Jul 30, 2008
Operator
Good day everyone. And welcome to today's Crane's Co.
Earnings Release Conference Call. Today's call is being recorded.
At his time I would like to turn the call over to the Director of Investor Relations, Mr. Richard Koch.
Please go ahead sir.
Richard E. Koch
Thank you, operator. Good morning everyone.
Welcome to Crane's second 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 new Vice President and CFO. We will start our call off 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 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.
Eric C. Fast
Thank you, Dick. Before discussing our earnings, I would like to welcome and introduce you to our new Vice President for Finance and CFO, Tim MacCarrick.
As you saw in our separate press release yesterday Tim joins us from Xerox. His 20 years of service there has given him a broad operating finance background with solid international experience.
Today is his first day at Crane, and we welcome him to the team.
Timothy J. MacCarrick
Thanks Eric. It's so great to be here.
Eric C. Fast
Last night we reported second quarter of 2008 net income of $59 million or $0.97 per share, compared with net income of $45.7 million or $0.75 per share in the second quarter of '07. After adjusting for non-recurring items on a non-GAAP basis, our second quarter EPS was $0.93 compared, to $0.84 in 2007 up 11%.
Let me now highlight several key items for the second quarter. We've increased the quarterly dividend by 11%, reflecting confidence in our businesses and strong financial position.
Fluid Handling had record second quarter sales and operating profits, core sales increased 4% in the quarter to a record $301 million. Operating profit increased 39%.Operating margin reached 15.5% compared to 11.9% last year.
Merchandising Systems operating profit increased 46% with strong improvement in both Vending and Payment Solutions. The stronger than anticipated performance in Fluid Handling and Merchandising Systems more than offset the anticipated higher engineering spending in aerospace, in unfavorable end markets for engineered materials, which deteriorated sharply during the second quarter particularly for the recreational vehicle and transportation market.
We maintained our EPS guidance for the year of $3.45 to $3.60 on a GAAP basis, which includes a $0.97 in the second quarter, but in the face of an uncertain economy, we expect to be near the low end of the range. I would note the second quarter results included $0.05 per share of recoveries for cost previously incurred relating to environmental remediation.
Free cash flow will be at or above our $170 million guidance. Turning now to specific segments comments; Aerospace and electronics.
Aerospace Group sales of $108 million increased $12 million or 12.5% from $96 million in the prior year period. OEM and after market sales were higher than last year with OEM sales growing 19% and after market sales growing 2% on a comparable basis.
The OEM after market mix was 65%, 35% compared to last year's second quarter of 62%, 38%. Operating profit in aerospace declined by $3.5 million reflecting the $9.6 million increase in engineering expense, due to the heavy investments in the 787 and A400M and a higher OEM mix offset part [ph] by negotiated cost recovery of $5.6 million for prior engineering work done for an aerospace customer.
Absent the heavy investment in new programs for future growth, operating margins were consistent with our long-term goal of 20%. I point this out to you...
I point this out so that you will understand that excluding our heavy investment in these two new programs, Aerospace Group is performing well and in line with our long-term expectation. Our aerospace engineering spending in the second quarter of 2008 was $26 million compared, to the first quarter of 2008 of $24 million and $16 million in the second quarter of 2007.
This increase in engineering spend all of which is expense is because of the 787 and A400M program and will continue through the balance of the year at a run-rate... at the run-rate of the second quarter or slightly higher.
Crane, GE and Boeing engineers are working side-by-side to continue development of the brake control software. Boeing told the press at the Farnborough Airshow that they are confident that the quote will meet stringent certification requirements, and expect that first flight will occur on schedule in the fourth quarter.
We share Boeing's confidence that this software will be completed on schedule for our first flight. We expect to partially offset our high engineering spending this year with potential additional negotiated cost recoveries.
Recoveries arise when changes of scope occur, that is when the customer changes his design which impacts design cost or schedule and resources. The cost of the change of scope is identified in a claim that is submitted to the customer by the supplier.
By their very nature claim recoveries are discrete items and could be hard to predict because they are a result of negotiation. Electronics Group sales of $58 million, decreased $6 million or 10% primarily due to lower sales in power and microwave solutions due primarily to avoid flip outs and funding delays on current programs.
While Electronics Group operating profit declined $2 million compared to the second quarter of 2007. Operating margins remained above10%.
Engineered materials; in the second quarter, engineered materials core sales decreased $21.5 million or 25% reflecting substantially lower volumes to the company's traditional recreational vehicle and transportation customers, partially offset by $6.7 million of sales related to the composite panel business we acquired from Owens Corning last August. This is a significantly greater decline in core sales than the 16% we experienced in the first quarter of 2008.
In the second quarter of 2008, excluding the sales of the acquired business, we saw a 43% decline in sales to our recreational vehicle customers. This was greater than the deterioration in RV industry's retail sales, because there have been significant inventory liquidations at the OEM and retail level.
We experienced a 28% decline in our sales to transportation related customers, consistent with reduced trailer build rates and a 6% decline in our building products customers. A number of RV manufactures took extended vacation shutdowns in June and July, reduced their work forces consistent with lower industry demand, closed plants and/or ceased operations entirely.
The sharp downturn in RV market, particularly laid in the second quarter, surprised many industry experts. What we've seen is clearly worse than what we expected, and is the major factor in our decision to be more cautionary about our total corporate earnings to guidance for the year.
Operating profit declined 55%, as a result of lower volume with price increases offsetting higher material cost. Since the beginning of the year, our headcount is now been reduced by 24% and disciplined expense controls are in place.
We view the disruptions in the marketplace as opportunities to support our customers when market share and actively develop new product. We had a record second quarter for Merchandising Systems; sales increased 16% with improvements in Vending and Payments Solutions lead by a solid demand for the glass front BevMax III and strong demand for coring and build validation and our coin dispensing products.
Operating profit increased $5.4 million or 46%, reflecting effective leverage of a higher sales and throughput efficiencies. Global demand for Payments Systems remained strong with increased market penetration, broad base acceptance to new product offerings and delays in any potential adverse regulatory changes in overseas markets.
Orders from the major borrowers for the BevMax III machine were seasonally strong in the second quarter in part reflecting the significant efforts to dramatically perform... improve the performance of this new machine.
As we move through the second quarter, we saw more pronounced effects of high gas and food costs on the North American vending industry and their impact will become more evident as move into the seasonally slower second half of the year, as is normal in the industry. Reflecting those market issues, headcount in our North American vending business has been reduced by over 16% as compared to January 2008.
New product introductions in the second half should help mitigate these conditions. At this point I feel Merchandising Systems is on a pace to post record earnings this year, and should exceed the guidance we provided at our February Investor Day.
Fluid Handling, which represents about 43% of Crane's total sales turned in a record second quarter with sales increasing 7%, operating profit growing 39% with a profit margin of 15.5%. The operating profit increase was broad based across all major units in this segment reflecting continued global demand and pricing discipline.
We have continued to see broad based demands from the chemical and pharmaceutical industries and to a lesser extend energy. As noted on our prior conference call, we expected operating margins to decline somewhat from 15.5% in the first quarter.
This guidance was too conservative, because everyone of our major Fluid Handling businesses had favorable operating profit margin comparisons to the second quarter of last year. We remain committed to the concept of profitable growth with strong discipline on pricing.
Raw material escalation issues continue to affect the entire industry and could potentially pressure margins going forward. Our foundry restructuring efforts are on schedule with the Ipswich, England foundry closed in June and the Brantford, Canada facility on schedule.
These are important steps to increase our low cost country sourcing and improve profitability in 2009. I would echo my Merchandising Systems comments as I look at the strong year that Fluid Handling is experiencing.
They are also on pace to post record earnings this year and will clearly exceed the guidance we provided at our February Investor Day. While we bought back 958,000 shares of stock for $40 million in the first quarter to mitigate dilution for the year, we did not repurchase any stock in the second quarter which was consistent with our prior comment.
As you all know, our policy is not to pre-announce stock repurchases, and we may re-enter the market if conditions warrant. The second quarter reported tax rate was 29.8% compared, to 31.3% in the second quarter of 2007.
We anticipate the 2008 annual cash rate will approximate 30% with some variability of course in the quarter. This guidance assumes the restatement of the R&D tax credit, retroactive to January 1st.
We continue to have a strong balance sheet, and ended the quarter with $322 million in cash. Now back to you Dick.
Richard E. Koch
Thank you, Eric. This marks the end of our prepared comments.
Operator we're now ready to take questions. Question And Answer
Operator
Thank you. [Operator Instructions].
We'll go first to Shannon O'Callaghan with Lehman Brothers.
Shannon O'Callaghan
Good morning, guys.
Eric C. Fast
Good morning, Shannon.
Shannon O'Callaghan
Eric, first on the guidance. I think you said in your remarks that it includes $0.97 in 2Q, I mean I guess I would have thought, you called out the nickel benefit and talked about $0.93 as an adjusted number.
Is there a reason why you're including this in the annual guidance?
Eric C. Fast
Well a couple of things first off, we had a big debate here whether or not to include it in the [Indiscernible] and do the non-GAAP table, and I just felt that they were large enough that given our transparence we should include them. Secondly, we worked really hard on the recoveries and they do represent a cost that we previously had in the past.
And thirdly, in the future, going forward there will be some albeit, modest cost that get recovered on a going forward basis, probably not enough to break out. And in addition, we have some planned expenditures for remediation activity that will be expensed going forward.
So as we looked at it, our judgment was to look at the $0.97.
Shannon O'Callaghan
Okay. And I mean as you look forward to give… what the expenses in the future, I guess benefits, I mean is this going to be a number that moves considerably year-to-year?
Eric C. Fast
No. In fact, I don't, the expenditures that we're going to have or going to recover in the next couple of years could be up to a couple of million dollars for example.
But I am not going to break them out.
Shannon O'Callaghan
Okay.
Eric C. Fast
It's a judgment call and we just felt we had to be transparent about it. But we worked hard to get to recoveries.
Shannon O'Callaghan
Okay. On Merchandising Systems, I mean those margins obviously really strong.
I mean were they... can you talk about a little bit of the drivers behind that and were they a surprise to you?
Eric C. Fast
I would not characterize them as a surprise to us. We are continuing to see very good global demand for our Payment Solutions business.
As I mentioned, we haven't got any adverse regulatory changes, we're seeing excellent acceptance of our new products. And that business is a much higher...
has been historically and continues to be a much higher margin business than our... of any business.
Shannon O'Callaghan
And I mean, you mentioned the vending seasonality and the effects of the economy that you're starting to see in the quarter, what about the Payment Solution side?
Eric C. Fast
Haven't seen... the Payment Solutions business is a global business and see nothing in orders that are a concern, but clearly we saw it in orders on the vending side, and we’ve already taken the appropriate action.
Shannon O'Callaghan
Okay, and then in Engineered Materials, I mean can you... yes, obviously you are saying things are a lot worse than people thought I mean, how much more pain do you think is here and are there additional actions you can take?
And you said price offset costs, so I guess it's not a matter of more price. I mean, what are you thinking you can do from here to adjust to the deteriorating condition?
Eric C. Fast
Well, I think we have done everything that we said we are going to do. We said we're going to put in the price increases and we've got the price increases.
We said we're going to integrate the acquisitions, and we integrated the acquisitions and we're basically on plan with that activity. And we said that we're going to...
even with the price increase, we're going to try to make sure we at least held market share and try to get it in some places. That's an ongoing battle.
We clearly did not anticipate... we were kind of hoping that core growth was down 60% in the first quarter.
We were hoping that... we thought that might be the bottom, and that’s down 25% here in the second quarter.
So it's been much worse than we anticipated particularly in RV. The recent statistics that I've seen suggest that there has been a reduction in the amount of RVs that are in inventory and in dealer lots.
I’ve seen comments that. It's gone from three months to one month.
So, and clearly our orders and sales are less than what the industry is experiencing. So it may be wishful thinking, but we're hoping that it's a little bit more stable here.
But frankly much of the industry was closed in the first half of July, and it's too early for me to make that call.
Shannon O'Callaghan
Okay and thanks. I'll pass it along.
Richard E. Koch
Okay.
Operator
Thank you. We'll go next to Deane Dray with Goldman Sachs.
Deane Dray
Thank you very much. Good morning everyone.
First, just I'll add our comments on the guidance and a question related to that. And I've liked the fact that you're putting in everything and showing it on a GAAP basis, and that does add to transparency.
So, from our perspective, it's very helpful. But on that theme, how much precision do you think you have right now Eric, in keeping the range as it is today by going to the low end of the range.
I would think with some of the variability you're seeing in the second half cost pressures and especially what you've seen so far in Engineered Materials that there might be more risk to the downslide?
Eric C. Fast
We are confident in that guidance we gave.
Deane Dray
Okay, and then--
Eric C. Fast
This was not done lightly.
Deane Dray
I appreciate that. And just not to beat the Engineered Materials dead horse here, but it's interesting, how much capacity you added last year, between, the capacity at Noble and the acquisition of Fabwell.
How much of the margin hit do you feel is just unabsorbed cost at this additional capacity that's come on?
Eric C. Fast
Well, my first comment would be, we clearly did not anticipate the size of this decline. However, we've already gone in and reduced the headcount by 24%, which is roughly 250 people.
So, we've gone after cost here in an aggressive way.
Deane Dray
That's okay. That's fine and then if I switched over to the flow business, with organic revenue growth of 4%, you still hit your margin targets.
You actually exceeded the margin targets and I think I've asked this question before, but if I look at the 66% incremental margins, that would suggest that you’ve had some additional benefit, maybe it’s these cost reductions at the foundry closings, but it just seems you're getting more boost on incremental margins than you would get from volume? Can you comment on that.
Eric C. Fast
Again I think it's important to look at the $300 million in revenues, and the throughput efficiencies that we're getting on the core business versus just the incremental sales. I feel very strong when you look at the results.
Every single major unit improved their operating margin in Fluid Handling. And as we go down and we look through why that happened, it's consistently better discipline on price whether it be on projects, whether it be on how we roll the annual contracts over or just our core day-to-day MRO business.
So, that core discipline on price and not chasing projects that aren't going to bring us an acceptable margin, I think is where we load up our plans with unprofitable business is a key to that leverage. But you have to look at the overall impact on $300 million in sales versus just the incremental volume.
Deane Dray
I appreciate that and just a last question. On the mix in Fluid, we're surprised to hear that chemical and pharma customers were a bigger factor than energy, because energy has been really a big plus over this past several quarters, is that mix supposed to carry through to the second half?
Eric C. Fast
Well, I think our part presence in the chemical market is 2.5 times the size that it is in energy and certainly much stronger in terms of market share, global reach in scale. So, I wish one of the reasons why we don't get as big a kick in the earnings that some of the other Fluid Handling businesses is we're relatively light in energy, when you look at our overall Fluid Handling business.
Deane Dray
Great. Thank you very much.
Eric C. Fast
Both did well by the way in the second quarter.
Deane Dray
Got it. Thank you.
Operator
Thank you. We go next to Ned Armstrong with FBR Capital Market.
Ned Armstrong
Thank you, good morning.
Eric C. Fast
Good morning.
Ned Armstrong
Could you talk a little bit about Dixie-Narco within your merchandizing Systems business and how it's progressed relative to your original expectations, and whether you think that those expectations might have been too low or too high to begin with?
Eric C. Fast
Well as you know, as a matter of policy we've announced in the fourth quarter of last year that Dixie-Narco was making a turn profitable, and that we weren't going to break out the results of Dixie-Narco anymore. We're going to look at it as part of our just...
part of our North American vending business because we sell it both to the bottlers and we're selling it to the full line operators. And we're increasingly starting to move some of the new products down to Williston in the Dixie-Narco facility.
But all that being said as far as Dixie-Narco is concerned, I think as the management team looks at it, we just think materially we're in a much stronger place. We think that we're starting to drive the kind of results that we expected and we're more than happy with that acquisition.
Ned Armstrong
Okay and then with respect to your guidance while keeping the range the same... you clearly said that you would...
you thought that right now you tend towards the bottom end of that range and you called out one of the puts and takes between the bottom and the top as being the Engineered Materials business. Is that the vast majority of this puts and takes source, are there other situations in there that could work in your favor that may take you above that lower end of the range?
Eric C. Fast
Well I think there is pluses and minuses. But if you ask me the change in between the first quarter and the second quarter, we as a management would point to the Engineered Materials and the downturn is Engineered Materials.
Otherwise, we are reasonably operating to the expectations that we've had I think.
Ned Armstrong
Okay. Good.
Thank you.
Operator
Thank you. And we will go next to Wendy Caplan with Wachovia.
Wendy Caplan
Thank you. Good morning.
Thanks. I just wanted to speak for others, I am sure in welcoming you Tim to the Crane Co.
team, and we look forward to getting to know you. But I won't bother.
I won’t ask you a question on your first day.
Timothy J. MacCarrick
Thank you, Wendy.
Wendy Caplan
Eric as to Engineered Materials and Merchandising, do you think at this point that we're right sized for demand or should we expect to see some more actions, and would they be on the headcount side or are there other opportunities that you see at this point in terms of cutting cost?
Eric C. Fast
I think we are at the right spot as we see it now in terms of cost, certainly in terms of headcount. I think as we look out the next couple of years, we'll have to see where demand is, the impact of new products.
Our ability to gain market share and take a look at the overall facility situation. But I don't hear...
I currently have no present plan.
Wendy Caplan
And in Fluid Handling, is there any reason at this point given mix of product or after market OEM, etcetera, why the margin that you posted in Q2 now is not sustainable, or are you thinking expandable from here?
Eric C. Fast
I'm not going to give future guidance on the margins. I was wrong in the first, when I gave you guidance in the first quarter, I was wrong on the second quarter, because I was too conservative.
So, I think that all that I would say Wendy is it's real. There is nothing unusual in the numbers.
It’s broad based across Fluid Handling and the management team in Fluid Handling and here at corporate, we all feel that there is a lot of additional opportunities left in the Fluid Handling to improve those businesses.
Wendy Caplan
Okay. And finally and then I'll let someone else jump on.
Could you help us understand what you're seeing relative to acquisitions? Is there...
for you is there... is the pipeline full as they say, are you seeing any changes in terms of what you're looking at relative to size and market etcetera and pricing of those transactions?
Eric C. Fast
We're seeing… our radar screen, our pipeline is filling up. Many of them are in very preliminary discussions.
So, you are not sure whether you are going to get them or not, we are seeing reduced competition for the assets without the leverage buyout firms involved. So it tends to be a few strategic players.
We are seeing some improvement in price at least from the acquirer's point of view, not the full... not as much as I would have expected.
But I think that is a matter of time, and we would hope to be successful on some acquisitions here before the end of the year.
Wendy Caplan
Thank you very much.
Eric C. Fast
Thank you.
Operator
We will move next to Matt Summerville with KeyBanc.
Matt Summerville
Good morning. Couple of questions.
First in Aerospace; can you talk about why you're seeing a deceleration in your after market business. And then in the second quarter, you had the increase in engineering spend partially offset by the recovery you got.
I guess you kind of quantified where you think engineering spend is going to be for the year. Are you netting any additional recoveries against that, and if not I guess how much in recoveries are you building into your outlook?
Eric C. Fast
Our formal forecast in guidance does not... the formal one, does not really include any additional recoveries.
In Aerospace, we do have... we constantly have ongoing discussions about trying to get those recoveries.
If they do occur, I would expect them to be relatively modest. But, our formal guidance does not include recoveries.
Secondly, on the after market, I mean, I think the industry generally experienced, correct me if I'm wrong here, slower after market and this is what I got, informally at the Airshow, slower after-market growth in the second quarter, than it did in the first quarter. We did have some relatively high initial provisioning last year which kind of impacted that but, as we look forward there we see relatively little impact in the third quarter on the after-market.
We think it should be okay at this point. Now there are a lot of airplanes that are going to be get parts in the fourth quarter, but we're going to have to wait and see how the airlines execute on that reduced capacity.
Does it all come out in the fourth quarter and what the impact is?
Matt Summerville
Okay and then one more question just in terms of pricing and raw material cost, the price increases you put in place in Merchandising and Engineered Materials when did those increases go into effect and have you been able to get any additional price on the back half of the year and what I'm trying to get out is whether or not you think you are in parity, second half of '08 with raw material prices and selling prices?
Eric C. Fast
All of them are in effect in the second quarter. At the moment we're not contemplating additional price increases up in either area and both businesses have a material price pressures which I believe we have included in our formal guidance.
Matt Summerville
Great, thanks Eric.
Operator
Thank you. [Operator Instructions].
We'll go next to Ronald Epstein with Merrill Lynch.
Ronald Epstein
Yes, good morning, guys. Eric can you talk a little bit about, what you're seeing out on the M&A front.
And have you seen valuations come back in with a broader market. Are they still sticky?
What's going on in the M&A world?
Eric C. Fast
Yes, they are still sticky, but they have improved. So, we're seeing a bit more realism on pricing.
We're continuing to see this game of high initial indications and then everybody falls by the wayside as they look at the asset and then you kind of have to be there at the end, to be successful and the look for realistic price. So, it takes a lot of time and energy, in that, but generally continuing to improve from an acquirer's point of view.
Ronald Epstein
Okay, okay and what do you think about your own portfolio, are there any areas that you are more interested in building on?
Eric C. Fast
We would be certainly interested in Fluid Handling given the successes that we have and it’s an industry in terms of that global valve business that continues to… need to be consolidated.
Ronald Epstein
Okay. And then just maybe one more on Aerospace.
Bombardier launched a new airplane at Farnborough, the C series. Do you view that as an opportunity for Crane Aerospace?
Eric C. Fast
We have some potential content there, but not anything significant.
Ronald Epstein
If you were to win it, would it require much R&D or no?
Eric C. Fast
No. not at this point.
Not with the size of the ships that we're talking about.
Ronald Epstein
Okay, that's great. Thank you.
Operator
Thank you. And ladies and gentlemen that will conclude our question-and-answer session.
At this time I'll turn the conference back over to Mr. Koch for any additional or closing remarks.
Richard E. Koch
Thank you all for joining us today and for your continued interest in Crane. Good bye.
Operator
Thank you. And once again ladies and gentlemen that will conclude today's conference.
We do thank you for your participation. And you may disconnect at this time.