Q2 2023 PHINIA Inc Earnings Call
123 earnings conference call.
Today's conference is being recorded and all lines have been placed on mute to prevent any background noise.
After the Speakers' remarks, there will be a question and answer session.
I would like to ask a question during that time simply press. The Starkey followed by the number one on your telephone keypad.
If he would like to withdraw your question Press Star one a second time.
Thank you and I will now turn the conference over to Mike <unk>, Vice President of Investor Relations you may begin.
Thank you Ravi and good morning, everyone. We appreciate you joining us dania completed its separation from Borgwarner on July 3rd and started trading on the New York Stock Exchange on July 5th prior to the separation was a wholly owned subsidiary of Borgwarner comprised of the company's fuel systems.
And aftermarket segments.
Sending us historical GAAP financial information is presented on a carve out basis. In addition, we present certain adjusted non-GAAP financial measures on today's call and in supporting materials. Our conference call materials were issued this morning and are available on <unk> Investor Relations website.
We are also broadcasting this call via webcast joining us today is Brady Ericsson CEO and Chris crop CFO .
During this call we will make forward looking statements, which are based on management's current expectations and are subject to risks and uncertainties.
Actual results may differ materially from these statements due to a variety of factors, including those described in our SEC filings and with that it's my pleasure to turn the call over to Brady.
Thanks, Mike and thank you all for joining Phineas first earnings call.
Mike mentioned on July three we completed the spinoff from Borgwarner and we're honored to ring. The opening Bell on July 5th prior to our stock trading for the first time as an independent company.
Our entire leadership team family members in key supporters were present to celebrate this key milestone.
It was a great event, but it would not have been possible without the dedication and commitment of nearly 13000 employees and for that our leadership team and board of directors when I say thank you.
In the weeks after our leadership teams scattered around the world to share our excitement and to celebrate the milestone with as many of our employees as possible.
The celebrations were great and the level of excitement and commitment shown was extremely high.
While our journey is just beginning we are confident in our future given how our team came together to meet extraordinarily tight deadlines related to separation and not missing a beat in servicing our customers and executing on our day to day business.
We've assembled a strong team, bringing together the right talent and experience to deliver on our strategies.
We have a balance of legacy Borgwarner and Delphi as well as top outside talent.
As we built the team one thing became very clear, we all chose to be here because we believe in the long term potential of the business.
We all support our focus on product leadership, and our drive to achieve carbon neutrality by 2035.
We have long term relationships with many of the top Oems in the world and their feedback around the spinoff has been highly supportive.
Last few years have challenged our supply chain and have demonstrated the importance of strong reliable suppliers that have a technology that brings value for global footprint and solid financial footing.
With their increasingly limited resources, they will rely on us more and more to provide complete systems as well as software and calibration services, increasing our share of wallet and further integrating us into their business.
With this backdrop, we're confident we will have multiple avenues for growth as an ideal supplier partner.
Now I want to take a few minutes to talk about our strategy.
Over the last few months I've met with many of you and appreciate your feedback we've heard a few things that really stand out about our story.
First this is not a pure light vehicle OE ice business.
Today more than 50% of our sales come from commercial vehicle and industrial applications original equipment service and the independent aftermarket channels.
Second we have both the desire and clear path to profitably grow the business for the long term.
We believe that we can accomplish this without sacrificing our margins our cash generating ability.
We will leverage our core technologies competencies brand's footprint and distribution to add synergistic products and to enter adjacent markets.
And finally, there was an acknowledgment that bev will not be the only solution needed to achieve carbon neutrality.
For many applications, a carbon neutral carbon free fuel liquefied or gaseous will provide the optimal overall performance and utility for many applications, especially those requiring high power high loads traveling long distances operating off highway and with high uptime requirements.
These applications require the energy density the portability and the practicality of these fuels.
There are also some regions focusing on carbon neutral fuels is their pathway to carbon neutrality, rather than bad reasons.
The reasons include availability of renewable energy infrastructure challenges.
National Security and energy independence.
In the midterm, we still see opportunities in the light vehicle market with secular growth in gasoline direct injection or <unk> we.
<unk> technology is key for full hybrid and plug in hybrid applications.
Next I'd like to touch on our capital allocation.
In the coming weeks, we'll be meeting with our board of directors to align on our overall capital allocation strategy.
We already communicated our intentions for an appropriate dividend at our Investor day, and expect to provide more color around our entire capital allocation strategy in due course.
We remain confident in our business is strong earnings and cash generation ability over the long term.
As we previously articulated our focus will be to maintain our strong balance sheet and maximizing total shareholder returns.
This will include one dividends.
Two optimizing our debt structure.
Three strategic and rapidly accretive and high ROIC <unk> acquisitions to grow our commercial and industrial and aftermarket businesses.
And for Opportunistically repurchasing shares.
Many of you have also asked about our key metrics for tracking the performance of the business.
We strongly believe that an economic value and ROIC framework, along with cash generation, we will provide appropriate alignment between the incentives for our employees and the interests of our shareholders.
We will look to roll this out for 2024.
Now moving to Q2.
I'm proud of the team's execution in Q2.
Our results demonstrate positive momentum on a sequential basis as well as our year over year.
Versus the same period in 2022, we expanded our adjusted operating margins by 180 basis points to 10, 6% and our adjusted EBITDA margins by 140 basis points to 14, 7%.
As we shared our expectations in June on our Q1 to Q2 2023 basis. We've also improved our adjusted operating and adjusted EBITDA margins from the first quarter by 80 basis points each.
It's important to note that the portion of this improvement improvement reflects timing and lumpiness of customer recoveries for realization of supplier inflationary costs.
We had an easy comparison with Q2 of last year in Q1 of this year in both periods were incurring costs from our supply base, but.
But not yet receiving reimbursement from our customers.
In Q3 of last year, we received retroactive reimbursement.
As well, creating more difficult margin comparison coming up in our next Q3.
We expect our underlying positive operational performance to continue in the second half of this year, but will be offset by increasing corporate cost as a standalone company.
Our support for our sustainable profitable growth objective.
Let me walk you through some of the existing recent new business wins.
Senior secured a major business award to supply injectors to a European OEM for our heavy duty commercial vehicle that is compliant with euro seven emission standards.
We've been selected as the main partner to our U S Department of Energy project announced on May 19, 2023, and funded by the Doe.
To advance research development and implementation of technology to reduce greenhouse gas emissions the.
The project will feature Phineas, new hydrogen medium pressure direct injection fuel system technology.
We also secured a contract to supply powertrain domain control units or PDC use to a leading Asian OEM.
And finally finish secured a contract to supply of startup motors for a medium duty application for a large U S. OEM.
These last two comp. These last two were conquests and will support our continued profitable growth.
With that I'd like to hand, it over to Chris who will walk us through in more detail, our Q2 results and the outlook for the rest of the year Chris.
Thanks Brady.
And I'd like to add my congratulations to the finance team.
Greatly appreciate the commitment and long hours that the team has put in over the last few months to get us over the finish line to a successful separation.
I know the same commitment and momentum will carry forward and help us drive the success of Affinia.
Before diving into the financials for the quarter I would like to note again that the following discussion regarding Q2 results reflects the fuel systems and aftermarket business units that were under Borgwarner ownership prior to completion of the spin off on July 3rd.
At quarter end <unk> is not operating as a standalone business.
Our 10-Q to be filed later today reflects GAAP carve out basis.
There are allocations between us and our farmer former parent that will eliminate going forward.
Countless other changes as a result of the spin which impact any takeaways within our Q2 reported numbers as filed.
To help the investment community better understand our historical underlying operating performance by segment. We included an adjusted quarterly table in today's earnings presentation within the appendix section of the document.
This table aligns with the presentation that we shared at our Investor day.
We expect our Q3 results will be a more accurate representation of the performance of.
<unk> as a standalone business that will still have some adjustments due to transition services agreements and contract manufacturing, which we expect to fully exit by the end of 2024.
That said our intent is to make these comments helpful to gauge our fuel systems and aftermarket performance. During this quarter and help you think about the business going forward.
In Q2, 2023, we generated $887 million and total sales up 11% year over year.
We achieved $94 million and adjusted operating income and $130 million of adjusted EBITDA, resulting in an adjusted operating margin of 10, 6%.
And an adjusted EBITDA margin of 14, 7% a year over year improvement of 180 basis points and 140 basis points respectively.
Sales growth in the quarter was driven by higher <unk> sales in Europe , and continued expansion of DDI and the Americas.
We saw favorable sales from volume and net new business accounting for 8% of the year over year growth.
Additionally, positive customer pricing of $30 million, including $19 million of inflationary customer recoveries made up the balance of our growth.
Somewhat offset by a slight FX headwind.
These recoveries represented 72% of our realized inflationary cost for the first half and have reached agreement on recovery mechanisms with most of our top customers for inflationary cost recovery for the year.
Please note that some Q2 recovery customer recoveries were retroactive to the beginning of the year.
Therefore, when looking at our adjusted margin performance going forward its more instructive to consider overall first half performance as a jumping off point.
From an overall margin perspective perspective, we benefited from higher volumes in both fuel systems and aftermarket as well as positive price from customer inflationary cost pass throughs, partially offset by commodity product mix inflationary and other supplier related costs.
We also saw a benefit from reduction in corporate cost versus a year ago.
Looking at performance on a segment level, we are pleased with the year over year and sequential improvements in fuel systems margin.
Fuel systems, adjusted operating margins improved 220 basis points from the same period, a year ago or 11, 3%.
And 280 basis points from Q1 of this year.
This improvement is largely due to timing of non commodity inflationary cost recoveries, which.
Which as Brady mentioned earlier can be lumpy.
In the second quarter of last year's margins.
Margins were depressed as we were incurring higher inflationary supplier cost and we're not yet being reimbursed by our customers.
In Q2 of this year, we received inflation recovery that not only cover the second quarter that was also retroactive to the beginning of the year.
Fuel systems also continues to benefit from higher European CV business and GDP growth in the Americas.
Our aftermarket businesses.
Sales grew 4% year over year, driven by positive price and growth in European markets.
Adjusted operating margin came in at 14, 6% down 120 basis points from the same period, a year ago due to product mix.
Overall, we expect to continue our margin expansion momentum as we laid out in June target longer term EBITDA margins of 14% to 15%.
We continue to assess our cost and footprint on an ongoing basis with an eye to further efficiencies.
In addition, we will continue to incur costs related to the spin as we adjust our footprint to reflect the separation.
Okay.
We continue to expect corporate cost to be $60 million to $70 million for the full year.
We expect corporate cost to annualize next year at approximately $80 million that there will still be some noise from transitional services as we finalized new contracts complete our staffing and finalized allocation between segments and corporate.
Year to date cash from operations was $26 million cash flow was impacted by spin off costs and some working capital build related to separation activities that are expected to normalize by year end.
I wanted to spend a minute talking about our liquidity, we are committed to a strong financial foundation, and having ample liquidity to run our business and execute our strategy.
Upon completion of our spin on July 3rd we entered into a five year credit agreement consisting of 500 million revolver.
$300 million term loan a and a $425 million term loan b.
We have $800 million outstanding under these agreements at an average interest rate of eight 7%.
On July 3rd we also had approximately $300 million in cash, giving us total liquidity of more than $700 million.
And net leverage of approximately one time EBITDA.
Finally, I would like to reiterate the 2023 outlet we provided at Investor day.
There is no change to our underlying full year guidance at our Investor day, we disclosed we have short term contract manufacturing arrangements with Borgwarner.
We anticipate contract manufacturing sales to be 45 million to $50 million for the second half of this year with an annualized run rate of approximately $100 million and negligible profits.
We expect these sales to trail off over 2024, Consequently, we will be adjusting our sales guide to exclude these temporary low margin pass through sales in order to provide a more accurate view of our business performance over the longer term.
We expect full year sales, excluding contract manufacturing debate, 345% to $3 55 billion and adjusted EBITDA of 485 million to $505 million.
With that I want to thank you for your time, and we will now move to the Q&A portion of our call.
Thank you.
At this time I would like to remind everyone in order to ask a question Press Star and then the number one on your telephone keypad.
And we will pause for just a moment to compile the Q&A roster.
Okay.
Yeah.
Again, it is star one if you would like to ask a question.
Yeah.
Okay.
And we will take our first question from Jake Shaw with BNP Paribas. Your line is open.
Hey, guys and congratulations on successfully getting through the spinoff.
First thing.
Want to ask you guys is.
So on Borgwarner call, they mentioned that they expect a $450 million payment.
Third quarter.
Could you talk about how.
How that's going to impact your financials and.
That's sorry, that's already accounted for on your pro forma balance sheet.
Yes.
On the spin on.
July 3rd we as we took on that additional debt the term loan a and b and revolver.
There wasn't a lot of cash payments kind of going back and forth to pay off all of the intercompany.
Due to Borgwarner borgwarner due to us.
I believe there. The net result is what they were mentioning after all of this spin costs was.
Was the $4 50.
Don't have that full walk again.
There was an $800 million net payment that we had from all of our debt that we gave to borgwarner and that's net of other payments.
Alright, Thank you guys.
Nothing going to impact us going forward that all happened on July 3rd.
And.
Go ahead.
Sure.
Oh, sorry go ahead.
And I think my other question is you guys you guys just give us the work.
Net leverage now which stands at about one times to your year end net leverage which.
Looks like it also at about one times so is there any.
Are there any like cash payments that are.
Sections in guidance can you just talk Steve talks with good Sir Thank you.
Yeah, if I understand the.
Are you talking about the net leverage point youre not seeing on that chart is the cash generation that we're going to have in Q3 and Q4.
So our net cash would probably is going to be going up.
With our profits and improvement in our working capital.
And so we will then determine what do we do with that cash as part of our capital allocation do we pay down debt dividends and other items.
So I do see us.
Maintaining that are improving on our net leverage too.
Alright, thank you.
Okay.
As a reminder, the star one if you would like to ask a question.
And with no further questions at this time I will now turn I.
I do apologize we did get another question.
Next question comes from Douglas Duffy with BC Partners. Your line is open.
Good morning.
After all your efforts on the spinoff could you comment a little bit about the management inside of the stocks and sort of compensation philosophy relative to your key performance parameters. Thank you.
Sure I think right now.
Obviously, we had incentives that were put in place with Borgwarner those are basically carrying over.
We're going to be working with our board and our comp Committee and this next meeting as we do those conversions, but as I mentioned on the call we're going to be resetting.
Kind of our key metrics that will be focused on economic value and ROIC.
As well as the overall cash generation of the business on a year over year basis.
And so that will be rolled out for the 2024 and beyond.
Is is how we're going to do things.
Okay got it thats helpful and look forward to seeing that just the other comment now.
A much smaller company youre not part of the I guess, the very large company and just comment how that will affect you going forward I mean, we deal with a lot of smaller companies they have fewer resources.
It's different than running a big campaign.
Do you see that.
So I think in general the way things are set up.
Under the prior ownership as most of our business units were pretty Standalone.
From finance supply chain engineering, our plants were pretty pretty standalone, so from that perspective.
Theres not a lot different.
There is obviously going to be some differences in the fact that legal investor Relations Treasury.
Tax are going to be some of the additional corporate costs that we need to we need to add to our organization because that was where some of the primary support that we had from our from our prior parent.
So from our perspective, that's going to be the biggest synergy.
With that said I think we're going to be a lot more nimble.
In supporting our business and so I think we're going to be a lot more focused on.
Our customers and our markets to help grow our business.
And Thats, where I made the comment earlier around.
Our customers are actually excited about the spin.
Because they know theyre going to have a trusted partner to supply them.
With combustion technology, whether it's carbon neutral carbon free aftermarket parts for decades, and decades, and so they were quite supportive and excited about the opportunity because they see us continuing to invest in that space and we're going to continue to help them transition to a carbon.
Carbon free fuels going forward.
Alright, Thank you very much.
Okay.
And again it is star one if you would like to ask a question.
And with no further questions I will now turn the call back to Mr. Brady Erickson for closing remarks, great.
Great. Thanks, everyone really appreciate your questions and feedback we truly believe in what this business can deliver after visiting many of our sites over the past few weeks as a newly independent company. Our organization is extremely excited and eager to demonstrate growth and value creation. We appreciate your time and interest in our story have a great day.
Thank you.
Ladies and gentlemen, this concludes today's conference call and we thank you for your participation you may now disconnect.