Crane Co (CR) 2006 Q1 法說會逐字稿

Good day, everyone and welcome to the Crane Company first quarter 2006 earnings analyst conference call. Today's call is being recorded.

At this time, I would like to turn the call over to the Director of Investor Relations, Mr. Dick Koch. Please go ahead, sir.

Thank you, operator. Good morning, everyone. Welcome to Crane's first quarter 2006 earnings release conference call. I'm Dick Koch, Director of Investor Relations and Corporate Communications. On our call this morning we have Eric Fast, our President and CEO, and Bob Vipond, our Vice President 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 would 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 the table at the end of the press release, which is available on our Website at www.Craneco.com in the Investor Relations section.

Now let me turn this call over to Eric.

Thank you, Dick. I'm pleased with the Company's performance in the first quarter. Earnings per share of $0.61 exceeded our guidance, and we're up 45% from the first quarter of 2005. Strong core sales growth is 7%, improving margins and very good cash flow were all evidence of continued solid improvement. Operating profit increased 37% with strong performance in the Fluid Handling and Aerospace and Electronics segments. Flat operating profit in the merchandising systems segment was a reflection of the acquisition of CashCode in January, which offset a reduction in core vending results.

Overall, operating margins improved to 10.4%, up from 8.3%. Cash flow from operating activities of 17 million in the quarter, was an improvement of 23 million from the prior year. Our progress reflects the strength in processes, in our supply chain and manufacturing areas, and as well as improved disciplines in our collection efforts. During the first quarter, our sales grew 42 million, or 8% from the prior year, while our investment in accounts receivable and inventories declined 14 million, or 2%. We are raising our cash flow guidance for the year by 20 million to 215 million.

In January, we spent 85 million for the acquisition of CashCode, and during the quarter, we repurchased 12 million of our common stock. As a result our net debt to capital ratio increased to 20% at the end of the first quarter of 2006, including 96 million of cash on the balance sheet, compared to 13% at December 31, 2005. As I said at our December Investor Conference, we feel we are in a position to more aggressively deploy our capital.

Turning now to specific segment comments, and beginning with Aerospace and Electronics segment. In the Aerospace group, OEM and after-market sales were both higher than their respective levels last year, with OEM sales accounting for the majority of the 5% sales increase. The OEM after-market mix was 63/37%, virtually the same of last year's of 62/38%.

During the quarter, the Aerospace group continued its success in winning new business. Notable wins included a $4.3 million award for retrofit of F-16 wheel speed transducers for delivery in the second half of this year. A $40 million three-year memorandum of agreement with BE Aerospace for our Porter brand seat actuation, and a $15 million order over 10 years for a new generation control system for the doors and slides for the Airbus 330/340 family of aircraft.

As our Aerospace business continues to be successful in winning in the marketplace, our spending on engineering is increasing substantially to develop, win, and manage new programs, with revenue streams largely in the next three years. Even with our higher engineering spending of approximately 6 million in 2006, we expect solid improvement in 2006 operating profit.

The Electronics group profit margins more than doubled from the prior year. We continue to focus on strengthening the management team, expanding engineering resources, and executing on our lean manufacturing initiatives. But we have made progress in reducing past due orders, and production costs on key programs, and we have significant opportunities to continue to improve this business. Orders which can be lumpy were weaker in part reflecting delayed DOD funding for our wireless initiative, which slipped into the second quarter.

In Engineered Materials, revenues increased 6%, and operating profit was off 1.2 million, or 7%. Sales were generally as anticipated, with higher volumes in building products, and transportation offsetting a slight decline in recreational vehicles. We expect a similar sales trend for the remainder of the year. Operating margins were 18.3%, down from last year, largely as a reflection of both new product development costs, and certain warranty costs. In 2006, we increased our spending to support the growth of our newer products, such as decorative panels, and Zenecon thermal plastic products, we expect to begin production of the Zenecon product in the second quarter.

During the first quarter, we also incurred product support costs in conjunction with a distortion issue, and a product quality issue, some of our RV customers have experienced. Margins in the second quarter for Engineered Materials are expected to be similar to the first quarter, and return to the 20% level for the second half of the year.

In Merchandising Systems, beginning with this conference call, we will discuss our results in terms of our vending business, and our payment systems business. Our payment systems business is comprised of NRI, our coin validation business, which we have owned for years, and CashCode, which was acquired in mid-January.

CashCode, you will recall, was a privately held company specializing in niche applications for bank note validations, storage, and recycling devices for use in vending, gaming, retail, and transportation applications. We are pleased with the sales, profits, and cash flow, that CashCode has provided us in the first quarter. The overall performance of our payment system's business has offset substantially weaker sales and earnings from our vending business. In the first quarter of 2006, we continued to see weak orders for our vending machines.

The weak demand is caused by route operators higher costs for gasoline, and confectionery food, coupled with continued weaknesses in their end markets. Our vending machine sales in the first quarter of 2006 were $5 million, or 15% below 2005. We believe that what we are seeing is a vending industry trend, and that we are maintaining market share.

In spite of softness in our end markets, we remain confident about our business model, and longer term outlook for our business. In the near term, we are taking strong steps to mitigate the effects of lower sales. Crane's vending operations in the United States reduced employment levels by 18%, compared to March 2005.

During the first quarter of this year, we negotiated a new contract with the union at our St. Louis vending manufacturing operations, that helps position us to compete more effectively in the future. The contract freezes salaries at the existing work force for three years, and provides for lower rates for new hires. The contract also provides an incentive for workers to voluntarily discontinue employment.

In the first quarter, we incurred severance costs of 1.1 million, for both the voluntary and involuntary severance. Additional severance charges for voluntary separations are expected in the second quarter. Weak demands continued in the second quarter, and we are reducing our work week to four days, and taking a one-week shutdown in both April and May.

The Merchandising Systems management team has done an outstanding job under very difficult vending market conditions, while continuing to drive both process improvements and growth initiatives in both payment systems and vending.

Turning now to Fluid Handling. To better align our external financial reporting with our strategic focus and management structure, we are now including Resistoflex and Crane Limited in the Valve group. Crane Pumps and Systems and Crane Supply remain unchanged, and will continue to be reported separately.

The new reporting format reflects our current management structure under Max Mitchell and how we are working to leverage current and future synergies and products, facilitate utilization, low cost country sourcing, and Information Technology infrastructures.

Fluid Handling representing 45% of Crane sales have by far the best performance of the five segments. Exceeding even our own first quarter plan. Every major unit contributed to the growth in operating profit. I was pleased to see the core sales in Fluid Handling increased 9%, before foreign exchange and acquisitions, reflecting good demand due to the late cycle nature of our markets, which include nonresidential construction, chemical process industry, and power.

Operating profit of 24 million, up 96%, from the first quarter of 2005. Fluid Handling cash flow provided from operations was 12 million in the first quarter of 2006. Compared to a negative 6 million in 2005, an improvement of 18 million, and continues the strong momentum we experienced during the second half of last year. All three major categories of the Fluid Handling segment showed improved performance in the quarter.

Our progress in Fluid Handling has been a journey, reflecting improving markets, excellent brands, reduced physical footprint, strengthened management teams, low cost country sourcing, and improved planning and manufacturing processes. Margins approaching 10% and strong cash flow generation are a testament to our progress.

Now, let's turn to the three businesses in the Fluid Handling segment. In the involve Valve group, operating profit increased 84% over the first quarter of 2005, and margins increased from 6% last year to 10% this year. Reflecting higher sales, improved operating costs, and the absence of 1.9 million of severance costs.

Our improvement initiatives continued during the first quarter of 2006. We announced that we will be closing two small facilities, made key additions to the management teams and process flow, Crane Valves in Australia, while driving real productivity improvements. Specifically, head count was reduced by 4%, while sales increased 9%.

Last week, we also completed the sale of our Westad Valve business located in Norway. This small business with 56 employees had sales of 25 million in 2002, and in recent years, had been marginally profitable or has lost money. This sale is consistent with our strategy of trimming the portfolio, where we have a small business that cannot be leveraged in a larger unit. The sale generated cash proceeds of about 3 million, and a modest loss.

In Crane Pumps & Systems profits and margins increased due to the productivity gains realized from the Salem Ohio plant closure last year, the ability to effectively leverage the incremental volume, and the absence of 1.5 million of closure and severance costs recorded in the first quarter of 2005. Crane Supply continues to post solid results with stronger sales and improved low cost country sourcing, helping to offset higher prices for steel pipe and copper tube.

Turning now to Controls, briefly our controls business continues to grow. Excellent markets in oil and gas and transportation, strengthened management teams, and a real focus on customer metrics and new products are driving the improved results.

Now turning to our second quarter guidance, we expect earnings per share to be in the range of $0.62 to $0.70, including $0.02 for option expense, versus $0.59 in the second quarter of 2005. Based on our strength of our first quarter, including the acquisition of CashCode and our overall view of the businesses, we are increasing our total year earnings per share guidance from the range of $2.45 to $2.60, to a range of $2.50 to $2.65. As I mentioned earlier, we are also increasing our free cash flow guidance for the year from 165 million to 185 million.

I want to remind everyone that as is our practice, we do not intend to comment on our estimate of the Company's asbestos 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 them complete and informative.

Now let me turn the call over to Bob Vipond, our CFO.

Thank you, Eric. As Eric mentioned, we are pleased with our first quarter results. Let me discuss a few other items impacting our financial performance.

First of all our corporate expenses were 12 million, compared with 9 million in the first quarter of 2005. The difference was primarily due to expensing of stock options, which we began in this first quarter of 2006. And higher provisions for incentive compensation, and some environmental-related costs.

The miscellaneous income line was higher than the first quarter of 2005, was driven primarily because of the performance of our joint venture with Emerson Electric, and to a lesser extent there was a gain on the sale of an unused building. In the first quarter of '06, our effective tax rate was 30.3, compared with 32% last year. During the first quarter, our rate was lower, primarily due to the resolution of audit issues.

We are expecting that the R&D legislation will be renewed at the federal level during the second quarter, which will result in our tax rate being approximately 30% in the second quarter as well. For the year, we are expecting our tax rate will be in the range of 31 to 32%.

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 that each of you 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, ladies and gentlemen, [OPERATOR INSTRUCTIONS] We will take our first question from Deane Dray with Goldman Sachs.

Thank you, good morning.

Good morning.

Eric, you made some interesting comments on the Fluid Handling margins, congratulations on getting them to this level, to you and the team, and you referred to it as a journey, so with that in mind, where is the upside in this business? And could you map out for us on the margin improvement this quarter, what that contribution might be from either mix, you identified some of end markets, nonres construction, helping you, and how did pricing help, and so forth?

For Fluid Handling, if you look at the volumes Deane, and I will break it out for you, 8% was pure volume, 1% was price, 1% was the small [headline] acquisition, product addition that we did last fall, offset by about 3% negative foreign exchange. So for a net, that's how you get to the 7%. So it was, there are real earnings there. I think I don't really have much to add, Deane. I don't really feel there is anything new to the Fluid Handling story.

This is a culmination of a myriad of initiatives and process, and people improvements that we have been putting in place. It is a journey. I think the more progress we make, the more opportunity we see, and we don't consider the first quarter a one-time event by any stretch of the imagination. I've said consistently that long-term, we've got a 12% target, and we're confident about reaching that.

And what would the timeframe be, are you willing to take a stab at that?

I've never been pinned down on that.

All right. So I won't try again.

But you have to admit it is approaching faster.

It absolutely is. If we could switch over to Engineered Materials, the comment on higher warranty costs, and then in the prepared remarks, you reference some product quality issues in RV. Is that all related?

It is a little bit different. The distortion costs, the distortion issue is truly a product support cost that we don't think is our fault. It relates to when we ship our FRP panels to either an OEM or a laminator, and they laminated it on a back substrate.

Oftentimes, they use luan wood and we, based on all of our experience and Six Sigma quality work, if you get a high moisture content in that wood, it can cause some distortions in the FRP skin, and while we felt strongly that it wasn't our fault, that the facts represented that, We are the industry leader. We do stand behind our product, and wanted to support our customers and we have done that. And will continue to do that.

We did have, in March, we are putting on a new environmental emission control equipment in our Jonesboro plant, and that equipment increases the airflow over the ovens by something like 2 times, and it will substantially increase how much of that oven is covered, and as a result of that, the airflow dynamics and some of the temperature gradients get changed, and it impacts the quality of the cure process, and as we're kind of fine tuning to get that mixture right, we had some product that while we take samples as we go along, that did escape, and as a result we had a few, what I would call just a few escapes, quality issues in the field that we are looking into, and examining, and standing behind.

That's one of the key reasons why margins were in the 18% area during the first quarter, and while we don't know, as of yet, we are assuming that we may have some additional product support costs in the second quarter, which is why I said we expect Engineered Materials margins to be, you know, similar, but we think it is the second quarter phenomena, and will be behind us in the second half.

That was very helpful explanation on the dispersion issue and the product quality issue. Is there any way you can quantify what you think that margin impact is for the second quarter? And does that spill into the third quarter?

I think I will live with the guidance that we've given, which is margins here were I think 18.3% in our first quarter, and we are expecting them to be about that level in the second quarter.

And just last question, for the second quarter guidance, is there an internal growth assumption that that is based on?

Not really. Our plans are really throughout the Company, but particularly for Fluid Handling as you know, have assumed a conservative sales increase, and I think in Fluid Handling, for planning purposes, we assume 4%, because we want to make sure we're very disciplined about our costs, and that we're able to leverage a sales increase if it comes in better than what we planned, and that is kind of a consistent theme across the Company.

That was 4% for Fluid Handling, or for the Company as a whole?

For Fluid Handling. As an example. We haven't really given sales guidance in the past, Deane.

Thank you.

We will go now to Scott Graham of Bear Stearns.

Hi, Eric. Hi, Dick. Hi, Bob. I just wanted to ask about the acquisition environment out there. Your debt to capital obviously is a very attractive number, very liquid, what are you seeing and where are you seeing it?

Well, we're clearly seeing more opportunities, and spending a lot more time on acquisitions. My own view is that the world currently is overpriced. And I think the management team shares that. So we're trying to be highly very careful and very selective. We are staying very focused in the niche, some of the niche markets that we operate, so that when we do get to the final end game, we tend to be the one big strategic buyer present, and the other people not so much.

The second issue that I think is, that we want to stay mindful of, is making sure that it strengthens our existing business. So even if we're paying what we believe to be a full price, that by adding that small business with the synergies to strengthen a larger business that is buying it, we think gives us down side protection.

So we're seeing more opportunities, we're spending more time on it, but as you know, Scott, you can work on something for a year and have it fall through the cracks. So it is a very uncertain game.

Sure. Thank you. Second question is, I saw you purchased more than you issued on the common stock line in the cash flow statement, and is that something we can see continue, and how much is remaining on the authorization?

We don't as a matter of policy, because Crane has never indicated what its intentions were on buying stock, nor what if any authorization there was, and I would reiterate that we do feel we are in a position to more aggressively deploy our capital, and I talked at the Investor Conference that it is either acquisitions, dividends, or stock repurchase.

Thanks a lot.

Thank you.

We will go now to David Smith of Citigroup.

Good morning, guys.

Good morning.

Quickly, the Fluid Handling business, there is no question the margins look great there, but can you give us a sense, Eric of how much of the improvement is coming from cost restructuring and low cost sourcing, and then how much is coming from volume? Maybe I guess some comments perhaps around what you expect the incremental operating profit in this business should be?

Well again, the volume was 8%, price was 1%. I feel strongly that it starts with the quality of the people, that where we stand today, in our Fluid Handling businesses versus where we were three or four years ago. Particularly as it relates to operating people, and the focus on processes. We are experiencing good markets. We're in the late cycle markets, and I think we're showing wonderful discipline on cost to leverage it.

But I can't honestly have a substantially smaller footprint. I think our goal is to low cost country sourcing in Fluid Handling is going to go from 32 to 36, 38% this year. Again, continuing the program.

More importantly, maybe even than that increase in percent, is the fact that the maturation and sophistication of our supply chain, so that it is here on time with dependable lead times. It is just, it is a whole accumulation of all those events. And as we discussed here internally, there is no one silver bullet that is causing this.

Well, this gain, like, you know, you mentioned to Deane 12% just a second ago, but 12% almost to me seems a little light given these gains. Now, is it something that you expect to continue based upon low cost sourcing and the benefits from this restructuring, or is the volume really going to drive the upside there?

First off, that is music to my ears because when it was at 6 and 7% operating margin, people thought that 12% was going to be a gift of God.

I agree.

But I think that, I really believe one of my senior operating people said this to me, I'm not sure who it was, that, you know, the better we get, and the further we get on this journey, the more we're seeing our eyes are open to the opportunities we have to improve the business. And I, we feel very confident about the momentum that we have in Fluid Handling.

As I mentioned in my remarks, that we're seeing it across the board here, in our businesses. And look for it to continue this year. I'm just -- you know, it is a journey and we're on it, and I'm very confident about the trajectory, I'm just not quite sure how long it is going to take us.

I have said that we think that we can get to the 12% with just all the programs and initiatives that we've got. I feel that the opportunity to get to say a more like a 14 or 15% level will require, you know, kind of the next step in that program, in terms of becoming more of an integrated operating company. A fewer number of units. But we're just really starting to take a look at that, and think about that, and that will be part of our strategic planning.

Is that 12%, do you really think you can get there even without the volume?

Well, no, you know, we need a basic core increase in volume, but personally, when you look at nonresidential construction and the chemical processing industry and power, which goes anywhere from nuclear to oil and gas, to ethanol, I don't see any reason why we shouldn't have a couple of years here of, you know, solid market growth here globally.

Yes.

Again, we're planning on 4%. I'm happy if it is just 4%. We're seeing a lot, you know, twice that.

Okay. And just a quick follow-up, on the guidance side, you beat the low end of the guidance on the quarter by 15%, yet raised the year by a nickel. Is there anything that causes some hesitancy in your outlook for the rest of the year? You talked about the warranty costs and the Engineered Materials, but do things like copper, obviously, and oil --

Nothing other than what I've mentioned. We feel, look at it as just one quarter.

And secondly, I don't want to put guidance out there that is going to stop us doing the things that we need to do in the business. So if I got a plant to close, or some trimming to do, we're going to, we want to aggressively go after it as opposed to, you know, I got to get a penny to make the quarter.

And nothing on --

It is a mind set.

Nothing on raw material costs really caused concern for you?

Copper is up, so you know, our bronze businesses in the Valve area is being impacted, that is going to be, we're ratcheting prices. We're very disciplined about it. We do have some titanium issues in our Aerospace, where you've got some sole suppliers and you're kind of locked in, but we think the price versus material we're managing well and is in balance here.

Okay. Great. Thanks.

We will go to Ned Armstrong with Friedman Billings Ramsey.

Good morning.

Good morning.

I had a couple of questions regarding Merchandising Systems. First with regard to the vending business, the difficulties now, are you viewing that more as a temporary cyclical type of element, or are you sensing a fundamental change in the business?

I'm viewing it as more of a temporary cyclical. You know, it is not easy for the operators to raise prices mechanically in the machines. It takes quite a bit of work and reprogramming, and they've got the confectionery costs going up so that it lags and it squeezes them. You know, gas prices where they are, long term hard to believe that that is sustainable. We just feel that a $21 billion form of distribution for the food and drink business, and long-term, it is going to be okay. We clearly are seeing a slowdown, not just in purchases of new machines, but they are refurbishing old machines.

They are refurbishing old machines at a slower rate or -- ?

At a greater rate.

At a greater rate, okay.

At a greater rate. And as a result of that, part of one of the challenges that we have in terms of as we move forward strategically, is how do we stimulate that installed base, where the new machine is substantially different from the installed base, and refurbishing doesn't quite work, and strategically that is something we are working on.

But I think we're again, we have the leading market share, we're the leading company, we have direct sales and service, our business model I think is superior to anyone that is out there, and as I commented on my call, we really are quite pleased with the management team, and while it is stretched here, has really performed admirably under the circumstances.

Okay. My second question regarding CashCode, are your forecast numbers for this year, assuming any contribution from CashCode, or will acquisitions costs make it a neutral contributor for this year?

You've got a heavy amortization of intangibles that come in here early in the year. We do expect that it, I think we said that it will contribute, and is contributing a little bit, so you can expect that. I would add on CashCode that the integration plans, activities that we've got, as it relates to targeting sales accounts, synergies with NRI, as it relates to the new product, joint new product development, as it relates to real operating improvement, and some discipline in the manufacturing processes at CashCode, have gone exactly on-plan. And the people and the team at CashCode have been a fabulous addition to Crane.

Good. Thank you very much.

[OPERATOR INSTRUCTIONS] We will go now to Ron Epstein with Merrill Lynch.

Good morning.

Good morning, Ron.

Just a couple of quick questions. You mentioned titanium in Aerospace. What are you guys seeing there? And how are you addressing that issue?

I think that's something we've seen across the sector for all of the suppliers in Aerospace. We're trying to find alternate suppliers, but it is difficult and it is difficult to get them qualified, and we're stuck with it, in some cases we're trying to go back to the OEMs to get relief. Fortunately, it is not a huge deal for us. But it is definitely more than an irritant.

Yes, sure. Sure. And then just circle back on the Fluid Handling margin, the 12%, what sort of timeframe were you thinking you would get there? I think you mentioned this, and maybe I missed it, maybe not.

No, I didn't mention it, I ducked it.

Okay.

We're very happy to see margins here for Fluid Handling, you know, right at 10%. And I think we've come a long way, and demonstrated that we're on the right track here.

Okay. Okay. Fair enough. And then, you know, kind of back to Aerospace. What other after market opportunities are you guys looking at, given we're at a point now we're in a cycle where there is more of the kind of a rotation into the OEM market, right, the after market seems to be slowing a bit relative to the OEM market, are there any new opportunities that you guys are pursuing to maybe get more share on different platforms in the after market?

We're you know, after market is really a couple of different businesses for us. There is a commercial, there is military, and there is commercial and military spares, and then there is commercial and military modernization and upgrades. And in our spares business in commercial has been pretty strong, but in the military, it has been, that is the military has offset some of that strength.

We are very focused on increasing our modernization and upgrades. This is the tire pressure, wireless tire pressure monitor, this is trying to get some success with our weight and balance, this is existing products off the shelf, in our fuel pump area.

And we're having some success and expect to continue to have some success there. So I think after market for the rest of the year will be a positive contributor for us.

Okay. Great. Thanks again.

Okay.

And it appears that we have no further questions at this time. Gentlemen, I would like to turn the conference back over to you for any additional or closing comments.

Thank you for your time, interest, and investment in Crane Co.

Thank you, operator.

Thank you. Once again, ladies and gentlemen, that concludes today's call. Thank you for your participation. You may disconnect at this time.