Earnings Call Transcript - PHIN Q3 2025

Operator, Operator

Good morning. My name is Audra, and I will be your conference operator today. At this time, I would like to welcome everyone to the PHINIA Third Quarter 2025 Earnings Call. Today's conference is being recorded. At this time, I would like to turn the conference over to Kellen Ferris, Vice President of Investor Relations.

Kellen Ferris, Vice President of Investor Relations

Thank you. Good morning, everyone. We appreciate you joining us. Our conference call materials were issued this morning and are available on PHINIA's Investor Relations website, including a slide deck that we will be referencing in our remarks. We're also broadcasting this call via webcast. Joining us today are Brady Ericson, CEO; and Chris Gropp, CFO. During this call, we will make forward-looking statements, which are based on management's current expectations and are subject to risks and uncertainties. Actual results may differ materially from these statements due to a variety of factors, including those described in our SEC filings. We caution listeners not to place undue reliance upon any such forward-looking statements. And with that, it is my pleasure to turn the call over to Brady.

Brady Ericson, CEO

Thank you, Kellen, and thank you, everyone, for joining us this morning. I'll start with some overall comments on the third quarter and then provide some thoughts on the remainder of the year and beyond. Chris will then provide additional details on our third quarter financials and discuss our updated 2025 guidance. We will then open the call for questions. The highlights of the third quarter include the closing of our acquisition of Swedish Electromagnet Invest or SEM, our first acquisition as a public company, delivering our second quarter in a row of year-over-year net sales growth with Q3 being over 8% higher than the prior year. This led to a record quarter for adjusted sales and adjusted EBITDA dollars as a public company. For the first time, our results are mostly being compared like-for-like against the prior year quarter as we had substantially exited all transitional service agreements and contract manufacturing from our former parent in the third quarter of 2024 and nearly all of our corporate structure and costs were fully in place. And finally, with our strong adjusted free cash flow, we were able to acquire SEM and returned $41 million to shareholders via dividends and share repurchases while maintaining ample liquidity and our net leverage of 1.4x EBITDA. Let's start with SEM. In June, we announced plans to acquire the company, and we were able to quickly close the transaction in August. SEM is a 100-year-old leading provider of advanced natural gas, hydrogen, and other alternative fuel ignition systems, injector stators and linear position sensors to the commercial vehicle and off-highway sectors. With SEM, we have expanded our ignition and electronic control capabilities, broadening our system offerings. By combining PHINIA's expertise in engine management systems with SEM's deep knowledge of advanced ignition technologies, we are creating a powerful platform for innovation and efficiency. We're excited to welcome SEM to the PHINIA family and look forward to growing with them. Moving to our results. Our third quarter performance reflects steady progress in executing our strategic priorities and our ongoing commitment to returning value to shareholders in the form of dividends and share buybacks. We are executing several structural initiatives to enhance efficiency and data visibility. We are consolidating four ERP systems into a single global SAP S/4HANA platform, which we will phase in across the globe over the next several years. Additionally, the integration of SEM and our ongoing cost savings initiatives are laying the groundwork for a more agile, efficient organization. Although the macroeconomic and industry outlook remain uncertain, we are focused on what we can control through operational and cost efficiency initiatives, providing value to our customers and driving sustainable performance across all our markets. Net sales in the quarter were a record $908 million, up 8.2% from the same period of the prior year as we benefited from the SEM contribution, favorable foreign exchange, customer pricing related to tariff recoveries and increased volume in Asia and the Americas. Excluding SEM and FX, revenue increased 5%. This is the second consecutive quarter where both segments reported higher year-over-year sales. We reported adjusted EBITDA of $133 million with a margin of 14.6%, a 30 basis point year-over-year expansion. The margin expansion was primarily due to lower R&D expenses and strong performance from our Fuel Systems segment. This was partially offset by unfavorable product mix and increased employee costs. The $133 million of EBITDA was also a quarterly record as a stand-alone company. Fuel Systems delivered a strong quarter with adjusted operating income up 33% and the margin expanding 190 basis points, which is partially diluted from the SEM acquisition. Adjusted operating income was driven by research and development savings, overhead cost control measures and efficiencies. Those are partially offset by unfavorable product mix. Aftermarket margin was down 80 basis points. The decrease was primarily due to unfavorable product mix. Our combined Fuel Systems and Aftermarket segment adjusted operating margin was 14%, an 80 basis point increase when compared with the third quarter of 2024 and a new record for a quarter as a stand-alone company. Adjusted earnings per share, excluding non-operating items as detailed in the appendix of our presentation, was $1.59, up from $1.17 in the same period of the prior year. Finally, as we disclosed in an 8-K last week, we reached an agreement with our former parent company to equitably resolve our litigation and move forward in a positive manner. We expect that a substantial portion of the settlement payments will be offset by collection of pre-spin VAT refunds, tax credits and various other tax recoveries. As a result, we do not believe that the settlement will have a material impact on our capital allocation strategies, liquidity or our net leverage ratio. This quarter marks an important milestone for PHINIA. It's our first quarter of fully comparable year-over-year results since the spin with all transitional service agreements and contract manufacturing now complete and nearly all corporate costs were in place. The third quarter reflects the true underlying performance of our business. As a general overview and consistent with recent quarters, our results in the third quarter highlight the strength and resiliency of our business in the face of a challenging and unpredictable environment. This is consistent with the benefits of having a truly diversified industrial business with diversity in customers, markets, industries, and regions in which we support. Our innovation strategy remains at the center of our growth story. We continue to invest heavily in R&D, roughly $200 million annually or about 6% of sales, and our customers reimburse us for about half of that through software and calibration services, demonstrating our position as a true development partner. In turn, we are making important investments in our business that are advancing our competitive position in key markets and allowing us to capture incremental growth opportunities and support our customers. Our brand is strong in the market and customer preferences for our products remain high. Our excellent service is supporting our growth with both new and existing customers. Let me highlight a few of the new business wins on Pages 6 and 7. The new next-generation canister technology with leak detection devices for a leading North American OEM on two hybrid light commercial vehicle programs; a brushless alternator for industrial applications to a leading off-highway OEM in Asia for mining haul trucks; a conquest gasoline direct injection, or GDi, fuel rail assembly and controller for light passenger vehicle applications, securing our first win and new business with a major Chinese OEM. Moving next to our aftermarket business, as shown on Slide 7, we're winning both new business and expanding relationships with existing customers. Importantly, these wins are across diverse geographies. Expanding our market-leading product coverage and growing our share of wallet with a major Middle Eastern customer, signed an agreement with a new large customer in the United Kingdom for braking and suspension components, and new starter and alternator business with additional distributors in North America. Our value proposition is differentiated and continues to attract new customers as well as deepen relationships with existing customers. As shown on Slide 8, our business is diverse by end markets and geographies. Most recently, we've expanded into the aerospace and defense industries. As I've mentioned on prior calls, this is an emerging and exciting adjacency for us. We're launching multiple programs with a key aerospace customer that leverages our existing engineers and manufacturing infrastructure. We have started initial shipments on our first aerospace business award and expect our second program to launch in early 2026. These wins validate our strategy to extend core combustion and control technologies into adjacent markets. Now moving on to Slide 9 for a discussion of capital allocation. We have taken a disciplined approach to capital allocation while remaining opportunistic about M&A. We will continue to evaluate selective M&A opportunities that enhance our product offerings in precision machine components and assemblies, electronics and controls, as well as increasing our presence in key markets and industries such as aerospace, commercial vehicles, off-highway, industrial and the aftermarket. Our approach remains opportunistic and disciplined. Consistent with our capital allocation priorities to invest in our business for long-term profitable growth, we invested $26 million in capital expenditures during the third quarter with funds expended primarily on new tooling and equipment. Also on the capital allocation front, during the quarter, we returned $41 million to our shareholders, including $11 million in quarterly dividends and $30 million in share repurchases. We have $194 million remaining under our current repurchase authorization, and we expect to continue to evaluate the best use of capital on a quarterly basis. Since the spin-off in July of '23, we repurchased approximately 20% of our outstanding shares. Even with the acquisition of SEM, capital investment in our operations and capital return to shareholders, our balance sheet remains solid with cash and cash equivalents of $349 million, total liquidity of approximately $900 million and our net leverage ratio remaining at 1.4x, which is under our target of approximately 1.5x. This was possible due to our strong adjusted free cash flow of $104 million in the third quarter. As we look to the remainder of the year, we see some market and tariff risk as CV tariffs are coming into effect on November 1. Importantly, we will continue to work with our customers on recovery and similar to the auto tariffs, we expect to substantially recoup the costs from our customers because CV OEMs are also qualifying for the same 3.5% rebate as are the auto OEMs. We have adjusted our 2025 outlook to account for the SEM acquisition and some external factors. On the revenue front, the midpoint of our outlook is up $40 million from our prior guide, driven by approximately $15 million from SEM and the remainder from favorable FX, volumes, and pricing. The midpoint of our adjusted EBITDA guidance is up slightly as it continues to be constrained by tariff-related revenue that carries zero margin. Adjusted free cash flow has been a good story for us, and we're raising the midpoint of our 2025 outlook by $10 million. To wrap up, we've continued to build momentum across our diversified end markets while maintaining disciplined cost and cash management. Our teams are executing our long-term strategy that is focused on product leadership, stable growth, financial discipline, and total shareholder returns. With that, I'll hand it over to Chris, who will walk us through our Q3 results and discuss our outlook for this year.

Chris Gropp, CFO

Thanks, Brady, and thank you all for joining us this morning. As a reminder, reconciliations of all non-GAAP financial measures that I will discuss can be found in today's press release and in the presentation, both of which are on our website. Beginning on Slide 11. Our financial results in the quarter were solid and include the contribution from SEM, which closed in August, as Brady mentioned. The external environment has not changed dramatically from the prior quarters. However, we continue to see strength in our OE sales across the globe, enhanced by strength in aftermarket sales in select markets. We are pleased that the teams have responded appropriately and delivered strong revenue and EBITDA in the quarter. Specifically, we generated $908 million in net sales, an increase of 8.2% versus a year ago. Our top line benefited from favorable foreign exchange tailwinds of $19 million and an $8 million contribution from SEM. Excluding these impacts, net sales increased 5%, a result of better pricing, tariff recovery, and increased volumes in Asia and the Americas. Let me now bridge our adjusted revenue and adjusted EBITDA for the third quarter, which you can find on Pages 11 through 13 in the presentation. Fuel Systems segment sales were up 13.4%, including prior year contract manufacturing sales or 13.7%, excluding the effect of contract manufacturing, which ended in Q3 of 2024. The increase in Fuel Systems revenue was also attributable to foreign exchange, customer tariff recoveries, and the contribution from SEM of $8 million. Segment margin was 13.3%, up 190 basis points year-over-year, primarily due to supply chain savings, productivity improvements, and reduced engineering costs. Our aftermarket segment sales were up slightly year-over-year on positive European results, combined with a small amount of tariff recovery. This revenue was partially offset by lower volumes in North America and Asia. With respect to profitability, the aftermarket segment margin of 15% was down 80 basis points from the prior year and impacted by unfavorable product mix. On a consolidated basis, our Q3 segment adjusted operating margin and adjusted operating income were healthy at 14% or up 80 basis points and 11.1% or up 70 basis points year-over-year, respectively. Our teams worked hard to cut costs and improve productivity despite some volatile market conditions. Our adjusted net earnings per diluted share in the third quarter were $1.59, an increase of $0.42 per share for the quarter. These amounts exclude non-operating items, which are described in the appendix of our presentation and influenced by a lower share count as we continued share repurchases. On August 1, our team was excited to welcome new colleagues to the PHINIA family with the close of the SEM acquisition. Total paid was $47 million, comprised of $15 million in cash proceeds to seller and $32 million used to extinguish debt assumed through the acquisition. While we expect SEM to contribute sales annually of approximately $50 million and adjusted operating income of $10 million, we anticipate the first year sales and resulting returns may face some initial headwinds given SEM's reliance on a challenged CV market and potential distractions from ongoing integration efforts. In addition to SEM, we settled a claim regarding the tax matters agreement with our former parent following the close of the quarter. Our full year 2025 guidance, which we will discuss, has incorporated the impacts of this settlement appropriately. We expect that a substantial portion of the settlement payments will be funded through refund payments we receive from various tax authorities related to certain indirect tax payments made prior to the spin-off, with the remaining portion funded with available liquidity. As described in last week's 8-K, the settlement with our former parent also provides clarification on the company's ability to obtain and use the benefit of certain tax attributes. This has the potential to provide us with additional flexibility as we continue to optimize our tax structure. Intense focus by our teams delivered a strong balance sheet, providing substantial current liquidity despite all the extra activities in the quarter. Cash and cash equivalents were $349 million, while available capacity under our credit facility remained at approximately $0.5 billion for a resulting liquidity of approximately $900 million. Cash flow from operations was $119 million in the quarter, and adjusted free cash flow was $104 million, a significant increase from $60 million in the same period of the prior year. We continue to remain confident in our ability to generate free cash flow to support our capital allocation priorities. As such, we paid $11 million in dividends and repurchased $30 million in our stock in Q3, bringing our year-to-date returns to shareholders to $202 million. This balance consists of $32 million in dividends and $170 million in share repurchases. Now moving to Slide 14 for a discussion of our refined full year 2025 outlook. As Brady indicated, we have adjusted our outlook slightly to account for the acquisition of SEM, minor tariff changes, and other macroeconomic factors. We are adjusting our 2025 sales guide, increasing the high end of the guide to $3.45 billion and bringing up the low end of the guide to $3.39 billion for an increased midpoint of $3.42 billion. We are narrowing our adjusted EBITDA range with a high end of $480 million and low end of $465 million for a slightly higher midpoint of $473 million. In addition, we are taking the midpoint of our adjusted free cash flow up by $10 million to $190 million and improving our tax rate for the second quarter in a row. Our expected adjusted tax rate is now projected to be in an improved 33% to 37% range from the prior projection of 36% to 40% as ongoing tax structuring projects gain traction and progress. We do not expect this change to have a material impact on cash taxes in 2025. Overall, we continue to be confident in the delivery of solid returns as we deal with zero or low-margin tariff recoveries, choppy markets, and foreign exchange movements. As Brady mentioned, as we look forward, we are also disclosing the implementation of a strategic effort to align our legacy structure to more effectively match the business as it develops globally. As such, we anticipate a step-up in restructuring charges, approximating $35 million in infrastructure rightsizing, professional fees, and other costs to yield an estimated $25 million in annual savings, with a less than two-year payback once all projects are fully implemented. This is complementary to our normal ongoing work to ensure our operations and corporate functions are agile and meet the future needs of our invested constituencies. We are operating from a strong financial foundation and executing on clear strategic priorities. In closing, we remain firmly committed to building sustainable value for all our stakeholders.

Robert Brooks, Analyst

So excluding the acquisition and currency impact, sales were up 5.1% year-over-year, a really, really healthy number. I was just curious if we could dive a little bit deeper into that 5.1%. Like how much of that was pricing and tariff recoveries versus increased volumes or even just new products being shipped out?

Brady Ericson, CEO

Yes. I mean it's a balance between kind of all three of them. I mean pricing and tariffs are going to be about the same as volume is the same. There's a little bit of foreign exchange headwind. So not a lot of difference between the three. It's kind of equally balanced.

Robert Brooks, Analyst

Understood. Regarding pricing, you mentioned pricing and tariff recovery, which seem like two distinct areas. Do you think pricing will remain stable in the future? How should we approach that?

Brady Ericson, CEO

Yes. I mean obviously, they're linked directly because as we have tariffs, we're passing on price, and so that's the bulk of it. And that's going to be sticky because unless the tariffs are going away, it's going to stay there. And again, that's one of the reasons why our EBITDA is not going up as much is because those are basically at breakeven EBITDA or margin and a little bit of headwind in that. But we don't see it going away. We think it's going to be there. We just got to continue to drive productivity and other efficiency improvements to get our margin back to where we expected.

Chris Gropp, CFO

Bobby, regarding the tariffs, we have been making some adjustments instead of passing through the tariff costs. We have achieved concessions in other areas, which has allowed us to adjust pricing. In the aftermarket, this is more about increasing prices, but the impact is not significant — just a few million dollars when we consider the pricing without the tariff costs. We are focused on ensuring we recover all of these costs.

Robert Brooks, Analyst

Got it. That's very helpful color. And then last one for me. It's great to hear you begin shipping components for your first aerospace program. That's really exciting news. Do you think achieving this milestone will sort of serve as a cowbell to alert other aerospace companies, your legit and certified potential supplier? And maybe asked a different way, do you feel there are potential customers waiting in the wings to see you successfully deliver those components for the first couple of projects before stepping in and placing an order?

Brady Ericson, CEO

Yes. And absolutely true. I think ever since we've announced them and then at the Paris Air Show in June, the level of interest, the RFIs and RFQs coming to us has gone up substantially. And as I mentioned, I think in the last call, we fully expect to get additional awards here in the coming quarters that will continue to support that expansion. And so we're having conversations with pretty much every major engine manufacturer out there and see some good opportunities for us to continue to grow in that space.

Joseph Spak, Analyst

I have a couple of questions. First, regarding the implied guidance for the fourth quarter, it seems a bit softer than expected. Could you provide more detailed commentary on the organic end market? Additionally, I want to understand the business moving forward. It looks like the guidance suggests about $7 million in the fourth quarter from SEM, which is $1 million less than the third quarter, even though the fourth quarter is a full quarter. Is there some seasonality affecting this, or is it related to the softer demand you mentioned for the first year of owning the business? If so, should we consider $7 million or $8 million as a good baseline to start thinking about for 2026?

Brady Ericson, CEO

Sure. In the fourth quarter, we typically discuss seasonality, and we haven't experienced a standard season for some time. However, it appears we are returning to a more typical pattern where the first and fourth quarters are slower. This year's first quarter was likely lighter than usual, and historically, the fourth quarter is about 5% lighter than the second and third quarters. We are gradually getting back to that usual seasonality, though there are factors affecting volumes in the fourth quarter due to potential shutdowns. We're keeping that in mind to ensure we're well-prepared for the fourth quarter overall. Regarding SEM, we are still understanding their seasonal trends. We've noticed that the second half of their year tends to be significantly slower than the first, compounded by some softness in the CV sector. They typically shut down during the summer and return later in August, and they are likely to shut down earlier in December this year as well. Consequently, their performance in the second half generally sees some decline. We remain optimistic that they will reach around $50 million, as mentioned, when the market improves and meet our expectations. Currently, there is some initial impact as various teams work on refining their systems and processes, which may be adding costs at this stage while they work towards our anticipated performance levels. Overall, this does not significantly affect the entire company, but we expect them to emerge stronger next year as the market rebounds. We will provide more details at our Investor Day next year as we prepare guidance for 2026 and offer additional insights into SEM.

Chris Gropp, CFO

And Joe, I'll add a little bit to it because I think that with so much going on in the market, our units are being very cautious about what they're putting out there because you mentioned the issue. We are not being materially affected by any issues like the JLR problems. That's not a significant concern for us. However, there are tariff issues and many other factors in play. None of them are materially impacting us, but our units are being a little cautious. Therefore, we're just trying to be conservative in Q4.

Brady Ericson, CEO

The other one is the aluminum supply issue for Ford.

Joseph Spak, Analyst

Very fair. Fair enough. I guess just in the quarter, Chris, you sort of talked about some of the factors driving the results. Specifically in Fuel Systems, I just want to understand, you had plus $37 million volume mix only $1 million flowed through to EBIT. And I know you sort of talked about negative mix, but it feels like there has to be something more than that in there. Is there anything else we should be thinking about that sort of really weighed on the flow-through there?

Chris Gropp, CFO

No, a significant part of it relates to the ECU, which we specifically mention due to the separation from BorgWarner. We sell the ECU from them, and it essentially has no margin. Those contracts will expire in the coming years, allowing us to reassess the situation. However, ECUs are quite costly, and we are considering how to manage those costs, possibly by passing them through or selling directly. Additionally, while the contribution margin is low, it is based on standard expectations. The other areas show improved productivity and cost management, which should enhance my standards next year. As long as my units can cover the low contribution margin with improved productivity and reduced costs, I'm satisfied, as this indicates that I'm improving and my products are becoming more affordable due to proper unit performance.

Joseph Spak, Analyst

I appreciate the additional information. If I may add another question regarding Slide 8, I noticed that power generation was mentioned, and there seems to be a heightened emphasis on integrating turbochargers into power generators. Most modern turbochargers now incorporate direct injection technology. Have there been any upticks in inquiries related to this sector? Is this area becoming a growing opportunity and pipeline for your business?

Brady Ericson, CEO

Yes, we consider this aspect part of our industrial side, which includes power generation and the linear generator we're developing for hydrogen to generator sets, covering both small to medium and large plug-in or range-extending EV power generation units. We are beginning to see increased business in this area. Additionally, we plan to separate our commercial vehicle and other original equipment revenue next year since it is becoming a significant part of our overall revenue. We will provide more details on this as we move into next year.

Thomas Scholl, Analyst

Congrats on a strong quarter. I just wanted to circle back to the Ford fuel pump recall from a few months ago. Now that you guys have had a chance to work through that, can you talk about kind of what impact you're seeing on the business, especially on the cash side?

Brady Ericson, CEO

No cash impacts, no update, still no concerns on our side. We haven't adjusted our warranty accruals and no cash impact at this point.

Thomas Scholl, Analyst

All right. And then can you just provide some color on the timing of the restructuring program you announced? When do you expect that to come out? And then when do you expect to fully realize the $25 million in savings?

Brady Ericson, CEO

Yes, we see that it's starting to roll out now. The initial go-live is expected in 2026, and it will take us a few years. There are several sites at different stages of system capabilities that we will be implementing. I believe everything will be fully completed by 2028. This is a multi-year effort. It involves a larger investment than usual, which we deemed important to highlight due to its long-term nature and the benefits we anticipate. This initiative also represents the next phase in our efforts to enhance efficiency by streamlining the number of data centers and simplifying our software and systems. We aim to consolidate everything into a single instance, cutting down on redundant software and licenses to drive significant operational efficiency. Since we were spun off, we have inherited various systems from old DELCO REMY, DELPHI Automotive, and parts of BorgWarner, which have their complexities. Our goal is to establish a core standard that will serve as a template for future acquisitions and locations, simplifying our operations considerably.

Operator, Operator

And that concludes our Q&A session. I will now turn the conference back over to Brady for closing remarks.

Brady Ericson, CEO

Great. Thanks, everybody, for joining. And just again, a shout out to all of our PHINIA employees, a really great quarter. As we mentioned, with record sales, some great cash flow, first acquisition, continuing to give cash back to our shareholders through dividends and repurchases and still maintaining a very robust balance sheet. And actually, I think our cash balances are up from the prior quarter after the acquisition and the share repurchases and the dividend. So really proud of the team. Looking forward to closing out the year in a very positive manner and continuing the momentum that we have. So thank you very much for joining.

Operator, Operator

And this concludes today's conference call. Thank you for your participation. You may now disconnect.