Enpro Inc. (NPO) Earnings Call Transcript & Summary

This is Matt Fields. I'm the high-yield metals and mining and industrials analyst for Bank of America. Thanks for joining us this year at 2021 Leverage Finance Virtual Conference. With me this morning is EnPro Technologies. And from the company, we have Milt Childress, Executive Vice President and CFO; Chris O'Neal, Interim President and CFO of Sealing Technologies; and Chris Ravenberg, Vice President and Treasurer. I think we're going to have a short overview of the company, and then we'll launch into some Q&A right after that. So Milt, if you're ready to take it away.

Yes. Good morning, everyone, or good afternoon if you're calling in from outside the United States. I want to thank you for the BofA team for inviting us to the conference this year, which we are talking with Matt. He has every expectation that next year, we'll be back in person, and we look forward to seeing you in person at that time. I want to spend just a few minutes talking about how each -- all of you have slides, and so I'm going to refer to just a couple of slides as part of the intro, and then we'll go back to Q&A and the fireside chat with Matt. I'm going to hit Slide 4, real quick because it's important to us as a company. We are a purpose driven company, strong values, our culture, our way of working means a lot to us. We think it's forward-thinking, and we believe that it's a way of driving our results and also driving the development of people as we drive results. So I want to start there, it means a lot to me, I was just on a town hall with people across our company right before this started, and you could just feel the difference that it makes and the way the culture works in our company and the collaboration and the ideas that come from the collaboration. So we refer to it as a dual bottom line, maybe it's a triple bottom line, but it's results, it's the development of people, and it's making a difference in the world. Moving on to Slide 5. The core elements of our strategy, I'll hit this real quickly, and then a brief description of the company and turn it back to Matt. So our strategy, you see the 4 prongs here. We are focused on high growth, high-margin industrial technology businesses with strong cash flow. We've been evolving as a company in very intentional way, and you've seen the results of that. For those of you who know us, in a pretty significant way over the past 2 or 3 years. I think we'll talk more about that as we get into Q&A with Matt. We are investing in faster-growing markets, while also maintaining a strong exposure to recurring revenue, whether you call it aftermarket or other forms of recurring revenue. We have a capability center where we're bringing best practices across our company with a focus on improving our margins and our cash flow return on operating capital. And we're maximizing shareholder returns through commitment to sustainability and disciplined capital allocation. We have many stakeholders that we balance the objectives and the needs of our various stakeholders as we do our work. Flipping over to the next slide. This will give you just a few facts about our company. We're headquartered in Charlotte. We've got about 20 principal manufacturing facilities, 4,400 employees. Market cap, as of to date this was published of $2.1 billion. You see our LTM revenue, our LTM EBITDA margin of 18.4%, and you see the balance on aftermarket that I was referring to earlier. We did pay a dividend, you see what the current yield is, at least based on the time this was published. We report in 3 segments Sealing Technologies, Advanced Surface Technologies and Engineered Materials. We have done a fair amount of work over the past couple of years in both Sealing Technologies and Advanced Surface Technologies and reshaping those parts of our businesses. We'll talk a little bit more about that, I'm sure, as we go. One of the things that I would say that really is descriptive across our entire portfolio of products, whether it's Sealing, Advanced Surface Technologies or Engineered Materials is that we serve critical applications. We help customers solve difficult problems and challenges through the products that we help customers design that we design ourselves, that we manufacture and bring to market, whether it's products or solutions. And the cost of our products and solutions are very small compared to what's at stake in the whole system that our products are going into. So we do have a number of different businesses and products, but I think they could all be described -- they could all fall into that general descriptor. And one of the other slides that I want to turn to before we get going, just to level set everyone, I want to flip over to Slide 15. I mentioned that we have been undergoing a significant reshaping of our portfolio over the past several years. You see on the left, the 4 elements of the strategy that I've talked about earlier. You see on the right some of the major transactions that have happened over this period of time. So you see a series of divestitures, many of these were in the heavy-duty truck part of our business, but also we sold one of our segments, our engine segment in the first quarter of 2002 sic [ 2020 ] to Fairbanks Morse, which is a significant divestiture. We've recently announced the divestiture of one of our major businesses, Compressor Products International and then a number of heavy-duty truck components and other Polymer Components, which was also in our Sealing Technologies segment. And then we've been building through technology, industrial technology businesses in the semiconductor and optical filtration spaces. Most recently, the announced acquisition of NxEdge, which was an $850 million transaction that we just recently announced and we expect to close by the end of the year. So I think this is important, as you think about who we are, the journey that we've been on, because there has been a fair amount of work in looking at our overall portfolio, reshaping who we are as a company. It's all been informed by our experience, it has been informed by mistakes we've made in the past as we're learning along the way. And I must say, I've been with the company for a long time, I've never been more excited than I'm today about where we stand. I think one more slide, and we'll turn it back to Matt. So go -- if you would flip to Slide 24. I cited earlier the LTM sales and the LTM EBITDA, this provides a pretty good snapshot of how we have evolved and how we look as a company, including the most recent divestitures that have been announced, the acquisitions that have either been completed in 2021 or in the case of NxEdge announced in 2021. So the pro forma column on the far right, it equates to the midpoint of our guidance for 2021, adjusted for the divestitures and acquisitions that were completed or announced in 2021 as if those transactions had happened in January 1 of this year. So you can see on that basis, $1.175 billion in sales for '21, about $250 million in EBITDA for 2021. And then as we leave '21 and going into 2022, with EBITDA margins of 21%. So that's a snapshot of financially of what we look like today with the benefit of all the portfolio reshaping that's happened. So Matt, with that, I will turn it back to you.

Thanks, Milt. Yes, I think you kind of led into sort of my first couple of questions here, which is going to go over the portfolio reshaping. In the last few years, you bought the Aseptic Group, LeanTeq, Alluxa, NxEdge. What are the commonalities among these M&A targets and kind of end markets, OEM versus aftermarket? Why these business?

Yes, thanks. That's a good question. We've been very intentional about the 4 elements of the strategy that I referred to earlier. So we've been very intentional about working on our existing portfolio of businesses to determine, can we drive margins, EBITDA margins above 20%. So a lot of our product portfolio pruning as well as our additions have been driven by -- there's been a financial element to them. There's a strategic element, there is the financial element. I'll start with the financial element, is that we have set a goal that as a company, we want in total to be EBITDA margins greater than 20%. And what we refer to as cash flow return on operating capital greater than 20%. And so we did a scrubbing of our portfolio a few years back. Chris O'Neal, who's on the call today, was part of that in addition to several other people, we scrubbed our portfolio and we looked at the potential of all of our existing businesses that we had at the time of whether we felt like we could get there. In many cases, we just did some serious work and we were successful in driving up and bringing up margins above our hurdle. But in some cases, we felt that the industry structure was so significant that it was going to be challenging to be able to reach those levels. And then that, in turn, drove a lot of the divestiture activity that you saw across a number of our businesses. So -- and then on the acquisition side, similarly, we were interested in moving into markets that have underlying faster growth, growing faster than GDP, which typically meant that there was a technology element to them. And in the case of Aseptic, it's about tech, the applications of serving and in case of LeanTeq and NxEdge. It's the semiconductor market, in the case of -- I guess I hit the major points there on acquisition. So any other follow-up questions to that, Matt? Matt, are you still there? Let me ask Chris O'Neal, Chris Ravenberg, can you hear me?

I can hear you okay. I was just going to ask the moderators on the…

Matt's getting a low bandwidth. I'll message him right now.

Okay. Well, I'll tell you what, let me go ahead and I will go back to some of the slides and highlight a few other points while we're waiting for Matt to rejoin. Give me one second. Let's go back to -- because I think this is what Matt was speaking to, to Slide 15 in the deck. We made a decision, when you look at our existing portfolio, 2 or 3 years ago, and I -- we had a semiconductor business that was tucked inside our Sealing Technology segment. And we added online to the semiconductor business in 2019, so about 2 years ago, a little over 2 years ago with the acquisition of a company based in Taiwan, with also a location in Milpitas, California, the company was LeanTeq. We completed that and LeanTeq expanded our semiconductor offering to, I would call it, very high-technology training services, where we clean the equipment that goes into producing wafers. It's a very critical step in the process. And then a year later, in the fourth quarter of last year, we closed on the acquisition of Alluxa, which is an optical filtration company. And there's some similarities, interestingly enough between optical filtration and the semiconductor industry and chip reduction. In terms of -- you start with a substrate and it's a matter of putting a lot of coatings on a substrate that either results in the buildup of ultimately a chip or in the case of filters, an optical filter. And so -- and Alluxa serves many markets, but including the semiconductor industry. And at the time we acquired Alluxa, we made the decision to take our semiconductor business and the optical filtration business out and formed what we call the Advanced Surface Technologies segment, to form a new segment, which provided greater visibility for our investors on our higher growth, higher technology businesses that we're building on. And so -- and then we followed that recently with the announced acquisition of NxEdge, which is our largest move to date, and this significantly expands about doubles our semiconductor business. NxEdge is very complementary to our semiconductor business. They have strength, significant strength of a leading-edge on coating technology. They are complementary with what we do with LeanTeq and other parts of the EnPro semiconductor business. So a few other thoughts, while we're waiting for Matt to come back on.

I just got back on. Sorry about that, it is a technology issue.

Okay. Back to you then.

Okay. And then my next question, if you didn't cover it was going to be on the divestment. I mean you addressed Fairbanks Morse and Polymer Components, Compressor Products. Just maybe talk about why these businesses were noncore. Why not -- why didn't these sort of serve to be part of the portfolio?

Yes. Let's start with Fairbanks Morse, which was divested about 2 years ago. It was very different. It was -- it was -- and characteristics were very different than the rest of our portfolio at the time. We weren't really sure what to do with that business. We were investing for some growth and some new wins in technology, it is very capital intensive business relative to our other businesses. And going back to my comments earlier on our financial criteria, we just did not believe that long term, it was a business that we wanted to continue to invest in because of that capital intensity. There's a little bit of an ESG element to it as well. We made medium speed diesel engines primarily for the U.S. Navy. And in the process of building and testing these facilities, we've burned a lot of diesel fuel. So we felt like really for both reasons that business would be better off in the hands of someone who wanted to continue to invest in the business because it wasn't going to get a lot of ongoing capital from EnPro. And we were very fortunate, Chris O'Neal, who's on the call, was running the Strategy and M&A team at the time, and our team did a terrific job and moving that forward in a very, very expedited way selling to a private equity group. And by the way, the business continues to prosper. So it's a real win-win. It's right thing for EnPro and the business has been successful of sale. So that was the rationale in the case of Fairbanks Morse. And that was pivotal because that was a fairly large divestiture. It's pivotal for giving us more fuel and capacity to expand in industrial technology businesses as we've done over the past couple of years. In the case of some of the divestitures in heavy-duty trucking, we had -- in the sake of growth, and this gets a little bit to some mistakes we've made in the past that we've learned from. In the sake of pursuing growth, we made a number of moves in heavy-duty trucking that took us into product categories that really were, I would say were structurally disadvantaged in terms of if you just look at the competitive playing field. If you look at the technology that goes in, the ability to command margins. And while not bad businesses by any means, they were not meeting our financial criteria. And so we made the painful decision to unwind some of those, and you saw a lot of that execution last year continuing into this year. And now we're back to a very profitable core business in heavy-duty trucking. It's part of our Sealing Technologies segment, significantly smaller than we were. So that was the story there. And then there have been a few other divestitures that we divested for several reasons. Businesses that we didn't believe that over time could meet our financial criteria.

Okay. That's really helpful. You mentioned in Sealing Technologies, you're still somewhat of an emphasis on trust, maybe less than you used to. But everybody has been talking about the chip shortage and sort of automotive production challenges. Can you talk about kind of what you're seeing in that end market and how that sort of global supply chain is working or not working as you see it?

Yes. I'm going to refer to one slide, then we'll turn it over to Chris O'Neal to address that question. If you turn to Slide 16, this slide shows our end market exposure. And the gray bar shows where we were in 2018. And the green bar 2021 pro forma, including the impact of the completed and announced acquisitions and divestitures. So you can see the big moves, semiconductor has gone from 7% and will be roughly 32% of our business. Heavy-duty trucking -- medium-duty trucking has gone from 25% in 2018 to about 15% on a pro forma basis in 2021. And then with the announced divestiture of CPI that takes our direct oil and gas exposure from 7% down to 3%. So I wanted just to highlight the significance of the moves that we've made that you see in heavy trucking, and then I'll turn it back to Chris to address your question about the chip shortage.

Good morning everybody. So I guess I would probably highlight 2 factors that we're dealing with in our heavy-duty truck business. One is the chip shortage, there's no doubt. The tractor OEs, in particular, are chip constrained and supply chain constrained overall, which is limiting tractor production. In fact, MacKay, which is one of -- and [ FER ], they are the 2 kind of industry organizations that attract demand have been lowering their forecast both for this year and into next year because of the shortages. I would say from our perspective, that we have absolutely no lack of demand. Our backlog is growing every month this year. And so we've been struggling with some supply chain shortages as well, mostly on the material side and bearings coming from China. I expect that over the next few months, that will abate and that we will start to catch up essentially, but really that the biggest inhibitor really to the business. We're just -- we're having a great year, just a matter of getting product.

Okay. Great. Understood. And then I think I'm moving over to Advanced Surface Technologies. A lot of people are talking about chips and semiconductors and kind of with this global chip shortage, how is your semiconductor businesses fit? How do they fit into this kind of phenomenon or this supply chain, if at all?

It's a significant way. So we do feel like we have some tailwinds that we will work hard as a team to take advantage of and be part of the solution going forward. I want to refer to one slide because it will give you an idea of some of the -- of where we're positioned. Let me go -- tell you what I'll just talk to it for the sake of time. We are positioned in the 2 parts of the world that are going to -- that we think will continue to get the most capital investment in terms of supporting increased wafer production. And that is in Taiwan and in the United States. So we established a position in Taiwan, which, as you know, is a major producer of wafers in the world with TSMC based there. And we established a base with the acquisition of LeanTeq a couple of years ago in Taiwan. And then we have an existing semiconductor business in the United States. And then we've just recently announced the acquisition of NxEdge, which adds significantly to our U.S. footprint. And so with all of the customer relationships that we have, we're well positioned to serve the 2 what we think will be the fastest-growing centers of wafer production in the world and that being Taiwan and the migration and the reshoring, so to speak, of wafer production in the United States. I'm sure many of you are aware that there have been announcements by TSMC, by Intel, by Samsung of plans and specific plans about establishing wafer production facilities in the United States with both Intel and TSMC announcing plans in Arizona and Samsung, I believe in Texas, near Austin. So we are -- our teams will be working with our customers to support those expansion in the United States. And it really plays well with where we're positioned. So we're looking forward to the next few years and being part of the solution and -- which we think is going to fuel the growth in this part of our business for several years.

Okay. And then maybe you can explain to us, we're just simple bond guys, maybe you can explain to us the nuance and the different businesses within this segment? The differences between Technetics versus LeanTeq versus Alluxa versus NxEdge and how the different businesses kind of complement different parts of the overall semi space?

Yes. Good question. I touched on this a little bit when I was dancing as you were having audio/video problems, Matt, and I'll come back to it. But we -- most of the work that we do is inside the chamber. So it's pieces of the equipment that's inside the chamber that help build the chips or the wafers throughout the semiconductor process. And with the -- with our existing semiconductor business, we made certain -- or we make and refurbish certain components that go inside the chamber. I'll use e-chucks, electrostatic chucks, as an example. And then -- but we also make some other products and do some other things related to the equipment that's inside the chamber. And I want to leave it at that at a high level because we're short on time. But when we added LeanTeq, we specifically were looking to move into the cleaning space and cleaning is a critical operation in the process and equipment needs to be cleaned on a regular basis because any contamination can destroy yields in the chip making process. And so the foundries, companies like TSMC will take equipment off-line periodically, send it out to be cleaned. And this is not a simple cleaning operation. It's very sophisticated. The inspection, the cleaning, it sometimes requires recoding in order to put the equipment back in place, in the foundry. And so we intentionally were looking for a way to expand into that part of the market, and we found just a great company in LeanTeq, which we added a couple of years ago. We've also been working on coating technology because coating technology is very important that is a way to extend the life of some of the components that are used in producing wafers. And we are developing our own coating tech -- we have our own coating technology, and we have been in discussions with NxEdge for a number of years. We did the company quite well. And when the opportunity presented to us, we were fortunate enough to be able to step in and make that work. And we're really looking forward to Jackson Chao, who's helped build that company and his team to join EnPro shortly in the next few weeks after the transaction closes. So that will add another capability that's important for the coating technology, which is a real strength. NxEdge is doing some other interesting things as well. Vertical integration, where they're offering customers an opportunity to essentially cut lead time half and eliminate the need to send products from United States to Asia, back to United States, back to Asia, maybe 2 or 3 round trips in order to complete the -- a piece of equipment that's going into wafer production. So there's some other things that -- that NxEdge is doing that are a very high interest to us that we think will be beneficial, especially with the growth in the United States.

Okay. Thank you for that. You've -- switching over to the balance sheet, you guided towards taking leverage up to 3.7x post the NxEdge close, which would fall to about 3.3 after the CPI divestiture. You've got a 2 turns leverage target, though. So how do you see kind of bringing leverage down to 2 turns following this acquisition?

Chris, do you want to -- Ravenberg, do you want to jump in and I'll add in any other comments that I have?

Yes. So Matt, you're absolutely right. And part of that initial step down will be the proceeds from the sale of our CPI business will give us that initial drop in leverage. And then as we look over the course of the next 18 months, the businesses that we have, and particularly with the addition of NxEdge will generate a good bit of free cash flow that we'll use to pay down debt. And then as we look across our business, in addition to free cash flow, what opportunities do we have from a portfolio perspective. But a big driver of that will be as we transform these businesses, you look at say getting rid of Fairbanks Morse that kind of capital-intensive business. Cash flows are more predictable, and we have higher free cash flow than we get in previous years. Milt, do you want anything to add there Milt?

No, I think you covered it well. Further portfolio optimization is a possibility. Nothing has been decided or [ finalized ] on that front. But that could be an accelerator, if we chose to go down the road.

Okay. And then I think maybe we have time for one more, but philosophically, maybe now with more predictable capital spending, less -- less capital intensity with Fairbanks Morse specifically out of the portfolio, maybe businesses that do generate higher cash flow is 2x kind of the right leverage target? Is it something that you go higher with the new shape of kind of the EnPro portfolio? Or how do you think about that?

Yes, that's a really good question because you're right, with more predictable cash flow and less cyclicality in our portfolio, it does give us an ability to operate on an ongoing basis with a little more leverage than we did in the past, perhaps. So I think we'll step back. We're still new in our portfolio reshaping. We need to execute, we need to see what the portfolio looks like when it generates. And then maybe over time, there's an opportunity to possibly live with a little bit more leverage, maybe we move it 2, 2.5 is the new range rather than 1.5 to 2. And -- gives us more opportunity to continue to invest in industrial technology businesses.

Okay, great. I think we're a few minutes over. I apologize for my tech issues, but thanks so much for joining us, everyone, and please join me in thanking Milt and Chris and Chris and the team from EnPro. We're happy to have you and next year in BOCA.

Great. Thanks, Matt.

Thanks, everybody.

Thanks, everyone. Bye-bye.