Earnings Call Transcript - PHIN Q2 2025

Operator, Operator

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

Kellen Ferris, Vice President of Investor Relations

Thank you, and 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'll be referencing in our remarks. We are also broadcasting this call via webcast. Joining us today are A - 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's my pleasure to turn the call over to Brad.

A - Brady Ericson, CEO

Thank you, Ken, and thank you, everyone, for joining us this morning. I will start with some overall comments on the second quarter and then provide some thoughts on 2025 and beyond. Chris will then provide additional details on our financials and discuss our 2025 guidance. We will then open the call for questions. Earlier this month, we celebrated the 2-year anniversary of the spin-off from our former parent. We've accomplished a lot in that short period of time, expanding into new markets, establishing a strong foundation, refinancing our debt and notably, returning over $464 million to shareholders in the form of dividends and share repurchases. For all their hard work and dedication, I want to say thank you to our entire PHINIA team. Now, our results for the second quarter highlight the strength and resiliency of our business in the face of a challenging and unpredictable environment. Before getting into the specific operating results and commentary, I want to highlight a few key messages from the quarter. We returned approximately $50 million to shareholders via share repurchase and dividends. Our balance sheet remains healthy. We're moving into new markets and winning new business, including Conquest. We recently announced our first acquisition. Both segments performed well as we manage tariffs. And lastly, we are refining to a narrow 2025 guidance. Now let me discuss each of these in more detail. During the second quarter and for the first time since the spin, both Aftermarket segment sales and Fuel Systems segment sales were higher on a year-over-year basis, albeit benefiting from favorable FX and customer tariff recoveries. It was still nice to see. Net sales in the quarter were $890 million, up 2.5% from the same period of the prior year, which included contract manufacturing or CMA sales. Excluding the impacts of foreign currency and CMAs that ended in '24, sales increased 1%. Both segments also had strong adjusted operating income performance. Aftermarket again over 16% and Fuel Systems returning above 10% to 11.5%. While the external environment continues to evolve, our results reflect our strong operational execution, along with our diverse products, markets and customers we serve, which drive more stable and predictable results. We reported adjusted EBITDA of $126 million with a margin of 14.2%, a 60 basis point year-over-year expansion. Our EBITDA margin expansion highlights the success of the actions we are taking, which include an increased focus on pricing, supplier cost savings efforts, and productivity improvements. Total segment adjusted operating margin was 13.4%, a 120 basis point increase when compared with the second quarter of 2024. We are also starting to show solid progress on reducing our tax rate and have adjusted our expected range for the full year accordingly. Adjusted earnings per diluted share, excluding non-operating items as detailed in the appendix, was $1.27, up from $0.88 in the same period of the prior year. In an uncertain market, our performance in the first half was solid. Let me now provide a quick update on the impact of tariffs. Our strategy to source and produce in the same region where we sell to customers not only results in improved customer service, but also limits our exposure to tariffs. The diversification of our customer base and our geographic footprint puts us in an advantaged position. To the extent we have direct tariff exposure, we believe we have substantially mitigated the current tariffs with customer price increases, tariff recoveries from OEMs and supply chain initiatives. We still had a net headwind in Q2, but substantial progress has been made, and we expect further progress in Q3, including completing the necessary customer audits. As a reminder, the majority of our products produced in Mexico are USMCA compliant, and we continue to work with customers and look at our operations for ways to drive our compliance higher. Our strong financial performance in the quarter is a testament to our team's disciplined execution in a highly dynamic environment. We remain nimble and focused on delivering positive revenue growth while managing costs in a deliberate manner and leveraging our global sourcing infrastructure to adeptly respond to geopolitical and market uncertainties. Let us now move to Slides 5 and 6 for a discussion of new business wins. We continue to leverage our strengths, particularly during these uncertain times, offering our customers great products manufactured at state-of-the-art facilities, industry-leading SKU coverage and order fill rates. Our well-recognized brands and high-quality products are helping us secure new customers and increase share of wallet with existing customers. We are privileged to work with a diverse and innovative group of customers. Now let me highlight a few recent business wins on Page 5. New business award for a gas direct injection, or GDi Fuel Rail Assembly and pump for a leading domestic Chinese OEM to be applied on a new hybrid engine platform for multiple vehicle models within China and for a Brazilian market flex-fuel E100 application. First GDi pump business with a leading North American OEM, a port fuel injection, or PFI compressed natural gas injector for a major Indian OEM, our first PFI application with this customer. Moving next to our aftermarket business, which is an important driver of sales. As shown on Slide 6, we're also winning both new business and expanding relationships with existing customers. We highlighted an aftermarket business win with a new diesel fuel injection service with a major off-road equipment supplier, in our earnings release. But as shown on this page, there were other key wins across product lines and geographic regions, including share of wallet gains with customers, growing our propulsion-agnostic braking and suspension technology. The outlook is encouraging for nondiscretionary aftermarket parts for the internal combustion engine market. According to industry reports, the average age of U.S. light vehicles increased by 2 months for the second consecutive year and rose to roughly 12.8 years according to the same report. We're focused on leveraging our ability to offer a broad range of products for all makes and models, not only in light passenger vehicles globally, but also light commercial trucks, medium-duty trucks and heavy-duty Class 8 trucks. Tariffs continue to cause uncertainty, but despite these challenges, we expect rational prices for our products from our customers. We remain committed to offering quality products and being a reliable partner. This, combined with exceptional value-added services, will continue to distinguish our company. Our expanded portfolio of innovative solutions has further diversified our end markets. As I mentioned on a previous call, we're now winning new business in the aerospace and defense industry, and we're actively pursuing additional opportunities across both military and civil aviation. To support this initiative, we recently exhibited at the Paris Air Show, our first time as an exhibitor. We are bringing our expertise for high-performance applications to this industry and are committed to becoming a long-term high-value partner in the global aerospace supply chain. As a reminder on Slide 7, our long-term strategy is to grow our CV industrial and aerospace OE business and aftermarket and service offerings, which currently account for 73% or roughly $2.5 billion of our revenues, while maintaining our light vehicle OE sales level at roughly $900 million through market share gains. Favorable long-term industry dynamics continue to bode well for the company, and we're well positioned for sustainable top and bottom line growth. Now moving on to Slide 8, capital allocation. Consistent with our capital allocation priorities to invest in our business for the long-term profitable growth, we invested $34 million in capital expenditure during the quarter. I am also pleased that in June, we announced our first acquisition with plans to acquire Swedish Electromagnet Invest or SEM, a 100-year-old leading provider of advanced natural gas, hydrogen, and other alternative fuel ignition systems, injector stators and linear position sensors for the commercial vehicle and off-highway sectors. This strategic transaction brings together 2 industry leaders in alternative fuel technology. SEM also opens up adjacent market opportunities for us as well as providing customers with a wider range of products and turnkey solutions. We will pay approximately $47 million for SEM, which is expected to generate approximately $50 million in annual revenue and approximately $10 million of annual adjusted EBITDA. We expect the transaction to close in the third quarter. Also on the capital allocation front, during the quarter, we returned $50 million to our shareholders, including $10 million in quarterly dividends and $40 million in share repurchases. We have $224 million remaining under the current repurchase authorization, and we expect to continue to look at what's best for our shareholders on a quarterly basis. Since the spin-off in July of '23, we have repurchased approximately 18.6 million of the outstanding shares. We have a solid balance sheet with cash and cash equivalents of $347 million. And combined with our undrawn revolver, our total liquidity is approximately $850 million. Importantly, our net leverage ratio remained at 1.4, just under our 1.5x target. Looking forward, global economic activity remains subdued, but we continue to perform well and are maintaining our full year outlook, which Chris will discuss in more detail. To wrap up, we're pleased with our solid first half performance and the momentum we carry into the second half of the year. This reflects the operational improvements we've made and continue to make throughout the business. Despite ongoing economic uncertainties, we are optimistic and encouraged by our team's execution. Looking to Q3, I look forward to another milestone when we compare our results to clean numbers from Q3 of 2024 as we had substantially exited all TSAs and CMAs by then, along with all corporate costs being in place. With that, I'll hand it over to Chris, who will walk us through our Q2 results and discuss our outlook for the 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. Looking at Slide 4. Our business and financial results were solid and in line with our expectations in the face of a challenging geopolitical economic environment. We generated $890 million in net sales, an increase of 2.5% versus the same period a year ago. In contrast to the first quarter, we experienced favorable foreign exchange tailwinds and began recovery of new tariff regimes from customers. Excluding the impact from foreign currency and contract manufacturing sales that ended last year, sales increased 1% year-over-year, reflecting the noted tariff recoveries and improved pricing. Our Aftermarket segment sales were up slightly year-over-year, primarily due to favorable FX, tariff recoveries and volume increases in the European aftermarket. This was partially offset by lower OE volumes in North America, mainly related to heavy-duty product lines. Fuel Systems segment sales were up 3.7%, including prior year contract manufacturing sales or 4.7% excluding the effect of contract manufacturing. The increase in Fuel Systems was also attributable to favorable FX and customer tariff recoveries. From a core business performance standpoint, our segments reported solid overall margins. Q2 segment adjusted operating margin was healthy at 13.4%, up 120 basis points from the same period of the prior year. This was primarily related to favorable volume and product mix, combined with positive supply chain savings, offset by net tariffs and other costs. Our adjusted net earnings per diluted share in the second quarter were $1.27, which excludes non-operating items, which are described in the appendix of our presentation and influenced by lower share count as we continued share repurchases. Moving to Slide 10. Adjusted operating income was $94 million or 10.6%, up 90 basis points. Corporate costs were higher mainly on increased employee stock compensation plans. The Aftermarket segment margin increased 100 basis points, ending the quarter at 16.1%, benefiting from favorable product mix. This was partially offset by some slower customer tariff recoveries, which we expect to recover via pass-through to customers in the coming months. Q2 Fuel Systems segment margins were 11.5%, up 140 basis points year-over-year, primarily due to supply chain savings, productivity improvements and favorable foreign currency impacts. Let me now bridge our adjusted revenue and adjusted EBITDA for the second quarter, which you can find on Pages 11 and 12 in the presentation. Beginning with revenue. Compared to Q2 2024, FX was a tailwind of $18 million as the dollar weakened mainly against the British pound and euro. Revenue in the quarter also benefited from tariff recovery of $9 million. Overall, we saw strength in sales within the independent aftermarket in Europe, light passenger and light commercial vehicle sales in China, while commercial and heavy-duty vehicle sales remained flat to down in all regions. Moving next to the bridge on Slide 12. Adjusted EBITDA was $126 million with a margin of 14.2%, representing a year-over-year increase of $9 million and 60 basis points. Higher sales created a tailwind of $6 million in the quarter on positive product sales mix. Corporate costs were higher by $4 million, reflecting increased employee costs. Foreign exchange created gains of $8 million. Supplier cost savings were a tailwind of $6 million, offset by net tariff costs of $2 million and other costs of $5 million. Now for a quick recap of our balance sheet and cash flow. Maintaining a healthy balance sheet is a priority for us and provides the financial flexibility to support our growth initiatives and capital allocation priorities. We ended the quarter with substantial current liquidity. Cash and cash equivalents were $347 million, while available capacity under our credit facilities remained at approximately $0.5 billion for resulting liquidity of approximately $850 million. Net cash generated from operations in Q2 was $57 million compared to $109 million in the same period of the prior year. During the quarter, adjusted free cash flow was $20 million compared to $108 million in the same period of the prior year. Working capital was negative in the quarter as our Aftermarket segment added strategic inventory to help ensure full product coverage over the busy summer season, in addition to timing for capital spend. We continue to remain confident in our ability to generate full year adjusted free cash flow in the $160 million to $200 million range, as noted and reiterated in our 2025 outlook. Capital spend was $34 million or 3.8% of sales and $69 million or 4.1% of sales for the 3 and 6-month periods, respectively. Funds were primarily used for investments in new machinery and equipment for new program launches. Now moving to Slide 13 for a discussion of our 2025 outlook. As a reminder, more than 60% of our sales are generated outside of the U.S., and our strategy is to source and produce in the same region where we sell to customers, which reduces our tariff exposures. Also as a reminder, we have not closed on the announced SEM acquisition, so our outlook does not factor in the proposed transaction. With all this in mind, we are refining our outlook on net sales to increase the low end from $3.23 billion to $3.33 billion and keeping the high end of our range the same at $3.43 billion. This projection tightens our expected sales range and acknowledges the increased sales as a result of tariffs and foreign exchange, offset by continued softness in our CV business. Adjusted EBITDA and adjusted EBITDA margin are projected to be $455 million and 13.7% of sales to $485 million and 14.1% of sales, adjusted from our previous guidance of $450 million and 13.7% of sales to $490 million and 14.5% of sales. The performance of our segments gives us confidence that we can achieve our originally stated adjusted EBITDA. However, the addition of tariff revenue with 0 margin will result in a slightly lower percentage of sales return. We project no changes to our full year adjusted free cash flow guidance, which remains strong despite minor delays related to timing on tariff recoveries. Our adjusted tax rate is now projected to be an improved 36% to 40% range from our original projection of 38% to 42% as ongoing tax structuring projects gain traction and progress. We do not expect this will have a material impact on our cash taxes in 2025. Our diverse and global customer base continues to provide resilience to our business in the face of a challenging macroeconomic environment. This strong foundation, combined with our performance year-to-date and our outlook for the second half gives us a high level of confidence in our trajectory for the remainder of the year. We remain extremely proud of the focus and execution demonstrated by our teams who continue to drive value for our customers and shareholders alike. We will continue to execute on our strategic priorities in operating with excellence and driving productivity. We are pleased with our financial performance to date and are optimistic about the second half of the year as the teams are expected to welcome and work to integrate the SEM business into PHINIA. In closing, we remain firmly committed to building sustainable value for all our stakeholders. Thank you, all, for your attention today, and we will now move to the Q&A portion of our call.

Operator, Operator

We will take our first question from Bobby Brooks at Northland Capital Markets.

Robert Brooks, Analyst

So it was really great to see such a strong bounce back in the business from the first quarter. And you guys touched on it a little bit, but I was curious if you could dive a little bit deeper on the dynamics driving that? Obviously, you guys had very good visibility on the bounce back, but maybe it was more so dynamics in the first quarter that were a drag and alleviated in 2Q. Just curious to hear more discussion on this.

A - Brady Ericson, CEO

Yes. As we mentioned at the end of the Q1 call, things returned from the Christmas holiday shutdown a bit slower, and it took some time for everyone to ramp up as they made inventory adjustments. We recognized this and communicated it during Q1, which is why we were confident in meeting our H1 expectations based on the order board we had for Q2. We also experienced some benefits from foreign exchange and tariffs, though we noticed some of that impact at the end of Q1. We continue to see strong momentum heading into the second half, which is why we raised the lower end of our revenue guidance.

Robert Brooks, Analyst

Got it. You mentioned that you hosted the booth for the first time at the Paris Air Show during the quarter. I was curious about the conversations there and would like a reminder on the timing and some of the aerospace certifications you are working towards this year for launching your first products in the fourth quarter.

A - Brady Ericson, CEO

Yes. We've got our first launch in the fourth quarter, our second launch in Q1 of next year. Things are progressing well. I think at the Paris Air Show as well, we got our kind of first piece kind of plaque from our customer. Safran is the one that we're working with. And so had great meetings with them as well as great meetings with a number of other folks while we were there. Our certification process is going well. We had another audit here this past month, or actually earlier this month, went well, and we're just kind of going through that process. And so we're on pace to get fully certified and approved. And I think the final certification will come a little bit after SOP because they want to see some of the production going through, but everyone is very confident and excited about our progress so far.

Robert Brooks, Analyst

Got it. For my last question, could you elaborate a bit more on the strategic rationale behind the SEM acquisition? Do you see significant cross-sell opportunities with your current commercial vehicle customer base? Additionally, how should we view the growth potential with this acquisition? It seems like a really unique technology that could be leveraged.

A - Brady Ericson, CEO

Yes, they are focused on various alternative fuels, including hydrogen and natural gas. This aligns with our expertise in fuel injection and engine control units, where we have several applications and test engines in collaboration with customers. Our systems integrate the SEM injector, ignition system, and ECU for calibration of both ignition and fuel injection. This presents a valuable opportunity for us to offer enhanced systems solutions to our clients since we already perform significant calibration work on these components. Additionally, SEM is a smaller company that has struggled with global expansion, allowing us to utilize our established manufacturing sites and engineering teams in different regions to support customers and help accelerate their growth. We believe that in the commercial vehicle and industrial sectors, the trend towards alternative fuels, including more carbon-neutral and carbon-free options, is promising. We anticipate continued growth for our product line alongside our alternative fuel injection systems.

Operator, Operator

We'll move next to Jake Scholl at BNP Paribas.

Thomas Scholl, Analyst

First, I just wanted to ask about the Ford recall announced in the quarter. So Ford announced a recall of 850,000 vehicles for potentially faulty fuel pump. PHINIA was the supplier named in the recall. So could you talk about just any impact you expect to have on your financials this year from the recall?

A - Brady Ericson, CEO

Yes, we haven't made any updates to our disclosures, and there's really nothing more to add. This is a Ford issue. They made a decision and are working with NHTSA regarding that, and we're comfortable with our numbers at this time. Are there specific questions about the cause or why we reference the Ford Motor Company?

Thomas Scholl, Analyst

All right. And then, can you talk a little bit about your capital allocation intentions for the rest of the year? You did $42 million of buybacks in the quarter when most of the suppliers didn't do anything. And we also have the SEM acquisition closing later this year. So how do you think about repurchases for the remainder of the year?

A - Brady Ericson, CEO

Yes, just to clarify, the total was actually $40 million, which included about $2 million in taxes related to some of those buybacks. As mentioned during the call, we will continue to evaluate this. Our balance sheet remains strong, and we have ample cash. Cash flow was somewhat lower than we anticipated in Q2 due to working capital issues, but we're confident in managing that for the rest of the year. We expect our cash flow to remain robust even after the SEM acquisition, and we are still within our leverage targets. We believe that purchasing our shares at current prices was a good investment for our shareholders. We will continue to assess our cash flow and expectations on a quarterly basis to decide on our repurchase plans. However, as we noted previously, while SEM will require some of our cash, it doesn't significantly impact our expected cash flow, and we do not feel pressured regarding our cash or balance sheet at this time.

Operator, Operator

We'll go next to Joseph Spak at UBS.

Joseph Spak, Analyst

Chris, I want to confirm something from your notes. You mentioned tariff recoveries of around $6 million or possibly $5 million. My notes are a bit unclear on this point. Can I confirm that these recoveries are related to tariffs? Additionally, you mentioned a net tariff impact of minus $2 million. Are you referring to the same items when discussing recoveries and the net tariff headwind?

Chris Gropp, CFO

The total tariff is clear in our quarterly report. In this quarter, we recovered $9 million, while $11 million went out, resulting in a net negative of $2 million. When combined with the $4 million from Q1, we expect to recover the total amount over the full year. Currently, $9 million serves as the starting point for recovery, though there is a small amount still lagging.

A - Brady Ericson, CEO

I think the team did a good job. We have closed the gap but still have some work to do in Q3 to finalize things. The team is making good progress. One note, the quarterly report may not be released yet, so you might not have access to it.

Chris Gropp, CFO

Sorry.

Joseph Spak, Analyst

Okay. So looking at Slide 12, you mentioned that supplier savings are recovering $6 million. How does that connect to the numbers you just provided? That's where I'm feeling a bit unclear.

Chris Gropp, CFO

Supplier savings refers only to GSM material savings. This is different from the tariff cost net of a $2 million recovery. We are not detailing the tariff here, but it will be clearly presented in the upcoming quarterly report, where you will see a detailed explanation. Currently, the supplier savings are a result of our GSM team focusing on cost savings and reducing material costs.

Joseph Spak, Analyst

Okay. And since the Q is not out yet, Brady, regarding your earlier response about the fuel pump issue with Ford, you mentioned updating your disclosures. Can you provide any additional information on that? Did your accrual balance change? Also, when issues occur, how is the responsibility for work divided, such as parts versus labor? Or is that decided through negotiations with your customers and possibly NHTSA?

A - Brady Ericson, CEO

Yes. I can confirm that there are no changes to our disclosures and our expected accruals remain consistent. This situation is unique as it involves public discussions and various interactions with customers. It's a complicated system, and we have only recently become involved. We will allow Ford to provide specific responses regarding this matter. At this point, everything remains unchanged on our side.

Joseph Spak, Analyst

Okay. Is the conversation with Ford finalized at this point or is it still ongoing?

A - Brady Ericson, CEO

I mean they haven't announced a fix yet. So they don't have a solution of how they're going to solve it. So it's still an ongoing discussion as we have many ongoing discussions in general.

Operator, Operator

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

A - Brady Ericson, CEO

Thank you all for your questions. I really appreciate it. I want to extend my gratitude to all our employees across the globe. We had a solid quarter, and I believe it's one of our best in terms of revenue since our spin-off. The earnings per share from the team were impressive, and we delivered strong performance despite a challenging market. We plan to continue operating efficiently moving forward, and I want to thank the team for their efforts. Thank you, and we look forward to speaking with you again soon.

Chris Gropp, CFO

Thank you.

Operator, Operator

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