Atmus Filtration Technologies Inc. (NYSE:ATMU) Q1 2024 Earnings Call Transcript

Atmus Filtration Technologies Inc. (NYSE:ATMU) Q1 2024 Earnings Call Transcript May 3, 2024

Atmus Filtration Technologies Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Hello, and thank you for standing by. At this time, I would like to welcome everyone to Atmus Filtration Technologies’ First Quarter 2024 Earnings Call. All lines have been placed on mute to prevent any background noise. After the speakers’ remarks there will be a question-and-answer session. [Operator Instructions] I would now like to turn the conference over to Todd Chirillo, Executive Director of Investor Relations. Please go ahead.

Todd Chirillo : Thank you, operator. Good morning, everyone and welcome to the Atmus Filtration Technologies First Quarter 2024 Earnings Call. On the call today, we have Steph Disher, Chief Executive Officer; and Jack Kienzler, Chief Financial Officer. Certain information presented today will be forward-looking and involve risks and uncertainties that could materially affect expected results. Please refer to our slides on our website for the disclosure of the risks that could affect our results and for a reconciliation of any non-GAAP measures referred to on our call. For additional information, please see our SEC filings and the Investor Relations pages available on our website at Atmus.com. Now I’ll turn the call over to Steph.

Steph Disher: Thank you, Todd, and good morning, everyone. We delivered strong performance in the first quarter. On the call today, I’ll provide an update on our performance in the quarter. Our outlook for the year and provide some comments on delivery of our growth strategy. Jack will then provide additional details regarding our financial performance. Before I discuss the quarterly performance, I’d like to acknowledge the significant milestone of Atmus becoming a fully independent company on March 18. On February 14, Cummins announced an exchange offer, whereby Cummins shareholders could exchange all or a portion of Cummins common stock for shares of Atmus. Investors showed significant interest in the offer with the transaction approximately 12 times oversubscribed.

The divestiture of Atmus shares by Cummins was completed on March 18 and resulted in the full separation of Atmus. With the successful completion of the exchange offer, all former Cummins appointed Directors have resigned from the Atmus Board of Directors and two new independent directors, Diego Donoso, and Stuart Taylor have been appointed to the Board. A majority of the Atmus Board of Directors is now independent, and I’m excited to be working with the Board, as we continue to accelerate growth and deliver long-term value for our shareholders. Now let’s turn to the first quarter financial results and our current outlook for 2024. We delivered strong financial performance in the first quarter. Sales were $427 million compared to $419 million during the same period last year, an increase of approximately 2%.

Adjusted EBITDA in the first quarter was $80 million or 18.8% compared to $79 million or 18.8% in the prior period. Adjusted EBITDA for the quarter excludes $6 million of one-time stand-alone costs and $4 million for the same period last year. Adjusted earnings per share was $0.60 in the first quarter of 2024 and adjusted free cash flow was negative $13 million. Adjusted free cash flow excludes $6 million of one-time separation-related items. Now let me provide some insight into our global market. As expected, we saw softer freight activity during the first quarter. However, our continued market share gains are offsetting some of the market weakness. Demand in the first-fit markets has started to show signs of slowness in the US, in India markets remain robust, while in China, the market continues to fall short of expectations.

Looking ahead to our outlook for global markets, I will start with aftermarket for both on-highway and off-highway. In North America, we saw the cash freight index down 5% in the first quarter compared to the prior year. The rate of decline slowed through the quarter with the month of March down 3.6% year-over-year. While we are expecting year-over-year freight activity to gradually improve through the balance of the year, we are still experiencing year-over-year declines and have not yet seen positive freight activity compared to the prior period. In global off-highway markets, we continue to see strength in North American construction for both residential and non-residential construction, partially aided by government infrastructure spending.

Economic conditions in Europe continue to be depressed with weakness in construction activity. And in the Asia Pacific region, we are seeing low utilization rates across a number of our key end-markets. Overall, we expect aftermarket for on-highway and off-highway to be flat to up 2% during the year, down slightly from our previous guidance of flat to up 3%. Let us turn to our first-fit markets. In the US, we are anticipating declines to primarily impact the second half of 2024. We are modestly raising our outlook for U.S. heavy-duty truck to be down 7% to 12% for the full-year. From our previous guidance of down 10% to 15%. In medium-duty truck, our outlook remains unchanged at flat to down 5%. In China, we expect weakness to persist and demand for trucks in India is expected to remain robust, driven by strong on-highway performance.

While the outlook for our markets is mixed, we continue to execute on our growth plans and expand our market share in both aftermarket and first-fit. Our revenue guidance is unchanged at down 1% to up 3%, with global sales in the range of $1.61 billion to $1.675 billion. We expect continued strong operational performance and to deliver adjusted EBITDA margins of 18.25% to 19.25%, unchanged from prior guidance. Additionally, adjusted EPS is unchanged from our prior outlook and anticipated to be in a range of $2.10 to $2.35. As we have separated from Cummins, we have incurred separation costs and cash impacts associated with establishing a stand-alone company. These costs and cash flows are onetime in nature. We want to be transparent and highlight those items to enable a clear understanding of the ongoing performance and cash generation of our business.

In relation to cash flow outlook, I want to highlight a onetime cash outflow, which is estimated to be $30 million in 2024. This impact arises as a result of a change in working capital. Cummins previously processed our payroll on our behalf, and we received 60 day terms. As we transition to managing our own payroll directly, this cash will flow innately upon payment to employees. Now I would like to take a moment to share the progress we have made on implementing our growth strategy. As a reminder, there are four pillars of our growth strategy. Our first pillar is to grow share in first step. We are a leader in Fuel Filtration and Crankcase Ventilation products, and we are focused on growing this leadership position with global OEM customers.

We are winning with the winners and have continued to secure Cummins new vehicle platforms, we are also accelerating growth with other leading global OEMs. We have recently won the fuel filtration business of a global OEM for their European and North American business, and we are actively pursuing new customers who were out of reach to us as part of Cummins. Our second and third pillar are interrelated and focus on accelerating profitable growth in the aftermarket and transforming our supply chain. We are relentlessly focused on our customers and providing the right product when and where it is needed. Our agility allows us to continue gaining share in the aftermarket with our world-class Fleetguard products. As a key component of our agility is the continued transformation of our global distribution capabilities to provide our customers with industry-leading product availability.

Earlier this year, we inaugurated our southern distribution center near Dallas, Texas, and we recently opened our newest distribution facility in Singapore. We now have coverage for over 80% of our volume being distributed through dedicated Atmus warehouse facilities. We are on track to establish additional centers in Europe throughout 2024. We are also focused on driving efficiencies through our purchasing organization and investing in automation in our manufacturing operations. These focus areas will support continued reduction of our operating costs. We have demonstrated delivery of our transformation initiatives through expansion of our adjusted EBITDA margin 300 basis points during 2023. Our guidance for 2024 reflects continued momentum, as we execute on our strategy.

Our fourth pillar is to expand into industrial filtration markets. We intend to pursue this growth inorganically, and we see a strong pipeline of opportunities, which our team is continuously evaluating. We will take a disciplined programmatic approach with a focus on creating long-term shareholder value. Our capital allocation priorities will continue to reflect our focus on growing our business, both organically and inorganically. We are also assessing our approach to returning cash to shareholders now that we are an independent company. I am proud of our Atmus team, who delivered another strong quarter of performance. As a fully independent company, we will accelerate our growth strategy as we move through 2024. Now I will turn the call over to Jack, who will discuss our financial results in more detail.

Jack Kienzler: Thank you, Steph, and good morning everyone. We continued to deliver strong financial performance in the first quarter. Sales were $427 million compared to $419 million during the same period last year, an increase of approximately 2%. The increase in sales was primarily driven by pricing of approximately 2% and the favorable impact of currency, partially offset by a modest decrease in volume as market share gains continued to counterbalance challenging conditions across many of our markets. Gross margin for the first quarter was $112 million, an increase of $2 million compared to the first quarter of 2023. In addition to pricing, we also benefited from lower commodities which more than offset the impact of higher freight and manufacturing costs, along with lower volumes.

Selling, administrative and research expenses for the first quarter were $53 million, an increase of $5 million over the same period in the prior year. The increase was primarily driven by higher people-related and consulting costs, as we continue to stand up our team and separate our functions from Cummins. Joint venture income was $10 million in the first quarter, an increase of $2 million from 2023, primarily due to strong performance at our joint venture in India. This resulted in adjusted EBITDA in the first quarter of $80 million or 18.8% compared to $79 million or 18.8% in the prior period. Adjusted EBITDA for the quarter excludes $6 million of one-time stand-alone costs and excludes $4 million for the same period last year. We believe these costs will be in a range of $10 million to $20 million in 2024, an increase from our prior guidance of $5 million to $15 million.

These one-time costs primarily related to the establishment of functions previously co-mingled with Cummins, such as information technologies, distribution centers and human resources. Adjusted earnings per share was $0.60 in the first quarter of 2024 compared to $0.67 last year. The decrease was primarily due to higher interest expense incurred from debt issued at our IPO in May of 2023. Adjusted free cash flow was negative $13 million this quarter compared to $37 million in the prior year. The higher cash usage was primarily related to increased working capital requirements and the payment of incentive compensation for strong performance achieved in 2023. Free cash flow has been adjusted at $3 million for capital expenditures related to our separation from Cummins compared to $1 million in the previous year.

As Steph mentioned earlier in the call, we are also adjusting free cash flow for working capital inefficiencies associated with the move from intercompany settlement terms with Cummins to stand-alone practices. In the first quarter, this adjustment is $3 million and relates to Cummins processing payroll on our behalf prior to the full separation and we reimburse them on 60-day terms consistent with historical practices. As we take over the payroll process, these cash obligations are funded as incurred. We expect these inefficiencies to impact us through the end of the third quarter of this year. The effective tax rate for the first quarter of 2024 was 22% compared to 23.7% in 2023. The decrease was driven by a change in the mix of earnings between U.S. and foreign operations.

Now let us turn to the continued strength of our balance sheet. We ended the quarter with $149 million of cash on hand, combined with the full availability of our $400 million revolving credit facility, we have $549 million of available liquidity. Our cash position and continued strong performance during the first quarter of 2024 has resulted in a net debt to adjusted EBITDA ratio of 1.5 times for the trailing 12 months ended March 31. Our balance sheet provides us with operational flexibility as we focus on value creation, and delivering total shareholder value by deploying capital for continued organic growth and strategic inorganic initiatives. In closing, I want to thank our global team for their hard work and dedication as we begin our first year as a fully independent company.

I am looking forward to continuing our momentum and delivering on our strategy throughout the year. Now we will take your questions.

Operator: [Operator Instructions] The first question comes from the line of Rob Mason with Baird. Please go ahead. And the second question comes from the line of Tami Zakaria, JPMorgan. Please go ahead.

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Q&A Session

Tami Zakaria: Hi, good morning. Thank you so much. So the share gain you mentioned in the quarter, can you provide some color? Is that on the OE side or aftermarket side, is it through coming from new customers or increase in share of wallet gains? Any color on the share gain comments you made?

Steph Disher : Hi, Tami, good morning. Thanks for the question. I would say that the share gains are primarily coming in the aftermarket that our share gains there in the aftermarket more than offset any headwinds we saw in market conditions. So that’s primarily where we’ve seen the share gain.

Tami Zakaria: Got it. That’s helpful. And then my second question is, can you comment on whether you see any opportunity for your current products, especially in the coolant side to be used in the data center end-market in light of the liquid cooling technology that these data centers require?

Steph Disher : Yes. So I guess Tami to answer your question broadly, we certainly see opportunity for growth, I think this week on their call, Cummins talked about the significant growth in the power gen markets strongly linked to data centers. Certainly, we have product opportunities, both filtration and coolant opportunities across that market. And if we see it as a strong growth market. I think I would just say that many of those applications are standby applications. We saw direct-drive as much recurring revenue opportunities. But certainly, we see strong tailwinds in that market that we will avail ourselves of in both our filtration product range and coolant.

Tami Zakaria: Got it. Thank you so much.

Operator: Our next question comes from the line of Rob Mason with Baird. Please go ahead.

Rob Mason: Yes, can you hear me.

Steph Disher : Yeah, hi Rob. Good morning.

Rob Mason: Hi, sorry about that. Just — I’m just curious how the first quarter may have compared to your internal plan? I know you don’t provide formal first or quarterly guidance, but I was just curious how it compared to internal plan. And if there is any thoughts you can maybe give us on how you think about seasonality as we start into the second quarter.

Steph Disher : Absolutely. Thanks, Rob. So firstly, I would say slightly ahead of expectations on our first quarter mostly driven by our market share gains in the aftermarket that I spoke about. I’d say our price expectations were broadly in-line market expectations overall broadly in-line. But certainly, I think, slightly ahead because of the share growth in aftermarket would be how I would encapsulate the first quarter. As we look ahead, I’ve given a bit of an outline to the markets and how I see 2024 playing out. I’ll just start with first-fit markets for a moment. Really the only change since our last guidance is the increase in our guidance on the heavy-duty truck in the U.S. markets, aligned with where our customers are seeing it really – but moved up from down 10% to 15%, up to down 7% to 12% with a midpoint of 9.5%.

So that’s really the only change in the first-fit market. I would say we see that impact of declining markets in first-fit really starting to impact in the second half. It’s a little earlier than that in Europe, but we are less — we’ve got less exposure on first- fit markets in Europe. And so that’s the first-fit side. If I turn to aftermarket, I talked about — this is predominantly — I guess, the U.S. is a heavy market for us in this regard. I talked about the cash freight index through the first quarter, down 5% year-over-year. We certainly saw that moderate throughout the quarter and the March month was down more like 3%. So we are certainly seeing freight activity starting to improve year-over-year, and the comparables in the second half of the year, as you know, on aftermarket because of the significant destocking through 2023 are much lower for us.

So we see aftermarket through the full year at around 0% to 2%. So a flattish market, I guess, is the best way to describe it with the trend starting to lift here through the second quarter and then moderate through the rest of the year gradually is how I would describe it.

Rob Mason: That’s helpful. Just as a follow-up, I noticed there was a revision to the separation cost outlook for the year. How are you thinking about — as we go through this year, completing all those activities or what might extend beyond 2024, just maybe the reason the cost went up this year.

Steph Disher : Yes. Thanks, Rob. I’ll just give some context about the overall separation, where we are on that journey and what we see ahead of us. And then I’ll let Jack talk to the sort of sequential story and expense on cost separation costs. So I just — it’s been a significant unstacking as we step out of Cummins. Obviously, the IPO in 2023 — May of 2023, we completed the full separation from an ownership perspective just here in the quarter. And we have a number of transition service agreements in place with Cummins to continue to provide a level of services. The original approach to those services was that I would run no longer than 24 months from IPO. We are about 55% of the way through those transition services agreements or winding them off, if you like.

A significant amount of that happened in the first quarter of 2024. And we expect to be majorly done through the — by the end of 2024 effectively. I’ll let Jack just talk to what drove the revision for the 2024 cost and the timing of this.

Jack Kienzler: Yes. Thanks, Steph. In terms of the revision, it is really pulsed by timing of certain projects, Rob, in this case, largely associated with IT systems and ensuring we are balancing — switching the go-live on those systems with risk mitigation. And obviously, there is a cost settlement there, but I want to make sure we get the transition right in order to optimize the business moving forward. As a — in terms of sequential move, as you noted, it was $6 million in the first quarter, which I would just say indicates that the majority of the anticipated 2024 expenses were incurred in that first quarter, and we should see a moderation or a tapering as we move sequentially through the year. And again from a comparison standpoint, our — the onetime costs that we incurred last year were about $29 million, and that compares to the range here of $10 million to $20 million, which kind of coincides, I would say, largely with the progress of 55% that Steph highlighted.

We do anticipate to be substantially through that by the end of 2024 with really one more distribution center to go inside of 2025.

Rob Mason: Very good. Thank you.

Jack Kienzler : Thanks Rob.

Operator: Our next question comes from the line of Jerry Revich with Goldman Sachs. Please go ahead.

Jerry Revich: Hi, yes. Good morning everyone. I wonder if I can probably get an update on the M&A landscape. You folks are coming up on a year as a public company, and I’m wondering what’s the range of M&A opportunities for you folks over the next, call it, 12 months to 18 months in terms of how much capital you expect to put to work and what that might look like based on your pipeline as you sit here today?

Steph Disher : Thanks, Jerry. As you know, an important part of our strategy is expanding into industrial filtration markets. We have an established team that are working that significantly. We’ve conducted all of our analysis of those markets where we see the opportunity, obviously attractive market for us and the opportunity for us to have a compelling and winning proposition. We’re assessing a strong pipeline of targets. Our team are continuously assessing that as we speak. We’ve worked through assessment on a number of those And have decided not to proceed with the numbers so far. And really, as always, with M&A, difficult to predict exactly when that opportunity will present itself. The way I see this playing out is consistent with what I’ve discussed previously.

It is really a programmatic approach to acquisitions around that sort of $100 million, $150 million acquisition price, I guess in terms of the capital outlay for each transaction really important that we get the right first step underway. And that at a cadence going forward, you could see us doing one to two, a year as we build out our footprint in industrial filtration. So that’s the landscape, as I see it — nothing to report specifically yet. We are working through a strong pipeline of targets very focused on balancing, pivoting our company into attractive growth markets, whilst balancing strong returns to shareholders.

Jerry Revich: Okay. Super. And then as we think about what 2027 U.S. regulations could mean for your business, you have good visibility on engine platforms at this point. Can you talk about the range of content increases that you expect to see on the new specifications. And then part of the warranty program that’s essentially going to be included, it will be a 5-year type warranty on the entire engine platform. So to what extent could you see higher market share as a result of that essentially extended warranty on every truck.

Steph Disher : Yes. Thanks, Jerry. I think we are a leader in fuel filtration and crankcase ventilation. We’re certainly actively pursuing all opportunities ahead of us to move on to new platforms. And as we look to the change in 2027 emissions, that’s been a big focus for our sales team, our OE sales team. We’ve secured those platforms with Cummins. And as you would expect, without going into all the specific details of this rising emissions regulations, gives rise to more significant content for filtration products because of the complexity that’s required in those filtration needs. So we certainly see that with the 2027 platforms that we’re on, and we’ve had really strong wins in the fuel filtration and crankcase ventilation space.

In terms of your question about warranty and ownership, we really — we see a very high aftermarket retention in that first [INO] (ph). So certainly, the way I would have you think about this is as we see extended periods of warranty, I would expect our aftermarket capture to extend would be the trend I would see associated with that.

Jerry Revich: Thank you.

Operator: Our next question comes from the line of Joseph O’Dea with Wells Fargo. Please go ahead.

Joe O’Dea: Hi, good morning everyone. Just wanted to touch on the aftermarket share gains and sort of talk about your approach to that a little bit. I would think in terms of like-for-like replacement, the incumbent has the natural advantage. And so when you’re gaining share in the aftermarket, what efforts have been going on there, whether that’s introducing new products to more broadly sort of compete what you’re doing on the pricing side? And any quantification of how much share you think you’re picking up.

Steph Disher : Yes. So I would say, there is a number of things driving aftermarket share. And as you think about our strategy of accelerating profitable growth in the aftermarket, that pillar, it has a number of focus areas underneath that we’ve been very disciplined in working on. And we’re starting to see those many initiatives, I would say, come to fruition. And so the first is just making sure we’ve got a highly capable distribution network that is very focused on aftermarket customers and having product availability where we need it. I think I’ve mentioned this several times before, previously our distribution centers were intermingled with Cummins supply chain management Cummins — Cummins is predominantly our first-fit market.

And so that meant we weren’t focusing on our customers in the right way in terms of their availability needs in product. And we’ve just been able to capture gains because that’s actually our customers prefer to have our products. It was just we weren’t putting it where they needed it to be. So that’s been a big part of driving our share gain. It’s been predominantly in the US, I would say, but also we’ve seen that across other markets across the world. So that’s the first thing I would say is seeing that come to life. This strategy of winning with the winners and partnered with those that are successful in growing their share. I would say that’s playing out in our market share gains in aftermarket as well. So we see that we’re partnered with those that are really capturing share as well, and we are seeing the flow-on benefits of that.