PHINIA Inc. (PHIN) Earnings Call Transcript & Summary

Thanks for being back with us. We have PHINIA Inc. up for this session, a global supplier of fuel systems and aftermarket components and had spun out of BorgWarner a couple of years ago. With us are Brady Ericson and Chris Gropp. We will dive into the company it is today, the strategy in the near term and the longer term. So thanks for being with us.

Thank you for having us.

Needless to say, we've seen some very volatile news flow around trade and policy in the past few months. I hope things have calmed down a little bit. It seems like it. So maybe to start, I just wanted to ask how the quarter is unfolding so far across different regions that you play in?

Yes. I mean, for us, really consistent, not a whole lot of change in our build rates. And again, all the noise that we keep talking about is North America focused. And light passenger vehicle in North America for us is less than 9% of our revenues. So everyone is reacting to all the different trades and tariffs and everything else. And from a light passenger vehicle, it's relatively small. Our aftermarket is doing quite well in North America. And our commercial vehicle is still running relatively low, but it's still at a consistent number. Our European business is kind of coming in as expected, maybe a little bit better. And in China, our light passenger vehicle is actually a little bit stronger than we expected. So we've got a very global business in a lot of different markets. And I think a lot of people are kind of overreacting on the North American light passenger vehicle SAAR number and the impacts. And so right now, we're kind of happy with where we are and things are kind of steady for us.

Yes. Maybe -- you mentioned a little bit of weakness in North America. Can you just talk about how the various different OEMs are responding? Have you been -- a little bit keeping in contact with them? Where do you see them sort of panning out in the second half?

Yes. I mean our -- as far as our EDIs and our build rates, we see them consistent with where we are kind of right now. Again, we supply into the engine side of things. So there's always a little bit of buffer between us, the engines, the engines and the vehicle plants and the vehicles to final production. And those schedules don't maybe move around that much. And so at least as far as our order board, things are looking solid on the OE side. And again, if the OE as it came in -- is coming in a little bit softer this year than we originally expected, but our aftermarket is coming in a little bit stronger because the vehicles are getting older and staying on the road longer, so our aftermarket provides us the excellent buffer as well.

Yes. And if it's discussion on the reimbursement of the tariffs, I mean, we discuss with the customers every day, and those are pretty much wrapped up now. We're getting the last couple of them tied up, but trying to get those tied down before the end of the second quarter is done -- in good shape.

Is that pretty immediate in terms of the flow-through...

In immediate, in [ retro ] -- going back to when they started.

Yes. It's just going to be an add-in to the normal invoice that we have.

And that's on the OE side. On the Aftermarket side, we already put a price increase across the board for North America only on Aftermarket, and that started in mid-April.

Yes. Okay. In general, do you think your customers are sort of in a wait-and-see mode to make any sort of footprint or production changes? Because I mean, we see some coming, for example, GM last night. We see them making some changes a few weeks back. So you're starting to see that taking place. I'm curious to see behind the scenes, what you're seeing from maybe your other customers that may not be as public.

Yes. I think a lot of it is just more tweaks to their existing production plans. I think most of it is on the vehicle side. And again, they have plenty of excess capacity. And so if you're running one shift in the U.S. and one shift in Mexico or two shifts in Mexico, do you shift a little bit between those two, is, I think, what you'll see first. I don't see anybody out there saying, "Hey, we're going to shut down the plant in Mexico and build a new plant somewhere else." And so I think people are just shifting between the currently installed capacity that's in place.

And most of it is more the final assembly, not engine plant movement that we see right now. Will it change over time, you know...

Yes. What about tariff on steel and aluminum? Any sort of...

No real impact to us. Again, most of the components that we purchase are going to be highly engineered. There's a lot of value-added content that's going to go into that base metal and steel. And so for us, even the raw commodity, steel, aluminum, resin, copper, it makes up a small percentage of our overall sell price. And so these -- it's, again, just a little bit of a noise, nothing significant for us.

Yes. Amid all of this uncertainty, you see suppliers across the board launching, whether they call it net performance or whether they call it self-internal health actions. Just curious to hear what you guys are thinking about in terms of that? Any sort of internal plans in place to help you manage costs better in the longer term?

No. I think we're a very decentralized organization, and we expect people to manage costs in all environments. And so we have some plants in locations that revenue wise is going down and they need headcount and they need to manage if they need to reduce some headcount in order to bring their cost structure in line with the new volumes. And we have other locations that continue to grow. And so again, we hold each of our general managers and the plant managers that are running their businesses accountable for having good incrementals and decrementals. On the downside, to try to keep it less than 20% and on the upside, convert it 20%, 25% on the upside. And so if we have to impose something globally, just in my opinion, that means we failed as an organization because each one of our locations should be adapting on a real-time basis based on what they're seeing and not waiting 3 months to then have me come in and say, "Hey, you guys need to cut your costs." They know what they need to do. And guess what, their bonus is tied to them driving economic value on a year-over-year basis. So the incentives are there for them to react quickly rather than just kind of waiting.

We did proactively at the end of last year. I mean it's been a few years since we've had a downturn, thank goodness, and I probably just jinxed us all, but since we've had a downturn. So we did, during the budget process last year, have everybody get out there, 10% and 20% downturn plans and go through the actions because there are certain things you have to do like looking at how much temp labor you have or looking if you need to do a partial shutdown or put people on a part-time benefit. And each country is different, and they just get those out, dust them off and get ready so that the teams are ready to do what they need to. Thankfully, we haven't had to really do much of that, but they're ready.

Some of our locations did do an extended shutdown. They shut down some lines in some areas for a few days or a week just to adjust the volumes. And they've been doing that since. A lot of the downturn that we started seeing was probably Q3 of last year, especially on some of the commercial vehicles and some of the light vehicles. And so we've been dealing with it for quite a while. And since we've spun, commercial vehicle was at a high and they've kind of declined. Light vehicles has been kind of declining year-over-year. So at least our view is that we're kind of getting close to the trough in the cycle. And so we've had both 2/3 of our markets, both CV and light vehicles now kind of closer to a trough. Aftermarket has always been consistently good for us, and we expect that to continue. And when they just stop declining and hopefully have a little bit of upturn, I think we'll be kind of hitting on all cylinders at that point.

Yes. What about automation or the use of AI? Because we've been hearing a lot about that, whether it's in manufacturing, whether it's humanoids. How do you think about that in the midst of...

I mean we have -- if you look at a lot of our plants, there's a lot of automation. A lot of our manufacturing processes, we're holding plus or minus 0.5 micron, the measurement capabilities, cleanroom environments, very, very automated. From an AI perspective, there's probably a half dozen to a dozen specific programs that we have running around, whether it's part inspection, whether it's warranty analysis, scrap reduction is where we're using it more in a targeted fashion. We don't have a lot of customer service or chatbot that we're trying to answer questions type of thing. And so ours is going to be more around can we use it for software, can we use it to speed up some of our processes and reduce some of the waste.

Maybe one last question on the near term. So you did deliver 12.9% EBITDA margin in Q1. In the full year, you have a target of 14.5%. Can you walk us through what are the drivers for that improvement?

Yes. I think in general, our EBITDA, one, it was slightly impacted in Q1 because we had about $4 million of tariffs that was not recovered. So once you adjust for that, we're in the low 13s. And if you take a look at our history, we're generally in the 13% to 15% range, kind of bouncing around. So I'm not going to get overly excited or overly pessimistic just because of 1 quarter. And so from -- we kind of then focus more on the full year. We still have the midpoint at around $470 million EBITDA and 14.1% EBITDA percentage, which is consistent with last year. And so we think we're in a good position. Q1 is always -- we haven't had a normal cycle or seasonality for about 5 years. But a normal seasonality is Q1 is going to be light, Q2 and Q3 tend to be a lot stronger and then tails off a little bit from a revenue perspective in Q4. And that's -- last year was really strong first half, weaker second half. If we have that normal cycle, we expect Q2 and Q3 from a revenue perspective to be a lot stronger than Q1 just because of working days with our customers. Aftermarket starts a little bit slower in Q1. We build up some more inventory. We get more of the sales in the summer months. And then in Q4, we tend to have a good aftermarket as well, and that may help margins in the second half as well. So our view is that we're still right in line with our guide just because you have 1 quarter doesn't mean the whole year is going to be like that.

I want to turn a little bit to the midterm and longer term. I was wondering if we can talk about the longer [indiscernible]. Are you getting calls from OEMs on maybe program extensions or much more than what's covered in the media? Or how should we think about that?

It's been happening even before spin. People didn't believe us before spin when we told them, hey, we get a lot of inquiries for people wanting next-generation combustion technology, 350 bar GDi, 500 bar GDi. And so that -- our order board and our RFQs has been really consistent for the last 3 years -- 3, 4 years. And so we continue to have a good strong inbound of RFIs and RFQs from customers and as well as winning a lot of those programs and gaining share. So we see it continuing. I just think the press and the perception is catching up with what's actually been happening in the background. Customers are a good example. 3 years ago, they would not have announced a $1 billion investment in an engine plant. They did it. They did a $1 billion investment in an engine plant 3 years ago, but they didn't advertise it. Now they make a $1 billion investment and they advertise it. So we've always seen those investments, but just now it's becoming more public.

But we do have conversations with -- especially on the CV side in the last 2 to 3 years, a very heart-to-heart discussions Brady has had with their leaders of are we in it, are we going to be there for the long term because they are looking for that stability. They're looking for their suppliers that are going to be there at 2035. And we've actually seen quotes on the LV side come back to us because competitors would not commit beyond 2030. So it's an interesting market out there. But yes, there -- some of them are looking and asking. We've seen a little bit of change on some of the mix. GDi has been one of our fastest-growing segments. And so certainly, for hybrids and plug-in hybrids, that has been a lot of noise for the last 3 years, not the last year, but the last 3 years or more of growth in that area.

Are you seeing more of that in certain regions versus others? Or is it pretty much...

Each region is going to be a little bit different. And our view was that there's a lot of regions that are not going any battery electric. South America, a great example. They're not going battery electric. They're going ethanol. And so we've launched a number of E100 fuel injection systems for them. India is a little more on natural gas and some hydrogen application. Even China is pulling back on their battery electric. People talk about China is over 50% electric. Well, half of that is plug-in hybrid and hybrid and range extending EVs that have a combustion engine in it. So -- and that's why we're talking about in China, a lot of our growth in China right now is plug-in hybrids and range extending EVs. And so we're seeing some good pull because the consumer likes that type of vehicle. It gives them a lot of flexibility and it meets their needs. And I think the sentiment, I think, has changed since we've spun from, hey, electric vehicles are going to not only take over all of light passenger vehicles, but it's going to take over all of commercial vehicle and combustion is dead, to now I think they're realizing EVs are going to -- battery electric vehicles are going to continue to increase in penetration rates, but there's probably going to be a point where it becomes more asymptotic. Is that at 25% of penetration, 30%, 35%? Wherever it may be, guess what, there's still 65% of the vehicles out there on light vehicle that still have combustion engines. They're going to get cleaner whether it's through hybrid, plug-in hybrid, but also looking at alternative fuels, renewable fuels and carbon-neutral fuels.

But China and North America have definitely been the 2 regions where we've had the fastest growth on -- so definitely for us, that doesn't mean Europe is not, but just for us, we're definitely seeing a lot more pull out of China.

In terms of investment into product development, I'm just curious, how do you sort of manage because on the one side, the market [ curved ] very well, changed very quickly. But on the other side, you want to capture as much of the demand as possible through better products and things like that. So just curious how you sort of manage that? We also recently saw GM, right, I mentioned last night, they made the announcement that they are putting -- spending that into ICE. So I guess what are some of the implications here when you hear some of these announcements, what's your first reaction? How do you sort of react to it?

To be honest, it's kind of in line with our original expectations. So we've been very consistent. And so we're committed to combustion. We thought combustion is going to -- and we still believe combustion is going to be around in transportation for the rest of the century. It's just going to change a little bit, maybe more ethanol, more renewable fuels, carbon-free, carbon-neutral fuels, but it's just too inefficient and energy dense of a product.

Sorry. We do -- I mean, several -- when we -- when BorgWarner took over the Delphi group, one of the things that was missing was a good engineering tracking system. And so that was the first thing that we put in because we needed to understand what projects the engineers were working on because that's a huge cost. That's 95% of your cost on the R&D side. And putting that back in place enabled us to look at how much are we spending on hydrogen. And so we're controlling that. We looked at it last year and at budget, what they put forward and we said, we think that's a little much, let's pull it back a little bit. But those engineers are redeployable. They can work on hydrogen. They can work -- you can take that same engineer and put them on to aerospace and work, just a different fuel, but same sort of issues. You can have them working on ethanol. You can have them working across the spectrum. So we look at those projects and we sort of decide what does it look like? Has it changed since last year on the outlook in the next 5 to 10 years. And then we can move them around. And it's the engineering groups themselves that are really monitoring themselves and regulating that to a big degree.

And so we've maintained our position that we think R&D is going to be consistently around 3%, plus or minus in that range. CapEx around 4%. And that allows us -- we think there's plenty of R&D to allow us to go into these new markets, develop the next-generation products and be a strong supplier for our customers. Now that 3% is a net number, just to kind of give people an order of magnitude. We actually receive about $100 million a year from our customers for services and support. And so whether that's calibration services, giving them a turnkey solution, development of prototypes and as such. And so we get -- our gross spend is closer to [ 6% ], which is a pretty healthy number, but we're fortunate that we get about half of that covered from customers and/or government subsidies.

So you guys have spin out of Warner for a couple of years now. I'm just curious, post that spin, maybe highlight some of the changes that you're making that's worth highlighting? Anything that...

I think a couple of things. One is we can actually make an acquisition in combustion. We did announce one yesterday, small in nature, just getting our kind of feet wet, but it generated a lot of excitement internally of feeling excited about, hey, we're reinvesting in interesting areas for us to continue to grow. So that's kind of one area. I think it's -- in many ways, it's -- if you look at the asset when it was originally part of kind of the Aptiv-Delphi Automotive, this was an asset that was cast off, spun out on its own, had to do a lot of restructuring, got acquired not for our assets, but for the power electronics assets and then cast off again. And so if you think about that, it's been like a decade since they felt as if we're the strength of the company. And so I think the energy level of people is really high. They see it with the acquisition. They see the consistency of our performance now. And I think people are really proud to work in PHINIA. And I think we really have [ no ] difficulty whatsoever attracting talent because people are excited what we're doing, and they believe that the combustion engine, especially in commercial and industrial applications is going to be around for a long time.

So the only other material change we've made since then was that we put back in place a bonus structure that Brady and I both like, which is everything is based on economic value models. So not only us, everybody down to our plants and our facilities and shop floor, if they're getting a bonus, it's based 50% at least on economic value and cash flow. So not only do they have to control their profitability, they also have to make sure that their working capital stays in line, that their capital spending doesn't go off the rails and stuff. So it incentivizes them to also do the same things that we have to do, which is control the whole business, watch the assets, watch your entire balance sheet and your profitability. That was the only other change.

And I think the one little tweak in there, too, is on the economic value. It's really easy to calculate what the bonus target is going to be next year. It's better than last year. I don't care what the market is doing. I don't care if going into a downturn. We, as a leadership team and organization have to figure out a way to create value on a year-over-year basis, full stop. And so if the market is down and our economic value goes down, we're not going to get bonuses. And that's trying to align everything that we've done with both TSR for stock-based compensation and cash and economic value is we're trying to tie our incentives as close to what means -- what's important to our investors as well as shareholders.

Yes. So you mentioned M&A. Any areas that you're looking to close the gap? And then you guys mentioned you did a small deal yesterday. I think -- maybe a quick rationale for that. Anything else that we should be on the lookout for?

I think what's key on -- we're not looking to be a consolidator in the light passenger vehicle market. That's going to continue to have pressure with electrification, and there's plenty of capacity. Why would we go out and buy someone else's capacity when we have plenty and we can just win it via conquest with my own designs. Why go out and pay for it? On the light passenger vehicle side, we just see ourselves just kind of leveraging our existing installed capacity, gaining share to offset any reductions due to battery electrics. On the commercial vehicle and industrial side, that's really where we want to grow and including Aftermarket. So you look at the acquisition, they're all commercial vehicle and industrial focused. It also comes with an aftermarket because they have a lot of service parts that go with it. That's really where we're going to be focusing a lot of our efforts to grow that area. We like light passenger vehicle. It's about $900 million to $1 billion of revenue. We expect that and want that to continue to kind of stay flat, keep those plants humming, generating a lot of cash as we continue to grow in CV, industrial, aerospace and defense and aftermarket businesses. And our goal is to get those other areas to close to $4 billion by the end of the year -- or excuse me, end of the decade. And that means our light passenger vehicle side is less than...

Got you. Maybe as we think about the current policy environment in both light vehicle and in commercial vehicle side, what do you think are some of the advantages that you can do?

Well, I think one of the bigger changes is the fact that they're not mandating battery electric vehicles, especially from CARB in California and trucks. And they're saying, hey, let's be pragmatic about it and let's continue to drive for improvements in CO2 and not just mandating one solution. And so we think there's a lot of advantages there, much more pragmatic. And so obviously, I think it will -- rather than seeing a lot of headwinds, that's slowing the headwind on the light vehicle side. On the commercial vehicle industrial, most of the segments that we're supporting is not seeing a lot of electrification just because of the size of vehicles, the weights and distances they have to go. And so from our perspective, it's tweaks to the emissions regulations and some of the standards, but it's not going to fundamentally change our direction and what we're doing.

You mentioned that in Europe, it's more consistent. Like with the -- maybe a slight pullback in some of the requirements, are you seeing the volatility there? Or has it been pretty consistent?

Yes. I mean I think the automotive -- the European supplier conference came out with some recommendations on emission standards, I think, yesterday or this morning, saying, hey, let's be a little bit more pragmatic. And I think as we get closer to some of these kind of cliff events, I think they'll maybe ease a little bit because I think it's very difficult for our industry to make sharp ramp-ups and ramp downs or changes. And so I think it needs to be a little more of a trend line. I think the regulators are kind of coming to that realization as well. And if the consumer is not buying into going to pure electric either. So from our perspective, things are moving like this. I know industry and reporters thinks of doing this, but it's really just doing -- it's not moving as fast as maybe some of the press releases.

Yes. So you have a longer-term plan to increase commercial vehicle market exposure. Maybe dive a bit more into where you are on that path? And in the end, how do you want investors to view PHINIA?

I think we're going to operate very much like an industrial. We have a number of different markets that we're supporting globally, in region, and many are going to be kind of offsetting. So we see ourselves as a GDP, GDP plus type grower, consistent cash flow, good margins and a good allocator of capital. Commercial vehicle, if we add the light commercial, medium commercial, heavy-duty and off-highway, that's already making up 38%, 39% of our revenues. And so it's a big portion of it, and we see that as an opportunity to continue to grow north of 40%. And we see Aftermarket also continuing to grow from about 34% last year to north of 40%. And so we're going to have north of 80% of our revenue is coming from commercial and aftermarket, which is not -- in our view, our peer group is not light passenger vehicle combustion folks. It's going to be much more commercial vehicle, industrial and aftermarket.

Yes. Overall capital allocation, maybe you could comment on that?

Very disciplined. I think you've probably seen that we think our share price is low, and we think our shares are a good value, which is why we've been buying a lot of them. I think since we spun, it will be our 2-year anniversary on July 3 of this year. In the first 7 quarters since then, we bought back over -- 16.5% of our shares in that time period, and we still have relatively low net debt at 1.4x. We generate cash flow on a consistent quarterly basis, and we have a strong cash position on hand. And so each quarter, we're going to sit down and take a look at our cash flow projections, where our debt and net leverage is, do we have any M&A on the horizon, where our stock is trading. And then we'll say, hey, based on that, do we repurchase shares and how much? And what would the grid be to repurchase shares? And so we generally set it up at one quarter at a time. If the stock price goes to $80 a share, we're probably not buying back shares at that point. There's probably a better allocation. M&A may look more attractive for us at that point. But I think we were -- we've been fairly disciplined on the acquisition side and the one that we just announced is -- it's positive, it's margin accretive, and it was at 4.7x EBITDA. And so when we looked at that compared to us trading in the 5.25 type range, we thought, hey, that was a really good investment. It was consistent with our commercial vehicle focus, and we see it as a nice product line that we'll continue to see mid- to high single-digit growth from as well.

Is there -- from a regional perspective, is there more exposure than you want to get into from a geographic standpoint?

We'll go where the opportunities are. Each region has its strengths and weaknesses in those different markets. And so based on relationships and technology that they're looking for. We have a pretty good balance right now of the Americas right around 40%, Europe right around 40% and Asia at 20%. Asia is a little bit lighter primarily because we do have a joint venture on the diesel side in India. That's another couple of hundred million that we would add to Asia. We balance things out a little bit better. So we have a pretty good footprint. We have all the -- I guess, all the number of plants that we need. We don't need to do any expansion. We have room to grow our businesses within our existing footprint. So we're feeling pretty comfortable with where we're at right now.

Questions from the audience?

[ Position ] that you have with OEMs where they're asking if you sort of commit to being around 2030, 2035 plus, are they willing to pay for that? So do you see sort of margin upside from your commitment there and obviously, to some degree, market consolidation?

Yes. I mean we've -- hopefully, you take a look at our margins, we have pretty solid margins right now that allows us to continue to reinvest. Is there some opportunity to -- in the commercial vehicle and aerospace and defense for us to expand margins? I think there is. Obviously, consolidation of the competition is good or some exiting. But I think we still have to be competitive. We can't define whatever price we want to. There's still two other good competitors out there for us. So we need to be competitive and provide good value for our customers. And that's really what we focus on is ensuring that what we're developing from an R&D perspective actually adds value and what they're willing to pay more for. And we've seen that with our 500 bar technology. It's allowing us to continue to gain market share on the light vehicle side. On the commercial vehicle side, market share shifts are not as much. Everyone is still -- it's both our two main competitors and us are the three major players, and we're all still kind of committed there. But we do see opportunities to where we are the only viable option. And we're not going to act like a private equity and try to [ gouge ] short term. We're in it for -- in many ways, we won a piece of business before spin with a customer was asking us, we're looking for a partner for 2040 and beyond. And so these are long-term relationships. And so we want to treat them fairly and we want to be treated fairly. And I think they -- a lot of our customers have treated us fairly because they've given us a lot of noncontractual inflationary pass-through. They're helping us in covering the tariff costs. And so we see the relationships shifting to maybe more like commercial vehicle and industrial, where they really are partnerships with our customers, and they're not looking to swap suppliers every 3 years as they used to do on the pass car side. And so I think the pass car folks are saying, "Hey, we want the long-term reliable suppliers as well."

So the other thing we did a couple of -- probably been 4 years ago now is we did -- it used to be very common that when you win a program and you bought new capital, you've run the capital over the 12-year life of the capital. But if the program is only 4 to 5 years, we've really reinforced with our units. You have to amortize it and depreciate it over the life, which means you're basically doubling the depreciation rate that goes into the quote. And we're not reducing our return. So it pushed a higher price. We didn't lose any business. Effectively, we've already managed through that. So some of those programs have come out on in the last couple of years at a slightly expanded rate just to protect ourselves. It's likely we're going to get the follow-on program, and we'll continue using that equipment, but we just want to make sure that especially 3 or 4 years ago with there is so much noise, we were just trying to be -- take some risk out of the scenario.

We have another question.

My question is just on how do your margins maybe in Asia specifically kind of compare with the rest of the world? And are you seeing -- as Chinese domestic suppliers become maybe a bit more of a force in the manufacturing side of things, are you seeing more competition there? Are your products something that they are even interested in taking share from you from?

Yes. I mean as far as margins between regions, there are really not a lot of variance. I mean, as I see -- we see more variance in margin just between a different customer program depending on how it was launched. So there's always going to be some noise in there. And so not a whole lot of variance when you take a look at the whole region. As far as competition, once you go from, let's say, a port fuel injection to a direct injection, 350, 2,000 bar, 3,000 bar type system, you're really down to the three competitors. There's no local competitors for direct injection. And so there may be some that have part of the system, some may do a rail, some may do a pump. But there's no local competitor there that does a complete system. And there's really only -- the three of us that can do the pump, the rail, the injectors and the ECU and calibration work. And that's why we receive about $100 million a year from customers. A lot of that is in Asia for a lot of that calibration and services that we provide. And so that also kind of puts a pretty big moat around our business and prevents a lot of individual suppliers but, yes, they can do a forging and make a rail. But the customer is not just buying a rail, they want to buy the complete...

Thank you. With that, I think we're up on time. Chris, Brady, thank you.

Thank you.

All right. Thank you.