Cummins Inc (CMI) — Q1 2023 Earnings Call Transcript

Thank you. Good morning, everyone, and welcome to our teleconference today to discuss Cummins’ results for the first quarter of 2023. Participating with me today are Jennifer Rumsey, our President 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 statement in the slide deck and our filings with the Securities and Exchange Commission, particularly the Risk Factors section of our most recently filed Annual Report on Form 10-K and any subsequently filed Quarterly Reports on Form 10-Q. During the course of this call, we will be discussing certain non-GAAP financial measures, and we will refer you to our website for the reconciliation of those measures to GAAP financial measures. Our press release with a copy of the financial statements and a copy of today’s webcast presentations 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 President and CEO, Jennifer Rumsey, to kick us off. Thank you.

Thank you, Chris. Good morning. I’ll start with a summary of our first 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 first 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 first quarter. In March, Cummins announced the launch of Accelera by Cummins, a new brand for our New Power business unit. Accelera provides a diverse portfolio of zero emission solutions for many of the world's most vital industries, empowering customers to accelerate their transition to a sustainable future. Coupled with our brand announcement, Accelera shared that it will supply a 90-megawatt PEM electrolyzer system for Varennes Carbon Recycling plant in Quebec, Canada. This will be the largest PEM installation in North America and a key step in advancing the green hydrogen economy. Accelera and Blue Bird also announced that we will increase production of electric school buses, more than doubling the zero-emission school buses that we've collectively put into operation over the next 12 to 18 months. In addition, progress continues to be made on the planned separation of the filtration business. In February, we announced that our filtration business, Atmus Filtration Technologies, filed a registration statement on Form S-1 with the US Securities and Exchange Commission for a proposed underwritten IPO of newly issued common stock. Now I will comment on the overall company performance for the first 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 continues to be strong across all of our key markets and regions, with a slow improvement in China, resulting in record revenues in the first quarter of 2023. Revenues for the first quarter were $8.5 billion, an increase of 32% compared to the first quarter of 2022, driven by the addition of Meritor, strong demand, and improved pricing. EBITDA was a record $1.4 billion or 16.1% compared to $755 million or 11.8% a year ago. First quarter 2023 results include $18 million of costs related to the separation of the Filtration business, while the first quarter of 2022 results include $158 million related to the suspension of operations in Russia, and $17 million related to the separation of the Filtration business. Excluding these costs, EBITDA percentage increased in the first quarter, driven by higher volumes and improved pricing, offset by supply chain and compensation cost increases. Research and development expenses also increased in the first quarter of 2023 as we continue to invest in the products and technologies that will create advantages in the future, particularly in the Engine, Components, and Accelera segments. Gross margin dollars improved compared to the first quarter of 2022 as the benefits of higher volume, pricing, and the acquisition of Meritor exceeded the supply chain cost increases. As we noted previously, Meritor results are included in our overall guidance for 2023 and we will continue to provide updates on the progress of our value capture initiatives, which will be focused on the portion of the business within our Components segment. In the first quarter, Meritor's operating performance and financial results showed improvement with sales of $1.3 billion and EBITDA of 9.4%. The improvement in profitability from the comparable EBITDA margin of 7.2% in 2022 was driven by improved pricing, operational improvements, and cost reduction activities aligned with our value capture initiatives. Our first quarter revenues in North America grew 39% to $5.1 billion, driven by the addition of Meritor and strong demand. Industry production of heavy-duty trucks in the first quarter was 76,000 units, up 17% from 2022 levels, while our heavy-duty unit sales were 29,000, up 27% from 2022. Industry production of medium-duty trucks was 33,000 units in the first quarter of 2023, an increase of 11% from 2022, while our unit sales were 30,000, up 13% from 2022. We shipped 39,000 engines to Stellantis for use in the RAM pickups in the first quarter of 2023, down 5% from 2022 levels. Engine sales to construction customers in North America decreased by 6% as volumes declined, partially offset by positive net pricing. Revenues for North America power generation increased by 14% as industrial and data center demand improved and supply chain constraints began to ease. Our international revenues increased by 24% in the first quarter of 2023 compared to a year ago with the addition of Meritor and strong demand across most markets. First quarter revenues in China, including joint ventures, were $1.7 billion, an increase of 16% as on-highway markets began to recover. Industry demand for medium and heavy-duty trucks in China was 268,000 units, an increase of 2% from last year. Our sales and units, including joint ventures, were 46,000, an increase of 31% due to increased penetration within our joint venture partners and new product launches to meet NS VI standards. The light-duty market in China was up 2% from 2022 levels at 476,000 units, while our units sold, including joint ventures, were 36,000 units, an increase of 6%. Industry demand for excavators in the first quarter was 57,000 units, a decrease of 26% from 2022 levels, due to the change in emissions regulations and related adjustments in inventory levels. Our units sold were 9,000 units, a decrease of 8%. The decrease in the excavator market was offset by improved share with the new and expanded customer relationships and first quarter engine sales to replenish inventory levels at construction OEMs. Sales of power generation equipment in China decreased 28% in the first quarter, primarily driven by a decline in data center activity. First quarter revenues in India, including joint ventures were $752 million, an increase of 21% from the first quarter a year ago. Industry truck production increased by 26%, while our shipments increased 7%. Power generation revenues increased by 30% in the first quarter as economic activity remains strong. In Brazil, our revenues increased 48%, driven by improved demand in most end markets. Now let me provide our outlook for 2023, including some comments on individual regions and end markets. We have raised our forecast for total company revenue in 2023 to be up 15% to 20% compared to our prior guidance of up 12% to 17%. This guidance reflects an improved outlook in North America, including stronger demand for Meritor. We are forecasting higher demand in heavy-duty truck and power systems markets and expect aftermarket revenues to increase compared with 2022. We are increasing our forecast for heavy-duty trucks in North America to be 270,000 to 290,000 units in 2023 compared with our prior guide of 260,000 to 280,000. While supply chain constraints continue to limit our industry's collective ability to produce, end customer demand remains strong. In the North America medium-duty truck market, we are continuing to project the market size to be 125,000 to 140,000 units, flat to up 10% from 2022. Similar to heavy duty, supply chain constraints continue to limit our ability to produce and fully meet end customer demand. 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 consistent with 2022. In China, we project total revenue, including joint ventures, to increase 16% in 2023, an improvement from the previous guidance of up 7% driven by share growth, better than expected construction volumes, and content increase. We project a 15% to 25% improvement in heavy and medium-duty truck demand and a 10% to 20% improvement in demand in the light-duty truck market, coming off the low market levels in 2022, consistent with the prior guide. We expect China construction volume to be flat to down 10%, improved from our prior guidance of a decline of 25% to 30%. While the market is adjusting to new emissions regulations, shipments to replenish inventory and export demand exceed our prior expectations. As we discussed previously, our guidance assumes a slow recovery in demand in China this year. We have continued to improve our presence in the region, through the down cycle of 2022 and are well-positioned for continued outgrowth. Our technological expertise and emissions experience positions us well to outgrow the market and support our partners. We are seeing this in 2023 with improved on-highway share now that NSVI is fully implemented, along with higher share in the construction market as we expand our partnerships. We also continue to ramp production and expand our presence in automated manual transmissions as our market share increases in the heavy-duty market that is increasingly adopting this technology. In India, we project total revenue, including joint ventures, to be up 1% in 2023. 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 and mining engines are expected to be down 5% to up 5%, consistent with the prior guidance. Demand for new oil and gas engines is expected to increase by 15% to 25% in 2023, driven by increased demand in North America. Revenues in global power generation markets are expected to increase 10% to 15%, driven by increases in non-residential construction and improvement in the data center market. For Accelera, we are expecting full year sales to be $350 million to $400 million, consistent with our prior guidance. Revenues are expected to approximately double from 2022 due to higher battery demand in the North American school bus market and the additions of the electronic powertrain portion of the Meritor business and Siemens commercial vehicle business. The electrolyzer market continues to gain momentum as well with the near-term forecast on expanding capacity to meet the growing demand. As mentioned on our previous call, Meritor results are included in our overall guidance for 2023. Within components, Cummins expects revenue contributed by the Meritor business for 2023 to be between $4.7 billion to $4.9 billion, an increase from $4.5 billion to $4.7 billion in our previous guidance. 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 quarter with visibility to strong demand beyond the first half of the year, we have raised our sales growth outlook for the year to 15% to 20%. We have also revised our forecast for EBITDA to be in the range of 15% to 15.7%, from our previous guidance of 14.5% to 15.2%, reflecting very strong incremental margins while continuing to invest for the future within our core business and Accelera. Demand in most of our core markets is strong. Our products are performing well, and we are excited about the investments we are making in the future. During the quarter, we returned $222 million to shareholders in the form of dividends, consistent with our long-term plan to return approximately 50% of operating cash flow to shareholders. Strong execution resulted in record sales, EBITDA, net income, and earnings per share in the first quarter, despite the continued challenging operating environment. I'm impressed and grateful for the commitment of our employees and leaders around the world who are delivering for our customers and generating strong financial performance at the same time. Our excellent results further enhance Cummins' ability to keep investing in future growth, bringing sustainable solutions that will protect the planet for future generations and return cash to our shareholders. Now let me turn it over to Mark.

Thank you, Jen, and good morning, everyone. We had a strong first quarter with organic revenue growth of 12%, record quarterly EBITDA, net income, and earnings per share, and improved operating cash flow compared to a year ago. Given the strength of the first quarter results and improved outlook, we have raised our full year expectations for sales and profitability. Now, let me go into some more details of the first quarter performance. Revenues were a record $8.5 billion, up 32% from a year ago. Sales in North America increased 39% and international revenues increased 24%. Of the total increase, 20% was driven by the addition of Meritor. Organic growth was driven by strong demand for products in all segments and improved pricing. Foreign currency fluctuations negatively impacted sales by 2%. EBITDA was a record $1.4 billion or 16.1% of sales for the quarter, including $18 million of costs related to the planned separation of the Filtration business. EBITDA for the first quarter of 2022 was $755 million or 11.8% of sales, including $158 million of costs related to the suspension of our operations in Russia, and $17 million of costs related to the separation of the Filtration business. Excluding these items, the higher EBITDA percent was driven by higher volumes and improved pricing, partially offset by increased investment in new products and capabilities. To provide clarity on the first quarter operational performance of our business and allow comparison to prior year and guidance and excluding the costs related to the separation of the Filtration business and the suspension of our operations in Russia in my following comments. Let's look a little more detail by line item. Gross margin of $2 billion increased $440 million, but as a percent of sales decreased by 90 basis points, as the benefits of higher volumes and improved pricing were offset by the dilutive effect of Meritor. Across our businesses, we saw mixed trends on input costs, with the Engine business experiencing some increases, while other segments saw some benefits in freight and commodity costs. Results for Meritor improved from prior quarters due to improved pricing and operational improvements. Selling, admin, and research expenses increased by $191 million, driven by the addition of Meritor, higher variable compensation and research costs, as we continue to invest in new products and capabilities to support future profitable growth. Selling, admin, and R&D decreased 110 basis points as a percent of sales. Joint venture income of $119 million decreased $8 million from the prior year, with higher earnings from joint ventures operations offset by lower technology fees. In China, we did see higher earnings than anticipated, as truck OEMs increased build rates to restock channels after a very challenging 2022. We have not yet seen signs of sustained improvement in end-user demand, however. Other income was $71 million, an increase of $123 million from a year ago. The improvement in other income is driven by a gain of $19 million in mark-to-market investments compared to a loss of $37 million a year ago. We also, a year ago, incurred an asset write-down of $36 million. Interest income and gains on foreign exchange also increased year-over-year in this line item. Interest expense increased by $70 million due to financing costs related to the acquisition of Meritor and rising interest rates. The all-in effective tax rate in the first quarter was 21.7%, including $3 million or $0.02 per diluted share of favorable discrete items. All-in net earnings for the quarter were $790 million or $5.55 per diluted share, up 90% from the $418 million or $2.92 per diluted share a year ago. Our strong performance in Q1 continues our trend of raising performance over successive cycles. All-in, operating cash flow was an inflow of $495 million, $331 million higher than the first quarter last year, primarily due to higher earnings. I'll now comment on segment performance and our guidance for 2023. As a reminder, 2023 guidance includes the impact of Meritor all year and assumes that the operations of the Filtration business will be included in our consolidated results for the full year. Segment results and guidance exclude the costs or benefits related to the separation of the Filtration business as and when that occurs. Components segment revenue was a record $3.6 billion, an increase of 79%, while EBITDA decreased from 16.4% of sales to 14.6%, primarily driven by the addition of Meritor. Meritor revenues in the first quarter in the segment were $1.3 billion and EBITDA was $120 million or 9.4% of sales, up from last quarter and in line with our expectations. Components, we expect total 2023 revenues to increase between 32% and 37%, up 4% from prior year guidance and EBIT margin to be in the range of 14.1% to 14.8%, unchanged from three months ago. For the Engine segment, first quarter revenues were a record $3.3 billion, an increase of 8% from a year ago. EBITDA was 15.3%, flat with a year ago as the benefit from pricing was offset by higher material and variable compensation expenses. In 2023, we expect revenues for the Engine business to grow between 2% and 7%, up 2% at the midpoint from our prior guide, driven by continued strength in the North American truck market and a lower pace of deceleration in the China construction market. 2023 EBITDA is projected to be in the range of 13.8% to 14.5% of sales, flat with previous guidance. Our overall projections for the Engine business include a modest tapering in both the top line and the bottom line in the fourth quarter. In the Distribution segment, revenues increased 14% from a year ago to a record $2.4 billion. EBITDA also increased to 13.9% of sales compared to 9.9% a year ago, driven by higher volumes in both whole goods and aftermarket as well as improved net pricing. We expect 2023 distribution revenues to be up 5% to 10% and EBITDA margins in the range of 11.3% to 12%, and we've raised our guidance for sales by 3% at the midpoint and margins by 100 basis points. In the Power Systems business, we also had a strong quarter with revenues of $1.3 billion, up 16% year-over-year. EBITDA increased from 9.5% to 16.3% of sales driven by higher volumes, a strong Parts business, and higher pricing. In 2023, we expect revenues to be up 5% to 10%, consistent with our prior guidance. EBITDA is projected to be approximately 13.7% to 14.4%, an increase of 70 basis points from our prior projections. Accelera 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 and Siemens commercial vehicle business. Our EBITDA loss was $94 million as we continue to invest in the products, infrastructure, and capabilities to support strong future growth. In 2023, we anticipate Accelera revenues to increase to the range of $350 million to $400 million and net losses to be in the range of $380 million at the midpoint, entirely consistent with our projections from three months ago. As Jen mentioned, given the strong performance in the first quarter and the outlook in our key regions and end markets, we are raising full year company guidance. We now project 2023 company revenues to be up 15% to 20%, a 3% increase from our prior guidance. Company EBITDA margins are now expected to be approximately 15% to 15.7%, up 50 basis points from our prior projections. Our effective tax rate is expected to be approximately 20% to 22% in 2023, excluding any discrete items. Capital investments will be in the range of $1.2 billion to $1.3 billion, consistent with our prior forecast, as we continue to make the critical investments necessary to bring to market new products and capacity expansion to support future growth. We remain committed to our long-term goal of returning 50% of operating cash to shareholders over time. As we said last time, in 2023, our primary focus will be on dividends and strengthening our balance sheet by reducing debt for this year while we continue to deliver profitable growth for our shareholders. In summary, we delivered record sales, EBITDA, net income, and earnings per share in a very strong first quarter. Our customers are indicating stronger visibility into the second half of the year, giving us confidence to raise our forecast. We will continue to focus on 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 the adoption of new technologies. There is one last matter I would like to bring to your attention. You will see in our Form 10-Q to be filed later today that we have updated our risk factor disclosure related to our ongoing discussions with the EPA and CARB on their review of our emission systems, most notably our pickup truck applications. We understand that these agencies are likely to propose resolving this matter by requesting in the relatively near future that we agree to one or more consent decrees and pay certain civil penalties. We are not able to estimate the amount of these penalties today, but we anticipate that the amount is likely to be material. We look forward to providing additional information on this topic when we reach a resolution. Thank you for joining us today, and now I'll 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 and a related follow-up. If you have any additional questions, please rejoin the queue. Operator, we are ready for our first question.

Yes. Hi, good morning, everyone. Congratulations on a really strong quarter. I just wanted to ask for the Power Systems and Distribution businesses, outstanding first quarter, the guidance is for margins to decline significantly off of the first quarter run rate. Can you just step through? Is that just early in the year, and we want to make sure the results are sustainable, or are there any discrete items that you think declined sequentially for these two businesses?

Yes, we've definitely been asking those questions internally as well, Jerry. Really strong results from both. I think pricing, of course, has been positive. I think in both those businesses, we haven't yet seen some of the cost increases that we anticipated for the full year. We had some beneficial moves in commodities that helped power systems. So we're not assuming that they continue. And then in distribution, of course, very strong parts margins, and some lag effect before some of the cost increases take place. So we're still expecting strong full year results. Of course, we'll continue to push for improvement everywhere we can. And again, there were modest benefits from one or two corporate items that improved all of the segments. But I think the main takeaway I want you to leave with is that we're really pleased with the performance in particular of those businesses. The Distribution business now has established quite a track record of improving margins over time, and we're really encouraged over the last three or four quarters by the progress in the Power Systems business. So we'll keep pushing for more. But I think one or two factors that we're not certain can continue through the subsequent quarters. And we are trying to drive down inventory a little bit, which may have some absorption impact in the Power Systems business.

Super. Thank you, Mark. And then can I just shift gears, Jennifer? You folks do a really good job of expanding your market share every time we have new regulations. I'm wondering if you could just expand on the comments that you folks made in the prepared remarks and just talk about the opportunities that you folks have in terms of potential market share gains as we see rising content and rising complexity on these engines, particularly within the context of the EPA's electric vehicle plans laid out recently as well? Thanks.

Yes. Great. Thanks for the question, Jerry. So as I commented and you saw start to come through in Q1, our pattern of leveraging emissions regulation change to drive outgrowth in market position as well as added content is playing out in China now following the launch of the NSVI. We've seen that playing out in India with BSVI regulation previously. We believe that there's continued opportunity both in the Engine space with future EPA regulations of the ultra-low NOx build rule to, to some degree, increase our position in the market, although, of course, we have a strong position today in the US market. So content expansion. That continues to be a tailwind and outgrowth opportunity slowing to some degree in North America on-highway, but there continues to be upside there. We are working clearly in our Accelera business to establish a position in the electrified powertrain and in particular, our position in key components and as well as integrated powertrain. So batteries, power electronics, and motor generators, eAxles, fuel cells. We feel like we've got the right portfolio of technologies and are forming partnerships and getting experience in the market to position ourselves over time as that market starts to electrify.

Thank you. Good morning. Mark, to start with the Engine segment, you've increased the full-year revenue outlook along with the joint venture income, while the margin guidance remains the same. Can you explain what challenges are impacting the top line regarding profit or EBITDA guidance?

Yes. In the short term, that segment has been under more pressure due to rising input costs. We have made significant progress in other areas, making this the primary concern. Regarding joint venture income, we are still trying to establish a firm presence in the market. While Q1 performance was better than anticipated, it wasn't outstanding; it simply exceeded our expectations. However, we lack clear insight into improving demand from end users, which we believe will eventually increase and provide potential benefits. Currently, we do not have visibility into this. Overall, this particular business continues to face some difficulties on the supply side, which is the main issue, although other businesses also encounter challenges.

Got it. Okay. And then, wouldn't be a Cummins call without an update on China. You mentioned that on the on-highway side, you've seen a pickup from a production standpoint that is not yet reflecting on the retail side. What is the team observing and learning, not just regarding on-highway, but perhaps in some of the other key end markets for you? You mentioned excavators, but what about some of the other markets in China and what is expected for the balance of the year for the China operations as a whole? Thank you.

Yes, I'll start and then Mark can add any additional points he wants to. As Mark mentioned, we are forecasting a slow recovery in the on-highway business, and we believe we are witnessing this trend. There was some inventory buildup this past quarter, but we are not seeing a significant increase in end-user demand, which contributes to the slow recovery and opportunities for growth that we have already discussed. In the off-highway segment, particularly in construction, the emissions changeover is negatively affecting the China market, though it's less severe than our previous guidance due to some stocking up in the channel and increased export demand. We continue to see stable markets in mining and oil and gas. Overall, there is some upside in the on-highway sector, but the situation in off-highway construction and power generation remains mixed.

Hi. Good morning and congrats on a nice quarter. I guess, Mark, first question, similar to engines, on components too were increasing our sales guidance marginally, but the margins are unchanged. So what would be the reason behind that? And then, Jen, I guess, based on what you're saying, it sounds like you're seeing fairly good demand trends everywhere in your order book, is pretty good for 2023. But are there any areas where you're sort of seeing red flags? And in the event of a recession or downturn, how do we think about decrementals, or is there any other self-help that Cummins could do to sustain higher earnings, assuming the macro weakens? Thank you.

Yes. I think components continues to do well. The main factor is just really the mix in the business. The underlying businesses are performing well. Again, not such a big help from price/cost in this segment relative to power systems and components. But I think really it's really some minor changes in the mix going forward. We've obviously got strong North America. Meritor continues to improve, but it's still dilutive to that overall segment, but no fundamental issues.

From a margin performance perspective, we are focused on enhancing the Meritor business consistent with our acquisition plans, aiming to drive incremental margin improvements across our core businesses while sustainably increasing investments and moving towards breakeven in our Accelera business. We are monitoring each of these aspects to ensure we reach our targets. Regarding the overall market demand, the feedback we receive from customers remains strong. Our confidence is growing for the second half of the year as we carefully observe broader macroeconomic indicators, acknowledging that we operate in a cyclical business. Despite the atypical cycle caused by supply constraints, we are prepared to take action to manage decremental margins and excel during the downturn, as we have previously. This year, we are investing in critical areas for our future while limiting headcount growth in other sectors and closely monitoring plant operations to align with current demand. We will continue to observe and adjust as necessary.

Okay, thank you. I appreciate it.

Hi. Sort of picking up on trying to look beyond 2023. I'm just curious, the conversations you're having with your off-highway customers for initial thoughts on what they need from you in 2024 relative to on-highway. Just curious if you have any distinguishing features between those different conversations?

David, is in the construction area or more in the high horsepower markets just to make sure we're answering your question correctly?

Open question on purpose. Off-highway versus on-highway.

Yes. I would say we haven't provided guidance for 2024 yet. We haven't observed any weakening in the construction markets in North America similar to what we're seeing in on-highway, although we are monitoring this closely. The situation appears to be quite similar when comparing construction and on-highway, and we are likely to remain cautious as we approach the fourth quarter. However, we now have good visibility that this trend will continue well into the third quarter.

And I'll just add, of course, in China, you talked about the emissions changeover. So, there's a dynamic in that market and a question on does China do any action in the economy there that we'll pay attention to. And in Power Systems, same in terms of broader macroeconomic indicators I'm watching that, but we do have places where we're starting to take orders into 2024. And so it's a space that we're just watching closely at this point.

I appreciate that. And people also are just curious about truck historically hasn't been the best market for maintaining price. But it's also been a pretty unique pricing power era we're living through right now. So, I'm just curious how are you thinking about or what are the early conversations like for 2024? I'm not saying if you have to give back price, there can't be commensurate offset in lower costs for you. But just trying to think about pricing in isolation, what are the initial conversations for 2024 given the pricing levels where we've been coming up to the last 12, 18 months?

We have emissions changes coming in some of our markets in 2024, which is certainly a factor. However, we have long-term agreements with some customers and we regularly adjust prices with others. We are closely monitoring price costs. As mentioned, the situation remains mixed. We are committed to delivering strong returns and managing price costs as they fluctuate. Currently, we are seeing improvements in certain areas, while inflationary pressures persist in others, making it somewhat challenging for 2024.

But for price, I'm just curious about any price concessions. We hear that some component suppliers were even being asked for concessions mid-year, likely because OEMs are wondering why not. I'm interested in the structural aspect for 2024. Are we receiving any requests for price concessions? Should that be considered a base case, and then it’s about driving down costs even further ideally?

I think there are a lot of factors that go into pricing, David, including input costs, agreements with customers, supplier availability. A lot of those things, but that's not a main topic of conversation right now at all. I think the thing we're most thinking about is how long does this cycle run on and off-highway and right now, customers are telling us their confidence for the rest of the year is, on average, has gone up, not stayed the same. We recognize and appreciate the same questions really about demand levels for 2024. That's our radar is mostly upon any signals around demand. That's going to be the biggest driving factor of our performance.

Almost just following up on that question with maybe a slightly different angle. Your businesses where you, I think, have more pricing control and distribution power systems did really well at margin. And the OEMs that you serve and on-highway truck have had a really good quarter as well. Just overall, is your general sense that you're pricing to those OEMs and components should catch up over time, and there's still runway to go, or is that too strong?

Well, first of all, we aren't fully aware of all the pricing dynamics of the OEMs, as that's their business. We need to focus on our costs and business performance. Additionally, we are making significant investments as we have many new products that we're excited about, and some of our customers are as well. This has resulted in increased engineering costs, especially in engine components. We're pushing forward with new initiatives that may not generate substantial revenue immediately but have secured more business for the future. We're also optimistic about securing more with the new technologies we are introducing. This year, we are price cost positive, which is a key factor in our results, and we will seek pricing wherever possible. The aftermarket generally provides stronger pricing opportunities for us. However, when evaluating margins, it's important to consider how much we are investing, as this reflects our commitment to growth. Currently, we are increasing our engineering investments throughout the business because we are excited about what lies ahead.

That's a helpful answer. Thank you. If I may revisit a question I believe I've asked before, how should we interpret the margins as revenue in Accelera begins to increase? Will project-level economics consistently yield positive margins, or is there a risk that they may not? Are you still pursuing projects that could potentially incur losses as your volumes increase? How should we understand the underlying dynamics of the margin in this context?

I believe we have seen an increase in fixed costs related to battery electric vehicles. For electrolyzers, we anticipate positive gross margins as we increase production. As we have previously mentioned, our goal is to reach EBITDA neutrality by 2027 with our current strategy. Therefore, as our revenues increase, we expect our losses to decline over time. We are gaining momentum in sales, particularly in the first quarter, where most of our sales growth came from battery electric vehicles. Additionally, our electrolyzer backlog has significantly increased, and we are optimistic about that. We are closely focused on improving margins as our production volume rises, although battery production does carry a higher fixed cost.

Hi, this is Ishan on behalf of Tami. Congratulations on the great print. My first question is, are you preparing to ramp production assuming 2025 or 2026 could be pre-buy years ahead of the emission regulations in 2027? And then if I may ask a second on Meritor as well. Are you able to pass on cost inflation as anticipated or are customers pushing back? Thanks.

We are making planned investments because we expect to gain more business regardless of the economic cycle. We are increasing capacity in some parts of our business and launching new products. The nature of our business requires us to be ready to adjust our operations according to the economic climate. It can be challenging to predict with certainty what's ahead in two or three years. However, as a general statement, our capital expenditures are up this year because we are optimistic about our long-term prospects. Regarding pricing, it is always competitive and challenging. We are all aware that there has been significant inflation in the industrial sector, which has driven the need for price increases. Earlier in 2021, it took us some time to adjust our prices, so we have been catching up with those trends. This situation is ongoing.

You saw some of that as Meritor specifically reflected in the EBITDA improvement.

Hi, thanks. Good morning. Wanted to just follow up, if I could, on the EPA and CARB legal situation that you mentioned, if there's any color on the potential timing of resolution that you can offer? And then I know this is obviously sensitive and I suspect you don't want to negotiate with yourself on a conference call, but just how to think about framing the size of what this might be? Is this something that might be in sort of the multi-hundreds of millions of dollars? Is this something that you could fund within your just ongoing cash flow and might it affect any other investment plans or spending plans that you might have?

So, first, thanks for the question. I do want to start by saying that Cummins is fully committed to emissions compliance. We have been and will continue to cooperate with agencies all along and work through this matter to the best of our abilities. Our updated disclosure today is consistent with what we've done since we first announced our voluntary internal review in 2019 of disclosing transparently throughout this process. So, as Mark said, we think that we are nearing the end. It is premature to speculate though exact timing or exact amount at this point. We feel like the business is well positioned in a strong financial position and continuing to generate strong returns.

Okay. That's helpful. And then, I'm wondering, just to follow up on some of the price versus cost discussions. Are you able to actually quantify the price versus cost kind of cadence for this year and sort of the margin cadence for the rest of the year? And I'm thinking about the whole company, but if it makes sense to talk about highlight any specific segments, that would be helpful. Thank you.

Well, in the first quarter, we were about 2% net positive between price and cost. And as we said in the earlier remarks, it very much varied by business. And in fact, you can see it, since you're asking a lot of questions about the different margins in the business, you can see that. I mean, the pricing is pretty much set. The aftermarket is one area where we have the potential that we're just pricing more frequently. That's the nature of the aftermarket business. I don't think that's unique to Cummins. But pretty much, I think the course is largely set for this year, and then it's really looking for efficiencies in every part of operations, working with customers, working with suppliers. We all enjoy it when the costs are lower. That's just not where we'd be. It's been an unprecedented period of supply constraints, some of which, frankly, we're not out of yet, and it's been a period of unprecedented complexity and very, very robust demand. We've continued to grow our business faster than some of the underlying markets. So that's been a positive, but that’s been a lot of work for our supply chain teams. But I think, largely, it's going to be a net positive for this year, Steve. I don't imagine dramatic changes quarter-to-quarter. The commodities can ebb and flow a little bit, and we saw some benefit copper prices in the Power Systems business. And again, we're using hedging and other techniques to try and smooth out those costs. But I don't expect fundamental changes to the reason for variation in earnings. We're really focused on this demand side. And right now, our confidence has gone up based on the confidence of our customers through the rest of this year.

And just to keep in mind as context here. Over the last couple of years, as we saw that rapid increase in demand, there have really been two factors at play with the inflationary pressure and supply challenges. So one is cost versus our ability to pass that on a price, and we made a lot of progress through 2022, and you see that continue in 2023 to offset the inflationary pressure, and then it's operating leverage. And because of all the supply disruptions, we didn't see in those early quarters the normal operating leverage that we would, and that has also improved and is reflected in some of the numbers that you see in Q1. So just to give you a sense of what that's like for us now in our Rocky Mount Engine Plant, which produces midrange engines. Last year, our on-time delivery from our suppliers was at 60%. In Q1, it was at 70%. Historically, we would expect something closer to 80%. And so that plays out in operating efficiency for us in our plant. So, it's improved. There's still a little bit of opportunity. But running at the rate that we are, we are continuing to be constrained by a couple of our supplier components. I'm shocked we made it this far into the call without anybody asking about supply chain. Yes, chips and electronics have improved, but they're still operating at capacity, which means small disruption hasn't impacted. But overall, underlying operating leverage has improved.

Good morning. Thank you. On the rail side, wondering if you see any potential long-term content opportunities from the new locomotive rule that California issued on Thursday, which includes mandates on freight, passenger, and industrial locomotives. So, if it stands and goes national, there could be a big build cycle as well as a lot of new technology upgrades. Is there any opportunity for you guys from that?

It's still early for me to add a lot of response here. We, of course, now are in the passenger rail business with our 95-liter engine. We have a Tier 4 compliant product, and then we've also entered the rail market with certain customers with fuel cells. So we'll continue to explore opportunities with the product offerings that we have in that market.

Got it. I have one broader question considering your strong results and improved outlook. Do you perceive a divide between your strong performance and the overall strength of the machinery sector, compared to the rest of the economy being weak? Is this primarily due to catching up on demand from the past two and a half years while production was disrupted, or is there more to it, as you mentioned, that this isn't a typical cycle?

There are definitely factors at play, such as limitations in supply and high usage, particularly in commercial trucking, which continues to drive customer purchases. Additionally, new products are becoming more fuel-efficient. Investments in infrastructure are boosting demand in construction, and increasing funds in cloud services are fueling demand for data centers. Some specific indicators for our business might be independent of the overall economy. However, the broader economy does have an impact, which is why we are careful about our investment decisions and cautious in increasing our workforce.

We observe other parts of the economy and often question the pace of hiring and resources allocated to new areas, only to see subsequent cutbacks. This can contrast sharply with our business model. We collaborate with highly efficient customers, and there is a significant focus on efficiency. Even when some sectors are experiencing strong growth, the dynamics we observe do not align well with our experiences.

Thanks very much. Before we conclude, I want to turn it back over to Jennifer for a few closing comments.

Yeah. Thanks, Chris. Just to wrap up today, I want to again recognize the strong performance of the company in the first quarter, delivering record revenue, EBITDA, net income, and earnings per share. We're in a strong financial position and are confident in our strategy and our leaders in the future of the company and look forward to continuing to update you on our progress in future calls.

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