Enpro Inc.

Greetings and welcome to the EnPro Q3 2024 earnings conference call. At this time, all participants are in a listen-only mode. A brief question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star and then zero on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, James Genterly. Thank you. You may begin.

Thanks Irene and good morning everyone. Welcome to EnPro's Q3 2024 earnings conference call. I will remind you that our call is being webcast at EnPro.com where you can find the presentation that accompanies this call. With me today is Eric Vallencourt, our President and Chief Executive Officer, and Joe Brederick, Executive Vice President and Chief Financial Officer. During today's call, we will reference a number of non-GAAP financial measures. Tables reconciling the 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. Also note, during this call, we will be providing full-year 2024 guidance, which excludes unforeseen impacts from these risks and uncertainties. We do not undertake any obligation to update these forward-looking statements. It is now my pleasure to turn the call over to Eric Vallencourt, our President and Chief Executive Officer.

Eric? Thanks, James, and good morning, everyone. Thank you for joining us today as we review our third quarter results and updated outlook for the balance of 2024. Third quarter sales were up year over year and up slightly organically. Despite persistent softness in more than half of our served markets, aftermarket or recurring revenue solutions comprise 54% of our revenue -to-date, which provides underlying stability to our portfolio and enables us to perform well on a variety of demand environments. Our results have been quite good, even in the face of demand headwinds in certain large served markets. Overall, consolidated adjusted EBITDA margin was a healthy 24.6%, demonstrating the inherent strength and balance in the Enpro portfolio. Our teams are motivated and working hard, excited by our vision and our strategy for long-term growth. Our long-term vision is for revenue growth in the ceiling technology segment to be in the -single-digit range and AST to grow in the -single-digit range. Both segments have demonstrated the ability to generate 30% adjusted EBITDA margins, plus or minus 250 basis points, depending on the macroeconomic environment and mix. We plan on achieving this consistently by investing in a number of areas where we are strongest while implementing our continuous improvement playbook to optimize our performance over time. We would like to thank our colleagues across the company for their commitment to our core values of safety, excellence and respect while remaining motivated and agile as we provide critically important solutions to our customers. Now on to our third quarter performance. After my review, I will turn the call over to Joe for a more detailed discussion of our results and a revised outlook for the balance of the year. Operating performance in the ceiling technology segment was solid in the third quarter, with .5% sales growth and consistent profitability despite steep declines in commercial vehicle OEM sales. At AST, while we delivered a 5% sequential improvement in sales, profitability was flat, both year over year and sequentially. We continue to see areas of strength, particularly in our precision cleaning solutions tied to advanced chip production. Demand, however, continues to be choppy for the remainder of the semiconductor business, which has broad exposure to the semiconductor capital equipment spending. In ceiling technologies, adjusted segment EBITDA margins expand at 300 basis points to 32.7%. Continuous improvement initiatives, effective supply chain management and favorable mix contributed to another strong quarterly result. As a reminder, our continued positive momentum and profitability in ceiling technologies reflects the underlying strength of this segment. We have created a firm foundation for profitable growth by focusing on applied engineering differentiation, compelling aftermarket characteristics, incremental investment in organic growth and a strong continuous improvement culture. Additionally, we continue to pursue strategic opportunities in adjacent markets that built upon our core competencies in safeguarding critical environments. Our outlook for this segment remains positive. In the advanced surface technologies segment, revenue improved .5% year over year and 5% sequentially. Adjusted segment EBITDA margin, however, narrowed both year over year and sequentially, driven mainly by a shifting demand profiles for waiver fab equipment. Strategic growth investments, especially for precision cleaning solutions and operational improvement initiatives proceed as we continue to position AST for long term growth. We are beginning to lap year over year AST sales, but see a more protracted recovery than we previously expected. We continue to see strength in areas tied to advanced node chip production. Orders for equipment concerning key solutions such as coding were choppier than we expected as the third quarter progressed. Overall, capacity utilization remains low across the industry, currently resulting in slow semiconductor capital equipment spending. Long term, we are focused on executing our multi-year strategy to drive AST's growth in attractive markets while building differentiated capabilities and efficiency improvements that showcase our technological and process advantages and provide our customers with essential value in the semiconductor supply chain. Our balance sheet remains in excellent shape. Our free cash flow generation and strong underlying returns on investment enable us to pursue a variety of growth opportunities, both organically and through strategic acquisitions. We are adjusting our outlook to reflect the slower finish to 2024 than previously expected. Our strong execution and disciplined capital allocation will continue as we drive our value creating strategy forward.

Joe? Thank you, Eric, and good morning, everyone. Let's now go into the details of our third quarter performance. In the third quarter, sales of $260.9 million increased 4% compared to the prior year, with organic sales up slightly. We saw strong ceiling technologies performance overall and year over year sales growth at AST, despite steep declines in commercial vehicle OEM and slow capital equipment sales in portions of our semiconductor business. Third quarter adjusted EBITDA of $64.1 million increased 11% compared to the prior year period. Adjusted EBITDA margin of .6% expanded 160 basis points driven by strong performance and ceiling technologies. Growth initiatives on new products and investments in our differentiated capabilities continued, along with ongoing continuous improvement discipline and supply chain efficiency. Corporate expense of $10.3 million in the third quarter of 2024 increased from $9.8 million a year ago. The increase was primarily due to an increase in share price based incentive compensation expense, partially offset by lower current year annual incentive compensation accruals and lower professional expenses. Adjusted diluted earnings per share of $1.74 increased 10%, largely driven by the factors that drove the adjusted EBITDA improvement year on year. Moving to a discussion of segment performance, ceiling technology sales of $169 million increased .5% and organic sales were relatively flat. General industrial sales increased year over year driven by a demand recovery in Europe and firm North American performance offsetting tepid Asian markets. In addition to our solid general industrial performance, growth in space and commercial aerospace applications, improved food and farmer sales and firm nuclear sales offset steep declines in commercial vehicle OEM revenue. Strategic pricing actions and the acquisition of AMI completed in January this year also contributed. Aftermarket sales comprised 63% of total segment revenue. For the third quarter, adjusted segment EBITDA increased 15%. Strategic pricing, continuous improvement initiatives, the contribution from AMI and improved aftermarket mix drove the segment's profit growth during the period. Adjusted segment EBITDA margin was .7% in the third quarter, up 300 basis points. For the first nine months of 2024, ceiling delivered adjusted segment EBITDA margins around 33%. As we have said since the beginning of the year, we expect a return to normal seasonal patterns in 2024, where the fourth quarter usually represents the low point of sales in adjusted EBITDA for the segment. We are excited about the number of drivers of long-term growth and value creation in ceiling technologies as we focus on expanding opportunities through growth investments and strategic acquisitions. Turning now to the advanced service technology segment, third quarter sales of $92.5 million were up .5% year over year and up 5% sequentially. We saw growth and precision cleaning solutions tied to advanced node chip production supporting applications such as artificial intelligence and high bandwidth memory. However, demand for capital equipment, coatings, and optical filters remains choppy. Market forecasts from a variety of sources suggest that while the overall semiconductor market is in a strong secular growth position long term, the timing and magnitude of an overall recovery in capital equipment spending continues to evolve and move to the right. And we are seeing similar dynamics play out for us in the near term. In the third quarter, adjusted segment EBITDA was flat year on year. Adjusted segment EBITDA margin was 20.8%, down 80 basis points from last year and 90 basis points sequentially. While we saw segment revenue increase, fixed cost of leveraging tied to slow wafer fab equipment demand and operating expense increases tied to growth investments crimped segment margins during the third quarter. We expect these dynamics to continue into the fourth quarter and expenses associated with the qualification work for advanced node applications are expected to accelerate. Throughout the downturn, we have invested in targeted capacity expansions that will position AST well as the semiconductor market resumes a growth trajectory. As well as our AST platform matures, we are implementing select continuous improvement and optimization initiatives. The playbook underlying the success of the ceiling technologies platform. Turning to the balance sheet and cash flow. At the end of the third quarter, our net leverage ratio stood at 1.8 times trailing 12-month adjusted EBITDA. Free cash flow year to date was approximately $83 million, down from about $134 million last year. Timing of working capital and higher cash tax payments compared to last year were the primary drivers of the year over year reduction. For the year, we expect free cash flow to exceed $110 million. We are reducing our CAPEX forecast for 2024 to around $40 million versus our previous expectation of $60 million. Progress continues to be made on technical innovation for a number of leading edge applications supporting critical in-chamber tools in addition to other exciting growth projects across the company. But spending will be more phased than previously expected. We continue to be excited about our pipeline of organic growth opportunities as we invest to drive long-term, high-margin growth. We have strong financial flexibility to execute our strategic initiatives, both organically and through acquisitions that broaden our capabilities, while continuing to return capital to shareholders. In the third quarter, we paid a $0.30 per share quarterly dividend, with -to-date payments totaling $19 million. Finally, last week, the NPRB Board of Directors renewed our two-year $50 million share repurchase authorization that recently expired. Moving now to our current view of guidance. Taking into consideration all the factors that we know at this time, we are reducing our full-year 2024 earnings guidance ranges, and we also now expect total and pro sales to be down low single digits compared to 2023 versus our previous revenue guidance of approximately flat. The primary factors in adjusting our sales view are slower sales in AST, given variability in orders for wafer fab equipment and coatings lines for the fourth quarter, and continued weakness in commercial vehicle OEM sales and ceiling technologies. We now expect adjusted EBITDA of between $250 million to $255 million, and adjusted diluted earnings per share to range from $6.75 to $7, versus our previous view of $260 million to $270 million and $7 to $7.60, respectively. The normalized tax rate used to calculate adjusted diluted earnings per share remains at 25%, and shares outstanding approximate $21 million. In AST, we expect current soft demand conditions to persist into 2025. Lower than expected demand for critical in-chamber tools, lower shorter cycle orders and coatings, and accelerated growth spending related to qualification work for leading edge applications will drive AST segment profitability down in the -single-digit range for the fourth quarter. In ceiling technologies, we continue to see a resilient backdrop during this seasonally low period, although commercial vehicle OEM sales will remain weaker than previously expected. Fourth quarter ceiling results will represent the lowest point of the year, while still showing strong profitability. I will now turn the call back to Eric for closing comments.

Thanks, Joe. While near-term pressures in semiconductor and commercial vehicle OEM demand cause us to adjust our full-year view, our balanced portfolio generates attractive margins and cash flow returns. We are advancing numerous opportunities to further optimize on-pro operationally, while investing in attractive opportunities to drive long-term high margin growth. Our balance sheet is in great shape, and we continue to build upon the strong foundation that we have for driving long-term value creation. Every day, we deliver critical, leading edge solutions for our customers that safeguard critical environments and applications that meaningful impact our lives. Thank you again for joining us today. There is no better time for you at Powered Event Pro. I now welcome your questions.

Thank you. We will now be conducting a question and answer session. If you would like to ask a question, please press star and then 1 on your telephone keypad. The confirmation tone will indicate your line is in the question queue. You may press star and then 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. The first question we have is from Jeff Hammond of KeyBank Capital Markets. Please go ahead.

Hey, good morning everyone. Morning Jeff. So, maybe just to start with semiconductor, we've kind of seen from peers that it's taking longer to inflect. Just wondering what you're seeing from our order, funnel, conversation with customers to kind of frame maybe early thinking on 2025. Is this kind of a slow bounce off the bottom or do we finally see more meaningful inflection?

Well, Jeff, the way I would describe it is still being choppy. As you said, maybe a slow rebound from the bottom. But at this point, it's just people are just pulling in their horns like a conservative. We've looked at the announcements with some of the leading IDMs in the third quarter to create a little bit of uncertainty. And our customers are just being cautious. So right now, our demand profile just keeps bouncing around a little bit.

Sorry Jeff, I was just going to add, yeah, I mean the build plans that we see from our key customers are just moving around. As Eric mentioned, a couple of the dynamics have caused our customers to kind of retrench on inventory a little bit and kind of wait out that uncertainty. So as things move into 2025, we kind of expect these conditions to remain through the beginning of the year. After that, we just don't have good visibility right now in what the rest of the market will do.

I think, Jeff, just to add to it, we had a customer meeting and at one point they were happy with the inventory they had. And then as the quarter went on, I think they're doing a little bit more destocking based on some recent customer news. And so there's a little bit more destocking than there was previously. Okay, that's a really good color.

Shifting gears to ceiling, can you just level set us on your nuclear business, how big it is today, and just, you know, there's been kind of a lot of news flow around resurgence and nuclear and some announcements around data centers and just wanted to understand better how you think you might participate in that resurgence.

Nuclear business for us is about 7% of sales, Jeff. That's where it is today. It's obviously good for us. At the same time, it's not going to change our trajectory fundamentally. When you look at the average reactor in terms of the content we have, it's significant to us, but at the same time it's not going to be significant to the portfolio, to our nuclear business, it's good. But it's not going to create double digit growth for Enpro or anything like that. So we have the seals for the reactor pressel vessels, and while that's substantial, there's only two of them. And they buy two or three at a time, and they replace them every couple of years. So it's not going to be what you would consider a home run. So it's substantial and it's good profitable business, and it's a great long term solution, and it's leading to these small modular reactors, there'll be more and more of them. At the same time, I don't want people building in a huge increase for nuclear that's likely not going to be that for us. It'll be consistent, long term steady growth that's very profitable.

When we think about the structure of the ceiling technology segment, I mean, nuclear and sustainable power generation are just one of many growth nodes that, you know, when we talk about the dynamism of the segment, you know, we put together five or six kind of bundt singles and doubles that can kind of build that organic growth dynamic into that mid single digit range long term. And our teams are working really hard to make sure that we deliver that level of performance, complemented by incremental strategic acquisitions that expand our capabilities to customers.

Okay, thanks. I'll get back into you.

The next question we have is from Steve Ferrazani of Sadochi and Company. Please go ahead.

Good morning, everyone. Appreciate all the detail on the call this morning. I wanted to ask about part of the margin softening on ASTs related to increased spending for growth initiatives. And then I know, Joe, you mentioned expecting accelerated spending on the certification process in 4Q. Can you walk us through those two elements?

Yeah, thanks, Steve. Yeah. So our progress in Arizona has gone quite well operationally, right? We've executed the build out of that facility quite well. We're actually a little bit ahead of schedule there. So working with our key customers, we've accelerated the qualification for leading edge node cleaning. And so we can demonstrate copy exact into that Arizona facility. And we're kind of pulling that work into 2024 a little bit more than previously expected. So that's going to put a little bit of cost ahead of demand in 2025 into the fourth quarter. And that's why I said some of that is accelerating. Remember, this is just phase one of the work we're doing in Arizona. And we're very excited by that. But we've accelerated some of the qualification work and early returns are quite positive there. So, you know, we're just pulling some of that into 2024.

The other thing I expect to go ahead. You know, they said the other factors

are we're implementing our operational excellence playbook in the group. So what you're seeing is investment ahead of the value that will come later on. You're seeing it in terms of things like improving our inspection process or our cost of performance is lower. We've had some recently some very significant innovation in both our optical business and also our semiconductor business where some automation is reduced inspection time from hours to minutes in some cases. And so things like that, along with some little facility consolidation, moving some equipment around to get more positive flow throughout the factories, you saw the success of those initiatives and our ceiling technologies, ceiling technologies businesses. And we're just getting started really in the AST platform. So all that takes extra investments ahead of the benefit that comes from it. At the same time, it's a slower time in the industry. And so you've got a lot of people that are trying to, I shouldn't say trying to keep busy. We're having them working on very meaningful projects. We don't get time to do when things are busy. And so we have the cost of those initiatives without the benefit at this point. But those benefits will flow in over time. And as we said earlier, that business will rebound to be 30 percent, even plus or minus a couple hundred fifty basis points, depending on the mix and volume at the time. So we're still really excited about that business.

If I could just ask about the expected ramp on Arizona, the certification process, when you would expect to see meaningful revenue generation out of that operation?

That's the best answer we could give you right now. You may have thought of the press report yesterday. It talked about one of our key customers mentioning they're starting up a ramp on four nanometer sometime in the middle of 2025. And that would drive some of our volume at that time. But I don't expect full ramp personally until twenty six.

Yep. OK, that's helpful. When you bought Alexa, you talked a lot about that being really customers came to Alexa because of their strong reputation for doing a very specific custom build, which they didn't have to market themselves. Have you flipped that at all? Are you trying to more aggressively market the capabilities of Alexa now, given the week demand? That's the recent week demand of the last, you know, multiple months.

We wouldn't we wouldn't we wouldn't have flipped it. We're still investing in the same place as they were. And those opportunities are coming back now. As I said before, in previous calls, they had a flip really because of covid. People stopped traveling and started to stop doing new projects. Everybody's working from home. That just caused it's like a snake swallowing a large animal. And so they had this bulb that went through or this bolt that went through without something behind it. The pipeline is now very active. We've had some very significant customer wins in the last few months. And so that business is starting to improve dramatically.

There are several end markets that Alexa could be successful in and they have a very diversified customer base. But some of the areas of strength are in free space communications, certain new space applications, semiconductor areas as well. So, you know, the outlook remains steady for Alexa for us. And, you know, they continue to be at the top of the pyramid business in the industry.

Their life sciences surgical applications have also taken off recently again.

Yeah, great. Thanks. Last one for me. One, you lowered capex. Just what what what do you what spending is not taking place? And then to seeing some debt reduction. Does that ramp up that reduction if you're if you're lowering capex?

Yes, Steve. So, yeah, as you said, we lowered our capex guy to 40 million. Frankly, you know, we probably overestimated our ability to execute a little bit on capex going into this year. Our capacity is probably more in the 40 to 50 million dollar range. At the same time, there's some really advanced work we're doing on on gas dispersion equipment. And so our engineering teams have been working on that in multiple locations. And based on the innovation that's coming through that and some of the learnings, it's probably better to face some of that over time. And it'll ultimately result in a more advanced solution, more optimized solution at the end. So even though some of that was a little bit ahead of ourselves, you know, it will result in in in a better ultimate solution because we're going to face some of that spending over a multiple periods there. You know, I think going forward, we're always going to prioritize organic investments and, you know, prioritize investments in M&A from a capital allocation standpoint. And those are going to be our two primary areas that we're investing in. We're not at the current moment looking to to act on other legs of capital allocation. And the majority of our focus will be on organic and inorganic growth.

Yeah, I mean, we're going to generate well over one hundred and ten million dollars of free cash flow in twenty twenty four, partially driven by the fact that we have a lower capex budget. And as we look forward from a percentage of revenue perspective, you know, we'd like to, you know, put put about three and a half to four percent of revenue to work in capital spending, two thirds of which will be focused on, you know, high margin growth projects.

Right. Thanks, everyone.

Ladies and gentlemen, just a reminder, if you would like to ask a question, you're welcome to press star and then one. The next question we have is from Ian Zofino of Oppenheimer & Co. Please go ahead.

Great. Thank you very much. I just wanted to drill down a little bit more. You know, where exactly are you seeing that weakness? Is it very leading edge or less so? And maybe what is kind of moved against you in that kind of spectrum? Thanks.

I think you said was it leading edge. I didn't hear the first part of your question. Yeah,

exactly where you kind of see the difference. Where are things weaker than you had expected? Is it kind of on the leading edge, non leading edge? Exactly. Where is it?

The leading edge cleaning and applications are very, very strong. And so everything leading edge, we're doing very well within our cleaning and refurbishment business and new product testing as well. On the legacy pieces and the capital equipment spending, which some of that does go to leading edge as well. So it's hard to break it out and say this much is leading edge and this much is trailing edge. That's where it's a little bit slower. They're still not full. The factories still aren't fully utilized. And so when utilization rates go up, they'll buy more equipment. But that's the slowest piece of it. The rest of our services, businesses and stuff is very strong. Okay. We

also saw a little incremental weakness in coatings compared to certain, you know, just the order flow is a little choppier than we had initially felt in that Q2 into this, you know, throughout this quarter as well. And those tend to be shorter cycle product and solution lines that, you know, just kind of move around a little bit.

Okay. And then, you know, as we look at like a return to growth in that space or the division, comps definitely get a lot easier, I guess, in the first half of next year. Is that enough to kind of move back into, let's say, positive growth? Or do we really need to see like a big semi-cap equipment rebound, you know, or just cleaning solutions like enough to kind of get you back to positive growth?

I mean, so we were up in AST sequentially 5%. We were up .5% year over year. This is the first material quarter of like those lower comps starting to lap. We are still seeing for Q4 just kind of a flat, flattish from Q3 result from a top line perspective with a little bit of headwinds on the margin like we discussed in the guidance section. You know, I think we're going to see a slow first half, but we're probably kind of still past that little, the lowest point because there are dynamics that should drive a little bit of growth. But in terms of that, you know, industry forecasted hockey stick type of acceleration, that likely will not come to fruition, which actually kind of benefits us when we think about balancing our costs with the intermediate demand outlook while still investing in those opportunities for long term growth. Yeah, I mean, the

first quarter we talked about last year or this year represented the bottom for what we expected. And so we've seen slight sequential improvement of demand, you know, quarter over quarter. It's just not as much as we originally expected. And so as we go into the fourth quarter and then the first and second quarter of last year, our expectations that we'll see year over year growth, we're just not seeing sequential, substantial improvement that was originally predicted to come in the back half of this year. Yeah,

like over the next few quarters, it's just going to be choppy until some of these things kind of come to fruition. That's just the realistic situation at hand for us and many others.

OK, thank you very much,

guys. We have a follow up question from Jeff Hammond of KeyBank Capital Markets. Please go ahead.

Hey, guys, maybe just an update on the AMI integration and just, you know, actionability in your M&A pipeline.

AMI acquisition is a home run by every standard. We're very thrilled with that. That team, Kevin and the team are doing an outstanding job culturally. Every aspect of that business has been just a home run. And we're very excited about it. Term of actionability, we have a robust pipeline we look at all the time. We literally look at opportunities every week. I don't think a week goes by we don't look at something. But we'll remain disciplined and we're going to find another business similar to AMI at some point here. And it

seems like things coming to market have kind of picked up. The activities picked up through the second half quite a bit. So we're seeing more opportunities of things that we've been looking at closely over a softer period now coming to market. So the pipeline is really active, Jeff. And, you know, we've got a couple of things that we're really interested in. Nothing that's actionable yet. But, you know, we continue to look at key focus areas and sealing technologies for extension opportunities and, you know, food and pharma and test and measurement and other spaces that we're really interested. AMI is a really good model for the type of business that meets all of our input criteria both strategic and from a culture and leadership perspective. So we've got a number of opportunities like that in our pipeline that we're hopefully going to execute on here soon.

Yeah, it's just more about timing rather than, you know, opportunity set in terms of availability of some of these assets.

Great. Thanks, guys.

At this time, they are no further questions. And I would like to turn the floor back over to James Genterly for any closing remarks.

Thank you for your interest today. Have a terrific day and see you next quarter.

That concludes today's conference. Thank you for joining us. You may now disconnect your lines.