Greetings, ladies and gentlemen, and welcome to the Cummins Inc. Third Quarter 2021 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. It is now my pleasure to introduce your host, Jack Kienzler, Executive Director of Investor Relations. Thank you, sir. Please go ahead.

Thank you and good morning, everyone. Welcome to our teleconference today to discuss Cummins results for the Third Quarter of 2021. Participating with me today are our Chairman and Chief Executive Officer, Tom Linebarger. Our President and Chief Executive Officer, Jen Rumsey, and Chief Financial Officer, Mark Smith. We will all be available for your questions at the end of the conference. Before we start, please note that some of the information that you will hear or be given today will consist of forward-looking statements within the meaning of the Securities Exchange Act of 1934. Such statements express our forecasts, expectations, hopes, beliefs, and intentions on strategies regarding the future. Our actual future results could differ materially from those projected in such forward-looking statements because of a number of risks and uncertainties. More information regarding such risks and uncertainties is available in the forward-looking disclosure statement in this slide. deck and our filings with the Securities and Exchange Commission, particularly the Risk Factors section of our most recently filed Annual Report on Form 10-K and any subsequently filed quarterly reports on Form 10-Q. During the course of this call, we will be discussing certain non-GAAP financial measures and we refer you to our website for the reconciliation of those measures to GAAP financial measures. Our press release with a copy of the financial statements and a copy of today's webcast presentation are available on our website at www.cummins.com, under the heading of Investors and Media. But with that out of the way, we will begin with our Chairman and CEO, Tom Linebarger.

Thank you, Jack and good morning. Welcome everybody. I'll start with a summary of our Third Quarter financial results and our market trends by region and finish with a discussion of our outlook for the rest of 2021. Mark will then take you through more details of both our third quarter financial performance and our forecast for this year. Demand remains strong in the third quarter as the global economy continued to improve, driving strong sales growth across most businesses and regions outside of China. In China, industry-wide sales of trucks and construction equipment has slowed sharply, but in line with our expectations. We remain encouraged by the economic trends in our markets, which point to strong end-user demand extending into 2022. We also continue to see orders for our products outpace our competition as a result of their strong performance in the field. Unfortunately, supply chain constraints continue to significantly impact our ability to produce and ship products, driving up costs and limiting sales growth in the short run. These supply chain constraints are impacting our OEM customers in much the same way. Before getting further into our results, I want to take a moment to highlight a couple of strategic milestones in the evolution of our next-generation products and technologies. In October, we announced that we will bring a 15-liter natural gas engine for heavy-duty trucks to the North American market. This engine was launched earlier this year in China and has been well-received in the market, demonstrating excellent performance and reliability thus far. The 15-liter natural gas engine is an important part of our path to zero-emission strategy, by offering a significant reduction in both criteria pollutants and greenhouse gases in a product that’s available today and utilizes existing infrastructure. Equally exciting is that this engine is designed to accept a range of gases and renewable fuels, including hydrogen in the future. In fact, all of Cummins' engine platforms are being designed with the same fuel flexibility. At the same time, we are working with Chevron and others in the energy industry to increase the availability of renewable natural gas and other renewable fuels to ensure infrastructure is in place to meet our customers' needs. We also signed a letter of intent to establish a joint venture between Rush Enterprises and Cummins, which will produce Cummins branded natural gas fuel delivery systems for the commercial vehicle market in North America, combining the strengths of momentum fuel technology's compressed natural gas fuel delivery systems and Cummins powertrain expertise along with the engineering and support infrastructure of both companies. These are important steps in expanding our portfolio of Power Solutions options to help customers meet their business goals and operational objectives, while also meeting increasingly stringent emission standards and achieving our customers' sustainability goals. Now, I will comment on the overall Company performance for the third quarter of 2021 and cover some of our key markets. Revenues for the third quarter of 2021 were $6 billion, an increase of 17% compared to the third quarter of 2020. EBITDA was $862 million or 14.4% compared to $876 million or 17.1% a year ago. Higher freight and logistics expenses, rising material costs, and other manufacturing inefficiencies associated with the ongoing supply chain challenges in our industry more than offset the benefits of global volume increases compared to the third quarter of last year. As a reminder, EBITDA in the third quarter of last year was helped by temporary salary reductions, which lowered our cost by approximately $90 million. Our third quarter revenues in North America grew 13% to $3.4 billion, driven by higher engine and component shipments across the heavy and medium-duty on-highway markets. Industry production of heavy-duty trucks in the third quarter was 55,000 units, an increase of 10% from 2020 levels. Cummins sold 22,000 heavy-duty engines in the same period, up 30% from 2020 levels. Industry production of medium-duty trucks was 26,000 units in the third quarter, a decrease of 5% from 2020 levels, while our Cummins unit sales were 23,000, an increase of 25% from 2020. We shipped 43,000 engines to Stellantis for use in the RAM pickups in the third quarter of this year, a decrease of 2% from 2020 levels, but still a very strong quarter. Revenues for power generation grew by 2% due to higher demand in recreational vehicle, standby power, and datacenter markets. Our international revenues increased by 22% in the third quarter of 2021 compared to a year ago. Third quarter revenues in China, including joint ventures, were $1.5 billion, a decrease of 11% due to lower demand in the medium and heavy-duty truck markets. Industry demand for medium and heavy-duty trucks in China was 217,000 units, a decrease of 53% as the industry worked through the national standard 5 truck inventory on hand and lower demand for newer higher-cost national standard 6 unit. Our unit sales in units, including joint ventures, were 40,000, a decrease of 49% versus the third quarter last year. Our light-duty engine sales were 33,000, a decrease of 40% driven by supply chain constraints and weaker market demand. Industry demand for excavators in China in the third quarter was 56,000 units, a decrease of 15% from 2020 levels. Our units in Cummins sold were 88,600 units, a decrease of 20%. Power generation sales in China increased 52% in the third quarter compared to a year ago, based on strong demand in data centers and other backup power applications. We continue to hold a market-leading position in the data center segment in China, driven by strong end-user relationships and our compelling product offerings. Third quarter revenues in India, including joint ventures, were $520 million, an increase of 76% from the third quarter of 2020. Industry truck production increased by 120%, while our shipments increased 135% as our joint venture partner continued to gain share. Demand for power generation and construction equipment also rebounded strongly in the third quarter compared to a very low base a year ago. In our Power Systems market, industrial engine revenue increased 33% in the third quarter compared to the same period last year driven by mining in oil and gas. In Brazil, our revenues increased 26% driven by increased demand across all end markets. Now let me quickly cover our outlook for the remainder of 2021. Based on our current forecast, we expect our revenue to be at the lower end of our guidance, up approximately 20% versus 2020. EBITDA is now expected to be approximately 15%, below our previous guidance of 15.5% to 16% of sales. Our expected EBITDA margins are lower because of the persistence of the supply chain constraints and disruptions, which are now exacerbated by escalating material and freight prices. We've lowered our forecast for industry production of heavy-duty trucks in North America to 228,000 units, up 25% compared to 2020, but below our prior guidance of 264,000 units. This is again due to the supply chain constraints impacting our customers rather than a lack of end-user demand. In the medium-duty trucks market, we are decreasing our forecast for industry production to 118,000 units, up 15% year-over-year, but below our prior guidance of 134,000 units. We expect our engine shipments for pickup trucks in North America to be up 25% compared to 2020, an increase of 7.5% from our expectations three months ago. In China, we continue to expect domestic on-highway demand to decline from record levels a year ago. Our 2021 outlook for medium and heavy-duty truck market demand is 1.65 million units, and our 2021 outlook for light-duty trucks market is 2 million units; both unchanged from our previous guidance. We continue to expect industry sales of excavators to be flat with the record levels achieved in 2020 and unchanged from our previous guidance. In India, we anticipate industry demand for trucks to be up 75% compared to levels experienced in 2020. And our other businesses are showing promising growth due to continued infrastructure investment; this is also unchanged from previous guidance. We now expect demand for mining engines to increase 60% in 2021, up from our expectation of 45% three months ago based on continued strength in commodity prices. We continue to expect global power generation revenue to increase 15%, primarily driven by the data-center and recreational vehicle markets. Summing up the quarter, strong demand across many of our markets drove continued sales growth in the third quarter. Despite the strong demand, supply chain constraints continue to significantly impact both our operations and those of our customers, resulting in higher material and logistics costs, as well as capping revenue growth. We are working collaboratively with our customers and suppliers to navigate these challenges and position the Company for better performance in 2022. Customers are recognizing the strong performance of our products, resulting in our sales growing faster than industry demand in a number of important markets. We continue to invest in bringing new technology to our customers, outgrowing our end markets, and providing strong cash returns to our shareholders. The Company expects to return over 75% of our operating cash flow to shareholders in 2021 in the form of dividends and share repurchases. Thank you for your time today and now let me turn it over to Mark.

Thank you, Tom and good morning everyone. There are four key takeaways from our third quarter results. End-customer demand remains strong in the third quarter, driving strong sales growth across most end markets and businesses outside of China, where truck and construction demand has weakened in line with our expectations. Global supply chains remain constrained, impacting our industry's ability to meet strong customer demand and resulting in higher freight, labor, and logistics expenses and rising material costs. As a result of the continued supply challenges and associated costs, we are lowering our full-year sales and profitability outlook even though underlying demand remains very strong. Finally, we'll return $345 million to shareholders through cash dividends and share repurchases in the quarter, and a total of $1.83 billion for the first nine months of the year consistent with our plan to return 75% of operating cash flow to shareholders this year. Now let me go into more details on the third quarter. Revenues were $6 billion, an increase of 17% from a year ago. Sales in North America grew 13% and international revenues rose 22%. EBITDA was $862 million or 14.4% of sales for the quarter, compared to $876 million or 17.1% of sales a year ago. As a reminder, EBITDA in Q3 last year was boosted by $90 million of temporary salary reductions and the $44 million VAT recovery in Brazil. Along with the strong demand, the key feature of our performance in Q3 was that our gross margin continued to be challenged by the supply chain constraints and elevated costs. Gross margin of $1.4 billion or 23.7% of sales increased by $65 million but declined as a percent of sales by 270 basis points. Global supply chain constraints continue to impact the industry's ability to meet elevated customer demand and have resulted in higher costs. We incurred approximately $90 million of additional freight, labor, and logistics costs in the third quarter, in addition to rising material costs, partially offset by increased pricing in the aftermarket. SG&A expenses increased by $38 million or 7%, and research expenses increased by $42 million or 19% from a year ago, primarily due to higher compensation expenses. As a reminder, due to the significant uncertainty during the onset of the COVID-19 pandemic, we implemented temporary salary reductions in April 2020 through the end of September last year. These salary reductions resulted in approximately $90 million of pre-tax savings for the Company last year and affected gross margin as well as our operating expenses and impacted the comparisons of the results of all of our operating segments. Joint venture income was $94 million in the third quarter, down slightly from $98 million a year ago due primarily to weaker demand for both trucks and construction equipment in China. Other income of $32 million increased by $11 million year-over-year. Net earnings for the quarter were $534 million or $3.69 per diluted share compared to $501 million or $3.36 per share from a year ago, primarily due to a lower tax rate and a reduced share count. The effective tax rate in the quarter was 19.9%. Our income tax expense included favorable discrete items of $11 million or $0.08 per diluted share. Operating cash flow in the quarter was an inflow of $569 million compared to $1.2 billion a year ago. An increase in working capital led to the lower operating cash flow for this quarter. Now, let me comment on segment performance and our latest guidance for the full-year 2021. For the engine segment, third quarter revenues increased 22% from a year ago, driven by increased demand for trucks in the U.S. and construction equipment in the U.S. and Europe. EBITDA decreased from 18.1% to 15.2%, primarily driven by higher supply chain costs, lower joint venture income, and higher compensation expense, partially offset by the benefits of stronger volumes and lower warranty expense. For the full year, we've reduced our revenue guidance to be up 24% at the midpoint, down 1% from the full year. We now expect EBITDA margins to be between 14.2% and 14.7%, a little below our prior year guidance of 14.5% to 15%, primarily due to the weaker sales and ongoing supply chain challenges. In the distribution segment, revenues increased 14% from a year ago. EBITDA increased in dollars but decreased as a percent of sales from 10.6% to 9.8%, primarily due to some of the supply chain challenges but again the higher compensation costs. We have maintained our 2021 outlook for distribution segment revenues to be up 8% and increased EBITDA margins to 9.3% of sales at the midpoint of our guidance. Component segment revenues increased 16% in the third quarter, driven primarily by stronger demand for trucks in North America. EBITDA decreased from 16.9% to 14.1%, primarily due to higher supply chain costs and higher warranty expenses compared to very low cost of quality in the year-ago quarter. For the full year, we now expect components revenue to increase 28%, lower than our prior guidance of up 32%, primarily driven by a weaker outlook in North America and a slightly lower outlook for China truck. We have also lowered our forecast for EBITDA margins for the segment to be at 15.5% of sales at the midpoint, down from our prior guidance of 17%, as this segment has been more hard hit by the supply chain challenges and the slowdown in truck production in North America and China. In the Power Systems segment, revenues increased 19% in the third quarter, driven by stronger demand for power generation and mining equipment. EBITDA increased by $33 million, and expanded by 10.3% to 11.5% of sales, primarily due to the benefits of higher volumes and lower product coverage expense, partially offset by elevated supply chain costs. For the full year we're increasing our Power Systems revenue guidance to be up 22% from our prior guide of 18% growth driven primarily by a stronger outlook in the mining segment. We're also increasing our EBITDA margin forecast to be 11.5% of sales at the midpoint from our prior guidance of 11.25%. In the new power segment, revenue increased $23 million, up 28% due to stronger sales of battery electric systems. EBITDA losses for the quarter were $58 million as we continue to invest in new products and scale up ahead of widespread adoption of the new technologies that we're developing. For the full year, we now project new power revenues of $120 million at the midpoint, and EBITDA losses to be in the range of $200 million. We expect total Company revenues now to grow approximately 20% at the low end of our prior guidance. We’re also lowering our EBITDA margin guidance to be approximately 15% for the full year, down from our prior guidance of 15.5% to 16%. A slower pace of improvement in North American truck production and continued elevated costs associated with the global supply chain challenges were the primary drivers of the lower outlook. We expect joint venture earnings to be up 10% for this year, in line with our prior guidance. We're forecasting our full-year effective tax rate to be 21.5%, excluding discrete items. Capital expenditures were $150 million in the quarter, up from $116 million a year ago, and we continue to expect full-year capital spend of between $725 and $775 million. To summarize, we faced incredibly strong demand in many of our core markets but continue to face global supply chain challenges which have impacted our cost base, more so than we'd expected in the second half of the year. However, this end-customer demand remains strong, outpacing supply in many important markets and setting us up for a strong 2022, assuming the global economy remains strong. I want to thank all of our employees for their tireless work this year to ensure that we've met the needs of our customers while continuing to deliver solid financial results. We continue to prioritize improving our performance cycle-over-cycle, investing in technologies that will power profitable growth and returning excess capital to shareholders. Thank you for your interest today. And now let me turn it back over to Jack.

Thank you, Mark. Out of consideration to others on the call, I would ask that you limit yourself to one question and a related follow-up. And if you have any additional questions, please rejoin the queue. Operator, we are now ready for our first question.

Thank you. As a reminder, if you have a question, please follow the instructions provided. For those using speaker equipment, you may need to lift your handset before pressing the star keys. Additionally, please limit yourself to one question and one follow-up. Our next question is from Stephen Volkmann of Jefferies. Please go ahead.

Hi, good morning. Thanks for taking the questions. Maybe I'll just dive in on some of these supply chain issues. Is it possible to just bucket the impact that you guys have seen? I'm thinking about price costs being a headwind, I'm thinking about logistics costs I think you gave us a number for that Mark. I'm guessing there's probably some productivity headwinds. I'm just trying to see if we can better understand exactly what you're seeing relative to these supplier interruptions.

Happy to do that and good morning, Steve. So yes, we are almost 2% worse between the price increases we've made, mainly in the aftermarket this year, which has contributed about 70 basis points to our results. We've lost more than 2.5 points due to premium freight, rising material costs, and inefficiencies in our operations. This is obviously higher than we anticipated three months ago. We did see a reduction in premium freight from the second quarter to the third quarter, but we've started to notice further increases in material costs.

And Mark, is it too early? I mean, I'm assuming for 2022 your goal will be to get right with that. Or maybe even a little bit better. I don't know, any commentary you can make as we go out into '22?

I will just say this continues to be a high area of focus both on our operational side and also working through this with suppliers and customers and implementing price increases.

Hey Steve, this is Tom. The one thing that everybody is still worried about in our industry is semiconductors. It's not that things haven't improved some because they have, but it's marginal improvement. It's still a really tight supply chain, so there's a lot of issues across the supply chain, labor shortages, freight, etc. But semiconductors look like they have a longer-term capacity issue and I'd also say the freight side of things just seems like it's not quite getting better yet when you look at where containers are and what ports look like. So there's no question that, as Mark said, internally, we are working as much as we can to address our cost side inefficiencies. He talked about going out and negotiating price increases, and as you know on the material cost side, those come automatically, but we'll have to negotiate for the rest. It's just that some of these things look like they are likely to be somewhat persistent. That doesn't mean we're not hoping to improve them all. I just want to be realistic about those. There'll be some element that looks like it goes into next year too.

Understood. Thank you, I guess high freight costs are probably good long-term for you guys, but we'll have to wait and see how that plays out. Thanks.

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

Hi, good morning. I guess Tom, I just wanted to get more color from you on how you're thinking about China as we head into 2022, that's an important market for you. And what, in terms of like the power shortages and outages over there, how that's impacting your business goals from a negative perspective and potentially a positive perspective over time. So I guess I'll start there.

Yeah. Let me let Jen talk a little bit about how the China market is now and how we're seeing it, and I can jump back in and see us talk about sort of longer-term things.

Hi, Jamie. As Mark mentioned, we have seen a decline in the China market, particularly in the on-highway segment, around the middle of the year due to the transition from NS V to NS VI emission standards. We observed inventory increasing in the first half of the year, which is now decreasing as products are sold in regions that permit NS V sales. This situation, coupled with the higher costs associated with the new emissions products, has led to a drop in on-highway demand, although we anticipate some recovery. The year 2020 was a record year for China, so we expect the market to align more closely with what we experienced in 2019 for on-highway. Additionally, we are gaining from increased content in the components business due to new emissions requirements, as well as the introduction of the endurance transmission in China. We believe our NS-VI products will perform well, providing some upside potential despite the overall market decline. The construction market has also softened, but we are still seeing some strength in the power generation sector. We are keeping a close eye on the power shortage issues in China with our suppliers; while it hasn't caused significant disruptions so far, it remains a situation we are monitoring closely.

I would like to follow up on what Jen mentioned about the power shortages. While there are some impacts on production, the cost impact has not been significant. However, as you pointed out, Jamie, we believe this situation can benefit us in the market. As I noted earlier, our power generation business is well-positioned in China, and I now see us with a strong presence across all our markets. Regarding the truck segment, as Jen indicated, our automatic transmissions are gaining traction, and our engine content is increasing. The market is consolidating, which reflects a stronger position for us as things begin to recover. Additionally, we are collaborating with a partner in China on electrolyzers and have fuel cell launches planned there. Although developments in the new power sector in China are slower than expected a few years ago, this has enabled us to strengthen our presence in these markets for when they do expand. Overall, I believe our position in China has never been more robust. While I wish the market was stronger this year, I am confident that as it rebounds, we will be able to consolidate and enhance our position.

And we have the new N15 natural gas product launched in China as well now, and that I think positions us better for what's a fairly sizable natural gas market in China as well.

Okay. Thank you. And then just as a follow-up, can you just talk to how far your order book extends today and to what degree there's risks that the order book has unfavorable pricing in it, and are you concerned about double ordering at all? Thanks.

Yeah. I mean, at this point, the demand out there is very strong. We're seeing growing back orders in some of our businesses. And I've been out in recent couple of months talking with both OEMs and customers and there is strong demand out there that for sure is real at this point, customers are not getting all the trucks that they would like to get this year and do not believe even looking into next year, they think that there's going to be some limitations. I think that orders are strong and as Tom said, we've got some contractual pricing on metals that we'll get, as we go into next year. We've been taking pricing actions where we go direct to the market and aftermarket on PowerGen, and we're continuing to work with our OEM customers, on first-fit to negotiate pricing just in light of that cost environment we see right now.

Thank you very much.

Thanks, Jamie.

Thank you. Our next question is coming from Ann Duignan of JP Morgan. Please go ahead.

Hi. Good morning. Thank you. Just to follow up on the supply chain, a quick follow-up, please. Would you expect the announcement that we're eliminating the European tariffs on steel and aluminum to have any impact on U.S. steel prices in 2022?

Hi Ann. I'm Tom, it's good to hear you. I really don't know because again, there are, as you know, export, I mean, sorry, import caps on that too. So how much that's going to really impact prices is unclear to me. And demand, of course, for metals is pretty high now. So the markets are pretty well-supported. In fact, our mining, you saw our mining numbers are up, and that's primarily driven by metal prices. So just in the U.S., it feels to me like it's going to have a moderate long-term impact. Short-term, it may provide a little bit of relief, but I would have said that given the import caps, it's probably not a big move medium or long term.

Okay. Thank you. I appreciate the color on that and my real question though is more fundamental. I mean, you're talking about the 15-liter engine being able to use fuels like hydrogen as their major fuel. If it's so easy to convert a 15-liter internal combustion engine to burning hydrogen, why are we investing in fuel cells at all? If we can do it with just a new fuel injection system or some minor re-engineering of an internal combustion engine, why go down the path of the hydrogen investments or in particular fuel cells at all?

The hydrogen investments will remain consistent. We need to produce hydrogen, and specifically green hydrogen, to effectively reduce the carbon dioxide impact of the fuel. Hydrogen combustion can be a viable solution, but it is less efficient compared to a fuel cell. For our long-haul heavy-duty trucks, where fuel is often the largest expense, the increased efficiency provided by a fuel cell is significant. For vehicles with a shorter range or vocational use, a hydrogen engine could be more suitable, particularly if converting to a fuel cell is prohibitively expensive or if there are fewer vehicles to justify it. We believe there is a role for both technologies, but to truly advance the transportation economy in the next 15 to 20 years, the efficiency of fuel cells, especially in combination with electric systems, will be crucial. Our perspective remains that fuel cells are likely to dominate the trucking industry, though hydrogen engines are a valuable addition to our range of products available in the market.

There is also a time factor to consider. As fuel cells improve and costs decrease, there may be times when hydrogen engines have a cost advantage. However, as Tom mentioned, over time costs will decline, and the efficiency benefits for customers focused on total ownership costs will likely lead to a shift toward fuel cells and applications like Line Haul.

Okay, I'll take mine more engineering-related questions offline and then.

You have a lot of them. I'm looking forward to having a longer conversation.

You have a lot of them. I'm looking forward to a longer conversation.

I'm oversimplifying just simple fuel injection system re-engineering.

Exactly, I think it takes 30 seconds on it, we're designing this platform that the physical hardware for flexibility is exactly as you said, this fuel system and some other components differences and then the tuning. Of course, the calibration and control of the engine is different based on the fuel, but we're able to leverage some of that manufacturing and engineering investment in a common platform.

Okay. Thank you. I'll get back in the queue. Appreciate that.

Thank you, Ann.

Thank you. Our next question is coming from Tim Tse of Citigroup. Please go ahead.

Thank you. Good morning. The question really is just hoping you could give some help in terms of how we should think about the relationship between heavy and medium-duty engine sales for Cummins versus industry truck production, both in the fourth quarter and then as we get into '22. I'm just thinking about how you outpace the industry as your OEM customers deal with all these red-tag trucks. How should we think about that, again, relationship? Obviously, a global impact or maybe just thinking about the heavy-duty segment here in the near term.

Yes, there are a couple of factors to consider. We have added several new OEM customers, which influences our sales in the medium-duty and heavy-duty segments. You have likely heard about the percentage of the total market represented by Cummins engines, and we feel confident about our position. Our products are performing well, there's significant demand from end-users, and we have a solid market presence. In the fourth quarter, we have generally managed to overcome supply constraints, allowing us to continue meeting the needs of our OEM customers. In most cases, we are not the reason they have been unable to build trucks. As they adjust their production rates, stabilize operations, and finish the trucks built with incomplete components, we have noticed a decrease in engine demand. This is part of their efforts to stabilize and optimize production with the current supply and inventory levels. This situation is affecting us in the fourth quarter, which is partly why we revised our revenue guidance.

What I would add, Tim, is what we see is our products are performing incredibly well. We see it in our financials with very positive results on cost of quality and overall strong sense of enthusiasm for the products that we're putting in the market. Invariably, you're going to get some volatility quarter-to-quarter, as we always do, but we feel really good about the position of our products in the market. I think that's the message when you step back and when we're done with this year and we look at the message you want you to leave with, and, of course, we're optimistic about picking up more business over time.

Got it. Mark, regarding the margin impact from components, many metals like platinum and palladium are involved, and I understand there is typically a time lag. Can you provide insight into the margin impact this year, especially considering a potential timing gap if things stabilize? Is it possible to determine what might be a short-term impact that could reverse next year, or is that too complicated to assess?

If I take a step back, there's quite a bit of noise in the year-over-year comparisons due to some actions we implemented last year. We need to look past the noise in the numbers. We'll revisit that shortly. Currently, we are facing three issues in that business that differ from our expectations from three or six months ago. First, production in North America hasn’t increased in the latter half of the year; in fact, it has slightly declined, which we had factored into our guidance. However, we believe that underlying demand supports a strong market for next year, and we expect things to improve. Second, while we anticipated a significant decline in China in the second half of the year, that has unfolded as expected. This sector is undergoing a significant product transition from NS-5 to NS-6, and when we launch new products, we typically start below optimal scale. Demand for NS-6 remains relatively low, but as we ramp production, we anticipate an improvement in margins. The more significant challenge is the rise in supply chain costs. In the first half of the year, we primarily saw OEM availability affecting our operations, supply chain, and engine business, but we have noticed increased costs spreading to more electrical components. The components segment has experienced rising costs and efficiency challenges, which we are working through. While we are dealing with metal costs and the usual contractual adjustments, our primary focus is on managing supply chain issues and other actions discussed earlier in the call. To simplify the message, there is a lot of noise currently. I want to clarify something that wasn’t asked: while we mentioned higher product coverage costs in this segment, this is in comparison to an unusually low number from last year. There isn't a significant charge for product coverage or warranties in these segments. I wanted to make that clear for other listeners. Thank you.

Got it. All right. Thanks for the time, Mark.

Cheers, Tim. Yeah.

Thank you. Our next question is coming from Jerry Revich of Goldman Sachs. Please go ahead.

Yes. Hi. Good morning, everyone.

Hi, Jerry.

Hi, Jerry.

Tom, you folks target structural improvements in the business every cycle and I'm wondering as you look at the supply chain challenges that the entire industry face here, how are you folks thinking about potential changes in the way you manage inventories or the way you manage the supply chain going forward? Is there an opportunity to reduce some of the volatility by meaningfully increasing inventories given where cost of debt is, etc.? I'm wondering how you're thinking about positioning comments coming out of this pretty complex environment we're facing here.

Jerry, that's a great question, and it's been on my mind for some time. Early in the pandemic, we made some structural changes. We mentioned in previous calls that with the market downturn, we aimed to adjust our capacity appropriately, and I believe we accomplished some good work in that regard. However, with the supply chain issues we've faced, new challenges have emerged that we hadn't encountered before. You pointed out several of these, including whether we have sufficient inventory in the right locations and if we are outsourcing in areas where we should be insourcing. Furthermore, trade challenges between countries raise the question of whether we depend too much on cross-border trade. All these factors are now part of our strategy as we look to reposition our supply chain. Currently, we are focused on reducing costs, increasing production to meet customer demand, and ensuring our supply chain team can keep working around the clock despite the difficulties. It's been quite challenging, so while we are undertaking significant analysis and work on the strategic elements, our priority in the last few quarters has been to maintain operations. Nevertheless, these issues are crucial for our leadership team as we consider our future positioning. Broadly, we realize that we need to rethink our outsourcing and insourcing strategies moving forward, in part due to the supply chain challenges we've observed, but also because further industry consolidation seems likely. We need to ensure we remain a reliable supplier for our customers. Therefore, we will be assessing how best to position ourselves within different supply chains, and I believe you have identified a key point regarding the optimization that could benefit us in terms of cost and reliability over time.

Terrific. On a separate note, I'm wondering if you could talk about the outlook for your electrification opportunities in off-highway markets, obviously a pretty fragmented supplier base in terms of other engine systems in the market now. How do you see that as an opportunity set for Cummins and are there significant major new product milestones that we should look forward to as you folks electrify the off-highway offerings?

Off-highway markets are more fragmented, and conversations about battery electric powertrains tend to lag behind those in on-highway. However, these discussions are taking place. Many major off-highway producers are trying to determine their long-term strategies regarding carbon emissions and sustainability. We are engaging with numerous producers, and the dialogue around battery electric solutions is occurring at a strategic level for all. Each producer is looking for solutions and wanting to understand when the total cost of ownership becomes favorable for end-users. Currently, that generally only applies to publicly financed applications like trains, buses, or ferries. In commercial applications, it doesn't quite work yet, although the situation is changing rapidly. They are assessing how to position themselves for when these solutions become viable, including who they should partner with and how to approach it. At this stage, most partnership discussions have been postponed since there isn't a feasible offering available, nor is there a clear path to a viable solution given the current technologies and costs. Everyone is looking ahead to define what the future will look like. I believe that off-highway will continue to face the same challenges they have today, with not enough volume to justify a specialized solution but unique requirements for their applications. We believe Cummins is well-positioned because our on-highway products will provide volume and scale, and we understand their specific applications, making us a strong partner as we adapt technologies effectively for off-highway. That’s essentially the message I am conveying to them, positioning Cummins as the ideal partner in battery electric solutions as we are with engines.

I appreciate the discussion. Thanks.

Thank you.

Thank you. Our next question is coming from Noah Kaye of Oppenheimer. Please go ahead.

Hi. Good morning. Thanks for taking the questions. Tom, I wonder if you could kind of update us on how the natural gas pipeline is developing. I think we've seen some of the companies in the industry just a really robust demand growth since the start of the year. And if you can also comment, obviously it's not set in stone, but there appear to be some pretty healthy incentives for nitrogen production in the reconciliational provision. So just wondering if you'd comment on potential impact of that on the natural gas business?

I appreciate your question. We have continued to see growth in the backlog for the electrolyzer business. A key strategic goal for us was to include larger projects in that backlog, and the discussions around those projects have been progressing well. Last time we checked, our backlog stood at around 60 megawatts, which is quite promising, especially with the addition of some new larger projects. However, larger projects typically require more time to organize and may face funding delays, but they are essential for market growth. It's encouraging to see these larger opportunities being integrated into our backlog. Interest in electrolyzers remains strong, particularly with incentives from the Build Back Better Plan for hydrogen production, especially low-carbon ammonia. We believe this will enhance the use of electrolyzers initially. Evidence from Europe shows that a carbon price is already in play, and there are fertilizer-related projects where transitioning from gray hydrogen to green hydrogen can be valuable. While calculations for achieving cost equivalency are complex, they are feasible with appropriate funding and incentives, which explains their presence in the bill. If these incentives are adopted into law, I anticipate a swift advancement in the green hydrogen and green ammonia sector in the U.S.

Thanks. And then just on a different topic, wonder if we could get any update on the filtration business, particularly in light of the comments made earlier about some of the operational changes or realignment from a high level that you're planning. Where are you at in terms of exploring the alternatives for that business?

Hi Noah, this is Mark. Yes, we continue to make progress in exploring alternatives for that business. Our plans remain the same, and you should expect an update in the new year as we continue our work. I don't foresee any significant changes in the next three months, but an update will come in the new year, and our enthusiasm for that process remains strong. Additionally, the performance of that business has been very strong this year. It's part of the components business, but it continues to perform very well.

Yes. Thanks very much, Mark.

Thanks.

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

Good morning. Thank you. So guys, in the U.S., we're looking at significant upcycles in truck production as well as construction and mining equipment. As these upcycles begin to unfold, are there opportunities for you guys to increase the percentage of your engines with your customers, both on-highway and off-highway? And if I take it a bit longer term, are there opportunities for potentially gaining new customers who may currently be fully integrated?

Yeah, great question. We are constantly working to make sure that we have the most competitive engine in the market that drives end-user pull and grows our position in the market, and also ensuring that we have capacity to meet OEMs' needs through strong cycles. And we continue to have conversations. You've seen announcements around the partnerships with Isuzu, with Hino, with Dymo. We're continuing to have those conversations with customers that may not offer Cummins engines today to introduce those in the future. So we expect that those opportunities will continue over time.

So generally, during an OEM cyclical production up-cycle, does the vertical integration usually go up or down for the OEMs?

Matt, it depends, but at the very top of the market, generally speaking, our penetration goes up a little bit because they run out of capacity if they use both, if they have both their own demand and ours. But again, generally is not a good indicator for a given quarter and as Mark was saying earlier, quarter-to-quarter variation is pretty high because they may have backlogs. In this case, they may have unfinished trucks with more of their engine. So just quarter-to-quarter, it's hard to see. What's more is because of the supply chain challenges, right now, OEM truck production is capped by suppliers. So we're not anywhere near the maximum production of the industry today. I mean, we hope to be based on what engine users demand, but we're not. We're in an area where they can produce more if they could get more parts. So I think we're not really near the spot that you're asking about in terms of industry production.

Got it. Next question and then just one follow-up question on the natural gas engine. In the U.S., it's very small. I think you produce about 10,000 engines and you dominate the market. With the 15-liter engine, can you talk about the growth opportunity and when you could see it unfold? I mean, is it going to be a meaningful opportunity next year or is this more long-term?

Yes. We have announced our plan to introduce the N15 natural gas engine, which is currently in production in China, to the U.S. market by 2024. This means we are a couple of years away from making this product available. Customers have expressed great enthusiasm for this product, especially as they work towards their own carbon reduction goals. In the next few years, they view natural gas, including renewable natural gas, as an excellent solution to help achieve those goals. We anticipate potential growth opportunities as we launch this new platform in the market, coupled with increasing interest in natural gas.

Which again should boost our share given our position in natural gas, yeah.

Thank you very much.

Thank you.

Our next question is coming from Rob Wertheimer of Melius Research. Please go ahead.

Thank you. You guys touched on pricing earlier, could you remind us maybe just give a quick recap overview of how pricing works on engine platforms. Is that the only one where you have constraints on what price that includes material costs, escalators, but not freight maybe if I understand right. And then, what portion of the mix do you then have to go after things like freight on?

Broadly speaking, we have long-term agreements with major customers for engines and key components. These agreements often ensure that we receive consistent customer orders throughout the production phases of trucks and engines. Generally, these contracts include provisions for basic material costs, with an escalator or pass-through feature, while other aspects require negotiation if changes are necessary. In the case of generator sets and aftermarket sales directly to retail customers, we rely solely on the orders we have in the pipeline for pricing. As we discussed earlier, we adjusted our prices in the aftermarket early in the year and again mid-year, continuously evaluating if further adjustments are needed. We also promptly adjusted pricing for generator sets. Currently, we are in discussions with all our OEM customers regarding various escalators, including those related to logistics, material costs, special shipments due to semiconductor delays, and other products, as we seek to recover these costs through negotiations.

Okay. That's helpful. Tom, could you provide an overview on semiconductors? When do you think the industry will improve, and what specific actions is Cummins taking, such as re-qualifying and qualifying new suppliers and redesigning chips, before that improvement occurs? I'll stop there, thanks.

Yeah, I will comment on that one. So it's something we've been working really closely throughout the year and we've started to see some improvement quarter-over-quarter since the middle of the year in supply of microprocessors for most of our components that we've seen some growing disruption on other electrical components. That has become a bigger issue for us in the second half of the year. And we have also in parallel been working and I think we'll revisit inventory strategies as we are able to build inventory. Not today in the current very constrained environment. And we're also looking at sourcing strategy and doing dual-sourcing back all the way to a tier 3 level to make sure we've got more flexibility in the future.

We really need domestic semiconductor production in the U.S. that focuses on the automotive industry. It’s concerning that almost all our semiconductor wafers come from one factory or a few factories in Taiwan, and we represent a very small portion of that output. This is not an ideal situation for our supply chain. The strategic plan must involve semiconductor manufacturers who view the automotive industry as essential to their success, ideally positioning some facilities closer to shore or onshore. This way, we can better assess total capacity and demand, especially since modern trucks and buses are increasingly incorporating electronics. Each new product introduction typically adds around 30% more chips or sensors, but the semiconductor capacity is not increasing at the same pace. Therefore, we need to enhance capacity and specifically target these customers.

Thank you.

Thank you, Tom. And thank you, everybody. I believe that concludes our teleconference today. As always, thank you to everybody for your continued interest in Cummins and for joining today. I will be available for questions after the call. Thank you again.

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