Crane Company (CR) Q2 2012 Earnings Report, Transcript and Summary

Good day everyone, and welcome to Crane’s Second Quarter 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 Crane’s second quarter 2012 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. 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 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. On core 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 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 niche technology, we were unable to leverage the business with other parts of Crane. The sale of 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’re 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 condition. 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 counsels is required, as well as appropriate communications to our own people. The repositioning actions are primarily focused…

Thank you Eric. I’ll turn now to the 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 million, while operating profit increased 5% to $39 million. Operating margin improved slightly to 21.8% from 21.7% in the prior year. 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 a 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…

Thank you. (Operator instructions) Our first question comes from Deane Dray of Citi. Your line is open. Matt McConnell – Citi:

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 the – I consider – you know, we have been working on these activities. They have very detailed plans around them and we are moving up particularly manufacturing process, but largely product lines from one existing Crane facility to another, which is dramatically lower cost. So I view these activities as kind of 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 quantify the revenues that it impacts but this to me is you know, just an acceleration of a product movement to reduce cost. Matt McConnell – Citi: Okay, great, and have you said where those new facilities are, and I'm assuming there is…

There is no new facilities involved here. This is moving product from a higher cost location to a lower-cost location in existing Crane plants that we have owned for a long time. Matt McConnell – Citi: Okay, great. Thank you and are there any buffer inventory requirements and is that part of the free cash flow guidance reduction or is…

Inventory issues here are nominal at best.

The free cash flow guidance reduction is very slight. It really just reflects the fact that we are losing a little bit from not having the divested businesses and also some cash flow associated with the restructuring this year. Matt McConnell – Citi: Okay, great.

I would just add that if we use the word repositioning on purpose to reflect in our view relatively modest kind of trimming movement, relatively low-risk activities as opposed to you know, closing major facilities et cetera, et cetera. Matt McConnell – Citi: Right, okay, and is the margin target for fluid is that down just because of its energy piece, it is being restructured or are there any other headwinds in that business that are worth calling out, any update on price cost or anything else?

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 the tax we've got a concern about the European markets and the tax, those costs principally in energy but other parts of fluid handling as well. Matt McConnell – Citi: Okay, great. Thanks very much.

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.

Good morning. Robert Barry – UBS: Thanks by the way for all the added disclosure in the release and on the call today. I appreciate it. So I just, you know, wanted to follow up on a few things in fluid. First of all it sounds like there is 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 kind of labor protocols and working through the working counsels and as I said we thought we could get some this year, but really working through that process, it is going as planned but it's just taking longer than anticipated. That being said there are activities that we are implementing both in energy and throughout Fluid Handling with respect to reduction in temporary workers, contractors, overtime, travel, discretionary spend. They are 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 cost in this year. Robert Barry – UBS: Yes, 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 that half of that is from better revenue and half of that is from just other productivity things, belt tightening kind of stuff is that right?

Just that I mentioned, I mean there is very specific productivity plans throughout the Fluid Handling organization, and again related to those items that I mentioned that our well underway. Robert Barry – UBS: Yes, and so I guess my question would be just maybe tough to answer but you know, it sounds like half of the expected improvement is related to revenue and as you called out in the prepared remarks there is, you know, projects being pushed out, there is obviously macro weakness in Europe. I mean, you do have a very good backlog going into third quarter. So, I don't know how you're thinking about the kind of over or under on that $5 million from the revenue related piece.

We are 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 if you and our backlog still up $20 million. So you got a good backlog going into certainly the third quarter and that backlog runs you know, 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 is not risk, but we wouldn't have said we expect revenues to be up to $20 million unless we felt we can do that, but I would acknowledge some risk there. I don't think there is risk in our reducing costs. We are pretty good about those activities. Robert Barry – UBS: Okay, just finally shifting focus to Aero, I mean, off to a pretty good start there. You know, you raised the guidance but it still implies only about 3%, 3.5% revenue growth in the back half versus you know, about 6% in the first half. Is that deceleration, it sounded like perhaps related to caution on after-market, and if so can you just share some thoughts on what you're seeing in after-market, and if there is anything else causing that deceleration as well. Thank you.

Yes, Robert, let me just comment on the after-market. You know, as we mentioned in the remarks commercial spares have flattened out for us, and we think you know, some customers are working off of inventories, likely driven by some over provisioning in 2011, but for us helped by, you know, our strong M&U sales we expect the total after-market 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. Robert Barry – UBS: Great, thanks a lot guys.

Matt Summerville – KeyBanc Capital Markets: Good morning. Couple of 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.

What you said is true Matt. You know, we have seen some of those prices come down and you know, there is some potential benefit of some input cost upside on the back half of the year. We have 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 you know, it's primarily styrene in Engineered Materials. That is a little help, but it's not – it is more of the margin here in the third quarter from what I can see. It takes a while for them to read through, and I would say the same with you know, steel and copper as it just takes a lot of work to the system and your inventory. So I don't see much help in the third quarter. Matt there might be a little bit more in the fourth. Matt Summerville – KeyBanc Capital Markets: Okay, and then with regards to the backlog in 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 or worse rate than what you entered. Can you kind of 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. Matt Summerville – KeyBanc Capital Markets: Okay great, and then…

Still growth but the rate of growth, particularly in MRO is much reduced. Matt Summerville – KeyBanc Capital Markets: Given the dynamics you mentioned there Eric, and how they are playing out, would you expect backlog then in your business because 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 some sort of -- see if there is some sort of expectation there for the back half.

I don't know how to answer that. I think we -- in fluid handing we can feel comfortable about the revenues that we've got. I'm less comfortable with kind of articulating where we end up in backlog at this point. Matt Summerville – KeyBanc Capital Markets: Okay, and then just one more for Andrew, what euro-dollar exchange rate are you using in your current updated you know, FX guidance for Crane?

We use the month-end May rates, which is about $1.24. So we are pretty close to those levels if you touch on this. Matt Summerville – KeyBanc Capital Markets: Great, thank you.

Thank you.

(Operator instructions) Our next question is from Ronald Epstein of Banc of America/Merrill Lynch. Your line is open. Ronald Epstein – America/Merrill Lynch: Hello, good morning guys.

Good morning. Ronald Epstein – America/Merrill Lynch: So Eric, since we met over at Farnborough just a couple of weeks ago.

Right. Ronald Epstein – America/Merrill Lynch: Has anything changed from kind of the economic backdrop and are you feeling any more optimistic, less optimistic?

You know, 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 their ground. And my concern, so I see continuing very slow growth in the United States and globally slowing economy and the concern is I articulated at the Airshow is that financial institutions in corporate America facing that will continue to -- would start trimming discretionary spending and reducing headcount, and I think you participate in all the calls. I mean, we clearly are tightening our belts here, positioning ourselves, making sure we’re well positioned for 2013. I would just you know, it's not clear to me yet what all the other companies are but in that scenario I think that's prudent and we’re doing it. Ronald Epstein – America/Merrill Lynch: Yes, that’s great. Thank you Eric for, you know, the comments. All right, 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 will talk to you in October if not before at one of the conferences. Thank you. Bye-bye.

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