Alarm.com Q4 2022 Earnings Call Transcript

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Provided by Quartr
February 6, 2023

There are 14 speakers on the call.

Operator

Greetings and welcome to the Cummins, Inc. 4th Quarter 2022 Earnings Conference. At this time, all participants are in a listen only mode. A brief question and answer session will follow the formal presentation. As a reminder, this conference is being recorded.

Operator

It is now my pleasure to introduce your host, Chris Kulo, Vice President of Investor Relations. Thank you. Please go ahead.

Speaker 1

Thank you very much. Good morning, everyone, and welcome to our teleconference today to discuss Cummins' results for the Q4 of 2022 as well as the full year performance. Participating with me today are Jennifer Rumsey, our President 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 1934.

Speaker 1

Such statements express our forecasts, Expectations, hopes, beliefs and intentions on strategies regarding the future. Our actual future results could differ materially from those projected in such forward Looking statements because of a number of risks and uncertainties. More information regarding such risks and uncertainties is available in the forward looking disclosure Statements 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. During the course of this call, we will be discussing certain non GAAP financial measures, And we will refer you to our website for the reconciliation of those measures to GAAP financial measures. Our press release with a copy of the financial statement A copy of today's webcast presentations are available on our website within the Investor Relations section at commons.com.

Speaker 1

With that out of the way, I will turn you over to our President and CEO, Jennifer Rumsey to kick us off.

Speaker 2

Thank you, Chris. Good morning. I'll start with a summary of 2022, discuss our Q4 and full year results and finish with a discussion of our outlook for 2023. Mark will then take you through more details of our Q4 and full year financial performance and our forecast for this year. Last year was an incredibly exciting one for Cummins and our stakeholders.

Speaker 2

We made significant strides in our inorganic growth strategy, most notably through the acquisitions of Jacobs Vehicle Systems, Meritor and the Siemens Commercial Vehicles Business. We also navigated complex global supply chain challenges, advanced our preparation for the separation of our filtration business And transition from Tom to me as the CEO. We accomplished all of this and delivered record revenues, EBITDA And earnings per share in 2022. We did so with a focus on the exciting opportunity in front of us Decarbonization is a growth opportunity for Cummins, uniting our business and climate goals. In 2022, we launched Our long term decarbonization growth strategy, Destination 0, which includes making meaningful reductions in carbon emissions through advanced internal combustion Technologies widely accepted by the market today, while continuing to invest in and advance 0 emissions technologies ahead of widespread market adoption.

Speaker 2

As part of our organic growth strategy, we unveiled the industry's first unified fuel agnostic internal combustion powertrain platforms. And we continue to see momentum in our electrolyzer technology and green hydrogen production opportunities. Demand for our products remains strong across all of our key markets and regions with the notable exception of China, resulting in strong revenues in the 4th quarter. 4th quarter revenues totaled $7,800,000,000 Excluding the Meritor business, revenues for the Q4 of 2022 We're $6,600,000,000 an increase of 13% from the Q4 of 2021, primarily driven by increased demand in many of our North American markets. To provide clarity on the Q4 2022 full year operational performance of our business and allow comparison to our prior guidance, I am excluding the Meritor operating results and associated acquisition and integration costs.

Speaker 2

The costs related to the separation of the filtration business and the costs associated with the indefinite suspension of our operations in Russia. Mark will provide more detail on the reported results in his comments. With these exclusions considered, EBITDA was $1,100,000,000 or 16.1 percent of sales in Q4, above our guidance of 15.5% and stronger than the $705,000,000 12.1% reported a year ago. EBITDA and EBITDA percentage improved due to an increase in gross margins with Positive pricing, higher volumes, lower product coverage costs and some improvement in logistics costs, all of which offset increases in material costs. Gross margin improvement is key to meeting our long term goals of increasing the In the Q4, Meritor operating performance and financial results showed improvement and we continue to accelerate value capture Our employees have done an excellent job in integrating the Meritor operations and people within Cummins and continue to make strides in identifying cost reduction opportunities.

Speaker 2

We remain confident in our ability to achieve the $130,000,000 in Pre tax synergies we referenced upon completion of the acquisition. And in addition, we expect to deliver incremental tax synergies as we integrate the business. Excluding Meritor, 2022 revenues were a record $26,200,000,000 9% higher than 2021. Also excluding Meritor, the costs related to the planned separation of the filtration business and the impact of the indefinite suspension Of our Russia operations, full year EBITDA was $4,000,000,000 or 15.1 percent of sales, compared to $3,500,000,000 or 14.7 percent of sales in 2021. Improved volumes, better price realization And an improved supply chain environment more than offset higher compensation expenses, increased material costs and lower joint venture income for the year.

Speaker 2

EBITDA percent improved year over year in Engine, Power Systems, Distribution and Components segments. Leading the way was the Components segment, which delivered 150 basis points of EBITDA margin expansion. The Power Systems business finished 2022 with another solid quarter and delivered full year EBITDA of 12.2%, Up from 11.2% last year. The improvement in performance in this segment over the past 6 months is encouraging Our reported full year 2022 results include 5 months of operational performance for Meritor or $1,900,000,000 of revenue And $26,000,000 of EBITDA, including $115,000,000 of acquisition, integration and purchase accounting related costs. Now let me provide our overall outlook for 2023 and then comment on individual regions and end markets.

Speaker 2

Our 2023 guidance includes our expected results of the Meritor business and excludes the costs or benefits associated with the separation of the filtration We are forecasting total company revenues for 2023 to increase 12% to 17% Compared to 2022 and EBITDA to be 14.5% to 15.2% of sales, Driven by the inclusion of a full year of sales from Meritor, continued strength in the North American truck market, improved demand in power generation markets, Overall pricing improvement and slow improvement in the China on highway markets. Industry production for heavy duty trucks in North America is projected to be 260,000 to 280,000 units in 2023, A range of a 5% decline to 2% improvement year over year. In medium duty truck, we expect the market size 125,000 to 140,000 units, flat to up 10% from 2022. We expect our deliveries in North America Continue to outpace the market as the engine partnerships we announced in 2021 continue to phase in. Our engine shipments for pickup trucks in North America are expected to be 140,000 to 150,000 including joint ventures to increase 7% in 2023.

Speaker 2

We project a 15% to 25% improvement in heavy and medium duty truck demand And 10% to 20% improvement in demand in the light duty truck market coming off the low market levels in 2022. Industry sales of excavators in China are expected to decline 25% to 35% in 2023 as the market Adjust to new emissions regulations and digest the inventory on hand. We are watching the situation in China closely With ensuring the safety and well-being of our people as our first priority, the change in the country's COVID lockdown policy could positively impact our operations in Guidance assumes a slow recovery in 2023. In India, we project total revenue, including joint ventures, to be up 1% in We project our major global hydrospire markets to remain strong in 2023. Sales of mining engines are expected to be down 5% to up 5%, dependent upon the trajectory of commodity prices and supply chain improvement.

Speaker 2

Demand for new oil and gas engines is Expected to increase by 15% to 25% in 2023, primarily driven by increased demand in North America. Revenues in global power generation markets are expected to increase 10% to 15%, driven by increases in non residential construction and improvements in the data center market. In New Power, we expect full year sales to be $350,000,000 to $400,000,000 more than doubling our 2022 revenues. We have a growing pipeline of electrolyzer orders, which we expect to convert to backlog and to be delivered over the course of the next 12 to 18 months. At the end of the Q1 of 2022, we shared that we had reached the milestone of $100,000,000 in electrolyzer backlog.

Speaker 2

This tripled to $300,000,000 at the end of 2022, demonstrating the strong momentum in this market. With demand continuing to rise, we are focused on adding capacity for electrolyzer production. During 2022, we announced Several capacity expansion investments and expect to have more than 2 gigawatts of scalable capacity in the 2024 to 25 timeframe across Europe, North America and China. Additionally, we will continue to deliver battery electric and fuel cell As mentioned, Meritor results are included in our overall guidance for 2023. We are continuing to drive improvement in our margins post acquisition and expect Meritor to be accretive to earnings per share in 2023.

Speaker 2

We will continue to provide updates on the progress of our value capture initiatives, which will be focused on the portion of the business within our Components segment. Within Components, we expect Meritor to add $4,500,000,000 to $4,700,000,000 in revenue in 2023 with EBITDA margins in the range of 10.3% to 11%, An improvement from the comparable 2022 EBITDA margin of 7.2%. The electric powertrain portion of the Meritor This has been integrated within the new power portfolio with projected 2023 EBITDA losses of $55,000,000 included in the overall guidance for that segment. In 2023, we anticipate that demand will remain strong in most of our key regions and markets, especially in the first half of the year. While some macroeconomic indicators have weakened in recent months, we have not seen a significant change In summary, we expect full year sales growth of 12% to 17% and EBITDA to be 14 Very strong incremental margins within our core business and improve the margins of the Meritor business, while continuing to invest in our new power business.

Speaker 2

Having effectively managed through the challenges of the past couple of years, we expect improved performance in 2023 and are well positioned to invest in future growth, while continuing to return cash to shareholders. Now, let me turn it over to Mark, who will discuss our financial results in more detail.

Speaker 3

Thank you, Jen, and good morning, everyone. There are 4 key takeaways from my comments today. First, we delivered strong results in the Q4 of 2022, Exceeding our own projections for revenue and EBITDA from 3 months ago, and we delivered stronger margins in engines, components, Distribution and Power Systems compared to a year ago. 2nd, we continue to make good progress on the integration of Meritor, and we remain on track to deliver $130,000,000 of pre tax synergies by the end of year 3. We returned $1,200,000,000 to shareholders in 20 2 in the form of dividends and share repurchases.

Speaker 3

Finally, demand for our products remains strong, supporting increased revenues in our core business and new power And growth in EBITDA and earnings per share in 2023. Now let me go into more details on the 4th quarter. 4th quarter reported revenues were $7,800,000,000 and EBITDA of $1,100,000,000 or 14.2 percent. For the full year, revenues were $28,100,000,000 and EBITDA $3,800,000,000 or 13.5 percent of sales. Also in the Q4, Meritor generated $1,200,000,000 of revenue, dollars 60,000,000 of EBITDA After incurring $27,000,000 of acquisition and integration related costs.

Speaker 3

Our 4th quarter results also included $19,000,000 of performance for Meritor, yielding $1,900,000,000 of revenue, dollars 26,000,000 of EBITDA, reflecting $115,000,000 of acquisition integration and purchase accounting related costs. We'll all look forward to a cleaner set of Our full year 2022 results also included $81,000,000 of costs related to the planned separation of the filtration business $111,000,000 of costs related to the indefinite suspension of our operations in Russia. To provide clarity on the Q4 2022 full year operational performance of our business and allow comparison to our I am excluding the Meritor results and the separation of filtration And the indefinite suspension of Russia in my following comments. But hopefully, you're clear after my Earlier remarks about the magnitude of those each of those items. 4th quarter revenues were $6,600,000,000 an increase 13% from a year ago.

Speaker 3

Sales in North America were up 25%, driven by continued strong demand in truck markets. International revenues decreased 1% with strong demand for power generation and mining equipment in most markets, offset by declines in China And of course, the impact of our suspension of our operations in Russia. Currency movements negatively impacted sales by 4% 705 or 12.1 percent a year ago. EBITDA increased by $359,000,000 due mainly to improved pricing, Higher volumes, lower product coverage expenses, all of which contributed to stronger gross margin performance and more than offset Now let's go into our income statement a little more detailed by line item. Gross margin of $1,700,000,000 26.3 percent of sales increased by $420,000,000 or 3.80 basis points From a year ago, selling, admin and research expenses increased by $52,000,000 or 6% due to higher compensation and research costs as We continue to invest in new products and capabilities to support future profitable growth, particularly in the Engine and New Power segments.

Speaker 3

Joint venture income decreased $28,000,000 due to lower demand for trucks and construction equipment in China. Other income was 44,000,000 dollars an increase of $13,000,000 from a year ago, primarily due to higher pension income. Interest expense increased $8,000,000 largely driven by the financing costs associated with the acquisition of Meritor. The all in effective tax rate in the 4th quarter was 17.2%, including $52,000,000 or $0.36 per diluted share Favorable discrete items. All in, net earnings for the quarter was $631,000,000 or 4.4 $3 per diluted share, up from $394,000,000 or $2.73 a year ago.

Speaker 3

Operating cash flow in the quarter was an inflow of $817,000,000 including Meritor and $85,000,000 Higher than the Q4 last year, driven primarily by higher earnings. For the full year, 'twenty two revenues were $26,200,000,000 or up 9% from a year ago with sales in North America up 18% And international revenues down 2%. Currency movements negatively impacted revenues for the full year by 2%. EBITDA was $4,000,000,000 or 15.1 percent for 2022 compared to $3,500,000,000 or 14 point Partially offset by increased investment in New Power and more than $100,000,000 of mark to market losses on investments That underpin some of our non qualified benefit plans. All of that ran through our operating EBITDA.

Speaker 3

All in net earnings were $2,200,000,000 $15.12 per diluted share compared to $2,100,000,000 or $14,600,000 per diluted share a year ago. Full year cash from operations was $2,000,000,000 down from $2,300,000,000 primarily due to higher inventory levels. Capital expenditures in 2022 were $916,000,000 an increase of $182,000,000 from 2021 As we continue to invest in new products and capacity expansion critical for future growth. We returned $1,200,000,000 of cash to shareholders or 63% of operating cash flow in the form of share repurchases and dividends last year. Now moving on to our guidance for 2023, which includes Meritor and thankfully reduces the number of exclusions we'll have to explain each quarter And I appreciate your patience as we work through that in 2022.

Speaker 3

We are excluding Any separation costs associated with filtration and for now we're assuming that the operating results of filtration are in our guidance for the full year 2020. 3, as the timing of that separation is not yet determined. We expect Meritor to add $4,500,000,000 to $4,700,000,000 of revenue in 2023. We currently project 2023 company revenues, including Meritor, to be up 12% to 17% And company wide EBITDA margins expected to be in the range 14.5% to 15.2%. In 2023, we expect revenues for the engine business will be flat to up 5%, driven by continued strength in North American truck market And a modest recovery in China.

Speaker 3

2023 EBITDA is projected to be in the range of 13.8% to 14.5% compared to 14.4% in 2022. We expect distribution revenues this year to be up 2% to 7% And EBITDA margins to be in the range of 10.3% to 11% compared to 10.5% In 2022, including Meritor, we expect 2023 components revenues to increase 28% to 33% EBITDA margins in the range of 14.1% to 14.8% compared to 15 point 0% in 2022. In 'twenty three, we also expect Power Systems revenues to be up 5% to 10% Due to higher demand for oil and gas, engines and power generation equipment globally, EBITDA there is projected to be Between 13% 13.7%, up from 12.2% of sales last year. And Also this year, we expect new power revenues to increase to the range of $350,000,000 to $400,000,000 We expect new power net losses to be in the range of $370,000,000 to $390,000,000 as we continue to make targeted investments capacity technology to support growing customer demand. Our goal remains to achieve breakeven EBITDA In 2027, our effective tax rate this year is expected to be approximately 22%, excluding any discrete items.

Speaker 3

Capital investments will be in the range of $1,200,000,000 to $1,300,000,000 this year. We remain committed to our long term goal of returning 50 percent of operating cash flow to shareholders over time and have accelerated cash returns to shareholders in recent years above that 50% goal When we have generated more cash than required to support our strategy. In 2023, we will prioritize cash towards dividends and debt reduction Following the acquisition of Meritor, while continuing to invest to deliver future profitable growth. Having a strong balance sheet is an important asset as we navigate through economic cycles and sustain our investments in To summarize, we delivered record sales, strong full year earnings in 2022, While managing through supply chain challenges and a very weak demand environment in China. As we move through 2023, Demand for our products remains strong in most of our core markets with good visibility into the first half of the year.

Speaker 3

We'll continue to focus on raising margins in our core business, driving improvements in the performance of Meritor, generating strong cash flow And investing in the products and technologies that position us to lead in the adoption of new technologies and penetrate new markets through our new power business. Thank you for your interest today. Now let me turn it over to Chris.

Speaker 1

Thank you, Mark. Out of consideration to others on the call, Operator, we're ready for our first question.

Operator

Thank you. The floor is now open for questions. As just mentioned, please limit yourself to one question and one related follow-up At the time, to allow everyone the opportunity to ask questions. The first question today is coming from Jerry Revich of Goldman Sachs. Please go ahead.

Speaker 4

Hi, good morning, everyone.

Speaker 5

Good morning, Jerry. Good morning, Jerry.

Speaker 4

I know it's early post the acquisition of the Siemens Propulsion Systems and Maritor, but I was wondering if you could just comment on what the acceptance has been of the products in the marketplace Post Cummins ownership, what's the pipeline from the developments look like? How is that cross selling Working out versus what you folks had expected before acquiring ManAssets? Thanks.

Speaker 2

Yes. Thanks, Jerry, Yes, we are right now really focused on integrating the Meritor business, the Siemens commercial vehicle business and the investments We were already making within New Power and having a number of conversations with our customers on how we bring that together to deliver We're seeing growing opportunities as we have relationships at a senior more strategic level with these customers to grow our business going forward. It's really early days at this point, so we'll continue to talk about that as we bring those businesses together.

Speaker 4

Sounds good, Jennifer. Thanks. And Mark, can I ask in terms of the pricing that you're expecting in 'twenty three within the outlook? And if you could just touch on The logistics costs embedded in the guide as well, you folks have been running pretty hot to hit deliveries in 'twenty two. I'm wondering to what extent is that A tailwind within the guidance?

Speaker 3

Yes, we've got about 2% of price cost benefit embedded in the That's the biggest single driver of margin improvement.

Speaker 4

Great. Thanks.

Operator

Thank you. The next question is coming from Jamie Cook of Credit Suisse. Please go ahead.

Speaker 6

Hi, good morning. I guess two questions. Just given the concern on the macro out there, can you guys speak to by business line where you see the most visibility or where demand trends you see sort of weakening? And then I guess on the engine margin guidance, I guess I would have thought margins would have been a little better in the implied guide just given maybe price cost going away, China improving. So if you can just help me bridge 2023 to 2022 engine margins, what's implied?

Speaker 6

Thank you.

Speaker 2

Great. Thanks, Jamie. Let me speak first to what we're seeing in the markets. And we're we of course are paying attention to some of these Macroeconomic trends, if you take just the North America truck market as a starting point, while there has been some decrease in spot rates, we Still continue to see healthy freight activity and strong backlogs out through the first half, which gives us confidence that The market is going to remain strong certainly through the first half of the year. And it's important to note, it's just not been a typical cycle for us because for the last two years, We've been undersupplying to the market demands.

Speaker 2

They've been using that equipment. We're seeing that reflected in very high aftermarket demand, which continues and these new trucks provide efficiency benefits to the fleet. So we continue to expect strong North America Truck market. In the Power Systems business, again, we have a healthy backlog of products and strong demand across Many of our markets mining we're forecasting to remain around flat, but growth in power generation, Growth in the oil and gas business. And so we're feeling pretty confident about that as well.

Speaker 2

The biggest uncertainty is really around China. And as I said in my comments, we do project some slow recovery throughout 2023 With the lift of the stringent lockdowns that they had in the last couple of years in December, we expect that that may Result in economic strengthening and certainly less operational disruption, but we're still monitoring what happens with the COVID Waves there, is there any government stimulus into the economy? We feel really well positioned there. We've launched our NS-six Products which we think will enable Cummins to grow our position in the market. We've launched the automated manual transmission There we've got a new natural gas platform, so we're really well positioned as China continues to strengthen and just uncertainty on exactly what the shape of that will look like.

Speaker 2

I'll let Mark talk about the margin question.

Speaker 3

Yes, I think the main thing on the engine business margins is that we haven't got building a very strong And then the other piece that you didn't mention, Jamie, is that we've got fairly sustained investments ahead of us over the next couple of years because we're updating Several of our platforms, we've won a lot of external business and we've got to meet future emissions regulations. So that's the only other element that's Running through the engine business that may not be obvious from the outside, but otherwise, yes, we'll expect them to do well if markets continue to be strong.

Speaker 6

Okay. Thank you, Jennifer. Thanks, Mark.

Speaker 3

Thank you.

Operator

Thank you. The next question is coming from Stephen Volkmann of Jefferies. Please go ahead.

Speaker 7

Hi, good morning, everybody. Maybe just following on the engine margin question, Mark. Given what you just described around increased spending, R and D, etcetera. Should we think about sort of flattish incremental margins over the next few years? Or Can it still be better than that if we have some volume?

Speaker 3

I think it can definitely be better than that. We're still Battling some inefficiencies here and there, Steve. We're still expecting to have aftermarket growth over time. So no, we're not locked Into these margins, I was just trying to be clear on what the underlying factors. I've seen a few comments around engine business margins, but no, I think they can go Hi.

Speaker 3

Getting China up, which is the world's biggest truck market, I know the earnings come through JV. We had the lowest market in a decade. And we think we still got more share to gain there. We've got more content in the components business. So if I sit What could be the one thing that could move that could change our guidance most clearly, I would agree with Jen, it would China right now, we don't have visibility.

Speaker 3

People are more enthusiastic, but the activity hasn't yet materially picked up. So that would be One important factor.

Speaker 7

Great. Understood. And then my follow on, maybe a bigger, broader question, but as we Start very early days, but we start to think about the 2027 emissions regulations. Do you guys feel like you have a line of what you need to do technically to get there. We're starting to hear that this is going to be sort of the biggest emission hurdle ever and that some people may have trouble getting there or it maybe have some massive costs associated with it, which has some Implications for pre buys and maybe whether people do it themselves or outsource it to you, just Your big picture thinking on 2027 and how that kind of plays through?

Speaker 2

Yes. We're focused on continuing to meet More stringent regulatory requirements than do so with products that will provide benefits to the environment and exceed our customer needs. We now have clarity on the EPA 2020 7 NOx regulations that happened late last year, and they finalized that standard at a 0.035 gram NOx and our intention is to offer a full product Line up with our new fuel agnostic engine platforms to meet that regulation and we're finalizing our product plans right now With our customers on those, but we really feel well positioned to invest in really as a part of our Destination 0 strategy, Reduce CO2 and NOx impact to the environment and offer products market leading products to our customers with that regulation.

Speaker 7

All right. Thank you, guys.

Operator

Thank you. The next question is coming from David Raso of Evercore ISI. Please go ahead.

Speaker 8

Hi, thank you. The China guide, the up 7%, I assume that includes consolidated and JV revenue, sort of how you usually Yes. Can you update us on the mix of your end markets? It feels like the consolidated Off highway, the construction exposure you have that shows up in the P and L more so than JV and the JV is more the on highway. I'm surprised with the mix, because that construction business at this stage must be pretty small after the declines we've seen.

Speaker 8

So to have truck up double digit for China for heavy and light, even though the excavator is down a lot, The mix would suggest you'd be up more than 7 if truck is up double digit and that now relatively small construction business is down. Are there other businesses keeping it only at 7? Is there a share comment there? Just trying to understand why only up 7 with that China end market

Speaker 3

I don't think there's anything significant in there, David. I mean, obviously, whether it's Consolidated or unconsolidated trucks probably 70% plus when you add up all of our markets. So Truck does better, we'll be up more than 7%. If it doesn't, we won't. I think, for components, that's all consolidated revenue.

Speaker 3

That's Almost entirely on highway. It's really the engine business, that has the off highway business And then, yes, I think Power Systems has been pretty strong last year in China. It's probably been the To what we've seen in every other market, but there's no big change in dynamics.

Speaker 2

Just on your share, we expect to continue to grow our share in the China market with the launch of the NS-six product, so that's assumed in our guidance.

Speaker 8

I'd even think with some of the transmissions as well. So I'm just trying to understand like Photon is struggling more than I would have thought. It's still barely making money now for 2 quarters in a row. Is there something about that dynamic we should be more sensitive to on the margin recovery in China in the JV because of Photon?

Speaker 3

No, we did get some sizable tech fees and other things in the early part of last year, which kind of helped prop That's the wrong word. We were entitled to those based on product launches, but no, I don't think there's anything significant there.

Speaker 8

And I'll hop off just one A modeling question. If you take the interest expense in the 4th quarter and annualize it, it's 3.48%. You mentioned there's debt reduction, but your guide is 3.80. What are we assuming for interest rates from the Q4 on to have up interest expense, but you're targeting debt reduction?

Speaker 3

Right. So I think the answer to that is we'll need to keep working that down. I think we've got some floating rate exposure. It's not all fixed. And probably the debt reduction will come in the second half of the year, but let me come back to you on that.

Speaker 8

All right. Thank you very much. I appreciate it.

Operator

Thank you. The next question is coming from Rob Wertheimer of Melius Research. Please go ahead.

Speaker 9

Hi. I know it's still early days, but you're starting to see some ramp in electrolyzers. And I guess there's obviously a lot of So I wonder if you have Any thoughts on when you see clarity? Any thoughts on where gross margins might trend? Maybe you're still heavily investing, but the gross margins are improving?

Speaker 9

Or just your thoughts on how the curve

Speaker 2

Yes. The electrolyzer business is really going to drive the majority of our Progress towards breakeven in 'twenty seven for New Power and the growth aspirations that we shared for 2,030. And so we During that timeframe to scale up the product, the supply chain and manufacturing, and continue to see growing backlog And conversion of orders into revenue. And so through that time period, you'll see margins going positive and improving the exact Margin structure of that business is still unclear. There's not a lot of Suppliers in the market and we expect demand to be quite strong through that time period.

Speaker 2

So I'm optimistic on what margin structure for the business will look like, but obviously

Speaker 1

Yes. Rob, one thing I'll add is For the gross margin on a project basis, we're at gross margin positive last year, which is a good early indicator. We have other costs that are going into for Capacity expansion and other things that obviously offsets that, but it's a good indicator that we're on the right path for profitability as we move forward with more volume.

Speaker 9

Okay, that's helpful. Thank you. And obviously, there's just still a lot of build out in manufacturing and supply chain. So Do you have a sense as to how you stack up competitively on either design cost or I guess you have a lot of advantages in manufacturing as you build out and I'll stop there.

Speaker 2

I mean, one of the advantages we have here is we're able to leverage our existing footprint and capability that we have as a part of the broader comment. So you saw us announce Recently, we plan to use our Fridley manufacturing facility for electrolyzer production in North America. So We are tapping into that strength we have in our footprint and supply chain capability to help build out Profitable both product as well as supply chain, and that's an advantage that I think Cummins has here.

Speaker 5

Thank you. Thank you.

Operator

The next question is coming from Nicole DeBlase of Deutsche Bank. Please

Speaker 5

go ahead.

Speaker 6

Yes, thanks. Good morning, guys.

Speaker 1

Hi, Nicole.

Speaker 6

Maybe just on the distribution margins, it looks like You guys aren't expecting margin expansion there even though sales are up 2% to 7%. I guess, what is the reason for that?

Speaker 3

I think there's a little bit of improvement baked into the guidance, but we've got a pretty track record of improving. There's no structural Impediments to growing margins over time. It's a range, so under the different revenue scenarios, there's some variation, Nicole. But over the time, we The margins to keep going up.

Speaker 6

Okay, understood. Thanks. And then, I guess Power Systems stood out to me on the other side. It's just The margins look really impressive year on year in 2023. Is price cost the biggest driver of that or is there any other big drivers of the

Speaker 3

I think certainly that's been a big factor. And we've got Pretty healthy demand locked in now. So there's been a lot of focus on that business. We're being pleased with the solid results In the second half of this year, we've got a very, very strong focus on continuing to drive.

Speaker 2

For that business, it's important to keep in mind you see Very long we have a very long lead time on orders. So as costs accelerated, it took a while for us to pass on

Speaker 6

Thank you. I'll pass it on.

Speaker 5

Thanks, Nicole.

Operator

Thank you. The next question is coming from Matt Elkott of Cowen. Please go ahead.

Speaker 10

Good morning. Thank you. If you can give us a sense of how much of a growth moderation can we expect in the So it sounds like you guys are more cautious on the second half. So how much of a growth moderation are we expecting?

Speaker 3

You can roughly split our revenues 52% to 53% in the first half versus the second half, Matt.

Speaker 10

Got it. That's very helpful. And then just one follow-up on the new power front. It's been about a year since you guys announced the fuel agnostic So any update on that and the receptiveness from customers in your conversations? And also, I think back in August, PACCAR announced that they're using your new natural gas engine.

Speaker 10

So is there anything new on that front as well?

Speaker 2

Yes. So the fuel agnostic platform, just to clarify, that's being developed as a part of our engine business. And as I mentioned earlier, we'll launch a full Lineup in North America of that product as a part of the 27 EPA regulation. As you've seen, PACCAR It's integrating and plans to introduce the natural gas version and we have customers that are very interested in that product, including with renewable natural So we announced partnerships around that. We also announced the memorandum of understanding with Tata Late last year on the hydrogen version of that platform.

Speaker 2

And so really we see a lot of interest in those platforms both As a way to improve efficiency of diesel engines and then create flexibility to move to other fuels such as natural gas or hydrogen With the platform and really minimizing the integration, pair up that's required for customers as they move between those platforms. So we'll begin to launch those With the natural gas version here in North America in late 'twenty three, early 'twenty four and then accelerate introduction in the coming years after that.

Speaker 10

Perfect. Thank you very much.

Operator

Thank you. The next question is coming from Noah Kaye of Oppenheimer, please go ahead.

Speaker 5

Good morning. Thanks for taking the questions. Can you characterize the current mix Of investment spending in new power, just kind of give us a sense of the key buckets where you're spending. Maybe you can even give us some guidelines on how much of the CapEx for this year would be attributed to New Power? And then I think the higher Question here is, are you ready to call 2023 kind of the peak of net investment spending for the segment?

Speaker 2

So at a high level, the different categories of investment in new power, of course, there's big investments happening in electrolyzers and we talked about the growth And capacity investments that we're making there. The other buckets include investments in batteries, Other electrified components in the electric powertrain and then in fuel cells. So we're investing in both the prime roofer as well as some of the key components To position ourselves as our current markets start to move to electrified powertrains to be both the powertrain Provider as well as provide key components similar to the model we have today with Engine Business and Components. You want to talk about allocation of investments? Yes.

Speaker 5

So CapEx,

Speaker 3

Probably in the $100,000,000 to $125,000,000 range. So just under 10% of the total for The company in the new power segment, and most more of that's weighted towards electrolyzers We're of course, we're ramping up production, albeit using existing common sites where possible and appropriate. And then yes, I'd love to call the peak in new power losses. They're going to have to peak soon Because we're aiming towards breakeven in 2027 at the EBITDA level. The only caveat is if there's a significant change, should we invest in some new capabilities that aren't part of our current That's not part of our plan today, Noah, but that would be the only variation.

Speaker 5

That's helpful. And then just give us some expectations around the cadence of earnings this year. Obviously, you're guiding to EBITDA, not EPS. But Thinking about China JV modestly improving, getting better synergies captured on Meritor throughout the year, but then Maybe some offset from potential deterioration in some end markets. So just any guidepost you would give us on first half versus second half EBITDA or even EPS?

Speaker 3

No, I mean, by and large, it will go along with the revenue. Unfortunately, we had a tough Q3 in 2022, so that probably gives us the easiest comp just Kind of going through by quarter and then we started the year much stronger. So ex JV, I think we'll Have a good first half of the year. The JV will be the biggest single swing factor. When you look at our P and L, I would think In the first half of the year, maybe that helps in the second.

Speaker 3

Q3 gross margins were disappointing. We've rebounded well in here in Q4. So yes, I modestly expect first half to be stronger all in unless revenues in the second half change direction

Operator

Thank you. The next question is coming from Tami Zakaria of JPMorgan. Please go ahead.

Speaker 11

Hi, good morning. Thanks for taking my questions. So my first question is, are you expecting any synergy savings from the Meritor acquisition this year? I believe you were expecting $130,000,000 in total by year 3, so anything this year?

Speaker 3

Absolutely, yes, we're working very hard on that. Me personally, along with Many members of the Meritor Cummins team. So yes, and we'll talk about those as we go along. Yes, we're feeling confident about that one, progress towards that 130.

Speaker 11

And some of that is embedded in guidance, I'm Would that be incremental?

Speaker 3

We'll try and get as much as we can, that both helps the long term interests That business and improves the cost structure. So yes, we expect the results clearly to improve, Especially in the components segment, we're assuming that's all in for now. If we get more than happy to report We won't get more than 130 in year 1, just to be clear, that's a year 3 number, but we're making good progress.

Speaker 11

Got it. And so, I'm sorry if I missed it, but can you give some color on the embedded merit or margin expansion cadence for the year? Should it be in the guided 10 to 11 or does it ramp towards the back?

Speaker 2

Yes. So let me just reiterate the guidance that we had. Within the components business, we have $4,500,000,000 to $4,700,000,000 in revenue And EBITDA margins

Speaker 5

for the

Speaker 2

Meritor business, 10.3% to 11%, compared to in 2022 that was 7 0.2% and some of that is progress on price cost in that business operating efficiency as well as synergy cost savings.

Speaker 11

Got it. Thank you.

Speaker 3

I think you should just expect sequential improvement through this first half of the year from the Q4 levels.

Speaker 11

Perfect. Thank you so much.

Speaker 1

Thanks, Tammy.

Operator

Thank you. The next question is coming from Avi Yur Uslovic of UBS, please go ahead.

Speaker 12

Hey, guys. Thanks for taking our questions. On for Steve Fisher. Just in terms of the power generation market, can you talk a little bit more about what's driving that market We might have expected data centers weakening a little bit. It sounds like you're expecting that to be Up still again this year, but if you could just talk about some of the drivers in that market?

Speaker 2

Yes. The power generation market, really non residential construction as well as data centers. And Despite some of the announcements that you've seen from our data center customers regarding staffing levels, they continue to show interest in investing in Data centers and have demand and drive backup power demand on our products in that market. So We are still quite bullish about the opportunities there for 2023.

Speaker 3

I think it's fair to say it's pretty broad based across multiple markets, Broad parts of the economy, yes, the data centers gets a lot of attention. It is a significant individual segment, But we're seeing robust underlying demand for power generation across multiple segments.

Speaker 12

Okay. Appreciate that. Thank you. And then just in terms of the new power business, have you seen an acceleration in recent months Following the IRA, in terms of customer interest there and does That possible acceleration in the market change your view on when we could see breakeven in that business?

Speaker 2

Yes. How I would describe it is the Inflation Reduction Act and the investments around that are really going to be key to enable the adoption Rate that we anticipate it is going to drive an acceleration in hydrogen investment. The details around that investment And business definitely is going to drive growth in the hydrogen market in the U. S. Between now and 2,030 as that As those incentives come into place to both put the hydrogen production in place as well as drive adoption of some of these technologies, which today frankly just cost more.

Speaker 2

So you need those incentives in order to start to drive customer adoption and bring down the costs and make them more viable in the market.

Speaker 3

I mean, the short run, we're investing more because we're building up capacity as are others in the industry. So the faster we go in the short run could consume more cash. But obviously, we want the market to move. We expect to deliver good gross margins Once we get to this kind of investment phase. So could go faster.

Speaker 3

It's quite a long incubation period, so very different from So, yes, we're on highway engine business where we take an order and then typically we're shipping in a few weeks and it's not been that typical in the last 12 months versus sometimes more than a year between headline announcements to actually putting We are encouraged, strong adoption for our technology and yes business Doing well on the business development side in Newhall.

Speaker 12

Understood. Appreciate the time. Thank

Speaker 5

you. Thanks.

Operator

Thank you. We're showing time for one final question today. The final question is coming from Michael Feniger of Bank of America. Please go ahead.

Speaker 13

Thanks everyone for squeezing me in. When we look at China revenue, the consolidated plus JV in 2022, it's basically the lowest it's been over 3, 4 years, I think slightly below 2019. I'm just curious in those 3 years how Profitability looks maybe post some restructuring and optimization. If units in China recover, are you more profitable on Each of those units than maybe you were in the past.

Speaker 3

Well, what's happening over time is that the content is going up, right. So One thing that's been a big positive for our business is China consistently adopting more advanced emission standards. So the amount of revenue that we're selling is going up per vehicle quite significantly over time. Certainly cycle over cycle, it's 1,000,000,000 of dollars of extra revenue growth a year. We're just at the lowest market in a decade.

Speaker 3

So we agree that that growth rate is modest. We don't have any signs of yet of a rapid adoption. We'll be Looking at the same data you're looking at and obviously taking on board the feedback from our customers. But we are profitable In our operations, we don't disclose profitability by region, but for sure when China volumes improve, our profits will go up.

Speaker 13

Thank you. And we've seen quite a few emerging suppliers in the EV, e mobility space really struggle the last 12 months with Deliveries or profitability, do you see some of the dynamics driving OEM conversations back to you and traditional suppliers

Speaker 2

Yes. We talked about this in our Analyst Day about a year ago. We expect that this transition is going to take a long time for our industry. And that positions incumbents like Cummins well because you need to invest for the long term regardless of what our customers are adopting. We've got in our portfolio.

Speaker 2

And so for sure, you see the benefit of a company like us that has a portfolio of options to meet their needs It's going to be around for the long term, and continuing to invest in some of these new technologies and be able to do that and The product is an advantage and it's playing out to be more of an advantage as time goes on compared to some of the new entrants. We continue to pay attention to those new entrants though and how they advance the technology and work to enter the market. So wouldn't discount them, but certainly this Long investment period makes it more challenging for them to stay in and be successful.

Speaker 3

And I think also Our reputation for dependability whatever our customers operate is leading us to be approached in new segments by Global large industrial players, so it's not just in the market that we operate in today. We've been approached To expand into different market applications, that's particularly exciting.

Speaker 5

Thank you. Thanks, Mike.

Operator

Thank you. At this time, I'd like to turn the floor back over to Mr. Kullo for closing comments.

Speaker 1

Thank you all for your participation today. That concludes our teleconference. I really appreciate the interest. And as always, the Investor Relations team will be available for questions after the call this afternoon. Take care.

Operator

Ladies and gentlemen, thank you for your participation and interest in today's conference. You may disconnect your lines or log off the webcast at this time and enjoy the rest of your day.

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Earnings Conference Call
Alarm.com Q4 2022
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