Crane Co (CR) 2013 Q2 法說會逐字稿

Good day, everyone, and welcome to Crane's second quarter 2013 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, Mr. Richard Koch. Please go ahead, sir.

Thank you, operator. Good morning, everyone. Welcome to our second quarter 2013 earnings release conference call. I am Dick Koch, Director Investor Relations. On our call this morning we have Eric Fast, our Chief Executive Officer; Max Mitchell, our President and Chief Operating Officer; and Rich Maue, our Chief 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 will be using some non-GAAP numbers which will be reconciled to the comparable GAAP numbers at 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. Before commenting on our second-quarter earnings, I'd like to briefly touch upon the MEI update that we announced on Friday. As mentioned in the release, the European commission has cleared the pending acquisition of MEI The clearance by the European commission is conditioned upon Crane Co's entering into agreements to implement remedies regarding two of our product lines. As agreed, we will be divesting our B2B bill recycler product line and related assets as well as providing a technology license covering our Currenza coin recycler product line for the European vending market. The B2B bill recycler product line is sold primarily in transportation markets in Europe and North America for fare collection and off street parking. These two remedies only affect the operation of Crane's payment systems business, and MEI will continue to offer its competing lines of coin and bill recycler products in these same markets.

As previously reported, we are in negotiations with Bain Capital and Advantage Partners, the owners of MEI, concerning the economic effects of these required actions. The time necessary to implement the remedies will shift the anticipated closing of the acquisition into the fourth quarter of 2013. We remain excited about the potential acquisition of MEI. This acquisition is consistent with our strategy of niche market leadership. The combination of MEI with our CPS business creates a global platform to drive product innovation and integration for the benefit of customers in developed and emerging markets. We are hopeful that we will be able to come to an agreement with MEI's shareholders over revised pricing and timing to allow us to complete this acquisition. But as we previously announced, no assurance can be given that a mutually satisfactory adjustment to the transaction terms will be achieved.

Now, I'd like to move to our second-quarter results. As outlined in our press release last night, excluding special items, I am pleased to report second quarter EPS of $1.06 per share, an increase of 10% versus $0.96 last year. Operating profit increased 14% as margins reached 14.8%, a substantial increase over 12.8% last year with improvements led by our fluid handling segment. In the first quarter of 2013, our total Company sales declined 2.4%, and our second-quarter decline was just under 1%. While we have seen some sequential improvement, we remain cautious on the global economy and its impact on our sales and earnings.

We have adjusted our guidance accordingly, bringing down the top end by $0.05 per share, and our 2013 EPS is now expected to be in the range of $4.10 to $4.25 per share, excluding special items, compared to our previous range of $4.10 to $4.30 per share, primarily reflecting the impact of lower than previously anticipated revenue growth, mostly offset by strong productivity. The 2013 guidance does not include potential impacts from the pending acquisition of MEI. Full-year 2013 free cash flow remains in the range of $190 million to $220 million. Reflecting our confidence in the future, we increased our dividend 7%. Rich Maue 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 second quarter of 2013 to 2012. Aerospace and electronic sales decreased 3% to $172 million compared to $179 million in the second quarter 2012, while operating profit declined 5% to $37 million. Operating margin decreased slightly from 21.5% from 21.8% in the prior year. Sales in the electronics group are $107 million compared to $111 million last year. Commercial OEM increased 5% as strong sales to large aircrafts and private jet manufacturers were partially offset by a decline in regionals and our SEAT actuation business.

Total aftermarket sales were lower by 14% compared to a strong second quarter of 2012 with declines in commercial and military spares and in military modernization and upgrade sales. The decline in military modernization and upgrade sales reflect the completion in late 2012 of the carbon brake upgrade program for the C-130 aircraft. The OEM to aftermarket mix was 63% to 37% in the second quarter of 2013, which compares to 58% to 42% in the second quarter of 2012, reflecting the aforementioned continued strength in OEM and lower aftermarket sales. While sales declined, operating profit in the aerospace group increased by approximately $1.3 million, and margins were strong driven by productivity and solid cost management, including lower pension expense as well as lower engineering spending due, in part, to the timing of certain development programs.

Market conditions in the aerospace industry remain positive. The International Air Transport Association is forecasting slightly improved profitability for the airline industry in 2013 with passenger traffic projected to increase 5% worldwide and industry load factors to average 80.3%, which is a record high. We continue to benefit from increasing OEM build rates across a broad range of platforms and we are cautiously optimistic about commercial aftermarket spares improving in the second half of the year. The electronics group sales were $66 million in the second quarter of 2013, $2 million lower than in 2012, reflecting continued delays in defense-related programs. Operating profit declined as a result of the sales decline and unfavorable sales mix, as well as higher costs.

Based on our forecasted production schedule, with improved product mix from our shorter cycle, higher-margin profit lines and cost actions already taken, we expect improvement in both sales and operating profit in our electronics group during the second half. Aerospace and electronics backlog grew to $403 million at the end of the second quarter compared to $398 million in March and $378 million in December. While our aerospace and electronics backlog supports improved performance in the second half of the year, the slower commercial aftermarket recovery and the year to date weaker performance in electronics is expected to result in modestly lower sales and profits in the segment compared to what we communicated at investor day.

Engineered materials sales increased $3 million, or 6% to $58 million. Sales of our RV-related applications increased to 24% versus the prior year, reflecting higher RV OEM build rates. The RVIA wholesale build forecast remains at 307,000 units, an 8% increase compared to 2012. Building products related sales declined 5%, reflecting the continued soft commercial construction market, and transportation related sales increased 1%. We expect these market trends to continue in engineered materials for the balance of the year. Excluding special items, operating profit increased to $9.2 million, and operating margins group 380 basis points to 15.9% compared to 12.1% in the second quarter of 2012. The improvement was due to the higher sales, savings from the 2012 repositioning actions and strong productivity.

Merchandising systems sales at $85 million decreased $13 million, or 13% versus the prior year. With slightly higher sales in payment solutions, more than offset by a significant decline in vending solutions. The decline in vending solutions was driven by lower sales to certain US bottlers and weak market conditions in Europe. The higher sales in payment solutions was driven by strength in the retail, vending and casino gaming vertical markets. Excluding special items, segment operating profit of $9 million decreased $2.5 million, reflecting the impact of a lower sales and vending solutions, partially offset by continued strong performance in payment solutions and strong productivity across the segment.

Operating margin decreased to 10.5% compared to 11.7% in the same quarter of last year. For the full year, we now expect vending sales to decline by approximately $25 million compared to our February investor day guidance. This reduction reflects shortfall in sales experienced in the first half, partly offset by expected improvement in vending sales in the second half of the year as a result of recently received and anticipated orders from certain US and European customers. In spite of the decline in vending sales, the operating profit in 2013 for the merchandising systems segment is only expected to be modestly lower than our February guidance, driven by continued productivity gains, strong cost management in vending, and higher operating profit in payment solutions.

Fluid handling sales increased 2% to $334 million in the second quarter, a core sales increase of 3% was partially offset by unfavorable foreign exchange of 1%. The increase in core sales was driven by higher sales in our ChemPharma energy and our nuclear eval services businesses. Partially offset by lower sales in certain short cycle book and ship businesses primarily in Europe and Canada. Backlog was $350 million at the end of June compared to $365 million at the end of March and $343 million at the end of December.

With respect to key end markets for our process valves, while conditions remain generally uncertain in Europe, border and quote activity was solid during the quarter, and there are encouraging signs from European based customers who remain committed to projects on a global basis. Chemical industry demand in North America and Asia-Pacific was soft and investments in the Middle East and China are generally moving forward. Refining demand has been picking up and refinery turnaround activities are showing gradual improvement. Demand from power markets in China is relatively strong, while the Americas, Europe, and India remain soft.

With respect to our commercial valves business, nonresidential construction and mining activity in Canada, which was strong in 2012, continues to be soft and we continue to see weakness in Europe. Excluding special items, fluid handling operating profit of $54 million increased 29% and margins increased to 340 basis points to 16.2% compared to 12.8% in the same quarter last year. The improvement in operating profit and margins reflected the impact of higher sales, improved productivity, and the benefits of the European repositioning actions that we took in 2012. We expect fluid handling sales to will increase modestly over the course of the second half of the year and margins will return to the 15% range as we have some normal seasonal slowing in our valve services product line and a higher mix of projects to MRO in our process valve business.

Turning now to more detail on our total Company results and forecasts. While we experienced raw material cost pressure on certain commodities in the quarter, the effect was modest in aggregate. Foreign currency translation had a negligible impact on EPS in the second quarter and first half, on a full-year basis, we expect foreign currency exchange headwinds could be slightly unfavorable to what we anticipated back in February. As a reminder, the operating profit impact of foreign currency translation for Crane tends to be about 10% to 15% of the revenue impact.

Our second-quarter tax rate from continuing operations was 13.9 -- 32.9% on a GAAP basis compared to 31.7% in the second quarter of 2012. During the quarter, MEI transaction costs, which are not deductible for tax purposes, together with withholding taxes related to acquisition funding, were $7.3 million. Excluding the impact of these two items, our tax rate was 30%. This compares to 29.6% in the prior year, which excludes the impact of the 2012 repositioning charges and the impact of the two divestiture gains. Our full-year tax rate guidance of 30%, which excludes the impact of MEI, remains unchanged.

Overall free cash flow was $24 million in the second quarter of 2013 compared to $52 million in the second quarter of 2012. The year over year decline was driven by higher working capital requirements, including higher payments related to MEI transaction costs. In addition, capital spending for the second quarter of 2013 was $6.6 million, unchanged from 2012. For the full-year, capital expenditures are expected to be $25 million to $30 million.

Our balance sheet remains strong, and we ended the quarter with $421 million in cash. As Eric mentioned earlier, our 2013 EPS is expected to be in a range of $4.10 to $4.25, representing an increase of 11% to 15% over 2012 earnings per share of $3.70 before special items. Our 2013 guidance does not include potential impacts from the pending acquisition of MEI. Now back to you, Dick.

Thank you, Eric and Rich. This marks the end of our prepared comments. Operator, we're now ready to take questions.

Thank you.

(Operator Instructions)

Matt McConnell, Citi Research. Please go ahead.

Thank you, good morning. Could you talk about that fluid handling margin? I know you've been talking about getting to 15% for a while, and so that 16.2% looks really nice. How big of a contributor was mix in the quarter? Because I know there was a lot of nuclear valve service activity. Was that a big driver of that? And I know the expectations are for a step down. Is mix a part of the kind of second half step down as well?

Matt, just to an extent, yes, most of the benefit that we actually saw from a margin perspective was in our core process chempharma and energy business. We did see some mix benefit from valve services, but the expectation going forward leaning more towards that 15% is due in part to some of the removal of valve services, but also to a greater extent, more on that mix of project to MRO as we move into the balance of the year. So, no significant -- I would not to point to significant mix issues in the quarter for fluid handling.

Okay, great. Helpful. Thanks. And then as we think about that $0.25 first year accretion target for MEI, how would that be impacted when you're going forward without the two product lines that you have to divest? Would those be material enough to impact that target?

Matt, what I would say, first off, we're in -- it would be inappropriate, I think, for us to comment here while we're negotiating economic terms with the owners of MEI. What I would say is what we've said publicly, which is together, we have got a $600 million -- $625 million sales business, and we've announced publicly that the two products that are involved here, that would be -- that are conditions of closing, represent less than 10% of the combined sales. And what I would say, and this is all I'm going to say to it, is that in my view represents a relatively modest impact, but an important one. Which is why we're having to discussions with Bain and Advantage as the owners of MEI. I just think, because there may be other questions here, we are going to leave this at -- with that comment until we conclude -- hopefully conclude those negotiations.

Okay, certainly understood. And then maybe even independent of MEI, how has Crane's payment solutions business performed over the past couple of quarters? Just to give us a sense of how the end markets have performed since -- maybe year to date would be helpful.

So we -- I would say it's on track with good margins, and like what's going on with our current -- our business. And good results in vending, good results in retail, gaming is fine. A little weak in AWP or with prices over in Europe, but tracking and good execution. Rich, you can correct me.

We're excited about the performance in payment solutions year-to-date, Matt. First quarter we were up in a big way on a core basis, and that continued in the second quarter. And when we look at our plans, we're feeling really good about how they are executing and meeting their plans.

Which is in spite of all the integration plans.

Okay, great. Thanks very much, guys.

Matt Summerville, KeyBanc.

Good morning. A couple of questions. You mentioned, Rich, in your prepared remarks, that aftermarket was down 14%. Can you maybe give a little more granularity in terms of military versus commercial around that 14%?

Sure. So overall, we're down 14%. I think from a commercial point of view, we're down 6%. And that's a combination of spares, M&U and R&O. Recall though that commercial total aftermarket includes military modernization and upgrades. So, we had the headwind from the C-130 program. But at a high level, I think -- from last year. At a high level, I think that provides the color I think you are looking for.

I think the C-130 program ended --

October.

October of last year. So, we've got that comparison through October.

Got it. And then I guess the year-over-year delta in commercial spares, is that starting to trend favorably? If you look month-to-month, is your order rate in the commercial aftermarket piece of the business starting to show any inflection?

We expect it to increase as we move through the balance of the year. So, our forecast would indicate that that progression should start occurring in commercial spares.

Mostly in the fourth.

Okay, and then a question on fluid handling. The performance in the second quarter doesn't sound like there were any major aberrations there, which is encouraging. So, do you rethink the long-term margin profile target for this business? And the other question would be, the quote in order activity you're seeing in fluid would support what kind of book to build do you think in the back half of the year?

Yes, so it's -- I don't think we're going to comment on the go forward book to bill, but I would say for the margins in the quarter, at 16.2%, that's a high water mark. Executed really well in the quarter. That followed really strong execution in the first quarter. And we made comments here that suggest that we should see it come down in that 15% range for the balance of the year. From a long-term perspective, we would expect that to continue to improve as we continue to see sales leverage come down. So, as we grow, we would expect margins to continue, to also improve.

The core strategy for the whole Company recalls, as we're running at 60%, 65% capacity, two shifts, five days per week, as we grow core sales, we can leverage that $0.25 on the dollar. So, this is just as true for the rest of the Company, but particularly for fluid handling. I can get -- we can get constant positive margin pressure as we grow core sales. We've been fighting a headwind in the first half. That would be my first comment.

The second comment would be that, remember that in our process, we consider that the process valve is a higher-margin of business than the commercial valve business, although the commercial valve businesses, for what we've got invested in, is a very good business, and we have changed those business models. So, we started to run into a little bit of a mixed tension with Crane Supply up in Canada, our commercial valve business versus process, when you start to look at overall margins. And that has to be considered. But clearly in process valves, that's a good business that long-term will do better than what it's currently doing.

And then from -- last question, from a restructuring standpoint, our cost to takeout standpoint, you've mentioned seeing cost pressure in military. You've already taken some actions there. Is there anything you are doing and/or contemplating in the vending business in response to what sounds like a pretty big downdraft relative to your initial forecast?

We already did it.

Yes.

When would you have incurred those expenses?

In the second quarter.

Great, thank you.

Michael Callahan, Topeka.

Thanks for taking my question here. I guess first thing I want to dig into a little more, on the commercial aftermarket side of things, minus 6% I guess is somewhat of a disconnect to really systemwide capacity increases that have taken place globally here in the quarter. In your guys ' minds, what do you attribute that to? Is it more new builds entering the system or just, what are your thoughts around that?

We would not necessarily be comparable to some of the others, right? We have -- most of our commercial spares are on condition, whereas others would not be on condition. They are more sort of engine repair, they're on fixed schedules based on usage of aircraft. So, you are going to have a disconnect in comparing, I think, Crane to other larger organizations that are centered around engines, for example. So, that would be the primary reason for a disconnect in comparison.

I think secondly, there's -- our sense is, as we have talked to the marketplace, that there was some over inventory here early in the year, and that's been marked down. Which is one of the reasons we expect an improvement in the second half. Which I would add to Rich's comment.

Okay, and then along those same lines, as it relates to margin improvement in that segment, can you guys achieve margin improvement in the back half without an improvement in just overall aftermarket?

Look, the way I would answer that is I think that aerospace -- the aerospace group as part of the aerospace and electronics segments, aerospace group had an excellent quarter. Sales were down slightly, a negative mix with a lot of OEM and a weak aftermarket, and yet operating profit was up 1.3% -- excuse me, $1.3 million, driven by productivity. So, we clearly executed well in aerospace, and we look at our backlog and our OEM backlog looks solid and in really good shape. And we are anticipating better commercial spares here as we -- particularly as we get more towards the end of the year. So, that would be how I would characterize aerospace, and we feel quite good about those results. And the commercial spares will come, it's just a matter of timing.

In our electronics business, we had down sales, and had a negative mix in terms of our short cycle, higher-margin businesses in that segment that impacted margin. And we had a couple of programs that shipped -- big shipments on programs that were at low margins. As we sit here -- so that's what happened in the second quarter. We expect the third in the fourth quarter in electronics to be better. We -- with some of the orders on that short cycle, higher-margin business, looking to us, indicating that they should be a little bit stronger. And as we mentioned, we already had some cost takeout in electronics that's already behind us. The combination of those two factors give us confidence that the third and fourth quarter will be better in electronics.

Okay, great, thanks. And then just maybe one last thing here, on the merchandising systems side of the business, I guess it seems like the folks that run payment solutions, MEI, will obviously try to greatly enhance that product offering. On the flip side, vending has been weak and appears to be taking another leg down here for several years. Is there a point at which maybe you guys exit that business altogether and just focus on payment solutions? Or have you guys given any thought to that kind of thinking?

We are not prepared to exit the vending machine business, which I have been consistent on as we go through here. You want to deal with the volume drops?

Yes, so as Eric mentioned, committed to the segment for sure. It's still strategic for us. In the period we saw a few customers who we obtained routine forecasts from experience senior management changes that impacted of those forecasts and reduced capital spending, and it really impacted us here in the second quarter. We expect for the balance of the year for the demand to improve, so when you are looking at it sequentially first half to second half, we do expect revenues to come back. I would point out that there hasn't been any share loss, which is important to us, naturally. And to Eric's point earlier, we have taken costs out already to make sure that we can see that the margins continued to improve as we move through the balance of the year. But strategically, no change in direction.

Okay. I appreciate it. Thanks, guys.

Thank you.

(Operator Instructions)

Brian Konigsberg, Vertical Research.

Thank you, good morning. I saw or I heard that you had mentioned, I apologize, I was a little bit late to the call, so if you said this, my apologies in advance. But North American Chemical, you mentioned was still weak. I think you have been saying that for a couple of quarters. Maybe just give us some -- your take on how this market unfolds? Are you starting to see projects start to materialize as far as bids and quotes? Maybe just start with that, we can add on.

Yes, I think that North American Chemical, where our products have strong application are in severe service application. So, where demand I think is occurring today is in the more in the traditional chemical applications not necessarily requiring severe service valves. That would be the primary reason that we're not seeing a strong pickup maybe compared to others that are supplying valves into the North American Chemical marketplace. That said, we are seeing activities in quotes reading through and projects on the horizon. We would expect a lot of that to readthrough towards the first half of 2014.

Okay. Do you see the pricing on those projects coming into '14 fairly stable, or is it the kind of ramp that you potentially see a little bit more competitive than your typical --

No, I wouldn't characterize this as us seeing price pressure in any way. It's the normal sort of pricing routine that we go through. So, nothing unique.

On these process valves in chemical plants and power plants, typically, you have to be on the, what's called the AML list. So, you have got to be approved by the chemical company. They typically approve two or three different vendors for different severe service applications. You've got to be on that approved list. So there's always price competition, but it's among a high-quality group and a small group.

And then just lastly, just on aero margins, took a step down in Q2. I think you were suggesting we are going to see a little bit of a pickup in the second half, especially as spares picks up. I'm just curious. As far as the customer base, obviously you guys are just printing money in that business. Longer-term, do you think -- and I know you're spending a little bit less in R&D than usual, but are we thinking kind of sustainably that you're within 20% plus for an extended period of time? Or is this kind of an elevated period which maybe is kind of temporary in nature and should come down to a more normalized level?

No, I wouldn't suggest that there's anything necessarily temporary. I think our margin profile has been consistently growing through -- mainly through us, executing in a different way. Increasing our productivity, continuing to look at costs.

You can see the productivity in the aerospace group reading through on down sales and down aftermarket 14%, and the profitability -- that's making money the old-fashioned way.

And the customer base isn't pushing back on it, I guess that's my question.

Again, these are long-term contracts. It's price where we have got niche special technology. You have got a $200,000 brake control on a $200 million plane. It's got to work every time. This is -- the technology on the 787 brake control is in the wheel well operated wirelessly from the cockpit. Never been done before with software as emergency brake backup versus mechanical. This cost $110 million to develop. So, this is niche special -- there's two people in the world who can stop a big commercial airplane. This is --

Fair enough, yes, fair enough. Just last question. So, in R&D, I think you -- I didn't hear, but I remember you said in Q1 that you were expected to step up to 8% aero sales on the R&D front. Do you anticipate it's going to remain around these levels for some time? Or does it drift back to that 10% to 12% that you had previously talked about as the normalized range?

What I would say is engineering is going to be a little bit higher in the second half than it was in the first half. And we've clearly got some nice winds here in the marketplace, so I would expect engineering to go up a little bit. But we manage that and we are careful about it. Some of the big programs we have already won, for example, the 919 has taken a lot longer than what the original schedule was, so that offsets it. We are very sensitive about where that engineering expense needs to be through a combination of making sure we win the right -- win the best programs, make sure we're on the right ones and manage it in a way to produce a good return for our shareholders. We will lay out what that engineering expense is going to be when we do our investor conference in February.

But I think you said for the year around 8%. That's still the view.

It's going to be slightly higher in the second half than in the first half.

Yes, so given that we are seeing some sales decline through the lower aftermarket, it's still going to likely fall in that 8% range. But from an overall dollars perspective, we are pointing to about $35 million in total for the aerospace group.

Fair enough. Great, thank you very much.

You're welcome.

Thank you. And I'm not showing any further questions at this time. I would now like to turn the call back to Richard Koch for any further remarks.

Thank you for joining us today and for your continued interest in Crane. Bye-bye now.

Ladies and gentlemen, thank you for participating in today's conference. This does conclude today's program. You may all disconnect. Everyone have a great day.