Crane Co (CR) 2003 Q2 法說會逐字稿

Good day, everyone and welcome to the Crane Co. second quarter 2003 earning release conference call. Today’s call is being recorded. At this time, I’d like to turn the call over to the Director of Investor Relations, Ms. Pamela Styles. Please go ahead, ma’am.

Thank you very much, Abe and good morning everyone. Welcome to our Crane Co. second quarter 2003 earnings release conference call. As you know, I’m Pam Styles, Director of Investor Relations and Strategic Planning. This morning on our call we have Eric Fast, our President and CEO, and George Scimone, our Vice President and CFO. Before we get into our prepared remarks, just as a reminder, the comments we make on this call may include some forward-looking statements. We would refer you to the disclaimer language at the bottom of our earnings press release and also in our annual report and 10-K, pertaining to forward-looking statements. With that, let me turn this call over to Eric.

Thank you, Pam. I’d like to start with a few overview comments. George will then go through our segment financial highlights and then we’ll both be available for questions. Our second quarter performance was satisfactory, given our many end market challenges. We earned 44 cents in the quarter, in line with our previous guidance of 40-45 cents.

We are also maintaining our full year, 2003 earnings guidance of $1.65-$1.75 per share and providing third quarter guidance of 42-47 cents. There were some changes in end market dynamics during the second quarter that have resulted in revised segment forecasts, which largely offset each other. Specifically, our aerospace and electronics performed above plan, while our other segments faced market weaknesses. We expect this offset will continue for the remainder of the year.

The inclusion of incremental sales and modest accretion in the second half of 2003 from acquisitions during the second quarter also reinforce our confidence in this guidance. To characterize the business environment, there is no evidence yet in our order books that would suggest an economic recovery. Our markets continue to exhibit weak demand and price pressure. Aerospace and electronics’ strong performance reflects continued strong demand for military spares, repairs and other opportunities and strict cost controls, including realization of the 8 million annualized savings this business created through the restructuring and severance actions initiated in the first quarter of this year.

We continue to invest in this business and have authorized an additional 1.5 million spending this year for retrofit opportunities in the aerospace group that we had not previously planned. Our electronics business, which is principally defense electronics performed well in the quarter and we completed the Signal Technologies acquisition, which I will cover later.

Crane’s fluid handling units continue to experience price pressure and demand weakness across their major end markets, which include the chemical processing industry, power and general industrial. Our focus in fluid handling continues to be on reducing costs through facility rationalizations, foreign low-cost sourcing procurement and headcount reductions.

During the quarter we completed the transfer of Crane Valve North America’s Long Beach, California Operations to Chihuahua, Mexico and continued the consolidation of Resistoflex’s Bay City, Michigan facility into Marion, North Carolina, which is expected to be completed in August or early September.

On July 11, Crane Valve North America announced the closure of its Washington, Iowa’s foundry as a result of a strategic decision to exit the iron foundry business. Total cost of this closure will be about 1.5 million, approximately 800,000 of which we recorded in the second quarter, with the remaining cost to be booked in the second half of this year.

We are not hesitating to take the appropriate actions to improve our fluid handling businesses, even though the added costs are impacting our P and L. Clearly with the costs of these aggressive actions, the margin improvements we are seeking for this segment are still in front of us. Our Kemlite business continues to face a weak industrial market and uncertain recreational vehicle market, while the transportation market appears to remain strong. The RV Industry Association revised its predictions of production activity in 2003 as a whole to be down 2 percent in units produced in 2002, versus their previous expectations of 6 percent growth.

At merchandising systems we continue to experience depressed demand and price pressures, with no improvements projected for the rest of this year. Commercial office vacancy rates continue to rise and manufacturing plants continue to run with reduced work forces. Let me now turn to our acquisition activities in the quarter.

As you know, we are focused on an acquisition strategy of materially strengthening our existing businesses and expanding our market reach with new or complimentary products in our core businesses. Both the Signal and Etex acquisitions during the quarter met this standard. Our Signal acquisition integration into our existing electronics group is off to a very good start. We have already implemented our planned corporate overhead savings, which will result in $3 million savings for the remainder of this year and will begin to positively impact underlying margin performance in the third quarter.

We are working closely with the Signal management team over the next 60 days to detail the steps and actions required to realized the additional planned synergy opportunities. We feel very good about the integration of the Power portion of Signal’s business with our existing power conversion business, which together gives us an aerospace defense, customer power supply business greater than 100 million with the complete spectrum of capabilities in the high to low voltage that we believe is unique in the industry.

As you know, Signal also greatly enhances our presence in defense electronic through the addition of radio frequency and microwave. With the Signal acquisition we have doubled the size of our electronics group to $200 million on an annualized basis or roughly 40 percent of our total aerospace and electronics segment.

The acquisition of the product line from Etex enhances our product offering as a solution supplier within fluid handling, extends our reach into the international gas and water markets, and leverages our UK manufacturing facilities. The brands we have purchased are terrific, particularly Victaulic in the UK, Viking Johnson, which is well known in the water utility market for couplings and Wask, which is a well known component supplier in the gas transmission market.

We paid approximately 29 million for a business with 58 million in sales. We are working closely with the acquired management team and have already identified synergies in terms of procurement savings, sales force combinations, cross-selling and certain headcount optimization.

On the asbestos front, as you know there has been substantial activity during the quarter in Washington regarding potential legislative reform and the marked-up bill to establish a $108 billion trust fund has advanced from the Senate Judiciary Committee to the Senate Floor. While we remain supportive of the legislative reform effort, there are too many uncertainties for us to comment meaningfully on the current bill except to say that the finality on this topic would clearly be a benefit to Crane. As is our practice, we do not intend to comment quarterly on our estimate on the company’s asbestos liability, which was provided for in the fourth quarter of last year. Details regarding claims filed and disposed of and the cost of defending and settling claims, will be disclosed, as in the past, in our quarterly report on Form 10-Q.

Now George will work through the financial highlights.

Thank you, Eric. Good morning all. Our total company sales in the second quarter were 406 million, up 4 percent from prior year, flat after exchange. And on a pure comparable basis, excluding acquisitions and dispositions, sales were down 2 percent. Operating profit of 43 million was essentially even with last year. Margin was 10.6 percent, down from 11.1 percent last year, but up sharply from 7.5 percent in the first quarter of this year.

Total aerospace and electronics segment sales increased 21 percent from the prior year, driven principally from the incremental sales from General Technology acquired last November and Signal Technology acquired at the end of May. Operating profit was up 14 percent, while margins were down slightly to 22.4 percent, reflecting the lower margins of our newly acquired electronics businesses. Excluding these acquisitions, total segment margin improved to 24.6, from 23.7 percent last year.

Sales in the aerospace businesses were down slightly. Commercial airlines continue to optimize their fleets for minimal operating costs, while increasing load factors with their in-service aircraft. Parked aircraft continue to rise, resulting in decreased opportunities for maintenance. Total aerospace after market sales were flat with prior year levels, while sales to the US government in military increased 7 percent in the quarter. With government and military bookings and backlog up over 30 percent in total, versus the prior year second quarter. Military spare sales continue to be strong across all Crane aerospace companies.

Electronic sales increased significantly as a result of the additions of GTC and Signal. Importantly, our base business was up 4 percent from the prior period. Segment operating profit margins, excluding these acquisitions improved 200 basis points, to 21.1, from 19.1 in the prior year. GTC and Signal’s lower margins combined were 11.7 percent, because of their higher percentage of defense and military sales, which diluted the total group margin to 16.8 percent.

The majority of Signal’s corporate expenses were eliminated during the quarter, which we’ll begin to realize in the third quarter results. As Eric mentioned earlier, we’re in the process of fully integrating these businesses into Crane and capturing appropriate operating synergies and margin improvement. Aerospace and electronics’ June ending backlog levels were 305 million, which was essentially even with the prior year, excluding the GTC and Signal acquisitions.

We expect the commercial aerospace business to remain weak, however, with the incremental sales from the Signal acquisition, strong military spares demand in the second half, most of which is already in the backlog, and continued cost savings. We are upgrading our full-year 2003 guidance to a 10-20 percent operating profit improvement over 2002, versus our prior guidance of a 5 percent decline in operating profit, year-over-year.

Moving to engineer materials, their sales decreased 3 percent of 5 percent, excluding the recent acquisition in divestiture. Operating profit was down slightly. Kemlite sales increased over 40 percent to the transportation market, while sales to the RV market were flat, versus the prior year second quarter. The hesitancy in RV OEM orders we saw at the end of the first quarter continued into April, as OEMs waited to see if RVs sold off the lot in spring. Demand picked up again in May, though softened somewhat later in June, as we headed into summer, which historically has light demand due to a model year change over and industry inventory reviews.

Sales into the industrial building market were also up somewhat due to the mid second quarter 2002 Glasco acquisition. Regarding raw materials, we began to see softening of resin and styrene pricing during the quarter. We have revised our full year, 2003 operating profit expectations in the engineer material segment to a range of up 5-10 percent over last year, versus our previous guidance of a solid 10 percent, given the change in the RV Industry Association’s production forecast for 2003.

In merchandising systems, sales declined 3 percent. This business generated a 1.3 million operating profit, 700,000 below operating profit levels in the second quarter of last year. Market weakness continued for vending machines in North America and Europe and coin changes in Europe. NRI was unable to return to profitability in the second quarter, following the first quarter resizing efforts due to difficult market conditions and a very weak German economy. And market demand in the automated merchandising market in both US and Europe is expected to remain weak in 2003. Hence, at this time, we believe full year 2003 operating profit performance is likely to be below prior year performance.

For our fluid-handling segment, sales, operating profit and margins were even with last year. In addition to the Long Beach, Bay City and Washington, Iowa’s consolidations Eric mentioned, fluid-handling management is also in the process of several additional facility rationalizations. We’re in the process of closing or downsizing two high-cost manufacturing facilities in Europe and three service centers in the United States. We will begin to benefit from these actions during the second half of the year.

Within the fluid handling segment, the continued weak end markets and costs from facility consolidations was offset by demand strength at Bell Services, up 27 percent over prior year period and margin improvement in our pumps business. Pump operating profit margins improved to 14 percent from 10 percent, as it realized benefits from utilization of low-cost manufacturing facilities and divestiture in the first quarter of this year of Chempump, which had operating losses last year.

You should note that the Etex acquisition closed on June 13th, so impact to the quarter was limited to just two weeks. Continued weakness in the end markets across most of the fluid-handling segment, plus additional plant closings, have forced us to re-look at our total year guidance in this segment also. We are revising our full year 2003 operating profit to a 10-15 percent improvement over 2002, compared to our previous guidance of a 15-20 percent improvement.

Lastly, controls segment sales and operating profit were slightly below the second quarter last year. We are making modest investment in R and D and new product applications, while major end markets remain weak. Hence, we continue to expect operating profit for our control segment to be below prior year 2002 levels.

In anticipation of your questions on the income statement, let me give you a breakdown of some of the costs. Cost of sales in the quarter were 274.4 million. SG and A was 88.7 and included within these categories was depreciation and amortization of 12.8 million. Also, our goodwill as a percent of total assets was 31 percent.

Moving to cash, on July 22nd, the company entered into a new, four-year, senior unsecured revolving credit facility for $300 million, arranged by J. P. Morgan Securities, replacing a revolving credit agreement for a like amount, due to expire in November of this year. The interest rate is pegged at LIBOR plus 47.5 basis points. We generated 31 million in cash flow from the operations during the quarter. We spent nearly 170 million on acquisitions in the quarter in addition to capital spending on dividends. Prolonging the completion of the Etex product line acquisition, which was the last acquisition in the quarter, S and P reaffirmed our senior credit BBB+ rating on June 13th.

We repurchased 15,000 shares in the quarter at an average price of 17.47 per share and ended the quarter with a net debt to capital of just under 34 percent. Through the first six months of this year the company generated 54 million in cash flow from operations and 29 million of free cash flow after deducting dividends in capital expenditures. We are behind last year’s free cash flow generation, mostly through the timing of inventory reductions. We built inventory in merchandising systems to protect customers for a potential strike, which was avoided and carried additional inventory for plant closings in Bay City and Long Beach. We are in the process of bringing those temporary blips down.

As those of you who have been following our company for some time know, the second half is historically the strongest period for cash flow and this year will be no different. We have plans in place to support the working capital improvement required to maintain our target of $120 million of free cash flow for the year.

And finally, through the first half of 2003 we incurred $6 million of severance cost, 4.6 million more than the same period last year and we have reduced our work force by approximately 370 employees. We anticipate recognizing the benefits of those reductions during the second half. As mentioned earlier, we are in the process of multiple facilities closures that will reduce the workforce an additional 150 over the second half of the year. Severance and associated closure costs are built into our second half forecast. With that, I’ll turn the call back over to Pam.

Thank you, George. Before we open up our call to questions, I’d just like to remind you that as is our practice, we’ll provide the earnings estimate range for the full year 2004 on our third quarter conference call. Abe, we’re done with our prepared comments now. You’re welcomed to open up the call for questions.

Thank you, Ms. Styles. Our question and answer session is conducted electronically. If you would like to signal to ask a question, it’s star 1 on your touch-tone phone. Again, that is star 1. Please make sure you haven’t muted yourself before signaling. So again, star 1. We do have a couple of questions, beginning with Deane Dray, from Goldman Sachs.

Yes, good morning. Given the changes in the aerospace segment, I’d like to get a walk-through as to the nature and the composition of the business today. How much is defense, versus commercial, how much is OEM, versus after market? And then I’d like to dig in a little deeper with regard to Signal. How much additional book business came in the door to Crane this quarter that was able to be reflected in the very strong earnings that we saw this quarter? Thank you.

Deane, let me handle it this way. Our traditional commercial aerospace component business, what we now call the aerospace group, really had better than planned performance in the quarter and through the first half of this year, with the really strong military spares and the benefit of the cost. In the second half we’re looking for a continuation of those trends, although we do expect a softening in our after markets backlog. In terms of detailed mix on OEM and after market, we really haven’t given out other data, I don’t think, Pam, other than 2/3 OEM, 1/3 after market and the rough 60-40 commercial-military on a fully annualized basis going into 2004. You follow that?

I do. How much was that changed from Signal?

We haven’t yet calculated the Signal impact to those sorts of [indecipherable] and I don’t have that information.

Well, Signal’s running about $90 million a year.

And that’s entirely military or 90 percent military?

Almost all of it’s military.

Okay, so the numbers you gave, about 2/3 OEM, 1/3, that’s pre-Signal?

No, that’s in traditional commercial aerospace. Signal has north of 90 percent sales to the military and government, but we don't have a split on the Electronics Group at this point for you.

We’ll do all that for you on the next quarterly call. We’re going to lay all this out when we lay out 2004.

In the release it sounds like you’re going to give two separate cuts at this, the aerospace and the electronics would then be what was traditionally the aerospace segment. Is that going to be a separate segment or you’re just going to give us those two data points?

It’s not going to be a separate segment, but we’re going to look to talk to the aerospace group and the electronics group and we think that that will – and we’ll talk to margins and we’ll talk to revenue growth, but we are going to continue to do this as one segment. We think this will make it easier for people to understand the business. And as I said, we will make a special effort in the next quarter release and the outlook for 2004, to highlight just the questions you’re asking.

All right and I just want to get clarification as how much additional business came in the door with Signal, that was either pre-booked or pre-sold in the quarter that we might not have otherwise expected, versus let’s say its normal 12 percent operating margin?

Well, all the backlog increase in the segment is due to Signal. And the revenues in the quarter that we booked were about $11 million.

Eleven from Signal?

Eleven from Signal.

And that was reflective of one month?

It was a little bit more than that.

Okay and what was the incremental interest expense with regard to the payment for Signal?

We haven’t given that out. What we’re saying is that both Signal and the Etex acquisitions are accretive in the second half and they clearly are going to help our operating earnings and the earnings per share, even if we were to do some longer-term financing. And rather than giving the details, we basically just said that these are helping us and giving us more confidence in our $1.65-$1.75 – haven’t given the breakout, Deane.

Okay and should we just assume for modeling purposes that you funded it with the same senior facility at LIBOR plus 45?

47.5.

All right. And then last question, I know with regards to the comment on asbestos, what is your sense in terms of – and if you can’t answer this I understand, but you’ve got a reserve set up. Have you given an idea as to what the difference will be between, potentially, what you’d have to pay into the trust, versus what you’ve had in reserve? It’s our sense that you’ve over-reserved, so it would likely be less.

I can’t touch that, Deane.

Okay. I understand. Thank you very much.

It’s the right question, but we can’t go there, Deane.

I appreciate it.

We’ll now go to Scott Graham, at Bear Stearns.

Hi. I’ve got a couple of housekeeping questions first. Tax rate full-year should stay at about 32?

At this point in time we’re looking at about 32.

Okay. Could you, George, give us if you have it, FX implications by segment?

Yeah, I have the FX for the quarter was $14 million against sales of 406 million of sales. It was about $1 million of operating profit impact. I don't have in front of me – except I do have – I don’t have it by segment, but we can get it for you, Scott. I have it by the currencies.

That would be great. Could you also tell us, now that you’re doing this aerospace breakdown differently, what third and fourth quarter sales and operating income were for one of the segments, whereby we could sort of push the second? In second half of ’02.

Scott, we’ll be giving that out as we proceed throughout the year. We did not cut those breaks down at the beginning of this year when we decided we were going to create those separate groups.

We’re really evolving here, Scott. And we’ll try to do a much better job in the third quarter disclosure and the ’04 outlook.

You guys do fine. Don't worry. Can we talk a little bit about fluid handling? The margins there, obviously as you indicated, Eric, that the margin improvement to 12 percent is still all ahead of you. Second half of the year, based on what we’ve seen in the first half, probably this is more, when we say ahead of us, probably begins more in ’04 or will we see some type of improvement in the second half of this year, year-over-year?

I would characterize the third quarter in fluid handling as a lot going on. We have the iron foundry closure. We have the pump manufacturing facility that we bought in China in the second quarter we’re getting our hands around. We have new bronze manufacturing facility in China for Crane Limited. We finished the move to Chihuahua, but we’ve got to kind of settle the plant down. We’re finishing out the Bay City and Marion closure. So from my perspective we have a lot going on in the third quarter.

I would like to think that – actually, I think margins in the third quarter last year in fluid handling were a little bit better in the third quarter than the second quarter. And we should be looking to stay on that track. And I think in the fourth quarter we’re really looking for a lot of this activity to kind of start behind us, so personally I’d like to see an early start on the improvement coming in the fourth quarter with a continuation of that into ’04. I wouldn’t get carried away on the improvement in the fourth quarter, but I’d like to start to see some of it.

All right. Last question and I guess that’s probably a decent segue, because I would expect fluid handling to be a contributor to that fourth quarter, but given your guidance, we sort of chose a mid-point in Q3 and extrapolate what Q4 would be, it suggests to get even to the low end of your guidance, Eric, that fourth quarter is going to have to see a pretty significant pop. Now I know that we’ve got acquisition accretion and based on what you’ve said, there’s fluid handling as well. But it still suggests 23ish type of percent growth in the fourth quarter year-over-year. Can you maybe kind of give us, other than what you just highlighted there, other highlights as far as how we’re going to get there?

We clearly need the fluid handling to start to come through and we’re planning for that. I would expect a little help from merchandising systems. Maybe a little bit from [Mangineer] [phonetic] materials. It didn’t have a particularly strong fourth quarter last year. And the improved forecast is because of the acquisitions in electronics. So we’re going to get some help all the way around, but we clearly need to start to show – we’re going to improve the handling. I think you’ve highlighted a key issue for us.

I’m impatient for the results there also, Scott.

And once again, that is star 1 if you would like to signal to ask a question, star 1. We’ll now go to Wendy Caplan, at Wachovia Securities.

Thank you. Good morning. Just to go to fluid handling again, I’m embarrassed but honest enough to say that we’ve been calling for double-digit margin in this segment for longer than I care to remember. This issue of moving to low-cost regions, whether it be China or Mexico, can you talk about how much of the manufacturing, once these particular moves are done, what it will be? And what your intention is, relative to the manufacturing in low-cost regions, strategically, as we go forward?

Wendy, I honestly can’t sit here and detail out the exact numbers as we speak, other than our Western European operations are moving and have a planned program moving product to Hungary. I already talked about the two new manufacturing operations in China for bronze valves and our pumps, which are both very significant. We have other planned moves to drive existing product to our existing manufacturing location there. We just finished a major move or our high performance valves from Long Beach, California to Mexico.

So I would characterize the activity and moving it to our facilities as substantial. And there is a lot of it continuing to happen here in the third quarter, which takes some time and money. I think both in the quarter, but in particular in our analyst meeting this fall, I intend to break out this in a lot of detail. Because I think it’s key to the earnings in ’04.

And how much, the foundry closing, is that expected to make a meaningful move in terms of the margin?

Well, to give you some idea, the foundry closing is going to cost us $1.5 and I can see the benefit of that next year of over 3 million in operating profit to us. We actually have a higher number. I just won’t choose to use it. So as George characterized to me the other day, some of the actions we’re talking are painful today, but they’re pretty significant in terms of what we hope to realize on them.

Okay, thanks. I have a couple more questions. You said that STC Signal was 11 million roughly for the month that you owned it in the quarter. If my math is right, if I multiply that by 12, I get a whole lot more than 90 million.

Yes, but we owned it for a little bit more than a month. It was 5.5 weeks or something.

Still, I think that probably doesn’t add up. Was there something unusual about seasonally or in terms of projects or something that shipped?

Not that I’m aware of. Signal is on track. I think that their book to bill and their backlog and how the year looks is what we expected. This was an unusual opportunity and we actually did due diligence three times during the course of the nine months we were looking to buy Signal. So I would say no surprises either way and I think our business is in pretty good shape. We’ve got a couple of major bookings that we’re looking to make that have moved to the right on u, but we fully expect to have in hand here this year. So, I don’t see anything unusual there.

Okay. And the RV issue – through April, the industry was saying that RV shipments were up 5 percent. And they had been calling for plus 2, I guess, recently for the year. They switched that, as you said, to minus 2. You said May was strong. June was down seasonally. I’m confused as to why your RV business is such an issue here. I know it’s very profitable, but it doesn’t seem that it’s reflected anywhere else in terms of RV suppliers or RV manufacturers or other suppliers. Can you give us some more detail on that please?

I’m not sure I understand the question. RV, from a product mix point of view, has the highest margins and it’s very difficult for us to forecast the entire business year, no matter which market segment, RVs, transportation, building supplies, because our lead times run about four days. So it’s just a real quick book and ship business and we’re not getting any clear indication from the RV market as to directionally how that’s going to look in the second half.

Okay. I guess the confusion is that the RV manufacturers are saying that things look okay. The industry pundits are saying down 2. Other component suppliers are saying they haven't seen any impact. Is it your view of the future that makes you nervous or the current quarter in terms of the impact?

No, we really based that forecast on the industry guidance that it’s going to be down. Not something that happened last week.

We are unsure about how this is going to unfold, given the short lee times and the signals that we’re getting from the market. That being said, the Kemlite continues to really perform in an outstanding fashion in terms of margins, working capital as a percent of sales, cost control. No issues on how they’re operating, just hesitancy on our part in terms of what the market’s going to look like in the second half.

So it’s not something that you felt in the quarter, but it’s more something that you’re concerned about for the second half?

We had anticipated a weaker second quarter than what we had originally planned when we gave you our April forecast. And I think that came in largely as we had anticipated. So, it’s really the uncertainty in the outlook.

Okay. And finally, you mentioned a share buyback in the quarter, but George, can you just –

It was way at the beginning of the quarter. It was pretty small. It was less than $250,000.

We had been buying stock in the first quarter when people were big doubters and we had 15,000 –

The first quarter we had 350,00 and in the second quarter, 15,000. So, it’s very little in the second quarter.

Okay, thanks very much.

And once again, it is star 1 if you would like to signal to ask a question. And again, star 1. And again, we’ll pause a moment just to give everyone a chance to signal. And we have no other questions in the queue at this time, so I’ll turn it back to the speakers for any closing comments.

Super, Abe. Thanks so much and thank you all for your time and interest in Crane. If you have any further questions, please feel free to call me directly. And again, thank you for your time.

Thank you. That does conclude our call. We do appreciate your participation. At this time you may disconnect. Thank you.