Crane NXT, Co. (CXT) Earnings Call Transcript & Summary

All right. Good afternoon. Welcome, everyone. Thank you for joining us for a fireside chat today. With me are members from management from Crane NXT, which recently separated from Crane Holdings. With us, Aaron Saak, to my left, President and CEO; and then to his left, Christina Cristiano, the CFO. With that, I think Aaron wanted to make a few prepared remarks. So I'll pass it over to Aaron before we go into Q&A.

All right. Well, thanks, Matt. Thank you for having us here and for both those here in the room and online. It's really a pleasure to be here today. I think for everyone, almost by definition, Crane NXT is a new story. We're 5 months a little over since our separation from Crane Holdings. So to Matt's point, I just wanted to take a moment to introduce the company for those who are less familiar with who we are. At our core, we're a technology company. And our mission is to provide trusted technology solutions that secure, detect and authenticate our customers' most important or valuable assets. And we go to market and report in 2 segments. The first is Crane Currency, whereas the name implies, we design, print and help provide to our customers, which are central banks all over the world, the most secure beautiful currency in the market. But the core business is really about providing anti-counterfeit technology. That's the core of the business, and we're expanding that business into noncurrency applications as well, which is an exciting growth area for us. What we're particularly proud of in that business is we've been supplying to the United States government for over 140 years. It's our longest contract and one that is really at the core of the franchise of the business. The second segment is called CPI, that's short for Crane Payment Innovations. And there, we provide detection equipment, so think of sensors and embedded hardware with embedded software to authenticate payment transactions, both coining cash as well as we offer remote connectivity software to monitor capital equipment and field services. So we have a fleet of technicians around the United States that service our equipment all over the country. And so those are the 2 parts of Crane NXT. This year we'll be about $1.4 billion in revenue. 40% of our business is recurring and reoccurring revenue. EBITDA will be 27% plus as we talked about in our Q2 call. And I think one of the hallmarks of the company is our free cash flow conversion, we're at 100%. And so that's a background on who we are. When we went through our Investor Day as we launched the company, just a little over 5 months ago, we talked about where we want to take the company. And that's to grow to be a $3 billion enterprise by 2027. That includes really 3 main pillars. The first is investing in these core businesses, which are very resilient and have some natural tailwinds to them that I'm sure we'll talk about here a little bit later, Matt. To continue to drive operational improvements in the business, I think this is the hallmark of both what was Crane Holdings and continues to be a hallmark of who we are as Crane NXT, our Crane business system that is apparent in how we've expanded margins over the last many years in these businesses. And that's led to good free cash flow generation as well. And that then really brings to the third pillar of the strategy, which is deployment of M&A. This business has been built over many years through 17 acquisitions. M&A is at the core of how we built the portfolio. It's at the core of our strategy going forward and our plan is to deploy as we move forward. So we believe when you put all 3 of those together and you look at the growth, both organically and inorganically, it's a fantastic new opportunity for many investors to get into a company that has the potential to be a strong compounder as a premier industrial technology company long term. And so with that, again, just in summary, a very resilient business. We have franchises that are #1 or #2 in every market we play in, high EBITDA, strong free cash flow conversion. We've come out at relatively low leverage, and we've delevered in the last 5 months. We're at 1.5x net debt to EBITDA leverage, and that gives us dry powder to deploy to M&A to grow the company, which we're excited about doing as we get into 2024. So with that, maybe I'll pause, Matt. Hopefully, that's a good overview for folks new to the story.

Yes. And along those lines for those that are new or newer to Crane NXT, I think it's important just to kind of get it out of the way in the sense that how would you respond to the pushback that these businesses seemingly would have a melting ice cube aspect to them due to the proliferation of digital payments, currencies and how this business faces potentially sizable secular headwinds because of that. So start with currency and then maybe run through the same sort of dialogue with respect to CPI.

Yes. And I think you got to think about both of these differently. And I think currency, there's a really 2-part growth algorithm, too. And for some people, it's a got to believe. And that first is cash in circulation is actually increasing. Most people don't necessarily intuitively understand that, but that's actually been the case for the last 40 years. It was the case here in the United States last year. And it's true in aggregate globally. So we expect the first part of the growth algorithm of the business is that there is a low single-digit growth in the volume of currency in circulation. Again, those are the facts. And once people start to understand that, right, there's a little bit of disbelief to the melting iceberg question, but it's the truth. So fact-based pattern. That's #1. So that gives you a low single growth digit business. The second is that governments around the world and central banks are increasingly worried about counterfeiting. And I think we can all understand that, that that's a natural trend, whether you're actually in the currency business or you're in other products, whether those are CPG, pharmaceuticals, you name it. Certainly, in currency, anti-counterfeiting technology is at the top of the list of what central banks are worried because the counterfeiters are getting more sophisticated. So for our business, our position, as I said at the beginning, is we provide the world's leading anti-counterfeiting technology for currency. And that puts us in a position to benefit long term from the volume growth plus the need to put new technology on to currency around the world that leads to a mid-single-digit growth type business, where we're expanding operating margins because as we add that new technology, the margin profile of the business expands. That's the growth algorithm of Crane Currency. CPI, I'll just answer the second part of your question, that's different. There's no doubt there is growing -- continually growing digital transactions, and we all experienced that ourselves. But what's also occurring is cash transactions continue to be very robust all over the world and the move -- the macro driver in the CPI business is really around automation. So our customers, our casinos, the retailers, they're financial service providers, all looking at ways to automate their business to drive productivity in the face of increased labor scarcity. And so we have a real value equation to give to those end retailers, casinos and financial institutions that helps them drive productivity, provide a better consumer experience, and that's at the core of everything we do at CPI.

Very helpful. Let's stick with the currency business for the first few questions. For those that aren't aware, the Fed has communicated it's in the midst of a major biannual redesign cycle for the 10, 50, 25 and 100, if I have those in the proper order. Beginning to go to print during the government year's fiscal '25 with the 10, talk about your positioning here. What incremental content gains might be expected? There is publicly available data suggesting the cost to print the USD 100 is 20% to 25% above the next highest cost denomination with a variable spread that, again, is publicly disclosed is even higher. So maybe you speak to that.

Christina, do you want to take that?

Yes. I mean, I think you've got it right, the way you described it in terms of the costs going up as there's more density of technology in the notes. And what that means for us is more technology is a higher-margin product for us. So you would see our profitability increase along with the cost density there as the notes get released. And so that'll start with the 10. And then every 2 years as a new note comes out, you can imagine more advanced technology each time, culminating with the 100 in 10 years from now.

Can you talk about specifically where the Fed is at with the redesign process now, when you expect to start to see that impact -- realizing the 10 is not the most printed bill out there, but when do you expect to start to see things move along for you guys?

Yes. I think I would say we're right on track to meet that schedule of a launch of the new $10 bill in 2026. As I mentioned in the earlier remarks, our relationship with what is today's Fed goes back 140 years. We feel very good about our relationship and helping them to design the next-generation bills and by extension of that, the incorporation of our technology into that. So what that means for us in the near term is 2024 is a year where in working with the Bureau of Engraving and Printing, we are piloting the new technology. It requires changes in their manufacturing processes to print currency as it does in ours. So we're working hand-in-hand together to be ready to go through that pilot phase. So as you said rightly, Matt, that in 2025, you start building up the inventory for the public launch in '26. So I would say largely on target focuses on the 10. That becomes the platform technology for the 20, 50, 100, the big volume bills. And as Christina mentioned, each successive launch, we expect increased technology density, which is more use of our technology.

For those that aren't aware, the BEP actually prints all of the currency. Crane Currency provides a substrate and the security threats as you talked about. Right now, micro-optics is only on the $100 bill here in the U.S. Is a thought that, that migrates down to all the other denominations mentioned? And will that require substrate upgrades as well?

Yes. What I would say is the BEP or the Fed in this case, has not -- or the treasury ultimately has not released the design of the 10, and that's theirs, and we can't comment on that. I would draw a parallel to what's occurring in the international market, where what you see is the use of our micro-optics technology, typically entering at the higher denominations, the store value currencies. USD 100 is the best example of that and moving down to lower denominations over time as each central bank redesigns their currency. I think it's fair to assume that that kind of trend should be occurring in the United States as well.

Understood. Sticking with currency, I want to dig in specifically on micro optics. What about this technology specifically differentiates your business versus the other large players in the space? If you can speak to G+D's RollingStar, De La Rue's Kinetic? And when there is a security threat up for grabs, what's your win rate historically speaking? And is that accelerating?

Yes. So I think that's, again -- the hallmark of this business is what we call micro optics. That's the term we use. And for those who aren't familiar, it's a surface treatment of different polymers that creates different reflective properties, impossible to replicate. But also part of that is a software design feature that's proprietary to us to actually get images and colors and enhancements into those threats. The USD 100 has a blue thread, but currencies around the world actually have now multiple colors and very sophisticated patterns for consumers and the public to recognize. And I think that's the core difference. So when you think about some of these other competitors in the market, you may think of holograms that are -- and you receive those on consumer goods as well, those are getting easier and easier to counterfeit. And in fact, they're getting counterfeited so well, you can't tell the difference. And that's the core of the problem. For micro-optics, because of how the optical lens is constructed and how the software interacts to create the shape shift and characteristics cannot be replicated. And so we keep advancing our technology, always to try to stay ahead of the counterfeiting technology. That's what establishes this difference between what we do and some of those competitors that you named. So I think the proof as they say is in the pudding. On that matter of why do we win. Is our win rate improving? If you look at our backlog in Crane Currency and what we reported both in Q1 and Q2, Q2 backlog is up 90%, that's simply because we're winning. And we're winning at an accelerated rate, and you can see it in the backlog growth.

Appreciate that. Still sticking with currency. Let's talk about the strategy with respect to product authentication. What is typical in the market now from an authentication standpoint? You mentioned holograms, maybe some of the other technologies. How serious is product-related counterfeiting? Where is the market going? And how can you become more front and center...

I think this is one of the more exciting areas for us. We -- the origins of our technology have always been applied to currency. And it's only recently we've been taking that technology to extend it into consumer packaged goods, into pharmaceuticals as well as into higher-end luxury goods and even into OEM spare parts. As you said, for those who can -- I'm sure you can all appreciate, picking up a product that had a hologram on it, that is an overt anti-counterfeiting type technology for the consumer and the retailer to recognize they bought a genuine part. That's the core technology today. And as I mentioned, it's very easy in most cases now to counterfeit. So what we're seeing is this opportunity to extend the technology, [ a pool buy ] retailers that are more and more worried about counterfeiting. And I think when you think about pharmaceuticals and the idea of counterfeit pharmaceuticals, that concept, just in that industry alone, wasn't near at the pitch or pace it was -- it's at 10 years ago to today, the same in high-end luxury goods, the same in counterfeit OEM parts, and these are the highest margin parts of most -- components of most people's businesses, so protecting that, either the brand equity, the consumer experience or in the case of pharmaceuticals, the efficacy of the drug and the downside risk, which are obvious, is so critically important. These retailers and producers are taking multiple steps to provide track and trace through the supply chain and anti-counterfeit technology. And we think we have a very unique distinguishable technology to use in those markets. It's a business, while small for us today, is growing at very high double digits. We're investing more in it, and it's opened up the TAM for us of where we can play to be significantly bigger than the core currency market. So it's a really exciting area for us.

Do you need to do anything from an M&A standpoint to really explode that business to the upside? Or can you do it all organically?

I think it's a question of aspiration more than it is of can we, to use your words, exploded. I guess that's -- what does an explosion look like in the best sense of the word. It's going to grow at high-double digits as far as we can see and become material quickly over the next several years to the currency core business. But with -- as I mentioned in my earlier remarks, with our M&A capacity, we see this as a market where there's fragmented players, small players, unique technologies that have not really been coalesced together into a portfolio that when you pair that with what we can do with track and trace software, other physical overt and covert security technologies, there's a beautiful franchise here. And so for us, it's a combination of both. We'll get strong organic growth, and we can accelerate that with our M&A.

Perfect. Last one on currency, then I'm going to kick it over to CPI. Operating margin volatility and variability over the last 24 months ago, pretty significant. I mean we've seen segment-level margins as low as 10%, as high as 39%. Most recent quarter, still a very great impressive 30%. Can you help magnify what drives the volatility and what can be expected from a linearity standpoint or not going forward?

Yes, I think it makes sense to separate the U.S. business from the international business because it's really 2 different profiles. So when you think about the U.S. over the last 24 months, as you said, during COVID, a time of uncertainty, a lot of demand for high denomination notes like the $100 bill, and that comes at a higher margin for us because it has more security features. Then post-COVID, we normalize and there's a greater demand for transactional notes just because people are out transacting again. So that's closer to the $1 bill lower margin because of less security features. And so if you looked at an individual quarter, if you look at the quarters this year, you'd see on the U.S. side that margin down and also volume down because of the work we're doing to prepare for the new series. And so that's a low point. But over time, it normalizes. So I think that's a little bit of the variability that you've seen on the U.S. side. Internationally, it's a project-based business. So we've got to go out and bid on the work. And depending on the nature of what we're bidding on, the denomination, which if it was a higher denomination would have more security features, that will impact the margin. And then just the timing is just variable in terms of when we actually complete the project and ship it out. So there, you'll see more variability quarter-to-quarter, but in the long term, as we win more denominations, which we continue to do, that will also normalize.

Maybe let's kick it over to CPI. So a similar question I had to currency. What differentiates CPI's core technology around cash and coin validate dispense versus your competitors?

Yes. So CPI in each of the verticals we play in, we typically have 1, maybe 2 major competitors. So it's a mature marketplace, I think, with very rational competitors as well, good competitors in that market. But our distinguishing feature is the sophistication of our sensor package with the embedded software that operates under more extreme high volume conditions that you would typically see in a retail environment that has to be very robust, right, in that environment. We are at the premier level of putting together that sensor package with the software in a form factor that's very durable. And I think our manufacturing know-how to do that is unsurpassed. And so we're typically the higher quality, higher reliability player in the market because we can do all 3 of those in a very strong, robust form factor. And I think what's further distinguished us since 2020 is the acquisition of a business called Cummins-Allison that's added on a service component to this business. So now not only are we selling the capital equipment, but we're adding in a connectivity software for remote services that takes a SaaS model, a typical SaaS model, and an aftermarket field services organization where we offer preventative maintenance contracts. So we service the entire life cycle. We've expanded our wallet share then into the customer, and it's a very sticky business. So that's a distinguishing factor that those other competitors don't have in terms of the full package of offering.

That's helpful. Let's talk about the 4 core verticals to CPI, what you're seeing. I mean automation is a key theme really across all of them. But speak to gaming, retail, vending, financial services, what you're seeing right now?

Do you want to start with gaming, Christina?

Yes, sure. So I mean, gaming has been very strong for us, particularly this year. And when we speak about just the high backlog, as Aaron mentioned earlier, that was a little bit over 90%, up from last year. A lot of that relates to gaming, and that's because during COVID, there was a very long lead time to get that equipment. And so now we're starting to see supply chain easing, lead times coming back to normal. And so that business continues to be strong, but we'll draw down on the backlog we expect for the next 6 months or so. And what's really, looking forward, the great tailwind there is the connected service offering that we have that we can add to the component sales. So if you think of a casino floor, the slot machines, from the back of the office, someone can monitor the health of all those machines, when does it need a service, what is the level of cash inventory inside the machine. And so this really improves productivity and efficiency of the operators. So that's a great nice segue for that market. First, the component sale, the connectivity, and then ultimately, we'll follow that up with service, where we could do preventative maintenance on the machines as well. So I think the underlying trends in that vertical are very strong. We're going to see a normalization of lead times. So, in the short term, you'll see that become more normal just based on essentially overordering during COVID because the lead times were so long and now that's going to get back to normal, there'll be a realignment there.

I think you mentioned financial services as another vertical. There, you have this trend going on where the front office where we sell equipment where you walk into a local bank branch, they would be sorting cash, handling cash, authenticating it, unchanged largely. But it's that back-office operation that's getting much more automated and also outsourced to cash and transit handlers. And that's where we have a unique position with very sophisticated capital equipment that in Q2, as an example, we announced a nice win that read through in Q2 due to just the sophistication of our offering and again, the drive for automation. So the got to believe in that market is that as labor scarcity continues, as banks look to get more productive, they're going to continue to want to automate the back end of their operation. And I think we're in a very good position there in that market. You mentioned retail that you know very well, again, driven by labor scarcity and automation. We feel that market is still an agreement, I think, with your notes, Matt, underpenetrated, and that's going to be a long tail. Perhaps we'll be more closely tied to consumer spending and what retailers are deploying in CapEx, but long term is a robust growth market for us. And then lastly, our last vertical, I think you mentioned was vending. Again, we've gone through COVID and have a structural change in that market where certainly the office market is down. It will not recover to where we were pre-COVID. But we're going to see growth in that business year-over-year because we've come through COVID, we've hit the downturn, so to speak, but we're seeing growth in hospitality, we're seeing growth in education, all places where our vending equipment, both our credit card reading terminals, our cash handling and our connectivity offering where we can monitor the sales of those pieces of equipment, and we act as a PayFac in parts of that business as well is growing. And we see recurring revenue coming off those other offerings outside of just the original capital equipment expense.

I know we're nearing the end of time, but I want to spend a couple of minutes and maybe we'll run a minute or two over since we got started a minute or 2 late. NXT has roughly $1 billion of dry powder on the balance sheet, as you mentioned, is 1.5x net levered. So there's plenty of capacity. Organic investment and inorganic, potentially repurchases down the road, dividend. How are you thinking about these from a priority standpoint? And can you talk about the actionability of the funnel?

Yes. You want to talk about priorities, and I'll take actionability.

Yes. Yes, sure. So I mean, the priority is organic growth, right? We're great operators of the business, and we're going to continue to focus on doing just that, just operating the business very well and continuing to support the business where it needs for organic growth. We'll continue to pay a competitive dividend, which is mid-teens payout ratio as a percent of free cash flow, which we've done now for the last 2 quarters. And then M&A, the funnel is very attractive. So Aaron will talk through that a little bit more, but we're continuing to cultivate that same funnel that we had prior to the separation with a lot of new opportunities also. So if anything, the funnel has just gotten even strong.

Yes, I think that's correct. And I would just add to what Christina said, and we said it at our Investor Day, the first several quarters for us strongly believe it's about operational execution. We've got to do what we say we're going to do, and I feel very proud of the whole team in the first real quarter post separation. We've done that, and that's our priority. All through this period, though, the funnel is increasing. And I think our position is getting stronger. As we delivered, we have, I think, the other side of potential acquirers for these companies, that's not as an active market, meaning a lot of what we look at is PE-owned where we have opportunities to work with those sponsors. And we're in no rush. Honestly, Matt, we laid out a criteria for our M&A. The first word is disciplined, which we have been, I would say, over the last many years. We won a 10% or double-digit ROIC by year 5. We want to make sure we're better owners of the business. We have line of sight to the synergies. That's always been the case. And you can see that in the last acquisitions we've done pre-separation. And we want to make sure that we're targeting deals that we can absorb. So no big transformative deals. We're looking at deals that add a meaningful growth to NXT, but are deals we can consume. And so we want to be just very pragmatic about that approach. And again, we'll be patient and disciplined when we pull the trigger.

Just to kind of wrap that up and then we'll conclude. You mentioned nothing is needed, that's more transformational in nature, but can you see Crane NXT maybe adding a third leg to the stool?

Simple answer is yes. Yes. Simple answer is yes. So I think it's a combination where a set of opportunities that are both into the core, but adding a third leg first, right, and potentially other legs, but I think that's right.

Very good. Well, thank you both very much. That will conclude today's fireside chat. Thanks, Aaron. Thanks, Christina.

Thanks, Matt.

Thank you.