Q2 2023 Atmus Filtration Technologies Inc Earnings Call
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Okay.
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Good morning, My name is David and I'll be your conference operator today at this time I would like to welcome everyone to the Atmos filtration technologies second quarter 2023 earnings call. Today's conference is being recorded all lines have been placed on mute to prevent any background noise. After the speakers' remarks, there'll be a question and answer session if you'd like to ask you.
Question. During this time simply press the Star key followed by the number one on your telephone keypad, if you'd like to withdraw your question Press Star one once again, thank you Todd cello executive director of Investor Relations you May begin your conference.
Thank you David Good morning, everyone and welcome to the Atmos filtration technologies second quarter 2023 earnings call on.
On the call today, we have step this year, Chief Executive Officer, and Jack Kinzler, 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 relation pages available on our website at <unk> Dot Com now I will turn the call over to staff.
Thank you Todd and good morning, I'm excited to be here for our company earnings call and to provide you with an update of our second quarter 2023 result.
At the end of May we completed our initial public offering a significant milestone for our company and the culmination of multiple years of work.
The launch of Atmos provides us with a unique opportunity to grow.
Both in our core markets and through expansion into industrial filtration market.
Our successful IPO would not have been possible without the tireless dedication of our global employees.
Every person on our team from a quality inspector at our dedicated media production facility in Korea.
<unk> safety laid out in Cookeville, Tennessee is key to our success.
Our people provide premium fleet God luck and deep industry knowledge to support the success of our customers.
We have made significant progress in our first quarter as a public company and are on track with plans to separate <unk> from Cowen.
I do want to bring to your attention that we filed an 8-K on Tuesday, right sizing, our first quarter 2023 financial statements and revising annual prior period for 2020 through 2022.
Jack will provide more detailed information later in our call and of course, we want to address any questions you have.
We are committed to ensuring a strong internal control environment and to communicating transparently.
I would like to now turn to a summary of our strong second quarter results.
I'll start with a high level overview of our markets and the drivers of our results and then turn to our financial performance.
Demand remained strong in our first fit markets through the second quarter and.
And we expect this to continue through the second half without customers reporting strong orders through the end of the year.
In the aftermarket we experienced some destocking by customers during the second quarter, and we expect a softer second half connected with slower economic activity.
China market continues to be challenging to predict.
And whilst we see some recovery from 2022 demand levels. It is a slow recovery and we expect to continued muted recovery through the end of 2023.
Sales in the second quarter 2023 for $414 million.
An increase of approximately 5% from the second quarter of 2022.
Increased pricing more than offset lower volume and FX headwinds.
Adjusted EBITDA margin Rose 220 basis points from the prior year to 19, 3%.
The benefit of pricing actions.
Coupled with the moderation of commodity and freight costs drove the improvement in profitability.
We are adjusting EBITDA for one time separation costs.
Which were $9 million in the second quarter of 2023 compared to 1 million a year ago.
Adjusted earnings per share was <unk> 63.
And adjusted free cash flow was $35 million, an increase of $11 million over the same period last year.
We have adjusted free cash flow for $2 million of one time capital expenditures related to separation.
Overall, it was a strong quarter and we are continuing to build momentum.
We have strong leadership in place and we are working together to create atmos.
I would like to make some brief comments on our strategic progress in the quarter.
You may recall, our strategy is focused on four pillars.
Gross share in first fit in our core market.
Accelerate profit profitable growth in the aftermarket.
Transform our supply chain.
And expand into industrial filtration market.
I would like to highlight three areas of strategic momentum during the second quarter.
Firstly, we are a technology leader.
Our proven leadership enables us to win first fit business by solving our customers' complex program.
During the second quarter, we launched our Wuhan, China Technical Center.
This was the first of three transitions as we progressed, our technical strategy and establish full separation from comments.
During the opening of our Wuhan facility, we introduced our next generation of media technology Nano net plus for China.
Which further extends the performance capabilities of our existing nano net technology.
The next generation nano net plus along with our new Technical center enables us to continue to develop differentiated products in fuel filtration.
This further underpins our global market, leading position in fuel filtration.
Secondly, we are focused on transforming our supply chain.
One element of this transformation is improving the availability of products for our cost to customers, which will drive share in the aftermarket and profitable growth.
During the second quarter, we progressed the implementation of our global distribution strategy through the establishment of new Atmos warehouses in Sao Paulo, Brazil.
And San Luis Potosi in Mexico.
Our teams have done an outstanding job, establishing these new facilities embedding capabilities and ensuring improved delivery for our customers.
Progress in the quarter to deliver enhanced availability for our customers, while maintaining disciplined inventory management was remarkable.
And finally I wanted to focus on our growth potential through expansion into industrial filtration market.
As Atmos, we intend to pursue pursue this growth opportunity through a disciplined programmatic approach to acquisitions.
We have established a strategy and corporate development team, we have developed a robust pipeline of targets.
And are continuing to assess acquisition opportunities aligned with our strategy.
My latest ship came and I are focused on growing beyond our call and we will continue to update you on our progress.
It has been a big quarter, a successful IPO and launch of Atmos.
Progress on multiple fronts against our strategic priorities and strong financial performance.
I want to thank all of the Atmos team for their significant contribution.
Now I will turn the call over to Jack.
Thank you Steph and good morning, everybody before reviewing our quarterly results and full year 2023 outlook I want to provide you with some additional details regarding the recent 8-K filing which Steph referred to.
We restated our March 31, 2023, <unk> financial statements and revised our annual financial statements for 2000, 22021 and 2022.
As we close the books in the second quarter of 2023, we identified errors within our intercompany and related party accounting practices.
These errors principally included Overstatements of related party receivables and related party payable and an understatement of net parent investments.
When combined with other prior period errors originally considered to be immaterial, both individually and in the aggregate the amount of the overstatement of cash provided by operating activities totaled approximately $25 million for the period.
These overstatements and cash provided by operating activities were offset by an overstatement of cash used in investing activities of $3 million in cash used in financing activities of $22 million.
It is important to note that these errors had no impact on revenue net income or EBITDA for the first quarter of 2023.
Nor did they have an impact on the amount of the companys cash balance upon closing of the initial public offering which was $115 million.
Now, let's discuss our second quarter 2023 results compared to the same period last year.
As Jeff mentioned at the beginning of the call we delivered strong financial performance.
Sales were $414 million compared to $393 million from the same period last year, an increase of approximately 5%.
The increased sales were driven by $32 million of pricing, which more than offset $7 million.
The decreased volume and $4 million of foreign exchange headwinds.
Gross margin for the quarter was $114 million, an increase of $19 million compared to the second quarter of 2022.
In addition to favorable pricing, we saw commodities and freight improved by $12 million.
This was partially offset by higher variable compensation costs.
The impact of lower volumes.
And foreign exchange headwinds.
SG&A expenses were $46 million.
An increase of $14 million over the same period in the prior year.
Both in costs was driven by higher variable compensation.
In addition, we experienced some cost inefficiencies as we incurred corporate costs from our parent company, while standing up our own dedicated resources we.
We expect this inefficiencies to continue until we are fully Standalone company.
The increase in variable compensation as a result of the efforts of all of our employees as they delivered strong results through the first half of the year relative to our expectations.
Equity royalty and interest income was $8 million, an increase of $3 million from 2022, primarily due to higher earnings from our joint ventures in China and India.
This resulted in adjusted EBITDA of $80 million, or 19, 3% compared to $67 million or 17, 1% in the prior period.
Adjusted EBITDA for the quarter excludes $9 million of one time standalone costs.
These onetime costs, primarily related to the establishment of functions previously co mingled with our parent company.
Such as information technology distribution centers and other human resources matters.
Overall, we delivered strong profitability driven by higher pricing and a moderating cost environment.
Our effective tax rate for the second quarter was 24, 5%.
An increase of 500 basis points from the second quarter of 2022.
The increase was primarily due to a change in the mix of earnings among tax jurisdictions.
Adjusted earnings per share was <unk> 63.
For the same period last year adjusted EPS was <unk> 67.
Adjusted free cash flow was $35 million this quarter compared to $24 million in the prior year.
Now I would like to discuss our approach to capital allocation, which is focused on delivering long term shareholder value.
We maintained strong liquidity to protect against volatility and uncertainty.
We ended the second quarter with $140 million of cash.
Combined with $350 million of availability under our revolving credit facility, our total liquidity was $490 million or.
Approximately 30% of the last 12 months.
We paid down $20 million of our outstanding revolving credit facility following the quarter end.
This reflects our strong performance and confidence in our ability to generate cash.
We plan to allocate capital for the sustainable growth opportunities, which Seth addressed earlier these.
These include growth in our traditional business and the inorganic expansion into industrial filtration markets.
Finally, we will continue to assess returning cash to shareholders.
Next I will turn to our guidance for the full year of 2023.
We expect sales to be in a range of $1 $5 8 billion to $1 63 billion.
We expect adjusted EBITDA margin in the range of $17 two five to $18 two 5%.
This excludes an expected 30% to 35 million of one time separation costs for the full year of 2023.
Moving to adjusted earnings per share our outlook for 2023 is in the range of $2 five.
The $2 25.
As we look towards the second half of the year, we expect to incur interest expense of approximately $25 million to $30 million as we service debt incurred at the IPO.
Our effective cash tax rate will be in the range of 23% to 25% for the full year of 2023.
This range is consistent with our year to date average tax rate.
Overall, our team did a fantastic job delivering strong results during the second quarter and we look forward to a strong full year of 2023.
Now I will turn it back over to the operator, and we will take your questions.
Thank you at this time I'd like to remind everyone in order to ask a question Press Star then the number one on your telephone keypad will take our first question from Tami Zakaria with Jpmorgan Chase. Your line is now open.
Hi, Good morning, Steffen, Jack Hope you're doing well.
My first question is.
It seems like volume growth was flattish in the first half.
So can you help us understand what's the volume.
Decline outlook is embedded and for the back half as you think about the full year guide, meaning can you quantify what kind of volume.
You are expecting for the back half and whether.
<unk> should be worse than <unk>, because I think compared stepped down in the fourth quarter. So any color on volume expectations would be very helpful.
Okay. Good morning, <unk> and thank you for your question I think is where I provided in my overview comments and I'll, let Jack talk to the specifics of how it plays out into the third and fourth quarters and our guidance.
Overall, I would say, we're seeing a softening in the second half relative to the.
Yes.
We are seeing strong performance in the first quarter, particularly we saw that softened somewhat in the second quarter, particularly in the U S market as we see some destocking through the channel. We expect our customers are doing that are different right.
<unk> had had progressed that through the second quarter, we would expect more of that in the third quarter and through the fourth reduced a softened economic activity.
Impacting largely in the fourth quarter I would say and.
And thats strongly connected to economic activity, which is a primary driver of our after market obviously.
So I'll, let Jack at any other specific sure. Thanks, Tim.
So generally speaking.
It can vary year by year, but over.
Over the long period of time, we generally see the second half from a seasonality perspective in being softer than the first.
Somewhere in the range of 5% or less our outlook implies a little bit more of a softening.
In the second half of this year driven by the factors that stuff just <unk>.
Just described.
Usually we've seen the third quarter.
The decline to be more pronounced in the third quarter with a little bit of recovery in the fourth quarter.
But it's hard to say precisely in this period.
Okay.
Got it. Thank you so much and if I can ask a follow up question.
Vince do you want to enter into industrial Association market can you tell us whether your current product portfolio has any product and that can be.
You did or leverage to enter.
Some some industrial end markets relatively quickly.
Hum.
Certainly assessing.
Our opportunity to grow into industrial filtration markets, we see this as a significant growth opportunity today's market.
Growing at twice the rate of our existing core markets.
And we see the market size opportunity being three times the size of our current market opportunity.
We were primarily focused on assessing accessing that growth opportunity through inorganic expansion.
And we discussed that in our remarks we.
We do see some possibilities of entering through organic and we are exploring nice it really would be leveraging off our media types.
Capability at.
It would need some product development still die Tammy.
<unk> has finished goods that would service those markets.
That's how I would characterize it with you, but we are certainly exploring the full realm of possibilities there as to how we would fast could fast track organic development.
In to those markets as well.
Great. Thank you so much.
Thank you Jamie.
Next we'll go to Jerry Revich with Goldman Sachs. Your line is now open.
Yes, hi, good morning, everyone.
Morning, Jerry.
Okay.
Really impressed by the margin performance you are now running at 19% year to date I'm wondering if you could just update us on how youre thinking about long term margin targets.
Obviously, you're reducing production sequentially.
The guide, but it feels like the margins to step down.
Significantly I am wondering is that just a function of.
First couple of quarters out of the gate.
Sure expectations are manageable versus something that's meaningfully different.
First half thank you.
Thanks for the question Gerry.
Obviously, our guidance puts our full year, adjusted EBITDA and a $700 per quarter to 18 in the quarter.
The first two quarters of the year have been very strong in terms of margin performance. There is a number of factors that I think is better into that.
Pleased with that however, certainly not at.
<unk> level I would say is sustainable at this point, so we're getting the benefits and.
In the first half both the first and second quarter.
Significant pricing actions, which will catch up actions and at the same time, we have seen some moderation of costs in our quarters, plus we've had a strong volume environment with back orders and sorry for that we have caught up on largely at this point.
It was kind of a lovely makes a strong margin.
So that first and second quarter as we've spoken about previously we certainly see margin expansion opportunity in our business and we started to realize some of that related to the short term actions of pricing and costs.
<unk> moderating.
We are focused on expanding our margins into the future.
Volume moderation in the second half certainly puts downward pressure as the as you discussed and we've got a number of inefficiencies still factored into our EBITDA margins overall as we become a standalone company.
Okay, that's clear.
Good morning.
To expand on the M&A opportunity set can you characterize for us the size of that.
The M&A pipeline that you folks are pursuing again, just talk about your process and building that pipeline.
Give us a sense for.
What's the opportunity set could look like.
From a transaction standpoint.
Over the next six to 18 months.
Yeah, Yeah, and I don't have a specific target to talk to you about I, hoping some of these future calls I will be able to be very very specific about the opportunity that we're going to proceed forward with that.
The rigor and the process, we are putting in place I am very pleased with our progress as.
As I restaurants, we have established a strategy team our corporate development team.
They've built a pipeline of targets, we filter that pipeline of targets down to <unk> that made our strategic criteria and our financial criteria.
We're evaluating regularly every month.
Multiple targets.
And as you as you know we have to we have to fish for many before we actually are guiding the other find the right opportunity for us to take that first step.
We've described our acquisition strategy as a disciplined programmatic acquisition strategy, Jerry So I say there is a smaller acquisition that we will.
Look to build out the synergy opportunity over time.
Love to be able to give you more color than that hopefully that gives you a sense of the discipline and a robust.
Establishment of team and capability, we're building to really be able to set us up for a programmatic acquisition of price to industrial filtration markets.
Appreciate it thank you and congratulations on the strong start here. Thanks.
Thank you Jerry.
Okay next we'll go to Joe O'dea with Wells Fargo. Your line is now open.
Hi, good morning, Thanks for taking my questions.
I wanted to circle back on aftermarket and if you could kind of parse it by what.
Are you seeing on the destock side, and then what Youre anticipating on the slower economic activity side, and so just any color on what you're seeing from a cadence perspective on the destock, whether kind of the right thinking is that you saw.
And <unk>, maybe it's a little bit steeper headwind in <unk> and then that.
And <unk>.
And then regarding the softer economic activity.
Degree to what you're actually hearing and seeing from customers.
As opposed to sort of what you're anticipating just based on what you're seeing on the macro.
Yes, maybe I'll take a ago and so if you can can weigh in here too.
So Joe I think I think it's a little difficult to in the aftermarket.
Where.
To parse out the specific driver I think all of our broader customers have approached this year from an inventory management standpoint, a little bit differently, and so youre seeing destocking occur at different times with.
Different customers and so we did see some of that in Q2, as Jeff alluded to and I expect some more of that here.
Over the back half as everyone right sizing their inventory relative to their expectations.
Our expectations in terms of the overall.
Economic activity I would say we are seeing some slowdowns there.
You can look at a number of different.
Inputs, whether it's great indices or.
Truck tonnage to point to.
Slowdown in activity.
Yes.
Perhaps it isn't as pronounced as we all thought a quarter ago and so we're keeping a close eye on how that unfolds.
Yes.
We'll continue to monitor what happens in the aftermarket.
Got it and then.
Question on R&D, I think that was up.
20% sequentially and year over year.
I'm not sure how much of that is tied to standalone or how much is tied to maybe some initiatives underway, but if you could you could touch on anything that contributed to that.
Specific programs or any organic efforts toward industrial.
Yeah, absolutely. So generally speaking we think about R&D.
As a percent of sales right in that two and a half call. It in the 2% to 3% of sales range and Thats kind of where we've been pretty consistently.
We do have some lumpiness if you will in terms of.
Prototype recoveries in particular, as we work with our customers to develop new products.
Timing of reimbursements for that can be can cause some some differences quarter on quarter, but overall, we continue to invest from.
From an R&D perspective.
And are excited about what the team can do not only in our core markets as they bring new solutions forward for our customers, but also.
Through the evaluation of these industrial markets.
What capabilities can we leverage into those new markets.
Got it thank you.
Thanks, Jim.
And next we'll go to Rob Mason with Baird. Your line is open.
Hi, Yes, good morning all.
Hi.
It's good to see the benefits of <unk>.
Pricing initiatives flow through that's pretty visible I was curious what you are.
Outlook for the full year includes with respect to price as we go forward and just also around your pricing initiatives the stickiness of that price that you've put through.
As you think about the balance of the year and if some of these costs do.
Continue to come down like freight.
Input costs et cetera.
Yeah no. Thanks.
Thanks, Rob.
Good to talk to you.
Sorry, let me just give an overview on where I say, we are in the sort of price cost story.
Largely through now.
The second quarter with core up on price cost I would say has you as you've reflected in terms of our margin performance. We obviously had the lag for.
Previous periods of performance, so I'd say largely caught up now and we are seeing inflationary pressures on commodity prices moderate.
So I do expect pricing in our outlook and what's contained in our guidance.
To return much more to historical.
Trends is is where I would guide you to.
Of course, if we do see cost escalate further we will adjust for that you will see the lag that we have experienced in the past, but we would adjust for that.
I'm not I'm not expecting any issues that stickiness.
You really have been able to successfully put price into the market as you're saying and demonstrated in and so I wouldn't I wouldn't flag any issues there at this point.
Okay. Thanks for that Steph.
Just as a follow up it looks like you're kind of onetime separation costs. The outlook for the year suggest those could increase sequentially as we go through the second half of the year could you just update us on where you think you are in terms of.
Your ability to move off from some of the TSA and you also mentioned some.
Inclusion of inefficiencies in the outlook as well is there any way to frame up what those inefficiencies amount to Qantas quantitatively right now.
Yeah. So let me give an overview of how we're tracking.
Overall is that it's a significant separation from Cummins and I will give some more color to that too.
Give you a sense of that.
And then I'll.
I'll ask Jack to add anything that he thinks are missing.
Overall, we see.
And there are certain elements certain functions that we are heavily entangled with comments, but we've called those out a few times, but I would describe that is predominantly as warehousing and transportation.
And <unk>.
And we are tracking very well in terms of our separation plan and the individual projects I would just broadly describe as being on track.
<unk> to a couple of those stages in my highlights we've established.
Two of our warehouses and distribution centers.
So we are very much on track with where we expected to be at the end of the second quarter.
I think the challenge in terms of just where those inefficiencies might lie that.
We're just guiding against is.
It is our anticipated ela.
Elements of it perhaps that we need to keep on lung for example, that's what I would characterize it as.
And a good example, I feel like we are adequately integrate that this but.
As we stand up our cyber security capability, we do need to keep coverage of common cyber security for the whole period, while ever we're using any of common applications right. So we can't really turn that pays off right until we get to the end of a two year journey. If you like at the end of at the end of 2020.
<unk>.
But we're on track right now.
We will be managing it very well.
And we will wind down the TSA as we turn off the activities in this side of it.
Yeah, and just to add a little bit here, Rob. So I think as you think about the cadence of the onetime costs as you alluded to we are expecting.
Come to remain at this level, if not a touch elevated as we move through the back half of the year.
As a reminder, we had about $4 million of these onetime costs.
Our first quarter of 2023, and the $9 million here in the second quarter.
Our guidance is $30 million to $35 million for the full year and so we do expect to continue to incur these costs as we separate.
Facilities from Cummins systems from Cummins, so on and so forth and just for color.
Roughly a third of those that 30% to $35 million.
Should be incurred in our cost of sales.
With the balance down in <unk>.
SG&A primarily.
That's helpful. Thank you.
Thank you Rob.
Okay.
And next we'll go to Andrew <unk> with Bank of America. Your line is open.
Yes. Good morning, good morning, good morning, Andrew.
Hi, Yes, just a follow up on the commentary.
There are a lot of dynamics here I think one of your competitors would really have to do with.
Specifically with one of our customers was driven but are you seeing destock at the distributor level or are you seeing destock at your OEM customer level, whereas the destock that youre talking about.
Yeah.
And Sir Andrew I'll focus.
<unk> on the North America market with my comments. It is it is the majority of our after market.
To give you a sense can you still hear me Andrew.
Yes.
Yes.
And sorry, I'll just focus on North America, what I would say it is varying by are we actually.
That's the color I would give you.
Some of our customers our OE it were really all the way through that dealer and distributor channel and it's moderated back to.
Normal levels.
The inventory through the chain and we are seeing quite most of the way through the destocking.
In others, we're kind of still in the distributor or dealer level and then in others again.
At the at the OE level. So it is bearing actually we're seeing some.
Moving through that foster than others, we expect it to play out almost that variation is helping US is this as it moderates through is how I would describe it we're expecting that.
That de stocking.
To play out over the remainder of quarter three and four.
Got you and just a follow up question on inflation.
Industry is starting to talk about disinflation or maybe it's all talked about deflation I think you guys are talking about that are.
Price from your supply chain.
I think historically the industry would give back pricing.
The deflationary environment have you adjusted the contract just remind us if you have adjusted your contract structure going forward.
To sort of to mitigate that or should we look at sort of legacy patterns, where inputs go down first and then you guys have to give back some price can you just talk about structurally what do contracts look like thank you.
Yeah.
So I'll talk at a high level just to the differences between our first fit business and aftermarket as it relates to pricing.
It's roughly 80 20, 80% after market, 20% fit our first eight contracts are very much based on our contractual arrangement.
<unk> have rise and fall causes integrated into them and you have seen that flow through and now previous period result in terms of the Austin market, we pause in our price increases to the after market and.
Roughly on a on a twice a year basis.
But it varies by region.
At the moment, we are not seeing deflationary pressures I would say certainly we're seeing a lower inflationary environment.
Rmi really caught up I would say in those markets to the previous rising an escalating cost environment.
Certainly.
Now looking at a deflationary.
Based in our forward pricing outlook.
But generally in aftermarket good point is that pricing should be a lot more stable.
Travel.
Exactly.
Thanks, so much and congratulation on a great quarter.
Andrew.
And there are no further questions at this time, Todd Shaw I'll turn the call back over to you for any additional or closing remarks.
Thank you that concludes our teleconference for today. Thank you for participating and your continued interest and as always the Investor relations team will be available for questions. After the call.
This concludes today's conference call you may now disconnect.
Okay.
Yeah.
Yes.
Yeah.
Yeah.