Q3 2022 Cummins Inc Earnings Call
Good day, ladies and gentlemen, and welcome to the common core.
Q3, 2022 earnings conference call all lines have been placed on a listen only mode and the floor will be opened for questions and comments following the presentation.
You would like to enter the queue for questions. Please hit star one on your telephone keypad.
This time it is my pleasure to turn the floor over to your host critical Lowe Vice President of Investor Relations, Sir the floor is yours.
Smith, our Chief Financial Officer.
We will all be available to answer 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 of 1034.
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 will 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 within the Investor Relations section at Cummins Dot com.
With that out of the way I will turn you over to our president and CEO , Jennifer Ramsey to kick us off.
Thank you, Chris and good morning, all.
I'll start with a summary of our third quarter financial results, then I will discuss our sales and end market trends by region and I'll finish with a discussion of our outlook for 2022.
Mark will then take you through more details of both our third quarter financial performance and our forecast for the year.
Before getting into the details of our performance I want to take a moment to highlight a few major events from the third quarter.
On August 3rd comments completed the acquisition of Meritor, a leading global supplier of drivetrain mobility, breaking aftermarket and electric powertrain solutions for the commercial vehicle and industrial markets.
The integration of <unk> people products and capabilities and axle and brake technology will position comment as a leading provider of integrated powertrain solutions across the internal combustion and electric power applications.
We've been excited to welcome our new colleagues into our company.
The company announced several collaborations that further enable our customers to achieve their de carbonization goals and advance our destination zero strategy.
During the third quarter comments announced collaborations with Warner Enterprises transport enterprise leasing and versatile to deliver 15 liter hydrogen internal combustion engines when available.
<unk> eight <unk> hydrogen engine part of Cummins fuel agnostic platform will enable a more timely solution to reduce carbon emissions by providing customers with an option that has powertrain installation commonality and end user familiarity.
The new power business continued to expand its green hydrogen presence globally as demand continues to rise in the key markets of North America, Europe and China.
Cummins announced it will expand Pam electrolyze, our manufacturing capacity.
<unk>, Belgium factory to one gigawatt. The company also announced it will begin producing electrolyze, there's in the United States Underscoring our continued dedication to advancing the nation's green hydrogen economy.
Electra laser production will take place at our Fridley, Minnesota facility, starting at 500 megawatts of manufacturing capacity annually and scalable to one gigawatt in the future.
In addition, we continue to make progress in preparing for the separation of our filtration business. The addition of meritor and the planned separation of the filtration business are positive mood moves for our future. However, there are costs associated with both transactions, which you can see from our press release and earnings materials heavily influenced.
Our reported results this quarter.
We expect that the most significant costs associated with both transactions are behind us and we look forward to updating you on our progress in future quarters.
Now I will comment on the overall company performance for the third quarter of 2022 and cover some of our key markets, starting with North America before moving onto our largest international markets.
Demand for our products remains strong across all of our key markets and regions with the notable exception of China, resulting in strong revenues in the third quarter.
Third quarter revenues totaled $7 3 billion.
Excluding the meritor business third quarter revenues were $6 6 billion.
An increase of 11% from the same quarter in 2021.
EBIT dollars in the third quarter was $884 million or 12, 1% of sales excluding the meritor business result.
<unk> 25 million dollar related acquisition and integration costs, EBITDA was $907 million or 13, 8% of sales.
Compared to $862 million or 14, 4% of sales a year ago.
Third quarter results include costs of $16 million or nine cents per diluted share related to the planned separation of the filtration business.
Adjusting for these costs EBITDA without meritor infiltration cost was $923 million or 14% of sales.
My comments moving forward will exclude the results of meritor the costs associated with its acquisition and the costs associated with the expected separation of our filtration business.
Our EBITDA percentage decline in the third quarter for three main reasons first we saw a 32% drop in joint venture income from the third quarter of 2021, driven primarily by the slowdown in the China markets.
Second we increased investments in research and development as we continue to invest in the products and technologies that will create competitive advantage in the future, particularly in the engine and new power segment.
And finally, we made an investment in our people through a one time bonus in recognition of their intense work and commitment to meet customer demand and navigate supply chain and other challenges.
This bonus did not apply the company officers are motivated and highly effective workforce is critical to delivering our customers.
Executing on our strategy and to creating shareholder value and this bonus will pay dividends over time, and the retention and engagement of our people.
We continue to make positive progress in improving gross margins of our business and offsetting the impact of elevated supply chain and other inflationary costs that we have experienced since the start of 2021.
Gross margin percentage improved in the third quarter compared to the third quarter of 2021, as the benefit of higher volumes and pricing exceeded the manufacturing logistics and material cost increases and higher product coverage costs during the quarter.
Yes.
Our third quarter revenues in North America grew 19% to $4 billion.
Driven by improved pricing higher volumes and higher aftermarket demand industry production of heavy duty trucks in the third quarter was 64000 units.
Up 23% from 2021 levels, while our heavy duty unit sales were 25000 up 15% from 2021.
Industry production of medium duty trucks.
It was 29000 units in the third quarter of 2022, an increase of 26% from 2021 levels. While our unit sales were up 27000 up 20% from 2021.
We shipped 41000 engines distal lantus for use in their Ram pickups in the third quarter of 2022 down 4% from 2021 levels.
Engine sales to construction customers in North America increased by 16% over 2021 due to strong capital spending by rental companies and pricing.
Power systems, North America sales were up 30% compared to 2021, driven by higher volumes and strength that aftermarket.
Power systems, North America, industrial sales were up 122% compared to the third quarter of 2021, driven by strong oil and gas demand.
North America power generation sales also increased by 10% from the third quarter of 2021.
Our international revenues decreased by 1% in the third quarter of 2022 compared to a year ago.
Third quarter revenues in China, including joint Ventures were $1 2 billion, a decrease of 18% due to lower sales in on highway and construction markets.
Industry demand for medium and heavy duty trucks in China was 164000 units a decrease of 25% from 2021.
Weaker new vehicle demand contracted property investment and economic impacts from the shutdown as the country continues to respond to the COVID-19 outbreak.
Have pushed the market to the lowest level in a decade instead of our projected recovery of the market in the second half of the year.
Our sales and units, including joint ventures were 30000, a decrease of 27%.
The light duty market in China decreased 8% from 2021 level to 387000 units in the third quarter, while our unit sold including joint Ventures were 24000, a decrease of 30%.
Industry demand for excavators in the third quarter was 57000 units an increase of 3% from 2021 level.
And RV unit sold were 7800 units a decrease of 8%.
Sales of power generation equipment in China decreased 29% in the third quarter due to the economic impacts of the COVID-19 resurgence.
Third quarter revenues in India, including joint ventures were $614 million, an increase of 18% from the third quarter a year ago.
Industry truck production increased by 37%, while our shipments increased 20% lagged.
Lagging the industry production due to the lower growth in the heavy commercial vehicle segment.
Demand for power generation increased in the third quarter as economic activity continued to improve resulting in record revenue in the quarter for that market.
Now, let me provide our outlook for 2022, including some comments on individual regions and end markets.
To provide clarity in our projections, we will first provide guidance excluding the results of meritor from the acquisition date through the end of 2022.
We will then provide a view of the expected meritor results for 2022.
Based on our current forecast, we are maintaining full year 2022 revenue guidance of up 8% versus last year.
This guidance reflects stronger performance in North America, and a continued weak market outlook in China as well as the indefinite suspension of our operations in Russia we.
We are forecasting higher demand in global mining oil and gas and power generation markets and expect aftermarket revenues to increase compared with 2021.
EBITDA is now expected to be approximately 15% of sales, excluding the meritor results and costs associated with the acquisition and integration costs of the indefinite suspension of our operations in Russia, and the costs associated with preparing for the expected separation of our filtration business.
This is below our previous guidance of approximately 15, 5% of sales as a result of the lower than expected market in China in the second half of 2022, and the onetime employee bonus investment made in the third quarter.
This guidance reflects our expectations of increased profitability in the fourth quarter as we continued to drive the improvements we've seen throughout the year on pricing relative to inflationary costs and improve our operating efficiency.
Based on our current forecast, we expect production of heavy duty trucks in North America to be at 260000 units in 2022.
A 15% increase year over year.
The supply chain constraints in our industry is expected to continue to limit our collective ability to fully meet the sustained strong end customer demand.
In North America medium duty truck market, we are continuing to protect the market size to be 120000 to 130000 units.
5% to 10% increase from 2021.
We are projecting our engine shipments for pickup trucks in North America to be flat compared to 2021 consistent with prior guidance.
In China, We now project total revenue, including joint ventures to decrease 25% to 30% in 2022.
An update to our previous guidance of down 20% to 25%. We now project, a 55% reduction in heavy and medium duty truck demand and a 15% to 20% reduction in demand in the light duty truck market compared to a 50% decline in 15% reduction respectively and our previous guidance.
Industry sales of excavators in China are expected to decline, 30% from record levels in 2021, consistent with our prior guidance.
Despite the difficult economic and market environment in China, we have continued to improve our presence in the region through the down cycle and are well positioned for continued outgrowth across our end markets in the region.
As we look ahead industry volume of NSX product will continue to increase as the new regulations are implemented more broadly.
Our technological expertise and emissions experience positions us well to outgrow the market and support our partners through this transition.
With our NSX share continuing to run ahead of our N S five share.
We also continue to ramp production and expand our presence in automated manual transmissions as our market share increases and the heavy duty market is increasingly adopting this technology.
In India, We project total revenue, including joint ventures to increase 15% to 20% in 2022, an improvement from our previous guidance of up 15%.
We expect industry demand for trucks to increase approximately 30% in 2022.
<unk> performance in power generation within India is also contributing to this improved outlook.
Most major global high horsepower markets are expected to remain strong through the end of 2022 sales of mining engines are now expected to be up 5% compared to the prior year.
An improvement from our previous guidance of flat.
Demand for new oil and gas engines is expected to increase by 120% consistent with our prior guidance.
Strong demand in the U S and other oil and gas markets amid energy and security has fueled the strong outlook.
Revenues in global power generation markets are expected to increase 10% driven by increases in nonresidential. Construction. This is an increase from our prior guidance of up 5% driven by the increased production is supply chain constraints slightly ease and improved pricing.
We are projecting aftermarket sales to increase 15% to 20% from 2021 consistent with our previous estimate the strong outlook is driven by parts demand within our North America on highway business as well as global power systems market.
And new power, we expect full year sales to be approximately $180 million down from our previous guidance of $200 million.
Due to customer scheduling and supply chain impacts we have a growing pipeline of electrolyzed, there's which we expect to convert to backlog.
And be delivered over the course of the next 12 to 18 months and we are seeing increased momentum in North America. Following the passage of the inflation reduction Act.
Additionally, we will continue to accelerate our collaboration with customers on both electrified power and fuel cell applications in 2022.
This was demonstrated in the third quarter as we successfully launched the Cummins HD 120 fuel cell system in China.
By delivering 52 units to those and gang government for a bus application.
For Meritor, we are expecting full year revenues since the date of acquisition to be between $1 7 billion to $1 9 billion EBITDA is expected to be approximately four 5% of say sales during the same period, including the impact of required purchase accounting and integration costs.
This represents the financial impact of meritor across our components and new power businesses.
During the quarter, we returned $245 million to shareholders in the form of dividends and share repurchases consistent with our plan to return approximately 50% of operating cash flow to shareholders for the year.
As I sum up the third quarter I want to emphasize that we are making progress in our strategy to lead in decarbonising, our industry, although profitability drop from the second quarter levels. The fundamentals of our business have not changed our products are performing well leading to record demand from customers and rising market share in some of our core markets.
This is a direct result of the comp contribution from our outstanding workforce.
Do want to acknowledge the clear improvement in the financial performance of our power systems business this quarter and I'm enthusiastic about the prospects for future earnings growth. We do expect total company profitability to improve in the fourth quarter from third quarter levels as implied in our guidance for the fourth quarter.
We are committed to improving the underlying financial performance of our business and delivering strong incremental margins through the remainder of 2022 and beyond.
Now, let me turn it over to Mark.
Thank you Jen and good morning, everyone.
There were a number of factors that impacted our reported results in the third quarter.
I'll step through them to provide clarity on the underlying performance of the company and allow for comparison to our prior guidance.
Key takeaway I want you to leave with is the fundamentals of our business remains strong.
As you are aware, we completed the acquisition of Merit order in August and active and are actively working through the business integration.
Our third quarter results included two months of operational performance for the medical business, resulting in $737 million of sales.
Total EBITDA loss of $23 million.
Which includes both the impact of purchase accounting.
Physician and integration costs.
Our third quarter results also included $16 million of costs related to the planned separation of the filtration business.
To provide clarity on the operational performance of our business excluding the acquisition.
<unk> to our prior guidance I am excluding the impact of these items in my following comments.
Now, let me get into more detail.
Third quarter performance.
Revenues were $6 $6 billion grew 11% from a year ago.
Sales in North America were up 19%, while international revenues decreased 1% driven by the decline in China the impact of the suspension of our operations in Russia.
And the unfavorable foreign currency fluctuations, primarily due to a stronger U S dollar, which reduced our reported sales by 3%.
Earnings before interest taxes, and depreciation and amortization or EBITDA was $884 million or 2012, 1% of sales.
Excluding the merit medical business results.
<unk> integration costs and the costs associated with the separation of filtration EBITDA was $923 million or.
14% of sales for the quarter compared to $862 million or.
A 14, 4% of sales a year ago.
The lower EBITDA percent was driven primarily by an increase in engineering support engineer.
The engineering spend to support new product development.
Joint venture earnings in China, and the one time bonus to recognize the commitment of our employees.
This one time bonus totaled $56 million and impacted the reported results of all operating segments with $41 million of those costs reported within gross margin and $15 million reported within selling admin and research costs.
Now, let me go into more detail by line item.
Gross margin of one $6 billion or 24, 7% of sales increased by $213 million or.
A 100 basis points compared to last year due to the benefits from stronger volumes and higher pricing, which more than offset higher material and people costs.
Selling admin and research expenses increased by $110 million or so.
13%, primarily due to higher research costs supporting the development of products critical to achieving our destiny destination zero strategy.
Adding the fuel agnostic engine platform battery electric hydrogen fuel cell.
Pam Electrolyze it technologies.
Joint venture income declined by $30 million.
Compared to last year, primarily driven by lower demand for trucks and construction equipment in China.
Other income was $10 million $22 million lower than a year ago, driven by $29 million of mark to market losses on.
On investments that underpin our nonqualified benefit plans.
This compared to a gain on those investments of $1 million.
A year ago.
Interest expense increased by $33 million due primarily to financing costs related to the acquisition of meritor.
Net earnings for the quarter were $468 million or $3.30 per diluted share down from $534 million.
Or $3 69, a year ago with the decrease primarily attributed to increase in the effective tax rate for the quarter.
The all in effective tax rate in the quarter was 32, 7%, including $57 million or <unk> 40 per diluted share of unfavorable discrete items, primarily related to the planned separation of the filtration business.
Operating cash flow in the quarter was an inflow of $382 million.
Versus $569 million in Q3 of last year.
Now, let me comment on our segment performance and our guidance for 2022.
For the engine segment third quarter revenues increased 8% from a year ago to $2 8 billion.
EBITDA decreased from 15, 2% to 13, 1% of sales as the benefits of pricing were more than offset by higher manufacturing and product coverage costs lower joint venture income in China.
For the full year 2022, we expect revenues to be up 10%.
Assistant with our prior guidance.
EBITDA is expected to be approximately $14 two 5% a decrease from our previous guidance of 14, 5% due to a weaker outlook in China and the impact of the onetime employee bonus.
In the distribution segment revenues increased 14% from a year ago to $2 $2 billion.
EBITDA increased as a percent of sales to 10% compared to nine 8% a year ago due to pricing and stronger demand for pumps engines and power generation equipment.
We expect 2022 distribution revenues to be up 11% compared to last year.
In line with our prior guidance.
EBIT is now expected to be approximately 10, 5% of sales consistent with our prior projections.
Components revenue increased 10% in the third quarter, primarily driven by strong demand in North America.
EBITDA increased from 14, 1% of sales to 16, 2% of sales driven by the benefits of pricing actions.
Lower warranty expense.
We expect full year revenues to increase 3%.
Project EBIT.
EBITDA margins to be approximately $16 seven 5% unchanged from our view three months ago.
Clearly the components segment results were most impacted by the acquisition of <unk> and I just want to underline.
The.
Performance. Excluding the addition of Meritor was exactly in line with our guidance for the quarter four.
For the full year.
In the power systems segment revenues increased 16% in the third quarter to $1 3 billion a record for the quarter for the segment.
EBITDA increased from 11, 5% to 14, 3% due to higher volumes strong price realization and the increased demand for aftermarket parts in.
In 2022, we expect revenues to be up 10% an increase from our prior guidance of up 8%.
EBITDA is projected to be approximately 11 two 5%.
Also from our prior guidance of 11% driven by strong price realization and continued strength in sales.
And the new power segment revenues were $45 million of 96% from a year ago.
Due to stronger demand for battery electric systems.
Our EBITDA loss was $86 million in the quarter as we continue to invest in the products infrastructure and capabilities to support strong future growth.
For the full year 2022, we expect new power revenues to be up approximately $180 million down slightly from our prior guidance of $200 million.
Due to delays in some customer projects and some supply chain constraints.
Underlying demand however continues to grow for both battery electric systems and Electrolyze.
<unk> expense for this segment is now projected to be $310 million compared to our prior guidance of $290 million.
Driven by an increased investment scale of Electrolyze, it production capacity and bring new products to market.
As Jen mentioned, we are maintaining our 2022 expectations of total company revenues to be up 8%.
And we now expect our EBIT margins at approximately 15% for the full year.
To be clear once again this guidance excludes the marital business and related acquisition and integration costs.
Indefinitely, the impact of the indefinite suspension of our operations in Russia.
And then any expenses associated with preparing for the separation of the filtration business.
This does imply an improvement in profitability in the fourth quarter.
We expect earnings from joint ventures to decline by 25% to 30% in 2020 to.
Due to the ongoing weakness in China, and the impact of suspension of our business in Russia and that is slightly worse than our prior guidance of down 25% all due to the conditions in China.
Our effective tax rate is now expected to be approximately 20% to 22% in 2022 lots of 'twenty twos exclude.
Excluding any discrete items, an increase from our prior guidance of 21, 5%.
Excluding monotonal capital expenditures in the quarter were $179 million up from $150 million, a year ago, and we're maintaining our full year guidance for capital expenditures to begin in the range of 850.
$900 million.
We returned $245 million to shareholders through dividends and repurchase of shares in the third quarter, bringing our total cash returned to shareholders to $1 billion year to date for.
For the full year 2022, we still anticipate returning approximately 50% of operating cash flow to shareholders through dividends and share repurchases.
As already mentioned, we expect the meritor revenues to be in the range of one seven to $1 9 billion for the five months of this year under our ownership.
EBITDA to be approximately four 5%, including the impact of purchase accounting.
Closing.
To again reinforce that Cummins is in a strong position growing our leadership in our core markets, while setting up the company for stronger future through investment in new products and capabilities and we are adjusting our portfolio of businesses all while returning cash to shareholders, we do expect to deliver stronger profitability.
In the fourth quarter as implied in our fourth full year guidance.
Thank you for your guidance today, Thank you for.
You're interested in my guidance your interest. Thank you now let me turn it over to Chris.
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 if you have an additional question. Please rejoin the queue. Operator, we are ready for our first question.
Okay. Our first question comes from Stephen Volkmann with Jefferies. Please state your question.
Great. Good morning, guys. Thank you Mark I'm interested in your guidance.
Thank you Ken.
You kind of have my head spinning here I apologize for that it's a busy day.
How are you going to report the next quarter in terms of.
Meritor I assume that'll be in the numbers, but youll, probably adjust out maybe the purchase accounting I'm just trying to figure out sort of on a like for like basis kind of how we're supposed to think about the next quarter.
Yes, so what we're trying to do and we realize it.
<unk> also has a lot going on stage. So what we're trying to do is make clear how we're performing against our guidance.
<unk>.
Cummins business prior to the Meritor acquisition, which we lowered that guidance just to be clear.
<unk> tried to be clear for the reasons why and then we layer on the merit of performance. So we're trying to give projections for both we will report all in and then just as we've done this quarter in the earnings material, we will break out the business pre marital meritor separately and the different elements. So you can try and get us.
A picture and then next year, we will move to the all in all and reporting but we will continue to provide details around merit also that you can gain confidence that we're making progress on executing on the integration and growth of that business going.
Going forward. So the answer is yes, it's going to look similar in.
In Q4 to this quarter the noise from the purchase accounting, we will start to go will taper down next quarter and then subsequent quarters, but we're going to report with them without so we are not.
Reducing the visibility of our performance on either front.
That's the main goal.
Okay, Alright fair enough, maybe just a quick switch then we've seen a couple of months now of pretty amazing heavy truck orders in the United States, North America, and I'm curious kind of what you're hearing as you talk to customers and sort of the outlook.
Longer term I mean.
Are you guys starting to slot in deliveries for these big orders that we're seeing and just kind of any color that you can give us there would be great.
Yes, Steve we continue to see strong heavy duty customer order interest the conversations that I have with both end customers and Oems are around.
We're working through supply constraints that continue to exist and increase production.
Production rate and this is just not been a typical cycle. So all of those fundamentals for the business remains strong we project that the market will remain strong into next year, because they've been using the trucks.
At a high rate they have not been able to replace at the level that they want to and and as well as these new trucks that are coming out new powertrains have improved efficiency and as we see higher fuel prices. That's also attractive. So we continue to watch the broader economic indicators and what that May mean over time right now we're continuing to work too.
Increased production rates and see strong underlying demand.
Okay. Thanks, I'll pass it on I appreciate it.
Thanks, Steve.
Okay.
Our next question comes from.
Jamie with credit Suisse. Please go with your question.
Hi, good morning.
Just just two questions.
The R&D was up considerably sequentially.
I know, we're continuing to invest but I'm wondering if we should think about that as a new run rate is R&D going to be structurally higher than sort of the implications for 2023.
And I guess my same question is on the SG&A side, even if we back out the $15 million that hit.
SA SG&A because of the bonus the onetime bonus that was also up materially and I'm just trying to think about spending in the context.
Of of concerns on the macro understanding your customers are still saying things are strong now but are we are we taking any <unk>.
Actions.
In the case.
The macro does weekend. Thank you.
Yes, great. Thanks, Jamie for the question.
Hear from you.
We have as you noted taken up our R&D spend in particular in the engine business and the new power business, where we have strategic investments.
In the fuel agnostic platforms and growing investments in electrical is this another key new power technologies.
And so we will continue to make those investments and as we have in the past, we're going to manage through the cycles and improve.
Performance underlying financial performance of the company through the up and the downcycle as while still making these key strategic investments that will position us to outgrow overtime. We are looking closely at our priorities for next year, we are starting to.
More closely manage any head count additions so that we make sure that we're continuing to invest in key strategic areas.
While also managing those investments for potential.
Downside scenario. So we are more closely scrutinizing those priorities right now yes.
Yes, and I would just add to that we have lowered our admin costs by three quarters in a row. There is a tremendous focus on trying to.
And our costs out there in particular the increase in the SG&A was really in the selling side, which is a lot of that's tied to our aftermarket business.
The power systems business, which is great.
Okay engineering on whether Youll put pressure.
Under the other type of pressure.
Okay. Thank you I appreciate it.
Okay.
Our next question comes from.
Yeah.
Rob with Melius research. Please state your question.
Thanks, and Hello, everybody.
My question would be I'm not sure it's an easy one to answer.
But when you look at your blended pricing on engines versus the OEM pricing on trucks.
Cross your customer base or if you wanted to specify North America.
Feel like you're caught up in that regard or do you have a couple of hundred bps to catch up and could you lay out the timeframe at which you would catch up if you think you are behind the OEM prices, which have a little bit more flexibility.
Yes, Rob. This is this is how I would describe it over since the start of 2021, what we've seen is supply challenges in inflation that is service cost and inefficiency into our business.
For 2022, we are expecting 400 basis point improvement in price compared to 230 basis point impact on cost. So we are ahead for the year. When you think about that price cost balance and we're also working to make <unk>.
Improvements in operating efficiency and we continue to have work to do to get back to where we were at the start of 2021, and we're able to price more rapidly into our aftermarket business, but of course, we're we've got high backlog.
And the power systems business are long term contracts right that takes time to flow through as we negotiate with customers and that we have metal market and other contractual agreements that that.
Also flow through over time, but not immediately.
And just to confirm the reason one of the reasons why we're ahead on price and material. Because this year is in fact, we bought a lot of those costs in the second half of 'twenty.
Thanks to them.
Yep Yep.
Okay got it got it and then could you give a general comment on just supply chain do you feel like we picked out on the risk China, maybe doing lockdowns again.
If you take that answer globally, how does the risk of upside downside on cost and supply chain appeal to you.
Thanks.
So on the supply chain side, we continue to see improvement and we also still have issues. So at this point electronic components continues to be our big.
Biggest risk and disruptor, but as you said there continue to be these dynamic lockdowns in China.
Congestion in certain ports that are more on the east coast more on Europe , and so we continue to see some supply chain disruptions.
From where I said quarter over quarter, it's been improving and we've been taken build rates up.
Unable to drive some operational improvement and those issues are not completely gone until that is empire influencing this.
The expectation that we will see improvement going into Q4 and into next year.
Okay.
Alright, thank you.
Thanks, Rob.
Our next question comes from David with Evercore. Please state your question.
David you are there.
Yes, I am sorry about that just so I can understand exactly the fourth quarter sort of what you are.
Adding back to <unk> can you tell us what is your implied EBITDA margin for the fourth quarter segment level.
And a half.
Okay.
<unk>.
So $15 five for the fourth quarter compared to the fifth cohort.
And then when I think about China, obviously is a big driver in the EBITDA margins just given a lot of the truck business comes in as JV income under the Consol.
Consolidated aspect of construction activity there for your business, but obviously truck looking forward.
How should we think about what youre seeing in China, just from what you normally would see around Chinese new year, obviously with.
Congress. They just had their stimulus a lot of things going on I'm just curious.
Thought Beijing photon in particular was a little weaker than I would've thought.
But I'm just curious what youre seeing on the truck side in particular.
No no significant momentum at all right now David Thats, certainly not part of the improvement from Q3 to Q4.
Yeah, and as you noted I mean, they just had the Congress elected Cheetos third term, we typically see some seasonality in that market.
It's difficult to predict at this point so as Mark said, we're not projecting improvement through the end of the year.
And when it comes to the power Gen business.
You, obviously have some of the mining can you give us a little perspective, I mean early look at 'twenty three how youre thinking about that business just given the.
The recent results were pretty healthy.
Like the U S truck market the power systems.
Markets continue to remain strong.
There is a large backorder there so we're projecting strength going into next year.
Thank you very much.
Thanks, David.
Okay.
Our next question comes from Jeff.
<unk> with Goldman Sachs. Please state your question.
Yes, hi, good morning, everyone.
Gary I'm wondering.
Hey, Mark I'm wondering if you folks can talk about.
We head into 'twenty three you've got a number of tail winds in terms of electrical larger production ramping up the <unk>.
<unk> ramping up at <unk>.
Meritor.
Maybe some medium duty engine production ramping based on your recent wins looking at the new product contribution.
<unk> versus 'twenty, two could you just outline for us the demand.
Sort of.
Tailwind it feels like the Elektra lies our opportunity is tracking ahead of expectations, but maybe I can get you to expand on that if you don't mind.
What I would say is.
Yes, we've got line of sight into improving demand in new power business I would expect this point in time without getting into specific numbers both growth in battery electric systems and Electrolyze a sales lift next year. So I think the momentum is going to continue in new power.
And then yes, we've got strong customer demand on the E axle side again, I don't think thats going to be.
Dramatic.
Change relative to $27 billion company.
Demand is strong clearer visibility into the new power side right now.
Yes on the <unk>.
<unk>.
I talked about some of the investment and production capacity. So we're in the early stages of building up that production capacity. The building up the backlog, it's going to be lumpy at this point and it's going to grow as as Mark said over time, and we still feel really good in fact.
The inflation reduction act and the climate provisions around that are strengthening the hydrogen outlook in the U S.
And can I ask.
The initial customer response.
The marital integration can you talk about what those conversations have been like.
Particularly as it pertains to selling <unk>, congrats <unk> actuals to.
Traditional comes customers that haven't been to our customers and if you could touch on.
Within Meritor margin guidance, what's the inventory step up that's embedded.
Awesome results looks like by at least two points, but I'm wondering if you could.
Outline that relative to the full year guide on slide 14 for Meritor.
Yes, we're obviously in the early days of integrating the merits of our business.
Cited to have that as part of us starting to have conversations with customers at a strategic level.
And it's a positive for them that we have added meritor to our portfolio and can talk about how we're serving them both in the core businesses, the new power business going forward.
Early days in those conversations are both on operational and supply.
Well as the strategic opportunities that we have.
A lot of focus on demand and delivery right now as there is in other parts of our business Gerry So we arent shorter demand.
We need to keep raising those production production rates.
And Jamie on your question on the inventory step up and Theres a good reconciliation in the earnings deck, which talks through the complicated picture that as meritor for this quarter, it's about $32 million was the impact in the third quarter of that inventory step up.
Any in the fourth Chris.
Just a small bit most of that inventory burns off quickly as you would expect here.
Super Thank you.
Our next question comes from Tami with Jpmorgan. Please state your question.
Hi, Good morning, Thank you for taking my questions. So I am modeling question Hi.
So my first question is I saw in your presentation that meritor.
GAAP EBITDA rate I think you said was four 5%.
Okay.
<unk>.
And so can you help us with what it would have been on a non-GAAP basis.
Because as we think about incorporating meritor in our model, let's say for next year, what non-GAAP EBIT that rates should we be using and do you expect that rate to improve over the next few years as the better integrate that business.
Yes, So let me, let me try to unpack that a little bit so on the U S. GAAP results essentially for Meritorious itself was essentially breakeven in the second quarter and as Jen mentioned our guidance for the full year for 2022 is about four 5%. So that implies the U S. GAAP when you take out.
Including the purchase accounting in Q2, and a little bit in Q3 implies EBITDA of about 9% in the.
<unk>.
In the fourth quarter and that was up from if you take take out some of the noise in the third quarter that was approximately seven 3% operating EBITDA.
We're seeing a step up there and then we would continue.
As we go toward the future continue to drive improvement there both through the synergies we gain as well as other improvements in the business. So so that gives you. Some some view of kind of the trajectory there and happy to talk through more separately. If you like but also the performance in the short run of course is going to be dependent on the market and we will give you all of those ela.
<unk> both in the Q4 and as we get to next year I realize it's Michigan I appreciate everyone's patience as we've tried to work out the best disclosure to give you. All this information will continue to air on the side of sharing more and not less to make it as clear as possible.
Got it that's super helpful and another quick one from me from a modelling perspective, the bonus that you gave to employees this quarter.
As we lap it next year.
We should be treating it as well.
One off for now right.
Yes.
It wont be present, even in the fourth quarter results and that's one of the factors why.
Our EBITDA margins will not the only factor, but one of the factors why our margins will be better in the fourth quarter.
Okay awesome, great. Thank you very much.
Thank you.
Our next question comes from Steven with UBS. Please state your question.
Thanks, Good morning, so lots of puts and takes but just to kind of summarize at a high level is the overall message that basically your power Gen business is a bit better.
Then youre expecting China is a bit worse.
And the China drag is just a kind of a bit bigger than you have the benefit from power. Gen. You have slightly higher investments in new power I mean is that sort of the key summary of it of the core business and then you gave the 15, 5% margin implied for Q4 is there any bridge you can give us.
From Q3, EBITDA Q4, I know you just mentioned, obviously the $56 million of employee costs.
Are there any other sort of just direct bridge you can give us to help go from Q3 to Q4.
Yes, there are really three core elements to the bridge, Steve the bonus we mentioned little bit of improvement in pricing from Q3 to Q4, and then we did have some operational challenges concentrated in one or two areas and we expect those to improve.
And those three elements are the key drivers of the margin rebound.
No okay in China baked in no significant increase.
The increase in expense is expected in the fourth quarter.
Okay.
And would you agree with the sort of the summary, I gave of kind of what the main puts and takes of the core business.
Yes.
The other thing is we continue to incur these mark to market losses. So we didn't call them out at some point that will stabilize and rebound those were present in the third quarter, but at a lower rate than in the second quarter. So that's noise in the other income line.
Okay. That's very helpful. And then just in terms of the heavy duty truck market in North America I'm curious how much visibility you have to the second half of 2023 at this point and then you talked earlier about the order strength I guess I'm just curious how far into 2023 of the Oems have given.
Their work plans and the confidence you have there relative to the first half. Thank you.
Yes, I mean, we are of course talking about outlook and forecast with our with our OEM customers and staying close to them on that at this point, we've got about a nine month.
Backlog based on strong orders in September and October and we will continue to stay close to them to watch how that outlook evolves in the second half of the year.
Perfect. Thank you.
Thanks, Steve.
Our next question comes from Matt <unk> with Cowen. Please state your question. Please.
Good morning. Thank you can you just talk about the rationale behind doing a onetime bonus rather than further pay increases.
Is it just you didn't want to lock into pay increases ahead of a possible.
Moderation of labor cost overall in the economy or the.
Our specific happen in a quarter that made it necessary to do the bonus in order to.
It has.
A lot of attrition.
Yes, really it was more of the latter so of course, we're always looking at.
At pay and what's happening with the market as it relates to labor to labor costs, but really we felt very strongly that given the.
The tremendous effort of our employees over the last 18 months to deliver revenue at the level, we did and work through all of the supply chain challenges and continue to commit to deliver key strategic growth initiatives and given the environment, where they are experiencing higher inflation and the impact to them.
And the labor market is tighter we felt that this onetime recognition was very appropriate to show appreciation.
To mitigate attrition and really motivate people to be connected to delivering and continuing to deliver for the company.
Got it makes sense and then just.
A bigger picture question, you're expecting strong demand in mining and oil and gas for the rest of the year does it looks like this momentum should continue into 2023 and on the mining side does it look like the demand is being driven by equipment replacement.
No we had.
And equipment replacement cycle threatening to happen for the last decade, it's been false starts does it does it look to you guys. This time it could be a multiyear replacement cycle on the mining side.
Yes, we do see that demand continuing into next year of course in oil and gas with the with the energy challenges are theirs.
A lot of demand to invest there and and we'll have to continue to monitor those economic indicators over time, but right now in both of those markets. We continue to see.
Strong demand holding into 2023.
Yes, we're pretty much sold out for this year.
There are some renewals.
Increased coal production in India with some local factors as well as.
The overall <unk>.
And the availability of energy across borders.
Thanks very much.
Thanks Matthew.
Our next question comes from Noah <unk> with half and Highmark. Please state your question.
Alright, thanks for taking the questions just sticking with off Highway first you mentioned that is really the <unk>.
Engine sales to.
So the construction customers in North America that growth being driven by Capex from rental companies and pricing.
Have you started to see any benefits kicking in from IHA, yet is that sort of a demand tailwind for 2003 or potentially beyond.
Yes.
Inflation reduction act is going to drive investment and infrastructure to support some of these.
These.
Our energy technology. So we expect over time, we'll see increased.
Electrolyze or demand as I alluded to earlier and that could also provide underlying benefit to underlying construction.
Demand in the U S. It's.
Early right to actually see the specific impact of that but certainly it.
Should provide a positive benefit.
Sorry, I know we've had a lot of legislation out of Washington, I was I was talking about.
Hey.
Sure sure did I respond on the rise.
Yeah, well thanks, Michael.
Those shots on goal, but I'm just wondering if you can talk through kind of any impact from from the infrastructure Bill So far.
Yes. So thanks, no I think the infrastructure Bill is similarly, actually having a very similar outcome, whereas obviously IRA is driving more into the new power space. We are seeing some good momentum in that space.
We benefit that whether through the rental companies or some of the other construction equipment in North America has remained strong through this year and it has and is carrying forward that momentum as those we continue to build out and Theres a lot of work to be done as you know.
That is certainly helping us.
Okay, Great and then I know.
Folks have asked about meritor impact going forward for next year. So.
I know, we won't be precise here, but just for everybody's modeling as we think about components margin.
Annualize this year seven 5% EBITDA margin add some synergies capture and some growth it's still going to be a margin headwind and components are probably a couple of hundred bps right. As we look on that what you're telling me is that a good starting point.
Yes on a percentage basis, it's clearly going to be dilutive in.
In the early part of the ownership from the goal is to keep working that up over time.
And any early color on the cadence of the synergies capture that you can give us.
No I mean, we're working on that and we've got teams dedicated to that working on that every day, we still feel confident about the numbers, we gave earlier of $130 million pre tax.
By year three.
I will say, we're finding some of the synergies as well in taxes and other things that are not included.
A lot of work still ahead of us.
Good progress to stop.
And of course integrating employees.
So a lot of work.
After a good start.
The business that business is also very busy with demand and supply challenges just as we are in our calls where we've already much appreciate the hard work of the employees.
Listening to what was driving synergies and improvement in their operations. They are all very busy and we appreciate that.
Okay. Thanks, so much for the color.
Thanks, Neil Thank you.
That was our final question and that concludes the Q&A session of this call I'll turn it back over to Chris for closing remarks.
Thank you everyone to everyone for joining as always we will be available. This afternoon to answer any questions that you may have from the Investor Relations perspective, and I. Appreciate your attendance today. Thank you.
Okay.
Thank you. This concludes today's conference call. We thank you for your participation you may disconnect. Your lines at this time and have a great day.
Yeah.
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