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Crane Co. (NYSE:CR)

Q4 2008 Earnings Call

January 27, 2009 10:00 am ET

Executives

Richard Koch - Director of IR

Eric Fast - President and CEO

Tim MacCarrick - VP and CFO.

Analysts

Shannon O'Callaghan - Barclays

Matt Summerville - KeyBanc

Wendy Caplan - Wachovia

Operator

Good day everyone and welcome to today's Crane's fourth quarter 2008 earnings results conference call. Today's conference 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.

Richard Koch

Thank you operator. Good morning, everyone. Welcome to Crane's fourth quarter 2008 earnings release conference call. I'm Dick Koch, Director of Investor Relations. On our call this morning we have Eric Fast, our President and CEO, and Tim MacCarrick, our Vice President and CFO.

We will start off our call with a few prepared remarks after which we will respond to questions. Just as a reminder, the comments we make on this call may include some forward-looking statements. We would 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 our press release which is available on our website at www.craneco.com in the Investor Relations section.

As another reminder, we will hold our annual investor conference on February 19 in New York City from 8:30 until noon. Eric, Tim, and the Group Presidents will be sharing their outlook and strategies for 2009. Please contact me if you would like to attend.

Now, let me turn the call over to Eric.

Eric Fast

Thank, Dick. Last night we reported a fourth quarter 2008 net loss of $8.3 million or $0.14 per share, compared with fourth quarter 2007 net income of $45.2 million or $0.74 per share. Fourth quarter 2008 results were adversely impacted by an after-tax restructuring charge of $25.7 million, $0.44 per share, and an after-tax environmental provision of $15.8 million, $0.27 per share.

Excluding special items in both years, fourth quarter net income was $33.2 million or $0.56 per diluted share, compared to $47.3 million or $0.77 per diluted share in the fourth quarter of 2007. Full year earnings per share, excluding special items in both years were $2.93 in 2008, as compared to $3.19 in 2007.

I believe the company is well positioned given the current credit crisis and sharp downturn in economic activity. Over the past several years, we have been very disciplined in our acquisitions and allocation of capital which has resulted in a continuing strong balance sheet with excellent liquidity.

As you saw in our press release, we ended the year with $232 million in cash; a $300 million committed revolving facility, and debt maturities that are far out in the future.

While the economic decline clearly accelerated in the fourth quarter, several of our short-cycle businesses, particularly Engineered Materials and Vending began to feel the slowdown earlier in the year, and we have taken significant steps to reduce costs in those businesses.

Overall, employment levels were reduced 34% in Engineered Materials and 16% in North American Vending and general expense reduction programs were implemented.

With the accelerated decline in economic activity in the fourth quarter reflected in our core sales decline of 7%, we increased the size of our Restructuring Program and initiated general spending reductions across the company. With the $37 million in savings from the Restructuring Program, expected reductions in Aerospace Engineering from the completion of key milestones on several large development programs and our overall cost containment efforts, savings in 2009 will approach $75 million.

Our earnings per shares guidance of $2.10 to $2.40 per share reflects the considerable uncertainty in the economy and the end markets we serve. However, with strong discipline in our working capital management, we expect free cash flow to exceed the $146 million achieved in 2008.

While executing on the Restructuring Program, our focus in 2009 will be winning in the marketplace. Our plans are to maintain our customer-facing activities, continue to drive our operational excellence programs, accelerate the introduction of new products to win market share, and selectively and carefully make acquisitions.

We have continued to invest in our sales and manufacturing capabilities in Fluid Handling with our new regional sales office in Dubai, we have increased our customer focus in the Middle East, and deployed additional sales personnel in Asia and CIS as well.

Our presence in Eastern Europe was enhanced by the December '08 acquisition of the Krombach group, a leading manufacturer of leading manufacturer of specialty valve flow solutions for the power, oil and gas, and chemical markets, and provides our expanded global sales force with additional products. Krombach greatly expands our capability to make large valves, and we now have production capability for valves up to 11 feet in diameter.

In Merchandising Systems, we are looking to take market share with our successful glass front machines at the major bottlers and the new merchant snack machine with full line operators. The new Currenza c2 is being introduced this spring, and will be our new global coil validation offering.

Within our Aerospace business during the fourth quarter we've reached key milestones for the 787 program, including delivery of initial hardware and software for first flight, and expect to complete a version for commercial application during the second quarter.

We do expect that there will be modifications to the products we have delivered as information from the test flight and other analysis is completed. However, absent new major change requests, development spending will be reduced substantially in 2009.

No doubt, 2009 will be an extremely challenging year with considerable uncertainties. However, I am confident in our ability to execute our plans successfully. Now, let me turn the call over to Tim MacCarrick, who will provide additional details on our fourth quarter results, strong liquidity position and cost focus in 2009.

Tim MacCarrick

Thank you, Eric. Turning now to specific segment comments, including operating profit results before restructuring charges which compare the fourth quarter of 2008 with 2007. Aerospace Group sales of $93.6 million decreased $1.7 million or 2% from $95.3 million in the prior-year period.

OEM sales declined 4% compared to the fourth quarter 2007, and after-market sales were flat on a comparable basis. The OEM after-market mix was 59% to 41%, compared to last year's fourth quarter of 60% to 40%.

Operating profit in Aerospace declined $3.8 million, primarily reflecting the $6.8 million increase in engineering expense due to the heavy investments in the 787, and the A400M and lower OEM sales from the Boeing strike, partially offset by cost reductions.

In the fourth quarter of 2008, our Aerospace engineering spending was $28 million, compared to third quarter 2008 spending of $33 million and $21 million in the fourth quarter of 2007.

This engineering spend, all of which is expensed, is due to the heavy investment in 787 and A400M programs. The decline in engineering spending from the third to the fourth quarter reflects the delivery of key parts of the 787 and A400M programs, and the scaling back of the number of contract engineers, overtime, expediting in other costs.

Our Aerospace engineering spending was about 27% of sales in 2008, and we anticipate, this should begin to decline in the second half of 2009, during a transition year in which we expect the 787 to commence test flights. This would provide us with about a $50 million pretax tailwind to our operating profit from 2008 to 2010, based on 2008 sales levels. We expect that we will realize about half that benefit in 2009, which will help mitigate the effects of expected lower aftermarket sales.

Our engineering spending on the Boeing 787 and the A400M accounted for about 65% of our engineering expense of $111 million this year. As we mentioned on previous calls, we are in dialogue with certain customers concerning cost recoveries for engineering work, and those discussions are continuing.

Electronics Group sales of $61 million decreased $5 million or 8%, largely because of lower sales in our power business. As a result, Electronics Group operating profit declined $3 million, compared to the fourth quarter of 2007. Orders in the fourth quarter exceeded sales by $3.6 million and backlog was up 12% over December 2007.

In the fourth quarter, Engineered Materials core sales decreased $33 million or 45%, reflecting substantially lower volumes and further deterioration in our end markets from that experienced in the third quarter.

In the fourth quarter of 2008, we experienced a 72% decline in sales to our recreational vehicle customers, off considerably from the 49% decline in the third quarter, a 30% decline in sales to transportation-related customers, consistent with reduced trailer build rates and a 19% decline in sales to our building products customers.

Engineered Materials posted an operating loss of $0.8 million, compared to an operating profit of $8.6 million in the fourth quarter of 2007. As Eric mentioned, we have reduced employment levels in the last year by 34%, and in addition, a significant part of the Restructuring Program relates to facility rationalization in Engineered Materials.

Further cost reduction efforts are being implemented, reflecting, what are expected to be ongoing depressed markets.

Overall, segment sales in Merchandising Systems declined 15% compared to the fourth quarter of 2007, reflecting continued difficult market conditions in Vending. Operating profit decreased $6 million or 67%, and the operating margins declined six margin points to 3.6%, reflecting lower sales, cost inflation and unfavorable sales mix.

The difficult economy has impacted demand for both our Vending and Payment Systems products. As a result of this slowing demand, particularly during the second half of the year, we have reduced employment levels by about 14%, compared with the beginning of 2008.

For the full year 2008, Merchandising Systems operating profit was $45 million, consistent with our February 2008 guidance. Our full-year 2008 margin of 11.2% exceeded our guidance of 10.7%.

Fluid Handling, which represents 45% of Crane's total sales, had a slight increase in operating profit, despite a $22 million reduction in sales. Core sales were essentially flat as the fourth quarter sales decrease was primarily driven by a $32 million of unfavorable foreign currency translation, partially offset by $11 million of sales from the Delta Fluid Products and Krombach acquisitions.

I would note that Fluid Handling operating margins in the first half were extremely strong, exceeding 15% in both the first and second quarters. As we said on the third-quarter conference call, we expected fourth-quarter operating profit to increase from third quarter levels as we cleared a number of delayed shipments.

Our fourth quarter operating profit increased $3.9 million or 11% compared to the third quarter. Margins also improved to 13.9% in the fourth quarter of 2008 from 11.9% in the third quarter of 2008, and 12.7% in the fourth quarter of 2007, driven by pricing discipline, productivity and favorable sales mix.

For the full year 2008, Fluid Handling operating profit was $165 million, exceeding our February 2008 guidance of $162 million. Our full year 2008 margin of 14.2% also exceeded our guidance of 13.2%.

In December 2007, we announced our intention to close two foundries which resulted in the shutdown of our Ipswich, England plant last June, and we expect to close our Bradford, Canada facility in the first quarter of 2009.

These are important steps to increase our low cost country sourcing of castings, and drive profitability in 2009. We previously disclosed that these actions would favorably affect margins by approximately 75 basis points in 2009. Fluid Handling backlog increased $60 million over December 2007, and includes $57 million associated with the Krombach and Delta Fluid acquisitions in 2008.

We continue to see certain customers pushing out shipment dates. Demand is trending lower as chemical companies have announced substantial layoffs and temporary or permanent closure of facilities; and the oil and gas industries are slowing as the price of energy has declined substantially. We've also seen demand moderating for valves for the pharmaceutical, building products and services industries, as well as at Crane Supply in Canada.

In light of further deterioration in the US and global economy and its impact on Crane's end markets during the fourth quarter; we expanded the scope and size of the Restructuring Program, resulting in a charge of $40.7 million pretax.

The restructuring actions reflect a broad-based program to align the company's cost base to market conditions, and include several facility consolidations, severance and other related costs.

Certain actions involved in this program are confidential, highly sensitive, and have not yet been communicated to various parties, and accordingly, further details cannot be shared on this call. However, we will provide details at our investor conference on February 19th.

We expect to record an additional charge in 2009 of approximately $15 million pretax, related to the Restructuring Program. Savings associated with the Restructuring Program actions are expected to be $37 million in 2009, and on an annualized basis, should exceed $50 million.

The restructuring program, together with an anticipated reduction in Aerospace engineering spending, and other ongoing general cost reduction efforts will result in pretax year-over-year savings approaching $75 million in 2009.

Core revenue for 2009 is expected to decline approximately 7% with lower demand anticipated across each of the five business segments. The wide range of our 2009 earnings per share guidance of $2.10 to $2.40 reflects considerable uncertainty about the global economy.

The guidance reflects headwinds from pension expense of $20 million and foreign exchange of $28 million, and assumes an estimated annual tax rate of approximately 30%. The guidance also includes the previously mentioned additional charge in 2009 of approximately $15 million pretax related to the Restructuring Program, and integration costs associated with the Krombach acquisition.

The guidance further assumes that development activities in connection with the current design of the Boeing 787 brake control system will be substantially completed in the spring of 2009, resulting in a decrease in Aerospace engineering spending.

I would note that our earnings in the first half of 2009 are expected to be substantially lower than the second half of the year, reflecting the very difficult current economic conditions, and because the full benefit of the cost savings initiatives, restructuring efforts and the anticipated reduction in Aerospace engineering spending will not be realized until the latter part of 2009. We will provide additional details on this guidance at our Investor Day in February.

The fourth quarter tax rate before special items was 20% compared to 24% in the fourth quarter of 2007, driven by the entire 2008 impact of the R&D tax credit, which was recorded in the fourth quarter of 2008.

For the year, the tax rate before special items was 29% in both 2007 and 2008. Our balance sheet remained strong, and we ended the quarter with $232 million in cash. We have no significant near-term debt maturing, as half of our long-term debt of $398 million is due in 2013 and the other half is due in 2036.

On a full-year basis, 2008 cash flow provided by operating activities was $191 million. This compares to $233 million in 2007, which was favorably affected by an asbestos-related insurance receipt of $32 million.

However, cash flow before asbestos-related payments, net of insurance recoveries was $249 million in 2008, compared to $243 million in 2007. Our 2008 free cash flow of $146 million exceeded our October guidance of $130 million.

We remain sharply focused on cash flow from operations during this time of economic uncertainty through continued diligence on credit, collections and inventory management. We anticipate that our capital spending will be substantially reduced in 2009 compared with the $45 million spent in 2008, and we will provide a more precise estimate at our Investor Day.

Now back to you, Dick.

Richard Koch

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

Question-and-Answer Session

Operator

Thank you, sir. (Operator Instructions) And our first question comes from Shannon O'Callaghan with Barclays. Please go ahead.

Shannon O'Callaghan - Barclays

Good morning. Can I ask you to start by just filling out the comment around the first half, second half a little bit and can you frame the substantially lower comment a little bit?

Eric Fast

Shannon, this is Eric. We're going to wait till our February conference to lay that out and lay out the whole picture on 2009, and I would like just to leave it at the way we did which was, it's substantially less in the first half than the second half. Again, a big piece of that is our engineering spends, because the 787 will go into the second quarter so that spend doesn't start to reduce till the second half. And secondly, a number of the restructuring initiatives, which we need to keep confidential, some of those activities don't occur again until well into the year.

Shannon O'Callaghan - Barclays

Okay. So, it's fair to say, we're going to be tracking well below the low end of your range in terms of declines in the first half of the year, in terms of percentage declines, and then maybe above it at the end of the year?

Eric Fast

Again, I prefer to leave it the way we did, Shannon.

Shannon O'Callaghan - Barclays

Okay. How about on Fluid, you mentioned some of the weakness there, I mean you called out the backlog, but it had the Krombach acquisition in there. What are the core underlying order and backlog trends?

Eric Fast

I think we're seeing what everybody else in industry is seeing. We're seeing pressure on all of our short-cycle businesses for orders. And we're seeing the big projects globally pushed out or readjusted or downsized. That being said, there continues to be a fair amount of project activity out there. And I think partially it's reflected in the fact that we build out that global sales force. And I think, we've got better presence and a better client [effort], but no different than anybody else is seeing.

Shannon O'Callaghan - Barclays

How about on pricing? Pricing's been a big positive. Are you're starting to see pushback on that or any pricing pressure coming at you?

Eric Fast

Our pricing in Fluid Handling continued to be positive versus material costs, somewhat less positive as it was in the second and third quarter. Our goals as we think about 2009, I think for planning purposes, we're not assuming much benefit from pricing. But we are assuming, and we do have aggressive plans to attack material costs. So, we're going to look to hold pricing in 2009.

Shannon O'Callaghan - Barclays

Okay. Engineered Materials -- clearly, you're not saying it looks like it’s going to better soon there. So, just in terms of going after these cost actions, how are you thinking about the profitability of that business in terms of what's the path back to breakeven as this used to be a very high margin business. So, how are you thinking about the plan going forward there?

Eric Fast

The first thing we're doing is, aggressively attacking costs, both in terms of headcount and in terms of the restructuring with potential facility rationalizations. And I'm going to leave it at that because we owe it to our own people to talk to them first. So, we'll aggressively start to get at the gross margin issue. And then strategically, we're maintaining our customer facing activity. So, we've got a number of new products that we're working on, whether it's the composite floors for RVs and all-composite floors for trucking, the all-composite floor for RVs, the all-composite truck body, spending more time focusing on international activities, as well as new applications for composite. So, we need to clearly look about how we get out of the box, a little bit of our traditional market.

Shannon O'Callaghan - Barclays

Do these cost actions get you back in a positive territory quickly or is it going to get worse before it gets better?

Eric Fast

In our February investor conference, we're going to layout, and I apologize for putting this off, but this has been our practice for the last three years. We will give you sales and Op guidance by segment, even though it's difficult this year at our February investor conference, as well as to build the business model and strategic case around that Shannon. I'd rather do it for the whole company at one time and have the heads of the businesses lay it out for you.

Shannon O'Callaghan - Barclays

I understand. All right, thanks lot.

Operator

And our next question comes from Matt Summerville with KeyBanc. Please go ahead.

Matt Summerville - KeyBanc

A couple of questions. First, Eric, I really want to try and get a sense of your level of confidence with respect to the RD&E spend in Aerospace, and that you're going to see that $25 million reduction in the back half of the year. In other words, how confident are you that there won't be any more major changes in scope, if you will?

Eric Fast

Well, I can't read Boeing's mind on major changes in scope. But, to the extent there is a major change in scope, I would expect that Boeing or GE, who we contract with would pay for it. Our current expectation on the MOD-2 that we've delivered, MOD-3 that we're delivering here in the second quarter, that we'll deliver that, we'll deliver it in a timely fashion, and that, we'll be able to get you and us the $25 million in engineering reduction.

Matt Summerville - KeyBanc

Okay. With respect to Fluid Handling, can you talk sequentially as you went through the fourth quarter, what the core business looked like, what orders looked like thus far? I guess, it sounds like sequentially you've definitely seen a little bit of a change there given this kind of order of magnitude?

Eric Fast

I can't quantify it, but I think, like every other industrial company, we weakened as we went through the quarter. And orders weakened as we went through the quarter, and it wasn't just in Fluid Handling and this is part of the other reason why we think it's going to be such a difficult first half.

Matt Summerville - KeyBanc

Okay. Then just one more question on pension. I believe you quantified the year-over-year change in P&L expense. Can you also talk about what the cash component's going to look like in '09, and what it could look like in 2010?

Eric Fast

I don't have that. We've said its $20 million in pension expense. We don't have it right at hand, Matt. It's going to be higher than it was in '09 than it was in '08. I forgot what the number is.

Matt Summerville - KeyBanc

Okay. That's all I have. Thanks.

Operator

(Operator Instructions). And we'll take our next question from Wendy Caplan with Wachovia.

Wendy Caplan - Wachovia

Thanks, good morning. You talked about the RD&E spending in aerospace. But, new products were an important part of your presentation this morning, Eric. Can you talk about what your R&D spending plans are for '09? What's your sort of strategic view of internal development? Do you have any metrics that you're looking at, at this point, that you can share with us?

Eric Fast

I would say, across the entire company, we are continuing to aggressively invest in new products. We're investing a $1.5 million additional in our standard power business and electronics. You've seen the amount of money that we've invested in these huge new programs in Aerospace that are coming to an end.

In Merchandising Systems, we've got the new Merchant. We've got this glass-front having real success capturing market share with the bottlers. In Fluid Handling, we've got three new valves coming. We've been working on for a year in our ChemPharma business, and we've got all the new products from Krombach to go through the new sales force.

So, I would just say that, overall, it's a key strategy of ours to help us take market share during these down markets. In the case of Aerospace, we've pretty much finished the Joint Strike Fighter brake control. We're delivering a key piece and a key milestone on the A400M here in March. And in 787, as we've discussed, we're going to deliver a commercial version here in April which we've still got the test fly it for a year. But again, these are important new developments that are starting to ramp down. I think Tim here has got the answer on the cash and pensions which we can share with the group, Wendy, if I could?

Wendy Caplan - Wachovia

Sure.

Tim MacCarrick

Matt, I think your question was what are the expected cash payments in 2009? We expect that to be between $17 and $20 million.

Wendy Caplan - Wachovia

And if I can go back to my questions?

Eric Fast

Yes.

Wendy Caplan - Wachovia

Okay.

Eric Fast

Didn't I answer it? Sorry.

Wendy Caplan - Wachovia

That's all right.

Eric Fast

I tried.

Wendy Caplan - Wachovia

Can you go through the FX hit by segment for us for the quarter?

Tim MacCarrick

This is Tim. It's predominantly in Fluid Handling with a small portion of it in Merchandising Systems.

Wendy Caplan - Wachovia

And how much was that?

Eric Fast

Can we give you that offline, Wendy?

Wendy Caplan - Wachovia

Sure, that would be fine. And when we come to your meeting in February, as you did your strategic review and made some of these cost cutting decisions that you made, in Engineered Materials, and when we come to the meeting, should we expect to hear about any divestitures of businesses, any places where you've made the strategic decision that it doesn't make sense to be in these businesses?

Eric Fast

No.

Wendy Caplan - Wachovia

Okay. Thank you very much.

Eric Fast

We're on the same path of trimming around the edges which is a constant discipline that we employ, but nothing significant.

Wendy Caplan - Wachovia

And one more, I just wanted to confirm that when you gave your earnings guidance for '09, it included the additional restructuring that you discussed?

Eric Fast

Yes.

Wendy Caplan - Wachovia

Okay. Thanks.

Eric Fast

It's about $0.15 or $15 million pretax.

Wendy Caplan - Wachovia

Okay. Thank you very much.

Eric Fast

Thank you.

Operator

And there are no further questions. I'd like to turn the conference back over to our speakers for any additional or closing remarks.

Richard Koch

This is Dick Koch. Thank you for joining us today and for your interest in Crane. Bye-bye now.

Operator

And that concludes today's teleconference. Thank you for your participation. Have a good day.

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