Crane Co (CR) 2007 Q1 法說會逐字稿

Good day, everyone, and welcome to the Crane Co. first quarter 2007 earnings analyst conference call. Today's call is being recorded.

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

Thank you, operator. Good morning, everyone. Welcome to Crane's first quarter 2007 earnings release conference call. I'm Dick Koch, Director of Investor Relations. 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 that 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 on 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 for the comparable GAAP numbers in the table at the end of our press release, which is available on our website at www.craneco.com in the investor relations section. Now, let me turn the call over to Eric.

Thank you, Dick. First quarter earnings per share increased 16% from $0.61 last year to $0.71, primarily because of the profit increases in Fluid Handling and Merchandising Systems. Our operating margin increased 50 basis points to 10.9%. Continued strong core backlog growth of 18% in Aerospace and 31% in Fluid Handling, coupled with our solid first quarter results, strengthened our belief that we will be at the higher end of the range of our full-year earnings per share estimate of $2.80 to $2.95.

Turning now to specific segment comments beginning with Aerospace and Electronics. Operating profit in the Aerospace and Electronics segment declined $1.4 million attributable to the performance of the Aerospace Group. In the Aerospace Group, strong OEM and after-market demand was offset by the $4.6 million increase in engineering expense and a supplier quality issue, which resulted in a recall. Our engineering spending, all of which is expense, is a key investment in Aerospace's future. Our engineering spending in the first quarter of 2007 of $15 million is expected to continue at that rate throughout most of the year. In 2007, we are spending heavily on three major landing solution programs.; the Boeing 787, the Joint Strike Fighter, and the Airbus A400 M. First production hardware delivery for the 787 will be in the third quarter of 2007, the Joint Strike Fighter will be in the fourth quarter of this year, and the A400 M will be in the third quarter of 2009.

We are also incurring significant engineering expenses for our wireless tire pressure system called Smart Stem. We have sales for this device on the Boeing 777 beginning in May of this year and are developing this application for Boeing 787. We also have a contract to develop this project with a business jet OEM. As these larger programs are completed we expect engineering expense to decline in 2008. As we noted in our press release, we had a recall of some pump connectors due to a soldering problem that our subcontractor encountered after the product had undergone initial certification testing. This had an impact in the quarter of reducing sales by $2.8 million and operating profit by $1.1 million. We are working with the subcontractor and our OEM customer to determine the root cause of the issue and are replacing the installed connectors on an accelerated basis.

Demand for our Aerospace products was strong in the quarter and is expected to remain strong for at least several more years and our goal is for operating profit margin to be 20%. In the Aerospace Group, OEM and after-market sales were higher than last year, excluding Resistoflex Aerospace, which was sold in May. The OEM after market mix was 65%, 35% compared with last year's first quarter mix of 61%, 39%. OEM sales grew 23% and the after market was strong, growing 7 % compared to the first quarter of 2006. The Electronics Group operating profit and margins were approximately the same as the first quarter of 2006 and performed on plan. We continue to build a solid foundation in Electronics, strengthening the management team, improving our new product introduction process, and better cost discipline. These improvements are being felt by our customers, as good order inflow resulted in the backlog being 9% higher than a year ago.

In Engineered Materials, sales and operating profit were 2% higher than the first quarter of 2006. Overall sales increased $1.8 million, with the increase due to Noble Composites. Excluding the Noble acquisition, our sales for the quarter declined 22% in recreational vehicles, 17% in transportation , and 4% in building products, reflecting general industry softness in those end markets. Good results from Noble, disciplined cost control and better standard work in the plants resulted in 18.3% operating profit margin, equal to last year. Our total sales in the RV industry actually increased by 19% as a result of the Noble Composites acquisition last fall. Noble had sales of nearly $13 million in the first quarter and operated near capacity. Yesterday, our board of directors authorized an expansion of Noble to add a second manufacturing line, which will double its capacity. The expansion should be complete in the second quarter of 2008.

Turning now to Merchandising Systems, we continue to be excited about the growth opportunities we see in Merchandising Systems and are pleased with the first quarter performance. Merchandising Systems turned in a solid quarter, with sales increasing 85% and operating profit increasing 153% to $9.6 million. The acquisitions we made in 2006 are performing well. The strategic synergies among both the vending and payment systems businesses are proving better than anticipated. Payment systems results were very strong, as both NRI and CashCode experienced strong demand in their traditional gaming and amusement markets, and very effectively leveraged the increase volume to operating profit. During the quarter we began several key strategic initiatives in payment systems for the vending market. NRI signed a long-term contract to provide coin validation with a major European vending operator. In the U.S, we introduced a new payment system called [Corenza], using 100% Crane bill and coin technology, and are selling it as a package with the vending machine.

The integration of automatic products into our St. Louis plant was completed as planned in the first quarter. Three new products were made available to the AP distribution channel to broaden the brand's product line. Dixie-Narco's operating loss during the quarter was reduced from fourth quarter levels in spite of very weak sales. We continue our efforts to become a valued supplier to the major beverage companies, with a focus on developing an enhanced performance fix to our glass front machines. Importantly, the improvements are completed for the Bev Max 2 and we are entering the testing key phase with several of the beverage companies. We remain confident that the Bev Max 2 Glass Front machine provides a superior value proposition to the operators. As planned, we continue to drive numerous cost and productivity-improvement programs. Employment today has been reduced 40% from a year ago to 600 people.

Fluid Handling, which represents about 42% of Crane's total sales, turned in a very solid quarter, with sales increasing 9%, operating profit growing 22%, and profit margin expanding to 11.8% compared to the 10.5% in the first quarter of 2006. Our core sales, which exclude the foreign currency effects in Fluid Handling, increased 8%, reflecting solid and broad-based demand from the chemical and pharmaceutical industry, energy, which includes power and oil and gas, and non-residential construction. Importantly, Fluid Handling orders remain strong and the backlog at the end of March was 31% above year-ago levels, excluding Westad, which was sold last year.

Fluid Handling is truly a global business where we expect to see strong demand for at least several more years. The profit and margin improvement we have seen over the past few years in Fluid Handling is the result of many types of initiatives, which include: Improved front-end processes; tighter working capital management; increased productivity; a reduced manufacturing footprint; and expanded low-cost country sourcing in places like China, Mexico, and Hungary. This year, we have aligned our sales and marketing organizations around key markets, which include chemical and pharmaceutical industries and energy. Our goal is to improve all aspects of our interactions with customers so they can feel the difference.

Turning to our second quarter guidance, we expect our earnings per share to be in the range of $0.74 to $0.82 versus $0.71 in the second quarter of 2006. While we are maintaining our 2007 earnings per share guidance of $2.80 to $2.95, we are more confident in achieving results toward the higher end of the range.

Now let me turn the call over to Bob Vipond, our Chief Financial

Thank you, Eric. The Company's tax rate was 32.5% for the quarter compared to 30.3% for the same quarter last year. The primary reason for the increase was a favorable resolution in the first quarter of 2006 of a Federal tax audit for our years 2003 and 2004. We continue to expect our annual tax rate will be about 32% for the totality of 2007.

Let me call your attention to the non-GAAP financial table, which accompanied our press release. Cash provided from operating activities before expenses-related payments was 15 -- at 15.7 was $10.6 million lower than 2006. This was driven primarily by higher tax payments of $15 million and an up-front lease payment of $11 million for a seven-year-old plane, which we have leased to replace our previous aircraft, which was 15 years old. The up-front lease payment was roughly offset by proceeds from the sale of the old plane. which is shown on the cash flow statement as proceeds from disposition of capital assets. The primary variance from last year's asbestos-related payment was because of Equitas. In January, 2007, we received a $31.5 million insurance settlement payment from Equitas. which has been in escrow since we reached agreement with them in 19 -- in 2005. Capital spending was lower in the first quarter of 2007 than 2006, but we expect it will pick up as a result of the Noble Composites expansion we just talked about. For 2007, we continue to expect free cash flow will increase to the range of $175 million to $190 million compared to $154 million in 2006.

Turning now to some changes in our guidance in the future. I want to highlight several changes we will be making in our investor relations program in 2008. Total year EPS and free cash flow guidance for the entire Company will be provided in conjunction with the fourth quarter earnings release in January 2008. We will maintain our practice of giving business segment sales and operating profit guidance once a year at our annual investor conference, which will be moved from December each year to February in order to better focus on our total year results. Also, beginning in January of 2008, we will discontinue providing quarterly EPS guidance. This decision is consistent with the recent recommendations of the U.S. Chamber of Commas -- Commerce and reflects our desire to focus our investors' attention on annual results. 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, back to you, Dick.

Thank you, Bob. This marks the end of our prepared comments. Operator, we are now ready to take questions.

Thank you. (OPERATOR INSTRUCTIONS) We'll go first to Deane Dray of Goldman Sachs.

Thank you, good morning.

Good morning.

I was hoping, Bob, you could take us through in terms of the margin hit in Aerospace -- and it's very clear that you're making an investment on the R&D side -- if you could size for us the R&D impact, as well as what that mix issue? The good news is you've had more of an OE mix, but that's coming at lower margins I would presume, so if you could size for us what the -- how that margin shortfall reconciles between higher R&D versus the mix?

Well, as Eric said, our engineering spending was higher by $4.6 million, Deane, so we are trying to make sure -- and that's really an important investment in our future as we expense all of our engineering development costs that aren't specifically covered by government or by the customers, which isn't much in the OEM market. And as Eric articulated, the OEM content was higher than it was a year ago, so there was a bit of a mix impact on our business with the after market being lower. There was some pressure on us there, but the real story was our higher investment in engineering expenses.

And I'm not sure if you said this, or if you did I apologize. What was the impact of the recall on the quarter and what might it be for next quarter?

It was $2.8 million in reduced sales. We reversed some sales we'd previously made and the OP impact of that was $1.1 million. And we don't expect -- back to one-time events, we feel, Deane , we're retrofitting everything and we don't expect that there's -- we're working with the vendor to replace the products that were out there and -- though, in fact, they may come back as sales as we get this thing

How does this compare? You had a pump recall several years ago that seemed to be handled very well and you put the issue behind you pretty quickly. How does this recall compare to that one?

I don't have the particulars, Deane. I think that we're doing all the right things that we need to do to manage this and I'm comfortable that we're on top of it.

Good. And then if I could just ask a couple questions on the Fluid Handling side. That core growth sales of 8% is exceptionally strong, and one of the things that struck me is, when you talked about your backlog being up as high as it is, valves and pumps tend to be a little bit more shorter cycle, so I'm impressed that you have that kind of visibility. So how do you have a backlog as high in pumps and valves, and then what gives you the confidence to talk about a growth expectation over the next couple of years?

Again, I think we have a global business here geared towards the process industries. And I'm actually going to the Middle East on Sunday for a week, and the demands that we're seeing from the global process industry is what's clearly driving those orders. I would reiterate that I think that you could probably even make it look better if we didn't have the price discipline that we've got in terms of making sure that we only take on the projects that -- where we're going to get a satisfactory margin. And finally, I think you're starting to see accumulation you saw us in and you saw us leverage that demand very effectively. And again, it's a the accumulation of all the positive steps that we've taken in the past.

And then on Merchandising, do you have a sense of how sustainable these higher single-digit operating margins are going to be?

Well we don't give intra-year guidance, as you know, on the segments. I would only say that we've been very pleased with our payment systems in the aggregate. They've performed exceptionally well. I think we should continue to see -- we continue to see reasonable demand there. We did see our core vending business in North America was up slightly in the first quarter,a but frankly, I don't read too much into that. There was some unusual orders there. I would say that we do -- you have to have some concern here on vending because the two big components of cost for the operators are food prices, which are going up pretty dramatically here -- food and beverage prices are to them and their pricing lags, and gas prices. But overall, we're -- as I said in my remarks, Deane, you should look at the overall performance in Merchandising Systems which was, I think, very solid and we're looking for continued solid growth there.

Okay, thank you.

Thank you. We'll go next to Scott Graham of Bear, Stearns.

Yes, good morning. I've got a couple of questions on the Fluid Handling business and the Aerospace business in terms of the previous question about backlogs and what have you. It looks to me like valves has kicked up into a higher growth level over the last couple of quarters in sort of -- in sort of low to mid-teen levels. Given the backlog as strong as it is, is that a number that we can see for the rest of the year, Eric?

I'm not going to comment on that. We've got an excellent backlog and a strong price discipline. We've been consistent that the overall segment goal is to get to 12%. We've got to 11.8%. We are spending a lot of money to move towards this more integrated operating Company, where we go from six valve companies to two. That's going to continue. But with this global demand and the improved intellectual capital and customer focus that we've got, we feel very confident about Fluid Handling moving forward.

With respect to Merchandising, that's a business that also really flipped around and even though the comparison -- the sales comparison are really going to be easy now for awhile, nevertheless, up is up, I'm wondering if this -- have we maybe here as well like my question on valves, have we crossed the plain here in Merchandising where maybe the worst in the end market is behind us and then maybe we're starting to see operating leverage help the margin? And then my second question on that business is on the other hand, it looks like Dixie-Narco sales were substantially down year over year and maybe you could explain that?

Let's start with the last. Dixie-Narco's sales were substantially down, and the reason is is because we have the lack of glass front sales [inaudible] to major business companies. And as I said in my prepared remarks, we are starting to move into the testing phase with several of them. We've fixed any and all quality issues there, and we think that after several months of testing, we'll hopefully resume a normal relationship. I think that -- but Dixie sales were definitely weak because of that. In terms of vending, we are -- there's huge opportunities in vending. We continue to exploit it, but I do not see any -- a real change in the overall market because of the economic factors that I mentioned. I feel that the performance of this segment does not represent a turnaround. The payment systems business has and continues to perform exceptionally well. These were, the business that we bought, and in particular, CashCode was high growth, high margin, and we're now combining now with NRI, the same kind of characteristics with our traditional NRI business, which are doing -- really performing extremely well. And I expect a lot of that demand to continue, particularly if we -- with the new strategic initiatives we've got for vending, so that's how I would answer your three questions.

That's fine. Last question relates to expenses overall. And it's a couple of questions within it. The Aerospace, from what I understand, from what I gleaned from your comments, Eric, this $4.5 million, $5 million incremental expense, this is a number that we should see continue is what I thought I heard you say? Additionally, the RV production issues with the [luwan] and the lamination, could you update us on that as well?

Well, as I said, we expect -- we've got program deadlines to meet, some that the 787 comply and the JFS, so we are -- expect to continue a heavy level of engineering expense throughout most of the remainder of this year. We do expect a pretty sharp falloff into -- as we start to move into '08 on engineering, as we get over this bulge of these very big programs. What was the second question?

The RV business, the luwan --?

Our expectation for product support remains exactly as it was at the beginning of the year, where we expect it to mitigate from prior-year level.

So it's coming down?

That's what that means.

Right. Eric, if I may, I'm sorry, just back on the Aerospace thing.

Yes.

You guys went into pretty exhaustive details during your analyst meeting and actually laid out for us where research and development engineering costs, where you expect that they were going, And this is -- it appears to me to be another step up and I'm was just wondering, did this number take you by surprise and why was this not maybe talked about more in December?

This is a higher number than the $52 million that we gave you in December. This is a number that caught me by surprise as of about three weeks ago, and it was accumulation of several months of work to -- we knew we were going to run over, Scott, but we did not expect it to be of this large. And so when we fully vetted out the programs and what it was going to take -- some of these were primary programs, which require substantial interface between Boeing, Smith, et cetera -- we came out, we realized that we had a higher number and we needed to talk about it.

Will this number come down substantially in 08?

Yes.

Thank you.

Thank you. We'll go next to Ian Fleisher of Friedman, Billings, Ramsey.

Hi, good morning.

Morning.

Could you touch on the oil & gas market, both domestically and overseas?

I would say no big changes either way. And there's people more qualified to talk about that than me, frankly. You know, our energy business has been orders in power and orders in our [inaudible] American business has been just fine, and I don't see any issues there.

And the strength you note in the Fluid Handling segment with respect to commercial applications, are you speaking specifically to non-residential construction or something more broad?

No, our non-residential -- our UK business in the commercial valves has been quite strong. Our U.S. business and commercial valves has been quite strong. And not just in non-residential construction, but as you start to move into ethanol, ethanol demand's obviously have been very strong and some of the power [inaudible].

Okay, can you --on your income statement, you you had $1.8 million in other income. What specifically was that?

It's primarily -- the other income -- let me go to that. Miscellaneous net, it has a number of different things in it, but included in there was a gain on the sale of our used aircraft and we also have in there the income from the joint venture we have with [Furgason] and there's a number of other little things. But overall, those things ended up being up about 550 compared to the first quarter of last year.

Right, and just one final question. In Merchandising Systems, can you touch on Dixie-Narco, where it is profitability wise?

For competitive reasons and protect our customer base, we're just not going to give specific profit guidance other than to say we continue to lose money in Dixie-Narco.

Okay, great. Thank you.

Thank you. We'll go next to Shannon O'Callaghan of Lehman Brothers.

Good morning, guys.

Morning.

Just a question on some of the Engineered Materials markets. I guess not surprising in terms of RV and trailer, but building products I think you said was down as well. What's going on there? I think you had a more favorable outlook for the year. Is that a first quarter issue or --?

I think we -- of the three markets, RV's, transportation, and building materials, we expected the RV to be down and it's pretty much in line with what we had planned for the year. The surprise came to us and the industry in trailers, where at the beginning of the year, the industry association -- and we thought though, too. We could see 2% to 4% increase in trailers as they stopped buying the tractors. And in fact, the industry's now talking about the industry was down something like 30% in the first quarter. So that's a surprise, both to us and to the industry. And then we expected building materials to be up slightly 3% to 5% and it's actually down -- I think it went down 4%. And we've mitigated this because of the really strong performance in Noble and that new table glass panel and how it's being received in the market. We've been very disciplined in terms of cost controls and manning, so I think maintaining the 18.3% margins there in the quarter was some good work by the team.

Yes, I agree. I think putting up that margin with those kind of declines is impressive. I guess I'm just wondering also on that, when you answered earlier in terms of the customer support cost mitigating, was that a comment on some that's already mitigated in the first quarter or do you expect it to go down further from here?

It was actually a little bit higher in the first quarter, but we;re looking at it over the course of the whole year and clearly that's going to help margins it didn't help in the first quarter.

So the first quarter is basically stronger Noble or what would you -- ?

Again, I think we've frozen hiring. We've aggressively managed direct labor. We've taken out indirect. We've done very good disciplined job in pricing versus our material costs and good sourcing initiatives. This is -- the standard work in the plants on these machines is better than it's been in a long time.

Okay. One more follow-up on vending. You mentioned -- and don't read too much into it in some of the challenges in vending -- can you just comment a little more on the unusual orders you mentioned? I mean I know you can't give a lot of detail but -- on what they were, but why do you think they were unusual?

No, we're just seeing very strong demand from non-U.S. gaming customers, particularly in Eastern Europe and Russia. We expect that to continue for a while, we just don't -- it's hard to -- with all of the changes in regulation, we're not sure how long that's going to continue in payment systems. I think in Vending, we saw a big customer come in here and order some volume prior to a price increase, which helped, here in North American so I don't want to read too much into that. But we actually know that that customer has more capital to spend this year than they did last year. So just hard to say at this point.

Okay. Thanks a lot, guys.

Thank you. We'll go next to Ronald Epstein of Merrill Lynch.

Yes, hey. Good morning, how are you?

Good morning.

Just got a couple questions. Just back to Aerospace for a moment. So when I think about Aerospace, were they still going to be able to achieve 20% margins, now that the R&D higher?

That 20% margins is our goal for the Aerospace Group business.

Okay, so for the year, so that hasn't changed.

Not at all.

And then what R&D should we expect for the year?

Well we're not giving the specific number on that, Ron, but it is going to be in excess of the 52 million that we gave guidance on. I expect it to be offset in part by stronger demand than what we M planned, both OEM and after market, and that's the way we're managing the business.

Okay, okay. And then -- you haven't really talked about this too much -- Eric, when you look at the M&A pipeline, what do you see?

Well, that's a good question. I think we didn't see much towards the end of last year other than vending, and we didn't see much early this year. Recently I would say we have a more robust pipeline than we've had, but it's all at very early preliminary stages.

How are evaluations out there?

High.

Yes.

No change. The only difference we see is a beginning bifurcation of larger companies versus small companies and their ability to leverage and sell the syndicated loans, so we are seeing smaller acquisitions at more reasonable valuations than the larger ones.

Okay.

In spite of the ability to syndicate -- sell off all the debt.

Okay, okay. And then just one follow on here. You guys purchased a lot of shares in the quarter, almost two-thirds of what you did all of last year.

Right.

So when I think about the rest of 2007, are you guys going to keep chugging along at that pace or how should we think about the share count at end of year or share buyback here?

Well, unfortunately, I'm not going to be of much help here. We don't pre-announce our intentions to buy stock.

Okay.

We do it and then we adjust. We felt strongly at the end of the year that we didn't have a big acquisition pipeline, and we felt strongly that our stock represented a really attractive investment. And you were all at our investor conference and we said we were going to invest in Crane. We said we're going to invest in engineering, we're going to invest in CapEx, we're going to invest heavy new products. And frankly, this was just another way to show our confidence in Crane's future. As that acquisition pipeline moves around, and as we look at our cash flow and alternatives, we'll adjust this back and fourth, so I don't want to give you any guidelines for it.

Okay, that's great. Thanks.

(OPERATOR INSTRUCTIONS) We'll go next to Matt Summerville of KeyBanc.

Most of my questions have been answered, just a couple things. Eric, can you comment as as you look at the Company overall what you're seeing in terms of price realizations '07 versus '06? And then can you comment a little more specifically on what you're seeing in your Fluid business in terms of pricing?

I'm seeing price discipline across the Company. I'm seeing people more focused on this. We have a project here we call Value Stream Linkage and one of the first steps in the 11-step gate is to review the business model and the pricing by SKU. If you look at our 5% core growth, about 2% of that's price. 3% was volume overall, so I'm seeing pretty good price discipline and an ability to maintain that discipline and covering the material costs.

Are you seeing higher price realizations in Fluid than the corporate average of 2%?

No.

Okay.

Therefore, demand -- volume growth there was very strong in '06, right?

Right. Okay, and then with respect to your CapEx budget, it's up pretty significantly from last year. Can you talk about any big projects that are in there?

Again, we are spending more on new products than we've ever spent, and if you take that and overlay the costs of this Noble expansion, to double their capacity, that's how you start to get to the $40 million, $45 million level.

Okay, that's all I had. Thank you.

Thank you.

Thank you. And with no further questions I'd like to turn the conference back over to Mr. Richard Koch for any additional or closing remarks.

Thank you very much for joining today and for your continued investment in Crane Co. Bye, now.

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