Q3 2019 Earnings Call
Ladies and gentlemen, thank you for standing by and welcome to the Q3 2019 Cummins earnings Conference call. At this time, all participants are in listen only mode.
Speaking presentation, there will be a question and answer session technical question. During his section you will need to press star one on your telephone. Please be advised that today's conference is being recorded.
If you require any further assistance. Please press star zero I would now with <unk> friendship over to your Speaker Mr., James Hopkins Executive Director of Investor Relations Mr. Hopkins you may now be Ken.
Thank you good morning, everyone and welcome to our teleconference today to discuss Cummins results for the third quarter of 29 team.
Participating with me today, our chairman and Chief Executive Officer, Tom Weinberger, Our Chief Financial Officer, Mark Smith.
President and Chief operating Officer, Tony Shatters weight, and retiring Chief operating officer return.
We will all be available for your questions at the end of the teleconference.
Before we start please note that some of the information that you will hear or be given today will consist of forward looking statements within the meaning of the Securities Exchange Act was 934.
Such statements express our forecasts expectations hopes beliefs intentions on strategies regarding the future.
Our actual future results could differ materially from those projected in such forward looking statements because of a number of risks and uncertainties.
More information regarding such risks and uncertainties is available in the forward looking disclosure statement in the slide deck and our filings with the Securities and Exchange Commission, particularly the risk factor section of our most recently filed annual report Form 10-K , and subsequently filed quarterly reports on Form 10-Q .
During the course of this call, we'll be discussing certain non-GAAP financial measures and we refer you to our website for the reconciliation of those measures to GAAP financial measures.
Our press release with a copy of the financial statements and a copy of today's webcast presentation are available on our website at www Dot Cummins dot com under the heading of investors in media.
<unk> out if the way, we will begin with our chairman and CEO Tom Weinberger. Thank.
Thanks, James Good morning, I, just want to start one correction of James remarks, retiring Chief operating officer, which we then had said he will not be available for questions. After the call and lesser about how cute as grandchildren, our or about golf [laughter] I'll start with a summary about about third quarter results and finish with a discussion of our outlook for 2019 mall.
I will then take you through more details of both our third quarter financial performance.
<unk> forecast for the full year.
Revenues for the third quarter of 2019 were $5.8 billion, a decrease of 3% compared to the third quarter 2018.
EBITDA was $958 million or 16%, 0.6% compared to $983 million or 60.5% a year ago.
Positive pricing lower variable compensation material cost reduction activities and lower warranty expense, partially offset the impact of lower volumes and increased investments in research and engineering.
Engine business revenues declined 11% in the third quarter compared to a year ago.
Revenues in North America decreased by 6% as we began to see the impact of Oems preparing for lower production of heavy duty trucks in North America as well as declines in shipments to construction markets.
International revenues declined by 25%, primarily it was as a result of lower demand in China light duty truck and construction markets.
EBITDA margin for the quarter was 14.1 per cent compared to 14.9% for the same period in 2018 and included a 33 million dollar charge related to ending production of our five leader I ask the engine for the U.S. picked up market.
<unk> pricing and lower material costs, partially offset the impact of lower volumes reduced joint venture income and the $33 million charge.
Sales for our distribution segment grew by 4% year over year, driven by higher demand for power generation equipment in North America.
Third quarter, EBITDA was a record $186 million or 9.3% of sales compared to 8% in the third quarter of 2018.
EBITDA margins benefited from higher volumes positive pricing and lower variable compensation costs.
Third quarter revenues for the component segment declined by 6%.
Sales in North America increased 2% driven by higher demand the U.S. picked up market well revenues in international markets declined by 18% as a result of lower truck demand in Europe , India and China.
EBITDA for the third quarter was $286 million or 17.3% compared to 16.4% and the same for a year ago.
The increase in EBITDA percent was primarily due to lower warranty costs and the benefit of material cost reduction programs, which offset increased investment in the development of new products to meet advancing emission standards in China, and India as well as a lower impact excuse me the impact of lower volumes.
Our system sales in third quarter increased by 2%.
Demand in industrial markets increased 3% with a lower sales to oil and gas markets offset by say increased sales to marine rail and mining customers.
Our generation sales increased 8% in North America, driven by continued strength in data center markets offset by a 4% decline international markets, mainly in Europe in the Middle East.
Well sales increased compared to a weak third quarter last year sales declined 6% sequentially lower demand in power generation oil and gas and mining markets.
EBITDA in the third quarter was 14% compared to 14.7% a year ago.
The decrease in EBITDA percent was largely due to the impact of higher material costs, including tariffs and lower sales of industrial engines.
And the electrified power business EBITDA was a loss of $36 million in the third quarter and inline with our expectations. We completed the acquisition of Hydrogenics, a leading producer of fuel cells in electrolyzers for the production of hydrogen on September nine.
Our third quarter results included a $2 million EBITDA loss related to Hydrogenics.
Now I will comment on the performance in some of our key markets for the third quarter 2019, starting with North America, and then I'll cover some of our largest international markets.
Our third quarter revenues in North America were flat at $3.6 billion increased sales of power generation equipment, especially the data center customers were offset by lower shipments of heavy duty truck and construction engines.
Industry production of heavy duty trucks increased 3% in the third quarter 2019, compared to a year ago and decreased 4% compared to the second quarter of this year with low truck orders declining industry backlog and historically high levels of new truck inventory driving lower industry production.
Well industry truck production increase compared to last year, our shipments declined decline as OEM prepare Oems prepare to ramp down production in Q4 or market share through September was 32%.
Production of medium duty trucks increased 4% in the third quarter, a growing U.S. economy, coupled with high levels of consumer spending low unemployment and low interest rates continues to drive demand for medium duty trucks or market share in the medium duty truck market was 78% through September compared to 81% a year ago.
Total shipments to our North American pickup truck customers increased for the third consecutive quarter quarter to over 41000 units supported by strong demand for the Ram 20, 530, 500 pickup trucks.
Engine demand for construction equipment in North America decreased 30% in the third quarter.
Well nonresidential construction spending remains high we are seeing industry participants take steps to reduce their equipment inventory, which currently stands at historically high levels.
Revenues for power generation grew by 8% due to higher demand in data center markets, partially offset by lower sales to recreational vehicle Oems.
Demand for <unk> engines, and oil and gas markets declined by 86% due to continued low purchases of new fracking equipment.
Our international revenues decreased by 8% in third quarter of 2019 compared to a year ago.
Quarter revenues in China, including joint ventures were $1.2 billion, a decrease of 2% over the prior year.
Lower demand and construction and light commercial vehicle markets was partially offset by increased demand in medium and heavy duty truck markets.
Industry demand for medium and heavy duty trucks in China increased 1% compared to a year ago and it was positively impacted by it impacted by a prebuy of natural gas engines ahead of the move to Ns six standards.
We estimate the impact of this prebuy to be approximately 27000 units this quarter, increasing market size by 10%.
This increase in addition to the 20000 unit Prebuy that occurred in the second quarter.
Our market share improved to 16.1% this quarter from 15.6% a year ago as we increased our shared photon and saw a shift towards over the road trucks versus construction related dump trucks.
Industry sales of light duty trucks declined by 3% in the third quarter and 15% sequentially.
Our engine market share was 7.4% 0.2 percentage points higher than a year ago.
We continue to be impacted by increased enforcement of loading regulations were truck models that has historically been registered as light duty trucks are now to be classified as medium duty trucks, which limited access to urban areas and requires additional licensing for drivers.
Oh, yes did begin to launch new light duty vehicles in third quarter, resulting in higher industry production than we had originally forecasted.
Third quarter demand for excavators in China increased 16% from year ago, our market, you're also increased from 15% to 15.4% driven by the strong performance of our local partners.
Well industry sales in our market share increase compared to a year ago, our sales for the quarter, including joint ventures declined 29% due to Oems and dealers, reducing inventory built primarily in the second half of last year.
Demand for power generation equipment was flat in the third quarter lower demand for standby power, partially offset by growth in demand for data center markets.
Third quarter revenues in India, including joint ventures, with EUR $344 million, a reduction of 29% <unk> third quarter, a year ago lower demand in all of our major end markets.
Industry truck sales decreased 52% year over year end, even larger decline than we'd expected driven by continued lack of credit availability.
Credit availability also started impact other markets during the third quarter with construction revenues down 75% as companies struggle to finance construction projects, placing pressure on equipment purchases.
Now let me provide our overall outlook for 2019, and then comment on individual regions in end markets.
We now expect company revenues to be down 2% for the year compared with our prior guidance of flat.
We are low lowering our forecast for industry production of heavy duty trucks in North America slight.
Well.
Okay, hopefully we're off mute now okay more concerning the industry backlog declined 31% or 61000 you.
Uh huh.
Do 103000 units from its peak of over 300000 units a year ago.
Inventory remains elevated 81000 units and third quarter orders of 34000 units were the lowest since 2009.
Industry production decreased monthly as we.
Third quarter, we expect monthly declines to continue through the end of the year.
We expect our market share for the year to be at the low end of our forecast range of 32% to 34%.
Market share is being negatively impacted by lower shipments to Oems ahead of truck production cuts.
Demand in our parts and Remanufacturing business remained stable in the third quarter as we continue to see the impact of increased capacity of fleets and lower freight demand, resulting in lower utilization is available equipment in the industry.
We continue expect parts demand to be relatively weak through the end of this year as dealers reduce parts inventory in anticipation of lower market activity.
In the medium duty truck market, we're lowering our forecast for industry production to 130000 units or up 5%.
Compared to our prior guidance of 140000 units or up 6% year over year.
While retail sales of medium duty trucks remained strong.
Up 13% year to date industry truck production has now been above water intake for seven months lowering the industry backlog to levels that will result in lower build rates.
We continue to expect our market share to be in the range of 74% to 76% unchanged from our prior guidance.
We expect our engine shipments for pickup trucks in North America to be flat for 2019 compared to a very strong 2018 and unchanged from our expectation three months ago.
Shipments of construction engines are now expected to decline, 5% compared to our prior expectations of 10% growth as Oems and dealers reduce inventories from historically high levels.
In China, we now expect domestic revenues, including joint ventures to be down, 1% in 2019 and improvement compared to our prior guidance of down 2%.
We are increasing our outlook for medium and heavy duty truck market demand to 1.23 million units were down 7% compared to our prior guidance of downtime due to the additional pre buy of natural gas trucks that occurred in the third quarter.
In the light duty truck market, we now expect to 7% reduction in demand compared to our prior guidance of down 12%. This improvement is driven by Oems launching new truck models in light of the more stringent enforcement of overloading regulations that began in the second quarter.
We expect our market share in the medium and heavy duty truck market to be in the range of 13% to 14% and light duty, we expect our market share to be 8% to 9% both inline with our prior guidance.
We now expect industry sales its excavators in China to increased 8% from the record levels achieved in 2018 compared to our prior guidance a flat.
Industry sales are expected to increase this year, we are expecting lower levels of industry production. The second half of 2019 compared to 2018 as the industry prepares for lower demand in the spring 2020 selling season.
In India, we now expect total revenue, including joint ventures to be down 20%.
Compared to our prior guidance of down 5%.
Anticipated.
We anticipate industry demand for trucks to be 30% lower than the record levels experienced in 2018 compared to our prior guidance of down 17%.
We now expect construction demand declined 40% compared to our prior outlook of 5% to 10% growth.
The lack of financing for construction projects lowering demand for new equipment.
Demand for power Gen <unk>, Joe our generation equipment is now expected to be flat compared to fiber to the 10% growth.
In Brazil, we're now projecting truck production to be flat into <unk>.
Down from our forecast of 2% growth three months ago, while domestic demand in Brazil continues to increase from levels experienced in twin.
Truck production in Brazil for export markets. This decline is expected declined 50 per cent compared to 2018.
Primarily due to weak demand for trucks in Argentina.
We continue to project total revenues for Brazil could be down 10% this year.
We now expect our global high horsepower engine shipments to be down 10% this year compared with our prior guidance of down 5%.
Demand for new oil and gas engines is now expected to decline, 50% compared with our prior guidance of just down 40%.
We now anticipate sales in North America will decline by 85% compared to our 75% expectation three months ago with lower demand for new equipment in the Permian basin as well as reduced demand for engine rebuilds.
The deterioration in our in our outlook for North America is partially offset by growing sales in <unk>.
Would you have represented 61% of oil and gas engine sales to date demand for mining engines has moderated.
Three months as commodity.
And capital budgets have been cut we now expect mining.
We now expect Muddying engine sales.
Sorry, the mute on our phone keeps.
That's why we're we're seeing you're hearing us stuttering here, we now expect mining engines.
Hey, down 7% lower than our prior guidance of down 5%.
Demand for power generation equipment increased 2% compared to the low levels experienced in the third quarter of last year and declined 3% sequentially.
But patients primarily due to lower demand in India.
We expect full year revenues to be down 2%.
We now expect a full year revenues to be down 2% compared to our.
Merrily due to lower demand, India for the full year growth in data centers.
And.
So it's being offset by lower sales of general.
Lower demand and backup power applications in China, and India, and a drop in large part in power applications in Europe .
In summary, we're now expecting revenues to be down 2%.
For the year lower than our prior guidance or flat.
This revenue decline is driven by lower demand and domestic international truck markets weakness in India in end markets and lower demand in several off highway markets.
Lower sales reduced joint venture income in India, and the acquisition of Hydrogenics impact our EBITDA for the year, which we now project at 15.9% to 16.3% sales down from our prior guidance of 16.25% to 16.75% of sales.
Strong execution across all of our businesses resulted in record revenues being translated into record EBITDA and operating cash flow in the first nine months of this year are strong and consistent cash flow generation continues to support our plans to return cash to shareholders and we returned $910 million its cash from third.
Uh-huh buying back 2.9% of outstanding shares.
Well.
While we were pleased with our operating performance in third quarter, we've been working to prepare the company for what lies ahead in the fourth quarter and in 2000.
As we have discussed before several of our end markets have been above replacement level for some time and we're now expecting cyclical reduced demand.
Our third quarter revenues declined 7% sequentially and our guidance projects that they would decline another 8% in the fourth quarter.
Steve This deep level of decline resulted in a number of actions to align costs with production levels, including the recently announced voluntary retirement package, United stage, which we.
Reduced head count by 400 to 450 people.
We are in the process of making additional structural changes in several areas the business and we'll continue to drive actions to improve costs.
As always we will capitalize on the downturn period to improve our company emerge as a stronger and more profitable comments, we will also maintain our investments and the key to.
And product development programs that one sure leadership and sustainable growth in the future.
During the third quarter, we announced new wins.
Powertrain and launch an updated IODEX 15 engine for the North American heavy duty truck market. These actions demonstrate our commitment to lead both in alternative powertrain technologies and continue to lead in traditional powertrain power trains we closed on our acquisition of Hydrogenics one of the world premiere fuel.
Selling hydrogen production technology providers in September .
Expertise and innovative approach will strengthen.
Fuel cell Kate.
This is another step forward as we continue to invest in a broad range of clean fuel efficient and high performing products and technologies that will deliver value to customers.
Made investment in.
Who design and manufacture fuel cell rainiest range extenders and announced a partnership with young guy to jointly evaluate opportunities to develop and commercialize electric and fuel cell power trains.
While we increased investments alternative power trains, we continue to enhance our diesel and natural gas products delivering more fuel efficiency power and lower emissions.
At the North <unk>.
Vehicle show in Atlanta, We are currently showing our new IODEX 15 efficiency series the.
With an enduring transmission will provide up to 5% improvement in fuel efficiency friend you.
The meeting 2021 greenhouse gas standards one your early now let me turn it over to Mark.
Thank you Tom and good morning, everyone I'll start with a quick summary of our financial performance in the.
On our.
Oh.
For the full year.
Third quarter revenues were $5.8 billion, a decrease of 3% from either.
Sales in North America with flat.
International <unk>.
8%.
Currency movements negatively impacted revenues by 1%.
Earnings before interest taxes, depreciation and amortization were $958 million or 16.6.
For the quarter.
Compared to $993 million or 16 point.
[noise] consent of sales a year ago Paul.
Some issues with the phone here.
EBITDA decreased by $25 million.
Driven by the negative impact of Lewis.
Reduced joint venture income and highest.
[noise], partially offset by mid two.
Material cost reduction activities, lower warranty and decreased variable compensation expenses.
Gross margin of $1.5 billion, or 25.9% decreased by $57 million or 20 basis points.
[noise] benefits from favorable pricing actions material cost reductions.
Little warranty and variable compensation expenses mitigated the negative impact lower volumes.
Charges included to cease production of certain unprofitable product lines.
Hi, Thanks.
Our selling administrative and research cost of 842 million, but was increased by 9 million year over year, driven primarily by new product development in the engine components and electrified kind of west segments, partially offset by lower than that.
Variable compensation expense.
Joint venture income.
Joint venture income declined by $22 million due to weaker demand for light duty trucks in China, and lower truck production in India.
Other income of $61 million increased by $54 million driven primarily.
By $35 million of gains related to closing out certain derivative contracts associated with the company's foreign exchange hedging program.
Net earnings for this quarter was $622 million or.
$3 97.
The dialogue.
Hi, just 600 <unk>.
[noise] hopeful.
Third quarter results with positive.
Positively impacted by $23 million or 14 cents per diluted share in discrete tax items.
After tax gains of $28 million.
Yes.
From closing out the funding.
Hedging contracts I just referred to.
During the.
We can could after tax expenses of $35 million, all 23 cents related to.
Actions taken to cease development.
[laughter].
During the quarter, we included after tax expenses.
35 minutes.
Yes, I think would just having some significant problems with the phone we're going to we're going to.
We're going to reconnect by another phone I apologize for that we will resume.
But make appropriate time available for Q when they just bear with US Please apologies.
Okay. This is mark Smith, and they'll come to new and thank you for your patience.
[laughter] Delta.
Net Oh, we still have told US Parago net earnings for the quarter was $622 million all three dollarsninety seven per diluted share compared to $692 million a full build is 28 from the Utica.
Third quarter results were positively impacted.
By $23 million or 14 cents per diluted share in discrete tax items and the after tax gains of $28 million or 18 cents from closing out the foreign exchange hedging contracts I've just alluded to earlier.
During the quarter. We also include after tax expenses of $35 million or.
23 cents per share related to actions taken to cease development and production certain products. These actions will benefit future financial performance.
The effective tax rate in the quarter was 18.4%.
Excluding discrete tax items, the tax rate was 21.5% in the third quarter and inline with our full year focused.
Operating cash flow in the quarters was a record inflows of $1.1 billion.
That's $208 million higher than last year on year to date, we've generated record $2.3 billion of cash from operating activities <unk> $955 million from the same period last year, the driven by higher earnings on a much slower pace of working capital expenditure.
I will now come into our revised guidance for 29 team.
For the engine segment, we expect full year revenues to be down between five and 6%.
Compared to previous guidance the flat at the midpoint.
The reduction in sales is driven by declines in heavy duty engine shipments in North America with the demand for construction equipment in North America, India, and a lower out looks a medium duty truck engines in North America you visit.
We revised our forecasted EBITDA margins for the engine business to be in the range of 14.3% to 14.8% down from our prior guidance 15 to 15 in homes and driven primarily by the impact of lower volumes, we could joint venture incomes and the costs incurred in the thought third quarter. So.
Yes, you did with any and begun production of one engine platform.
The distribution segment, we now expect revenues to be 2% to 3% compared to a previous guidance of 1% to 5%.
Due to lower sales of construction engines in North America nowhere engine rebuild volumes.
With oil and gas and mining customers.
We are raising our outlook for EBITDA margins by 35 basis points to be in the range of 8.4% to 8.8% has come to you.
Solid operating performance lower variable compensation expense more than offset the slightly lower.
Sales.
The 29 team, we now expect components revenues to be down between four and 5% compared to prior projection of flat at the midpoint and this decline is being driven by reduced demand in North America, India, you <unk> and Brazil.
As a result, the Louis sales outlook, we've revised our focus for EBIT margins to be in the range of 15.6% to 16.1% down from our prior guidance 15 in three quarters to 16 during the quarter person.
Power systems revenues are forecast to be down 3% to 4%.
Lower than our previous guidance a flat at the midpoint Julie to lower demand for power generation equipment in international markets and we could demand for the engine rebuilds and new engine shipments in mining and oil and gas markets.
It also revising our focus for EBITDA margins to be in the range of 12 in the home to 15% down from our prior forecast that's even in a quarter to 14%.
And the electrified power segment, we now expect net expense of $145 million at the high end developed previous guidance range due to the completion of the acquisition of Hydrogenics.
The net impact of the changes to individual segment projections that we now forecast total company revenues to be down 2% company EBITDA margins to be between 15.9 and 16.3%.
This compares to a prior guidance a flat sales and EBITDA in the range of 16 in a quarter to 16 in three quarters consent.
Full year operating cash flow is projected to be a record $3 billion due to strong full year earnings and lower working capital.
Capital expenditures for the third quarter $153 million, but now you have today total investment to $395 million, we expect our full year capital investments will be in the range of 650 $700 million unchanged from our prior guidance.
In the third quarter returned to a record $910 million to shareholders.
We repurchased 4.6 million shares for a total of $706 million and for the first nine months, we've returned $1.4 billion through dividends and share.
Purchase activity still plan to returned 75% of operating cash flow to shareholders. This you while maintaining a strong balance sheet summarize we delivered a solid set of results in the third quarter, including record quarterly operating cash flow.
In response to a slowing the global economy driving weaker demand in a number of I would end markets. We have taken a number of actions to reduce cost and address some underperforming parts of our business consistent with prior downturns, we will continue to and identify additional opportunities to drive efficiency and cost reduction whilst maintaining investor.
In the products and services that will deliver a stronger future.
Finally, I want to remind everyone of our upcoming analyst day on over the November the 21st at the New York Stock Exchange I look forward to seeing you all the webcast of our presentation will also be available on our Investor Relations section of our website. Thank you for your interest today and your patience with the difficult phone call now, let me turn it back over to Tom.
Before we move to keep winning Marcus with all the challenges we haven't fuel cells and electrification I did not expect can be supported by a phone there you have it.
Just to conclude our prepared remarks as you remember we announced on April 29.
And then discussed in our first and second quarter, earning calls that we initiated an internal review of our mission certification and compliance processes for pickup truck applications. As a result of conversations with the EPA and the California Air Resources Board.
A review continues and we are proactively working with the VPN carb as well as with the Department of Justice and that's you see to address their questions and information requests.
During conversations with regulators they raise concerns that certain aspects of our mission system on the model year 2019, Ma'am engine may reduce the effectiveness of our mission control systems, and thereby actors defeat devices.
Based on these discussions we've developed a new calibration for the engines in model year 2019, Ram 2500, 3500 trucks that has been included on all engines shipped since September .
During our discussion the agencies have asked us to look at other model years and other engines. The primary focus of our view has been the model year 2019 Ram.
Consistent with the values in the history of our company, which include a strong commitment to compliance we will work with regulators and other agencies to address the issues identified in our internal review and develop future technologies that will advance our industry.
We are making already making changes to our processing organization structure. It as a result of our review however, it's too soon to know what the response of our regulators are agencies will be to our review or to determine any potential financial consequences.
Now, let me turn it back to James for Q and a great. Thank you Tom I'm out of consideration to everybody on the call to ask you limit yourself to one question unrelated follow ups and if you have any additional questions. Please rejoin the queue.
With that operator, we're ready for questions.
Okay sounds great as a reminder, ladies and gentlemen, Please press Star then one on your telephone to ask a question.
My first question comes from Joe O'dea with vertical research.
Hi, good morning.
So.
Tom I'm, just curious about what your assessment as of Whats currently underway in terms of what we're seeing on slowing demand I think other pockets of these end markets that you've been talking about things slowing for at least a couple of quarters, now, but whether or not you're seeing this more as we're coming off of a level of very strong demand or whether there's something else.
At play in terms of kind of how you're thinking about things slowing down here.
Yeah, well I want to I want Tony to talk more specifically about what's happening in the truck market needs.
Hi, good chance for him to.
He's been very close to it is good transferred to talk about that I would just say that broadly speaking.
We've seen a number of our markets been I've been at cyclical peaks.
The last couple of years, which has been terrific for the company. We've generated strong earnings and cash flows as a result, but indeed some of those markets are beginning to turn down and we've been seeing signs of that typical signs that we are rig used to reading things like slowing orders inventory build et cetera, and now what we're seeing as those things.
Starting to come to fruition, maybe what's surprising to me is it's broader than I thought like we are seeing challenges in India challenges in China challenges in.
Even in Europe is slowing we saw in North America coming that was all part of what we expected, but some of the challenges in some of the other markets. How quickly we've seen in the large engine markets sort of peak out and begin to turn the other way has been a little surprising. So maybe that's what's what's new not that not the necessary that things would turn down.
Just how broadly and how quickly they have and Tony once you just talked about what you're seeing in North America.
Just a thanks. Thanks, Tom jobs, just had we are definitely seeing freight growth has slowed we have seen orders slow and production is got to come down to me to to match the backlog and meet those orders and so we are seeing things well I agree with Tom the surprise has been how how quickly things have gone bad internationally and.
That was probably not expected at the beginning of the year.
I do believe in North America. It is a cyclical downturn I don't quite know what you mean by anything else other than that but that's basically what we're saying construction has also slowed down in the U.S. as Tom mentioned in his remarks, which I think is another sign that perhaps it is a broader slow down than just freight and truck markets, but we'd.
Been seeing this comment all year and it's here.
I guess the other than that so that Joe's really in North America. The pickup truck market is the only one that's been holding out steady I'm strong through are you.
That's helpful. And then just a cost related question you maybe in the context of whats implied on for Q EBITDA margins. You can you give any sense of what the impact would be from related cost actions that you're taking right now so.
But what kind of margin lift you would anticipate if you've got the full benefit in the quarter or some of the cost actions underway.
I think you should think about the actions that we're taking was really setting 2020 . The biggest impact will be 2020 by the time, we fully executed those actions and again you will give a framework for 2020 .
That would analyst day, we're not gonna give specific guidance today, Joe but our guidance.
The results without the cost of those actions, we will call out the cost him the benefits at the appropriate point in time, what's really driving our margins from the third quarter to the full quarter, which I think its underlying your question number one it's the significant decline in revenues that's by far the biggest some single impact.
Number two whilst we haven't changed our full year outlook for warranty or put a coverage as a percentage of sales is a little bit lower than trend rate in Q3, the little bit higher than Q3 run rate in Q4 for the unchanged for the and then the third factor is really that you know our variable compensation plan is working as designed so is.
Our outlook is lower than our projected a payout for short term compensation has gone down I'm not trued up through the third quarter and will move back to more of a normal run rate in the in the fourth quarter I'm really those are the three main factors. So the key now is I'm really talking about the cost reduction.
Initiatives going forward and again, we'll provide a framework Tony let some comments.
Yeah I was just said we are you know we've been ready for this all year, we are committed to flexing our cost down with demand we're committed to managing the cycle.
We've been tight on discretionary spending in hiring all year, and we actually really started to take things out in the third quarter, we've been analyzing underperforming businesses and as Mark said, we decided to close one in the third quarter.
We launched a retired voluntary retirement program here in the U.S. and so these are all actions, we're taking the majority of which will bear fruit in 2020, but we are moving now to take our take out cost as demand drops.
I appreciate it thank you.
<unk>.
Thank you. Our next question comes from Jerry Revich with Goldman Sachs.
Yes, hi, good morning, everyone.
Hi, Jerry Ginger.
I'm wondering if you can talk about what level of restructuring is embedded in guidance Mark just a follow up on the last question. So in the past few folks have been able to put up 20% Decrementals as you've got production now embedded in guidance looks like your restructuring it sounds like price cost is positive so can you.
Just help us disagreed it a bit more and I. Appreciate there's a wide range of restructuring actions that could be taken but what level of core decremental margins are you folks expecting.
Well, we're going to we're going to give that core margin kinda framework Jerry in a couple of weeks when we when we would view in and and all you'll see is New York, So I'll defer that piece, but doesn't say the guidance.
Really does not anticipate <unk>, there will be costs some cost in the fourth quarter associated with further cost reduction activities Tony's talked about.
But most of those benefits, leaving the benefits of exiting production some of the products. We've exited here theyre going to flow into next year. So we would include costs now well actually even if we ignore the cost were going up year over year improvement for those but again, we'll come back and kind of bundling overall picture together for you going forward, but as Tony said, we're committed to money.
Virgin costs, and managing well through the down cycle and I guess, the Jerry just to your talk about decremental margins, because we will get into the framework, but as you expect.
The decremental margins in the fourth quarter or not where we want them to be and Thats and that just reflects the typical situation when the market starts falling quickly and we're still spending money on future investments it doesn't work out in quarter one.
And so that's one of the reasons Tony is really focused he and his staff on how to take actions right away. So that were as we go into 2020, we bring those decrementals around to what our goals are and you you know those well. So we will be as Mark said, we will be showing you. The targets we have for the core business why were.
Confident we can hit them and then what are some of the other things in and around that what are some of our new investments et cetera that that were that work that we're having to stretch to meet how's that all going to fit together, but needless to say Q4 is not representing what our goal for decremental margins is going to be in that that's just because the market falling fab.
Now and we're still doing the actions that were taken so it's sort of hard to read core decremental margins from the quarter, where all the revenues fall off.
Sure No I appreciate that and be in terms of the light duty diesel platform for you folks with exiting the five liter production here in new U.S. can you give us an update there you folks finding but there are opportunities to source similar products from elsewhere.
<unk> joint venture or otherwise because if you folks who had been looking for light duty diesel to be potential option value for for you folks over next couple of years. So can you just update us on the decision tree to discontinued production here in the U.S.
Yeah, I think it it's a from a strategic point of view, we still think light duty. The light duty diesel business is a good business for coming in as you said, we we are talking to a suzhou of about how to to cooperate fully across that market. It's a market that requires relatively high volume and scale to be successful until.
That's one of the reasons that we think the opportunities between come into the students who are significant I.
I think one of the things that we recognized with the Nissan related business. The ice V is we just didnt reach the scale, we needed to reach and that was a function of the customers and the and the segments that we were after the scale wasn't there, but the scale across the light duty segment for comments is our is significant as you know we have.
Very large scale across our 3.82, 0.84, and a half and six 6.7 liter engines, we have a global scale, which is unmatched in the industry that's of course, helping us.
Good good profits good returns off that engine and and we do expect by the way electrification and lower power segment go faster and that in the higher power segment, having said that we think the transition is going to be relatively slow and we think the opportunity to consolidate and earn returns over many many years.
To come in there for Cummins and and ideally there for to come into Susan partnership. So we are investing there.
And I'm trying to see you have what we can do to consolidate and the industry.
In the light duty segments, just sit with with that one of the ice. The we were after a certain segment in the U.S. It just didn't appear to to offer scale for the engine.
Okay. Thank you.
Patrick.
Thank you. Our next question comes from Andy Casey with Wells Fargo Securities.
Hi, good morning, and congratulations.
[laughter].
Just a couple of clarifications and then a question on China.
In the quarter.
You talked about 35 million charges for.
Cessation of development of product exit.
33 that shut up and engines.
It was the remaining two also when engines or once that somewhere else.
Components.
Okay. Thank you Mark and then.
Uh huh.
I'm China.
Come back off line for the other one on China.
You talked about the.
The lack of credit availability.
Do you see that changing in the <unk> you know in the near future in 2020.
The credit availability issues really in India, and just to kind of maybe provide a little more back on it the there.
And it market is supplied by non bank credit institutions, sometimes in the country. They call. It the shadow banking system, but it's it's these private credit institutions and they had a couple of bankruptcies in there.
In that in that segment and the market is largely closed end to the extent. It's opened up prices are very high. So that's what's going up on India. So we do expect it to find its way through as things do in India. We do expect that to mitigate we just don't think its mitigating really fast it's going to take some time goods the financial problem financial crisis Nada.
No not an economic one.
So it is this some significant issue in the country and there are other economic challenges in India. So it is we do expect that that things are definitely worse than we expected at this time and we we'd expect some of those things to to linger the opportunity for US remember, though is be a six is coming.
And we are.
Fully prepared for B S six our technology.
We believe is leading in the market. We think we have not only a technology, but well south of cost and scale leadership as well as a service network, which we think is better than competitors. So we do hope to see that that this b S. Six gives us an opportunity to increase share and increase profitability in India. We just think next couple of quarters are going to.
The rough that's just the way I'd summarize it.
Okay. So I'll leave it there thanks for the correction.
You bet you.
Thank you. Our next question comes from Jamie Cook with Credit Suisse.
Hi, good morning, and congratulation Rich I hope you have a fantastic retirement and thanks for all your out throughout the years.
I guess sort of <unk> first question I. Appreciate the color you guys gave uncertain what impacts the margins you know going from the third quarter it into fourth quarter, but I think everyone was also trying to get their arms around just the magnitude negative revenue step down in the fourth quarter. So I know you talked markets globally being weaker but how much of that is just demand versus you guys.
Also making adjustments relative to.
What your customers are doing sort of on that production cut size to rightsize inventory and then I guess my second question Tom as as you look to 2020 can you sort of talk about cost conversations you're having with customers are they sort of reevaluating where their investments are going and how that could potentially be an opportunity for commons and if so should we think it.
That is it 2020 opportunity. Thank you.
Great Jamie So let me, let Tony talked a little bit about what's happening in North America.
And I think it's applicable in some other markets to about inventory and forward toward corrections. So.
So Jamie Hi, Jamie This is Tony just you know we have a OEM supply chain, where we don't hold a lot of inventory for our OEM customers, we pretty much delivered to their schedule as they adjust their schedules they move their inventory around a bit or just their production flow and we think that's part of the challenge we're seeing in the market today.
Those adjustments are making it difficult to kind of pinned down exactly what our numbers are gonna be versus the market, but we are seeing a little bit of that I would say none of our OEM customers have significant engine inventory, but there is inventory of trucks in the field that we that we see peaked here at the end of September .
So that's just another signal I think that we're gonna see demand coming down.
There the last of the vast majority of the revenue dropped into the fourth quarter is from the North American truck side, though rather than all the other markets. They are down you know bets, but it's really North America. This down the most.
And we do expect market share our market share to be impacted Jamie to some degree in the fourth quarter as well I mean, it happens every downturn what happens is as a as the Oems basically built keep building to fill orders and the slowdown shipments of our engines and they they use up their engines more than our engines we see.
That market share move just as we see it move our way when things start to get busier and fall. These you know these quarter to quarter variations smoothed out pretty quickly and we still expect to be.
In our normal range, 32% to 34% or there are there about but in the short term. We expect we'll see some short term market share numbers, which are which are lower just because it's me. This is just what happens every time. So we expect it this time do I.
I think with regard to your question about conversations with Oems. There's no question that every OEM I talk to is wondering where they want to put their investments their decisions.
We are still in front of them for many of them.
But they are wondering because they have they're looking at autonomous vehicle investments, they're looking at of course, a whole new set of truck range is very competitive markets, they're looking at where they want to go internationally, what that takes in what joint ventures and partnerships. They want to do their thinking about telematics and other information technology investments there. Thanks.
Electrification fuel cells other Seo too late investments, especially for the European truck makers of Seo two rigs are really really tough. So they're just look staring down the barrel of a set of investments that look two or three times, there an average R&D spend and asking themselves what they want to do there they're mostly made.
In money.
Selling diesel engines today, so that it's the difficulty is due I keep selling to investing the things that are making money today or do I prepare and myself for the future where money is going to be made tomorrow I wonder as hard set of discussions and we are in discussions with them. All the time trying to demonstrate to them that we can help partner with them take some of those diesel.
Investments off the table also of course have electrified powertrains and no fuel cell power train soft for them too.
But all of this is to say we can take some of those investments and still partner with you. So you can you can do the rest and succeed in competition and those conversations are our hot and happy to all the time, where they'll come out we'll see but Theres. No question you can hear in my voice that I think it's an opportunity for us to expand our relationships with Oems.
And increase our our opportunities to sell more of both traditional power trains and alternative power trains.
Okay. Thank you I appreciate the color.
Thank you. Your next question will come from Ross Gilardi with Bank of America.
Hi, good morning, guys.
I don't have a loss.
I'm Tom I'm, just wondering how do you what your thoughts are on on how some of your more stable businesses like aftermarket component and distribution in power Gen.
Would perform in a downturn I mean do you think they move sideways or do they actually go down the on the on the you know aftermarket side are you seeing much deferred maintenance at you know at this point, that's that's impacting that business.
Yeah. Ross. This is Tony you know, we expect distribution and our aftermarket business to mostly move sideways in a downturn, it's not perfect, but you know it it does not go through the same cyclical ups and downs as our first fit business and you know we've been growing the aftermarket significantly over the last couple of years, we're seeing a little.
As Tom and Mark said a little.
Slowdown this year, a little moderation of the growth, but we have strong confidence in the aftermarket both distribution and the parts businesses are going to look really perform really well in a downturn and part of the Tony's due to the grueling population of Cummins engines out in the field in a number of end markets that mean, we've got a building pipeline.
After market opportunity over time.
I think you you have it right. We've got so we've got some we think are going to main relatively sideways, while the others go down the other thing going on which you probably saw the numbers is in the distribution business, especially in North America Theres been still quite a bit of improvement driven from our initial acquisition of all of our North American distributors. We spent the first.
For years, making sure we consolidated got the right managers and the right place made sure we held on to customers and let them know that were a good distribution business and care for customers and now what we're beginning to do as figure out how to operate those businesses more like a north American distribution business, rather than a a bunch of different branches.
And so we're beginning to see some improvement in profitability, we'll see where that goes from here, but there's a lot of good plans and that distribution business. So my own view is I'd like to see it do better than sideways, because I think there are opportunities for it to do better than sideways during the downturn.
But I think tonys called the aftermarket point just right you know, we always see a little bit annoys, where utilization goes down here or there rebuilds go down a little bit, but we're talking about 5% drops as opposed to 30 or 40% drops.
Got it thank you and then.
Just unrelated follow up I mean, your biggest customers still seeing in mid single digit growth for for parts and your components business is down.
6% I know, they're not apples to apples and it sounds like most of the weaknesses is international as opposed to North America, but.
Do you are you losing share in any of your key markets for.
Four components and is the model changing at all in a particularly with respect to that customer that they're focusing very very heavily on their distribution business and seem to be stocking more parts from.
Others as well, so and just thoughts there.
The best proxy for our overall parts business is really the distribution business the components businesses, probably 70% for this fit Ross. So turbochargers fill it was going on the new equipment, obviously, that's down quite heavily in some of the markets right now our underlying parts business. We're confident in that that's not the real issue here.
And by the way, we believe that with Oems like like our customers they.
Them doing well in parts is not a detriment to comments because remember there's a whole group of parts players second hand cards players and.
You know rebuild we meant parts builders and even people that are bringing in.
You know different mix of parts and so what we are wanting to do is make sure our end customers get.
Real quality parts.
And they get a good service experience and if they do that Cummins and our and our customers grow their market share and we earn good parts revenue. So we earn good parts margin selling through our OEM channels, just as we do sell into our own channel. So from our point of view just gaining share in the market through our customers and to US all looks like a wind to lessen.
Turns of both revenue growth and profit growth.
So for US you know them that our customers gaining share is not a bad thing, but a good thing.
Thank you.
<unk>.
Thank you know next question will come from Joel Tiss with BMS.
Hey, guys hasn't gone hi, John but.
I just wondered if you can talk a little bit about powergen you know the revenues were up a little bit you guys have been working on that business for four or five years to lower the cost than I'd, just any any color on why the margins are under pressure there.
I'd, Joe I'd love to throw that went to Tony but [laughter], there probably isn't very yet I'll give them a quarter or two but.
You hit it on the head I mean, we're we're not where we want to be on the power Gen business. The good news has.
Course overwhelmingly been Datacenters. The datacenter business has continued to grow you know, we keep expecting it may be to be built out but it just turns out not to be we're continuing to see more datacenter business.
And of course, we've now got the Asian section of of datacenter business also growing which is which gives kind of a second kicked to the datacenter business. The basic standby business has not been good for some time, it's not that is there isn't any there is there's a there's it's a big business and it does is a lot of business for our distribution system, but it hasn't been growing it hasn't.
The recovered in any significant way and we saw a little bit a recovery earlier this year and that will finally, and then it kinda tailed off and then of course, we had we've had a couple of really bad areas like the middle East has been really bad for a while that I've just kind of pulled them the life out of whatever growth. We did see so you know.
We're not exactly sure what what that means about the market. We you know we have a lot of market data about it and trying to understand what the future trend is I mean, we could we understand what the past is really well what the future trend looks like.
It's hard to see but it looks like.
Broadly speaking that energy demand, while still increasing is increasing at a rate that's lower than energy capacity build and that's mostly because while there has been growth since since the downturn in 2008 and nine the growth has been relatively modest and infrastructure is kept up as compared to the high high growth.
If we saw especially in developing countries in in the decade before that said, we got a lot more work to do it's still a profitable business for us and good returns, especially when you consider the fact, we've got a distribution part two at plus we've got all the industrial business engines that come from it but we wanted to be more profitable.
We're disappointed with where we are there's just nothing else to say about that.
Okay, and then so telling it doesn't feel left out can you give us your you're kinda best shot at 'em. If you think the underlying demand for transportation is enough to absorb all the excess capacity that's in the channel now by the time, we exit 2021.
That's a tough question it probably I, probably was better prepared to answer the power.
And this was given I ran that business on quite a few years [laughter]. That's a great question <unk> and I don't I don't think I have a good answer to be honest I don't really have a strong view of that yet so maybe in a very unfair thing I'll see if rich wants to have.
Sure Yeah, that's one of those babies, yeah, well he's got to bring out as mentioned in his grandkids first and then he'll answer [laughter] just just play back one more time just drilling Joel.
Yes, the <unk> the growth in transportation demand. The way you guys see it is enough that by the end of 2021. It can absorb all the excess capacity that we're seeing in the channel right now over okay. Yeah.
I mean.
I think so and what you have joel's you know when.
When lead times get long.
Order boards actually get over inflated because people are wanting to get build slots and all that and right now I think actually.
It's underrepresented what the what the demand is good I think I mean, what the future demand is there like I talked to fleets, they're not putting orders and right now because there's a lead times low.
I can put it in later I can delay that but eventually the trucks run and they need to be replaced and so I think I just think run have our normal shake out over a few quarters and then kind of get the backlog cleared out in the orders will begin to come back in and that's we and maybe just a little historical perspective, Joel just because it's always hard when you're here at the Florida.
Her out when is it all get right, but you know historically, if you say what I mean, you'd say in four quarters. The market will be back getting there may be something unique about this but isn't obvious that there is something unique so we'd expect by that by the end of the year that we would indeed have absorbed whatever there is the one there's one other trend underlying you you probably.
Seen this but you know people like the new engines in trucks, they're seeing much better.
Performance reliability out of new engines and trucks. So I think anything that's older than 2017, you're going to see no matter how wherever we are in the cycle people are going to want to switch out those trucks and engines, just because they're getting such lower operating costs out of the newer engines in trucks that that.
That that'll be a little bit of a boost.
I think as we start to get out today to the back half a year.
Okay and things like time for one last question.
Thank you and your final question will come from and Jason with JP Morgan.
And.
Well and they had dropped almost we missed their joint center isn't going to chance.
Excellent operator, Okay. Our next question will come from David Raso with Evercore ISI right. Thank you, but then you slip then David where to go.
I've a question about the JV income really a clarification, but then I want to top of the market's real quickly I apologize with the phone cutting out maybe I missed it the GE incomes implied bouncing back in the fourth quarter versus the third quarter that relates to somebody emerging markets and how you're handling the.
The upcoming emission standards I'm, just curious why it bounces back from 68 million to implied 79 million in the fourth quarter.
Yeah, Hey, Ross this is James So there's a couple little things go I'm.
Sorry go on in from the third to the fourth quarter.
So most of the markets are relatively stable as we go from Q3 Q3 to Q4, China gets a little bit better and somebody on highway markets like commercial vehicle starts popping up just a little bit as well and so you've got a couple of.
Positive things going in the right direction, there, but it's a relatively modest bump up from Q3 to Q4 in the Grand scheme of things.
I was trying to think about is what will you are implying about 2020 to have that bounce back because in the quarter. The royalty an interest income really dropped down I wasn't sure what was going on there. So we'll talk offline what I wanted to ask about particular, though outside of North America truck and obviously, Tom you have great insight from your customers on markets, what they're telling you defer.
Players do different things and getting ahead of the curve behind the curve outside of North America truck can you just take me around the horn quickly on which markets do you think what you're hearing from your customers.
They are actually getting ahead of the curve on taking production down it's almost leading things out by the end of year, which ones are so clearly behind the curve and which ones look about just right just we'll get some level set.
Yes, geographies and end markets going it yeah, well, let's let's let's start with China. So clearly in China. The construction guys over bill.
In the second half of 2018 thinking they're going to have a great 2019, they overbuilt and they're they're clearly behind the curve right. There. There you saw that you heard the numbers like that markets up and were down a pile and that's just because they're just selling dealer inventory and and their own manufactured inventory so thats for sure.
It won't take very many quarters before there are caught up but.
They are in a they're in a nod that stronger market. So this is stronger than we thought it would be today, but it's not so strong. So that you know we're hopeful they'll catch up in a few quarters, but can you just really depends on end markets I think truck markets, a little bit better than we thought I think people are pretty much caught up now, but nobody's really far ahead. The only thing as you heard was there some prebuy done.
Which means they'll have some inventory, but it's mostly in gas [laughter] pretty pretty small markets I'd say no China, we got the construction markets to catch up and there are behind and the truck markets kind of on in that in India. It's just you know we get Scott the rug pulled out the whole the whole finance thing means it's all under.
Why there is nobody carrying a bunch of inventory or anything there's there's somebody that's not the big problem. The big problem as the demands all completely flatness back. So there's there's really I mean that the whose behind a head is kind of the side story in Europe by the way is straight on so Europe , Scott No no big challenges inventory a little bit here in there, but just generally speaking you.
Up is kind of moved some pretty good okay, they're not it's not a disaster. It's it's just okay and I see.
You know pretty quickly everybody's adjusting hourly rates in Europe , I was just talking to a bunch of the Oems there, they're all adjusting down everybody is making the adjustments there will be there will be down to the right numbers in a quarter or too.
So I'd say, that's right on the mining side, they adjusted Super quickly I mean in my opinion.
Real quickly, maybe but weve mining is not a it's not a disaster or anything it just rose up and it kind of leveled out pretty quickly and they're not overbuying.
For obvious reasons, they already did and it's bad.
So so mining is one where I don't think we have a lot of there. They are on plan in fact, maybe maybe keeping costs lower than than they would have in the past segments and then Latin America. I guess, you know broadly speaking things aren't very strong we thought Brazil would be better.
But it is and the big issue has been export markets. The domestic demand is about where we thought it's up a few percent and GDP I mean and underlying demands up but the export markets because Argentina is a big wreck and frankly, all around Latin America, what you're having is used to be Brazil was the problem. Now you got every other economy is a problem and so there is.
As a little inventory there, but the numbers have been so low that it's nothing to worry about so I I guess, the only place I'm really worried about is the China construction with regard to inventory and we're already reporting those numbers there off and in North America, Tony talked about this but there'll be a couple of quarters, where our market share will fall, while they use our own engines and get get all those get there.
Production down and get everything leveled out, but then it will be right back to normal and then just smaller market, but marines feels like it's on a bit of an <unk> finance took up the brutal yeah serious that's not simply because it doesn't pick up in Murray yet or is it production just getting back in line with a flat.
A flat business.
I think I think demands picking commence picking up a little but again, it's in a week friendships weeks set of markets. It's just that it's started came off the bottom base.
Thank you very much appreciate it. Thank you David Thank you David Thank you bye-bye. So thank you everybody there. Thanks.
Okay, well, ladies and gentlemen. This concludes today's conference call. Thank you seen participation you may now disconnect.