Crane Company (CR) Q1 2012 Earnings Report, Transcript and Summary

Good afternoon, and welcome to Crane’s First Quarter Earning 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 first quarter 2012 earnings release conference call. I am Dick Koch, Director of Investor Relations. On our call we have Eric Fast, our President and CEO; and Andrew Krawitt, our Principal Financial Officer. We will start off our call with a few prepared remarks, after which we will respond to questions. Just as 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 the 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. Now, let me turn the call over to Eric.

Thank you, Dick. Crane is off to a good start in 2012 with improved first quarter results driven by our Aerospace & Electronics and Fluid Handling segment. Sales grew 8% in the quarter with core sales also up 8%. Operating margin rose slightly to 12.1% from 11.9% a year ago, and earnings per share increased 8% to $0.88, a first quarter record. Excluding a $0.05 gain in the first quarter of 2011 related to the sale of a building and divestiture of a small product lines, EPS increased approximately 15%. Demand is robust and our late long cycle businesses with Aerospace and Fluid Handling and our backlog has increased accordingly. Notwithstanding, a relatively minor patent litigation settlement and merchandising systems and some efficiencies in certain Fluid Handling European operations, we remain optimistic about our 2012 prospects and are on track to deliver results consistent with the full year guidance that we provided in February. As you know, we don’t provide quarterly guidance. Our Aerospace Group is benefiting from increased OEM build rates and continued growth in passenger miles flown. Fluid Handling is positioned to benefit from its exposure to late cycle end markets, particularly in Energy and ChemPharma as evidenced by strong orders in growing backlog during the first quarter. As we indicated in February, our outlook is relatively stable for Electronics, Engineer Materials, and Merchandising Systems businesses. We continue to make investments to drive profitable growth. Our initiative is to increase sales on marketing sophistication and formalize sales processes progressing well. We remain focused on international opportunities across the company, in part by leveraging our expanded Fluid Handling infrastructure. We have implemented a rigorous approach for new product development to facilitate successful product launches. Importantly, we are focused on driving sales to our existing facilities, so that we can leverage our fixed cost base. In order to fund these initiatives, Crane has a productivity framework that is designed to make room before we invest. There has long been a cost conscious culture at Crane, and we are effectively transforming this into a productivity culture in order to drive cost reduction every year while improving operating efficiencies. This enables us to make investments we need to drive growth while at the same time allowing for margin expansion. 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 first quarter of 2012 to 2011. Aerospace and electronics sales increased 8% to $175 million, while operating profit increased 12% to $38 million. Operating margins improved to 21.7% from 21% in the prior year. Sales in the aerospace group increased $10 million or 10% to $109 million. OEM revenue grew 14% with increases to both commercial and military customers. We saw strong sales growth to business jet OEMs and large aircraft manufacturers while sales to regional aircraft manufacturers grew only slightly. After-market sales increased 6%, primarily driven by higher commercial repair and overhaul business. The OEM after-market mix was 61% to 39% in the first quarter of 2012 compared to a 59% to 41% mix in the first quarter of 2011. Operating profit in the aerospace group increased by approximately $5 million reflecting good leverage of the higher sales. Market conditions in the aerospace industry remain positive despite high fuel prices. The international air transport association recently projected that global passenger demand will grow 4% in 2012, while cargo demand is expected to turn up slightly in the second half. We expect to benefit from higher OEM build rates, increased sales from new products as outlined on investor day, and an expanded global sales force. The electronics group sales increased $3 million or 5% to $66 million. Electronics operating profit decreased approximately $1 million as operating margin returned to a more normal mid-teens level from a higher margin in the prior year due to product mix. In 2012, we continued to forecast reasonably stable results from the electronics group with growth in our commercial business expected to offset a slight decline in defense-related sales. Aerospace and electronics backlog was $438 million at the end of the first quarter.…

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

(Operator Instructions) Our first question comes from Deane Dray of Citigroup. Your line is open. James Banks – Citigroup: Hi, good morning, James Banks filling in for Deane. The legal cost in merchandizing in the quarter, from what you said, I’m assuming you are not able to disclose the amount but was that a cost or settlement? I’m just trying to gauge whether or not it’s going to recur or is that done with?

James, it’s a settlement, it’s a one-time settlement in the quarter that we incurred the cost in the quarter. So we would view this issue as being behind us. James Banks – Citigroup: Okay. So if you – if we go to the second quarter through the fourth quarter of this year and we look at it on a year-over-year basis, we should suspect margin improvement similar to what you guys have said in the past? I know you don’t give quarterly guidance, but I’m just trying to dig deeper into the margin impact from that.

James, we’re comfortable with our full-year guidance here, I think – just – let me put some more color on this because I think some others may have some questions on this, as well. We agreed to settle a long-standing patent litigation issue in the quarter. Other terms of the agreement are confidential. I reminded people a little bit earlier that we had $1.7 million of inventory step-up costs related to the acquisition or money controls in the first quarter of 2011. And as we’ve been discussing, we incurred some costs in the first quarter of 2012 to settle this patent litigation issue. I think the important thing to focus on here is that productivity improvements offset the underlying volume decline. And, we mention it because absent the settlement results for the segment would have been a bit better. But it’s not – it’s not a significant enough amount to affect our guidance for the full year for this segment. And we’re comfortable with our full-year guidance for merchandising systems. James Banks – Citigroup: Okay, that’s very helpful, thank you. And just on fluid if I could, I feel as though the throughput inefficiency, it happened before. If you could help me remember – I believe it was in the second quarter of last year and again with the Energy segment. Is it still that same issue that’s come back up again?

We did mention some issues related to our Energy business in the fourth quarter of 2010. What I’ll say, James is that we’re addressing the situation... James Banks – Citigroup: Okay.

And we’re actively analyzing several of our operations in Europe, particularly in light of, the economic uncertainty in that region. And to put a little more color on it, in some cases we’ve added some costs to support higher volumes. James Banks – Citigroup: Right.

In other cases, we have some facilities that are in suboptimal cost positions because of lower volumes. So, not only are we scrubbing our productivity initiatives here, we’re also, as we do in a normal course of business assess opportunities to right size our staffing levels and facilities and improve our cost positions. So we’re continuing to look at this. James Banks – Citigroup: Okay, great. All right, that’s all I have. I’ll jump back in queue. Thank you.

Thank you. Our next question comes from Robert Barry of UBS. Your line is open. Robert Barry – UBS: Hi, guys, good morning.

Good morning. Robert Barry – UBS: I just wanted to follow-up on the fluid. I think it was Krombach that you were referring to in the fourth quarter of, was it 2010?

That’s correct. Robert Barry – UBS: And just to be clear, I think you said that the issue was confined to Energy. I think Energy’s about a quarter of the segment. Is that right?

That’s approximately correct, right. Robert Barry – UBS: And that if you put that aside, the margins on the remaining 75% was tracking at about 15%. Is that what you said just to clarify?

We said we would have met our 15% target in the first quarter absent the Energy piece of fluid handling. Robert Barry – UBS: Okay. And it sounds like it will take another quarter to kind of rectify the situation in Energy and then is it fair to assume that in the back half, kind of all the components of that fluid segment will be operating at about the 15% level? Is that a fair interpretation?

Well, our full-year guidance for fluid handling is 14%. So we’re not – we’re still very comfortable with that guidance. And I think to the extent that we expect to have the improvement in the second half of the year rather than in the second quarter is a fair statement. On a full-year basis, we expect to be in line with our full-year guidance of 14%.

Let me – this is Eric, let me say this. First off, we say primarily Energy. It’s certain of our European businesses, these are plants that we thought we made more progress in than we actually had, not just isolated a combat plant, one of them happens to be a Krombach plant. So we haven’t made – it’s not that we slid back, we hadn’t made the progress. So when we put the volume in, we didn’t get the margins. From my point of view, we’ve clearly identified the issues. We’ve got a dedicated team focused on these issues. It is going to – I think, this is a proper assumptions, it’s going to take us through the second quarter to work through the majority of them. We do expect a strong second half in margins. It’s going to be a little bit tougher to achieve, but we remain on target with our Investor Day guidance with Fluid Handling which was our head operating margins slightly above up 14%. So, it’s going to be a tougher stretch, but based on our latest thinking, we think we’re still on target there. This is the way I would characterize it. I’d also remind you that our margins in Fluid Handling, if you go back and look at the last couple of years, I mean, they are not just steadily going up. I mean, yes, we have gone from in 2010 10.3%, ‘11, 11.13 – excuse me, in 2011, it was up 13.3%, in 2012, we’re guiding to slightly better than 14%. But during ‘11, for example, every quarter they fluctuated as much as a half of a margin point. And there’s some seasonality here. It depends on the volumes you put in the plan. From my perspective, I think what’s important here is that we are on track, it’s going to be a little bit tougher, but we still think we can get to 14% margins for the Fluid Handling. Robert Barry – UBS: Yeah. So whenever you gave the outlook at Investor Day –

Yeah. Robert Barry – UBS: That was already in February, right? So did that contemplate some weakness here in the first quarter?

First off, we don’t give quarterly guidance, right? I think that’s important. I do feel that – I would go back and say it the way I said it – we had thought we had made more progress here than we actually did. It’s not that we slid back; it’s just that we hadn’t made as much progress. The good news here is that we have the orders. Robert Barry – UBS: Yeah.

If you don’t have orders, that’s a – that’s a tough act to deal with. And I’m comfortable with the pricing. And we can – we have identified in our and are dealing are the cost. Robert Barry – UBS: Okay. And then just maybe one last one on Aero, if you’d have asked me where I thought the risk was in the quarter, I thought it would have been on the Aero side just given the tough comps you have and you were only guiding to 3% revenue growth, but you did 8%. And as we look to the back half of the year, the comps get a little bit easier. So is that 3% now just looking very conservative or is there some product cadence or something else that we should be aware of that – that may not make the 3% as conservative as it looks given you just posted 8?

Rob, I would say that we’re comfortable with our full year guidance. I would actually suggest that maybe our comps get a little bit tougher as we go through the year when we look at our overlaps. So, we’re pleased with the quarter. I think from a full year perspective, we’re comfortable with where we are in our guidance. Robert Barry – UBS: Okay. Thank you.

Our next question comes from Matt Summerville of KeyBanc. Your line is open. Matt Summerville – KeyBanc: Eric, just to follow-up on the Fluid Handling issue, can you talk about if there’s one-time cost to fix this issue? If so, are you able to ballpark that, how much has been incurred? And I guess, what is the actual issue? Is it quality, is it on-time delivery, is it throughput? Are you incurring customer penalties? Can you give us a little bit more of an idea in terms of just how big of an issue this is?

I’m going to let Andrew deal with it.

Matt, the issues we’re facing in Europe include inefficiencies related to past due deliveries, higher scrap in the associated rework, labor, some expedited freight charge for certain items like castings. There are a few plants involved, primarily in Germany and mostly related to our energy business, but we also have a plant in the U.K. that we’re dealing with some cost issues. And as I mentioned earlier, we’re developing plans to address and we really expect that in the second half results will show improvement. And I’ll also bring it back to just remind everybody that the rest of our fluid handling segment is on track. And we’re very comfortable with the guidance that we provided.

Matt, of course there’s some one-time, but there’s some ongoing, and we tell – the way I’ve chosen to deal with this is to kind of reaffirm that we think we can get to the 14% margin target for the full year for fluid handling as opposed to trying to dig through the details on what’s one time, what’s not one time, and etcetera. Matt Summerville – KeyBanc: Suffice it to say though, Eric, the reiteration of that guidance would mean that you’ve incorporated any costs associated with remediating or fixing this issue. That’s in your guidance now.

We have just reaffirmed our overall Crane Co. guidance here in our press release. Let me leave it that way. Matt Summerville – KeyBanc: And then I want to ask a question on the engineer materials business. When you look at the RVIA numbers and what Act reports on reefer shipments, the numbers aren’t necessarily lining up with the organic volume you experienced in Q1. Was that more that your OEM customers are taking down their work in process inventory? I think something was mentioned from a competitive standpoint in the truck/trailer business. So can you talk about that, please?

Yeah. Matt, a few different issues combined to result in the sales decline which we think is partly timing related. And to give you a sense for that, there were some design changes at some of our accounts and some rescheduling of orders. In one case there was a customer assembly problem unrelated to Crane’s product. So there is some timing there. That being said, we are experiencing some competitive pressure from lower cost providers, which is also a factor here. So you know, we think – on a full-year basis, we’re going to be, you know, we’re comfortable with where we are in guidance. And some of this is timing, some of its competitive pressure. Matt Summerville – KeyBanc: And then I just wanted to see if you guys could talk about – you mentioned specifically chem pharma and energy is kind of driving the backlog higher in fluid. I guess how do you feel about the sustainability in backlog trajectory? And then can you also talk about what you’re seeing from a demand standpoint in your non-res, general industrial type of end market that you put in that pie chart on fluid.

We feel very comfortable with trends in the backlog. And obviously, I mean that would be a major factor in terms of reaffirming our guidance up for the year. I can – I can take – maybe take people through what we generally think about our markets. And specifically, you asked about the general industrial markets. I would say it’s stable with fairly stable project activity’s a bit higher in the U.S. from a general industrial perspective. Would it be helpful for me to go through some of the other markets and the ones with more color? Matt Summerville – KeyBanc: Sure.

Our refining markets are starting to pick up. And we’re seeing capital budgets open up for projects in the refining arena. In North American power, the market is somewhat sluggish. Our MRO quoting activity is fairly flat versus a year ago. We remain cautious about Asia power markets as we mentioned last quarter, and this is driven by a slowdown in demand from India. A bright spot here is chemical plant activity. Particularly in the U.S. remained strong. And given the lower feedstock costs, we think export demand is growing. I mentioned general industrial related demand is fairly stable. Commercial construction is relatively flat, but we continue to gain distributor share. And then just to touch on a few of the markets outside of the U.S., in the U.K., the water and building services markets are fairly stable. And in Canada, construction activity is also reasonably stable supporting our distribution business up there.

Matt, from my perspective, you know, we grew core sales 14%, and the backlog is up – what was the backlog? 11%. This was pretty – this is not coming from one place. This is pretty broad based, both project and MRO activity. And I think, frankly, there’s a fair chunk of it that’s market share wins that we have got from expanded presence that we have globally and some of the new products. Matt Summerville – KeyBanc: Thanks, guys.

Okay.

Thank you. (Operator Instructions) And I’m showing no questions in the queue at this time. I’ll hand the call back. Thank you.

Okay. Well, thank you very much for joining us today and your continuing interest in Crane. Thank you and good bye.

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