Enpro Inc.

And welcome to the NPRO Q2 2021 earnings conference call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, James Gentile, Vice President of Investor Relations. Please go ahead.

Thank you, Brock. Good morning, and welcome to Enpro's second quarter earnings conference call. 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 Valencourt, our Interim President and CEO, and Milt Childress, Executive Vice President and CFO. Before we begin today's discussion, 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 the impacts from the COVID-19 pandemic and related governmental responses and their impact on the general economy, as well as other risks and uncertainties that are described in our filings with the SEC, included including our most recent Form 10-K and Form 10-Q. Also during the call, we will reference a number of non-GAAP financial measures. Tables reconciling historical non-GAAP measures to the comparable GAAP measures are included in the appendix to the presentation materials. We do not undertake any obligation to update these forward-looking statements. Also during this call, we will be providing full year guidance which excludes changes in the number of shares outstanding, impacts from future acquisitions, dispositions, and related transaction costs, restructuring costs, raw material availability and pricing, and other costs subsequent to the end of the second quarter. The impact of foreign exchange rate changes subsequent to the end of the second quarter, impacts from further spread of COVID-19 and other variants, and environmental and litigation charges. It is my pleasure to turn the call over to Eric Valancourt.

Eric? Thanks, James, and good morning, everyone. We appreciate you joining us today and hope you and your families are all staying healthy and safe. You have likely seen the management transition press release we issued this morning. I want to begin by saying how honored I am that the Board of Directors has placed their trust in me to lead ENPRO as interim president and CEO I also want to recognize Marvin for his contribution to ENPRO over the last several years. On behalf of the board and management team, I wish him the best in his future endeavors. By the way of background, for those who may be unfamiliar, I have been with ENPRO for the better part of 12 years, and over that time have had the opportunity to work in a variety of leadership positions across our Ceiling Technologies segment. I most recently served as president of Ceiling Technologies, a segment which I'm proud to say delivered an exceptional quarter. I also have had the pleasure to serve as a member of the NPRO Executive Council, which is a team of leaders from across NPRO focused on developing and implementing our commercial, strategic, financial, and operational objectives. Serving in these positions has given me the opportunity to experience firsthand what is truly so special about this organization, our collaboration and focus on empowering our colleagues. I know as well as anyone that the success of our organization is built on the hard work dedication, and tireless execution and commitment of our 4,400 employees around the world. As we will discuss throughout today's call, our team has continued to deliver for each other, our customers, and our shareholders in the second quarter, and I know I speak for the entire leadership team when I say I am incredibly proud of what we have accomplished. My goal is to continue to work with our leadership team to encourage and position our employees to unleash their full potential as we continue the clear strategy articulated over the past year. We are excited about what is ahead. With that introduction, let's move on to our second quarter highlights. As I noted, and as our results show, we had another exceptional quarter. In the second quarter, sales of $298.6 million increased 20.9% year over year, with organic sales increasing 27.1%. We saw sequential growth of 6.9% from the prior quarter. Our strong top-line results were driven by organic revenue growth and the addition of Alexa. Importantly, our growth was broad-based, as we experienced positive momentum across all of our businesses. Our second quarter adjusted EBITDA of $57.2 million increased 52.5% year-over-year, and the adjusted EBITDA margin expanded 400 basis points to 19.2%. This strong performance reflects the sustainable benefits of our portfolio reshaping actions, operating leverage and pricing strategies, partially offset by higher incentive compensation accruals and raw material inflation. All three business segments contributed to our adjusted EBITDA growth year over year. Thanks to the focused execution of our team, we were able to secure key materials while holding supply chain disruptions to a minimum. In the past year, we took action to increase the level of collaboration between supply chain, manufacturing, and our commercial teams. This enhanced focus and coordination throughout our organization has helped us improve customer engagement and respond quickly to mitigate raw material issues. Nevertheless, the raw material environment remains highly dynamic due to pandemic-related impacts, and we expect these conditions will likely persist at least through year end. Our order trends in the quarter were extremely strong. surpassing our solid first quarter, and are at the highest level in three years. As we look ahead, we continue to see broad-based strength across our businesses and are encouraged by what we are hearing from our customers, particularly in the general industrial, semiconductor, heavy-duty truck, food and pharma, automotive, and petrochemical markets. Together, these factors played a role in our decision to raise our full-year guidance, which Milt will touch on in his presentations. Now I will hand the call over to Milt for a deeper dive into our financial results for the quarter.

Milt? Thanks, Eric. As Eric mentioned, we had another exceptional quarter. Positive momentum across most major end markets, as well as the addition of Alexa, contributed to strong top-line results, partially offset by the reduction in sales due to last year's divestitures. As reported, sales of $298.6 million in the second quarter increased 20.9% year over year. Organic sales for the quarter increased 27.1% compared to the second quarter of 2020. As Eric noted, sequentially, sales were up 6.9%. Gross profit margin of 39.2% increased 580 basis points versus the prior year period. The increase was driven primarily by strong organic sales volume and the benefit of divesting lower margin businesses. Adjusted EBITDA of $57.2 million increased 52.5% over the prior year period as a result of higher operating leverage from solid organic sales growth, the addition of Alexa, and increased pricing, partially offset by increased raw material costs and higher incentive compensation accruals. Adjusted EBITDA margin of 19.2% increased approximately 400 basis points compared to the second quarter of 2020. Corporate expenses of $12.8 million in the second quarter of 2021 increased from $7.1 million a year ago. The increase was driven primarily by higher incentive compensation accruals, reflecting the stronger year-over-year performance company-wide. Adjusted diluted earnings per share of $1.56 increased 77.3% compared to the prior year period. As noted during prior calls, during the fourth quarter of 2020, we changed our adjusted EPS from the previous presentation of this non-GAAP measure to one that excludes after-tax acquisition-related intangible amortization. Amortization of acquisition-related intangible assets in the second quarter was $11.3 billion compared to $9 million in the prior year period, reflecting the addition of Alexa. We anticipate amortization of acquisition-related intangibles will be between $44 million and $46 million in 2021. As a reminder, our estimated normalized tax rate used in determining adjusted EPS is 30%. Moving to a discussion of segment performance. Sealing technology sales of $162.5 million increased 7.9% compared to the prior year period. despite the impact of divestitures in 2020. Excluding the impact of point exchange translation and divested businesses, sales increased 25.3%, driven by strong demand in the heavy-duty truck, general industrial, food and pharma, and petrochemical markets, offset partially by power generation and aerospace markets. Sequentially, sales increased 10.9%, as we saw momentum accelerate in our heavy-duty truck, general industrial, aerospace, and petrochemical markets. For the second quarter, adjusted segment EBITDA increased 39% to $42.4 million, and adjusted segment EBITDA margin expanded 580 basis points to 26.1%. The margin expansion was driven primarily by operating leverage commensurate with strong volume, portfolio reshaping, select pricing actions, and continuous improvement initiatives. Excluding the impact of favorable foreign exchange translation and divestitures, adjusted segment EBITDA increased 45.6% compared to the prior year period. Turning now to advanced surface technologies, second quarter sales of $59.2 million increased 48%, driven by continued strong growth in semiconductor, and the addition of Alexa. Excluding the impact of foreign exchange translation and the Alexa acquisition, sales increased 23.8% versus the prior year period. Sequentially, sales increased 8.2%, driven by growth in semiconductor markets. For the second quarter, adjusted segment EBITDA increased 41.8% to $15.6 million, and adjusted segment EBITDA margin contracted from 27.5% a year ago to 26.4%. Excluding the impact of Alexa and foreign exchange translation, adjusted segment EBITDA remained unchanged. Results for the quarter were impacted by increased operating costs related to the stand-up and qualification of a third lean tech facility in Taiwan and by foreign exchange transactional charges. As a reminder, LeanTech is a highly differentiated cleaning, coding, and related service provider with industry-leading solutions that support the most advanced technology nodes within the semiconductor industry, a high-growth market that has strong secular tailwinds. The new facility nearly doubles our capacity in Taiwan. More broadly, across the entire AST segment, we continue to see secular growth signals and expect sustained organic revenue growth and strong profitability over the long term. In engineered materials, second quarter sales of $80 million increased 36.5% compared to the prior year, driven by stronger sales in all major markets, including general industrial, automotive, oil and gas, and petrochemical. Excluding the impact of foreign exchange translation and the divestiture of TGB's bushing block business completed in the fourth quarter of last year, sales for the quarter increased 34.2%. Sequentially, sales were flat when compared to a very strong first quarter. We saw quarter-over-quarter sales growth in petrochemical and oil and gas markets offset by a slower automotive production environment due to the supply chain constraints affecting that market. Based on conversations with automotive customers, we believe that sales growth will resume in the latter part of the second half of the year as supply chain shortages are resolved and production schedules normalize. Second quarter adjusted segment EBITDA increased 165% over the prior year period to $13 million, and adjusted segment EBITDA margin expanded 790 basis points to 16.3%. A strong year-over-year increase in EBITDA and EBITDA margins was driven primarily by the brisk volume recovery from the pandemic low, partially offset by increased material costs. Excluding the favorable impact of point exchange translation and the impact of the bushing block business divestiture, adjusted EBITDA increased 155% compared to the prior year period. Now let's turn to the balance sheet and cash flow. We ended the quarter with cash of $262 million and full availability of our $400 million revolver, less $11 million in outstanding letters of credit. At the end of June, our net debt to adjusted EBITDA ratio was approximately 1.1 times, a sequential improvement from the 1.4 times reported at the end of the first quarter. Our balance sheet remains solid, and we have ample financial flexibility to execute our strategic growth initiatives. Free cash flow for the first six months of 2021 was $48 million, up from $25 million in the prior year, driven primarily by higher operating profits, offset partially by working capital investments supporting stronger sales. During the second quarter, we paid a 27 cent per share quarterly dividend. For the first six months of the year, dividend payments totaled $11.3 million, a 4.6% increase versus the prior year. Moving now to 2021 guidance, taking into consideration all the factors that we know at this time, including current order patterns, we are increasing our guidance for 2021 adjusted EBITDA to be in the range of $200 million to $210 million, up from our previous guidance of $190 million to $200 million. The updated adjusted EBITDA range is based on sales growth of 9% to 14%, over 2020 pro forma sales of $983 million, up from a previous range of 7% to 12% growth. We expect adjusted diluted earnings per share from continuing operations to be in the range of $5.16 to $5.50, up from the range of $4.74 to $5.08 provided last quarter. Our guidance assumes depreciation and amortization expense excluding amortization of acquisition-related intangible assets in the range of $30 million to $32 million, and net interest expense of $14 million to $16 million. Like each of you, we continue to monitor developments around COVID-19 and new variants, and we'll evaluate potential impacts of such developments on our business while focusing on the health and safety of our colleagues. Now I'll turn the call back to Eric for closing comments.

Thanks, Milt. Our second quarter results, again, demonstrate the benefits of our clear and consistent strategy, the sustained benefits of our portfolio reshaping actions, and our intention to continue investing in organic growth opportunities. We expect this momentum to continue as we focus on driving safety, commercial, and operational excellence throughout the company. With a strong financial foundation in place, I am confident that our experienced leadership team, diverse and dedicated workforce, and compelling, profitable businesses will lead to continued growth and increased shareholder value. I'm proud to be in a position to lead this organization forward, and I look forward to speaking with many of you over the coming months. Thank you, operator. We'll now open the line to questions.

At this time, we'll be conducting a question and answer session. If you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we poll for questions. Our first question today comes from Jeff Hammond of KeyBank Capital Markets. Please proceed with your questions. Hey, good morning, guys.

Good morning, Jeff. Good morning.

Hey, so the CEO change is certainly pretty abrupt, and I'm just wondering if there's anything you can expand on with respect to the change and, you know, what you think the timing is for a new CEO. And then just as a follow-on to that, you know, how you think the CEO change impacts any cadence in terms of, you know, M&A or other portfolio moves. Yeah.

Thanks, Jeff. Appreciate the question. As we... Outlined in the press release that you received this morning, the Board and Marvin reached a mutual agreement for him to step down as CEO. And I am very happy to say that the Board chose Eric to step in, who is well qualified to step in as the interim CEO. And in terms of process, the release also indicated that the Board has engaged nationally recognized executive search for search for firm to move forward with a search for our permanent CEO which will include Eric so internal candidates as well as external candidates and we don't know at this time how long that process might take but I would guess it would be you know within six months and in terms of strategy I can make that really clear the The agreement reached by the board and Marvin had nothing to do with our strategy or our financial results, and nothing changes. So we're on the same track that we articulated during our investor day and as we've articulated in our earnings calls over the past year. So I continue in our team. I know Eric joins me. We continue to be excited about our path ahead. We have made... some tremendous strides in our portfolio reshaping and our speed and our agility of execution, and all of that will continue under ERIC.

Okay, great. Just on AST margins, is there a way to quantify these startup costs and the FX transaction costs, you know, just impacting the margins and what the expectation is for those, you know, into 3Q, 4Q?

Yeah, that's another good question. First of all, let me start by saying that we are just every bit as excited about this business as we've ever been. I mean, the future of what's happening in the semiconductor market, especially where we're playing at LeanTech and the advanced nodes, is very bright, and we believe you know, will be so for quite some time. And the investments that we've made have resulted in some additional costs for the quarter. It's just a natural part of supporting that growth. So if you look at the two factors that I cited in my prepared remarks, the currency, the transactional, basically is... gives rise to a difference of currency rates between the time we book receivables and payables and collect or pay. So that's what we mean or what I mean by transactional cost. That was roughly $600,000 for the quarter year-over-year impact. And then if you look at startup costs, it was another probably roughly half a million dollars in total, so this is over a million dollar impact for the quarter. And we don't disclose specific sales on Lean Tech, but it probably goes without saying, given the models that I'm sure you have and the estimates that you have, that has a significant impact on the margin for that particular business in the quarter and had an impact on the overall AST margins. There was also a slight impact on a major customer that was going through the systems integration during the quarter that slowed up orders a bit in the last part of the quarter, and that will recover in the second half of the year. But once again, I will just end on the note that we remain very excited. We've got just an outstanding team that's running that business. The other impact I would cite on AST in the quarter, if you're looking at margins, we had strong growth in what we've called the legacy semiconductor business, the business that we owned and operated prior to acquiring LeanTech. We had very strong growth in that business in the quarter year over year. And there is a significant margin differential between that business and the advanced nodes business that we acquired through Lane Tech. That has an impact on mix for the quarter, which impacts the overall margins in the segment.

How should we think about margin trajectory into the second half with those moving pieces? Do some of those continue or go away?

We will start to fill up the capacity in the second half of the year in the new building in Taiwan. We will start to see, we will certainly see the recovery from the systems integration situation that I referenced earlier. We have been qualified on the three nanometers and So the timing on revenue for the balance of the year is going to be affected in part by what's the ramp-up rate for three nanometers and when does that begin. But that's a positive, whether it happens in the second half of this year fully or if it moves into next year. But that's a real positive for the business and part of the reason we're continuing to invest and expand our capacity. So that's a positive. And then overall, we've We would expect overall to be at 30% or so for the full year in the AST segments.

Okay, great. I'll get back to you. Thanks, guys.

The next question is from Steve Farazani of Sidoti & Company. Please proceed with your question.

Good morning, everyone. Obviously, very nice improvement on sailing technologies, both on revenue and margins. I'm trying to think about the margins despite clearly higher material costs and how much of that is straight volume versus other changes you've made in the segment and how to think about that given ongoing material cost growth over the rest of the year.

Thank you for the question. I expect our margins will continue to be excellent as we go forward. We've given some guidance in the investor day that we expect to remain around 25%, and I think that's appropriate going forward. There will be some adjustments along the way as we add more travel costs back to our sales team, et cetera. But overall, I expect them to continue. Our supply chain raw material prices are mostly impacted by steel, and we've been able to move those prices through. in ceiling technologies, mostly at STEMCO. So I expect us to continue to have outstanding results going forward.

Steve, I'll just add one other comment on ceiling. We just had outstanding leverage overall in the segment. If you look at it on normalized, so you normalize for all the year-over-year differences related to the divestitures in the segment year-over-year. Our operating leverage was about 40% year over year in the segment. And that's just a result of the outstanding work that Eric and the team are doing overall in the segment as we're looking for opportunities to become more efficient, operate the business through some shared service models. And so you're starting to see the benefit of that. Naturally, it was a really, really good year over year volume. And so the volume impact was noticeable. And as Eric said, we're still operating at fairly low travel costs carryover from last year. So we'll see some of those costs come back in, as Eric noted.

And then on engineered materials, still a nice quarter. You commented a little bit about the chip shortage and the potential impact on automotive. Just to clarify, did you see it in the quarter? on your sales to automotive customers and how you're thinking about that over the next couple of quarters, because it was still a very nice revenue quarter.

Yeah, yeah, you're right, Steve, and thanks for the question. It's sequentially, as I noted, our sales were down in automotive from Q1 to Q2, so we had a really, really strong bounce back in Q1. As you may remember, if you turn the clock back a year, the automotive industry essentially stopped in the latter part of the first quarter, and production came to a halt, an abrupt halt. So last year was a pretty tough year. We bounced back strongly in the first quarter, had an outstanding quarter. We had a good quarter in the second quarter, just that compared to Q1, which was an exceptionally Strongport, you know, we were down a bit in automotive. And part of that, you know, is a function of supply chain. And our team believes that we will see some of that correct in the latter part of the second half of this year. Don't know if we're going to see it in Q3 or whether it will be Q4.

Thanks, Milt. Thanks, Eric. Appreciate the time.

Yeah, thanks, Steve.

The next question is from Ian Savino of Oppenheimer. Please proceed with your question.

Great. Thank you very much. I wanted to get your sense or if you could tell me how maybe July paced, particularly in the international markets that may have been hit by the Delta variant first, maybe as a way that we could read through and what could maybe happen in the U.S. as well. Thanks.

Yeah, and good morning, Ian. As you know, we have a fair amount of European exposure, and most of it is in engineered materials, at least that's the largest concentration. And we have had, if you look at the year so far, we've had nice growth in our European sales. And right now, we're still operating We have figured out a cadence and a way to maintain, you know, the safety and health in our factories. And so we're continuing as we have been now for a number of quarters. In terms of third quarter, you know, it's not unusual for us to see, you know, all things being equal, some moderation in Q3 because of, in part, because of European holidays. And so, you know, when you look at... our guidance in the implied second half versus first half of the year, you'll see it modestly down and part of it reflects what we're expecting for Q3 as a result of the European exposure and the holiday season in Europe. I guess those would be some of my responses. We're not seeing any significant problems with the Delta variant in any of our factories in Europe, we're watching it and we're taking appropriate action. First and foremost, we're looking for the safety and health of our colleagues around the world and also while we take care of customers.

Okay, thanks. And then can you maybe then talk about pricing versus cost, maybe labor raw materials, you know, how quickly can that all be recouped? And, you know, is there an opportunity to get some market expansion above and beyond that? Thanks.

Yeah. Uh, yeah, thanks. That's something we're watching carefully. Uh, Eric mentioned we've had, uh, intentionally through our capability center, we've brought a closer collaboration between our commercial teams and our supply chain team so that we're moving quickly, uh, with pace as conditions change. And, uh, We have managed quite well in the first six months of the year. If you look at overall pricing versus cost increases, we've stayed above water. Now, I think the challenges become a little bit more significant in the second half of the year for us. However, we also have additional pricing programs that we're putting in place for the second half of the year. I'm going to let Eric provide a little bit more color from his experience, but I will tell you that where we see the most pricing pressure is in engineered materials and our heavy-duty truck business because of metals.

Yeah, we've done an outstanding job pushing pricing through to our customer base. In general, customers have been accepting of price increases as everything is going up due to labor shortage and material price increases. So it's common. It's being seen by everybody in the industry in general as acting as a whole. We had announced price increases July 1st, and the STEMCO business that have just went in will affect our second half of the year favorably. I continue to see surcharges, and we've been using them effectively as well to offset some of the freight charges that we get from containers, et cetera. So I expect that pricing impact will be consistent throughout the year. It should be. I don't think it's going to affect our results significantly.

All right, great. Thank you very much.

As a reminder, if you would like to ask a question, please press star 1 on your telephone keypad. Our next question is from Justin Bergner of Gab Alley Funds. Please proceed with your question.

Hi. Welcome aboard, Eric, into your new role. Hi, Mel.

Hi, Justin. Thank you.

With respect to advanced surface technologies, is it Are you able to comment in regards to the Alexa margins? Were they sort of more or less sequentially flat within the context of some of the other dynamics you described for the segment?

Well, I will say this. With regard to the Alexa business, we're right on track with our estimates for this business. At the time we made the acquisition, so things are you know, continue to move quite well and as expected. So the, you know, the business and the team are performing quite well, excited to be part of InPro. There are some kind of small synergies that are already taking place and working with the rest of the advanced service technologies team, particularly in the semiconductor market. And so we're, you know, we're very positive, continue to be very positive about the outlook for that business as we are a semiconductor business over the longer term. We think we could have some opportunities over time to continue to add to our optical filtration business through some other moves that we might make down the road. We plan to continue to invest in that business as we are a semiconductor business.

Okay, understood. With respect to, you know, you mentioned opportunities to add to that business. With respect to M&A, obviously sort of an unplanned development with the CEO transition, do you still feel that the organization can do material M&A in the coming quarters, or is it going to be more bolt-on just given the CEO search process?

Well, first of all, I would say absolutely. Our organization has the ability, capability, the readiness to move forward with additional acquisitions. Our board is fully supportive of that. So the change in CEO does not impact the board's views on our plan and support. So absolutely, if we find the right opportunity, whether it's a bolt-on or a larger move, we're continuing to go down the same path. So our M&A team... is active in vetting candidates that we're looking at on a regular basis, and that will continue. And we'll continue to be following our guidance that we've communicated in the past. We're looking for opportunities that are material science, technology-related, that have the type of margins that we defined at greater than 20% EBITDA margins, greater than 20% cash flow return on investment, and mid to high single-digit minimum organic sales growth. So that work continues. So no changes there.

That work is led by our M&A team, and integration is executed by the Capability Center through the divisions. So the entire team remains in place other than the CEO. And I may be new to NPRO to this role, but I've been in the NPRO now for 12 years and been part of the Executive Leadership Council for that entire time. So our strategy remains sound, and we remain ready to execute. I do not see any change.

Okay, great. Great, thank you. And then just one last quick one. The question of inflation came up. A lot of companies have struggled with freight inflation. Maybe you could just comment on that, how you're managing that, or the supplies that are coming in perhaps, you know, not turned around so quickly as to make it an issue for MPRO. Are you pricing that through?

Sure. We're able to move most of that through, especially container freight, through surcharges versus price increases. Our customers in general would prefer a surcharge if it doesn't hit the same place in their P&L. And as a result, they accept them more readily, and they also expect them to go down as freight charges go. The container freight has gone up dramatically, as you know, over the last several months, and will also adjust in the future. And so as it adjusts, we move the surcharges accordingly so it doesn't move their overall material price the way they look at their standard cost. So using surcharges, we can move as the market moves. We've been able to capture those freight increases.

Thank you. Best of luck, Eric.

Thank you.

There are no additional questions at this time. I would like to turn the call back to James Gentile for closing remarks.

Thank you for joining us this morning. Have a great day.

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