Crane Co (CR) 2003 Q3 法說會逐字稿

Welcome to the Crane Co. third quarter 2003 earnings conference call. Today's call is being recorded. At this time I would like to turn the call over to the Vice President and Chief Financial Officer of Crane Co., Mr. George Scimone. Please go ahead, sir.

Thank you Sylvester, and good morning everyone. I am George Scimone, Vice President and Chief Financial officer. As many of you know, Pam Styles, Director of Investor Relations, is on maternity leave, but she'll be returning back in a few weeks. Eric Fast, our President and CEO, and I will have a few prepared comments and then we will open the lines for Q&A. Before we get into our prepared remarks, just a reminder that the comments we make on this call may include some forward-looking statements. We refer you to the disclaimer language at the bottom of our earnings press release, and also our annual report and 10-K pertaining to forward-looking statements. Now let me turn it over to Eric.

Thank you George. I'd like to start with a few overview comments, and then George will walk you through detailed third quarter segment results. Our third quarter performance was satisfactory, given our many end-market challenges. We earned 47 cents in the quarter, in line with our previous guidance of 42 to 47 cents. As you saw in our press release, our guidance for the fourth quarter is 51 to 56 cents, resulting in a full year range of $1.70 a to $1.75, as compared to the previous guidance of $1.65 to $1.75. In the end-markets that we serve there is no evidence yet in our order books that suggests the positive GNP comments the rest of the economy is experiencing. Our markets generally continued to exhibit weak demand, except for engineered materials, and severe price pressure.

With the exception of fluid handling, I thought the Company performed well in the third quarter. The story in fluid handling was the same as in the second quarter, as difficult market conditions, price pressures, declining volumes and onetime charges to reduced costs caused a decline in margins. As I mentioned in the July conference call, we had a lot going on in fluid handling during the third quarter -- specifically, 2 new facilities in China, the Long Beach and Mexico facility consolidation, closure of the Washington Iowa iron foundry and the completion of the Resistoflex Bay City closure. That being said, results in fluid handling both in terms of margins and customer metrics, are not satisfactory, and we clearly need to execute better on our initiatives. We expect only very modest improvement in the fourth quarter but it should give us more of a positive trend going into 2004.

Both the Etex and Signal acquisitions which we made in the second quarter had sales and operating profits on target, and we are moving forward with the facility rationalizations we had in our synergy plan. I did want to note that we reduced our 2003 free cash flow forecast -- that's after dividends and capital expenditures -- from 120 million to 105 to 110 million. Part of this was a conscious decision to allow increased spending on capital for productivity projects and new products. Delays in aggressive working capital initiatives, particularly in fluid handling, accounted for the remainder of the shortfall. We're targeting the 120 million in free cash flow for 2004, and it should prove to be a conservative number. Finally, in the third quarter we refinanced all of our outstanding debt under the 300 million revolving credit with a 200 million ten-year bond deal with a coupon of 5.5 present. Note that this was extremely well-received in the market.

Turning now to 2004, we have issued preliminary guidance of $1.85 to $2, up from the $1.70 to $1.75 for 2003. I want to caution you that we are only halfway through our formal 2004 planning process, so it is indeed preliminary. At this point, I do not want to go beyond the comments in the press release except to say, for the first time in three years, we expect to begin seeing some stability in our markets, allowing the improvements we have made in our businesses to show through. This is particularly true in fluid handling and merchandising systems. We intend to be very disciplined on cost so that increases in volume leverage operating profit at 30 to 40 cents on the incremental sales dollar. With the exception of fluid handling, which requires continuing focus on operations, the rest of the Company is operationally well prepared to leverage the improved markets. We will comment in greater detail on our 2004 plans in the Crane Co. Investor Conference November 19 in New York City, to which you all are invited.

Finally, as is our practice, we do not make quarterly comments on the estimate of the Company's asbestos liabilities, as full details will be in our quarterly 10-Q. As previously stated, however, it should be noted that past trends and claims and related costs are not necessarily predictive of future trends, and there may be significant differences in these amounts from quarter to quarter due to litigation trends in specific state and local jurisdictions, adverse court decisions -- whether or not against the Company -- legislative developments and other factors. And with that, I will have George walk you through the segments.

Thanks Eric. Our total Company sales in the third quarter were $425 million, up 10 percent from the prior year. Excluding exchange, sales were up 7 percent. On a pure comparable basis, excluding acquisitions and dispositions, sales were down won percent. Operating profit of 45 million was up 40 percent over last year. I do want to point out that last year's quarter comparison included a 4 million charge -- $4 million charge for fuel pump inspections and higher corporate cost expenses, principally for environmental remediation and asbestos claims. Margin in the quarter was 10.5 percent, essentially flat with the second quarter 2003 and up substantially from the weak comparable quarter last year.

The aerospace and electronics segment sales increased 32 percent from the prior year, principally from the incremental sales of the General Technology acquisition in November last year and the Signal Technology business acquired at the end of May. Excluding the acquisitions, sales were down 5 percent, principally in the commercial OEM market segment. Operating profit margins were 28.5 percent compared to 18.4 percent last year. Last year, margin was lower as a result of the $4 million charge for fuel pump inspections. As a follow-up to a question raised by Deane Dray during our last conference call, sales during the quarter for the total aerospace and electronics segments were split 43 percent commercial and 57 percent military defense. Within the aerospace and electronics segment, sales in our aerospace group were down 10 percent in the quarter, where we continued to be affected by the weak commercial OEM business. The aerospace group sales were 75 percent commercial and 25 percent military defense, with 40 percent going to the aftermarket. These ratios are unchanged from the third quarter 2002. Operating margins were up 300 basis points in the quarter due to cost containment initiatives and a weak comparable quarter last year.

The electronic group sales more than doubled as a result of the GTC and STC acquisitions. Significantly, the base business sales increased 11 percent from the prior period as a result of the increased demand for power supplies. In the electronics group, sales in the quarter were 10 percent commercial and 90 percent military defense; again, about comparable with last year's percentages. Operating profit margins were down to 20.2 percent from 21.1 percent as a result of the inclusion of the lower margins at STC and GTC. We continue to capture the synergies of integrating both businesses into Crane, and anticipate margins to improve for the combined group as the projects are completed. Although we expect the commercial OEM business to remain weak over the balance of the year, increased demand for military products and incremental sales from the STC acquisition will more than offset that weakness. As a result, we are upgrading our prior guidance for the aerospace and electronics segment for 2003 from 10 to 20 percent improvement -- from 10 to 20 percent improvement to 30 percent higher than last year. Engineered materials sales were down 5 percent in total, and 2 percent excluding the CorTec sale, which was divested in the third quarter 2002. Operating profit was down slightly from last year.

Compared to the year ago quarter, we saw softened RV sales, down 5 percent, mass merchandising down 11 percent, building product sales down 4, offset by increases in the sales to our truck trailer market, which was up a strong 11 percent. We expect sales into the truck trailer market to remain strong and resin and styrene prices to stabilize over the next quarter, and are maintaining our previous 2003 guidance for the engineered materials segment to increase 5 to 10 percent above 2002. The merchandising systems segment sales were up 1 percent and operating profit doubled from prior year. The increase is the result of manufacturing efficiencies at Crane Merchandising Systems and reduced losses in our European National Rejectors business, where market demand continues to be weak. During the first half, we incurred severance costs to resize the NRI business, which we expect to continue benefiting from during the next quarter. For the full year, we are maintaining our prior guidance for the merchandising systems segment of operating profit below prior year.

In our fluid handling segment, reported sales were up 9 percent in the quarter. Backing out the pipe coupling and fitting business acquired from the Etex Group in the UK and the currency effect in the quarter, sales were down 4 percent. Operating profit was down from last year as a result of difficult markets, the cost for facility rationalization and a significant customer bankruptcy that cut across four of the fluid handling businesses. During the quarter, we incurred almost $2 million to complete the Bay City, Michigan closure in the Resistoflex business and the Long Beach closer in the valves business, and initiated the Washington Iowa foundry closure. Within the fluid handling segment, continued weak end-markets in the chemical process industry, power, marine and industrial markets, coupled with the facility rationalization cost, reduced operating profit 17 percent in the quarter. A bright spot, however, was pumps, where operating profit increased 41 percent on flat sales -- reflecting the benefits from a previous facility rationalization and cost savings initiatives. Continued weakness in the end-markets across most of the fluid handling segment and plans for potential additional rightsizing during the fourth quarter have led us to revise our guidance, to a decline of 5 to 10 percent from last year. We previously anticipated a 10 to 15 percent improvement. Our control segment was generally flat in sales and operating profit compared to last year. Continued weak end-markets have been offset by productivity and cost containment. We are maintaining our guidance in this segment that full year operating profit will be below last year. In anticipation of your questions, cost of sales in the quarter was 289 million, SG&A was 92 million, and included within these categories was depreciation and amortization of 14 million. Goodwill as a percent of our total assets was 31 percent.

Our treasury group had a very busy quarter. As Eric mentioned, in September we completed a 10 year $200 million senior note; coupon rate 5.5 percent. We also completed the new four-year senior revolving credit facility for $300 million, replacing a like amount revolver due to expire in November. And finally, we completed a new shelf registration with the SEC for up to $300 million in debt securities. During the quarter, we generated $38 million in cash flow and invested $7 million in capital expenditures, and paid $6 million in dividends to our shareholders. We ended the quarter with a net debt to capital of 31 percent compared to 34 percent at June 30. Finally, to keep you up-to-date on our actions to reduce headcount, through the first nine months we incurred almost $7 million of severance costs, an increase of $4.5 million over last year, affecting approximately 475 employees.

That concludes our formal remarks. Eric and I will be happy to answer your questions. You may now open the call up for questions.

(OPERATOR INSTRUCTIONS) Deane Dray, Goldman Sachs..

First question, just to make sure I heard it correctly, George, when you said what was the total restructuring done in the quarter -- you said it was -- was it all in fluid, and what was the total amount?

It was up almost $2 million. $1.6 million.

Was that the only area that you had done restructuring that you flowed through operating results, or was there some also in merchandising?

No.

If we total up what you've done for the year, how much total restructuring, how much of that would be cash charges? And then, what sort of benefit should we be looking for in '04 from these restructurings? And what kind of payback?

It is all cash.

And the total?

$7 million for the severance piece.

The payback is probably within a year?

Yes.

(indiscernible) what you might be thinking about in the fourth quarter, in terms of restructuring?

We are looking at a number of alternatives at this point, Deane. We haven't formally finalized that decision process. But most of it would be in the fluid handling business.

Shifting gears, on the balance sheet, what are you thinking about -- were there any buybacks in the quarter, share buybacks?

No.

What are you thinking about in terms of optimum capital structure? You're down now 31 percent, net debt total cap. Where is Crane most comfortable, in what kind of range?

To maintain our ratings we can run it at 40 percent debt to cap, as you well know. So we've got it set up now so that we've got this cash flow to pay off the note in April. And our revolver is totally available then for acquisitions, it's just going to depend upon the acquisition timing.

Before I hand it off I would like to say congratulations to Pam on the birth of her daughter.

Wendy Caplan, Wachovia Securities.

The lower cash flow assumptions -- maybe I correctly or incorrectly inferred from your comments that the working capital reduction impediment was related to fluid handling. Can you -- perhaps the bankruptcy? Can you talk about that? And next year, as you look at the 120 million assumption, what are you assuming in terms of -- can you characterize the cash -- the CAPEX, rather, that you are expecting for next year, in terms of maintenance versus growth CAPEX?

Let me take a broad shot at this and then George can fill in. What happened to us in fluid handling in the quarter in cash flow -- you're right that fluid handling had a fair amount to do with that shortfall. In the third quarter, our book and ship business in fluid handling was, I don't know whether to say the word materially, but it was a lot weaker than what we had planned and forecasted. And this wasn't just isolated in one or two units, it was almost across the board. So we found ourselves during the quarter with substantially less book and ship business, and as a result of that, a cost structure which we started -- which was higher than what we needed for that volume of business. So we are going back again on that cost structure, and we'll be doing so more in the fourth quarter and probably even tripping over into the first quarter. At the same time during the quarter in fluid handling, we had all these different facility rationalizations and movements going on, which caused us in some cases to increase inventory in anticipation of a facility being closed. And then we are trying to work that off after the closure so that we don't have client disruptions. And we didn't have the book and ship business to do it. I guess that's kind of a general comment on fluid handling, as well as the fact that where we are slow on working capital is in fluid handling for both those reasons.

Before we get to the CAPEX question, if I can just ask something else about fluid handling. You must be extremely frustrated by this performance. Since -- call it 5, 6, 7 years ago -- fluid handling has just been a subpar performer in terms of the portfolio of businesses at Crane Co. Is there something inherently wrong with a portion of this business, specifically the valve business, that continues to frustrate us? Are there management issues that yet again need to be addressed? How should we -- how are you thinking about this?

I think we -- I remain fundamentally positive and constructive on the business, although clearly, the end markets here power -- power, marine, chemical processing industry -- the declining volumes have resulted in just huge decreases in our operating leverage that have made it difficult to operate. We remain very confident about our market positions, the quality of our products, our marketshares. I think we've got better intellectual capital than we've had, people, than we've had in a long time. We don't have all that we need but we've made improvements, so I do not see any kind of radical changes. I don't see any -- what I see is an intense focus to execute on the initiatives that we've got before us and the same strategy. So as you point out, I am disappointed and frustrated. I actually think you were more right about the quarter in fluid handling than I was, but I don't see any real change. We clearly have to do some things differently, but there's a lot of costs that have come out of this business, and that are continuing to come out, and there will be some more. I'm going to really try to late this out in detail in our '04 conference, our November 19th analyst conference. In fact, (indiscernible) -- I think four of the fluid handling leadership is going to present at that, and I'll let you get up close and personal and see for yourself. But clearly, we are frustrated and disappointed here on the delay and the margin improvement, and it's going to be, as we've said on the fourth quarter, we think it will start going a little bit in the right direction. But there is some more work to do on the cost because of the lower volume.

And the question about characterizing the CAPEX, if you could?

CAPEX we expect to be in the $35 million range. As Eric mentioned, we are only halfway through our plan reviews for the full company. I would characterize it as growth in the aerospace and electronics business and -- growth initiatives in aerospace and electronics, probably engineered materials and the merchandising systems. The rest would be what I would describe as maintenance, and I don't have a split that I can give you that I would have some confidence in, of what that 35 would split between those two pieces. The other question I think you had, Wendy, was on the bankruptcy?

Yes.

It was U.S. Flow that filed for bankruptcy in the quarter. We wrote off one of our distributors, and it cut across four of the fluid handling businesses. And it amounted to about $500,000.

David Smith, Smith Barney.

Can you give us a sense on what's going on with the tax rate? I think guidance was a little higher than what it would end up being. And what we should expect going forward?

We had submitted our September return -- completed our return and submitted it during September, and finalized it. Based on our R&D efforts and our foreign tax credits, we will be reporting a 31 percent tax rate for the full year. And we're confident that that will last over -- we can extend that for a long period of time, based on where we are today. It was a catch up during the results for the quarter, and that we'll have it in the fourth quarter.

So 29 is good for the fourth quarter?

No, 31 will be good for the first quarter, the 29 was a catch up for the first half of the year, to get the first nine months a 31 percent.

You mentioned in your release pension expense as well. Can you tell us what the year-over-year impact there was?

I need to look that number up.

What should we be looking at, then, on a corporate expense run rate? That came in a little lower than I would have thought. And I understand last year there were certainly some extraordinary some extraordinary items, but even sequentially it seemed like it was down a bit.

Pension (indiscernible) we get to the pension cost, it's about $1 million of that.

Year-over-year?

Yes, yes.

In the quarter?

In the quarter.

Then on the corporate expense?

We probably -- I'm sorry, you're talking 2004?

Yes, just looking at the quarter. The quarter actually looked lower than what we had, and sequentially it just seemed like it was lower. Should we expect it in this range going forward? I know last year there was a couple of items that raised the number, but should we be assuming this kind of 5.5 million number?

Maybe a little bit higher.

Again, we are only halfway through the plan. Let us --

(multiple speakers)

He meant for (indiscernible) next quarter, and I think it's still a little bit higher -- (multiple speakers)

Was it low this quarter? Was there any reserve? Was it a reversal of anything in there, and was there a reason why it was down?

No.

Nothing in particular?

(multiple speakers) bonus accruals, unfortunately.

And then on engineered materials, can you just quickly run over how much of the business is related to the truck trailer market versus the RV market?

Yes, hang on one second. Let me pull a piece of information out here. Bear with me. Okay, in the quarter about 1/3 is the RV, so about 30 percent is RV. 15 percent is transportation. 25 percent is building. And then the rest is spread around international, mass merchandising, industrial. That's sort of the split of the total.

If I look at RV compared to last year, was it about 1/3 of total as well, or was it a little higher?

It's about the same.

And transport has moved up a little bit I guess?

Yes, transport is moved up.

Following Wendy's question on working capital, is there any ideal we are looking at, in terms of getting inventory down to -- say within a year to two years -- say, on a day's supply basis?

The measurement that we're using on a broad basis to try to reduce working capital as a percent of sales -- at least one percent a year. It gets you 15 to $20 million out of working capital if you look at it that way.

And the majority coming out of inventory, I guess?

(multiple speakers)

Yes, that's correct.

Steve Tusa (ph), J.P. Morgan.

Solid recovery in the merchandising systems margin. What kind of ramp should we expect here into the fourth quarter? I know you have given the annual year-over-year change in profitability, but is this kind of change on a sequential basis? I would assume that it would be a little bit less, but it's still pretty solid. Can you comment on that?

I don't have the specifics right here in front of me. I'll let George look for them. Both those markets remain very depressed, both the coin changer market in Europe -- and it's hugely price competitive -- and our U.S. business here. So that margin improvement is coming from the costs that we've taken out of the business. We expect to kind of hold it, but I don't see any dramatic improvement near term, until we start to get some volume we can leverage.

Onto the free cash flow, you guys have talked about what happened this quarter. Is there anything in the fourth quarter that we should expect? I know it's typically been strong in the past. Are there any kind of onetime benefits, from a tax basis or anything like that, that give you some confidence in the fourth quarter performance?

No, it's interesting. When I look at the total -- the income that we are driving is going to be 65 to 70 percent of that cash flow that we need to get in the fourth quarter to meet our external number. The balance, 30 to 35, is focused on working capital; mostly on inventory, focusing on inventory. We have set up with the, what we refer to them as the 8 -- the big players that are driving all this inventory reduction. We have monthly reviews, making sure that plans are in place and that action are in place to drive that inventory down, to give us some confidence that we're able to get that piece of it. We just finished a 2 day review with the president, reemphasizing the commitment that we have on cash flow -- not only on the inventory side, but make sure they are engaged on the receivables and on the payables side. I think we have the focus to address that 30 to 35 percent of what we need in the fourth quarter in working capital, to meet that year-end goal that we have established.

You talked a little bit about -- in fluid, I know on the valve side, you've gone through some of the issues there. You mentioned pricing in particular. Everybody is seeing pricing pressure. Is this something that's specific? And also you mentioned in aerospace -- I would be interested to know what the issue is, and where that pricing is in aerospace?

No real change. There is no real change, it's just a continuation of the environment that we are in. And frankly, we expect that to continue. We're basing our improvement plans on that assumption -- no volume increase and no ability to get price improvement. So you've got to take the cost out and make sure your productivity is in place.

So nothing beyond the norm?

No.

Lastly, I noticed that you had an asset sale for some cash, 2.7 million on the cash flow statement. Was there any gain associated with that, with that sale?

I'm sorry, was there any what?

Was there an asset sale on the quarter? I noticed there was some cash from a disposal of asset on the cash flow statement of (indiscernible) million. Was there any gain associated with that?

It would have been in other income.

I have to take a look at that. I'm not sure where you're looking.

It's something we can talk about offline.

Give me a call or follow up specifically on that. We did not have an asset sale.

Proceeds from disposition of capital assets?

We'll follow up on it and get back to you.

(OPERATOR INSTRUCTIONS). Scott Graham, Bear Stearns.

A couple of things -- the aerospace margin, just the aerospace only piece of the division -- if we add back the charge at this time, I come up with an aerospace margin that (indiscernible) in the quarter. I was wondering -- A, if that was jiving with reality? And B, if so, why?

Let me just make a quick calculation here. Actually it's about the same.

You and I can go through that after the call. The third question I have is back on our old friend fluid handling. It looks like about a half a dozen facilities closed this year and a lot of heads coming out. What, Eric, do you think is the run rate cost savings achieved to date?

We've got severance stuff, but we're going to -- I'm going to lay this all out at the introduction for fluid handling in the November analyst investor call. Both facility rationalization, severance, movement of product to low-cost countries -- we're going to try to lay out for you why we think we can get some improvement in the margins next year, and share with you our plans. I think it's best to wait until then and give you the whole picture.

Fair enough. Last question is on merchandising. There historically, we have seen merchandising margins as high as 18 percent four or five years ago. Presumably, the structure of the market has changed, particularly in Europe, of course. I assume that we should kind of take that 18 and (indiscernible) it. But still, with the margin right now running in the low singles, how high and how quickly can we get that margin up? And do you need -- how much of an end-market improvement do you need to maybe cross the double-digit border in margins in that business?

I'm not sure I have the specific answer. Remember that the bulk of the revenues are in the North American vending business, okay? That's 120 versus 20 in Europe, in the coin changer business. We are looking for that business, which is based on employment and based on commercial office vacancy utilization -- we are looking for that to stabilize and gradually, very gradually, start to improve. And we have a high degree of confidence of being able to leverage 30 to 35 cents on the dollar in that business. We feel strongly we are taking marketshare here in a down market. And our business model is such that -- and I don't have the specific number in mind -- but this business -- the U.S. business will be back to 15 percent margins at some point. There's no reason, we have a superior business model here.

(OPERATOR INSTRUCTIONS). Wendy Caplan.

Eric, I'm a little confused about your comments about the RV business, because other suppliers that we follow described that during the quarter the market strengthened. Certainly, at the end of the summer the retail sales were just very hot. So can you help us understand why your comments are different? And also, whether you did see a sequential improvement as the quarter went on? There is a comment in the release as well, that says you expect strength to remain strong. So did you mean that things got better and now they are going to be stronger in 4Q?

The third quarter last year was a record quarter for Revenues, and we were just under that, I think, this third quarter. And as you know, that's a better margin product for us. Okay?

Wendy, what we are looking at for RV builds -- what's in the marketplace and what we are reading from the statistics is, we're showing -- the 5 percent reduction we had in our RV build is consistent with the marketplace build, and that is they are forecasting another 5 percent decrease in the fourth quarter. Overall, year-over-year 2003 to 2002, they are about flat. They had a strong first quarter of up 8 percent over 2002, which is offsetting the weakness we are seeing in their build forecast for the balance of the year.

It feels okay now, but as you know, the leadtime there is four days book to ship.

Right. So I guess just to ask my question again -- did you see a sequential improvement as the quarter went on, and you are expecting that improvement to be sustainable in 4Q?

I don't remember. We expect what was going on -- what we saw in September is still going on in October, and it was pretty good in RV.

Mr. Scimone, there appears to be no further questions at this time. I would like to turn the call back to you.

Thank you very much. We look forward to seeing all of you in New York on November 19 at our analyst conference meeting. Have a good day.

This does conclude today's conference call.