Atmus Filtration Technologies Inc. (ATMU) Earnings Call Transcript & Summary

Welcome, everyone. We're joined here today by Jack Kienzler from Atmus Filtration Technologies. Jack began his career at Cummins in 2014 and after a series of roles, took on the role as CFO of the recently sub-IPO'ed Atmus Filtration.

So Jack, this is a pretty recent transaction, a new entrance to the public market. Can you tell us a little bit about Atmus business and the end markets that you serve?

Absolutely. Thank you, Regina. Good to see you, and thank you, everyone, for your interest. So Atmus, as you mentioned, we're a bit of a unique combination of a 65-year-old company, that has existed for a long time and a mature player in our markets, combined with the opportunity to have a start-up-type mentality as we sub-IPO outside of Cummins. We are an advanced filtration technology provider to the broader commercial vehicle market. We serve both the on-highway space as well as the off-highway space, with 60% of our revenues generated in the on-highway space and 40% generated in the off-highway space. Our business is essentially a high aftermarket filtration supplier. And so we're about 20% first-fit, 80% aftermarket. And what that's allowed us to do is really operate with more muted peaks and troughs and inherently less cyclical revenue and earnings in the core markets that we serve. We're partnered with many of the leading OEMs in the markets that we serve. Obviously, Cummins is our largest customer and one of our most important strategic partners, but we are also suppliers to other major OEMs like PACCAR, Volvo, what have you. So we're excited about our future as we step outside of Cummins and embrace on our new strategic growth pathways ahead.

So that's a very different profile than Cummins core business. Now that you are a separate stand-alone company, what do you see the opportunities for being able to advance the business and this new configuration?

Yes. I think there's multiple different growth pathways ahead of us. We're kind of focused on 4 key strategic growth pillars. One is enhancing and growing our share in the first-fit market in our core markets. The second is to enable profitable growth in the aftermarket. The third is transforming our supply chain. And the fourth is expanding into industrial filtration market. As you think about what we've -- how we've been managed within the broader Cummins umbrella, we were largely managed to suit Cummins needs and for cash generation. That cash was been deployed into other areas of strategic priority for Cummins. And so we're really excited to be able to really deploy capital to meet our own strategic imperatives. And so what does that look like? I think, obviously, continuing to bring compelling technologies to our customers as they navigate the technology transition ahead. And we anticipate winning with the winners, so to speak, as we grow share with our existing customers. We're deploying capital into a number of different digital analytics capabilities to allow us to map opportunities in the aftermarket and really drive more on-shale availability in the aftermarket, which is really king in terms of growing share in that space. From a supply chain perspective, we're excited to step outside of the traditional Cummins umbrella and really embrace a more end user-focused supply chain. And so really focused on, again, availability for our customers but also focused on driving incremental investment to really bring automation capability into our supply chain. We've, as I mentioned, kind of been managed for cash generation and so not been given a lot of capital to deploy into our business. And so we can really make some important strides from an automation standpoint by increasing the capital we spend in that space. And then perhaps, most importantly, as we evaluate the expansion into industrial markets, that's really been an area that's been essentially off-limits as part of the broader Cummins umbrella. They're largely focused on the future of powertrains and how that evolves. And we're looking to get into other adjacent areas from an industrial standpoint, which maybe didn't adhere to their strategic priorities. And so a lot more to come in that space, and we see a lot of opportunity to it.

Have you seen -- I mean, it's only been a few months since you've done that sub-IPO, but have you seen more openness from some of those end markets, which may have been a little bit off-limits when you were part of Cummins start to open up for you in terms of dialogue and receptivity?

Yes. I think -- I certainly think that we have some technologies that we can lever into that space. Media is one of our core technologies which essentially enables filtration efficiency and allows us to retain contaminants that we remove from the various liquids and air that we filter. We certainly think we can get into some of these markets organically. Although one of the things that is key to success in the broader filtration landscape is the channel. And so we do think to more rapidly get into some of these markets, we'll have to evaluate an inorganic approach, and we're excited to do that. We have not done anything since the IPO, but we've seen a lot of opportunities out there. Generally speaking, the industrial space is a bit more fragmented than the core markets that we serve. And so we are envisioning a programmatic approach to acquisitions, looking to take some small steps out, build our synergy capabilities, demonstrate to you all that we have capabilities from an M&A standpoint and then build that momentum as we evaluate the second, third, fourth opportunity ahead.

When you think about evaluating those inorganic opportunities, how do you think about weighing that against other opportunities you have to deploy capital? It's sort of a little bit like the box was closed to you for sometime now, the world is your oyster. How do you filter through those differed opportunities and prioritizing your deployment of capital?

Yes. It's a good problem, how we generate a substantial amount of cash flow. And so having -- again, having the ability to deploy that in a number of different areas is really exciting for us as a management team. As we think about inorganic expansion, there's 3, I would say, main financial criteria we're evaluating. One is the ability to expose the market to higher growth segments. As we look at some of these industrial segments, we're seeing a CAGR closer to about a 5% range compared to what we've seen in our core markets, which is closer to 2%. So looking for that revenue acceleration. The second would be margin expansion. The various opportunities we've looked at do seem to present some compelling margin expansion for the business. And we think that's a good growth avenue for the company. And then third is making sure we balance that growth mindset with a value mindset. So looking at return on invested capital is an important criteria as we deploy M&A capital. And of course, comparing all of those metrics against what we can do organically. I mentioned how we're looking to invest organically. Historically, the amount of capital deployed as a percentage of sales in this business has been relatively low, largely in line with depreciation shield. And so as we lift that to a 2% to 3% of sales range, we can really do some of that supply chain transformation that I discussed. And then just real quick. I think the other thing that we're looking at qualitatively as we think about M&A is just the ability to leverage technology synergies, expose the business to continued areas where there's a high aftermarket content. And then again, the channel is key as we think about these opportunities.

Right. So you've spoken a few times now about leveraging your expertise in filtration media to diversify. Can you just contextualize a little bit the competency and walk us through how this gets supplied in these different adjacencies?

Yes, absolutely. So media is really the secret sauce in terms of what we do from a filtration perspective in many respects. We have advanced capabilities in this area through our NanoNet and NanoNet Plus technology and are continuing to invest in our broader media portfolio, both in terms of capital and expanding our media capacity but also looking to drive new separation science initiatives as we think about filtration. Certainly, those are applicable to all of our core markets. We believe that we will have the ability to leverage that learning into some of these industrial markets, particularly those that are perhaps a bit closer to home, if you will. So to give you an example, some of the areas we've looked at is expanding into the machinery and equipment space or the metals and mining space. We already serve a mine site, for example, today, via the excavation side of the mine. And so can we get into the process inside of the mine, for example, and deploy that similar technology to that side of the mine. I think one of the big things that we'll look at is how do we need to package that media for different applications, right? We're experts as it relates to on-engine and off-engine commercial vehicle filtration, but how do we leverage that into industrial markets where the packaging may be a bit different.

And one of the things that's been a big theme about these end markets that we've talked about is this energy transition. How do you think about EV penetration rates? And what are the implications for that for your business?

Yes. I think it's probably important just to ground ourselves in the makeup of our business as it is today. So currently, we do expect continued growth in our core markets from an internal combustion engine space, at least through the end of this decade. And everyone's got a different inflection point there, but we continue to see plenty of opportunities to grow in our core markets. Our business, as I mentioned, is heavily aftermarket. And so even when you see that inflection point, you've got a pretty nice tail for a long period of time thereafter. Often the useful life of these vehicles are 10, 15, maybe even longer in terms of a number of years. And so that aftermarket tail will take us forward for a long period of time. The last one I'd make on that side is just the makeup of our business. We're about -- on the on-highway space, about 2/3 heavy-duty, 1/3 medium duty. And so I think certainly, the heavy-duty space is the murkiest perhaps in terms of the technology that will win today. All that being said, we are committed and excited to partner with our OEMs as they navigate the technology transition. I think the filtration requirements will differ a bit depending on the type of propulsion technology we're talking about. So If I walk through kind of the main headlines, the battery electric in our view would be certainly the lowest in terms of filtration content compared to an internal combustion engine. That does not mean that there are no opportunities, certainly coal and chemical opportunities and other broader filtration opportunities in that landscape. But as we look at it right now, it would be lower content than a diesel internal combustion engine. Another technology example would be fuel cell electric vehicles. As we look at that from a content perspective, it could be essentially at par with an internal combustion engine, a little bit different type of filtration products needed but a lot of compelling opportunities there as we look at it and partner with our OEM partners, albeit fuel cell is probably a bit further afield or further out in terms of adoption. And then not quite of 0 emissions vehicle but a number of different fuels that could power an internal combustion engine, hydrogen being one of those. That presents, I would say, a similar level of filtration opportunity than what we see today from a diesel perspective. It's just a different type of fuel that you're filtering. So we continue to have robust dialogue with all of our OEMs, continue to bring our technical expertise to the table alongside theirs to see how we can meet their needs, and we're excited about that transition.

Great. How do you see the second half of the year unfolding and the implications for 2024?

Yes. So we've had a really strong start to the year, both in first-fit and in the aftermarket. We are expecting the aftermarket, in particular, to taper a bit and soften as we look at the back half of the year. I would say that's in part driven by some broader recessionary dynamics but also driven by destocking in the channel across a number of the different channels that we serve. It's hard to point to exactly which piece of the channel that relates to. There's -- as we think about some of our larger OEM channels, that's multiple dealers that make up that channel. And so everyone has approached the buildup of inventory to mitigate some of the supply chain constraints a little bit differently. And I think what you're seeing is levels of inventory were probably at a peak and now people are working through that as they no longer have as many concerns perhaps on being able to secure the product that they need to push into the market. So certainly seeing some of that destocking and I would say it's varied by region, by channel, by customer. On the first-fit side, we expect it to remain pretty resilient, I would say, through 2023. All of the production slots are largely spoken for as we think about 2023. And so it will be interesting to see once the OEMs open their order books for next year, what the implications are for 2024. We're not guiding to 2024 at this point, but we're keeping a close eye on how the second half of the year unfolds, and we'll update everyone accordingly then.

Great. When we think about the separation from Cummins, what type of infrastructure sites you put in place to facilitate that infrastructure and unwind the TSA?

Yes. So as you can imagine having been part of the broader Cummins ecosystem for 65 years, the company was fairly intertwined across a few different areas. But I would describe that there is largely IT, HR, some finance and then our distribution centers and warehouses and whatnot. And so as we think about the separation, we announced the broader intent to separate from Cummins the way back in August of 2021. So we've been working diligently to try to stand the business up since then and we've made a lot of strides. It's one of the indirect benefits perhaps of a delay in that broader IPO due to market conditions. So we've made good strides, I would say. A few examples of that is on our distribution centers, we've decoupled and are fully stand-alone in our largest distribution center, which is in Walton, Kentucky, outside of Cincinnati. Our warehouse, for example, in Mexico, and in Brazil, are now fully stand-alone, and we'll continue down that separation journey of the distribution centers over the back part of this year and largely be done as we move through 2024. Other areas we continue to make good strides on and are largely there. Broadly speaking, the TSA period is 24 months post separation. But we and Cummins are committed to turning that support off as soon as we are able and are doing so as we speak across a number of different areas. IT is probably the most difficult in constant admiration of our IT personnel as they navigate a bunch of different challenges to separate the business. And so that's probably the longest full intent as I think about the TSA.

And are there any onetime cost implications going forward?

Yes, we're trying to highlight for all of our current and prospective shareholders just the amount of onetime costs that we're incurring as we embark on this separation. So -- and we expect that on the P&L side, the expense side to be about $30 million to $35 million over the course of 2023 and on the capital side, between $20 million and $25 million. What is that related to? It's essentially the onetime costs associated with moving a warehouse into a new space with upfitting that warehouse with hardware and software from an IT perspective and other onetime costs that we incur along the journey. So it is not inclusive of any recurring costs that we need to essentially operate as a stand-alone public company.

And then any color on the evolution of Cummins stake and their relationship with you?

Yes. I would kind of describe the relationship between Atmus and Cummins across 3 broad phases, right? We talked a little bit about the support that we continue to rely on them for us. So that's the broader TSA area. Both companies are committed to moving through that as expeditiously as we can, but they also don't want to leave us, unable to operate. And so I would expect, again, that relationship to largely conclude approximately 24 months post separation. The other area is, obviously, them as a large shareholder within Atmus. They hold 80.5% of our shares outstanding at the moment. Their stated intention is to pursue a share exchange or a split, whereby their existing shareholders will have the opportunity to convert on a discounted basis or turn in their shares for in Atmus share. That timing and when they do that is solely their decision. But again, we would expect that to not be a long-term shareholder, and we would expect them to divest that 80.5% in one fell swoop. The third area of our relationship is, of course, the ongoing commercial relationship that exists. They are our largest customer at about 20% of our sales. And we're really excited about the potential to continue to treat them as a valued customer and continue to work with them to meet their needs as they think about both first-fit and aftermarket filtration needs. So we're really excited. It's a great relationship. It's been exciting now to transition it from a sort of a captive subsegment into a valued strategic partner, and we're excited to continue to serve them.

And as you think about the progress of the business overall, are there any time line or targets out there that we should be mindful of?

Yes. So we talked a little bit about that journey ahead of us as we think about diversifying the business. Hard to put an exact timetable on either the organic or inorganic side of that. But I would expect over the course of the next 3 to 5 years for us to make substantial progress as we think about diversifying into industrial end markets. Our goal there is, again, not to do that in a transformational way, but to do it in a more measured programmatic way, which allows us to balance our growth ambitions with our value ambitions. I think the other things that we've talked about are some of the opportunities that lay ahead of us in terms of margin expansion and thinking about transforming our supply chain. So we do see some opportunities there. We talked about the automation of some of our manufacturing sites. We feel like there's some procurement opportunities ahead of us as well as we put a more disciplined focus on that side of the business. So excited for the times ahead, all while separating from Cummins and creating Atmus as we call it. So it's an exciting time in the company's life cycle, and we're excited for all the positive momentum from a culture standpoint that we've been able to embrace with our people.

Great. Well, we have a few minutes left, and I wanted to open it up for questions. Any questions in the audience?

I've got a question. So you've got a couple of months now. You're out of the Cummins mothership. You're -- have some transformation ideas, some growth ideas. You're competing against some pretty big guys with good balance sheets, good trading multiples. How are you feeling positioned in an industry that's consolidated pretty aggressively. There are some pretty big guys out there, how do you feel your position against them?

Yes, absolutely. It's a good question. So we feel, I would say, highly confident in our market position in our core markets. That's, of course, underpinned by securing one of the largest, if not the largest player in the market in terms of Cummins for the foreseeable future. I think in addition to that, we're really excited about what this separation enables us to do in terms of serving other customers. And so we feel really good about where we sit, both in the on-highway space, also in the off-highway space. In the off-highway, really important markets for us would be mining, construction, power generation, ag. And so excited about what we can continue to do with our existing partners in our core markets. And then as we separate from Cummins, we'll see what other opportunities make themselves available to us. We have not historically served other off-highway OEMs, for example. And so excited about what the separation can do for us in terms of growth opportunities.

Any other questions? There you go.

Given the extent that your business is aftermarket focused, how have you been able to evolve price as inflation has slowed?

Yes, it's a great question. So pricing sort of works a bit differently, whether we're talking about the aftermarket portion of our business or the first-fit. First-fit, it's generally on a program-by-program basis and works on a long-term agreement basis. And so there are some contractual price downs that we experienced as part of that evolution over a program's life cycle. In the aftermarket, it's different. We do have more to generally bring pricing to the market at the beginning and the middle of the year. Certainly coming off of a pretty dynamic environment from an inflationary cost perspective, I would say that we were a bit slow to react and certainly slow in terms of the magnitude of the pricing actions that we went to market with. We've largely caught up as we moved into 2023. And I do think it was a bit of an eye-opening time for all of us in the industry and certainly has us thinking about what the -- how we can react more swiftly and nimbly moving forward and also what the pricing opportunities for the business are moving forward.

Great. Any more questions? Well, we really appreciate your time. I think we're all excited to see the journey that you guys are on, and I look forward to seeing what you can build now that you're a separate company.

Thank you. Thank you, Regina, and thank you, everyone, for your interest.