Crane NXT Q1 2024 Earnings Call Transcript

Quartr
Provided by Quartr
May 9, 2024

There are 10 speakers on the call.

Operator

Please be advised that today's conference is being recorded. I would now like to hand the conference over to your speaker today, Reema Hyder, Vice President of Investor Relations.

Speaker 1

Thank you, operator, and good morning, everyone. I want to welcome all of you to the Q1 2024 earnings call for Crane NXT. Before we begin, the slides we will reference during this presentation can be accessed via the Investor Relations section of our website at cranenxc.com. A replay of today's call will also be available on our website. Before we discuss our results, I encourage all listeners to review the legal notice on Slide 2, which explains the risk of forward looking statements and the use of non GAAP financial measures.

Speaker 1

Additionally, we refer you to the cautionary language at the bottom of our earnings release and in our Forms 10 ks and 10 Q filings pertaining to forward looking statements. During the call, we will also be using 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 krainenxd.com in the Investor Relations section. On our call this morning, we will discuss our financial results, the completion of the OpSec acquisition and the updated 2024 guidance. For this discussion with me today are Aaron Saic, our President and Chief Executive Officer and Cristina Cristiano, our Senior Vice President and Chief Financial Officer. After our prepared remarks, we will open the call to analysts for questions.

Speaker 1

Let me now turn the call over to Aaron.

Speaker 2

Thank you, Rima, and good morning. We appreciate everyone joining the call today to discuss our Q1 2024 results and to learn more about the acquisition of OpSec Security, which we announced earlier this week. We are well on our way to become a premier industrial technology company here at Crane NXT. 13 months ago when we launched the company, we had a clear strategy for growth through investing in our core businesses and diversifying our portfolio, maintaining our operational excellence and increasing our trusted technology solutions to protect our customers' most important assets. Completing the acquisition of Opsec is a major milestone in our journey to becoming a company with $3,000,000,000 in sales.

Speaker 2

As our first M and A transaction, OpSec aligns with our strategy of expanding our leadership in the growing and large authentication market. I'd like to give a special welcome to our OpSec associates worldwide. We are thrilled that you're part of the Crane NXT family. As part of this acquisition and with an eye towards serving our customers better, we're announcing a new alignment to our reportable segments. We are renaming our Crane Currency segment Security and Authentication Technologies or SAT for short.

Speaker 2

We believe the new segment aligns better with our strategy on growing technology solutions that secure, detect and authenticate our customers' most valuable assets. And I'll talk more about this in a few minutes. Moving to our results. Our first quarter performance was in line with our expectations. With the acquisition of OpSec closed, we're increasing our full year sales guidance to a new range of mid single digit to high single digit growth of 5% to 8% and reaffirming our EPS guidance of $4.10 to $4.35 Both the currency and CPI businesses are on track to deliver their financial targets for 2024.

Speaker 2

I'm particularly excited about Crane Currency continuing to win new orders with their technology leadership and gaining share in the international market. In the Q1, we won 5 new micro optics denominations, bringing the total to 155 globally. And in the U. S. Currency business, we're on track with our investments to upgrade our equipment in preparation for a decade long U.

Speaker 2

S. Banknote redesign program and its associated growth. Finally, we continue to have a strong balance sheet in place to further expand and diversify our portfolio and OpSec was the first step in this journey. Turning to Slide 4. As announced earlier this week, we have completed the acquisition of OpSec Security, which significantly increases our position in the growing authentication market.

Speaker 2

Opsec is a global leader in brand protection and authentication solutions with more than 4 decades of expertise in optical security technology development and online brand protection services. Opsec goes to market with 2 strategic platforms as shown on this slide. Through its authentication solutions platform, OpSec provides technology which enables digital and physical authentication of products including monitoring, tracking and tracing of goods through supply chains as they're used by consumers. Through its online brand protection platform, Offsec provides online monitoring for counterfeit goods, anti piracy of content and fraud protection services. The company offers a full end to end solution to secure the physical and digital assets of the world's most recognized brands.

Speaker 2

This acquisition complements our growing business and physical product authentication by expanding our customer base and product offerings and enables Crane NXT to deliver the entire product and brand authentication value chain. Additionally, Opsec has an attractive financial profile comprised of a high percentage of digital and reoccurring and recurring revenue. The business has a stable and growing revenue base generating mid single digit revenue growth year over year. Additionally, OpSec's business boasts resilient long standing customer relationships with an average customer tenure of 20 years among its top customers. We expect that OpSec will contribute approximately $80,000,000 to $90,000,000 in revenues to Crane NXT in 2024 at approximately 15% adjusted EBITDA margins.

Speaker 2

OpSec is a natural extension of our strategy to secure, detect and authenticate our customers' most important assets and giving us a strong position in the growing $3,000,000,000 authentication market. One of the exciting capabilities OpEx brings to NXT is the combination of digital and physical authentication solutions. We see this as a key differentiator for the company. As shown on the first chart on the slide, approximately 60% of OpSec's revenues include digital services enabled through proprietary software. The physical offerings include a variety of labels containing anti counterfeiting technology including advanced holograms.

Speaker 2

OpSec also brings to NXT a scalable software platform that enables the traceability of products, manages the licensing of brand properties and detects and enforces against online brand abuse and content infringement. As shown in the middle pie chart, the majority of OpSec sales come from customers with long standing contracts. We refer to this as reoccurring revenue and it represents approximately 65% of sales. The remainder of OpEx revenue is primarily recurring in nature from contracts with durations of 1 or more years that has a very high renewal rate. Finally, as shown on the chart on the right side of the page, Opsec has a diverse customer base, including companies in Sports and Media, Consumer Goods, Technology, Industrials and Pharmaceuticals, as well as government agencies and financial institutions.

Speaker 2

The combination of OpSec's digital and physical offerings, high reoccurring and recurring revenue and diverse set of global end markets further adds new capabilities and provides increased resiliency to Crane NXT. As I mentioned earlier, in connection with this acquisition, we're renaming our Crane Currency Reportable segment to Security and Authentication Technologies, which will consist of the Crane Currency business and OpSec. Additionally, our existing product authentication business will be combined with OpSec. This updated structure will enable us to better serve our customers with an expanded technology portfolio, while also driving further growth in business efficiencies. The updated segment presentation will be effective in the Q2 of 2024 and has no effect on the Q1's financial results.

Speaker 2

As part of this new structure, I'm also excited by the promotion of Sam Keys to the role of Senior Vice President of Crane NXT and leader of the new Security and Authentication Technologies segment.

Speaker 3

Sam has done

Speaker 2

a fantastic job leading Crane Currency for the past 5 years and I look forward to working with him closely as he grows this segment. We believe this alignment of the company enables us to accelerate our strategy as we continue to expand and diversify our portfolio. In summary, I'm pleased with how we started the year, especially with our first M and A transaction. Would like to thank our employees around the world for their efforts to deliver our Q1 results, while also closing the OpSec transaction. I'm now going to hand the call over to Kristina to walk us through our Q1 financial performance as well as provide more details on our updated 2024 guidance.

Speaker 4

Thank you, Aaron. Good morning to everyone joining the call today. And I would also like to express appreciation to our global associates for their continued hard work and to welcome the OpSec team to Crane NXT. Starting on Slide 5, our Q1 results were in line with our expectations. Core sales declined approximately 4% year over year, reflecting the expected lower sales at CPI and a challenging comparison to the Q1 of 2023.

Speaker 4

Adjusted segment operating margin of 27% was flat year over year despite lower volumes, driven by strong productivity across both segments. Adjusted free cash flow was impacted by normal seasonality and the timing of working capital. We also have higher CapEx related to our continued investments in the U. S. Banknote redesign program.

Speaker 4

Finally, adjusted EPS of $0.85 is on track with our full year guidance. Moving to our segments. CPI reported a decline in core sales of 7% in the Q1 as expected. Adjusted segment operating margin decreased 110 basis points to 29% year over year, reflecting the lower volumes and an unfavorable product mix due to lower sales in the gaming end market, offset by strong pricing execution and productivity initiatives. The gaming end market performance was as expected and customers continue to draw down on inventory overstock resulting in lower new orders.

Speaker 4

Backlog, which was elevated due to extended lead times, continues to come down and we are on track to reach more normal levels by the end of the second quarter. We are working closely with our customers to understand their demand and managing our inventories accordingly. Overall, the underlying gaming market continues to be healthy and we are maintaining our strong share position with offerings in hardware, software and services. Outside of gaming, our other end markets are growing as expected and we expect the full year revenue growth in the non gaming verticals to be mid single digit in line with what we communicated last quarter. Moving to Crane Currency, core sales were slightly down due to the lower U.

Speaker 4

S. Volumes as expected, which is related to some of our papermaking equipment being offline in the quarter, so we could make necessary upgrades for the upcoming U. S. Banknote redesign program. Adjusted segment operating margin improved 2 70 basis points year over year reflecting favorable mix and increased productivity.

Speaker 4

Overall, international sales continue to be strong and we have high confidence in our full year projections based on the strength of our backlog, which is up 13% year over year. I'd like to take a moment to further discuss the investments we are making to upgrade our equipment to accommodate the new designs and technology for the new U. S. Banknote series that commences in 2026. We are happy to partner with the Bureau of Engraving and Printing on this very important program.

Speaker 4

The necessary upgrades require The necessary upgrades require taking some of our equipment offline for a period of time, which has an impact on revenue phasing this year. The first upgrade cycle, which impacted our Q1 results, went very well and we resumed production on schedule. We will have another upgrade cycle beginning in the Q4 of this year, which will continue into the Q1 of 2025. As a reminder, we recognize revenue as we produce currency paper for the U. S.

Speaker 4

Government. We experienced lower revenue in Q1 related to the upgrade cycle and expect that to repeat in Q4. This will be partially offset by higher revenue mid year as normal production resumes. Overall, we are very excited about the new series and are confident that the investments we are making will provide us with a multi year growth opportunity. Moving on to our balance sheet.

Speaker 4

Our net leverage ratio was approximately 1.2 times at the end of the Q1. In May, we borrowed $210,000,000 on our revolver to fund the OpSec acquisition along with cash on hand. As a result, our net leverage ratio post close is approximately 1.8 times, which provides us with ample capacity for further M and A. And with our strong free cash flow generation, we will continue to pay down debt throughout the year. Turning to our 2024 guidance on Slide 13.

Speaker 4

We are updating our guidance to reflect the impact of the OpSec acquisition. We expect OpSec to add approximately $80,000,000 to $90,000,000 in revenues in 2024 with a 15% adjusted EBITDA margin. This translates to 5% to 8% overall sales growth for Crane NXT. There are no changes to the core sales guidance provided in February for the CPI and currency businesses. We now expect our adjusted segment operating margin to be in the range of 26% to 28%, reflecting dilution related to OpSec.

Speaker 4

Non operating expenses will increase to $47,000,000 as we incur approximately $10,000,000 of additional interest related to borrowings for the OpSec acquisition. Expected adjusted EPS for the full year will remain at $4.10 to $4.35 as operating income from OpSec is offset by higher interest expense. We expect OpSec to be accretive to our adjusted EPS in 2025. Now let me turn the call back to Aaron for closing remarks.

Speaker 2

Thanks, Christina. In conclusion, our Q1 results are a clear example of doing what we said we were going to do and in line with our expectations. Investing in our core business, driving productivity through CBS and executing on M and A to diversify and expand the portfolio. Looking ahead, we are on track to execute our 5 year strategic roadmap to significantly grow NXT. We continue to see strong results from our currency business and CPI is on track to exit the year growing at mid single digits.

Speaker 2

Given our strong balance sheet, we continue to cultivate our M and A pipeline to further expand and diversify our portfolio through disciplined and strategic M and A with a focus on differentiated technologies and services that secure, detect and authenticate our customers' most valuable assets. We have a very strong foundation in place and with our unique and differentiated technology leadership, strong capital position and ability to drive operational excellence through CBS, I'm confident we will deliver on our long term objectives, drive profitable growth and create sustainable long term value for our shareholders. Thank you again for your time this morning. And I would like to again thank all of our associates around the world for their dedication to NXT and welcome the OpSec team to the NXT family. And now operator, we're ready to take our first question.

Operator

Thank you. Our first question comes from Matt Summerville with D. A. Davidson. You may proceed.

Speaker 3

Thanks. Good morning. I apologize for the background noise and traveling. But there's obviously some sort of moving parts with the businesses, right? The time going gaming inventory drawdown that is well known at this point.

Speaker 3

And then you have the outages and sort of the goalposts around the year with the mid portion of the year seemingly being stronger in currencies. So with all of those moving pieces, can you maybe help us think of what's the right way to kind of think about the quarterly cadence for the business and therefore operating profit margin?

Speaker 2

Sure, Matt. Good morning. Thanks for the question. Good to hear from you. Well, I think you're right.

Speaker 2

I think you framed it up exactly how I would think about it. So inside of CPI, again, that business performed just as we expected with continued burn down of the backlog in gaming. As we communicated last quarter, we have line of sight to our customers' inventory levels in gaming. And as expected, we saw those trend again with our expectations. So what we see for CPI is orders are zooming in Q3, building again in Q4 in revenue, again commensurate with what we talked about last quarter.

Speaker 2

And the other verticals are on track, Matt, doing as expected, exiting this year with CPI growing in mid single digits in revenue, again kind of coming in where we thought. So I think CPI is exactly this burndown of gaming followed by consistent strong performance from the rest of the verticals. As Cristina mentioned then on currency, it's really the story of the bookings, using your words, of the upgrades going on in Q1 and Q4 that will mean, as Christina mentioned, a little less linearity in that business than what we've seen in the past and a stronger middle part of the year. And then the international business though continues to perform very strongly for us. And as we talked about in the prepared remarks, winning new applications with Micro Optics and the backlog up 13% year over year.

Speaker 2

So we feel very good about the international currency business. So again, in terms of putting that all together, again, this year just a little less linear than we've seen in past years. First half lower in CPI, building in the second half. And then currency strongest in the middle part of the year, probably skewed a little bit into Q3. So with that, again, margins coming in very much in line with what we would have expected where CPI again with what we're doing with CBS and continuously improving the business going to be roughly at the same margin rate we believe for the full year as we saw in 2023.

Speaker 2

And then when you think about currency with the investments we're making particularly in this U. S. Upgrade, slightly less in terms of operating segment margins than we saw last year. So a lot of information there, Matt. I hope that gives you a little more color of what we're seeing.

Speaker 3

Yes. Thank you. And then a finer point on the international side of the business. You mentioned 5 new denominational wins in the Q1. That puts you on an annualized pace above what was already, to my recollection, record number of new denominational wins in 2023.

Speaker 3

So maybe talk about how that international funnel is trending? And relative to the organic projections you have for the Crane Currency business, how does the U. S. Government look versus international around that kind of midpoint, if you will, for the full year? Thank you.

Speaker 2

Sure. Hey, well, I appreciate the question on international. And you're right. We had a good set of wins in the Q1, really led by technology and that's the hallmark of this business. This is a technology forward company, even more so with the acquisition of OpSec that builds out and really starts our new platform, in security and authentication technologies.

Speaker 2

I think you know as well as anyone, Matt, the wins in currency are a little bit more episodic. So I wouldn't quite extrapolate fully the Q1 to the full year. But I think the trajectory is right and you're right about that. We continue to win and as we've said, we expect on average 10 to 15 new denominations under management every year. We're on a pace to do that this year.

Speaker 2

Again, different timing to different wins consistent with how this business has operated for a long time. I think where we're at now, particularly as we get into the Q2 and we look at our backlog, we're really looking now at customer deliveries starting to get into 2025. As you know, deliveries run anywhere between a 6 to 12 to 18 month timeframe from a booking. And with the strong backlog, that's why we have confidence in 2024 and I think continued confidence as we go into 2025 with the international business. So I think that just naturally starts to create the dynamic that's positive for us, but it starts to hone in on our confidence on 2024, but more of an outlook on the strength of the business to 2025.

Speaker 2

In terms of the U. S. Government, I just again would reiterate what Christina mentioned. This team in the company focused on our currency upgrades just did an excellent job in the last several months. It's just a fantastic example of CBS in action of executing a very large capital improvement program and production is ongoing as expected now in Q2 and we're fast at work preparing for again a very significant upgrade in Q4 as Christina mentioned again.

Speaker 2

So we feel we are on track as expected in the U. S. Currency program. This is going to be very positive, as you know, for our business in how we work with the BEP. And we fully expect the Treasury Department will be making their announcements at the appropriate time on the new designs, and we're going to follow their lead obviously at that.

Speaker 2

But in terms of how we see the year outside of the bookings, to your first question on production, mix is in line with prior year. That's what we've expected and how we've forecast the business and volume holding flat year over year. So again, pretty consistent, Matt, with what we said last quarter.

Operator

Thank you. One moment for questions. Our next question comes from Bob Labick with CJS Securities. You may proceed.

Speaker 5

Good morning. Thanks for taking our questions and great start to the

Speaker 2

year. Hey, thanks, Bob. Good to hear you.

Speaker 5

Yes, you guys as well. So obviously OpSec

Speaker 3

is a lot of

Speaker 5

the big news. We knew about it. You closed it. It's great. It fits the strategy you've been articulating since pre spin.

Speaker 5

Now that OpSec's closed and part of the company, how, if at all, does this impact your acquisition strategy? Will you be looking for more software now or more hardware or to acquire customers to put into your platform? How does it fit and how does it help you shape the next few acquisitions?

Speaker 2

Yes. Thanks, Bob. Well, and I appreciate the comment and I hope everyone's seen this that we laid out the strategy 12 months ago, now 13 months ago since the launch of the company. And we're really executing it in a way of doing exactly what we said we were going to do around the thematic of secure, detect, authenticate in markets that are large, growing and fragmented and we think there's a lot of opportunity to grow our portfolio with businesses that have moats around them. And OpSec, we think, is a great example of that.

Speaker 2

And it's part of why we announced the new segment structure and put currency together with OpSec because we fundamentally believe this is an area we can continue to grow. A $3,000,000,000 market growing at mid single digits, highly fragmented and again, really unique technology and service companies out there of which we are now a leading player. So that feels very good to us to your question where we can continue to do more. Now our first focus, Bob, as I'm sure you'll appreciate, is to grow these businesses, and that includes both currency. Christina walked through the investments we're making there.

Speaker 2

That's core to the growth strategy we have and certainly to grow OpSec, and we're really excited even more so about that coming into the portfolio as we've closed. But we do see more opportunities here. And I think you can think about those as both the offerings themselves, which include differentiated niche technologies and also enhanced digital capabilities to your question. Both go together. I don't believe it's 1 or the other, but it's putting both together that forms a very sticky differentiated solution with wide moats.

Speaker 2

And where we see this playing out even more in the future and you could see that in the OpSec business are tailoring the solutions to individual vertical markets, whether that's consumer, media, pharmaceuticals and government businesses, that's where a lot of the fragmentation still sits inside the competitive set and that's where we see more opportunities to pull together again additional assets inside the new segment. And we come out of this Bob with a fantastic position in our net debt and our leverage at 1.8 that gives us ample capacity to go do more. And so that's our focus. We're in day 3 post the announcement of OpSec. So our number one focus is integrating and welcoming our new OpSec colleagues into the business and going out and talking to our customers to go achieve the synergies we see, particularly on the commercial side.

Speaker 2

And with that said, as I alluded to here in my comments just a few minutes ago, we have a strong funnel of opportunities. And with our leverage, we are going to continue a very disciplined M and A process and feel, again, very optimistic on where we're headed in the year ahead.

Speaker 5

Okay, great. And just following up with that answer, and I'm sure the answer to this question will be a bit of both as well. But in terms of growing the existing OpSec business, how would you think the growth will be weighted more towards new customers or new logo ads or more towards kind of expanding share of wallet, for lack of better term, with your existing customers? I'm sure it's a bit of both, but where's the weight going forward? And how should we think about that?

Speaker 6

That's a

Speaker 2

good Yes. Thanks, Paul. That's a good question. I am going to actually use your answer because you're right. It is a bit of both.

Speaker 2

And I mean that sincerely that I think what we've been I was going to say pleasantly affirmed or not surprised, but encouraged by the affirmation of our strategy with our customers and their response to this acquisition because it's very clear to the customers that can see the benefits of bringing in our truly differentiated micro optics technology along into that OpSec channel and completing a wonderful portfolio of technology that includes the OpSec physical technology and their holograms with our micro optics on top of their software and services. We've got a lot of positive response from the customer base on that. So that's where I see the share of wallet expansion inside the customers, not necessarily all new logos, but folks who are willing to move up the technology stack with our new offerings and things we can now do for them that OpSec can do for them that they didn't have access to in the past. And as we mentioned before, we see $3,000,000 of commercial synergies by 'twenty six just off of this expansion of our technology through the OpSec channel. And so that feels very good and we're very confident on delivering those synergies.

Speaker 2

And then to your point, I think with the fact OpSec now has a more complete set of solutions, there are opportunities for new logo expansions. And I think those are broad, around all of the segments that we referred to earlier. That's the sports and media market, that's the consumer market and pharmaceutical as part of that and government. So I think it is a bit of both. I wouldn't want to weight it one to the other.

Speaker 2

But again, we built in $3,000,000 of synergies as we mentioned last quarter just from expansion of the share of wallet side of this business. So feel very good about that as we've gone through the final weeks of leading up to our close. And now that since we've closed, we're out with a very detailed 100 day plan going to our customers and they're excited about the combination.

Operator

Thank you. One moment for questions. Our next question comes from Damian Karas with UBS. You may proceed.

Speaker 7

Hey, good morning everyone.

Speaker 2

Good morning, Damian.

Speaker 8

So you gave a little bit

Speaker 7

of color on the gaming market and kind of what's going on there. You talked about sort of your expectation mid single digit growth for the rest of CPI outside of gaming. So wondering if you could just maybe share with us any additional color kind of walking across those verticals, what you're seeing and kind of how each part of the business is progressing?

Speaker 2

Yes. Thanks, Damian. Appreciate the question. I'll go back a little bit to what I said with Matt. It's first question of we think the business has performed here just as expected and consistent with what we said last quarter.

Speaker 2

When we think about gaming, again, that underlying market is very healthy. We see that growing at low single digit to mid single digits depending on geography, and that's unchanged. And so that gives us a lot of confidence as we go through this year. Also through our own checks, we're maintaining our strong share in the market. And that's again based on the differentiated technology.

Speaker 2

So nothing changed there from our perspective. And the order pattern we're seeing in gaming is playing out as expected as well. The backlog, as Christina showed, for CPI was drawn down, again, as expected, driven by gaming. We understand where customer inventories are sitting. There's still a few months as we indicated last quarter that they're going to be drawing down through Q2.

Speaker 2

And then we fully expect order rates to start to come back to the levels that we would normally see in the run rate of the business and that's driven by casino floor upgrades and the normal replacement cycles driving that demand. And again, we don't see any changes to that. So I'd say gaming is playing out just as we expected and in line for the rest of the year. To the rest of your question on the other parts of CPI, again, we're confident we're going to end this year growing mid single digits for all the other verticals as we discussed last quarter. When you think about retail, I would just say I'm encouraged by what I see in the start of the year.

Speaker 2

The underlying market, particularly for self checkout is healthy. We're seeing major retailers moving ahead with their upgrades. And again, we think it's aligned to these secular trends of labor scarcity and increased automation that are unchanged. And so our retail segment is on track to grow mid single digits this year in line with our expectations and we see good performance for the year coming both from our OEM customers and from customs self checkout applications as well. And then finally, I'll just end with, again, the rest of the vertical is growing as expected.

Speaker 2

And one area that we've seen just continued strength, particularly since the pandemic is vending, which finished last year in strong fashion growing at mid single digits and we expect that for the vending business this year. So again, kind of a nice robust resiliency around the business, understanding the inventory normalization that I alluded to in gaming. So hopefully that helps, Damian.

Speaker 7

Yes. No, very helpful, Aaron. Thank you. And this question might be a little bit more for Christina. It looked like free cash flow maybe a little bit lighter in the quarter and seems like that's maybe on the working capital side and perhaps you're carrying a little bit more inventory.

Speaker 7

Could you just kind of clarify that and help us understand why what might be driving that? Is it related to the U. S. Currency business shutdown or anything else? Or just how should we think about kind of working capital and free cash flow as the year progresses?

Speaker 8

Yes, thanks. I appreciate that question. When you think about free cash flow overall, just to take a step back, we have such tremendous and strong free cash flow generation and that enables us to maintain our low leverage while we continue to invest in our organic growth and in strategic M and A. And as an example, last year we were able to pay down $245,000,000 of our term loan in less than 1 year. So that just shows the strength of our free cash flow.

Speaker 8

Now to provide further context on Q1, we saw a lower free cash flow based on the timing of cash used for working capital specific to our currency business. And as you know, currency is a project based business, which can be lumpy quarter over quarter. And that impacts the timing of orders and shipments and that impacts working capital. We also had higher CapEx investments in the new series, which Aaron spoke about earlier, which is a tremendous opportunity for long term growth in the business. So we're so excited to make those investments now.

Speaker 8

So when you think about the currency trends in Q1, that's really a timing. And when you overall look at the full year, we expect free cash flow to be on track at approximately 100% conversion. And I'll also just say in the quarter on the CPI side, we had very strong margins and free cash flow in the quarter. So this really was specific to currency and a little bit of seasonality as Q1 tends to be the lowest of the quarters.

Operator

Thank you. One moment for questions. Our next question comes from Bobby Brooks with Northland Capital Markets. You may proceed.

Speaker 6

Hey, good morning, everyone. Thanks for taking the question. So when thinking about OpSec and the associated spending maybe over the next 12 month timeframe, excited for cost synergies via elimination of duplicate expenses or things of that nature? Or are you seeing more opportunities to invest into the invest into OpSec to spur further growth?

Speaker 2

Hey, good morning, Bobby. Thanks for the question. Well, again, I think it's a little bit of both, to be honest. Let me start with at least the way I think about it of where have we in through our due diligence and in our modeling have line of sight to synergies in the business. And we've said that we were looking at about $8,000,000 of synergies by 2026, dollars 3,000,000 coming from commercial synergies and I talked about those earlier and that's really driving the sales of our micro optic technology through the OpSec channel.

Speaker 2

The other remaining 5 is from operational synergies. Think about that with supply chain, the scale that we bring to OpSec and really the rigor that will apply with our CBS operating discipline. So that $8,000,000 is part of our thesis. We feel very confident about that and we're getting to work on it again at day 3 with a very detailed integration plan that will include going out to our customers, which is happening immediately to drive the commercial synergies as well as going into the facilities and doing training and deploying our CBS operating principles. Again, feel very confident on achieving those synergies.

Speaker 2

Now to the point you've raised about is there additional investment in OpSec and are there more growth opportunities in the business? I think that's where we're excited. We see this business growing at mid single digit plus. That's what we've communicated before. And I feel again very confident with the outlook for the business both near term and long term.

Speaker 2

We're going to continue to make the investments in OpSec. But quite frankly, the OpSec business was already making in building out not only their physical technology, but remember they have just a good portion of that business as shown in the pie chart on the slide that I went through that's in digital assets. So I see continued investment in OpSec that's in line with where they've been investing historically through their PE ownership and continuing to create wide moats both physical technology and digital. So I do think it's a little bit of both. But the story of OpSec for us is about growth and it's about growth of our technology combined with theirs and growth as the market's growing as well and it's opened up a much bigger TAM for us as part of CraneNXT.

Speaker 6

Got it. Appreciate that color. And then maybe going back to Christina, I know she talked about the free cash flow and just kind of go back to that. Could you maybe just go through just the maybe a little bit more in-depth and more color on just the confidence and visibility of maintaining that and you guys maintaining the 100 percent adjusted free cash flow conversion guide, because that would kind of extrapolate and now you guys would have to be more towards what you saw in Q3 of 2023 with 150 percent free adjusted free cash flow conversion rather than the 110% maybe that you saw in the Q4 of 2023. So I guess just kind of looking more towards that confidence and visibility and where that kind of stems from?

Speaker 8

Yes. Thanks, Bobby, for the follow-up question on that. When you think about what happened in Q1, a little bit of seasonality there. Q1 tends to be the lowest quarter and each quarter gradually we expect to be higher and that's consistent with the operations of the business in prior years. So that's it's quite normal to see that escalation happening throughout the year.

Speaker 8

Now specific to this Q1, we had just some temporary things that were happening in the quarter just related to the investments in the U. S. New series and also just timing of shipments in Q1 related to international currency and also on the delivery on our U. S. Business.

Speaker 8

So those are a little bit of timing. And as we look at our full year projections, we do expect to be on track for that full year approximately 100%.

Operator

Thank you. And our next question comes from Isaac Selhuysen with Oppenheimer. You may proceed.

Speaker 9

Hey, good morning. This is Isaac on for Ian. Thanks for taking all the questions. Most have been answered already, but it was very helpful to see the excuse me, time line for the equipment upgrades at currency. Could you maybe touch on the level of investment required there?

Speaker 9

And do you anticipate your facilities maybe internationally to have similar upgrades? Or all those equipped to serve international customers of the growth that business is seeing there?

Speaker 8

Yes. I'm sorry, Isaac, can I just ask you to repeat the first half of your question? I just didn't follow what you said.

Speaker 9

Yes. Just on the currency investments in terms of the equipment upgrades, could you just touch on the level of investment required there? And do you anticipate other facilities having to be upgraded or any downtime maybe internationally?

Speaker 8

Yes. Thanks for that and thanks for the clarification. I mean in terms of the CapEx investment we're making in the U. S. New series this year, which is again is such a tremendous program for long term growth for the company that we're so excited about.

Speaker 8

We'll see CapEx be a little bit higher this year than we've historically expected. So generally, a change for us in the business specific to this problem excuse me, this a change for us in the business specific to this problem excuse me, this project. And that investment will pay off over the decade long cycle that the new series will bring to us. We are continuously doing maintenance across all our facilities, right? Our continuous improvement initiatives are ongoing.

Speaker 8

And so you'll see normal CapEx in every year, again, approximately 2% of sales. There's not anything specific that's happening internationally, certainly nothing like the magnitude of what we're doing in the U. S. Series today that we're forecasting.

Speaker 9

Okay, great. Thanks so much.

Operator

Thank you. One moment for questions. Our next question comes from Matt Summerhill with D. A. Davidson.

Operator

You may proceed.

Speaker 3

Yes. Just a quick follow-up. This migration that we expect down denomination with the U. S. Government redesign cycle, are you starting to see a heightened level of down denomination migration with the other 50 central banks you deal with?

Speaker 3

And if not, when do you think we'd start to see that inflection? Does it is it coincidental to the U. S. Government cycle? Does it maybe happen obviously, it's an extended cycle, right?

Speaker 3

It works into the next decade. Is it more front end loaded relative to the U. S. Government? I don't see how the same sort of playbook isn't run with the other major central banks in the world given what they're trying to combat in with these upgrades?

Speaker 3

Thank you.

Speaker 2

Yes. Hey, thanks for that question, Matt. I think the way you're framing that is exactly right. If I zoom up a little bit or go back to the history of the U. S.

Speaker 2

Program and let's say it's 2013, the introduction of micro optics to the U. S. Dollars 100 bill set off what we're seeing today is this very strong demand for increased any counterfeiting technology across the world. And that obviously as you know and allude to here starts at the higher denominations and it moves down market, if you will, because fundamentally, the concern on anti counterfeiting is still unchanged regardless of the denomination and some lower denominations have just as big of anti counterfeiting risk. And the U.

Speaker 2

S. $20 bill and $50 bill are good examples of that. So we are seeing exactly the phenomena you outlined. And I think that's reinforced by our other your other question of the win, the wins we're seeing at Micro Optics, which is consistently 10 to 15 denominations a year and arguably Q1 was a very strong start for us, to your question. So I think that is the phenomena that's playing out.

Speaker 2

It's been playing out for several years. And I would say it's a consistent philosophy central banks are adopting to increase more anti counterfeiting technology in the every new bill redesign. That's what's happening in the United States, in a big way, which will benefit us And that's what's happening denomination by denomination in central banks around the world. Now just remember that these are typically slower processes that central banks will not redesign bills very often. That's very deliberate process.

Speaker 2

And so it takes a number of years to go through not only the full fleet of the denominations, but also the redesign process. So I think that really plays to our advantages as more people adopt technology. Our technology specifically, they get accustomed to it and understand its advantages that you see this continual increase. That's a virtuous cycle for us that we again think has a lot of tailwinds to the currency business and you see it, Matt, playing out in the numbers.

Operator

Thank you. One moment for questions. And our last question comes from Bobby Brooks with Northland Capital Markets. You may proceed.

Speaker 6

Hey, thanks for taking the follow-up question. So just going back to OpSec and on the cross sell on cross selling micro optics into OpSec customers, I'm just trying to frame it better for myself. Obviously, OpSec has really good hologram technology. But am I right to assume that your guys' micro optics technology is a notable step up in terms of the durability of the physical authentication piece? And then let's say an offset customer switched over all its physical authentication pieces to micro optics.

Speaker 6

What would that drive a notable boost in revenues and expand margins? Just trying to help frame that opportunity.

Speaker 2

Yes. No, that's a really good question, Bobby. Thanks for that. I would view it a little at least how we're talking about it and many customers are viewing it as it's a portfolio of solutions that's dependent on what you're looking at, particularly for the aesthetics. There are different features and aesthetic properties that OpSec's really terrific hologram technology can provide that micro optics can't.

Speaker 2

They're both very durable. I would not really argue one over the other. There's different form factors and certain grades of the products. But from a true anti counterfeiting perspective of what we can provide with micro optics, it's truly at the high end of that type of feature set of if that's your primary function. So most customers are going to weigh a very a variety of different features to make a decision.

Speaker 2

It's not just any counterfeiting. It could be the color fit format of the label that they're looking for. So we think having this broad portfolio is the right answer for the customer. It's not always a migration to micro optics. It's probably a combination of both for most customers depending on their product or depending where they want take their brand and their brand image.

Speaker 2

And I think that's what now very few, in fact, no other competitor can offer in the market. And that's the mode and the differentiation that OpSec will have going forward. So again, it's a little bit of the best of both worlds in some ways. To answer your question on margins, both the Offset Physical Margins are very robust as is our Micro Optics. On a net net basis, it's more accretive on the Micro Optics, but both are very good, quite frankly.

Operator

Thank you. I would now like to turn the call back over to Aaron Sake for any closing remarks.

Speaker 2

All right. Thank you very much, operator. And again, this quarter, I couldn't be more excited by our announcement that came out earlier this week for a major milestone in the history of Crane NXT as we completed the acquisition of OpSec and it's reflected in the questions here this morning of how important this is, this first acquisition for Crane NXT and adding to our portfolio. I'd again like to thank all of our NXT associates around the world for their efforts in Q1, just an outstanding focus and dedication to the business, all while closing our first acquisition. And it's hard to believe it was just 13 months ago that we launched the company.

Speaker 2

And our 1st full year, I think, has been very rewarding. Needless to say, as I look forward, I am excited by the journey ahead in 2024. So thank you again to everyone who joined us today. Thank you for your questions, And I hope you all have a great rest of your week.

Operator

Thank you. This concludes the conference. Thank you for your participation. You may now disconnect.

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Earnings Conference Call
Crane NXT Q1 2024
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