Cummins Inc.
Q4 2020 Earnings Call Transcript

Published: 4 Feb 2021

[Operator:]

Greetings, and welcome to the Cummins Inc. Fourth Quarter 2020 Earnings Conference. 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, Mr. Jack Kienzler, Executive Director of Investor Relations. Thank you, sir. Please go ahead.

[Jack Kienzler:]

Thank you, and good morning, everyone, and welcome to our teleconference today to discuss Cummins' results for the fourth quarter and full-year of 2020. Participating with me today are our Chairman and Chief Executive Officer, Tom Linebarger; our President and Chief Operating Officer, Tony Satterthwaite; our Chief Financial Officer, Mark Smith; and the President of our Components Business, Jennifer Rumsey. We will all be available for your questions at the end of the teleconference.

[Thomas Linebarger:]

Thank you, Jack, and good morning, everybody. If that voice sounded different to you, because it was, that was Jack Kienzler, not James Hopkins. And I want to welcome Jack to the Investor Relations function and to this quarterly earnings call. Jack is not new to Cummins. He has been with the company since 2014. He has worked in Finance, he has worked in Strategy. He has a great understanding of our business and our financial performance. He will be a terrific addition to the Investor Relations team. And he will, I think, continue James’ efforts to not only improve communication with investors, but make sure that you have the insights and understanding you need of our business and financial performance. James also worked with managers across the company to make sure that we understood what you as investors need from us. And for that, I am very grateful. James is now working in the Engine Business and Strategy, and I know he'll do a terrific job. So thanks to James. Before I go through the summary of our fourth quarter and full-year results, I want to take a moment to acknowledge and thank our employees for the sacrifices they've made over the course of 2020. In the second quarter, we faced the most severe decline in quarterly sales in our history, followed by a rapid recovery in demand and supported by a supply chain that was severely impacted by the pandemic. Our employees have worked tirelessly to navigate the many challenges caused by COVID-19 across the globe in order to support our customers and operate with financial discipline. I can't thank them enough for their commitment, their agility and their resilience.

[Mark Smith:]

Thanks, Tom, and good morning, everyone. I'll start with a quick summary of our financial performance in the fourth quarter and full-year 2020 before moving to our outlook for 2021. As a reminder, in the fourth quarter last year – 2019, we recorded restructuring charges of $119 million pretax or $90 million after-tax. I'm going to exclude any references to those charges in my subsequent comments to provide clarity and consistency on the underlying operating performance. There are four key highlights this quarter. First, the pace at which customer demand for Cummins products rebounded and our employees’ agility in responding to the higher customer orders. Second, we delivered solid profitability, especially when we peel back the expenses associated with cost reduction activities and some elevated costs tied to – tightness in global supply chain. Third, we converted the sales into cash, delivering $1.1 billion of operating cash flow, our second consecutive quarter of delivering more than $1 billion in cash. And fourth, we increased cash returns to shareholders in the fourth quarter as a visibility to improving demand increased. And I will let me go into more details on the fourth quarter and full-year performance. Fourth quarter revenues were $5.8 billion, an increase of 5% from a year ago and snapping a five-quarter run up declining sales. While the origins and depths of each of the downturns in the past 20 years have varied, each one has yielded negative sales growth for Cummins of between four and six quarters. Sales in North America were flat and international revenues increased 12%. Currency movements in aggregate had a minimal impact on revenues in the fourth quarter. EBITDA was $837 million or 14.4% of sales compared to $682 million or 12.2% of sales a year-ago. EBITDA dollars increased by $155 million with the positive impact of higher sales, the benefits of restructuring and lower variable compensation expense, more than offset higher product coverage costs and additional supply chain cost. Fourth quarter EBITDA included $36 million of expenses associated with the reorganization activities and facility closures primarily driven by transformation initiatives in our distribution business. That $36 million was equally split between gross margin and our operating expenses. Gross margin of $1.4 billion or 23.3% of sales increased by $48 million, but decreased as a percent of sales by 20 basis points year-over-year. Higher product coverage expense and additional costs associated in meeting rising demands more than offset the positive impact of higher volumes and the benefits of restructuring leading to a slight reduction in gross margin as a percent of sales. Combination of a sharp recovery in demand in nearly all of our end markets and the ongoing COVID-19 pandemic have led to tightness in global supply chains. We leveraged our global footprint to respond to the rapid increase in demand, but did incur additional freight and labor costs in doing so, which reduced fourth quarter margins by approximately 60 basis points. We anticipate that these elevated costs will continue through the first half of 2021 and have incorporated them into the midpoint of our guidance for this year. Selling, general and administrative expenses decreased by $56 million or 9% due to the benefits of restructuring, reduced discretionary expenses and lower variable compensation. Research expenses decreased by $16 million or 6% from a year-ago. Joint venture income increased by $36 million, primarily due to continued strong demand for trucks in China, which we converted into earnings growth and higher profits in our India operations. Other income of $24 million increased by $4 million from a year-ago. Net earnings for the quarter were $501 million or $3.36 per diluted share compared to $390 million or $2.56 from a year-ago. The effective tax rate in the quarter was 19.7%. Operating cash flow in the quarter was an inflow of $1.1 billion, $304 million higher than the fourth quarter last year. Higher earnings and lower working capital contributed to the strong cash generation. Now I'll move to the full-year 2020 commentary. Revenues were $19.8 billion, a decrease of 16% or $3.8 billion from a year-ago, the largest dollar decline in sales in company history. Sales in North America decreased 21% and international revenues decreased 7%. Currency movements negatively impacted revenues by 1%. EBITDA was $3.1 billion or 15.7% of sales for 2020 compared to $3.7 billion or 15.8% of sales a year-ago. The benefits of restructuring, lower compensation expenses due to temporary salary reductions, lower variable pay and record joint venture performance in China were more than offset by the impact of lower volumes. The record performance in China is remarkable when considering the COVID-related restrictions faced by all people in operations in the first quarter last year, and throughout much of the remainder of last year. Net earnings were $1.8 billion or $12.01 per diluted share. This compares to $2.4 billion or $15.05 per diluted share a year-ago. Importantly, our results in 2020 extended our track record of raising performance over successive cycles with earnings per share, 46% higher than we delivered in the prior downturn of 2016. Full-year cash from operations was an inflow of $2.7 billion, our second highest year. Solid profitability and lower working capital in the second half of the year contributed to the strong cash generation. Capital expenditures in 2020 were $528 million down $172 million from 2019 as we reprioritize and reduced our plans in response to the pandemic-induced global economic contraction. We returned $1.4 billion of cash to shareholders or 52% of operating cash flow in the form of share repurchases and dividends in 2021. We repurchased 3.9 million shares throughout the year at an average price of $164. After pausing share repurchases at the end of the first quarter in the face of unprecedented uncertainty, we resumed repurchases in the fourth quarter. In doing so, we completed the ninth share repurchase program approved by our Board of Directors and began repurchasing under our 10th program. In October, we raised our quarterly cash dividend by 3% as visibility to improving demand increased. Moving on to the operating segments. I will summarize the 2020 results and provide our current forecast for 2021. For the Engine segment, 2020 revenues decreased 20% from a year-ago, while EBITDA increased from 14.6% to 15.4% of sales. In 2021, we expect revenues to grow between 10% and 14%. While this increase primarily driven by higher truck production in North America and stronger aftermarket revenues also in North America. 2021 EBITDA projected to be in the range of 14% to 15% compared to 15.4% sales in 2020. The benefits of higher volumes are expected to be more than offset by lower joint venture income, which I’ll comment more a little later, and an increase in product coverage costs associated with new product launches. In the Distribution segment, revenues decreased 12% from a year-ago to $7.1 billion. EBITDA increased as a percent of sales to 9.3% compared to 8.6% a year-ago. We expect 2021 distribution revenues to grow between 6% and 10% compared to 2020, but this increase primarily driven by a stronger aftermarket activity in North America. EBITDA margins are expected to be between 9.6% and 10.6% up from 9.3% in 2020, as we continue to realize the benefits of our North American transformation work and other improvement actions in international markets. Components segment revenues declined 13% in 2020, while EBITDA decreased from 16.2% of sales to 16%. This year, we expect revenues to increase 9% to 13% primarily due to higher industry truck production in North America and incremental revenues from new products in China and India following the implementation of National Standard VI and Bharat Stage VI emissions regulations. EBITDA is projected to be in the range of 14.4% to 15.4% of sales compared to 16% in 2020, primarily due to lower joint venture income in China and launch costs associated with some of our new NS VI products in China. In the Power Systems segment revenues decreased 19% in 2020, and EBITDA declined from 11.7% to 9.4% sales. In 2021, we expect revenues to increase between 7% and 11%, primarily due to higher demand for mining engines and power generation equipment. EBITDA is projected to be between 10.1% and 11.1% of sales, up from 9.4% in 2020, primarily due to the benefits of higher volumes. In the New Power segment, revenues increased $72 million in 2020, and our operating loss was $172 million. In 2021, we anticipate revenues between $110 million and $130 million. Net expense is projected to be between $190 million and $210 million as we continue to make targeted investments in our technology portfolio consistent with the projections we made at our Hydrogen Day. As Tom mentioned, we are projecting 2021 company revenues to be between 8% and 12%, company EBIT margins expected to be in the range of 15% to 15.5% of sales compared to 15.7%. The benefits of higher volumes are expected to be partially offset by weaker joint venture income and the impact of restoring compensation following temporary salary reductions in 2020. Weaker demand in China following a record year in 2020 and lower earnings in India following tax and other one-time benefits last year are the main drivers of the lower joint venture income. As Tom mentioned, our guidance for joint venture income assumes that truck demand in China will decline sharply in the second half of 2021 following the country-wide adoption of National Standard VI emissions regulations. At this time, we have limited visibility to industry demand beyond the first quarter and we will continue to provide updates in this important market as the year progresses. We are projecting our effective tax rate to be approximately 22.5% in 2021, excluding discrete items. We expect our 2021 capital investments will be in the range of $725 million to $775 million. As we've discussed in prior years, our base case is to return 50% of operating cash flow to shareholders, and in years when we expect our cash flow to exceed the needs of our core business to return more. In 2021, we currently plan to return 75% of operating cash to shareholders in the form of dividends and share repurchases. To summarize, we delivered strong results in 2020 in the face of unprecedented challenges, extending our track record of raising performance cycle-over-cycle. The solid financial performance was only made possible by our employees who work tirelessly to support our customers, managed through customer shutdowns and amidst significant fluctuations in demand. They managed all of this, while adjusting the way they work and maintaining financial discipline throughout. As we enter 2021, we are well-positioned to capitalize on strengthening markets to deliver another strong year. We will continue to invest in the products and technologies that will fuel profitable growth in the future and return capital to shareholders, while maintaining the flexibility to ensure that we can weather any volatility that may lie ahead. Thank you for your interest today. Now let me turn it back to Jack.

[Jack Kienzler:]

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

[Operator:]

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

[Jamie Cook:]

Hi, good morning. I guess a couple…

[Thomas Linebarger:]

Good morning, Jamie.

[Jamie Cook:]

Good morning. I guess a couple of questions. First, the commentary on China. Just wondering, I think you said you only – just wondering if you could clarify how much visibility you have into that market or what the OEs are telling you about production relative to that your forecast is down 25% to 30%, and given, I think, January was up about 60%. So I'm just trying to figure out how conservative that forecast could be or what you expect first-half versus second-half? And then my second question, the market is talking a lot about supply chain issues. You talked about that in the fourth quarter and rest into 2021. So if you could sort of elaborate there and what are the supply chain risks and costs embedded in your guidance? Thank you.

[Mark Smith:]

Yes. Jamie, this is Mark. So I'll cover China here. So we do not have concrete forecasts for the full-year, of course. In any situation demand varies due to a number of considerations, but we are hearing a very cautious tone from our OEM customers in China about demand in the second-half of the year. It is true that demand held up strongly through the second-half of 2020. And yes, you're right. The industry is off to a strong start in Q1. We don't expect to see that significant decline in Q1, that's for sure. So hence we may clear our assumption and we will keep you updated, but we don't have concrete visibility.

[Thomas Linebarger:]

Jamie, just one thing to add on China. I think you hit on the key point. The first-half to second-half is going to be really different and so it's really going to be hard to tell whether our assumption is conservative or not in the first-half. We will just see. It just seems like the number of trucks and excavators being produced, it just seems like a lot for us relative to the economy’s ability to absorb it. Again, that's just from history and experience and we'll see. I mean last year was just an enormous production build. And as Mark said, OEMs are cautious about the same thing, but nobody has a firm grasp on it. And then there's the emissions change in the middle, which also seems like a good impact thing. So we're using our experience and history here to make this call. We did the same thing in 2020 and got it wrong. It ended up being strong all year. So we'll see, but the first-half is likely to be good. And then we'll know a lot more as we get through the end of the second quarter about how the second-half is going to go. Let me let Tony talk a little bit about the supply chain. There's a lot to say about that. And Tony has got a lot of details about what we're doing to try to work through with our customers and our suppliers on supply chain issues.

[Livingston Satterthwaite:]

Good morning, Jamie. Just very quickly, I just want to say that the most interesting thing that's happening is the rate at which demand has increased. We've never seen an increase in demand happened as quickly. And that combined with COVID and the pandemic has really stretched the supply chain. Mark mentioned, we did have elevated freight costs in the fourth quarter of last year. And as he said, we expect those to continue through the first-half. We are working with all of our suppliers. The supply base is generally tight, not just semiconductors, which has gotten a lot of press, but many of our components are on longer lead times, our suppliers and we are struggling with absenteeism due to COVID. And we are working very closely with our customers to remain connected and to continue to supply them as best we can. We are working through all of these issues on a daily basis, and the cost that we expect are included in our guidance. And we expect to be able to supply what we believe our market forecast is that Mark said earlier.

[Jamie Cook:]

Are you going to give what the costs are? And then I guess is, are the supply chain issues – to what degree are they limiting your top line forecast if any? I'm just wondering if your top line forecast is more conservative because you're just worried about supply chain issues and that sort of a headwind to your guide outside of just costs?

[Livingston Satterthwaite:]

So the – just to clarify. So the costs of about 60 basis points of a hit in Q4. We'd expect that level to continue in Q1 and Q2. And after that, our guidance assumes that starts to get better for you.

[Jamie Cook:]

And is there anything limiting your top line guide, Mark, in terms of like you just assuming sales are lower because the industry has bottlenecks?

[Mark Smith:]

I mean, it's clear. In the short run, it's tight. We anticipate that supply chains ease in the second-half of the year. That's the best way to say it. But no, we've given our range of market sizes and we expect to be able to meet all of those.

[Thomas Linebarger:]

But, Jamie, if you step back from it, there's no question that supply chain constraints are impacting everybody's view of what the production is going to be. So OEMs, suppliers like us first tier, and then second tier, everybody knows that their supply chain limits. It's just – it’s hard for us to see as because our customers are driving our demand, how much they're weighing in their own limitations versus what they see customers ordering and things. But it just - as every conversation, supply chain comes up. So I just assume it's having some impact, but we are expecting to be able to fulfill our customers’ needs, as Tony said, throughout the year. It's just hand-to-mouth every day.

[Jamie Cook:]

Okay.

[Mark Smith:]

And just to build on what…

[Jamie Cook:]

Sorry, go ahead, Mark.

[A - Mark Smith:]

[Jamie Cook:]

Okay. Mark, I'll let someone else give you a hard time about your margin guidance. Just kidding.

[Operator:]

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

[Ann Duignan:]

Hi, good morning. I'll skip margin questions and turn to more strategic questions. Yesterday, you were part of an industry announcement on Hydrogen Alliance that was put forward, particularly for the U.S., and I'm wondering if you could talk about that. And where do you see the U.S. going in terms of a hydrogen future versus Europe? It's easier to see it happening in Europe given their lack of energy independence, but maybe not the same sense of urgency in the U.S. So just curious to hear your thoughts on that and where you think we go from here with this alliance?

[Thomas Linebarger:]

Thanks for that, Ann. We appreciate the question. Yes, the Hydrogen Forward Alliance is really just trying to make sure that those of us that are investing in the industry are making it clear to policymakers and other potential participants, what the opportunity is with hydrogen. Because I do think if you just check in with people's imagination about what a low-carbon future can look like, I think, everybody from government regulators to my kids understand what battery cars might mean and all that, and they get it. I think the role that hydrogen is going to play in larger energy use more energy dense demand is just not as clear. And I think we need to be more proactive in helping people understand what it can mean to our entire energy system, and of course, what it can mean to equipment that we might supply. So we decided that since a lot of us have been investing a lot of time and energy in that and see the opportunity, we better start telling people about it. So that, of course, includes Biden administration and regulators, but it also includes general public. And I think a bunch of industry participants or people who could be participants understanding what investment might makes sense. That's the goal of that initiative. And I agree with exactly what you said that Europe has moved much faster to understand the role that hydrogen can play both in energy storage, cleaning up a high-carbon industries, steel making and others as well as potentially in transportation like trucks and trains. And I think the U.S. really does lag there. And part of it is, is what I said is just the understanding of regulators and others is not as good. But part of it is also because we kind of went into a different phase, I guess, over the last four or five years where we weren't really doing much for energy planning. I see that changing. We've already had several conversations with members of the Biden administration or transition people about trying to put together a more comprehensive energy strategy that for a low-carbon future. So I'm optimistic that not only will we have a more comprehensive plan, but that hydrogen will play a role in it and we're trying, of course, to impact that. I think we do believe that for the kind of commercial industrial applications that we're involved with anyway that hydrogen-based technologies can have a big role, so – which is why we're investing in it.

[Ann Duignan:]

Clearly, and I appreciate that. And I agree with everything. But then during your Hydrogen Day – just a quick follow-up, I mean, you guided to revenues for electrolyzers, but you didn't guide any revenue for fuel cells and in particular, the rail side, is that because in your timeframe those will still not be really material and will have to wait beyond that, or was there any other reason why you didn't guide to any revenue for fuel cells?

[Jack Kienzler:]

Ann, this is Jack. I think there's nothing more behind it besides the fact that we just have a bit lower visibility and the lead time behind those orders is a bit lower than on the electrolyzer side. So as Tom mentioned in his comments, there's solid momentum in the rail space with Alstom and others and as well as on the fuel cell markets with some prototypes with fleets hopefully this year.

[Thomas Linebarger:]

And we'll try to give more visibility to what those look like in the future. Again, as you heard from Jack, the rail side, we know what the orders are. We just don't know the rate and pace by which they're going to be able to take them. It's still a pretty low scale operation both on Alstom side and our, so we're working through all that. But we'll give more visibility as we understand. I guess why it might be interesting to those that are watching the industry. So we'll see what we can do to provide more guidance there.

[Ann Duignan:]

Okay. I appreciate that. And I'll get back in queue. Thank you.

[Operator:]

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

[Noah Kaye:]

Good morning. Thanks for taking the question. I guess, can you maybe talk a little bit about the priorities for R&D investment this year? You had mentioned some of the launch costs associated with NS VI and BS VI. But as we kind of get through that, we've got advanced clean trucks on the horizon, some other emissions standards plus the ongoing investment on the New Power side. So just kind of highlight for us where the investment is going? And I guess at the end of that, are you kind of looking for R&D to get back to the 2019 level? Are we looking for a step up in R&D here?

[Thomas Linebarger:]

Yes. It's a good question, Noah. We will continue to invest significantly in R&D both in our core businesses and in our New Power businesses. As we talk about, maybe it was last year, beginning of last year, we expected R&D over time to increase some over what we’re experiencing when we really just had one technology to invest in. So as a percent of sales, we expect to continue to drive up R&D to some degree because we just now are investing both for low-carbon future and the existing products at the same time. And so there are significant investments for both low emissions diesel products across the world, those are in components and in engines. We’ve now got new regulations in California to meet plus we've got all those New Power technology. So we have a lot to invest in. So you should expect R&D cost to come back to normal after 2020 and in fact, to continue to grow as a percent of sales, although again, some are shown in the New Power business, some in the Engine business. So they're mixed around, but as a total matter, we are investing more in R&D.

[Noah Kaye:]

Okay. That's very helpful. And then just want to ask about the pipeline for new platform wins. Congratulations, say on Isuzu starting to ramp this year. But do you look at 2021 as kind of a sort of a ratable year of potential new platform wins? Are we maybe getting to an inflection point this year where there are just more decisions being made until you have more short-term goal?

[Thomas Linebarger:]

It's a great question. And of course, you know that as we've said, we are having conversations with lots of different customers, partners about this and have been for some time. And I've been thinking that the year it has – that they need to make decisions with the year I mean for the last several years. It's a complicated conversation for all involved because there's a lot of strategic choices for the customer about where they want to invest and where they don't. There's employees and facilities and other decisions to make. So it's a complicated set of decisions. We are talking to a number of customers and do expect some of them to choose to invest in other technologies other than diesel in the coming years. And we think we're positioned well, we'll see, but we think we're positioned well to win some of that business, but we are continuing those conversations. And again, I expect some more to come this year, but then I expected more last year, too. So we'll just see where it goes. But we are having conversations with lots of people. And as you said, with Isuzu, it’s a really – it's a meaningful step in that partnership. That's a good example. We’ve actually had a collaboration with them for several years now. It's been very meaningful conversations, but it's complicated for them to figure out how to navigate this. And this is an important and meaningful step for them. And I think it’s the beginning of a lot of things we can do together, and I believe that other customers are in the same spot.

[Noah Kaye:]

Okay. Thanks, Tom. Good luck and good health to the team in the year ahead.

[Thomas Linebarger:]

Thank you. Noah.

[Operator:]

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

[Jerry Revich:]

Yes. Hi. Good morning, everyone.

[Mark Smith:]

Hi, Jerry.

[Jerry Revich:]

Hi. Mark, I'm wondering if you could talk about, if we do see a upside in revenue relative to your outlook. Can you just talk about what level of incremental margins you would expect to achieve in that scenario if sales are 5% or 10% above the range that you outlined? How would you expect given the supply chain issues, operating leverage to look relative to the starting point of the initial guide?

[Mark Smith:]

Yes. Jerry, I think typically we've demonstrated over a long period of time that if it's products that we're already making and in serial production, and we can get incremental and the supply chain is functioning well, and we can get incremental gross margins in that kind of low 30% range incrementally. I think we've done that consistently over time. The issue becomes when we get these extreme changes. And then we need to adjust and supply chain needs to adjust. But yes, if we get more revenue, we can deliver that efficiently. That's the range of incremental gross margins on current products.

[Jerry Revich:]

Okay. Terrific. And then Tom, in terms of the electrification products that you mentioned, obviously you have strong position on school buses, trains and buses. Can you just talk about based on the production plans for the industry that you have visibility on? Where do you expect your market share to shake out on buses versus trucks? Is that something that you could talk about at this point or if it's too soon, maybe you could just talk about platform share any way for us to pick them out would be helpful?

[Thomas Linebarger:]

Yes, it's a great question. And of course, we're all interested in this question because I think you know our strategy as a supplier to the industry is to maintain leadership, irrespective of technology. And we're investing in the key technologies that we think take us from fuel cell today through hybrid, through other fuels all the way up to low and zero-carbon – tailpipe carbon technologies. And our intent is to invest in the technologies and with the customers that we think are going to win. So we end up – we're leading today and we ended up leading then in those new technologies, there's a lot to play for in that. But that's what we're – that's our strategy. That's what we're aiming for. And the challenge now on the BEV or battery electric vehicle, or even fuel cell technologies, is that they're not in the money in trucks. So when you try to put a truck into production or into operation, you're going to be out of the money at the start. And so they're mostly regulatory-driven or some other subsidy driven, which means that it's not really a strength, technology and performance kind of discussion. And so right now market share is bouncing all over the place. And because there's a lot of different players that can offer a system, that system is unlikely to be competitive long run and even in the systems we offer are not – do not return if you compare them to a diesel system today. So market share is really, really difficult to say right now because the basis of competition is not technology and performance and costs. It's a whole bunch of other things. But that said, we are intending to win as many partners and as many products as we can. So we can get, a) practice and learning on the technology, and b) help customers understand how they might be able to turn these technologies into winners over time. So we are competing, don't get me wrong, but it's just the basis of competition is not the normal performance cost trade-off we used to do with diesel.

[Jerry Revich:]

Thank you. Appreciate the discussion.

[Operator:]

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

[David Raso:]

Hi. Thank you. Yes, my question is on the margins. First, the incremental margins, all in they’re implied only 11%. Obviously the lower JV income is the big drag, but even if we exclude the JV income from both years, the implied incrementals are only 17%. So that's about a $150 million to $250 million of higher costs than you would normally expect, right? Meaning a set of 17% incremental as you would think 25% to 30%. But when you said 60 bps, I think Mark, you mentioned it was 60 bps of a drag expected for the next two quarters, $150 million to $250 million, call it $200 million midpoint. That's like a 400 basis points of drag. So can you help us understand how do we bridge that? Can you talk about some costs that you already know can be quantified? And then I have a quick question on the JV income related to margins. China, how big of the decline do you expect from the total company JV income going down about $125 million year-over-year? How much do you expect that to be from China? Because China was about $215 million last year. I'm just curious, how much of the total $125 million do you think is from the JVs from China decline?

[Thomas Linebarger:]

Yes. Good questions and your math is all right, David. So that makes it a lot easier for me to answer your questions. So of the JV income, you need to remember that we had about $54 million of income in India, which was more one-time in nature. $37 million from the change in the tax legislation, which reduced our prior accrued withholding taxes on our JV earnings in India, and we also had a fairly large tech fee in the first quarter of 2020. So that’s $50 million, and then the balance is really market decline in China. On to your other question…

[David Raso:]

real quick, though. The China decline, if you went from $215 million all the way down to say $140 million, right, that's accounting for the rest of the total company decline. JV income in China hasn't been that low in four or five years. And I'm just trying to understand if you know that the decline is coming in the back-half was the way you're managing your business. Why would the JV income in China fall that hard? I mean, the JV income hasn't been really even at that level and much below it for a decade. So I'm just trying to square up. Why such a decline in the JV income in China you're predicting it's coming?

[Thomas Linebarger:]

We've assumed its coming. Right now – that's the second-half assumption. But it's principally a volume assumption. Again, there are some incremental costs associated with launching products, but the primary reason is the volume decline. There is always some other bits and pieces and all the other 54 joint ventures. But these are the base of the basic. Two things, David, there's nothing else I'm trying to not share with you about the numbers. When we get back to the bigger margin, you're exactly right. Yes. The piece that's missing, which I've been trying to telegraph to everybody is $165 million in salary reductions last year. Normally, we expect to deliver 20% plus incremental margins. You're absolutely right. What was abnormal about the actions we took in 2020 was that salary reduction, which was a $165 million. That's really – yes, our incentive comp will be, if we hit our targets slightly higher this year. When you add those, they take those two items alone, take about a 100 basis points off the margin. And that's the piece I think that's missing, there's other puts and takes.

[David Raso:]

So the price cost to be fair provides a little bit of risk than, if it's the comp coming back, that reduces it from 25%, 30% down to 17% for the core business price costs. I assume then you must not have too much of a negative price cost in the guide.

[Thomas Linebarger:]

No, we are kind of 0% to 50% positive on those.

[David Raso:]

Okay. That's helpful. I appreciate it. Thank you.

[Thomas Linebarger:]

All right. Thanks, David, and thanks everybody else. Jack, I think we are at the top of the hour.

[Jack Kienzler:]

Yes. That concludes our teleconference today. As always thanks to everybody for your continued interest in Cummins. I will be available for questions after the call.

[Operator:]

Ladies and gentlemen, thank you for your participation. You may disconnect your lines at this time and have a wonderful day.