Q3 2021 Cummins Inc Earnings Call
Greetings, ladies and gentlemen, and welcome to the Cummins, Inc. Third quarter 2021 earnings Conference call. At this time, all participants on a listen only mode. A question and answer session will follow the formal presentation. If you would like to ask a question. Please press star one on your telephone keypad, if anyone should require operator.
Her assistance during the conference. Please press Star Zero on your telephone keypad. As a reminder, this conference is being recorded it is now my pleasure to introduce your host Jack Kinzler Executive director of Investor Relations. Thank you. Sir. Please go ahead.
Thank you and good morning, everyone welcome to our teleconference today to discuss Cummins results for the third quarter of 2021.
Participating with me today are our chairman and Chief Executive Officer, Tom Linebarger, Our President and Chief operating Officer, John Rumsey.
Chief Financial Officer, Mark Smith, we will all be available for your questions at the end of the conference.
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 of $19 30 for such.
Such statements express our forecasts expectations hopes beliefs and 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 factors section of our most recently filed annual report on Form 10-K, and any subsequently filed quarterly reports on Form 10-Q.
During the course of this call we will 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 and media.
With that out of the way, we will begin with our chairman and CEO Tom Linebarger.
Thank you Jack and good morning, welcome to everybody I will start with a summary of our third quarter financial results and our market trends by region and finish with a discussion of our outlook for the rest of 2021 Mark.
Mark will then take you through more details of both our third quarter financial performance and our forecast for this year.
Demand remains strong in the third quarter as the global economy continued to improve driving driving strong sales growth across most businesses and regions outside of China.
In China industry wide sales of trucks and construction equipment has slowed sharply but in line with our expectations.
We remain encouraged by the economic trends in our markets, which point to strong end user demand extending into 2022.
We also continue to see orders for our products outpaced our competition as a result of their strong performance in the field.
Unfortunately supply chain constraints continue to significantly impact our ability to produce and ship products driving up costs and limiting sales growth in the short run.
These supply chain constraints are impacting our OEM customers and much the same way.
Before getting further into our results I wanted to take a moment to highlight a couple of strategic milestones and the evolution of our next generation products and technologies.
In October we announced that we will bring a 15 liter natural gas engine for heavy duty trucks to the North American market. This engine was launched earlier this year in China and has been well received in the market demonstrating excellent performance and reliability thus far.
The 15 liter natural gas engine is an important part of our path to zero emission strategy by offering a significant reduction in both criteria pollutants and greenhouse gases and a product that's available today and utilizing utilizing existing infrastructure.
Really exciting is that this engine is designed to accept a range of gaseous and renewable fuels, including hydrogen in the future. In fact, all of Cummins engine platforms are being designed with the same fuel flexibility.
At the same time, we are working with Chevron and others in the energy industry to increase the availability of renewable natural gas and other renewable fuels to ensure infrastructures in place to meet our customers' needs.
We also signed a letter of intent to establish a joint venture between Rush enterprises, and Cummins, which will produce Cummins branded natural gas fuel delivery systems for the commercial vehicle market in North America, combining the strengths of momentum fuel technologies compressed natural gas fuel delivery systems and Cummins powertrain expertise.
Along with the engineering and support infrastructure of both companies.
These are important steps in expanding our portfolio of power solutions options to help customers meet their business goals and operational objectives, while also meeting and Clinton increasingly stringent emission standards and achieving our customers' sustainability goals.
Now I will comment on the overall company performance for the third quarter of 2021, and <unk> cover some of our key markets.
Revenues for the third quarter of 2021 were $6 billion.
An increase of 17% compared to the third quarter of 2020.
EBITDA was $862 million or 14, 4% compared to $876 million or 17, 1% a year ago.
Freight and logistics expenses.
Rising material costs and other manufacturing inefficiencies associated with the ongoing supply chain challenges in our industry more than offset the benefits of global volume increases compared to the third quarter of last year.
As a reminder, EBITDA in the third quarter of last year was helped by temporary salary reductions, which lowered our costs by approximately $90 million.
Our third quarter revenues in North America grew 13% to $3 4 billion driven by higher engine and component shipments across the heavy and medium duty on highway markets.
Industry production of heavy duty trucks in the third quarter was 55000 unit increase of 10% from 2020 levels.
Come and sold 22000 heavy duty engines in the same period up 30% from 2020 levels.
Industry production of medium duty trucks was 26000 units in the third quarter.
A decrease of 5% from 2020 levels, while our unit sales are coming as unit sales were 23000, an increase of 25% from 2020.
We shipped 43000 engines, just Atlantis for use in the Ram pickups in the third quarter of this year, a decrease of 2% from 2020 levels, but still a very strong quarter revenues.
Revenues for power generation grew by 2% due to higher demand in recreational vehicle standby power and datacenter markets.
Our international revenues increased by 22% in the third quarter of 2021 compared to a year ago.
Third quarter revenues in China, including joint Ventures were $1 5 billion, a decrease of 11% due to lower demand in the medium and heavy duty truck markets industry demand for medium and heavy duty trucks in China was 217000 units a decrease of 53% as the industry works through the <unk>.
National standard five truck inventory on hand, and lower demand for newer higher cost national standard six units.
Our unit sales and units, including joint ventures were 40000, a decrease of 49% versus the third quarter last year.
Our light duty engine sales were 33000, a decrease of 40% driven by supply chain constraints and weaker market demand.
Industry demand for excavators in China in the third quarter were 56000 units a decrease of 15% from 2020 levels are.
Our units have come unsold were 88600 units a decrease of 20%.
Power generation sales in China increased 52% in the third quarter compared to a year ago based on strong demand in data centers and other backup power applications.
We continue to hold a market leading position in the datacenter segment in China, driven by strong end user relationships and a compelling product offering.
Third quarter revenues in India, including joint ventures were $520 million, an increase of 76% from the third quarter of 2020.
Industry truck production increased by 120%, while our shipments increased 135% as our joint venture partner continued to gain share.
Demand for power generation and construction equipment also rebounded strongly in the third quarter compared to a very low base a year ago.
In our power systems markets industrial engine revenue increased 33% in the third quarter compared to the compared to the same period last year, driven by mining and oil and gas.
In Brazil, our revenues increased 26% driven by increased demand across all end markets.
Now, let me quickly cover our outlook for the remainder of 2021.
Based on our current forecast, we expect our revenue to be at the lower end of our guidance are up approximately 20%.
Versus 2020.
EBITDA is now expected to be approximately 15% below our previous guidance of 15, 5% to 16% of sales are expected EBITDA margins are lower because of the persistence of the supply chain constraints and disruptions, which are now extra activated by escalating material and freight prices.
We've lowered our forecast for industry production of heavy duty trucks in North America to 228000 units up 25% compared to 2020, but below our prior guidance of 264000 units.
This is again due to due to the supply chain constraints impacting our customers rather than a lack of end user demand.
In the medium duty truck market, we are decreasing our forecast for industry production to 118000 units up 15% year over year, but below our prior guidance of 134000 units.
We expect our engine shipments for pickup trucks in North America to be up 25% compared to 2020, an increase of seven 5% from our expectations three months ago.
In China, we continue to expect domestic on highway demand to decline from record levels, a year ago, our 2021 outlook for medium and heavy duty truck market demand is 165 million unit.
2021 outlook for light duty truck market is 2 million units, both unchanged from our previous guidance.
We continue to expect industry sales of excavators excavators to be flat with the record levels achieved in 2020 and unchanged from our previous guidance.
In India, we anticipate industry demand for trucks to be up 75% compared to levels experienced in 2020, and our other businesses are showing promising growth due to continued infrastructure investment. This is also unchanged from previous guidance.
We now expect demand for mining engines to increased 60% in 2021 up from our expectation of 45% three months ago based on continued strength in commodity prices.
We continue to expect global power generation revenue to increase 15% primarily.
Driven by the data center and recreational vehicle markets.
Summing up the quarter strong demand across many of our markets drove continued sales growth in the third quarter. Despite this strong demand supply chain constraints continue to significantly impact both our operations and those of our customers, resulting in higher material and logistics costs as well as cabinet capping revenue growth.
We are working collaboratively with our customers and suppliers to navigate these challenges these challenges and position the company for better performance in 2022.
Customers are recognizing the strong performance of our products, resulting in our sales growing faster than industry demand in a number of important markets. We continued to invest in bringing new technology to our customers outgrowing, our end markets and providing strong cash returns to our shareholders. The company expects to return over 75.
5% of our operating cash flow to shareholders in 2021 in the form of dividends and share repurchases. Thank you for your time today and now let me turn it over to Mark.
Thank you Tom and good morning, everyone. There are four key takeaways from our third quarter results.
End customer demand remains strong in the third quarter driving sales growth strong sales growth across most end markets and businesses outside of China, where trucking construction demand has weakened in line with our expectations.
Mobile supply chains remain constrained impacting our industry's ability to meet strong.
Customer demand and resulting in higher freight labor and logistics expenses and rising material costs.
As a result of the continued supply challenges and associated costs, we are.
Lowering our full year sales and profitability outlook, even though underlying demand remains very strong.
Finally, and we returned $345 million to shareholders through cash dividends and share repurchases in the quarter and a total of 1831.
$1 $83 billion for the first nine months of the year consistent with our plan to return 75% of operating cash flow to shareholders. This year.
Now let me go into more details on the third quarter.
Revenues were $6 billion, an increase of 17% from a year ago.
Sales in North America grew 13% and international revenues Rose 22%.
EBITDA was $862 million or 14, 4% of sales for the quarter compared to 876 million or 17, 1% of sales a year ago.
As a reminder, EBITDA in Q3 last year was boosted by $90 million.
Temporary salary reductions and $44 million of the recovery in Brazil.
Along with the strong demand the key feature of our performance in Q3 is that our gross margin continues to be challenged by the supply chain constraints and elevated costs.
Gross margin of $1 4 billion or 23, 7% of sales increased by $65 million, but declined as a percent of sales by 270 basis points.
Global supply chain constraints continue to impact the industry's ability to meet elevated and costa demand.
And that resulted in higher costs, we incurred approximately $90 million of <unk>.
Additional freight labor and logistics costs in the third quarter. In addition to rising material costs.
Actually offset by increased pricing in the aftermarket.
SG&A expenses increased by $38 million or 7% and research expenses increased by $42 million or 19% from a year ago, primarily due to higher compensation expenses.
As a reminder, due to the significant uncertainty at the onset of the COVID-19 pandemic, we implemented temporary salary reductions in April of 2020 through the end of September last year.
These salary reductions resulted in approximately $90 million of pre tax savings for the company last year and impacted gross margin and our operating expenses and impacted the comparisons of the results of all of our operating segments.
Joint venture income was $94 million in the third quarter down slightly from $98 million a year ago, due primarily to weaker demand for both trucks and construction equipment in China.
Other income of $32 million increased by $11 million year over year.
Net earnings for the quarter with $534 million or $3 69.
<unk> per diluted share compared to $501 million or $3 36 per share from a year ago, primarily due to a lower tax rate and a reduced share count.
Effective tax rate in the quarter was 19, 9%.
Our income tax expense included favorable discrete items of $11 million or <unk> pushed to the diluted share.
Operating cash flow in the quarter was an inflow of $569 million compared to $1 $2 billion a year ago, an increase in working capital led to the lower operating cash flow for this quarter.
Now, let me comment on segment performance and our latest guidance for the full year 2021 for.
For the engine segment third quarter revenues increased 22% from a year ago, driven by increased demand for trucks in the U S and construction equipment in the U S in Europe.
EBITDA decreased from 18, 1% to 15, 2%, primarily driven by higher supply chain costs, lower joint venture income and higher compensation expense, partially offset by the benefits of stronger volumes and lower warranty expense.
For the full year, we've reduced our revenue guidance to 24% at the midpoint down 1% for the full year.
Now expect EBITDA margins to be between $14 2 million and 14, 7% a little below our prior guidance of 14, 5% to 15% primarily due to the weaker sales and ongoing supply chain challenges.
In the distribution segment revenues increased 14% from a year ago.
EBITDA increased in dollars, but decreased as a percent of sales from 10, 6% to nine 8% primarily due to some of the supply chain challenges, but again the higher compensation costs.
We have maintained our 2021 outlook for distribution segment revenues to be 8% and increased EBITDA margins to nine 3% of sales at the midpoint of our guidance.
Yeah.
Components segment.
Revenues increased 16% in the third quarter, driven primarily by stronger demand for trucks in North America.
EBIT decreased from 16, 9% to 14, 1%, primarily due to higher supply chain costs and higher warranty expenses compared to very very low cost of quality in the year ago quarter.
For the full year, we now expect components revenue to increase 28% lower than our prior guidance of 30.
2%.
Primarily driven by a weaker outlook in North America, and slightly lower outlook for China truck.
We have also lowered our forecast EBITDA margins for the segment to be at 15, 5% of sales at the midpoint down from our prior guidance of 17% as this segment has been more hardly that's been hit harder.
By the supply chain challenges.
The slowdown in truck production in North America and China.
In the power systems segment revenues increased 19% in the third quarter, driven by stronger demand for power generation and mining equipment EBIT increased by $33 million and expanded by 10 from 10, 3% to 11, 5% sales primarily due to the benefits of higher volumes in <unk>.
Lower coverage expense, partially offset by elevated supply chain costs.
For the full year, we're increasing our power systems revenue guidance to be at 22% from our prior guide of 18% growth driven primarily by a stronger outlook in the mining segment with.
We're also increasing our EBIT margin forecast to be 11, 5% of sales at the midpoint.
Our prior guidance of 11 two five.
And the new power segment revenues increased $23 million up 28% due to stronger sales of battery electric systems.
EBIT losses for the quarter were $58 million as we continue to invest in new products and scale up ahead of widespread adoption of the new technologies that we're developing.
For the full year, we now project new power revenues.
$120 million at the midpoint and EBIT.
Losses to be in the range of $200 million.
We expect total company revenues now to grow approximately 20%.
The low end of our prior guidance. We're also lowering our EBITDA margin guidance to be approximately 15% for the full year down from our prior guidance of 15, 5% to 16%.
A slower pace of improvement in North American production and continued elevated costs associated with the global supply chain challenges with the primary drivers of the lower outlook.
We expect joint venture <unk>.
Earnings to be up 10% for this year in line with our prior expectations with forecasting our full year effective tax rate to be 21, 5% excluding discrete items.
Capital expenditures were $150 million in the quarter up from $116 million a year ago. When we continue to expect full year capital spend of between $725 million to $775 million.
To summarize we face incredibly strong demand in many of our core markets.
But continue to face global supply chain challenges, which have impacted our cost base.
And more so than we'd expected in the second half of the year.
However, this end customer demand remains strong outpacing supply in many important markets and setting us up for a strong 2022, assuming the global economy remains strong.
I want to thank all of our employees for their tireless work this year to ensure that we meet the needs of our customers, while continuing to deliver solid financial results.
Continue to prioritize proving our performance cycle over cycle investing in the technologies that will power profitable growth and returning excess capital to shareholders. Thank you for your interest today.
Now, let me turn it back over to Jack.
Thank you Mark out of consideration to others on the call I would ask that you limit yourself to one question and a related follow up and if you have any additional questions. Please rejoin the queue.
Operator, we are now ready for our first question.
Thank you as a reminder, ladies and gentlemen, if you do have a question. It is star one on your telephone keypad at this time.
If you would like to remove your question from the queue. You May press star two for participants using speaker equipment. It may be necessary to pick up your handset before pressing the star keys again that is star one to register any questions at this time and as <unk>. Previously stated please make sure your limiting yourself to one question and one follow up our next question is coming.
I'm sorry, our first question is coming from Stephen Volkmann of Jefferies. Please go ahead.
Hi, Good morning, Thanks for taking my question, maybe I'll just dive in.
Some of these supply chain issues is it possible to just kind of bucket. The impact that you guys have seen im thinking about price cost being a headwind I'm thinking about logistics costs. I think you gave us a number for that mark.
I'm guessing, there's probably some productivity headwinds I'm just trying to see if we can kind of better understand exactly what youre seeing relative to the supplier interruptions.
Yes, happy to do that and good morning, Steve. So yes, we are almost two.
2% worse between the price, we have recovered and equipment recover the price increases that we've made principally in the aftermarket this year.
Which has added about 70 basis points to our results and we've lost more.
More than two five points between the premium freight.
Rising material costs and inefficiencies in our operations.
And that's a little bit that's higher obviously than wed anticipated.
Three months ago, we did see a reduction in premium freight from the second quarter to the third quarter, but we start to see more increase on the material cost side.
And Mark is it too early I mean, I'm, assuming for 2022 year goal will be to get rate with that maybe even a little bit better I don't know any commentary you can make as we go out into 'twenty two.
Well I would just say this continues to be a high area of focus both on our operation side and also.
Working through this with suppliers and customers and implementing price increases.
Hey, Steve This is Tom the one thing that everybody is still.
Worried about in our industry is semiconductors, it's not that things have improved some because they have but it's marginal improvement there. It's still a really tight supply chain. So there's a lot of issues across the supply chain labor shortages right.
Et cetera, but semiconductors look like they are they have a longer term capacity issue and I'd also say the freight side of things just seems like its not quite getting better yet and when you look at where containers are in what ports look like so there is no question that as Mark said.
Internally, we are working as much as we can to address our our cost side inefficiencies you talked about are going out and negotiate price increases and as you know on the material cost side that those come automatically but we'll have to negotiate for the rest.
It's just that some of these things look like there are likely to be somewhat persistent that doesn't mean, we're not hoping to improve them. All I just wanted to be realistic about those be some element that looks like it goes into next year too.
Understood. Thank you I guess high freight costs are probably a good long term for you guys, but we'll have to wait and see how that plays out. Thanks.
Thank you.
Thank you. Our next question is coming from Jamie Cook of Credit Suisse. Please go ahead.
Hi, Good morning, I guess, Tom I.
Just wanted to get more color from you on how youre thinking about China on as we head into 2022, that's an important market for you.
And you know.
What in terms of like the power shortages and outages over there how that's impacting your business from a negative perspective and potentially a positive perspective over time, so I guess I'll start there.
Let me, let Jen talk a little bit about how the China market is now and how were Siena and I can jump back in and see if you talk about sort of longer term things okay.
Hi, Jamie Yes, as you heard from Mark and we have been forecasting we have seen a drop off at the middle of the year in the China market on highway market in particular with the changeover between <unk> and NSX admissions data until we saw inventory build or not.
The first half of the year and we're now seeing that coming down in Gainesville, and regions that are still allowing an S. Five product sales into that that combined with a higher cost of the new emissions product has as we expected given that drop.
On highway demand, which we expect <unk> to come back to some degree 2020 was a record year for China.
Our expectation is that market is going to come back to be more in line with what we saw in <unk>.
19.
Our on highway we are benefiting in China from additional content.
And the components business with new emissions requirements in after the launch of that.
Transmission now in China, So, we see that VAT benefit Ed.
Our analytics products are going to perform.
Well in the market as well and give us some upside potential but the market overall is down the construction market has also.
Downtime and we are continuing to see some strength in the power Gen market. There we are watching that the impact of those.
The power shortage issues in China very closely with our suppliers is not created a major disruption for us at this point that it is something we continue to watch closely.
Would just pick up from what agenda.
The power shortages as she said some impacts on production, but not a huge cost impact, but as you suggested Jamie we do think it helps us in the market and as I mentioned in my remarks, our powergen business is positioned well in China and now I look at China in Ics positioned across all of our markets that truck side is <unk>.
Jen said, we've got now got our automatic transmissions are taking off our content across the engine is growing there's more consolidation in the market. So as things start to come back I think we are better position we've ever been add to it that we're now doing electrolyze with a partner in China, We've got fuel cell loss.
<unk> and China, so on the new power side, while things are moving slower in China than maybe than people anticipated. Several years ago that has just allowed us to position ourselves to be in those markets more strongly as they take up so again to date looking where I am today I'd say our position in China has really never been stronger so yeah do I wish the mark.
<unk> was stronger this year sure but.
As it as it turns back down we're able to consolidate more and strengthen our position and we have a new the new <unk> natural gas product launched in China, as well now and that I think positions us better for.
What.
A fairly sizable natural gas market in China as well.
Okay. Thank you and then just as a follow up can you just talk to how far your order book extend today to what degree there is risk that the order book is.
Unfavorable pricing in it.
Are you concerned about double ordering at all.
Thanks.
Yes, I mean at this point.
Demand out there is very strong we're seeing growing.
Growing in back orders in some of our businesses.
I've been out and reset.
A couple of months talking with both Oems and end customers.
There is strong demand out there that for sure.
Israel at this point customers are not getting all the trucks that they would like to get this year.
And do not believe even looking into next year. They think that that is going to be some.
So I think that that orders are strong in.
As Tom said, we've got some contractual pricing on metals that we'll get as we go into next year, we've been taking pricing actions, where we go direct to the market and aftermarket in powergen.
We are continuing to work with our OEM customers on first fat cat to negotiate pricing just in light of that cost of borrowing that we see right now.
Okay. Thank you very much.
Jamie.
Thank you. Our next question is coming from Ann Duignan of Jpmorgan. Please go ahead.
Hi, Good morning. Thank you just to follow up on the supply chain.
A quick follow up plays out would you expect.
Yes.
We're eliminating the European tariffs on steel and aluminum to have any impact on U S steel prices in 2022.
Hi, Ann Tom Good to hear you.
I really don't know because again there are as you know export or import.
<unk> on that too so how much that's going to really impact prices is unclear to me.
And demand of course for metals is pretty high now so the markets are pretty well supported in fact.
In our mining you saw our mining numbers are up and that's primarily driven by metal prices. So it just in the U S.
Seems to me like it's going to have moderate long term impacts short term it may provide a little bit of a of a.
A little bit of relief, but I would've said that given the important caps, it's probably not a big move.
Medium or long term.
Okay. Thank you I appreciate that the color on that.
My real question now is more fundamental I mean, you're talking about.
The 15 liter engine being able to use them.
Fuels like hydrogen as their major fuel.
If it's so easy to convert to 15 liter internal combustion engine to burning hydrogen.
Why are we investing in fuel cells at all I mean, if we can do it with just a new fuel injection system or some minor reengineering of an internal combustion engine what might go down the path.
Hydrogen investments are in particular fueled sales at all.
Well as you know the hydrogen investments would be the same still we would need to generate hydrogen and of course, we need green hydrogen in order to actually reduce the impact of the fuel and really.
Hydrogen combustion is a good answer it's just not as efficient as a fuel cell. So if youre running.
Long haul heavy duty truck, where fuel is your number one cost or power energy is then that efficiency increase from a fuel cell is going to be worth. It to you. If you have a relatively short range, where you have a vocational truck. Our view is may be a hydrogen engine might work for you, especially of the converged into fuel cell or or is.
Too expensive and you're not having that many units. So our view is there's a place for both but if you want to think what's going to really drive the transportation economy 20 years 15 years from now youre going to need the efficiency that our fuel cell, especially with an electric system is going to provide so.
Our field are feeling still is fuel sales win for the for the majority of the trucking industry, but.
<unk> engines are a real a real addition to the portfolio of products that can.
Can be available across our markets and there is a time factor too as you can imagine as fuel cells advance and costs come down and there may be a peer.
Period of time, where hydrogen engine.
Have an economic advantage that as Tom said overtime.
Our cost come down that efficiency benefits for customers that are really driven strictly by total cost of ownership, we think will drive a shift towards fuel cell applications like longhorn.
Okay, I'll I'll take mine more engineering related questions offline then.
I'd be happy to have.
Have a logon JV.
And I'd be happy to have a longer kind of any sure im over simplifying just a simple fuel injection system reengineering.
Ed.
And taken 30 seconds on it in our designing the platform the physical hardware flexibility is exactly as you said those fuel system.
Other components differences and then the Tony and of course the calibration.
Control of the engine is different based on the field, but we're able to leverage some of that manufacturing and engineering investment at a common platform.
Okay. Thank you I'll get back in queue I appreciate that thank you Ram.
Thank you. Our next question is coming from Tim <unk> of Citigroup. Please go ahead.
Thank you and good morning.
The question really is just.
Hoping you could give some help in terms of how we should think about.
The relationship between heavy and medium duty engine sales for Cummins versus industry truck production.
Both in the fourth quarter, and then as we get into 'twenty two.
Thinking about how.
You out pacing the industry, but.
Your OEM customers deal with all these these red tagged trucks, how should we think about kind of that again.
<unk> sure.
Obviously at a global impact or maybe just thinking about the heavy duty segment here in the near term.
Yes.
A couple of dynamics there of course.
We've added some additional OEM customers sell when you think about.
Our sales through Oems and medium duty and heavy duty.
<unk> heard some of the numbers around how much of the total market, we're seeing with Cummins engine. So we feel really well positioned our products are performing well, there's a lot of end user pole.
We think our position in the market the dynamic that is happening in the fourth quarter. In most cases, we have been able to work through the supply constraints and continue to supply to our OEM customers and have not.
In most cases than the reason they have not been able to double track so as they take down some of their build rate stabilize their production.
Complete these shocks that they've built sort of some component.
We have seen some reduction in demand on the engine itself as they're working to really stabilize and get to a more efficient build rates that makes sure that building with what.
Supply and inventory they have in level that out for that that is impacting us in the fourth quarter in part why we adjusted our revenue guidance.
What I would add Tim is what we see is.
Our products are performing incredibly well, we'll see it in our financials with <unk>.
Very positive results on cost of quality.
Overall strong sense of enthusiasm for the products that we're putting in the market invariably youre going to get some volatility quarter to quarter as we always do but we feel really good about position of our products in the market I think thats the message when you step back and when we're done with this year and will go with that's the message.
You to leave with and of course, we are optimistic about picking up more business over time.
Got it and then Mark just on the margin impact in components, obviously a lot of.
Metals, and platinum and palladium et cetera use there.
And I know, there's always a time lag is there a way to think about.
The margin impact this year, that's effectively a timing gap that you.
Presumably presuming things stabilize which maybe is a wrong assumption, but is there a way to think about what is kind of more of a short term impact that gets reverse next year or is it.
Is it too hard to kind of.
<unk> set apart.
But if I just step back because a lot of noise year over year, because some of the actions. We took last year that boosted results less adverse to step back from the noise of the numbers I'll come back to that in a moment.
Really we're wrestling with three <unk> three issues in that business.
There are somewhat different than wed anticipated three or six months ago number one production in North America has not picked up in the second half of the year, if anything it's drifted down a little bit and we were counting on that in our guidance.
But we think underlying demand supports a robust environment for next year and that should get.
Take care of itself number two whilst we anticipated.
A sharp drop in the second half of the year in China, and that's playing out largely as we've expected. This business is doing a major product transition from minus five to six.
Invariably when we start with the launch of new products well below optimal scale demand is still pretty light for NSX. So as we ramp we would expect margins to recover.
The bigger challenge all the more naughty challenges the rising supply chain cost, which is really what we've seen where in the first half of the year, we saw our ecm's principally.
<unk> ability impacting our operations and supply chain in the engine business, we've seen that spread more to more electrical components and what's happened is the components business has picked up more cost and inefficiency. So that one's not you were working through all that yes, we've got the metal costs, we've got the normal contractual.
Just months around that but it's that focus on the supply chain.
On the other actions that we talked about the start of the call that we're focused on here, but I just wanted to try and simplify the message so a lot of noise out there.
I'll just say one other thing just you Didnt ask me just to clear up some noise here.
Yes.
In the explanations, we mentioned higher product coverage costs in this segment. It is compared to an extraordinarily low number last year Theres no big charge for product coverage of warranty in this segment. So I just wanted to clear that for other listeners. Thank you.
Got it alright, thanks for the time Mark.
Yes.
Thank you. Our next question is coming from Jerry Revich of Goldman Sachs. Please go ahead.
Yes, hi, good morning, everyone.
Hi, Jerry Tom.
Tom you folks.
Target structural improvements in the business of recycling I'm wondering as you look at the supply chain challenges that the entire industry has faced here how are you folks thinking about potential changes in the way.
You manage inventories or the way you.
Manage the supply chain going forward is there an opportunity to reduce some of the volatility by meaningfully increasing inventories given where.
Cost of debt is et cetera, wondering how youre thinking about.
<unk> comments coming out of.
This is pretty complex environment, we are facing here.
Sure. It's a terrific question and as you can imagine it's been on my mind for a while.
We did early in the pandemic, we did do some structural reform I think we talked about on some previous calls trying to say hey, while the market's down let's make sure that we get our capacity right sized I think we did some good work early on on that.
But with the supply chain challenges. We've also seen a bunch of new problems that we weren't seeing before you highlighted some of them are do we have enough inventory in the right places are we outsourced in places we should be in sourced.
And then of course with trade challenges between countries or are we relying too much on cross border trade. So all of those things now are in our strategy looking forward about how we want to reposition our supply chain. So today, what we're doing is trying to get our costs down trying to get our production up to meet customer demand and <unk>.
Trying to keep our supply chain people.
At work when its there basically work in 2007, it's been really really rough so I would just say that the strategic elements. While we're doing a lot of work and analysis on them. There is no question that we have taken a backseat to try to keep operations going in the last couple of quarters.
But those issues are first and foremost.
For us in the leadership team thinking about how we want to position on and I'll. Just say this broadly speaking what we're thinking about as we do need to reposition.
What we outsource and what we in source for the future partly because of some of the supply chain challenges. We've seen here, but also because the industry is likely to consolidate further and we need to make sure that we can be the reliable supplier that we need to be for our customers. So we will be looking at that and thinking through where it the right way to position ourselves.
Sales in different supply changes.
But I think you've hit on a key point that there will be some optimization that will be helpful to us both from a cost and reliability point of view overtime.
Terrific.
I'm wondering if you could talk about the outlook for.
Your electrification opportunities in off highway markets, obviously, a pretty fragmented.
Supplier base in terms of other engine systems in the market now how do you see that as an opportunity set.
For comments.
Are there significant major new product milestones that we should look forward too.
Folks electrify the off highway offerings.
As you said off highway is more fragmented and generally speaking conversations are.
As behind on highway in battery electric powertrains, but they are common as you would guess a recent major off highway producers trying to figure out what their long term strategy is from carbon point of view and sustainability point of view. So we are having conversations with many of them in all cases, I think the battery electric.
Conversation is is at a high level strategically is the same thing all of them need a solution.
All of them want to figure out when is the cost the total cost of ownership for end users workout and it generally doesn't today unless you're in a publicly financed application if you're in a train or a bus or a fairy okay. If youre in a commercially viable thing it doesn't quite work out yet.
The numbers as you know are changing quickly, but it still doesn't work out. So they are trying to figure out how to position themselves for when it does work out who they partner with and how and today. Most of those partnership conversations are pushed out because there is not a viable offering to make today, nor is there a way to to get to.
A viable offering with new technologies and the cost as they are now so everyone's looking forward to trying to figure out what does it look like off highway I believe strategically we will we'll be in the same.
Challenge that they're in today not enough volume to justify a special one but very specific needs to their application and our view is that Cummins will be well positioned because we will have products and on highway which will give us volume and scale and then we'll have an understanding of their application and how to adapt the technology's most effectively to <unk>.
If highway so that will represent a good partner to them and Thats as you would guess that's sort of the pitch on making to them.
Now that we would be the right partner for them in battery electric as we are with engines.
Okay I appreciate the discussion thanks.
Yes.
Thank you. Our next question is coming from Noah Kaye of Oppenheimer. Please go ahead.
Hi, good morning, Thanks for taking the questions Tom I Wonder if you could kind of update us on how the ultra lights, our pipeline is developing.
Seen from some of the companies in the industry, just a really robust demand growth.
We started the year.
And if you can also comment.
It's not set in stone, but they appear to be some pretty healthy incentives for nitrogen production.
In the reconciliation to build provision. So just wondering if you could comment on potential impact of that to outgrow the business.
Hey, Thanks I appreciate your question and the answer is.
We have consent continued to see backlog growth and the electrolyzed or a business and I'd say the big the big strategic move we wanted to make was to add some bigger projects to the backlog and that those conversations have been going much better backlog I think last time, we checked with 60 megawatts or something quite a good backlog and some newer large.
There are projects, which were exciting.
To add in there and of course, the problem with larger projects they take longer to get together, so and more likely delays in funding, but but that's where the that's where the market's going we need to have those big ones. So it was good to see some of those come in the backlog.
And I would just say that debt.
The interest in Electrolyze yours is still quite strong as you mentioned.
The bill the build back better plant has some incentives in there for producing.
Hydrogen, especially low.
Carbon free ammonia, we think thats going to be a good use of electric <unk> in the early phases of Electrolyzed yours, we thought we see it in Europe, where there is a carbon price already that.
We see some fertilizer related projects and it's an area, where theres a lot of carbon used in fertilizer through through great hydrogen and making that hydrogen green is a way theres already demand calculations.
Calculations about how to get cost equivalency are pretty straightforward theyre not theyre not easy they take some funding and they take some incentives which is why you see those in the bill but.
Once you do the calculations you can see how you can get there. So I do expect that to be one of the markets is likely to move more quickly, especially if those incentives make it through.
La I do think it will promote the green hydrogen green Green nitrogen I guess, the green ammonia business pretty quickly in the U S.
Okay. Thanks.
And then just on a different topic.
Wonder if we could get any update on the filtration business, particularly in light of the comments made earlier about.
Some of the operational.
Changes of realignment.
From a high level that Youre planning.
Where are you at in terms of.
Exploring the alternatives for that business.
I know this is yes, we continue to make progress.
Sure.
In.
Pursuing the alternatives for that business. Our plans are unchanged and you should you should expect an update in the new year as we continue that would be no.
Anticipate any significant change in the remaining three months, but an update in the new year.
And the direction and the enthusiasm for that process remains unchanged and I would just say the performance of that business has also been very strong this year that is.
It's embedded within the components business, but the business continues to do very well.
Yes.
Thanks, very much mark.
Thanks.
Thank you. Our next question is coming from Matt Alcott of Cowen. Please go ahead.
Good morning, Thank you.
So in the U S. We're looking at significant up cycles in truck production as well as construction and mining equipment.
As these up cycles begin to unfold are there opportunities for you guys to increase the percentage of your engine was with your customers both on highway and off highway.
And if I take a bit longer term.
Are there opportunities for potentially gaining new customers, who may currently be fully integrated.
Yes, Great question, we are constantly working to make sure that we have the most competitive engine in the market that drives end user pole and.
And grows our position in the market.
Also ensuring that we have capacity to meet OEM needs to stop strong cycle.
And we continue to have conversations you've seen announcements around the partnerships with Latino with Daimler, we're continuing to have those.
Conversations with customers that may not offer Cummins engine today to introduce in the future. So we expect that those opportunities will continue over time.
So generally during a an OEM cyclical production up cycle.
Does the vertical integration, usually go up or down for the Oems.
Matt It depends.
But at the very top of the market generally speaking our penetration goes up a little bit because they run out of capacity if they use both if they have both their own demand and ours, but again generally is not a good indicator for a given quarter.
And as Mark was.
Saying earlier quarter to quarter variation is pretty pretty high because they may have backlog that in this case. They may have unfinished trucks with more of their engine. So just quarter to quarter. It's hard to see what's more is because of the supply chain challenges right now OEM truck production is capped by suppliers. So they're not we're not any.
We are near the maximum production of the industry today, we'd hope to be based on what engine user demand was but we're not.
We're in an area where.
They can produce more if they could get more parts.
I think we're not really near the spot that you're asking about in terms of industry production.
Got it makes sense, Tom and then just one follow up question on the natural gas engine.
In the U S. It's very small I think it's you guys produce about 10000.
And then you dominate the market with a 15 liter engine can you talk about the growth opportunity and when you could see it unfold I mean is it going to be a meaningful opportunity next year or is this more longer term.
Yes, so the plan, we've announced that we're bringing <unk> and natural gas engine that we have in production in China now in the U S market by 'twenty four.
So we're a couple of years out from offering that product.
As I've talked to end customers. They are very excited about this product and in particular.
They pursue their own calls for our carbon reduction and the coming years AC natural gas is a great way to to meet those.
<unk> using renewable natural gas so we expect some.
Syed opportunities can we bring that new platform.
Enter the market.
And also some growing interest in natural gas in the market.
Which again should boost our share given our position in natural gasoline.
Thank you very much.
Thank you.
Thank you. Our next question is coming from Rob Wertheimer of Melius Research. Please go ahead.
Thank you.
You guys touched on pricing earlier could you remind us maybe just give a quick recap overview of how pricing works on engine platforms is that the only one where you have sort of constraints on what you can price.
That includes material cost escalators, but not.
But not freight maybe if I understand right and then what portion of the mix do you then have to go after go after things like freight on.
Broadly speaking Rob the way. It works is that we have OEM long term agreements with large customers for.
Engines and in the major components, that's the sort of sectors, where youll see some of those long term agreements the benefit of those of course is that we can count on continued.
Customer orders over a.
A period of time over a phase of production of trucks and engines.
And the pricing arrangements in those for the most part again, they're each one's a little different but the general deal is.
Basic material costs, Theres, an escalator or a pass through and on the rest you need to negotiate if you want to make a change doesn't mean you can't negotiate just means you have to negotiate with your partner and then on generator sets and aftermarket where we go directly to retail customers than we only have what's on the order book is what what you can.
You can't price on so.
As Mark and Jen said, we this year, we priced in the aftermarket early in the year, we priced in the aftermarket again in the middle of the year and we always are looking back at that to see if we should do more and then Gen sets. We also move pricing right away and then now what we're doing is talking with all of our OEM customers about the fact that we've had these escalators.
Not just rate by the way freight logistics material cost.
Special shipments as a result of delays in semiconductors and other products that we want to recover from them and we're in negotiations with them now.
Okay. That's helpful. And then I don't know Tom if you can give an overview on on you touched on it earlier on semiconductors do you have a sense on what you think the industry will be in better shape in the what is common is doing specifically I don't know if you re qualifying supplier to qualify new suppliers redesign chips et cetera, before the industry gets better and I'll stop there. Thanks.
Yeah, I'll comment on that one so it is something we've been working really closely throughout the year.
And we've started to see some <unk>.
In that quarter over quarter since the middle of the year and supply of.
Microprocessors for most of our components that you use as well.
<unk> seen some growing disruption on other electrical components. So that has become a bigger issue for us in the second half of the year and we have also in parallel been working and I think we'll revisit inventory strategies as we are able to build inventory not today in the current very constrained environment and we're also looking at sourcing strategy.
And doing dual sourcing back.
All the way to a tier three level to make sure we've got more flexibility in the future.
And Rob the thing, we really needed in the U S of course is we need we need domestic semiconductor production that's targeted at the automotive industry. That's I mean, that's I don't mean to be pie in the sky about it but that strategically it is kind of a nightmare that we only have all of our semiconductor wafers are coming from pretty much one factory.
Or one set of factories in Taiwan and that we're a very small part of that that company's output that is not the ideal situation for our supply chain. So if you said hey, what's the strategic plan the strategic plan has to be defined.
Semiconductor manufacturers, who think the automotive industry is more critical to that.
To their success and ideally to have some closer to shore. Our onshore. So that we can look at the total capacity and demand because right now most automotive most trucks and buses are adding a significant portion of our.
<unk> electronics, each revolutionary each time that their new product revs come out they add 30% more more chips or sensors or something and that's not the way the industry semiconductor.
Capacity for semi characters is moving so we need to we need to add more capacity and we need to add it targeted at those at those customers.
Thank you.
Yes.
Thank you Tom.
Thank you everybody I believe that concludes our teleconference. Today as always thank you to everybody for your continued interest in Cummins in for joining US today I will be available for questions. After the call. Thank.
Thank you again.
Ladies and gentlemen, thank you for your participation. This concludes today's event you may disconnect. Your lines at this time or log off the webcast and enjoy the rest of your day.
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