains strong with the highest RB fourth quarter demand level ever, and transportation demand from increased production both refrigerated and dry vans. At Resistoflex (ph) operating results were weak reflecting the chemical processing industry, and the costs of closure of the bay City Michigan plant We expect the RV market to remain strong. It was up 20% in 2002. We see another 5% in 2003, and the truck trailer transfer market should also improve in 2003. We're expecting approximately 25%. Based on the strong performance of Kemlite and the completion of the plant consolidation and Resistoflex, we currently expect engineered materials operating profit to be up approximately 20% for the full year 2003.

Merchandising system segment sales were down approximately 23% and incurred a slight operating loss of 236,000, solely due to the impact of NRI of the completion of the Euro coin conversion in 2001. National Vendors on a 12% increase in sales was profitable versus a loss in the comparable quarter in the prior year. While the market in North America continues to be very soft with no improvement in unemployment or office vacancy rates, we feel we're in a very strong position here. We have an excellent flow of new products, improved customer service, and believe we are aggressively gaining market share.

NRI had an operating loss in the quarter of $1.6 million versus a profit of $5.9 million in the fourth quarter of 2001. Please note that on a full-year basis, NRI generated $26 million in sales. This year, in 2002, versus $77 million in 2001, and $43 million in the more normal year 2000. N market demand in the automated merchandising market in both the U.S. and Europe is expected to remain weak in 2003, resulting in only modest operating improvement from 2002. First quarter 2003 results will be negatively impacted by downsizing at NRI. Fluid handling sales were 4.7% ahead of last year, operating profit improved from 8.6 million to 13.7 million in the fourth quarter. Margins improved to 8.2% in the quarter.

I would characterize the quarter as ordered or generally weak, especially in the chemical processing industry. We are -- continue to be focused and very active with respect to head count reductions, low-cost foreign sourcing facility rationalization, raw material procurement initiatives and synergy sales. We continue to look for a 20% improvement in fluid handling in operating profit in 2003 as our margin improvement efforts offset the impact of continued weakness in the chemical process and power industries. Control segment sales were 6.4% below prior year and operating profit in the quarter of 1.4 million was flat with the prior year. We expect operating results here to increase slightly in 2003. As I commented previously, we do expect earnings in the first quarter of '03 to be 27 to 29 cents which includes the anticipated severance charges of four million or five cents a share, and we have held our outlook for 2003 of $1.65 to $1.75 per share.

Lisa, we're done with our prepared comments. You can open thrall for questions.

Thank you. Today’s question-and-answer will be conducted electronically. If you would like to ask a question please do so by pressing the star key followed by the digit 1 on your Touch-Tone telephone. If you are on a speakerphone, please make sure your mute function is turned off. Once again, that's star-1 to ask a question. We'll go first to Deane Dray with Goldman Sachs.

Good morning. The first questions have to be on the asbestos side and the extent to which you can comment on these, I would appreciate it. The first would be clearly the number of claims continues to go up, but it went up 25% from third quarter to fourth quarter, but the reserve that you've now put on the books increased by a factor of 10. So what kinds of assumptions are making in terms of the number of plaintiffs, the settlement sizes, and so forth?

As I commented previously, Deane, we have been using long-term assumptions with respect to claims and settlement costs and litigation costs, and that we felt that with the -- with the changes we were seeing very late in the year that it was no longer acceptable or relevant for us to use those, and that we needed to use our recent experience to account for the potential liability here. So it's a function of both the acceleration of claims and our using very recent experience.

Were there claims settled in the fourth quarter?

Well, we're constantly settling claims.

Okay.

There wasn't -- we had 9,000 cases in Mississippi which we took the charge on in the third quarter, which actually were cleaned up in the fourth quarter. But not a material amount, no. You're thinking of a roughly 10,000 increase with a net?

Yes.

Not a material number, Deane.

I guess what's puzzling is you're choosing to go and make a projection out to 2007 on asbestos claims when this is clearly a dynamic situation month to month, and you certainly weren't foreseeing this kind of impact when you were projecting the fourth quarter. So what gives you confidence to make -- put a number on an '07 exposure?

Our assumptions, whenever we've calculated this, Deane, have always been for five years, number 1. But we felt that to be -- from an accounting point of view, to properly reflect our recent experience, that we had no choice but to do this.

Okay. Is your --

So I have not changed -- we've always had the five-year assumption, and, you know, our view was we would properly represent what we are experiencing in -- and we did this.

Okay. Is your insurance -- in previous calls, you talked about a 50% insurance. Is it -- what swings it from 40 to 50? Are there multiple carriers involved? And is that capped?

We think we have adequate insurance coverage ranging from 40 to 50% of our exposure. We have -- I think the 40% that we've used in our reserve is to be conservative, and we have a consortium of insurers.

Okay. And then in the '03 outlook in November, your corporate expense had implicit asbestos expense for '03. Now since you've taken the reserve, how should we think about that budgeting for corporate expense? It's anywhere between a nickel and a dime --

Let me clarify on that. We have openly discussed and disclosed that in the forecast that we gave to the Wall Street and all the investors, that we had contingencies in there for any unanticipated charges, and that those contingencies, among other potential general contingencies, would include asbestos. Okay? Now, clearly, with the asbestos contingency set aside here and no longer applicable because we've taken this charge, I would say that -- and we have not changed our guidance, but I would say that it has given us a lot more confidence in our ability to achieve our guidance, even though we've got very uncertain market conditions.

I would also note that, given the guidance that I've done in the first quarter, a lot of this is coming in, you know, the latter part of the year. So I think we're being conservative, but the way we've handled this is to say we're more confident on the $1.65 to $1.75.

This last question --when you do the payouts, will the payout settlements be coming out of the corporate experience or taken out from the reserve?

I think I've said, they will all be coming out of the reserve.

Okay. Thank you.

We'll go next to Don MacDougall with J.P. Morgan.

Good morning, Eric. Continuing to kick the asbestos horse here --

As long it's not me, Don.

Never you.

Thank you.

On the insurance issue you answered part of Deane's question, but beyond the '05 planning period, is there remain asbestos insurance coverage?

The insurance coverage is not limited in time.

Is it capped in absolute?

I'm not willing to disclose that. What we have said and consistently said that we believe that we have adequate insurance coverage to handle between 40 to 50% of our exposure here.

Okay. I'm not sure --

The reason is, is because, again it's information that could be used against us here.

Understood.

The other question related to asbestos was your expected cash flow payouts this year, I can't remember if you disclosed that already.

We have said that in 2002, it was a million four, and we have not disclosed anything for '03 or '04, what the actual cash will be.

Okay. And then last one on asbestos, just the average payout for claims that you did settle in the fourth quarter, compared to recent history, was there any change, and could you give us a sense for what that amount is?

You know, I don't think there's -- [pause] -- I'm not sure we want to go there with an answer on that. I don't think the answer is material, either in the context of what we're talking about here.

OK, so we'll leave asbestos and go to aerospace. I would say that the results were reasonably impressive on the margin line. I'm wondering if you could talk about the impact from the defense side. We've seen a pattern here from some of your peer companies in aerospace supply, where they've had pretty good results in the fourth quarter, I'm sure some related to spares but any comments on that front would be helpful.

I would make a couple comments. First off, on our traditional aerospace business, unfortunately we just don't have much of a commitment to the military. I think it's about 10%. And where we have it, we have seen strength pretty much across the board. So it's nice to have. I would say that over the course of the fourth quarter, while I don't think the outlook -- the industry's gotten any better, in fact, if might have gotten worse we have -- are confident in our business and our ability to control our own destiny by consolidating our activities and eliminating costs I think has strengthened. And secondly, we've done a lot more work in looking at our after-market and concentrations. I noted in the call that there's no single customer in our after-market that accounts for more than 1.5% of our after-market business.

And we looked at that, thinking to ourselves there was a lot more parts for (ph) planes, where could they come from, and what is the impact? And we've gotten more comfortable even with further deterioration in the industry, we can hold our results here in the commercial aerospace. At the same time in the electronics segment, the acquisition of GTC, as well as the -- you know, a very aggressive business plan, we are trying to grow that electronics part of that business. Again, a lot of that is in the latter part of the year, though.

Final question on engineered materials, just wondering if you could comment on your outlook for raw material cost pressure on the business there, how much is hedged and what the outlook is there from the cost side.

On Kemlite specifically, they've done really an extraordinary job in nailing down pricing and contracts on the material side, and we are confident that we're in very good shape there and we feel good on the demand side for recreational vehicles and transportation. So on the Kemlite business, which as you know, is a big-- important business for us, I think we feel quite comfort.

I guess just to interpret your comment about feeling good about the cost side, does that mean that you expect costs to be flat this year? Or at least your spread between cost and selling price to remain reasonably flat?

I haven't quite thought about it like that. The way we measure our division's material cost and procurement activities is we kind of look at versus the prior year and prior two years, and I have a number in my head which wouldn't be relevant to you which tells me that they have been very successful in kind of holding costs in-line.

Thank you.

Next is Scott Graham with Bear Stearns.

Good morning, Eric, good morning, Pam. Two questions on asbestos and then two on aerospace. The asbestos calculation, obviously we're not going to go into the details here, but it looks like you extrapolated what happened in your experience in the fourth quarter to sort of a five-year situation here. Is that fairly close to what your people did?

In some cases we used the fourth quarter, and in some cases we used the last year. In other assumptions we used the last couple years. We exercised some judgment to see what was appropriate. But, largely, again, reflecting our very recent experience versus the very long-term experience that we were using -- Keep in mind here that for 20 years there was no claims, and then even from -- and from '95 to 2000, it non-event. So we've been using a historical norm that's been fine, but increasingly was not relevant.

I think that there is an interpretation here that the number is just so large that perhaps there was still some adverse experiences within the fourth quarter beyond even the cost per claim, as well as the number of claims --

I don't feel that way.

It's not higher quality claims, perhaps, that kind of thing?

No. No. We got more claims, and we looked at this and said if we honestly want to comply with the accounting rules and look at this and communicate it, then let's try it. We need to use more recent experience. I mean, it's as simple as that.

Because Moody's has announced recently just within the last 15 minutes that they're putting your -- putting you guys on watch for possible downgrade, which I found to be curious, given the non-cash nature of the charge.

Right. What Moody has told us -- I haven't seen it -- is they are going to look at it, and give us a chance to talk with them. I know S&P reaffirmed. And I know that we are at the very top of the BBB – BAA category. We have plenty of access to capital.

That's for sure. Could you just elaborate further on these cash costs? What exactly do they entail? - the $1.4 million, and maybe compare and contrast that to the settlement of $7.3 million and the legal of $4.8 million for 2002?

It's all timing. Keep in mind the $7.3 million was pre-insurance. So the actual cash that went out of Crane to net on everything was a million four last year.

Right. But that number will be at least in the five to ten million range, just based on the other two numbers.

I don't know what the numbers will be this year all right? And it's not clear to me that the cash -- even though we set up this $73.3 million after-tax charge to cover until 2007, it might well take a much longer period of time than that for us to pay out the cash. We're extraordinarily difficult people to deal with on settlements.

: I think everyone wants you to stay that way.

Let's talk about better things. The quarter, you know, looks like it was a little bit better than expected overall, certainly attributable in no small part to the aerospace results. You indicated that your after-market business was up, which I had to get up off the floor where I heard that. Can you talk about what were the tenants of that, and what gives you the confidence that more planes won't be taken off-line and put in the desert in 2003?

I think you saw a stabilization in the number of planes in the desert, so instead of increasing dramatically the way it did over the last year, we've seen a stabilization of that. You see people who, after 9/11, were not doing the repairs and maintenance quite as aggressively, and again, what I would point you to is the lack of concentration that we have in our after-market business. Again, it's 1.5%, the biggest client, and we're all focus the on the U.S. airline industry, which by far in the worst shape. The rest of the world is not nearly in such bad shape.

Understood.

So we're -- based on what we know now, we feel pretty comfortable and confident about where we are.

Last question on the pumps problem, is that largely behind us? Under control?

Let me say it this way. I think so. The resolution of the wire chafing issue is proceeding as planned, okay? Several additional pumps have also been returned with a different issue which is a mechanical overheating issue and, as the FAA announced, they adopted under the existing air willingness directive these additional pumping from mechanical overheating, and we are working closely with Boeing and the FAA to understand the root cause of the problem. And I don't really know anything other than that.

Eric, once again, nice job on transparency. Pam could call me after the call?

Absolutely.

Next is Dave Smith with Salomon Smith Barney.

Good morning. Just to follow up very quickly on the asbestos, , is there any indication that the increase has been isolated to? And secondly has been there been a significant jump in January so far?

I'm sorry, is there any state it's been isolated to?

Is it Mississippi or any area in particular?

Well, we've got -- I would say there's a concentration -- as we disclosed in the all Qs, there's a concentration in Mississippi and New York, and then there's a smattering all over the rest of the country.

Has a lot of the increase come from any one state?

The increase in the third quarter came from Mississippi, and we've continued to see increases there, as well as modest in New York, and then the rest of the country. It will be in our Q, David.

And is January seeing any significant jump?

I'm not really going to comment on a month to-month basis. What we try to do is review this extensively on a quarter.

Okay. And just to get to the business, on the engineer (ph) materials business, you have a twenty- [inaudible] % increase in refrigerated trailers. Can you just give us a better sense of where the optimism comes from there? And maybe about the non-refrigerated trailer market [inaudible] truck figure into your assumptions as well?

I don't as a rule have all the colors [ph] that you need here, David. I know the industry on the trailers, reefers and drive hands [ph] is actually more aggressive than the 25% I gave you. Isn't it actually closer to 30, 35 percent, Pam? And secondly, a lot of them bought the trucks ahead of the environmental, and now they're going out to buy the trailers for them.

Okay. And then on aerospace, how much -- you've talked about how no one customer is more than 1.5% but how much of that after-market business is international, non-U.S.?

I don't have that breakdown, but it's a very healthy chunk. The largest customers are international. Rather than guess, why don't we get you some statistics on that?

Okay. Then the last question I've got is foreign exchange. It seemed to be a benefit for the year, but can you just mention the sales impact and earnings impact in the quarter?

Well, for the year -- is it for the year or quarter? Year was 13 million and about 700,000 in OP for the year.

Meaning on the quarter?

I don't have that number. Pam will get that for you.

Thanks, guys.

Next is Andrea Wirth with Robert W. Baird.

Good morning, on the food handling side, could you comment on the individual end markets there and quantify the weakness? [ inaudible ] can you quantify exactly the extent of the weakness, and can you comment on the oil and gas market?

We have relatively little exposure in the oil and gas market. I would say that as we went through the quarter -- I think this is true for orders generally, but also food handling, just general industrial activity softened during the quarter, and our orders did also. Not by much, just softer in December than in November, and November was softer than September, and it looks to me the economic statistics that are coming out here now, contrary to the euphoria around Christmas, are suggesting that. There's clearly been an abrupt halt to the power market, which is now kind of sorting itself out, albeit at a substantially lower level. And chemical processing industry to us, we had been looking for it to be stable. In fact that's what we have in all our business plans. If you look at the Dow and DuPont and recent announcements, and you look at their feedstock cost at $34 a barrel, suggests that CPI could be weaker.

Great. Thank you.

Once again, ladies and gentlemen, if you would like to ask a question, it's star-1. We'll go next to Mike Neek at Atlantic investments.

Hi. Just one last follow-up on the asbestos issues. Some companies have been reporting a bubble in claims due to asbestos reform initiatives. Did you take that into account when you were evaluating the charge?

I haven't heard anybody reporting a bubble in claims because of the performing issues. I think it's pretty clear that there's a substantial division among the plaintiffs' bar of lawyers who are representing people who are really sick and those that are totally unimpaired, and that's creating momentum in Washington, perhaps, for some legislation. I would say Secondly there's, a growing awareness of the gross injustices that are being carried on in places like Mississippi, with the venue shopping and I think if you just pick up the newspapers every day, there's more and more about asbestos costing people jobs. So there seems to me to be some momentum here that there hasn't been before, and certainly it's a gross travesty of justice what's going on.

Yeah, I guess some companies have been saying, though, they saw their claims accelerate greatly in December, for instance, in Mississippi to get ahead of the reform legislation down there. Is that consistent with your guys' experience?

I don't -- we didn't think about it.

Okay.

It would be nice if that was the case.

Um-hmm. Okay. Thank you.

Okay.

We have a follow-up question from David Smith, with Salomon Smith Barney.

High, guys. Have you got an actual number for cost of goods sold in the quarter?

Yeah, I do. Cost of sales in the quarter was 360. SG&A was 79.6, depreciation and amortization was 12.8.

Okay. And then any thoughts of free cash flow for next year? I know you put 120 million, but where it's going to come from? CAPEX or Or D NA number for next year. And then do you expect any improvement on working capital?

We expect a little higher earnings. I've been consistent in saying we expect working capital as a percent of sales to be coming down, a percent and a half, kind of every year. We're going to keep the Cap Ex at the same level. We are continuing to say it's $120 million. Frankly, we took over $30 million of inventory out of here last year. I don't see many people giving us credit for it. And we're going to take out even more inventory for higher sales next year as we substantially improve our business processes that allow us to do that and maintain and maintain our onetime deliveries.

Last time, on corporate expense was there anything more accrued for environmental cost in the quarter?

Quarter expenses were up a little bit, there are some additional environmental expense in there.

Does that relate to the same as we saw last quarter?

Yeah.

How much was that actual portion?

I don't have the specific number. It's less than -- I'm going to say it's a million and a 1/2, maybe, and our hope is that that finishes it.

Great. Thanks a lot.

We have another follow-up from Deane Dray from Goldman Sachs.

In your prepared remarks, you talked about a willingness to look at alternative solutions to the asbestos issue for Crane. Would that include a trust structure that Halliburton used, the 524 G that would shield the company from pending claims? Is that on the table?

We have had any number of questions from everybody as it relates to what we're going to do and I will stick to my comment that we will of course explore any feasible 589 tiff solution.

Okay. Thank you.

At this time, we have no further questions in our queue.

I'd-like to turn the call over to Ms. Styles for any additional comments.

Thanks all of you for your time and interest and your investment here in Crane. If you have any further questions please feel free to call me directly, and have a great day.

This does conclude today's conference call. Thank you for your participation. You may disconnect your line at this time