Greetings, and welcome to the Cummins Incorporated. Third Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Chris Clulow, Vice President of Investor Relations. Thank you, Chris. You may begin.

Great. Thank you very much. Good morning everyone and welcome to our teleconference today to discuss Cummins’ results for the third 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 and 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 statements in the slide deck and our filings with the Securities and Exchange Commission, particularly the Risk Factors section of our most recently filed Annual Report on Form 10-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 and good morning everyone. I'll start with a summary of our third 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 about our third quarter financial performance and our forecast for the year. Before getting into the details of our performance, I'm excited to first highlight a few major events from the third quarter that demonstrate the continued execution of our strategy. On September 6th, Accelerate by Cummins, Daimler Truck and Bus and PACCAR, along with EV Energy joined forces to accelerate and localize battery cell production and the battery cell supply chain in the United States. The planned joint venture will manufacture battery cells for electric commercial vehicles and industrial applications, creating highly desirable manufacturing jobs in the United States in the growing clean technology sector. Total investment by the partners is expected to be in the range of $2 billion to $3 billion for the 21 gigawatt hour factory with production expected to begin in 2027. We see this partnership as an opportunity to share investment with two long-standing partners while advancing a key technology solution for our customers and industry and collectively to accelerate the energy transition in the United States. In October, Cummins completed its acquisition of two Faurecia commercial vehicle manufacturing plants and their related activities, one in Columbus, Indiana and one in Roman Netherlands. This acquisition is a natural addition to the Cummins Emission Solutions business and will help ensure we meet current and future demand for low emission products. Lastly, Cummins announced several collaborations with our natural gas X15 engine that further enable our customers to achieve their decarbonization goals. Freightliner announced they are working…

Thank you, Jen, and good morning, everyone. Third quarter revenues were $8.4 billion, up 15% from a year ago. Sales in North America increased 16% and international revenues grew 13%. Organic sales growth was 10%, driven by improved pricing and strong demand for our On-Highway and power generation products. 5% of the total increase in sales was driven by the addition of Meritor. EBITDA was $1.2 billion or 14.6% of sales for the quarter including $26 million of costs associated with the planned separation of Atmus. EBITDA in the third quarter of 2022 was $884 million or 12.1% of sales, including $16 million of costs associated with the planned set for [ph] Atmus. And $77 million of our integration and inventory valuation adjustments related to the acquisition of Meritor. Excluding the Atmus separation costs and Meritor adjustments, Underlying EBITDA third quarter was 14.9% compared to 13.3% a year ago. The higher EBITDA percentage was driven by favorable pricing to cover rising input costs and improved logistics costs, partially offset by higher variable compensation associated with the stronger overall company financial performance. In addition, we issued a onetime employee recognition bonus in the third quarter of last year, totaling $56 million. To provide clarity on operational performance in comparison to our guidance and excluding costs associated with the planned separation of Atmus and the acquisition integration and inventory valuation stats related to the acquisition of Meritor in my following comments. As a reminder, we completed the acquisition of Meritor in August of 2022, resulting in one additional month of operational performance in Q3 this year compared to last year. Now I'll go into more detail by line item. Gross margin for the quarter was $2.1 billion or 24.6% of sales compared to $1.7 billion or 22.9% last year. Gross margin increased…

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're ready for our first question.

Thank you. Our first question is from Jerry Revich with Goldman Sachs. Please proceed with your question.

Yes, hi. Good morning everyone.

Hey Jerry.

Jennifer, congratulations on the joint venture with PACCAR and Daimler. As we look forward to what that means for Cummins product availability and offering within EVs, can we just expand on that in terms of what's the opportunity to bundle it with e-Axles, battery management systems? And if you could just talk about, is there a plan use the plant to source batteries globally for your customers? Or is this strictly focused on the U.S. initially? Just would love your broader comments. Thank you.

Yes. So Jerry, I'll add a little bit more color to what we're doing with this partnership. As I said, this partnership is really focused on battery cell manufacturing. So, we have previously been investing and focusing on battery packs, e-Axles, motors, inverters, other key components and integrated powertrains for the electrified powertrain. And together with our partners saw the need to bring production of battery cells into the US and really design what we think is going to be a winning cell solution for commercial vehicles and industrial applications. So, this will be supplied into the battery packs that Cummins will produce. The cell will also go to PACCAR and to Daimler trucks here in North America for their battery cells, really is targeted at the US market. and having a domestic offering that we think will really do the market. And the chemistry here, for this, we will continue to offer battery packs around the world and chemistries, including LSP and NMC. But this one is focused on LFP technology, which, again, together, we think is going to be a winning commercial vehicle battery cell chemistry, lower cost, better durability, less dependency on some of these minerals that can be harder to source and also improve safety. So, really good opportunity for us and also to stay closely connected with those two partners as we're launching these electrified powertrains. Our intent is to offer that battery cell through our packs to other commercial vehicle and industrial applications here in the US as well.

Okay. It's super. And Mark, can I ask just a shorter-term question on the Engine segment, you folks had pretty solid performance in the quarter and for the year. The reduced margin rate at the midpoint seems like a big step down in profitability implied fourth quarter versus third quarter. Can you just talk about is that a significant production cut, China JV? Or is that just taking the midpoint of the range versus thinking about the broader, maybe higher end potential outcomes?

Yes, I think it's not related to China. It is related to the fact that we're going to have less production days. That's consistent with the industry forecast for lower heavy-duty truck, which isn't a surprise, but that's what we've kind of been projecting for a couple of quarters. The thing that's really changed through the course of the year, Jerry, is the decline in the aftermarket, particularly running through the engine business. No doubt, some of that's related to customers rationalizing inventory. I don't, I think the underlying rate of decline is less than the headline rate because we've gone from a period of everybody trying to keep up with demand and now like ourselves, many companies are looking at inventory levels and trying to right-size. But just to give you a sense within the engine business between the first quarter of 2023 in the fourth quarter, parts revenues are down about 18%. So that's kind of been slipping each time we've looked at it. So that's the one changing trend. I don't think it's foretelling do. I just think it's mostly inventory adjustments. But that, combined with the lower production days, the lower absorption means that, yes, even though the revenues are holding up for the fourth quarter, it's going to be a little bit tougher. And that's one of the reasons, not the only reason why we've decided to initiate the actions that we discussed earlier. We're not predicting like a precipitous decline in our revenues at all. We don't have a visible clearly a leveling off or a slight decline in some areas, but we feel it's prudent both to do the cost reduction actions, continue our focus on cash flow and debt reduction the year that should leave us with the best chances of being very successful in 2024.

One quick to add, Jerry. It doesn't change our overall guide for engine business, but it is a difference between Q3 and Q4 is our JV income does step down because of license fees timing. So, we had a lot of that happened in the third quarter that steps down about 40 basis points for Engine business margin from Q3 to Q4. So hopefully, that helps.

Thank you. Our next question is from David Raso with Evercore. Please proceed with your question.

Thank you. I'm curious, the cost-out decisions. How much is that related to what you're seeing on the horizon in 2024 and if you can give us any insight on what that is? And maybe margins in 2023 being maybe a little more of a, let's say, a heavier lift to expand margins than maybe we see across the machinery space broadly. Just curious how much is it sort of structural to what 2023 is playing out versus what you're seeing in 2024? And obviously, any sense of magnitude the cost outs would be really helpful. Thank you.

Yes, David, I'll start and then Mark can add if he wants to add anything. So, as we said, we see that many of our markets have leveled off. We're seeing some drifting down in some of the markets, aftermarket, off-highway. And we are continuing to focus on ongoing improvement and profitability and performance of our business and using softening markets as a further opportunity to take costs out. So, we still see a lot of strength as we go into next year. We're not going to provide guidance for 2024. Today, what I will say is if you look at backlog and heavy-duty truck and medium-duty truck continues to look quite strong as you go into the first half of the year. Power generation is very strong. And so we're not seeing any precipitous drop off, but we think it's wise to take some cost-cutting actions here in Q4 and then continue to monitor the situation. And if we need to take further action, of course, we would continue to do that.

And we'll give you a fuller assessment on the next quarterly earnings call about the both the cost and the benefit impact. Of course, what we're announcing today is voluntary actions, so we don't know what the exact take-up is going to be and then our assessment of what is the kind of momentum in markets going forward. There will be some other smaller actions around facilities and other things. But we'll lay that out in detail in the next quarter when we've got a more holistic or hopefully, clearer view of the full year next year.

That's helpful. Maybe you can educate me on something. I'm a little confused by the comment in the fourth quarter engine margin. And I appreciate Chris' comment about the JV income, how that will impact 3Q to 4Q, but you highlighted a lower parts impact benefit in the fourth quarter. But then when I see the Components business, which, obviously, has a lot of parts as well, it seems like you're implying a strong fourth quarter on margins for components. So, can you educate me on why the difference one division is getting hit on parts and really the parts division you would think for aftermarket, even more so components, is having a step-up in margins in the fourth quarter, at least appears to be…

The size of the parts business in the engine business is significantly bigger than the size of the aftermarket business in the Components.

Sure. I think difference one step down and one step up. And maybe I'm just doing the math right, but it seems like the component implied fourth quarter margins pretty strong?

Yeah, I think it's pretty stable. I think that's just the dynamics we're seeing between the two different businesses right now.

Well, both of those segments are anticipating lower volumes for North America, medium- and heavy-duty truck market in Q4 for the reasons that I outlined here. Frankly, there's a combination of focus on inventory reduction and supply constraints that are continuing to prevent OEMs from building to the full demand, and we expect to see that in Q4 impact our revenues for both of those segments.

All right. Thank you very much.

There can be some differing customer demand for Components and engines in any given short-term period, David. I think you're right in the longer run or medium over multiple quarters should correlate pretty well. But in this case, we're seeing a bit more pressure on the parts on the engine side. It's not all parts that are sourced directly from our Components business. That's the main part.

All right. Thank you.

Thank you. Our next question is from Rob Wertheimer with Melius Research. Please proceed with your question.

Hey, I have two. One is just on the parts destock that you have mentioned and that makes sense. I'm just curious if you have any sense as to how much channel inventory people carry if you're all the way through that, half the way through. If you just quantify that potential if you're able to?

It's a little hard to say would say what we tend to see more clearly on the Power Systems side is destocking almost every year into the fourth quarter. We are seeing some of that and some lower rebuilds, particularly in the slice of the oil and gas market that we supply, Rob. But I would say the engine -- on the engine side, the on-highway side, the seems to have been a more sustained multi-quarter approach. And I think part of that there was a focus on prioritizing OEM newbuilds, first-fit build as we started to ramp up through the cycle and wrestle through supply chain. And then the parts was in catch-up mode, and now we're finding truck utilization has leveled off. Everybody is trying to do a better job on the inventory management. It feels like it's -- we're getting towards the bottom of that right now. Of course, that always depends on what's the economic environment and what's the underlying level of truck utilization. So if you were to ask me today, do I think we're on a clear trend to have significantly lower parts in Q1? I'd say no. So it feels like this is the strongest step has been in the last three quarters with the information that we have right.

Perfect. And then if I can ask kind of a bigger picture question in China. It's obviously been very weak for a lot of industrials. Maybe it's bottomed in all your end markets maybe in some. I wonder if you could just give just your high-level view of what's going on in the economy there, whether fleet dynamics mean you have to be in recovery mode, whether that's true of trucks or power gen? Or just maybe give an overview of China, what you see in different parts of your business on the recovery? Thank you.

Yeah. So when we look at the China market, I mean over economic activity has continued to be pretty weak there. We've seen improvements in 2023 compared to 2022 when they were heavily impacted by COVID lockdowns even more extreme weakness. So you've seen some improvement. We've seen the strong demand for natural gas heavy-duty engines because of the cost delta between natural gas and diesel there. We've kind of come through the emissions change over in an on-highway market. And so if we see recovery and continued recovery in the economy there, so I think that will continue to positively impact our business. And with the product investments that we've made, the emissions change, we'll have more content, and we think continuing to increase our penetration. So we'll watch and see if any of the government stimulus does start to drive positive momentum and the economic activity, but it's been relatively weak this year.

Yeah. I mean just to give you a sense, I know we don't like talking about months, but July was like the lowest in a decade, right, in some of our JV production. It's crept up since there, but it has been tough. Again, it's not worse than we thought, but that just gives you a sense of how weak it was in the summer. Hopefully, there's upside from here, but we don't have good visibility to that.

Yeah, the RMB1 billion bond that's planned, I think that's encouraging to see the government moving that won't impact fourth quarter, but hopefully, it drives more infrastructure growth in next year. We'll wait and see that we're up.

Thank you. Our next question is from Tami Zakaria with JPMorgan. Please proceed with your question.

Hi, good morning. Thank you so much. So I just wanted to ask about the Power Systems business. Margins came out really strong. Sales growth is strong as well. But when we look at the fourth quarter guide, it seems like you're guiding to a step down of almost 200 basis points sequentially. So just wanted to get a sense of what's driving that? Is this conservatism? Or is there something that we need to be aware of for the fourth quarter for the segment?

Right. So the good news is they've been performing really well. So that's the underlying, and I think that's -- we expect that to be a continuing trend. As I mentioned earlier, typically, we see, particularly with the industrial side of that business that the customers really dropped down the purchase of parts in the fourth quarter. That's not new, but that that typically happens every Q4, and that's probably the main factor there -- the main negative factor. Otherwise, the underlying demand is strong. There's no major changes to pricing or the cost structure.

Got it. That's very helpful. And the next question is R&D spend. The R&D spend over the last five years have stepped up notably. How should we think about that spend, let's say, in the next couple of years, and any color on that?

Yes, Tami, as you noted in a period of increased R&D investment that we think will position Cummins well for the future. So in particular, now through the 2026, 2027 time frame when we launch these new fuel-agnostic engine platforms, we're making a major R&D and capital investments, and those are bringing new customer business to us and also will position us to have leading products through the energy transition. We've also been increasing our investment in the Accelera business as we ramp up the product investments for our electrolyzers and see growing demand for electrolyzer volume as well as in the electrified components. So that's really what you're seeing come through in the R&D line. And then we're continuing to really focus on improving underlying performance and efficiency in other areas so that we can continue to make the necessary R&D investments. A – Mark Smith : Yes. And that's why we've had a big push on the SG&A and continue to do that. So well, on gross margin. So we can grow margins, grow investment, grow the bottom line and keep improving the cash. That's a simple formula that we're working to. We'd like to see the cash flow come up. The engineering is going to remain these higher levels for a little while yet. And it's also the new engine business platforms are contributing to the -- yes, CapEx being higher in dollar terms. It's in our expected range as a percent of sales. But for the next couple of years, we've got these renewal of these major platforms, which is important for our future.

Thank you. Our next question is from Tim Thein with Citi. Please proceed with your question.

Thanks. Good morning. The first question is on Power Systems. And I'm just curious about kind of the visibility that you have looking into 2024. And backlog isn't something that we historically really talked about with Cummins, but just given the long lead times for large engines and just visibility you have from a rebuild perspective, can you just maybe speak to where you think you exit the year in terms of -- again, I know you're not giving 2024 guidance, but just any sort of help you can give in terms of what kind of revenue visibility you would expect to exit the year with in that business? A – Mark Smith: Yes, you're right, Tim, that there is more visibility, but long lead times and the underlying demand. Certainly, I think we've got great visibility through the first half of the year. And of course, we're seeing -- we're anticipating more pressure on the on-highway side just because not a severe downturn, but generally, market participants are expecting some moderation in heavy-duty truck orders going into next year. So we would expect more revenue headwinds on the engines and components side. Distribution, as you know, is very heavily aftermarket-driven. So absent some massive crush in the economy, that should be more stable. And then Power Systems, certainly, very strong visibility through the first half of the year and some into the second half of the year. We haven't seen a dramatic shift in trajectory at this point in time.

Yes. I mean we're continuing to, as Mark said, to watch the Power Systems markets and in the industrial markets, we have seen a little bit of softening in oil and gas, which is a relatively small market for us that's kind of its inverse. And so that has softened a little bit. And then in Power Gen, you see a lot of growth this year. And I expect continued strong demand in the data center market for our business, and we're well positioned there. A – Mark Smith: And it's encouraging that both Power Systems and distribution now are on multi-period margin expansion trends that serve us well going forward.

Yes. Okay. And then just a lot of discussion here in terms of the on-highway parts business for you. And again, I know it's probably a bit of apples and oranges, but just listening to the commentary from your largest customer and kind of the outlook there they have for their own parts business. What do you think -- again, I know you don't want to speak for them, but what do you think is the -- you mentioned down 18%, I think from the beginning of the year. I think they're down like 2% or 3%. What do you think is driving that invariability between you come in to experience versus at least some of the OEMs? And yes, I know that the businesses don't align perfectly, but presumably, their impacted by a lot of the same dynamics. Just curious how beyond that. A – Mark Smith: Generally, I think it's destocking, right? We've had -- we have -- there's obviously, we know returns levels and things like that from all parts of our channel have gone up as customers have been deep.

Yes. I think it's really important to note through this cycle, two very different dynamics because of the supply constraints than what you would previously see. So the aftermarket demand was really strong. And with the supply constraints, it was challenging for some of our customers to get parts. And so there was a lot of focus on building up inventory to try to buffer against those constraints and a focus, frankly, on addressing the gaps that resulted in an overbuild of inventory. So now that some of those supply challenges have eased this getting inventory back to appropriate levels has been a focus, and that's driven a drop-off beyond just the actual aftermarket demand in service. And then the same is true and happening on the first-fit build that we've had supply constraints that have limited our ability to meet industry demand and you see that resulting in the markets holding up longer than you would typically see and continue to see solid demand for first-fit trucks. A – Mark Smith: And then if I just step back from the noise in this kind of correction period, Tim, clearly, our market share in North America on-highway markets has gone up noticeably so that should all go well for the parts that will inevitably be purchased through Cummins. I just think just in this correction period. I was just trying to provide that extra color this time to explain what I think a short-term margin influences, but not long-term market trends.

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

Thanks. Good morning. Just curious about how much visibility you have to on-highway engine pricing going forward at this point into 2024. I guess to what extent is your pricing going to be dependent on the pricing of your OEM customers or how independent can that be?

Yes, we were price cost favorable this year, as we've shared previously, and we have -- we're continuing to focus on pricing with new product launches and where we've seen inflationary costs coming through. So we're working to continue to maintain that positive price/cost ratio. And we're seeing some slowing of course, in pricing in the market, but we'll expect to continue to have some of that. A – Mark Smith: Right. And again, when we give out for next year, then we'll, I'm sure you'll ask us about price cost. We'll be happy to share the dynamic.

Sure. Yes. Thank you. And then can you expand a little bit on your comments on the construction outlook? I think you cited inventory adjustments in North America, but maybe you can just talk about the broader global view of engine demand for construction applications and how you think the setup there is for 2024. Is there sort of a demand question or is it just sort of near-term inventory management? A – Mark Smith: I think part of it can be the age of construction fleets, right? So we're seeing a drop off in engine demand. That doesn't necessarily mean a dramatic shift in North America construction activity. The three biggest markets both in North America, China and Europe, I think generally, it feels like the pace of economic growth in Europe is slowing. In China, it surprised us a little bit that the construction equipment demand hasn't fallen even further given some of the trails in the overall kind of financial health of construction sector in China, but it has come down some. But yes, no clear picture yet going into next year, I would say, that of all the markets, we still got some tire kick in to do, Steve, to figure out where we land for next year.

Thank you. Our final question will be from Noah Kaye with Oppenheimer. Please proceed with your question.

Yeah. Thanks. You indicated some favorable testing around the X15 and coming to market next year. So just would love to get a little bit more color on your expectations for demand there, the extent to which this could be a driver of share gains and where you're hearing the sort of the strongest indicators of demand for that product?

Yeah. So we'll launch the X15 here in North America next as you heard me say, it's performing well in China. We'll have a US version of that, of course, meeting the regulatory requirements here next year, and we'll have availability now through two of our OEMs. And we are seeing end customers testing and interested in that product will have the only heavy-duty natural gas product offered here in North America. So of course, that creates some opportunity for us as customers where they've got infrastructure, environmental goals or even operating cost benefits associated with natural gas will start to adopt that solution more. So there's some opportunity there for sure.

Okay. And then I think we'd love to get a catch-up on the electrolyzer backlog and quoting activity. Any change in the trajectory there? Anything you noticed during the quarter? And can you update us on where you're at in terms of building out capacity?

Yeah. Really, on the same trajectory we've talked about previously with building up manufacturing capacity here in the US and Europe, continuing to have backlog growing. We are in the process of commissioning a 25-megawatt electrolyzer with Florida Power and Light over the course of this year. So another big project that we're delivering this year, and we continue to ramp up that business as we described previously.

Thank you. There are no further questions at this time. I'd like to hand the floor back over to Chris Clulow for any closing remarks.

Thank you very much for your interest today. And as always, the Investor Relations team will be available for calls and answer any further questions that you may have. Thank you.

This concludes today's conference. You may disconnect your lines at this time. Thank you for your participation.