Crane Co (CR) 2010 Q3 法說會逐字稿

Welcome to Crane third quarter 2010 earnings 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, Richard Koch. Please go ahead, sir.

Thank you, Operator. Good morning, everyone. Welcome to Crane's third quarter 2010 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, Andrew Krawitt, our Principal Financial Officer, and Richard Maue, our Principal Accounting Officer. 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 reconcilable 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. Before turning the microphone to Eric, I would like you to invite you to attend our annual investor day conference held on Thursday, February 17 in New York City. Please mark your calendars. Now, let me turn the call over to Eric.

Thank you, Dick. I'm very pleased with our third quarter. Revenues on a year-over-year basis have increased for two consecutive quarters. Core growth was 4%, a significant improvement from 1% in the second quarter and an 8% decline in the first quarter. We believe the aerospace market is emerging from its downturn and expect aerospace sales to increase moderately in the fourth quarter and provide solid growth for the next several years. In addition, we are forecasting a strong fourth quarter for electronics which has a solid backlog position.

Fluid handling sales have stabilized over the past couple quarters with evidence of bottoming out and we expect to see growth as we move into 2011 supported by a healthy backlog and an increase in project quote activity. Earlier this year we noted that some of our short cycle businesses have already rebounded and now we are seeing signs that our longer cycle businesses are returning. We are encouraged by our most recent results and believe we have solid momentum going into 2011.

As we noted in our press release last night, our strong year to date performance and our forecast for continued strength in the fourth quarter have allowed us to raise our 2010 earnings guidance. As I have noted on earlier calls, our strategy this year and last has been to utilize our substantial cash balance and liquidity position to fund key initiatives to accelerate growth as market demand returns. We have focused on developing new products, enhancing sales, marketing and engineering capabilities and continuously driving process improvement across the Company. We have, at the same time, started to leverage volume off a lower cost base as we continue to be relentless in our focus in our customer facing metrics such as lead time and on time delivery. We have taken market share and key markets as a result of our decision to stay on the offense through the downturn and we expect further gains as the economy recovers.

As we approach 2011 we are expanding these initiatives to further drive profitable growth. We are utilizing our operational excellence tools to enhance the capabilities and effectiveness of our sales and marketing activities as we deepen our knowledge of ever changing customer needs and end market verticals. We are identifying key productivity initiatives to drive improvement and material and other costs and we are focused on maintaining our disciplined approach to pricing based not only on passenger increased material costs but also on the overall value proposition we offer our customers. These initiatives, coupled with an eventual return of revenues to the $2.6 billion levels of 2007 and 2008, should allow us to increase our operating margin to 13% well above our previous peek of 11%.

I see the late cycle characteristics of many of our businesses as an advantage because it means that the best is yet to come and our fluid handling in aerospace businesses. Throughout this downturn we have significantly strengthened the Company and built a strong foundation for future growth. With our second and third quarter margins already near our previous peak levels, the progress we have made is evident. We are executing well, confident in our outlook and tracking to our 13% market goal more quickly than originally expected. Andrew will now take you through the businesses and provide some additional financial information.

Thank you, Eric. I will turn now to segment comments which compare the third quarter of 2010 to 2009. Aerospace and electronics sales increased 5% to $143 million while operating profit increased 27% to $25 million in the third quarter of 2010. Aerospace sales increased $5 million or 7% during the quarter. This marks the first time in eight quarters that aerospace sales have increased on a year-over-year basis, excluding $19 million associated with the Boeing agreement in the fourth quarter of 2009.

OEM sales increased 13%, while after markets sales declined 2%. It is important to note that as a matter of practice we include modernization and upgrade sales when reporting aftermarket sales. Sales related to the more traditional aftermarket of spares, repair and overhaul increased a strong 9% in the quarter. The OEM aftermarket mix was 60% to 40% in the third quarter of 2010.

Operating profit in aerospace increased by $8 million, primarily as a result of higher sales and a $4 million decline in engineering expense as several major development programs, including the 787, joint strike fighter and A400M programs near completion. In the third quarter of 2010 aerospace engineering spending was $11 million, equal to first and second quarter 2010 spending of $11 million and below third quarter 2009 spending of $15 million. We remain on track to achieve our previously announced target of a $20 million reduction of engineering spending in 2010 compared to our 2009 spending of $66 million, even as we continue to invest in new programs.

Aerospace sales continue to be stronger than anticipated and we are now forecasting full year sales in the $340 million range, well ahead of our investor -- our February investor day guidance $315 million and comparable to full year sales in 2009, once again excluding the $19 million Boeing agreement. Commercial aerospace trends continue to be favorable with airline fuel costs at moderate levels, flight frequency and capacity up around 6% each and load factors above 80% in July and August. We are optimistic about the balance of the year and prospects for 2011 for our aerospace group.

Electronics group sales in the third quarter increased $1.1 million or 2%. Year to date through September our electronic groups sales were $166 million and we forecast that our full year sales will approach the $240 million range we provided at our February investor day. Clearly, we expect a strong fourth quarter as new products begin ramping up production. Like much of the industry, we are experiencing some component shortages which are modestly impacting our revenue.

Electronics operating profit declined $2.7 million compared to the third quarter of 2009 reflecting the absence of profits from General Technology Corporation as well as higher costs associated with products moving from development to production. Overall operating profit margin percentage, while lower, remained in the teens. We have a strong backlog in the electronics group which will provide a good start to 2011. Since we are focused on the intelligence surveillance and recognizance space within the defense budget we expect our business to grow despite worries in overall reductions in defense spending.

Engineer material sales increased 14% during the third quarter as our demand for RV and transportation related application remained strong. Sales to the RV industry in the third quarter grew 25% despite the end of dealer restocking and more difficult comparisons versus the third quarter of 2009. RV OEMs are now reducing their build rates and adjusting their inventories for the seasonally slower fall and winter. Transportation related sales increased 14% compared to the third quarter of 2009 as a result of continued higher industry build rates for dry vans and refrigerated trucks. We are continuing the commercialization of [Armour Tough NXT], our new longer fiber reinforced panel for use in transportation applications and are pleased with its acceptance by the market. Building product sales were flat versus the prior year.

Operating margins in the third quarter were 14.5% compared to 15.7% in the third quarter of 2009, reflecting cost pressures across all major raw material classes. As a result, operating profit increased 6%. At this point we do not see materials price pressures abating and, therefore, are implementing price increases across all markets to be in affect around -- to take affect in the beginning of the year.

We are pleased with our quality and on-time delivery metrics and given our year-to-date performance expect to substantially exceed our February investor day guidance. Overall, merchandising system sales of $77 million increased 2% versus the third quarter of 2009. The sales increase was primarily in vending solutions.

Merchandising systems operating profit of $6.3 million declined 9%, operating margins decreased 100 basis points to 8.1% as a result of the absence of the favorable impact of a legal settlement and the reduction of a liability estimate associated with our restructuring program both of which occurred in 2009. Excluding the impact of these one-time items, operating profits and margins improved versus the prior year. The consolidation of our St. Louis vending facility into our Williston, South Carolina plant is largely complete and we are seeing the related productivity improvements. We continue to drive operating efficiencies from numerous operational excellence initiatives. Our customer metrics, including on-time delivery, lead time, quality and costs have continued to improve in the quarter and we are encouraged by our manufacturing process improvements.

As I mentioned on our second quarter conference call, our view of merchandising systems for the full year remains consistent with what we communicated at our February investor day. Our sales will be about the same as 2009 with higher vending sales approximately offsetting lower payment solutions sales. Operating profit will benefit from reduced manufacturing costs, somewhat offset by an unfavorable mix between vending and payment solutions. Food handling sales declined 4% to $256 million in the third quarter with a core sales decline of 1.8% and an unfavorable foreign currency impact of 2.4%. Food handling operating profit of $33.2 million was 5% lower than the prior year as a result of lower sales. Importantly, operating margins were 13% versus 13.1% in 2009 reflecting solid cost controls. Because we are experiencing some raw material cost pressures including steel, iron and copper, we are selectively increasing prices to maintain margins.

Our third quarter core sales decline of only 1.8% was the smallest decline experienced in six quarters. MRO business remained sales slightly higher while project activity was softer than expected. (inaudible) activity is increasing though and we expect revenue growth to return in the fourth quarter despite some currency headwinds. We are comfortable with our fluid handling backlog of $267 million and believe that in general markets are stabilizing and will gradually improve as we head into 2011. We are seeing an improved sales opportunities including several larger projects that could favorably impact in 2011. In addition, some recent wins in emerging markets have validated our strategy of leveraging our global sales force to provide a bundled solution to our customers. We will continue to leverage Crane's name recognition as a global player as we drive for growth and market share around the world.

In summarizing our overall Company results in the third quarter, we achieved year-over-year margin improve and profit growth by leveraging increased volume while maintaining our lower cost base. Core sales growth of 4% is evidence of our end markets recovering and our success in gaining market share. Certain raw material input costs are beginning to increase again and we are maintaining our disciplined approach to pricing. Encouragingly our longer cycled businesses are beginning to recover and have strong backlogs [arguing] well for 2011 and beyond.

Free cash flow for the third quarter 2010 was negative $9.8 million and included the effect of a previously disclosed $25 million discretionary pension contribution as well as higher working capital needs to support improving sales trends. This compares to $76.2 million in the prior year. We anticipated our third quarter cash flow would be impacted by higher working capital needs and continue to estimate that our 2010 free cash flow will be in the $100 million to $115 million range. While our lower year to date capital year spending is partially timing related, we are reducing our full-year capital spending estimate from a $30 million to $35 million to a $25 million to $30 million range. On a year to date basis free cash flow is $46 million and we expect strong free cash flow in the fourth quarter consistent with our experience in past years.

During the third quarter of 2010 the Company repurchased around 568,000 shares of its common stock for approximately $20 million in accordance with our practice of managing dilution related to our stock incentive plans. Our policy is not to pre-announce these purchases, tut to report them at the close of the quarter. Over the past three months the expected currency pressures that I discussed on our July conference call have abated somewhat. From a currency translation perspective to the first nine months of 2010 for Crane overall we had a favorable impact on our sales of approximately $13 million with our food handling segment representing $11 million of that tailwind. We continue to expect some headwinds in the fourth quarter, but on a full year business we expect a negligible overall impact. We had a currency tailwind of about $0.02 per share in the first nine months of the year and are estimating a headwind of $0.02 per share in the fourth quarter mostly related to our fluid handling segment given its geographic diversity.

This revised FX impact is included in our recently increased EPS guidance of $2.50 to $2.60. Our guidance also includes a $0.05 per share benefit in the fourth quarter from the expected reinstatement of the US R&D tax credit. This assumed benefit is not new. It has been included in our guidance throughout the year. On a year to date basis our tax rate was 29.5%. If the R&D tax credit is reinstated, we expect to maintain this rate on a full year basis or potentially even be a bit lower. If the R&D tax credit is not reinstated, we would expect our tax rate to be slightly above 30%. Our balance sheet remains strong and we ended the quarter with $316 million in cash. We also have access to our $300 million revolving credit facility and we have no significant debt maturing in the near term as half of our long-term debt of $400 million is due in 2013 and the other half is due in 2036. Now back to you, Dick.

Thank you, Eric and Andrew. This marks the end of our prepared comments. Operator, we are ready to take questions.

(Operator Instructions) Our first question from Deane Dray with Citi Investment.

Good morning, everyone. I was hoping to get a sense of how much of the raw material costs headwind impacted margins and fluid handling. It looked like you absorbed that but it didn't sound like you got a lot of price this quarter.

Deane, we again felt the impact of the rising impact costs in the third quarter. It was primarily in headwind and fluid handling, as you mentioned. We do expect this pressure to continue in the fourth quarter. Importantly, though, we have initiated actions across our businesses to increase prices so we are well positioned as we move into 2011. We expect those price increases to be in affect by the first quarter of 2011.

But the price increases won't be materially impacting the fourth quarter, is that correct?

We moved in some of the commercial fluid handling businesses already, Deane. We have incorporated material costs in the guidance that we give and, as you saw, we held margin in fluid handling to 13% so we are clearly dealing satisfactorily with the material costs as they are.

The commentary on fluid handling, I was interested in hearing that you expand on the point on quote activity being up and there is a potential project that could be a swing factor in 2011. What can you share with us about those?

Let's step back for a second. We have two very long, very late cycle businesses that together represent well over 15% of our Company's volume, commercial airspace which has clearly turned in the quarter. We have year-over-year sales increase, improving backlog. Clearly turned and I would say in a more positive way than I was on the second quarter because I said we were cautiously optimistic where I would say now with spares and OEM both up substantially in the quarter and backlog up, we are good to go there.

Now in fluid handling, particularly the process valves which are the largest piece of fluid handling business, is a long cycle business. We have seen a dramatic decline in the deceleration of our sales. We went -- I think we mentioned, we went core sales and fluid handling went from a decline of 13% in the first quarter, 4% in the second quarter and they were only down roughly 1.8% in the third quarter. Even with those declines and material increases we have been able to maintain margins. What we are seeing and have been seeing is on the day to day MRO activity which we track globally by product line, we are seeing steady and increasing orders from our MRO which are encouraging. We have seen more spotty projects in terms of what orders we have actually taken but as we look at the radar screen of project opportunities, it is rich with projects that we are chasing that are -- there is a lot of them. They are of pretty good size and the issue is capturing when they actually get left as we go forward. Our judgment is you have got to stabilize a late cycle business year where the day-to-day business is improving and we will start to see increased project activity and order capture as we move into the fourth quarter and into 2011.

On the aerospace size, the electronic, the comment about component shortage, and this came up last quarter for a number of other businesses, how much of an issue is this on what you were able to ship and is there some backlog that once these components are located, we will see those come through in the fourth quarter?

They are a relatively minor impact, Deane.

It is an industry issue, Deane, it's not our issue.

I'm aware of that. Just wanted to get a sense where that stood, but you said it is minor.

It is irritating and disruptive and we would like not to have it but we are managing through it.

Got it. On the aftermarket on the aerospace we have seen a recoupling of the global flying hours and utilizations back with, as you said, the basic MRO volumes, but what declined on the other side in your aftermarket?

That's a good question. We tried to clarify that. As you saw, I think our overall aftermarket was down 2% in the quarter but we tried to clarify in the script aftermarket is a combination of spares, repair and overhaul and what we call M and U, modernization and upgrade programs. What happened is we finished off some big modernization programs and so the overall aftermarket defined that way is down. Now the industry typically defines aftermarket as spares and R and O and that was up 9%. I want to be careful here because we just landed this quarter some very nice M and U business which is going to drive the M and U component up. One of the reasons we are constructive positive on aerospace is not only were spares and R and O up but now we have got some very nice orders in our M and U business which tends to be -- it's a much more spotty business. You get an award, you work it. We just happened to hit a GAAP in the quarter. Some nice orders and retrofit business.

Great. Last question for me on the decision to reduce the CapEx. What projects got pushed out or you decided not to pursue?

We can't spend it fast enough. We are not in any specific projects. We have the cash. We are aggressively spending on our growth investments. Frankly, a lot of those are in the P&L, new product development. Nothing -- it is just coming in a little bit less than we thought due to delays in getting the equipment, et cetera.

Thank you

Yes.

Our next question comes from [Ben Loper] with FBR Capital Markets. Ben, go ahead with your question. Could you trying pressing your mute button possibly? Our next question comes from Paul Mammola with Sidoti & Company.

Hi. Good morning, everyone. If I could take you back to fluid handling. Can you give us a send sense of how end markets performed in the quarter in terms of oil and power, chem pharma and mining and water?

No discernible difference really from a second quarter except that I would say overall MRO is a little bit better which is encouraging, but we see the chemical industry, MRO and projects globally clearly better improving and continue to improve. The global power business is strong in the Middle East and Asia but continues to be very weak here in the US and refineries are just kind of -- have been mixed. I would say -- I think that's the way I would characterize the end markets with again improving MRO activity.

Okay. That's helpful. I'm curious on the project side of things, it is good to hear some stuff is coming back but is it at a lower price, would you say, than what you have seen over the past 12 months?

I wouldn't say that. Based on the -- I would just say that we continue to be disciplined in terms of our pricing. I think we continue to be willing to lose projects if we can't make the kind of return that we expect on it. Projects are again more competitive than our MRO business. Based on everything I can see, we are winning our share and then some.

Okay. Finally, SG&A, your ability to manage operating costs has been impressive. As we look to 2011, have you budgeted to the extent that you can you tell us how much operating expenses are expected to move up if we assume sales were to be flat?

First off, I don't assume -- sales will not be flat next year. I can go through by market if you want but we expect sales up next year. We have the costs out so understand that the $40 million of restructuring costs are out and they are going to stay out. The engineering costs, $45 million are out and they will stay out. The other cost that we took out come from a cost conscious culture which we continue through the company. I'm very comfortable on the job -- we have done a great job and I'm very comfortable on the management teams and their focus here. I would add that we will have some headwinds next year, salary increases, ERP systems. I think we already have controls in place on healthcare. We will be driving a whole you new set of programs and productivity initiatives to make sure that we get superior leverage on the sales -- organic sales increase when it comes next year and it's going to come.

Sorry if I was unclear. I don't think anyone expects for sales to be flat. I was trying to capture how much you though incentive compensation, maybe healthcare costs or added engineering costs would be up next year, again if sales were flat. There is nothing I can grab in terms of percentage increase for the items you mentioned?

Well, first off, I just got the preliminary plans in yesterday. I think it is a little premature. The way I'm thinking about it is I expect overall engineering even with the sales increase to be down a bit. I expect SG&A as a percent of sales to continue to decline here, no question about it. Remember, we maintained our sales and marketing resources all through the downturn. It is not like I have to add to it. Now I have some increases and bonuses related to the higher sales, but we maintained our investment here through the downturn.

Okay. Thanks for your time, Eric.

Our next question with Matt Summerville from KeyBanc.

Good morning. A couple questions. First, I want to spend a minute on aerospace. I want to make sure I'm doing my math properly. I think maybe it was Andrew that remarked the aerospace group should do something in the range of $340 million in revenue this year, the electronics group I think the number was $240 million which gives you $580 for the full year. That implies again, unless I'm doing my math wrong, a substantial sequential uptick in the aerospace and electronic segment revenue. Am I thinking about that properly, you are going to have that big of an increase in Q4?

It is going to be approaching that. You have a year-over-year sales increase in our commercial aerospace business in the third quarter and we have a better backlog and some M and U work, we feel good going into the fourth quarter. Electronics we are all booked. So the issue is our new programs that we got that have been in engineering that are getting ready to start to hit the floor that are getting through cast and qualification and making them for the first time and seeing if we can't get those out the door. It is not a matter of bookings. It is a matter of what can we get out the door. In electronics, it is a lot. I don't expect to get it all out. If it spills over in the first quarter, that is fine with me. We expect both groups to be strong both in terms of sales, profitability and margins.

So then as we sort of frame up in our heads next year, I guess, Eric, are you seeing will the electronics backlog flush be significant enough, did it weigh on segment organic growth next year? Is there any reason arrow pace and electronics can't grow high single to low double for Crane next year?

I'm not going to comment on the specific percentage, but I expect both commercial -- remember something, first off, commercial aerospace is a up. We are good to go. The whole industry is a late long cycle business. You can't find a single trend that doesn't suggest for the next three -- two or three years commercial aerospace is not going to be good. Secondly, in commercial aerospace all our big development spending is behind us. We are taking all that cost which were engineering costs now instead of being an expense is now going to be incremental revenue from the 787, A400M, LGCIU on the 320. We feel strongly about our commercial airspace business and its prospects and growth rates better than the industry because of the size of our new program. In our defense electronics business, remember a third of it is commercial aerospace. So we start out with a third of it in good space. The other two-thirds is tied to IS&R which is intelligence, surveillance and recognizance. Our backlogs are up. Our order trends are pretty good. We feel we can increase orders and sales in that segment also. We are looking for both to contribute and it's not going to just all get flushed out in the fourth quarter.

Okay and then one followup on fluid handling and engineering materials for that matter just on the raws versus pricing issue. Are you seeing other players in the market, your competitors also coming out with similar price increases or is Crane sort of leading that trend would you say?

We are the leader in the marketplace. We lead in terms of quality, on-time delivery, metrics, we lead in new products, we lead in the scale. We are the guys who have to lead the price increase. They always are late to follow and they always ankle bite. Trying to pick us off but we are going to be disciplined about it because our value proposition in terms of quality and delivery is powerful here and important.

Last question, Eric, would you anticipate in Q4 fluid handling backlog to continue to see this stuff function uptick like we have seen now three or so quarters?

It has gone up for three quarters. I'm expecting a good quarter from fluid handling, both sales and orders.

Great. Thanks, Eric.

Our next question comes from Ron Epstein with Banc of America.

Good morning. A while ago you guys set out to target of 13% for margins. How are we tracking towards that and when do you think maybe we can get there?

Here is the way we think about it at Crane. The current revenue levels we are running at about 11% operating margins which is our previous peak. When we look -- secondly, we feel that over half the revenues are late long cycle which haven't even started to kick in terms of growth. Thirdly, when we look at our capacity, we feel good that our physical floor space plan is about right but we are actually only operating at 50% of our capacity because we are running most of the plants at one shift versus two and two and a half shifts. So the opportunity here as our late long cycle businesses come in with some revenue growth and with the opportunity in terms of that capacity we are only adding primarily direct labor to it as we have an unusual and unique special opportunity to leverage that volume and our job as a management team is to make sure we take advantage of this opportunity. We are very confident about the 13%. We think it is conservative. I think when we hit it depends all on the rate of organic sales growth that we can generate. We haven't pointed to a year but if sales growth 6% or grow 9%, you hit it in 2012. If they grow 6% you hit it in 2013. You can do the math as well as I can. The key is just a matter of time. We feel very confident about that opportunity and we think it starts to put us in a very different position about how people look at our portfolio as a business.

How about M&A? You haven't talked too much about that. I know that is something we talked about in the past. What is going on out there? Is there anything interesting?

Well, we have nothing to show for it. There is some pretty size increase in market activity. There is certainly an increase in our activity, although nothing to show for it. I would say seller prices are going up, or at least their expectations are, but there continues to be kind of a divergence between what people pay and what people want to get. Some deals are not happening. We have a very proactive process. We remain disciplined and an important issue here is for us to intelligently deploy this excess capital that we have got.

And then maybe one final question. On the engineered materials front, have you seen much restocking into the RV market?

I think that is a good question. Our view is, and we have confirmed this with some of the OEMs who agree, most of the restocking ended after the second quarter. What you saw in the third quarter was largely a real demand. Our view going forward on RVs, of course we have a cyclical downturn in the fourth quarter, but the industry is projecting RVs to be up next year something like 10%. As we think of engineer materials which is clearly a book and ship sort cycle business with their 3M markets of RVs, transportation and building materials, we see kind of a rolling recovery. So this year, as you know, is largely led by RVs to a lesser extent transportation. As we move to next year -- we still expect to see today, anyway as we look at it, some modest growth in RVs, continued solid growth in transportation and building materials which was flat in the third quarter which I consider to be excellent performance in this market, because of market shares and some product development we have done and improving what should be a very gradually improving market, we expect even potentially a little help from building material.

Okay. Great. Thank you.

I'm not showing any other questions at this time. I would like to turn it back over for closing comments.

Thank you very much for being with us today and for your continued interest in Crane. Bye bye now.

Thank you. Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the conference. YOu may now disconnect. Good day.