Cummins Inc.

Good day, ladies and gentlemen, and welcome to the Cummins Incorporated Second Quarter 2023 Earnings Conference Call. Our host for today's call is Chris Clullo, VP of Investor Relations. At this time, all participants are in a listen-only mode. If you would like to ask a question throughout the conference, please press star, then the number one on your telephone keypad. Later, we will conduct a question and answer session. 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 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. 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 3rd, 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, Atmos Filtration Technologies Incorporated 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 Atmos outstanding shares. The Atmos IPO generated $299 million of net proceeds, and Atmos added $650 million of debt. Cummins realizes the benefit of the IPO proceedings and the debt issuance, as Atmos 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 key markets starting with North America before moving on to our largest international markets. Demand for our products continue to be strong across many of our key markets and regions, resulting in record revenues in the second quarter of 2023. Revenues for the quarter were $8.6 billion, an increase of 31% compared to the second quarter of 2022, driven by the addition of Meritor, strong demand, and improved pricing. EBITDA was $1.3 billion, or 15.1%, compared to $1.1 billion, or 16% a year ago. Second quarter 2023 results include $23 million of costs related to the separation of the filtration business. This compares to second quarter 2022 results, which include $47 million in recovery of amounts reserved related to the indefinite suspension of operations in Russia, offset by $29 million of costs related to the separation of the filtration business. Excluding those items, EBITDA percentage of 15.4% in the second quarter of 2023 represented a slight decline from the 15.7% we delivered in 2022, principally due to the addition of Meritor activity, which currently has a lower gross margin percentage than our other businesses, and increased SDMA and development expenses. EBITDA and gross margin dollars improved compared to the second quarter of 2022, as the benefits of higher volumes, pricing, and the acquisition of Meritor exceeded the supply chain cost increases. The strong EBITDA performance of the business in the first half drove an increase in selling and administrative expenses versus the prior year as we recorded higher accruals related to our variable compensation plans during the quarter. Research and development expenses also increased in the second quarter as we continue to invest in the products and technologies that will create advantages in the future, particularly in the engine, components, and accelerator segments. As we noted previously, Meritor results are included in our overall guidance for 2023. In the second quarter, Meritor operating performance and financial results showed improvement with sales of $1.2 billion and EBITDA of 12.2%. The improvement in the profitability from the first quarter EBITDA margin of 9.4% was driven by pricing to cover inflation, operational improvements, and cost reduction activities, which more than offset material cost increases that we expect to persist through the second half of the year. Our second quarter revenues in North America grew 31% to $5.3 billion, driven by the addition of Meritor and strong demand in our core markets. Industry production of heavy-duty trucks in the second quarter was 77,000 units, up 11% from 2022 levels, while our heavy-duty unit sales were 29,000, also up 11% from 2022. Industry production of medium-duty trucks was 37,000 units in the second quarter of 2023, an increase of 11% from 2022 levels, while our unit sales were 34,000, up 27% from 2022. We shipped 38,000 engines to Stellantis for use in their RAM pickups in the second quarter of 2023, flat with the 2022 levels. Engine sales to construction customers in North America increased by 8%, driven primarily by positive net pricing. Revenues in North America power generation increased by 16% as industrial and data center demand improved and supply chain constraints eased modestly. Our international revenues increased by 32% in the second quarter of 2023 compared to a year ago, with the addition of Meritor and a strong demand across most markets. Second quarter revenues in China, including joint ventures, were $1.7 billion, an increase of 37%, as markets began to recover compared to a very weak second quarter of 2022, which was impaired by COVID shutdowns in Shanghai and other regions. Industry demand for medium and heavy-duty trucks in China was 279,000 units, an increase of 61% from last year. Our sales in units, including joint ventures, were 41,000, an increase of 63% due to increased penetration within our joint venture partners and new products launched to meet the NS6 standard. The light-duty market in China was up 21% from 2022 levels at 460,000 units, while our units sold, including Tri-Ventures, were 28,000, an increase of 23%. Industry demand for excavators in the second quarter was 51,000 units, a decrease of 23% from 2022 levels. The decrease in the market size is due to weaker activity and construction. Our units sold were 8,000 units, an increase of 5%, driven by improved share with new and expanded customer relationships for both domestic and export usage. Sales of power generation equipment in China decreased 8% in the second quarter, primarily driven by a decline in the data center market. Second quarter revenues in India, including joint ventures, were $724 million, an increase of 22% from the second quarter of a year ago. Industry truck production increased by 2%, while our shipments increased 1%. Power generation revenues increased by 75% in the second quarter driven by strong economic activity and customer demand ahead of a July 1st emissions regulation change. Now let me provide our outlook for 2023, including some comments on individual regions and end markets. Based on our current forecast, we are maintaining full year 2023 revenue guidance of up 15 to 20% versus last year. EBITDA is still expected to be in the range of 15 to 15.7%. We now expect stronger revenue and profitability in both our power systems and distribution segments than we did three months ago, offset by increased costs in the Accelera business. We are maintaining our forecast for heavy-duty trucks in North America to be 270,000 to 290,000 units in 2023. Supply chain constraints continue to limit our industry's collective ability to produce, and while end customer demand remains strong currently, our current guidance forecasts lower industry truck production in the fourth quarter. In the North America medium-duty truck market, we are projecting the market size to be 135,000 to 150,000 units, up 5% to 15% from 2022. This is an increase from our previous guidance by 10,000 units. Similar to heavy duty, supply chain constraints continue to limit our ability to produce and fully meet end customer demand. However, through the rebalancing across our global plants and efforts to improve the supply base, we have been able to increase our production, resulting in the improved outlook. The improvement in the medium-duty outlook was offset by decreases in our forecast for two other markets. North American construction is now expected to be down 10% to flat versus our previous guidance of flat to up 10%. Secondly, Brazil truck is expected to be down 30% to 40%, a decline from our prior guidance of down 10% to 20% as the market adjusts to Euro 6 equivalent emission standards. Consistent with our prior guidance, our engine shipments for pickup trucks in North America are expected to be 140,000 to 150,000 in 2023, volume levels in line with 2022. In China, we project total revenue, including joint ventures, to increase approximately 15% in 2023, driven by share growth, better volumes, and content increases. We project a 15 to 25% improvement in the heavy and medium duty truck demand and a 10 to 20% improvement in the light duty truck demand coming off the low market levels in 2022, consistent with prior guide. Despite the slow pace of recovery and the China truck market, we are continuing to see strong performance for our products, including the 15 liter natural gas engine, which we launched in 2021. Due to the fuel cost differential, approximately 20% of the heavy-duty market is expected to be natural gas powered by the end of 2023. In the short time since we launched our new natural gas product in China, our share has been ramping up with strong customer reception in the heavy-duty market. And we look forward to launching the 15-liter natural gas engine at North America in 2024. We expect China construction volumes to be flat to down 10% in line with prior guidance. consistent with a tepid economy and weaker overall activity. In India, we project total revenue, including joint ventures, to be up approximately 6% in 2023, an improvement from our previous forecast of up 1%, propelled by stronger power generation and on-highway sales. We expect industry demand for trucks to be flat to up 5% for the year. We project our major global high horsepower markets to remain strong in 2023, Sales of mining engines are expected to be flat to up 10%, an improvement from our previous guidance of down 5% to up 5%. Revenues in global power generation markets are now expected to increase 15% to 20%, up from our previous guidance of a 10% to 15% increase, driven by non-residential construction and improvement in the data center markets. For Accelera, we expect full-year sales to be $350 to $400 million, consistent with our previous guidance. As noted in my highlights, the electrolyzer market continues to gain momentum with our near-term focus on expanding capacity to meet the growing demand. As we scale up to serve the electrolyzer opportunity, continue to develop our products, and support our customers in the field, costs are running higher than originally projected for the year. As a result, we have revised our EBITDA guidance for Accelera to an expected loss of $420 to $440 million for 2023 versus our prior guidance of $370 to $390 million. Within components, Cummins expects revenues contributed by the Meritor business for 2023 to be $4.7 billion to $4.9 billion, and EBITDA is expected to be in the range of 10.3% to 11% of sales, consistent with prior guidance. In summary, coming off a very strong first half where we produced record revenues and record EBITDA while delivering for our customers, we are maintaining our guidance of sales up 15% to 20%, and EBITDA of 15 to 15.7%. Demand in most of our core markets is strong while we continue to closely monitor global economic indicators. Should economic momentum slow, Cummins will remain in a strong position to keep investing in future growth, bringing new technologies to customers, and returning cash to our shareholders. Our guidance for the full year implies weaker revenue in the second half of the year. While demand remains strong in several markets, a weaker outlook in China versus the first half, an expected decrease in the North America heavy-duty truck production in the fourth quarter, and the previously mentioned North America construction and Brazil truck decrease are some of the factors driving the lower second-half run rate. In view of the lowered forecasted revenues in the second half of the year, we expect to manage our operating expenses below the second-quarter levels. During the quarter, we returned $223 million to shareholders in the form of dividends consistent with our long-term plan to return approximately 50% of operating cash flow to our shareholders. Shortly after quarter end, we announced a 7% increase in the quarterly dividend from $1.57 to $1.68 per share, the 14th consecutive year in which we have increased the dividend. The strong execution from the first quarter of 2023 continued into the second, resulting in record sales and strong profitability, despite the ongoing challenges in our operating environment. I want to thank our Cummins employees who continue to work tirelessly to meet customer needs and respond to the strong demand levels by ensuring quality products, strengthening our customer relationships, and navigating continued supply chain constraints. Our results reflect our focus on delivering strong operational performance, investing in future growth, bringing sustainable solutions to decarbonize our industry, and returning cash to our shareholders. Now, let me turn it over to Mark.

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 ATMOS. 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 Atmos. Excluding the Atmos separation costs and the impact from Russia a year ago, EBITDA in the second quarter of this year was 15.4% compared to 15.7% a year ago. The 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 then higher development spending. To provide clarity on operational performance and comparison to guidance, I'm excluding the costs associated with the planned separation of ATMOS 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. The Cummins Meritor business continued to show improvement in the second quarter and is performing in line with our expectations for the full year. In fact, most of our businesses delivered gross margin expansion in the second quarter. Selling, admin, and research expenses were $1.2 billion, or 14.3% of sales, compared to $892 million, or 13.5% last year. The increase in expenses was driven by the addition of Meritor, net of realized synergies, higher variable compensation, higher development costs as we continue to invest in the new products and capabilities to support future profitable growth. Income from our joint ventures was $133 million, up $38 million from a year ago due to slow recovery in demand in China. Other income was $24 million, an improvement of $42 million from a year ago. In the second quarter last year, we incurred $48 million of mark-to-market losses on investments that underpin our unqualified benefit plans, and those did not repeat this year, which largely explains the change in other income. Interest expense increased by $65 million due to financing costs related to the acquisition of Meritor and also rising interest rates. The all-ineffective tax rate in the second quarter was 22.3%, including $3 million or $0.02 per diluted share of unfavorable discrete tax items. All in net earnings for the quarter was $720 million or $5.05 per diluted share, compared to $702 million or $4.94 a year ago. All in operating cash flow was an inflow of $483 million, $116 million lower than the second quarter last year, primarily due to higher working capital associated with the higher sales. I will now comment on segment performance and our guidance for 2023. As a reminder, 2023 in guidance includes the impact of Meritor, and assumes that the operations of ATMOS will be included in our consolidated results for the full year. Segment results and guidance exclude the costs and benefits related to the separation of the filtration business. Components revenue is $3.4 billion, an increase of 76%. EBITDA percent decreased from 18.2 to 14.7, with EBITDA dollars growing from $355 million to $504 million. Both the big driver of the growth in EBITDA dollars and the decline in the percent was the addition of the Meritor business. which added $1.2 billion in sales and $152 million, or 12.2% of sales EBITDA. For the component segment, we expect 2023 revenues to increase between 32% and 37%, and EBITDA margins in the range of 14.1% to 14.8%, in line with our previous guidance. Within components, Meritor revenues are expected to be between $4.7 and $4.9 billion, and EBITDA are in the range of 10.3 to 11% consistent with our previous guides. For the engine segment, second quarter revenues were $3 billion, an increase of 8% from a year ago. EBITDA was 14.2% compared to 15.2% in 2022 due to higher development spending and higher variable compensation costs linked to the stronger overall performance of comments year over year. In 2023, we project revenues for the engine business will increase 2% to 7%, and EBITDA expected to be in the range of 13.8% to 14.5%, unchanged from our prior guidance. In the distribution segment, revenues increased 15% from a year ago to a record $2.6 billion. EBITDA increased as a percent of sales to 11.5% compared to 11.2% a year ago. We now expect 2023 distribution revenues to be up 10% to 15%, and EBITDA in the range of 11.7% to 12.4%. with sales increasing 5% from our prior outlook and margins of 40 basis points, extending the track record of margin expansion in this business. In the power systems segment, revenues were a record $1.5 billion, an increase of 21%, and EBITDA increased by 58%. As a percent of revenue, EBITDA rose from 10.6% to 13.8% of sales, driven by higher power generation volumes and improved pricing. We have an intense focus on improving the results of the power systems business, and this has yielded clear margin expansion over the past year, and we see much more potential for earnings growth going forwards. Results for the second quarter include $18 million of costs associated with actions that we have taken to support drive further improvement as we seek to transform the long term earnings power of this business. In 2023, we expect revenues for power systems to be up 8% to 13%, an increase of 3% from our previous outlook. EBITDA is now projected to be 14.3% to 15%, an increase of 60 basis points from our last forecast. Cellular revenues more than doubled to $85 million driven by higher demand for battery electric systems in the North American school bus market and the additions of the electric powertrain portion of Meritor business and Siemens commercial vehicle business. Our EBITDA loss was $114 million as we continue to invest in the product's infrastructure and capabilities to support strong future growth. In 2023, we anticipate revenues to be in the range of $350 to $400 million, unchanged from our previous outlook, and losses now expected to be in the range of $420 to $440 million, an increase of $50 million in those losses as we increase the level of resources dedicated to successfully ramp up and meet growing electrolyser demand. As Jen mentioned, our full-year outlook for the company is unchanged. We maintain our previous guidance with revenues expected to be up 15 to 20% from last year and EBITDA margins in the range of 15 to 15.7. Our effective tax rate is expected to be approximately 22% in 2023, excluding any discrete items. Capital investments will be in the range of $1.2 to $1.3 billion, consistent with our prior outlook. In 2023, we will continue to focus deploying cash to reinvest in our business, grow the dividend, and reduce debt. In summary, we delivered record sales and solid profitability in the second quarter of 2023, with a key feature being the improvement in the gross margins in most parts of our business. In the second half of the year, our focus remains the same, delivering strong incremental margins in our core business, driving improvements in the performance of Meritor, reducing inventory levels, and investing in the products and technologies that position us to lead in lower carbon technologies. Our guidance does imply lower revenues in the second half of the year, and we will manage our operating expenses below second quarter levels accordingly. Thank you for your interest today. We delivered solid second quarter. Continue to make good progress in executing our strategy. Now let me turn it back over to Chris.

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

At this time, we will conduct the question and answer session. If you would like to ask a question, please press star then the number one on your telephone keypad, and you will be placed in the queue. 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, you know, 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, you know, Jen, just bigger picture. I know, I know you don't want to guide to 2024 for 2024, but I know you're very close with, you know, your customers. So as you look out in 2024, given some of the industry forecasts that are out there, which markets are you more optimistic on versus markets that you're getting a little more cautious that we could see decline? 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, you know, 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 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 a first half. And then, yes, as you mentioned, the incentive compensations, 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, you know, the performance of our products continues to be very positive and strong and What I would say is my conversations 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 plans to increase capacity and medium duty for North America to meet that. So there's still really strong demand in that market. And we're a 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, you know, 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, yeah, we think, you know, the Q2 is going to be our revenue peak. And 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 Revick with Goldman Sachs. Your line is open.

Yes, hi. Good morning, everyone. Hi, Jerry. Jennifer, hi. I'm wondering if you just talk about the interest that you're seeing from your customers in alternative fuel technologies. You know, over the course of the quarter, we have the positive EPA mandate, essentially, for landfill gas, given the changes in the rent structure. I'm wondering if you 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.

Yeah, great. Thanks, Jerry. 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'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 gonna see a lot of demand for diesel in the next few years. One key thing that happened this quarter was progress with the CARB regulation and the alignment now to EPA in 27, which is a real positive, so we can focus on a nationwide solution and then some of these bridge and zero-emission solutions to start to adopt in applications and places where the infrastructure exists.

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

Yeah, I think in that business, they're all performing well. Obviously, the change in the mix has had an impact, but clearly Meritor results stepped up from the first quarter, so that was probably the biggest change. I don't want to talk about Atmos. 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.

Thought I'd try.

Thanks. Thanks, Jerry. Your next question comes from Tim Thien with Citigroup. Your line is open.

Thank you. Good morning. The first one is on power systems. I'm just as curious as maybe you could give an update there on anything of note within the order boards. I'm guessing that, you know, as you walk through some of the markets, a lot of the remains were to the upside. And yet, you know, 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 markets. Just curious your thoughts on that.

Hey, Tim. It's Mark. Thanks for the question. I think the only marked change, which isn't new this quarter, but has 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, but that's the one clear trend I would say right now. And 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.

Yeah, 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. We see strong demand, in particular data center demand. You know, the order board is out through next year for the data center market. We revised, you know, you heard us revise mining up a little bit. So we're seeing, you know, strength in parts of those markets. And then, as Mark noted, 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. So we're very pleased with the momentum in that business.

Okay, good. And then on distribution, and maybe tying back, Jen, to your comments on aftermarket activity, but if you look at parts had been in the kind of you know, mid-40% as a percentage of distribution sales and did step down. I imagine there's some mixed headwind associated with that. But maybe just is there an area worth calling out? You know, 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.

Yeah, I mean, the color is there is, you know, 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'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. You know, the aftermarket business for us from our margin perspective is a favorable one. But, you know, we still see it being healthy is what I would say. Got it.

A bit more science is leveling off than accelerating, I would say to him.

Yeah. Okay. Thanks for your time.

Thank you. Thanks. Your next question comes from David Razzo 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 24?

I would say, first of all, it's a shorter quarter just because of the holiday period. I think the industry has a lower build rate built into 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 hasn't changed. We've had that in since the start of the year.

Well, 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 is it still 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 what we would typically see, but it's at a very high level right now. Jamestown is producing as much as they can.

We're not trying to signal some coming specific issue here, David. It's just an 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 we picked it up. The conversations for 24 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 cost down as much, but I think people are just trying to figure out, Is there some price giveback after the last 18 months or so of very strong price increases? And I just wanted to see if you could provide some perspective on early conversations you're having for your truck ending pricing.

Yeah, look, you know, 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, you know, that will – you know, allow us to continue to, you know, have those conversations with customers, but really nothing dramatic there.

Okay. Thank you very much. Thanks, David. Thanks, David.

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

Hi. I also have a question on price and then maybe just generally on the truck market and your market share and mix development. 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, you know, 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, you know, our engine and powertrain solutions and options to the OEM and we, you know, 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 our product offered, to work with the end customers to create full for our product through the performance of our powertrain compared to others in the market.

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

Okay, no, I think that's clear. And then just, I'll beg your pardon.

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

Gotcha. The second question is trying to get up-to-date on mixed shifts in North American truck and how it flows through for Cummins. So if long-haul truck declines, in vocational slash um um day cab come up and i guess medium duty comes up i'm just trying to sort out uh which of those are are market share slash mix negative for you and not so is your your market share in long haul higher than your market share in vocational and i guess your market share in medium duty is quite high so i'm just trying to think about how the evolving mix in the truck market effect comes yeah i mean the main delta in all those things is you know media whilst our share is

gone up in heavy duty over the last couple of years, and it's very strong. Medium duty, it's much stronger. 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, we're really getting into splitting. The trend has been share going up in heavy and in medium.

Perfect. Thank you.

Your next question comes from Tammy Zacharia with JP Morgan. Your line is open.

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

For the year, yes. We'll be at about 3.5% to 3.75% plus on pricing.

and on costs will be about one and a half percent inflation got it and um on your full year guide i'm just trying to understand the segment sales guide uh was raised for both distribution and power systems but the full year guide was unchanged so can you help me bridge that

Yeah, we really – well, Chris, why don't you go?

Yeah. So, yeah, Tammy, right, we did raise in power systems and distribution. 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 the other way or not improving.

You 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 had 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 attention? thinking changed or is it not really changed at all?

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

I think it's correct that the forecasts for the industry are a lower Q4, just because of the number of the production days in the quarter. But part of it's just math for the remainder of the year, 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 you know, a bigger fade into the December holiday period and a slow ramp up. So we built that into our guidance at the start of the year. That's as simple as that.

So in the meantime, you know, 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, you know, 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 to 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.

Yeah. At this point, we're continuing to assume there's no stimulus. There was a meeting a few weeks ago. Well, I think the government recognizes they want to try to improve the economy. They want to do it. fiscally responsible, stable way. And so we're not assuming stimulus. China is playing out pretty much as we anticipated, some improvement off of the 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.

Yeah, but I would say that doesn't seem the most likely 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 isn't much sign of it right now.

Right. Makes sense. Thanks. Your next question comes from Matt Elcott with TD Callen. 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, you know, emerging new structural costs and investments needed that could change that timeline?

Yeah, we are still, you know, with the strategy we have in place right now, we continue to work towards EBITDA neutral in 2027. A big piece of that is this electrolyzer revenue growth, as you saw with the, you know, the comments on backlog that occurred. We'll continue to be confident in the outlook there. 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.

Jennifer, just one more question here on the construction side. The tempered outlook for the 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 temperate outlook for construction in North America?

Yeah, so our outlook for U.S. construction down to flat. right so data and data centers would show up for us in power generation data center market is definitely strong you know 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 um and that we're seeing we're seeing things part part of it's just a timing issue with 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 has come from.

Does any of the data center construction market, does any of it show up in construction for you guys? Or it's all, most of your exposure is just ours?

That's in our power systems segment.

Yeah, it's not a huge factor for us. I mean, the data center factor for us is that they buy these very large gen sets 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, you know, we're selling to the OEMs sometimes.

Yeah.

Rental.

That makes sense. Thank you so much.

Thank you.

Thanks, Matt.

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

Noah K. 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? 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.

Yeah, the industry and policy changes drive that optimism and the outlook and the growing demand that the higher cost is just not capital expenses of the plant as much as it is operating costs in engineering. and customer support as we're scaling up that product or running higher than we had previously forecast.

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, is that delivering kind of the expected, you know, margin contribution? We hear mixed indicators on, you know, EV adoption, particularly in North America. We'd 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, yeah, relatively modest, albeit increasing demand at this point in time. Yeah, so we're really looking for, you know, 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. So it's just making sure. History shows a bit of investment now. It pays off. multiple times in the long run.

Yeah, here's the, you know, there's a couple of things that we watch on this, how the market develops. So on the electrolyzer side, there's, you know, 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, you know, in the electrified powertrain, there's still a lot of uncertainty beyond the bus market where you've got, you know, 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. Thank you.

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 the day. Thank you all for participating in 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.