Atmus Filtration Technologies (ATMU) Q3 2023 Earnings Call Transcript

Atmus Filtration Technologies (ATMU 1.43%)
Q3 2023 Earnings Call
Nov 03, 2023, 11:00 a.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

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 any background noise.

After the speakers' remarks, there will be a question-and-answer session. [Operator instructions] Thank you. I would now like to turn the conference over to Todd Chirillo, head of investor relations. Todd, you may begin.

Todd Chirillo -- Executive Director, Investor Relations

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 pages available on our website at atmus.com. Now, I'll turn the call over to Steph.

Steph Disher -- Chief Executive Officer

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 markets 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 continued 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 margin on slightly lower sales as pricing actions, along with improved commodity and freight costs, drove margin growth. EBITDA has been adjusted for one-time separation costs which were 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 one-time 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, I 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 form 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 markets. 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 continued 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 plans. Now, I will turn the call over to Jack.

Jack Kienzler -- Chief Financial Officer

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 benefits and $3 million of 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 by -- 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 one-time stand-alone costs. These one-time costs primarily relate to the establishment of functions previously commingled with Cummins, such 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 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 the range of 1.6 billion to 1.625 billion.

We expect adjusted EBITDA margin in the range of 18% to 18.5%. This excludes an expected 30 million 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 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 question.

Questions & Answers:

Operator

[Operator instructions] Your first question comes from the line of Tami Zakaria from J.P. Morgan. Please go ahead.

Tami Zakaria -- JPMorgan Chase and Company -- Analyst

Hi. Good morning. 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 you're thinking about those two for the remainder of the year?

Steph Disher -- Chief Executive Officer

Yeah, thanks, Tami, and good morning. Let me just talk to the third quarter first and how we saw that playing out. And, you know, really we saw this in freight indices as well. We look significantly at the freight index.

September month was down 6% -- and I think -- year on year. And I think the quarter was down nine. So, from a demand perspective, we certainly saw a softer third quarter on the on-highway sector. And then, we had the -- you know, 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 significantly, 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 -- and -- and -- and as we'll see that come through in the fourth quarter. But from a destocking perspective, we think we're -- 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 -- JPMorgan Chase and Company -- Analyst

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 in the rest of the year?

Steph Disher -- Chief Executive Officer

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

Tami Zakaria -- JPMorgan Chase and Company -- Analyst

Great. Thank you.

Jack Kienzler -- Chief Financial Officer

Thanks, Tami.

Operator

Your next question comes from the line of Joe O'Dea from Wells Fargo. Please go ahead.

Joe O'Dea -- Wells Fargo Securities -- Analyst

Hi, good morning. Thanks for taking my questions. I guess on -- on the last topic and just in terms of some visibility to less destock headwinds is encouraging. I'm not sure about mix of price and volume in the fourth quarter, but it looks like, based on revenue midpoint, still looking at -- maybe it's 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 just the -- does the freight environment get a little bit more challenging or anything else just sequentially from 3Q to 4Q?

Steph Disher -- Chief Executive Officer

Yeah, thank you for the question, Joe, and good morning. So, where I would describe the key market drivers for us, and we've talked about this a fair bit, 80% of our business, aftermarket; 20%, first-fit. So, I may 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, while 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 in mid-single digits, as you -- as you described, decline. As we look at the first-fit, we're in a very strong position still in first-fit, certainly see that continuing through the end of the year. And we're -- we're more to the top of that cycle, I would say.

And we see the two, you know, flipping throughout 2024, as I -- as I alluded to, with aftermarket.

Joe O'Dea -- Wells Fargo Securities -- Analyst

Thank you. You framed that answer a lot better than I framed the question. That's all helpful. And then, in terms 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?

Steph Disher -- Chief Executive Officer

Yes, thank you. So, as I talk about our strategy, I go right back to the four pillars of our strategy and how I'm driving that focus throughout our entire company. And so, I'll talk to each of those in turn, perhaps, and reinforce the innovation component of your question. Firstly, we see ourselves in our first-fit markets in our core business as leaders in fuel filtration technology and crankcase ventilation. We want to further enhance and grow our market share leadership in those sectors, and we are investing specifically in programs and product development and innovating with our customers to secure greater share of those markets is the first piece I would talk about as a priority investment for us.

That's driving, I would say, continued sort of R&D investment in the range of this 2% to 3%. And we've got targeted capital expenditure that underpins and supports those programs for growth. So, that would be the first in the -- in the core first-fit markets. If I talk more broadly, the other components of our -- our strategy, accelerating profitable growth in the aftermarket, transforming in our supply chain, and expanding into industrial filtration markets. I think your comments on innovation relate more to the fourth element -- the fourth pillar of the strategy around expanding into industrial filtration markets. We already have a very strong position in terms of our media technology capability, and we want to leverage that technology capability across multiple horizontal end markets.

And we are investing both capital and research and development investment to expand that innovative technology capability. So, obviously, the largest one that I would point to there as a point of focus for us, I might build just one step further on the industrial expansion strategy. We are very very focused on how we're going to create value and by, you know, aligning or acquiring companies that we can stitch together with our core capabilities. And our technology and innovation is going to be fundamental to that creation of value.

Joe O'Dea -- Wells Fargo Securities -- Analyst

Very helpful details. Thank you.

Operator

Your next question comes from the line of Rob Mason from Baird. Please go ahead.

Rob Mason -- Robert W. Baird and Company -- Analyst

Hi, good morning. I wanted to ask about your gross margin. It actually again outperformed my expectation. So, it's -- and you noted some of the factors there.

And I'm just -- I'm just curious now that if you think that is a more sustainable level around 26 versus. Obviously, last year, around 24, had some challenges. But I'm just curious how the sustainability looks from here.

Jack Kienzler -- Chief Financial Officer

Hey, good morning, Rob. This is Jack. I'll take that one. Yeah, it's a great question.

It's one we've been talking about a lot internally here. Obviously, there's some big moving factors, you know, year on year as I think about gross margin price. Of course, the biggest mover year on year for us, which was offset by -- by volume. We also had some -- some positive tailwinds from a commodities and freight perspective. We are, I would say, quite focused on, you know, improving our efficiencies and taking costs out from a gross margin perspective, and we will continue to focus on that moving forward.

I think the biggest swing factors, we do expect price to moderate certainly going forward off of what's been quite volatile, you know, call it, 18-month span here, but I think, you know, a big factor will be what is -- what input costs do moving forward. We've seen those costs moderate, which has been quite helpful. And we'll keep a close eye on those all while continuing to drive efficiencies into next year in our manufacturing base.

Rob Mason -- Robert W. Baird and Company -- Analyst

There was one mention in the discussion around your gross margin, jack, around unfavorable manufacturing, is that -- was that different than volume in the quarter?

Jack Kienzler -- Chief Financial Officer

Yeah, so, you know, if I think about, call it. our normal targeted detrimental, there was a bit more inefficiency than that. You know, it's -- as we think about the cyclical aspects that Steph was highlighting, we're trying to make sure that we don't take out too much fixed -- fixed costs and not position ourselves to serve our customers in the aftermarket. And so, there was some inefficiencies. Obviously, there's a lot of work going on in our supply chain as we decouple that from Cummins.

Steph highlighted a few of the warehouses that have been decoupled inside of Q3, and we're continuing down that journey. As you can imagine, that -- that causes a lot of challenges just operationally for our team that we're continuing to progress through and again try to focus on improvement moving forward. But that was a bit of a factor, I would say, in our gross margin performance.

Rob Mason -- Robert W. Baird and Company -- Analyst

I see. Very good. Thank you.

Jack Kienzler -- Chief Financial Officer

Thank you, Rob.

Operator

Your next question comes from the line of Jerry Revich from Goldman Sachs. Please go ahead.

Jerry Revich -- Goldman Sachs -- Analyst

Yes, hi. Good morning, everyone.

Jack Kienzler -- Chief Financial Officer

Good morning, Jerry.

Steph Disher -- Chief Executive Officer

Good morning, Jerry.

Jerry Revich -- Goldman Sachs -- Analyst

I'm wondering if you can just talk about the implied fourth-quarter margin guidance. You know, you obviously performed really well year to date. You're guiding to roughly 50 to 100 basis points of lower margin, 4Q versus 3Q. And I think the seasonality is more balanced than that, but maybe you can correct me if I'm wrong and just touch on the moving pieces 4Q versus 3Q, is that just make sure we're on track to hit numbers.

Or are there underlying headwinds that we should be thinking about sequentially beyond seasonality?

Jack Kienzler -- Chief Financial Officer

Yep, thanks for the question, Jerry. So, I think it's really all down to volume, you know, to be perfectly frank. Normally, you know, we have seen a bit of seasonality, but -- but as Steph alluded to, it's more of a market dynamic that we're looking at in Q4. We do expect some softness to continue, particularly in the aftermarket as we move into that quarter. And so, that, in terms of our normal detrimental coupled with some of the inefficiencies I was just commenting on to Rob, is really the driver in that margin degradation that we're guiding to Q3 to Q4.

And nothing really significant outside of that dynamic from a volume perspective.

Jerry Revich -- Goldman Sachs -- Analyst

OK, appreciate it. And in terms of -- as we think about the performance this year, you know, margins up on volumes down, how should we be thinking about operating leverage off of this base? Can we still get, you know, mid-20s incremental margins as volume come back? In other words, are we going to keep this price-cost gap that we built this year?

Jack Kienzler -- Chief Financial Officer

Yeah, I can -- I can go ahead and start there. Certainly, we would expect, you know, to keep the price-cost gap. We don't have, you know, history of pricing givebacks in the aftermarket historically. And of course, we'll continue to monitor our cost base and take actions to recover that cost should it increase, although, you know, we'll see based on where we sit today.

Overall, you know, I do think, obviously, we're continue to focus on delivering, you know, the -- the expected incremental margins in and around 20%. I think, as we look to next year, the big stories will be volume, right? And -- and then, you know, we'll have a couple of tailwinds. Variable compensation, as I highlighted in my -- in my comments, will be a tailwind. And so, you know, that, coupled with some of our hopefully recovering markets in the aftermarket, should present a -- an attractive backdrop as we move into next year.

Steph Disher -- Chief Executive Officer

Yeah. 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 -- we have kicked off that program. We've started to see some small benefits. Not enough to even sort of make it to the commentary of our earnings right now, but we're going to build momentum around that, continue to underpin, you know, a focus on – on -- on margin expansion. So, that's the only other piece I would reinforce.

Jerry Revich -- Goldman Sachs -- Analyst

That's clear. Thank you.

Operator

Your next question comes from the line of Andrew Obin from Bank of America. Please go ahead.

David Ridley-Lane -- Bank of America Merrill Lynch -- Analyst

Good morning. This is David Ridley-Lane on for Andrew Obin. Question on the sort of commodities and freight trend. What's -- what's embedded in your full-year EBITDA margin guidance for that in the -- in the fourth quarter?

Jack Kienzler -- Chief Financial Officer

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

David Ridley-Lane -- Bank of America Merrill Lynch -- Analyst

Got it. So, it would be kind of neutral year on year.

Jack Kienzler -- Chief Financial Officer

Q4 to -- yeah, Q4 to Q4 of last year, correct.

David Ridley-Lane -- Bank of America Merrill Lynch -- Analyst

OK. 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?

Jack Kienzler -- Chief Financial Officer

Yeah, so capex, it's really driven by timing of projects. Frankly, most of those are, you know, IT programs that we're 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 2024. 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.

David Ridley-Lane -- Bank of America Merrill Lynch -- Analyst

Got it. And, you know, 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.

Steph Disher -- Chief Executive Officer

Yeah. No, thank you, David, for the question. Actually, we are the majority of the way through in terms of our large inventory sites in our distribution separation. So, our distribution center in Kentucky is about 50% of, you know, our holdings.

And so, we already moved that at the, you know, beginning of this year. Mexico and Brazil, we've already moved across. So, the sites 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, you know, 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.

David Ridley-Lane -- Bank of America Merrill Lynch -- Analyst

Great. Thank you very much.

Jack Kienzler -- Chief Financial Officer

Thank you, David.

Operator

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

Todd Chirillo -- Executive Director, Investor Relations

Thank you. That concludes our teleconference for the day. Thank you all for participating and for your continued interest. As always, the investor relations team will be available for your questions after the call.

Have a great day.

Operator

[Operator signoff]

Duration: 0 minutes

Call participants:

Todd Chirillo -- Executive Director, Investor Relations

Steph Disher -- Chief Executive Officer

Jack Kienzler -- Chief Financial Officer

Tami Zakaria -- JPMorgan Chase and Company -- Analyst

Joe O'Dea -- Wells Fargo Securities -- Analyst

Rob Mason -- Robert W. Baird and Company -- Analyst

Jerry Revich -- Goldman Sachs -- Analyst

David Ridley-Lane -- Bank of America Merrill Lynch -- Analyst

More ATMU analysis

All earnings call transcripts