Greetings. Welcome to the Enpro Q4 2023 earnings conference call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. 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.
Thanks, Jarle, 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, our 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 re-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, our President and Chief Executive Officer. Eric?
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 Joe Bruderek, who recently joined our team as Executive Vice President Finance. Joe will be succeeding Milt Childress as Chief Financial Officer on April 1st. Milt will be staying 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 to Enpro. 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 a soft semiconductor market in AST. 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 underlying strength of the segment and how our team is positioning the business for future growth while maintaining our disciplined focus on profitability and continuous improvement. AST 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 multi-year strategy to drive growth in this attractive market 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 Enpro margins at 22.5%. We made 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. The unique insight we'll gain into our customers' processes will expand our competitive advantage in designing seals in a variety of critical solutions. We are excited to welcome our new colleagues, AMI colleagues to Enpro.
In AST, during the year, 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 around the end of this decade. I'd like to take a moment to comment on our safety accomplishments. We strive to create an 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 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 U.S. 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 Enpro. With our reshaped portfolio generating excellent margins and cash flow, and with a strong balance sheet, we are well positioned to drive continued growth through focused execution as, together, we empower technology with purpose. Milt?
Thanks, 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 the Sealing Technologies segment, where we saw a sharp decline in the commercial vehicle OEM market and lower demand in general 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 2022, 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 a 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 an Adjusted Segment EBITDA margin being flat with last year. Excluding the impact of foreign exchange and divestitures, Adjusted Segment EBITDA decreased 7.9%. Sealing's 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. We also 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. The phased upfit of our facility in Arizona is ongoing, and as Eric noted, we are expanding our capacity in Asia.
We are well positioned and see a bright future ahead for this segment. Turning to the balance sheet and cash flow, our balance sheet remains very strong. Subsequent to quarter-end in late January, we closed the AMI 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 continue 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 $0.30 per share, representing the ninth consecutive annual dividend increase since we initiated quarterly dividend in 2015. Moving now to our 2024 guidance. Taking into consideration all the factors that we know currently, we expect total Enpro 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-$280 million, and Adjusted Diluted Earnings Per Share to range from $7-$7.80 per share.
The 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 focused leading edge platforms in the Advanced Surface Technologies segment. In AST, we expect continued demand in the first half oh, excuse me, 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 EBITDA about 5%-10% below Q3 of last year. Capital spending typically lags unit growth after a trough, and approximately 2/3 of our semi-sales are driven by equipment builds, with the remaining 1/3 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 AMI will be accretive to Sealing'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 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 1/3 of our commercial vehicle business is tied to OEM trailer builds, with the balance serving the aftermarket. Also of note for the Sealing 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 segment.
We are well positioned currently and will continue to invest in various pockets of growth while focusing on broadening the segment's capabilities with select inorganic moves over time. We believe the timing of an upturn in our semiconductor business, to a lesser degree the magnitude of the decline in commercial vehicle trailer builds, as well as trends in global industrial production, will be the 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 to Eric for a few closing comments.
Thanks, Milt. 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 are the strongest while considering strategic acquisitions to build upon our leading edge capabilities. I would 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. We will now be conducting a question-and-answer session. If you would like to ask a question, please press star one on your telephone keypad. A 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. One moment, please, while we pull for your questions. Our first questions come from the line of Jeff Hammond with KeyBanc Capital Markets. Please proceed with your questions.
Hey, good morning, everyone. Congrats. Welcome aboard, Joe, and congrats, Milt. Sounds like we might hear from you one more time.
Yeah, I think that'll be the case. I'll be in the room next quarter.
Great. Great. Just want to dig in the organic guide. It looks like AMI is maybe included, so I'm kind of getting down 1 to up 1. I'm just trying to clarify that and then maybe how to think about the organic growth for each of the segments embedded in the guide.
Yeah. Jeff, hey, I'll take the AMI question, and then we can go back and forth a little bit on the segments. So with AMI, when we announced the deal, we had indicated that we paid approximately 13x EBITDA at a $220 million price. So that gives you a general idea of what the run rate earnings for the business has been prior or at the time of the acquisition. And so when you take into account this year, which will be 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'll work their way through in fairly short order, that will give you a general indication of what we've included in the $260-$280 million EBITDA guide.
That puts brackets in kind of the low-to-mid teens of EBITDA contribution for the year.
In terms of the organic growth guide, 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. In 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.
Okay. So
Is that?
Yeah.
Oh, go ahead.
Go ahead. Go ahead, Ian, with a little more clarification on what you'd like to hear about the segments in terms of guidance, Jeff.
Okay. So yeah, just so the midpoint of the guide says soft Q1, that's the bottom for AST. And then I think, James, you said brisk inflection into second half. And then I guess the lower end contemplates maybe a slower recovery. Is that fair to say?
Yeah, you got it. And then to a lesser degree, what we see in commercial vehicle markets for the year and then just the overall economy, obviously. But the big kind of the big swing factor is going to be the pace of pickup for our business in semiconductor. We're already starting to see green shoots. You've heard it from other companies. It just depends on where you play and where you're positioned in the industry, and it will happen for us. We're just working through this cycle for our business.
Hey, Jeff. Joe and I took a tour of our West Coast facilities a week ago, and we're seeing some optimism that typically during the peak, let's say we were making 20 parts a week, and then through the trough, we're making 10. And now it seems like we're making 12 or 13, as an example. So you're seeing that momentum and seeing customers 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, at every facility we're at, but it's still going to be a while before we see the full recovery.
Okay. Great. That's helpful. And then just Sealing, pretty kind of stark decline here in Q4. Don't know if you saw some destocking or if that's just the commercial OEM piece, but maybe just how should we think about that persisting into the first part of the year, that kind of organic revenue decline?
Yeah. It's mostly driven by the commercial OEM trailer builds that we started to see in the fourth quarter. And then we saw general slowness just in industrial production, really starting in December, October and November, 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.
But the clear variance was the commercial vehicle OEM decline quarter-over-quarter.
Okay. I'll get it back in queue. Thanks.
Thank you. Our next questions come from the line of Steve Ferrazzani with Sidoti. Please proceed with your questions.
Good morning, everyone.
Hey, Steve.
I guess I wanted to follow up a little bit on the previous questions. Just for Q4, the guidance had been 2023 sales would be relatively flat to 2022. So obviously, your Q4 sales had to have disappointed internally. Can you specifically point out was it primarily commercial vehicle? Were there other places where you were disappointed?
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 we would see some sequential improvement, which we did see in the fourth quarter. The commentary around guidance that we made in Q3 is that we anticipated being at the low end of our previously stated guidance range. When you take into account the $6.4 million of.
I'm just referring, Milt. I'm just referring to sales. I'm just referring to sales.
Sales. Okay. Okay. Yeah, I'll stop then.
Then back to the point of so if I take out AMI, I guess, to the previous questions, you're looking at relatively flat 2024 again. Where do you see some potential? Is the upside purely on an earlier recovery or semi, or where else do you see some potential benefits in 2024?
We see some upside in space. Of course, the biggest thing will be the semiconductor rebound. That'll be the biggest thing by far. But we see some optimism in pharma. It seems like 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, notwithstanding some of the weakness we saw in part of the business starting in Q4 of 2022, we did have a relatively strong first quarter, second quarter of the year before things turned down in a more 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 flat-ish on sales.
Okay. Any reason why Q1 for AST is worse than Q4?
It's just the order patterns and backlog.
Okay. Anything specifically hit in Q4? Because your Q4 was much better than Q3, as you noted on AST. Did anything specifically hit in AST, or that was the order pattern?
Just the order pattern. There's nothing specific.
Okay. Okay. The Capex guidance was a little higher than I would have expected. Can you just point to specific investments coming in 2024?
Yeah. We have several projects. Do we want to name them? Small? Well.
Well, yeah.
It's basically geographic expansion when you look at it. You see our investment in Asia. We also continue to 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 2025. And so we continue to make investments there, and then you'll see some geographic expansion to add capabilities to Asia.
You look at two of the key prongs, Steve, of our semiconductor strategy that's been in place for a better part of a decade. It's technology differentiation and geographic diversification are two of the three pillars. And so these investments are really supporting both of those. It's both geographic expansion and just keeping us on the leading edge, whether it's expansion in what we're doing on the cleaning side of our business or it's machining capability that give us capabilities that differentiate ourselves from others in the industry.
Okay. If I could just get one more in.
Technology is, we're still investing in areas to support kind of new product development, efficiency projects, modernization, etc.
Given the higher Capex in 2024 and the overall guidance, any kind of thoughts you can provide on expectations for cash flow in 2024, cash conversion, or anything around that?
Well, I would say roughly in the $120 million range for the year is what we would expect.
Great. And anything changing on your.
That's Free Cash Flow. Free Cash Flow.
Yeah. Right. And any changes in your capital allocation plans beyond the head of your Capex?
No. It's investing to take advantage of the organic growth that's before us in AST. And then in Sealing, it's continued to invest in pockets of growth in markets that are growing faster than the overall economy. So strategy remains the same.
Thanks, Eric. Thanks, Eric. Thanks, Milt. Thanks, James.
You're welcome, Steve.
Thank you. As a reminder, if you would like to ask a question, please press star one on your telephone keypad. Our next questions come from the line of Ian Zaffino with Oppenheimer. Please proceed with your questions.
Hey. Good morning. This is Isaac Sellhausen on for Ian. Thanks for taking our questions. The first is on Sealing. I guess outside of the OEM weakness you'll see in commercial vehicle, could you maybe touch on the aftermarket side and how you expect that portion of the business to perform for the year? And then maybe what are you seeing as far as pricing there, and do you expect to maintain some pricing power as we move through the year? Thanks.
Yeah. The aftermarket sales are strong, and they'll continue to be strong. Usually, when you see the OEM builds go down, you end up having more maintenance. And so the aftermarket is still very good. The mix does change, and the mix is helpful to us, but we need a certain amount of volume to 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 on the OEM piece. In terms of pricing, the aftermarket pricing will hold, and we'll give a little bit back, but not much, in the OEM piece here or there over time.
Isaac, this won't surprise you because it's true for all companies. The environment for pricing is not the same. The backdrop for pricing is not the same currently as it was a year ago, 18 months ago, just because of moderating inflation. So just to note that. So it's unlikely we see the same year-over-year impact from pricing as you saw in 2023.
Yeah. That makes sense. Thank you. And then just as a follow-up, could you discuss the AMI acquisition and the growth profile of that business, maybe as we look at it for this year and the longer-term growth algorithm compared to maybe some of the other sealing, industrialized markets? Thanks.
Yeah. We see AMI at kind of mid-single-digit growth, roughly, maybe a little bit more. But it positions us with new capabilities in compositional analysis that we're quite excited about. The primary focus of the business currently is on kind of midstream oil and gas, although the company does sell into other industry segments. And part of our excitement is to take compositional analysis into other applications.
All right. Perfect. That's all I had. Thanks so much, guys.
Thank you. Our next questions come from the line of Jeff Hammond with KeyBank Capital Markets. Please proceed with your questions.
Hey, guys. Just a couple of follow-ups here. Just on AMI, maybe just talk about. I know the financial metrics make a lot of sense, but just talk about fit within the business and how you think of it. I think it's in the Sealing segment. And then just I think, Milt, you said mid-single-digit growth. I thought the historical growth rate was higher than that. Maybe just clarify what AMI has been growing at the last four or five years. Thanks.
You're right, Jeff. I'll take the last one first and then turn it to Eric to talk a little bit more about AMI. But historically, the company has grown considerably faster than that. If you look at the underlying market growth, it's kind of mid-single-digit growth. And I think maybe we had indicated at that at one 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 company was relatively small, then incremental revenue from new product introductions adds a lot on a percentage basis to sales. And as the company gets a little larger, obviously, it doesn't have quite the same impact.
We, the AMI team, does have some exciting new products that we expect to be introduced in the market in the next year or so.
We put it in Sealing because it can affect both Technetics and Garlock, both. When you look at the Oxygen Sensors and Moisture Analyzers and H2S, they can be used in a variety of different applications, including food and pharma, General Industrial. So there's lots of applications for it. Spread that throughout the company so it fits nicely into Sealing.
Okay. And then just on Sealing margins, really phenomenal year. Maybe just how should we be thinking about kind of long-term margins? And if we see the soft patch that you saw in Q4 kind of extend, just speak to the resiliency of the margins in any kind of slowdown.
I mean, I think longer term, I think that we've definitely gone through a very successful reshaping 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. Well, we've commented before, I think back in the third quarter, that we were looking at somewhere around 28 ± a little bit. I think it'll still be in that range. It really depends on mix. So it depends on industry mix. That's really the biggest driver, mix and volume. But overall, I expect the margins to hold similar to where they are now.
Okay. Thanks.
Thank you. We have reached the end of our question-and-answer session. I would now like to turn the floor back over to James Gentile for any closing remarks.
Thank you for joining us today. Have a good day.
Thank you. This does conclude today's teleconference. We appreciate your participation. You may disconnect your lines at this time. Enjoy the rest of your day.