Greetings and welcome to Crane Company’s Third Quarter 2019 Earnings Conference Call. [Operator Instructions] Please note this conference is being recorded. At this time, I will turn the conference over to Jason Feldman, Director, Investor Relations. Jason, you may now begin.

Thank you, operator and good day everyone. Welcome to our third quarter 2019 earnings release conference call. I am Jason Feldman, Director of Investor Relations. On our call this morning, we have Max Mitchell, our President and Chief Executive Officer and Rich Maue, our Senior Vice President and Chief Financial Officer. We will 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 today may include some forward-looking statements. We refer you to the cautionary language at the bottom of our earnings release and also in our annual report, 10-K and subsequent filings pertaining to forward-looking statements. Also during the call, we will be using some non-GAAP numbers, which are reconciled to 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. As outlined in our press release last night, we reported Crane’s third quarter EPS excluding special items of $1.40 compared to $1.62 in the third quarter of last year. Sales of $772 million decreased 10% with an 8% decline in core sales, a 1% impact from unfavorable foreign exchange and a slight divestiture headwind. Operating profit, excluding special items, declined 14% from last year to $114 million. Adjusted operating margins declined 70 basis points to 14.8%. Execution was very solid in the quarter across all segments and with one customer demand related exception, all of our businesses performed in line with our expectations or better. The revenue shortfall in the quarter was related to lower shipments to the U.S. government at Crane Currency and let me explain what happened there. Every year, the Federal Reserve issues an Annual Currency Print Order to the Bureau of Engraving and Printing, or the BEP to cover deliveries of finished, printed banknotes for their fiscal year that runs from October 1 through September 30. Typically, this order is released in the July timeframe. In the late July and early August, we did see a slowdown in orders from the BEP, but we believed it was just the timing-related slippage from the third quarter to the fourth quarter. The Currency Print Order was then issued later than normal and publicly released in late August. When the print order was released, the total volume of banknotes that the Federal Reserve ordered from the BEP for the coming fiscal year was well below expectations and recent run-rates. Consequently, the BEP reduced their order rates for our products to match their expected run-rate for the start of their fiscal 2020. We believe that the primary driver of the lower order was a buildup of excess…

Thank you, Max and good morning everyone. As usual, I will be providing segment comments that will compare the third quarter of 2019 to 2018, excluding special items as outlined in our press release and slide presentation. Fluid Handling sales of $276 million declined 1% with 2% core sales growth offset by slightly more than 2% of unfavorable foreign exchange and a small divestiture impact. Fluid Handling operating profit increased 6% to $38 million with operating margins of 13.8%, 90 basis points higher than last year, reflecting productivity and repositioning benefits. This was a very strong performance by the team in the quarter, again driving very strong operating leverage while continuing to execute on repositioning actions as well as growth initiatives. Fluid Handling order backlog was $272 million at the end of September compared to $280 million at the end of 2018 and $298 million at the end of September of last year. After adjusting for foreign exchange, the backlog increased 1% sequentially and fell 6% year-over-year. Orders, also adjusted for foreign exchange, were flat compared to both last quarter and last year. Order activity in the quarter was approximately in line with our expectations and still consistent with the demand levels necessary for us to achieve our full year guidance. We expect to end the year with sales consistent with our original guidance and margins modestly better than our original guidance. From a market and geographic perspective, the commercial valve business continues to be stronger than process valves, particularly with strength from our Canadian distribution business. In our process valve business, we are seeing decent activity in the United States with projects moving along at a good pace across our verticals. In Europe, conditions remained stable at subdued levels and we are seeing continued positive activity in China, particularly…

Thank you. Our first question today is coming from the line of Kristine Liwag with Bank of America. Please proceed with your question.

Hi, good morning guys.

Good morning.

Max, if the fiscal year ‘20 volume from the U.S. government is the new normal and the U.S. government institutes more policies to keep notes in circulation longer, how should we think about volumes going forward after fiscal year ‘20 and how should we think about your $1 accretion target in 2021 from the Crane Currency deal?

Yes, thanks, Kristine. So it’s not the new normal, it is a inventory adjustment level. And so we have done – part of this time is for us to really dig in and get as much data and facts as we can and map this ourselves. This is not our customer data, this is our extrapolation. If you look at the revised run-rate, I fully expect on the next Currency Print Order after inventory is adjusted, the next year’s order, I am anticipating to be up at least 20% year-over-year. So there is going to be a reversion back to a mean run-rate once the inventory is corrected. That’s what I firmly believe. As it relates to the $1 of accretion, we are executing well to achieve the cost position that’s going to allow us to do that. Volume from U.S. currency is clearly going to come back. And based on everything that we know today, we are still holding again this broader macroeconomic uncertainty, but given what we know today in our multiyear earnings profile of achieving $7.50 to $8 by 2021, $1 of accretion from currency being a key part of that, we are still on track.

That’s helpful. And then Crane Currency was the largest acquisition you have done in a few years and it’s clear that this lower order took you by surprise. How are you thinking about your due diligence process now for other M&A candidates? And at what point would you consider pausing M&A and redirecting capital to buyback stock?

We always have a balanced approach to our capital allocation, Kristine. If we don’t deploy effectively, we are going to look at returning to our shareholders. So that will be an ongoing process. I don’t think that there is any change in our policy to-date. We have a number of opportunities that we continue to look at. In terms of our due diligence process, remember, we have called out that we have a number of – our Crane businesses have – any one of our businesses have very large customers that can have swings and some surprises. And we have seen those over the years. But I think you have seen us continue to manage for the long-term not the quarter. We continue to execute well, leverage beyond expectations in terms of – well, I am pretty proud of our execution, investing and reinvesting in the businesses, positioning ourselves for the future. So even at an Investor Day, we described we have lumpiness, we understand that, we manage it well, we are going to continue to manage well for the long-term.

Great. And one last follow-up, if you can’t find any targets by year end, I mean you are slated to generate free cash flow roughly around $300 million, would you then consider doing an accelerated share repurchase of about similar amount that you could do or maybe a regular share repurchase?

And as usual, Kristine, we don’t preannounce, we will continue to evaluate all options and I don’t have much more to say.

Great. Thank you.

Thanks, Kristine.

And our next question is from the line of Nathan Jones with Stifel. Please proceed with your question.

Good morning everyone.

How are you, Nathan?

Max, not surprisingly, I will follow up on the currency stuff here. Max, can you confirm that the $0.35 reduction in your EPS guidance is solely related to this lower order from the Fed?

Yes.

It’s about $25 million of operating profit this year. Are you able to disclose what the lower revenue number is in the second half of the year relative to what your prior expectations were or is that getting too deep?

Yes, it’s getting a little bit too deep, Nathan. We are a little concerned just this is an important customer of ours and we are trying to be cautious and sensitive to them.

Okay, understandable. A fair amount of this inventory correction looks like it did happen in the third quarter. I think, Max, you are talking $1.14 billion of total revenue, implies down only about 5% in the fourth quarter. Has most of this occurred in 3Q more of it occurs in 4Q and kind of the inventory correction is done then or does this spread out into 2020?

Yes. So the inventory correction will be balanced over – once that annual purchase order came up, it’s balanced over the course of the year. So you will see that reduced volume level play out. What we saw in the third quarter in almost, I can’t speak directly for our customers, but it almost felt like there was a bit of a surprise even within our customer side. So we saw an immediate slowdown while we were waiting for the order. Various information in terms of – that we couldn’t quite get our arms around which is why we had to take our time to really understand this, confirm it, go and meet with the Fed and the BEP, but it’s going to be normalized and smooth throughout the course of the year.

Okay, it maybe – sorry.

Yes. I was just going to say in terms of smoothing as it relates to the order that we receive, but in terms of our guidance here for the balance of the year, we are going to see more of the impact to us in the fourth quarter than we saw here in Q3.

More on the revenue line or the operating profit line?

Overall impact operating profit line.

Okay. Can you then start to smooth out the impact that this has to margins by taking appropriate cost actions. It’s obviously going to be very difficult for you to do anything about the cost side of this equation in 3Q when it took you off guard. Maybe it takes a little bit longer in 4Q, but should we see the margin impact from this kind of start to decrease as we go forward?

Yes. I mean – so as we look it, and we’ve already taken action as you might expect to adjust for the demand level change. We would expect margins to improve overall for the segment in the fourth quarter.

Okay, thanks. I will pass it on.

Thanks, Nathan.

Next question is from the line of Brett Linzey with Vertical Research. Please proceed with your question.

Hi, good morning all. Just back to currency, I just want to clarify a comment you said. Did you say that year-to-date sales were up 26% in currency, ex the U.S. and ex-Venezuela?

Yes.

Okay. And then I guess as we look into next year, I mean are there any larger contracts with specific countries that run the risk that you’re kind of in a similar situation where you have another tough comp. And then specific to Venezuela, does that continue to create another comp issue as we get into 2020?

No, not for 2020. And in terms of other – for Venezuela, and in terms of other similar situations, none that we’re aware of right now.

And then what are the assumptions that underpin the treasury snapback next year that you think that does come back up 20% from an order perspective just trying to get comfortable with some of the drivers there?

Well, I think, I mean, if you look at the historic run rates by currency, it’s all on the Fed website, this is our own extrapolation of a run rate of 7 billion notes for the past few years adjusting down to 5.2 billion. Extrapolating each individual currency, I believe it’s going to come back to at least 6.5 billion to 6.8 billion notes.

Okay. And then maybe just one follow-up on Fluid Handling, orders flat, which is improvement versus Q2, could you maybe just unbundle what the OE or project side did versus MRO and aftermarket, both on the sales and order basis, please?

Yes. From a – so you are in the process side of the business then Brett. So on that side, I would say that we’re seeing similar levels to what we saw in Q3 – coming into Q3, maybe a little bit better actually on the project side. MRO, I would say, steady as it relates again to the process side of the business.

And is that a sequential comment, Rich?

Yes.

Okay, alright. Great, thanks. I will pass on.

Thanks, Brett.

The next question is from the line of Damian Karas with UBS. Please proceed with your question.

Hey good morning guys.

Good morning, Damian.

Rich, maybe we could just take the financial impact of the currency situation one step further. Understand that that’s what’s driving the guidance reduction for this year. But could you just help us take it one step further and understand kind of what is the full year kind of run-rate financial impact you are expecting as a result of that 18% order decline for the U.S. federal government? And I guess, based on what Max had been saying, you would expect that to basically fully offset beginning late 2020 through 2021?

Yes. So just to make sure I understand that, so the impact of this year, as Max mentioned, is, the EPS reduction is the impact. It all is correlated to the reduction in demand that we saw with the U.S. government. As it relates to next year and our thoughts that the yearly currency order that we receive from the BEP, that new order comes in sort of that late July time frame, that we would expect for the succeeding full year, fiscal year, for the U.S. government where we would start to see that pickup start to happen, but we will see a continued headwind as we think about the first 9 months of 2020, if that helps.

Okay, I can follow-up. I guess, given that you’re caught a little bit off guard by this, and Max, you did mention that you don’t have any direct visibility into the BEP inventories, I’m just curious if there is anything that you guys think that you can do to increase visibility into your customer inventory or perhaps get an earlier read into their buying intentions going forward?

Our customer is very sensitive to this, we asked – Damian, we asked to participate even suggesting a facilitated Kaizen-type event partnering more closely. But it’s up for discussion, but for various reasons, there’s a precedent of not sharing this type of information. And my expectation is probably that’s going to continue. It’s closely guarded for various other reasons as well.

Got it. That makes sense. Thanks. And one last one just on Fluid Handling, I mean, the business seems to be holding up fairly well considering a lot of the short cycle and macroeconomic pressures out there. Just wondering if you’ve seen any indications from customers that some projects could possibly be deferred or even canceled as we kind of exit the year and move into 2020?

Rich can offer some comments as well, but the project – I’m surprised at the strength in the releases. So these are projects that we’ve been tracking. I had not seen an increase in any kind of cancellations we are really not seeing an increase in moving to the right. We’re seeing a steady release of those that had moved to the right. Chemical in the U.S. has been particularly strong. Some acetic acid plants, pharmaceutical and then a whole host of refining and petrochem turnarounds and MRO-type work. Europe has been quite stable. There’s been a chemical investment there on the polymer plant, a large project. So it’s been stable at its current rates, is the way I describe it. I don’t know, Rich, if you….

No, I would echo those same comments. I don’t think there’s too much more to add. We’re seeing some good strength across parts of the rest of the Fluid Handling business as well. As we highlighted or I think I highlighted on the prepared remarks, what we are seeing from municipal water here domestically in the U.S., Canadian non-res and even in the UK, the non-res portion of fluid in the UK also doing well even in the face of sort of the Brexit noise.

No. That’s true. Good comment.

Okay, great. Thanks for the help. Good color guys.

Thanks, Damian.

The next question is from the line of Robert Barry with Buckingham Research.

Hey guys. Good morning.

Good morning.

So lots of puts and takes in payment, but just in terms of this lower Fed order, in particular. Is the decline kind of ratably spread in dollar terms over the next four quarters, 3Q plus the next three quarters?

Did you say evenly spread?

Evenly, yes, like the amount of revenue that’s kind of coming out since the order was down, it’s kind of evenly allocated over the next – through call it 2Q.

Generally, yes. There is some minor mix month-to-month, quarter-to-quarter, but generally yes.

Got it. And the decrementals on this business are like in the low to mid-30s, is that fair?

No, no. As it relates to this particular customer, it’s a little bit more – it’s more significant, even relative to other portions in Crane, given the fixed cost structure that we had here with facilities dedicated to the U.S. government. So our de-leverage rate tends to be much higher here and correspondingly, when demand comes back, it comes back with much more operating profit contribution.

Got it. So it sounds like...

I would say just – I would offer off, in the quarter year-over-year, you almost don’t see that read through so much in this quarter, just given the performance in the rest of the business within payment. We really had an exceptional performance outside of currency. So with the de-leverage rate in the, I think, low 30s year-over-year, that’s pretty healthy, notwithstanding this kind of a decline that we experienced with the U.S. government.

Right. And that exceptional performance is that something that is like a handful of just large orders that hit or is there something more kind of run-rate that’s just accelerating and causing that? I guess, I am trying to get at sustainability here of that kind of momentum, that offsetting momentum?

Yes. I think the way to think about it is that we feel pretty good about the momentum, in particular, in the payment business that we have, right? That coupled with the actions that we’re taking with respect to the currency business in response to the demand decline, positions us, I think, for a pretty good margin performance as we think about the fourth quarter. So for us to hit that 16.5% full year after having a 14.5% quarter here in the third quarter, you can see that sort of that run rate would suggest a pretty good performance in Q4.

Right, right. Yes. So you mentioned for 2020 being back in the 18% to 22% range. I mean, just given this pressure is going to be with you in the first half at a high decremental, I mean is it fair to assume like we should be thinking about the low end of that range? Is that a fair kind of number to dial in at this point?

I think that’s fair.

Yes. I guess, just lastly, from me, kind of a bigger picture question. It was kind of alluded to earlier. I understand you expect this particular Fed order to snap back next year. But is this kind of trend of extending the useful life of notes, in part, as you pointed out, due to some of the things that you’re doing and selling, more of a kind of long-term underlying secular trend? People will keep recycling, et cetera, but just as we think about the midterm outlook for this business, even if currency in circulation is still growing, content per note is growing, but useful life of notes is also growing that, that would kind of just damp down the kind of midterm growth potential?

So the question – I’m not sure I quite got the question.

Yes, I’m trying to rethink what the midterm growth potential is for the currency business. I understand that notes in circulation and content per note, right, like anti-counterfeit content are positive trends, but it sounds like aside from this onetime kind of inventory correction, there’s also an underlying secular trend towards extending the useful life of notes.

So we didn’t say extending the useful life, that’s the interesting point. The interesting point is that it’s extending the bill in circulation. And so in checking for fit or unfit notes, there could be an argument to say, well, if you’re not receiving the note back in the same frequency, you have what would have been classified as unfit and destroyed notes in the past or staying out in circulation longer. So the challenge is going to be how do you get those notes back or what might you need to change from a policy standpoint to take this into consideration that there is more recycling taking place that is wearing out the bills and extending their life in circulation, while they’ve become unfit. I think that’s the broader question that’s going to be quite interesting to see play out. So is that actually an opportunity down the road. Honestly, we don’t have enough knowledge around that broader trend and what may take place, but I could just as easily make that case, quite honestly.

Right, right. Yes, just to clarify, I think what I was referring to as useful life, I meant to call life in circulation. So, alright great. Thanks. Thanks for all the color guys. I will pass it on.

Thanks Rob.

The next question is from the line of Ken Herbert with Canaccord Genuity. Please proceed with your question.

Hi, Ken

Hi good morning Max and Rich good morning. Just wanted to switch gears if I could. And in the Aerospace and Electronics segment, can you quantify to what extent the, I guess, longer-than-expected grounding of the 737 MAX has impacted the segment sales and/or margin relative to expectations earlier in the year as we probably all assumed a sooner return to service?

Yes, I would say just given the ongoing production of what we do deliver for the 737 MAX, not much from that point of view. Ken, we might be seeing a little bit of upside from aftermarket as they continue to fly the legacy aircraft, but really difficult to quantify what overall aggregate contribution that might be because it would be speculating, frankly. So I would say nothing really on the OE side and perhaps a little bit of tailwind on the aftermarket side.

Okay. And then if I think about that into 2020, then is it fair to say that maybe upside expectations, assuming the timing of the MAX return to service, may be not a significant tailwind? I mean, obviously, you’ll get some volume increase, but you don’t expect to see a significant catch up from your standpoint, it sounds like?

No nothing significant at this point.

Okay. And obviously, margins in the segment again continue to be incredibly strong. It sounds like aftermarket on both commercial and defense was probably a tailwind in the quarter. Was there anything one-time in the quarter in the segment either maybe on a model upgrade program or anything else that could have impacted or that stood out in terms of margins or the mix for Aerospace and Electronics?

Not really. Not on the aftermarket. I mean we saw some pretty good strength, as I mentioned, across commercial and even the military. So, nothing that I would call out, I would say lower IP spares relative to last year at this time, so mainly replenishment on the commercial. The overall aftermarket, as you know, Ken, has been real strong here throughout all of 2019. And notwithstanding my comment earlier about any sort of tailwind or headwind related to the MAX, as it relates to next year, is this really a sustainable trend, and that’s something that we’re digging into just overall from an aftermarket perspective as it relates to 2020.

Okay, perfect. I am sure you will give a lot more detail early next year. And Max, you’ve obviously alluded to the 2021 sort of $7.50 to $8 target you’ve put out. It sounds like the issues with payment and specifically the currency business now haven’t at all changed your view on that and you are fairly confident that you get sort of resumption to higher normalized levels coming out of or the midpoint of next year. Is that the fair way to think about it or is there anything else you’d highlight as sort of incremental risk around the 2021 EPS target?

I think just in terms of broader macroeconomic uncertainty, and we’ve seen continued strength. So taking that aside, and we’re about ready to head out on our annual operating plan visits with our businesses and really provide more information for you in January of guidance for 2020. But I think you summed it up exactly how I’m thinking about it, Ken.

Perfect. Alright, well thank you very much.

Thank you.

Our next question is coming from the line of Matt Summerville with D.A. Davidson. Please proceed with your question.

Thanks. Couple of questions. And I joined the call a few minutes late, so I apologize if I’m asking you to be redundant, but can you – within the payment business, can you drill a little bit deeper into what you’re seeing across the CPI verticals? I know you mentioned a little bit on retail, but maybe just a deeper dive across that business?

Sure, Matt. Overall, I would say, we are continuing to see pretty solid demand. We mentioned retail in our prepared remarks really being a driving factor there with automation and the desire for our customers to reduce costs. So we’re continuing to see that really move forward in a pretty heavy way. I would say across the rest of the business, on a year-to-date basis, we continue to see pretty good momentum in the vending portion of that business with cashless penetration, we are seeing healthy prospects and projects with transport. So pretty solid there, I think the one thing I would say is that on the gaming side and casino, we highlighted this last quarter, we are down year-over-year. We expected to be, given the amount of success we had in taking share last year as well as expanding our product upgrades to the connected casino, so to speak, so we saw a lot of that momentum last year that naturally slowed down and was expected, but we’re also seeing just a little bit of softness in that part of the business. But beyond that, fairly healthy, I would say, across the rest of the payment group.

And then with respect to Crane Currency, again ex Venezuela, ex U.S. government, business up 26%, how fast is the international market growing? I would imagine it’s not that fast. So it looks like – that I would assume you are gaining pretty meaningful market share. Can you talk about what’s differentiating Crane Currency in the marketplace to capture that share?

Combination. It is mostly share. And it’s a combination of our world-class printing facility in Malta, coupled with the technology solution that we have on micro-optics, offering a comprehensive suite of paper technology, print – thread technology for insertion and counterfeit detection, and we’re able to sell all or any of those to a myriad of customers around the world that see our value in addition to world-class design expertise.

Thank you guys.

Thanks, Matt.

Our next question comes from the line of Nathan Jones with Stifel. Please proceed with your question.

Hi, guys. Just wanted to follow-up on your progress on cultivating acquisitions, now that we’ve moved on from CIRCOR, I think you were talking fairly aggressively last quarter about looking to get some capital out into the market. So just any update you can give us on what the opportunities are, what you are seeing out there in the market?

Yes. Thanks for the question. The opportunities continue to be quite robust right now in each of our segments. So there is opportunities from small to midsize that we are investigating. Some private, some part of an auction process. And so our process continues. I mean, I think we have remained disciplined. We continue to have a robust process, we identify bolt-ons. We are focused on our three major platforms. Nothing has changed. Activity level, I would say, is above average right now.

Okay, that was it for me. Thank you.

Thanks Nathan.

Thank you. We have reached the end of the question-and-answer session. And I’ll turn the call over to Max Mitchell for closing remarks.

Thank you, operator and thank you all for your time this morning. Another quarter of solid execution and share gains but clearly a surprise in customer-driven demand at Crane Currency. As the late great author, Toni Morrison, once said, correct what you can; learn from what you can’t, a perfect message for how we think about our situation in management in Crane today. Thank you for interest in Crane. Have a great day.

This concludes today’s conference. You may disconnect your lines at this time. Thank you for your participation.