Cummins Q2 2022 Earnings Call Transcript

Quartr
Provided by Quartr
August 2, 2022

There are 12 speakers on the call.

Operator

Greetings, and welcome to the Q2 2022 Cummins Inc. Earnings Conference Call. At this time, all participants are in a listen only mode. A question and answer session will follow the formal presentation. As a reminder, this conference is being recorded.

Operator

I would now like to turn Conference over to your host, Chris Cloulow, Vice President, Investor Relations. Please go ahead, sir.

Speaker 1

Good morning, everyone, Welcome to our teleconference today to discuss Cummins results for the Q2 of 2022. Participating with me today are Tom Linebarger, Our Executive Chairman Jen Rumsey, our President and Chief Executive Officer and Mark Smith, our Chief Financial Officer. 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 1934. Such statements express our forecasts, expectations, given 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 ks and any subsequently filed quarterly reports on Form 10 Q.

Speaker 1

During the course of this call, we will be discussing certain non GAAP financial measures and we will refer you to our Web a copy of today's webcast presentation are available on our website within the Investor Relations section at cummins.com. With that out of the way, I will turn you Over to our Executive Chairman, Tom Linebarger, one more time. Thanks.

Speaker 2

Thank you, Chris. Brilliant. Good morning, everybody. I just I had to start by telling you about some rough math I did before I walked in today. And I believe this is my 70th earnings call.

Speaker 2

It's also going to be my last. I'm very grateful to the analysts and investors who are part of this journey with me. Many of you helped me better understand the perspective of our shareholders, which influenced how we ran the company, how we developed our strategies and priorities and how we communicated about our results and plans for the future. Always try to ensure that the senior leaders in the company understood your views and perspectives, and they understood who they were really working for. Some of you have been at this work almost as long as I have, and your commitment to understanding our company and its potential has been remarkable.

Speaker 2

I just want you to know that it meant a lot to me. I'm very proud to have served as the CEO for this company for 10 years as a senior executive for more than 20 years. It was an honor and a privilege. This company stands for more than its products and technology, its revenue or its earnings and even its performance for customers all over the world. The people that work here are exceptional humans, not just exceptional workers.

Speaker 2

That's why this transition was so important to me. It is perhaps the most important work of my entire career. And I have a smile a mile wide today because of the quality of the individual that replaces me and the strength of the team beneath her. Jennifer Rumsey is a once in a generation leader. She combines the leadership and technical skills needed with the characters and values required and the inspiration of a CEO that can take this company to places where I could not.

Speaker 2

I'm as proud as I was on the day I took the job to see her succeed me. Jen?

Speaker 3

Thank you, Tom. Good morning. I'm excited to join you this morning in this new capacity as President and CEO for Cummins. In July, we announced that Tom would end his term as CEO effective August 1. It is a bittersweet moment for me as he's been one of the most significant influences in my career and leadership.

Speaker 3

Tom has been an incredible leader for this company and a true partner and coach to me. Because of his leadership, we are in a strong position to navigate what comes next and execute our Destination 0 strategy. Tom and I share a common vision for Cummins and the role that our company plays empowering a more prosperous world. I feel deeply honored and proud to serve as the new CEO of Cummins, the first woman and just the 7th CEO of My life and leadership have prepared me for this role at this moment during a critical period for Cummins and our planet. A focus on purpose, people and impact has shaped my career and will influence how I lead.

Speaker 3

I look forward to working with all of you as we move forward. I'll start with a summary of our Q2 financial results, then I will discuss our sales and end market trends by region, and I will finish with a discussion of our outlook for 2022. Mark will then take you through more details of both our 2nd quarter financial performance and our forecast for the year. Before getting into the detail on our performance, I wanted to take a moment to highlight a few major events from the Q2. The company achieved significant milestones related to 2 previously announced acquisitions, Jacobs Vehicle Systems or JVS and Meritor.

Speaker 3

In April, Cummins completed the acquisition of JBS, adding engine braking, cylinder deactivation, start stop control and thermal management technologies, which are key components to meeting current and future emissions regulations. On May 26, Meritor shareholders voted in favor of the Cummins acquisition Further validating the potential of what Cummins and Meritor can achieve together. The companies are working together to complete the acquisition this week as we have received all regulatory approvals to close the transaction. During the Q2, Cummins announced Collaborations with Daimler Truck North America and Scania to deliver fuel cell electric powertrains for heavy duty truck applications and with Komatsu on development of 0 emission haulage equipment, including hydrogen fuel cell solutions for large mining haul truck applications. Cummins, Chevron and Walmart also share plans to integrate Cummins X-fifteen N natural gas engines, powered by renewable natural gas into Walmart's heavy duty truck fleet.

Speaker 3

These customer collaborations are significant steps in alignment with our Destination 0 strategy to evolve our company, our products and our customers' products to the technologies needed for decarbonized world. This strategy, which represents a significant growth opportunity for Cummins, includes reducing carbon emissions now by making improvements in engine based that are broadly available today, while rapidly advancing the 0 emissions technologies of the future. We continue to focus on our people and their development as a strategic advantage for the company. In the Q2, the company posted its first Human Capital Management report detailing our commitment to creating and maintaining a dynamic and exciting work environment for our employees. Now, I will comment on the overall company performance for the Q2 of 2022 and cover some of our key markets, starting with North America before moving on to our largest international markets.

Speaker 3

Demand for our products remains strong across All of our key markets and regions with the notable exception of China, resulting in record revenues in the Q2. Revenues for the Q2 of 2022 were $6,600,000,000 an increase of 8% compared to the Q2 of 2021. EBITDA was $1,100,000,000 or 16% compared to $974,000,000 or 15.9 percent a year ago. 2nd quarter results included costs of $29,000,000 related to the preparations for the separation of the filtration business. As discussed previously, we recorded a charge of $158,000,000 in the Q1 related to the indefinite suspension of our operations in Russia.

Speaker 3

In the Q2, received certain inventory and other expense amounts reserved previously and incurred some small additional charges, resulting in a net recovery of $47,000,000 Adjusting for these items, EBITDA was $1,000,000,000 for 15.7 percent of sales. My comments moving forward will exclude the financial impact of the EBITDA percentage declined in the 2nd quarter as strength in sales and increased gross margin were offset by a 31% drop in joint venture from the Q2 of 2021, driven primarily by the slowdown in China markets. Research and development expenses also increased slightly in the Q2 of 2022 as we continue to invest in products and technologies that will create advantage of the future, particularly in the Engine and New Power segments. Gross margin percentage improved compared to quarter of 2021 as the benefit of pricing and higher volumes exceeded the manufacturing, logistics and materials cost increases during the quarter. This pricing only partially offset the impact of elevated supply chain and other inflationary costs that we carried through from 2021 and experienced in the first half of twenty twenty two.

Speaker 3

Our second quarter revenues in North America grew 15% to $4,000,000,000 driven by improved pricing, higher volumes and higher aftermarket demand. Industry production of heavy duty trucks in The 2nd quarter was 62,000 units, up 9% from 2021 levels, while our heavy duty unit sales were 26,000, up 12% from 2021. Industry production of medium duty trucks was 30,000 units in the Q2 of 2022, an increase of 5% from the 2021 levels, while our unit sales were 27,000, up 21% from 2021. We shipped 38,000 engines to Stellantis for the use in their Ram pickups in the Q2 of 2022, down 9% from 2021 levels due to supply chain issues, which temporarily limited truck production. Engine sales to construction customers in North America increased by 9% as the rent companies maintain strong capital spending.

Speaker 3

Power Systems North America sales were flat compared to 2021 as strength and aftermarket offset lower volumes. Demand remains high in North America markets for power systems, but revenues for North America Power Generation declined by 3% as supply chain constraints limited our production for both U. S. Military and mobile power applications. Our international revenues decreased by 2% in the Q2 of 2022 compared to a year ago.

Speaker 3

2nd quarter revenues in China, including joint ventures, were $1,200,000,000 a decrease of 43% due to lower sales in the on highway and construction markets. Industry demand for medium and heavy duty trucks in China was 173,000 units, a decrease of 70% from 2021. Last year's numbers were strong supported by a pre buy ahead of NS VI, but weaker new vehicle demand and economic impacts from shutdowns as the country is responding to a COVID-nineteen resurgence have pushed the market to the lowest level since 2007. Our sales in units, including joint ventures, were 25,000, a decrease of 70% despite the very difficult environment in China. We did see growth in some of our power systems markets, particularly mining and oil and gas.

Speaker 3

The light duty market in China decreased 38 from 2021 levels to 380,000 units, while our units sold, including joint ventures, were 23,000, a decrease of 40%. Industry demand for excavators in the 2nd quarter was 66,000 units, a decrease of 32% from 2021 levels. The decrease was driven by declining demand within the property market and the COVID-nineteen impact on infrastructure demand. Our units sold were 9,900 units, a decrease of 41%. Sales of power generation equipment in China decreased 5% in the 2nd quarter due to the economic impacts of the COVID-nineteen resurgence.

Speaker 3

2nd quarter revenues in India, The joint ventures were a record $594,000,000 an increase of 51% from the Q2 a year ago. Industry truck production increased by 131%, while our shipments increased 78%, lagging the industry production due to lower growth in the Heavy Commercial Vehicle segment. The high level of growth in the Q2 is coming off a very low base when India was experiencing a COVID-nineteen peak in Demand for power generation and construction equipment increased in the Q2 as economic activity continued to improve. In Brazil, our revenue increased 7%, driven by improved demand in most end markets. Now let me provide our outlook for 2022, including some comments on individual regions and end markets.

Speaker 3

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 weaker market outlook in China, as well as the indefinite suspension of our operations in Russia. We are forecasting higher demand in global oil and gas and power generation markets and expect aftermarket revenues to increase compared with 2021. We are maintaining our forecast for heavy duty trucks in North America to be 250,000 units to 260,000 units in 2022, a 10% to 15% increase over a year ago. The supply chain constraints our industry is experiencing continue to limit our collective ability to fully meet strong end customer demand.

Speaker 3

In North America medium duty truck market, we are continuing to project the market size to be 120,000 to 130,000 units, with 5% to 10% increase from 2021. We are now projecting our engine shipments for pickup trucks in North America to be flat compared 2021, an update to our previous guidance of down 5%. In China, we are now projecting total revenue, including joint ventures, 20% to 25% in 2022, an update to our previous guidance of down 10%. We now project a 50% reduction in the heavy and medium duty truck demand and a 15% reduction in demand for the light duty market compared to a 40% decline and a 12% reduction respectively in our previous guidance. Industry sales of excavators in China are expected to decline 30% from record levels in 2021 consistent with our prior guidance.

Speaker 3

Despite the difficult economic and market environment in China, we have significantly improved our presence and profitability in the region compared to prior cycles and are well positioned for continued outgrowth across our end markets in the region. As an illustration, from 2019 to 2022, The demand for heavy and medium duty trucks is projected to be down 40%, while across the same period, we are forecasting As we look ahead, industry volume of NSVI This product will increase through 2022 as the new regulations are implemented more broadly. Our technological expertise and emissions experience positions us well to continue to outgrow the market and support our partners through this transition. We also continue to ramp production and to 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% in 2022, an improvement from our previous guidance of up 10%.

Speaker 3

We expect industry demand for trucks to increase approximately 30% in 2022. We continue to project most major global high horsepower markets will improve in 2022. Sales of mining engines are expected to be flat in 2022 compared to the prior year, consistent with previous guidance. Demand for new oil and gas engines is expected to increase by 120%, an update from our previous guidance of up 95%. Strong demand in the U.

Speaker 3

S. And other oil and gas markets have fueled this improved outlook. Revenue in global power generation markets are expected to increase 5%, driven by increases in non residential construction, consistent with our prior guidance. We are now projecting aftermarket sales to increase 15% to 20% from 2021, an improvement from our previous estimate of up 15%. This is driven by parts demand within our North America On Highway Business as well as Global Power Systems Markets.

Speaker 3

In New Power, we continue to expect full year sales to be approximately $200,000,000 We have a growing pipeline of electrolyzers, which we expect to convert to backlog and be delivered over the course of the next 12 to 18 months. Additionally, we will continue to accelerate our collaboration with OEMs on both electrified power and fuel cells for applications in 2022 as highlighted by the announcements I noted previously. We are maintaining our full year 2022 EBITDA guidance of approximately 15.5 percent, excluding the impacts of the indefinite suspension of our operations in Russia, the costs associated with preparing for the expected separation of our despite the supply chain constraints and rising inflationary costs that we are experiencing. During the quarter, we returned $240,000,000 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. Strong execution resulted in record sales in the quarter despite very difficult operating environment.

Speaker 3

The ongoing supply chain constraints and rising costs throughout the industry, continued COVID-nineteen related impacts and the effect of the conflict in Ukraine all present challenges to operating our business. I am grateful for the commitment of our employees across the organization who have worked tirelessly to overcome these challenges. Their efforts resulted in a strong quarter, enabling us to support our customers while generating with solid returns. Cummins is in an excellent position to continue to execute our Destination 0 strategy, invest in the products and technologies that will fund future growth and drive advantage for our customers. We will accomplish this while generating strong financial results and meeting our commitment to return cash to shareholders.

Speaker 3

It's an exciting time to become CEO. Thank you for joining us today. Now let me turn it over to Mark.

Speaker 4

Thank you, Jen, and good morning, everyone. We delivered strong results in the 2nd quarter, especially in the context of a challenging global business environment. As Jen mentioned, our second quarter results included a $47,000,000 benefit The reserves related to the suspension of our operations in Russia and $29,000,000 of costs related to the separation of the filtration business. To provide clarity on operational performance, I'm going to exclude the impact of these items in my comments. We have provided a breakdown of the costs associated with Russia and the filtration separation costs by line item and by segment in our earnings material to help Now let me go into more details on the 2nd quarter performance.

Speaker 4

2nd quarter revenues of $6,600,000,000 were up 8% from a year ago. Sales in North America were up 15%, While international revenues declined by 2% due to a sharp debt slowdown in China. Foreign currency fluctuations, primarily stronger U. S. Dollar reduced sales by 1%.

Speaker 4

EBITDA was $1,000,000,000 or 15.7 percent of sales for the quarter compared to $974,000,000 of 15.9 percent a year ago. The lower EBITDA percent was driven primarily by negative other income and lower joint venture earnings in China. Gross margins improved year over year and from the Q1. Now let me go into more detail by line item. Gross margin of $1,700,000,000 or 25.6 percent of sales Increased by $208,000,000 or 140 basis points.

Speaker 4

The benefits of stronger volumes and higher pricing More than offset higher freight and material costs for this quarter. Of course, we have been facing increased costs for an extended period of time, And now our gross margins have returned back to 2019 or pre COVID levels. Selling, admin and research expenses increased by £16,000,000 or 2%, primarily due to higher research costs supporting future growth, partially offset by lower variable compensation expense. Joint venture income declined by $42,000,000 versus a year ago. Lower demand for trucks and construction equipment in China with the primary driver of the decline in earnings.

Speaker 4

Other income was a negative $18,000,000 $87,000,000 worse than a year ago. We experienced $48,000,000 of mark to market losses on investments that underpin Our unqualified benefit plans in the 2nd quarter, and this compares to gains of $20,000,000 a year ago. This variation in this one category explains most of the change in other income. Net earnings for the quarter was $678,000,000 or $4.77 per diluted share Compared to $600,000,000 or $4.10 from a year ago. The earnings per share increased due to higher earnings, Lower taxes and a reduced share count resulting from share repurchase activity.

Speaker 4

The all in effective tax Rate in the second quarter was 17.3 percent, including $36,000,000 or $0.25 per diluted share of favorable discrete items. Operating cash flow in the quarter was an inflow of $599,000,000 compared to $616,000,000 a year ago. I will now comment on segment performance and our guidance for 2022. For the Engine segment, 2nd quarter revenues increased 11% from a year ago, while EBITDAR decreased 16.1 percent of sales to 15.2 percent of sales as the benefits of stronger volumes and pricing actions In our consolidated earnings were more than offset by lower joint venture income in China. In 2022, we expect revenues to be 10%, up 2% from our prior guidance.

Speaker 4

The increase in sales primarily driven by higher demand for engines and parts in North America. 2022 EBITDA is projected to be approximately 14.5%, in line with our prior guidance. In the Distribution segment, revenues increased 17% from a year ago to $2,300,000,000 a record quarter for the segment. EBITDA increased as a percent of sales to 11.2% compared to 10.5% sales a year ago, primarily due to stronger parts, Whole goods and pricing sales and pricing actions. We expect 2022 distribution revenues to be up 11% Year over year and EBITDA margins in the range of 10.5% of sales, both in line with our prior guidance.

Speaker 4

Components segment revenue decreased 2% in the 2nd quarter, primarily driven by weaker demand in China. EBITDA increased from 15.1 percent of sales to 18.2% of sales, driven by the benefits of pricing actions, which Offset material cost increases and lower warranty expense. We expect revenues to increase 3% for the year, down from an increase of 6% in our prior guidance, primarily to a lower outlook in China. EBITDA margin is expected to be 16.7 percent 75% of sales, in line with our prior guidance. In the Power Systems segment, revenues increased 5% and EBITDA decreased from 12.2% to 10.6% of sales as the benefit of stronger volumes and pricing were more than offset by higher material and logistics expenses.

Speaker 4

2022, we expect revenues to be up 8% and EBITDA is projected to be approximately 11% for Power Systems, unchanged from our prior guidance. In the New Power segment, revenues were $42,000,000 up 75% from a year ago due to stronger demand for battery Our EBITDA loss was $80,000,000 in the quarter as we continue to invest in the products infrastructure and capabilities to future growth and was in line with our expectations. In 2022, we still expect revenues The new Power business to be approximately $200,000,000 up 72%. Net EBITDA losses are still expected to be in the range of $290,000,000 for New Power, also unchanged from our prior guidance. As Jen mentioned, we are maintaining our 'twenty two expectations of company revenues to be up 8% Our EBITDA margin is approximately 15.5 percent of sales.

Speaker 4

This guidance excludes expenses outside of the normal course of business associated with the separation of the filtration business, the pending acquisition of Meritor or the indefinite suspension of our operations in Russia. We expect earnings from joint ventures to decline 25% in 2022, excluding the impact of suspension of our business in Russia, And this is down from our prior guide of a decline of 20%, due to continued weakness or further weakness, in fact, in the China truck market. We are projecting our effective tax rate to be approximately 21.5% for this year, excluding discrete items. Capital expenditures were $147,000,000 in the quarter, up from $125,000,000 a year ago. We still expect that our full year capital investments will be in the range of $850,000,000 to $900,000,000 We returned $240,000,000 to shareholders through dividends and repurchase of shares in the 2nd quarter, bringing our total cash returns to $758,000,000 for the first half of the year.

Speaker 4

We still anticipate returning approximately 50% of operating cash flow to shareholders in the form of dividends and share repurchases. While high inflation and rising global interest rates present risks to global economic growth, we do not experience any significant changes in aggregate demand from our customers Over the past quarter, our focus remains on raising financial performance cycle over cycle in our core business, While investing in technologies that will deliver future profitable growth, including in new markets, new applications and with new customers. We continue to advance our strategy in the second quarter, delivered record quarterly revenues and earnings And recently announced an 8% increase in our quarterly cash dividend, the 13th straight year of dividend increases. Thank you for your interest today. Now let me turn it back over to Chris.

Speaker 1

Thank you, Mark. Out of consideration to others on the call, I would ask that you limit yourself Operator, we're ready for our first question.

Operator

At this time, we will be conducting a question and answer session. A confirmation tone will indicate that your line is in the question Our first question is from Jerry Irvish with Goldman Sachs. Please proceed with your question.

Speaker 5

Hi, good morning, everyone. And Tom, Jeff, congratulations.

Speaker 3

Thanks, Terry.

Speaker 5

So Tom, over those 70 earnings calls, I just want to add some rough math too. So the earnings power of Cummins is up about 7 fold. So congratulations It's you and the team here.

Speaker 6

Thank you, Chip.

Speaker 5

I'm wondering if you could just talk about the supply chain environment. You folks are sending a lot more via airfreight than you do in a normal environment. I'm wondering if you could just flesh that out for us, What proportion of your shipments in our fair freight versus in a normal environment? And how should we think about Whenever demand does slow, what decremental margins might look like given the step down that we'd see in expedited freight in that environment?

Speaker 3

Great. Thanks, Jerry. Yes, we continue to experience an environment where supply chain is limiting our production in most of our markets. And as you've seen, the team here has worked really hard to navigate that and continue to deliver as much product as we can to our customers who are also experiencing issues. Some of those issues have lessened.

Speaker 3

We continue, however, to experience constraints, in particular, in the electronic Space microprocessors and other electronic components. We've seen improvement in our premium freight and Also are closely monitoring what's going on with the standard freight rates. So while we have some improvement off Each was still running at high levels as we continue to navigate disruptions caused by combination of supply constraints and COVID related disruption.

Speaker 4

And then you Go ahead, Jerry.

Speaker 5

No, no, please go ahead, Martha. I was just going to ask you if it's

Speaker 4

Well, at one point last year, we were running probably Four times the normal level of premium freight and that's come down. It has been that we've seen sequential improvement over the last 3 or 4 quarters, but we're still running 2x to 3x kind of extra cost right now. And then you'd asked about debt to decrement margins, Jerry, in the event there's a slowdown. What I would say to you is, We have to embrace these cycles when they come. We have a very experienced team that's navigated through several of them.

Speaker 4

We're very Proud of our record of raising cycle over cycle performance at the peak and trough. I can't give you exact decremental margin, But know that we will accelerate our plans As and when the next cycle comes. That's all I can say really at this point.

Speaker 5

Got it. Thanks, Mark. And just lastly, normally Your margins tend to be down in the Q3 versus Q2 seasonally. I'm wondering, given the supply chain dynamic that you have here, could we actually see Margins clap up for you folks sequentially depending on how supply chain performs.

Speaker 4

I think the biggest challenge in the second half, well, it's baked into our guidance is that we see a drop off in earnings in China. We typically see About a 25% to 30% lower JV income in the second half of the year, and we're projecting that again. You've heard from some of our important customers what their trajectory looks like on the top line going into the Q3. Yes, there's still a lot of moving parts. There's still a lot of challenges we're working through.

Speaker 4

We've maintained our full year guidance. Slightly behind the EBITDA percent for the full year through the first half of the year, but we're on track. Not expecting extraordinary

Speaker 1

We have a next question from the operator.

Operator

Yes. Our next question is from Tim Thein with Citigroup. Please proceed with your question.

Speaker 7

Yes. Thank you. Good morning. And hey, Tom and Jen, congrats to you both.

Speaker 3

Thank you, Tim.

Speaker 7

Yes. And Tom, I trust you'll be dialing into that 71st call just so you can hear Chris read through that legal disclaimer.

Speaker 8

No

Speaker 2

question about it.

Speaker 7

Yes. So, yes, Tom, maybe one for you just at higher level. Obviously, you've observed a number of cycles through Your time. And I'm just curious, you mentioned that you guys weren't seeing anything of note, But obviously, there's a lot of broader concerns regarding the potential for either a recession is here or on our doorstep. And I'm Just curious, as you have conversations with customers, what would you be alerting the team For in terms of signposts or indications of if that begins In fact, come through, where would you be watching and what kind of, again, signals would you be kind of putting the team for?

Speaker 2

Hey, thanks, Tim. And I have been through a lot of these and this is an unusual one. There's no question about it. But I'm going to flip it back to Jen just because in terms of conversations with customers about where they are, Jen has actually been doing more of those than I have. But I would say that, I just kind of repeat the point Mark made.

Speaker 2

It is an unusual period and it has been an unusual cycle. And I think our team has Continue to figure out ways to adapt to it, and I think we will hear too. But make no mistake, a lot of us in the industry are trying to figure things out That we haven't faced before, labor shortages, part shortages over extended periods and things like that, like you've heard from Jen. But let me just turn it back to her for Kind of your perspective, Jen, on the customers and what they're looking at with the product cycle.

Speaker 3

Yes, great. Thanks, Tom. As Mark and Tom have said, we're in a cyclical business. We have a strong team that understands how to navigate and manage over the cycles and use the cycles to strengthen the business and emerge stronger. And this is not a typical cycle because coming out of the cycle because coming out of the COVID-nineteen early part of COVID-nineteen pandemic, we have seen really strong demand that has been constrained by supply chain constraints across the industry.

Speaker 3

Demand as well as customers have been using these products heavily and had higher parts demand as they work to keep them running. So despite the fact that We do see some decrease in spot rates, some reduction off of Really high indicators. When I talk to customers and look at some of these backlogs and freight activity is still very strong and they still would like us to supply more than we're able to. So the conversations are all focused on Where are we at with supply constraints and can we ship more to them? We continue to monitor those Overall indicators at this point, again, end customer demand is strong, aftermarket demand is strong, used truck prices continue to be elevated and also recall with higher fuel prices, these more fuel efficient next Next generation products are attractive to customers and so we'll continue to stay close to it and monitor what happens.

Speaker 3

But right now, we see supply being the constraint through this year outside of

Speaker 7

China. Got it. All right. I will move it along. Thank you both for the time and best of luck.

Speaker 3

Thanks, Dan. Thank

Operator

you. Our next question is with Jamie Cook with Credit Suisse. Please proceed with your question.

Speaker 9

Hi, good morning. Congrats, Jennifer, and congrats, Tom, and thank you for all the support throughout the years. Wish you well, and I'm sure you're going to miss all our very insightful questions on earnings call. I guess, Jennifer, my first question Understanding that you and Tom have been working closely together and you co the Destination 0 strategy you both obviously worked close But sort of every CEO puts their own sort of stamp on a company. So just sort of As you're thinking about leading the company sort of maybe nuances or differences relative to Tom or how you're thinking about the company just slightly differently?

Speaker 9

And then I guess just my second question, and I'll Jennifer, this is for you or for Mark, it's probably unfair, but I'll ask Understanding you can't control a downturn if we have one, but I feel like coming downturn Theoretically in 2023 could be different as you think about, one, we have we're adding Meritor, you have market share wins. I guess we won't Have the filtration business and maybe China is actually okay in this downturn because we're so the markets are depressed. So Any way you want to sort of put buckets around how that could be additive to a normal downturn? Thanks. Sorry for an unfair first

Speaker 3

Thank you, Jamie. Appreciate the question. As you noted, Tom and I have developed the Destination Xero strategy together have been a member of the Cummins leadership team now for more than 7 years as Chief Technical Officer, leading the components business, Chief Operating Officer and now CEO. So the strategy, the focus of the company going forward remains the same. The commitment to all of our stakeholders to deliver strong results, to really create strategic advantage to our people.

Speaker 3

We'll continue. I think the big Difference is just that as we continue to operate in this evolving environment, paying attention to how markets execution and what does that mean for different parts of our business as our strategy evolves and paying attention to a more dynamic environment, and that's one of the reasons why I've kept the President Role in addition to CEO is to stay close to the businesses as we focus not only on continue to refine that strategy, but really driving strategic execution and delivering results. As it relates to next year, we'll of course talk Later, more about next year, you've heard us say we see supply being the limiting factor through this year. Backlog is strong. China is down and will improve, right?

Speaker 3

There A lot of opportunity to improve and Cummins is very well positioned. Our products are performing very well. The customer Demand for that product is strong. We have new partnership opportunities in the core business and in new power, and we'll continue to invest and products that will position the company for the future and manage through the cycles as they come.

Speaker 2

And by the way, I'll miss you, Jamie.

Speaker 9

No, I mean, that's fine. I was just wondering too. I mean, the incremental less there's more opportunities on

Speaker 4

I I think you just described most of my work plan from Torman or Jeff. We will be working hard on all of those. Thank you.

Speaker 3

Thank you.

Operator

Jamie. Our next question is from Steven Fisher with UBS. Please proceed with your question.

Speaker 10

Thanks. Good morning. I'm not sure if I missed this, but what was your first half aftermarket growth? I know you raised the full year to 15% to 20% from 15%. Just kind of wondering what you're assuming for kind of the second half Trajectory within that guidance, if some of the market activity is kind of slowing that down at all?

Speaker 1

Yes, Steve, it's Chris. We experienced about that same level in the first half and we expect it to hold throughout the year. I think that the demand is still very high, Particularly in the heavy duty market in North America as well as the global power systems markets, mining, oil and gas have Strong demands there for aftermarket parts, rebuilds and whatnot. So we expect that to hold certainly through the remainder of 2022.

Speaker 4

Yes. Q2 was a little stronger than Q1, but Tom and Jen mentioned, there have been some supply chain challenges. So those have eased a little bit and demand remains strong.

Speaker 10

Okay. And then as you're kind of discussing with Tim before, I mean, it seems like we're I guess I'm just curious how that is affecting any of your Investment plans or strategic actions, if that's changing the timing of anything?

Speaker 3

Yes, good question. So obviously, we've moved forward with our JBS acquisition and Meritor will complete this week. We're continuing to make these

Speaker 4

key investments

Speaker 3

in the future, and we are still in the In the future, and we are still in the process on the separation of our filtration business as we've disclosed previously and monitoring the environment as that continues.

Speaker 4

The other thing I'd add is, we're just As you'd imagine, we're not just waiting around for changing economic conditions. An important part of how we've grown the earnings over time It's just like a continual focus on trying to drive efficiencies in everything that we do. It doesn't always make the headlines, but Almost every aspect of our work, we're looking for efficiency, better output. So we're always looking for those types of

Operator

Our next question is from Rob Bardenheimer with Melius Research. Please proceed with your question.

Speaker 11

Hi. Good morning and congrats to both of you.

Speaker 3

Thanks, Rick.

Speaker 11

My question is really on New Power. There's a lot that's changed in the world in the last 6 months. Your revenue trends are pretty good. And I'm curious if you have any comments on competitive position within electrolyzers, whether you see it solidifying or standing. You guys have the wherewithal to invest and presumably that pays off somehow.

Speaker 11

And then just whether the outlook into, I guess, 23, 24, I'm not sure how far along your backlog extends is inflecting upwards as the world reevaluates its energy mix? Thanks.

Speaker 3

Yes, great question. So we did we delivered the highest revenue in the second quarter to date from our Power business at $42,000,000 and made a lot of progress across all parts of the business. So you saw announcements of new partnerships on on fuel cells both on and off highway where we think long term that the market will move, continuing to make progress and having lots of conversations on the electrolyzers and demonstrating the capability of our PEM electrolyzer solutions there. And we believe as we demonstrate some of those larger installations of PEM electrolyzer that the market is going to increasingly move towards that solution and We're well positioned competitively. The market is lumpy at this point, and a lot of our focus is on building up capacity and scale to meet the demand.

Speaker 3

And so we will Amy and I will continue to be talking about what are those key milestones that we see in the market and in our scale up activity and how that's evolving, we still feel very optimistic. And with this energy Challenge that we see in the global world expect that the focus and interest in green hydrogen will continue to grow. And lastly, with the Meritor acquisition. That's another key component that we think positions us well in the electric powertrain and we'll be building on the business that we have and very complementary to our existing to our existing new power business and an electrified powertrain. So overall, well positioned for the future with new power.

Speaker 11

Thank you. That's a comprehensive answer. Any inside track on whether the Inflation Reduction Act gets passed? And then you We benefit obviously from green hydrogen with that. I don't know if there's any production or any other obvious benefits that you saw in that potential bill and I will stop there.

Speaker 11

Thank you.

Speaker 3

Yes, great. So we're hopeful that the Inflation Reduction Act will get passed. It has many key provisions that we think are important for advancing lower carbon solutions and it fits well with our Destination 0 strategy. It's really critical that there's investment to build out infrastructure and to make these technologies more affordable as they scale and advance. So we are have been active in advocating for some of the key energy provisions in that act and we'll continue to do that as our Congress considers it.

Operator

Thanks, Question is from Matt Elkott with Cowen. Please proceed with your question.

Speaker 7

Good morning. Thank you. So After the initial COVID shutdowns in China, we saw a pretty record recovery in the remainder of 2020 and into 2021. I understand we're highly unlikely to see anything like that after the current lockdowns. But do you have any sense of how things could play out when Or if China moves fully past lockdowns like most of the rest of the world has and Just a longer picture question related to China as a follow-up.

Speaker 7

We've seen some Western companies like some automakers JVs in China. Do you guys still see your JV model in China as the right strategy? Any updated thoughts on that would be appreciated.

Speaker 3

Yes. What happens with China COVID lockdowns is one of the big Questions that we debate a lot at this point, they continue to have this dynamic lockdown strategy and we've continued to see some smaller scale lockdowns that have been happening and operating in kind of closed loop, closed circle environments within that from a business perspective. So I don't see when and how they completely evolve out of that. We're prepared to continue to operate in that type of environment. However, We do think that that market is going to come back.

Speaker 3

It's a large market. It's an important market for us to be a part of because of its size, and we are committed to continuing to invest in the product and joint ventures that we have there, while also ensuring from a global supply chain perspective that we have resiliency in our So that we can navigate through COVID, weather disruptions and other constraints.

Speaker 7

Great. Thank you very much.

Operator

Our next question is from Noah Kaye with Oppenheimer. Please proceed with your question.

Speaker 6

Hey, thank you. And let me add to the congratulations here. And I just want to follow-up on the IRA. So obviously, there's a lot of potential benefits for Cummins in this legislation. But among them, you could be looking at Up to a $3 per kg production tax credit for green hydrogen.

Speaker 6

And obviously, there's been kind of on again, off again For the last couple of years, have to imagine that some scenario planning has played out in some of these potential customer discussions. So At this point, is it possible to actually dimension the magnitude of the opportunities domestically that might pencil out With that kind of a PTC? And then how quickly do you think you can move to convert those opportunities to revenue if it does come to pass?

Speaker 3

Yes. No, it's a great question. And within that inflation reduction act, as you noted, there is incentive for Hydrogen production, which is significant as well as incentives for other Clean vehicles and clean fuels. It's important to note that there's also incentive for things like biodiesel and renewable natural gas within that. So a lot of things that will help drive ADDvantage.

Speaker 3

We have had active conversations In recent years in Europe and growing conversations in U. S, the Bipartisan Infrastructure Bill also put Some significant investment in hydrogen infrastructure, and so we believe that this will continue to add to that and are really focused on scaling up our product and production to meet the demand that we think will be there. So it's hard for me to mention specifically to you right now. As I said, we'll continue to talk about what we see as the key milestones in that business growing revenue and growing our return from the electrolyzer business over time.

Speaker 6

Okay, thanks. And maybe one quick follow-up and there was some discussions about Preparing for a potential downturn and how you can flex down amidst that. But one variable that I'm sure you're considering it's just the investment cycle for the next step up in the emissions reduction. So How do we think about that factoring into budgeting for next year, some potential increased investment spending on the combustion

Speaker 3

So you've seen us increasing our investments In both new power and engine business as we invest in the technologies and electrolyzers and new power and also these next Generation fuel agnostic platforms in the engine business, we have the scale advantage globally to do that. Those are investments that we will continue to make and we're also looking at driving efficiency and improvement in parts of our business that can adjust with the cycle. And so we will continue to deliver on our financial commitments and strong returns through the ups and downs as we invest in those key areas for our future.

Speaker 4

Okay, great. Thank you very much.

Speaker 1

Thanks Noah.

Operator

Our next question is from Jeff Kauffman with Vertical Research Partners. Please proceed with your question.

Speaker 8

Thank you very much. And then like everybody else, Tom, thank you for your leadership and Jennifer, best of luck In the future, I wanted to focus a little bit, you discussed supply chain costs and talked a little bit about what was going on with raw If we looked at the inflationary part of cost of goods sold, how do those Costs stack up against each other in terms of how much of the increase in expense is more on the raw input side versus How much more are we spending on supply chain than we normally would? And also noting that in recent weeks months, Supply chain costs while still high have been easing, raw material costs while still high have been easing. And I'm just kind Is any of that built into the guide at this point maintaining the margins where they are?

Speaker 4

Yes, Jeff, this is Mark. So I would say this year, if you look at our costs, the material costs have been increasing. That's been the biggest single driver on the cost side. Last year, certainly the first half of the year, it was very heavy on the freight Premium freight costs, but then we started to see more inflation in materials, play out over time. So as we talked about, the premium freight Costs have come down a little bit, part of that through better coordination and management of the expenses.

Speaker 4

Material costs continue to increase at this point in time. We I would say, it's within a fairly predictable range quarter to quarter so far. Yes, 1 or 2 commodity costs Have come off the peak, but remain at fairly elevated levels. And of course, whatever changes there are in the market costs Freight and Metal Markets, those take time to work through the supply chain.

Speaker 8

Okay. Mark, back to the question though. So for the quarter, cost of goods sold was About 5% on total revenue growth of about 8%. Ex inflationary Costs, what are we looking at in terms of that raw material or the cost of goods sold inflation? I'm just trying to understand How much is kind of temporary cost inflation on materials?

Speaker 8

How much is temporary cost inflation on supply chain costs? And kind of what's the underlying rate?

Speaker 4

Let me put it like this, our material costs in the 2nd quarter increased by 1.9% of sales year over year, just a quote What is temporary and what's we're always working to make changes to products, design things, take cost out. But right now, that's a pretty high level over what we certainly pre COVID, pre this inflationary environment that is a high level of cost increases. What's temporary and permanent is very hard to say, but about 1.9% Freight costs are fairly flattish year over year, but at a very elevated level. Material cost increase, There are some pressure on some of the categories, but those are the biggest elements.

Speaker 8

All right. That's helpful. And then in terms of the guidance, I'm assuming no real change And either of those in terms of your outlook or has there been a change built into that outlook of margins maintaining?

Speaker 4

No significant change on the cost side. We've lowered our outlook for JV earnings, which is not what you're talking about, but I'm just trying to triangulate back to The overall guidance of lower JV earnings and we've got slightly stronger aftermarket revenues, particularly in North America, Which balance those balance out, but no significant changes on the other categories.

Speaker 8

Okay. Thank you very much.

Speaker 4

Thank you.

Operator

Ladies and gentlemen, we have reached the end of the question and answer session. And I would now like I'll turn the call back over to Chris Cloullow for closing remarks.

Speaker 1

Great. Thanks, Maria. That concludes our teleconference for the day. Thank you all for participating and your continued Chris, as always, the Investor Relations team will be available for questions after the call. Thanks.

Operator

You may disconnect your lines at this time. Thank you for your participation.

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Earnings Conference Call
Cummins Q2 2022
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