Good day, ladies and gentlemen, and welcome to the Cummins Inc. Second Quarter 2023 Earnings Conference Call. Our host for today's call is Chris Clulow, VP of Investor Relations. At this time, all participants are in a listen-only mode. [Operator Instructions] I would now like to turn the call over to your host. Chris, you may begin.

Great. Thank you very much. Good morning, everyone, and welcome to our teleconference today to discuss Cummins results for the second quarter of 2023. Participating with me today are Jennifer Rumsey, our Chair and Chief Executive Officer; and Mark Smith, our Chief Financial Officer. We will all be available to answer questions at the end of the teleconference. Before we start, please note that some of the information that you will hear or be given today will consist of forward-looking statements within the meaning of the Securities 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 the slide deck and our filings with the Securities and Exchange Commission, particularly the Risk Factors section of our most recently filed annual report on Form 10-K and any subsequently filed quarterly reports on Form 10-Q. During the course of this call, we will be discussing certain non-GAAP financial measures, and we 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 statements and a copy of today's webcast presentation are available on our website within the Investor Relations section at cummins.com. With that out of the way, I will turn you over to our Chair and CEO, Jennifer Rumsey to kick us off.

Thank you, Chris. Good morning. I'll start with a summary of our second quarter financial results, then I will discuss our sales and end market trends by region. I will finish with a discussion of our outlook for 2023. Mark will then take you through more details of both our second quarter financial performance and our forecast for the year. Before getting into the details on our performance, I want to take a moment to highlight a few major events from the second quarter that demonstrate the continued execution of our strategy. On April 3, United States President, Joe Biden, visited company facilities in Fridley, Minnesota to tour Accelera by Cummins, first U.S. manufacturing location for electrolyzers, a key technology to produce no-carbon hydrogen. Accelera is initially dedicating 89,000 square feet of the existing Cummins power generation facility in Fridley to electrolyzer production with the opportunity to expand to meet the growing demand. Accelera also reached a further milestone of electrolyzer order backlog totaling over $500 million at the end of the quarter. The Fridley facility will help address that growing demand, along with other capacity being added globally. Lastly, progress continues to be made on the separation of the Filtration business. On May 26, Atmus Filtration Technologies Inc. began trading on the New York Stock Exchange under the ticker symbol ATMU in connection with its initial public offering. Upon the completion of the IPO, Cummins retained approximately 80.5% of Atmus outstanding shares. The Atmus IPO generated $299 million of net proceeds and Atmus added $650 million of debt. Cummins realizes the benefit of the IPO proceedings and the debt issuance as Atmus will hold the debt at full separation. Now I will comment on the overall company performance for the second quarter of 2023 and cover some of our…

Thank you, Jen, and good morning, everyone. Second quarter revenues were a record $8.6 billion, up 31% from a year ago. Sales in North America increased 31% and international sales increased 32%. Our organic sales growth rate was 12%, driven by improved pricing and strong end market demand for our products globally, with a balance of 19% increase in sales driven by the addition of Meritor. Foreign currency fluctuations negatively impacted sales by 1% overall. EBITDA was $1.3 billion or 15.1% of sales for the quarter, including $23 million of costs associated with the planned separation of Atmus. EBITDA in the second quarter of 2022 was $1.1 billion or 16% of sales, including a one-time $47 million benefit related to the adjustment of our reserves as we suspended our operations in Russia and $29 million of costs associated with the planned separation of Atmus. Excluding the Atmus separation costs and the impact from Russia year ago, EBITDA in the second quarter of this year was 15.4% compared to 15.7% a year ago. Lower EBITDA percent was driven primarily by the dilutive impact of Meritor, higher variable compensation costs, which showed up largely in our SG&A line and in higher development spending. To provide clarity on operational performance and comparison to guidance and excluding the costs associated with the planned separation of Atmus and the impacts from Russia in my following comments. Now let's look in more detail by line item. Gross margin for the quarter was $2.2 billion or 24.9% of sales compared to $1.7 billion or 25.6% last year. As a percent of sales, gross margin decreased by 70 basis points as the benefits of higher volumes and improved pricing were offset by the dilutive impact of the Meritor acquisition and higher variable compensation expenses. Our Cummins Meritor business…

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

At this time, we will conduct a question-and-answer session. [Operator Instructions] We are now ready to begin. Our first question comes from Jamie Cook of Credit Suisse. Your line is open.

Hi, good morning. I guess two questions. One, the engine margin, I’m just trying to understand. They were a little weaker than I thought. I understand there’s some compensation and investment in there, but your JV income was really high as well and margins in the back half versus the first half were lower. So can you just help us understand what’s going on, on the engine margin side and how to think about, like, what’s required in investment over the longer-term? And does that continue to weigh on the engine margin? And then my second question, Jen, just bigger picture. I know you don’t want to guide to 2024 – for 2024, but I know you’re very close with your customers. So as you look out in 2024, given some of the industry forecasts that are out there, which markets are you more after this [indiscernible] markets that you’re getting a little more cautious that we could see declines? Thank you.

Okay. I’ll go with the first question, Jamie. Thank you. Yes, so in the Engine business, there are really three themes to the numbers. One, we’ve raised the investment level in engineering, really to support all the additional business that we’ve won and meet future emissions and drive that profitable growth. Two, this is the business, more recently, it’s continued to face some continued inflation on material costs. We’re net pricing positive, but we’ve also continued to experience some increase in material costs. And then for the second half of the year, really, we’re expecting China JV earnings to weaken, which is typical having a weaker second half than the first half. And then yes, as you mentioned, the incentive compensation – we’ll describe it as an issue. It is a factor in our results across the company in that our performance is exceeding our internal plan and we trued up our accruals in the second quarter, which happens from time to time and also compares to a quarter a year ago when we were lowering them. But the business issues are really the increased investment and then the lower JV earnings in the second half of the year.

And on your second question, Jamie, in terms of what we’re seeing in the market, the performance of our products continues to be very positive and strong. And what I would say is my conversations in the – in recent months have continued to have conversations with customers, in particular in the medium-duty space, and even in the electrolyzer space, there’s a lot of demand and interest in Cummins products. And I noted that we’ve made some shifts in our global plants to increase capacity and medium-duty for North America to meet that demand. So there’s still really strong demand in that market. And we’re cyclical business. We’re used to being a cyclical business, I think this is going to likely be a more gentle cycle across markets than what we’ve typically seen, but we do see some indications in certain markets, a little bit softening in aftermarket, some anticipated down days and our guidance implies heavy-duty a little bit lower in the fourth quarter, in particular, construction a little bit lower. And China, really not growing significantly, seasonally softer in the second half versus first half. So I still feel quite good about market outlook and how we’re performing. And yes, we think the Q2 is going to be our revenue peak and we’re – our guide reflects that and we’re taking actions to make sure we’re prioritizing the places we need to invest for the future while also managing headcount discretionary spending and just SG&A down for the second half of the year.

Thank you.

Thanks Jamie.

Your next question comes from Jerry Revich with Goldman Sachs. Your line is open.

Yes. Hi. Good morning, everyone.

Hey, Jerry.

Jennifer. Hi. I’m wondering if you could just talk about the interest that you’re seeing from your customers in alternative fuel technologies. Over the course of the quarter, we have the positive EPA mandate essentially for a landfill gas, given the changes in the RIN structure. I’m wondering if you could just talk about what you’re seeing from your customers on interest in the 15-liter engine in North America specifically for that product. And any other comments that you would add on internal combustion hydrogen or other moving pieces, based on the visibility on the regulatory side? Thanks.

Yes, great. Thanks, Jerry. Yes, as you noted, I think there’s growing interest in what I call some of these bridge technologies, alternate fuels and engines, the natural gas product, we’re seeing growth in that in China. We’re going to launch that here. We expect to see some success in that market and looking at hydrogen engines where we’ve – we’re developing those and trying to figure out in which markets they’ll play a role. It’s slow going because of the infrastructure build out that’s required. And so we’re really focused on investing to have the right products, but at the right time. And so you’re still going to see a lot of demand for diesel in the next few years. One key thing that happened this quarter was progress with the car regulation and the alignment now to EPA in ‘27, which is a real positive. So we could focus on a nationwide solution and then some of these bridge and zero emission solutions to start to adopt and applications and places where the infrastructure exists.

Super. And Mark, can I ask within components, your EBITDA margins were up a touch sequentially 2Q versus 1Q, given just all the different piece in the portfolio between Meritor and Atmus. Can you just talk about how the different parts of business are performing?

Yes. I think in that business, they’re all performing well. Obviously, the change in the mix has an impact, but clearly, Meritor results stepped up from the first quarter. So that was probably the biggest thing to change. I don’t want to talk about Atmus. They’re going to have their own earnings call shortly. But I would just say in general, the performance trends are strong across that portfolio.

I thought I’d try. Thanks.

Thank you, Jerry.

Your next question comes from Tim Thein with Citigroup. Your line is open.

Thank you. Good morning. The first one is on power systems. I’m just curious if maybe you could give an update there on anything of note within the order boards. I’m guessing that as you walk through some of the end markets, a lot of the revisions were to the upside. And yet, if you look at the second half revenue growth, there is a slight step down from the first. So I’m just curious, is that a capacity issue or has there been any changes in terms of, some of the individual end markets. Just curious, your thoughts on that.

Hey, Tim, it’s Mark. Thanks for the question. I think the only market change, which isn’t new this quarter that’s been coming for a few months has really been a weakening order board on some of the consumer side, particularly the RV market where we’ve got a very strong presence, not surprising with interest rates where they are that overall market started to – the demand started to drift down. So I would say that’s the only one with some momentum change. I mean, oil and gas, there are different opinions at different points in time. That’s the one clear trend I would say right now. And then you’re right. The backlog is seeing us through this year. So we’re watching everything closely. But I would say, it’s stable outside of RV.

Yes. And the thing we’ve been able to do, we had a lot of supply challenges in that business last year. So through the first half, we’ve been able to really produce at a better level. And we see strong demand in particular data center demand, the order board is out through next year for the data center market. We revised – you heard us revise mining up a little bit. So we’re seeing strength in parts of those markets. And then as Mark noted, it’s a little bit of softening in other parts of that market. But the situation there is really stabilized from where it was last year.

And then, of course, we’re pleased with the step up in performance over the last year. And then you heard in my comments that we’ve taken yet more actions to keep boosting that profitability up. So we’re very pleased with the momentum in that business.

Yes. Okay, good. And just – and then on distribution. So the – and maybe tying back to, Jen, to your comments on aftermarket activity. But if you look at parts had been in the kind of mid-40% as a percentage of distribution sales and it stepped down. I imagine there was some mix headwind associated with that, but – and maybe just is there an area worth calling out, typically that business can kind of be a good early warning signal? So maybe just a little bit more color on what you mentioned earlier in terms of that?

No, I mean, the color I'll give there is, we were at incredibly high aftermarket levels because what was happening was customers couldn’t buy new trucks. So they were using trucks longer that drove more aftermarket demand. And so it’s still very healthy. We believe we’ve seen some – we’re seeing some inventory adjustment happening. And that the overall aftermarket demand has come down a little bit, but it’s still very, very healthy to your point, the aftermarket business for us from our margin perspective is a favorable one, but we still see it being healthy is what I would say.

Got it.

A bit more signs, it’s leveling off than accelerating, I would say, Tim.

Yes, okay. Thanks for the time.

Thank you.

Your next question comes from David Raso with Evercore ISI. Your line is open.

Hi, thank you. The comments about truck production in the fourth quarter. Can you give us a little more color on that in the sense of magnitude? How much is this your perspective versus already been laid out by your customers? And how to think about sort of dovetailing that into conversations for pricing for 2024?

So I would say, first of all, it’s a shorter quarter just because of the holiday periods. I think the industry has a lower build rate building at Q4, so that’s not coming specific. And then, yes, I think the rest is our assumption, David. It is not current outside of the shorter quarter. That’s not what we’re hearing from customers at this point in time. The question is really going to be what are the order momentum for the rest of this year and what’s sentiment as we get towards that end of the year? That’s how I would characterize what we’ve got embedded in our guidance and that doesn’t change. We’ve had that instance the start of the year.

That’s what I was trying to figure out. Have you heard a tone change? Nothing to do with less production days. Just truly daily line rates being communicated. Hey, we’re taking it down in the fourth quarter or so just your view. I’m just trying to make sure we understand…

It’s a tricky one. And as you can imagine, we are debating this a lot. So as I said, a little bit softer aftermarket is typically an indication that we’re going to see some softening in the market more down days in the fourth quarter. There’s just uncertainty from an economic perspective and the typical cyclical nature that we see in our markets that is causing us to anticipate in the fourth quarter. And as we look to next year that the market size is going to start to come down a little bit. As I said, I think it’s a softer cycle than we would typically see, but it just – it’s at a very high level right now. We – our Jamestown is producing as much as they can.

Yes. We’re not trying to signal some Cummins specific issue here, David. It’s just assumption about the market activity at the end of the year.

That’s fine. And the question on pricing?

Can you repeat that, David, sorry. I don’t think I pick it up.

The conversations for 2024 on pricing, and I know you have supply agreements, but just trying to get a sense of – and you might be able to take your costs down as much, but I think people are just trying to figure out, is there some price give back after the last 18 months or so very strong price increases. And I just want to see if you could provide some perspective on early conversations you’re having for your truck engine pricing?

Yes, look, we’re – our goal is to continue to balance the price with the cost pressure that we’ve been seeing, which is stabilized. And then we’ll launch some new products next year as well. So that will allow us to continue to have those conversations with customers, but really nothing dramatic there.

Okay. Thank you very much.

Thanks, David.

Your next question comes from Rob Wertheimer with Melius Research. Your line is open.

Hi, I also had a question on price and then maybe just generally on the truck market and your market share and mix developments. So the first one is truck OEMs have had some really good success in margin as prices have gone up. I’m actually just a little bit curious mechanically, when a customer walks in to buy a truck, and they choose either Cummins Engine or the OEMs engine, you don’t control the price of that engine at retail, right? So, maybe, I guess, in effect, the truck OEM would be making margin on the increased price of the truck and engine. Is that the way to think about it? And do you still have catch up to come there?

Correct. We don’t control the pricing that happens to the end customer. We have long-term agreements and we price our engine and powertrain solutions and options to the OEM. And we typically follow those long-term agreements with metal market adjustments and have done some inflationary adjustments with them over the last few years, but we don’t fundamentally dictate that pricing to the end customer. Our goal is to have a product offered to work with the end customers to create goal for our product through the performance of our powertrain compared to others in the market.

We made a big shift away from influence in retail price 20 years ago.

Okay. No, I think that’s clear. And then just a big part...

I was going to say, of course, in the heavy-duty space, a big factor and customer choices as fuel economy.

Got it. Second one is just trying to get up to date on mix shifts in North American truck and how it flows through for Cummins. So, if long haul truck declines in vocational/day cab come up and I guess medium-duty comes up. I’m just trying to sort out, which of those are market share/mix negative for you and not? So is your market share in long haul higher than your market share in vocational, or I guess your market share in medium-duty quite high? So I’m just trying to think about how the evolving mix in the truck market affects Cummins?

Yes. I mean, the main delta in all those things is – whilst our share has gone up in heavy-duty over the last couple of years and it’s very strong. Medium-duty, it’s much stronger, right? That’s the main difference. And then I would say it’s a different kind of angle to your question, Rob, the larger fleets, we tend to have higher share with the larger fleets than we do with the overall – within heavy duty than the overall market itself because that’s where we’ve got those deeper, stronger relationships. So there’s a theme that’s been support as larger fleets are becoming more effective, more competitive. That’s been a trend that’s been helping us. But individual take and we’re really getting into splitting as the trend has been shared going up in heavy and in medium.

Perfect. Thank you.

Your next question comes from Tami Zakaria with JPMorgan. Your line is open.

Hi, good morning. So, can you update us on your price realization and price cost assumptions for the year?

Well, yes, we’ll be at about 3.5% to 3.75% plus on pricing. And on costs, we’ll be about 1.5% inflation.

Got it. And on your full-year guide, I’m just trying to understand, the segment sales guide was raised for both distribution and power systems, but the full-year guide was unchanged. So can you help me bridge that?

Yes, we really – well, Chris, why don’t you go?

Yes. So, yes, Tami, you’re right. We did raise in power systems and distributions. And as we looked at the overall guide, just given the uncertainty in the markets we elected not to change the overall, it probably would trend towards the higher end of that revenue guide is what we’re looking at right now, but we didn’t want to change it at this point.

Okay got it. Thank you so much.

I think construction, though, construction and Brazil truck were the two key areas. And then I would say parts, it’s not dramatically different, but it’s leveling out. Those are the three themes that are going – go in the other way or not improving.

Got it. Thank you.

Your next question comes from Steven Fisher with UBS. Your line is open.

Thanks. Good morning. I just wanted to follow-up on the truck market messaging again. I have the sense that you guys were getting increasingly confident about the business for 2023 and thinking that 2024 might not be too much of a downturn, if at all. So has that thinking changed at all? And was that aftermarket trend you mentioned sort of, like, a catalyst for different thinking, or is it more just something in the macro that’s gotten your thinking changed, or is it not really changed at all?

Yes, I don’t – it really hasn’t changed notably from the thinking before and that this idea that we’re going to see a gentle cycle. So, some downturn in the market, not dramatic and anticipating that, that happening. And it’s really dependent on some of these broader economic things and what really happens, how that plays out.

I think it’s correct that the forecast for the industry are a lower Q4, right, just because of the number of the production days in the quarter. Part of it is just math for the remainder of the year, which is not. And then part of it is just history tells us if there is some erosion in confidence, which we haven’t seen in customer orders. Just to be clear, if there is, we tend to have a bigger fade into the December holiday period and a slow ramp up. So we just – we built that into our guidance at the start of the year. That’s simple as that.

But in the meantime, layered on that, what you’re seeing is we’re improving gross margin across the business, right? The base business gross margin performance has been strong, Meritor has continued to improve quarter-over-quarter. And we think now is the time to start managing our operating costs, expecting that we’re going to see some downturn and then continue to look at places as you’ve seen us do some structural things to improve the business and the focus this year has really been within the Power Systems business where we’re doing that.

Okay. And it sounds like part of your second half outlook is a bit weaker trend in China. How are you thinking about the potential for stimulus there? And whether there’s any chance for upside still that might come out of that?

Yes. At this point, we’re continuing to assume there’s no stimulus. There was, in a meeting, a few weeks ago, well, the – I think the government recognizes that they want to try to improve the economy. They want to do it and fiscally responsible stable way. And so we’re not assuming stimulus. China is playing out pretty much as we anticipated some improvement off of a very low 2022 and typical seasonality between first half and second half. And if there’s stimulus that comes in that impacts demand that would impact our outlook as well.

Yes, but I would say that just seem the most likely size source of upside to our guidance right now.

Got it. Thank you very much.

I’m worried about it. Just looking for more and there is much sign of it right now.

Right. Makes sense. Thanks.

Your next question comes from Matt Elkott with TD Cowen. Your line is open.

Good morning. Thank you. I was wondering if you guys still expect EBITDA neutral for Accelera by 2027, or are there any emerging new structural costs and investments needed that could change that timeline?

Yes. We are still – with the strategy we have in place right now, we continue to work towards the EBITDA neutral in 2027. A big piece of that is this electrolyzer revenue growth as you saw with the comments on backlog that we continue to be confident in the outlook there and we – the increased investment this year is really focused on making sure we’ve got the product and the supply chain right to enable us to do that.

Okay. And Jennifer, just one more question here on the construction side. The tempered outlook for the kind of latter part of the year, data centers are strong and public sector, non-residential construction is strong. Can you talk about some of the end markets driving a somewhat tempered outlook for construction in North America?

Yes. So, our outlook for U.S. construction down to flat, right? So data – and data centers would show up for us and power generation data center market is definitely strong. There’s parts of the market where construction, infrastructure investment and construction remains strong and there’s other segments of that market with rising interest rates and that we’re seeing things.

Part of it is just a timing issue of like what’s the replenishment of the fleet been a lot of ordering of engines for construction equipment. So it doesn’t necessarily mean it’s just the demand on us is kind of leveled out, right now. And again, we’ll see where that is going.

Does any of the data center construction market, does any of it show up in the – in construction for you guys, or it’s all most of your exposure to business…

That’s in our Power Systems segment.

Yes, it’s not a huge factor for us. I mean, the data center factor for us is that they buy these very large gensets for backup power and that drives significant revenue for power systems. The actual construction itself…

It’s hard for us to track exactly where the construct – we’re selling to the OEMs sometimes rental.

That makes sense. Thank you so much.

Thank you.

Thanks, Matt.

Your next question comes from Noah Kaye with Oppenheimer. Your line is open.

Hi, thanks for taking the question. Just wanted to expand if I could on Accelera and the increased investment spend this year about $50 million. I think you mentioned a couple of times it’s really to get electrolyzer production and product right. It is an operating expense, right? So is this mainly engineering resources? Maybe you can give us a little color on what you felt you needed to spend on to get ready for this ramp? And maybe you can even put in the context of some of the industry and policy changes that you’ve seen come through, obviously, some significant ones over the last year?

Yes. Yes. The industry and policy changes drive that optimism and the outlook and the growing demand, the higher cost of shifts, not capital expenses of the plants as much as it is operating costs in engineering and in customer support as we’re scaling up that product or running higher than we had previously forecasted.

Okay. So customer support as well as product engineering. All right. That’s helpful. But just to make sure we understand, there’s no change to the revenue guidance. The current book of business, which I think is more weighted towards EV, I mean, is that delivering kind of the expected margin contribution? We hear mixed indicators on EV adoption, particularly in North America, would love to sort of understand where that side of the business is tracking versus your expectations?

Right. So on the EV side, no, our demand today is mostly concentrated in the bus markets. I would say our margins have definitely been improving. The Accelera leadership team has done good work on improving the margins even with, yes, relatively modest, albeit increasing demand at this point in time. Yes, so we’re really looking for those next waves of demand, but the margins have been improving there. And on the electrolyzers, the demand keeps going up. The issue is not demand. It’s just making sure that we’re ready. There aren’t that many electrolyzers, new ones out in the field yet, right? We’re still building that capability. Yes, we’re shipping some, but that’s going to be going up to just making sure history shows a bit of investment now. It pays off multiple times in the long run.

Yes. Here’s a – there’s a couple of things that we watch on this, how the market develops. So on the electrolyzer side, there’s investments, but the actual details of how that government money flows and when it flows are still being defined. So that is a bit of a timing impact on some of that. And then in the electrified powertrain, there’s still a lot of uncertainty beyond the bus market where you’ve got cities and corporations that have incentives and want to electrify on exactly how that infrastructure is going to build out. So there’s regulations that’s going to start to drive more of that, but a lot of uncertainty I would say on the exact pace of that.

Appreciate it. Good to see you making the investments. Thanks so much.

Thank you.

Yes. Thanks, Noah.

At this time, there are no further questions. I’d like to turn the call back to Chris Clulow for any closing remarks.

Great. Thanks very much. That concludes our teleconference for today. Thank you all for participating and your continued interest. As always, the Investor Relations team will be available for questions after the call. Have a good day.

This concludes today’s Cummins Incorporated second quarter earnings conference call. Thank you, everyone, for your participation. Have a wonderful rest of your day.