Crane Company

Greetings and welcome to the Crane Company first quarter 2020 earnings conference call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. It's now my pleasure to introduce your host, Jason Feldman. Please go ahead.

Thank you, operator, and good day, everyone. Welcome to our first quarter 2020 earnings release conference call. I'm Jason Feldman, Vice President of Investor Relations. On our call this morning we have Max Mitchell, our President and Chief Executive Officer, and Rich Maui, our Senior Vice President and Chief Financial Officer. We'll start off our call with a few prepared remarks, after which we will respond to questions. Just a reminder that 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, 10K, 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 and tables at the end of our press release and accompanying slide presentation, both of which are available on our website at www.craneco.com in the investor relations section. Now let me turn the call over to Max.

Thank you, Jason, and good morning, everyone. As outlined in our press release last night, we reported first quarter adjusted EPS of $1.15. We estimate that impacts from COVID-19 had an approximate 15 to 20 cent impact on first quarter results, driven by some supply chain disruptions, softer demand in certain end markets, and minor operational challenges at some facilities related to government health directives and our efforts to ensure the safety of our associates. Until early March, we were solidly on track to exceed our original guidance for the year. Sales of 798 million declined 4% compared to the prior year with a 10% decline in core sales. Operating margin excluding special items of 12% compared to 14.4% last year. Given the extremely broad-based and substantial impacts we're seeing related to the coronavirus pandemic, that's probably about as much attention as our first quarter results merit. I will spend most of this call discussing our outlook provide you as much detail as I can about what we are seeing today and what we expect moving forward. First, however, let me start off with a few key messages I would like you all to take away from the call. First, we have a solid balance sheet at Crane, ample financial flexibility for the current environment, strong track record, a free cash generation, and consistently disciplined capital allocation. Second, we have a diverse portfolio of strong and resilient businesses that will recover nicely when the markets improve. Third, we have managed through downturns before. When I say we, I don't just mean Crane, I mean IHAB as well as Rich and the rest of Crane's senior leadership team. And lastly, you all know that we have an extremely strong track record when it comes to execution and cost management. Crane is an outstanding operator with differentiated CBS capabilities along with a high performance culture based on ethics and integrity. Those CBS capabilities along with our performance-based culture are even more valuable in challenging times like these. They enable us to make data-driven decisions quickly with flexibility to adapt as conditions change and with accountability. In a few minutes, I will discuss some of the cost actions we have already taken. However, and this is at least as important as our cost actions, if not more so, we are continuing to invest in all key strategic growth initiatives and our people. we will be ready to emerge from this pandemic in a strong position and ready to gain share from competitors. Turning to our guidance, obviously in the current environment, forecasting is extraordinarily challenging, and our ability to accurately project future financial results is lower than at any point I can recall. The guidance we will be providing today is based on actual March results, trends in sales and orders since the end of March, market research from a variety of sources, and market extrapolations, customer input and discussions, and a thorough analysis of our entire supply chain, and a comprehensive evaluation of numerous potential global scenarios capturing different timing and phasing of business reopenings. We've been as thorough as we can to date. All that said, our current and best estimate for full year 2020 is for adjusted EPS of $3 to $4.25. The total sales of 2.8 to 3 billion, reflecting a core sales decline of 17% to 22% driven by end market deterioration related to the COVID pandemic. That EPS forecast includes incremental cost savings of at least $100 million this year. We expect free cash flow of approximately 200 to 250 million with capital spending of approximately 45 million, which is a targeted reduction of 40%. We expect the second quarter to be the low point for adjusted EPS this year in the range of 40 cents to 50 cents per share. Given the challenges inherent in forecasting today, Confidence in our outlook is lower than usual, which is partly reflected in the unusually wide EPS guidance range. However, I think it is extremely important to give you our latest and best thinking about how we expect markets to perform, probably even more so than in more normal periods for several reasons. First, this outlook captures the various scenarios we believe to be the most likely to occur. And this is the range that we have used for internal planning. These are the assumptions guiding our cost and cash management actions. Second, while the investor community has historically been pretty good at identifying inflection points in various end markets, it has historically been very slow to calibrate estimates to rapidly changing conditions. We think our guidance reflects where the year will end up. and we would rather have concrete discussions with you about a realistic range rather than waiting for everyone to inch towards the outcomes which seem more likely to us. Third, I'm going to give more color than normal about the assumptions by business underlying our forecast. Feel free to have different views, but I expect that this information will help all of you better realistically adjust your estimates. At a high level, let me characterize the top and bottom end of our range as follows. Starting with the bottom end of our range, as I stated earlier, our forecast for the second quarter adjusted EPS is 40 to 50 cents, which reflects a core sales decline of approximately 27% to 30%. The bottom end of our full year range basically assumes that this level of sales decline persists for the remainder of the year. No improvement from second quarter levels in the second half. In that scenario, we would expect sequential improvement in EPS in the third and fourth quarter, but entirely related to the cost actions that we have taken. In this scenario, we also envision some incremental cost actions beyond those we are currently implementing. At the high end of the range, we expect a gradual improvement in underlying demand starting mid-year with a core sales decline for the second half in the mid to high teens. Based on what we know today, we think our range is balanced and the range is wide enough that we think both the top and bottom ends of our range are relatively unlikely outcomes. From a leverage perspective, remember that our original guidance for 2020 had low leverage related to unfavorable mix at crane currency, the impact of the 737 MAX production pause, and the impacts of the two acquisitions. Compared to our original guidance for 2020, our revised guidance reflects total deleverage rates in the 30 to 35% range, inclusive of our expected cost actions. That will be an impressive performance particularly considering the mix involved here. We expect our most profitable and one of our highest leveraged businesses, commercial aerospace electronics, to suffer the steepest sales declines for the next few quarters, with our commercial aftermarket business hit particularly hard. Compared to 2019, that total deleverage is closer to 40% to 45% due to the mix in acquisition factors I mentioned earlier. Let me now move to guidance assumptions by business segments. But fluid handling, a little over 60% of the segment's revenue is in our process valve business. Because our process valve business is one of our longer cycle businesses, we are seeing the impact of the current environment more heavily on our order rates than in sales, at least for now. Through the end of the first quarter, MRO activity has remained fairly stable, with MRO orders up 1% in January and February and then down 1% in March. However, to give you a sense of the severity and speed of the change in our project business, project orders were down in the high single-digit range in January and February, and then down 26% in March. We are already seeing project pushouts and customer requests for delays. We have also seen at least one case of a major project already halted in mid-construction. Through the 2014-15 industrial recession, we saw projects delayed, and some that hadn't started were canceled. But I can't recall the last time we saw a project shut down completely after construction began. By vertical market, our general industrial business, where we rely most heavily on distribution, experienced a substantial change over the course of the quarter. January and February global orders were down in the mid-single-digit range and then declined 17% in March. China was down the most, and in China the decline started earlier in the year. But even in the U.S., general industrial orders were down more than 30% in March. Refining orders increased approximately 13% in the first two months of the year and then declined more than 30% in March. These trends have continued over the last few weeks. In contrast, chemical has held up fairly well, with March order rates relatively unchanged from earlier in the quarter. While the overall process valve business is clearly being impacted by the current COVID environment, our nuclear valve services business, about 60 million of annual sales, is holding up very well, given that it provides service and replacement valves for nuclear power generation, which is non-discretionary. In the first quarter, process valve core sales declined approximately 11%. For the full year, we expect our process valve business to see core sales down somewhere in the high teens range, with total reported sales this year somewhat better given INS acquisition, sales contribution of approximately 55 to 60 million. Our commercial valve business is close to 40% of fluid handling segment sales, and it includes non-residential construction exposure primarily in Canada, the UK, the Middle East, and US, with some additional municipal exposure in the US. This is a very short cycle business. Core sales were down in the mid single digit range in the first quarter, but more recently, since the start of April, the rate of sales decline is in the 30% range. For the full year, we expect core sales down in the 20% range, with the UK and Middle East markets faring the worst. Across fluid hailing, we have also had a number of supply chain disruptions over the last two months, most notably related to castings from India and China. Fortunately, most supply chain-related delays will just push out revenue rather than result in a loss of business, and we already had some shipments planned for the first quarter shift to the second quarter. At payment and merchandising technologies, we have three different businesses in this segment which are being impacted in disparate ways. Our vending business was just under $200 million in sales last year. To date, this is one of the most impacted businesses at Crane. You may have seen Coca-Cola's recent earnings report with total April month-to-date volumes down 25%, attributed almost entirely to its away-from-home category, which includes restaurants and vending, among other channels. That away-from-home part of their business was down approximately 50%. We are seeing the same thing. Vending machines are typically located in settings such as office buildings, schools, manufacturing facilities, given that many, if not most, of those locations are currently closed. Demand has dropped sharply, down in the 50% range so far in April. And this is a short cycle business with limited backlog. For the full year, we expect this portion of the business to see sales decline in the 30 to 40% range. In our payment business, this is another short cycle business seeing substantially lower demand across all verticals, including retail, casino, vending, financial services, and transportation. We do believe that there may be some benefit, at least for the retail and financial services verticals in the medium term, as banks and retail locations like grocery and big box stores look to improve not only productivity, but now also hygiene by limiting direct contact between customers and employees. However, we don't expect to see that benefit for some time. On a four-year basis, we expect this business to see a core sales decline in the 20% to 35% range, with a contribution of approximately $150 to $170 million in sales from the Cummins Allison acquisition. At Crane Currency, we've seen no impact on demand. We're dealing with some manageable supply chain issues related to transportation and logistics of finished product. We've seen some minor disruption in our raw materials market. However, we expect this business to finish the year on target and well above last year's sales, albeit with Negative mix we have mentioned over the last few quarters with lower U.S. government and higher international sales compared to last year. Overall for this segment, we expect total sales, including the Cummins-Allison acquisition benefit, up slightly to down as much as approximately 10%. At aerospace and electronics, on the commercial side, we have already talked on previous calls about the headwinds we expected from the 737 MAX production pause. Now we are seeing OEMs cut build rates for most other major aircraft models as well. And as I'm sure you read about, some OEM facilities have been temporarily closed related to COVID-19 or weaker demand and order cancellations. Based on our current view of build rates, we expect a full year, 40 to 45% decline in our commercial OE sales. On the aftermarket portion of the business, Airlines have reduced flight schedules substantially, and this is already having a material impact on our spares and repair and overhaul businesses. We expect recent commercial aftermarket run rates to remain at April levels, down in the 60% to 65% range for the remainder of this year. Remember that the overall profitability and leverage rates on commercial aftermarket are generally very high, actually among the highest across our entire portfolio. Overall, we expect the commercial portion of our business down approximately 45% on a full-year basis. In contrast, the defense business, which was about 35% of last year's sales, is performing slightly ahead of our original expectations for 2020. We expect that business to grow in the low double-digit range this year. The segment overall, we expect full-year core sales down approximately 20% to 25%. Engineered materials is another of our shorter cycle businesses. Most of the RV manufacturers shut down production completely for most of April. We don't expect production to resume until early May. In the medium term, RVs may be incrementally attractive to families looking for a domestic and isolated safe vacation alternative. For now, however, high unemployment rates, weak consumer confidence will reduce demand heavily for some time. You may have seen the April 19th Wall Street Journal article that even discussed the challenges the pandemic is causing for RVers who are dealing with campground closings or restricting access. Fortunately, the RV industry has spent more than a year reducing inventories at the dealer level, so we are at least entering this week period without much excess channel inventory. We are also seeing weaker conditions across building products. There are a number of near-term opportunities related to temporary COVID health facilities where our products may be used, but our core markets include retail and restaurant settings, which have cut back on construction and renovation activity heavily. Transportation is also weak, driven by substantially lower trailer build rates. Overall, we expect segment sales down in the low 30% range for the full year. Overall, it's a difficult and challenging set of market conditions. As a broad-based, global, diversified industrial, we have visibility to a large cross-section of different vertical and geographic end markets, and what we are witnessing is hitting a wider range of markets more severely than what we have seen in any prior downturn. We are all still absorbing the first-stage direct impacts, but the secondary impacts will continue to spread as supply chain challenges move around due to closures, as virus hotspots emerge and then possibly reemerge, in different locations and as various government responses helps in some places and has unintended consequences elsewhere. We applaud the efforts of local and national government leaders around the globe who are dealing with the pandemic to the best of their abilities, as well as the healthcare professionals everywhere who are working tirelessly on the front lines and all those workers in the food supply chain and other essential industries. However, it is clear to us that a phased reopening of the global economy, which is the best and most likely path forward, will constrain the pace of the recovery. While our current best case, consistent with the midpoint of our guidance, assumes sequential sales improvement in the second half of this year, that improvement will be measured. The high end of our guidance range implies mid to high single digit sequential sales growth in the third and fourth quarters, off an extreme low point in the second quarter. That also implies a second half year over year core sales decline in the mid to high teens. If we're wrong and growth rebounds faster than we expect, we will clearly over-deliver to these expectations. But we think it's important for us to set appropriate expectations internally and externally. Regardless, in these challenging and highly uncertain times, the value of our consistent management cadence and discipline execution will differentiate us from peers. As we have discussed at Investor Day events for years, we have a rigorous data-driven management cadence, a constant focus on continuous improvement, extreme accountability in all aspects of our businesses. These disciplines help us manage every aspect of our operations. But I'll spend the next few minutes talking about our cost actions and supply chain conditions. I mentioned earlier that our guidance assumes $100 million of gross realized cost savings in 2020. Rich and I, along with our other senior vice presidents, have conducted thorough reviews with each of the businesses to discuss these cost actions. We have direct line of sight to the $100 million with specifically identified actions. A few takeaways I want you all to be aware of related to these actions. 100 million gross cost savings in 2020 is our current expectation based on our most recent forecast and thinking about the demand environment. And we will adjust from that baseline as the year progresses. We've been restructuring consistently across our businesses for nearly 20 years. You may recall that we already had several additional facility consolidations in progress well before COVID came to all of our attention, which we announced with our earnings in January 2018 and January 2020. At this time, we do not see the need or opportunity for future facility closures beyond those we have already identified. Throughout the reviews over the last few weeks, our teams have been aggressive in cutting costs. However, there have also been quite a few proposed cost actions which we rejected. We will cut costs as aggressively as appropriate, but I will not take actions that will jeopardize the long-term prospects or positioning of any of our businesses. All strategic growth initiatives are still funded, and we have reviewed all proposed reductions in force in great detail to ensure that we are protecting as many associates critical to our long-term success as possible, even if we are not able to fully utilize them in the near term. I am determined to exit this pandemic in a stronger position than our competitors and position to gain share as markets improve. From an operations perspective, all of our manufacturing facilities worldwide remain open as most of our manufacturing sites are deemed essential infrastructure related businesses and none are currently closed because of shelter in place or similar government directives. Operationally, in addition to demand adjustments and scheduling challenges related to COVID-19, we are addressing and planning for certain challenges related to our global supply chain that we expect to continue. We are tracking our supply chain situation at the individual purchase order level. as well as by supplier, by country, by business, and managing extremely effectively. To give you a sense of what we're seeing over the course of the last two weeks in our process-valued business, the biggest source of delay is shifted to India, where a majority of purchase orders have some form of delay. In terms of dollar value, China is the region with the next largest amount of delays, but China has improved significantly, whereas we don't expect any relief in India until at least early May when the shutdowns may begin to abate. While we don't source a substantial amount of materials or components from Italy, it is a region where the greatest percentage of our outstanding purchase orders, well over 95%, are experiencing major delays. Mexico isn't bad yet, with only a modest number of minor delays, but it does appear to be worsening as well. On the other extreme, we have no current supply chain issues at all from Korea, Australia, and only minor delays in the US. That picture does vary from business to business, but the general trends are similar. Well, with that overview of our recent business performance and outlook, let me turn it over to Rich for some additional commentary on our financial strength and some further guidance details.