Crane Company

Greetings. Welcome to Crane Co. Third Quarter 2020 Earnings 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. Please note this conference is being recorded. I will now turn the conference over to your host, Jason Feldman, Vice President of Investor Relations. Thank you. You may begin.

Thank you, operator, and good day, everyone. Welcome to our third 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, 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 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 third quarter adjusted EPS of $1.05. This was better than our guidance of 70 cents to 85 cents, partly related to timing and partly related to fundamental strengthening in a few markets. Specifically, currency, recreational vehicle, and fluid handling demand were all better than we expected, reflecting better underlying market strength in those businesses. Aerospace electronics demand held up somewhat better than expected in the quarter. although we believe that this was largely timing-related. Adjusted sales of $737 million declined 5% compared to the prior year, with a 13% decline in core sales partially offset by a 7% acquisition benefit and a 1% benefit from FX. Operating margin excluding special items of 12.4% compared to 14.8% last year. That reflects a deleverage rate of 64%. However, excluding the impact of the INS and Cummins Allison acquisitions, the deleverage rate was 34%. That reflects very solid execution given the magnitude of the market decline. And given that the steepest core sales declines were at some of our highest margin businesses, including aerospace and electronics and crane payment innovations. Our updated guidance is based on actual results through September, combined with our detailed analytics and scenario assessment planning for the balance of the year. Our operational performance and execution have been excellent this year, and to date, markets have performed modestly better than expected. However, we do expect a more muted fourth quarter given seasonal factors, as well as a flattening out of the underlying recovery. Based on our performance to date and our revised market outlook, we are substantially narrowing and raising our adjusted EPS guidance range for full year 2020 to $3.75 to $4, which now reflects a core sales decline of 17% to 19%. We continue to expect incremental gross cost savings of at least $100 million this year, We are also narrowing and raising our free cash flow forecast to 230 million to 260 million. Let me move now to our recent performance by business segment and our forward guidance for the remainder of 2020. However, we will not be commenting on the 2021 outlook in our prepared remarks or in Q&A today, consistent with our standard practice. We will provide 2021 guidance on our fourth quarter earnings call in late January. Fluid handling core sales declined 15% in the quarter, a little better than expected. Adjusted margins of 11.4% were solid, with a total deleverage rate of 38%, and with deleverage rate of approximately 24%, excluding the impact of the INS acquisition. Overall, execution has been outstanding at fluid handling. In April, we gave full-year guidance for the core process business to be down in the high teens. and our commercial business down about 20%. Both the process and commercial businesses are on track to do a couple of points better than that. On an FX neutral basis, core orders declined 16% compared to last year, but rose 2% sequentially. FX neutral core backlog increased 5% compared to last year, but was flat sequentially. The change in orders is more representative of underlying demand conditions And the year-over-year backlog increase was driven entirely by our nuclear services business, which has been largely unaffected by COVID and has substantial seasonality impacting the timing of its backlog and sales. For the fourth quarter, we expect fluid hailing to see a small seasonal sequential decline in both sales and margins, largely related to a decline in projects and non-residential construction activity as we enter the winter season. At payment and merchandising technologies, core sales declined 8%, with margins of 15.8%. The overall leverage rate was 27%, and excluding the Cummins-Allison acquisition, the deleverage rate was 7%, reflecting extremely strong execution on productivity and cost controls, as well as somewhat favorable mix. You may recall that in April, our full-year sales guidance for the segment was up slightly to down 10%. We should be somewhere in the middle of that range, down in the low to mid single-digit range. For the payment innovations business, core sales are trending towards the bottom end of the range we gave in April, with the full year likely down in the 35% to 40% range, primarily due to a few end markets recovering more slowly than we expected. Specifically, our vending vertical remains depressed as the pace of return to schools and offices has been slower than we thought. Also in retail, projects have taken longer to gain traction than we anticipated. At currency, however, we're having a good year, better than even our pre-COVID expectations for the business. Both the U.S. and international businesses are growing in the double digits this year on easy comparisons. But the upside is primarily related to our U.S. business. At aerospace and electronics, core sales declined 20%, with margins of 15.6%. Both sales and margins were slightly better than we expected based on the timing of rate reductions and aftermarket shipments. Our overall outlook is unchanged and we continue to expect full year sales down in the 20% to 25% range, but probably closer to the better end of that range down around 20%. However, the mix has been less favorable than we anticipated with strong defense growth, but with commercial aerospace remaining at depressed levels. From a market perspective, OE build rates were lowered by both Boeing and Airbus, which will impact Q4 and next year. And the OEs seem to be building at a higher production rate than they are delivering to airlines. We still expect a full commercial recovery to take a few years. However, we do continue to believe that the long-term growth prospects for commercial aerospace are strong. Lastly, at Engineering Materials, core sales declined 4%. with margins rebounding to an extremely strong 18.6%. After an extremely weak second quarter, with most RV manufacturers shut down through April and most of May, the recreational vehicle market has seen strong demand, driven by consumers looking for safe vacation options. Our other end markets, building materials and transportation, remain depressed, but overall this segment will end the year with sales down closer to 20% than the down 30% we guided to in April. Let me now turn the call over to Rich.

Thank you, Max, and good morning, everyone. To start with a brief update on our financial status, our balance sheet strength and cash flow generation allow us to remain confident in managing through this downturn and continuing to drive our long-term strategic growth initiatives. We are managing all aspects of our cash flow carefully, and our efforts are clearly evident in our cash flow performance to date. Capital expenditures in the third quarter of 2020 were $7 million compared to $15 million last year. Third quarter 2020 free cash flow was $124 million compared to $104 million last year. And year-to-date free cash flow was $188 million, putting us solidly on track to deliver on our updated full-year free cash flow guidance of $230 to $260 million. We now expect 2020 capital expenditures of approximately $40 million down from our prior forecast of $45 million. As of September 30th, we have more than a billion dollars of liquidity comprised of $605 million in cash and short-term investments and $413 million available under our revolving credit facility. As a reminder, we do not have any bond maturities before 2023. We believe that we have more than ample liquidity for the current environment and we have no need or plans to draw on our revolving credit facility at this time. We expect that we will further reduce leverage naturally in the fourth quarter, leaving the year in a stronger financial position than we entered it. From a cost perspective, we are on track to modestly exceed our target of $100 million in gross realized cost savings in 2020. Based on our outlook today, we are appropriately balancing near-term results with longer-term investments to strengthen our competitive position and prepare us to outgrow in the eventual recovery. 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. For the fourth quarter, our revised guidance implies adjusted EPS of $0.91 to $1.16. Remember that we told you in July that we expected a substantially lower tax rate in the fourth quarter due to the expiration of the statute of limitations on certain tax items. The primary offsets to the lower tax rate in the fourth quarter are lower sales and operating profit in both engineered materials and aerospace and electronics. At engineered materials, that decline is consistent with historical seasonality for the RV and construction markets. At aerospace and electronics, it is a result of timing related to certain defense programs which flattered the second and third quarters at the expense of the fourth quarter, as well as a further decline in commercial OE deliveries and commercial aftermarket activity. With that said, let's get to your questions. Operator, we're ready to take questions.

Yes. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. And for participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. Our first question is from Matt Somerville with DA Davidson. Please proceed.

Thanks. Good morning. With respect to aerospace and electronics, can you give a little bit more granularity in terms of how the commercial and military OE versus aftermarket businesses performed in the third quarter, and maybe a little bit more detail as to the timing impact you're talking about moving from Q3 to Q4?

Sure. So commercial OE, I would say overall, Matt, a pretty consistent performance relative to the second quarter, you know, flattered a little bit modestly relative to our expectations. But commercial OE was down 45% relative to the prior year. Commercial aftermarket down a little over 50% compared to last year. Military OE up about, call it 25% compared to last year, and military aftermarket up a similar amount. So a very solid overall performance on the defense and military side and the expected weakness on the commercial market activity. From a timing perspective, it was modest, but certainly did draw some revenues from Q4 into Q3, primarily on the military side, as well as in Q2, we benefited a little bit as well. But I would say it was a modest impact, but it did benefit the quarter a little bit more than we had anticipated.

Got it. And then with respect to the payment segment, you mentioned, just touched on a couple verticals for CPI. Can you do a little bit of a deeper drill down into kind of what you're seeing by vertical and maybe where you're seeing inline performance to the down 35 to 40, where you're seeing businesses maybe underperform that, outperform that. So just some more granularity on CPI, please.

So the two segments that are being impacted a little bit worse than we had anticipated coming into the cycle here post-COVID would be vending. We did mention that in the prepared remarks, I believe. But certainly the return to work, return to schools has continued to slow that vertical down a little bit more so than the others. And then in retail, while we remain pretty optimistic about the future here with that business and automation and impacts from demands around increased hygiene, we feel good about that. But in the near term, the project activity has been slow, a little bit slower than we expected, and hence our or view that will be towards the higher end of that downrange that we had communicated earlier in the year. The other verticals, you know, gaming performing, I would say, as expected, perhaps a little bit better, but modestly better, certainly from the second quarter. Transport also fairly stable, I would say, from the second quarter.

Great. Thank you.

Our next question is from Damien Karras with UBS. Please proceed.

Hi. Good morning, guys.

Good morning, Damien.

Good morning. I was hoping you might be able to provide a little bit more color on the currency business. Obviously, you've seen some large swings there, you know, from time to time. And if our estimates are correct, that was probably up a little bit better than 100% in the third quarter. But just wondering how we should think about the most recent Federal Reserve order and what kind of incremental EPS that could potentially translate to the business of next year.

Well, Damian, I would say that on easy comps, your range is accurate in the quarter in terms of what we've been up. International continues double-digit. We just continue to execute well with our value proposition and high technology solution provider that people value. On the U.S. order, you know, we've always said this was going to be a lumpy business, and we certainly were looking for a recovery. And COVID, this is one of those businesses that are impacted positively due to COVID. Uncertainty drives demand in cash. The way I think I'd like to have you think about this order, I'm going to read directly from the Federal Reserve note print order and just the specific words. To better address, and so I'm reading verbatim, to better address possible shifts in note demand and note production due to the pandemic, the fiscal year 2021 print order is summarized below as a range by denomination. During fiscal year 2021, board members and BEP staff will adjust production of each denomination within these ranges to best match available production with demand throughout the year, to best match available production. So this is a very unusual order. This is a very unusual time. We have never seen a range given historically. So the way I think I'd have you think about this or the way we're thinking about it is there is an immediate demand that the Fed would like to see satisfied, but there are production constraints both at the BEP and that we have that's going to smooth this over a couple years. I think the demand that we're going to be able to satisfy is probably closer to the lower end of that range. And so you might say that it helps ensure on the one hand, we're not gonna overproduce and see as dramatic downturn. I think there's gonna be some consistency and smoothing from 21 to 22, and we'll continue to see how this plays out. But this is new territory for the Fed, the BEP, and for us, and we're working with our very important customer on this as we move forward. So hopefully that helps. Now in terms of EPS impact for 2021, I think hold off until we get through our planned period and understand in the next month as we head into our meetings with our teams and give you a little more clarity in January.

David, just a couple of points I would just add and just to remind that the Q4 comps will be much different than they were in Q3. We had a really strong It goes for the whole segment, but the comp was really created largely, I would say, by the currency business last year. So the fourth quarter, you know, is going to be a very different year-over-year comp, right, with a very strong fourth quarter that we had last year, but still feel good about what's happening with currency. The only other comment that I would add to what Max said was we tend to leverage pretty well in that business, and when you consider the slower –

recovery or somewhat slower recovery that we're seeing on payments it's uh it's a nice it's a nice mix for us uh to have as we enter into 2021. okay that's really helpful color guys um and then i just wanted to ask you about the rv business it was certainly nice to see an inflection of positive growth there in the quarter um and it's been kind of a long time coming so just wondering do you feel like we're just getting started there in terms of an up cycle And maybe you could perhaps expand on the run rate you're seeing in that business and how much catching up there might still be given some of the stronger consumer demand this year.

Yeah, well, we do think that, you know, we obviously with the results in the third quarter saw a nice pickup. You see the volume. You see the margins moving from 7% to 18%, 19%. We're continuing to see that. We saw that through the entire quarter. The fourth quarter, we would expect to see some seasonality and adjustments reflecting not as strong of a quarter in Q4 as we historically have. But what we're hearing from customers is that there is good demand here for at least the next 12 months. But how that plays out, we'll see, and we'll be running that to ground in the coming quarter.

I think, Damian, that I jokingly said at Investor Day when we were calling this a little early that RV demand is going to see an increase because of limited vacation options, and that's exactly what's playing out. So, I mean, all the data would indicate that there is an entire new entrant coming in to the RV lifestyle that never considered it before. Just the September numbers that were reported from RVIA, towables are up 35%. So while motorhomes are kind of flat, we have a little more content on some of the higher end vehicles. You know, it's good news all in, really. And today's entry-level buyer is tomorrow's upsized buyer. So I think it's just a fascinating trend. I think it's going to continue. You know, we've got some work to do with our team to understand what we're going to expect for next year. I think the strength will generally continue, and it's a positive for the business.

Thanks, guys. Appreciate the caller. I'll get back to you.

Thanks, Damian.

As a reminder, just R1 on your telephone keypad if you would like to ask a question. Our next question is from Ken Hebert with Canaccord. Please proceed.

Good morning, Ken.

Good morning, Max and Rich and Jason. First, I wanted to ask on fluid handling, the backlog growth in the quarter, can you parse that out a little bit either by sort of where you're seeing maybe any strength there, but then also I know part of the story in fluid handling over the last several quarters, if not years, has been a share gain and your ability to generate better than industry growth, especially with some of the new product introductions. Can you just talk maybe about what you're seeing in that business from a fundamental standpoint and then relative to crane-specific performance?

Just to catch you up on the backlog and the performance that we're seeing through the third quarter, right, to just give you a little bit more granularity, just recall that we have the INS business that we acquired late in the year, last year, or I should say early this year. And we have the valve services nuclear business that's had really a very strong year this year with nuclear outages continuing and us winning additional share in that business. Neutralizing for that, can in the third quarter or year over year was up – well, sorry, was down about a point, right, and sequentially up a point. So it's a little bit more muted when you actually isolate those two elements from the backlog. What I would say is that we do believe that we're outperforming the market with the initiatives that we've been driving over the last several years with respect to new product introductions and what we're doing with channel strategies and so forth. Those continue, and we're looking forward to sharing more of those with you, you know, come our investor day.

Do you get any sense that the nuclear work is, like, do you see any near-term end in that? I know that business can be an incredibly long cycle, but is it fair to assume that that strength continues beyond just this year?

Oh, yeah. Just keep in mind our nuclear business. Services business unit is around the annual turnaround work that is mandatory. So there's a cycle of shutdowns that we participate with, very, very consistent. That business will continue with certainty as we move forward.

Okay, great. And just finally, if I could, on the aerospace business, How would you characterize on your defense side? I know it's a smaller piece of the business, but you're seeing good activity. How would you characterize sort of bid activity and opportunities there? And as related to that, are you at all concerned about sort of spending pressure out in the next few years as a result of what might happen on the budget?

I would say that on the defense side and across most of our solutions, or all of them, frankly, we have seen good bid and quote activity throughout the year, and that's continuing. We've been seeing 20% high teens, high 20% growth all year long. I would say that we can't expect that to continue at that type of a level. as we look forward. But we do feel real good about the initiatives that we've been pursuing strategically from a technology perspective and satisfying what our customers are looking for here, Ken. So we're very optimistic about it and, in fact, outgrow whatever happens with the market. But certainly we'll see what the election brings, and we'll do our best to be able to give you the right guidance for next year.

Great. Thank you very much. Thanks, Ken.

Our next question is from Nathan Jones with Stifel. Please proceed.

Good morning. This is Matt Mooney on for Nathan Jones this morning.

Good morning.

Good morning. A quick question regarding the payment and merchandising. Decremental margin of 20% was much improved from the 67% posted in 2Q. Can you give any detail what drove better incremental margins and can that be sustained at that 30% level going forward?

Yes. So it's been about a little bit of a mix, of course, assisting with the year-over-year comp that we saw relative to the currency business, but also all the cost initiatives that we drove midway through, I would say, the second quarter and then fully executing on here in Q3. So it's largely mixed, again, and the cost reduction initiatives. And in fact, if you exclude the acquisition of Cummins Allison, the deleverage rate was actually much better than even that. So we feel pretty good about the 30%. I think the real question is, how are we gonna leverage up when the demand comes back in 2021, which we feel pretty darn good about, and we'll be north of that 30%.

Okay, thank you. And then looking at the aerospace electronics, what can be done to kind of improve the decriminal margin going forward and kind of what's your thoughts?

Well, the decrementals that you're seeing here relative to the other businesses is higher mainly because of the margin profile in that business, in particular the aftermarket products that we provide to the market. So that's a very, very difficult – margin profile to overcome. We're continuing to look at our cost structure and feel like we've got it balanced correctly. We are not going to take actions in this business that structurally impair our ability to continue to win and make the investments that are necessary for the long term. This is not like a very short cycle business where you can take costs out real quick or want to, frankly. We continue with a very strong engineering managed business with the view that we're going to drive long-term growth beyond what the market offers us.

Got it. Thank you. I'll get back in queue.

Thanks, Matt.

We have reached the end of our question and answer session. I would like to turn the conference back over to management for closing remarks.

Thank you, Operator. I would like to thank our teams around the world for their continued outstanding execution and perseverance in these challenging times. We remain committed to ensuring a safe working environment for our associates while continuing to drive execution and innovation to best serve our customers. Next week, we enter our annual operating plan process and meetings with each of our 10 businesses to review our operating plans for 2021. It's certainly a unique time to be going through this process, but we believe our regular cadence of reviews and planning discipline provide better clarity in an environment with heightened uncertainty we are experiencing today. As the late great Ruth Bader Ginsburg once said, so often in life, things that you regard as an impediment turn out to be a great good fortune. Despite the challenges of the current environment, we remain focused on what we can control and I'm extremely excited about the opportunities that lie ahead and we are working diligently to position Crane for the market recovery. We look forward to sharing our 2021 guidance with you on our January earnings call with additional details at our February Investor Day event. Thank you for your interest in Crane and have a great day.

Thank you. This does conclude today's conference. You may disconnect your lines at this time and thank you for your participation.