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 Maue, 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.

Max H. Mitchell - President & Chief Executive Officer

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 $0.70 to $0.85, 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 I&S 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 & 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 $4.00, 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 I&S 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 Handling to see a small seasonal sequential decline in both sales and margins, largely related to a decline in projects in non-residential construction activity as we enter the winter season.

At Payment & 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% and 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 & 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 OE 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, in Engineered Materials, core sales declined 4% with margins rebounding to an extremely strong 18.6%. After an extremely weak second quarter with most RV manufactures 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.

Richard A. Maue - Senior Vice President & Chief Financial Officer

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 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 million 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 $1 billion 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 a 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 & Electronics.

At Engineered Materials, that decline is consistent with historical seasonality for the RV and construction markets. In Aerospace & Electronics, it is a result of timing related to certain defense programs, which flattered [Phonetic] 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.

Question & Answers

Operator

Thank you. [Operator Instructions] Our first question is from Matt Summerville with D.A. Davidson. Please proceed.

Matt Summerville - D.A. Davidson & Co. - Analyst

Thanks. Good morning.

Richard A. Maue - Senior Vice President & Chief Financial Officer

Good morning, Matt.

Matt Summerville - D.A. Davidson & Co. - Analyst

With respect to Aerospace & 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?

Richard A. Maue - Senior Vice President & Chief Financial Officer

Sure. So commercial OE, I would say overall, Matt, a pretty consistent performance relative to the second quarter, flattered a little bit on a - 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 commercial - 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.

Matt Summerville - D.A. Davidson & Co. - Analyst

Got it. And then, with respect to the Payment segment, you mentioned - you just touched on a couple of 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 in-line 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?

Richard A. Maue - Senior Vice President & Chief Financial Officer

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 in 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 view that we'll be towards the higher end of that down range 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.

Matt Summerville - D.A. Davidson & Co. - Analyst

Great. Thank you.

Operator

Our next question is from Damian Karas with UBS. Please proceed.

Damian Karas - UBS - Analyst

Hi. Good morning, guys.

Max H. Mitchell - President & Chief Executive Officer

Good morning, Damian.

Richard A. Maue - Senior Vice President & Chief Financial Officer

Good morning.

Damian Karas - UBS - Analyst

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 from time to time. And if our estimates are correct that was probably up a little bit better than 100% in the third quarter. So just wondering how we should think about the most recent Federal Reserve order and what kind of incremental EPS that would actually translate for the business over next year?

Max H. Mitchell - President & Chief Executive Officer

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 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, 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 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 I - 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 of 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 going to overproduce and see a dramatic downturn. I think there's going to 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 I'll hold off until we get through our plan period and understand in the next months as we head into our meetings with our teams and give you little more clarity in January.

Richard A. Maue - Senior Vice President & Chief Financial Officer

Damian 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, right. 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 is going to be a very - a 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 a nice mix for us to have as we enter into 2021.

Damian Karas - UBS - Analyst

Okay. That's really helpful color guys. And then, I just wanted to ask you about the RV business. It was certainly nice to see an inflection to positive growth there in the quarter 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 rates you're seeing in that business and how much catching up there might still be, given some of the stronger consumer demand this year?

Richard A. Maue - Senior Vice President & Chief Financial Officer

Yes. Well, we do think that we, obviously with the results in the third quarter, saw a nice pick-up. 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 the next - 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.

Max H. Mitchell - President & Chief Executive Officer

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.

It's good news, all in, really, and today's entry level buyer is tomorrow's upsize buyer. So I think it's just a fascinating trend. I think it's going to continue. 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.

Damian Karas - UBS - Analyst

Thanks guys. Appreciate the color. I'll get back in the queue.

Max H. Mitchell - President & Chief Executive Officer

Thanks, Damian.

Operator

[Operator Instructions] Our next question is from Ken Herbert with Canaccord. Please proceed.

Max H. Mitchell - President & Chief Executive Officer

Good morning, Ken.

Kenneth Herbert - Canaccord Genuity - Analyst

Hey, good morning, Max and Rich and Jason. First, wanted to ask on Fluid Handling, the backlog growth in the quarter, could 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 at 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's specific performance?

Max H. Mitchell - President & Chief Executive Officer

Just to catch 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 I&S 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, it's had really a very strong year this year with nuclear outages continuing and us winning additional share in that business.

Neutralizing for that, Ken, in the third quarter, our 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. So, those continue and we're looking forward to sharing more of those with you come our Investor Day.

Kenneth Herbert - Canaccord Genuity - Analyst

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 incredibly long cycle, but is it fair to assume that that strength continues beyond just the most - just this year?

Richard A. Maue - Senior Vice President & Chief Financial Officer

Oh, yeah. So just keep in mind our nuclear services business unit is around this, the annual turnaround work that is mandatory. So there is a cycle of shutdowns that we are participating with very, very consistent. That business will continue with certainty as we move forward.

Kenneth Herbert - Canaccord Genuity - Analyst

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 - 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?

Richard A. Maue - Senior Vice President & Chief Financial Officer

Yes, 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.

Kenneth Herbert - Canaccord Genuity - Analyst

Great. Thank you very much.

Max H. Mitchell - President & Chief Executive Officer

Thanks, Ken.

Operator

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

Matt Mooney - Stifel Financial Corp. - Analyst

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

Richard A. Maue - Senior Vice President & Chief Financial Officer

Yeah, good morning.

Matt Mooney - Stifel Financial Corp. - Analyst

Good morning. A quick question regarding the Payment & Merchandising. The incremental margin of 20% was much improved from 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?

Max H. Mitchell - President & Chief Executive Officer

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 mix, 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 going to leverage up when the demand comes back in 2021, which we feel pretty darn good about and we'll be north of that 30%.

Matt Mooney - Stifel Financial Corp. - Analyst

Okay, thank you. And then looking at the Aerospace & Electronics. What can be done to kind of improve the decremental margin going forward and kind of what's your thoughts?

Richard A. Maue - Senior Vice President & Chief Financial Officer

Well the decrementals that you're seeing here relative to the other businesses is higher mainly because of the margin profile on that business, in particular the aftermarket - 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 cost out real quick or want to, frankly. We continue with a very strong engineering manage business with the view that we're going to drive long-term growth beyond what the market offers us.

Matt Mooney - Stifel Financial Corp. - Analyst

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

Max H. Mitchell - President & Chief Executive Officer

Thanks, Matt.

Operator

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.

Max H. Mitchell - President & Chief Executive Officer

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, like 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.

Operator

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Q3 2020

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