Cummins Q2 2022 Earnings Results & Report

Cummins EPS Results

• Actual EPS: $4.77
• Consensus EPS: $4.37
• Beat/Miss: Beat by +$0.40
• One Year Ago EPS: $4.15
• EPS Beat Rate: 7 of last 8 quarters

Cummins Revenue Results

• Actual Revenue: $6.59 billion
• Expected Revenue: $6.48 billion
• Beat/Miss: Beat by +$106.54 million
• YoY Revenue Growth: +7.80%

Cummins (NYSE:CMI) is a global power technology company headquartered in Columbus, Indiana. Founded in 1919, the company designs, manufactures, sells and services engines and power systems for commercial vehicles, industrial equipment, mining, construction, agriculture, marine applications and other markets.

Cummins’ product portfolio includes diesel and natural gas engines, generators and other power-generation equipment, as well as fuel systems, filtration products, emissions-control systems, turbochargers and drivetrain components. The company also provides parts, maintenance, repair and other aftermarket services through its distribution and service network.

In addition to its established engine and power businesses, Cummins is developing lower-carbon and zero-emissions technologies through its Accelera by Cummins business. These offerings include battery-electric systems, fuel cells, electrolyzers and related components for commercial and industrial applications. Cummins serves customers in North America and international markets through manufacturing, distribution and service operations worldwide. Jennifer Rumsey serves as the company’s chair and chief executive officer.

Cummins Q2 2022 Earnings Call Transcript

Key Takeaways

• Executive leadership passed from Tom Linebarger to Jennifer Rumsey, marking the first female CEO in Cummins’ history and underscoring continuity in the Destination 0 strategy.
• Q2 revenues rose 8% year-over-year to $6.6 billion, with EBITDA of $1.1 billion and improved gross margins despite elevated supply-chain and inflationary costs.
• North American revenues grew 15% on strong aftermarket and OEM demand, while China sales fell 43% due to emissions regulation pre-buys and COVID-19 lockdowns.
• Closed the Jacobs Vehicle Systems acquisition, secured Meritor shareholder approval, and launched partnerships on fuel-cell and hydrogen powertrains to advance decarbonization.
• Maintained full-year guidance of 8% revenue growth and ~15.5% EBITDA margin, projecting 10–15% heavy-duty truck volume gains, flat RV engine shipments, and New Power sales near $200 million.

Presentation

[Operator]

Greetings, and welcome to the Q2 2022 Cummins Inc. Earnings Conference Call. At this time, all participants are in a listen-only mode. A question and answer session will follow the formal presentation. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. As a reminder, this conference is being recorded. I would now like to turn the conference over to your host, Chris Clulow, Vice President of Investor Relations. Please go ahead, sir.

[Chris Clulow, VP of Investor Relations at Cummins Inc.]

Good morning, everyone, and welcome to our teleconference today to discuss Cummins results for the Q2 of 2022. Participating with me today are Tom Linebarger, our Executive Chairman, 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 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.

[Chris Clulow, VP of Investor Relations at Cummins Inc.]

More information regarding such risks and uncertainties is available in the forward-looking disclosure statement in the slide deck in 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 these 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 Executive Chairman, Tom Linebarger, one more time. Thanks.

[Tom Linebarger, Executive Chairman at Cummins Inc.]

Thank you, Chris. Brilliant. Good morning, everybody. I just had to start by telling you about some rough math I did before I walked in today. I believe this is my seventieth earnings call. It's also gonna be my last. I'm very grateful to the analysts and investors who are part of this journey with me. Many of you helped me better understand the perspective of our shareholders, which influenced how we ran the company, how we developed our strategies and priorities, and how we communicated about our results, and plans for the future. I always tried to ensure that the senior leaders in the company understood your views and perspectives, and they understood who they were really working for.

[Tom Linebarger, Executive Chairman at Cummins Inc.]

Some of you have been at this work almost as long as I have, and your commitment to understanding our company and its potential has been remarkable. I just want you to know that it meant a lot to me. I'm very proud to have served as the CEO for this company for 10 years, as a senior executive for more than 20 years. It was an honor and a privilege. This company stands for more than its products and technology, its revenue or its earnings, and even its performance for customers all over the world. The people that work here are exceptional humans, not just exceptional workers. That's why this transition was so important to me. It is perhaps the most important work of my entire career.

[Tom Linebarger, Executive Chairman at Cummins Inc.]

I have a smile a mile wide today because of the quality of the individual that replaces me, and the strength of the team beneath her. Jennifer Rumsey is a once in a generation leader. She combines the leadership and technical skills needed with the character and values required and the inspiration of a CEO that can take this company to places where I could not. I'm as proud as I was on the day I took the job to see her succeed me. Jen?

[Jennifer Rumsey, President and CEO at Cummins Inc.]

Thank you, Tom. Good morning. I'm excited to join you this morning in this new capacity as President and CEO for Cummins. In July, we announced that Tom would end his term as CEO effective August first. It is a bittersweet moment for me, as he's been one of the most significant influences in my career and leadership. Tom has been an incredible leader for this company and a true partner and coach to me. Because of his leadership, we are in a strong position to navigate what comes next, and execute our Destination Zero strategy. Tom and I share a common vision for Cummins and the role that our company plays in powering a more prosperous world. I feel deeply honored and proud to serve as the new CEO of Cummins, the first woman and just the seventh CEO of this great company.

[Jennifer Rumsey, President and CEO at Cummins Inc.]

My life and leadership have prepared me for this role at this moment, during a critical period for Cummins and our planet. A focus on purpose, people, and impact has shaped my career, and will influence how I lead. I look forward to working with all of you as we move forward. I'll start with a summary of our Q2 financial results. I will discuss our sales and end market trends by region, and I will finish with a discussion of our outlook for 2022. Mark will then take you through more details of both our Q2 financial performance, and our forecast for the year. Before getting into the detail on our performance, I wanted to take a moment to highlight a few major events from the Q2. The company achieved significant milestones related to two previously announced acquisitions, Jacobs Vehicle Systems, or JVS, and Meritor.

[Jennifer Rumsey, President and CEO at Cummins Inc.]

In April, Cummins completed the acquisition of JVS, adding engine braking, cylinder deactivation, start-stop control, and thermal management technologies, which are key components to meeting current, and future emissions regulations. On May 26, Meritor shareholders voted in favor of the Cummins acquisition bid, further validating the potential of what Cummins and Meritor can achieve together. The companies are working together to complete the acquisition this week as we have received all regulatory approvals to close the transaction. During the Q2, Cummins announced collaborations with Daimler Truck North America and Scania to deliver fuel cell electric powertrains for heavy-duty truck applications, and with Komatsu on development of zero-emissions haulage equipment, including hydrogen fuel cell solutions for large mining haul truck applications. Cummins, Chevron, and Walmart also share plans to integrate Cummins X15N natural gas engines powered by renewable natural gas into Walmart's heavy-duty truck fleet.

[Jennifer Rumsey, President and CEO at Cummins Inc.]

These customer collaborations are significant steps in alignment with our Destination Zero strategy to evolve our company, our products, and our customers' products to the technologies needed for a decarbonized world. This strategy, which represents a significant growth opportunity for Cummins, includes reducing carbon emissions now by making improvements in engine-based solutions that are broadly available today while rapidly advancing the zero-emissions technologies of the future. We continue to focus on our people and their development as a strategic advantage for the company. In the Q2, the company posted its first human capital management report, detailing our commitment to creating and maintaining a dynamic and exciting work environment for our employees. Now I will comment on the overall company performance for the Q2 of 2022 and cover some of our key markets, starting with North America before moving on to our largest international markets.

[Jennifer Rumsey, President and CEO at Cummins Inc.]

Demand for our products remained strong across all of our key markets and regions, with the notable exception of China, resulting in record revenues in the Q2. Revenues for the Q2 of 2022 were $6.6 billion, an increase of 8% compared to the Q2 of 2021. EBITDA was $1.1 billion or 16% compared to $974 million or 15.9% a year ago. Q2 results included costs of $29 million related to the preparations for the separation of the filtration business. As discussed previously, we recorded a charge of $158 million in the Q1 related to the indefinite suspension of our operations in Russia.

[Jennifer Rumsey, President and CEO at Cummins Inc.]

In the Q2, received certain inventory and other expense amounts reserved previously and incurred some small additional charges, resulting in a net recovery of $47 million. Adjusting for these items, EBITDA was $1 billion or 15.7% of sales. My comments moving forward will exclude the financial impact of the suspension of our Russia operations and the costs associated with the separation of our filtration business. EBITDA percentage declined in the Q2 as strength in sales and increased gross margin were offset by a 31% drop in joint venture income from the Q2 of 2021, driven primarily by the slowdown in China markets. Research and development expenses also increased slightly in the Q2 of 2022 as we continue to invest in products and technologies that will create advantage in the future, particularly in the Engine and New Power segments.

[Jennifer Rumsey, President and CEO at Cummins Inc.]

Gross margin percentage improved compared to Q2 of 2021 as the benefit of pricing and higher volumes exceeded the manufacturing, logistics, and materials cost increases during the quarter. This pricing only partially offset the impact of elevated supply chain and other inflationary costs that we carried through from 2021 and experienced in the H1 of 2022. Our Q2 revenues in North America grew 15% to $4 billion, driven by improved pricing, higher volumes, and higher aftermarket demand. Industry production of heavy-duty trucks in the Q2 was 62,000 units, up 9% from 2021 levels, while our heavy-duty unit sales were 26,000, up 12% from 2021.

[Jennifer Rumsey, President and CEO at Cummins Inc.]

Industry production of medium-duty trucks was 30,000 units in the Q2 of 2022, an increase of 5% from the 2021 levels, while our unit sales were 27,000, up 21% from 2021. We shipped 38,000 engines to Stellantis for the use in their Ram pickups in the Q2 of 2022, down 9% from 2021 levels due to supply chain issues which temporarily limited truck production. Engine sales to construction customers in North America increased by 9% as rental companies maintained strong capital spending. Power Systems North America sales were flat compared to 2021 as strength in aftermarket offset lower volumes. Demand remains high in North America markets for power systems, but revenues for North America power generation declined by 3% as supply chain constraints limited our production for both U.S. military and mobile power applications.

[Jennifer Rumsey, President and CEO at Cummins Inc.]

Our international revenues decreased by 2% in the Q2 of 2022 compared to a year ago. Q2 revenues in China, including joint ventures, were $1.2 billion, a decrease of 43% due to lower sales in the on-highway and construction markets. Industry demand for medium and heavy-duty trucks in China was 173,000 units, a decrease of 70% from 2021. Last year's numbers were strong, supported by a pre-buy ahead of NS6. Weaker new vehicle demand and economic impacts from shutdowns as the country is responding to a COVID-19 resurgence have pushed the market to the lowest level since 2007. Our sales in units, including joint ventures, were 25,000, a decrease of 70%, despite the very difficult environment in China.

[Jennifer Rumsey, President and CEO at Cummins Inc.]

We did see growth in some of our power systems markets, particularly mining and oil and gas. The light-duty market in China decreased 38% from 2021 levels to 380,000 units, while our units sold, including joint ventures, were 23,000, a decrease of 40%. Industry demand for excavators in the Q2 was 66,000 units, a decrease of 32% from 2021 levels. The decrease was driven by declining demand within the property market and the COVID-19 impact on infrastructure demand. Our units sold were 9,900 units, a decrease of 41%. Sales of power generation equipment in China decreased 5% in the Q2 due to the economic impacts of the COVID-19 resurgence.

[Jennifer Rumsey, President and CEO at Cummins Inc.]

Q2 revenues in India, including joint ventures, were a record $594 million, an increase of 51% from the Q2 a year ago. Industry truck production increased by 131%, while our shipments increased 78%, lagging the industry production due to lower growth in the heavy commercial vehicle segment. The high level of growth in the Q2 is coming off a very low base when India was experiencing a COVID-19 peak in 2021. Demand for power generation and construction equipment increased in the Q2 as economic activity continued to improve. In Brazil, our revenue increased 7%, driven by improved demand in most end markets. Now let me provide our outlook for 2022, including some comments on individual regions and end markets.

[Jennifer Rumsey, President and CEO at Cummins Inc.]

Based on our current forecast, we are maintaining full year 2022 revenue guidance of up 8% versus last year. This guidance reflects stronger performance in North America and a weaker market outlook in China, as well as the indefinite suspension of our operations in Russia. We are forecasting higher demand in global oil and gas and power generation markets and expect aftermarket revenues to increase compared with 2021. We are maintaining our forecast for heavy-duty trucks in North America to be 250,000 units-260,000 units in 2022, a 10%-15% increase over a year ago. The supply chain constraints our industry is experiencing continue to limit our collective ability to fully meet strong end customer demand.

[Jennifer Rumsey, President and CEO at Cummins Inc.]

In North America medium duty truck market, we are continuing to project the market size to be 120,000-130,000 units, a 5%-10% increase from 2021. We are now projecting our engine shipments for pickup trucks in North America to be flat compared to 2021, an update to our previous guidance of down 5%. In China, we are now projecting total revenue, including joint ventures, to decrease 20%-25% in 2022, an update to our previous guidance of down 10%. We now project a 50% reduction in the heavy and medium-duty truck demand and a 15% reduction in demand for the light-duty truck market, compared to a 40% decline and a 12% reduction, respectively, in our previous guidance.

[Jennifer Rumsey, President and CEO at Cummins Inc.]

Industry sales of excavators in China are expected to decline 30% from record levels in 2021, consistent with our prior guidance. Despite the difficult economic and market environment in China, we have significantly improved our presence and profitability in the region compared to prior cycles and are well positioned for continued outgrowth across our end markets in the region. As an illustration, from 2019 to 2022, the demand for heavy and medium-duty trucks is projected to be down 40%, while across the same period, we are forecasting an increase in earnings from joint ventures in China. As we look ahead, industry volume of NS6 product will increase through 2022 as the new regulations are implemented more broadly. Our technological expertise and emissions experience positions us well to continue to outgrow the market and support our partners through this transition.

[Jennifer Rumsey, President and CEO at Cummins Inc.]

We also continue to ramp production and expand our presence in automated manual transmissions as our market share increases and the heavy-duty market is increasingly adopting this technology. In India, we project total revenue, including joint ventures, to increase 15% in 2022, an improvement from our previous guidance of up 10%. We expect industry demand for trucks to increase approximately 30% in 2022. We continue to project most major global high horsepower markets will improve in 2022. Sales of mining engines are expected to be flat in 2022 compared to the prior year, consistent with previous guidance. Demand for new oil and gas engines is expected to increase by 120%, an update from our previous guidance of up 95%. Strong demand in the U.S. and other oil and gas markets have fueled this improved outlook.

[Jennifer Rumsey, President and CEO at Cummins Inc.]

Revenue in global power generation markets are expected to increase 5%, driven by increases in non-residential construction consistent with our prior guidance. We are now projecting aftermarket sales to increase 15%-20% from 2021, an improvement from our previous estimate of up 15%. This is driven by parts demand within our North America on-highway business as well as global power systems markets. In New Power, we continue to expect full year sales to be approximately $200 million. We have a growing pipeline of electrolyzers, which we expect to convert to backlog and be delivered over the course of the next 12-18 months. Additionally, we will continue to accelerate our collaboration with OEMs on both electrified power and fuel cells for applications in 2022, as highlighted by the announcements I noted previously.

[Jennifer Rumsey, President and CEO at Cummins Inc.]

We are maintaining our full year 2022 EBITDA guidance of approximately 15.5%, excluding the impacts of the indefinite suspension of our operations in Russia, the costs associated with preparing for the expected separation of our filtration business, and the expected costs associated with the pending acquisition of Meritor. We expect to deliver this strong profitability despite the supply chain constraints, and rising inflationary costs that we are experiencing. During the quarter, we returned $240 million to shareholders in the form of dividends and share repurchases, consistent with our plan to return approximately 50% of operating cash flow to shareholders for the year. Strong execution resulted in record sales in the quarter, despite very difficult operating environment.

[Jennifer Rumsey, President and CEO at Cummins Inc.]

The ongoing supply chain constraints and rising costs throughout the industry, continued COVID-19 related impacts, and the effect of the conflict in Ukraine all present challenges to operating our business. I am grateful for the commitment of our employees across the organization who have worked tirelessly to overcome these challenges. Their efforts resulted in a strong quarter, enabling us to support our customers while generating solid returns. Cummins is in an excellent position to continue to execute our Destination Zero strategy, invest in the products and technologies that will fund future growth, and drive advantage for our customers. We will accomplish this while generating strong financial results and meeting our commitment to return cash to shareholders. It's an exciting time to become CEO. Thank you for joining us today. Now let me turn it over to Mark.

[Mark Smith, CFO at Cummins Inc.]

Thank you, Jen, and good morning, everyone. We delivered strong results in the Q2, especially in the context of a challenging global business environment. As Jen mentioned, our Q2 results included a $47 million benefit from adjusting the reserves related to the suspension of our operations in Russia and $29 million of costs related to the separation of the filtration business. To provide clarity on operational performance, I'm gonna exclude the impact of these items in my comments. We have provided a breakdown of the costs associated with Russia and the filtration separation costs by line item and by segment in our earnings material, to help you understand the underlying performance more clearly. Now let me go into more details on the Q2 performance. Q2 revenues of $6.6 billion were up 8% from a year ago.

[Mark Smith, CFO at Cummins Inc.]

Sales in North America were up 15%, while international revenues declined by 2% due to a slowdown in China. Foreign currency fluctuations, primarily a stronger US dollar, reduced sales by 1%. EBITDA was $1 billion, or 15.7% of sales for the quarter, compared to $974 million or 15.9% a year ago. The lower EBITDA percent was driven primarily by negative other income and lower joint venture earnings in China. Gross margins improved year-over-year and from the Q1. Now let me go into more detail by line item. Gross margin of $1.7 billion or 25.6% of sales increased by $208 million or 140 basis points.

[Mark Smith, CFO at Cummins Inc.]

The benefits of stronger volumes and higher pricing more than offset higher freight, and material costs for this quarter. Of course, we have been facing increased costs for an extended period of time, and now our gross margins have returned back to 2019 or pre-COVID levels. Selling, admin and research expenses increased by $16 million or 2%, primarily due to higher research costs supporting future growth, partially offset by lower variable compensation expense. Joint venture income declined by $42 million versus a year ago. Lower demand for trucks and construction equipment in China was the primary driver of the decline in earnings. Other income was a negative $18 million, $87 million worse than a year ago.

[Mark Smith, CFO at Cummins Inc.]

We experienced $48 million of mark-to-market losses on investments that underpin our unqualified benefit plans in the Q2, and this compares to gains of $20 million a year ago. This variation in this one category explains most of the change in other income. Net earnings for the quarter was $678 million or $4.77 per diluted share, compared to $600 million or $4.10 from a year ago. The earnings per share increased due to higher earnings, lower taxes, and a reduced share count resulting from share repurchase activity.

[Mark Smith, CFO at Cummins Inc.]

The all-in effective tax rate in the Q2 was 17.3%, including $36 million or $0.25 per diluted share of favorable discrete items. Operating cash flow in the quarter was an inflow of $599 million compared to $616 million a year ago. I will now comment on segment performance, and our guidance for 2022. For the engine segment, Q2 revenues increased 11% from a year ago, while EBITDA decreased from 16.1% of sales to 15.2% of sales as the benefits of stronger volumes and pricing actions in our consolidated earnings were more than offset by lower joint venture income in China. In 2022, we expect revenues to be up 10%, up 2% from our prior guidance.

[Mark Smith, CFO at Cummins Inc.]

The increase in sales primarily driven by higher demand for engines and parts in North America. 2022 EBITDA is projected to be approximately 14.5%, in line with our prior guidance. In the distribution segment, revenues increased 17% from a year ago to $2.3 billion, a record quarter for the segment. EBITDA increased as a percent of sales to 11.2% compared to 10.5% of sales a year ago, primarily due to stronger parts, whole goods, and pricing, sales and pricing actions. We expect 2022 distribution revenues to be up 11% year-over-year, and EBITDA margins in the range of 10.5% of sales, both in line with our prior guidance. Component segment revenue decreased 2% in the Q2, primarily driven by weaker demand in China.

[Mark Smith, CFO at Cummins Inc.]

EBITDA increased from 15.1% of sales to 18.2% of sales, driven by the benefits of pricing actions which offset material cost increases and lower warranty expense. We expect revenues to increase 3% for the year, down from an increase of 6% in our prior guidance, primarily due to a lower outlook in China. EBITDA margin is expected to be 17.5% of sales in line with our prior guidance. In the power systems segment, revenues increased 5% and EBITDA decreased from 12.2% to 10.6% of sales as the benefit of stronger volumes, and pricing were more than offset by higher material and logistics expenses.

[Mark Smith, CFO at Cummins Inc.]

2022, we expect revenues to be up 8% and EBITDA is projected to be approximately 11% for power systems, unchanged from our prior guidance. In the new power segment, revenues were $42 million, up 75% from a year ago due to stronger demand for battery electric systems. Our EBITDA loss was $80 million in the quarter as we continue to invest in the products, infrastructure, and capabilities to support future growth, and was in line with our expectations. In 2022, we still expect revenues for the new power business to be approximately $200 million, up 72%. Net EBITDA losses are still expected to be in the range of $290 million for new power, also unchanged from our prior guidance.

[Mark Smith, CFO at Cummins Inc.]

As Jen mentioned, we are maintaining our 2022 expectations of company revenues to be up 8% and our EBITDA margins at approximately 15.5% of sales. This guidance excludes expenses outside of the normal course of business associated with the separation of the filtration business, the pending acquisition of Meritor, or the indefinite suspension of our operations in Russia. We expect earnings from joint ventures to decline 25% in 2022, excluding the impact of suspension of our business in Russia. This is down from our prior guide of a decline of 20% due to continued weakness or further weakness, in fact, in the China truck market. We are pre-projecting our effective tax rate to be approximately 21.5% for this year, excluding discrete items.

[Mark Smith, CFO at Cummins Inc.]

Capital expenditures were $147 million in the quarter, up from $125 million a year ago. We still expect that our full year capital investments will be in the range of $850 million-$900 million. We returned $240 million to shareholders through dividends, and repurchase of shares in the Q2, bringing our total cash returns to $758 million for the H1 of the year. We still anticipate returning approximately 50% of operating cash flow to shareholders in the form of dividends and share repurchases. While high inflation, and rising global interest rates present risks to global economic growth, we did not experience any significant changes in aggregate demand from our customers over the past quarter.

[Mark Smith, CFO at Cummins Inc.]

Our focus remains on raising financial performance cycle over cycle in our core business while investing in technologies that will deliver future profitable growth, including in new markets, new applications, and with new customers. We continue to advance our strategy in the Q2, delivered record quarterly revenues and earnings per share, and recently announced an 8% increase in our quarterly cash dividend, the thirteenth straight year of dividend increases. Thank you for your interest today. Now let me turn it back over to Chris.

[Chris Clulow, VP of Investor Relations at Cummins Inc.]

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

[Operator]

At this time, we will be conducting a question and answer session. If you would like to ask a question, please press star one on your telephone keypad. A confirmation tone will indicate that your line is in the question queue. You may press star two if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. One moment, please, while we pull for questions. Our first question is from Jerry Revich with Goldman Sachs. Please proceed with your question.

[Jerry Revich, Analyst at Goldman Sachs]

Hi, good morning, everyone. Tom, Jen, congratulations.

[Jennifer Rumsey, President and CEO at Cummins Inc.]

Thanks, Jerry.

[Jerry Revich, Analyst at Goldman Sachs]

Tom, over those 70 earnings calls, I just wanna add some rough math, too. Congratulations to you and the team here.

[Mark Smith, CFO at Cummins Inc.]

Thank you, Jerry.

[Jerry Revich, Analyst at Goldman Sachs]

I'm wondering if you could just talk about the supply chain environment. You folks are sending a lot more via air freight than you do in a normal environment. I'm wondering if you just flesh that out for us. You know, what proportion of your shipments are now air freight versus in a normal environment. You know, how should we think about whenever demand does slow, what decremental margins might look like given the step down that we'd see in expedited freight in that environment?

[Jennifer Rumsey, President and CEO at Cummins Inc.]

Great. Thanks, Jerry. Yeah, we continue to experience an environment where supply chain is limiting our production in most of our markets. As you've seen, the team here has worked really hard to navigate that and continue to deliver as much product as we can to our customers who are also experiencing issues. Some of those issues have lessened. We continue, however, to experience constraints, in particular in the electronics space, microprocessors and other electronic components. We've seen improvement in our premium freight, and also are closely monitoring what's going on with the standard freight rates. While we have some improvement off the peak, we're still running at high levels as we continue to navigate disruptions caused by a combination of supply constraints and COVID-related disruptions.

[Mark Smith, CFO at Cummins Inc.]

And then you-

[Jerry Revich, Analyst at Goldman Sachs]

Jennifer, is that? Yeah.

[Mark Smith, CFO at Cummins Inc.]

Go ahead, Jerry.

[Jerry Revich, Analyst at Goldman Sachs]

No, no, please. Go ahead, Mark. I was just gonna ask you if it's possible to quantify, you know, how much higher that is than normal.

[Mark Smith, CFO at Cummins Inc.]

Well, at one point last year, we were running probably 4x the normal level of premium freight, and that's come down. It has been that we've seen sequential improvement over the last 3 or 4 quarters, but we're still running 2x-3x kind of extra cost right now. You'd asked about decremental margins, Jerry, in the event there's a slowdown. What I would say to you is, you know, we have to embrace these cycles when they come. We have a very experienced team that's navigated through several of them. We're very proud of our record of raising cycle-over-cycle performance at the peak and trough. I can't give you exact decremental margins, but know that we will adjust our plans, outcomes, operations as well to continue as and when the next cycle comes.

[Mark Smith, CFO at Cummins Inc.]

That's all I can say really at this point.

[Jerry Revich, Analyst at Goldman Sachs]

Got it. Thanks, Mark. You know, just lastly, you know, normally your margins tend to be down in the Q3 versus Q2 seasonally. I'm wondering, given the supply chain dynamic that we have here, could we actually see margins back up for you folks sequentially, depending on how supply chain performs?

[Mark Smith, CFO at Cummins Inc.]

I think the biggest challenge in the H2, well, baked into our guidance, is that we see a drop off in earnings in China. We typically see about a 25%-30% lower JV income in the H2 of the year, and we're projecting that again. You've heard from some of our, you know, important customers what their trajectory looks like on the top line going into the Q3. Yeah, there's still a lot of moving parts. There's still a lot of challenges we're working through. We've maintained our full year guidance. We're slightly behind the EBITDA percent for the full year through the H1 of the year, but we're on track. Not expecting extraordinary variation based on what we know today.

[Jerry Revich, Analyst at Goldman Sachs]

Thank you.

[Mark Smith, CFO at Cummins Inc.]

Do we have a next question from the operator?

[Operator]

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

[Tim Thein, Analyst at Citigroup]

Yes. Thank you. Good morning. Hey, Tom and Jen, congrats to you both.

[Mark Smith, CFO at Cummins Inc.]

Thank you.

[Jennifer Rumsey, President and CEO at Cummins Inc.]

Thanks, Tim.

[Tim Thein, Analyst at Citigroup]

Yeah, Tom, I trust you'll be dialing into that 71st call just so you can hear Chris read through the legal disclaimer.

[Tom Linebarger, Executive Chairman at Cummins Inc.]

No question about it.

[Tim Thein, Analyst at Citigroup]

Yeah, Tom, maybe one for you, just you know, higher level. Obviously, you've observed a number of cycles through your time, and I'm just curious. You mentioned that you guys weren't seeing anything of note, but you know, obviously there's a lot of broader concerns regarding you know, the potential for either a recession is here or on our doorstep. I'm just curious, you know, as you go through conversations with customers, you know, what would you be alerting the team to in terms of signposts or you know, indications of you know, if that begins to you know, in fact, come through, where would you be watching and what kind of signals would you be kind of looking to the team for?

[Tom Linebarger, Executive Chairman at Cummins Inc.]

Hey, thanks, Tim. I have been through a lot of these, and this is an unusual one. There's no question about it. I'm gonna flip it back to Jen, just because in terms of conversations with customers about where they are, Jen's actually been doing more of those than I have. I would say that I just kinda repeat the point Mark made. It is an unusual period, and it has been an unusual cycle, and I think our team has continued to figure out ways to adapt to it, and I think we will here, too. Make no mistake, a lot of us in the industry are trying to figure things out that we haven't faced before. Labor shortages, part shortages over extended periods, and things like that, like you've heard from Jen.

[Tom Linebarger, Executive Chairman at Cummins Inc.]

Let me just turn it back to her for kind of your perspective, Jen, on the customers and what they're looking at.

[Jennifer Rumsey, President and CEO at Cummins Inc.]

Yeah. Great. Thanks, Tom. Yeah, as Mark and Tom have said, you know, we're in a cyclical business. We have a strong team that understands how to navigate and manage over the cycles and use the cycles to strengthen the business and emerge stronger. This is not a typical cycle because coming out of the COVID-19, early part of COVID-19 pandemic, we have seen really strong demand that has been constrained by supply chain constraints across the industry. We have been unable to meet our collective customer demand in these markets outside of China that have been strong now for 18 months. You see that showing up in very high aftermarket demand as well, as customers have been using these products heavily and had higher parts demand as they work to keep them running.

[Jennifer Rumsey, President and CEO at Cummins Inc.]

Despite the fact that, you know, we do see some decrease in spot rates, you know, some reduction off of really high indicators, when I talk to customers and look at some of these backlogs and freight activity, it's still very strong, and they still would like us to supply more than we're able to. The conversations are all focused on where are we at with supply constraints, and can we ship more to them. We continue to monitor those overall indicators. At this point, again, end customer demand is strong, aftermarket demand is strong. Used truck prices continue to be elevated. Also recall with higher fuel prices, these more fuel-efficient next generation products are attractive to customers. We'll continue to stay close to it and monitor what happens.

[Jennifer Rumsey, President and CEO at Cummins Inc.]

Right now, we see supply being the constraint through this year outside of China.

[Tim Thein, Analyst at Citigroup]

Got it. All right, I will move it along. Thank you both for the time and best of luck.

[Tom Linebarger, Executive Chairman at Cummins Inc.]

Thanks, Tim.

[Jennifer Rumsey, President and CEO at Cummins Inc.]

Thank you.

[Operator]

Our next question is with Jamie Cook with Credit Suisse. Please proceed with your question.

[Jamie Cook, Managing Director at Credit Suisse]

Hi, good morning. Congrats, Jennifer, and congrats, Tom, and thank you for all the support throughout the years. Wish you well, and I'm sure you're gonna miss all our very insightful questions on earnings calls. I guess, Jennifer, my first question for you, understanding that you and Tom have been working, you know, closely together and you know, the Destination Zero strategy, you both obviously work closely with and have buy-in, but sort of every CEO puts their own sort of, you know, stamp on a company. You know, just sort of as you're thinking about leading the company, sort of maybe nuances or differences relative to Tom or how you're thinking about the company just slightly differently.

[Jamie Cook, Managing Director at Credit Suisse]

I guess just my second question, Jennifer, this is for you or for Mark. It's probably unfair, but I'll ask it anyway. Understanding you can't control a downturn if we have one, but I feel like coming downturn theoretically in 2023 could be different as you think about, you know, one, we're adding Meritor. You have market share wins. You know, I guess we won't have the filtration business and, you know, maybe China is actually okay in this downturn because we're so, you know, the market's so depressed. Any way you wanna sort of put buckets around, you know, how that could be additive to a normal downturn? Thanks. Sorry for an unfair first question as CEO, Jennifer.

[Jennifer Rumsey, President and CEO at Cummins Inc.]

No, thank you, Jamie. Appreciate the question. As you noted, Tom and I have developed the Destination Zero strategy together. I've been a member of the Cummins leadership team now for more than seven years as Chief Technical Officer leading the components business, Chief Operating Officer, and now CEO. The strategy, the focus of the company going forward, remains the same. The commitment to all of our stakeholders to deliver strong results, to really create strategic advantage to our people will continue.

[Jennifer Rumsey, President and CEO at Cummins Inc.]

I think the big difference is just that as we continue to operate in this evolving environment, paying attention to how markets are evolving, technologies are evolving, integration of Meritor, a major new company, and we're gonna be thinking a lot about strategic execution and what does that mean for different parts of our business as our strategy evolves. Paying attention to a more dynamic environment. That's one of the reasons why I've kept the President role in addition to CEO, is to stay close to the businesses as we focus not only on continuing to refine that strategy, but really driving strategic execution and delivering results. As it relates to, you know, next year, we'll of course talk later more about next year. You've heard us say we see supply being the limiting factor through this year.

[Jennifer Rumsey, President and CEO at Cummins Inc.]

Backlog is strong. You know, China is down and will improve, right? There's a lot of opportunity for it to improve. Cummins is very well-positioned. Our products are performing very well. The customer demand for that product is strong. We have new partnership opportunities in the core business and in new power. We'll continue to invest in products that will position the company for the future and manage through the cycles as they come.

[Mark Smith, CFO at Cummins Inc.]

By the way, I'll miss you, Jamie.

[Jamie Cook, Managing Director at Credit Suisse]

No, I mean, that's fine. I was just wondering too, I mean, the incremental unless there's more opportunities on foster, you know, Meritor, some of these market share wins start to help in 2023. If you wanna answer, fine. If not, that's fine. I can get back in queue.

[Mark Smith, CFO at Cummins Inc.]

I think you just described most of my work plan from Tom and Jen. We'll be working hard on all of those. Thank you.

[Jamie Cook, Managing Director at Credit Suisse]

Thank you.

[Mark Smith, CFO at Cummins Inc.]

Jamie.

[Operator]

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

[Steven Fisher, Analyst at UBS]

Thanks. Good morning. I'm not sure if I missed this, but what was your H1 aftermarket growth? I know you raised the full year to 15%-20% from 15%. Just kind of wondering what you're assuming for kind of the H2 trajectory within that guidance, if some of the market activity is kind of slowing that down at all.

[Chris Clulow, VP of Investor Relations at Cummins Inc.]

Yeah, Steven, it's Chris. Yeah, we experienced about that same level in the H1, and we expect it to hold throughout the year. I think the demand is still very high, particularly in the heavy duty market in North America, as well as the global power systems markets. Mining, oil and gas have strong demands there for aftermarket parts, rebuilds and whatnot. We expect that to hold, certainly through the remainder of 2022.

[Chris Clulow, VP of Investor Relations at Cummins Inc.]

Yeah. Q2 was a little stronger than Q1, as Tom and Jen mentioned. There have been some supply chain challenges, so those have eased a little bit and demand remains strong.

[Steven Fisher, Analyst at UBS]

Okay. You know, as you're kinda discussing with Tim before, I mean, it seems like we're kind of in this broad macro limbo at the moment. I guess I'm just curious how that is affecting any of your investment plans or strategic actions, if that's changing the timing of anything.

[Jennifer Rumsey, President and CEO at Cummins Inc.]

Yeah. Tim, good question. Obviously we've moved forward with our JVS acquisition and Meritor will complete this week. We're continuing to make these key investments in the future. We are still in the process on the separation of our filtration business as we've disclosed previously and monitoring the environment as that continues.

[Mark Smith, CFO at Cummins Inc.]

The other thing I'd add is, you know, we're just, as you'd imagine, we're not just waiting around for changing economic conditions. An important part of how we've grown the earnings over time is just like a continual focus on trying to drive efficiencies in everything that we do. Doesn't always make the headlines, but almost at every aspect of our work, we're looking for efficiency, better output. We're always looking for those types of ways to improve the underlying performance of the business.

[Steven Fisher, Analyst at UBS]

Got it. Best wishes, Tom and Jennifer. Thanks.

[Jennifer Rumsey, President and CEO at Cummins Inc.]

Thanks.

[Mark Smith, CFO at Cummins Inc.]

Thanks, Steve.

[Operator]

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

[Rob Wertheimer, Founding Partner and Machinery Analyst at Melius Research]

Hi, good morning, and congrats to both of you.

[Jennifer Rumsey, President and CEO at Cummins Inc.]

Thanks, Rob.

[Rob Wertheimer, Founding Partner and Machinery Analyst at Melius Research]

My question is really on New Power. There's a lot that's changed in the world in the last six months. Your revenue trends were good. I'm curious if you have any comments on competitive position within electrolyzers, whether you see it solidifying or expanding. You guys have the wherewithal to invest, and presumably that pays off somehow. Then just whether the outlook into, I guess, 2023, 2024, I'm not sure how far along your backlog extends, is inflecting upwards as the world, you know, reevaluates its energy mix. Thanks.

[Jennifer Rumsey, President and CEO at Cummins Inc.]

Yeah. Yeah, great question. We delivered the highest revenue in the Q2 to date from our New Power business at $42 million and made a lot of progress across all parts of the business. You saw announcements of new partnerships on fuel cells, both on and off highway, where we think long term the market will move. Continuing to make progress and having lots of conversations on the electrolyzers, and demonstrating the capability of our PEM electrolyzer solutions there. We believe as we demonstrate some of those larger installations of PEM electrolyzer, that the market's gonna increasingly move towards that solution and that we're well-positioned competitively. The market is lumpy at this point, and a lot of our focus is on building up capacity and scale to meet the demand. We will.

[Jennifer Rumsey, President and CEO at Cummins Inc.]

Amy and I will continue to be talking about what are those key milestones that we see in the market, and in our scale-up activity and how that's evolving. We still feel very optimistic. With this energy challenge that we see in the global world, expect that the focus and interest in green hydrogen will continue to grow. Lastly, with the Meritor acquisition, that's another key component that we think positions us well in the electric powertrain and we'll be building on the business that we have and very complementary to our existing New Power business in electrified powertrain. Overall, well-positioned for the future with New Power.

[Rob Wertheimer, Founding Partner and Machinery Analyst at Melius Research]

Thank you. That's a comprehensive answer. Any inside track on whether the Inflation Reduction Act gets passed. You would benefit obviously from green hydrogen with that. I don't know if there's any production or any other obvious benefits that you saw in that potential bill. I will stop there. Thank you.

[Jennifer Rumsey, President and CEO at Cummins Inc.]

Yeah, great. You know, we're hopeful that the Inflation Reduction Act will get passed. It has many key provisions that we think are important for advancing lower carbon solutions, and it fits well with our Destination Zero strategy. It's really critical that there's investment to build out infrastructure and to make these technologies more affordable as they scale and advance. We have been active in advocating for some of the key energy provisions in that act, and we'll continue to do that as our Congress considers it.

[Rob Wertheimer, Founding Partner and Machinery Analyst at Melius Research]

Thanks, Jen.

[Operator]

Our next question is from Matt Elkott with Cowen. Please proceed with your question.

[Matt Elkott, Equity Research Analyst at Cowen]

Good morning. Thank you. So after the initial COVID shutdowns in China, we saw a pretty record recovery in the remainder of 2020, and into 2021. I understand we're highly unlikely to see anything like that after the current lockdowns, but do you have any sense of how things could play out when or if China moves fully past lockdowns, like most of the rest of the world has? A longer, you know, picture question related to China as a follow-up. We've seen some Western companies, like some automakers, reconsider JVs in China. Do you guys still see your JV model in China as the right strategy? Any updated thoughts on that would be appreciated.

[Jennifer Rumsey, President and CEO at Cummins Inc.]

Yeah. What happens with China COVID lockdowns is one of the big questions that we debate a lot. At this point, they continue to have this dynamic lockdown strategy, and we've continued to see some smaller scale lockdowns that have been happening, and operating in kind of closed loop, closed circle environments within that from a business perspective. I don't see when and how they completely evolve out of that. We're prepared to continue to operate in that type of environment. However, we do think that that market is gonna come back. It's a large market. It's an important market for us to be a part of because of its size.

[Jennifer Rumsey, President and CEO at Cummins Inc.]

We are committed to continuing to invest in the products, and joint ventures that we have there, while also ensuring from a global supply chain perspective that we have resiliency in our supply chain so that we can navigate through COVID, weather disruptions, and other constraints.

[Matt Elkott, Equity Research Analyst at Cowen]

Great. Thank you very much.

[Operator]

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

[Noah Kaye, Managing Director and Senior Analyst at Oppenheimer]

Hey, thank you, and let me add to the congratulations here. I just wanna follow up on the IRA. Obviously there's a lot of potential benefits for Cummins in this legislation, but you know, among them, you could be looking at up to a $3 per kg production tax credit for green hydrogen. Obviously this has been kinda on again, off again for the last couple of years. Have to imagine that some scenario planning has played out in some of these potential customer discussions. At this point, is it possible to actually dimension the magnitude of the opportunities domestically that might pencil out with that kind of a PTC? Then how quickly do you think you can move to convert those opportunities to revenue if it does come to pass?

[Jennifer Rumsey, President and CEO at Cummins Inc.]

Yeah, no, it's a great question. Within that, Inflation Reduction Act, as you noted, there is incentive for hydrogen production, which is significant, as well as incentives for other clean vehicles and clean fuels. It's important to note that there's also incentive for things like biodiesel and renewable natural gas within that. A lot of things that will help drive advantage. We have had active conversations in recent years in Europe and growing conversations in the US. The bipartisan infrastructure bill also put some significant investment in hydrogen infrastructure. We believe that this will continue to add to that and are really focused on scaling up our product and production to meet the demand that we think will be there.

[Jennifer Rumsey, President and CEO at Cummins Inc.]

It's hard for me to dimension specifically to you right now. As I said, we'll continue to talk about what we see as the key milestones in that business, growing revenue, and growing our return from the electrolyzer business over time.

[Noah Kaye, Managing Director and Senior Analyst at Oppenheimer]

Okay, thanks. Maybe one quick follow-up, and there was some discussions about, you know, preparing for a potential downturn, and how you can flex down amidst that. But one variable that I'm sure you're considering is just the investment cycle, you know, for the next step up in emissions reduction. How do we think about that factoring into budgeting for next year, you know, some potential increased investment spending on the combustion side in preparing for tighter emission standards?

[Jennifer Rumsey, President and CEO at Cummins Inc.]

Yeah. You've seen us increasing our investments in particular in both new power and engine business as we invest in the technologies and electrolyzers and new power and also these next generation fuel agnostic platforms in the engine business. We have the scale advantage globally to do that. Those are investments that we will continue to make, and we're also looking at driving efficiency, and improvement in parts of our business that can adjust with the cycle. We'll continue to deliver on our financial commitments and strong returns through the ups and downs as we invest in those key areas for our future.

[Noah Kaye, Managing Director and Senior Analyst at Oppenheimer]

Okay, great. Thank you very much.

[Mark Smith, CFO at Cummins Inc.]

Thanks, Noah.

[Operator]

Our next question is from Jeff Kauffman with Vertical Research Partners. Please proceed with your question.

[Jeff Kauffman, Partner at Vertical Research Partners]

Thank you very much. Like everybody else, Tom, thank you for your leadership and Jennifer, best of luck in the future. I wanted to focus a little bit. You discussed supply chain costs, and talked a little bit about what was going on with raw material costs. If we looked at the inflationary part of cost of goods sold, how do those costs stack up against each other in terms of how much of the increase in expense is more on the raw input side versus how much more are we spending on supply chain than we normally would? Also noting that in recent weeks and months, supply chain costs, while still high, have been easing. Raw material costs, while still high, have been easing.

[Jeff Kauffman, Partner at Vertical Research Partners]

I'm just kind of curious, is any of that built into the guide at this point, maintaining the margins where they are?

[Mark Smith, CFO at Cummins Inc.]

Yeah, Jeff Kauffman, this is Mark Smith. I would say this year, if you look at our costs, the material costs have been increasing. That's been the biggest single driver on the cost side. Last year, certainly the H1 of the year, it was very heavy on the freight, premium freight costs. Then we started to see more inflation in materials, play out over time. As we talked about, the premium freight costs have come down a little bit. Part of that's through better coordination and management of the expenses. Material costs continue to increase at this point in time. I would say it's fairly within a predictable range quarter to quarter so far. Yes, one or two commodity costs have come off the peak, but remain at fairly elevated levels.

[Mark Smith, CFO at Cummins Inc.]

Of course, whatever changes there are in the market, costs of freight and metal markets, those take time to work through the supply chain, you know.

[Jeff Kauffman, Partner at Vertical Research Partners]

Okay. Mark, back to the question, though. For the quarter, cost of goods sold was up about 5% on total revenue growth of about 8%. Ex-inflationary costs, what are we looking at in terms of that raw material or the cost of goods sold inflation? I'm just trying to understand how much is kind of temporary cost inflation on materials, how much is temporary cost inflation on supply chain costs and kind of what's the underlying rate?

[Mark Smith, CFO at Cummins Inc.]

Let me put it like this. Our material costs in the Q2 increased by 1.9% of sales year-over-year, just to call it out. What is temporary and what's. You know, we're always working to make changes to products, drive, redesign things, take cost out. Right now, that's a pretty high level over what we certainly pre-COVID-19, pre this inflationary environment, that is a high level of material cost increases. What's temporary and permanent is very hard to say, but about 1.9%. Freight costs are fairly flattish year-over-year, but at a very elevated level. Material cost increase, you know, there are some pressure on some other categories, but those are the biggest elements.

[Jeff Kauffman, Partner at Vertical Research Partners]

All right. That's helpful. In terms of the guidance, I'm assuming no real change in either of those in terms of your outlook, or has there been a change built into that outlook of margins maintaining?

[Mark Smith, CFO at Cummins Inc.]

No significant change on the cost side. We've lowered our outlook for JV earnings, which is not what you're talking about, but I'm just trying to triangulate back to the overall guidance of lower JV earnings.

[Jeff Kauffman, Partner at Vertical Research Partners]

Mm-hmm.

[Mark Smith, CFO at Cummins Inc.]

We've got slightly stronger aftermarket revenues, particularly in North America, those balance out. No significant changes on the other categories.

[Jeff Kauffman, Partner at Vertical Research Partners]

Okay, thank you very much.

[Mark Smith, CFO at Cummins Inc.]

Thank you.

[Operator]

Ladies and gentlemen, we have reached the end of the question and answer session, and I would now like to turn the call back over to Chris Clulow for closing remarks.

[Chris Clulow, VP of Investor Relations at Cummins Inc.]

Great. Thanks, Maria. That concludes our teleconference for the day. Thank you all for participating and your continued interest. As always, the investor relations team will be available for questions after the call. Thanks.

[Operator]

You may disconnect your lines at this time. Thank you for your participation.

Participants

Executives

• Chris Clulow, VP of Investor Relations
• Jennifer Rumsey, President and CEO
• Mark Smith, CFO
• Tom Linebarger, Executive Chairman

Analysts

• Jamie Cook, Managing Director at Credit Suisse
• Jeff Kauffman, Partner at Vertical Research Partners
• Jerry Revich, Analyst at Goldman Sachs
• Matt Elkott, Equity Research Analyst at Cowen
• Noah Kaye, Managing Director and Senior Analyst at Oppenheimer
• Rob Wertheimer, Founding Partner and Machinery Analyst at Melius Research
• Steven Fisher, Analyst at UBS
• Tim Thein, Analyst at Citigroup