Crane Co (CR) 2005 Q3 法說會逐字稿

Good day, and welcome everyone to the Crane Co.’s Third Quarter 2005 Earnings Conference Call. Today’s call is being recorded. At this time, I would like to turn the conference over to the Director of Investor Relations, Mr. Richard Koch. Please go ahead, sir.

Thank you, Operator, and good morning everyone. Welcome to Crane’s Third Quarter 2005 Earnings Release Conference Call. I am Dick Koch, Director of Investor Relations. Before turning to our normal conference call, let me invite each of you to Crane’s Annual Investor Day on Tuesday, December 13th, in New York City at the Grand Hyatt on 42nd Street from 8:30 A.M. until noon. If you wish to attend, please R.S.V.P. to me at your earliest convenience at the e-mail address rsvp@craneco.com.

On our call this morning, we have Eric Fast, our President and CEO; and Bob Vipond, our VP and CFO. We will start off our call with a few prepared remarks, after which we will respond to questions. Just as a reminder, the comments we make on this call may include some forward-looking statements. We will refer you to the cautionary language at the bottom of our earnings release and also in our Annual Report, 10-K, and subsequent filings pertaining to forward-looking statements. Also, during the call, we will be using some non-GAAP numbers, which are reconciled to the comparable GAAP numbers in a table at the end of our press release, which is available on our website, www.craneco.com, in the Investor Relations section.

Now, let me turn the call over to Eric.

Thank you, Dick. I’m pleased to welcome Dick Koch to Crane. Dick joined us from Olin Corporation in September after 15 years heading up their investor relations efforts. I’m sure you will enjoy working with him.

In another important management change, Tom Perlitz joined us in September as VP, Operational Excellence, replacing Max Mitchell, who, as you know, became President of our Fluid Handling Group. Tom had over 10 years of experience in operational marketing walls within Danaher Corporation.

I am pleased with the Company’s performance in the third quarter. Earnings per share of $0.66 was above our guidance, up 12% sequentially from the second quarter, and up 18% from the third quarter of 2004, excluding the asbestos charge we took last year. Strong core sales growth of 8%, which excludes foreign currency, improving margins, and very good cash flow were all evidence of continued solid improvement. Our 18% growth in earnings per share reflects the strong recovery in margins in our Electronics Group and continued progress in margin growth in Fluid Handling. Four of our five business segments posted increases in operating profit, with merchandising systems operating profit impacted by weak demand.

Unlike last year, price increases have offset the material price inflation in Fluid Handling and engineered material. We are seeing some added pressures in stainless steel, titanium, styrene, and resins that are having an impact on our businesses, but at this point they are manageable.

Free cash flow, after asbestos payments and capital spending, doubled from the prior year and I was pleased to see inventories reduced by $10 million from June 30th. Reflecting our competence in the Company, we raised the bottom of our full-year earnings per share guidance by $0.05 to $2.20 per share, while maintaining the high end of the range at $2.25. Fourth quarter guidance is $0.53 to $0.58 per share versus $0.52 a year ago, which excludes the one-time benefits of the gain on the Victaulic divestiture and the gain from the reduction in asbestos liability.

At the end of September, our net debt to capital was a conservative 20%, with $114 million of cash and a $300 million revolving credit facility available for acquisitions. We are seeing considerably more acquisition opportunities; however, the marketplace remains highly competitive.

Turning now to specific segment comments. In the Aerospace and Electronics Segments, we did what we said we were going to do with margins improving strongly from the second quarter level of 13.6%. And at 18.7% in the third quarter, they were above the prior year. The Aerospace Group margins have improved each quarter this year and benefited from continuing strong improvement at P.L. Porter. There has been excellent market acceptance of Porter’s seat actuation system and margins are now at more acceptable levels as a result of value engineering the product, higher prices, and the completion of the closure of the Porter facility.

In the third quarter of 2005, the aftermarket sales were approximately the same as last year, with OEM sales accounting for most of the Aerospace Group’s 7% sales increase. The OEM aftermarket mix was 63.37% versus last year’s mix was 62.38%.

We continue to spend heavily on engineering, program management, and R&D for new products and program wins, with revenue streams largely beginning in the 2006 to 2008 period. As I have noted before, these wins include new contracts with both Cessna and Boeing Triple-7 for our new wireless tire pressure system, with shipments beginning in 2007, and our first ever Airbus brake control system on the A400M military transport, with shipments beginning in 2008.

Our challenge in the Aerospace Group is balancing the spending and costs associated with better than anticipated awards across all our solution sets, which enhance value and revenue growth long-term, but cause margin pressures today. We are, and will continue, to fund this growth through savings from the facility closures, the reduction in non-engineering headcount, and continued focus on value engineering.

Although the Boeing strike has been settled, there may be some minor disruptions in our demand during the fourth quarter, as we resume deliveries to their factories.

In the Electronics Group, margins have recovered, as we said they would, and are now at a satisfactory level. We expect margins to remain at approximately the same range in the fourth quarter. These margins confirm our view that the Electronics Group has a strong strategic position in the niche markets in which it competes. Electronics Group sales are up 11% sequentially since the second quarter and are up 19% over the third quarter of 2004.

Power Solution sales, representing approximately half the Electronics Group sales are up 30% -- 37% over the third quarter of 2004, and margins are also substantially improved. Power Solutions’ strong orders have created some engineering and capacity issues, which we are working aggressively to resolve. Overall, Electronics Group backlog is also up 10% versus last year.

While we are pleased with the Electronics Group’s performance in the quarter, we need to continue -- we need to make continued progress to realize its full potential. These efforts include strengthening the management team, expanded engineering resources, and continued focus on our lean manufacturing initiatives.

At Engineer Materials, we had another excellent quarter, with margins up nearly 21%, as price increases covered resin and styrene material costs. And OpEx improvements in material utilization all benefited margins. Sales increased 8%, as price increases offset lower shipments. There was some softness in the RV market, as end users reacted to higher interest rates and gas prices. The latest RVIA industry statistics indicate that the recreational vehicle deliveries for the third quarter of ’05 declined 4.8% over the prior year’s period. However, the towable segment of the market, which is key to our engineering material sales, declined by only 2.3%.

Although the RV and towable industry has benefited from FEMA orders related to the hurricane relief efforts, our engineering material business has not yet seen a significant benefit, as most of the FEMA orders are calling for aluminum units, largely because of their lower cost.

In Merchandising Systems, weak orders and the absence of a 600,000 software sale resulted in a decline in sales and operating profits compared with the third quarter of 2004. The weak orders stem from root operators higher costs for gasoline and food condiments, coupled with continued weakness in their end markets, particularly manufacturing. In spite of these uncertain markets, we remain confident about our business model and that we are maintaining, if not improving, market share. I would note the year-to-date operating profit is 46% above the prior year on a 3% sales gain, a testament to the results we are achieving from our operational excellence initiatives.

We have been investing in new and updated products in the food, refreshment center, and coffee machine categories, which have been successfully introduced into the marketplace. The introduction of our coin/bill recycler in the U.S., while at the very early stages, continues to show excellent promise.

Fluid Handling, I was pleased to see the core sales increase of 10%, reflecting both good markets and our strong market shares. In addition, currency added 2% to our sales for the quarter. Even more notable was the continued increase in operating profit and operating margin from the second to the third quarter of 2005 on essentially flat sales. We have had improved margins each quarter this year compared to the prior quarter last year, up 110 basis points in the first, 130 basis points in the second quarter, and up 140 basis points in the third quarter to 8.7%.

We continue to be focused on operational improvements throughout Fluid Handling. Strengthen management teams, including several key new operations leaders; the maturing of our China sourcing activities; and a disciplined approach to raising prices will continue to benefit margins and cash flow. Fluid Handling cash flow, provided from operations, was $38 million year-to-date through September, compared with $8 million the first 9 months of 2004. Just a few comments about several of the business units in Fluid Handling. In Crane pumps and systems sales were up 8% over the third quarter of 2004, and operating results strengthened through the quarter. We have higher sales and operating profits in the third quarter compared with the second quarter of 2005, and we expect further improvement in the fourth quarter.

In August, we announced the acquisition of PSI Edlon. They make Teflon pipe and have annual sales revenue of about $8 million a year. They will be an excellent addition to the Resistoflex product line.

I want to remind everyone that, as is our practice, we do not intend to comment on our estimate of the Company’s expressive liability beyond what we have said in our Form 8-K. I encourage you to read the disclosures carefully, as we are making every effort to make it complete and informative. Let me also invite you to attend our Investor Day Program in New York on December 13th. It is actually just the morning. And we hope you can join us. Please contact Dick to reserve a seat.

With that, I’ll turn the call over to Bob Vipond, our CFO.

Thank you, Eric. A few items of note. In the third quarter, our 2005 effective tax rate was 30%, about equal to last year’s rate, excluding the effect of our asbestos reserve. Our rate was 32% in the first quarter and 30% in the second quarter of 2005. We continue to be successful on executing our various tax initiatives and we now expect our fourth quarter rate to be 31%. As you know, each 1% change in the quarterly tax rate was approximately $0.01 per share in our quarterly earnings.

Our free cash flow, on another topic, our free cash flow, after asbestos and capital expenditures, was strong in the third quarter at $61 million versus $29 million in the prior year third quarter, and we are reaffirming our cash provided from operating activities target, before asbestos, of $175 million for the full year 2005. You will notice that we have modified our definition of free cash flow, as we stated on our non-GAAP financial measures table attached to the press release. It now includes net asbestos payments. Previously, we had excluded those from our definition.

On another topic, the improvement in our miscellaneous income for the third quarter reflected our strong operating performance in our Ferguson joint venture. Another topic, corporate expenses, at $6.8 million, benefited from the timing of expenditures and was a bit lower than our normal running rate.

Lastly, as we mentioned last quarter, Crane plans to adopt FASBE 123 on options expensing when it becomes effective for us January 1, 2006. The Company has disclosed its options, expense amounts in the footnotes to its Annual Report for several years, and they have ranged from $0.07 to $0.09 per share per year.

Now, let me turn it back to Dick.

Thank you, Bob. This marks the end of our prepared comments. Before we open the call for your questions, remember that we take questions in the order received. As a courtesy to your colleagues, we ask each of you to limit the number of your questions to just one or two at a time, in order to give others a chance to ask questions. You are welcome to get in the queue again with additional questions.

Operator, you may now open the call for questions.

Thank you. [Operator Instructions]. Deane Dray, Goldman Sachs.

Can I -- go into a little deeper into Electronics margin improvement? It really sounds as though the improvement there was higher than what you had been forecasting. So the first question is, were there anything unusual in terms of maybe contract adjustments that we had seen earlier in the year?

Dean, there was nothing unusual in the quarter. And that’s kind of implied by us by saying we expect margins to be about the same in the fourth quarter. And I -- margins were where we thought they were going to be, which is why we said we expected sequential quarterly improvement in each quarter this year.

How much of Electronics operates with a percentage of completion accounting method?

I don’t have the detail on that.

Okay. And then, Eric, you had identified the border business as being one of the drivers of the improvement and you’ve pointed out value engineering, price, and then a facility closure.

Right.

How much of each of those three factors contributed to the margin gain?

I don’t have that broken out, Deane. I think the important point is we made this acquisition, we have successfully introduced the new iMotion product, which is the first class, the upfront electric seat actuation, and we’ve taken costs out of it, we’ve got the plant consolidation behind us, and we feel that we’re having real success in the marketplace. And, as I mentioned, importantly, that sequential improvement in margins is, we think, real and sustainable and they were at, at least, acceptable levels. I always think they can be better, but we’re pleased with the progress there.

And then, just within P.L. Porter, how much of P.L. Porter contributed to the margin gain?

I don’t have that breakout, Deane.

Wendy Caplan, Wachovia Securities.

Can we walk through the Fluid Handling Segment please? The largest pieces of it. In the Valve Group, sales were -- the margin was about 6%. I think you said it was 8% in Q2, and given that that’s the largest segment, can you help us understand what the sequential decline was there?

You know I didn’t track it that way. I didn’t talk about the Valve Group because I don’t think there’s any specific news there, Wendy. We think that we’re tracking. We think we’re making the progress. You can see it is 300 basis points better than it was last year. But, frankly, 6% operating margins remain unsatisfactory. I don’t have the bridge to the second quarter.

Okay. And just a follow-up on that, as you look at, you and Max look at, kind of what you’re thinking going forward, do you expect that demand will be sufficient and manufacturing efficiencies will be sufficient to drive it by a couple hundred basis points on an annual basis, the operating profit, at this point?

Well, we’re going to give guidance at the December 13th meeting. Max and I both feel that, just in terms of continuing to improve on our operations, that there are at least a couple hundred basis points that are achievable from just doing that. And both of us remain consistent that our goal here is 12% in Fluid Handling.

Okay. And another follow-up on the pump business, in Q2, you said there was a decline in customer demand and you did address the issue of the plant consolidation disruption.

Right.

Can you give us an update on both of those please?

We still have some capacity issues and past dues. The capacity issues are centered around machining. And I think we’ve got the appropriate actions in place to -- that are starting to relieve that. We’ve made considerable progress on our pass dues in the third quarter. And some of the demand is weak because our lead times have lengthened out. But I feel good about the progress that’s been made here. Our forecast for the fourth quarter is that we expect to see much stronger results in the fourth quarter than we did in the third quarter, which tells me that we’re tracking.

Ned Armstrong, FBR.

With regard to Fluid Handling, do you have a breakout of the margin improvement, where it came from vis-à-vis demand versus productivity versus price?

I don’t have that.

Okay. With regard to -- you mentioned that you could get the margins overall to 12%?

Yeah.

How would that break out, those goals break out by the particular businesses within Fluid Handling?

Ned, I’m not going to deal with that on the call. We’ll share that at December 13th, in terms of some of those -- the broad-based plans that we’ve got to get there.

Okay, good. Thank you.

And by the way, on productivity, price, foreign exchange, we track that on a monthly basis for Fluid Handling. I just -- we just don’t choose to disclose it.

Scott Graham, Bear Stearns.

Nice quarter, Eric. Could you, if you would, unbundle a little bit more about what you see in Fluid Handling that makes this year-over-year improvement, which we’ve now seen for a couple of quarters consistent? What is Max doing there that his predecessors weren’t doing specifically, if you could?

Well, I think the two big issues that we see here that are being implemented are much more disciplined intellectual capital process in terms of performance and results. And the second is an intense focus on processes, whether it’s a supply chain, whether it’s a new product introduction, whether it’s capacity planning, whether it’s contract slowdowns. An intense focus on fixing processes that once they’re fixed we make standard work and then we can go on and fix the next process. And it allows us to more efficiently handle the order as it’s coming in and going through the plant. Those are the two issues that I point to. And, finally, just a different level of expectations as far as doing what we said we were going to do and achieving the results.

Okay, and if I may, the aerospace aftermarket was, versus my model at least, surprising in its being flat. And I’m wondering, do you think we’re at a point, Eric, one, two quarters from now where we reach that crossover where there are enough planes flying with you having enough content on them where aerospace sales, aftermarket sales, would be sustainably up?

I think, first off, we’ll lay that out at December 12th. Scott, I’m pretty confident about our commercial, the commercial aftermarket business being flat, to start to being slightly up. And we’ll try to lay that out in more detail. The lumpiness can come from our military, where you -- the military orders a bunch of spares and then you don’t see or hear from them for 3 months or 6 months. I think we need to do a little bit better job of laying that out, and I’ll try to do that on the 12th. But I -- we have a good underlying base and expect to see what I would call flight improvement in commercial aftermarket. Spares are no business for the future here.

[Caller Instructions]. Ron Epstein, Merrill Lynch.

What do you see on the M&A front, Eric? What are you guys thinking in regard to that?

Just pretty much what I said. I mean we are seeing a lot more opportunities. It’s as competitive as we’ve seen it. You got to be careful. Prices are high. And we’re fully engaged. I’m, personally, spending a lot more time. Curtis Robb, our new VP, Strategy and Corporate Development, is an additional resource here, very focused on it. But I can’t really -- I don’t really have much to comment about that.

Okay. I just wanted a quick follow-up. I mean maybe you can or can’t comment. I mean are you guys looking towards commercial or defense or either?

Our philosophy is not to take on somebody else’s challenges, opportunities, and problems unless you’re in really strong shape yourself. So we’re not aggressively looking at any Fluid Handling, for example. And I really would prefer not to do anything there. We are pretty active in looking at the other segments.

Okay. And then just one last one, and this you will probably address in December, but what are you guys thinking about commercial airplane OEM deliveries in 2006?

I think we’re pretty much -- again, I’m going to do the -- I’ve got the plan meeting. They just submitted their plans and I’ve got two days at Aerospace Electronics in two weeks, so you’re two weeks early for me. But it’s really going to track Boeing and Airbus. We are not going to argue with them.

James Sergo, Citigroup.

I have a couple of questions. First of all, can you talk a little bit more about the soft RV market? I know you addressed what happened in the tax quarter, slowed down 4.8% to 2.3%. But can you talk a little bit more about what you’ve seen so far this quarter?

Secondly, I didn’t catch what you had meant by FEMA and their orders. And if you can just touch on that again.

And finally, if you can talk a little bit more about the Electronics margins and where you’re seeing improvement coming from there?

I think actually the Wall Street Journal in the third section has got a pretty good piece on FEMA and truck towables and motor homes. They’ve ordered a lot of towables and motor homes for temporary housing for companies and displaced people. But most of that, from what we’ve seen, is really with aluminum siding because they don’t really care what it looks like. Even today, it’s a little bit cheaper than where we are with our fiberglass reinforced plastic.

In terms of the overall RV market, our view is that the combination of the baby boom, the lifestyle changes, that this ought to remain a good market going forward. I think we clearly are going to see it come off and we’re planning for it to come off because of higher interest rates and some gas prices. I used to have this factoid in my head, but I believe the big motor home actually is driven only a total of about 10 days a year. So every time I push on this, the industry pushes back and says, well, people don’t really drive it that much. But I would expect that it -- we would expect a somewhat soft and declining sales on a normalized basis here.

Okay, great. And then the margins in the Electronics Segment, where are you really getting the increase there? Is it mostly from pricing or are you managing the center better?

Well, I just think we’ve got better throughput through the plants. We’ve got better productivity out of our Taiwan facility. We’ve got -- we took our lumps on the bad jobs, and those, as I said, in the first quarter and the second quarter, we took our lumps and they were at breakeven. But now we are starting to finish those old bad jobs and get them out of the shop, so that we are able to go back to what I would consider to be a more normal margin. When we looked at the second quarter, we looked through the jobs, we looked through which ones we’re going to be completing, and that’s why we were able to have a high degree of confidence of getting back to more acceptable margins here. That’s not to say we don’t have a lot of work to do in the business, we do, but we are pretty pleased with the quarter.

[Operator Instructions]. Scott Graham, Bear Stearns

Eric, I was just wondering, you made an earlier comment about the ramp-up in shipping post the Boeing strike. I’m wondering, your guidance for the fourth quarter, the low end of the range is $0.01 above what the year ago number was. Is that maybe some conservatism laced in there because of that concern in aerospace?

I wouldn’t overemphasize the Boeing. I mean I view it as a disruption. It may cost us some money, but I don’t think it’s -- it’s not a big deal, Scott. I’m not going to comment on the forecast as to whether it’s conservative or not conservative at this point. I mean it’s just method. You try to help everybody with some general thinking.

Okay, that’s fair. Regarding the engineered materials sales where you said pricing was up but volumes were down. This is kind of a second straight quarter where we’ve had that dynamic. Is there anything that we should be reading into that, Eric? Are your end-market volumes -- are your end-markets, the -- industry-wise, if there is a way to characterize that, would you said that your end-markets of the engineering materials businesses are essentially flat on a volume basis right now as well?

I would say, overall, those end-markets were generally just a touch down on a square footage kind of basis and that the increase is coming from price.

So there is no share loss there or anything like that? You are not abandoning --

There are gives and takes in share loss. I am confident that we are certainly holding our own.

Very good.

I’m not -- we’re a tough competitor.

James Sergo, Citigroup.

Gentlemen, could you just address the answer that you made to the analyst from Bear Stearns regarding Fluid Handling. You said there are two main issues there that you are focusing on. One was fixing the business processes and then you mentioned the intellectual capital process. Can you just talk a little more about that? I’m not quite sure what you mean.

I just think we’ve done -- I think in a prior call, I talked about we’ve brought in a lot of new sight as plant leaders, if you will, and we have some key new operational leaders impacting overall operations in some of our major units. And we are starting to see real signs of when you go into the plants and the kind of progress that we’d like to see. We don’t always see them in the overall results yet because it might be we’ve got 2 cells out of 10 in really good shape. But we are actively engaged in moving to the rest of it. So I think that’s an important change, and, frankly, that’s why Max Mitchell is in that job, because this operational discipline.

Okay, so you are talking about brains, not patents.

Yes.

There are no further questions at this time. Let’s turn the conference over to Mr. Koch for any additional or closing remarks.

Thank you very much, Operator, and thank you for your time and your interest in Crane Co.

And that concludes today’s conference call. We thank you for your participation and have a nice day.