Q3 2022 EnPro Industries Inc Earnings Call

Greetings and welcome to the <unk> and Pro Industries third quarter 2022 earnings Review conference. At this time all participants are in a listen only mode. A question and answer session will follow the formal presentation. If you would like to ask a question. Please press star one on your telephone keypad, 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 Gentilly, Vice President Investor Relations. Thank you. Please go ahead.

Thank you Donna and good morning, everyone. Welcome to <unk> third quarter 2022 earnings Conference call I'll remind you that our call is being webcast at MRO industries Dot Com, where you can find the presentation that accompanies this call with me today is Eric Vaillancourt, our President and Chief Executive Officer, and Milt Childress Executive Vice President and Chief Financial Officer.

Please note that in the third quarter of 2022 of the engineered materials segment has been classified as a discontinued operation. Following the early September announcement to divest the remaining engineered materials businesses G. B G. G. B N G. P T. Both of which are expected to close this month.

The financial information discussed in this conference call is based on the continuing operations of Anne Crow, which exclude the engineered materials segment.

Included in the press release, our schedules showing quarterly re casted financial data based on continuing operations since the first quarter of 2021.

Before we continue today's discussion a friendly reminder, that we will be making forward forward looking statements on this call that are not historical facts. These statements involve a number of risks and uncertainties, including those described in our filings with the SEC, including our most recent Form 10-K 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 in the presentation materials also note that during this call we will be providing full year guidance, which excludes changes in the numbers of shares outstanding impacts from future acquisitions.

This 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 third quarter the impact of foreign exchange rate changes subsequent to the end of the third quarter interest rate increases differing from.

<unk> outlined in guidance impacts from further spread of COVID-19, or other variants and environmental and litigation charges. We do not undertake any obligation to update these forward looking statements and now it is my pleasure to turn the call over to Eric.

Thanks, James and good morning, everyone. Thank you for your time today as we review our third quarter the.

The organization is energized and firing on all cylinders focused on building upon our foundational sealing technologies that advance surface technologies businesses. Following the expected exit of the engineered materials segment as announced in early September .

Now onto our third quarter highlights we delivered another strong quarter delivered driven by exceptional performance across both the sealing technologies and advanced surface technologies segment, the differentiated value of our innovative solutions and basket abilities of our teams across the company continued to shine. We are pleased to report outstanding quarterly results.

Highlighted by double digit organic revenue growth and strong margin expansion reflects the resilience of our business model.

In the third quarter sales up $280 million increased 34% year over year with organic sales increasing 16%.

Our order trends remained firm in the third quarter, despite a volatile macroeconomic and geopolitical backdrop.

Our topline growth was driven by volume increases in many of our served markets effective pricing initiatives and the addition of <unk> or.

Our third quarter adjusted EBITDA of $71 3 million increased 70% year over year and adjusted EBITDA margin expanded 550 basis points to 25, 5% driven primarily by the addition of <unk> strong organic sales growth and effective pricing strategies in response to inflationary pressures.

The portfolio reshaping efforts, we initiated in 2019, along with the tireless work of the teams across Aimco have helped us build a streamlined portfolio of market, leading businesses, leading critical needs of customers.

Our go forward businesses operate in attractive end markets, where we are well positioned for growth throughout our enduring technological advantages.

Our portfolio transformation has also created a foundation for continued profitable growth our optimized portfolio of businesses generates higher margins and cash flows and enhance return on invested capital reflecting value provided to our customers through proprietary technology.

Applied engineering expertise and process Knowhow.

Additionally, a growing proportion of our revenue mix is derived from the recurring or aftermarket portions of our businesses, providing us with enhanced stability through market cycles.

We have also made substantial progress on gross margin improvement over time for context, our reported gross margin just before we began our transformation efforts was 31%.

Today, our portfolio of technology, driven products and solutions shows a gross margin approximating 40%.

Following the completion of the engineered materials divestitures, we will have reduced our European exposure eliminated eliminated our sales to the automotive market and significantly reduced our remaining oil and gas exposure or.

Our revenue generated in North America will account for approximately 70% of our total revenue and our aftermarket and recurring revenue will exceed 50% of total sales.

We will continue to pursue selective strategic acquisitions that fit our criteria of both broadening our already strong reach with technology enabled products and solutions and offering opportunities for strong recurring revenue.

Speaking of acquisitions. It has been nearly one year since we added <unk> to our family.

We are pleased with our leading edge capabilities and actually I just brought to our semiconductor business.

We're seeing the benefits of next edge combination with our advanced surface technologies businesses and our newly welcomed colleagues are integrating well into our broader organization and culture.

The success of <unk> and the opportunities. It has created for our business demonstrate the merits of our M&A strategy, bringing in leading businesses and applying our platform to accelerate growth with that I will now turn the call over to bill for a thorough look into our financial results for the quarter.

Thanks, Eric.

As reported sales of $280 $1 million in the third quarter increased 33, 6% year over year.

Revenue growth from volume increases in the semiconductor aerospace food and pharma and heavy duty truck markets.

The contribution from pricing actions in response to inflationary pressures as well as the addition of next edge was partially offset by the reduction in sales due to unfavorable foreign exchange translation and last year's polymer components divestiture.

Organic sales for the quarter increased 16, 2% compared to the third quarter of 2021.

Adjusted EBITDA of $71 $3 million increased 72% over the prior year period, driven by volume growth pricing actions and the addition of next edge, partially offset by the impact of unfavorable translation and the 2021 divestiture.

Adjusted EBITDA margin of 25, 5% expanded approximately 550 basis points compared to the third quarter of 2021.

Corporate expenses of $9 $1 million in the third quarter of this year decreased from $11 6 million a year ago, driven primarily by lower acquisition and divestiture related expenses and costs incurred from the CEO transition last year.

Adjusted diluted earnings per share of $1 91 increased 64, 7% compared to the prior year period.

Solid operating performance and the contribution next edge more than offset higher interest expense.

Moving to a discussion of our segment performance.

Sealing technologies sales increased seven 5% $157 $9 million driven by strong demand in aerospace food and pharma and heavy duty truck markets as well as pricing actions, partially offset by the impact of foreign exchange translation and the divestiture of the polymer components business.

Completed in 2021.

On an organic basis sales increased 16, 6%.

For the third quarter adjusted segment EBITDA of $39 $7 million increased 15, 1% driven by volume growth across the segment pricing improved mix and operational improvements in our heavy duty truck business, partially offset by the impact of foreign exchange translation.

Adjusted segment EBITDA margin expanded 160 basis points to 25, 1%.

Excluding the impact of the divestiture and foreign exchange translation adjusted segment EBITDA increased 23, 4% compared to the prior year period.

One additional note before moving to advanced surface technologies.

Historically two locations in the sealing technologies segment accounted for inventories under the LIFO method.

During the third quarter of 2022 in order to better align with peer practices and as a means of harmonizing our accounting method for inventories across all businesses, we converted the inventory accounting for these locations to the FIFO method.

This change in accounting has been retrospectively applied to our consolidated financial statements the impact of which benefited adjusted EBITDA. The sealant technologies segment in the first half of 2020 to about $2 4 million.

And the advanced surface technology segment third quarter sales of $122 5 million increased 95% driven by the acquisition of <unk> and continued strong demand in the semiconductor market.

On an.

Organic basis.

Sales increased 15, 1% versus the prior year period.

For the third quarter adjusted segment EBITDA more than doubled to $39 $9 million driven by the next edge acquisition and strong organic sales growth.

Excluding the impact of the next edge and foreign exchange translation adjusted segment EBITDA increased 27, 3%.

As we've mentioned on past calls, we are making investments to support the growth of ASE, Inc.

Including expanding capacity and enhancing our technology solutions to capture growth in the semiconductor market.

Recently, the United States Government announced new trade regulations for U S semiconductor technology exported to China.

We are in the process of working with our customers to evaluate the potential effects of these regulations on our businesses.

At this time, we expect a nominal impact on <unk> sales in the fourth quarter and based on our current analysis minimal impact into next year.

Given our robust portfolio of leading edge solutions.

Our depth of talent and the strength of our innovation engine. We are confident that <unk> is well positioned to capture long term organic growth opportunities, particularly as the semiconductor market expands and other leading edge applications development.

Turning to the balance sheet and cash flow, we ended the quarter with $166 million in cash and total debt of just over $880 million.

As communicated in early September after tax proceeds from the sale of the two remaining engineered materials businesses are estimated to be approximately $290 million. We expect to complete those transactions later this month as Derek noted earlier.

Free cash flow from continuing operations for the first nine months of 2022 was $101 million up from $67 million in the prior year, driven primarily by higher EBITDA.

We repatriated a total of $186 million in the first nine months of 2022, and a tax efficient fashion and the fourth quarter, we expect to bring another $50 million onshore, bringing our total repatriated cash in 2020 to over $230 million.

In September $200 million of <unk> cross currency swaps matured.

The swaps generated more than $27 million and interest expense savings since inception in March 2018.

We received an additional $27 million from settlement of the swap at maturity ended September .

Finally, we made a $5 $8 million payment during the third quarter to move closer to settlement of the Passaic River legacy environmental liability, which.

Which predated our spin out as an independent public company.

Approval for the Passaic River settlement is expected over the next 12 to 18 months.

Factoring in all of these items, we expect our net leverage ratio exiting 2022 to be below two times. This year's expected adjusted EBITDA.

We will continue to use available capital to support long term growth, both organically and through strategic acquisitions, we have ample flexibility to execute on our growth initiatives, while maintaining a strong balance sheet.

In October the board of directors approved a new $50 million share repurchase authorization, which runs through October 2020 for.

This authorization replaces the prior share repurchase authorization at the same amount which expired in October .

No purchases were made under the prior plan.

During the third quarter, we paid a <unk> 28 per share quarterly dividend and.

Now for the first nine months of the year dividend payments totaled $17 6 million.

Moving now to our 2022 guidance from continuing operations.

Underlying demand and order trends remain firm into the fourth quarter, even in the context of macroeconomic and geopolitical uncertainty.

As you can see on slide 11, taking.

Taking into consideration all the factors that we know at this time, we are raising adjusted EBITDA guidance from continuing operations to $253 million to $260 million on revenue of $1 <unk> to one 9 billion.

The guidance increase reflects sustained execution and the strength of our optimized portfolio of high margin industrial technology businesses.

Our revised guidance implies an adjusted EBITDA margin of approximately 24% for the year.

Sure.

Excuse me.

Further we expect adjusted diluted earnings per share from continuing operations.

To be in the range of $6 55 assets the $6 90.

Okay.

As you can see on slide 11. This slide provides a bridge from our previous guidance to our raised guidance.

In early September and our early September announcement discussing the intended exited the engineered materials segment.

We indicated that $34 million to $36 million of our previous adjusted EBITDA guidance of $270 million to $208 million.

Was attributable to this now discontinued segment.

Accordingly, our updated guidance for adjusted EBITDA from continuing operations represents a $16 million to $17 million increase over the equivalent prior guidance measure inclusive of the previously noted $2 $4 million benefit from the inventory accounting change.

With that I'll turn the call back to Eric for closing comments, Thanks, Mark I'm proud of our team and our many accomplishments I'd like to take a moment to thank all of our colleagues across <unk> for your dedication and outstanding performance. Their hard work continues to be the foundation of our success I'd also like to take a moment to thank our GGP and <unk>.

<unk> colleagues for their hard work in building World class businesses. We are confident that you all have bright futures ahead.

We have executed on our stated intention to reshape our portfolio to focus on the areas in which we have the strongest technological and process advantages.

We are moving forward as a streamlined organization centered on our foundational sealing technologies and advanced surface technologies businesses.

Both of which are leaders in attractive markets.

As we enter our next chapter we are focused on building on our leadership positions.

Our strategic road map shows promising opportunities for both organic and inorganic growth and we expect to use free cash flow and ample balance sheet capacity to prudently execute on these long term growth initiatives.

Our raised 2022 guidance implies adjusted EBITDA margins of approximately 24% up from 14% in 2019, when we began our portfolio reshaping strategy.

We have remained steadfast in delivering outstanding financial results and enabling the supporting development of our colleagues and the communities in which we operate.

2022 has been an important year for <unk> as we build the company into a growth engine for the future I am proud of our team and our many accomplishments that have brought us here to this point.

There has never been a better time to be a part of and growth I am honored to be here with you all and appreciate your support as we drive to capture the compelling opportunities. We see ahead. Thank.

Thank you again for joining us today, we appreciate your interest in our company now I'll open the line to questions.

Thank you the floor is now open for questions. If you would like to ask a question. Please press star one on your telephone keypad at this time.

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 once again Thats Star One to register a question at this time.

First question is coming from Jeff Hammond of Keybanc capital markets. Please go ahead.

Hey, good morning, everyone.

Or gesture.

So just you know I'll start with kind of the standard just maybe update us on you know.

The durability of the of the semi cycle I know you mentioned that the China regs, but just.

Versus all the kind of mixed news flow we've seen on semi you know kind of how how maybe that shapes. How you think gross shapes up into 'twenty three and then any kind of update on kind of your U S. A.

You know U S investments for you know for the you know the big build out here.

Okay. Thanks, Jeff.

The Big question. So there are lots of parts to it suddenly say, Eric and I will take you back a bit.

First of all I will take about the headline news that everybody is reading, we're all reading about what's happening with various semiconductor companies.

Including whats happening with the new.

Trade regulations.

Involving semiconductors to China. So first of all just the overall economy.

Outlook I'd start by saying that our bookings and our backlog remains strong.

So we are not saying currently in our business.

Signs of a slowdown.

<unk>.

Our outlook and our backlog as you know extends maybe a couple of quarters, but it doesn't go far beyond that so.

With that our visibility if you're looking at a full year ahead for 2023 for example is limited.

But that's not new that's just that's just the way our business operates.

The important thing for us.

We have a long term view on the semiconductor industry in the market.

We believe that the increasing demands for chips as technology evolves.

Will drive strong growth over the long term, so if you're taking a longer term look.

We're fully confident.

There will inevitably be some.

Ups and downs as there are in a lot of markets a lot of industries.

I will say this that we do think that our technology differentiation will.

It will be a positive should there be a downturn in the market, we will be able to leverage our technology and perhaps gain some stronger positions with leading customers.

So those those were our comments I would say I would also.

<unk> mentioned, Jeff that.

If you look at our semiconductor revenues in total roughly 50% of our revenues are recurring in nature.

So in that major more tied to wafer consumption than they are with new equipment build.

I'd also note that we are well positioned geographically with investments that are being made in the United States and so with that maybe we'll piggyback to.

What's going on on that trial, and maybe I'll just toss the ball to Eric.

I think we'll also see growth just from our vertical integration strategy.

News to gain speed from our acquisition of <unk>. The cleaning order you referred to is going to be strong throughout the cycle, because we all noticed with all the recurring revenue.

Should continue to go well and I think we're positioned very well for the long term.

In addition, we're all we focus primarily on the advance nodes.

These continue to accelerate over time as well.

We're looking for continued strong performance there over the cycle.

Okay.

Hey, Eric do you want to comment on.

Arizona, Arizona.

So we are investing for organic growth as well, we'll close on our real estate property.

And Arizona before the end of the year and Thats, a pretty substantial investment is less than $15 million and then we have outfitted and get ready to go to support some key customers in Arizona that you would know what their needs.

The buildup will happen over the next 12 to 18 months position us well for 2024 and beyond.

We're excited about that investment as well.

And we really don't have a whole lot more to say about the.

Trade restrictions and regulations.

And implemented.

Other than what I said mentioned earlier I will I will note that we do think that.

Some of it will shield us as our focus on advanced nodes and how we're positioned and it's simply because a lot of that product and technology as well.

It was not sold being sold into China before the new trade restrictions went into effect.

Okay. That's all very helpful.

Just kind of looking at your updated guidance it looks like you've got a fairly big step down I know theres some seasonality there, but it seems a little more more than normal. So I'm just wondering if there's anything to read in terms of it sounds like order and backlog trends are good anything to read into into kind of that bet.

<unk> you know ex the engineered materials guidance.

Well, we have we had a stronger third quarter of this year than we've had historically part of it is we're focused on our continuing operations and with continuing operations.

We don't have as much exposure to the slow the typical slowdown in Europe . In Q3. So you see you see the impact of that when you look at our year over year performance Q3, continuing ops versus Q3 continued.

<unk> of last year or if you just go back and look at the typical seasonality pattern I guess, that's the way I should state it.

And in the fourth quarter.

Our backlog remains constructive our book to Bill remains above one.

As a company so we are expecting to complete.

End of the year in <unk>.

In good fashion. The actual results of Q4 oftentimes are driven by timing of shipments at the end of the year, particularly around.

Markets like nuclear and aerospace, which can shift a bit.

There's also a little bit of caution, perhaps for Europe slowing down as a result of the Ukraine situation.

<unk> some of our European business is a little bit with assuming technologies segment.

So there's a little bit of uncertainty there, but we've got factored in.

Got it.

<unk> two.

Europe or.

Roughly in the ballpark.

14%.

Total sales on a pro forma basis.

And so while it's down considerably still have an impact.

Okay. Thanks, guys.

Thank you. The next question is coming from Steve <unk> of Sidoti. Please go ahead.

Good morning, everyone.

Just wanted to get an update on the <unk>.

Sure if the deal sounded like you said.

GGP should close this month anything that would have slowed that down and then whats the timing on the garlock pipeline.

Yes.

Thanks, Dave for the question.

We're moving forward toward closing as we mentioned.

When we announced the deal we have a signed agreement on the sale of GGP and we've been moving along on various regulatory approvals and we feel like we're in good shape and confident they will.

Closing that transaction in November .

When it comes to GPT, we're not as far along we still believe we will.

<unk> complete that deal September although there are a few more.

Hurdles to cross.

Before we get to completion there.

That will be assigned.

A simultaneous signing and closing so sitting here today, we're not holding assigned.

Sale agreement.

But once again, we are still confident that we'll be able to get that across the finish line later this month.

And the expectation would be primary uses to be debt reduction and anything you can say about what the pipeline is looking like out there next six to 12 months.

Yeah.

Initially, we'll be paying down outstanding revolver debt, we've already paid down our 364 day term loan.

So we'll pay down any outstandings at the time of our revolver debt and and then and then we will we will.

We are determining what we want to do with the balance in the short term.

We're able to invest now with with at least some constructive.

Constructive or meaningful interest income and so we are now with our treasury folks were looking at options of how we wanted to deploy the cash in the short term.

And then yeah.

We're continuing to work.

Work on our pipeline and we have several opportunities that we're tracking the timing is always uncertain.

But.

<unk> continues to be part of what we do day in day out.

Okay.

And then in terms of because we get through this quarter and now without engineered materials businesses are a little bit different now, but still hearing a lot of issues with inflationary pressures, particularly energy costs, how that might be impacting you also that supply chains remain.

Not constructive.

That might be impacting your businesses. So if you could just talk about inflationary pressures supply chain issues, because we get into the fourth quarter.

In general supply chain pressures have eased and continue to get a little bit better over time. In addition, energy has actually come off a little bit we just were able to negotiate a contract with.

One of the ceiling divisions it was much less.

Less than it had been in the past so right now I see things trending in a positive direction. There is more availability and price in general is falling off a little bit, but regardless, we still do an outstanding job of capturing price.

Europe is a little different energy prices. There of course are a little crazy a little uncertain at the same time, it's about 30% to 14% of our overall business.

And the team there is doing an outstanding job in mitigating the situation there.

And if I could get one last one in terms of corporate costs, which seemed you had expected that to remain tracking higher.

Given the fact that you won't have engineered materials and you'd like to leave that higher assuming you fill in that revenue over time, the corporate costs were reasonable this quarter. How are you thinking about that moving forward.

Yes, we're just in the process now of <unk>.

Going through our budgeting process.

We'll provide more clarity in the quarter ahead.

On.

Our outlook for the coming year, including corporate costs.

Yeah.

So.

I'll just leave it at that right now.

Sure.

When we indicated the $34 million to $36 million contribution to our prior guidance from engineered materials that that was inclusive.

<unk>.

So called stranded costs, which are costs that had been allocated to that division. So those costs have to be reallocated going ahead to our existing businesses.

Perhaps some held at corporate which could have some impact.

Little impact on our corporate cost lift going into next year.

Okay, great. Thanks, everyone appreciate the color.

Thanks, Steve.

Thank you. The next question is coming from Ian Zaffino of Oppenheimer. Please go ahead, great. Thank you very much.

You know there's been just a lot of change in the portfolio. It seems like it's all for the good.

How are you looking at maybe your mix domestic versus international going forward, if you kind of look out.

Call it three years or so when you done more M&A like you were talking about where do you think that ultimately settles out.

Yeah.

Yeah I.

I think the way I would answer it and then Erik and I can go back and forth on this but I would answer it is.

We're not intentionally driving our business to be more north American centric we're.

We're not unhappy that that's been an outcome, but first and foremost we are really looking at the strategic growth of our business.

And looking at opportunities and makes sense for us.

With our portfolio and how we're driving it going forward so.

I think that where we will take into account.

<unk> political concerns we will take into account, where we anticipate growth happening.

Depending on the markets that we're serving just as we are with semiconductor right now with more on shoring opportunities in the United States. So I think we are.

We're doing the right thing strategically for the business and then secondarily, we are considering what's what's happening in the world.

I think bill covered it nicely I think first its strategy and the right opportunities right end markets and then its geography.

Okay. Thanks, and then.

I don't want to turn towards pricing again.

For clarification purposes, I think did you say that pricing was rolling off or slowing down.

And where are you versus cost from the pricing side and.

What's the outlook for pricing and then when you go through pricing isn't all true pricing is there any surcharges.

I'm just trying to think about how hesitation may or may not come down.

How the pricing might be impacted.

Now, we're still doing a good job of capturing price in this environment.

Services and products, we provide create a lot of value and we capture the value that we create in general.

Surcharges in some cases are rolling off they're mostly freight and.

And so in container freight as an example.

But we don't really capture that is price.

They come in and go out.

Our pricing power is still exist.

Bill paying good attention to it and I continue to think we'll capture.

As it goes as we move along.

And just a clarification on that Ian and Eric's remarks, he suggested that maybe raw material cost increases had eased a little bit.

Commodity pricing is starting to fall, a little bit which helps us as well.

On your Cogs side not on your revenue side correct.

Trying to differentiate.

Correct.

Okay. Thank you.

Yeah.

Thank you at this time I would like to turn the floor back over to Mr. Jim <unk> for closing comments.

Thank you for your time today and we appreciate your interest in <unk>.

Ladies and gentlemen, thank you for your participation. This concludes today's event you may disconnect your lines or log off the webcast at this time and enjoy the rest of your day.

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