EnPro Industries Inc

NYSE:NPO

Earnings Call Transcript 2023-Q1

[Operator]

Greetings and welcome to the EnPro First Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded.

I would now like to turn the call over to James Gentile, Vice President of Investor Relations. Thank you. You may begin.

[James Gentile, Vice President, Investor Relations]

Thanks, Darrell, and good morning everyone. Welcome to EnPro's first quarter 2023 earnings conference call. I will 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 historic non-GAAP measures to the comparable GAAP measures are included in the appendix to the presentation materials.

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-K.

Also note that during this call, we will be discussing our full year 2023 guidance, which excludes unforeseen impacts from these risks and uncertainties, as well as changes in the 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 first quarter, the impact of the foreign exchange rate changes subsequent to the end of the first 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 Vaillancourt, our President and Chief Executive Officer. Eric?

[Eric Vaillancourt, President and Chief Executive Officer]

Thanks, James, and good morning everyone. I'm pleased to update all of you on another outstanding quarter at EnPro.

Before we begin. I would like to share that Milt Childress has announced his plans to retire in the first half of 2024. While Milt is not going away anywhere just yet, I would like to take a moment to recognize his many contributions to EnPro for the past two decades.

Milt has been a great partner to all of us and we know that his significant impact on our organization will live on well into the future. We are moving forward with the process of identifying the right leader to succeed Milt, and we are pleased that he will remain with us to ensure a smooth transition once his successor is named.

Now, I will turn to the first quarter results. We delivered outstanding financial results this quarter, driven by a record performance in Sealing Technologies segment and our Advanced Surface Technologies segment successfully managing the current slowdown in semiconductor equipment markets. We are proud of all of our team members across the enterprise who together have helped us to get off to such a strong start for the year.

In the first quarter, sales increased almost 5% year-over-year with organic sales increasing more than 6%. We saw strong demand in several of our Sealing Technologies markets, which more than offset headwinds in certain areas of our semiconductor business. Our performance this quarter highlights the benefits of our balanced portfolio of high margin businesses with technological advantages serving critical applications that touch our lives every day.

We achieved record results in Sealing Technologies during the quarter evidenced by the significant year-over-year increase in adjusted EBITDA. In AST, we are actively engaged with our customers to capitalize on growth opportunities when semiconductor markets recover.

We are proud of the agile culture we have built grounded on a focus on innovation and continuous improvement, which combined with our technological and applied engineering advantages, positions EnPro to outperform regardless of the macroeconomic environment. We had a terrific quarter.

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

[Milt Childress]

Thanks, Eric, and I appreciate the kind words in your introductory comments. EnPro has been my home for nearly two decades and I am incredibly proud of all of our team and what our team has accomplished over that time.

I've never even though -- there's news now of my retirement, I've never been more enthused about our company, never, in my 20-year -- nearly 20 years of being here and remain focused -- and I'll remain focused in the year ahead on continuing to build upon our strong momentum and to ensuring a seamless CFO transition prior to my retirement next year.

Now to our financial results. As Eric noted, we had another strong quarter of execution and results. Reported sales of $282.6 million in the first quarter increased 4.6% year-over-year and organic sales were up 6.3%. Strong demand across aerospace, nuclear, general industrial and commercial vehicle markets in addition to pricing actions in response to inflationary pressures more than offset a reduction in sales due to the current slowdown in the semiconductor market.

Adjusted EBITDA of $68.6 million, increased 16.3% over the prior year period, driven primarily by operating leverage on volume growth in Sealing Technologies and pricing initiatives in response to labor and material cost inflation, as well as cost controls keeping SG&A expenses in check.

Adjusted EBITDA margin of 24.3% expanded more than 240 basis points compared to the first quarter of 2022. Corporate expenses of $10.7 million in the first quarter of 2023 decreased from $12.9 million a year ago, driven primarily by decreased incentive compensation accruals and reduced restructuring and professional expenses.

Adjusted diluted earnings per share of $1.95, increased 25% compared to the prior year period. Strong operating results drove the increase in addition to the decrease in our normalized tax rate to 25% from 27% in 2022. Net interest expense was up only modestly despite higher rates and the majority of a portion of the net investment hedges in September 2022. Lower debt balances and the good work by our treasury team to deploy cash and short-term investments to save higher-yielding instruments, partially mitigated the increase.

Moving to a discussion of segment performance. Sealing Technologies' sales of $173.3 million increased 12.8%, driven by strong demand in several key end markets as discussed earlier. Excluding the impact of the business divested in the fourth quarter of 2022 and foreign exchange translation, sales increased 15.1%.

For the first quarter, adjusted segment EBITDA of $49.7 million increased almost 45% and adjusted segment EBITDA margin expanded 640 basis points to 28.7%. Strong volume growth and favorable mix, particularly in our aerospace and nuclear businesses, operational improvements in our commercial vehicle business and effective pricing strategies in response to inflationary pressures drove record performance in the Sealing Technologies segment.

Excluding the impact of the divestiture and foreign exchange translation, adjusted segment EBITDA increased more than 48% compared to the prior year period. Turning now to Advanced Surface Technologies. First quarter sales of $109.4 million decreased 6.3%, driven by the current slowdown in semiconductor capital equipment spending.

Excluding the impact of foreign exchange translation, sales decreased by 5.3% versus the prior year period. For the first quarter, adjusted segment EBITDA decreased 15.5% to $29.5 million, driven primarily by the decline in volume, unfavorable mix and higher material and labor costs.

Excluding the impact of foreign exchange translation, adjusted segment EBITDA decreased 13.5%. For the first quarter, adjusted segment EBITDA margin was 27%. We have taken measured actions to reduce operating costs in response to the slowdown in demand without sacrificing our ability to capitalize on the numerous opportunities for growth, driven by our positioning in the semiconductor industry and the differentiated products and solutions we offer our customers.

Turning to the balance sheet and cash flow. We ended the quarter with a net leverage ratio of 1.6 times. With cash and short-term investments of more than $370 million and nearly full availability under our $400 million revolving credit facility, we have ample financial flexibility to execute on our long-term strategic growth initiatives.

Free cash flow for the first three months of 2023 was $21 million, down from $24 million in the prior year. Year-over-year decrease in free cash flow was driven by higher net interest payments and higher capital spending and working capital investments to support growth, which offset the increase in operating profit. During the quarter, we paid a $0.29 per share quarterly dividend. For the first three months of the year, dividend payments totaled $6.2 million, a 5.1% increase versus the prior year.

Moving now to our 2023 guidance. We maintain the annual guidance issued in February and continue to expect revenue growth of flat to low single-digits, adjusted EBITDA of $248 million to $260 million and adjusted diluted earnings per share from continuing operations of $6.45 to $7.05. Compared to a quarter ago when we first initiated guidance for the year, we expect stronger full year results in Sealing Technologies, offset by lower results in Advanced Surface Technologies.

In Sealing Technologies, our guidance reflects expectations for continued strong results in the second quarter and the assumption of some macroeconomic softness in the second half. In Advanced Surface Technologies, our guidance reflects a softer second quarter relative to the first quarter and based on customer input, stabilization in semiconductor demand by the fourth quarter with resumption of growth in 2024. Thanks for your time today.

And now I'll turn the call back to Eric for some closing comments.

[Eric Vaillancourt, President and Chief Executive Officer]

Thank you, Milt. Our teams continue to execute at a high level and demonstrated agility to drive our strategic priorities forward and deliver for our customers. In the quarter results from the Sealing Technologies were exceptional and the power of the segments advantages are on clear display.

In Sealing, we will continue to invest in new product development and continuous operating improvements, while prudently considering acquisitions that will enhance our strong competitive positions overtime.

In AST, we are executing very well through a short-term demand slowdown in semiconductor. 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.

Our results demonstrate both our ability to outperform across economic and industry cycles and the resilience of our portfolio of businesses. With our well-capitalized balance sheet and strong free-cash flow generation, we will continue to invest in growth opportunities to build upon our strong foundation.

As I share every quarter, I am proud of our team and our many accomplishments as we continue to do what we said we would do, execute on our multi-year 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. Now, I'll open the line to questions.

[Operator]

Thank you. We will now be conducting a question-and-answer session. [Operator Instructions] Our first question comes from the line of Jeff Hammond with KeyBanc. Please proceed with your questions.

[Jeff Hammond, KeyBanc Capital Markets]

Hey, good morning, everyone. Milt, congrats on the announcement. It's been great working with you. I look forward to, certainly the next couple of quarters. Just really want to dig in on kind of the semiconductor incremental weakness where are you seeing it? What's kind of the confidence that this is the last cut here? And then just maybe expand on kind of the mix and cost takeout dynamics and how we should think about decrementals playing out in AST from here?

[Milt Childress]

Yeah, thanks, Jeff. And by the way, I'm not going anywhere. I'll be here for a while, so don't treat me like I'm retired. Yeah, I've told the team here that I'd rather have a Roy Williams type retirement, which is at the end of the season, rather than Coach K, but the Coach K announcement works best for the whole process.

So to your question, the dynamics in the first quarter in semiconductor are very similar to what we described on our fourth quarter results. We had areas that were still relatively strong and a good portion of our semiconductor business and what drove the decline and the weakness was primarily in the part of our business that is coatings related. And that happens to be one of the higher margin product lines as well.

So your question about leveraging. You saw fairly downward leverage on the decline in sales and it's primarily just because of mix in the pockets of our semiconductor business. That will rebound. And to your question of when. Based on customer feedback, we think Q2, Q3 likely will continue to be relatively slow in the industry and then stabilization in the fourth quarter and strong growth in 2024.

So, we have no concerns. We don't, we sleep well at night, we're doing the right things to control costs, we're still making the investments that we want to make, we're still having conversations with customers about new platforms, long-term growth and we're positioned extremely well and we're executing extremely well in that segment notwithstanding the results.

[Jeff Hammond, KeyBanc Capital Markets]

Okay. And then you mentioned kind of strong growth in 2024, just maybe update us on kind of new wins visibility there, obviously, it's hard to call a cycle, but just kind of seeing what you can control and some of the new opportunities kind of what kind of underpins that confidence in growth in '24?

[Eric Vaillancourt, President and Chief Executive Officer]

Underpinning the growth in '24 is our pipeline. When you look at our pipeline of new products, new customer wins, new vertical integration from the re-shoring, all that is very, very positive. I think we had 31 new opportunities since the fourth quarter and we expect to capitalize our typical close -- I should probably give it as typical close rates in the 30% range.

And so I expect us to ramp-up very, very quickly. And not only that we expect existing business is going to recover. So, we're going to continue to win new business, as well as just grow with our existing customers and we've also picked-up some new customers. That's really exciting with some technology.

[Milt Childress]

I would also like to add that some of the recurring revenue characteristics of the AST segment have continued to stabilize some of the cyclicality that we have. In the near-term here, given some weakness in the capital equipment space, but you can expect us to continue to move forward on building our refurbishment and cleaning coating capabilities moving forward.

[Jeff Hammond, KeyBanc Capital Markets]

Okay, great. I'll get back in queue.

[Operator]

Thank you. Our next question comes from the line of Steve Ferazani with Sidoti and Company. Please proceed with your questions.

[Steve Ferazani, Sidoti and Company]

Good morning, everyone. Appreciate all the color on the call. Wanted to follow-up with some of the questions on the chip industry. Obviously, as we go through earnings season, we're hearing a variety of very different outlooks and the timing of a recovery. I'm just trying to get your sense if it was stronger and faster in the second half than you thought? Can you give us some color on the costs you've taken out and how quickly you could put them back in if we do see a better recovery or faster than maybe you're guiding for right now?

[Eric Vaillancourt, President and Chief Executive Officer]

I'm not sure I understood all the question, but I can tell you that the costs we took out, we don't need to put back in. So the cost we took out we've gained an improvement. So we don't need to add to actually grow, but I'm not sure of the first part of your question.

[Steve Ferazani, Sidoti and Company]

What we've heard is, obviously, some of the larger chipmakers think that the recovery could come faster in the second half than maybe reflected in your guidance for AST is what I'm saying. So just quick -- how quickly you could step-up again to the idea of future temporary costs out?

[Milt Childress]

Yeah, we can step-up quickly. We've said on multiple occasions and it's worth repeating here is we're executing extremely well. If you look at our revenue declined, it really is pretty strong results given what you've seen in the industry with the industry decline data which now is WFE, the latest I think was down 22% for the year with Gartner on the semiconductor industry down 6% for the year overall if we just look at chip consumption units.

And so, our performance, if you look at the blend of those two has really been quite good. But yeah, we'll respond to whatever the environment is. We're being cautious, we don't know with the lag and how much inventory is in the system, when the uptick will start benefiting us, but when it does, we're ready.

[Eric Vaillancourt, President and Chief Executive Officer]

That's the issue, Ultimately, the customers have a fair amount of inventory and we won't respond to fully move through that inventory. So, well, they see the orders up-ticking, it may take a little lag before we see it, but once we see, we'll respond immediately. We can respond today frankly with new orders.

[Steve Ferazani, Sidoti and Company]

Okay. That's fair. That's helpful. Thanks. Can you give an update on the Arizona facility and how you're seeing development on U.S. chip infrastructure?

[Milt Childress]

We're ready and going and continue to be on target. So, we're ready as soon as the customers are ready.

[Steve Ferazani, Sidoti and Company]

Okay. And then turning to Sealing briefly if I can get one more in. Obviously, commercial aviation looks very strong for the remainder of the year, commercial truck the order books look good, but clearly the market thinks it's going to soften if we look at some of the stocks. How are you seeing orders right now in terms your commercial truck customers? And how are you getting more confident on the second half?

[Eric Vaillancourt, President and Chief Executive Officer]

No. Sealing is performing outstanding. If you look at our commercial truck market, FTRs latest report actually shows a recovery. So, since July of last year, they've been showing a decrease month over month and I think it went -- improved from negative 1.6% to flat for the outlook for the rest of the year.

Now that bounces around a little bit. And if you look at UPS package deliveries, they're down. So, it's little bit hard to tell. We're getting conflicting information, but our business is doing outstanding and continues to be outstanding. We talked about in the first quarter of last year of having some softness and improving in that business and we have. We continue to execute and do the things we say we're going to do.

When you look at the rest of the Sealing business, Technetics with space, aerospace business, nuclear performing just outstanding. It's incredible what they're doing today. And Garlock just continues to surprise and deliver more and more. When you look at the margin expansion in that business, continuous improvement efforts, it's just fantastic.

We have great businesses there and they're performing extremely well. And you look at our margins right now 28.7%. A few years back we said we get the 25 and I'm not sure where the Sealing is, but we continue to find ways to improve.

[Milt Childress]

And finally, Sealing and Sealing.

[Eric Vaillancourt, President and Chief Executive Officer]

I just played about all of our businesses and we're executing flawlessly across all of them. It's exciting to see.

[Steve Ferazani, Sidoti and Company]

Perfect. Thanks, Eric. Thanks, Milt.

[Operator]

Thank you. Our next question comes from the line of Ian Zaffino with Oppenheimer. Please proceed with your questions.

[Ian Zaffino, Oppenheimer]

Hi, great. Thank you very much. Milt, it's great working with you, you're going to be missed for sure.

[Milt Childress]

Thanks, Ian. Keep in mind, I'll be right around here.

[Ian Zaffino, Oppenheimer]

Yeah, obviously, for a little while, good. As far as just like sneaking another question on AST. When you talk about softness, can you maybe tell us where you're seeing that or maybe just kind of parse it by what are you seeing in the equipment side versus the cleaning and coating side? And then maybe what are you seeing in sort of logic versus non-logic or leading edge versus non-leading edge, if you could kind of help us understand what's the moving parts are, if you bucket it that way? Thanks.

[Milt Childress]

Yeah, go ahead, Eric.

[Eric Vaillancourt, President and Chief Executive Officer]

Yes, so, leading edge continues to be very strong and we see that across the portfolio. Weakness in memory and computing. CPUs, that's where it hits our coating business and the equipment business is, I would say, just getting inventory imbalance. So we have mixed kind of results across the segments, but the biggest margin pieces in the coating business and that's in memory and in CPUs.

And that's where we're seeing the biggest impact currently today. And then when you look at Alluxa is doing great. Alluxa is back growing and performing like we expect and margins are improving, another great business. So, overall, we're executing extremely well and the only thing we need is a little bit of market stabilization and our results will accelerate.

[Ian Zaffino, Oppenheimer]

Okay, good. And then also, how are you thinking about M&A here in the environment, as far as multiples, any holes you think you need to plug right now or any kind of other areas you want to enter or get deeper into?

[Eric Vaillancourt, President and Chief Executive Officer]

We would love to get deeper into the Garlock Hygienic Technology space. We'd also look at other opportunities in nuclear. But right now we're focused on Sealing. We have some great opportunities there. But again, we're going to remain disciplined and will be very disciplined in our approach. We look at opportunities all the day every day, almost, but we're looking for the right opportunities at the right valuation. And as we continue to be disciplined and look for good opportunities, we are definitely active, we just haven't found the right thing yet.

[Milt Childress]

It's also the question of availability and obviously with the recent rate increases affecting maybe the M&A market, there is no reason for us to press. We're just waiting for the right opportunities, our pipeline is incredibly robust with very solid high-margin businesses that are participating in secular tailwinds. When one or more of those properties come available, we will definitely play to win and we'll make sure that on the underlying strategy and underlying financial criteria, we'll delight.

[Eric Vaillancourt, President and Chief Executive Officer]

And I'll just add, we will remain vigilant and watchful to maintain a very strong balance sheet.

[Ian Zaffino, Oppenheimer]

All right. Perfect. Thank you very much.

[Operator]

Thank you. [Operator Instructions] Our next question comes from the line of Jeff Hammond with KeyBanc. Please proceed with your questions.

[Jeff Hammond, KeyBanc Capital Markets]

Hey guys, just a couple of follow-ups here. I'm just trying to understand kind of the magnitude of the good in Sealing versus the offset in AST just to kind of understand kind of how much better Sealing is, how much worse AST is?

[Milt Childress]

Yeah, you can tell by my comments around guidance for the year and the fact that we've maintained, but indicated that we expect Sealing to be stronger for the year -- for the full year and AST to be lower relative to where we were a quarter ago for the full year. So the two, essentially offset, right. I mean, that was the message in your takeaway from my comments earlier.

And if you look at the -- maybe the outperformance in Sealing relative to your expectations in the first quarter and add a little bit for a strong quarter, perhaps not the same magnitude of outperformance relative to your expectations that will give you a pretty good idea of the change from a quarter ago in our expectation. So Sealing up and then offset tempered by some caution on expectations for AST for the past year. Does that help you?

[Jeff Hammond, KeyBanc Capital Markets]

Yeah, that's very helpful. So and then just on Sealing any mix was favorable, but any kind of aberrations in that margin and maybe how to think about margin cadence from here and kind of revisiting that long-term margin target which you're kind of running above?

[Eric Vaillancourt, President and Chief Executive Officer]

No. We expect it to continue the way it's gone. There wasn't any aberrations. There wasn't any one-time thing that affected the margin, it was just excellent execution. And like I said before, we continue to have continuous improvement efforts, but we need to rebalance. The mix is very favorable right now when you look across the portfolio and also the second half of the year is a little bit unknown. So we have some caution in there for that as well. And it just depends on what the general economy does. But the team will continue to perform flawlessly. I don't have any doubt about that.

[Jeff Hammond, KeyBanc Capital Markets]

Okay, great. Thanks, guys.

[Operator]

Thank you. There are no further questions at this time. I would now like to hand the call back over to James Gentile for any closing remarks.

[James Gentile, Vice President, Investor Relations]

Thank you for your interest in EnPro and have a great day.

[Operator]

Thank you. This does conclude today's teleconference. We appreciate your participation. You may disconnect your lines at this time. Enjoy the rest of your day.