Enpro Q2 2023 Earnings Call Transcript

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August 8, 2023

There are 6 speakers on the call.

Operator

Greetings. Welcome to EnPro's Second Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen only mode. Question and answer session will follow the formal presentation. Please note this conference is being recorded.

Operator

It is now my pleasure to turn the conference over to James Gentile, Vice President of Investor Relations. Mr.

Speaker 1

Thanks, Rob, and good morning, everyone. Welcome to EnPro's 2nd quarter 2023 earnings conference I'll remind you that our call is being webcast at enproindustries.com, where you can find the presentation that accompanies this call. With me today is Eric Vaillancourt, our President and Chief Executive Officer and Milt Childress, Executive Vice President and Chief Financial Officer. During today's call, we will reference a number of non GAAP financial measures. Tables reconciling the historical non GAAP measures to the comparable GAAP measures are included in the appendix to the presentation materials.

Speaker 1

Also a friendly reminder that we will be making statements on this call that are not historical facts and that are considered forward looking in nature. These statements involve a number of risks and uncertainties, including those described in our filings with the SEC, including our most recent Form 10 Okay. Also note during this call, we will be discussing our full year 2023 guidance, which includes unforeseen impacts from these risks uncertainties as well as changes in the numbers number of shares outstanding, impacts from future acquisitions, dispositions And related transaction costs, restructuring costs, incremental impacts of inflation subsequent to the end of the second quarter, the impact Of foreign exchange rate changes subsequent to the end of the second quarter and interest rate increases differing from the assumptions outlined in guidance, We do not undertake any obligation to update these forward looking statements. It is now my pleasure to turn the call over to Eric Valancourt, President and Chief Executive Officer. Eric?

Speaker 2

Thanks, James, and good morning, everyone. We are pleased to have delivered another solid quarter with total adjusted segment EBITDA margins of 29%. Our optimized portfolio is showing balance as strong performance in Sealing Technologies roughly offset weakness expected in AST That was driven by ongoing headwinds in semiconductor markets. Consistent with our strategic priorities, we will continue to invest in multiple growth and productivity opportunities It will build upon our strong foundation as we position EnPro for long term growth and value creation. In the second quarter, Sales were essentially flat year over year with organic sales up slightly.

Speaker 2

We saw a steady demand in several of our Sealing Technologies markets With strong profitability in Q2 year to date, in AST, based on recent customer feedback and overall market forecast, We now anticipate the expected recovery in our semiconductor markets to begin in 2024. We continue to invest in various growth sectors Vector's AST as the semiconductor industry is expected to roughly double to $1,000,000,000,000 by 2,030. And our positioning on the leading edge will continue to serve us well as the industry recovers. In the meantime, we continue to successfully execute in AST As evidenced by the year to date adjusted segment EBITDA margins exceeding 25%. In Sealing Technologies, delivered fantastic results with strong operating leverage and price realization in each of the businesses.

Speaker 2

And in particular, saw incremental strength in our aerospace and nuclear energy markets as well as strong volume and profit performance in our commercial vehicle markets. The performance improvement in recent years through the Sealing segment is nothing short of remarkable as year to date Sealing segment margins exceeded 30%. Our results demonstrate the balance of EnPro's optimized growth portfolio. We are well positioned to outperform across a variety of macroeconomic and industry backdrops Over the long term, a credit to our focus on innovation and continuous improvement as well as technology and applied engineering advantages. The resilience of our portfolio of businesses is enduring and our well capitalized balance sheet and strong free cash flow generation enable continued opportunities to invest in growth and build upon our strong foundation.

Speaker 2

Now I'll hand the call over to Milt to discuss our financial results in more detail. Milt?

Speaker 3

Thanks, Eric. As Eric noted, we had another solid quarter of execution. Reported sales of 2 $176,900,000 in the 2nd quarter were flat year over year and organic sales were up slightly Despite the reduction in sales due primarily to weakness in semiconductor markets, strong demand across aerospace, nuclear Commercial vehicle markets, in addition to pricing actions, largely offset a reduction in sales in semiconductor and optical filters. Adjusted EBITDA of $64,900,000 decreased 11.9% over the prior year period and adjusted EBITDA margins in the 2nd quarter were 23 4%, down from 26.6% from a year ago. Total adjusted segment EBITDA was relatively flat year over year.

Speaker 3

The declines in total adjusted EBITDA and adjusted EBITDA margins resulted from 2 specific factors that in aggregate Adversely affected the year over year comparison by $9,000,000 $7,000,000 of the $9,000,000 was from share price driven incentive compensation expense and $2,000,000,000 from the favorable impact of currency on foreign cash balances a year ago. To elaborate a bit on the $7,000,000 swing related to incentive compensation, we incurred approximately $4,000,000 of incremental incentive compensation expense in the quarter, driven by the 29% rise in our share price During the Q2. In the Q2 of last year, we benefited from an approximate $3,000,000 reduction in compensation expense driven by a 16% decline in our share price. Variability from these two factors will lessen over time. The share price driven volatility will roll off gradually over the next 18 months as a result of a change in our long term will be paid in shares rather than cash, which will eliminate the fluctuation in expense from share price changes.

Speaker 3

The currency exposure on foreign cash has been eliminated in all material respects as a result of repatriation of significant overseas U. S. Dollar holdings. Corporate expenses of $15,000,000 in the Q2 of 2023 increased from $9,400,000 a year ago, Driven primarily by the share price related incentive increase incentive compensation expense that I just described. Adjusted diluted earnings per share of $1.83 decreased 10.7% or $0.22 per share compared to the prior year period.

Speaker 3

The higher share price related incentive compensation expense and last year's currency related benefit combined for a 0.3 $0.02 per share negative impact. Moving to a discussion of segment performance. Sealing Technology sales by $176,700,000 increased more than 13%, Driven by strong demand in aerospace, nuclear energy and commercial vehicle markets, along with a positive impact from pricing. In the quarter, we continued to see firm demand in our general industrial markets. Excluding the impact of the business divested in the Q4 2022 and foreign exchange translation, sales increased 13.9%.

Speaker 3

For the Q2, adjusted EBITDA adjusted segment EBITDA of $56,200,000 increased more than 27% And adjusted segment EBITDA margin expanded 3.50 basis points to just under 32%. Strong volume growth and favorable mix, Particularly in our Aerospace and Nuclear Businesses, solid demand and operational efficiencies in our commercial vehicle business and effective pricing strategies Across the segment were the primary drivers of performance. Excluding the impact of the divestiture and foreign exchange translation, Adjusted segment EBITDA increased more than 28% compared to the prior year period. Turning now to Advanced Surface Technologies. 2nd quarter sales of $100,300,000 decreased 17.4%, Driven by the current slowdown in semiconductor markets and to a lesser extent lower optical filter sales.

Speaker 3

Excluding the impact of foreign exchange translation, Sales decreased 17% versus the prior year period. For the quarter, adjusted segment EBITDA decreased 36 0.2 percent to $24,100,000 driven by the decline in volume and unfavorable mix and to a lesser extent, the earnings impact of growth investments. Excluding the impact of foreign exchange translation, adjusted segment EBITDA decreased 35.7%. For the Q2, we achieved an adjusted segment EBITDA margin in AST of 24%, a strong result light of the current weakness across the semiconductor supply chain. One brief update on our participation in the U.

Speaker 3

S. Semiconductor We continue the staged upfit of the building we purchased in Arizona and are seeking ChIP Stack support, Which would help us build out a state of the art semiconductor facility on an expedited basis. Turning now to the balance sheet and cash flow. We ended the quarter with a net leverage ratio of 1.5 times. Subsequent to the end of the Q2, in late July, we repaid our term loan A1 of $133,700,000 With available cash, taking this into account with pro form a cash and short term investments exceeding $275,000,000 And nearly full availability under our $400,000,000 revolving credit facility, we have ample financial flexibility execute on our long term strategic growth initiatives.

Speaker 3

Our foundational portfolio is generating significant free cash flow. For the 1st 6 months of 2023, free cash flow was more than $66,000,000 up from $56,000,000 for the same period in the prior year. The year over year increase in free cash flow was driven by strong cash generation across the company and lower cash taxes paid in the period, which more than offset Higher net interest payments and higher capital spending to support growth and efficiency projects. During the Q2, we paid a $0.29 per share quarterly dividend. And for the 1st 6 months of the year, dividend payments totaled $12,200,000 One additional note before moving to guidance.

Speaker 3

2nd quarter results of Alexa were below our expectations, Which required us to perform an interim test of Alexa's goodwill for impairment. Based upon the results of an updated analysis, We determined that the remaining balance of goodwill attributed to Alexa was impaired and a non cash impairment charge of $60,800,000 was recognized in the quarter. Acquired in the Q4 of 2020, Alexa is a leading provider of optical filters With differentiated optical coating capabilities to solve customers' most demanding needs in a variety of leading edge applications. The business remains on solid footing with expectations of high single digit organic growth over a multi year period Moving now to our 2023 guidance. We expect revenue to be relatively flat compared to last year And adjusted EBITDA to be in the range of $248,000,000 to $256,000,000 The decline at the top end of the adjusted EBITDA range is due primarily to the impact of the $4,000,000 share price related incentive compensation expense In the Q2 as discussed earlier, we are raising adjusted diluted earnings per share guidance to a range of $6.70 to $7.10 due primarily to the repayment of a portion of our long term Debt noted earlier and higher interest income on cash balances.

Speaker 3

Our latest net interest expense view for 2023 It's $32,000,000 to $34,000,000 which is down from our previous assumption of $35,000,000 to $40,000,000 Compared to expectations a quarter ago, we expect stronger full year results in Sealing Technologies, Offset by lower results in Advanced Surface Technologies. As Eric mentioned, based on customer input and updated market forecasts, We now anticipate the inflection point in semiconductor markets to move from the Q4 of this year to 2024. In Sealing Technologies, we had exceptional mix benefits in the first half that we expect will moderate in the second half. Thanks for your time today. And now I'll turn the call back to Eric for closing comments.

Speaker 2

Thank you, Milt. Our teams continue to execute at a high level and remain steadfast in driving our strategic priorities forward and delivering for our customers. Looking ahead, in Sealing, we look to continue building on our momentum, we are proceeding with investments in critical new product development and value added efficiency improvements, while prudently considering acquisitions We'll broaden our strong technology and market positions over time. In AST, we continue to execute very well as we navigate through the current demand headwinds in Semiconductor, which as noted, we anticipate will abate in 2024. Over a multiyear period, we continue to expect strong organic growth and are well positioned to capitalize on a variety of exciting opportunities Using our technological advantages to deliver comprehensive solutions for our customers.

Speaker 2

As I'm grateful to share every quarter, am proud of our team and our many accomplishments as we continue to do what we said we would do, execute on our multiyear strategy to drive EnPro forward As a leading industrial technology company, while empowering technology with purpose. Thank you for joining us today. We appreciate your interest in EnPro. I'll open the call to the line for questions. Thank

Operator

you. Thank you. At this time, we'll be conducting a question and answer Thank you. Our first question comes from the line of Jeff Hammond with KeyBanc Capital Markets. Please proceed with your questions.

Speaker 4

Hey, good morning guys.

Speaker 5

Morning. Good morning,

Speaker 4

Jeff. Just wanted to get a little more color on where specifically you're seeing incremental softness in semi or AST. Maybe help us with the shape of the second half. Is 2Q still kind of the bottom? And then just expand The Eluxo write down, I think this is the second one.

Speaker 4

It just doesn't seem that far off from kind of how you've been thinking about You know the business over the long term?

Speaker 3

Yes. I'll start, Jeff. So First of all, when you look at, I guess, what's changed from a quarter ago, as we mentioned in the guidance comments earlier, There's been a slight shifting to the right in expectations for the inflection point in semiconductor, and that's not our view. It's just data that you'll see from large semiconductor companies that have reported. And so the moderation for us And the second half of the year is just reflecting that.

Speaker 3

The comments on Alexa, The situation with Alexa is some of the dynamics with inventory destocking that have affected the semiconductor industry have Had an impact on a number of the markets that Alexa is serving also and semiconductors has been one of the largest Single markets for the optical filter business as well as we've mentioned in the past. And so it's a really good business, but Our expectations for growth this year for that business is relatively flat compared to At the time we did our previous goodwill impairment, we were expecting some stronger bounce back this year. So we just recognized that and we kind of dealt with it We determined that the balance of the goodwill is impaired. We get that behind us and we'll see good growth In that business in 2024 and beyond.

Speaker 4

Okay. And then just on sealing, I think you had previously built in some slowdown there, double digit growth in the first half. Just kind of how do you think about organic growth in Sealing? And then It seems like all the areas you point out that are benefiting, driving better mix seem like they're still strong. So What's informing kind of the less favorable mix into the second half?

Speaker 2

Yes, Jeff, it's Derek. We're just expecting some softness in general industrial. Our book to bill is still strong, but at the same time, All the leading indicators we hear about continue to be a little bit softer. When you look at freight, I always look at FTR. Their ton miles, it continues to be down a little bit.

Speaker 2

And so we're expecting some softness in general industrial over time. The other businesses we still expect to be strong.

Speaker 3

The one added point that I would make is, when it comes to some of our nuclear Shipments, for example, there's a sequence of orders and timing and that business just based on the rate Nothing that's changing overall in the outlook. But we expected, have expected and continue to expect A stronger first half of the year with nuclear shipments versus the second half. And so that's the mix comment, in addition to just An assumption that we'll see some flattening of the general industrial markets. Jeff, I will also add, if you look at the second half of the year, given The current views on semiconductor recovery, we're expecting the 3rd quarter 4th quarter to be relatively equal. A quarter ago, we had indicated that we thought that we would see Q2, Q3 being the low points with some recovery happening in Q4.

Speaker 3

So that's the only thing that I would point out in terms of the sequencing of Q3 and Q4. But for

Speaker 1

the year, we probably expect total segment margins to approximate 25% plus or minus a little bit. In AST. In AST. Yes.

Speaker 4

And that comment about the balance 3Q, 4Q is AST as well, not total company?

Speaker 3

That's total company. If you look at total company Q3 and Q4 being relatively split equally for the second half of the year.

Speaker 4

Okay.

Operator

Thanks. Thank you. Our next question is from the line of Steve Farizzoni with Sidoti and Company. Please proceed with your questions.

Speaker 5

Good morning, everyone. Appreciate all the color on the call. In terms of the performance on Sealing, Can you break that out a little bit in terms of the margin strength of volume pricing mix?

Speaker 3

Yes. If you look at Sealing in the second quarter, the organic growth that It's roughly 14%. About 60% of that was the impact of year over year pricing and about 40% of that was volume. So still good organic volume growth. If you do the math, that gives you what, 5.5% or thereabouts of volume growth in the Sealing segment.

Speaker 3

So And then, on the question of next, I'm not sure I have anything else to really add from what I mentioned yesterday or previously to Jeff's question. And if we looked at the second half, we are expecting maybe some of the favorable mix, particularly Nuclear to soften for us. The other thing is in the second half, we'll just be catching up a little bit on price.

Speaker 5

If we expect some slowdowns as we get into next year, and I know it's a little bit earlier, but potentially on commercial transportation, I know you have a significant aftermarket. I'm trying to get a feeling for how much your pricing you think sticks as inflationary pressures ease if we see some of your markets slow?

Speaker 2

Specifically to heavy duty trucking or overall?

Speaker 5

Both, if you could.

Speaker 2

Heavy duty trucking, I think, well, overall, let me say, Garlock and Teknetics will likely stick. I don't see any reason for that to erode. In general, we typically hold those margins very well. And the heavy duty truck business, I think, will hold on to most of that. It will get a little more pressure on from the EMS, but our aftermarket will also pick up.

Speaker 2

And so I expect we'll hold on to most of it. There'll be a little bit Possibly a little bit with OEMs, but not much.

Speaker 5

Right. Appreciate it. Milt, you commented on Probably an update on the Arizona facility. You were breaking up a little bit to me. Can you repeat that?

Speaker 5

It sounded like you were trying to expedite the progress.

Speaker 3

Yes. Well, the major point was we're pursuing CHIPS Act support in order to expedite the Upfitting of the facility that we purchased last year.

Speaker 5

Any reason to expedite it? Do you expect any kind of Benefit from the build out faster or you just want to get it done ahead of time?

Speaker 3

Well, we're Coordinating with our customers and we just want to do everything we can to make sure that we're ready for that. And CHIPS Act support obviously would be helpful in that process.

Speaker 5

Great. Last one for me. Obviously, cash flow was very strong. We're seeing you getting back towards that 100% conversion. It looks like receivables Collection picked up a little bit.

Speaker 5

How are you the balance sheet is in great shape again. How are you thinking about, 1, can you maintain that conversion rate? How are you thinking about cash usage besides debt pay down?

Speaker 3

Yes, we anticipate that we'll stay on pace, the second half of the year from a cash flow perspective Compared to the first half, so yes, we're going to be at or at least it will be in the same zip code or vicinity as adjusted Net income, so a really strong conversion rate, which is a good characteristic of our new foundational portfolio. It's one of the things that was we had in mind as we were looking at Reshaping our portfolio over the past few years, a more dependable and stronger cash flow generating company.

Speaker 5

And uses of cash beyond timing on debt pay downs based on your guidance and or how you're expecting timing based On that guidance and other uses of cash?

Speaker 3

Yes. Well, I noted that at the end subsequent to the end of the quarter, we repaid our term loan A-one That had a maturity of September of next year of 'twenty four. So we decided given our cash position to go ahead and pay that down. The remaining term debt has a 2026 maturity date. And just for liquidity reasons, we saw no reason to pay that down.

Speaker 3

So we don't have expectations currently to pay down additional debt. We're more focused on investing, Investing for growth. And so we're obviously day in and day out, we're evaluating options for both Investing capital in our businesses to support growth as well as evaluating opportunities that might fit From an inorganic standpoint.

Speaker 5

Great. Thanks, everyone.

Operator

Thanks, Steve. Thank you. At this time, we've reached the end of the question and answer session. I'll turn the call over to Mr. Gentile for closing remarks.

Speaker 1

Have a great day, everyone. Thanks for your interest in EnPro.

Operator

This will conclude today's conference. Thank you for your participation. You may now disconnect your lines at this time.

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Earnings Conference Call
Enpro Q2 2023
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