Crane NXT Co

NYSE:CXT

Earnings Call Transcript 2023-Q1

[Operator]

Greetings, and welcome to the Crane NXT's First Quarter 2023 Earnings Call. [Operator Instructions] This conference is being recorded. It is now my pleasure to introduce your host, Jason Feldman, Vice President of Investor Relations. Thank you. Please go ahead.

[Jason Feldman, executive]

Thank you, operator, and good day, everyone. Welcome to our first quarter 2023 earnings release conference call. I'm Jason Feldman, Vice President of Investor Relations. On the call this morning, we have Aaron Saak, our President and Chief Executive Officer; and Christina Christiano, 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 on Form 10-K and subsequent filings pertaining to forward-looking statements. Also during the call, we will be using some non-GAAP metrics, 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.cranenxt.com in the Investor Relations section.

Now let me turn the call over to Aaron.

[Aaron Saak, executive]

All right. Thank you, Jason, and good morning to everyone, and thanks for joining our call today. As many of you know, this is our first earnings call for Crane NXT, and I'd like to thank all of our associates for their hard work and dedication as we executed our separation and at the same time, delivered a very strong start to the year.

Starting on Slide 5. We reported $0.97 of adjusted EPS for Q1, driven by 3% core sales growth with strong adjusted EBITDA margin of approximately 27%. Additionally, we had significant growth in our backlog, increasing by 34%.

Overall, the results were ahead of our expectations. The outperformance was led by Crane Payment Innovations, which delivered stronger-than-expected core sales growth of 10%, accompanied by more than 400 basis points of margin expansion with adjusted segment margins just over 30%. Consistent with our culture, these results were driven by the disciplined execution of the Crane business system and our dedication to continuous improvement.

Crane Currency's results were consistent with our expectations. We remain very confident in our full year performance targets for Currency given the strong order rate and backlog growth in the quarter, with core orders up 36% and backlog up 132% compared to last year.

Our cash flow performance was also strong and in line with the normal seasonality of the business. We remain confident in our plan to achieve approximately 100% adjusted free cash flow conversion this year. Given the strength of our first quarter results, we're raising the midpoint of our full year adjusted EPS guidance by $0.10 to the range of $3.75 to $4.05.

Well, those are the highlights of the quarter, and Christina will walk you through in more detail our financial performance in a few minutes. Now as I mentioned earlier, this is our first earnings call. And given this, I'd like to focus on why we have such an exciting investment thesis here at Crane NXT.

As shown on Page 6, NXT is an industry leader providing trusted technology solutions to secure, detect and authenticate what matters most to our customers. We have 2 industry-leading businesses, Crane Currency, which provides proprietary technology to secure Currency and other high-value physical products and Crane Payment Innovations, or CPI for short, which offers detection equipment and systems, aftermarket services and connectivity solutions focused on detecting and authenticating payment transactions.

We finished 2022 with our strongest year in company history with revenue of $1.3 billion, approximately 40% of which comes from reoccurring and recurring revenue adjusted operating margins of 28% and adjusted free cash flow conversion of 116%. This is the financial profile you would expect of any premier industrial technology company and I believe our Q1 results certainly reinforced this position.

As we discussed at our March 9 Investor Day, our core business is resilient, with mid-single-digit growth through multiple economic cycles. Additionally, we have very clearly demonstrated our ability to drive operational improvements through the deployment of the Crane business system over many years. This is truly a hallmark of the company and has resulted in best-in-class financials and very strong free cash flow conversion.

And that financial profile is built upon a number of core strengths and capabilities, including our technology leadership demonstrated through launching new and innovative products. For example, during the first quarter, Crane Currency launched its next generation of banknote security technology named RAPID Vision, the world's first multicolor micro-optic security thread for bank notes. This product retains the eye-catching movement, proven durability and easy printability of Crane Currency's existing line of products while also providing a broader range of fully customizable multicolor movement effects.

The design possibilities with RAPID Vision or even larger, counterfeit resilience even stronger and verification by the public is even easier. We launched this product at our recent conference in March held at our state-of-the-art banknote printing facility in Malta. This event was attended by more than 100 central bankers and industry partners from 45 nations. That event, along with the features of this product have already generated a strong pipeline of customers for RAPID Vision with one central bank already specifying the product in its top denominations.

RAPID Vision is a further extension of the product portfolio we have built and commercialized over the last 15 years, starting with MOTION Switch technology that is most well known to many of you for its use on the U.S. $100 bill.

And that culture of innovation is just as strong at CPI with differentiated capabilities in the design and manufacturing of detection systems and image recognition software built on advanced algorithms to authenticate products. For example, in the first quarter, CPI deployed the new ALIO PRO terminal for processing credit card and mobile payment transactions paired with our Simplify cloud management platform for electric vehicle charging applications in Europe.

We successfully integrated the solution with EV charging OEMs, and we're launching a program involving a major hotel chain in the U.K. These are both examples of the continued focus we have at NXT of extending our technology leadership and developing products that solve our customers' most important challenges.

Another hallmark of our company is our disciplined operational execution built on the tools and resources of the Crane Business System. It's with this same focus on operational excellence, that we developed our formula for shareholder value creation as shown on Slide 7. It starts at the top of this image, built on a foundation of a very resilient core business growing at mid-single digits. We continue to deploy CBS to increase margins and improve productivity in the core.

This generates our strong free cash flow conversion of approximately 100%. We put this free cash flow to work through our disciplined capital allocation strategy. This includes investment into the core business, paying a competitive dividend and deploying M&A, targeting higher growth and resilient end markets. This cycle is continuous. And over time, it will clearly position NXT as a strong compounder creating significant shareholder value.

And as part of this value creation strategy, we've set very clear goals for the business over the next 5 years. Through a combination of organic growth and M&A, we plan to grow the business to $3 billion in revenue growing at mid-single digit plus. We'll maintain high 20% operating profit margins, along with free cash flow conversion of approximately 100%. To achieve this plan, we'll focus on 3 priorities: first, continuing to invest and grow our core business; second, focusing on operational excellence through CBS to expand margins and drive our free cash flow conversion; and third, executing our proven playbook on M&A to further expand and diversify the portfolio into near adjacencies.

Through the combination of these actions, we plan to move from a mid-single digit to a mid-single-digit plus growth portfolio. Additionally, today, the company has low leverage of approximately 1.7x net debt to EBITDA. We plan to keep our leverage at less than 3x as we execute this strategy. In total, these clear measures of success position NXT both now and in the future, to be a leading industrial technology company and create significant value for our shareholders.

So with that, let me pass the call over to Christina, who will provide additional details on our financial performance in Q1, capital structure and our updated full year guidance.

[Christina Cristiano, executive]

Thank you, Aaron, and I'd like to thank all the Crane NXT and Crane company associates for their incredible commitment to complete the separation of our 2 fantastic companies. We are so appreciative of your hard work. As Aaron mentioned, we have a very strong start to the year. As shown on Slide 9, adjusted EPS of $0.97 was ahead of our expectations. Core sales growth was solid at 3%, and we delivered strong margins with 23.3% adjusted operating margins and 26.7% adjusted EBITDA margins.

Moving to Slide 10. We Crane Payment Innovations had a great quarter, with core sales growth of 10%, driven by a combination of solid end customer demand and some easing of the supply chain constraints that we've been managing over the last few quarters. The improved supply chain conditions allowed us to ship products out of our backlog earlier than we originally expected.

Adjusted segment margins increased 420 basis points to 30.1% reflecting strong pricing, positive mix from increased shipments of backlog, lower inflation and the execution of productivity programs throughout the business. We had a lot of exciting activity in the quarter. We had great price execution and broad-based strength across most vertical markets, led by gaming where we have been very successful with both new casino openings and converting new customers to our solutions.

A significant part of our success in this market is our ability to pay our best-in-class payment validation hardware with our comprehensive [ EzyTrak ] software solution. Moving to Crane Currency on Slide 11. The quarter unfolded as we expected. As we explained last quarter, we are seeing lower U.S. production volumes as the Bureau of Engraving and Printing focuses on the $10 bill redesign program as well as a higher mix of lower denomination bills.

The international currency business continues to perform very well, and you can see that reflected in our 132% backlog growth this quarter, which gives us confidence in our ability to deliver on this year's expectations. And in this market, Crane Currency continues to take new market share with our banknote security features. Two recent examples include high-value banknote denominations with both Iraq and Argentina adapting RAPID HD micro-optics security thread. And we were awarded the first banknote series in the world to feature both MOTION SURFACE and RAPID HD DETECT together on the same bank notes, which will launch in 2024.

Moving to Slide 12. Cash flow was solid in the quarter at $33 million, consistent with normal seasonality, and we are confident in achieving an adjusted free cash flow conversion ratio of approximately 100% this year. Our capital structure is strong and flexible and slightly improved from our previous guidance. As of April 4, we held cash of approximately $270 million, and we had total gross debt of approximately $900 million. Based on that, net debt is $630 million, and using our adjusted EBITDA guidance, net debt-to-EBITDA is approximately 1.7x. This gives us approximately $1 billion of M&A capacity and substantial flexibility to deploy capital in a manner that best maximizes shareholder returns.

Moving to guidance on Slide 13. As Aaron mentioned, we are raising the midpoint of our adjusted EPS guidance by $0.10 to a range of $3.75 to $4.05. Compared to prior guidance, we are seeing slightly higher interest expense in 2023, now at $50 million given the higher rate environment. More than offsetting that, however, will be a combination of modestly higher margins and core growth that is now likely to be in the upper half of our 2% to 4% range.

The key drivers of the business remain unchanged from what we discussed at our recent Investor Day. At CPI, we have strong secular trends supporting investment in automation and productivity, and we are seeing some modest improvements in the supply chain. The segment is off to a better-than-expected start to the year and should deliver strong core growth and margin improvement in 2023 and beyond

At Crane Currency, we continue to gain share in the international business and in product authentication. The U.S. business is performing as expected with somewhat lower production as the U.S. government prepares for a series of newly redesigned bills, which is a very good opportunity for us in the years ahead. Overall, our investment thesis is unchanged. We had very solid execution in Q1, and we are optimistic for the remainder of the year.

Let me now hand it back to Aaron for a few closing comments.

[Aaron Saak, executive]

All right. Thanks, Christina. As we come to a close of our prepared remarks, I want to summarize our key messages that we discussed today about Q1, and that's provided on Page 14.

Our performance across multiple metrics was better than expected. This includes orders, sales and operating profit. This was driven by our focus on continuous improvement, deployed through the Crane Business System to drive both growth and profitability. Given our results and outlook, we're raising the full year EPS guidance by $0.10 to the range of $3.75 to $4.05 and we continue to have very strong balance sheets for future capital deployment, as Christina mentioned.

And with that strong position and start to the year, we're confident in our ability to deliver on our 5-year goals to grow NXT to $3 billion in revenue by executing our strategy, and that's shown on Page 15. We're a leading provider of trusted technology solutions to secure, detect and authenticate our customers' most valuable assets. We have a durable, resilient business growing at mid-single digits with best-in-class margins and free cash flow conversion.

We have a strong balance sheet with substantial capital available for acquisitions. A great track record of disciplined M&A generating high returns and we're focused on expanding the business via M&A to adjacent higher growth end markets. Our performance in Q1 is a very important step in this journey, and it gives us continued confidence in achieving these objectives.

Now before I close, I'd again like to thank all of our associates around the world for the hard work that they put in and their dedication to enable a very strong start to the year and a very strong start to Crane NXT. So thank you for your time this morning. And Dana, we're now ready to take our first questions.

[Operator]

[Operator Instructions] Our first question is coming from Matt Summerville of D.A. Davidson.

[Matt Summerville, analyst]

I wanted to spend a few minutes maybe first talking about currency. Is there a way to frame up, Aaron, how much time the BEP is taken off of the print shop, so to speak, to dedicate to the forthcoming redesign cycle? And to that point, when should you start taking inbound orders from the USG, [indiscernible] to the $10 that I believe is supposed to go into production in their government year fiscal '25? And then I have a follow-up.

[Aaron Saak, executive]

Sure. Matt, thanks for that question. So I would say, broadly speaking, as we've been discussing, Matt, we're on track with the work with the BEP. We feel very good about that and our relationship. As I believe we mentioned in our Investor Day, we'll be looking at some upgrades inside of our facility that starts at the end of this year and beginning of next year to prepare for that $10. So as you can imagine, that's perhaps relating to some of the changes just in production that I think you're alluding to.

Again, I would say it's going as planned and kind of as what we expected. In terms of actually seeing orders, I need to comment, and I think, as you know well, we haven't really received the contract for that. We feel very, very good about that and given our long-standing relationship but we'd be looking well into '24 and '25 as you'd really start to scale up production. So I think it's still many quarters out, but everything is on track, and we feel very good about where we're at.

[Matt Summerville, analyst]

And then as a follow-up, maybe I'll just move over to CPI. You provided a little bit of color on the gaming side of the business as being strong in the quarter. You talked about 4 main focus end markets, those being gaming, retail, financial services and vending. Can you maybe talk about performance more broadly speaking across each one of those 4 important buckets for CPI and what the outlook is for this year?

[Aaron Saak, executive]

Sure. Sure. Thanks, Matt. Yes, I would just reiterate to the remarks Christina made. Gaming has been strong for us this year. It was strong for us last year, too, as you might remember, as our portfolio we think, is the best in the industry, both in the hardware and the software, and we've taken share over the course of the last several quarters. That's continued, and we still see strength in that, that read through here in Q1, we're going to see that, we believe, for the rest of 2023.

Financial services remain strong for us. Those are, again, larger ticket and some smaller ticket equipment and services. That remains strong, and we're confident in our performance there, again, driven by the secular trends of increased automation in that market. Retail, again, particularly as we think about the longer-term secular trends here of labor scarcity and the drive for more productivity leading to automation and self-checkout. We still believe in that very strongly.

I think both retail and vending would be the 2 markets that are a little shorter cycle for us. And when we're going to watch closely order rates, I think as the year progresses, again, off to a strong start in Q1 but given that, that's the shorter cycle, probably more sensitive part of our business, that's again where we'll look to order rates and what's happening in the back half of this year.

I would say overall, Matt, kind of everything in CPI coming in as expected and as Christina mentioned, with some of the improvements we did see in the supply chain, thanks to the team's execution, we were able to convert a little bit more of that backlog in Q1.

[Operator]

The next question is coming from Bob Labick of CJS Securities.

[Bob Labick, analyst]

Congratulations on a great quarter and great start to the new NXT. So I wanted to just kind of follow up on answer from the last question as well, you talked a little bit about the upside in CPI coming from improvements in supply chain and inventory and whatnot? Can you give us a sense, are you fully caught up now? Are you still restrain what areas are headwinds? Or how should we think about just the normal cadence of business in CPI and any remaining hangover headwinds from supply chain?

[Aaron Saak, executive]

Yes. Bob, we still have very strong backlog in CPI. Like all companies of similar products, particularly where you're relying on PCBs and electronic subcomponents, it was a challenging last several years for anyone in that space, and we were not immune to that. I think the team has done an excellent job helping us to get caught up and improve the supply chain. I would say it's not getting worse. It has gotten better for us in the last quarter, but there's still some episodic issues in the supply chain.

I don't think we're fully through it, but it has improved. And I think that's what led to impart some of the over delivery in Q1 for CPI.

[Bob Labick, analyst]

Okay. Great. And maybe just to expand on another point as well. If you look back to a year or so ago, we were almost certain to be in a recession by now. Obviously, things are going okay. I'm not going to make any forward predictions here, but I want to take advantage of that. Can you tell us about the economic sensitivity of CPI? You mentioned, I think, vending and retail have shorter cycle times. Just talk about the end markets and which ones are more or less sensitive to the economy and how you view those and what signals you're getting from them?

[Aaron Saak, executive]

Yes. And maybe I'll take that, Bob. Thanks for the question and just talk about NXT broadly. I think it's important to point out a little over 40% of our revenue is reoccurring or recurring. That is not sensitive in the near term. Those are the long-held currency contracts that we have or our service agreements inside the CPI business. So that's a substantial part of NXT in total.

And then when you get to the balance or let's say that 65% or so -- or excuse me, the nonrecurring or recurring side, there's also currency contracts that make up part of that business that we wouldn't classify in recurring or reoccurring. And we had a very strong order intake in Q1, as you saw, a very strong backlog. So I think we feel very good on that for the balance of the year.

And then to the question that Matt asked earlier and you were asking, you get into CPI in their 4 main verticals, again, strong performance in gaming. We don't see necessarily any significant risk there in the balance of the year, a very strong backlog. And again, I think a winning product portfolio that has us continuing to gain share.

Financial services is strong. And then retail and vending again, I think our position there is very strong, particularly in self-checkout, where we have excellent relationships with OEMs, with system integrators that are becoming more important in that market, and the end customer as well. We had strong orders in Q4. We've seen new lanes go online in Q1, and we feel good about the funnel in that business, but that is the shorter cycle side of the business, along with vending, and we'll be watching it. But again, I think overall CPI performing in Q1 better than our expectations. We see a strong funnel even in the shorter cycle parts of that business.

[Bob Labick, analyst]

Okay. That's great. And then maybe showing my [indiscernible] a little bit here, but I'm sure others could benefit from this question as well. Could you talk about the backlog in Crane Currency? It sounds like it was implied it relates all to or mostly to international. But obviously, a huge pickup year-over-year. How should we view the backlog in general in Crane Currency as a forward indicator? And what was the big jump this year over last year.

[Christina Cristiano, executive]

Yes. Thanks, Bob. I'll take that one. We had a significant growth in the backlog in Currency, as you saw. And you're right to say it was largely related to the international side of the business. So really just timing of international orders. As you know, the business can be a little bit lumpy. And so we just saw a strong increase in Q1 related to a few big customers. And so that's -- we know for the full year, we've got a very strong backlog and orders lined up. So the full year is very solid, but that timing can vary from quarter-to-quarter.

[Bob Labick, analyst]

Okay. Great. And then maybe one more for me, and I'll jump back in queue. But related to capital allocation and M&A, it's probably too soon to talk too much more, but as you're just standing up the company. But maybe in this forum, criteria for M&A in your pipeline and give us a sense of general timing, if you could time things, I know that's not always in your control or anyone's control, but how you're thinking about it broadly would be great.

[Aaron Saak, executive]

Sure, Bob. Well, I'll take that last comment. Timing is everything, and I don't -- I've never been in a place where you can time it that precisely, but -- certainly, I won't comment on anything specific in terms of targets or actions on M&A. But I'd go back to kind of our process here. We want to start first with the market focused on areas that we think can really accelerate strategy. So call that a strategy-first approach around Secure, Detect and Authenticate. Then look at the company itself that could be a potential target and make sure that there's differentiation in their technology, brand or channel, the right size to give us some scale.

And then most importantly, at the end of the day that we can be good owners of that business and generate a strong return for our shareholders. I think about that as the criteria. With that said, we feel very good about the funnel. As we talked about, we had a funnel coming in to the separation that we had paused through the separation and that it was very public. We weren't going to do any M&A during that period of time. In [ Simpson ], we're seeing opportunities. We're out actively cultivating.

And again, we will, first and foremost, take a very disciplined approach to this. So patience here is a key word. We want to make sure it's on strategy. It's the right asset. We can be good owners and we can deliver value. So with that said, I also know probably to the nature of your question, this first deal for us is very important. So again, it speaks to discipline and patience, and that's how we're executing the play here of how we think about when and exactly which target to execute on. So hopefully, that gives you a little more color, Bob.

[Operator]

The next question is from Matt Summerville of D.A. Davidson.

[Matt Summerville, analyst]

I realize you can look back at the history of the old Payment & Merchandising Technologies segment. But given that the business, to your point, can be a bit lumpy from quarter-to-quarter. Is there anything you can do to kind of help us out with respect to how we should be thinking about kind of the go-forward earnings linearity from quarter-to-quarter for the balance of the year? Anything that you'd like to point us to?

[Aaron Saak, executive]

Yes. Thanks, Matt. And you're right. And certainly, this year, Q1, we had a tough comp on the currency side, as you know, and we've been talking about -- and that read through here, kind of in line, as I said, with expectations. I think when you think about the linearity, first, maybe think about the revenue linearity of the year, we're going to be slightly weighted to the second half of the year this year. it depends on the year, but I think about it that way for this year. But we're going to see some improvement in margin rates likely driven out of the currency side of the business just due to mix.

As Christina mentioned, we start to execute a different part of the international backlog. The U.S. side of the currency business continue going to provide a little bit of a headwind as we've seen the mix to the lower denomination $1 bills. We expected that coming into the year. Volume and mix has largely been on target. So nothing fundamental there. But really, this driver, if you kind of work that math through would suggest, again, we'll see an increasing margin as the year progresses.

That's consistent with also our updated guidance that we gave today, Matt, of saying it's 27% plus margins. Obviously, that's margin improvement from where we ended Q1, and that's driven by really the increased mix we expect out of currency. And with that said, the headwind that Christina pointed out is in interest expense, nonoperational for us, but one that is going to read through simply due to the higher rates that have rolled forward. So Hopefully, that gives you a little color, Matt.

[Matt Summerville, analyst]

Yes, for sure. Maybe then just for my final question, if you can maybe talk strategically a little bit, Aaron, updated views on authentication, the growth trajectory, what's needed to really break into and unlock that TAM? I don't have the deck in front of me, but I thought you identified it as a $5 billion TAM growing at healthy double digits. So what's the playbook look like there?

[Aaron Saak, executive]

Yes. Well, I think similar to the rest of the business -- thanks for the question on that one as well, Matt. We're bullish on that market. We think that's where our core technology and micro optics sits. We have very unique defensible position with wide moats around it in a market that's continuing to grow from secular drivers around the need for any counterfeit technology, whether that's in luxury goods, tax, stamps or you name it.

For us to unlock it, it's going to take 2 things. One, it starts with our organic efforts which we've set up a team dedicated to product authentication. And as we mentioned in our last quarter, we expect that business, while small, still to have very high growth this year. And we feel very confident in that high growth in 2023.

I think to really unlock that part of the market, it goes back to a prior question around M&A. And that's where we're spending time in developing the funnel, cultivating opportunities and would be one of the areas we've highlighted where to really gain scale and create a bigger moat for NXT in this market, we will need to deploy M&A.

[Matt Summerville, analyst]

And if I can, maybe I'll just lob in one other one here what I'm thinking about it. Within Crane Currency, talk a little bit about the competitive behavior you're seeing in the market. I mean it's been pretty widely publicized that one of your larger competitors is struggling a bit to say the least, from a financial perspective?

[Aaron Saak, executive]

Yes. I think, again, Currency continues to perform very well. It's a tale of 2 businesses of the U.S. government side, which is in some ways, given the nature of the contract has a very wide moat around it. And again, is in line with expectations to the question you asked earlier, and we feel bullish on that long term. When you think about the international side, that team has been executing very well for the last several years, and that continued in Q1. And you can see that by the backlog growth that Christina mentioned earlier.

So we wish certainly no, it will on anyone in the market, but I would first say if we look in the mirror at ourselves and provide the best product with very high quality out of both in Malta and in our other factories around the world, whether that's papermaking or with our [ micro ] thread world-class operations that continue to have us gaining share. So again, feel very good about the positioning of that business and I'd have to leave comments to others in the market for those folks to answer.

[Operator]

Thank you. This brings us to the end of the question-and-answer session. We would like to thank you for your participation in today's event. You may disconnect your lines or log off the webcast at this time, and enjoy the rest of your day.