Greetings, and welcome to Cummins Inc. Third Quarter 2023 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] As a reminder, this conference is being recorded. I will now turn the conference over to, Chris Clulow, Vice President of Investor Relations. You may begin.

Thank you. Good morning, everyone and welcome to our teleconference today to discuss Cummins’ results for the fourth quarter and full year 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 2023 and discuss our fourth quarter and full year results and then I'll finish with the discussion of our outlook for 2024. Mark will then take you through more details of our fourth quarter and full year financial performance and our forecast for this year. As I reflect back on 2023, I am incredibly proud of what Cummins and our employees accomplished for our stakeholders and I feel energized about the opportunities ahead for us as we continue to demonstrate our relentless focus on being a global leader in clean energy technology and innovation. We made significant progress in achieving our Destination Zero strategy and it continues to be clear that this dual path approach to reducing greenhouse gas and air quality impacts of our products is the right approach to meet our customers' needs today and continue to grow our business and impact. We did this by advancing our core business as well as developing new zero emission solutions through Accelera by Cummins. Most notably, for our core business in 2023, we committed to investing more than $1 billion across our US engine manufacturing network to support the industry's first fuel-agnostic engine and platforms, as well as unveiled the X10 fuel-agnostic series launching in North America in 2026. Additionally, we initiated several collaborations with our natural gas X15 engine, which will launch in North America this year and further enables our customers to achieve their decarbonization goals. This is the industry's first natural gas engine design specifically for heavy duty and on-highway truck applications, offering customers the opportunity to realize reductions in nitrous oxide and greenhouse gas without compromising performance. We are continuing to see strong interest from both OEMs and end users ahead of the…

Thank you, Jen, and good morning, everyone. I will acknowledge I have a heavy cold this morning. So if I sound more dour than usual and a little rougher, please take that into consideration. We delivered solid operational results in the fourth quarter, exceeding our expectations for revenue and delivering EBITDA margins in line with our guidance. Compared to 2022, our full year sales grew 21% and our operating cash flow more than doubled to a record $4 billion, reflecting the strong focus of our employees on meeting customer demand and improving working capital. Now let me go into more details on the fourth quarter and full year performance. Q4 revenues were $8.5 billion and EBITDA was a net loss of $878 million, or negative 10.3% of sales. For the full year, we reported revenues of a record $34.1 billion and EBITDA was $3 billion, or 8.9% of sales. As Jen mentioned, we recorded a one-time charge of $2.04 billion in Q4 to settle the previously disclosed US regulatory claims. Fourth quarter results also included $42 million of costs associated with the voluntary retirement and separation programs. Costs associated with the planned separation of Atmus were $33 million in the fourth quarter and $100 million for the full year, compares to $19 million in the fourth quarter of 2022 and a total of $81 million in the previous year. Full year 2022 results also included $111 million of costs related to the indefinite suspension of our operations in Russia. To provide clarity on the fourth quarter and 2023 full year operational performance of our business, I am now excluding the costs associated with the regulatory settlement, voluntary retirement separation programs, planned separation of Atmus and the indefinite suspension of our operations in Russia in my following comments. Q4 revenues were…

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. [Operator instructions] Our first question is from Jerry Revich with Goldman Sachs. Please proceed.

Yes, hi. Good morning, everyone. Jennifer, Mark, Chris, so normally when you folks have new engine regulations, we tend to see higher margins from you folks. I know we're a couple of years out from the 27 regulations, but can you just share some high-level thoughts? It looks like the average selling price of the engine could double given that embedded warranty increase and I'm wondering if you'd just comment on that and then broadly just talk about the parameters of how do you expect the dynamic to play out for your business compared to the margin expansion we've seen on prior emission cycles where you folks have increased your value add. Thanks.

Yeah, thanks for that question, Jerry. So as you've seen from us in the past, as we launch product with new emissions regulations, typically we see a content increase, of course, and then also look at creating value for our customers and have an opportunity to price accordingly with them. So we are looking to continue to do that as we launch new products, in particular, these fuel agnostic engine platforms. Of course, we also typically see a bump up in our warranty costs because we are beginning to accrue in at a high rate until we've demonstrated capability of that platform. So that's the other factor to watch as we launch those products, but what you see us doing right now is really focusing on improving operating performance of the business, as well as investing in the key platforms for the future that we believe will bring value to our customers and position the company for profitable growth.

Okay, super. And then can I ask separately, given the high logistics costs that the industry saw in 2023, can you comment on where your labor hours per unit stand today versus normal? And to what extent could that be a source of upside relative to the guide?

Yeah, Jerry, I think that has been, as we've progressed through 2023, continue to drive more and more efficiency. Some of the supply chain hiccups that we have experienced are beginning to iron out, we're getting better on time to delivery, and that does allow us to drive more efficiency in our plants. So I think we are continuing to see that as we progress through the latter half of the year. As we expect, as both Jen and Mark mentioned, volumes to particularly in the North America heavy duty truck space come down a bit and moderate a bit, we can continue to drive those efficiencies. So I think the cost per labor hour will continue to get better and I would say the overall costs on labor have somewhat levelled out. We went through, as you know, a long period of them rising and through the course of the last six months that has settled down and become much more of a flat.

Yeah, I would say in the near term, there's a little bit of increased anxiety about events in the Middle East and some shipping delays and some reversing of the trend we've seen in logistics costs, which have been actually going down for us, Jerry. I don't want to overstate that, it's obviously is a little bit of a concern in the near term.

Our next question is from Tim Thein with Citigroup. Please proceed.

Maybe just one bit of a clarification, but on the comments on for engine shipments in North America for on highway, I think you said 140,000 down 5% to 10%. Is that -- was that relative to the total North heavy and medium duty market, or was that a comment just on heavy duty in terms of?

Yeah, on the medium duty, Tim, we had a down, down 5% to flat, and that's 140,000 to 150,000. The heavy duty market, we have it down at 10% to 15% and that's our guide for the year.

And I'll just give a little color. This has been an unusual cycle, I think, in the '21, '22 timeframe and supply constraints that prevented the industry from fully meeting customer demand and that has improved over the course of 2023. We saw the markets peak really in the second quarter and saw some slight drop off in the second half, but to the high end of our guide, it was not as much as we had forecast going into Q1. Backlogs look strong, in particular, feeling quite good about the medium duty market and continuing to watch what happens. We are still predicting a shallow cycle and further softening as we go into the second half of the year. So that, just some color behind those numbers is how I would describe that.

Okay, I had a question on kind of what that implied in terms of the market share, but I can follow up with Chris after and then maybe the second one is just on the implied decrementals for the engine segment in '24 and obviously, the kind of a high 30% number, the JV income will certainly be a drag on that, but maybe with not to go through every single piece, but the parts headwind was pronounced in '23 for Cummins and I'm just curious for that piece, specifically, you outlined that the guidance for the off highway parts outlook, but for that and anything else that maybe you'd call out that's relevant to the year-over-year margin performance for engines? Thank you.

Yeah, good, good question, Tim and the main thing that you didn't cover there was just our assumptions around product coverage. We're not expecting any significant change, but baked into our guidance is a little bit higher product coverage or warranty as a percent of sales in the engine business. We'll see how that plays out, but, that's the other factor that's in there that you didn't list.

Our next question is from David Raso from Evercore ISI. Please proceed.

Hi, thank you. Just sort of a bigger picture question, I know there's been a lot of costs involved and you're right in the thick, of course, call it a decade long energy transition that there's a lot of expenses. I'm just curious, if you look out over the next year or two, is there an inflection point that you see your cost begin to recede and if not, is there a thought of maybe a larger cost out program? I recognize the separation program you discussed, but just something maybe more substantial size, just given relative to other names we look at, they've had a real strong run on profitability the last couple years and it's been a little more of a challenge for your margin. So just curious if you see something on the horizon that really changes that, be it cost inflection, or maybe an idea you've proactively taken, sorry, spend inflection coming down, or something on the cost side that maybe you can do. Thank you.

Yeah, David, thanks. Thanks for the question. And first, I'll say, I think you said decade long energy transition, I would just put an S on that decades long, right? It's going to take time. The reality is, if you look across our different markets and regions, it's going to take time for that transition to occur. We are in a period, though, of really peak investment in the engine business. As we invest in these fuel agnostic engine platforms, we've got a major investment in R&D and capital to do that. And we think that those engines are going to really position us well with high efficiency diesel products as customers have and continue to decide not to invest in their own platforms and to use Cummins and then also the fuel flexibility that will help customers as they begin to transition, whether its natural gas or hydrogen-based engine solutions. And so the next few years until we launch those platforms in the '26, '27 timeframe, we're seeing higher levels of R&D in those products and then, of course, we're also in a period where we've got somewhat lower revenue and higher investments in the accelerator business and we are pacing that investment based on how we see the market moving. We're looking at opportunities to share investments while having a leading solution, like you saw us do with the battery cell joint venture. As revenues grow, we improve parts of those businesses and electrified components. We've now delivered 1500 buses with Bluebird and ramping up the electrolyzer that will help improve margin performance of the business there. And then the last thing I'd say is, as Cummins has done, and we will continue to do, we're looking at how do we improve different parts of our business and so following the acquisition of the North America distribution business, we had a focused investment on improving margin there and you see that playing out in the distribution business performance and I talked about the focus last year that started in our power systems business. You see that playing out there, the Meritor integration, and we're continuing to look at places that we can improve operating performance of our business and then watch market demands and cost and so the voluntary reduction actions that we took last year help us as we see some reduction in revenue this year. So all those things come together to allow us to continue to improve our returns to investors while making sure we're investing in key products and technologies for the future.

All right, thank you. And just a minute real quick, and I'll hop off. The cadence of the declines in North America truck that you're looking to experience as the year goes on, can you give us a little sense of the cadence, maybe from an industry perspective, and would your declines, the cadence be any different? Just the idea of the lead lag between what's in inventory, how early you ship, just trying to get a sense for the cadence and how you relate to the industry cadence. Thank you.

Yeah, great. So, obviously, there's some lead that we have in supplying engines into truck build. So our engine build rates will slightly lead truck build rates, but as I said earlier, from a guide perspective, we think where we were running as we ended the year is going to hold pretty steady through the first part of the year and then we're forecasting some softening toward the end of second quarter and into the second half of the year.

In a medium duty truck, there really isn't that much difference between the two, and market and hours and then heavy duty, that's where we see a little bit more vulnerability for the market and would largely expect us to move in line with the market.

And then the last dynamic is in pickup, we've got the product changeover that'll drive Q4 volumes lower and pickup.

Our next question is from Angel Castillo with Morgan Stanley. Please proceed.

Hi, good morning. Thanks for taking my question. I just wanted to unpack that cadence for the second half a little bit more. I think last quarter you had indicated aftermarket was an area that maybe was giving you a bit of a signal that there was a bit of a softening. And I think you indicated that things came in maybe the higher end of your expectations, and you kind of see that continuing into the first half. So as we kind of position that second half slowdown and now an expectation for aftermarket to actually pick up from the kind of flat to up 5% through the year, can you tell us, I guess, what you're seeing in terms of customer commentary and any kind of signs or what kind of gives you confidence in that second half slowdown as we think about the year?

Yeah, I'll have a go -- first go at that question. First of all, I'll just say on aftermarket, we saw a very pronounced, I would say some element of de-stocking or lower production across our lower demand in parts in Q4, which we largely attribute to customer cash flow management. We don't expect that to be a continuing trend. We expect to recover from Q4 levels on parts and be pretty steady across the year. On the truck builds, well, of course, you've heard from most of our major customers. So we really don't have much more to say other than the backlog of trucks has been slowly edging down and then the thing that gives us the broader concern is the spot rates and the health of the truck fleet operators. That's our principal concern. It's not our OEM customers and right now that the backlog and the orders still continue at quite decent levels. It's what's happening to the underlying economics of freight activity. That's what's giving us the concern combined, which hasn't been moving in the right direction, combined with the slowly easing heavy duty backlog. So it isn't a kind of pronounced downturn we might have seen in prior cycles at this point, but those are the factors that are weighing into our consideration and I think our guidance isn't more conservative than anybody else's and we don't have any other observations beyond those really.

Got it. That's helpful and then maybe pivoting to Accelera, I just wanted to maybe unpack that a little bit in terms of curious what you're seeing in the backlog trends from 3Q to 4Q and as you kind of deliver on at least the electrolyzers over the next 12 months to 18 months, can you talk to us, I guess, about the cadence of the profitability of that business? We kind of exit 2024 and you start to have higher deliveries on those and maybe what you kind of foresee the exit rate will be in terms of that profitability?

Yeah, so we are in a period of still pretty heavy investment in Accelera businesses are really making both R&D and manufacturing investments to scale up the product and we're fortunate we have, existing plant and data that we can invest within to do that, to begin to produce electrolyzers and we continue to see growing demand and backlog is, as I noted, at a record level for electrolyzers. So that production rate is going to begin to grow and then you'll see margin performance in the electrolyzer portion of the business improving as the revenues grow and we deliver that backlog out into the market. Same thing in our electrified components business as we see revenue growth there. You'll see margin performance improving. One thing we have now included in our 2024 investment, of course, is beginning to invest in the battery cell joint venture and we believe that, that is a key investment that we're making together to ensure we have a leading cell for commercial vehicles here in the U.S. and domestic supply, which will both allow us and our customers to take advantage of incentives that are available and ensure security of supply over time into this market.

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

Yeah, hi. I wonder if you could give us some thoughts on what's happening in the data center and large engine market. Obviously, it's very strong. I don't know how many years of visibility you have or what that market looks like. Your primary competitor announced a capacity expansion. I don't know where your capacity and your room to grow into that market if it is, a multiyear kind of curve. So I wonder if you could kind of give us an update on dynamics there.

Yeah, the data center market is an exciting growth market, has been for several years a trend with increasing cloud, data storage in the cloud and now with artificial intelligence and other investments. We continue to see very strong demand. We guided up 10% to 15%. Backlog for that market is very, very strong. We're looking at our capacity to make sure that we can meet the market demand and feeling good about the product offering that we have and of course, that business and the focus on improving underlying performance of that business will help us as that market grows.

Probably the clearest secular trend over the next couple of years.

I don't. Yeah, I think it will continue.

And then do you have room to grow in '25 and '26? Maybe not sure too much on your capacity, but it seems as though you're probably, you're probably being asked to quote or to think about, capacitor that far out, right.

Yeah, I will just say we expect that that trend of data center market growth will continue and we are and we'll continue to look at our capacity and how we position to meet that demand.

Okay. Perfect. I'll stop there. If I can sneak one more in on medium duty, there's a bit of a narrative that as the COVID constrained production, the OEMs prioritized large class state over the medium duty and that's reflected somewhat in industry outlooks in your out. I'm just wondering if medium duty has more inherent demand than that being helped by interest rates or anything else, or if that's kind of where the market is kind of flattish? I'll stop there.

Yeah. There were certainly the OEMs experienced a number of supply chain constraints and continued in '23 and even into the early part of this year, frame rails in particular. So we are, as you as you saw, really expect the medium duty market to continue to hold pretty flat to where it is now. It's quite strong. We, of course, have a strong position in that market and we're seeing continued demand and pent-up demand from some of the customers in that market for our product. So less often in there than heavy duty.

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

Hi, good morning. Thanks for taking my question. So I think you highlighted DV [ph] adoption scenarios at your last Analyst Day. As of today, I know you're hosting another Analyst Day this year, but as of today, which scenario, the fast versus slow, seems more likely? And how do you think that affects your Accelera target of $6 billion to $13 billion revenue by 2030? Any updates on that?

Yeah, as you said, we did a kind of a low and a high scenario for adoption at our last Analyst Day and you can expect that we're going to refresh our view of that as we go into the Analyst Day in May. What I would say is that, there are regulations and incentives that are helping to start to drive that adoption, maybe more towards the lower end of those scenarios is what we would think and we are continuing to look at pacing of investment to make sure that we're managing that in line with how we see adoption actually occurring.

Got it. So if it's more leaning toward, let's say, the slower version, does that have a dampening or somewhat negative or slowing impact on the Accelera targets that you have out there?

Yeah, we're still within, it would still fall within the range that we gave in the Analyst Day, consistent with those range of scenarios that we suggested and recall that, a large portion of that revenue in 2030 for Accelera is in the growth of the electrolyzer business as well.

Our next question is from Noah Kaye with Oppenheimer and Company. Please proceed.

Thanks so much. First off, a housekeeping question. I'm trying to understand cash flow dynamics as we exit the year and the leverage profile. Obviously the settlement impacts that a bit, but, you typically have a target to return 30% of cash flow to shareholders. How are we thinking about return to capital this year and where you're kind of aiming to end the year on leverage?

Yeah, so morning, Noah. So we're going to start the year with the same stance as last year, invest in the business, dividend focus and some more de-levering. That's the way we start in the year. We'll continue to evaluate that with our board as we see how the cycle unfolds. At least that's our initial stance. Of course, part of our, in years where we've generated more cash than we've needed, then we've returned significantly more than the 50% in any given year, but anyway, we think this is the approach right now until we see a little bit more on the cycle.

All right. So you do expect to de-lever as we get to the end of the year.

Yes.

Okay. And then just the guide for China truck seems a bit wide. Can you kind of talk us through the low end and the high end of the range in terms of the scenarios you're envisioning? Is it high end contingent on stimulus? Walk us through what you're seeing and assuming.

Yeah. That really reflects low visibility, right? So we've come off a very weak base, but there just isn't clear signals yet from the market as to what's actually going to happen. So we can build a case. It's hard for me to think of a case that's a lot lower than where we are today, but just the overall pace of the economy continues to be sluggish and so that upside really leaves room for something unexpected on the stimulus side, which has happened from time to time in China, but we don't have brilliant insight at this point in time. The outlook is cloudy and the conviction from OEMs is not quite there yet. We're doing well with our customers, launching more products. We're bullish on continuing to outgrow in the market in China, both consolidated revenues and in the performance of the JVs. We're all set to outperform. We just need a little bit of help from the market overall, but it's not as tangible as we'd like at the start of the year. Of course, we'll look at the same data points and provide you with an update. Hopefully, by the end of Q1, we tend to have a stronger view of the. And my voice is done for the rest of the morning.

Chris and I will answer the rest of the questions.

We'll see how much it clears on China.

Our final question is from Michael Feniger with Bank of America. Please proceed.

Yeah. Thank you guys for squeezing me in. Just the share count's been kind of flat to slightly up. There's a comment in the release about a focus on debt reduction, payment of dividends. Can you just flesh out the priorities in 2024, because I know Mark mentioned with Atmus, I heard buybacks. Just maybe you can reiterate the framework of how we should kind of think about Atmus in 2024 as we move through the years, some of the puts and takes there.

The main impacts of Atmus operation will be obviously, they'll set off on their own pursuing their growth strategy and as this final step, we will swap Cummins shares for -- investors will retire Cummins shares in exchange for Atmus shares. So our share count will go down if the exchange is successful. The reason our share count here in the past 18 months hasn't been changing or drifting up is because we stopped the share repurchase as well. We de-levered post the Meritor acquisition, which we've been telegraphing to investors. We've got a little bit more of deleveraging to go, and then we'll continue to evaluate whether we, what our opportunities are to generate the best returns for investors, either through organic growth or through more capital returns, but that's the basic way it's going to work. The share count will go down on the separation.

Fair enough. And Mark, I want to let you go and get better. Just quick question for you is just on Meritor, I think '23, I think there's revenue about $4.8 billion, maybe EBITDA a little bit above $500 million. Just when we think of the guide for '24 on components, anything you can help us unpack about how that Meritor in '23, how that kind of trends in '24 relative to your overall components guide? Thanks everyone.

Got it. And I will say I'm feeling better than I sound, and that's largely because of the record cash flow. So please, as I said at the start, don't read into my breaking voice. Meritor achieved the goals we had for this year. It is not a segment on its own. We provided that data for the first full year for transparency purposes to make sure investors had a read on how we were doing after a little bit of a bumpy start when we first acquired Meritor. So that's all rolled into the guidance, but it's safe to say we've got further improvement in Meritor going into 2024 and we're really pleased with how the team is doing there, Ken Hogan and his team. So we're excited about that going forward. So thank you. Thanks everybody. Appreciate it.

This will conclude our question-and-answer session. I would like to turn the conference back over to Chris for closing comments.

Thank you, everybody. That concludes our teleconference for the day. I appreciate all of you participating and your continued interest. As always, our Investor Relations team will be available for questions after the call. Take care.

Thank you. This will conclude today's conference. You may disconnect your lines at this time, and thank you for your participation.