Richard Koch – Director, Investor Relations and Corporate Communications
Kristine Liwag – Bank of America Merrill Lynch
Crane Co. (CR) BAML Industrials Conference Call December 6, 2011 11:20 AM ET
This is Kristine Liwag, I work with Ron Epstein at the Aerospace and Defense team here. And today we have Richard Koch. He has served as Director of Investor Relations and Corporate Communications of Crane since 2005. His background includes over 40 years of corporate experience and Investor Relations, Public Affairs, Business Planning and Engineering. Richard holds the B.S. in Civil Engineering from Bucknell and M.B.A from the University of Chicago.
So, without further ado, we have Richard here.
Look at that door.
Can we please close the door?
Good morning. Thank you very much Kristine. It’s a pleasure to be here. Eric Fast, our CEO; and Andrew Krawitt, our Co-CFO unfortunately were not able to attend today. But I’m happy to share with you the Crane story.
There are number of faces to me in audience and so, I just spoke with Kristine, we are going to modify the format just a little bit here. There is a handout package that hopefully you’d been able to pick up, there are few extra copies of the handout package that are on this table that floor rows back, so but there are many more handouts that out in the main resource area.
So in any case, we want to call your attention to the forward-looking statements disclaimer. And again, since many people here that I don’t know, I’m assuming that you may not know Crane all that well. So just kind of give you a company overview before getting into the individual segments.
So, first of all, Crane is a diversified manufacture of engineered industrial products. We have substantial presence in focus niche markets and by niche markets we normally mean, $1 billion to $2 billion. While our businesses typically have high returns and access cash flow.
One of the core values of Crane is to conduct all of our businesses, business dealings with integrity and honest dealings, this goes back to 1855, R.T. Crane, the founder of the company. Crane has been on the journey for the last 10 years, since Eric Fast came at the company, moving much more from a holding company to operating -- integrated operating, and the Crane business system is really the cornerstone of that integrated operating company.
So we do think the same way in each of the divisions from an operational excellence point of view. Our strategy reviews standardized or monthly reviews are standardized, so we really a very much open integrated company and we do acquisitions to strengthen our existing businesses.
I mentioned moment go that we are in niche markets. I won’t go through each of these pie charts with you, but it does give you an idea that fundamentally we look for markets that are $1 billion to maybe as much as $2 billion in size.
For instance in Aerospace, our landing systems business is a key market leader. We are really one of two major companies in the world that design brake control systems for large commercial aircraft. And we like these spaces because it creates high barriers entry and give us a technology -- leading technology position.
So when I talk about leading market shares, it -- this is really something that is evident in across the company, in Aerospace and Electronics, we are number one in brake controls and Engineered Materials we provide fiberglass reinforced plastic to recreational vehicle manufacturers for sidewalls.
In Merchandising Systems we are number one in terms vending in North America, so we make vending machine for people Coke and Pepsi for instance. And we are number two in global payment solutions and these businesses fundamentally coin and bill validation systems.
In the Fluid Handling we are key leader for process valves and Sleeved plug valves in Europe, Diaphragm valves in Europe and Teflon lined pipe in Americas. So we really use our technology to create leading market share positions.
We have a number of proprietary or custom technologies. The wireless brake control system for the Boeing 787 is a state-of-the-art design, no one else have ever done this before. We make miniature device for Cochlear – for the Cochlear hear implants for people that are seriously hard of hearing. And we make fiberglass reinforced panels that replace wood for step van like that better express and UPS will be using, we’re taking weight out of the product, so that the gas efficiency improves.
We also an instantaneously validate currency in a 100 different currencies and we are on improve manufacturing list for process valves. So we really work to develop highly engineered custom and proprietary technologies as an industry layer.
Our strategy is really quite simple. We want to grow profits from our existing operations and then redeploy that free cash flow for acquisitions. We work very hard to materially improve our operations again through using the Crane business system and we form strategic linkages among the businesses to give us a smaller number of larger business units.
Again our Crane business system is really a cornerstone of our performance includes really, listening very carefully to the voice of the customer and creating a serious of tools for both growth, as well as manufacturing efficiency and productivity tools, as well as leadership tools, our strategic deployment process and then intellectual -- very discipline intellectual capital development process. So these are the common business process across the company that drives our integrated operating culture.
When I talk about mergers before, for instance in our Aerospace Group at one time we have four different sets of -- solution sets really essential grant in the individual companies and where we are today is for Boeing for instance they will get one invoice from Crane that represents every thing that we do for them. But and we’ve done some merger and I’ll get to this in the next slide in Fluid Handling, where we are just streamlining and moving more toward a vertical marketing approach.
So in Fluid Handling you can see here on the left side of page that there were six business units that were really form into two business units. So we took three different businesses and then created a chemical and pharmaceutical and vertical market for us to sell in to, and we combined the number of our valve manufacturing operations with energy related applications for refinery applications, as well as the North American power market.
So the whole idea is to target a vertical, establish a very firm and discipline sales process, manage that channel and then bundle the portfolio of products, so that we are selling greater amounts of ships that content if you will to a given customer.
Along the way we have trimmed some smaller business units that really we were not able to leverage as effectively as we want to or did no longer fit and since 2000 we reduced our sales by about $200 million as a result of these divestitures.
But for Crane the story really is an acquisition-related story and everything that you see in green our businesses that have been acquired since 1999. So we are very positive, you can see that we’ve acquired in all portions of the company and every each of our business unit President has really kind of license to hunt if you will to bring forward new ideas. Since 1999 approximately 44% of our total sales in 2010 were comprised of acquisitions done in that period of time.
So in terms of capital deployment, we do have a balance capital deployment strategy. We do internal investments to drive organic growth that includes capital expenditures, but also research and development, as well as sales and marketing resources have been added particularly in the downturn in 2008, ’09 and the early part of 2010.
We do acquisitions really to strengthen our existing businesses. Do not look for Crane to have a major portfolio shift. We maintain an attractive yield with our dividend and we raised the dividend over most of the past five years, many of the past five years. We do share repurchases to offset dilution and we make pension contributions to meet our pension commitments.
If you look at this chart, we’re continue to using the start out with, but the purpose of the chart is to call out the fact that Crane does have an asbestos liability, we never made asbestos, but we did utilize components that contain asbestos, and so there are number of lawsuits that we have been involved in. At the present time, we will spend about $40 million a year after tax and after insurance to satisfy the legal proceedings, as well as payments to plaintiffs and we settled most of the cases.
So we have about $42 of cash outflow related to asbestos that’s the bad news, the good news is the company has very strong free cash flow and cash flow from operations. So we anticipate this year that our free cash flow will be in a range of $140 to $160 million.
So let’s a look at 2010 results, but to do that we really have to just touch on 2009. So as our businesses began to soften in the second half of 2008, we were really amiable position because we had a very strong cash position with $232 million at the end of December 2008.
We wanted to main liquidity at all times. We also decided we want to remain only offense and so wanted to continue to win in the marketplace and to take market share even though the markets were going down. So we maintain our customer facing activities. We drove operational excellence to get improved lead times and share on time delivery schedules, so we satisfying changing customer needs and we wanted to accelerate new product introductions.
We also aggressively reduced costs and we’ll come to that in just a second. And we certainly realize the cash was paying in that environment and we again maintain liquidity at all times. And we successfully and carefully executed several acquisitions in the 2008 timeframe. All this strategies and tax philosophy are really design to build sustainable value.
So in 2010 the world kind of stabilized, sales were up 2% and operating profit fortunately increased by 19% largely as a result of cost reductions that achieved during the downturn. So if we look at this on a more granular basis, again you can see, sales up 2%, our EPS in 2010 increased 21%.
So as we think back at 2010, we certainly feel that we have emerged from a downturn as a much stronger company. We feel like we were tested. We stayed on the offense and we actually gain market share, which was what the intension always was.
We maintained our cost reduction efforts throughout 2010 and we also improved a portfolio consistent with our strategy by making several acquisitions. One which was called Money Controls which is a -- which positions us as one of the leaders in coin and bill validation and dispensing technologies. And we also acquired company called Merrimac Industries, which really increase the size of our microwave components business by approximately 50%. In addition, we divested two non-core businesses in our control segment.
So as we kind of look at the picture at the end of 2010, backlog was building in this -- particular in the second half of 2010, and we’ve began to see a recovery in our core sales growth for the last three quarters of 2010.
This picture here is design to depict the changing economic environment and the recovery of the business cycle, it was a snapshot taken in February of 2010 and the businesses have actually improved since that period of time. But we want to call to your attention is about 50%, more than 50% of our businesses are late long cycle businesses and number of these businesses, again this horizontal red line that you see, is really the zero growth line, so anything above that is positive growth, and at this point fortunately all the businesses are now above that line and are continuing to grow in development.
So as we look at 2011, just a couple of, we just back up here. So for 2011, our sales in the third quarter were up 18% and EPS was up 27%, again, getting effective leverage of this growing sales. Some commentary to go with the third quarter is we saw an improved -- improvement in sales operating margins and earnings. We raise the low end of our full year EPS guidance by $0.05, and our engineered materials business and our merchandizing system segments which are the short cycle businesses are generally tracking to the Investor Day guidance that we provided last February.
But our longer late cycle businesses and Aerospace and Electronics and Fluid Handling are really exceeding the prior guidance. So for instance our Aerospace business, our sales are now expected to exceed $400 million in comparison to our February estimate of $365 million.
Our Fluid Handling margin is expected to exceed 13% in comparison to our 2000 – our February guidance of 12.7%. it’s important to remember that back in the second – first and second quarter of 2008, our Fluid Handling business had large the 15.5% and so we still feel that we have an opportunity to enhance margins as the volume comes back to business, and we have strong backlog in both of businesses.
The other thing is kind of interesting is, if you look at our Aerospace and Electronics business and you look at the Fluid Handling business and look at that operating profit compare that to the operating profit of the total company excluding cost of course, you account for about 80% of Crane’s operating profit in the Aerospace, Electronics and Fluid Handling segment.
So in the year-to-date results in the third, through the end of September sales were up 16% and EPS was up 33%.
Backlog it continue to increase during the course of 2011 just falling off slightly in the third quarter, but importantly core sales growth is now been positive for six consecutive quarters. So we are coming in cycles working with us.
So our revised guidance that we came out with the in October really showed a sales now indicated in the range of $2.55 to $2.57 billion at the 15% to 16% change over the prior year, operating profit expected to be up 27% to 32% and EPS up 29% to 33%, free cash flow guidance maintained at the $140 to $160 million.
So we are seeing some of the sales improvement really coming from core sales growth about 9% to 10% of core sales growth and acquisitions and FX are providing about 3% of the sales growth each. Operating profit margin forecasted at 12.1% to 12.5% and we are assuming a 31% tax rate in these results.
So we really about positioning Crane for future growth. We had a solid execution through the downturn. We stayed on the offense and we significantly reduced costs. We increased our Aerospace sales and marketing resources to go really where the growth was and to stay very, very close to the customer.
We have enhanced sales and marketing capabilities on our Fluid Handling business. We have really expanded the global coverage that we have and now we are effectively bundling products or cross-selling products to sell more ships at content into our customers with and again, a lot of emerging market emphasis here to sense where lot of the growth is.
We’ve increased our capital expenditures to support growth as well, so CapEx this year will about $40 million in comparison to about half that amount in the prior year. We’ve maintain our new product development efforts throughout this and our Crane business system continues to get better and better as we work it.
So here is the model that we first introduced about two years ago and the model goes like this. We had peak sales and about $2.6 billion in both 2007 and 2008, and then as we dropped out at $2.18 billion. The idea is that when we get back to $2.6 billion at core sales if you will because there have been acquisitions in here, when we get back there we would expect that our operating profit would be $340 million or 13% operating margin. So this would be 200 basis points better than the operating margin we previously had at our peak in 2007, 11.1%. And so we are with our current guidance at $335 to 345 a share you can see that, we are making good progress towards the goals that we establish a couple of years ago.
So just a quick summary, we have an attractive portfolio of businesses in mature Crane business system that should drive profitable growth as we go forward. We are position for record margins and we believe we have significant available -- capital available to do acquisitions and we certainly are expecting increase sales and operating profits and margins in 2011.
So let me take you now to the businesses and we’re just kind of give you some headlines and dealing or granular about them. Okay. First of all, Aerospace and Electronics, this business segment represents approximately 60% of the sales come from Aerospace and approximately 40% from Electronics. You see on a more granular basis, well, that the Aerospace sales are 79% commercial related and 21% defense related. The Electronics sales 34% commercial and 66% defense, so the Electronics business really is more weighted to the defense related applications than commercial.
This is now we are just going to take a look at the Aerospace Group in particular, so we have the different kinds of products that we make or solutions down in the left hand side, so with respect to landing systems, we don’t make the brakes, we don’t make the hydraulics, but we make the brains to activate the brake control system. So this involves real speed transmitters and sensors, and computer code, as well as different kinds of manifolds that actually actuate the hydraulics.
We make sensing utility systems these are small position indicators that will tell you whether the flaps are up or down, whether the hatch doors are locked in or not. In Fluid management we manufacture lubrication and scavenging pumps, as well as fuel transfer pumps. And in Cabin we manufacture small motors that are about the size of this water bottle little bit smaller than this, that actually allow the sit to move forward or backward, up or down.
As we report the business out we separate our Aerospace sales from Electronic sales, but we do a combined operating profit and margin. So you can see with respect to Aerospace, the -- everything in the red ink if you will is the Investor Day guidance, so you will see that really throughout the rest of slides here. We don’t change our Investor Day guidance. We always show that to you, so you can see what our initial expectation for the year was.
But, again, Aerospace late long cycle, niche businesses, we have a strong sustained Aerospace industry recovery that is in progress and is expected to continue. We have four major development programs that we have been involved in for the last four year that are largely complete now, and we saw really in the third quarter broad base strength in OEM sales being up 22% and our traditional aftermarket sales being up 16%. Again, our Aerospace sales expected now to exceed $400 million dollars in 2011. So it’s been a good recovery from the $340 million at the prost.
In terms of our end markets, you can see that large transports sales are expected to increase approximately 13% and overall for OEM sales about a 13% increases as well. Our aftermarket sales particularly defense related sales are up significantly due to a major brake control revision program if you will for the C-130 transport plane where they are moving from steel brakes to graphite or carbon brakes, which give them better durability, greater life, as well as lower weight, so had required a new brake control systems to operate those. Commercial spare sales up 11% and we believe we have good outlook going forward.
Again, a little closer to the business, you can see that of our -- commercial OEM sales our transport represent approximately half those sales, business jets and regional jets at 16% and 12%, respectively. What we call Cabin or these motor actuators that are 15% of our sales.
In the trends going forward, probably Ron Epstein is a great Aerospace Analyst, so he would enjoy this as well. So as we look forward to 2014, 7% CAGR on large commercial transports, we estimate regional jets up 11% and business jets up 10%.
Now one parts of the margins story as you look back historically at Aerospace Group is to recognize that we expense all of our self-funded engineering, it goes, run through P&L, we’ll have that on the balance sheet.
So what we do here, is there are number of programs such as the Boeing 787, Joint Strike Fighter Airbus A400M that require a lot of engineering spending in the 2007, ’08, ’09 and ’10 kind of timeframe, so that it peaked out in 2008.
So we are now back down at level of about $11 million of engineering spending a quarter or $44 million a year and that will leave us in our kind of our guidance range and our business model range of 12% -- 10% to 12% of sales and that’s where we intended to operate the business going forward.
And so what do we get for our money. This slide is designed to talk about some of the new programs that we developed in the last four years. They are now contributing to sales in 2011 and you will see further growth from these programs in 2012 and 2013.
So in our Electronics business itself, we have thee kinds of solutions, power solutions where we create components that will transform electricity from a given voltage or average to one very specific types of equipment on a plane for instance.
In microwave, we manufacture a number of microwave components that we would sell to people such as L3 Communications or Raytheon for instance and then we have a very small micro electronics packaging business.
So as we look at the electronics sales, we just noted that we kind of dropped out at about $230 million this year forecasting $255 million or so. We saw favorable sales comparisons in the third quarter and in 2011, we were benefiting from moving several programs, production into -- from development in to production, so that’s helping drive our improve sales this year. Margins in this business remain in the mid-teens.
We also have, if you look more granularly at the business we have commercial sales, as well as the defense related sales and you can see the commercial sales are improving as the base on the strength of the Aerospace business. And then in the defense related area, we are showing higher sales, particularly in the power and microwave area.
In our Engineered Materials business, this is fiberglass reinforced plastic, it’s about the second sort of packet here and we sell up to OEM that will manufacture the sidewalls of recreational vehicle or do wall covering or it’s utilizing ref application or refrigerated truck application in the interiors.
This is a business in 2007 that had strong sales of $330 million dropped at $172 is back at $230 as we’ve seen recovery in both the RV markets, as well as an with building products kind of getting along the bottom here and transportation applications of 9% in the third quarter after being up significantly more than that in the earlier part of the year. But this business is tracking toward our Investor Day guidance as shown in red.
Merchandising Systems, about half the business is vending machines and the other half is what we call payment solutions, again the coin and bill validation system. So, again, this short cycle business is tracking toward the Investor Day guidance that we provided both $375 million in sales, the large increase in sales from 2010, 2011 is as a result of the acquisition of Money Controls in December of 2010.
The business is related to office employment certainly on the vending machine side of things office employment, as well as manufacturing employment, which is if you know has been very flat here for several years.
Our Fluid Handling business, which is our largest business represented about half the company sales, three quarters of the sales are industrial valves, primarily industrial heavy duty valves, as well as valves were use by heating ventilation and air-conditioning kinds of uses. We have 17% of our sales through Canadian distribution business with over 30 different distributor stores in Canada and 7% of our sales are centrifugal water and waste-water pumps.
So our Fluid Handling business in the third quarter, you can see if you look at the overall guidance that, we should exceed a 13% -- the 12.7% operating margin guidance that we have provided. We believe our margins will now exceed 13%. And we’ve seen good growth in core sales across the number of geographies and the number of parts of our business.
As we break the business down here just to understand a little bit better, we end up with 23% of our sales going to chemical and pharmaceutical applications, 22% energy, 25% building services, 11% gas and water utilities primarily in the U.K. and rest just general industrial.
In terms of where the sales are located 25% U.S. it’s a globally balanced business, 22% Canada, Western Europe 30% and then developing countries 23%.
This graph is very similar to the cycle that we showed earlier for the whole company and again, all these businesses now are essentially above the growth line. The backlog of the business has been improving and core growth has return to the business for the last four consecutive quarters.
We did a small acquisition called the W. T. Armatur that made zero emission valves which are increasing important in the chemical industry. And we really feel that Fluid Handling business is well-positioned for profitable growth going forward.
And so, with that, we will take some questions.
Sure. Why don’t I start with the first one? So your long-term goal of, when your sales reached $2.6 billion and operating margin reached 13%. What needs to happen for that to occur in 2012? Or, I guess, other question would be what would be the downside risk for that occur till 2013?
Well, the $2.6 billion goal is, we’ve been very intentional about not a putting a specific timeframe to it and certainly we will not put timeframe to it today. But, what we are generally expecting is that we will see continued growth across most parts of the business. It’s we are not really expecting a double dip to occur, each business unit has good opportunities ahead, but the Fluid Handling business is, it’s global, it’s in the many, many different industries, many growth initiatives that are in place, the bundling of products. So we can sell smarter and better then we have. We can markets smarter and better than we have. We’ve got new products that are available to us and the global reach is going to be very important. The Aerospace cycle still look like it has good legs to it at this point.
So those, again, that’s where, again, 80% -- nearly 80% of the operating profits coming from those two business. So those are the keys as we push the volume.
And then can you talk about what you are seeing in terms for commercial aftermarket, for commercial Aero and then how that may have changed in the past couple of months?
Well, in terms of our commercial aftermarket, approximately 41% of our third quarter sales were aftermarket sales in our Aerospace Group and we have continue to see strength pretty much across the board, there seems to be kind of choppy ordering a lot of the aftermarket is, it’s kind of book and ship business as suppose to big commercial airline or bills where it’s really predictable. So as long the airlines have money and they’re flying still fair number of hours, they are going to be replacing products, as well as being sure that they have spares handy for them.
Yeah. C-130 program on the military aftermarket, how much of the aftermarket growth was driven by that one program and is that program done?
And the second question on Merchandizing you got back to those double-digit margins, I think it’s the first time in while I’ve seen those, is there timing issues in there or what do you see that more sustainable going forward? Thanks.
Okay. So the C-130 program brake upgrade is a $24 million program that was initially started, basically in the fourth quarter last year, so it’s a two year program and so we still have another year to go on the deliveries from and that’s the key driver of the military aftermarket increase, okay.
Now in terms of the vending business they did have good -- the best margins that they have a long time and it’s a little bit of return of some growth in the vending side of the business, as well as in the payment solution side of the business. The Money Controls acquisition in the first quarter we still have transaction costs and amortization that, the set up of inventory, we had to work our way through, and we’ve now work through that. So that’s facilitating some better growth.
And the payment solution side of the business traditionally has margins in the mid-teens of the vending businesses kind of in the single digits, so there is some mix that’s going on that’s helpful there as well.
And regarding M&A, is there anything you’re looking back in the next couple of months that you think would be an opportunity for Crane, is there an end market that you want to increase your exposure to?
Each of our business units can bring forward by deals and but I think the highest probability is that we’ll find something in the Fluid Handling space, perhaps in the Aerospace area. But for instance like last year, the Money Controls acquisition that was done by our Merchandizing Systems Group was not even on the radar screen. So privately held firm, family oriented and family run and they decided to sell the business but it was unexpected.
So we are opportunistic.
And can you talk about your production -- your capacity for the 787 program and where you are in terms of meeting Boeing announced goal of getting return somewhat by 2013?
We will be able to meet the Boeing production schedule.
And where are you today?
In terms of how many units that we build?
Rate per month, the rate per month?
I don’t have the precise number but we feel confident that we can meet whatever their production schedule is.
And then, I guess, with the, past couple of quarters you’ve really focus on internal M&A to boost like operational efficiency. How much upside can you see in operating margins with the remaining part of you initiative for Fluid Handling and some of the other segments?
Well, as I said for this year, we are anticipating the Fluid Handling margins will be a little bit north of 13% and we’ve been as high as 15.5%, it’s going to take additional core sales growth to get back to the levels that we saw in 2008. So it require over a $100 million of additional sales.
It just replace what we had there were some acquisitions in 2008 that kind of mess a little bit the kind of decline in core sales volume in Fluid Handling. So you have to adjust for that. But it’s going to take about another $100 million in sales to gives the volume leverage that we really need to the business.
And then on in terms of trends in the business jets markets it seem like the light and medium jets are still little slow? What are you seeing in terms of order trends from your customer?
For light jets, yeah, I think it still slow in its body.
Okay. Is there an opportunity for you maybe for next year?
Could be, it’s a hard market to forecast with great decision. Anybody else? Okay. Well, I thank you very much for you attention, if you have further questions, feel free to contact me right after, I’ll probably around. Thank you.