Richard E. Koch - Director of Investor Relations & Corporate Communications Max H. Mitchell - Chief Executive Officer, President and Director Richard A. Maue - Chief Financial Officer, Principal Accounting Officer and Vice President of Finance.

Joseph K. Radigan - KeyBanc Capital Markets Inc., Research Division Ajay Kejriwal - FBR Capital Markets & Co., Research Division.

Good day, everyone, and welcome to Crane's First Quarter 2014 Earnings Conference Call. Today's call is being recorded. At this time, I would like to turn the call over to the Director of Investor Relations, Mr. Richard Koch. Please go ahead, sir..

Thank you, operator. Good morning, everyone. Welcome to our First Quarter 2014 Earnings Release Conference Call. I'm Dick Koch, Director of Investor Relations. On our call this morning, we have Max Mitchell, our President and Chief Executive Officer; and Rich Maue, our Chief Financial Officer.

We will start off our recall 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 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'll 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, www.craneco.com, in the Investor Relations section. Now let me turn the call over to Max..

Fluid Handling should benefit from a continued global economic recovery, a pickup in North American specialty chemical capital spending and worldwide infrastructure investments.

We also expect an improving capital spending environment for unattended payment systems, increasing commercial aerospace OEM build rates, a further recovery in the aerospace aftermarket and an improvement in North American and U.K. nonresidential construction markets.

In addition, end market dynamics will be complemented by our ongoing growth investments in all segments. Based on first quarter sales, order momentum and backlog trends, we believe that we are on track to deliver on our guidance of full year core growth of 1% to 3%. Operating profit, excluding special items, increased 12% from last year.

First quarter operating margin, excluding special items, was 14.1%, which was in line with our expectations. Regarding the MEI integration, we are proud of the work the combined payment team has completed to date, and the integration is progressing nicely.

The acquisition has been well received by our customers, who are seeing the value we can offer through the combination of MEI and our legacy business. We are on track to deliver both $0.20 per share of accretion from MEI this year and $25 million of annualized synergies by the end of 2016.

As a reminder, we expect to incur total transaction and integration-related costs in the range of $18 million to $21 million in 2014.

While certain end markets for this business can have uneven demand tied to the timing of customer capital spending, the secular trends are favorable, and we continue to expect strong long-term growth for the Payment business. In addition, we are making good progress in our previously announced repositioning actions that will benefit 2015 and '16.

These actions will improve Crane's cost position in our U.K. Fluid Handling and Electronics businesses. We remain on track to incur $10 million to $13 million of costs related to these actions this year, with savings of $5 million in 2015 and an annual rate of $10 million in 2016.

Overall, we are pleased with the first quarter results, and we are reaffirming our 2014 EPS guidance of $4.55 to $4.75, excluding the special items we discussed last quarter and at our February Investor Day. Rich Maue will now take you through the businesses and provide some additional financial information..

Thank you, Max. I'll turn now to segment comments, which compare the first quarter of 2014 to 2013, excluding special items, as outlined in our press release and accompanying non-GAAP tables. In the first quarter, Fluid Handling sales of $311 million declined 0.7%, with a core sales decline of 0.6%.

Backlog was $351 million at the end of March, compared to $334 million at the end of December 2013, a 5% sequential increase, with broad-based strength across the business. Importantly, order momentum improved as we moved through the quarter. Compared to the prior year, backlog declined 4%.

The year-over-year decline in both sales and backlog is largely a result of unfavorable comparisons in our Valve Services business, which benefited from a strong nuclear outage season early last year. Specific to our process valve business, refining remained strong in North America, China, India and the Middle East.

We also saw continued strength in power in the Middle East, India and China, with ongoing softness in North America. Chemical demand remained soft in the quarter, although we play primarily in the later-cycle portion of this end market downstream of ethylene production.

We continue to expect improvement in our process valve business as the year progresses and into 2015, and we are seeing increased quote activity in both the Americas and Europe, as well as momentum in our project funnel.

With respect to our commercial valve-related businesses, commercial construction and mining activity in Canada continues to be soft, while our U.K. and Middle East-based businesses have seen positive order momentum over the last several months.

Fluid Handling operating profit increased 4% to $48 million, and operating margins increased to 15.4%, compared to 14.7% in the same quarter last year, primarily reflecting productivity gains, with some benefit from lower pension expense.

We expect operating profit margins will continue to grow, driven by leverage on higher sales and our ongoing focus on productivity. Payment & Merchandising Technologies sales of $169 million increased $80 million, or 89%, versus the prior year, driven by the MEI acquisition. Core sales declined 3.7%, and currency translation reduced sales by 1.2%.

Sales at Crane Payment Innovations declined in the mid-single-digit range as a result of unfavorable comparisons in the retail end market and the timing of capital spending from certain large customers. We believe these end market dynamics will improve, and we remain confident in our outlook.

Continued demand for our products in China and India supported a strong quarter in our financial services vertical. Merchandising System sales were roughly flat compared to the prior year. Segment operating profit of $20 million increased 95% from $10 million last year, primarily as a result of the MEI acquisition.

Operating margin increased 30 basis points to 11.7% from 11.4% in the same quarter last year. We were very pleased with the margin performance in the quarter, however, we do expect mix to be less favorable as 2014 progresses.

The MEI integration is well underway, and we are on track to deliver $0.20 of accretion in 2014, including $7 million of synergies this year and an annual run rate of $25 million by 2016. In the first quarter, we realized $1 million of pretax synergies, consistent with our expectations.

Aerospace & Electronics sales increased 2.5% to $169 million, compared to $165 million in the first quarter of 2013. Segment operating profit decreased 12% to $35 million, and operating margins decreased to 20.9% from 24.3% in the prior year.

The decrease in margin was largely driven by a planned increase in engineering expense and other program investments supporting new product development in both our Aerospace & Electronics businesses.

These investments, a portion of which have concluded in Q1, are associated with key program wins and new product development opportunities that we shared with you at our February Investor Day.

These are welcome investments, as they reflect the impact of winning key strategic sales targets in our Aerospace Group, as well as new product technology investments in our Electronics Group. Sales in the Aerospace Group were $110 million, an increase of 5% from $104 million in the first quarter of last year.

Commercial OEM sales increased 7%, driven by strong sales to large aircraft manufacturers. Total aftermarket sales increased 4%, driven by strength from commercial spares and commercial repair and overhaul, more than offsetting lower modernization and upgrade sales and lower military spares.

The OEM to aftermarket mix was 63% to 37%, versus 62% to 38% in the first quarter of last year. We expect the aftermarket mix to improve modestly as the year progresses. Electronics Group sales were $59 million, a 2% decline from $61 million in the first quarter of 2013, driven primarily by lower defense-related shipments.

We believe demand is relatively stable at current levels. Our previously announced repositioning actions are underway and on track, and these actions bring our footprint in line with current and expected levels of demand.

Aerospace & Electronics backlog was $398 million at the end of the first quarter, compared to $361 million in December 2013 and $398 million at March 31, 2013. Engineered Materials sales increased $8 million, or 13%, to $68 million.

Sales of our RV-related products increased 26% versus the prior year, as RV OEM build rates remain strong, with both dealer and retail demand continuing through the quarter. Transportation-related sales rose 25% versus the prior year, and building products-related sales decreased 7%, reflecting a slow recovery in commercial construction end markets.

You may recall that RV demand continued to be strong throughout most of 2013, even beyond the spring selling season. This was contrary to the seasonality that we typically experience in this business.

While we were very pleased with our RV sales performance in the quarter, year-over-year comparisons will get more difficult over the course of 2014, as we expect a return to a more traditional sales profile in the second half.

Operating profit increased $2.2 million to $11 million, and operating margins grew 170 basis points to 15.9%, compared to 14.2% in the first quarter of 2013. The improvement was due primarily to leverage on the higher sales and strong productivity gains, partially offset by unfavorable product mix.

Turning now to more detail on our total company results and forecasts. Foreign currency translation had a negligible impact on EPS in the first quarter. Our first quarter tax rate was 31.9% on a GAAP basis, compared to 28.2% in the first quarter of 2013.

Excluding the impact of the special items, our first quarter tax rate was 31.7%, which compares to 27.3% in the prior year. The lower tax rate in the first quarter of last year was primarily a result of the $0.05 per share benefit realized from the reinstatement of the R&D tax credit.

We continue to expect our 2014 full year tax rate, excluding special items, to be roughly 31%, which includes the assumption that legislation will be enacted during 2014 that extends the U.S. federal research tax credit retroactive to January 1, 2014.

As a reminder, the increase in our forecast to 2014 tax rate reflects the January 2013 benefit from the reinstatement of the R&D tax credit, which was retroactive to 2012, as well as increased earnings in the U.S. and Japan as a result of the acquisition of MEI.

Free cash flow declined $2 million from last year to a use of $28 million in the first quarter. Capital expenditures increased $4 million compared to the first quarter of last year.

Our first quarter is consistent with our previously disclosed 2014 free cash flow guidance of $225 million to $250 million, which includes a $15 million increase in full year capital expenditures. We ended the quarter with $250 million in cash, down from $271 million at year end 2013.

Total debt at the end of March was $893 million, compared to $875 million at December 31. Before we move to Q&A, I would like to announce that Dick Koch has decided to retire from his position as our Director of Investor Relations.

Dick is completing a long, distinguished career in various engineering and financial roles, including nearly 9 years with Crane leading our Investor Relations program. Dick has built a wonderful platform at Crane upon which we will continue to build. We will certainly miss his wisdom and thoughtful approach to our Investor Relations activities.

We wish Dick the best in his retirement. Replacing Dick as Director of Investor Relations will be Jason Feldman. Jason joins Crane from Wall Street, with a 10-year career in sell-side research. I look forward to working closely with Jason to continue our dialogue with the investment community. Please help me in welcoming Jason to the company.

Now back to you, Dick..

Thank you, Max and Rich, for your kind words. I've enjoyed working with you and the team and the investment community. Best wishes to everyone. This marks the end of our prepared comments. Operator, we are now ready to take questions..

[Operator Instructions] Our first question comes from the line of Matt Summerville from KeyBanc..

This is Joe Radigan on for Matt. First, congratulations, Dick, on your retirement..

Thank you..

First question is on the chemical end market. Rich, I think you said that you're still seeing softness there. Is there any signs of improvement? I understand that you're further downstream, so maybe you'll see it later in the cycle. But there are companies that are seeing improvement there.

So when, realistically, would you expect to see an uptick on the chemical side?.

Yes, Joe, this is Max. So as we've tried to explain where we're positioned, we have a leadership position with niche severe service applications, valves and solutions, and really specialty consumer chemicals and organics, fertilizer and -- at really highly erosive, corrosive, abrasive conditions.

And what we're seeing is where we have this evolution of, certainly from a U.S. standpoint, shale gas, shale gas investment, moving to ethylene capacity additions, as we're seeing the movement downstream to base polymers and downstream petrochemical, that's really where we're going to see the growth.

And we continue to be consistent here with seeing momentum in the later part of the year into '15, '16. We see this in terms of our project funnel, in terms of quote activity and we feel pretty confident of this. We track our product lines, and we've got some real granularity on this.

I feel really pretty comfortable around where we're seeing some of the weakness in terms of slowness, a little bit of overcapacity on chemicals in a global basis, the shift to North America ethylene investment and how it's going to translate into opportunity as we move through the back half of the year.

So I hope that adds a little bit of color around what we're seeing in chemical..

That does -- that's helpful, Max. I appreciate it. And then on the margins in Fluid, the year-over-year improvement is attributable to productivity. But even sequentially, you had some improvement despite almost $10 million in lower revenue.

Is that strictly productivity driving that? Is it favorable mix in the quarter? Is it a sign that the quality of your backlog has improved year-over-year? Just maybe a little more color on the margin side for Fluid..

Sure. I think one of the additional items that contributed in the quarter itself was a little bit of a tailwind from reduced pension expense. We took some actions towards the end of 2013, where we closed our U.K. pension plan and -- or froze it. And from that action, our Fluid Handling business in particular, has benefited from that.

So there was a slight pickup, from a margin perspective, attributable to pension..

Okay. And then last question, just on the Aerospace margins. You had higher RD&E, which you called out. I think, Rich, you said a portion of that has concluded in Q1.

So does that mean there's still some going forward? And how much of a drag, if so, how much of a drag will that be, or should we expect that to be going forward?.

Yes. So we did have some conclude here in the first quarter. So the R&D spend and the other investments a little bit more front-loaded. We, at our Investor Day back in February, did communicate that we would expect to see our engineering expense return to a 9% to 10% level, compared to, I think, it was around 7%, 7.3% last year.

So we're going to see that continue through the balance of the year. And we did guide to margins being down overall for the segment, as a result primarily of those R&D investments and program investments. So again, some -- while some did conclude, we will see some further investments as we move through the balance of the year.

That said, we do also expect to see revenues also increase as we move through the balance of the year and also continue to see some additional favorability from mix settlements associated with the aftermarket side of the business improving..

So just in terms -- just a clarification on that, though, Rich. So I mean, margins were down over 300 bps on a year-over-year basis in the first quarter. I mean, that was just a little bit more severe than what we had modeled.

Should we expect year-over-year improvement going forward on the Aerospace margins? Or is it still going to be a year-over-year headwind, where you're going to see degradation?.

Yes. So you'll see it continue to improve as we move through the balance of the year as a result of those elements I just described. So when we look at our guidance on a full year basis, we feel comfortable on the margin target that we provided back at Investor Day..

[Operator Instructions] Our next question comes from the line of Ajay Kejriwal from FBR Capital Markets..

So just to follow up on that Aero margins question, your full year forecast kind of implies improvement for the rest of the year. So maybe any color on what would drive that. Is it improvement in the aftermarket business? Or I imagine the engineering spend remains kind of flattish from what you saw in the first quarter.

So what would get that margin up from 1Q levels?.

Yes, so the primary area will be improved absorption as we move through the balance of the year with higher sales, Ajay, as well as a better mix in the aftermarket side of the business. So we -- thinking about coming off of 2013 and our year-over-year comps continuing to improve over the last, I think it was 3 quarters or so.

And then here we are again with some nice improvement in the aftermarket mix or growth over the prior year. We would expect that to continue as we move through the balance of '14..

So the aftermarket of 4% in the quarter is the expectation that, that rate picks up for the course of the year?.

Yes, that's correct..

Okay, good. That's helpful. And then, Max, maybe a big-picture question. So organic growth rate 1% in the quarter. And I know there are puts and takes here, Electronics not really helping.

But when you think about the organic growth profile, could there be an opportunity to improve the growth profile for the company? I know you mentioned end markets, new products and all that.

But how do you think about restructuring the portfolio? How could that fit into the mix of improving the growth profile here?.

Well, you asked quite a bit there, Ajay. Growth, growth profile and portfolio. We like the portfolio, as we've consistently said. We've become more focused over time, over the last 10 years. And with our 3 large growth platforms, I think it sets us up extremely well.

From a Fluid Handling standpoint, now we feel very confident in our guidance of 1% to 3%. As we continue to move through the year, as we communicated on Investor Day, we have, in addition to market growth, we're driving at increasing our served market.

And we gave some of those examples on our Investor Day, with the Soft Seated Ball Valve expanding market size by $350 million, examples in Gate, Globe, Check, so forth. So I'm very pleased with our teams' efforts across the board with investment in technology and driving growth. We're seeing recovery in the U.K., which is quite strong.

Outside of the chemical space, I'm very pleased with our performance by product line and by region, related to power, refining. I'm seeing some real pleasing momentum there.

Our Aerospace Group, as we communicated on Investor Day, we won content that is equivalent to $2.6 billion, moving out through 2020 and provides us with 4% to 5% compound average growth rate. We have combined our legacy payment business with MEI in end markets that we like, that are above GDP growth. And I'm excited about where we are.

And as you know, we'll continue to look at the free cash flow that we free up and deploy to reinvest both in core, as well as through acquisition, and looking at those businesses to strengthen our core as well as near adjacencies..

That's helpful. My question, I guess, I was trying to get a response on if divestitures might be something you would consider to help drive the growth rate higher..

So we'll be consistent with how we've addressed this in the past. We've been -- deployed capital with 20 acquisitions, 19 divestitures over the last decade. And we will continue to carefully look at a pruning that makes sense, Ajay, and we do that in normal course..

And that concludes our question-and-answer session for today. I would like to turn the conference back to management for any concluding remarks..

Well, thank you, Karen. I have a few closing comments before we conclude the call. The first quarter was a solid start to 2014, and we expect momentum to improve over the course of this year.

We had strong secular tailwinds in several of our businesses, and the cyclical outlook is improving for key end markets, including chemicals, aerospace and nonresidential construction. The integration of MEI is progressing smoothly, and we remain confident in our accretion targets for 2014 and beyond.

We are always gaining -- we are also gaining traction with our repositioning actions and importantly, we are executing on our long-term growth investment strategy. We are on track to deliver on our 2014 guidance and remain committed to our long-term target of at least 10% EPS growth per year.

Thank you for your interest in Crane, and Rich and I look forward to speaking with you next quarter. Thank you all..

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..