Q3 2023 Cummins Inc Earnings Call
Yeah.
Greetings and welcome to the Cummins, Inc. Third quarter 2023 earnings Conference call. At this time all participants are in a listen only mode. A brief question and answer session will follow the formal presentation. You May press star one at any time to answer the question Kipp.
If anyone should require operator assistance during the conference. Please press star zero on your telephone keypad.
A reminder, this conference is being recorded it is now my pleasure to introduce your host Chris <unk>, Vice President of Investor Relations. Thank you, Chris you may begin.
Great. Thank you very much good morning, everyone and welcome to our teleconference. Today discuss cummins's results for the third quarter of 2023.
Participating with me today are Jennifer Ramsey, our chair and Chief Executive Officer, and Mark 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 and Exchange Act of <unk>.
1934.
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 uncertainty 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 these 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'll turn you over to our chair and CEO, Jennifer Ramsey to kick us off thank.
Thank you, Chris and good morning, everyone.
I'll start with a summary of our third quarter financial results, then I will discuss our sales and end market trends by region I will finish with a discussion of our outlook for 2023 Mark will then take you through more details about our third quarter financial performance and our forecast for the year.
Before getting into the details of our performance I'm excited to first highlight a few major events from the third quarter that demonstrate the continued execution of our strategy.
On September six et cetera by Cummins, Daimler trucks, and bus and tank car, along with EV energy joined forces to accelerate and localized battery cell production and the battery cell supply.
And in the United States, the planned joint venture well manufacturer of battery cells for electric commercial vehicles, and industrial applications, creating highly desirable manufacturing jobs in the United States and the growing clean technology sector.
Total investment by the partners is expected to be in the range of $2 billion to $3 billion for the 'twenty, one gigawatt hour factory with production expected to begin in 2027.
When you see this partnership as an opportunity to share investment with two long standing partners, while advancing our key technology solution for our customers and industry and collectively to accelerate the energy transition in the United States.
In October <unk> completed its acquisition of two for Asia commercial vehicle manufacturing plants and their related activities, one in Columbus, Indiana and one in warm on Netherlands.
This acquisition is a natural addition to the Cummins emission solutions business and will help ensure we meet current and future demand for low emission products.
Lastly, Cummins announced several collaborations with our natural gas X 15 engine that further enable our customers to achieve their decarbonization goals.
<unk> announced they are working with comments to offer the Nu X 15, and natural gas engine and its heavy duty Freightliner Cascadia trucks.
So coming to the Knight Transportation, Inc announced that the industry's largest full truckload company has successfully tested Cummins Nu X 15, and engine and southern California, using renewable natural gas to realize reductions in nitrous oxides and greenhouse gas without compromising performance.
<unk> 15, N, which will launch in North America in 'twenty 'twenty four is the first natural gas engine to be designed specifically for the heavy duty on highway truck application.
Now I will comment on the overall company performance for the third quarter of 2023 and cover some of our key markets, starting with North America before moving onto our largest international markets.
Demand for our products continued to be strong across many of our key markets and regions revenues for the quarter were $8 $4 billion, an increase of 15% compared to the third quarter of 2022, driven by the addition of meritor and strong demand across most global markets.
As a reminder, the third quarter of 2022 included two months of consolidated operations for Meritor. Following the completion of the acquisition on August 3rd of 2022.
EBITDA was $1.2 billion or 14, 6% compared to $884 million or 12, 1% a year ago.
Third quarter 2023 results include $26 million of costs related to the separation of the filtration business.
This compares to third quarter 2022 results, which included $77 million of costs related to the acquisition integration and inventory valuation adjustments of meritor and $16 million of costs related to the separation of the filtration business.
Excluding those items EBITDA percentage of 14, 9% in the third quarter of 2023 represented an improvement from 13, 3% we delivered in 2022.
As the benefits of higher volume and pricing exceeded increased selling administrative and research and development expenses and inflation costs.
Third quarter of 2022 also included a one time employee recognition bonus of $56 million.
Research and development expense increased in the third quarter as we continue to invest in the products and technologies that will create advantages for us in the future, particularly in the engine components and accelerate segments.
In addition, operating cash flow for the third quarter of 2023 was a record inflow of $1 $5 billion compared to the $382 million in the third quarter of 2022, as we continue to focus on our working capital management within the business I'm.
I am proud of our leaders and employees for their efforts in driving down costs and operational focus to achieve this record result for the quarter and we will continue to focus on strong cash generation moving forward.
Our third quarter revenues in North America grew 16% to $5.2 billion compared to last year, driven by the addition of meritor and strong demand in our core markets.
Industry production of heavy duty trucks in the third quarter was 74000 units up 1% from 2022 levels, while our heavy duty unit sales were 29000 up 18% from last year, reflecting strong demand for our products.
Industry production of medium duty trucks was 37000 units in the third quarter of 2023, an increase of 7% from 2022 levels, while our unit sales were 32000 and up 19% from 2022.
We shipped 41000 engines, just Atlantis for use in their Ram pickups in the third quarter of 2023 flat with 2022 levels.
Engine sales to construction customers in North America decreased by 8% driven primarily by high inventory in the channel.
Revenues in North America power generation increased by 15% is industrial and data center demand.
Improved and supply constraints ease modestly.
Our international revenues increased by 13% in the third quarter of 2023 compared to a year ago with the addition of meritor and strong demand across most markets.
Third quarter revenues in China, including joint ventures were $1 $6 billion, an increase of 24% as markets continue to recover compared to a very weak third quarter of 2022.
Industry demand for medium and heavy duty trucks in China. It was 243000 units an increase of 48% from last year, our sales and units, including joint ventures were 41000, an increase of 36%.
In light duty market in China.
We saw increase of 14% from 2022 levels at 442000 units, while our unit sold including joint Ventures were 26000, an increase of 12%.
Industry demand for excavators in the third quarter was 40000 units a decrease of 30% from 2022 levels.
The decrease in market size is due to weaker act.
In construction our units sold were 7000 units flat with 2022 levels as increased penetration at new and existing customers offset the declining market.
Sales of power generation equipment in China increased 5% in the third quarter, primarily driven by slight improvement in non data center markets.
Third quarter revenues in India, including joint ventures were $730 million, an increase of 13% from the third quarter a year ago industry truck production.
So an increase by 17%, while our shipments increased 23%.
Power generation revenues decreased by 16% due to the second quarter pre buy ahead of emissions regulation changes.
Now, let me provide our outlook for 2023, including some comments on individual regions and end markets.
Based on our current forecast, we are raising full year 2023 revenue guidance to be up 18% to 21% versus last year. We are also narrowing our EBITDA guidance range to be 15.2% to 15.4%.
We now expect higher full year revenues in our components segment and higher profitability in our power systems segment offset by decreased profitability in our engine business as a result of softening aftermarket and off highway markets.
We are raising our forecast for heavy duty trucks in North America to be 280000 to 300000 units in 2023 after a strong third quarter.
Our current guidance forecast lower industry truck production in the fourth quarter, while orders remain relatively strong inventory management truck component shortages limiting our OEM production rates and fewer working days are all contributing to our view for the quarter.
In North America medium duty truck market, we are maintaining full year 2023 market size guidance of 135000 to 150000 units.
Up 5% to 15% from 2022.
While we continue to work to increase our production through rebalancing across our global pants and improving the supply base industry production continues to be limited due to other supply chain constraints.
Consistent with our prior guidance our engine shipments for pickup trucks in North America are expected to be 140000 to 150000 units in 2023 volume levels in line with 2022.
Additionally, we maintain our guidance for North America construction to be down 10% to flat driven by high channel inventory and softening market conditions.
In China, We project total revenue, including joint ventures to increase approximately 15% in 2023, driven by share growth better volumes and content increase we project, a 15% to 25% improvement in heavy and medium duty truck demand and 10% to 20% improvement in light duty truck market coming off the <unk>.
Low market levels in 2022, and that's consistent with the prior guidance.
Despite the slow pace of recovery in the China truck market, we are continuing to see strong performance for the 15 liter natural gas engine, which we launched in 2021.
Due to the expanding fuel cost differential approximately 20% of the heavy duty market is expected to be natural gas power by the end of 2023.
In the short time since launching our new natural gas product in China, our share has been ramping up with strong customer reception and the heavy duty market and we expect momentum to continue into the fourth quarter. We look forward to launching the 15 liter natural gas engine in North America in 2024.
We expect China construction volume to be flat to down 10% in line with prior guidance consistent with a tepid economy and weaker overall activity.
In India, We project total revenue, including joint ventures to be up approximately 6% in 2023 consistent with our prior forecast we.
We expect industry demand for trucks to be flat to up 5% for the year.
We project, our major global high horsepower markets to remain strong in 2023 sales of mining engines are expected to be flat to up 10% consistent with our prior guide revenues in our global power generation markets are expected to increase 15% to 20% consistent with our prior guide with a strong performance driven primarily by.
Improvement in the datacenter and mission critical markets.
For accelerated we expect full year sales to be $350 million to $400 million and also maintain our EBITDA guidance of the expected loss of $420 million to $440 million for 2023.
Within components Cummins expects revenues contributed by the Meritor business for 2023 to be $4 7 billion to $4 9 billion and EBITDA is expected to be in the range of 10, 5% to 11%.
In summary, we are raising our guidance on sales of up 8%.
The 21% and narrowing our EBITDA guidance range from 15.2 to 15, 4%.
Our guidance for the full year employers weaker revenue in the fourth quarter, while demand remained strong in several markets softening in the aftermarket demand a continued weak outlook in China continued industry supply constraints impacting North America truck production and inventory management efforts across many markets are some of the factors.
Given the lower fourth quarter run rate.
In view of the lower forecasted revenues, we have initiated actions to reduce costs in our business, particularly in selling and administrative costs.
In order to lower costs as we move into next year, we are offering voluntary retirement and a voluntary separation program in select regions and parts of our business for eligible exempt employees.
We will continue to monitor our end markets closely and assess the need for further action, while continuing to invest for our future.
During the quarter, we returned $238 million to shareholders in the form of dividends. Our long term strategic goal is to return approximately 50% of operating cash flow to shareholders.
The strong execution from the second quarter of 2023 continued into the third quarter driving record operating cash flow. Despite the ongoing challenges in our operating environment.
As we look forward to the opportunities ahead, we have a strong capable leadership team, who will help us successfully navigate an exciting and changing future.
Today I was also pleased to announce several promotions on my leadership team, which will be effective January one of next year.
Shrikant <unk> currently vice President and President of the engine business will take on a newly created role of executive Vice President and President of operations.
In this role Shrikant will be an important work that will define and drive improvements in how we operate as a company through the energy transition and ensure our success of our operational priorities.
Throughout his more than 30 years at comments III, Kansas worked across many of Cummins businesses and regions and consistently push the boundaries of customer focused innovation to position Cummins as the leading powertrain supplier of choice and the transition to a net zero future.
Sri Count as a result, and people driven leader and is the perfect choice to lead this work.
Second Brett Merritt currently Vice President of on Highway engine business and strategic customer relations will assume the role of Vice President and President of the engine business, replacing shrikant when he takes his new role.
Brett has spent more than 25 years in the automotive and commercial vehicle industry and more than 14 at comments. The past 11 spent leading and growing in the on highway business from 800000 engines in 2012 to $1 2 million engines last year.
<unk> is an experienced business leader and a trusted partner to many of our key customers and I'm excited for Brett to lead this segment.
Bonnie search currently vice President of global supply chain will assume the role of Vice President and President of our distribution business, replacing Tony Saturday, who has been acting as interim head of DBA.
Bonnie who previously led supply chain for D. Bu has led the Cummins global supply chain and manufacturing organization, including Cummins New in recon parts business. Since early 2022, where she led her team in navigating the many complex supply chain challenges as well as improved operational and functional performance.
Her more than 30 years of experience, including 20 years at Caterpillar before come into comments includes general management, HR and supply chain leadership and makes her uniquely qualified for this role I'm excited for her to leverage her broad experience to run this segment.
This is a period of change for our company and it's also an exciting one I want to end by thanking our Cummins employees, who continue to work tirelessly to meet our customer needs and respond to the strong demand levels by ensuring quality products strengthening our customer relationships and navigating continued supply chain challenges.
Our results reflect our focus on delivering strong operating performance investing in future growth and bringing sustainable solutions to decarbonize our industry, while returning cash to shareholders now let me turn it over to Mark.
Thank you Jen and good morning, everyone third quarter revenues.
<unk> billion dollars or 15% from a year ago.
Sales in North America increased 16% and international revenues grew 13%.
Organic sales growth was 10% driven by improved pricing and strong demand for our on highway and power generation projects.
5% of the total increase in sales was driven by the addition of meritor.
EBIT dollars $1 $2 billion or 14, 6% of sales for the quarter, including $26 million of costs associated with the separation of items.
EBITDAR in the third quarter of 2022 was $884 million or 12, 1% of sales, including $16 million of costs associated with the plan.
$77 million of acquisition integration and inventory valuation adjustments related to the acquisition of <unk>.
Excluding the separation cost and inventory adjustments underlying EBITDA in the third quarter was 14, 9%.
13, three a year ago.
EBITDA percentage was driven by favorable pricing to recoup a rising input costs and improved logistics costs.
Partially offset by higher variable compensation.
With the stronger overall company financial performance.
In addition, we issued a one time employee recognition bonus in the third quarter of last year totaling $56 million.
To provide clarity on operational performance in comparison to our guidance I'm, excluding costs associated with the planned separation of Atlas.
The acquisition integration and inventory valuation adjustments related to the acquisition of <unk> in my following comments.
As a reminder, we completed the acquisition of Meritor in August 2022, resulting in one additional months of operational performance in Q3 this year.
To last year.
Now I will go into more detail by line item.
Gross margin for the quarter was $2 $1 billion or 24, 6% of sales compared to $1 7 billion or 22, 9% last year.
Gross margin increased by 170 basis points, driven by favorable pricing and logistics costs and the impact of the onetime employee bonus last.
Last year, partially offset by higher variable compensation expenses.
Selling admin and research expenses.
$2 billion or 14 one.
Sales compared to $997 million or 13, 6% with the increase primarily driven by both higher variable compensation on higher engineering costs associated with new products across the company.
Income from joint ventures was $118 million $48 million higher than the previous year.
Driven by the receipt of technology fees.
Slowly improving demand in China, which boosted the operational.
Other income was a negative $7 million or $20 million lower than a year ago, driven by foreign currency translation.
Also included in other income was $28 million of Mark to market losses on investments.
Interest expense increased by $36 million.
Morally due to highest higher interest rates on the floating rate portion of our debt.
The all in effective tax rate in the third quarter was 21, 4%, including $5 million or <unk> <unk> per diluted share favorable discrete.
Hi, James.
All in net earnings for the quarter was $656 million or $4.59 per diluted share, including $26 million or 14 cents per diluted share.
Costs associated with the separation of <unk>.
All in net earnings in the third quarter of last year with $400 million.
Or $2 82 per diluted share, which included $16 million.
Dollars of costs associated with the planned separation of Atlas $77 million of acquisition integration costs associated with the acquisition of volatile.
All in operating cash flow was a record quarterly inflow of $1 $5 billion $1 $1 billion higher than last year, driven by solid earnings and continued focus on working capital management.
Generating strong operating cash flow remains a key focus area for the company.
Pleased with the progress in the third quarter.
I will now comment on segment performance and our guidance for 2023.
As a reminder, 2023 guidance includes a full year of operations for Meritor, and Atmos and excludes any costs or benefits related to the separation of that.
Guidance also excludes the impact from the cost reduction activities within Cummins in the fourth quarter.
As John mentioned, we are raising our revenue guidance for the company to 18% to 21%.
Slightly from our prior view previous guidance of 15% to 20% driven by strong demand in North America.
EBITDA is now expected to be 15, two to 15, 4% compared to our previous range, 15% to $15 seven.
And we are also narrowing the EBITDA ranges from most of our business segments.
Co components segment revenue was $3 $2 billion, an increase of 20%.
EBITDA was $14 two.
With the prior year, while EBIT dollars increased from $384 million to $461 million.
<unk> Commons meritor revenues in the third quarter were $1 $2 billion.
EBITDA was $129 million or 11% of sales.
<unk> improvement from last year and in line with our expectations for the components segment. We now expect total 2023 revenues to increase 35% to 40% or 3% increase from our previous revenue guidance.
EBITDA in the range of 14, two to $14 seven.
Compared to <unk> 40, a previous range of 14, 1% to $14 eight.
Within components Meritor revenues are expected to be four 7% to $4 9 billion.
As with prior guidance.
Yes.
Expected to be in the range of 10, 5% to 11% compared to our previous forecast of $10 three to 11 lots of small changes in the individual segment guidance as we get closer to the end of the year for.
For the engine segment third quarter revenues were $2 9 billion, an increase of 5% from a year ago.
EBITDA was 13, 5% compared to 13% in 2022, driven by operational improvements and the impact of the onetime employee bonus in the prior year.
In 2023, we project revenues for the engine business will increase.
To 7%.
System with our prior projection.
EBITDAR in the range of 13, 6% to 14, 1% a slight decrease from our previous guide of 13, 8% to 14 five.
5% due to a continuing softening in aftermarket revenues.
And some weaker demand in some off highway markets.
In the distribution segment revenues were $2 5 billion, 13% higher than last year.
EBIT increased as a percentage of sales to 12, 1% compared to $10.
Sales a year ago driven.
Driven by stronger volumes improved pricing and the <unk>.
Fact of the warm term employee bonus last year.
We expect distribution revenues to be 10% to 15%.
Consistent with prior guidance and narrowing the expected EBITDA range to 11 nine to 12, 4%.
Yeah.
In the power systems business revenues were $1 $4 billion, an increase of 7%.
<unk> increased from 14, 3% to 16, 2% continuing a trend over the last seven quarters of improving margins driven by <unk>.
Pricing higher volumes operational improvements and cost reduction activities are all contributed to the continuing improving performance.
In 2023, we expect revenues to be up eight.
13% consistent with the prior year.
And we're raising the expected EBIT to be in the range of $14 eight to $15 three.
From our previous projection of 14, 3% to 15%.
Salary revenues more than doubled to $103 million driven by Electrolyze project delivery high demand for battery electric systems in the North American School bus market.
The addition of the Siemens commercial vehicles business electric powertrain portion.
Okay.
Thanks.
Those.
Okay.
To support strong future growth.
Guidance for the top line on the bottom line.
It seems unchanged with revenues in the range of 300.
<unk>.
Net losses of 420.
Cool.
Thank you.
Tax rate for the year is expected to be approximately 22% in 2023.
Excluding any discrete items.
Our outlook for capital investments is unchanged and expected to be in the range of one.
We will continue to focus on deploying cash to fund investments that drive profitable growth.
And returning cash to shareholders through dividends this year.
In summary, we delivered strong sales and solid profitability in the third quarter and record operating cash flow.
Continue to focus on managing working capital delivering strong margins and investing in the products and technologies that will drive future growth as.
As we indicated last quarter, we see signs of softening aftermarket demand.
We did in London.
Sure.
These factors combined with less production days in the fourth.
Quarter.
It to contribute to lower revenues and profit.
We.
We have initiated some steps to lower costs as Jennifer outlined it will continue to monitor our end markets closely and assess the need for further actions.
Our priorities in 2023 for capital allocation.
As I've said to reinvest for growth increase the dividend and reduce debt.
July we announced a 7% increase in the dividend our 14th consecutive year of quarterly dividend growth and through the end of the third quarter, we have reduced debt.
$390 million.
The more in October.
Reduced debt by a further $650 million consistent with our plans for the year. Thank you for your interest today now let me turn it back 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're ready for our first question.
Thank you.
Our first question is from Jerry Revich with Goldman Sachs. Please proceed with your question.
Yes, hi, good morning, everyone.
Thank you.
Okay.
Jennifer Congratulations on the joint venture with backhaul and Daimler as we look forward to what that means for Cummins product availability.
And offering within Evs can you just expand on that in terms of what's the opportunity to bundle it with actuals.
<unk> management systems and.
If you could just talk about is there a plan.
Use deployment to source.
Batteries globally for your customer resources.
Strictly.
Just on the U S.
Initially just just would love your broader comments. Thank you, yes, yes, sure Jerry I'll add a little bit more color to what we're doing with this partnership.
As I said this partnership is really focused on battery cell manufacturing. So we have previously been.
<unk> been investing and focusing on battery packs.
<unk> motor inverter to other key components and integrated power powertrain for the electrified powertrain and together with our partners saw the need to bring production.
Production of battery cells into the U S and really designed what we think is going to be.
Winning sell solution for commercial vehicles and industrial applications. So this will be supplied ended the battery packs that Cummins will produce the cell will also go.
Two two Pat car and to Daimler trucks here in North America for their battery cells really is targeted at the U S market.
And having a domestic offering that we think will really lead the market in the chemistry here for this we will continue to offer battery packs around the world and Chemistries, including LSP in NMC, but this one is focused on LST technology, which <unk>.
And together, we think it's going to be a winning commercial vehicle.
Battery cell chemistry, lower cost better durability.
Less dependency on some of these.
Minerals that can be harder to source.
So improved safety, so really good opportunity for us and also to stay clean stay closely connected with those two partners as we're launching these electrified powertrains. Our intent is to offer that battery cell through our packs to other commercial vehicle.
And industrial applications here in the U S as well.
Okay Super.
Mark can I ask just a shorter term question.
The engine segment, you folks had pretty solid performance for the quarter and for the year.
<unk> reduced our margin rate.
The midpoint seems like a big step down in profitability implied fourth quarter versus third quarter can you just talk about is there a significant production cut China JV or is that just taking.
Taking the midpoint of the range.
Versus.
No.
Thank you Bob.
The broader maybe higher end central outcomes.
Yes, I think it's it's not related to China.
It is related to the fact that we're going to have less production days less consistent with industry forecasts for lower heavy duty truck.
Which isn't a surprise, but that's what we've kind of been predicting for a couple of quarters. The thing Thats really changed through the course of the year jewelry is the.
The decline in the afternoon.
Particularly it's running through the engine business no doubt some of that's related to.
Customers rationalizing inventory I don't I think the underlying rate.
Decline is less than the headline rate because we've gone from a few relative.
Everybody is trying to keep up with demand and now.
Like ourselves as many companies are looking at inventory levels and trying to right size, but just to give you a sense within the engine business between the first quarter of 2023.
In the fourth quarter.
<unk> revenues are down about 18%, so thats kind of been slipping each time, we've looked at it. So that's the one changing trend I don't think it's foretelling do I just think it's mostly.
Inventory adjustments, but that combined with the lower production days, the lower absorption means that yes, even though the revenues are holding up for the fourth quarter is going to be a little bit tougher.
And one.
One of the reasons not the only reason why we have decided to.
Initiate the actions discussed earlier.
Predicting.
A precipitous decline in our revenues at all we don't have them.
This is a leveling off of a slight decline in some areas.
Feel its prudent both too.
Due to the cost reduction actions continue our focus on cash flow and debt reduction.
Should leave us with the best chances of being very successful in 2024.
One quick Jerry it doesn't it doesn't change our overall guide for engine business, but it is a difference between Q3 and Q4 is our JV income does step down because of.
License fees timing. So we had a lot of that happened in the third quarter steps down about 40 basis points for engine business margin from Q3 to Q4, so that hopefully that helps.
Thank you. Our next question is from David Raso Evercore. Please proceed with your question.
Hi, Thank you I'm curious the cost out decisions how much is that related to what youre seeing on the horizon in 'twenty four and if you can give us any insight on what that is and maybe margins in 'twenty three being maybe a little more of a let's say a heavier lift to expand margins and maybe we see across the machinery.
Space broadly just curious how much is it sort of structural towards.
'twenty three is playing out versus what youre seeing in 'twenty, four and obviously any sense of magnitude.
The cost outs would be really helpful. Thank you.
Yes, David I'll start and then Mark can add if he wants to add anything so as.
As we said, we see that many of our markets have leveled off foreseen.
Some do.
Drifted down and some of the markets aftermarket off highway.
And.
We are continuing to focus on ongoing improvement and profitability and performance of our business and using.
Softening markets has as a further opportunity to take costs out. So we still see a lot of strength as we go into next year, we're not going to provide guidance for 2020 for today, what I will say is if you look at our backlog.
Backlog and heavy duty truck and medium duty truck continues to look quite strong as you go into the first half of the year power generation is very strong.
And so we're not seeing any precipitous drop off but we think it's wise to take some cost cutting actions here in Q4, and then continue to monitor the situation and if we need to take further action of course, we will continue to do that.
We will give you a fuller assessment on the next quarterly earnings call about.
Both the cost and the benefit impact of course, what we're announcing today is voluntary action. So we don't know what the exact take up is going to $1 billion in our assessment.
What is the kind of momentum in markets going forwards.
There will be some of the smaller actions around facilities and other things, but we will we will lay that out in detail in the next quarter. When we've got more logistical hopefully clear review with a full year next year.
That's helpful. Maybe you can you can educate me on something I'm, a little confused by the comment in the fourth quarter engine margin and I. Appreciate chris's comment about the JV income how that'll impact at <unk>, but you highlighted a lower parts.
Impact benefit.
Fourth quarter.
But you don't want to see the components business, which obviously is a lot of parts as well it seems like youre, implying a strong fourth quarter on margins for components. So can you educate me on why the difference one division is getting hit on parts and.
Really the parts Division you would think for aftermarket even more so components is having a step up in margins in the fourth quarter or at least at least appears.
These are the parts business in the engine business is significantly bigger than the size of the.
Aftermarket business.
The components.
Sure Ben I think that that's one step down in one step up and maybe I'm just doing the math right. It seems that the component implied fourth quarter margins pretty strong.
I think it's pretty stable I think.
That's just the dynamics, we've seen between the two different businesses right now.
Both of those segments are anticipating.
Lower.
Volumes for North America medium and heavy duty truck market in Q4 for the reasons that I outlined there.
Frankly, there is a combination of focus on inventory reduction and supply constraints that are continuing to prevent Oems from built into the full demand and we expect to see that in Q4 impact our revenues for both of those segments.
Alright. Thank you very much can be some there can be some differing customer demand for components and engines in any given short term period David.
I think youre right in the longer run our medium over multiple quarters.
Should correlate pretty well, but in this case, we've seen a bit more pressure on the boats.
On the engine side.
It's not all parts sourced directly from our components businesses.
<unk>.
Alright, thank you.
Thanks, Dave.
Thank you. Our next question is from.
Rob Wertheimer with Melius Research. Please proceed with your question.
Two one.
Just on the Park Destock, you had mentioned and that makes sense I'm. Just curious if you have any sense as to how much channel inventory people carry if you're all the way through that halfway through if you just quantify.
That potential if youre able to.
It's a little hard to say I would say, what we tend to see more clearly on the power systems side is the stocking almost every year into the fourth quarter. We are seeing some of that in some lower rebuilds, particularly in the slice of the oil and gas market that we supply Rob what I would say the engine.
On the engine side of the on highway side that seems to have been a more sustained multi quarter approach and I think part of that.
There was a focus on prioritizing OEM new builds for builds as we started to ramp up through this cycle and Russell through supply chain.
And then the parts was in catch up mode now we're finding.
Utilization has leveled off everybody's trying to do a better job on the inventory management.
It feels like it's.
And towards the bottom of that right now of course that always depends on what the economic environment and what's the underlying level of.
Yeah.
Utilization. So if you were to ask me today do I think.
We're on a clear trend to a significantly lower parts in Q1 and say no.
It feels like this is.
The strongest step has been in the last three quarters with the information that we have won.
Perfect and then if I could ask kind of a bigger picture question in China. It's obviously been very weak for a lot of industrials, maybe it's maybe it's bottomed in all your end markets I did so I wonder if you could just give just your high level view of what's going on in the economy. There whether fleet dynamics, you kind of have to be in recovery mode, whether that is true.
Trucks or power Gen or just maybe give an overview of China, what you're seeing in different parts of your business.
On the recovery. Thank you.
Yes, so when we look at the China market I mean overall economic activity has continued to be pretty weak. There. We have seen improvements in 2023 compared to 2022, when they were heavily impacted by Covid lockdowns even more.
Extreme weakness so you've seen some improvement we've seen a strong demand for natural gas heavy duty engines because of the cost delta between natural gas and and and diesel there we've kind of come through the <unk>.
Emissions changeover.
And on highway market and so.
If we see recovery and continued recovery in the economy. There I think that will continue to positively impact our business and with the product investments that we've made the emissions change we will have more content and we think continuing to increase our penetration. So we'll watch and see if any of the government stimulus does.
Does start to two <unk>.
Drive positive momentum and the economic activity, but it's been rather relatively weak. This year, yes, I mean, just to give you don't like talking about months, but July was like the lowest in a decade right in some of our JV production, it's crept up since there, but it has been so again, it's not worsening.
We thought but that just gives you a sense of how weak it was in the summer.
Okay.
Hopefully there's upside from here, but we don't have good visibility to that.
Yes.
One 1 billion RMB bond that's planned I think thats encouraging to see the government impact.
Impact.
The fourth quarter, but hopefully at some drive some more infrastructure growth.
And next year, we'll wait and see though Rob.
Okay.
Thank you. Our next question comes from Tami Zakaria with.
J P. Morgan. Please proceed with your question.
Hi, good morning, Thank you so much.
So I just wanted to ask.
About the power systems business, our margins came out really strong.
Sales were strong as well, but when we look at the fourth quarter guide it seems like you're guiding to a step down of almost 200 basis points sequentially.
Sequentially.
So just wanted to get a sense of what's driving that is just conservatism or is there something that we need to be aware of for the fourth quarter for the segment.
Alright, so the good news is they've been performing really well. So that's the underlying I think thats, we expect that to be a continuing trend.
As I mentioned earlier, typically we see particularly with the industrial side of the business that the customers really.
Dropdown purchase of parts in the fourth quarter, that's not new but that.
<unk> typically happens every Q4.
It's probably the main factor the main negative factor otherwise the underlying demand is strong there is no major changes to pricing all of the cost structure.
Got it that's very helpful and.
The next question is our R&D spend.
R&D spend over the last five years that have stepped up.
Notably how should we think about that spend that's in the next couple of years.
And any any color on that.
Yeah, Jamie we are as you noted in a period of increased R&D investment that we think will position come in as well for the future. So in particular.
Now through the <unk>.
The 'twenty six 'twenty seven timeframe when we launch these new fuel agnostic engine platforms, we're making a major R&D and capital investments and those are bringing a new customer.
Business to us and also will position us to have leading products through the energy transition. We've also been increasing our investment and accelerate business as we ramp up.
The product investments for our Electrolyze theirs and see growing demand for electrical either.
Volume.
As well as an electrified components. So that's really what you're seeing come through in the R&D line and then we're continuing to really focus on improving underlying performance and efficiency in other areas. So that we can continue to make the necessary R&D investments.
And that's why we've had a big push on the SG&A and continue to do that.
Well on gross margin. So we can grow margins grow investment grow the bottom line and keep improving the cash flows.
Simple formulae that we're working through it.
I'm glad to see the cash flow the engineering is going to remain.
These higher levels for a little while yet on this also.
The new engine business platforms are contributing to the yes.
Yes, capex being higher in dollar terms, it's in our expected range as a percent of sales.
The next couple of years, we've got these renewal of these major platforms, which is important for our future.
Thank you. Our next question is from Timothy <unk> with Citi. Please proceed with your question.
Thanks, Hey, good morning first question is on.
Power systems I'm just.
Curious about kind of the visibility that you have looking into 'twenty four and back.
Backlog isn't.
Historically, you really talked about with Cummins, but.
Just given that the long lead times for large engines.
And just.
Visibility you have from a rebuild perspective can you just maybe speak to where you are.
Where do you think you'll exit the year in terms of.
Again, I know youre, not giving 'twenty for guidance, but just any sort of help.
Help you can give in terms of what kind of revenue visibility you would expect to exit the year with that business.
Yes, Youre right.
There is more visibility both long lead times and the underlying demand.
Certainly I think we've got great visibility through the first half of the year.
Of course, we're seeing.
We're anticipating more pressure on the on highway side just because.
Severe downturn, but generally market participants were expecting some moderation in heavy duty truck orders going into next year. So we would expect.
More revenue headwinds on the engines and components on distributions.
So really heavily.
Heavily aftermarket driven so absent some massive crushingly economy that should be more stable and then power system, certainly very strong visibility.
Through the first half of the year and some into the second half of the year, we haven't seen a dramatic shift in trajectory at this point, yes, I mean, we're.
And as Mark said to watch the power systems markets and.
In the industrial markets, we haven't seen a little bit of softening in oil and gas, which is a relatively small market for us that kind of goes in fits and it's inverse and so that that has softened a little bit and then in power. Gen. You know you see a lot of growth this year and I expect continued strong demand in the data center.
For our business and we're well positioned there.
Courage in both power systems and distribution now on multi period margin expansion trends.
So those will go forward.
Okay, and then just a.
A lot of discussion here in terms of the on highway parts business for you and again.
And again, I know, it's probably a bit of apples and oranges, but.
Just listening to the commentary from your largest customer.
The outlook there they have their own parts business.
When do you think.
I know you don't want to speak for them, but what do you think is the.
No.
You mentioned down 18% and he can beginning of the year.
We're down like two or 3% what do you think is driving that.
That no variability between.
You come in to experience versus at least some of the Oems and yet I know the businesses don't align perfectly, but presumably they're impacted by a lot of the same dynamics just curious beyond that generally I think it's destocking.
We are.
Obviously, we know returns levels and things like that from you all parts of our channel have gone up as customers.
Yes, I think it's really important to know through this cycle.
Two very different dynamics because of the supply constraints than what you would previously see so the aftermarket demand is really strong and that with the supply constraints. It was challenging for some of our customers to get parts and so there was a lot of focus on building up inventory to try that buffer against those constraints and a focus frankly on <unk>.
The gaps that resulted in an overbuild of inventory so now that some of the supply.
Challenges of ease this getting inventory back to appropriate levels as has been our focus and that's driven.
Drop off beyond just the.
Aftermarket demand and in service and then the same is true and happening on.
The first that bill that we've had supply constraints that have limited our ability to meet industry demand and you see that resulting in the markets holding up.
Longer than what you would typically see in continuing to see.
Solid demand for our first set trucks.
Trucks.
And then if you just step back from the noise in this kind of correction period.
Clearly our market share in North America on highway markets has gone up noticeably so that should all go well for us.
That will inevitably be purchased through Cogs.
Yeah.
I'm just thinking just in this correction period I was just trying to provide that extra color at this time to explain what I think are short term.
Our margin influences, but not long term market trends.
Thank you. Our next question is from Steven Fisher with UBS.
Please proceed with your question.
Thanks. Good morning, just curious about how much visibility you have to on highway engine pricing.
Going forward at this point into 2020 for I guess to what extent is your pricing going to be dependent on the pricing of your OEM customers are how independent can cannot be.
Yeah, you know we were price.
Costs favorable this year as we've shared previously and we have you know we're continuing to focus on our pricing with new product launches and where we've seen.
<unk> costs coming through so we're working to continue to maintain that positive price cost right.
Ratio and we're seeing some slowing of course and pricing in the market, but expect to continue to have some of that.
And again, when we're talking about.
For next year, then we will I'm sure you'll ask us about price cost will be happy to share that.
Dynamic for sure.
Yes. Thank you and then just can.
You spend a little bit on your comments on the construction outlook I think you said that the inventory adjustments in North America, but maybe you can just.
Talk about the broader global view of engine demand for construction applications and how you think the set up there is for 2024 is there sort of a.
Demand question or is it just sort of near term inventory management.
Yes, I think part of it can be the gauge of construction fleets right. So we've seen a drop off in engine demand that doesn't necessarily mean, a dramatic shift in.
North America.
Construction activity the three biggest markets for us in North America, China and Europe.
I think generally it feels like the pace of economic growth in Europe is slowing.
In China.
It surprised us a little bit of construction equipment demand hasn't fallen even further given some of the trials.
And the overall financial health of the construction sector in China.
But it has come down some.
But yes, no clear picture yet going into next year I would say all of the market.
Some tire kicking to do see figure out where we want it for next year.
No.
Thank you.
Our final question will be from Noah Kaye with Oppenheimer, we used to do with your question.
Yeah. Thanks, Mike you indicated some.
Some favorable testing around the extra feet and coming to market next year.
We'd love to get a little bit more color on your expectations for demand there.
Turning to which this could be a driver of share gains and where youre hearing this from the strongest indicators of demand for that product.
Yes, So we'll launch the <unk> and here in North America next year as you heard me say its performing well in China will have a U S version of that of course meeting.
Regulatory requirements here next year, and we will have available already announced two of our Oems and we are seeing end customers testing.
And interested in that product will have the only heavy duty natural gas.
<unk> offered here in North America. So of course that creates an opportunity for us as customers, where they've got infrastructure environmental goals or even pop.
Operating cost benefits associated with natural gas will start to adopt that that solution more so theres some opportunity there for sure.
Okay.
Then I would love to get a catch up on the electrolyze or backlog and quoting activity.
Any change in the trajectory there anything you've noticed during the quarter and can you update us on where you're at in terms of building out capacity.
Really on the same trajectory, we've talked about previously with building up manufacturing capacity here.
Here in the U S and Europe, continuing to have a backlog growing we are in the process of commissioning at 25 megawatt Electrolyze, there with Florida power and light over the course of this year. So another big projects that we're delivering this year and we continue to ramp up that business as we described previously.
Yeah.
Thank you there are no further questions at this time I would like to hand, the floor back over to Chris <unk> for any closing remarks.
Thank you very much for your interest today and as always the Investor Relations team will be available for calls and answer any further questions that you may have thank you.
This concludes today's conference you may disconnect your lines at this time. Thank you for your participation.