PHINIA Inc. (NYSE:PHIN) Q4 2023 Earnings Call Transcript

PHINIA Inc. (NYSE:PHIN) Q4 2023 Earnings Call Transcript February 21, 2024

PHINIA Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Good morning. My name is Brianna and I will be your conference operator today. At this time, I'd like to welcome everyone to the PHINIA Q4 2023 Earnings Conference Call. Please note that today's call is being recorded. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there will be a question-and-answer session. [Operator Instructions] I will now turn the call over to Michael Heifler, PHINIA Investor Relations. You may begin your conference.

Michael Heifler: Thank you, Brianna, 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 will be referencing in our remarks. We are also broadcasting this call via webcast. Joining us today are Brady Ericson, CEO; Chris Gropp, CFO. Today, we will discuss our Q4 and full-year 2023 results and forecasts for 2024. Please keep in mind when we make year-over-year or second-half 2023 to first-half 2023 comparisons, we are comparing our standalone results, including actual or expected corporate costs to pro forma results with corporate allocations when we were part of BorgWarner. During this call, we will be making 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. And with that, it's my pleasure to turn the call over to Brady.

Brady Ericson: Thanks, Mike. Thank you all for joining this morning. I'd like to thank our more than 13,000 employees who remain focused on delivering quality products to our customers and making our first six months as an independent public company successful. I'd also like to thank our customers who've been highly supportive and have been awarding us new business at a record pace. I'll get into some of those numbers shortly and then hand it over to Chris for more details. But first, let me provide an update on our journey so far. As I mentioned in our last call, I continue to spend considerable time with our customers, employees, and investors. The feedback has been overwhelmingly supportive and positive about PHINIA's focus on its core business and strategy for the future.

A vessel being refueled at a port from a fuel logistics tanker.

Customers appreciate our commitment to combustion products and that we will be a reliable partner for them for decades to come. They are aligned with our efforts to develop robust practical solutions for today and the carbon-neutral and carbon-free solutions of tomorrow. Our employees are excited that the profits and resources are being reinvested in our product lines and operations to further strengthen and grow our business. Finally, our investors are supportive of our strategy, commitment to being financially disciplined and our focus on total shareholder returns. Continuing to deliver solid financial performance and executing on our strategies will be key to building shareholder confidence. Along these lines, we are separately announcing today that our compensation committee has approved the company's 2024 incentive compensation program that we believe will best align our leadership team with shareholders' interest.

As I've been sharing since our Investor Day last year, we are managing the business with a laser focus on generating economic value, or EV, and free cash flow. The 2024 annual cash incentive will be based on the company's achievement of two equally weighted performance metrics; EV and free cash flow. This program sends a clear message throughout our organization that investment decisions are made through the lens of earning an adequate return on capital. Our 2024 long-term equity incentive will be solely based on the company's relative total shareholder returns compared to that of a peer group company. We have filed a separate 8-K this morning with more details. Now let's go ahead and jump to the fourth quarter highlights on Slide 4. I'm pleased to share that we ended 2023 on a strong note.

Chris and I challenged a team to find incremental efficiencies and with their efforts, along with lower than expected impact from the strikes of North America and less of a currency headwind than expected, we came in at the top end of our revenue range and above our revised guidance range for an adjusted EBITDA and adjusted EBITDA margin perspective. Chris will provide more specifics later. Providing great products and service for our customers have allowed -- has allowed us to continue to win new business across all product lines and in all regions in support of our strategies. A few examples from Q4 on Slide 5. PHINIA secured new conquest business to supply a GDI fuel system to a leading OEM, specializing in hybrid and low-emission powertrain technology in the light vehicle segment.

PHINIA won a contract extension to supply heavy-duty diesel fuel systems to a leading global OEM, securing revenue in our core commercial vehicle segment. And PHINIA achieved an important business win to supply medium-duty diesel systems to a leading global OEM, retaining and expanding our incumbent revenue. Now let's move to Slide 6. We accomplished a lot in 2023 from the successful spin, the strong operational performance. One area I want to highlight is our performance on securing our long-term future. In 2023, we had robust quote activity and strong win rates. When we were the incumbent, we won over 90% of the time. When trying to win conquest business, we won over 60% of the time. In total, approximately 40% of our business wins in 2023 were conquest.

Our objective to increase market share to offset market headwinds is working well and I'm very pleased with our results. With these gains in our significant exposure to commercial vehicle, industrial and aftermarket businesses, we see continued organic growth through this decade and beyond. Finally, since becoming independent, we returned $47 million to our shareholders via dividends and share repurchases. Now, looking to 2024, we see the momentum continuing. Regarding the transition from our former parent, we now believe we are several months ahead of our original timeline and we expect that we will be exiting all material transitional service agreements, or TSAs by the end of summer. We're also planning to exit all contract manufacturing agreements or CMAs with our former parent by the end of Q2 in a stepped and managed fashion.

We will also be launching several key new technologies that will help our customers improve efficiency and reduce the CO2 output of their engines. We've also made progress on our corporate costs and are now confident that we will achieve our original target of $80 million per year or $20 million per quarter, as we are nearly fully staffed and most of the service and support contracts have been finalized. Our constant drive for efficiency and improvement across all areas of our business, operations, supply chain, engineering, corporate and even opportunistically refinancing our debt on more favorable terms is what will allow us to continue to return capital to our shareholders and drive long-term shareholder value. As you can see on Slide 7 and 8, our focus remains on growing our CV, industrial and aftermarket business, while optimizing our light vehicle OE business.

We remain aligned and confident in achieving our 2030 revenue target of $5 billion, with greater than 70% of our revenues coming from CV, Industrial and OES independent aftermarket channels. On Slide 9, we will execute on our strategies in a very disciplined manner in order to maximize shareholder returns by utilizing our ROIC-based investment analysis. In other words, efficient and profitable growth, not just growth. Capital return to our shareholders will continue to be a key part of our plan to maximize shareholder value. And finally, maintaining our strong balance sheet and liquidity ensures we will be a consistent and reliable company for all of our stakeholders. This leads us to my last Slide on Page 10. Given our strategies and execution thus far, we remain confident we will be able to deliver an average organic growth rate through the decade in the 2% to 4% range.

We plan to do this in a disciplined way by maintaining strong margins and cash flow, all while maintaining appropriate leverage. We believe our business is resilient, with about a third of our revenue coming from the OES and independent aftermarket channel, which generally performs well even in poor economic conditions. Our commercial and industrial business, making up nearly a quarter of our sales, provides a stable growing opportunity. And in the light vehicle segment, we see our increasing market share and higher market penetration rates of GDI, especially in hybrids, supporting our position that our light vehicle business has staying power. With that, I'd like to pass it over to Chris to dive deeper into Q4 and full-year 2023 results and our 2024 guide.

Chris Gropp: Thanks, Brady, and good morning, everyone. I also want to thank our team for their extraordinary efforts this year and their hard work in closing out 2023 on a positive note. As we discuss our results and outlook, please keep in mind, there continue to be TSAs and CMAs with our former parent which we are rapidly phasing out. Also, we continue to work with them on balance sheet items related to the spin and expect it will take the next few quarters for operational payables and receivables to and from them to close out. In Q4 2023, we generated $858 million in adjusted total sales, up slightly versus a year ago. Our adjusted earnings per share were $0.71. We earned $89 million in adjusted operating income and $127 million of adjusted EBITDA, resulting in an adjusted operating margin of 10.4% and an adjusted EBITDA margin of 14.8%, a year-over-year decrease of 80 basis points and 20 basis points, respectively.

These results were meaningfully better than what we expected going into the quarter for the following reasons. The impact from the North American strikes only reduced our revenue by $5 million in the quarter, which was less than we had anticipated. We had strong commercial recoveries and cost controls and a somewhat lower headwind from currencies as the dollar softened in the quarter. Let me now bridge our revenue which you can find on Page 12 of the deck we made available on our website. Our sales performance in the quarter was affected by continued softness in our CV business in China. Volume mix was a headwind of $20 million, mostly due to lower CV sales in China as I just mentioned. We saw favorable sales from positive customer pricing, an inflation pass-through of $12 million and FX was a $15 million tailwind in the quarter.

As we move to Slide 13, the teams managed their business well as volume mix impact was only $3 million, or approximately a 15% downside conversion. We also had additional supplier savings to help improve our results, offset by $19 million of inflationary costs from suppliers. As a reminder from the prior page on the sales bridge, we recovered $12 million of inflation from our customers for recovery of just under 70% in the quarter, all in a good Q4 result. Slides 14 and 15 summarize the full year. Volume and mix upside conversion was light due to mix. We recovered over 70% of supplier inflationary costs from our customers and drove additional efficiencies from our supply base. From a core business performance standpoint, our segments reported overall solid margins.

Q4 segment adjusted operating margins were healthy at 12.6%, exceeding our first nine months performance by 90 basis points as our aftermarket segment rebounded from depressed margins in Q3 on the back of strong cost controls, strengthen sales in Europe and price. Looking at our performance on a segment level, Q4 fuel systems margins, while strong at 10.3% contracted somewhat on a year-over-year basis due to lower CV sales in China and partially due to supplier inflationary cost recoveries from our customers. On the supplier front, as we have mentioned, we are making strong progress and will see some benefit in 2024 from resourcing and/or settlements. Our aftermarket business adjusted operating margin recovered from a weak Q3, coming in at 16.3%, still down 40 basis points from the same period a year ago as non-commodity inflationary costs were not recovered by prior pricing actions and we experienced weaker mix.

Corporate costs were well controlled, coming in at $19 million. We continue to expect approximately $20 million in quarterly corporate costs going forward. Q4 cash from operations was $62 million. During the quarter, we generated adjusted free cash flow of $55 million. I'm particularly proud of the team for focusing on inventory efficiency. We reduced overall inventory by $42 million from the end of Q3. We continue to see an opportunity to further improve our working capital going forward as we institutionalize inventory optimization programs, exit the CMAs, and complete production realignments. Next, turning to liquidity. We are committed to a strong financial foundation and have ample liquidity to run our business and execute our strategy.

We ended the year with $365 million in cash and $425 million of committed revolver availability, giving us total liquidity of more than $790 million and net leverage of less than 1 times EBITDA. Now, let's look at 2024. I'll share our guidance, assumptions, and insights into our expected performance starting on Slide 16. From a market perspective on the OE side, industrywide CV volumes in 2024 are expected to decline by mid to high single digits in North America and Europe, while other global CV markets are expected to be flat to up slightly. Global LV volumes are expected to be down low single digits with engine production declining mid-single digits. Our good performance in 2023 has set the stage for the coming year and beyond. We expect strong earnings and cash generation in 2024 as we continue to drive operational efficiencies, exit agreements with our former parent and grow our aftermarket sales.

Now let's move to Slide 17. For 2024, we expect adjusted sales of $3.4 billion to $3.55 billion, down 1% to up 3% in a difficult market environment. Market headwinds are being offset by our resilient and growing aftermarket and market share gains on the OE side. We expect adjusted EBITDA of $470 million to $510 million and adjusted EBITDA margins of 13.8% to 14.4%. For year-over-year comparisons, we would assume corporate costs of $80 million for 2023 rather than the $64 million related to carve-out accounting. This gives us a 2023 starting point of $3.45 billion in revenue, $474 million in EBITDA, and a 13.7% EBITDA margin. In 2024, we expect aftermarket growth, inflationary cost pressure reduction and resolution of troubled supplier issues to offset lower CV volumes in North America and Europe.

PHINIA expects to generate $160 million to $200 million in adjusted free cash flow. Our adjusted tax rate is expected to be between 28% to 32% as we continue to work on reducing this to at or below 20% over the next couple of years. In closing, I want to reiterate Brady's message regarding our focus on financial discipline and generating strong shareholder returns. And with that, we'll now move to the Q&A portion of our call.

Brady Ericson: Brianna, can you queue up our questions, please?

Operator: [Operator Instructions] Your first question comes from Jake Scholl with BNP Paribas. Your line is open.

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