Enpro Inc. (NPO) Earnings Call Transcript & Summary

Greetings, and welcome to the Enpro Q4 and Full Year 2024 Earnings Conference Call and Webcast. [Operator Instructions] As a reminder, this conference is being recorded. It's now my pleasure to turn the call over to James Gentile, Vice President, Investor Relations. Please go ahead, James.

Thanks, Kevin, and good morning, everyone. Welcome to Enpro's Fourth Quarter and Full Year 2024 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; and Joe Bruderek, Executive Vice President and Chief Financial Officer. 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 2025 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 2024 and provide a business update that introduces our outlook for 2025. Before we get started, I would like to thank our colleagues across the company for delivering another great year of results. I very much appreciate all of your hard work and the remarkable contributions that you make each day to enable our company's success. I look forward to continuing our work together as we empower technology with purpose and create opportunities for each of us to flourish and thrive. Now on to our results. Enpro performed well in 2024, executing effectively despite persistent weakness in semiconductor capital equipment demand and a sharp decline in commercial vehicle OEM sales. Excellent performance across Sealing Technologies segment offset an overall soft demand environment in AST, driving improved bottom line results year-over-year. Thanks to the inherent balance and quality of the Enpro portfolio and the resilience of our business model, we generated strong free cash flow in 2024 and ended the year with a net leverage ratio of 1.6x, well within our desired range. In Sealing Technologies, our excellent performance and efficient operations drove an adjusted segment EBITDA margin of over 32% for the year. We are very pleased with the strength of the segment and how our teams are positioning the businesses to drive above-market growth by leveraging our applied engineering capabilities and specification positions to deliver important solutions to our customers in areas where we have clear technology and process advantages. Our efforts to improve and evolve Sealing Technologies to position this segment for world-class performance have unlocked significant value. In 2019, when we embarked on our portfolio optimization strategy, the Sealing adjusted segment EBITDA margin approximated 17%. Through this purposeful and structural transformation, we have created a group of businesses that can deliver adjusted segment EBITDA margins around 30% consistently. Now that this portion of our evolution is complete, we are leaning into our strengths and our best growth opportunities, identifying adjacent markets for our products to drive long-term organic growth while considering selective acquisitions that would expand the segment's capabilities. At AST, revenue ended the year down roughly 10% as weakness in semiconductor capital equipment spending continued, partially offset by the strength of our solutions serving leading-edge applications. The low point of AST's revenue in 2024 came in the first quarter and then sales modestly improved sequentially each quarter as the year progressed. Adjusted segment EBITDA margin finished the year above 21%, reflecting our resilient performance in a choppy demand environment. In total, Enpro reported approximately $255 million in adjusted EBITDA for 2024, up 7% year-over-year. Considering weak demand in areas of semiconductor capital equipment spending and the sharp decline in commercial vehicle OEM demand, we are pleased with Enpro's adjusted EBITDA margins of 24.3% that are up 180 basis points from prior year. Next, I would like to take a couple of minutes to share some recent highlights from our January leadership conference where 85 leaders from across the company gathered to launch Enpro 3.0, the next phase of our purposeful value creation journey. Our team is aligned on our long-term strategic goals and focused on areas where we can accelerate profitable business growth and meaningful personal and professional advancement. But first, what is Enpro 3.0? We think of our company's elevation in 3 phases. Following our spinoff from Goodrich Corporation in 2002, the company's first phase was about permanently resolving significant legacy liabilities while establishing the beginning of our dual bottom line culture. The second phase, Enpro 2.0 was about portfolio transformation. We began this phase in 2019, divesting a number of businesses and product lines that did not meet our growth, profit and return criteria while reallocating proceeds from these divestments in the growth markets where we added strong technological and applied engineering capabilities. During this phase, we optimized Enpro portfolio and widened adjusted EBITDA margins by 1,000 basis points, creating significant shareholder value, returning nearly 27% annually since 2019 upon a much more efficient and profitable revenue base. These moves optimize our go-forward group portfolio and set the stage for Enpro 3.0, a period where we expect higher revenue growth, coupled with best-in-class profitability and strong returns on invested capital. Successful execution of this next phase of Enpro will accelerate our value-creating strategy and continue our excellent track record of delivering double-digit shareholder returns. At the leadership conference, we had several discussions and exercises that focused on driving top line profitable growth, while encouraging a growth mindset to embrace challenges, refine our processes and actively implement our continuous improvement playbooks to reimagine areas where both commercial market expansion and efficiency opportunities exist. I was struck by the genuine excitement that our leaders have for our businesses, and their motivation to achieve profitable growth to unlock additional opportunities for our colleagues and value for our stakeholders. With our optimized portfolio in place, Enpro is positioned to generate mid- to high single-digit top line growth over the long term, as strong profitability and return levels. Over the next 5 years, we are targeting mid-single-digit growth in Sealing, while at AST, we are targeting at least high single-digit growth with both segments capable of generating 30% adjusted segment EBITDA margins, plus or minus 250 basis points. The entire team is excited to deliver the next phase of growth in Enpro 3.0. Before I turn the call over to Joe to discuss our fourth quarter results in more detail and provide 2025 guidance, I would like to comment on safety, which is our most important core value. In 2024, our safety results for total recordable case rate and lost time case rate continue to be much better than industry averages. While proactive measures such as employee engagement, safety opportunities corrected, training completion rose by double digits, we are building on Enpro's approach to safety culture by aligning with ISO 45001 occupational safe health and safety management systems to ensure repeatable processes and drive continuous improvement. This year, 3 Enpro locations received third-party certifications for ISO-4001 (sic) [ ISO 45001 ]. Joe?

Thanks, Eric, and good morning, everyone. In the fourth quarter, sales of $258.4 million increased 3.7% and organic sales increased 1.2%. The increase was primarily driven by strong sales performance in the Sealing Technologies segment. Strong demand in aerospace and nuclear markets and a recovery in European general industrial and food and pharma demand as well as strategic pricing initiatives and the addition of AMI more than offset slower sales tied to wafer fab equipment at AST and a sharp decline in commercial vehicle OEM demand. Fourth quarter adjusted EBITDA of $58.2 million increased 24% and adjusted EBITDA margin of 22.5% expanded 370 basis points year-over-year. Positive mix in both segments, the addition of AMI, the benefits of cost mitigation actions and lower corporate expense were the primary drivers of this year-over-year improvement. Corporate expenses of $13.4 million were down from $14.7 million in the fourth quarter of 2023, primarily due to the decrease in long-term incentive compensation expense related to cash-settled share-based rewards tied to share price performance compared to last year. Adjusted diluted earnings per share of $1.57 increased 32% compared to the prior year period, largely driven by the factors increasing adjusted EBITDA. Moving to a discussion of segment performance. Sealing Technologies sales were $163 million in the fourth quarter, increased 11% from the prior year period. Strong demand in aerospace and nuclear markets, strategic pricing actions, the addition of AMI and a recovery in food and pharma and European general industrial markets, more than offset continued weakness in commercial vehicle OEM and Asian industrial markets. Organic sales increased 6.7%. For the fourth quarter, adjusted segment EBITDA increased nearly 32% from the prior year period, with adjusted segment EBITDA margin expanding almost 500 basis points to 31%. Positive mix, strategic pricing, improved volume and the addition of AMI contributed to the strong year-over-year profit performance. We are very pleased with the impressive performance throughout the Sealing Technologies segment and plan to continue making targeted investments to drive incremental organic growth, along with considering select strategic acquisitions that meet our rigorous criteria to expand our capabilities and market positioning. With 2/3 of the segment comprising critical specified positions in the aftermarket and the sustained structural improvements made in the segment in recent years, we expect to continue achieving world-class performance in Sealing and driving mid-single-digit top line growth at superior margins. Turning to Advanced Surface Technologies. While we saw a sequential improvement from the third quarter, sales of $95.6 million decreased 6.4% year-over-year. Continued weakness in semiconductor capital equipment spending offset strength in solutions serving leading-edge applications, which continue to be a bright spot for AST in the fourth quarter and throughout the year. For the fourth quarter, adjusted segment EBITDA decreased approximately 7% versus the prior year period. Adjusted segment EBITDA margin of 22.1% improved sequentially by 130 basis points and was flat year-over-year. Positive mix and continuous improvement initiatives offset the overall volume decline, material cost increases and operating costs related to growth investments. We were pleased that we were able to hold the line on decremental margin in AST year-over-year during the fourth quarter. We see several long-term revenue growth and continuous improvement opportunities throughout AST and are taking actions to unlock the potential of this business. We have made progress in identifying levers to implement our optimization playbooks, that led to the improved performance within the Sealing Technologies segment that we will expect will enable us to expand margins in AST towards 30%, plus or minus 250 basis points more consistently as volume and mix normalize. Finally, the accelerated qualification work that we discussed last quarter in Arizona gained traction, and we generated small initial revenue from the facility during the quarter. We believe the long-term growth opportunities in AST far outweigh the recent market choppiness, which we expect to continue this year. Accordingly, we will continue to invest in this segment to drive high single-digit long-term revenue growth with improved profitability. Turning to the balance sheet and cash flow. Our balance sheet remains strong, and we exited 2024 with a net leverage ratio of 1.6x, inclusive of the $210 million in cash used to acquire AMI in late January of 2024. We continue to generate ample free cash flow to invest the necessary capital and operating expenses into our strategic organic growth opportunities. In 2024, we generated $130 million in free cash flow, net of $33 million of property, plant and equipment and capitalized software expenditures in addition to approximately $7 million that remained in payables on December 31. 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 on our leading edge positions in markets with secular growth drivers that safeguard critical environments and applications that touch our lives every day. We are also maintaining our commitment to return capital to shareholders. And during 2024, we paid a $0.30 per share quarterly dividend totaling $25.3 million for the year. On February 13, our Board of Directors approved another increase to the quarterly dividend to $0.31 per share, representing the tenth consecutive annual dividend increase since we initiated a quarterly dividend in 2015. Moving now to our 2025 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 2025. We expect adjusted EBITDA to be in the range of $262 million to $277 million and adjusted diluted EPS to range from $7 to $7.70 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. This view does not contemplate any material macroeconomic or trade-related variability. In 2025, capital expenditures are expected to approximate $50 million or around 4.5% of sales as we continue to invest in future growth opportunities across the company at accretive margin and return thresholds. In the Sealing Technologies segment, we expect demand drivers to remain largely the same as we saw in 2024 and expect low to mid-single-digit revenue growth in 2025. Areas with longer cycle backlog, such as aerospace, space and nuclear, are expected to continue to be strong, while we expect commercial vehicles to be flat to slightly up. In North America and in Europe, we expect firm general industrial demand with some recovery in food and pharma. We expect adjusted segment EBITDA margin to again exceed 30% in 2025. In the Advanced Service Technologies segment, we expect AST sales to grow in the mid- to high single digits with the second half of 2025 being slightly stronger and adjusted segment EBITDA margins to remain above 20% for the year. Industry sources and conversations with our customers suggest continued weakness in semiconductor capital equipment spending throughout 2025 and we are making targeted cost adjustments to account for this reality. While overall capital spending for wafer fab equipment will remain muted again this year, we expect our solutions serving leading-edge nodes and advanced chip architectures to continue to grow. We also expect demand for optical filters to improve. Thank you for your time today. I will now turn the call back to Eric for closing comments.

Thank you, Joe. As we enter 2025, we are energized and working hard to deliver another year of strong results for our customers and shareholders. We continue to operate the business with a balance in an effort to achieve excellent financial results in a variety of economic environments. Our value-creating strategy remains unchanged. And we continue to invest in areas where we are strongest, while considering strategic acquisitions that build upon our leading edge capabilities. I want to again thank our dedicated colleagues across the company who are the driving force for our company's success. And we believe we have built a clear path to achieve our vision of Enpro 3.0. Thank you for joining us today. There's no better time to be a part of Enpro and we now welcome your questions.

[Operator Instructions] Our first question is coming from Jeff Hammond from KeyBanc Capital Markets.

We'll start with the $64,000 question, semiconductor, kind of just wanted a better -- I think you said mid- to high single-digit growth for AST. So just trying to better get a sense of what you're assuming for WFE or wafer starts and when you think you see an inflection or if the growth is really just all kind of outgrowth in leading-edge focus?

I think it is mostly outgrowth in leading-edge applications, but I also see here, in some degree, a small -- of the law of small numbers, that's just gone down so much. There's room to improve at this point and also a little bit of market share gain in there. We can look at our funnel and see some programs we've won to give us some confidence we'll get to those numbers by the end of the year. But I'm not looking for strong market recovery. We expect it to be quite choppy throughout the year.

Yes. Jeff, I think when you look at a lot of the industry sources, they're kind of saying low to mid-single digits. It varies depending on where you're exposed and how much China exposure you have versus non-China. But that's sort of what we're expecting low growth in WFE overall for the market in 2025 and then the investments that we've made and the growth initiatives that we have, especially on leading-edge applications to kind of outperform and that drives our overall kind of forecast for 2025.

Okay. And then just how should we think about AST sequentially, you kind of ramp through '24. I don't know if you step back down? Or if fourth quarter is kind of a new run rate to think about?

Yes. I think it's going to be choppy for the first half a little bit again. We could see a little bit of a step back to be slightly flat to slightly down in the first half, but not materially. We do think it will be second half slightly stronger than the first half overall for AST. So you could see some choppiness quarter-to-quarter. But I don't think we're going to see a material step down in any way. We've invested behind all the growth investments. Arizona, as we talked about, had some initial revenue in the fourth quarter. Now that testing revenue and qualification work will continue in 2025. But the reality is that, that will be mostly spending ahead of demand for now. We see that ramping up a little bit through 2025, but materially production volume coming in 2026 and even beyond that as our key customers kind of ramp their volume. But it's another year of strong growth investments for us behind AST and then scaling with our customers as they grow.

Okay. And then last one, just a lot of news flow on tariffs. So I know it's pretty new. But just how are you thinking about and how you built tariff risk into the guide? Maybe just talk about any pricing actions you're considering? And maybe just remind us of kind of any sourcing footprint, China, Mexico or Canada.

Sure. So most of our sourcing is done in region. And the largest part of our supply chain is actually source directed by customer. So the areas where we have exposure, we have 3 product lines, one small one in Mexico, one small one in Canada and then another one, again, small volume out of China. Altogether, it wouldn't be material. And I also think there'll be some offsets in the U.S. if and when the tariffs are enacted, depending on how much they are. But we've already got price plans in place, and we'll also use -- in some cases, we call them -- I'm sorry -- surcharges to capture them immediately. And so we can also adjust as the administration sorts out what they're doing. So we will capture most of the price. And in any event, in the worst-case scenario, it wouldn't be material.

And the customer directed sourcing, is that have pass-throughs for tariffs?

We buy it at a net cost. So whatever price we get it from them at their net cost so that tariffs would already improve in there, and we would go from that point, Jeff. It would be in the base, if you will. It wouldn't affect us. The customers are specifying it.

Next question is coming from Steve Ferazani from Sidoti & Company.

I appreciate all the detail on the call. I was actually a little positively surprised by your AST margins this quarter, given I know you were going through that certification process. I assume there would have been a sequential decline. You actually had a sequential increase. Given the costs associated with that, was it just much better mix this quarter? Can you walk us through how you got to that sequential increase despite the certification process in Arizona?

Steve, yes, we talked, as you mentioned last quarter about the qualification work that we were accelerating and pulling from 2025 into 2024. We did all that and frankly, it went as according to plan. So we did see a little bit higher cost in the fourth quarter than we originally intended. But we did see positive mix especially on leading-edge work, both in Taiwan and in the U.S. And that drove favorable mix. Volume was pretty strong through the back half of the year or back half of the quarter. And so that favorable mix ticked our margins up a couple of points, more favorable than we expected even going into the fourth quarter.

As you expect the solutions to be the stronger side in '25, and that's the better margin -- or it appear to be the better margin side. Is there any reason to think you can get above low 20s in 2025 on the margin side?

You're right in the fact that we do see the solutions side to be stronger, and that will kick our growth rate up a little bit through the year. But we continue to invest in the work in Arizona and in other opportunities for growth that we're going to really pay off in '26 and beyond. So we're still investing ahead of demand. And frank, we're investing a little bit increasingly more than we did in '24. So if volume -- overall volume growth is a little stronger than we're talking about and were on the higher end of our overall revenue guide, I think we could see margins tick up a little bit, but the reality is they'll probably be in the same range as we saw, above 20%, in '25.

Okay. That's helpful. On the Sealing side, I want to ask the tariff question in a different way. We've seen some markets, maybe the spending on the industrial side slow down given general uncertainty, Europe and other places being concerned about what might be coming. I know a lot of your stuff on Sealing is mission-critical. But have you seen any kind of a slowdown given the uncertainty in the world?

Short answer is no. We really haven't seen any slowdown at all.

Okay. Fair enough. Last one on the much higher CapEx next year. Anything specific you want to highlight, and it looks like some stuff probably pushed out of 2024, given how well that number came in. Is that fair?

Yes, that's right, Steve. I mean, as we talked about, we lowered our CapEx number as we move through the year. A lot of the projects that -- not Arizona, but other growth investments that we're making in additional capabilities, both geographically and from a technology standpoint, were kind of getting off the ground a little bit in '24. And so as we refine the scope, laid out our engineering plans on that, they were a little bit paced through the year. They start later than originally expected. So that's going to push into 2025. Those projects are often going now. We're in execution mode. So we do feel a little bit higher confidence in our ability to spend at that level. We did talk about -- we got probably -- our eyes got a little bit ahead of our stomach in '24 a little bit, but we're off and running in those projects. And the $40 million to $50 million is probably our normal capacity to spend.

[Operator Instructions] Our next question is coming from Ian Zaffino from Oppenheimer.

This is Isaac Sellhausen on for Ian. And also on the details on the Enpro 3.0 phase. I guess on AST what would be sort of the steps or high-level thinking to get to 30% EBITDA margins versus around 20-plus percent today? I guess the main drivers as far as like top line growth or operational improvements or contributions from the Arizona facility.

Yes. It's our investments that we've been making over the last number of years in leading-edge technology will start to pay off over time in '26, as Joe stated, it will start to ramp up there. But in addition, there will be some market share gain along the way and then a bunch of operational improvements. So when you look at it, it's the same as we ran in the ceiling playbook. So we say it's an overnight success. But as you saw earlier in the script, it was from 2019 to today, we've improved about 1,000 basis points. So it's a little bit of everything. It's a little bit of 80/20. It's a little bit of customer mix, it's a little bit of a share gain, and it's a little bit of leading-edge technologies they have, of course, have a little higher margins.

Yes. There's no doubt, I think the majority of that will come from just growth whether it be market recovery or outsized growth that we're driving through our strategic positioning. But there will be a decent element from the continuous improvement and other operational efficiency programs that we're driving now that will affect over a multiyear period that will clearly have -- be part of the algorithm to get to that 30% sustainably.

Okay. Great. And then just a quick follow-up on the semi-cap equipment side. Maybe if you could provide any kind of details you could give with conversations you've had with customers and maybe sort of how they're thinking about growth beyond '25 or into '26?

Yes. So I guess the best way -- I've been in conversation with customers, what they're saying is basically choppy 2025 and 2026 is too far ahead to have a great look at it right now. And the customers are hesitant as we are to say anything more than that because we've been saying now that it will be coming back in 6 months now for 2 years. And I don't know that we have more visibility than that. So I think Gartner is probably as good a reference as anybody right now, and our customers are the fair amount of uncertainty still with what's going on with the U.S. situation, let's say.

We reached the end of our question-and-answer session. I'd like to turn the floor back over to James for any further or closing comments.

That's all today. Thank you for your interest in Enpro.

Thank you. That does conclude today's teleconference and webcast. You may disconnect your line at this time, and have a wonderful day. We thank you for your participation today.