Q4 2023 Enpro Inc Earnings Call

Participants

James Gentile; Vice President - Investor Relations; Enpro Inc

Eric Vaillancourt; CEO; Enpro Inc

J. Milton Childress; Chief Financial Officer, Executive Vice President; Enpro Inc

Jeff Hammond

Steve Ferazani

Ian Zaffino

Presentation

Operator

Greetings and welcome to the EnPro Q4 2023 earnings conference call. (Operator Instructions) Please note this conference is being recorded.
I will now turn the conference over to James Gentile, Vice President, Investor Relations. Thank you. You may begin.

James Gentile

Thanks, Darrell, and good morning, everyone. Welcome to EnPro's Fourth Quarter and Full Year 2023 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 Vaillancourt, President and Chief Executive Officer; Milt Childress, Executive Vice President and Chief Financial Officer; and Joe Bruderek, Executive Vice President, Finance.
During today's call, we will reference a number of non-GAAP financial measures. Tables reconciling the historical 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 including our most recent Form 10 K. Also note that 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 Vaillancourt, President and Chief Executive Officer. Eric.

Eric Vaillancourt

Thanks, James, and good morning, everyone. Thank you for joining us today as we review our results for the fourth quarter and full year 2023 and provide a business update that includes our outlook for 2024.
Before we get started, I'd like to introduce introduce Joe rhetoric, who recently joined our team as Executive Vice President Finance. Joe will be succeeding Milt Childress as Chief Financial Officer on April first, and I will be standing through the end of May to ensure a smooth transition of finance leadership. We are delighted to have Joe join our team following his almost 25 years of senior financial and operational experience. This is an exciting time in our company's history, and I'm glad to have Joe's partnership. As we look to capitalize on the opportunities ahead, please join us in welcoming Joe and Pro.
We are pleased with EnPro's strong performance and execution in 2023 Sealing Technologies delivered strong performance, largely offsetting the negative year-over-year impact from the soft semiconductor market NAST.
In Sealing Technologies, we saw record segment profitability with adjusted segment EBITDA margins exceeding 29% for the year, despite a sequential decline in the fourth quarter that we anticipated and communicated on our third quarter call. We are very pleased with the underlying strength of the segment. Our team is positioning the business for future growth while maintaining our disciplined focus on profitability and continuous improvement. As TI revenue ended the year down roughly 16%, driven by weakness in the global semiconductor industry. Despite the drop in volume, adjusted EBITDA margins for this segment was approximately 24% for the year, clearly demonstrating the segment's value added capabilities and resilience, our multiyear strategy to drive growth in this attractive market. It remains unchanged. We reported $238 million in adjusted EBITDA for 2023, which is inclusive of $7.1 million in share price driven long-term incentive compensation expense. Given the downturn experienced in the semiconductor market throughout the year, we are pleased with the total NPI margins at 22.5%. We made meaningful meaningful progress on several long-term strategic initiatives this year, including the recently completed acquisition of Advanced Micro instruments or AMI, which broadens our Sealing Technologies segment capabilities into compositional analysis. We expect to leverage AMI's differentiated gas analyzer technologies across multiple industry segments. See any insight. We will gain into our customers' processes will expand our competitive advantage in designing seals in a variety of credit and a variety of critical solutions. We are excited to welcome our new colleagues and my colleagues can growth in AST.
During the year, we execute we continued to execute on our multifaceted strategy of technological differentiation, vertical integration and regional expansion, making significant progress on the phased buildout of our Arizona facility and expanding our capabilities in Asia. We are executing this expansion and strategic positioning in collaboration with key market leading customers in 2024, we anticipate additional investments in our semiconductor business to support what's widely expected to be a near doubling of the semiconductor market by end by around end of this decade. I'd like to take a moment to comment on our safety accomplishments. We strive to create an injury-free injury-free workplace as we deliver critical products and solutions to our customers, safety, which includes both physical and psychological safety is our number one core value. And for 2023, we are celebrating a 59% reduction in our total recordable incident incident rate as well as a 47% reduction in our lost time case rate. These outstanding results build upon our already world-class safety record and are well below the latest industry averages presented by the Bureau of Labor Statistics. I want to recognize our environmental health and safety leadership team and our colleagues across the company for these terrific results.
Before turning the call over to Milt to discuss our fourth-quarter results and 2024 guidance. I want to reiterate what I've said on many occasions. There is no better time to be part of and growth with our reshaped portfolio, generating excellent margins and cash flow. With a strong balance sheet, we are well positioned to drive continued growth through focused execution is together. We empower technology with purpose.

J. Milton Childress

Thank you, Eric, and good morning, everyone. In the fourth quarter, sales of 249.1 million decreased 8.4% and organic sales declined 9%, driven primarily by lower results in the AST. segment due to ongoing softness in semiconductor. The decrease also reflects lower results in Sealing Technologies segment where we saw a sharp decline in the commercial vehicle OEM market and lower demand in general and industrial, commercial, aerospace and pharma markets. As a reminder, we posted very strong results in Sealing in the fourth quarter of last year. Fourth quarter adjusted EBITDA of 46.9 million decreased roughly 12% compared to the prior year period. And adjusted EBITDA margin of 18.8% decreased 80 basis points year over year. Volume declines just noted were partially offset by strategic pricing, cost mitigation and continuous improvement initiatives.
Results for the quarter were also adversely affected by $6.4 million of incremental long-term incentive compensation expense tied to our strong share price performance during the fourth quarter by comparison in the fourth quarter of 2020 to share price driven long-term incentive compensation expense was 4.8 million. We do not contemplate compensation expenses related to share price changes when determining guidance as such the incremental long-term compensation expense of $6.4 million during the fourth quarter of 2023 was not considered when providing prior 2023 guidance commentary, modifications made to the long-term incentive compensation program during 2023 will lessen this impact in 2024 and eliminate the impact in years thereafter.
Corporate expenses of 14.4 million in the fourth quarter of 2023 were down from $15.6 million a year ago, primarily due to lower total compensation expense. Adjusted diluted earnings per share of $1.19 decreased 8.5% compared to the prior year period, largely because of the decline in adjusted EBITDA, partially offset by a 35% reduction in net interest expense driven by debt repayment during the year and higher interest income on cash balances. The previously noted 6.4 million share price driven incentive compensation expense in Q4 equates to around $0.23 per share.
Moving to a discussion of segment performance. Sealing Technologies sales of 147 million decreased 6.3% during the quarter, we saw a sharp decline in commercial vehicle OEM sales as well as softness in our general industrial aerospace, pharma and commercial vehicle aftermarket demand softness in these markets was partially offset by strategic pricing actions and continued strength in nuclear energy. Excluding the impact of foreign currency translation and our divested business, sales decreased 7.5% in the quarter for the fourth quarter adjusted segment EBITDA decreased 6.3%, in line with the sales decline, resulting in adjusted segment EBITDA margin being flat with last year. Excluding the impact of foreign exchange and divestitures. Adjusted segment EBITDA decreased 7.9%. Ceilings margin performance through a sales decline reflects the benefits of strategic pricing actions, cost mitigation efforts and ongoing 80 20 pruning across the segment. As Eric noted earlier, we are pleased with the progress made over the past few years in rationalizing the Sealing Technologies segment, and we will continue to invest in targeted growth opportunities while maintaining cost discipline and continuous improvement.
Turning to Advanced Surface Technologies. While we saw sequential improvement from the third quarter fourth quarter sales of $102.1 million decreased 11.5% over the prior year, driven by continued weakness in semiconductor capital equipment spending, our Cleaning Solutions business tied to advanced node chip production was a bright spot in the quarter and throughout the year. So we saw stabilization in the optical filter business with improved profitability during the quarter.
For the fourth quarter adjusted segment EBITDA decreased approximately 21% versus the prior year period. Adjusted EBITDA margin of 22.4% improved sequentially. And as Eric mentioned earlier, finished the year close to 24%. The volume decline in addition to mix, material cost increases and increased operating expenses supporting growth investments were the primary drivers of the year-over-year reduction in profitability offset in part by cost mitigation efforts and pricing actions. We continue to invest in AST. as the long-term growth opportunities in the segment far outweigh the recent market headwinds phased update of our facility in Arizona is ongoing. And as Eric noted, we are expanding our capacity in Asia. We are well-positioned to see a bright future ahead for the segment Turning to the balance sheet and cash flow, our balance sheet remains very strong. Subsequent to quarter end and late January, we closed the ATMI acquisition using 210 million of cash. Our net leverage ratio, inclusive of the acquisition stands at approximately two times 2023 adjusted EBITDA. With our reshaped portfolio, we continued to generate substantial cash free cash flow in 2023 was over 174 million compared to about 77 million in the prior year. Working capital management across the Company and lower cash taxes were key drivers of cash flow during 2023. In addition to the stellar results in Sealing Technologies, we have strong financial flexibility to execute our strategic initiatives, both organically and through strategic acquisitions that broaden our capabilities. Our goal is to build upon our leading edge positions in markets with secular growth drivers that Safeguard critical environments and applications that touch our lives every day.
During 2023, we paid a $0.29 per share quarterly dividend totaling 24.3 million for the year. On February 15th, our Board approved another increase to the quarterly dividend to $0.3 per share, representing the ninth consecutive annual dividend increase since we initiated a quarterly dividend in 2015.
Moving now to our 2024 guidance. Taking into consideration all the factors that we know currently, we expect total and Pro sales growth to be in the low to mid-single digit range in 2024, we expect adjusted EBITDA to be in the range of 260 million to 280 million and adjusted diluted earnings per share to range from seven to $7.80 per share. Normalized tax rate used to calculate adjusted diluted earnings per share remains at 25% and fully diluted shares outstanding are approximately 21 million. Capital expenditures are expected to be approximately 60 million or around 5% of sales in 2024 as we continue to invest in compelling future growth opportunities across the Company. Two thirds of this capital spending for 2024 will be in support of growth investments on focus leading edge platforms in the Advanced Surface Technologies segment in AST., we expect continued demand in the first half. Should we expect continued demand weakness in the first half of 2024 after seeing sequential improvement in AST. in the fourth quarter of last year. Based on current backlog and order patterns, we anticipate results to decline sequentially in the first quarter of this year. We believe the first quarter will represent the bottom of the semiconductor decline for our business, with adjusted EBIT top EBITDA about 5% to 10% below Q3 of last year, while capital spending typically lagged unit growth after a trough and approximately two thirds of our semi sales are driven by equipment builds. With the remaining one-third tied to wafer production. We are well positioned when capacity utilization improves and capital spending recovers.
In the Sealing Technologies segment, we anticipate normal seasonality to return this year, resulting in incrementally stronger first half of the year compared to the second, the largest portion of segment revenue follows trends in global industrial production and North American commercial vehicle production. Although we have growing exposure to faster-growing markets such as aerospace space, sustainable power generation and pharma. As Eric noted, the acquisition of AMR will be accretive to Susan's results, both in the coming year and longer term. In commercial vehicle. The sharp decline in OEM demand anticipated this year is expected to be partially offset by improved after our aftermarket mix and new product advancements as the year progresses. According to industry forecasts, commercial vehicle trailer builds are expected to decline 25% in 2024. As a reminder, approximately one-third of our commercial vehicle market, our commercial vehicle business is tied to OE and trailer builds with the balance serving the aftermarket.
Also of note, for the C&I segment, in 2024, we expect a smaller impact from strategic pricing initiatives compared to 2023. We have made progress over the past several years, optimizing and repositioning the Sealing Technologies segment, resulting in significant improvements in the composition and profitability of the segments. We are well positioned currently and will continue to invest in various pockets of growth, focusing on broadening broadening the segment's capabilities with select inorganic moves over time. We believe the timing of an upturn in our semiconductor business and to a lesser degree, the magnitude of the decline in commercial vehicle trailer builds as well as trends in global industrial production will be a primary swing factors driving our performance in 2024. The mid to high end of our guidance range reflects a robust second half recovery in our semiconductor business, while the lower end reflects the possibility of the uptick happening later. Regardless of the precise timing, we are well-positioned for the widely expected upturn, and we are making the appropriate investments to drive future growth and value.
Now I'll turn the call back there for a few closing comments.

Eric Vaillancourt

Now we continue to demonstrate our best-in-class balanced portfolio that generates attractive margins and cash flow returns in a variety of economic environments. Our value-creating strategy remains unchanged, and we continue to invest where we have the strongest while considering strategic acquisitions to build upon our leading edge capabilities.
I'd like to recognize the hard work of all of our colleagues across the Company as we continue to differentiate ourselves in a disciplined and consistent fashion.
Thank you for joining us today. We appreciate your interest in EnPro. We'll open the line to questions.
Thank you.

Question and Answer Session

Operator

(Operator Instructions) Jeff Hammond with KeyBanc Capital Markets. Please proceed with your question.

Jeff Hammond

Hey, good morning, everyone. Congrats, welcome aboard, Joe and congrats. Mitch, on sounds like we might hear from you one more time. Just wanted to dig into the organic guide. It looks like am I is maybe included, so I'm kind of getting down one to up one. I'm just trying to clarify that man. Maybe how to think about the organic growth for each of the segments embedded in the guide?

Eric Vaillancourt

Yes, Jeff, hey, I'll take the AMR question and then we can go back and forth a little bit on the segments. So one for Dana, when we announced the deal, we had indicated that we paid approximately 13 times EBITDA calculation at a price.
That gives you a general idea of what the run rate earnings for the business has been prior at or at the time of the acquisition. And so when you take into account this year, which is a partial year, we'll have it for most of the year, but it's not a full year and some one-time integration costs that will work their way through in fairly short order. That will give you a general indication of what we've included and the 250 to 200 a million dollars EBITDA guide. So yes, that that that puts brackets in capital than the low to mid 10s of EBITDA contribution for the year.
In terms of the organic growth guide on, you know, with the balance in Sealing and the sharp decline in the commercial vehicle OEM market you can expect kind of flat plus or minus a little bit excluding AMI and Advanced Surface Technologies. As we said in the prepared remarks, the second half is expecting kind of a more brisk recovery, but we still expect some softness to persist through the first half of 2024. So the yes, I'll go ahead and weigh in with a little more clarification on what you'd like to like to hear about the segments and in terms of guidance.

Jeff Hammond

So okay. So yes, just sort of midpoint of the guide says soft 1Q, that's the bottom for ASP. And then I think, James, you said brisk inflection in the second half and then yes, I guess the lower end contemplates maybe a slower recovery. Is that is that fair to say?

Eric Vaillancourt

Yes, you got it. And then to a lesser degree what we see in commercial vehicle markets up for the year and then just the overall economy, obviously. But the big kind of a big swing factor is going to be the pace of take-up for our business. And semiconductor were already starting to see green shoots, you've heard it from most companies is depends on where you play and where you're positioned in industry and it will come it will happen for us. We're just we're just working through the site cycle for our business.
And Jeff, John, Joe and I took a tour of our West Coast facilities a week ago, and we're seeing some optimism that typically would during the peak, I'd say we're making 20 parts a week and then through the trough for making Tennant. And now it seems like we're making 12 or 13 as an example. So you're seeing that momentum and team customers who haven't purchased in a long time. So I think we're starting to see the supply chain come back into balance where they've been destocking before. So we're seeing a little bit of optimism basically in every facility around, but it's still going to be a while before we see a full recovery Okay, great.

Jeff Hammond

That's helpful. And then just sealing up pretty kind of start decline here in 4Q. I don't know if you saw some destocking or if that's just that the commercial OE, it appears, but but maybe just how should we think about that persisting into the into the first part of the year, that kind of organic revenue decline and it's mostly driven by the commercial OE and trailer builds that we started to see in the fourth quarter.

Eric Vaillancourt

And then we saw a general slowness just in industrial production and really starting in December, October, November were actually where we expected. And then December, we started to see some falloff, but nothing significant other than I would say, industrial production and the commercial vehicle decline at the clear variations in commercial vehicle OEM decline quarter over quarter.

Jeff Hammond

I'll get back in queue.

Operator

Steve Ferazani with Sidoti. Please proceed with your questions.

Steve Ferazani

Morning, everyone. On stage. I guess what I wanted to follow up a little bit on the previous question for 4Q. The guidance had beyond 2023 sales would be relatively flat to 2022. So obviously, your 4Q sales kind of disappointed internally. Can you can you specifically point out on where it was primarily commercial vehicle. Were there other places where you were disappointed?

Eric Vaillancourt

Well, it really is commercial vehicle OEM and then the continued softness in semiconductor and AST., although at the time of our Q3 call, we did anticipate that that we would see some sequential improvement, which we did see in the fourth quarter. And the commentary around guidance that we made in Q3 is that we anticipated being at the low end of our previously stated guidance range. And when you take into account the $6.4 million of tunnels refining and melt. I'm just referring to sales and just for sales of Gail's.

Steve Ferazani

Yes, I'll stop there. And then back to the point of so if I take out AMI, I guess to the previous questions, you're looking at relatively flat 24 again, where do you see some potential if the upside purely on an earlier recovery or SME or where else do you see some some potential benefits in 24 if we see some upside in space?

Eric Vaillancourt

Of course, the biggest thing will be the semiconductor rebound that will be the biggest again far, but we see some optimism. And pharma seems like some that's I would say, recovering from the bottom as well, but it's going to be slow growth.
And Steve, what you'll remember is if you look at just the cadence of AST. last year and notwithstanding some of the weakness we saw in part of the business starting in Q4 of 22. We did have a relatively strong first quarter, second quarter of the year before things turned down. And I mean you're in a demonstrable way in Q3. So part of what you're seeing now is working through the trough, which is going to be a year-over-year decline. And that's the reason that for the year, it's flattish on sales.

Steve Ferazani

Yes, any reason why Q1 for AST. is worse than Q4, it's just order. The order patterns and the kind of guy, I think lost in value from that initiative in Q4 because Q4 was much better than Q. three, as you noted on AS. to get anything specifically hit in AST., it was just that was the order pattern just the order pattern, there's nothing specific. Stop to CapEx, guidance was a little higher than I would have expected. Can you just point to where specific investments coming in 24?

Eric Vaillancourt

Yes, we have several projects. We want to name a small, but. Well, yes, basically geographic expansion. When you look at it, obviously, as our investment in Asia, we also continue active upfit, our Arizona facility, Joe and I were there last week, we expect to start testing in the second half of this year and be ready for revenue as soon as our customers are somewhere in 25. And so we continue to make investments there. And then you'll see some geographic expansion and capabilities to Asia.
And you look at two of the key prongs, Steve, with our semiconductor strategy that's been in place in oh four of that a part of a decade. It's technology differentiation and geographic diversification are two of the pillars to the three pillars. So so these these investments are really supporting both of those both geographic expansion and they just keeping us on the leading edge, whether it's expansion and what we're doing on the cleaning side of our business or its machining capability that give us our capabilities that that differentiate ourselves from others in the industry, we can if I could just get one more in the US retail investing in areas to support kind of new product development and efficiency projects, modernization, et cetera.

Steve Ferazani

And then given given the higher CapEx in 24 and the overall guidance and any kind of thoughts you could provide on kind of expectations for cash flow in 20 for cash conversion or anything around that well, I would say roughly roughly in the $120 million range for the year is what we would expect. And I mean no change on that on your operating cash flow. And any changes in your capital allocation plans beyond the net of your CapEx?

Eric Vaillancourt

Now it's investing to take advantage of the organic growth that is before us in AST. and then sealing. It's continue to invest in pockets of growth in markets that are growing faster than the overall economy. Our strategy remains the same.

Operator

(Operator Instructions) Ian Zaffino with Oppenheimer.

Ian Zaffino

Hey, good morning. This is accounted for in. Thanks for taking our questions. First, on ceilings, I guess outside of the volume weakness you'll see in commercial vehicle. Could you maybe touch on the aftermarket side and how you expect that portion to business for the year and then maybe what are you seeing as far as pricing there and do you expect to make some pricing or to maintain some pricing power as we move through the year?

Eric Vaillancourt

And aftermarket sales are strong and will continue to be strong. Usually when you see, though we unbilled go down, you end up having more maintenance. And so the aftermarket is still very good. The mix does change in the mix is helpful to us, but we certainly need a certain amount of volume that also drive outstanding profitability there. But overall, that business is strong and continuing to do well and really don't have any concerns once the market recovers and OEM piece in terms of pricing, the aftermarket pricing will hold and we'll give a little bit back when not much in the OEM piece here or there over time as they get that this won't surprise you because it's just true for all companies.
The environment for pricing is not the same. The backdrop for pricing is not the same as currently as it was a year ago, 18 months ago just because of moderating inflation. So just to note that too, it's unlikely we see the same year-over-year impact from pricing as you saw in 2023.

Ian Zaffino

Yes, that makes sense. Thank you. And then just as a follow-up and could you discuss the Avon acquisition and the growth profile of that business?

Eric Vaillancourt

Maybe as we look at it for this year and the longer term growth algorithm compared to it may be some of the other ceilings industrial end markets.
And we see a and I had a kind of mid mid single digit growth, rough roughly maybe a little a little bit more, and that positions us in with new capabilities and compositional analysis that we're quite excited about.
The primary focus of the business currently is on midstream oil and gas, although we the company does sell into other industry segments and part of our excitement is that tape, compositional analysis and other applications.

Ian Zaffino

Perfect. That's all I had. Thanks much.

Operator

Jeff Hammond, KeyBanc Capital Markets.

Jeff Hammond

Hey, guys. Just a couple of follow-ups here. Just to I'm a am I maybe just talk about I know the financial metrics make a lot of sense, but let's just talk about fit within the business and how you think of it.
I think it's in the Sealing segment. But and then just I think, Milt, you said mid-single digit growth. I thought the historical growth rate was was higher than that. Maybe just clarify what what am I has been growing at the last four or five years?

J. Milton Childress

You're right, Jeff, the I'll take the last first and then turn it to Eric to talk a little bit more about A-Mark. But Doug, the historically the Company has grown considerably faster than that. If you look at the market, the underlying market growth, it's up kind of mid-single digit growth. And I think maybe we had indicated at that point, we'll obviously aspire to do better than that. Part of the Company's historical growth rate is a function of the size of the company as it's ramped up with new product introductions when the bid when the company was relatively small, then then incremental revenue from new product introductions adds a lot on a percentage basis to sales. And as the Company gets larger, obviously, it doesn't have quite the same impact. But we do have some exciting new are we the A. and my team does have some exciting new products that we expect to be introduced in the market in the next year or so.
And we can we put it in Sealing because it can have it can affect both Technetics and Garlock, both when you look at the oxygen sensor or interest sensors and H2S, I think we have a variety of applications including food and pharma, general industrial. So there's lots of application work spread out throughout the Company. So it fits nicely into ceilings.
And then just on the ceiling margins, you know, really phenomenal year. And maybe just how should we be thinking about kind of long term margins? And if we see the soft patch that you saw in 4Q kind of extend. I'll just speak to the resiliency of the margins in any kind of E&O slowdown.
And I think, you know, longer term, I think that, you know, we have definitely gone through a very successful reshaping of the of the segment that enabled us to exceed our previous long-term forecast of 25% through a cycle.
And I'll give it to Eric in terms of the drivers moving forward, we've commented before, I think back in the third quarter that we were looking at somewhere around 28 plus or minus a little bit and I think it will still be in that range. It really depends on mix. And so depends on industry mix, and that's really the biggest driver of mix and volume. But overall, I expect the margins to hold similar to where they are now. Okay.

Operator

We have reached the end of our question and answer session, and I would now like to turn the floor back over to James Kelly for any closing remarks.

Eric Vaillancourt

Thank you for joining us today and have a good day.

Operator

This does conclude today's teleconference. We appreciate your participation. You may disconnect your lines at this time and enjoy the rest of your day. Yes.