Q2 2023 Crane NXT Co Earnings Call
Participants
Aaron W. Saak; President, CEO & Director; Crane NXT, Co.
Christina Cristiano; Senior VP & CFO; Crane NXT, Co.
Jason D. Feldman
Matt J. Summerville; MD & Senior Research Analyst; D.A. Davidson & Co., Research Division
Robert James Labick; President; CJS Securities, Inc.
Presentation
Operator
Greetings, and welcome to the Crane NXT, Co. Second Quarter 2023 Earnings Conference Call. (Operator Instructions) And please note that this conference is being recorded.
I will now turn the conference over to your host, Jason Feldman, Vice President, Investor Relations. Thank you, Jason. You may begin.
Jason D. Feldman
Thank you, operator, and good day, everyone. Welcome to our second quarter 2023 earnings release conference call. I'm Jason Feldman, Vice President of Investor Relations. On our call this morning, we will also have Aaron Saak, our President and Chief Executive Officer; and Christina Cristiano, our Senior Vice President and Chief Financial Officer.
As usual, 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 on Form 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.cranenxt.com in the Investor Relations section.
Now let me turn the call over to Aaron.
Aaron W. Saak
Thank you, Jason, and good morning. We appreciate everyone joining the call to discuss our second quarter financial results reported yesterday afternoon. Before we begin, I'd like to take this opportunity to thank all of the NXT team members around the world for their efforts to produce a very strong Q2.
As many of you know, this is our first quarter post separation, and I'm very pleased with our operational execution. Overall, the results were ahead of our expectations. Both Crane Payment Innovations and Crane Currency had very strong quarters, and year-to-date, both businesses have done better than we guided at the beginning of the year.
You can see the highlights on our Q2 performance on Slide 3. We delivered $352 million in sales with 6% core sales growth ahead of our expectations. Adjusted EBITDA was $104 million with adjusted EPS of $1.12 in Margin performance was also very strong with adjusted EBITDA margins over 29% and adjusted operating margins of over 26%. Notably, adjusted operating margins were above 30% in both segments, and these margins reflect significant sequential improvement.
Finally, adjusted free cash flow was $70 million. This supported $50 million of debt repayment in the quarter, driving down our net debt-to-EBITDA to approximately 1.5x. This leverage continues to give us substantial financial flexibility for M&A, and we remain confident in our plan to achieve approximately 100% free cash flow conversion this year. Consistent with our culture, these results were driven by the disciplined execution of the Crane business system and our mindset of continuous improvement. The strong first half positions us very well for the remainder of 2023 and gives us confidence to raise our full year adjusted EPS guidance by $0.10 to a range of $3.85 to $4.15.
The increased guidance primarily reflects our revised outlook for higher core growth driven by the strong orders and backlog at Crane Currency. In total, we now expect core growth to be in the range of 3% to 5%, up approximately 100 basis points from our prior guidance. We're very happy with how we performed in Q2 and the improved full year guidance. I'm also very pleased with the progress of our separation. We continue to wind down the [TSAs] with Crane Company, and we are on track with our expectations for all aspects related to the separation.
Now I'm going to hand the call over to Christina to walk us through more details on the financials. I'll come back after she speaks and provide some additional comments on our continued progress around our strategy. With that, let me pass the call over to Christina.
Christina Cristiano
Thank you, Aaron. And I'd also like to thank our global Crane NXT associates for their hard work and great execution this quarter. We appreciate you. As Aaron mentioned, we had another strong quarter. As shown on Slide 4, adjusted EPS of $1.12 and core sales growth of 6% were ahead of our expectations and reflect core sales acceleration relative to last quarter. We also delivered strong margins with significant sequential improvement from last quarter. Adjusted operating margins of 26.5% increased 320 basis points as compared to the first quarter and adjusted EBITDA margins of 29.6% also increased significantly on a sequential basis. Free cash flow of $70 million reflects free cash flow conversion of 109%, consistent with normal seasonality and supportive of our full year expectation of adjusted free cash flow conversion of approximately 100%.
Overall, we had great execution by both of our strategic platforms. Moving to Slide 5. Crane Payment Innovations had a solid quarter with core sales growth of 8% driven by a combination of continued end-customer demand and some further easing of the supply chain constraints that we have been managing over the last few quarters. Again, this quarter, the improved supply chain conditions allowed us to ship products out of our backlog earlier than we originally expected. Adjusted segment margins increased 430 basis points to 31.1% as compared to last year, reflecting strong pricing, net of inflation, productivity and cost savings actions along with higher volumes, all partially offset by modestly unfavorable product mix, great execution, both operationally and on pricing.
From a market perspective, we continue to see solid demand in the gaming sector, where we are winning new casinos and growing share. We are also seeing continued strength in our service business, allowing us to increase our recurring revenue. This includes a large order won during the quarter from a financial services customer to refresh their equipment and provide ongoing maintenance services. Looking forward, we remain confident in our outlook for 2023 at CPI. As anticipated, we will continue to reduce our backlog in Q3 and Q4 given the improvements in the supply chain. Additionally, we expect order rates to normalize to pre-COVID levels as our customers adjust their inventories to reflect reduced lead times.
We are continuing to assess the overall demand conditions for CPI's end markets, especially in the shorter-cycle businesses. In total, given our backlog and strong competitive positioning, we remain confident in our full year guidance for CPI. As we discussed at our Investor Day in March, a key component of our strategy is continuing to introduce new products that help our customers improve their productivity and the consumer experience. For example, we recently announced the launch of Paypod Compact, the latest addition to our portfolio of automated cash management solutions for retailers seeking fully customizable, self-service or attended checkout systems. This new product built on the foundation of our core payment detection and authentication technology has the same advantages as other payment automation solutions, including reduced labor needs and improving the consumer experience, but with a flexible footprint that is superior to other self-checkout solutions for many smaller retail environments.
The solution also has the added benefit of complete integration with our Simplifi Remote Management Software, giving our customers real-time data on hardware health, cash inventory and other diagnostics. Paypod Compact is another example of how we continue to leverage our differentiated technology to create value-added solutions for customers.
Moving to Crane Currency on Slide 6. The quarter was ahead of our expectations with core sales growth of 3.7% and adjusted segment operating margin of 30.2%, a 330 basis point improvement over the prior year. The outperformance was driven by international sales with strong operational performance and productivity across the business. As we explained last quarter, we are seeing lower U.S. government production volumes as the Bureau of Engraving and Printing focuses on a $10 bill redesign program. Additionally, we are continuing to see a greater mix of orders for lower denomination bills. We expect these trends to continue for the balance of 2023. Overall, we remain confident and excited about the opportunity that the U.S. government's bill redesign program creates for our business over the next decade.
On the international side of the business, we are seeing broad-based strength reflected by our backlog nearly twice the size it was at this time last year. And in this market, Crane Currency continues to take market share with our industry-leading micro-optics technology. For example, in the quarter, we launched new banknotes with our machine-readable RAPID HD Detect technology. This technology is invisible to the eye, but easily verified by banknote processing equipment, including CPI's detection and authentication equipment.
This is just another example of how Crane Currency continues to win with its best-in-class technology. Given the strength of the recent orders and existing backlog, we expect currency to exceed our original expectations for core growth for the full year, with operating margins in line with our prior guidance. On Slide 7, free cash flow was $70 million, and we are confident in achieving an adjusted free cash flow conversion ratio of approximately 100% this year. Our capital structure is flexible and continues to get stronger. We repaid $50 million of our term loan during the second quarter, given the strength of our free cash flow, reducing net debt to EBITDA to approximately 1.5x. This gives us approximately $1 billion of M&A capacity and substantial flexibility to deploy capital to M&A going forward.
Moving to guidance on Slide 8. As Aaron mentioned, we are raising the midpoint of our adjusted EPS guidance by $0.10 to a range of $3.85 to $4.15. Compared to prior items, the primary driver is higher core sales growth driven by Crane Currency, which flow through to margins at a normal operating leverage rate. We now expect core sales growth of 3% to 5%, up from our prior range of 2% to 4%. More broadly, the longer-term key drivers of the business remain unchanged from what we discussed at our March Investor Day. At CPI, we have strong secular trends supporting investment in automation and productivity, and we continue to see improvements in the supply chain, allowing us to ship our backlog sooner than expected.
At Crane Currency, we continue to gain a share in the international business and in product authentication. The U.S. business is performing as expected with 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 Q2, and we are optimistic for the remainder of the year. Let me now hand it back to Aaron for a few additional comments.
Aaron W. Saak
All right. Thanks, Christina. Moving to Slide 9. I want to summarize the key takeaways for our second quarter results. For another quarter, we delivered better-than-expected performance on both sales and operating profit. Crane Currency had a very strong quarter. It continues to gain share, and we have greater forward visibility from an increasingly strong backlog position. For creating payment innovations, it remains on track and it meets our expectations for the rest of the year with the supply chain continuing to improve. Taken together, these factors give us confidence to raise our guidance for a second time this year, and we now expect full year adjusted EPS in the range of $3.85 to $4.15. In addition to the strong operational performance, our balance sheet continues to get even stronger. We have already paid down $50 million of the $350 million term loan we incurred at the time of separation, and this gives us flexibility for M&A at approximately a 1.5x net debt-to-EBITDA.
Moving beyond the recent financial performance. For the benefit of those newer to the story, and as a reminder, for those already familiar with Crane NXT, we're a technology-driven business with substantial opportunities to grow the company both within the core and beyond into near adjacencies. More specifically, as shown on Page 10, 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 CPI, which offers detection equipment and systems, aftermarket services and connectivity as well as other solutions focused on detecting and authenticating payment transactions.
These businesses are on track to deliver $1.4 billion in sales this year, with adjusted operating margins above 27% and free cash flow conversion of approximately 100%. In addition to the strength of our technology, the business profile includes about 40% of sales, which come from reoccurring and recurring revenue. As we discussed at our 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.
Our financial profile is built on a number of core strengths and capabilities, including our technology leadership. This leadership is demonstrated through launching of new products like Paypod Compact and RAPID HD Detect as we discussed earlier today. Beyond our technology and innovation, another hallmark of our company is our disciplined operational execution built on the tools of the Crane Business System. It's with the same focus on operational excellence that we developed our formula for shareholder value creation as shown on Slide 11. It starts at the top of the image, built on a foundation of a very resilient core business growing in mid-single digits.
We continue to deploy CBS or the Crane business system to increase margins and improve productivity in the core. This generates our strong free cash flow conversion of approximately 100%. And we put this free cash flow to work through our disciplined capital allocation strategy. This includes reinvestment in the core business, paying a competitive dividend and deploying M&A targeting higher growth in resilient end markets. The cycle is continuous. And over time, it will position NXT as a strong compounder creating significant shareholder value. As part of this value-creation strategy, we've set very clear goals for the business over the next 5 years. As shown on Slide 12, building off our strong foundation, we plan to grow the business to $3 billion in revenue and grow core revenue at mid-single-digit plus. We'll maintain high 20% adjusted EBITDA margins along with strong free cash flow conversion of approximately 100%.
Our performance in the second quarter is another important step in our journey as a new company, and it gives us continued confidence in achieving these longer-range objectives. Again, I'd like to say a sincere thank you to the entire NXT team for their strong efforts in Q2 and for everyone who took time to join the call this morning. So with that, operator, we're now ready to take our first question.
Question and Answer Session
Operator
(Operator Instructions) And the first question comes from the line of Matt Summerville with D.A. Davidson.
Matt J. Summerville
Aaron, can you maybe spend a minute talking about the backlog burn you saw in CPI, whether that's a concern? It sounds like for your comments, that's more of a normalization than a concern, but I'd kind of like to cement that. And maybe can you comment on incoming order rates across the key verticals in the quarter? And then I have a follow-up.
Aaron W. Saak
Sure. Thanks for the question. I think that's right, how you framed it. I think what we're seeing are customers across all the verticals in CPI adjusting their orders given shorter lead times, remembering those lead times have gone down from extended months to now back to weeks. And I think that's due to the execution of our supply chain team, which we're very proud of here. So I think we're seeing what's similar in other businesses that have reported recently.
I believe and I think we all believe this is going to continue through the balance of '23. And ultimately, we're normalizing, as you said, to order rates and behaviors that are more what we saw pre-COVID. So long story short then, Matt, the backlog burndown in the quarter is probably a little faster than we originally thought. Again, that's just due to execution and customers who've been waiting on products. So we're happy to ship those products. It's going to be more in line going forward with the backlogs you would have experienced in CPI pre-COVID. And we still feel very good, though, about our market position here, Matt, and our share. So again, in talking to customers, we feel very good about that. So -- given the current backlog, we feel confident about '23, as Christina said, but realize our first half was a little bit better than we really thought at the beginning of the year due to the supply chain improvement. And certainly, that comes out of some of what we expected in the second half. So full year is intact for CPI, again, really strong first half improvement. So maybe I'll pause there, Matt.
Matt J. Summerville
Yes, sure. I'd like you to comment a little bit on the 4 main verticals. Obviously, gaming sounds like the real standout. So maybe talk about kind of where you're at in the context of the gaming cycle, maybe using a baseball analogy from an innings standpoint? And then as you know, we follow 2 of the big self-checkout OEMs. They've been very vocal about driving down their own inventories to your comment to improve their own respective cash flow. Have you seen a fairly pronounced impact on your business? And do you expect that to continue to play out in the latter part of the year?
Aaron W. Saak
Yes. No, that's a great question. Let me go back to the top then to gaming in each of the verticals. So again, we've had a really strong year -- strong several years in gaming. We feel very good about our share position there and our win rate with new casinos. Certainly, we think that that's playing out. And we're probably normalizing that kind of use your baseball analogy. We're into the back half of the game, so to speak, into the later innings. But again, we have now a very rich, deep installed base in gaming that gives us a long-term ability to continue to grow our service business and to have spare parts and upgrade cycles which is fantastic for NXT. We see strength in financial services, too.
As Christina mentioned, we won a large order. This quarter, we think there's additional service business to come that will continue to grow recurring revenue. So again, feel good about financial services. I think vending another one of our large verticals kind of executed as expected. We're going to see growth in that vertical this year. But again, probably one of the more challenged verticals coming out of COVID, as we've talked about at Investor Day. And then to your last point in retail, I think the dynamic you just described is exactly what we're seeing with our -- 2 of our largest customers in that vertical in Diebold and NCR, where we know they're focused on a variety of other things right now from separations to coming back out of bankruptcy and exactly the dynamic you mentioned is playing out in our business.
Now with that said, if you zoom out on the long-term trends and the focus here on how do we continue to provide solutions that help the labor scarcity with automation? Is that trend going to continue to play out long term? Absolutely. I think we have high conviction in that. And in fact, we think both Diebold and NCR, who are very good customers of our, come out better and stronger post the separation and bankruptcies. So I think in the near term, it certainly created a different focus for them in the long term. We feel very confident in the dynamics underlying the market.
Operator
And the next question comes from the line of Bob Labick with CJS Securities.
Robert James Labick
Congratulations on another strong quarter.
Aaron W. Saak
Thanks, Bob. Thank you. Appreciate that.
Robert James Labick
Absolutely. So maybe I'll jump over to currency. And it sounds like U.S. kind of remains on track with expectations going into the year, and the upside really is from the international. Can you tell us, is it new country wins? Is it more volume at existing customers? Is it more technology shift in kind of mix? What's the upside in international? And how does this play out beyond this year as well?
Aaron W. Saak
Sure, Bob. So just a reminder, I know for some other folks listening, currency versus the CPI business, certainly very project-based. So we look at projects coming in, whether those are new currency designs or those are existing customers wanting upgrades to a particular bank note. And it tends to come in these type of waves. But what I'll tell you is we're winning multiple projects for new designs incorporating in our technology, and it's fairly broad-based.
So we feel very good about the backlog build reported again today being up over 90%. That's giving us visibility into the rest of '23, now into early parts of 2024. So it's not just one country or it's not one bill. It's multiple coming through that have already entered into the backlog. And when we look out in just the amount of volume going on with our sales team and quoting and activity in the funnel, we feel very good about that. And fundamentally, to answer your question, Bob, it's technology. It's the superiority of our micro-optics technology, and we're -- that's already been deployed. It continues to increase share across the fleet of denominations.
And then I think secondly, and something we probably don't talk about as much, but it's incredibly important here is the quality of our product, the quality of our paper, the quality of our facility in Malta and Dalton. And the teams who have worked very hard to produce the world's most beautiful and well-designed banknotes and our customers feel that. So I think that's, again, some confidence we have here in currency, just the broad-based nature of wins we're seeing internationally. And then the U.S. government business, as Christina mentioned, meeting expectations. As you know, it's one customer who is going through a new design cycle and they're performing as expected this year, and again, progressing very well along the new design of the $10 note.
Robert James Labick
Okay. Great. And then just one more for me, and I'll jump back in queue. But can you talk a little bit about -- I think you mentioned product authentication, brand authentication. I know it's a small but rapidly growing and increased focus part of your business. Give us a sense of where you are right now, any new opportunities out there? Or how you see that playing out the balance of this year and maybe going forward from there?
Aaron W. Saak
Yes, happy to, Bob. As you mentioned, this is a very small part of the business right now, far less than -- or less than $10 million. We had a few million dollars, $5 million last year. As you said, we see this growing and it's going to grow this year at a very high rate, which we feel good about. I think when you look at the funnel of this business and just the amount of inquiries coming in, it's very optimistic of where we think we take this business over the next several years.
We also think it wins based on technology, and that's what we're seeing based on applying the micro-optics technology that is the hallmark of our currency business into product authentication. And so again, to summarize, Bob, we feel very good. We're going to have high growth rates in that business this year in a funnel that's building in an area we're applying more people, more resources, and a more focus to continue to diversify NXT over the long term.
Operator
(Operator Instructions) And the first question is a follow-up from Matt Summerville with D.A. Davidson.
Matt J. Summerville
Just a couple of quick follow-ups. Can you guys maybe comment on how we should be thinking about the second half earnings cadence given some of the mix and just general revenue lumpiness for lack of a better term, dynamics you see in both CPI and currency?
Aaron W. Saak
Sure. I think, Matt, as we look at the back half, with the updated guidance, let's call the midpoint at 4, we see that playing out kind of an equal part, call it, 50-50 in terms of where we see earnings per share playing out in Q3 and Q4. And as you rightly just said, that's due to where we see some order shipping out of currency, where we see the backlog burn probably being strong again in Q3 here in CPI just due to the supply chain improving. So again, I would kind of say, if you think both about revenue and you think about earnings or OP, it's probably a 50-50 split in Q3 and Q4.
Matt J. Summerville
Perfect. And then just as a follow-up on M&A. Can you talk about how the activity levels maybe have been evolving over the last 90 days, actionability in the funnel, which business segment you see the most near-term opportunity, what you're seeing with multiples, et cetera?
Aaron W. Saak
Yes. what I'd say, Matt, is I think we're optimistic in how that's playing out over the last 90 days. I think that's a good frame of what's changed since the last time we spoke. We continue to see more deals coming our way. By nature of this discussion, there's some we passed on, but we're getting good looks, and we see that activity probably increasing for us. And we think our position is stronger with how -- how our stock has performed, but also the strength of our balance sheet, as Christina mentioned, the ability to pay it down and reduce our leverage.
So we've got the capacity. We see some targets playing out in both areas of the business. But I think even more importantly, as we discussed at Investor Day in near adjacencies, they really start to expand and diversify NXT, which we're particularly excited about. So we're going to continue to cultivate the funnel. It's an active part of what I'm doing. It's an active part of what a lot of folks across the NXT leadership team are focused on, not taking our eye off the ball, obviously, on operational execution, that's first and foremost. But as we've said before, Matt, you know the first deal is very important. It's more important to us than the deals probably that follow because, by nature, it's the first and sets the tone. So we're going to be very disciplined in our process. And with that, we're going to make sure it fits the strategy around secure, detect, authenticate that we're good owners of the business, and we can add value and generate that double-digit ROIC that we talked about is a threshold for us and generate strong returns long term.
So with all that said, our focus here, I think, as you've seen both last quarter and this quarter is to get out of gate strong operationally, to cultivate the funnel. We're doing that, let the stock season that's occurring and make sure we don't miss a beat operationally. And we're going to keep doing that for the balance of the year. And when the right opportunity comes, which I have a lot of confidence, it will, based on what we're seeing, we're going to be ready to go.
Operator
Ladies and gentlemen, at this time, there are no further questions. And I'd like to pass it back over to Aaron for any closing comments.
Aaron W. Saak
All right. Thank you, operator. Well, I'd like to end today's call by again thanking all the NXT team members across the world for just excellent performance in Q2. It's really their hard work, their dedication to our customers that makes the results like we reported today possible. Also, I'd like to thank everyone listening today and for the questions that were asked. And so with that, I hope you have a great rest of your day, and we look forward to speaking to you again next quarter. Thank you.
Operator
Ladies and gentlemen, this does conclude today's teleconference. You may disconnect your lines at this time. Thank you for your participation, and have a great day.
