Crane Co (CR) 2012 Q2 法說會逐字稿

Good day, everyone, and welcome to Crane's second-quarter earnings conference call. Today's call is being recorded. At this time, I'd 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 second-quarter 2012 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 Andrew Krawitt, our Principle Financial Officer. We will start off our call with a few prepared remarks after which we will respond to questions.

Just a reminder, the comments we make on this call may include some forward-looking statements. We 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'll be using some non-GAAP numbers, which are reconciled to 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.

Crane reported record earnings per share in the second quarter. Our core sales growth -- oncore sales growth of 6% we delivered earnings per share of $0.96, up 13% versus last year, excluding the divestiture gains and repositioning charges. Operating margin, excluding the repositioning charges, increased to 12.8% versus 12.5% a year ago.

Taking into account the absence of earnings for the balance of 2012 related to the divestitures we have reduced the midpoint of our 2012 earnings per share guidance range by $0.05. Reflecting our continued confidence in the Business, we are increasing the quarterly dividend by 8%. As part of our strategy to trim smaller, non-core assets we divested our Azonix business from the controls group, as well as a valve service center within Fluid Handling.

Although Azonix is a small, very successful company with impressive company with impressive niche technology we were unable to leverage the business with other parts of Crane. The sale is the valve service center is the third of three service centers that we previously owned. We sold the other two in the 2007, 2008 timeframe.

These divestitures represent modest trimming of small disparate parts of the Company that did not fit into our strategic vision. We are comfortable with our current portfolio of businesses and have no plans for further divestitures at this time.

The repositioning actions that we are announcing relate to the transfer of certain manufacturing operations from higher cost to lower cost Company facilities and other staff reduction actions, principally in response to weak European economic conditions. It is important to understand that we are in various stages of implementing these changes, as European employment rules and protocols are complex and time-consuming. Thoughtful interaction with workers' councils is required, as well as appropriate communications to our own people. The reposition actions are primarily focused on expanding operating margins in our European Fluid Handling business as leverage on incremental sales in the first half has not read through as expected and economic concerns in Europe will likely continue.

We have targeted opportunities in our Energy business, primarily in our manufacturing operations at Krombach, Germany, as well as other European sites within Fluid Handling. While we have consistently delivered Fluid Handling margins in the 13% range, executing on these important actions will accelerate continued improvement. We expect the benefit of these actions to impact our results beginning in 2013. Krombach is a highly engineer provider of specialized double and triple offset butterfly valves, as well as metal and soft seated ball valves.

Our manufacturing operation in Krombach -- at Krombach in Kreuztal, Germany, with a highly-skilled workforce continues to be a significant strategic platform to drive profitable growth. As we previously discussed, the integration of the Krombach operation presented challenges typically associated with a long-standing, privately-run business in Germany. While we've complete a number of actions, including upgrading the information systems, consolidating product lines from another German facility to improve plant utilization, and various other operational improvements, all of which has taken longer than planned, we are taking targeted actions to drive significant cost improvements as we close 2012.

Specifically, we are transferring certain Krombach product lines to lower-cost Crane facilities, dedicating additional Crane resources to drive both commercial and operational improvements, and reducing headcount at the primary manufacturing facility. In addition to the European repositioning actions, earlier in the year we initiated an internal merger between our ChemPharma and Energy groups. This merger will further streamline the organization and provide better leverage of a wider pool of resources to help drive these important actions.

It is also important to recognize that excluding our Energy business we are very pleased with the balance of the Fluid Handling segment, where operating margins exceeded 15% in the second quarter. In April we said that we expected full-year Fluid Handling margins to be at 14%, although it would be tougher to achieve given first-quarter results. Excluding special items we have revised our full-year Fluid Handling operating margin guidance to 3.5%, as the 12.6% margin in the second quarter was slightly below our expectations and our repositioning programs, while moving forward, are taking longer than anticipated to work through, principally due to German labor protocols.

As a result, the benefits that we expected to realize from these trance actions will now start in 2013. To achieve the 13.5% margins on a full-year basis implies 14% margins in the second half, which would be a full-point improvement from margins in the first half. Our revised guidance assumes $20 million of higher sales in the second half of 2012 as compared to the first half, and $10 million of additional operating profit. We expect the incremental sales to leverage about 25%, contributing $5 million of operating profit.

In addition, we expect general productivity gains, aided by a renewed focus on reducing discretionary costs throughout Fluid Handling, to contribute approximately $5 million of operating profit. The implied profit improvement in the second half is significant, but is supported by a detailed bottoms-up forecast for the remained of the year.

Our Aerospace Group is benefiting from increased from OEM build rates and continued growth in passenger miles flown. Although we are cautious about the aerospace after-market, modernization and upgrade and repair and overall sales helped to offset lower commercial spares in the quarter. Merchandising Systems performance strengthened considerably, driven by strong productivity gains. Fluid Handling is benefiting from its exposure to late cycle end markets.

Overall, Crane is on track to achieve operating margins of 13% in 2012, a level that we predicted we could achieve when our core sales return to $2.6 billion and an increase from 12.3% in 2011. Our continued vigilance on cost management, sales growth, operational metrics and profitability gives us confidence that we will have a successful second half in 2012. Both our recent dividend increase and the $30 million of share repurchases we executed during the second quarter reflect this confidence.

Andrew will now take you through the businesses and provide some additional information.

Thank you, Eric.

I'll turn now to segment comments, which compare the second quarter of 2012 to 2011. To assist in better understanding our outlook, we have provided updated segment guidance for 2012. Please refer to the table in yesterday's press release for detailed comparisons to 2011 on a continuing operations basis, as well as changes from the guidance that we provided in February, which also shows the impact of discontinued operations.

Aerospace and Electronics sales increased 4% to $179 while operating profit increased 5% to $39 million. Operating margin improved slightly to 21.8% from 21.7% in the prior years. Sales in the Aerospace group increased $7 million, or 7%, to $111 million. OEM revenue grew 8%, with an increase in both commercial and military applications. Sales to business jet OEMs and large aircraft manufacturers increased, while sales to regional aircraft manufacturers declined slightly.

Despite a decline in commercial spares sales in the quarter, after-market sales increased 4%, aided by modernization and upgrade programs. Commercial spares sales in the second quarter were flat compared to first-quarter levels, but had a difficult comparison versus the prior year. The OEM after-market mix was 58% to 42% in the second quarter of 2012, compared to 57% to 43% mix in the second quarter of 2011.

Operating profit in the Aerospace group increased by approximately $2.5 million, reflecting good leverage of the higher sales. Market conditions in aerospace have softened a bit given recent global economic concerns, and the International Air Transport Association estimates that the net profit margin for the airline industry will be only 0.5% in 2012. However, air travel is expected to grow an encouraging 5% this year and load factors remain relatively high.

We expect modest sales growth in the second half of 2012, reflecting more difficult OEM sales comparisons and a cautious outlook for after-market activity. Electronic sales were $68 million, up very slightly from the prior year. Operating profit decreased slightly, in part reflecting a less favorable product mix, and operating margin remained in the mid-teens area. We continue to expect reasonably stable results in 2012, with growth in our commercial business expected to offset a slight decline in defense-related sales.

Aerospace and Electronics backlog was $423 million at the end of the second quarter, down sequentially from $438 million in March, but $12 million higher than the $411 million level in December 2011. We have raised our full-year sales guidance to $710 million from $700 million, reflecting strong first-half results and a solid backlog going into the second half. Our full-year operating profit guidance is now $158 million compared to our investor-day guidance of $155 million.

Engineered Material sales declined 9% to $54 million. Demand for our RV-related applications was relatively flat versus the prior year. Transportation related sales, although representing less than 20% of segment sales, declined 29%, reflecting difficult competitive conditions and customer production delays. Building Products-related sales decreased 2%, reflecting soft commercial construction markets. Operating profit before special items declined to $6.6 million from $9.1 million, and operating margin, also before special items, was 12.1% compared to 15.2% in the second quarter of 2011, primarily as a result of lower sales and higher material costs.

As part of the repositioning actions we announced yesterday we anticipate closing a small facility in England given challenging European economic conditions. We expect to supply selected European customers from our US-based facilities. Repositioning charges of $1.1 million on a pretax basis were recorded in the second quarter of 2012. In addition, the amounts recorded in the second quarter, we expect to incur additional pretax charges related to these actions in the second half of 2012 of approximately $2 million. We estimate that this action will result in pretax savings of $1 million annually beginning in 2013.

We have reduced our full-year sales guidance to $215 million from $225 million previously, reflecting soft first-half results. Our full-year operating profit guidance, excluding repositioning costs, is now $29 million compared to our investor-day guidance of $32 million.

Merchandising System sales of $98 million increased $4 million versus the prior year, or 4%, reflecting higher sales in Vending, and to a lesser extent Payment Solutions. Both businesses also strengthened sequentially from the first quarter. We have seen some improvement in the German gaming market, as some operators have resumed their purchases, despite uncertainty around recently-enacted legislation. Segment operating profit before special items of $11.4 million increased $4.3 million from the prior year, and operating margins improved to 11.7% from 7.6%, as solid productivity gains and benefits from the 2010 acquisition of Money Controls increased the leverage on the $4 million of higher sales.

As part of our repositioning actions we plan to consolidate the manufacturing of certain products and optimize engineering resources within Payment Solutions. Repositioning charges of $2.3 million on a pretax basis were recorded in the second quarter of 2012. Pretax savings associated with these actions are expected to approximate $1 million annually beginning in 2013.

We are maintaining our full-year sales guidance of $375 million, but forecast slightly better operating profit based on the success of our productivity initiatives. Our full-year operating profit guidance, excluding repositioning costs, is now $37 million, compared to our investor-day guidance of $35 million.

Fluid Handling sales increased 6% to $302 million, with a core sales increase of 8% and an increase in sales from the WTA acquisition of 3%, offset in part by unfavorable foreign currency translation of 5%. This marks the seventh consecutive quarter that core sales have increased on a year-over-year basis. Backlog was $335 million at the end of June, down slightly when compared to $338 million at the end of March, but higher than the December 2011 level of $314 million. The decline in backlog from March to June was due to changes in foreign currency translation rates and the divestiture of the Houston valve service center, which together negatively impacted backlog by $9 million. The foreign exchange impact was $6 million and the divestiture impact was $3 million.

During the second quarter of 2012, market conditions in Europe have trended lower, particularly for our MRO and Book and Ship businesses, reflecting economic uncertainty. The major European-based chemical customers are generally moving forward with larger projects on a global basis, but with some orders being delayed.

Chemical industry demand in North America is strong, with MRO sales benefiting from healthy plan operating rates and low-energy feed-stock costs. Refining, quote, activity is good, both in the US and the Middle East. Demand from global power markets has softened, with some customers delaying delivery dates. In Canada, demand from commercial construction has been stable, and we have benefited from MRO orders from chemical companies doing plant turnarounds.

Fluid Handling operating profit of $38 million before special items increased 4%, primarily reflecting the higher sales, and operating margin was 12.6%, a slight deterioration from the prior year. On our first-quarter conference call we said that we did not expect improvement in our Fluid Handling margins in the second quarter because it would take some time to adjust the cost base in Europe, particularly in our Energy business.

The repositioning actions we announced today should favorably impact our 2013 operating profits, particularly from our German-based operations. Within the Fluid Handling segment the Company incurred repositioning charges of $11.4 million on a pretax basis in the second quarter of 2012. In addition to the amounts recorded in the second quarter, we expect to incur additional pretax charges related to these actions in the second half of 2012 of approximately $3 million. Pretax savings associated with these actions are expected to approximate $10 million annually beginning in 2013.

Our full-year sales guidance for Fluid Handling remains at $1.22 billion, which now represents a 7% increase versus an adjusted sales level of $1.14 billion in 2011. Despite the loss of sales from the divestiture, strong first-half results and solid backlog going into the second half have allowed us to maintain our sales guidance. As Eric touched on earlier, our full-year operating profit guidance, excluding repositioning costs, is now $165 million compared to our investor-day guidance of $175 million.

Operating margin is expected to gradually improve in the second half of the year, and we now project a 13.5% operating margin for the segment on a full-year basis. This implies an operating margin of approximately 14% in the second half of 2012. Currently we expect operating margins to be slightly less than 14% in the third quarter, and slightly higher than 14% in the fourth quarter.

Turning now to more detail on our total Company results and forecasts. We again experienced raw material cost pressure in the quarter, but increases in our selling prices effectively offset this impact. The operating profit impact of foreign currency translation for Crane tends to be about 10% to 15% of the revenue impact.

Foreign currency translation negatively impacted EPS by approximately $0.03 in the second quarter. As the currency impact in the first quarter was small, the EPS impact of foreign currency translation for the first half of 2012 was also about $0.03. Based on current FX trading levels, the third and fourth quarters will also have difficult comparisons versus prior-year levels, and on a full-year basis, we expect a headwind of currency translation of $0.08 to $0.10 per share.

Our second quarter tax rate associated with continuing operations was 32% in 2012 compared to 31% in the second quarter of 2011. Excluding the impact of repositioning charges and divestiture gains, the normalized tax rate for continuing operations was 29%. Our full-year tax rate guidance of 30%, excluding special items, assumes that the US Congress passes legislation during 2012, which would extend the research tax credit retroactive to January 1, 2012. The assumed benefit associated with the R&D tax credit is worth approximately $0.05 per share in 2012.

Free cash flow was $52 million in the second quarter of 2012 compared to $21 million in the second quarter of 2011. Free cash flow for the first half of 2012 was $2 million compared to a negative $3 million in the first half of 2011. We are slightly reducing our 2012 free cash flow guidance to a range of $150 million to $180 million, reflecting the divestitures and expected cash flow related to repositioning actions.

In 2012 we expect pretax cash payments of approximately $5 million related to the repositioning actions, and in 2013 we expect an additional $10 million of pretax cash outflow. Capital spending for the second quarter of 2012 was $7 million, roughly similar to the first-quarter level. We are slightly reducing our capital expenditure guidance for 2012 by $5 million to $35 million, reflecting the modest first-half activity.

During the second of 2012 we repurchased approximately 772,000 shares of our common stock for about $30 million. These repurchases reflect our confidence in the Company's future and our willingness to more than offset stock incentive plan dilution if conditions warrant. As previously communicated, our policy is not to preannounce these purchases, but to report them at the close of the quarter.

Sales from continuing operations for 2012 are expected to increase 4% to 5%, driven by a core sales increase of 6% to 7% and sales related to the WT acquisition of less than 1%, partially offset by unfavorable foreign exchange of approximately 2%. The revised full-year sales guidance reflects strong first-half sales growth in Fluid Handling in Aerospace, and a stable outlook for overall Crane in the second half.

The updated 2012 earnings per share guidance range, excluding special items, is $3.75 to $3.85, which is a reduction of $0.05 to the mid point of the previously committed guidance range of $3.75 to $3.95. This primarily reflects the absence of second-half earnings from the divestitures that we completed in the second quarter.

We've also narrowed it guidance range from $0.20 to $0.10, given that we are already halfway through 2012. The Company's 2012 EPS guidance on a GAAP basis is $3.80 to $3.90. On a full-year basis $0.31 of divestiture gains are expected to be offset by $0.26 of repositioning charges. As a result, GAAP guidance is $0.05 higher than the guidance excluding special items.

Our balance sheet remains strong, and we ended the quarter with $252 million in cash. We have access to our $300 million revolving credit facility, which we recently updated and now matures in May of 2017. Half of our long-term debt of $400 million is due in 2013 and the other half is due the 2036.

Now back to you, Dick.

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

Thank you.

(Operator Instructions)

Our first question comes from Deane Dray of Citi. Your line is open.

This is Matt McConnell in for Deane. Thanks for taking my question. Could you put some numbers around the magnitude of the equipment relocation, and start with how much revenue is impacted? And then maybe some details around timing? I know there are probably negotiations ongoing, but would it be correct to assume that any capacity relocation would be completed by the end of 2012?

What I would say is that, first off, we expect to complete all our repositioning activities within 2012 and are confident in doing that. Secondly, I consider -- we've been working on these activities, have very detailed plans around them, and we're moving, particularly manufacturing processes, but largely product lines, from one existing Crane facility to another, which is dramatically lower costs. So I view these activities as an acceleration of trends that have been going on here for a long time. So I see them as low risk, impacting -- we're not going to quantity the revenues that it impacts, but this to me is just an acceleration of product movement to reduce costs.

Okay, great. And where -- have you said where those new facilities are? I'm assuming there's --

There's no new facilities involved here.

Okay.

This is moving product from a higher-cost location to a lower-cost location in existing Crane plants that we've owned for a long time.

Okay, great. Thank you. And are there any buffer inventory requirements? And is that part of the free cash flow guidance reduction? Or is --?

Nothing -- inventory issues here are nominal at best.

The free cash flow guidance reduction is very slight. It's really just reflective of the fact that we're losing a little bit from not having the divested businesses and also some cash flow associated with the restructuring this year.

Okay, great.

I would just add that we use the word repositioning on purpose, to reflect, in our view, relatively modest trimming movement, relatively low-risk activities as opposed to closing major facilities, et cetera, et cetera.

All right. Okay. And is the margin target for Fluid -- is that down just because of its Energy piece that's being restructured? Or are there any other headwinds in that business that are worth calling out, and any update on price cost or anything else?

Well, again, as I said in my comments, away from Energy, the rest of the business operated at 15% margins, which indicates we've got healthy good businesses and the repositioning, I think, attacks -- we've got a concern about the European markets and attacks those costs, principally in Energy but other parts of Fluid Handling, as well.

Okay, great. Thanks very much.

Thank you. Our next question comes from Robert Barry of UBS. Your line is open.

Good morning.

Good morning.

Thanks, by the way, for all of the added disclosure in the release and on the call today; appreciate it.

So I just wanted to follow up on a few things in Fluid. First of all, it sounds like there's no benefit at all from the headcount reductions, the other repositioning actions in this year. It sounds like it's all coming in 2013; is that right?

The benefits -- that's correct, from the repositioning activities; and this is primarily due to the length of time it takes to follow these -- the German labor protocols and working through the working councils. And as I said, we thought we could get some this year; but really, working through that process is going as planned, but it's just taking longer than anticipated. That being said, there are activities that we're implementing, both in Energy and throughout Fluid Handling, with respect to reduction in temporary workers, contractors, overtime, travel, discretionary spend. There is stepped-up activity with respect to negotiating with certain key suppliers with reductions to get reductions in material costs, and all of these activities are ongoing, particularly in our European Fluid Handling businesses, but basically throughout Fluid Handling as we look to reduce costs in this year.

So I just wanted to make sure I was very clear on what's going to drive the margin improvement in the back half, and it looks like about $10 million of incremental EBIT in second half versus first half, and half of that is from better revenue and half of that is from just other productivity things, belt-tightening stuff, is that right?

Just that I mentioned. There's very specific productivity plans throughout the Fluid Handling organization, and, again, related to those items that I mentioned that are well underway.

Yes. And so I guess my question would be just -- maybe it's tough to answer -- but it sounds like half of the expected improvement is related to revenue, and as you called out in the prepared remarks, there's projects being pushed out, there's obviously macro weakness in Europe. You do have a very good backlog going into third quarter, so I don't know how you're thinking about the over/under on that $5 million from the revenue-related piece?

We're giving guidance that revenues are going to be up $20 million. You look at our backlog compared to -- here we've had organic growth in Fluid Handling -- what is it? 6%, 7% in the first six months, and our backlog's still up $20 million. So we've got a good backlog going into certainly the third quarter and that backlog runs three to four months, typically. We've tried to account for some slowing in the MRO business. I would say there is some risk there, unless you have a crystal ball on economic outlook. So I wouldn't say that there's not risk, but we wouldn't have said we expect revenues to be up $20 million unless we felt we could do that.

I would acknowledge some risk there. I don't think there's risk in our reducing costs. We're pretty good about those activities.

Okay. Just finally shifting focus to Aero -- off to a pretty good start there. You raised the guidance, but it still implies only about 3%, 3.5% revenue growth in the back half versus about 6% in the first half. Is that deceleration related to some caution on aftermarket? And if so, can you just share some thoughts on what you're seeing in aftermarket, and is there's anything else causing that deceleration as well? Thank you.

Yes, Rob, I'll --

Let me just comment on the aftermarket. As we mentioned in the remarks, commercial sales have flattened out for us, and we think some customers are working off inventories, likely driven by some over-provisioning in 2011. But for us, helped by our strong M&U sales, we expect total aftermarket sales in the second half to be really similar to first-half levels, so that would result in a modest growth in the second half of the year versus the prior year.

Okay. Thanks a lot, guys.

Our next question comes from Matt Summerville of KeyBanc. Your line is open.

Morning.

A couple questions, in particular on input costs. Eric, I think you mentioned, in Engineered Materials your input costs are up, oil prices have come down; in Fluid, a lot of metals prices have come down. I guess I'm wondering when that starts to positively benefit your P&L?

Well, what you said is true, Matt. We have seen some of those prices come down, and there is some potential benefit of some input cost upside in the back half of the year. We've, I think, tried to be somewhat conservative about it, but obviously, if prices continue to come down, we would expect to see some benefit.

I think it's primarily styrene in Engineered Materials, and that's a little help, but it's not -- it's more at the margin here in the third quarter from what I can see. It takes a while to read through, and I would say the same with steel and copper as it just takes a while to work through the system in your inventory. So I don't see much help in the third quarter, Matt,; might be a little bit more in the fourth.

Okay. And then with regards to the backlog and order momentum in Fluid -- as you progressed through the quarter, how did that momentum -- if it did change, how did that momentum evolve? Did you exit at a better rate, a worse rate than what you entered? Can you talk about the cadence throughout the quarter in your order book there?

The rate of growth decelerated as we went through the quarter. We see the projects -- project activity relatively stable. The rate of growth year over year declining slightly on the projects, as not so much that they were canceled, but they were pushed out. We see the rate of growth year over year on MRO activity clearly lower in June and declining through the quarter. I think that's the fair way to say it.

Okay, great. And then --

Still positive.

Still growth in the second quarter.

Still growth, but the rate of growth is -- particularly in MRO -- is much reduced.

Given the dynamics you mentioned there, Eric, and how they're playing out, would you expect backlog then in your business, because it's -- we obviously don't know what kind of deferral rates you're seeing. Would you expect the backlog to move higher from here, or moderate? I just want to see if there's some sort of expectation there for the back half?

I don't know how to answer that. I think we -- in Fluid Handling, we feel comfortable about the revenues that we've got. I'm less comfortable with articulating where we end up in backlog at this point.

Okay, and just one more for Andrew.

What euro/dollar exchange rate are you using in your current, updated FX guidance for Crane?

We used month-end May rates, which is about $1.24, so we're pretty close to those levels, just a touch under.

Great. Thank you.

Thank you.

(Operator Instructions)

Our next question comes from Ronald Epstein at Banc of America, Merrill Lynch. Your line is open.

Hello. Good morning, guys.

Morning.

Eric, since we met over at Farnborough just a couple of weeks ago --

Right.

-- has anything changed from the economic backdrop? And are you feeling any more optimistic, less optimistic?

We clearly have a slowing global economy; we clearly have slower growth rates here in the United States in the second quarter than what people had anticipated. And I think the real question is, are things going to get any better in the second half? And at this time I don't see any real growth activities being put in place other than monetary easing, which I think is losing its ability to boost the economy with the third round.

And my concern -- so I see a continuing very slow growth in the United States and globally slowing economy, and the concern, as I articulated at the air show, is that financial institutions in corporate America facing that will continue to -- would start trimming discretionary spending and reducing headcount. And I think you've participated in all of the calls. We clearly are tightening our belts here, positioning ourselves, making sure we're well-positioned for 2013. I would just -- it's not clear to me yet what all of other companies are, but in that scenario I think that's prudent and we're doing it.

Yes, that's great. Well, thank you. Thank you, Eric, for the comments. Thanks.

Thank you. I'm showing no further questions in the queue at this time.

That's great.

Okay. Thank you very much for your interest in Crane, and we'll talk to you in October, if not before, at one of the conferences. Thank you; goodbye.

Thank you. Ladies and gentlemen, this concludes the conference for today. You may all disconnect and have a wonderful day.