Enpro Inc.

Greetings and welcome to NPRO Industries' second quarter 2022 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. It is now my pleasure to introduce your host, James Chantilly, Vice President, Investor Relations. Thank you. You may begin.

Thanks, Doug. Good morning and welcome to Enpro's second quarter 2022 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 Valencourt, our President and Chief Executive Officer, and Milt Childress, Executive Vice President and Chief Financial Officer. 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 impacts from the 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, 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 these 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 note, 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, incremental impacts of inflation, geopolitical variables and trade tensions on market demand, and costs subsequent to the end of the second quarter. The impact of foreign exchange rate changes subsequent to the end of the second quarter, interest rate increases differing from assumptions outlined in guidance, impacts from the further spread of COVID-19 or other variants, and environmental and litigation charges. And now I will turn the call over to Eric.

Good morning, everyone. It's my pleasure to provide an update on our second quarter results and outlook for the balance of 2022. I would like to take the opportunity to thank our colleagues for their hard work as we are reporting an outstanding quarter in a challenging macroeconomic and geopolitical environment. Now on to our second quarter highlights. We delivered another strong quarter driven by continued organic growth and operating leverage across all three business segments. In the second quarter, sales of $333.3 million increased 11.6% year-over-year, with organic sales growth of 9.5%, about half of which was volume, another half price. Our reported revenue growth was driven by solid demand in most of our end markets, the benefits from our strategic pricing action, and the addition of NexEdge, which more than offset divestitures completed last year. With inflation at 40-year highs, we have been nimble in our pricing initiatives, which, in most cases, offset rising raw material costs and wage inflation during the second quarter. Hats off to our supply chain and commercial excellence teams for terrific execution in this difficult environment. We thank you for your hard work. Our second quarter adjusted EBITDA of $82 million increased 43.4% year-over-year, and we achieved a record adjusted EBITDA margin of 24.6%, a 540 basis point improvement from the prior year. Our margin expansion was driven primarily by the addition of NextEdge, divestiture of lower margin businesses, and operating leverage on organic growth, including strategic pricing initiatives. This is the second quarter in a row we have exceeded 20% adjusted EBITDA margins, the first in our history. Our strong momentum is a testament to the success of our transformation initiatives over the past several years. As you may remember, we finished 2019 with a 14% adjusted EBITDA margin. Three short years later, the midpoint of our increased guidance range implies an adjusted EBITDA margin in excess of 20% for 2022. We are proud of what we have achieved in reshaping our portfolio of businesses while solidifying our position as a leading edge industrial technology company. Our agile operating model has been a constant in our portfolio transformation, allowing us to continue to drive growth even in this challenging environment. A quick update on NextEdge, our most recent strategic acquisition. In the early going, NextEdge is more than meeting our expectations. as the teams are integrating seamlessly into the advanced surface technology segment. We are very pleased with the technological capabilities and process know-how NextEdge has brought to our customers and to our organization. Our strong results continue to reflect the sustainable benefits of our strategy as we lean into our best growth opportunities while maintaining cost efficiency and purpose throughout EnPro. We will continue to invest both organically and through strategic M&A in faster growing markets where we have competitive advantages while maintaining robust aftermarket and recurring revenue streams across our portfolio. Our performance and disciplined approach to capital allocation is translating into significant value for our Mpro stakeholders and we are confident that we are well positioned to build on this momentum. Now I will turn the call over to Milt for a deeper dive into our financial results for the second quarter. Milt?

Thanks, Eric. As Eric noted, our second quarter performance was robust, despite the persistent headwinds we and many others continue to face. As reported, second quarter sales of $333.3 million increased 11.6% year over year. Positive momentum in the semiconductor, power generation, aerospace, and food and pharma markets, as well as the contribution from NextEdge, more than offset the reduction in sales due to last year's divestitures, and softness in European automotive market. Organic sales for the quarter increased 9.5% compared to the second quarter of 2021 as a result of both volume increases and pricing initiatives. Adjusted EBITDA of $82 million increased 43.4% over the prior year period, driven primarily by the addition of NextEdge and organic growth, including the impact of pricing initiatives, partially offset by the impact of divestitures completed in 2021 inflationary raw material costs, and rising labor and travel expenses. In addition, adjusted EBITDA in the second quarter was positively impacted by a $2.8 million foreign exchange benefit from revaluation gains primarily on foreign cash balances due to a strengthening dollar and a $2.5 million reduction in incentive compensation accruals due mainly to the share price decline experienced during the second quarter. Year-to-date, revaluation gains from the stronger U.S. dollar totaled $4.5 million, and share price-related incentive compensation reversals equaled $3 million. Second quarter adjusted EBITDA margin of 24.6% expanded 540 basis points year-over-year, excluding the impact of foreign exchange translation and currency-related revaluation of foreign cash balances and the share price-driven incentive accrual changes in both periods, adjusted EBITDA margin expanded 370 basis points over prior year. Corporate expenses of $9.5 million in the second quarter decreased from $12.8 million a year ago, driven primarily by the reduction in share price-related incentive compensation accruals that are discovered. Adjusted diluted earnings per share of $2.32 increased 49% compared to the prior year period, driven by growth in operating earnings, offset in part by higher interest expenses compared to last year. Moving to the discussion of segment performance, ceiling technology sales of $155.9 million decreased 4.1% versus the second quarter of last year as a result of the vestiture of polymer components business completed in September 2021. Organic sales grew 6.3% year-over-year. Strategic pricing initiatives and strong demand and power generation through the farm and aerospace markets were the primary drivers of our quarterly performance in the segment. Adjusted segment EBITDA of $42.5 million was essentially flat compared to the prior year period due to the divestiture of the polymer components business. Excluding the divestiture and foreign exchange translation, adjusted segment EBITDA increased 10%. Adjusted segment EBITDA margin expanded 120 basis points to 27.3%, driven by the investor impact and by leverage on organic growth, including strategic pricing that more than offset inflationary pressures on raw material and labor costs. Turning now to advanced surface technologies, second quarter sales of $121.5 million more than doubled from the prior year. driven by the acquisition of NextEdge and continued strong demand in the semiconductor market. Organic sales increased 19.1% versus the prior year period. Adjusted segment EBITDA increased more than 140% to $37.8 million compared to the second quarter of last year, driven primarily by the NextEdge acquisition and strong organic sales growth. Excluding the impact of NextEdge and foreign exchange translation, Adjusted segment EBITDA increased 33.3%, reflecting strong operating leverage and an improved mix compared to a year ago. Our growth investments supporting semiconductor supply chain development in the United States continue, as we've discussed on previous calls, and we are encouraged by the long-term growth picture in our advanced surface technology segment. In engineered materials, Second quarter sales of $56.5 million decreased 29.4% compared to the prior year, resulting from the CPI divestiture completed in December 2021. Organic sales for the quarter increased 7.6%, driven by strength in aerospace, oil and gas, and domestic automotive markets, which more than offset weakness in the European automotive market and COVID-related lockdowns in China. Second quarter adjusted segment EBITDA decreased 26.9% over the prior year period as a result of the CPI divestiture. Excluding the impact of the divestiture and foreign exchange translation, adjusted EBITDA increased 13.6% compared to the prior year, reflecting organic sales growth, including pricing initiatives and cost management. Turning to the balance sheet and cash flow, In the first half of the year, we reduced borrowings by $136 million, finishing the second quarter with $991 million in total debt in cash of $222 million. During the second quarter, we repatriated a total of $76 million in cash, bringing our year-to-date total repatriation to $119 million. We expect to repatriate another $100 million by year-end. At June 30, we had $294 million available for borrowing under our evolving credit facility. Our balance sheet remains in a healthy position, and we have ample financial flexibility to execute against our strategic growth initiatives. Free cash flow for the first six months of 2022 was $59 million, up from $48 million in the prior year, driven primarily by high operating profits and lower capital expenditures. During the second quarter, we paid a $0.28 per share quarterly dividend. For the first six months of the year, cash for dividend payments totaled $11.7 million. Moving now to our 2022 guidance, taking into consideration all the factors that we know at this time, including current underlying demand and order patterns, we now expect low to mid double-digit revenue growth over our reported 2021 sales of $1.14 billion. We are raising our adjusted EBITDA guidance to a range of $270 million to $280 million, up from our previous guidance of $263 million to $275 million. Further, reflecting the increase in our adjusted EBITDA outlook, we now expect adjusted diluted earnings per share from continuing operations to be in the range of $6.80 to $7.30 using a normalized 27% tax rate. As noted in my earlier remarks, our strong first half adjusted EBITDA benefited from currency-related revaluation on foreign cash balances and accrual reductions related to the share price decline. Excluding these impacts, We forecast adjusted EBITDA to be modestly lower in the second half compared to the first half, reflecting ongoing supply chain constraints, normal third quarter seasonality largely in our European exposed businesses, and currency translation headwinds. Overall, we are very pleased with our performance and encouraged by the outlook in this uncertain environment as backlog and order patterns remain constructive. Now I'll turn the call back to Eric for closing comments.

Thanks, Milt. Our performance demonstrates our team's ability to successfully execute on our strategic, financial, commercial, and operational objectives. We are focused on building upon our differentiated and high-performance culture to deliver results in any environment. We are committed to fostering a workplace that supports both physical and mental health and safety of our team so they can do what they do best, offer customers mission-critical, leading-edge products and solutions that safeguard critical environments and improve processes in a variety of secular growth markets. Our team's performance is rooted not only in our operating model, but in our culture that revolves around our values of safety, excellence, respect, and our commitment to sustainability and diversity. I am proud of how colleagues across our organization embrace our cultures and values and prioritize our business performance alongside personal and professional development. By doing so, they are creating value for Enpro stakeholders, including our shareholders, customers, and communities. We greatly appreciate your interest in Enpro. Our company is positioned well to execute even in uncertain markets. Now I'll open the line to questions.

Thank you. Ladies and gentlemen, at this time, we will be conducting a question and answer session. If you'd like to ask your question, you may 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 key. Our first question comes from the line of Jeff Hammond with KeyBank Capital. Please proceed with your question.

Hey, good morning, guys. Good morning, Jeff. Just any aberrations in the ceiling margin? You know, obviously very good performance. Is that really just, you know, truck pricing coming through and the timing there? Or maybe just elaborate? Thanks.

Go ahead. I'll provide some comments and then turn it over to Eric to talk a little bit about trucking. Jeff, a big driver for us in the corridor was... The results we saw in power generation and aerospace, it's in our high metallic ceiling part of ceiling technologies. We had significant organic growth, volume growth. That business has been firing on all cylinders. So that was the primary driver. I mean, there were other drivers, but when we look at margin expansion for the segment, that was a big part of it.

Jeff, it's overall good performance throughout the whole ceiling segment. And in trucking, we talked about in the past, there were some headwinds, and it took us a while to catch up to price. And I think we've caught up to price now, and so you're seeing the impact of that flow through the system. And also some of the backlog has been shifted to have the old pricing in place, so you're seeing more leverage there.

Okay, great. And then, you know, clearly very good results in advanced surface technology, but Just on semiconductor, you know, worries about, you know, pockets of slowing, just, you know, any impact from, you know, CapEx timing with key customers. And then maybe just give us a better sense of kind of, you know, either your customers or your exposure to, you know, consumer electronics, which seems to be, you know, maybe more at risk versus kind of the high performance compute and auto industrial, which seems more resilient.

In general, we're more exposed to the, not the memory side, to the logic side, Jeff. So we don't have as much exposure to the personal computer business. Also, it's important to keep in mind that basically 50% of our portfolio is recurring revenue. We call it aftermarket or service business, if you will, from the cleaning, coating, and refurbishment part. So it's not tied to the capital expenditure in a direct way. So we expect our results to continue to be okay.

Feedback we're getting from customers is still generally constructive. There always are timing differences from quarter to quarter based a lot on supply chain other than us because the supply chain of other suppliers to big semi-companies affect our overall shipment dates with customers as well.

In general, they move things out a little bit just because of supply chain. But they haven't canceled. There aren't many cancellations. Our backlogs are still really strong. It's still growing.

Okay. And then just, you know, again, I mean, great performance in what's becoming maybe a more mixed macro picture. Any cracks you're seeing, you know, across the businesses that maybe, you know, we can't see in the overall results? Thanks. Thanks.

I'm not sure I would call it a crack, Jeff. The one thing that we've seen is because the refineries are running full out, they're not doing as many turnarounds. We're seeing that at Scarlock. There were several turnarounds postponed in the first quarter. So later in the year, I don't know if they'll happen later in the year because they're still running full speed, if you will. But that's a good news, bad news scenario for us. The good news is they still have to do maintenance and it's more expensive when they do it. If you don't do the planned maintenance, you do more expensive maintenance later. And so I expect some of that maintenance will get moved into the third quarter, but we've already, or into the first quarter of next year. That's also in our forecast. So I don't see it having any material impact.

Yeah, I don't really have anything to add other than macro events. You know, we're watching you know, gas supply coming out of Russia, how that impacts the European economy. You know, we have those factors that we and other companies do.

Okay. Great. Thanks, guys.

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

Hi, Greg. Thank you very much. You know, on the guidance, can you guys just tell us how much is, or what your assumptions are for the FX impact, or maybe what the constant currency growth rate might be? Thanks.

You want to take that today, James? Yeah, sorry.

Melt is not feeling well at the moment. So, When we think about the foreign exchange translation, our forecast is based on where the US dollar has strengthened up until July. What we would expect from a constant currency perspective is that we generally exclude translation impacts in our top line forecast overall, but there will be a headwind in the back half. Assuming July rates hold, included in our forecast, probably hit us from an adjusted EBITDA perspective by about a million dollars.

And Ian, I'll jump back in now. That's translation. So we're expecting an incremental roughly, if June 30 rates hold, roughly a million dollar headwind on translation compared to the first half of the year. We also, on the transaction side, we highlighted the revaluation of foreign cash that gave us a tailwind in the first half of the year. Since we don't predict currency changes, we're assuming that that's neutral, basically, for the balance of the year. And so that was a benefit, as we mentioned in the first half, by about $4.5 million. So when you think about currency and you think about H1 versus H2, you have to think about both of those components.

Okay, perfect. And then just sticking on international, in Europe, can you just maybe give us kind of a flavor of what you're seeing there, maybe some of the better businesses and then maybe some of the other businesses that have been impacted more just given kind of Russia and Ukraine and the geopolitical landscape there. Thanks.

Our biggest European exposure resides in engineered materials by GGB. And we have seen some volatility in the European auto market, which does contribute a bit to GDB's profitability in the second half, which is included in our forecast. Other than that, the smaller European exposure is largely in ceiling technologies. and also, you know, via Garlok and Technetix remain quite strong.

Okay. This is a great color. Thank you, guys.

Our next question comes from the line of Steve Ferrazani with Sudoti. Please proceed with your question.

Good morning, everyone. wanted to ask about performance and engineered materials because obviously you had the impact from from the slower european automotive production and even domestic hasn't been the expectation would be a significant ramp into the second half hopefully and certainly into 2023 and then on aerospace getting better but potentially getting a lot better given the leverage you have in that business how are you thinking and i know first half is typically better than second half but Despite the European headwinds, how are you thinking about that segment into the second half and then beyond?

Yeah, we do have the most put out seasonality, Steve. We noted that earlier. And the first half of the year has been relatively strong because our domestic auto, a lot smaller than our European auto, helped offset some of the weakness that we saw in Europe. in the automotive industry, so we're encouraged by that. It seems that some of the supply chain issues are starting to loosen up a little bit, particularly we're seeing it once again in the domestic auto part of our business. Aerospace is relatively small in this segment. It's more significant in the ceiling segment, but it does make a difference, and we are seeing growth in aerospace and engineer that led to our strong results in the first half of the year. So yeah, but we do have seasonality and we expect to see it again this year as we typically do with European holidays being pretty heavy in the third quarter. We usually see a dip in the third quarter in our European exposed businesses.

When I think about the strength you're seeing in AST and then when you talked about the next edge acquisition last year, you talked about the benefits given the significant expected investment in the U.S. chip industry. After months, we finally saw the chip bill move forward. How positive are you and how much is that going to translate, not near term, but over the longer term for the growth in that business? Now that we see clear signs, we're going to get that big investment in the U.S. chip market.

we certainly are hopeful to get a piece of that at some point with the chips act and we certainly play in that supply chain we're going to continue to make investment and the investment in the u.s is certainly going to help us dramatically over time but it's still a couple years away you're a year and a half away not immediate no of course um when i think about the balance sheet which is continuing to improve you're generating a ton of cash

What's your appetite for acquisitions? Obviously you're still working through Next Edge, but what's the pipeline look like and what are you seeing out there and what's your appetite right now?

We have a very active pipeline and we are certainly hopeful and working diligently at it every day to find ways to add value. And so we will take advantage of opportunities that are strategic as they come about. But at the same time, we're comfortable where we are. We don't feel any pressure to actually be disciplined in our approach.

Yeah, and just to highlight what we've already said several times on the call that in our existing portfolio with the moves that we've made, we thought we have seen the fit-up side, particularly in our AST segment on the growth end.

Great. Thanks, Eric. Thanks, Milt. Appreciate it.

If there are no further questions, I'd like to hand the call back over to Mr. Gentile for closing remarks.

Thank you for your interest this morning and have a great day.

Ladies and gentlemen, this does conclude today's teleconference. Thank you for your participation. You may disconnect your lines at this time and have a wonderful day.