Good afternoon, and welcome to the 22nd annual CL King Best Ideas Conference. I am Tom Hayes, senior industrial analyst here at CL King, and we're pleased to have the management team of Atmus Filtration with us today. Specifically for the company, we've got Jack Kise, CFO. Jack, appreciate you participating today. For those in the audience online, if you wish to ask a question, you can type that question into the Ask a Question box at the bottom of the webcast screen. These questions will be sent to me, and I'll work to integrate them into today's discussion. With that, I've asked Jack to give us a brief overview of the business, and then we'll jump into some Q&A. Jack?
Great. Thanks, Tom, to you and CL King team for having us, and thank you everyone for your interest. I thought I'd start just with a quick background on who Atmus is, and then, yeah, look forward to taking all of your questions. So, we are a global leader in filtration products for on-highway and off-highway commercial vehicle markets. We generated $1.6 billion in sales in 2023. On-highway represents approximately 60% of our business, and off-highway would be approximately 40%. We design and manufacture advanced filtration products. We are a technology leader with five technical centers around the world, and approximately 1,250 active and pending patents as of the end of last year.
About 50% of our revenues come from North America, and the other 50% are generated outside of U.S. and Canada, and we have a strong global footprint, primed to support future growth. We have a very strong global aftermarket presence. Approximately 80% of our revenues are generated in the aftermarket, and really what that creates is a recurring revenue base and allows us to experience more muted peak to troughs relative to the inherently cyclical markets that we serve. We are partnered with leading OEMs in both the on-highway and off-highway space, including Cummins, which is approximately 17% of our sales, as well as PACCAR, Traton, Komatsu, Foton, and Volvo, to name a few. A brief history, we are a relatively new public company.
We IPO'd in May of 2023 and completed our full share exchange in March of this year. We are, however, not a new company. We were started in 1958 by our former parent, Cummins, for their captive filtration needs and have grown from there across a number of different customers. From a strategy standpoint, which we can certainly get more into, we have four key areas of focus: growing share in our first-fit in our core markets, accelerating profitable growth in the aftermarket, transformation of our supply chain to accelerate that profitable growth and to address some issues from a cost standpoint, and then finally expanding into industrial filtration markets. So, with that, maybe, Tom, I'll turn it back to you, and happy to go deeper on any areas you'd like.
Yeah, let's... I mean, we'll just kind of jump into your four pillars for a minute, but I think one of your opening comments was, you know, you kind of called yourselves out as a technology leader in filtration space. What does that kind of translate to for you, and kind of, you know, how do your customer base view that as well?
Yeah, absolutely. Technology is a critical piece that we can bring to the equation, particularly in the first-fit, as you're engaging with our customer base to meet their needs.
Oftentimes we'll engage early with our customers from a first-fit standpoint to understand the problems that they're trying to address and determine how our products can meet their needs. Our ability to separate harmful particles is a clear differentiator, largely fueled by our media capabilities, which we produce primarily in-house. The media is the fibrous material within the filter that allows us to separate harmful particles and retain those harmful particles in order to protect our customers' equipment, whether it's the engine that we're mounted on, or the broader vehicle that the engine is powering. We separate harmful particles and ensure that the end users are able to meet their uptime.
Maybe just stepping back a little bit, and myself being a little bit relatively new to the story, I just wanted to double-check. Do you do both liquid and air filtration? I just wanted to kind of clarify that.
We do, yeah. So, our primary product categories are fuel filtration, lubricant filtration, air filtration, coolants and chemicals, and then crankcase ventilation. So, all of the above, both in the first fit and in the aftermarket.
Then you can really provide just, you know, all filtration needs for your customer base?
That's correct. So generally speaking, our goal, particularly for our end users, is to be a one-stop shop from a filtration product standpoint, and so we ensure that we can meet all of their needs anytime they're getting their vehicle serviced.
Have you talked publicly... I know you're like you mentioned, kind of a new public company, but as far as the dollar amount of filtration equipment per vehicle, I'm not sure how to kind of... Is there a metric along those lines?
Yeah, it's a tricky metric to be too specific about because it varies, as you can imagine, across applications, across duty cycles, size of vehicle, so on and so forth. We do describe the business as a bit of a low-cost insurance policy, if you will. You know, to give you some rough figures, and again, these would change depending on the application, but if you just take a Class 8 truck, for example, in the first fit, you know, say that truck costs about $150,000, the filtration content on that would be between $200-$400. So, and then, you know, a lot of service events thereafter, which generate a significant aftermarket revenue stream tail.
Okay. Again, just kind of, I apologize, it's a little simplistic, but most of your liquid solutions also, or your vehicles that you sell products into are diesel-powered by nature?
That's correct. So the vast majority of the products that we serve in our on-highway and off-highway would be internal combustion engines powered by diesel fuel. We do, of course, serve internal combustion engines served by natural gas. And then are also collaborating with our customers across a number of alternative power solutions, including hydrogen-powered internal combustion engines, and then, you know, certainly battery electric and fuel cell applications. The volumes in that space are relatively low, but it's been good to collaborate with our customers and, you know, and have some units in the field as well.
Okay, no, that makes sense. Kind of maybe going back to, you know, some of your growth pillars, if you will, you know, how does, you know, a company such as yourself go about trying to grow the share of your first fit business?
Yeah, so, I would describe kind of three categories, if you will, that we're going after in the first fit. The first is winning with the winners. And so, looking at our existing customer base, really blue-chip OEMs in those categories, all of whom have their own growth initiatives, and we're looking to partner with them along those growth pathways, so that as they win more and more market share, we grow alongside them. I think Cummins is a great example of that, you know, whereby they've announced a number of different engine partnerships, leading to increased market share for their business, and in turn, as we provide them with filtration solutions, that is a market share gain for us as well.
The second category would be customers who perhaps had a competitive dynamic with Cummins, our former parent, who we didn't pursue historically. This would largely be in the off-highway space, where those OEMs perhaps were hesitant to source from a competitor's captive supplier. And now those avenues are open for exploration. And then the third category would be, you know, really looking to, you know, some of the other OEMs in largely in the off-highway space, that we didn't do business with historically, largely driven by resource constraints. And so those could be in the rail space, or in the agriculture space, or the construction space, where we're looking to cultivate those new relationships. In many cases, you know, they may be open to an additional source of supply.
We didn't focus there historically because, you know, we didn't have all of the resources to invest in those sales personnel or those engineering capabilities to cultivate those relationships. And so, you know, now that we have full autonomy over how we allocate our own resources, it's been really helpful to go after in a much broader market within our core markets and really try to exploit that growth opportunity.
Yeah. Are the First-fit markets a little cyclical in that you need an engine redesign to kind of get that business available? I'm not quite sure how to frame the question.
Yes
... but I think-
No, no, yeah, so, so generally speaking, it's there is a catalyst for a platform, you know, coming up for bid, that, generally speaking, is a, an emissions regulation. And so, you know, if you look in the on-highway space, the upcoming 2027 EPA emissions regulations would've been a catalyst for new engine program redesigns. And therefore, you know, it was important for us to continue to cultivate those relationships and get on those platforms. We generally would be engaging in those conversations with customers, you know, two, three, four years before that emissions regulation, to understand their technical requirements, meet their specifications, engage in commercial discussions, and then, you know, move through prototyping and ultimately start up production. So, you're right, it's a bit of a long cycle, if you will, on the first-fit.
Not necessarily a quarter-to-quarter momentum thing that we can track, but it's really important as we continue to cultivate these customer relationships to get our name out there and our capabilities out there for new customers.
Okay, that makes sense. Maybe just next, on your comment on supply chain cost. I think it was focus on cost improvements?
Yeah, so really two things I would call out in the supply chain strategy. The first is actually not so much a cost story but really focused on delivery capabilities and availability for our customers. As you can imagine, in the aftermarket in particular, on-shelf availability is critical, and amidst a challenging supply chain backdrop over the past few years, it was a critical initiative for us to improve our delivery capabilities to meet the needs of our customers, and so that they have our product whenever an end user ultimately demands it. That's been a big focus for us, and I've been really pleased to see the traction the team has been able to generate on that front.
As you know, we're currently undergoing a number of separation-related activities from Cummins, one of which is the decoupling of our distribution centers, which were previously managed by Cummins and co-located with Cummins. We're now about 80% of the way through, from a volume perspective, that separation of distribution centers, and that's allowed us to really have autonomy in the management of our distribution centers and logistics centers. You know, really focused on putting inventory where it needs to be in the right amount, so that we can meet the needs of our customers, and we have now the full autonomy of that decision, whereas you know, under Cummins, that was managed by a Cummins central team.
And so, you know, on-shelf availability and delivery is the first piece of the supply chain transformation. And then we're also looking at, you know, really looking at cost opportunities in our supply chain. You know, that can be achieved through, you know, enhanced procurement capabilities, getting more of our supply base under contract, establishing, you know, multiple sources of supply, all of those various initiatives. And then lastly, is really focused on increasing the efficiency within our production facilities. And so, you know, this is generated through, you know, continuous Lean activities, if you will, as well as increased automation spend. Not in large chunks of capital, but, you know, looking to, you know, survey our manufacturing landscape and implement automation wherever we can to help drive efficiency and productivity in our supply base.
We've seen, you know, certainly a lot of improvement, and really healthy margin expansion that we've been able to generate, and certainly in part by our supply chain transformation. So, a big thank you to our team who's been driving those initiatives.
Just kind of, maybe kind of a bit of an offshoot, 'cause it was one of my questions, is kind of where you were in, you know, decoupling from Cummins. Have you guys talked about, you know, maybe some of the final components and the timeline?
Yeah, absolutely. It's been, you know, quite a journey, and a lot of efforts on behalf of the team, really across functions to engage in this separation work. You know, I would describe the level, the layers of commingling largely in supply chain, as I talked about in the distribution centers, and then in some of our centralized functions, such as finance, HR, IT, where, you know, we were previously reliant on Cummins centers of excellence, and are now, you know, pursuing standalone capabilities. We've continued to make really good progress. I mentioned the distribution centers, from a volume perspective, are about 80% of the way through.
We have two more significant sites to go through, which will take us through the back part of 2024 and into the first part of 2025 to complete. And then that leaves largely some of our information systems that we're continuing to transition. A good example of that would be our financial ERP system, which we're currently undergoing a wave of transitions. And we would expect to complete that by about the middle of 2025.
Okay. No, I appreciate that. Maybe kind of before I get into some of the other end markets, maybe just talk about, 'cause I think you added one distribution center down in Texas this year. I think you've talked about that.
Yes.
Do you think you're at the right number of distribution centers, both kind of domestically, internationally right now?
It's a great question, and one that we continuously evaluate. You know, this notion of, you know, proximity to the customer and making sure that we're able to meet their needs from a delivery standpoint, and what initiatives can we do to increase that. That could result in increased inventory, at, you know, more of a central hub, or it could be, you know, opening more regional hubs, whether here in North America or around the world. I would say right now, we feel pretty good about our distribution center footprint, and are really focused on getting through the remainder of the decoupling from Cummins. But it's something that we'll continuously evaluate as we look at our broader logistics footprint and continue to engage with our customers on what makes the most sense to enable their success.
Okay, makes sense. I guess maybe shifting gears a little bit, you know, can you talk a little bit about the opportunity and the competitive environment in the off-highway business?
Yeah, absolutely. So I mentioned, you know, off-highway is about 40% of the business, overall. Within that 40%, you know, the biggest sub-end market would be construction, followed by mining, followed by, you know, agriculture and some of our power generation applications. We are continuing to engage with, as I mentioned earlier, new potential first-fit leads, to determine how we build our presence in these off-highway markets. We're certainly, you know, looking across the spectrum, as many of our core products and existing products are applicable into a number of different off-highway applications.
Oh, okay.
So we see a lot of opportunity there. There may be need to be some investment from a product development standpoint or a manufacturing capability to increase the size of some of our products, but excited about the future there. You know, we are operating in some challenging end markets at the moment, both in the on-highway and the off-highway space, but wanna use this time to begin to cultivate new relationships and try to expand the business.
Yeah, that makes sense. I guess, you know, you know, shifting to the industrial markets, I mean, where, where do you see as far as... You know, obviously, it sounds like, you know, before the split, it wasn't a focus, but, you know, where, where do you see some of the most attractive opportunities?
Yeah. So, you know, we believe that the industrial markets represent a significant opportunity for us. You know, they're about three times the size in terms of addressable market relative to our core market, and growing at about twice the rate. And so, you know, overall, really what we're looking at is an expansion into industrial filtration markets through a programmatic M&A approach. And the reason for that is, even if we can develop some of the products, we still need to acquire the customer relationships and the channel to effect this expansion in a timely fashion. We're thinking about this expansion really across three verticals, I would say. Industrial air, industrial liquids, excluding water, and then industrial water.
You know, we've talked about a programmatic approach to this M&A, and so not a transformative, you know, at the detriment of our balance sheet. But really looking at how we grow organically, prove our capabilities, begin to integrate these businesses, and realize those synergies, all of which will open up more synergy realization opportunities as we move from asset to asset. So really excited about the team's work there. We've built a strong and capable strategy and corporate development teams in-house here, and they've been churning through not only the underlying strategy in terms of, you know, what's our right to win in all of these markets, but also into, you know, evaluating a number of transactions and building a pipeline.
The M&A markets have been a bit slow, as you all know, but the opportunities in the pipeline are building. So, we're excited about where we're at and hopeful to be able to provide you all with some tangible examples as we move forward.
No, that's helpful. Appreciate that. Maybe just kind of a broad brush on competitors. You guys are certainly a relatively diverse company within markets and being relatively new publicly traded. You know, what can you kind of just call out a few of your main competitors?
Yeah, so, you know, broadly speaking, we would look at kind of a competitor landscape of ourselves, certainly Donaldson and Parker Hannifin here in the U.S., as well as Mahle and Mann+Hummel, both of which are based in Germany. We all have, you know, our strengths, you know, certainly from a product standpoint, as well as from a regional dynamic standpoint, but those would be kind of our primary competitor set. And then obviously, as you move through different regional pockets and different subsegments, you encounter other players, of course, but...
Okay. Maybe changing gears a little bit, you touched on it a little bit, maybe your a little bit more formalize your thoughts on cash deployment and use of cash going forward.
Yeah, of course, so you know, first and foremost, I'll go in kind of order of priority, if you will, so our first priority is to reinvest in the core. Again, as I described, we see a lot of compelling growth opportunities in our core markets, and we wanna make sure we unlock those by reinvesting in the business. That reinvestment can come in the form of, you know, increased operating expense through additional headcount or targeted programs to unlock that growth. It can come in the form of, you know, capital expenditures as we look to win new programs and build out prototypes and manufacturing capabilities. We think that CapEx level that's right for this business is about 2%-3%.
That compares to historical levels under Cummins ownership of kind of in that 1.5%-2% range. And so, an increased investment, but still not, you know, unmanageable, if you will, in terms of a cash outlet. The second area of priority, I would say, is our inorganic industrial expansion strategy. We believe that, again, a programmatic approach to M&A is the best path for us to get to some of those markets, and so that will continue to be a focus for us and a priority for us from a cash deployment standpoint. We do generate very strong free cash flow and certainly have ample access to capital at the present time, to you know, continue to go out and effect that inorganic expansion, so looking forward to doing that.
And then lastly is, you know, we did recently establish a cash return to shareholders program. We initiated a dividend in the third quarter, and we'll continue to evaluate, you know, the appropriate growth of those dividends over time. And then in addition to that, we have initiated a cash return share repurchase program, $150 million over an indefinite period of time, and we will continue to evaluate, you know, how we balance that lever against, you know, inorganic M&A deployment. We feel good about where the balance sheet is. At the moment, we're about 1.4 times net debt to EBITDA at the end of the second quarter.
And so, feel, again, good about our liquidity position and our ability to execute against our growth strategy moving forward.
Okay. No, I appreciate that color. Did have a question come in from online, kind of refers to your industrial filtration market opportunity. Question is, what competitive advantages will Atmus bring to that market that the companies you may acquire, you know, to get into that market don't have?
Yeah, absolutely. It's a great question. So first and foremost, I would say, you know, as we've looked at some of these different opportunities, we do feel like there's a few, you know, areas of synergy that we can bring. You know, we often, I think, think about ourselves as a smaller company, certainly relative to our former parent, Cummins. But as we look at some of the targets in this range, you know, we can bring a certain level of size and scale, which will bring, you know, purchasing leverage opportunities, certainly some synergy realization in the central buckets, central functions, as well as some, you know, R&D-related synergies-...
whether by, you know, bringing our media capabilities to the, the new end markets we're trying to address, or even bringing, you know, our testing and laboratory capabilities, to help prove the products of, you know, our potential, potentially acquired companies, you know, in their own, in their own market. So, all of those we feel can be, you know, compelling, differentiators that we bring relative to what those individual companies can generate on their own. The last piece would just be our global footprint, and our ability to get into, you know, multiple different markets, around the world. We do have, significant market presence in, in growth areas such as India.
We go to market in that region via a joint venture and have a very significant market share in our core markets, but also you know access to a number of different retail outlets, which can allow us to get product out into the hands of end users quite quickly, and so you know many of the smaller companies that we've engaged with you know certainly have global aspirations of growth but are challenged whether by you know their inability to get across international lines or from an investment standpoint, and we feel like we can bring that global expansion to them.
Okay. No, I appreciate that. Maybe shifting gears a little bit, one of the questions we get relatively often from investors is, with the clean energy movement and the kind of a goal towards lower emissions from vehicles, you know, is that a headwind or tailwind for Atmus?
Yeah. So, you know, generally speaking, we have seen, you know, more stringent emissions regulations leading to the need for more advanced filtration content. Crankcase ventilation is probably the one area from a product standpoint that I would point to that's directly tied to emissions. And so as people have moved from, you know, an open to a closed crankcase ventilation hierarchy, that's driven content expansion for us along that product line. But even in, you know, things like fuel filtration, again, you know, more advanced, the engine becomes, the more advanced the filtration requirements have become.
And so generally speaking, that's led to, you know, content expansion for us, which is kind of embedded in our historical 4-5% growth algorithm, and has allowed us to, you know, increase the content, that we can bring in a per price, per filtration price, as well as to extend service intervals, which is always, a goal of our end customers. As I think about, you know, alternative power solutions more broadly, as I mentioned, you know, the vast majority of our business is diesel-powered internal combustion engines today. We are continuing to engage with our OEs and a number of customers across the broader alternative power solution landscape.
If it's an alternative fuel powering an internal combustion engine, we feel the content will largely be the same as what we have today, and we continue to engage with our customers across that landscape, whether it's, you know, natural gas or hydrogen. And then as you, you know, continue into, like, the fuel cell space or even battery electric, we continue to engage with our customers on applications there, and we'll continue to see what the market opportunities look like as those volumes increase and develop.
Okay, that's fair. Maybe just maybe one more, and you may have touched on it kind of, you know, throughout the session here. But, you know, I think one of your growth pillars is to continue to grow the aftermarket part of the business and, you know, kind of continue to expand that. You know, certainly you have a good position now, and it's certainly a profitable part of the business. You know, how does one go about, you know, continuing to grow that aftermarket business?
Yeah, I think it's through a number of different initiatives, and we've really been trying to invest across, you know, many different opportunities to see what, you know, what can continue to move the needle. Certainly, want to continue to build brand awareness. Our Fleetguard brand is synonymous with durability and quality, and allows us to continue to experience a pull-through demand from our end users as they, you know, desire the uptime and reliability that a Fleetguard product can provide. In addition, we continue to engage in a build-out of our independent distributor network. That was, you know, an avenue that was under penetrated for us as a business historically, and so, you know, looking to generate more on-shelf availability through cultivation of additional independent distributor outlets.
And then lastly is again just continuing to win with the winners. Our OE dealer network, the likes of, you know, Cummins distribution business, for example, or the PACCAR dealer network, to name a couple, is very significant and strong. And so we wanna continue to cultivate those relationships, increase awareness of our, you know, of our product through their dealer networks, and continue to win in those winning channels.
Okay. Maybe just lastly, and we've got a couple of minutes left, you know, as when you guys reported your June ended quarter, I think you had some both negative and, you know, and positive commentary as far as end markets. Can you just remind us, you know, kind of what you saw as you reported Q2 as far as end market activity?
Yeah, absolutely. So I'll start maybe in, in our first-fit markets. We're certainly seeing a softening, you know, in line with broader industry expectations, which will really be, you know, hitting in the, in the second half of 2024 and into 2025. You know, I think you've seen similar sentiment from our big customers, such as PACCAR, Cummins, Traton, to name a few. And, you know, that's driving a pretty significant pullback in our outlook over the, the, you know, the second half of this year. We've guided to overall about 9% down in our first-fit markets, and they were relatively flat compared to last year in the first half of the year. And so most of that slowdown is driven by, you know, the activity pullback in the second half.
In the off-highway, we also are seeing pretty soft market conditions in first-fit. You know, that tends to be a bit more regionally driven for our business, and so, you know, certainly seeing some softness in Asia Pacific, in the EMEA region, as well as in North America, as we think about our construction business, for example, and so we'll see, you know, as overall economic activity, you know, most likely remains pretty muted, certainly through the election and maybe over the balance of 2024. That's what's embedded in our guidance. In the aftermarket, you know, it's been a bit more of a prolonged downturn than we originally expected at the beginning of this year.
We had originally based our 2024 outlook, assuming a second half increase and a positive inflection in aftermarket activity. We have yet to see that. The, you know, just a... there's a few indices that we track, certainly the Cass Freight Index and whatnot, which just came out today and still shows negative year-over-year trajectory for August. And so we're keeping a close eye on that. Certainly, I would say customer sentiment in the aftermarket matches that, and we would expect pretty muted market conditions through the balance of 2024, in line with our guidance. The, you know, the one dynamic which is worth calling out is just the destocking impacts that occurred over the course of 2023. That largely happened in the second and third quarters of 2023.
We would certainly view that we're through, you know, any kind of destocking and that inventory levels are at normal levels. And so that will be a bit of a positive or a tailwind as I think about year-over-year comps in the back half of 2024. But again, largely offset by just overall weaker market conditions. So, we'll see how the year finishes out, and obviously as we move into next year, initiate, you know, our 2025 market outlook. But that's where we are right now, and in the meantime, we'll continue to focus on, you know, continuing the market share increases that we've been able to achieve and executing in a disciplined way.
Great. I appreciate it. I think we'll kind of wrap it up there. Again, appreciate the time today. It's always good to learn more about the work you guys are doing, 'cause it's pretty interesting. So, thank you, Jack, participating in the conference.
Thank you, Tom, for having me, and thank you everybody for your interest. Have a great day.