Atmus Filtration Technologies Inc. (NYSE:ATMU) Q3 2023 Earnings Call Transcript

Atmus Filtration Technologies Inc. (NYSE:ATMU) Q3 2023 Earnings Call Transcript November 4, 2023

Operator: Good morning. My name is Krista, and I’ll be your conference operator today. At this time, I would like to welcome everyone to the Atmus Filtration Technologies’ Third Quarter 2023 Earnings Call. All lines have been placed on mute to prevent 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, Head of Investor Relations. Todd, you may begin.

Todd Chirillo: Thank you, Krista. Good morning, everyone, and welcome to the Atmus Filtration Technologies’ third quarter 2023 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 page is available on our website at atmus.com. Now I’ll turn the call over to Steph.

Steph Disher: Thank you, Todd, and good morning. It’s great to be here with you today to provide an update on our third quarter financial results and business highlights for Atmus. The Atmus team achieved another quarter of superior performance by focusing on our customers and delivering technology-leading Fleetguard products. I am pleased with the progress we have made to establish Atmus as an independent company. We are a purpose-driven company, and our culture is shaped by our shared values. We have a clear strategy, which is beginning to deliver results. Let me now turn to an overview of our performance in the quarter. First, I will review our global market and provide you with a summary of our solid third quarter. We continued to see strong demand in our first-fit markets in the third quarter, and we expect this strength to continue through the end of the year.

In the aftermarket, as expected, we continue to see softening conditions driven by lower freight activity and continued destocking by customers. Most of our customers have now worked through destocking and we expect this impact to now moderate through the end of the year. In the China market, there continues to be a sluggish economic recovery from last year, which is likely to persist through the remainder of the year. Now let’s review our third quarter results. Sales in the third quarter 2023 were $396 million, a decrease of approximately 1% from the third quarter of 2022. Lower volumes were partially offset by higher pricing and FX tailwinds. Adjusted EBITDA margin rose 40 basis points from the prior year to 18.3%. We were able to grow margins on slightly lower sales as pricing actions, along with improved commodity and freight costs drove margin growth.

EBITDA has been adjusted for onetime separation costs which was $7 million in the third quarter of 2023 compared to $2 million a year ago. Adjusted earnings per share was $0.52 and adjusted free cash flow was $50 million. We have adjusted free cash flow for $2 million of onetime capital expenditures related to separation. Our performance in the third quarter has enabled us to fully repay our revolving credit facility during the quarter. Additionally, we are also raising our full year 2023 guidance. Jack will provide additional details later in the call. As I reflect on our performance, it is clear our people provide the foundation for delivering these impressive results. During the quarter — launched our first leadership catalyst event. This event brought together our top 75 leaders to engage them in leading the Atmus way.

This enabled us to engage key leaders in our purpose, culture and strategy. The themes for the event were empowered, learning and customer focus. The energy and excitement I felt from my engagement with this group of extraordinary leaders fuels my passion to unleash the full potential of Atmus. As I have previously highlighted, our growth strategy is focused on four pillars: grow share in first-fit in core markets, accelerate profitable growth in the aftermarket, transform our supply chain and expand into industrial filtration markets. Our product and technology leadership formed the cornerstone for growth in our core first-fit and aftermarket segments. Our iconic Fleetguard brand is recognized in the industry as being synonymous with premium products.

We have a unique multichannel path to market. Our global presence provides us a diverse customer base across truck, bus, agriculture, construction, mining and power generation end markets. With over 80% of our business being aftermarket, we are well positioned to deliver strong results through the cycle. Our filters are available in over 45,000 independent aftermarket retail outlets. We will continue to grow the retail presence of Fleetguard products with expanded partnerships and improved availability. Our delivery metrics continue to rise, providing our customers the right product at the right time. I have been impressed by our team’s ability to drive superior performance in product availability. Achieving our growth and delivery targets will be fueled by the continued transformation of our supply chain.

In addition to the Brazil and Mexico distribution facilities we brought online earlier this year, we expect our Dallas facility to be operational in the fourth quarter. As we progress through 2024, we expect additional facilities to be operational across multiple locations in Europe and Asia Pacific, providing us with a greater ability to enhance customer satisfaction. We also continue to evaluate a robust pipeline of opportunities aligned with our strategy for inorganic expansion into the industrial filtration markets. While we are enthusiastic to execute on this opportunity, we intend to pursue this growth through a disciplined programmatic approach. I will continue to update you on our progress. This is an exciting time for Atmus and our customers.

I am confident we have the right strategy to deliver superior results, and we have a strong energized team who are demonstrating accelerated execution of our plan. Now, I will turn the call over to Jack.

Jack Kienzler: Thank you, Steph, and good morning, everybody. I will be discussing our third quarter 2023 results compared to the same period last year and provide an update to our 2023 outlook. As Steph mentioned at the beginning of the call, we delivered another quarter of solid financial performance. Sales were $396 million compared to $401 million from the same period last year, a decrease of approximately 1%. The decrease in sales was driven by lower volumes of $25 million, partially offset by $17 million of pricing benefit and $3 million of foreign exchange tailwinds. Gross margin for the quarter was $103 million, an increase of $3 million compared to the third quarter of 2022. In addition to favorable pricing, we saw commodities and freight improved by $16 million.

This was partially offset primarily by lower volumes and unfavorable manufacturing costs. Selling, administrative and research expenses were $52 million, an increase of $10 million over the same period in the prior year. The increase was primarily driven by administrative costs related to our separation and variable compensation. Variable compensation is higher this year as our team continues to deliver impressive results in 2023. Equity, royalty and interest income was $8 million, an increase of $1 million from 2022. This resulted in adjusted EBITDA of $73 million or 18.3% compared to $72 million or 17.9% in the prior period. Adjusted EBITDA for the quarter excludes $7 million of onetime stand-alone costs. These onetime costs primarily relate to the establishment of functions previously [indiscernible] with Cummins, such as information technologies, distribution centers and human resources functions.

Our effective tax rate for the third quarter was 23.1%, an increase of 110 basis points from the third quarter of 2022. The increase was primarily due to a change in the mix of earnings among tax jurisdictions, partially offset by a decrease in unfavorable discrete tax items. Adjusted earnings per share was $0.52. For the same period last year, adjusted EPS was $0.62. The decrease was primarily due to interest expense incurred as a result of the debt issued at our IPO. Adjusted free cash flow was $50 million this quarter compared to $42 million in the prior year. The improvement was a result of strong working capital management, partially offset by an increase in interest expense. Now let’s discuss our strong cash generation and liquidity position.

Our ability to generate cash during the third quarter provided us with the opportunity to fully repay the $50 million borrowed on our revolving credit facility at the close of our IPO in late May. We now have full availability of $400 million under our credit facility. Combined with $139 million of cash, our liquidity at the end of the third quarter was $539 million. This liquidity provides us with the flexibility to deploy capital for both our organic and inorganic strategic growth initiatives. Now I will provide an update to our guidance for the full year 2023. With the combination of delivering another solid quarter and the increased visibility we have for the remainder of the year, we are raising our guidance as follows: we now expect sales to be in a range of $1.6 billion to $1.625 billion.

We expect adjusted EBITDA margin in a range of 18% to 18.5%. This excludes an expected $30 million to $35 million of onetime separation costs for the full year of 2023. Moving to adjusted earnings per share. Our outlook for 2023 is now in the range of $2.20 and to $2.30. With the full repayment of our revolving credit facility resulting in lower debt levels, we now expect interest expense to be approximately $25 million. Our effective cash tax rate will be in the range of 23% to 25% for the full year 2023. This range is consistent with our year-to-date average tax rate. Overall, our team continued to deliver solid results during the third quarter, and we look forward to achieving a strong full year 2023. Now we will take your questions.

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Q&A Session

Operator: [Operator Instructions] Your first question comes from the line of Tami Zakaria from JPMorgan.

Tami Zakaria: Great quarter. So my first question is, could you provide a little more color on the destocking headwinds you saw in on versus off-highway markets in the quarter and how you’re thinking about those two for the remainder of the year?

Steph Disher: Yes. Thanks, Tami. Let me just talk to the third quarter first and how we saw that playing out. And really, we saw this in freight indices as well. We look significantly at the cash freight index. September month was down 6%. And I think year-on-year, and I think the quarter was down 9%. So from a demand perspective, we certainly saw a softer third quarter on the on-highway sector. And then we had the added factors of continued destocking with customers. As we’ve said throughout the year, we’ve seen our customers destocking at different rates. And some of that happened in the second quarter, some in the first quarter and then more significant than we saw some in this third quarter. We think we’re most of the way through that now, I would say.

We see that moderating here into the fourth quarter. We still see headwinds from a demand perspective in our on-highway aftermarket. And — so we’ll see that come through in the fourth quarter. But from a destocking perspective, we think we’re largely through it in the on-highway side. It hasn’t been as significant an impact on our results, I would say, in the off-highway side again, I would describe it as very similar. We think we’re most of the way through the destocking and expect that to be a much more muted impact as we head into the final quarter of the year here.

Tami Zakaria: Got it. That’s very helpful. And my second question is, I remember you took some pricing in July this year. Any incremental pricing actions since then or expected in the rest of the year?

Steph Disher: No, no incremental pricing actions. We did take them in July, as you indicated. And as Jack described in our bridge of the quarter, we saw some pricing impacts offset the volume downturn.

Operator: Your next question comes from the line of Joe O’Dea from Wells Fargo.

Joe O’Dea: I guess on the last topic and just in terms of some visibility to less destock headwinds is encouraging, not sure about mix of price and volume in the fourth quarter, but it looks like based on revenue midpoint, still looking at maybe at something like mid-single-digit volume declines. And if that’s the case, just kind of the handoff from destock maybe to more macro and you can talk about does the freight environment get a little bit more challenging or anything else just sequentially from 3Q to 4Q?

Steph Disher: Yes. Thank you for the question, Joe. Where I would describe the key market drivers for us, and we’ve talked about this a fair bit but 80% of our business aftermarket, 20% first-fit. So I might just try and talk about those two cycles generically. So if I just start with aftermarket, we certainly saw a sequential increase in September over August in terms of freight activity. So whilst we see we’re kind of at the bottom of the cycle in aftermarket, we still see continued declines year-on-year, probably through sort of mid next year is how I would describe the aftermarket dynamics as we’re seeing it. So still softer market conditions, demand driven in the fourth quarter. And so that’s where we see we are in the cycle on the aftermarket side and it’s mid-single digits, as you described, decline.

As we look at the first-fit, we’re in a very strong position still in first year, certainly see that continuing through the end of the year. And we’re more to the top of that cycle, I would say. And we see the two flipping throughout 2024 as I alluded to with aftermarket.

Joe O’Dea: You framed that answer a lot better than I framed the question. That’s all helpful. And then in terms of kind of strategic planning and as you’re thinking about ’24, any color on sort of where you’re focusing top priorities, and in particular, around innovation spend and thinking about the verticals or the applications that you are particularly focused on as you plan out next year?