Q3 2023 Atmus Filtration Technologies Inc Earnings Call

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 Atmos filtration technologies third quarter 2023 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. If you'd like to ask a question during that time. Please press star followed by the number one on your telephone keypad and if he would like to withdraw your question again press Star one.

I would now like to turn the conference over to Todd Trulia head of Investor Relations Todd you may begin.

Thank you Christina good morning, everyone and welcome to the Atmos filtration technologies third quarter 2023 earnings call on the call today, we have Steph Fischer, 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.

It's great to be here with you today to provide an update on our third quarter financial results and business highlights.

Ed.

The Atlas team achieved another quarter of superior performance by focusing on our customers and delivering technology, leading Blake guard products.

I am pleased with the progress we have made to establish atmos 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 market in the third quarter and we expect this strength to continue through the end of the year.

In the after market as expected, we continued to see softening conditions, driven by lowest rate 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 that continues to be a sluggish economic recovery from last year, which.

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 with $396 million.

A decrease of approximately 1% from the third quarter 2022.

Lower volumes were partially offset by higher pricing and FX tailwind.

Adjusted EBITDA margin Rose 40 basis points from the prior year to 18, 3%.

We were able to grow margin on slightly lower sales as pricing actions, along with improved commodity and freight costs drove margin growth.

Okay.

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 <unk> 52 cents.

And adjusted free cash flow was $50 million.

We have adjusted free cash flow for $2 million of one time capital expenditures related to the 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 will provide the foundation for delivering these impressive results.

During the quarter by not launched our first leadership catalyst events.

This event brought together our top 75 liters to engage them in leading the Atmos way.

This enabled us to engage key latest in our purpose culture and strategy.

The same for the event were empowered learning and customer focus.

The energy and excitement I felt for my engagement with this group of extraordinary latest fueled my passion to unleash the full potential of that.

Right.

As I have previously highlighted our growth strategy is focused on four pillars.

Gross share in first fit in coal market.

Accelerate profitable growth in the aftermarket.

Transform our supply chain and expand into industrial filtration markets.

Our product and technology leadership form the cornerstone for growth in our core first fit and aftermarket segments.

Our iconic <unk> brand is recognized in the industry as being synonymous with premium product.

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 cycles.

Our filters are available in over 45000 independent aftermarket retail outlet.

We will continue to grow the retail presence of Blake, our product with expanded partnerships and improved availability.

Our delivery metrics continue to rise, providing our customers the right product at the right time.

I've 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 progressed 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 continued to evaluate a robust pipeline of opportunities aligned with our strategy for inorganic expansion into the industrial filtration market.

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 atmos 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.

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.

Jeff 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 a foreign exchange tailwind.

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.

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.

The 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%.

Impaired to 72 million or 17, 9% in the prior period adjusted.

EBITDA for the quarter excludes $7 million of one time standalone costs.

These onetime costs, primarily related to the establishment of functions previously co mingled with Cummins.

As information technologies distribution centers and human resources function.

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.

An unfavorable discrete tax items.

Adjusted earnings per share was 52 seven for the same period last year adjusted EPS was <unk> 62 for.

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 62 5 billion we.

We expect adjusted EBITDA margin in a range of 18 to 18, 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 now in the range of $2 20.

The $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 2020 through this.

This range is consistent with our year to date average tax rate.

Overall, our team continues to deliver solid results during the third quarter and we look forward to achieving a strong full year of 2023.

Now we will take your questions.

If you'd like to ask a question. Please press star one on your telephone keypad.

First question comes from the line of Tami Zakaria from Jpmorgan. Please go ahead.

Hi, good morning, and thank you so much and 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 youre thinking about those two for the remainder of the year.

Yes, Thanks, Tommy and good morning.

Let me just talk to the third quarter first and how we saw that playing out and really we saw this in fright indices as well we look is significantly at the Cass freight index.

September month was down 6%.

And I think year on year, and I think the quarter was down nine site from a demand perspective, we certainly saw a soft.

Third quarter on the on highway sector and then we had the added factor of continued de stocking with customers.

As we've said throughout the year, we've seen our customers destocking at different right.

And some of that happen in the second quarter. Some in the first quarter and then more significantly we saw some in the 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 face headwinds from a demand perspective in our on highway.

After market.

And.

And so we will see that come through in the fourth quarter that from a destocking perspective, we think we're largely through it in the on highway side. It hasnt 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 where most of the way through the.

The Destocking and expect that to me a much more muted impact as we head into the final quarter of the year here.

Got it. Thank you 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.

And the rest of the year.

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 impact.

Offset the volume downturn.

Great. Thank you.

Thanks Darren.

Your next question comes from the line of Joe <unk> from Wells Fargo. Please go ahead.

Hi, good morning, Thanks for taking my questions.

I guess.

On that last topic and just in terms of some visibility to less feedstock headwinds is encouraging.

Not sure about mix of price and volume in the fourth quarter, but it looks like based on revenue midpoint still.

Still looking at maybe it's something like mid single digit volume declines.

That's the case, just kind of a handoff from destock, maybe some more macro and you can talk about.

Rate environment get.

A little bit more challenging or anything else just sequentially from <unk>.

Thank you for the question, Joe and good morning.

Where I would describe the key market drivers for us and we've talked about this a fair bit, but 80% of our business after market, 20% first fit so I might just try and talk about those two cycles generically.

If I just start with after market.

We certainly saw a sequential increase in September over August in terms of flight activity.

So whilst we say we're kind of at the bottom of the cycle and after market, we still see continued declines year on year.

Robley through sort of mid next year is how I would describe the after market dynamics as we are saying it fills.

Still softer market conditions demand driven in the fourth quarter.

And so thats, where we say we are in the cycle on the after market side.

Mid single digits as you as you described decline.

As we look at the first fit we're in a very.

Although that.

We'll see based on where we sit today.

Overall I do think obviously, we continue to focus on delivering.

The expected incremental margins in and around 20%.

I think as we look to next year.

Big stories will be.

Volume right and.

And then.

We'll have a couple of tailwind variable compensation as I highlighted in my and my comments will be a tailwind and so that coupled with.

Some of our hopefully recovering markets and the aftermarket should presenter.

An attractive backdrop as we move into next year.

And Jerry the only thing I would add on the back of that I've talked a lot about the supply chain transformation, our focus on becoming more efficient delivering cost benefits in that area.

We have kicked off that program, we started to see some small benefits not enough to even sort of make it to the commentary about earnings right now.

But we're going to build momentum around that continue to underpin.

First on on on margin.

Pension side.

Other peso of Greenfields.

That's clear thank you.

Your next question comes from the line of Andrew <unk> from Bank of America. Please go ahead.

Good morning. This is David Ridley Lane on for Andrew.

Question on the sort of commodities and freight trend.

What's embedded in your full year EBITDA margin guidance for that in the in the fourth quarter.

Yes, so sequentially versus Q3, we've seen some ups and downs as we move through the year, obviously overall, it's been a favorable.

Freight and commodity backdrop for us year on year, we did see some sequential elevation of that as we entered into Q3.

But all signs point to that I.

I would say moderating so essentially as I alluded to it's really a volume story as we move into Q4, not expecting any significant swings from a freight and commodity standpoint.

Got it so it would be kind of neutral year on year.

Q4 to Q4 to Q4 of last year correct. Okay.

Okay.

And then.

Sort of the change in the separation capex.

It looks like about $10 million of projects kind of pushed out to next year is that the right way to think about it.

Yes, so capex.

It's really driven by timing of projects.

Frankly, most of those are.

Programs that were.

Continuing to decouple from Cummins, which all coincide with different locations coming on online and so we have seen a little bit of a delay in some of that all for good reasons, but.

Just a little bit of pushing those projects out into 2020 for the overall amounts are still in line with what we've commented on it's just a shift as we think about 2023 versus 2024.

Got it and.

Should we expect any unusual inventory build as you stand up these distribution centers I'm, just thinking on kind of.

Do you need to fill them up before you start winding the others down.

Yeah no. Thank you David for the question.

The majority of the way through in terms of our large inventory side in our distribution separation. So al distribution center in Kentucky is about 50% of <unk>.

Holdings, and so we already moved that at the B B.

Beginning of this year, Mexico, and Brazil, we've already moved across so besides we have left are really lower inventory impact sites I would say overall.

I'm not expecting a material impact to comment on we certainly will manage the transition effectively that our customers are not impacted but I don't expect it to I expect it to be managed inside a quarter and I really don't expect it to make these calls.

Great. Thank you very much.

Thank you Devin.

And we have no further questions in our queue at this time I will turn the call back over to Todd for closing remarks.

Thank you that concludes our teleconference for today. Thank.

Thank you all for participating and for your continued interest.

The Investor Relations team will be available for your questions. After the call have a great day.

This concludes today's conference call. Thank you for your participation and you may now disconnect.

Okay.

Yeah.