Enpro Inc.

Macro forces including AI and the Internet of Things. As chip architectures evolve, complexity is increasing. More processing steps are needed to manufacture each new generation of chips, and increasingly sophisticated tools are required to complete these steps. With enhanced complexity, process yield deficiencies, contamination control, and lifecycle management of critical in-chamber tools become even more critical. Our semiconductor business sits squarely in the middle of these trends, and we are well positioned to participate in the industry's growth. To meet this opportunity, we are investing to maintain and expand our technological differentiation and to position our businesses in regions where above growth is expected. Above average growth is expected. We are excited to partner with our customers to drive the industry forward, including supporting the production of leading edge chips. This strategic focus paired with our customers, with our deep customers' relationship positions EnPro for sustainable long-term profitable growth. Now I'll hand the call over to Milt to discuss our financial results in more detail.

Thanks, Eric. Reported sales of $250.7 million in the third quarter were down 10.5% year-over-year. The decline in sales is primarily due to weakness in semiconductor markets. partially offset by growth in other markets along with a positive contribution from price. Adjusted EBITDA of $57.7 million decreased around 19% over the prior year period, while adjusted EBITDA margins in the third quarter were a still healthy 23%. Corporate expenses of $9.4 million increased slightly from $9.1 million in the third quarter of last year. Increased professional fees and personnel-related costs were largely offset by reduction in incentive compensation expenses. Adjusted to legit earnings per share of $1.58 decreased 16.4% compared to the prior year period. Lower AST segment results were the primary driver of the decline, offset in part by higher interest income. Moving to a discussion of segment performance, Sealing technology sales of $161.4 million increased 1.4% organically, driven by strong demand in nuclear and commercial vehicle aftermarket, along with a positive impact from pricing. Growth in these markets was mostly offset by a drop in commercial vehicle OEM sales, destocking in food and pharma, and some weakness in general industrial, particularly in Europe and China. For the third quarter, adjusted segment EBITDA $48 million increased 20.9%. Adjusted segment EBITDA margin expanded 460 basis points to just under 30%. Favorable mix driven by continued strength in nuclear and commercial vehicle aftermarket sales, the positive impact of pricing actions and cost controls more than offset rising labor costs and softness in certain markets just referenced. Year to date, adjusted segment EBITDA margins were 30.1%, up from 25.3% in the prior year. In addition to favorable mix in pricing, ongoing strategic and operational improvements continue to benefit our results. Turning now to advanced surface technologies, third quarter sales of $89.4 million decreased 27%, driven by the current slowdown in semiconductor markets and related customer inventory adjustments. For the quarter, adjusted segment EBITDA decreased a little over 50% to $19 million, driven by the decline in volume and unfavorable mix. Third quarter results were also impacted to a lesser degree by investments to support growth, including the build out of our facility in Arizona to expand our domestic advanced cleaning and coating capabilities. A brief update on our participation in the U.S. semiconductor expansion. We continue to update on a staged basis the building that we purchased in Arizona. As mentioned previously, we are seeking CHIPS Act support to help us transform this building into an advanced semiconductor facility on an expedited basis. We expect to use this facility to support the production of advanced node semiconductors at new fabs being constructed in Arizona. For the third quarter, adjusted segment EBITDA margin of 21.3% reflects unfavorable mix and the deleveraging impact of lower volume. Even with this year's decline in the semiconductor market, year-to-date adjusted segment EBITDA margins exceeded 24%. As Eric discussed, we continue to be excited about the multi-year trajectory of our AST segment against the backdrop of a widely expected doubling in the industry over the coming decade. Turning to the balance sheet and cash flow, we have ample financial flexibility to execute on our long-term strategic growth initiatives. We ended the quarter with a net leverage ratio of 1.4 times. Cash and cash equivalents were nearly $330 million, and we had nearly full availability under our $400 million revolving credit facility. During the third quarter, we reduced term debt by approximately $140 million, bringing our total long-term debt to around $650 million. We continue to generate strong free cash flow. For the first nine months of 2023, free cash flow exceeded $134 million, up from $101 million in the same period a year ago. Our focus on the cash conversion cycle throughout the organization and lower cash taxes paid in the period more than offset higher capital spending. During the third quarter, we paid a $0.29 per share quarterly dividend, and for the first nine months of the year, dividend payments totaled $18.3 million. Moving now to our 2023 guidance, we continue to expect revenue to remain relatively flat compared to last year. Adjusted EBITDA and adjusted diluted earnings per share are now expected to be toward the lower end of our previous guidance ranges of $248 to $256 million for adjusted EBITDA and $6.70 to $7.10 for adjusted diluted earnings per share. In ceiling, we expect continued strong results but lower sequentially in the fourth quarter given slowing demand in certain markets mentioned earlier. and typical seasonality returning in certain parts of the segment. In AST, based on current orders and production schedules, we expect higher results sequentially in the fourth quarter. Thanks for your time today, and I'll turn the call back to Eric.

Thank you, Milt. Our 3,500 colleagues across ENPRO continue to execute very well and are energized to win. Our teams have navigated exceptionally well for a variety of market cycles in the past, and today is no different. Our long-term strategic and financial plans remain unchanged. And day after day, we deliver differentiated products and solutions for our customers across several growing end markets. The ceiling segment's performance has been remarkable, and our teams deserve praise for delivering best-in-class profitability while producing highly engineered solutions that enable safe, sustainable, and reliable operations for our customers. In AST, despite a challenging year, we are a critical part of the global semiconductor ecosystem and continue to invest in a variety of growth opportunities. Our long-term growth trajectory remains intact, and we are focused on capitalizing on the investments we have made and will continue to make throughout AST. Thank you for joining us today. We appreciate your interest in ENVRO. Now I'll open the line to questions.

Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star two 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 your questions. Our first questions come from the line of Jeff Hammond with KeyBank Capital Markets. Please proceed with your questions.

Hey, good morning, everyone.

Morning, Jeff.

Morning, Jeff. Morning, Jeff. So just on AST, I guess maybe a better sense of what the shape looks like into 4Q, and then just how maybe you're thinking about the timing of recovery and flexion. I think you said weakness into 24, so it seems like maybe that's pushing out a little bit.

Jeff, let me jump in. Eric and I will just go back and forth on this one. As I indicated in my prepared remarks, based on current orders and schedules, we're expecting some sequential improvement in semiconductor markets in Q4. The outlook remains uncertain. And as you know, there has been pushing out in the industry, not just for us, but you've heard it from other companies as well, as the year has progressed. And in the third quarter, we saw some additional pushing out just based on inventory in the system. So we're expecting this progression and some improvement in the fourth quarter, and then we'll need to see what the year brings. We do think things are pushed out to the right. It's gonna be uncertain for a quarter or two, we'll see.

I think the key word is just uncertain, Jeff. When you talk to customers, the inventory stocking has been taking longer than we thought and longer than they anticipated. So things just continue to seem to move to the right a little bit. But at the same time, the long-term risk prospects haven't changed. When you look at what's going to happen over the next decade, we're still looking at doubling in the industry and we're still positioned extremely well. Between the on-shoring, the North American focus, and the leading edge nodes, our businesses overall are performing very well and we're still excited about the future. Our customers are working with us to make sure that we're ready for the recovery. The concern recently has switched, are we ready when things change? And so making sure that even though we've adjusted cost here or there, that we're positioned to grow quickly as this thing rebounds. And so that's where spending a lot of time with customers now is how quickly can you ramp up?

Okay, very helpful. And then just on ceiling, maybe just Update us on, you know, kind of this margin resiliency, even as you get, you know, maybe some seasonal step down in 4Q. And then just expand on general industrials. Is that destocking or is that real demand weakness? And I guess last and ceiling, you know, how long do you think this food pharma destock takes?

I'll take that first. The food and pharma destocking we think will continue into 24. But we don't have much more visibility than that. If you look at our margins, I expect them to hold pretty tight. There's a few things happening. So when you look at the FTR, which I always look at as a leading indicator of freight ton miles, ton miles are relatively flat according to the latest projection. I think it's down a couple, less than a few tenths of a point this year and up a few tenths of a point next year or something like that. But plus or minus one, so I'll call that flat. And so when you look at that, our aftermarket business should perform very well at STEMCO and it is. Our OEM business, when you look at that, trucking or trailer builds is projected to be down double digits. But it also improves our mix and our margin profile. Lastly, we'll get some price increases, we always do. We'll have some January 1st price increases that'll be strategic and let's say surgical. And then in addition to that, the supply chain is really in balance now from my point of view in ceiling, and we're starting to see more cost downs in the supply chain. So our prices in some commodities have dropped, and so we're picking up some margin there as well. We don't intend to give most of that price back. So overall, I expect our margins to remain robust and ceiling.

Okay, thanks, guys.

Thank you. Our next questions come from the line of Steve Farazani with Sedoti & Company. Please proceed with your question.

Good morning, everyone. I appreciate all the detail on the call this morning. I wanted to ask a little bit about AST margins, which now are declining some more. And you noted that weakness has extended. It also sounded like you made some comments about you'd look at some further cost cuts. I know you took pretty substantial ones beginning of the year. So the question is, are we bumping along? Is your expectation that we're bumping along the bottom of AST margins? Are there any meaningful cost cuts you can make knowing that the outlook is the timing of the recovery now is uncertain, so maybe it comes back faster?

Well, Steve, what I would comment is what you saw in the third quarter when you look at AST margins, when you lose the kind of year-over-year volume drop that we had, most of that is just deleveraging. And we took some additional actions, but it's I'll use the word surgical because we want to be prepared for the uptick when it comes. And as Eric said, the conversations with customers have really moved from uncertainty to we need to be prepared. Even though they're still in a certain environment, we need to be prepared for the uptick. And so those conversations are very constructive. So now really what we need in the business is volume. And also we've had some unfavorable mix as we've talked about throughout the year as a result of some of the more severe drops in volume we've had than in areas where we've had very strong profitable margins for certain product lines. And some of that is tied to the big drop in memory as we've So that will change, that will rebound, and the volume will come back, and we will leverage on the upside as much as we've deleveraged on the downside. And our focus is really, yeah, we're doing what we need to do in this environment, but our focus is really on the excitement about the long term. And we continue to feel, and the long term is not five years out, the long term is, you know, We expect to see some uptick in 2024 based on conversations with customers. Just uncertain of when we're going to see the start of that.

Some customers have started to talk about memory showing a little bit of life as well recently. So that would be exciting if that actually happens.

And then flipping, you addressed this a little bit, on the ceiling margins where you would also have expected to see some deleveraging. But I'm assuming it's getting more than offset by price. Is that a fair way to look at this? that your volume is down year over year more than offset by price, giving you that little bit of revenue uptick?

Our volume is off, but our back loads have returned to more what I'll call traditional levels. Still robust for us, and so we're still able to have operational efficiencies. And I do think it's fair to say we've captured more price. But overall, our volume is still pretty strong in ceiling historically.

Okay, and then you think about, obviously, you're starting to see that weakness in heavy truck, commercial truck, OEM, but that would typically be lower margin, right? So based on trends, your mix should be better entering 2024, and you get more pricing, right? So even if volume doesn't come back substantially in other areas, you still get some margin as long as volume holds up, right?

Yeah, that's absolutely correct. and we could see it in this quarter's results as well.

Steve, you know this, but I'll just remind you. As you know, our commercial vehicle business is much more heavily weighted toward aftermarket than it is on OEM.

Just another thought on the volume declines. As we exited the supply chain situation as a result of COVID, it seems like some of the industrial distributors are removing kind of that crust of safety stock. And that's just the normal course. So as you look forward, there are definitely some opportunities for mix and growth in the future. Great.

And just get one last one in on obviously a very strong cash flow quarter, good strong receivables collection. Meaningful debt reduction this year. What are you thinking about? The cash is growing. Your net debt's way down. How are you thinking about capital allocation at this point? Any shift in priorities?

No shift currently. We continue to have a focus first on investing in our business for growth, whether it's organic investments such as the investment we're making in the new facility in Arizona or selective acquisitions that meet our strategic and financial criteria. We continue to look at a lot of opportunities. We're very, I'll use the word, picky. We're not interested in making acquisitions just for the sake of growth and acquisitions, We do continually look at opportunities, and the pipeline is actually quite good, and we're trying to find the right fit for us. I think, as we've mentioned last quarter, we're spending more time in the ceiling segment and looking at opportunities that fit with us there and can advance our strategy going forward than we are with AST, where we have a you know, strong organic path ahead.

Thanks, Milt. Thanks, Eric, James.

Thank you. As a reminder, if you would like to ask a question, please press star 1 on your telephone keypad. Our next questions come from the line of Ian Safina with Oppenheimer. Please proceed with your question.

Hi, Greg. You know, just a couple of clarification questions. On the destocking, I know you mentioned food and pharma. Is there any other anticipated destocking that you might see across any of your other ceilings industries or end markets that we should expect?

In ceiling? No. I think right now we're back to seasonal demand and normal cycles. I do think one thing is different. Since COVID, we had elevated backlogs due to supply chain constraints. And I do think the supply chain is in balance. And so I think that part is cleared up. And when James talked earlier about taking out extra safety stocks, I think our distributors have returned to more normal inventory levels instead of increased safety stock. So overall, I think things are in balance. But I don't see any more destocking other than food and pharma.

OK. And then can you maybe give us an idea of what the pricing actions were versus volume actions?

When you look at the ceiling, you're referring specifically to the ceiling segment again?

Exactly, yes.

Yeah. It's mostly, if you look at the organic growth, it's going to be more heavily weighted toward pricing on a year-to-year basis than volume growth, just kind of where we are in the cycle, and then some of the seasonal or typical seasonal patterns that Eric referred to. We had volume growth in certain markets like nuclear and aerospace and space. And then we had some volume declines in general industrial because of slowdown in Europe and China. So the patterns were different depending on the market. So there are certainly pockets of growth. But overall, when you look at the year-over-year growth for the segment, it was more heavily weighted toward pricing.

Okay. And then just a final one. On the mix at AST, I know you mentioned memory weakness. Can you maybe give us an idea of what's been relatively strong versus memory and then also, you know, how did aftermarket versus, you know, the OE business do? Thanks.

In AST, I'll take the last question first. In AST, we've said in the past, and this is rough because it changes quarter to quarter, year to year a little bit, but we're roughly a third of our semiconductor business is driven by recurring revenues, and recurring meaning products, solutions that are driven by the production of chips where chamber components need to be refurbished or cleaned or recoded. And so that's what we mean by recurring. And then roughly the remaining two-thirds is driven more by new equipment that's being sold to the foundries and the IDMs to support growth. And so, yeah, on the recurring part of our business, given where we're positioned, a lot of that we are in advanced nodes. And so that part of our business is performing well. We're seeing some year-over-year growth there. The weakness has been more on the equipment side of the business, given the inventory situation that we alluded to earlier.

You captured it nicely.

Okay. Thank you very much.

Thank you. Our next questions come from the line of Jeff Hammond with KeyBank Capital Markets. Please proceed with your questions.

Hey, guys. Just a couple of follow-ups. One, you know, you guys have mentioned in the past wins, but I think you're reticent to kind of give an update there. But just within AST kind of qualitatively, what are you seeing from, you know, kind of new customers, breadth with current customers as you kind of roll out, you know, kind of this combination of Next Edge Lean Tech and, you know, just some of the opportunities as you think about, you know, Chips Act and the recovery.

I spoke a few quarters about our – and probably got myself a little bit of trouble about our pipeline. But I'll say – I won't quantify it, but I will say this. Our pipeline continues to grow. It continues to be exciting, and it continues to be more and more vertically integrated. So when you look at the new opportunities coming in, our customers are recognizing the value of what our vertical integration play can be, and they're excited about those opportunities. So our pipeline is very heavily weighted to vertical integration opportunities. I don't want to quantify it, but it's substantial. And it increases there monthly. So the number and size of our opportunities continues to grow, and our pipeline continues to grow. and we are holding our win rate.

Okay, and then just any update on, you know, Milt, we love having you around, but any update on kind of the CFO search?

I'll defer to Eric on that question.

We remain active and very selective, much like our acquisition strategy. We're looking for, we're being very disciplined in the search to find somebody that's going to perform equally as well as Milt and be as valuable as Milt is to the company. So we're excited about it and we continue to be in the process, but there isn't any immediate update.

Okay. Thanks so much, guys.

Thank you. We have reached the end of our question and answer session. I would now like to turn the floor back over to James Gentile for closing comments.

Have a great day, everyone. Thank you for your interest.

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.