Earnings Call Transcript
Crane Co (CR)
Earnings Call Transcript - CR Q2 2022
Operator, Operator
Greetings. Welcome to Crane's Second Quarter 2022 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. Please note, this conference is being recorded. I will now turn the conference over to Jason Feldman, Vice President of Investor Relations. Thank you. You may begin.
Jason Feldman, Vice President of Investor Relations
Thank you, operator, and good day, everyone. Welcome to our second quarter 2022 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 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 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.
Max Mitchell, President and CEO
Thank you, Jason, and good morning, everyone. Thanks for joining the call today. Another strong quarter with solid results across the board. Second quarter adjusted EPS was $1.90, consistent with our expectations and our guidance commentary and compared to $1.93 in the second quarter of 2021. Remember that the May divestiture of Crane Supply reduced EPS by approximately $0.05, both sequentially and compared to the prior year. We also delivered core sales growth of 7%, with further strength in demand reflected in core order growth of 14% and core backlog growth of 21% compared to last year, continued solid underlying trends in our primary end markets. Clearly, momentum continues with another quarter of strong results, differentiated execution despite a challenging operational environment as well as further evidence of our success in driving accelerating growth. Across all of our businesses, our commercial excellence, innovation and investment in technology road maps support our ability to drive outperformance compared to our peers across the cycle in an environment with continued supply chain constraints. In addition, everything is on track and progressing towards our early 2023 separation, which will unlock shareholder value and permit each post-separation company to optimize investment and capital allocation and further accelerate growth. Starting with the market environment, we continue to see robust demand across our end markets. We are carefully watching for any signs of softening, but order rates remain strong across our businesses. The supply chain, including material and component availability, remains challenging but still fully consistent with the outlook we provided in January of this year. We've clearly planned appropriately for this environment. From a cost and inflation perspective, we continue to be assertive with pricing actions across all of our businesses, and we continue to fully offset the impact of inflation. Overall, we still believe that we planned appropriately when we entered 2022 and that our current guidance is consistent with the demand conditions and supply chain constraints we are seeing today, and we expect similar conditions to persist throughout the year, consistently delivering on our commitments. The year is playing out as expected. And beyond execution for 2022, we remain intensely focused on all strategic initiatives, advancing technology to position our businesses for the future, and preparing for the next step of our journey, the April 2023 separation into Crane Company and Crane NXT. Each segment also continues to execute for growth. We remain highly confident in our ability to drive a 7% to 9% sales CAGR at Aerospace & Electronics through the end of the decade. Process Flow Technologies continues to drive record levels of product vitality and innovation. And at Crane NXT, we are aligned with secular trends and macro drivers in delivering solutions that enhance productivity and efficiency for our customers with leading technologies. So in summary, excellent execution and all efforts on track, an exciting set of opportunities for these businesses, both before and after the separation. At this point, I'll turn it over to Rich for some additional financial commentary.
Rich Maue, Senior Vice President and CFO
Thank you, Max, and good morning, everyone. We continue to make progress, both operationally and strategically on all fronts, and it shows in our results as we continue to find ways to drive profitable growth even through all of the challenges we are facing today. My thanks again to our leadership teams and associates globally for their focus and dedication driving sustainable value creation for all our stakeholders. Moving to segment comments that will compare the second quarter of 2022 to 2021, excluding special items, as outlined in our press release and slide presentation. Starting with Aerospace & Electronics, sales of $162 million increased 3% compared to last year. The segment margins of 17.5% were similar to last year's 17.8% and down from 19.6% last year when we had a particularly favorable mix. In the quarter, orders increased 27% compared to last year, but with sales still constrained by material availability. We are seeing improvement. Sales improved sequentially from last quarter by 3%, and we expect further sequential improvement in the second half of this year as the supply chain constraints continue to moderate gradually. In the quarter, total aftermarket sales remained strong and were up 7% compared to the prior year. Aftermarket strength was led by commercial, up 15%, driven primarily by spares and repair and overhaul. Defense aftermarket sales declined 6%, based on program timing and some temporary shipping delays. Commercial OE sales increased 13% compared to the prior year, driven by higher build rates. Defense OE sales declined 9% due to program timing and some transient material availability constraints. As we discussed earlier this year at our Investor Day event, we are very excited about the outlook for this business and continue to have confidence in a 7% to 9% sales CAGR over the next decade. Our confidence in this outlook is based on our differentiated technology, a continued post-COVID commercial aerospace recovery, and the numerous major multiyear programs, particularly on the defense side of the business that we have already won. This year specifically, we had solid performance that improved progressively over the last 6 months, and we expect modest continued sequential improvement in sales over the remainder of this year. Given the expected timing of specific projects, we expect margins to be strongest in the fourth quarter of this year, and we remain on track for full-year margins of approximately 18%. At Process Flow Technologies, sales of $296 million decreased 5%, driven by a 7% impact from the May divestiture of Crane Supply and a 4% impact from unfavorable foreign exchange, partially offset by 6% of core growth. Operating profit decreased by 6% to $46 million, but adjusting for the divestiture of Crane Supply, operating profit was approximately flat compared to the prior year. Operating margins were basically flat at 15.6% compared to 15.7% last year. Pricing continues to fully offset material inflation. Sequentially, compared to the first quarter, core FX-neutral backlog increased 5% with core FX-neutral orders up 7%, both adjusted for the Crane Supply divestiture. For reference, backlog at Crane supply in the first quarter was $32 million. Compared to the prior year, core FX-neutral backlog increased 14%, and core FX-neutral orders increased 8%, also both adjusted for the Crane Supply divestiture. Continued strong leading indicators suggest that we will see strong continued growth throughout 2022, led by our process business where overall order rates have already recovered to approximately pre-COVID levels. The strength is being led by the chemical, pharmaceutical, and general industrial end markets. After adjusting for the Crane Supply divestiture, which contributed approximately $45 million of sales in the second quarter, we expect third and fourth quarter sales run rate to be similar to the second quarter. However, we do expect margins to improve sequentially in the third quarter and then again in the fourth quarter. Moving to Payment & Merchandising Technologies. Sales of $334 million in the quarter increased 2%, driven by a 7% increase in core sales, partially offset by a 5% impact from unfavorable foreign exchange. Segment operating profit increased 4% to $81 million. Operating margins improved 50 basis points to 24.2%, reflecting strong pricing and productivity, partially offset by unfavorable mix. Currency markets are behaving as anticipated and previously communicated, with core sales roughly flat compared to last year in the quarter. Remember, currency hit new records in both U.S. and international sales last year. Full year 2022 will decline modestly, and we will then resume growth from an elevated base next year. At CPI, broad-based strength continues with double-digit core growth. Our gaming business has been very strong. Vending continues to improve, and the level of activity in the retail market remains very encouraging. We continue to see a proliferation of different solutions across the retail space, but the common theme is the need for productivity in an inflationary environment with labor shortages. For the segment, we expect sales to be similar sequentially from Q2 to Q3 before picking up further in Q4. From a margin perspective, we do expect margins to moderate in the second half due to anticipated mix, while full-year segment margins are on track to reach approximately 23%, exceeding last year's record levels. At Engineered Materials, sales of $73 million increased 23% compared to the prior year. Operating profit increased 40% to $11 million. Operating profit margins increased 180 basis points to 14.8%. Strength was broad-based across end markets and led by RV and building materials. The segment remains on track to achieve previously issued full-year guidance of 13.5% margins and 5% core growth. Free cash flow was $92 million in the quarter and consistent with our normal seasonality and a significant pickup relative to the first quarter. Adjusting for one-time cash outflows related to our portfolio actions, we believe that we are on track to achieve our full-year adjusted free cash flow guidance of $350 million to $390 million. However, it will be more back-end loaded than normal, given higher working capital related to the market recovery, most notably some improving inventory, and in many cases, we are making very conscious deliberate decisions to add inventory in the near term to best protect our customers. Our balance sheet is in extremely good shape. By the end of the year, we expect adjusted gross leverage towards the bottom end of the 2 to 3x Moody's gross debt-to-EBITDA target range for our current credit rating. Turning to guidance. We are maintaining our adjusted EPS range of $7.45 to $7.85 for the full year. As a reminder, when we announced the sale of Crane Supply in April, we maintained our then guidance range of $7 to $7.40 despite the loss of 7 months of earnings contribution from that business. So effectively, it was a 25% operational guidance increase at that time. Shortly thereafter, in May, we updated our guidance once more to reflect adding back the earnings of Engineered Materials after it no longer met the criteria for discontinued operations, resulting in our existing $7.45 and to $7.85 range. There is no change in our operational guidance assumptions in May, and we continue to remain confident in that outlook despite incremental foreign exchange headwinds of approximately $0.10. From a cadence of earnings perspective and timing through the quarters, we expect the third quarter to be similar to the second quarter after adjusting for the approximate $0.10 of earnings contribution from Crane Supply in the quarter. Said another way, we expect third quarter EPS to decline sequentially about $0.10, which is the amount Crane supply contributed in the second quarter prior to the May divestiture of that business. We then expect the fourth quarter to be stronger, driven primarily by sequential margin improvement at process flow technologies and both sequential sales and margin improvement at Aerospace & Electronics. Regarding the separation, our work is progressing very smoothly. We have completed the required carve-out financials and associated audits and we are making good progress preparing the initial Form 10 filing. We have completed the future state design for both post-separation businesses across every corporate function. We have made substantial progress on the staffing of both corporate organizations. All Crane corporate associates now know what company they will be working for as well as the specific role and we are executing against a structured hiring plan to fill the remaining open roles over the next 8 months. And we continue to further refine the details of the post-separation capital structures, our financing plans and our plans for legacy liabilities, and we expect to be able to share those details in early fall of this year. Overall, we are on track to complete the separation in the 12-month period we communicated on March 30. A solid outlook and even more exciting times ahead as we enter 2023 and complete the separation. We are all energized at the progress that has been made to date and the opportunities that we are unlocking and pursuing every day.
Operator, Operator
We are now ready to take our first question.
Matt Summerville, Analyst
First question maybe on process flow. Could you maybe put a little bit of a finer point around maybe of the 6% organic, how much of that is volume versus price? And then maybe add a little bit more detail around geographic and market color? And then I have a follow-up.
Rich Maue, Senior Vice President and CFO
Yes. So for the volume price, we did see a very modest drop in volume. So the substantial majority or all of it was related to price in the quarter. When you look at the order profile; however, you noted some of the commentary and what you saw in the release, we feel really good about the level of demand, the nature of the demand and the backlog that we have to execute against. So pretty positive about where we are today in relation to the second half of the year. From a geographic perspective, I would say that not too much has changed since the last quarter. I would say demand continues to be fairly strong here in the Americas, improving in Europe a bit. China remains a little bit constrained with respect to those end markets and COVID restrictions and so forth. Other than that, I would say it's fairly stable since the first quarter.
Max Mitchell, President and CEO
The only thing I might mention is less material, but our non-residential U.K. business is seeing some early signs of some pushouts, projects being questioned, not unexpected actually, but that's probably the only sign that I would say.
Matt Summerville, Analyst
Got it. And then as my follow-up, maybe just talk a little bit more detail around the currency business. Obviously, very tough compared there, no doubt about it. But when I look at kind of the numbers coming out of the BEP and where they're at fiscal year-to-date on their production seemingly below, tracking below the low end of an extremely wide range that they issued with respect to the purchase order. I was wondering if you could comment on what sort of dynamics you might be seeing there? And if you have any early thoughts on fiscal '23, as I know their planning process is well underway right now.
Max Mitchell, President and CEO
Thank you, Matt. Overall, the main reason for being below the wide range is the ongoing work that needs to be paused for the next series. We've previously mentioned our close partnership with Crane Currency regarding the micro optic thread, and we anticipate increased content as the NXT series is launched. There is a significant amount of work and progress happening, but we need to allocate time for trial runs, which is affecting us. Additionally, BEP has faced COVID-related challenges like many others, along with specific issues that I won't detail. However, demand remains strong, and it would be ideal for the Fed to increase shipment levels. I believe BEP is doing an excellent job managing these challenges while preparing for the future. This reflects positive long-term trends, and for 2023, it looks promising for BEP to maximize their output while also conducting trials.
Rich Maue, Senior Vice President and CFO
The only thing I would add is that we planned accordingly for the year. Even though we are at the lower end of the range, we still feel very good about where we stand for the remainder of the year. Additionally, outside of the U.S., we are beginning to see positive momentum on the international front. Last year was exceptionally strong internationally, which created some tough comparisons for us, but we are noticing an increase in order flow that should benefit us moving forward in 2023.
Matt Summerville, Analyst
Understood. Thank you, guys.
Operator, Operator
Our next question is from Nathan Jones with Stifel. Please proceed.
Nathan Jones, Analyst
Good morning, everyone. I'm going to follow up with some more on price versus volume. Obviously, prices are a big contributor to a lot of companies growth, not just yours at the moment. Any more color you can give us on price versus volume in order rates, in backlog growth, those kinds of things and any color, any detail on the different segments? And just any more details you can give us on price versus volume in each of the businesses.
Rich Maue, Senior Vice President and CFO
We are making similar progress in terms of price and volume across all of our businesses. This is not limited to the process end market or the commercial side; progress is being made in all areas. The relationship between price and material costs is generally slightly favorable across the board, which allows us to maintain our margin profile through the processes we are implementing in our business. There isn't one area that stands out as significantly stronger than the others; our teams are performing well overall in managing price and costs.
Max Mitchell, President and CEO
I believe it's accurate to say that while we've faced some supply constraints in managing sales and price volume, our backlog and order rates are showing more offsetting effects, and we are seeing a significant increase in core volume compared to just price.
Rich Maue, Senior Vice President and CFO
Yes, if you look at the order increases we've shared, the percentage that's attributed to volume compared to price is heavily skewed towards volume. There isn't much emphasis on price; it's primarily volume.
Max Mitchell, President and CEO
And having said that, we feel very confident about the pricing that we have in the backlog as well, where it's positioned and that means for forward...
Nathan Jones, Analyst
The volume increases in orders and backlog is across all of the businesses or are more heavily weighted to one or the other?
Rich Maue, Senior Vice President and CFO
I would say it's fairly widespread, right? I mean, fairly widespread.
Nathan Jones, Analyst
That's helpful. I wanted to ask about Engineered Materials. Since the sale didn't happen, can you discuss the plans for that? This business has historically been quite cyclical, and with rising interest rates and decreasing consumer confidence, are there any strategic buyers? Given that the business is performing well, does the current environment affect the outlook for pricing? Could that lead to a decision not to sell it? I would appreciate any thoughts you have on this.
Max Mitchell, President and CEO
I appreciate that. Nathan, just a reminder, I hope investors understand the importance of how we are comprehensively addressing the portfolio and are positioned to create significant value with the separation of Crane supply. It's been clear for years that while Engineered Materials is a great business with a great team, it is not strategic for us. We have moved forward with the sales process, but unfortunately, after a lengthy period with a potential buyer, the sale was blocked due to the current regulatory environment, despite only a minor overlap with Building Products. Time has not been on our side here. Given everything happening at Crane and the market conditions, it seems evident that a mild recession is underway, with consumer discretionary sectors feeling the impact first. We notice some adjustments in Engineered Materials, but I believe that our guidance remains solid and will not affect our performance. Therefore, investors should anticipate that Engineered Materials will likely remain part of Crane for the foreseeable future. It's a strong business with a great team, generating significant free cash flow in the U.S., which we will continue to utilize. We will revisit this topic at an appropriate time in the future.
Nathan Jones, Analyst
That makes sense. I'll pass it on. Thank you for taking my questions.
Operator, Operator
Our next question is from Damian Karas with UBS. Please proceed.
Damian Karas, Analyst
Good morning, everyone. I would like to ask about PMT. I didn’t hear you mention anything regarding shipment timing or any seasonal aspects. For the second quarter, is it reasonable to assume that the underlying demand is exceeding expectations? If so, where are you observing that primarily?
Max Mitchell, President and CEO
I think I might say in line with expectations, right? I mean we're tracking, I think, pretty well for the growth that we had expected for the year. There had been a little bit of shipment timing we mentioned last quarter, which favored 1Q at the expense of 2Q, but nothing more to kind of add on that.
Rich Maue, Senior Vice President and CFO
Yes. I would add that the percentages and growth align with our guidance and expectations. As I mentioned to Matt earlier, we are experiencing positive momentum on the currency side of our international business. When looking at the payment side, we see continued strength in retail and gaming, which is consistent with our expectations.
Max Mitchell, President and CEO
It’s worth noting that we haven't discussed this with investors yet. On a year-over-year basis, we are experiencing strong core performance in our end markets, including gaming, retail, and our systems business. Last year, there was a favorable dynamic with bitcoin kiosks, which significantly contributed to our growth by converting cash into bitcoin. However, following the decline of bitcoin and cryptocurrency, we have seen a substantial downturn in that segment. Nevertheless, our other markets remain robust. I want to emphasize the continued strength and positive trends we are observing, as we are still below 2019 revenue levels. We are seeing significant movement and encouraging indicators for 2023 and beyond.
Rich Maue, Senior Vice President and CFO
Yes, that's a great point. We experienced growth in the first and second quarters within our legacy payment components business, achieving double-digit growth on a core basis, even with bitcoin currently at zero. To provide context, the growth in our underlying business is actually higher than that.
Damian Karas, Analyst
Got it. Got it. Helpful color. And then, Rich, you mentioned that actions at Crane taking the secure inventory for your customers. I was wondering if you could maybe just walk through your assessment of where inventory levels are when you look across the various distribution channels that your business sells into.
Rich Maue, Senior Vice President and CFO
Yes, in the general industrial sector in the U.S., I believe companies are currently replenishing their stocks. There remains a significant underlying demand in this area of our business, which acts as our main distribution channel. They are not carrying much inventory, yet it is still necessary. My point is to ensure inventory levels are adequate to meet demand given the lead times. We are making deliberate choices in some of our business units to ensure we have the inventory needed to fulfill customer orders.
Max Mitchell, President and CEO
But even having said that, I wouldn't say it's unnatural or too unusual, I think it's more surgical. There's a couple of strategic. But some slightly higher inventory levels that we're intentionally trying to bring in, but nothing too dramatic.
Damian Karas, Analyst
Okay, got it. Thanks, guys.
Max Mitchell, President and CEO
Yes. Thanks.
Operator, Operator
Our next question is from Elizabeth Grenfell with Bank of America. Please proceed.
Elizabeth Grenfell, Analyst
Hi. Good morning. I was hoping you could give us a little more color on the decline in defense on both OE and the aftermarket side. When you expect that to turn the headwinds that you're seeing sort of the timing around it and any detail you could provide? Thank you.
Rich Maue, Senior Vice President and CFO
Yes. The declines we're experiencing were largely anticipated. Coming into the year, we set lower expectations for defense. As a reminder, we had experienced growth of over 20 percent for the past couple of years, so we faced tough comparisons. Regarding the shortfall, I mentioned material availability and timing, which are contributing factors. We anticipate a turnaround next year, possibly in the latter half. Overall, it wasn't unexpected since we had indicated lower expectations for defense. Our participation is mainly in ISR, and there are areas where others are seeing more growth compared to us this year.
Elizabeth Grenfell, Analyst
Thank you very much.
Operator, Operator
And our next question is from Kristine Liwag with Morgan Stanley. Please proceed.
Kristine Liwag, Analyst
Well, good morning, everyone. On the Crane supply side, how are you thinking about using the proceeds? And has there been a change in your capital deployment priorities given the tougher macro environment?
Rich Maue, Senior Vice President and CFO
Yes. There are strategic initiatives that we are actively pursuing. We've been clear about our plans regarding the defeasance of asbestos, which could be one potential use of the proceeds. We are also continuing to prepare for the separation and establish the capital structure for both companies after the separation. This is another area that could be beneficial as we consider the setup of these entities. Excluding Crane Supply, it is crucial for us to structure both businesses for significant success in terms of capital deployment, enabling them to grow through mergers and acquisitions and effectively implement their strategies. Currently, we anticipate that Crane Company will have a net debt-to-EBITDA ratio of less than 1x, including asbestos. For Crane NXT, we expect it to be around 1.5x net debt to EBITDA. This indicates a very strong balance sheet position for both organizations after the separation.
Max Mitchell, President and CEO
Between now and the end of the year, we have a lot to focus on with our current projects, and we are executing them effectively. Considering a potential acquisition before our separation in April would require careful strategy. Nonetheless, we have considerable activity ongoing across all organizations and plans to implement these initiatives soon after the separation.
Kristine Liwag, Analyst
And if I could do a follow-up. I mean, with respect to filling out the management team for Crane NXT, with the rise and fall of crypto plus the macro headwinds that we're seeing today, have any of these items led you to think differently about leadership and strategy for that business? Do you think this is going to be a growth segment? Or is it going to be just a cash-generative segment? How has that evolved as we factor in what's happened in the past few months?
Max Mitchell, President and CEO
We've always felt that it was a growth opportunity. And the leader we're looking for is going to be clearly capable of continuing to drive that growth as we move forward, not just with core but in adjacencies as well without a doubt.
Operator, Operator
And we do have a follow-up question from Damian Karas with UBS. Please proceed.
Damian Karas, Analyst
Just a couple of quick follow-ups here. I was wondering if you could help us on the math on PFT, just thinking about the margin improvement in the back half. You kind of need to be at 17% or a little bit better, I think, to hit the full-year guide. So Rich, maybe you could just walk us through like how much of that is from Crane supply coming out? And what's the good way to think about kind of the incremental margin for that business now, ex the distribution business?
Rich Maue, Senior Vice President and CFO
Yes, we did experience some unfavorable mix impacts in the first half of the year, but we anticipate improvements in the latter half. We expect to see enhancements primarily in the process side of PFT, with various solution types contributing more significantly as we progress. The current mix of products we're offering is different from what we expect in the second half. We're also continuing to implement repositioning savings, which should gradually increase as the year unfolds, alongside strong price and cost management. These factors will be critical to our success, and I'm feeling confident about our targets. This isn't mainly influenced by Crane supply; it reflects the fundamental dynamics of our business.
Jason Feldman, Vice President of Investor Relations
And look, incrementals, I think was the other part of your question, a little tricky given all the moving pieces with inflation and price and whatnot. But I think over the long term, we've talked about this staying at 35% to 40% incremental margin business right now. That may be obscured in any given quarter, but that's kind of the underlying long-term structure of the business.
Damian Karas, Analyst
Rich, you started this conversation, and I can't help but ask. Regarding asbestos, what do you think the likelihood is of any actions taking place before the end of the year?
Max Mitchell, President and CEO
I'll take it, Damian. It's significant interest. We're continuing to progress and progressing very, very well. Just leave it at that.
Damian Karas, Analyst
All right, sir. No. Thanks again, guys.
Operator, Operator
We have reached the end of our question-and-answer session. I would like to turn the conference back over to Max Mitchell for closing comments.
Max Mitchell, President and CEO
Thank you, operator. Another quarter with solid performance and further steps in our path to separation to drive further shareholder value. As the late great actor, James Caan, said as Sonny Corleone in The Godfather when discussing a meeting with Sollozzo. What did he say? He wants us to send Michael to hear the proposition and the promise is the deal is so good that we can't refuse. As fans of The Godfather Series, Rich and I, and the Crane team have an offer for investors, you can't refuse: rigorous discipline and differentiated execution, consistent investment for growth where our momentum is building and we are showing accelerating results and a firm commitment to shareholder value creation, including disciplined acquisitions, portfolio shaping through divestitures, and now a separation that will position our businesses for further acceleration of growth. What an exciting story and I look forward to sharing updates with all of you over the next several quarters. Thank you all very, very much and have a great day.
Operator, Operator
Thank you. This does conclude today's conference. You may disconnect your lines at this time. And thank you for your participation.