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Crane Co. (NYSE:CR)

Q3 2012 Results Earnings Call

October 23, 2012 10:00 AM ET

Executives

Richard Koch - Director, IR

Eric Fast - President and CEO

Andrew Krawitt - Principal Financial Officer

Analysts

Robert Barry - UBS

Matt McConnell - Citi

Brian Konigsberg - Vertical Research

John Moore - CL King

Matt Summerville - KeyBanc

Operator

Good day, everyone. And welcome to Crane's Third Quarter 2012 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.

Richard Koch

Thank you, operator. Good morning, everyone. Welcome to Crane's third 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.

I would like to invite you to attend our Crane's Annual Investor Conference, which will be held on Wednesday morning, February 27. Please save the date on your calendars.

Now, let me turn the call over to Eric.

Eric Fast

Thank you, Dick. Crane reported record operating profit and earnings per share on a continuing operations basis in the third quarter with strong execution across the organization. Excluding and repositioning cost and a favorable post-closing adjustment related to our divestiture of Azonix, which essentially offset each other.

Earnings per share from continuing operations increased 14% to $0.99. Core sale growth moderated to 2% in the quarter while operating margin excluding repositioning cost increased a record 13.6% versus 12.4% year ago. I'm particularly pleased with the improvement we achieved in our Fluid Handling segment where our margins increased to 14.2%.

Disciplined pricing, sound project management and improved operational efficiency all contribute to the solid execution in the quarter. We are on track to have the repositioning actions initiated in the second quarter complete by the end of 2012. As we said on our July conference call pretax savings associated with our repositioning actions are expected to approximate $12 million annually beginning in 2013 of which $10 million relates to Fluid Handling.

Given our cautious outlook on the global economy, we continue to drive productivity initiatives and a cost conscious culture across the company. We have trimmed our 2012 sales forecast to 4% the low end of our previously communicated range reflecting this caution.

Although cost savings will somewhat offset the weaker sales outlook, it is now more likely that our earnings per share will be in the lower half of our previously communicated guidance range of $3.75 to $3.85.

2012 has been a year off substantial improvement for Crane and we are poised to report record earnings for the full year. Reflecting our confidence in the company we repurchases an additional $20 million of Crane stock during the third quarter.

We are on track to achieve operating margins of 13% in 2012, a level that we predicted we would achieve on our core sales returned to $2.6 billion. This would be an increase from the 12.3% we reported in 2011 and a full 180 basis points higher than in 2007 when Crane sales were at a similar level.

Our previously announced repositioning action combined with continued vigilance on staffing levels and discretionary spending are helping to position us for will likely be a slower growth global economy in 2013.

Andrew will now take you through the businesses and provide some additional financial information.

Andrew Krawitt

Thank you, Eric. I'll turn now to segment comments, which compare to third quarter of 2012 to 2011.

On a continuing operations basis, Aerospace and Electronics sales of $171 million were similar to a year ago while operating profit increased 12% to $40 million. Operating margin improved to 23.2% from 20.7% in the prior year. Sales in the Aerospace Group of $106 million were equivalent to year ago levels.

OEM revenues were essentially flat versus the prior year. Sales to large aircraft manufacturers and business jet OEMs increased, while sales to regional aircraft manufacturers declined. Both commercial and military related sales were approximately equal to year ago levels.

In addition, aftermarket sales were flat compared to last year. A decline in spares revenue was offset by higher sales associated with modernization and upgrade program as well as an increase in our repair and overhaul business. The OEM aftermarket mix was 59% to 41% in both the third quarter of 2011 and 2012.

Operating profit in the Aerospace Group increased by approximately $5 million driven by improved mix within our OEM business, strong cost control and lower engineering spending in part due to the timing of certain development programs.

Market conditions in Aerospace remained generally positive with moderate oil prices and continued expectations for growth in passenger miles. We note that the International Air Transport Association is forecasting improved profitability for the airline industry in 2013.

As we look forward, we remain cautious about the Aerospace aftermarket but expect to benefit from increasing OEM build rates.

Electronics sales were $65 million, down slightly from the prior year. Operating profit decreased slightly as well while operating margin remained in the mid teens. Aerospace and Electronics backlog was $393 million at the end of the third quarter, down sequentially from $423 million in June and $18 million lower than in December 2011.

We estimate that about $10 million of defense related orders were delayed in the third quarter and we now expect to receive those orders in the fourth quarter.

In addition, approximately $5 million of the decline is related to certain customers changing from longer term order to monthly order releases rather than a change in underlying end-user demand.

Importantly, our current backlog that is orders we expect to ship in the next 12 months is just slightly below the current backlog that we had one year ago in spite of these timing impacts. Overall, we believe our Aerospace and Electronics backlog is supportive of our sales projections.

Engineered Materials sales increased $4 million or 7% to $57 million. Demand for our RV related applications increased 27% versus the prior year as RV OEM build rates remained strong through the summer months and retail registrations were encouraging.

Building products related sales were flat reflecting soft commercial construction market and transportation related sales declined 6%.

Operating profit before repositioning costs increased to $8.3 million from $5.9 million. An operating margins also before repositioning cost was 14.7% compared to 11.1% in the third quarter of 2011 reflecting the higher sales and effective cost controls.

Merchandizing Systems sales of $92 million decreased $6 million versus the prior year or 6%, primarily reflecting lower sales to [bottlers] and vending and unfavorable currency translation and Payment Solutions. Absent the impact of foreign exchange Payment Solution sales rose modestly despite a soft economy in Europe.

Segment operating profit of $9.5 million decreased $1 million compared to a strong performance in the prior year. Reflecting the impact of lower sales our operating margin remained above 10%.

Fluid Handling sales increased 1% to $303 million with a core sales increase of 5% largely offset by unfavorable foreign currency translation of 4%.

Backlog was $331 million at the end of September down slightly when compared to $335 million at the end of June but $17 million higher than in December 2011.

In Europe, market conditions in the third quarter remained depressed, particularly for MRO and [Book and Ship] businesses. Larger European based chemical customers are still generally moving forward with larger projects on a global basis, but some orders are being delayed.

Chemical industry demand in North America, which was very strong in first half of the year started to slow down in the quarter particularly for larger project orders. Refining quota activity both in the U.S. and the Middle East is still positive.

Demand from global power markets remained soft with some projects on hold in U.S. and we remain cautious about China and India. In Canada, fairly robust commercial construction and mining activity has benefited our Pipe, Valve and Fitting distribution business.

Fluid Handling operating profit of $43 million before repositioning cost increase 8%, primarily reflecting better project execution, price increases and improved productivity. Operating margin increased 90 basis point to 14.2% exceeding our previous guidance of slightly less than 14% for the third quarter.

Although total sales were relatively flat in the third quarter, core sales were up 5% and we successfully drove productivity and reduced discretionary costs.

Despite of [tempered] sales outlook, we continue to believe that our Fluid Handling operating margin will approximate 14% in the second half of 2012. Our repositioning activities in Europe are on track and we expect these actions to be completed by the end of the year.

Pretax savings associated with these actions are expected to approximate $10 million annually beginning in 2013.

Turning now to more detail on our total company results and forecast.

While we experienced raw material cost pressure on certain commodities in the quarter, the effect was fairly modest in aggregate and the increase in our selling prices more than offset this impact.

Year-to-date we have experienced negative profit impact from currency translations but those headwinds are now abetting. Relevant foreign exchange rates are now fairly close to prior year levels, so we would expect the currency effects to be modest in the fourth quarter.

On a full year basis we estimate the headwind from currency transition to be above $0.05 per share. Our third quarter tax rate associated with continuing operations with 30% in 2012 compared to 31% in third quarter in 2011.

Our full year tax rate guidance of 30% excluding special items assumes that the U.S. congress passes legislation during 2012, which would extend the research tax credit retroactive to January 1st 2012.

The assumed benefit associated with the R&D tax credit is worth approximately $0.05 per share in 2012.

Free cash flow is $57 million in third quarter of 2012 compared to $40 million in third quarter of 2011. Free cash flow for the first nine months of 2012 was $59 million compared to $37 million in the first nine months of 2011.

We are maintaining our 2012 free cash flow guidance in a range of $150 to $180 million. As a reminder the fourth quarter is a seasonally strong cash flow period for the company and we expect the generate significant cash through working capital reduction.

Capital spending for the third quarter 2012 was $6 million similar to the investment level in the first and second quarters. For the full year, capital expenditures are likely to approximate $30 million.

During the third quarter we repurchased approximately 500 thousand shares of our common stock for $ 20 million. As Eric mentioned earlier, these repurchases reflect our confidence in the company's future and also indicate our willingness to more than offset stock incentive plan dilution if conditions warrant.

As previously communicated our policy is not to preannounce these purchases but to report them at the close of the quarter. Our balance sheet remained strong and we ended the quarter with $281 million in cash.

In addition, we have access to our $300 million revolving credit facility which we recently updated and matures in May of 2017.

Now back to you, Dick.

Richard Koch

Thank you, Eric and Andrew. 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) Our first question comes from the line Robert Barry from UBS.

Robert Barry - UBS

Hey guys, good morning.

Eric Fast

Good morning

Andrew Krawitt

Good morning.

Robert Barry - UBS

Great work on the Fluid margins, very happy to see that. But I wanted to start there and get your sense of how things will track there going forward. It sounds like I don't want to put words in your mouth, but maybe it will stay flattish at this level and if the [net fuel] step up and improvement won't come until next year when you start implementing the restructuring, is that fair?

Andrew Krawitt

Yeah, as we mentioned in the remarks, Rob, we're still comfortable with 14% margins for second half of this year which would imply around that level in the fourth quarter, as well and we're not in a position to give specific guidance for next year but we will do that as we prepare for Investor Day.

Eric Fast

So I would – Rob, this is Eric – I was encouraged by the fact that we hit this without any benefit from the repositioning actions at work. Currently, we've got no benefit from those and we don't expect to get any benefit in the fourth quarter, and we're already hitting this level. And as we've discussed there is $10 million of benefit that we expect to get that full $10 million in 2013. So I think we initiated this early and we got at it and we've got a tailwind here going into 2013.

Robert Barry - UBS

Yep, those are very encouraging. Maybe just shifting focus to Aerospace and the margins there, I mean very strong performance. I think you alluded to some reduction in engineering spend, that may have helped. How sustainable is that?

Andrew Krawitt

Well, as you've observed, Rob, aerospace R&D expense was lower in the quarter versus the third quarter of last year. In part, this is because we're winding down spending on some key programs. A part of it is timing related so for example we're investing less than we expected this year on programs related to the COMAC C919. So the development of the overall aircraft is moving a little more slowly than we anticipated. We're meeting our obligations but we're just spending a little bit less than anticipated.

I would say in the fourth quarter we expect Engineering spending to increase a bit sequentially, but we don't see any significant changes to our current run rate.

Robert Barry - UBS

Thanks. And then just finally maybe if you carried away and with your thoughts on sequestration and the potential impact for your business, as to kind of how you're dimensioning it or, thinking about it at this point.

Andrew Krawitt

Well, I would say it's – believe it or not it's still too early to really make predictions on that. I would mention, as we've said in the past we run a really broad portfolio of programs. Most of these programs are concentrated in ISR – intelligence, surveillance and reconnaissance and we think generally that part of the budget will hold up better than other parts of the budget. But it's a big early to comment specifically on prospects for sequestration.

Eric Fast

I would say, Rob, in the list of the top five or ten things that I worry about is not of the things I'm worried about.

Robert Barry - UBS

Okay. Great, thank you.

Operator

Thank you. And our next question comes from the line of Matt McConnell from Citi.

Matt McConnell - Citi

Good morning. Thank you for taking my question. Can you give us a sense of what's left to do in the Fluid Handling restructuring in Europe. And then maybe an update on when this is finished how much of your production will be in low cost countries and is there more to slow movement of capacity over time. Just give us a sense of where this – restructuring fits within your longer term plan there?

Andrew Krawitt

I forget what the number is on the percentage in the low-cost country but, frankly this is – I consider there's normal activity also we did was accelerated here in Europe because of the reduced demand. So we're going to be finished with the programs that we initiated in the second quarter and we will be finished with these by the end of the year.

And are comfortable with that, they're on track and as we sit here today I'm certainly pleased with the execution, I see no reason why that will change. I think it's an ongoing program this is something that we've always done and continued to do and those of you that followed Fluid Handling for a long time I mean I think we've closed four or five foundries and plants and this is just an ongoing process.

Matt McConnell - Citi

Okay, great. And how does this – the progress that you made in this third quarter, does that help you put timing around, a 15% operating margin that you're targeting there?

Eric Fast

This is Eric, I would say the [execution] in the third quarter on the reposition gave me a confidence that we'll get the full benefit of the $10 million next year.

Matt McConnell - Citi

Okay, great. We'll leave it there for that. And then on the M&A side, you finished with plenty of capacity I think, at 9% net debt to cap and you're going to have strong free cash flow next quarter. So, where do you stand on an M&A pipeline, is there anything actionable or what do you see in there?

Eric Fast

We view the balance sheet and our cash position as a real opportunity to help us with our earnings growth. I'm personally spending with the team quite a bit of time on this and at the present time we have nothing for show forth. But typically we're seeing – we are seeing some opportunities, they tend to be little bit larger than what we've seen in the past as you know, I think our largest acquisition was $150 million or something like that. So we are seeing some larger opportunities and we're starting to see some of them but as I sit here today I have nothing to show forth.

Matt McConnell - Citi

And when you mean larger then do you mean larger than the $150 million, is there kind of a cap that you feel comfortable with that?

Eric Fast

The way we think about it is that we're committed to our investment grade rating. And we look at that and I view – I think the equity is cheap and so we would want to avoid issuing any kind of equity to maintain that rating.

Matt McConnell - Citi

Okay, great. Thanks very much.

Eric Fast

You're welcome.

Operator

Thank you. And our next question comes from the line of Brian Konigsberg from Vertical Research.

Brian Konigsberg - Vertical Research

Yes, hi good morning. Thanks for taking my question. Just first on guidance, so you kept the low end of the top line range looking at about 4% growth. But if you back into Q4, it does look like you're assuming acceleration into Q4, just given that we're seeing some declines in the order rates and obviously the slowing trends overall. Is there something in particular that you see starting to improve maybe a little color on that would be good?

Andrew Krawitt

I think your observation is correct. It is a bit higher growth in the fourth quarter than it was in the third quarter. I think – we've reduced our guidance given some of the caution that we have looking forward. And fundamentally we it maybe a little bit aggressive, we might that maybe at the high end of what we can achieve but we've got a forecast that supports it. And we think sequentially revenues are going to be higher in both Fluid Handling and Aerospace and Electronics which get us to the 4% overall sales growth for the year.

Eric Fast

That's fair.

Andrew Krawitt

4% would be the top.

Brian Konigsberg - Vertical Research

The top okay. And just on Fluid Handling, you mentioned some trend slowing in chemicals and order delays, can you just give a little more color around those comments, hence there have been a fundamental shift just given the uncertainty in the market with some of the projects you're pursuing?

Andrew Krawitt

I would say it's more of a continuation of the trends that we've seen and that it's – there's been some slowing. Overall we're comfortable with our backlog position. Our backlog is up [first] as the yearend, it's down a touch from the second quarter. But we wanted to indicate that we have – we've seen some slowing in certain areas and that being said we're comfortable with where the backlog is.

Eric Fast

I would say in terms of execution we feel comfortable with that we're winning, particularly in the process valves and we feel comfortable that we're holding price here.

Brian Konigsberg - Vertical Research

And if I can sneak one last one in, one of your industrial peers with a very large – [especially] its liability recently entered a transaction where they offloaded to a third party. Is that something that you have considered, is that something that you might pursue if not?

Eric Fast

It's not something we're going to pursue.

Brian Konigsberg - Vertical Research

Got it. Thank you very much.

Eric Fast

I've looked at every alternative on the [specimens] for ten years, that's not something we're going to do.

Brian Konigsberg - Vertical Research

Got it. Thank you very much.

Operator

Thank you. And our next question comes from the line of John Moore from CL King.

John Moore - CL King

Good morning, guys.

Eric Fast

Good morning.

Andrew Krawitt

Good morning.

John Moore - CL King

A couple of questions here, most of might have been answered. But just wanted to clarify on the Fluid Handling margins as you go from the fourth quarter into the first quarter of 2013, and you start to realize some of the benefits or the cost actions that you've taken here the repositioning actions. Is there any reason that margins would decline sequentially, or if I get some volumes remain steady, I guess is what I'm trying to get at there is can you continue to see sequential margin improvement going into the first half of '13?

Andrew Krawitt

First off we've not giving guidance on '13 here and until January. And secondly it's going to depend on our core sales growth right. So we have a high degree of confidence in our ability to leverage core sales growth. But with this slower growing global economy the issue is just how slow it's going to be.

I feel strongly that we have a company and portfolio and it's particularly true with Fluid Handling that if we get some global growth that we're positioned to win some market share and to win share in the marketplace that's so if you get we can do [GMT], we can [GMP] a little bit plus and then we can hold price.

And that's the way we think and I'm confident about our ability to leverage that core growth. So if you get the core growth you can leverage that $0.25 on the dollar and the companies running at 13% operating margin in the case of Fluid Handling at 14% that's the way we think about it.

John Moore - CL King

Okay. That color is helpful.

Andrew Krawitt

Okay.

John Moore - CL King

That's really, all I've got. Thanks for the time.

Eric Fast

Okay. Thank you.

Operator

Thank you. (Operator Instructions). Our next question comes from the line of Matt Summerville from KeyBanc.

Matt Summerville - KeyBanc

Good morning, couple questions. First on Aerospace, I think, Andrew you indicated that the OE business was relatively flat on a year-over-year basis. Given the relative size of the commercial and business versus regional, I'm having a hard time mathematically getting there, it'd be helpful if you're able to maybe provide a little color in terms of how much the large commercial/business was up and then how much the regional business was down?

And implied in your comments earlier than it sounds like Q4 should be better from the segment overall what sort of drives that sequential improvement on the top line?

Andrew Krawitt

Well, what I'd say Matt, is I'd rather not give specifics on how much the large business and regional were up versus down but we want to give some directional once we get some direction on that. I hope with that in perspective, we do expect a slight sequential increase in the fourth quarter on the OEM side, that's driven by what's in our backlog and what we expect to be able to ship.

On the aftermarket size there's a little bit less visibility there but we think that we'll be relatively similar to last year's level as well, and you put it all together it's a slight sequential increase and that gets us the our overall guidance.

As you know the biggest part of our commercial OEM business is large transport and that really – that was up but we had some weakness in on the regional side. And I think overall when we looked at this quarter and we looked that the on the OEM side when we looked at this year versus last year a lot was flat I mean you heard me in my comments and whether you cut it, a military versus commercial whether you cut it OEM versus aftermarket, it really was a pretty flat quarter in a lot of ways. So we'll give you a little bit of direction on those components but it wasn't stark contrast.

Matt Summerville - KeyBanc

Okay. And then on the Fluid Handling margin, you've been mentioning I think for a couple of quarters that outside of the oil and gas portion of that business Fluid Handling was running near or at or maybe and you said above Eric that 15% long term aspiration you have in terms of margins there.

And I guess what I am wondering this quarter was oil and gas an influencing factor in getting those margins back above 14% or was that the other business leveraging volume?

Eric Fast

I mean say – you know I forgot that when those numbers, I would say that oil and gas was stabilized and that was also encouraging but the real – we still have terrific opportunity in the oil and gas business for margin improvement and that's the area that's going really help us get to the – our 15% goal of Fluid Handling.

Matt Summerville - KeyBanc

If you look at the – how the backlog has been trending in fluid relatively stable pretty throughout the year, once you net the divestiture you made, is there any number you can throw out there in terms of how much you're being impacted by deferrals, delays or is have you seen outright cancelations and is that a concern?

Eric Fast

I don't have a number. I'd see – I don't hear the cancelations I hear the deferrals.

Matt Summerville - KeyBanc

Okay.

Eric Fast

And definite softening in some of the MRO.

Matt Summerville - KeyBanc

Is that a global statement, Eric on the MRO side?

Eric Fast

It depends on I was – again global refinery businesses is pretty good, chemical is definitely softened, the power business is spotty globally certainly non-existent in Europe, kind of some here slowing in China and you know what a mess it is in India, so this is just by vertical.

Matt Summerville - KeyBanc

Thank you.

Eric Fast

Thank you.

Operator

Thank you and I have no further questions in the queue at this time.

Richard Koch

Thank you very much operator. And thank you all for joining us this morning. Take care, bye-bye.

Operator

Ladies and gentlemen, thank you for your participation in today's conference. This does conclude the program. And you may now disconnect. Everyone have a good day.

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