Good morning. My name is David, and I'll be your conference operator today. At this time, I'd like to welcome everyone to the Atmus Filtration Technologies Second Quarter 2023 Earnings Call. Today's conference is being recorded. Thank you, Todd Chirillo, Executive Director, Investor Relations. You may begin your conference.

Thank you, David. Good morning, everyone, and welcome to the Atmus Filtration Technologies Second Quarter 2023 Earnings Call. On the call today, we have Steph Disher, Chief Executive Officer; and Jack Kienzler, Chief Financial Officer. Certain information presented today will be forward-looking and involve risks and uncertainties that could materially affect expected results. Please refer to our slides on our website for the disclosure of the risks that could affect our results and for a reconciliation of any non-GAAP measures referred to on our call. For additional information, please see our SEC filings and the Investor Relations pages available on our website at atmus.com. Now I'll turn the call over to Steph.

Thank you, Todd, and good morning. I'm excited to be here for our company's first earnings call and to provide you with an update on our second quarter 2023 results. At the end of May, we completed our initial public offering, a significant milestone for our company and the culmination of multiple years of work. The launch of Atmus provides us with a unique opportunity to grow, both in our core markets and through expansion into industrial filtration markets. Our successful IPO would not have been possible without the tireless dedication of our global employees. Every person on our team, from our quality inspector at our dedicated media production facility in Korea to our safety leader in Cookeville, Tennessee, is key to our success. Our people provide premium Fleetguard products and deep industry knowledge to support the success of our customers. We have made significant progress in our first quarter as a public company and are on track with plans to completely separate from Cummins. I do want to bring to your attention that we filed an 8-K on Tuesday, restating our first quarter 2023 financial statements and revising annual prior periods for 2020 through 2022. Jack will provide more detailed information later in our call. And of course, we want to address any questions you have. We are committed to ensuring a strong internal control environment and to communicating transparently. I would like to now turn to a summary of our strong second quarter results. I'll start with a high-level overview of our markets and the drivers of our results, and then turn to our financial performance. Demand remains strong in our first-fit markets through the second quarter, and we expect this to continue through the second half, with our customers reporting strong orders through the end of the year. In the aftermarket, we experienced some destocking by customers through the second quarter, and we expect a softer second half connected with slower economic activity. The China market continues to be challenging to predict. And while we see some recovery from 2022 demand levels, it is a slow recovery, and we expect a continued muted recovery through the end of 2023. Sales in the second quarter of 2023 were $414 million, an increase of approximately 5% from the second quarter of 2022. The increased pricing more than offset lower volume and FX headwinds. Adjusted EBITDA margin rose 220 basis points from the prior year to 19.3%. The benefits of pricing actions, coupled with the moderation of commodity and freight costs, drove the improvement in profitability. We are adjusting EBITDA for onetime separation costs, which were $9 million in the second quarter of 2023 compared to $1 million a year ago. Adjusted earnings per share was $0.63, and adjusted free cash flow was $35 million, an increase of $11 million over the same period last year. We have adjusted free cash flow for $2 million of onetime capital expenditures related to separation. Overall, it was a strong quarter, and we are continuing to build momentum. We have strong leadership in place, and we are working together to create Atmus. I would like to make some brief comments on our strategic progress in the quarter. You may recall, our strategy is focused on four pillars: grow share in first-fit in our core markets, accelerate profitable growth in the aftermarket, transform our supply chain, and expand into the industrial filtration market. I would like to highlight three areas of strategic momentum during the second quarter. Firstly, we are a technology leader. Our proven leadership enables us to win first-fit business by solving our customers' complex problems. During the second quarter, we launched our Wuhan, China technical center. This was the first of three transitions as we progressed our technical strategy and established full separation from Cummins. During the opening of our Wuhan facility, we introduced our next generation of media technology, NanoNet Plus, for China, which further extends the performance capabilities of our existing NanoNet technology. The next-generation NanoNet Plus, along with our new technical center allows us to continue to develop differentiated products in fuel filtration, which further underpins our global market-leading position in fuel filtration. Secondly, we are focused on transforming our supply chain. One element of this transformation is improving the availability of products for our customers, which will drive share in the aftermarket and profitable growth. During the second quarter, we progressed in the implementation of our global distribution strategy through the establishment of new Atmus warehouses in Sao Paulo, Brazil, and San Luis Potosi in Mexico. Our teams have done an outstanding job establishing these new facilities, embedding capabilities and ensuring improved delivery for our customers. The progress in the quarter to deliver enhanced availability for our customers whilst maintaining disciplined inventory management was remarkable. Finally, I wanted to focus on our growth potential through expansion into the industrial filtration market. At Atmus, we intend to pursue this growth opportunity through a disciplined programmatic approach to acquisitions. We have established a strategy and corporate development team. We have developed a robust pipeline of targets and are continuing to assess acquisition opportunities aligned with our strategy. My leadership team and I are focused on growing beyond our core, and we'll continue to update you on our progress. It has been a big quarter. A successful IPO and launch of Atmus, progress on multiple fronts against our strategic priorities, and strong financial performance. I want to thank all of the Atmus team for their significant contributions. Now, I will turn the call over to Jack.

Thank you, Steph, and good morning, everybody. Before reviewing our quarterly results and full year 2023 outlook, I want to provide you with some additional details regarding the recent 8-K filing, which Steph referred to. We restated our March 31, 2023 financial statements and revised our annual financial statements for 2020, 2021, and 2022. As we closed the books in the second quarter of 2023, we identified errors within our intercompany and related party accounting practices. These errors principally included overstatements of related party receivables and related party payables and an understatement of net parent investment. When combined with other prior period errors originally considered to be immaterial, both individually and in the aggregate, the amount of the overstatement of cash provided by operating activities totaled approximately $25 million for the period. These overstatements in cash provided by operating activities were offset by an overstatement of cash used in investing activities of $3 million and cash used in financing activities of $22 million. It is important to note that these errors had no impact on revenue, net income, or EBITDA for the first quarter of 2023, nor did they have an impact on the amount of the company's cash balance upon closing of the initial public offering, which was $115 million. Now, let's discuss our second quarter 2023 results compared to the same period last year. As Steph mentioned at the beginning of the call, we delivered strong financial performance. Sales were $414 million compared to $393 million from the same period last year, an increase of approximately 5%. The increased sales were driven by $32 million of pricing, which more than offset $7 million of decreased volume and $4 million of foreign exchange headwinds. Gross margin for the quarter was $114 million, an increase of $19 million compared to the second quarter of 2022. In addition to favorable pricing, we saw commodities and freight costs improved by $12 million. This was partially offset by higher variable compensation costs, the impact of lower volumes, and foreign exchange headwinds. SG&A expenses were $46 million, an increase of $14 million over the same period in the prior year. The growth in costs was driven by higher variable compensation. In addition, we experienced some cost inefficiencies as we incurred corporate costs from our parent company while standing up our own dedicated resources. We expect this inefficiency to continue until we are a fully stand-alone company. The increase in variable compensation is a result of the efforts of all of our employees as they delivered strong results through the first half of the year relative to our expectations. Equity, royalty, and interest income was $8 million, an increase of $3 million from 2022, primarily due to higher earnings from our joint ventures in China and India. This resulted in adjusted EBITDA of $80 million or 19.3% compared to $67 million or 17.1% in the prior period. Adjusted EBITDA for the quarter excludes $9 million of onetime stand-alone costs. These onetime costs primarily relate to the establishment of functions previously comingled with our parent company, such as information technology, distribution centers, and other human resources matters. Overall, we delivered strong profitability driven by higher pricing and a moderating cost environment. Our effective tax rate for the second quarter was 24.5%, an increase of 500 basis points from the second quarter of 2022. The increase was primarily due to a change in the mix of earnings among tax jurisdictions. Adjusted earnings per share was $0.63. For the same period last year, adjusted EPS was $0.60. Adjusted free cash flow was $35 million this quarter compared to $24 million in the prior year. Now I would like to discuss our approach to capital allocation, which is focused on delivering long-term shareholder value. We maintained strong liquidity to protect against volatility and uncertainty. We ended the second quarter with $140 million of cash. Combined with $350 million of availability under our revolving credit facility, our total liquidity was $490 million or approximately 30% of the last 12 months' sales. We paid down $20 million of our outstanding revolving credit facility following the quarter end. This reflects our strong performance and confidence in our ability to generate cash. We plan to allocate capital for sustainable growth opportunities, which Steph addressed earlier. These include growth in our traditional business and inorganic expansion into the industrial filtration market. Finally, we will continue to assess returning cash to shareholders. Next, I will turn to our guidance for the full year of 2023. We expect sales to be in the range of $1.58 billion to $1.63 billion. We expect adjusted EBITDA margin in the range of 17.25% to 18.25%. This excludes an expected $30 million to $35 million of onetime separation costs for the full year of 2023. Moving to adjusted earnings per share, our outlook for 2023 is in the range of $2.05 to $2.25. As we look towards the second half of the year, we expect to incur interest expense of approximately $25 million to $30 million as we service debt incurred at the IPO. Our effective cash tax rate will be in the range of 23% to 25% for the full year 2023. This range is consistent with our year-to-date average tax rate. Overall, our team did a fantastic job delivering strong results during the second quarter, and we look forward to a strong full year of 2023. Now I'll turn it back over to the operator, and we will take your questions.

We'll take our first question from Tami Zakaria with JPMorgan Chase.

So my first question is, it seems like volume growth was flattish in the first half. So can you help us understand what's the volume decline outlook is embedded in for the back half as you think about the full year guide? Meaning, can you quantify what kind of volume you're expecting for the back half and whether 3Q should be worse than 4Q, because I can compare step down in the fourth quarter. So any color on volume expectations would be very helpful?

I think as we provided in my overview comments, and I'll let Jack talk to the specifics of how it plays out into the third and fourth quarters in our guidance. Overall, I would say we're seeing a softening in the second half relative to the first. We've seen strong performance in the first quarter particularly. We saw that soften somewhat in the second quarter, particularly in the U.S. market. As we see some destocking through the channel, we expect our customers are doing that at different rates. Some had progressed that through the second quarter. We expect more of that in the third quarter and through the fourth. We do see softened economic activity impacting largely the fourth quarter, I would say, and that's strongly connected to economic activity, which is a primary driver of our aftermarket, obviously. So I'll let Jack add any other specifics.

Sure. Thanks, Tami. Generally speaking, it can vary year by year. But over the long period of time, we generally see the second half from a seasonality perspective being softer than the first, somewhere in the range of 5% or less. Our outlook implies a little bit more of a softening than that in the second half of this year, driven by the factors that Steph just described. Usually, we've seen the third quarter be that decline be more pronounced in the third quarter with a little bit of recovery in the fourth quarter, but it's hard to say precisely in this period.

Got it. And if I can ask a follow-up question. Since you want to enter into the industrial filtration market, can you tell us whether your current product portfolio has any products that can be fitted or leveraged to enter some industrial end markets relatively quickly?

We are certainly assessing our opportunities to grow into industrial filtration markets. We see this as a significant growth opportunity. These markets are growing at twice the rate of our existing core markets, and we see the market size opportunity being three times the size of our current market opportunities. We are primarily focused on accessing that growth opportunity through inorganic expansion, and we discussed that in our remarks. We do see some possibilities of entering through organic routes, and we are exploring those. It really would be leveraging off our media capability. It would need some product development still, though, Tami, to have finished goods that would service those markets. So that's how I would characterize it with you, but we are certainly exploring the full realm of possibilities there as to how we could fast track organic development into those markets as well.

Next, we'll go to Jerry Revich with Goldman Sachs.

Really impressed by the margin performance. You're now running at 19% year-to-date. I'm wondering if you could just update us on how you're thinking about long-term margin targets? And obviously, you're reducing production sequentially in the guide, but it feels like the margin step down is significant. I'm wondering is that just a function of the first couple of quarters out of the gate? One thing to make sure expectations are manageable versus something that's meaningfully different back half versus first half?

Thanks for the question, Jerry. Obviously, our guidance puts full year adjusted EBITDA in the range of $17.25 to $18.25. You're right, the first two quarters of the year have been very strong in terms of margin performance. There are a number of factors that I think have fed into that. We're very pleased with it. However, it's certainly not at a level that I would say is sustainable at this point. So we're getting the benefits in the first half, both the first and second quarter of significant pricing actions, which were catch-up actions. And at the same time, we have seen some moderation of costs in those quarters. Plus, we've had a strong volume environment with back orders and so forth that we have caught up on largely at this point. So it was kind of a lovely mix of strong margins for that first and second quarter. As we've spoken about previously, we certainly see margin expansion opportunity in our business, and we've started to realize some of that related to the short-term actions of pricing and cost factors moderating. We are focused on expanding our margins into the future as well. The volume moderation in the second half certainly puts downward pressure, as you discussed, and we've got a number of inefficiencies still factored into our EBITDA margins overall as we become a stand-alone company.

That's clear. And Steph, can I ask to expand on the M&A opportunity set? Can you characterize for us the size of the M&A pipeline that you folks are pursuing and just talk about your process in building that pipeline, just to give us a sense of what the opportunity set could look like from a transaction standpoint over the next six to 18 months?

Yes. Yes. And I don't have a specific target to talk to you about. I hope in some of these future calls, I will be able to be very specific about the opportunity that we're going to proceed forward with. The rigor and the process we're putting in place, I am very pleased with our progress. As I referenced, we have established a strategy team and a corporate development team. They've built a pipeline of targets. We've filtered that pipeline of targets down to those that meet our strategic criteria and our financial criteria. We're evaluating regularly—every month, multiple targets. And as you know, we have to fish for many before we actually are going to be able to find the right opportunity for us to take that first step. We've described our acquisition strategy as a disciplined programmatic acquisition strategy, Jerry. So I see there are smaller acquisitions that we will look to build out the synergy opportunity over time. I'd love to be able to give you more color than that. Hopefully, that gives you a sense of the discipline and the robust establishment of team and capability we're building to really set us up for a programmatic acquisition approach to industrial filtration markets.

Next, we'll go to Joe O'Dea with Wells Fargo.

I wanted to circle back on aftermarket. And if you could kind of parse it by what you're seeing on the destock side and then what you're anticipating on the slower economic activity side, and just any color on what you've seen from a cadence perspective on the destock? Whether the right thinking is that—you saw it in 2Q; maybe it's a little bit steeper headwind in 3Q, and then that eases in 4Q. And then regarding the softer economic activity, the degree to—what you're actually hearing and seeing from customers as opposed to sort of what you're anticipating just based on what you see on the macro?

Yes. Maybe I'll take it at a go, and Steph obviously can weigh in here too. So Joe, I think it's a little difficult to parse out the specific driver in the aftermarket, as you're aware, to parse out the specific driver. I think all of our broader customers have approached this year from an inventory management standpoint a little bit differently. And so you're seeing destocking occur at different times with different customers. And so we did see some of that in Q2, as Steph alluded to, and expect some more of that here over the back half as everyone rightsizes their inventory relative to their expectations. In terms of the overall economic activity, I would say we are seeing some slowdown there. You can look at a number of different inputs, whether it's great indices or truck tonnage, to point to a slowdown in that activity. Perhaps it isn't as pronounced as we all thought a quarter ago. And so we're keeping a close eye on how that unfolds, and we'll continue to monitor what happens in the aftermarket.

Got it. And then a question on R&D. I think that was up 20% sequentially in year-over-year. Not sure how much of that is tied to stand-alone or how much is tied to maybe some initiatives underway, but if you could touch on anything that contributed to that by sort of specific programs or any organic efforts toward industrial?

Yes, absolutely. Generally speaking, we think about R&D as a percentage of sales right in the 2.5%, call it, in the 2% to 3% of sales range, and that's kind of where we've been pretty consistently. We do have some lumpiness, if you will, in terms of prototype recoveries, in particular, as we work with our customers to develop new products. The timing of reimbursement for that can cause some differences quarter-on-quarter. But overall, we continue to invest from an R&D perspective and are excited about what the team can do, not only in our core markets as they bring new solutions forward for our customers but also through the evaluation of these industrial markets and what capabilities can we leverage into those new markets.

Next, we'll go to Rob Mason with Baird.

It's good to see the benefits of your pricing initiatives flow through; that's pretty visible. I was curious what your outlook for the full year includes with respect to price as we go forward? And just also around your pricing initiatives, the stickiness of that price that you've put through as you think about the balance of the year and if some of these costs do continue to come down like freight, input costs, etc.?

Yes. No. Thanks, Rob. Good to talk to you. So let me just give an overview on where I see we are in the sort of price-cost story. So largely through now, the second quarter, we've caught up on price and cost, I would say, as you've reflected in terms of our margin performance. We obviously had the lag through previous periods of performance. So I'd say largely we are caught up now, and we are seeing inflationary pressures and commodity prices moderate. So I do expect pricing in our outlook and what's contained in our guidance to return much more to historical trends is where I would guide you to. Of course, if we do see costs escalate further, we will adjust for that. You will see the lag that we have experienced in the past, but we would adjust for those. I'm not expecting any issues of stickiness. We really have been able to successfully pass price into the market, as you've seen and demonstrated, and so I wouldn't flag any issues there at this point.

Just as a follow-up, it looks like your kind of onetime separation cost the outlook for the year suggests those could increase sequentially as we go through the second half of the year. Could you just update us on where you think you are in terms of your ability to move off from some of the TSAs? And you also mentioned some inclusion of inefficiencies in the outlook as well. Just—Is there any way to frame up what those inefficiencies amount to quantitatively right now?

Yes. So let me give an overview of how we're tracking overall. It's a significant separation from Cummins, and I'll give some more color to that to give you a sense of it, and then I'll ask Jeff to add anything that he thinks I'm missing. But just overall, there are certain elements, certain functions that we are heavily entangled with Cummins, and we've called those out a few times, but I would describe those predominantly as warehousing and transportation, HR, and IT. We are tracking very well in terms of our separation plans and the individual projects. I would just broadly describe those as being on track. I spoke to a couple of those features in my highlights. We've established two of our warehouses and distribution centers. So we are very much on track with where we expected to be at the end of the second quarter. I think the challenge in terms of just where those inefficiencies might lie that we're just guarding against is just unanticipated elements of IT, perhaps that we need to keep on longer, for example. That's what I would characterize it as. A good example, I feel like we've adequately integrated this, but as we stand up our own cybersecurity capability, we do need to keep coverage of Cummins' cybersecurity for the whole period, wherever we're using any of Cummins' allocations, right? So we can't really turn that piece off until we get to the end of our two-year journey, if you like, at the end of 2024. But we're on track right now. We've been managing it very well, and we'll wind down the TSAs as we turn off the activities in the services.

Yes. And just to add a little bit here, Rob. So as you think about the cadence of the onetime costs, as you alluded to, we are expecting to remain at this level. It's not a touch elevated as we move through the back half of the year. As a reminder, we had about $4 million of these onetime costs in our first quarter of 2023 and then $9 million here in the second quarter. Our guidance is $30 million to $35 million for the full year. And so we do expect to continue to incur these costs as we separate facilities from Cummins, systems from Cummins, and so on and so forth. And just for color, roughly one-third of that $30 million to $35 million should be incurred in our cost of sales with the balance down in SG&A primarily.

Next, we'll go to Andrew Obin with Bank of America.

Just a follow-up on the destock commentary. I think there are a lot of dynamics here. I think one of your competitors would really have to do with specifically what one of their customers was doing. But are you seeing destocking at the distributor level? Or are you seeing destocking at the OEM customer level? Where is the destock that you're talking about?

Yes. And so Andrew, I'll focus largely on the North America market with my comments. It is the majority of our aftermarket, just to give you a sense. And so I'll focus on North America. Look, what I would say, it is varying by OE actually. That's the color I would give you. And some of our customers were really all the way through the dealer and distributor channel, and it's moderated back to normal levels of inventory through the chain and we think we're most of the way through the destocking. In others, we're kind of still in the distributor or a dealer level, and then in others, again, it's up at the OE level. So it is varying actually. We're seeing some customers moving through that faster than others. We expect that destocking to play out over the remainder of quarter 3 and 4.

Got you. And just a follow-up question on inflation. I think the industry is starting to talk about disinflation or maybe some talking about deflation. I think you guys are talking about better price from your supply chain. But I think historically, the industry would give back pricing in a deflationary environment. Have you adjusted the—just remind us, if you have adjusted your contract structure going forward, to sort of mitigate that? Or should we look at sort of legacy patterns where inputs go down first, and then you guys have to give back some price? Can you just talk about structurally, what do contracts look like?

Yes. So I'll talk at a high level just to the differences between our first-fit business and aftermarket as it relates to pricing. So it's roughly 80%-20%, so 80% aftermarket, 20% first-fit. Our first-fit contracts are very much based on our contractual arrangement. Many of those have risen full causes integrated into them, and you've seen that flow through in our previous period results. In terms of the aftermarket, we passed price increases to the aftermarket roughly on a twice-a-year basis, but it varies by region. At the moment, we are not seeing deflationary pressures, I would say. Certainly, we're seeing a lower inflationary environment. We have only really caught up, I would say, in those markets to the previous rising and escalating cost environment. So I certainly don't—I'm not looking at a deflationary piece in our forward pricing outlook.

But generally, in aftermarket, the point is that pricing should be a lot more stable than in the OE channel?

Exactly.

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

This concludes today's conference call. You may now disconnect.