Enpro Inc. (NPO) Earnings Call Transcript & Summary

Good afternoon, and good morning. Welcome to our Leveraged Financing Conference. We're pleased to have now in this presentation slot to Enpro industries. And from the company, we have Milt Childress, the CFO. Milt, I hand over to you.

Thank you, [ Yuma ], and good afternoon, everyone. I'm excited to be here today to talk about EnPro. And what I'd like to do is to start by looking at Slide 3. If you have your slide deck, you can flip to that slide. And I want to provide a little bit of context around our strategic direction before getting into an overview of the company because I think it's really important to understanding who we are. And specifically, if you look at our recent history over the past 18 months to understand and put it into context the actions that we've taken. So first of all, we have been reshaping our portfolio to accelerate growth and niche high-margin material science related businesses with strong cash flow. And I want to double-click on material science-related and businesses with strong cash flow. Second, we do have a nice overall mix of aftermarket versus OE. We're interested in maintaining the relatively high aftermarket exposure we have. And investing, whether it is internally -- internal investments or inorganically through M&A, investing in faster-growth end markets. Third, our operating system as a company is manifested in what we call our Capability Center. So the EnPro Capability Center is focused on providing best practices across our company. In various areas. I'll talk a little bit more about that later, but the ultimate objective is to increase returns on our invested operating capital, improving margins, improving cash flow. Fourth, perhaps this goes without saying, but we want to highlight our focuses on maximizing long-term shareholder value through a commitment to disciplined capital allocation. And then finally, and it's last on the list, but it's certainly very important to us and our culture is developing a way of working where we're empowering our employees through a forward way of thinking where we value authenticity and self awareness. And we believe that by doing that it really foster superior decision-making growth for individuals and results in our company and also being more attuned to the environment and what's happening around us. So if you flip over to the next slide, a statement that captures who we are as a company now, who we have evolved and who we are evolving to be, and that is a leading industrial technology company using material science to push boundaries in semiconductor, life sciences and other technology-enabled sectors. So with that as background, if you flip over to Page 5, I'm going to hit this -- touch on this real lightly because you can read it. We're headquartered in Charlotte, North Carolina, but we have operations globally. You can see about 4,400 employees worldwide. So our market cap revenues of about $1 billion, $1.1 billion in 2020, if you look at us on a pro forma basis, and I'll talk about what that means in a minute, closer to $1 billion. Adjusted EBITDA margins, 15.7%, once again, on a pro forma basis, 17%. And you see our aftermarket revenue and we do pay a dividend, and you see the yield here. We report in 3 segments, and I'll cover those briefly in a moment. You can see our overall geographic footprint as well as our market exposure. Flipping now to a little deeper dive on our segments on Slide 6. We report in 3 segments. Sealing Technologies, where many of our products or the majority of our revenues actually go into applications where we are safeguarding critical environments, whether it's keeping contaminants out of something that's being processed in food and pharma, for example, or keeping something that's being processed in chemical -- petrochemical facilities from getting into the environment. So that's what we mean by safeguarding critical environments. Sealing Technologies is by far our largest segment at this point. And you see we have an attractive EBITDA margin of north of 20% in the segment. And the products that we manufacture, we do have wheel end, heavy-duty seals. That is a big part of this segment as well as a number of metal seals and polymer-based seals. They go into various applications in aerospace, petrochemical and other markets. Advanced Service Technologies is our second segment listed here. This has been the part of our company that we have been investing in for growth. As you can see, we have a very attractive EBITDA margin that we generated in 2020. This segment arose as a result of our focus on higher-growth markets and moving into industrial technology spaces and the businesses that comprise the Advanced Surface Technologies segment is our semiconductor business and our optical filtration business. And offerings in this segment, if you look at semiconductor, we provide refurbishment, which is cleaning, coating technology where we actually take parts from the chambers with foundries being our direct customers and through a very sophisticated technology-based process, clean those parts, so you can go back into production to ensure high yields on wafer production. That's part of our business. And then another part of our semiconductor businesses, we provide subassemblies and bellows for the semiconductor industry in various applications. This too, just like sealing products. This segment is a very strong, not only margin, but cash flow generating business, and one we're very excited about to continue to build on for the future. The semiconductor markets that we're serving, the markets that we're serving in the optical filtration business have been, and we expect will continue to grow at the double-digit clip over the next several years. Our third segment is Engineered Materials. It's a PTFE largely -- a largely polymer-based group of products. And we serve the auto industry, the general industrial industry, the oil and gas and petrochemical industries in this business. Once again, PTFE-based. So fits our description of material science based. It is currently in a what we would call a little bit of self-help. We are focusing in this segment primarily on driving margins up. We believe that 2021 will be a better economic climate for the segment. The results that you see here for 2020 were impacted by significant drops in volume, particularly in automotive and European general industrial. And we do expect the markets to improve in 2021, and volumes make a big difference in this segment. So our objective is to drive the EBITDA margin in this segment up near or at or even above 20% over time. If you flip over to the next slide, I'm not going to talk about this. We'll leave it with you. But we have spent -- had a very focused effort, as many companies have this past year on designing our own approach and our response to what was happening with the -- in the world with the COVID-19 pandemic. And I'm really, really proud of the efforts of our team in designing our systems and processes to safeguard the health and safety of all colleagues across EnPro, and it's just included lots of things, including spacing out our production, putting in our own contact tracing system so that we can have good information to monitor who was contacted with whom and throughout our plan on a real-time basis. So we -- so the health and safety is, first and foremost, when it came into our response to COVID-19. We also had an intense focus on creating some scenario planning so we could manage our costs in an effective way. And we also tightened up our discipline around working capital as well as capital spending in 2020. And overall, the results that we've had is -- in response to the actions taken have been very positive if you look at our overall results for the year, which we'll talk a little bit more about that later. Flipping over to the next slide on Slide 8. This is a little bit more information around our Capability Center that I referenced earlier. And once again, the Capability Center is designed to bring and make available to our businesses, best practices in areas such as supply chain, our commercial operations, some manufacturing, data analytics, talent management, and it really is becoming a real differentiator for us and an important part of our ongoing efforts to drive margins and cash flow in our business. Our -- the way we work, it has become more of a pull from our businesses, pull on the resources as opposed to pushing resources. And it's part of our culture, it's not a corporate down initiative as much as it is a demand from our businesses. That -- it drives the activity of the Capability Center and our way of thinking in our culture, it's a much better way to work. Slide 9. I want to just hit -- we've had quite a change in our overall portfolio, as I mentioned in my early comments over the past 18 months. And the Slide 9 presents you or provides you with some of the details. We've had acquisitions over the past 18 months of close to $600 million of investment that we've made in the 3 acquisitions that you see listed here. And on the divestiture side, we've had roughly probably $500 million -- a little over $500 million of proceeds from the sale of these businesses. And all of this is intended to refocus our portfolio on material size businesses that are characterized by strong margins, strong operating cash flow and where we're investing for growth in the future to be investing in sectors that are growing at above GDP rates, which we're defining currently is a preference for markets that are growing at 7% or greater. Slide 10 provides a 3-year trend of our revenues, gross profit margins and adjusted EBITDA margins. And what this shows is a result of our portfolio is shaping. Sales are down, and that's been intentional because we've made a conscious decision to sell businesses that didn't meet our financial thresholds and also weren't consistent with our fundamental competence around material science. And so that's resulted in the decline in the revenue that you see here. Obviously, there's some in 2020, some impact of COVID-19 as well on the businesses that continue to be in our portfolio. On the flip side, you can see what's happening to our gross margins as we have embarked on this portfolio reshaping. Gross margins are up considerably as our adjusted EBITDA margins. Now if you look on the next page, which is probably one of the most important slides in here, I understand thus from a financial perspective. This helps bridge from reported 2020 to pro forma. And the reason for the importance of the pro forma is that we had a number of divestitures and an acquisition in 2020 that gives us a slightly different look going into 2021. So this slide shows these metrics as if all the divestitures and the acquisition that happened in 2020, as if all that happened effective January 1, 2020. So it gives you a full year run look at our business. And you can see that compared to reported EBITDA margins on a pro forma basis, our EBITDA margins are 130 basis points higher. So that really puts an explanation point on the change in the financial profile of our business as a result of the reshaping. As we've gone from EBITDA margins as a company of 14% in 2018 to a pro forma run rate going into 2021 of 17%. So 300 basis point improvement in a short period of time. Slide 12 will paint the picture for you of how we're planning around 2021 with growth of 6% to 10% in sales. Adjusted EBITDA margins showing some incremental improvement in margins over the pro forma 2020 that we just talked about, and a few other assumptions that help you kind of build to our thinking for the year. If I go on to Slide 13, I'll talk a little bit about our capital allocation strategy and how we think about that. Reinvesting in the business is our #1 priority. Our capital expenditures were relatively low in 2020. And part of that was because of our response to being very disciplined as the global pandemic hit. Looking ahead, we expect capital investment in our business to be probably a little over 3% of sales. And most of that is to support growth. One example of that is we are upfitting a new building in our semiconductor business that provides the refurbishment services for wafer manufacturing customers. We are also doing some small plant consolidations across our company, 1 in Europe and 1 in the U.S. So we do expect capital spending to be a little higher in 2021 than 2020, but much of that is going to be support growth. Second, continuing on with our portfolio reshaping, we have a continuing interest in strategic acquisitions, and we would define what we're looking for is, first and foremost, we want to add to our breadth of expertise in material science. Our recent efforts have been investing in semiconductor businesses. In the photonics space, life sciences, pharma-related, to give you an idea of where we have been looking for these material science businesses that are serving these sectors. Having management and the management team that comes to us with acquisitions is critically important to how we work and in our assessment process. I mentioned earlier, we are interested as we look at additions to our company at markets that are growing north of 7% per year. And we are pretty firmly entrenched in our criteria of anything that we look at having EBITDA margins greater than 20% and cash flow return on operating capital, also greater than 20%. We have been returning some capital to shareholders. We've been paying dividends now for a number of years, current yield is about 1.3%. We have a share repurchase authorization in place. The way we have been thinking about that is it's really a function of 2 things. It's a function of our balance sheet strength as well as our near-term outlook for investment opportunities in our company. And cash flow is king. So I wanted to leave you with that. Cash flow return on operating capital is a key metric. It is a key metric in our incentive compensation, it's a key metric in how we review and look at results from month-to-month and quarter-to-quarter. Flipping over to Slide 14. We'll just give you a snapshot at our history over the past 3 years of capital that we spent in -- internally in capital investments through M&A, through share repurchases and dividends. Going on to Slide 15, I just want to highlight a couple of things. If you looked at our balance sheet at the end of the year, we're financially very strong. Our net debt-to-EBITDA is -- or was at the time of about 1.6x. And you can see our capitalization on the right side we have a term loan A in place. We have an untapped revolver in place. And then we have the senior -- our senior unsecured notes of $350 million that mature in 2026. And you can see our current ratings by S&P and Moody's. On Slide 16, I want you to focus here for just a minute because you might wonder at first glance, when you look at the slide, what in the heck happened in 2020 to free cash flow. And the answer to that is we have been consciously working toward bringing to resolution, environmental legacy liabilities that were contributed to EnPro back in 2002 when we were formed through the spinoff from Goodrich. And Goodrich in addition to the industrial businesses that form the basis for our company in our early days, also stuffed some legacy environmental liabilities in the company. And we have made tremendous progress over the last 2 years in bringing to resolution number of those outstanding environmental liabilities. And it's one of the reasons why you see a relatively low free cash flow in 2020. We spent about $33 million outdoor in cash on bringing certain matters to a close in 2020. We also had 1 legacy litigation matter that came to closure in 2020, which was $7.5 million. And then the other factor that affected the comparison year-over-year is we sold, you saw it on a previous slide, we sold our Power Systems segment, our Fairbanks Morse Engine business, and it was a very successful divestiture, a significant gain on the sale. And that triggered significant taxes in 2020. And even though we accounted for Fairbanks Morse as a discontinued operation because tax is a total tax return for the company, all the taxes that we pay flow through cash from operations. So if you eliminate the tax delta year-over-year, the environmental delta and that litigation delta year-over-year. Our cash flow in 2020 was actually up 12% over 2019. And that's evidence of our disciplined approach to capital in response to what was happening in the world. So with that, I'm going to just maybe leave -- you can leave your slide on 17, which is just a wrap-up from what I talked about at the start of my remarks. And we have a few minutes for questions. So [indiscernible], I'll turn it back to you.

Thanks, Milt. Appreciate that. Yes, I guess I want to start off talking about your overall end markets, what you're seeing there. Obviously, you're very diversified by. You see a lot of different markets. This has been a bit of an unusual recession where the manufacturing economy generally has fared better than other parts of the economy. As you look forward to sort of the post-COVID environment. What are you seeing in terms of the key growth drivers in some of your key end markets?

Yes, that's a good question, [indiscernible], and that's a big area of focus for us, and I know most companies and most analysts, what does 2021 going to look like. And our view overall is it's shaping up to be a strong growth in most of our markets. And let me just take them one by one. I say -- before I do that, let me just provide a little context on what we saw in 2020 and also how we finished the year, specifically the fourth quarter. If you strip away the impact of acquisitions and divestitures to try to get at organic growth for 2020. Our growth for the year, our decline in sales for the year on an organic basis is about 11.5%. But if you look at the fourth quarter, fourth quarter year-over-year, we were down only about 1.5%. So the reason I wanted to mention this is it just provides evidence of the improvement that we were staying in our underlying markets as the year progressed. So Q3 was considerably better than Q2, and Q4 was better than Q3. So it's been encouraging to see the sequential improvement over the last couple of quarters. And it's also encouraging to see our current order patterns, which do reinforce this notion that many of our markets are going to see significant improvement in 2021. And I think all that's evidenced by our guidance of top line growth of 6% to 10% for the coming year. So let me just hit a couple of our more significant markets. I'll talk about semiconductor first. Semiconductor in '20 was 16% of sales. It would be on a pro forma basis, probably closer to 18% of our sales going into 2021. And there continues to be significant opportunity for growth in wafer production and much of our semiconductor business is tied to wafer production. We have a little bit that's tied to equipment, new equipment builds, but the majority of our earnings are driven in semiconductor are driven by wafer production. And just with advancements in chips going almost everything and with new nodes, 5-nanometer, now 3-nanometer going into some very, very highly technical applications. We think that 2021 is going to shape up to be another good year in semiconductor. '20 -- 2020 was a good year in semiconductor. So we think that continues. If you look at our heavy-duty truck exposure, it was 23% of 2020 sales. That will drop with the portfolio reshaping that we've done, the downsizing we've done in heavy-duty trucking. That will drop to the mid-teens, if you look at our exposure overall as a company. And we think it's set up very nicely. Our business in heavy-duty trucking is about 70%, 75% aftermarket on the balance OE. So the aftermarket business will be driven more by the general improvement in the economy. And the OE part of the business is going to be driven by new equipment builds new tractor -- I mean, trailer builds for us, more of OE exposures on trailers. And industry data suggests trailer builds could be up about 30%, 35% over 2020. So we think good growth in our trucking business, both because of improvements in the general economy as well as new trailer builds. Auto, we think, is going to rebound. We have exposure in auto and our Engineered Materials segment. We think there's going to be good improvement there year-over-year. And then I think the only 2 businesses where we have exposure that we expect continue to be a little soft, aerospace is one and oil and gas is another. We'll see what happens. A lot of speculation and data that suggests that, that oil and gas could improve as the year progresses in the second half of the year.

That's very helpful. And then maybe diving a little bit into your segments. Engineered Materials, you touched on sort of the soft help that you're trying to put in place here to improve margins. What time period are we looking at in terms of getting to that 20%-plus margins? And how much of it is sort of self-help versus a demand pickup in the overall industry?

That's a good question because in that segment, it will take a little of both. A lot of the work on the cost side has taken place or is in the process of wrapping up because we really did a lot of work. Our team did a lot of work in that area in 2020, both looking at our cost structure as well as our overall org structure and how we're running the business. So with help from volume, a recovery in automotive, recovery in European general industrial because our European exposure in this segment is higher than it is in the other 2 segments. So recovery in European auto, recovery in European industrial are big drivers in the business. And so I think it's going to -- to your question, Yuma, it's going to take both for us to take our margins up to meet our objectives of being at least 20% EBITDA as a percentage of sales. We have been at a peak of close to 18% at the high point in this segment. In the past, we have a better cost structure in place now than we did at that time. So I think that with both some improvements and overall volumes as well as the actions we've taken that we can get there. And to your question about how long? I think how long it's going to depend a little bit on how much recovery we see over the next couple of years because I think we need to get to -- back to pre 2019 volume levels, but that's just my view. I'm not going to underestimate the additional actions that our team might be able to take, but just looking at it for how we're positioned here currently.

And then looking at costs, one of the things that we're hearing a lot from industrial manufacturers is even costs from sort of input cost, material cost perspective, but also strains on the supply chain side. What are you seeing in your businesses?

Yes. It's another good question. There's definitely going to be some upward pressure on commodity prices in 2021. We've already seen it in steel. We're seeing it in other metals as well. We have a very well coordinated, orchestrated, centrally-managed supply chain effort. And we have not had in the past, our history would show that with our supply chain team, the efforts in place in managing commodities that we were able to manage successfully by looking out at commodity prices and buying ahead to lock in supply, number one; and number two, because of the nature of most of our revenue base, which is on the highly engineered side as opposed to our products selling into commodity markets. We do have the ability to respond with our customers as appropriate in rising commodity prices to pass those costs through. So while there might be some short-term disruption to cost structure. Overall, when we look at the period of time during rising commodity prices, those tend to be the periods when we perform better as a company. Because they're usually characterized by better economic activity in the overall economy. So that's one of the things that I've learned. When we go into a year where our net savings from supply chain efforts maybe are perhaps lower than in other years. Oftentimes, it means it's better economic times ahead. And overall, that's a good thing for our company.

And then on the environmental liability side, I mean you mentioned it a little bit I know I'm handicapping, so when you dissolve everything, it's a little bit difficult. But can you give us a sense for where you are in that journey in terms of resolving most of those liabilities?

Yes, that's a good question. If you go back and scan our 10-K for a number of years, you'll see that the space in our 10-K on environmental has gotten much skinnier than it was at one point in time. I want to emphasize that of all of the environmental matters that we're dealing with, most are in the steady state remediation phase where it's moderate. It's not a lot of money that we're spending year in, year out. We're executing on a remediation plan that's in place. And there only have been a handful of large environmental matters that we've had to address. Some involved third-party claims and some involve putting in new systems of remediation. And that's where the heavy cost have been and that very small handful of cases. So we have settled or resolved almost all of our big liabilities, and we have a plan in place with reserves now that we've made to address the couple of 2 or 3 remaining environmental legacy matters. So our environmental team has just done a tremendous job at dealing with these legacy liabilities, and then just doing the right thing, as a corporate citizen, doing the right thing and making sure that we're responding in a way that we can look back and be proud of efforts that we've taken to clean up the environment. And I would say, even though these are legacy environment. None of our operations that we have currently have any kind of significant or even meaningful environmental matters that we're having to deal with. So this is all falls into that bucket of legacy matters that will drop off. And as I mentioned, if you look at cash outflow, it affected free cash flow about $33 million in 2020. And in a couple of years for the next 4, 5 years, we're expecting to be low single digits. So it's -- that's just the -- that's the ultimate, I guess, evidence that we're successfully dealing with these and getting them behind us.

Thank you very much. That's all we have Milton, and appreciate you taking the time this afternoon. And we appreciate also investors listening in. And with that, we can end the webcast.