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

Good morning, everybody. Thank you so much for joining us. Once again, I'm Jerry Revich, Wells Fargo Securities, and thrilled to have with me here from Atmus Filtration, Jack Kienzler, Chief Financial Officer. Jack, thanks so much for joining our conference.

Thanks, Jerry, for having me, and thank you, everyone, for your interest. It's great to be here.

Jack, to kick off the conversation, I just want to go back to the 4-pillar growth strategy that you folks outlined. So you spoke about Grow Share in First-Fit, Accelerate Aftermarket, Transform the Supply Chain, and Expand into Industrial Filtration. You've made progress on all 4 points. Let's start with first-fit share. What has been the key progress since the spin? And do you have room to drive market share higher?

Yes, it's a great place to start. So let me just remind everybody what is all encompassed inside of that Grow Share and first-fit. So there's really 3, I would say, broad areas that we're focused on. The first is what we describe as Win with the Winners. And really, what that means is I want to continue to capitalize on the strong partnerships that we have with the leaders in the commercial vehicle industry, folks like PACCAR, folks like Cummins, et cetera, that we have strong relationships with. And as they continue to grow market share in their own right, obviously, that can pull through to our business. In addition to their own market share gains, we want to continue to expand our own penetration and share of wallet with each of those. And so that's been a nice catalyst for us. Last year, for example, as Cummins launched their new model-year engine inside of the Stellantis product, we did have a bit of a step-change in content. And that not only pulsed first-fit gains through sales to Cummins, but also grew our installed base and our Aftermarket through the Stellantis channel. The second piece of the first-fit market expansion is really trying to grow after customers that we historically haven't done business with, really driven by just the inherent ownership structure that we have had historically and the fact that, particularly in the large-engine space, you don't generally see OEMs source from their competitors' captive suppliers. And so really looking to cultivate those relationships now that we have an independent ownership structure, introduced Atmus and our capabilities to a number of different players and look to grow our penetration with them. It's been pleasing to see the ongoing conversations, and we feel like our technology leadership in these displacement ranges from a filtration standpoint can really open up opportunities for us. And then the third piece within the first-fit markets really is a number of other areas that didn't necessarily have a competitive dynamic with Cummins, but more just we didn't have the resources to really go after them. And so there's a number of different first-fit opportunities that we've been going after across a number of different OEMs, again, introducing them to Atmus and our technology opportunities and capabilities and opening up those avenues. So I'm pleased with the progress thus far. But I think as I look at our broader share, I think there's still plenty of room to run. And it's really about, again, having people understand what we can bring and the quality of our product.

Is Caterpillar at all a possibility as a customer?

I would say Caterpillar is certainly in that first category or the second category of potential customers that we would target among others and want to continue to try to open up a number of different avenues. As you can imagine, there's not -- it's not like you all of a sudden take off every filtration opportunity. And so we want to really focus on are there smaller pieces of the portfolio that we can go after and open up the relationship.

What kind of first-fit end-market outgrowth do you think you folks can deliver if these share gains play out?

Yes. So if you think about from a product family standpoint, where our strength has really been historically, it's on on-engine filtration. Obviously, that's driven by the historical relationship with Cummins and the deep embedded application knowledge that we have on things like fuel filtration, lubricant filtration, so on and so forth. And so that's probably our technology leader in terms of our product family. Obviously, we do all different filtration as well as things like coolant and chemicals, but from a technology standpoint, we really try to lead with that on-engine filtration with these customers.

Got it. And then another first-fit-related question. So Cummins genset business has grown dramatically. Can you just talk about Atmus' content for both prime power and for backup? What's that look like from an opportunity standpoint for you folks?

Yes, absolutely. So if you think about what -- where our product is today, certainly, just like in the on-highway space, we have essentially 100% share of wallet with Cummins in the Power Systems space as well. Most of that product today is going into various backup power applications. And so while we're on all of those gensets -- just like we're on, again, a 15-liter engine in the on-highway space, the aftermarket generation, which really pulses our business, is relatively immaterial just given the fact that it's backup, right? And so you do still change the filters every once in a while, but it doesn't have the same duty cycle as, say, a mining truck, for example. So obviously, we'll continue to support them as well as other potential customers in the space. And it's great to see their ambitions and their intentions to expand their prime power exposure through the launch of different capabilities, and we're excited to continue to support them. That's not a big piece today, at least for our business. And so I think it remains to be seen what that maintenance activity will be, how long those gensets are running and what inherent aftermarket content will be for us, but certainly an opportunity.

And what's your first-fit content? Is it similar to truck, $300 per unit? Or does it scale up considering these are pretty massive engines?

Yes. So it would be -- if you think about like the ratio, it would be the same. It's just a much larger engine and therefore, instead of 1, 2 fuel filters, et cetera, you've got a much larger amount. But from a portfolio like percentage perspective, it's the same.

So about $3,000 per unit, give or take?

Yes, roughly. It depends on the application...

And then if these units do truly run 24/7, how quickly do I generate $3,000 of aftermarket demand -- 1 year, 2 years? What's that look like, assuming a mining-type 24/7 operation?

Yes. So again, it's really about hours run in these spaces. And so in the on-highway space, you're talking about a change of filters every, what, 35,000 to 40,000 miles. And then as you move into the off-highway space, again, it will be kind of hours driven. So it just depends on how long the -- but the percentage or the ratio, if you will, of aftermarket content relative to the first-fit is quite substantial, as you can imagine, and over a very long period of time.

And I don't have the legacy notes, unfortunately, for obvious reasons given my transition. Can you just remind us what time frame do you folks generate aftermarket sales equivalent to the first-fit sales generally across the book? If I recall, I believe that's a 3-year, 4-year type number, but can you just refresh me, Jack?

Yes. So again, it depends on the duty cycle. But if you think about in the on-highway space, if you're talking about, on average, a fuel content of, what, $200 over the life of that vehicle, you could have $8,000 roughly in aftermarket content over the life of the vehicle. So it depends on how long it's driven, but you could get to that replacement of your first-fit content inside of 3 years depending on the application.

Super. And then the aftermarket part of the growth strategy, can you update us on your view of progress so far? And is there more opportunity to continue to drive that part of the business?

Absolutely. So if I think about the second pillar, Accelerating Profitable Growth in the Aftermarket, really, we've been looking at a few different things. One of the big pieces there is to increase our penetration into independent distributors. Historically, we've been quite strong in the OE dealer networks, and we want to continue to build on that strength certainly. But we also want to ensure that Fleetguard products are available anytime and anywhere a service event is occurring. And obviously, those service events don't always occur within the OE dealer network. And so that's been one of our strategic priorities, and we want to continue to build that out. We've seen good traction, I would say, on that in areas where we had relatively low penetration. I think Latin America is a good example of that, where historically, we've really only gone to market through the Cummins distribution channels. And now we've been able to continue to cultivate additional independent distributors. Some of whom carried the Fleetguard product historically, but we just didn't focus on them in terms of commercial activity as much. And so as we've built and strengthened those relationships, we've been able to experience growth inside their portfolio among other filtration brands. So that's been a nice growth story, and really pleased to see that progress. Underneath all of these different things, in the aftermarket, which, as you can imagine, is many different opportunities that are flowing through to our sales team to go after is the ability to deliver. And so kind of Synonymous with our third pillar, which we'll get to in a moment, is the Supply Chain Transformation has been a big focus on delivery capabilities and the ability to ensure that our product is available as and when our aftermarket channel partners need it and our end-users need it. And so we've had a lot of actions and initiatives going on in the supply chain. Historically, our distribution centers were all co-located for the most part with Cummins. And so one of the big undertakings of our separation was the separation of those distribution centers into Atmus-owned and -operated locations. And that's allowed us to really address our inventory levels and lift our inventory levels to hit the delivery metrics that we want to. We're really pleased with where that journey has been. It's been a lot of hard work from the supply chain team. So a big kudos to them for all the undertakings that they've had that comes with not only the physical movement of goods, but also an underlying IT initiative to separate systems. And so each one presents its own challenge, but we're pleased with where we're at now. And I would describe our delivery capabilities now as top-quartile. And really, what that does is, again, unlock many opportunities, not only with existing channel partners, but also with new channel partners.

And then to shift gears on the industrial filtration part of the strategy. Can you talk about the Koch acquisition? For those that have spent less time with the company, just remind people the size of the business, the multiple paid. And then just, if you don't mind, update us on how the integration is going.

Absolutely. So yes, so we were really pleased to close on the Koch acquisition here in January of this year, signed it last year. So overall, when you include the expected synergies, not only from a tax perspective, but also from the ongoing operational synergies, expecting the multiple to be about 10x to 11x. So an attractive entry point into these industrial sectors. The business -- it's a great business. I'll talk a little bit about what we found post-diligence, but for perspective, in 2025, on their fiscal year, they generated about $156 million of revenue. They were on a September year-end. So now obviously, this transition to our same fiscal year-end, which is calendar based. Really looking forward to what the team can accomplish moving forward. If I think about what's been a pleasing factor, if you will, post-acquisition has really been the cultural similarities that exist between the 2 organizations. If you think about it, they've been owned by a number of larger companies, Johnson Controls and embedded within ADTI, which is the parent company that the private equity firm whom we bought it from had acquired. And so they have a similar mindset to what we had, which is embedded within a larger organization and perhaps not quite able to spread your wings in terms of all your different growth initiatives. And now that they're with a filtration-focused company, I think they're really excited about what they can unleash with some focus and investment. So that cultural similarity has been fantastic to see, and I think has really unlocked not only a fairly seamless integration, but also a lot of collaboration as we think about not only the synergies that we expected to get, but also other potential synergies moving forward. So the synergies, as a reminder, was about $4 million of annualized synergies by the end of year 3. And really, the bulk of those were supply chain initiatives, so leveraging our scale and capacity to get some better rates in different direct material areas, et cetera. The -- what we found though is that there's potentially some other areas of collaboration now as we move forward that could involve cross-selling through each other's distribution networks, not only their products through our existing Power Solutions, as we call it, or commercial vehicle distributors, but also in reverse, potentially selling through some Power Solutions product, Fleetguard product through some of the independent distributors that they already have relationships with. In addition, obviously, we're looking at, particularly in the high-efficiency space in the HVAC areas, what can we bring in terms of media capability into their products where there's a need for elevated filtration science capabilities. So excited about where we can take that. There's been a lot of different growth forums, as we call it with them, where we bring the teams together, exchange ideas, and then really go out and trial a number of different things.

And given the explosive growth in data centers, we're finding that companies had 1% sales exposure to data center where all of a sudden becomes 7% exposure. Any opportunities for Atmus within data centers?

Yes, it's a great question. And I think -- if I think about where our exposure is today or historically, if you will, it's really in that backup power that we were just describing alongside gensets. And so that's exposure, but again, not a heavy-duty cycle from an aftermarket, so somewhat immaterial at the top line. Inside of the Koch business, they do provide HVAC filtration into data centers. That's about 8% of their business today. And so one of the things that we're focused on is how do we continue to lift the exposure to that end market given the significant and robust growth rates that it's experiencing. That could come with not only the addition of new products, but really probably the cultivation of new distributor relationships to make sure that we're available through a number of different service avenues into data centers. That tends to be relatively focused, particularly here in North America across a few different geographies. Today, the Koch business is really just North America-centric. And so another opportunity that we're thinking about more globally is just how do we explore geographic expansion from an industrial HVAC perspective.

And so $10 million to $15 million revenue data center today, where could that go?

I think it depends on, obviously, the longevity of this robust tailwind that we're experiencing today and then how quickly we can kind of shift the portfolio, right? So I think about -- if you think about the revenue algorithm that we talk about in our core, it's really been about 4% to 5% over a long period of time, 2% market, 1% price, 1% to 2% share gains. There's not a lot we can do in the commercial vehicle market to address that 2% underlying market growth rate. If I then look at the Industrial business, that revenue algorithm inherently lifts a bit where you've got the traditional commercial vehicle -- or sorry, commercial and industrial HVAC sectors growing at GDP levels. But if you can expose more of the portfolio to higher-growth markets like health care or data centers, you could really start to meaningfully shift that revenue algorithm up. So that's a big area of focus. And I think we'll see what the art of the possible is in terms of top-line growth.

And then in terms of M&A from here, since this is the first large deal as a public company, are you folks hitting pause to make sure you integrate? Or is the team out there actively looking for the next one?

Yes. So absolutely, integration was a big priority, but that hasn't slowed us down in terms of exploring other opportunities and continuing to cultivate the pipeline. I would say, as a reminder, the 3 broad areas that we've been looking at in terms of industrial expansion has been industrial air, which obviously the Koch business fits inside of, industrial water and industrial liquid. One of the great things about the Koch business, I think, is, frankly, the size of it. It was kind of a perfect entry point, which allowed us to get an asset of scale that we can now build on and potentially add on to in terms of bolt-on acquisitions that, by themselves might have been somewhat orphaned in the portfolio. And so it opens up that ability to focus on add-ons in the air space, while still exploring anchor platform potential in the industrial water and the industrial liquid space. The team is out there continuing to cultivate a number of different opportunities, and I would say that we're excited about where we can take it in the future. From a debt perspective and a leverage perspective, obviously, a little bit of a step-up following this acquisition, but finished the first quarter right at kind of that 2x net debt-to-EBITDA level. I think that's about right for this business in an ongoing acquisitive standpoint. And so we'll continue to naturally delever from that, which really opens up the door for more M&A moving forward.

And in terms of the end-market backdrop, really interesting to see strong aftermarket demand for you folks. In contrast to what we saw from PACCAR, 6% volume decline in their business. Replacement tire demand was down 6% in the quarter. Why isn't filtration facing those headwinds? It sounds like trucks were taken out of operation based on the PACCAR telematics data.

Yes. So it's been an interesting backdrop, I would say, in the aftermarket, really since we IPO'd back in 2023, pretty tepid market conditions. We haven't seen that overall growth per se, and it's kind of been either declining or now bouncing along the bottom. Certainly, we've seen as of late, an increase in some of the spot rates and whatnot. I think that's more driven by supply dynamics, driver shortages and a bit of consolidation in the carrier space. And it hasn't yet translated, I would say, to robust volume growth, just kind of steady along the bottom. And so what we've seen is some people taking trucks out of service. That does have tendency of pushing off larger maintenance events. And so that will kind of limit some of the broader parts churn and activity of, say, an engine rebuild or overhaul. At the same time, you're still seeing trucks needing normal-course maintenance. And when they do -- as and when they do that, generally, filtration content is getting a changeover. So that's kind of what we're experiencing. And again, I wouldn't say growth, but not that decline necessarily in the underlying market. And obviously, we try to counterbalance these tepid market conditions with continued share gain activity.

And in terms of what's fascinating about the way the cadence played out this quarter, based on our checks with PACCAR dealers, April, first part of May, really weak because of the magnitude of diesel headwinds for truckers that aren't well set up for surcharges. And then with the step change higher in spot rates in the back-half of May, there was just an acceleration in orders for one of the dealers, orders doubled between first-half of May and back-half of May as that played out. Is that consistent with the intensity of demand pickup in the market? It's been really interesting to see spot rates and the load-to-van ratio just get way out of whack in a really short period of time.

Yes, it's been interesting. As we think about our sales activity, so obviously, our sales activity is generally pulsed by our channel partners, whether it's PACCAR or many other folks in the aftermarket. We do sometimes see some timing nuances in terms of stocking or destocking activity, not to the levels that we had experienced back in kind of '23 time frame. But certainly, I think we saw some of that inside of the fourth quarter with some pretty robust activity and probably indicative of some stocking up and then relatively slow out of the gates in the first quarter of this year in terms of some destocking as they sold through inventory levels. As we sit here right now inside of Q2, I think really in line with our guidance levels, which is an expectation of flat to slightly up from an overall aftermarket perspective. And we continue to expect 1% to 2% market share gains. So we'll continue to keep an eye on it, obviously, continuing to take a pulse on the sentiment. Every time it feels like we start to get some green shoots or positive sentiment, a broader geopolitical/macroeconomic dynamic emerges. And so hoping to get some stability on that front. And I think overall, that will help lift overall miles driven, which really pulses our business.

And so the shipper-to-truck ratio just really accelerated exiting May, which I think historically bodes really well for aftermarket demand anytime we need to drive uptime. Has that played out the story of 2 halves in May? Is that the way it played out? So I understand overall, more or less in line, but did we see that acceleration that we're hearing about?

It's a little -- it's -- we can't see it like with that level of precision necessarily because, again, this difference in terms of when they're stocking up inventory levels and then when it's actually getting sold to the end user. So I would say that the second quarter has tracked again, in line with our...

Super. Can we talk about China? So they're transitioning to more EVs. What does that mean from an Atmus opportunity standpoint? What can you folks do to drive performance with that backdrop? And where do you see EV share in China going longer term?

Yes, absolutely. I think it's certainly the one area in the world where you're seeing pretty robust EV activity, which is contrary to every other region in the world, which is going the opposite way. Inside of China, obviously, we're continuing to focus on supporting our customers in whatever fashion that we can. If I think about the broader EV transition, first and foremost, it's important, I think, to note just the significant aftermarket nature of our business and the longevity of that tail. So even if you're seeing robust increases in penetration of EV vehicles in China, for example, you still have a lot of activity in the aftermarket based on units on road. We are working to support our customers really who are all global in nature on their alternative fuel ambitions and support them in any way we can. We saw some catalysts of that a few years ago, and now really, that's kind of dried up. So -- but we'll be ready to support them and continue to collaborate with them however we can. If I think about the nature of different types of alternative fuels and impact to the business, I would describe kind of alternative fuel-powered internal combustion engines as having largely a similar look to what diesel does in terms of filtration content on a vehicle. I think in terms of EV, it would be the most significant reduction relative to today. So we're keeping a close eye on it, and we'll see what happens. I think you're just going to continue -- if the current trend plays out, continue to see a pretty big disparity in terms of penetration of EV vehicles in China versus everywhere else in the world.

And can you spend a minute on that? So what are the specifications of the EV trucks in China? How big are the battery packs? And could the build-out in China drive other regions to take a look and see what they're doing?

Yes. So I mean, I think the various powertrain providers are probably better equipped to speak to the nuances in terms of size of battery packs and payload and charging infrastructure, et cetera. I think it will be interesting to see if the -- certainly, I think the Chinese battery-pack suppliers and have a lead in terms of capabilities from a technology standpoint. I think it remains to be seen and how successful they'll be enabled in terms of dropping that capability into other markets. And I think, obviously, the various OEs and powertrain providers will certainly look to retain their existing shares in those spaces. So I think it remains to be seen at this point.

Okay. And if we shift gears, talk about tariffs. The tariff rate decline from 25% to 15% for Ag and construction equipment. Any nuances within that, that might benefit Atmus? Obviously, trade policy is super complex. So what do you think?

Yes. So I wouldn't say anything that necessarily benefits us relative to others. It's kind of been, as you know, a moving target, if you will. So maybe it's best to kind of describe how -- what our approach to tariffs has been, which has remained consistent regardless of the underlying shifting policies and rates. So first and foremost, we look to avail ourselves of any exemptions available, the largest of which has been the USMCA exemption, which has allowed us to continue to mitigate our customers from tariff pricing increases by leveraging and certifying as much of our products that are coming out of Mexico under that exemption. The second has been exploring different supply chain changes and things that we can do. We have not done a lot of reshoring of production just given the changing landscape, and you might make a long-term fix and then all of a sudden, the rates change amongst countries, which is not necessarily fast or easy to unwind. So that hasn't been a big thing. We have done a few different creative initiatives such as establishing a Free Trade Zone in our U.S. Distribution Center outside of Cincinnati that allows us to import, export product without incurring the tariffs. The last lever that we look to pull is via pricing. And so obviously, there's a competitive dynamic with that, that we try to ensure that we're mitigating and insulating our customers from that impact wherever we can. But at the same time, we have to protect our own profitability levels. So we've moved, I would say, quite swiftly, and the team has done an excellent job to navigate in an ever-changing environment. We put pricing through as and when we're incurring those tariff costs and then adjusting that pricing as and when the tariff landscape changes. We'll continue to do so moving forward. And then I think, obviously, the second piece of tariffs is just what happens in terms of refunds and whatnot. And so certainly, we are working through the various reconciliation processes that you inherently do in the customs landscape and then looking to file for refunds through the CAPE system. Obviously, the rulings of that continue to evolve and we will continue to evolve with that. I think it remains to be seen how and when tariff refunds effectively flow through the market. Obviously, there's a lot of different partners there. So you've got our channel partners who we sell to in the aftermarket, who ultimately sell that on to the end users. So that will be a little bit interesting to see how we navigate through that, whereas the OEs are a little more straightforward.

And then USMCA up for renewal, let's say, we lose the USMCA exemption, costs become 15%, 20% higher. Does that change in that scenario, your manufacturing footprint at all?

Yes. So I think, obviously, we'd have to look at longer-term changes, if you will, if we had confidence that, that's going to be the new environment that we're working under. I think you saw many people, including us, with the onset of NAFTA and the USMCA, set up their supply chains in one way. And if that's going to change, then perhaps over the long term, our supply chains would change. I think it's really important that we continue to have strong trade agreements with important partners like Mexico. And I think what you see is the benefit of that accruing to end-users ultimately, right? Because we've been able to take advantage of that exemption and again, mitigate the impact to end-users, owner-operators of trucks, and we want to continue to do that to partner with our end-users. So that's what we're looking at. Obviously, we're closely looking at that, and we'll continue to navigate our supply chain environment as needed.

At the risk of leading the witness, so 15% to 25% type increase on a cost of goods sold basis, given the supply chain is already set up in Mexico, feels like the most likely outcome would be the price moves a little bit higher to pay for that, as opposed to resetting up the supply chain, would be my guess.

Yes. I think that's certainly what you should expect in the short term. And again, it's not a quick endeavor to shift and re-establish your entire supply base. So we would continue to evaluate that over time. But in the near term, you would expect to see it flow through in that.

Last question. What's the most significant supply chain opportunity for you folks? That was one of the pillars that we didn't double-click on until this moment?

Yes, absolutely. So first of all, I would just, again, thank the broader supply chain organization for all the hard work that they did during our initial supply chain transformation. That was really focused on some of the lower-hanging fruit in the procurement space, trying to get more of our supply base under contract, establish multiple different sources of supply. As we move into our next horizon of supply chain transformation, certainly want to continue our strong delivery capabilities as well as then look at efficiency opportunities. So really looking at our conversion costs and how we kind of streamline our operations. But excited about that. And certainly, we'll provide more details on that as time elapses.

Super. Please join me in thanking Jack for coming up for our conference. Jack, thank you.

Thank you, Jerry. Thanks, everybody.