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Atmus Filtration Technologies (NYSE: ATMU)
Q3 2024 Earnings Call
Nov 08, 2024, 11:00 a.m. ET
Atmus Filtration Technologies Shows Resilience Amid Market Challenges in Q3 2024
Meeting Overview:
- Prepared Remarks
- Questions and Answers
- Call Participants
Prepared Remarks:
Operator
Thank you for joining us today. I’m Kayla, your conference operator. At this time, it’s my pleasure to welcome everyone to the Atmus Filtration Technologies third quarter 2024 earnings call. All lines have been muted to prevent background noise.
We will have a question-and-answer session after the speakers’ remarks. [Operator instructions] Now, I’d like to turn the call over to Todd Chirillo, executive director of investor relations.
Todd Chirillo — Executive Director, Investor Relations
Thank you, Kayla. Good morning, everyone, and welcome. With me on the call are CEO Steph Disher and CFO Jack Kienzler. Please note that some of the information presented today will be forward-looking and can involve risks that might affect expected results.
For a full disclosure of these risks and a reconciliation of any non-GAAP measures, please refer to our slides on the website. Additional information is also available in our SEC filings and on the investor relations page at atmus.com. Now I’ll hand over the call to Steph.
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Steph Disher — Chief Executive Officer
Thank you, Todd. Good morning, everyone. Our team achieved another solid quarter despite ongoing challenges in the aftermarket and a softening first-fit market. The hard work and dedication of our global employees have allowed us to maintain performance in these tough conditions. Today, I’ll share updates on our quarterly performance, outlook for the year, and progress on our growth strategy.
Jack will provide further financial details after my remarks. First, let’s talk about our capital allocation priorities. Our focus remains on growing our core business and expanding into industrial filtration as we allocate capital to fuel that growth. Share repurchases and quarterly dividends are a part of our balanced approach.
We assessed opportunities for share repurchases, targeting an annualized amount to offset dilution from long-term incentive compensation. In Q3, we repurchased $10 million in shares as part of the $150 million program announced last quarter, and we declared a cash dividend of $0.05 per share. Now, let’s review our third quarter financial results and outlook for 2024.
Sales reached $404 million, up from $396 million during the same period last year, marking an increase of roughly 2%. Adjusted EBITDA for the quarter was $79 million or 19.6%, compared to $73 million or 18.3% previously. Excluding one-time costs, adjusted earnings per share stood at $0.61, with adjusted free cash flow at $65 million, after excluding $10 million of one-time separation costs.
We’re progressing well towards becoming a fully stand-alone company, moving from transition service agreements with Cummins. We’ve completed approximately 80% of this transition and expect 90% completion by year-end, a key milestone that will enable us to enhance our growth efforts.
Now, let’s discuss current market conditions starting with the aftermarket. We’ve noted ongoing softness in freight activity, a trend persistent throughout the year. However, our outperformance in market share, aided by last year’s destocking trends, has helped us manage this weakness.
In the U.S., heavy-duty first-fit markets have softened as expected, while demand for medium-duty vehicles has remained steady. Meanwhile, the Indian market is down, and we have yet to see a rebound in China.
Looking ahead, we’re optimistic about revenue growth in the aftermarket, estimating an increase of 2% to 4% from last year despite continued weak freight activity. Overall, we anticipate the global aftermarket will decrease by about 2% to 3% due to persistent market challenges in off-highway sectors including construction, mining, and agriculture.
We expect our strong market performance to push aftermarket revenue growth by 2%, coupled with another 2% from last year’s destocking effects. Additionally, pricing adjustments should contribute an extra 1.5% year-over-year growth. Now, let’s shift to our first-fit markets.
In the U.S., our projections for the heavy-duty market have not changed; we expect a decline of about 7% to 12% for the year. Anticipated softness in the fourth quarter aligns with industry forecasts. However, our outlook for the medium-duty market remains stable, projecting steady growth of flat to 5%. Demand will continue to be monitored as we look towards the future.
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Atmus Reports Strong Third Quarter Performance, Increases Revenue Guidance
Atmus has confidently raised its revenue outlook, citing solid operational results despite challenges in major markets.
For the upcoming quarters, the company expects lower demand for trucks in India and weak conditions in China.
Atmus is now forecasting revenue growth of 1% to 3% year-over-year, with global sales anticipated between $1.65 billion and $1.675 billion. Strong operational performance throughout the year has led to an increase in the adjusted EBITDA margin, projected to be between 19.25% and 19.75%. Adjusted earnings per share (EPS) are also projected, now expected to fall within a range of $2.35 to $2.50.
In the third quarter, company leaders gathered to strategize long-term growth as an independent entity. The growth strategy focuses on four main pillars:
1. Expanding First-fit Market Share
Atmus is realigning its organization and boosting resources in account management, aiming for increased business opportunities. As leaders in fuel filtration and crankcase ventilation, the company is partnering with top OEMs to capture more market share. This organizational shift, combined with technology advancements, allows Atmus to expand its partnerships globally.
2. Profitability in the Aftermarket
Despite market challenges, Atmus is strategically growing its aftermarket segment by expanding partnerships. The introduction of advanced digital tools is set to enhance sales strategies, allowing for better identification of cross-sell and upsell opportunities. This approach is beneficial for both Atmus and its dealers, aimed at boosting Fleetguard product sales.
3. Supply Chain Transformation
The supply chain is undergoing significant changes, transitioning to Atmus’s dedicated network. A new warehouse facility in the UK is operational, meaning around 85% of distribution now occurs through Atmus channels. By the end of the fourth quarter, the European facility will also join this network, ensuring improved product availability for customers. This operational transformation has resulted in record-high delivery and availability metrics.
4. Growth in Industrial Filtration
Atmus is focused on expanding into industrial filtration through acquisitions, with a particular interest in three sectors: industrial air, industrial liquids (excluding water), and industrial water. While pursuing inorganic growth opportunities, the company has also launched new products for organic growth in industrial filtration.
Financial Overview by Jack Kienzler, Chief Financial Officer
Sales for the third quarter reached $404 million, up from $396 million a year earlier, reflecting a 2% increase driven by higher volumes and pricing adjustments, despite a 1% drop from foreign exchange impacts.
Gross margin improved to $111 million, an increase of $8 million compared to the previous year. This improvement stemmed from higher volumes and pricing, as well as reduced commodity costs, which were somewhat counteracted by foreign exchange challenges, one-time separation costs, and increased manufacturing expenses.
During the third quarter, selling, administrative, and research expenses rose to $56 million, up $4 million from last year. The increase primarily resulted from higher personnel and consulting expenses given the transition to independence from Cummins, although this was partially mitigated by lower variable compensation costs.
Joint venture income remained steady at $8 million for the third quarter. Adjusted EBITDA was $79 million, or 19.6%, compared to $73 million, or 18.3%, in the previous year. This figure excludes $9 million of one-time separation costs, higher than the $7 million incurred last year.
Looking ahead, Atmus anticipates one-time costs related to separation will range from $20 million to $25 million in 2024, with completion expected by year-end. Adjusted EPS for the third quarter was $0.61, compared to $0.52 last year.
Free cash flow increased to $65 million from $50 million in the prior year, with adjustments made for capital expenses linked to the separation from Cummins. Expected one-time capital expenditures are projected between $13 million and $18 million in 2024.
The effective tax rate for this quarter was 18.4%, a decline from 23.1% in 2023, driven by changes in earnings mix and favorable discrete items.
The quarter concluded with Atmus having $197 million in cash and $400 million in revolving credit, providing $597 million in total liquidity. The strong performance has resulted in a net debt to adjusted EBITDA ratio of 1.2 times for the trailing 12 months as of September 30.
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Company Leadership Discusses Fourth Quarter Expectations
The global team’s commitment to our growth strategy continues to benefit our customers. We are now ready for your questions.
Q&A Session Begins:
Operator
[Operator instructions] Our first question comes from Jerry Revich with Goldman Sachs. Jerry, your line is open.
Jerry Revich — Analyst
Good morning, everyone. Steph, Jack, could you discuss the factors influencing your outlook for the fourth quarter? The margin performance in the third quarter was impressive, and it seems you’ve consistently met your operating efficiency goals.
Steph Disher — Chief Executive Officer
Thanks for the question, Jerry. To begin, I’ll address market influences affecting our top-line expectations for the fourth quarter. After that, I’ll ask Jack to provide insights into our margin projections. Overall, we anticipate relatively flat revenue as we transition from Q3 to Q4.
However, we expect two notable challenges. First, fewer working days will put pressure on our business, particularly since 80% of our activity is in the aftermarket. Second, a continued decline in heavy-duty truck production will affect our first-fit operations in the fourth quarter, contributing to lower volumes and impacting margins. Jack will explain how these factors influenced our third-quarter performance and their implications for Q4 margins.
Jack Kienzler — Chief Financial Officer
Thanks, Steph, and thank you, Jerry. Regarding the transition from Q3 to our Q4 outlook, we expect volume reductions to play a significant role. Lower volumes will not only decrease our top-line revenue but will also lead to fewer production hours, affecting profitability.
Add to this the variable compensation adjustments. Due to our strong performance in the first half of the year, we’ve been accruing at a higher rate. However, as we face a softer market without improvement in the aftermarket, our outlook has dimmed slightly. The $4 million benefit we saw in Q3 tied to variable compensation is not something we expect in Q4, which will affect our margin estimates.
Jerry Revich — Analyst
This is helpful. Thank you for the details on performance. Looking ahead to 2025, can you outline your visibility regarding pricing, potential material cost reductions, and other key factors? While we recognize that market conditions may shift, what insights do you have regarding the margin outlook for 2025 compared to 2024?
Steph Disher — Chief Executive Officer
Thanks for your inquiry, Jerry. I will share some thoughts on our 2024 expectations while avoiding specific guidance for 2025. As we approach the end of 2024, we find ourselves at a unique point where both first-fit and aftermarket markets are simultaneously at the bottom of their cycles. This is unusual. While we have been enduring slowing conditions in the aftermarket for a while, we expect first-fit production to remain low in the first half of 2025, with potential improvements later in the year.
The aftermarket is an area we’ve been closely monitoring, as we anticipate a market change, though it’s hard to predict when that will occur. Enhanced aftermarket performance will help with potential margin growth moving into 2025. It’s essential to consider these broader market conditions when assessing our future performance.
Regarding our margins, we have effectively expanded them throughout 2023 and 2024, and I am confident that we can sustain this trend as we move forward. Further updates on our 2025 guidance will be provided in future calls.
Operator
Our next question comes from Rob Mason with Baird. Rob, your line is open.
Rob Mason — Analyst
Hi, Steph and Jack. I’d like to follow up on your comments about 2025. Traditionally, the first quarter tends to show strong seasonal growth, transitioning from Q4. However, given the current first-fit downturn, do you have enough insight to suggest how this next quarter might play out? Are there any notable seasonal patterns we should be aware of for Q1 2025?
Steph Disher — Chief Executive Officer
Good morning, Rob. I appreciate your question. Unfortunately, I can’t provide much more detail than what I previously mentioned. We expect seasonal patterns to continue similar to what we’ve seen earlier this year. While we experienced unique conditions in the second half, we anticipate that traditional seasonal trends will still influence our performance.
Nonetheless, the downward pressure on first-fit markets will significantly affect our first half of 2025. Thus, while we expect seasonal activity to remain, the current market conditions will pose challenges that we must navigate carefully.
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Rob Mason — Analyst
Yes. Very good. Just to follow up, the one-time costs you mentioned came in higher. Could you provide a breakdown between cost of goods sold and SG&A?
Steph Disher — Chief Executive Officer
Absolutely. I’ll ask Jack to respond to that, Rob.
Jack Kienzler — Chief Financial Officer
Good morning, Rob. In the third quarter, we reported $9 million in one-time costs—$5 million in cost of sales and $4 million in SG&A. Let me explain. These one-time costs mainly stem from IT expenses related to our separation from Cummins, as well as supply chain costs as we separate facilities. The increase beyond our original estimates arises from two main factors. First, there have been delays in IT system transitions; as you can imagine, it’s complex to manage these changes.
We’re carefully balancing the need to move quickly with the need to reduce risk, which has led to some delays. The second key factor for this quarter’s spike in costs is the legal separation of our production facility in Mexico from Cummins. We initially anticipated this would occur in Q1, but it has now pushed into Q3, completing in August. This six-month delay has resulted in increased transition service costs from Cummins. Just to clarify, that transition is now completed, so we expect a decrease in costs in Q4, and we’re aiming to be substantially finished with these separations by 2024.
Operator
Your next question comes from Bobby Brooks with Northland Capital Markets. Your line is open.
Bobby Brooks — Northland Capital Markets — Analyst
Good morning. Thanks for taking my question. Could you elaborate on your international business? You mentioned a softening market in India and a lack of recovery signs in China. Could you break that down further and comment on Europe and APAC as well? What regions show strength, and which ones appear weaker?
Steph Disher — Chief Executive Officer
Good morning, Bobby, and thank you for the question. Overall, we are seeing downturns in nearly all international markets. It’s increasingly difficult to identify any bright spots. Until recently, India was our strongest market, and while I still believe it performs best globally, it has also softened lately. Jack and I will be visiting India next week to gain deeper insights. We have a joint venture there and hold a leading market position, so it’s still promising for us. However, we anticipate ongoing challenges in China, a trend we’ve observed throughout this year and expect to continue into 2025. We are focused on how to surpass market challenges in China through partnerships and product innovation.
Regarding Europe, we didn’t highlight it initially because it’s less significant for us, but we are indeed feeling the same market downturn there. Our projections for first-fit declines have moderated, dropping from an anticipated 18% down to around 10% for the full year, but that still represents a decline. Thus, our international and domestic markets face formidable challenges, and we are ensuring that we continue to outperform as much as possible.
Bobby Brooks — Northland Capital Markets — Analyst
Got it. Thanks for that detailed answer; it’s impressive to see how you’re excelling in the current tough conditions. Regarding margins, they remain a strong area for Atmus, benefiting from your improvements across manufacturing. I’m curious about the success of the green cartridge line in France as your first fully automated line. Are you considering implementing similar automated lines elsewhere?
Steph Disher — Chief Executive Officer
Thanks for your question. I want to highlight our wider supply chain transformation and where we’ve gained the most traction. The automation of our manufacturing, particularly exemplified by the green cartridge line, has been a significant success. We’re learning valuable lessons that will help us implement automation on a larger scale in our operations. Moving forward, automation will be a critical component in maximizing our operational value. Additionally, we’ve experienced substantial improvements through our purchasing strategies, collaborating with suppliers to manage input costs effectively, marking another area of growth potential.
Operator
Your next question comes from Tami Zakaria with J.P. Morgan. Your line is open.
Tami Zakaria — JPMorgan Chase and Company — Analyst
Hi, good morning. Thank you for taking my question. Do you expect volumes to remain positive in the fourth quarter? What trends are you noticing so far this quarter?
Steph Disher — Chief Executive Officer
For the fourth quarter, we do anticipate continuing to gain market share. However, we recognize that market conditions may put downward pressure on these figures. It’s a similar situation to what we experienced in the third quarter. Additionally, there are two new factors impacting us: the number of selling days in the fourth quarter and anticipated further declines in heavy-duty first-fit will also play a significant role.
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CEO Discusses Pricing Strategy and Global Manufacturing Landscape Amid Market Challenges
Tami Zakaria — JPMorgan Chase and Company — Analyst
Thank you for the insights. I have another question regarding your pricing plans for next year. What pricing strategy do you intend to implement in January?
Steph Disher — Chief Executive Officer
Sure. We’re currently assessing what 2025 will entail. In general terms, you can rely on our growth algorithm that we’ve discussed. This year has brought some challenges, affecting our market expectations.
We anticipate about 2% market growth in the core markets we’re engaged with, with a similar 2% expected from share growth. Additionally, we’re projecting a price increase of about 1% to 2%.
Tami Zakaria — JPMorgan Chase and Company — Analyst
That’s great to know. Thank you for the clarification.
Steph Disher — Chief Executive Officer
Thank you, Tami.
Operator
Your next question comes from Joe O’Dea with Wells Fargo. Please go ahead.
Joe O’Dea — Analyst
Good morning. I would like to discuss your manufacturing strategy, particularly in relation to tariffs. How much do you rely on manufacturing facilities outside the U.S. for your domestic revenue?
Steph Disher — Chief Executive Officer
Thanks for the question, Joe. We are a global company and fully support free trade. The introduction of tariffs can complicate matters for us. However, we have thoroughly analyzed this situation.
Overall, our manufacturing facilities are regionally focused. For instance, most of our production in China is intended for the Chinese market, though we do make some exceptions, such as our facility in Mexico that supplies the U.S., and our media production in South Korea.
We remain vigilant to potential impacts on our supply chain strategies.
Joe O’Dea — Analyst
Okay. Is Mexico a significant source for your filtration supply in terms of competition?
Steph Disher — Chief Executive Officer
Indeed, Mexico is our largest manufacturing site worldwide, which has proven beneficial. This location has positioned us competitively in the market.
Operator
Next, we have Andrew Obin with Bank of America. Your line is open.
David Ridley-Lane — Analyst
Good morning. I’m here for Andrew. Can you elaborate on your growth in the industrial filtration sector?
Steph Disher — Chief Executive Officer
Thank you for asking, David. I mentioned it earlier not because it’s driving considerable revenues yet, but because it represents the beginning of our innovative efforts. We have recently introduced products for the industrial filtration market, utilizing our established distribution channels.
While we’re starting modestly, I view acquisitions as the main driver of growth in this area. However, I am encouraged by our team’s progress in innovation.
Immediate revenues won’t be significant from this initiative, but it will foster our innovation trajectory in the long run.
David Ridley-Lane — Analyst
Understood. To clarify, in 2024, you anticipate a 2% benefit from previous de-stocking. If there is no market improvement in 2025, would you expect revenue to be 2% lower?
Steph Disher — Chief Executive Officer
The main uncertainty lies in market trends, David. This year has brought significant challenges, and while we have benefitted from de-stocking, we are also facing market headwinds.
Operator
[Operator instructions] Our next question comes from Bobby Brooks with Northland Capital Markets. Your line is open.
Bobby Brooks — Northland Capital Markets — Analyst
Thanks, everyone. I want to revisit the M&A topic briefly. You’ve mentioned a solid pipeline, yet no deals have been finalized. What factors are causing delays in closing these deals? Is it mainly due to sellers expecting higher valuations or legal issues?
Steph Disher — Chief Executive Officer
Thanks, Bobby. I’m glad you brought that up. We have a clear strategy in place and are focusing on three key verticals within industrial filtration. There are various reasons why deals haven’t progressed, including differing expectations on valuations, but we continue to engage with potential opportunities.
Strategic Insights from Recent Conference Call
Balancing Growth with Investment Returns
In the recent teleconference, company representatives discussed their approach to industrial water and air markets. They focus on various strategic factors to evaluate potential deals. It’s clear that the company is committed to balancing profitable growth with strong investment returns.
Confident in Future Deals
Despite the complexity of navigating growth opportunities, executives expressed optimism about their deal pipeline. With a disciplined filtering process in place, several deals have already reached the due diligence phase. The aim is to select the right targets that align with their long-term objectives.
Long-term Vision and Investor Engagement
Building confidence as a new company is essential, and executives are taking measured steps to ensure long-term success. The anticipation of the first deal reflects a programmatic strategy intended to establish a solid foundation for future expansion.
Conclusion and Future Outlook
As the call concluded, Todd Chirillo, Executive Director of Investor Relations, thanked participants for their engagement. The investor relations team remains available for further inquiries, emphasizing the company’s commitment to transparency and communication.
Thank you for joining us, and we look forward to continuing this journey together.
Operator
[Operator signoff]
Call Participants:
Todd Chirillo — Executive Director, Investor Relations
Steph Disher — Chief Executive Officer
Jack Kienzler — Chief Financial Officer
Jerry Revich — Analyst
Rob Mason — Analyst
Bobby Brooks — Northland Capital Markets — Analyst
Tami Zakaria — JPMorgan Chase and Company — Analyst
Joe O’Dea — Analyst
David Ridley-Lane — Analyst
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