Crane Company (CR) Q4 2011 Earnings Report, Transcript and Summary

Ajay Kejriwal - FBR Capital Markets & Co. Robert Barry - UBS

Good day everyone and welcome to Crane’s fourth quarter 2011 earnings conference call. Today’s call is being recorded. At this time I would like to turn the call over to Director of Investor Relations, Mr. Richard Koch. Please go ahead sir.

Thank you operator. Good morning everyone. Welcome to Crane’s fourth quarter 2011 earnings release conference call. I am Dick Koch, Director of Investor Relations. On our call this morning we have Eric Fast, our President and CEO; and 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 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 will be using some non-GAAP numbers, which are reconciled to the comparable GAAP numbers in the table at the end of your press release, which is available on our website at www.craneco.com in the Investor Relations section. Before turning the microphone to Eric, I would like to invite you to attend our Annual Investor Day on Thursday, February 16, in New York City. Please let us know if you wish to attend. Now, let me turn the call over to Eric.

Thank you Dick. Last night we reported 2011 results, which we extended the time horizon of our asbestos liability from 2017 to 2021, reflecting the more stable trends we have experienced over the last several years. In addition, we increased the environmental liability for our legacy Superfund Site in Arizona. Excluding the special item, as outlined in our press release yesterday, Crane’s full year EPS of $3.43 increased 32% from 2011 and was a record for the company, significantly exceeding the $2.80 to $3.00 EPS range that we expected a year ago. The fourth quarter results capped off a very successful year in 2011. Sales grew 10% in the quarter with core sales up 7%. Excluding special items, operating profit increased 26% in the quarter and operating margin was 12.6%, continuing the journey to the 13% margin goal, which we now expect to achieve in 2012. Earnings per share also excluding special items increased 29% versus the fourth quarter of 2010. We are optimistic about our 2012 prospects for our later, longer cycle businesses within the aerospace and electronics and fluid handling. These segments delivered significantly better than anticipated results in 2011 and are positioned to benefit from exposure to the late cycle end markets. We note that these segments accounted for 80% of Crane’s segment operating profit in 2011. Our outlook is relatively stable for our short cycle engineered materials and merchandizing system segments, with the potential for some slight improvements in 2012. Although a slower global economy is a likely scenario as we look forward, Crane is well positioned to achieve profitable growth in 2012. We invested during the 2009 economic downturn, even while we took out cost and we have maintained our customer focus strategy throughout. As we have indicated before, the maturation of the Crane business system, combined with solid management teams is enabling us to execute well and win in the market place. We expect a combination of end market growth, gains in market share and focus on productivity to drive the improved results in 2012. For 2012 sales are expected to increase 3% to 5%, reflecting 5% to 6% core growth and a benefit from the WTA acquisition of less than 1%, partially offset by an unfavorable foreign exchange translation of approximately 2%. We expect EPS to be in the range of $3.75 to $3.95 or a 9% to 15% increase compared to 2011, excluding the special items. Our free cash flow guidance is in the range of $160 million to $190 million. Andrew will now take you through the businesses and provide some additional financial information.

Thank you Eric. I’ll turn now to segment comments, which compare the fourth quarter of 2011 to 2010, before the special items were identified in our press release last night. Aerospace and electronic sales increased 7% to $172 million, while operating profit increased 17% to $39 million. Operating margins improved to 22.6% from 20.7% in the prior year. Sales in the aerospace group increased $13 million or 13% to $108 million. OEM revenue grew 10%, with increases to both commercial and military customers. Sales to business jet OEMs continued their recovery from depressed levels, while sales to large and regional aircraft manufacturers grew more modestly. Aftermarket sale increased 18% reflecting higher sales revenues for both commercial and military applications, as well as higher modernization and upgrade sales, primarily for the C130 Carbon Brake Control upgrade program. Our more traditional aftermarket sales, excluding avenue increased 13% compared to the fourth quarter of 2010. The OEM aftermarket mix was 60% to 40% in the fourth quarter of 2011, compared to a 62% to 38% mix in the fourth quarter of 2010. Operating profits in the aerospace group increased by approximately $9 million, reflecting very good leverage of the higher sales. In the fourth quarter of 2011, aerospace engineering spending was $11 million; the eighth straight quarter of investment at this level and consistent with our targeted development spending range of 10% to 12% of aerospace crude sale. Market conditions in the aerospace industry remain positive, with the International Air Transport Association recently projecting that global passenger demand will grow 4% in 2012, down slightly from it’s previous forecast. We note that cargo demand is expected to be flat in 2012, down from the IATAs previous forecast of 4.2% growth. We expect to achieve higher sales and profit as we benefit from increasing…

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

Thank you. (Operator Instructions) Our first question comes form Deane Dray with Citigroup. Please go ahead with your question.

Thank you. Good morning everyone. The first is more of a comment on the asbestos true-up of what you believe, what tenure liability is and the comment is you all provided terrific disclosures throughout the years, so we are not surprised to see you true this backup to the 10 year, original 10 year estimate. And just based upon the claims and insurance recoveries, that’s actually been – again, a terrific disclosure and it does not raise our eyebrow here in terms of what your liability is, but we appreciate that disclosure.

Thank you Deane.

So the question regarding, where are you seeing is your bias and your exposure to more late cycle markets between the aerospace and fluid handling. So the first question is, can you talk a bit more about your visibility into both the energy market and the ChemPharma code activity, increases in capacity your seeing with the customers; now just give us a sense of that – this late cycle really is gaining traction.

Let me take the first shot at that; Andrew can fill it in. The first thing I look at is our – the heart of fluid handling, which is our process valve business serving ChemPharma and energy and when I look at that, again the heart of fluid handling, our backlogs are up substantially. So that gives me a lot of confidence going into next year. When we look at both projects, and MRO Deane, we track this on a monthly basis and clearly the rate of growth is not as rapid as it was early in the year, its slowed, but we are still seeing year-over-year growth in both our MRO and our project business. So we feel very confident about our process valve and fluid handling business going into 2012.

Are you assuming a lift from pricing in 2012 in this business?

Well, we remain vigilant on pricing and I feel comfortable that our backlog is appropriately priced as we are quite – as you know from following us a long time, we are very disciplined there and we’re – how do I say this Andrew? I don’t anticipate any issues in pricing versus material going into 2012. We did a good job this year, we covered it and I’m confident that we can cover it next year should there be material pressure and imbalance in next year.

That’s helpful and then related to the backlog, you know give the visibility on the valve side, I’m still surprised to see the total backlog is kind of lagging expectations up a percent year-over-year. So it sounds like some of that’s on the aerospace side, but you used to take us through the dynamics on the backlog and why we might not have seen it build to the pace that would suggest at this point in the cycle.

I would just say from – I’ll let Andrew cover aerospace and electronics, but we as a company, I don’t look at total backlog. We look at backlog and our aerospace and electronics and then our fluid handling businesses and that’s where we are really focused and we feel very comfortable with both of those backlogs. The earlier shorter cycle businesses, book and ship businesses Deane, its – I’m just not too sure it helps much to look at those backlogs and I might add, as Andrew said, we expect them to be relatively stable to slightly up next year. So Andrew, you want to comment on aerospace and electronics.

Yes Deane, so we talked a little bit about this over the past year, but you know as we have side, I think – but we certainly said on at least one previous call. We booked some large orders in the fourth quarter of 2010 and a portion of those orders that we booked at the end of 2010 will ship in 2012. We also talked a little bit about, in 2011 we had a couple of sort of one time times where we moved a project out of our electronics backlog related to a program cancellation, that might come back at a future date and we also removed another order from our backlog associated with the contract that more accurately should have been booked over a longer period of time. So a number of factors sort of contribute to the backlog but we believe that the backlog remains at a healthy level and as we stated in our remarks, when we compare where we are today versus where we were a year ago in terms of what we expect to ship in the upcoming year, we are in a pretty similar position. And also, there were several defense-related electronics orders that we thought we’ll receive in Q4 2011 that are now sort of slipping into 2012, but we think it’s a healthy backlog level Deane.

Great, thank you.

Our next question comes form Ajay Kejriwal with FBR Capital. Please go ahead with your question. Ajay Kejriwal – FBR Capital Markets & Co.: Thank you, good morning. Just first may be a clarification on that pension point. So that $20 million for ’12, is that total pension expense number or is that a year-on-year increase?

Ajay, the $20 million is what we expect for total pension expense in 2012. That compares to about $6 million that we spent in 2011, so about a $14 million increase year-over-year. Ajay Kejriwal – FBR Capital Markets & Co.: Got it. And that’s baked into your guidance.

That is baked into the guidance. Ajay Kejriwal – FBR Capital Markets & Co.: Got it, good. Hey, and then on aero margins, obviously very strong in the quarter and I guess part of that’s the mix, but when I think about ‘12, looking at aftermarket continuing to grow, so I guess any color on how should we think about the margin improvement from here. I mean is that 20%, 22%, is that kind of sustainable?

I won’t comment specifically Ajay, except to say that from an overall company perspective, we expect to leverage incremental sales at about a 25% rate and we actually internally try to do a little bit better than that. So I’ll leave it as sort of a general response at this point and then we’ll get into more specifics around the growth in our aerospace sales at our Investor Day next month. Ajay Kejriwal – FBR Capital Markets & Co.: No, that’s fair. But I was wondering if you can may be just talk conceptually about the R&D expense. You’ve done a great job taking that down last couple of years. Has it kind of stabilized at the current rate or you think with new programs that could go up from here?

As we mentioned in our remarks, we’ve had a similar level of R&D spending for the past several quarters and we are very focused on maintaining our R&D as a percentage of aerospace group sales in that 10% to 12% range. There clearly will be programs as we go forward that we’ll need to support and we’ll have to budget accordingly, but we are very confident in communicating a 10% to 12% of sales range for R&D spending going forward. Ajay Kejriwal – FBR Capital Markets & Co.: All right, good. Thank you. Operator Our next question comes from Robert Barry of UBS. Please go ahead with your question. Robert Barry – UBS: Hey guys, good morning.

Good morning.

Good morning. Robert Barry – UBS: First, just a quick follow-up on Deane’s question. When you were talking Eric about the process valves, now that’s kind of the heart were you just referring to the piece that’s not come from supply.

There’s a water and a commercial valve business and it’s – that’s located in the UK or the other three pieces. Robert Barry – UBS: Got you. I was just wondering if you could just expand a little bit on why you are seeing in Europe, kind of how the demand trended there during the quarter and what you’re assuming for growth in the Europe, parts of the business for next year or for ’12.:

You want to frame that answer?

Yes, let me just frame it up a little bit Rob. About 25% to 30% of Crane sales by destination relate to Europe; so that includes the Untied Kingdome. For fluid handling its about 30% that relates to Europe and thinking about our European exposure, about half of it is in the UK and about half in Western Europe, mainly in Germany and as a reminder, our European customer base includes some pretty large companies with global operations and lots of cash which make us feel better. Our sales and earnings guidance in 2012 does include the effect of some softening demand, as well as a somewhat weaker euro. So we built that into guidance as well. But I wanted to just frame up that we are talking about 25% to 30% of the company with the European exposure.

So from a company point of view, since our strategy plans in August and putting together annual plans in fall, we’ve assumed that the European sector was going to go, in the aggregate was going to have a mild recession, zero or negative one percent growth and we’ve incorporated that in our plan. I think the key is, the bulk of what we have in Western Europe is in Germany and the fluid handling business, the bulk of it is with BASF there; the major German industrial companies which are in great shape and feedstock’s getting cheaper, so just how much that’s going to be impacted we’ll have to see, but our customers are in good shape here. We are not dealing with the consumers. Robert Barry – UBS: Yes. A question on aero; you talked about orders slipping. I think you mentioned that the last quarter, maybe the last couple of quarters. I was wondering if you could elaborate on what you attribute that to? You think there is a risk that just continues to happen until there’s clarity on kind of the budget in 2013 and beyond, the defense budget?

I can’t point to anything. I would say it is certainly around the defense budget and again primarily, it really just relates to the electronics business, which is a smaller piece of that segment.

With that we are planning to see orders slip rather than being canceled. Robert Barry – UBS: Yes, that’s fare. And then just finally, I was wondering if you could comment on Money Controls and did that actually growth in 2011? And what’s your exception for Money Controls in 2012.

Well, let me start with saying that the integration of Money Control is on track and we are pleased with our progress. Sales in 2012 declined versus 2011, due in part to lower than expected sales, to retail self-checkout customers that we believe is mainly due to timing. We are still pretty bullish, very bullish on self-checkout and believe it’s a short term versus a long-term issue. In addition Money Controls was impacted by some recently enacted German legislation, which is designed to reduce the number of gaming halls in Berlin, so we’ve seen a bit of an impact there. But as we step back, we are quite positive about our payment solution business. This acquisition has significantly strengthened our business and again, we are quite optimistic about prospects longer term. Robert Barry – UBS: Yes, your assumption is that it will grow in 2012?

Same as the systems, yes. Robert Barry – UBS: Okay, thanks guys.

Our next question comes from Matt Summerville with Keybanc. Please go ahead with your question.

Good morning. Just a couple of questions. I was hopping Andrew we could clarify the pension a little bit more. That seems like a pretty big increase I guess year-over-year. How much did you have to reduce your discount rate? And then given that you had a pretty sizable voluntary contribution on top of some other money you had put in to the plan this year. what does the funded status of that look like at 1231?

Okay, Matt I don’t have the set of discount rates in front of me. We actually have several different plans and each one of them has a slightly different discount rate. But what you’re seeing is the power of a decline in interest rates, in terms of what that does to pension expense. But it is significant and I think we can break out more information on that. When we look at the overall funded level of our plans worldwide, what we talked about at our February, Investor Day when we looked at 2011, we talked about those pension plans that have liabilities greater than assets, we were in an under funded position of about $76 million at that time. When we look at our pension plans with liabilities greater than assets, which is we think is the conservative way to look at this, in an under funded position of about $168 million. So it’s about a $92 million increase versus the end of 2010. That being said, we think this overall funded position is very manageable and we are staying ahead of it, in part by making some discretionary pension contributions. So in terms of framing it up, the overall under funded amount for those plans with liabilities in excess of assets, its about $168 million, very manageable.

The relative size of our pension assets to the size of the company are compared to most, most industrial companies I think is relatively small and keep in mind, in the US we grand fathered our main pension plan, what year was that?

2005.

2005 and put in a defined contribution plan.

Okay. And then with regards to fluid, I just want to make sure I understand what you’re saying. In Europe it sounds like you’re seeing moderation and I want to make sure that I have that adjective correct and that you’re not seeing a decline in your business, but a moderation in growth and then, could you also characterize then what you are seeing. It hasn’t come up from an emerging market standpoint in fluid and then a little more color on order relates in North America there.

I would say. My comment Matt was that we’re seeing a moderation in growth, it’s still growing in our process valve business. I’m trying to remember what the data looked like for Europe, but it was clearly a little bit softer than it was in other parts of the world. But importantly, globally its still growing and we are seeing a continued flow of orders in – certainly in China. Power in India is a little rough, but power in the US is better. You want to give some specific comments Andrew?

I think Matt, just may be fill in a little bit. I think when we look at our refined markets, significantly better than they were at the end of 2010; we probably seen them soften just a little bit. As we mentioned, North American power market is continuing with a very gradual recovery. We are a little cautious about the Asia power market, mainly by what’s happening in India. And when we look at general, industrial and commercial related demand here in the U.S., that’s been pretty stable. Chemical plan activity in the U.S., its remaining pretty strong and softer than Europe and as we talked about, we are seeing a little bit of slowing in order trends, but still strong in the US, a little softer in Europe. Does that help?

Yes. No, I appreciate that. And then I apologize if you already answered this Eric. I think you may have, but I missed it, but I’m going to just ask it again. The defense orders that have been slipping in aerospace I guess why the comfort that after a couple of quarters of slippage those begin to hit the backlog again in Q1. Have you already seen that happen?

It was really just in electronics, not in the airspace group.

Yes, I apologies, yes.

I think the general observation is that we have seen defense related order slip. There are a number of different programs, a lot of programs and its not as though the programs are being canceled, its just the intake of orders has slowed down a bit. So we think its largely timing and there clearly is some uncertainty around the defense part of the project.

Thank you.

(Operator Instructions) Our next question comes from Jeff Sprague with Vertical Research. Please go ahead with your question.

Thank you. Good morning. Just a couple of clean up questions. Just to be clear on the tax rate, when your guidance is using the 30% is that the R&D tax credit’s renewed.

That’s correct Jeff. We are assuming it will be renewed, retroactive to January 1, 2012.

And where would the rate be if it’s not limited?

I don’t know what the answer is to that. It would be a little bit higher Jeff. Let us come back to you with a little bit of an impact.

I guess I would point out on the tax rate – this is Eric. Now last year our guidance for the tax rate was 31% and this year our guidance is 30% for 2012 and that’s due to a lot of good work on international taxes here.

One other thing as I kind of reviewed some information Jeff is that R&D tax credit is not extended. It would probably impact our full year EPS by about a nickel.

Okay. On asbestos, just trying to square up what your showing as your new after tax cash liability and what you said about cash out-the-door, it looks like your assuming roughly kind of a linear burn rate on this over that 10 years. Is that correct and I’m just – at what point do we see this swing start to bend south if you will kind of get the grip to my question. Is there kind of a tailing off process that’s inside, out there and is out here?

My comment would be for assumption purposes we’ve assumed its relatively stable, $40 million to $50 million, with a little bump because of the hole in our insurance in 2012. Personally, over the last decade, when I came to Crane there was a little footnote in the annual report and there was 2,500 claims in the footnote and in 2005 they went up to 89,000 claims and today we’re roughly at 58,000 claims. And the key here is that you can clearly see the stability that we are experiencing in both, and particular in the meso area and there’s actually a slight decline in our total cost over the last three years, which I’m encouraged about. I’m particularly encouraged about the change. What I’m seeing in the case of our developments and I point out most recently that the Supreme Court of California in the 70 decision in the Patrick O’Neill case ruled that equipment manufacturers cannot be held liability for replacement parts or insulation supplied by others. Now this is obviously – we’ve got the same kind of ruling that exists by the Supreme Court in the State of Washington. So I’m sensing a – I feel that there is kind of a change in term events here that are positive. Now that’s not, you know there’s 48 more states to go and some favorable rulings in the other states, but I’m more encouraged than I’ve been for quite some time, both in terms of the case war and the stability. So maybe we’ve been conservative in setting it up with relatively stable after tax, after insurance cash flow for the next 10 years, but that’s what we’ve done.

And one finally just strategically and I know you probably can’t hit this completely head-on, but there is a lot of liquidity out there, right. I mean SPX, a big divestiture today, Dover and IR have been cleaning house, ITT breaking up, Tyco breaking up; the portfolio is coalesced strongly around fluid and aero and electronics. I mean, how do you think about where do we go from here, maybe even like in a multi year framework.

I would say, no change in course. We’ve done a really nice – we’re constantly trimming around the edges, anything that’s small and descript. We’ve done a lot of internal mergers and we feel good about the portfolio. I would say that you can see some very good work that we’ve don’t in controls that’s come through here in 2011 with very strong results. But you won’t see major changes in our portfolio. On the M&A side we continue to hunt and our spending a fair amount of time on it, but it is a competitive market place with relatively high prices. But again, in terms of us doing something on M&A, it will be as I said – I’ve said pretty consistently here, its probably going to be, will be in the areas of fluid handling process valves and possibly our aerospace business, the principal areas of focus. Is that helpful?

Yes, it is. Thank you very much.

I’m not showing any further questions in the queue. I would like to turn it back over to Richard Koch for closing comments.

Thank you very much for joining us today and please let us know if you want to come to our Investor Day. I appreciate it. 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.