Cummins Q4 2023 Earnings Call Transcript

Participants

Corporate Executives

• Chris Clulow, Vice President, Investor Relations
• Jennifer Rumsey, Chair and Chief Executive Officer
• Mark Smith, Chief Financial Officer

Analysts

• Jerry Revich, Goldman Sachs & Co. Inc.
• Tim Thein, CITI Investment Research (US)
• David Raso, Evercore ISI International
• Angel Castillo, Morgan Stanley & Co., LLC
• Robert Wertheimer, Melius Research
• Tami Zakaria, J.P. Morgan Securities
• Noah Kaye, Oppenheimer & Co. Inc.
• Michael Feniger, BofA Securities

Presentation

[Operator]

Greetings. Welcome to Cummins, Inc. Fourth Quarter 2023 Earnings Conference Call. [Operator Instructions]

I will now turn the conference over to Chris Clulow, Vice President of Investor Relations. Thank you. You may begin.

[Chris Clulow, Vice President, Investor Relations at Cummins]

Thank you. Good morning, everyone, and welcome to our teleconference today to discuss Cummins results for the fourth quarter and full year of 2023. Participating with me today are Jennifer Rumsey, our Chair and Chief Executive Officer; and Mark Smith, our Chief Financial Officer. We will all be available to answer questions at the end of the teleconference.

Before we start, please note that some of the information that you will hear or be given today will consist of forward-looking statements within the meaning of the Securities 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 in our filings with the Securities and Exchange Commission, particularly the Risk Factor section of our most recently filed annual report on Form 10-K and any subsequently filed quarterly reports on Form 10-Q.

During the course of this call, we will be discussing certain non-GAAP financial measures, and we will refer you to our website for the reconciliation of those measures to GAAP financial measures. Our press release with a copy of the financial statements and a copy of today's webcast presentation are available on our website within the Investor Relations section at cummins.com.

With that out of the way, I'll turn you over to our Chair and CEO, Jennifer Rumsey, to kick us off.

[Jennifer Rumsey, Chair and Chief Executive Officer at Cummins]

Thank you, Chris, and good morning, everyone. I'll start with a summary of 2023 and discuss our fourth quarter and full year results, and then I'll finish with a discussion of our outlook for 2024. Mark will then take you through more details of our fourth quarter and full year financial performance and our forecast for this year. As I reflect back on 2023, I am incredibly proud of what Cummins and our employees accomplished for our stakeholders, and I feel energized about the opportunities ahead for us as we continue to demonstrate our relentless focus on being a global leader in clean energy technology and innovation. We made significant progress in achieving our Destination Zero strategy, and it continues to be clear that this dual-path approach to reducing greenhouse gas and air quality impacts of our products is the right approach to meet our customers' needs today and continue to grow our business and impact.

We did this by advancing our core business as well as developing new zero emission solutions through Accelera by Cummins. Most notably for our core business in 2023, we committed to investing more than $1 billion across our U.S. engine manufacturing network to support the industry's first fuel-agnostic engine platform, as well as unveiled the X10 fuel-agnostic series launching in North America in 2026. Additionally, we initiated several collaborations with our natural gas X15 engine, which will launch in North America this year and further enables our customers to achieve their decarbonization goals. This is the industry's first natural gas engine designed specifically for heavy-duty and on-highway truck applications, offering customers the opportunity to realize reductions in nitrous oxides and greenhouse gas without compromising performance. We are continuing to see strong interest from both OEMs and end users ahead of the launch later this year.

In our Accelera business, we announced a joint venture with Daimler Trucks & Buses, PACCAR, and EVE Energy to accelerate and localize battery cell production and the battery supply chain in the U.S. We further announced this quarter the selection of Marshall County, Mississippi, for the 21 gigawatt factory that is expected to create more than 2,000 U.S. manufacturing jobs, with production anticipated to begin in 2027. Accelera also reached a further milestone this year of electrolyzer order backlog totaling over $500 million. In order to meet the growing electrolyzer demand, we began production at our first U.S. manufacturing location for electrolyzers in the Cummins power generation facility in Fridley, Minnesota.

Lastly, we are resolute about the leading role we play in the energy transition, and emissions compliance continues to be a critical element of this work and central to our values. We were transparent about this in December when we announced that we reached an agreement in principle to resolve U.S. regulatory claims regarding our emissions certification and compliance process for certain engines primarily used in our pickup truck applications. After 4.5 years of working diligently with the regulators, reaching an agreement was the best way for us to achieve certainty on this matter and move forward with certifying our new products and advancing our Destination Zero strategy. We have expanded and strengthened our emissions compliance program to help ensure our products comply with increasingly stringent emissions regulations around the world. Our Product Compliance and Regulatory Affairs organization, which we launched in 2019, has a reporting line directly to me and positions Cummins to meet global product compliance requirements and deliver solutions for our customers that are safe and lead to a cleaner environment.

Now I will comment on the overall company performance for the fourth quarter of 2023 and cover some of our key markets. Demand for our products remains strong across many of our key markets and regions. Revenues for this quarter totaled $8.5 billion, an increase of 10% compared to 2022, driven by strong demand across most global markets. EBITDA was a loss of $878 million, or negative 10.3%, compared to positive $1.1 billion, or 14.2%, a year ago. Fourth quarter 2023 results included $2.04 billion of costs related to the agreement to resolve U.S. regulatory claims, $42 million of costs related to a voluntary retirement and separation program, and $33 million of costs related to the separation of the Atmus business. This compares to the fourth quarter 2022 results, which included $19 million of costs related to the separation of the Atmus business. Excluding those items, EBITDA was $1.2 billion, or 14.4% of sales, compared to $1.1 billion, or 14.5%. EBITDA dollars increased from a year ago as increased pricing and higher volumes more than offset increased selling, administrative, research and development expenses, and inflation costs.

Research and development expense increased in the fourth quarter 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. In addition, operating cash flow for the fourth quarter of 2023 was very strong at $1.5 billion compared to $817 million in the fourth quarter of 2022 as we continue to focus on working capital management within the business. 2023 revenues were a record $34.1 billion, 21% higher than 2022, driven by the addition of Meritor and strong demand across most global markets.

EBITDA was $3 billion, or 8.9% of sales compared to $3.8 billion, or 13.5% of sales in 2022. 2023 results include $2.04 billion of cost related to the agreement to resolve U.S. regulatory claims, the voluntary headcount reduction program I noted previously, and $100 million of costs related to the separation of the filtration business. This compares to our 2022 results, which included $111 million of cost related to the indefinite suspension of operations in Russia and $81 million of costs related to the separation of the filtration business. Excluding those items, EBITDA was a record $5.2 billion, or 15.3% of sales for 2023, compared to $4 billion, or 14.2% of sales for 2022, as the benefits of higher volume and pricing exceeded increased selling, administrative, research and development and inflation costs. EBITDA percent improved year over year in the Distribution, Components, and Power Systems segments. Our Power Systems business in particular finished 2023 with a full year EBITDA of 14.7% of sales, up from 12.2% in 2022. This segment completed the first year of their focused business transformation effort, and the improvement in performance is encouraging. You will see from our guidance that we expect further margin gains this year in addition to our segments, Meritor finished 2023 with full year EBITDA of 10.8% of sales, up from 7.4% in 2022 as our employees did a tremendous job of executing value capture opportunities across the business. I'm very pleased with the performance of Cummins Meritor to date as we continue our program to improve margins in that business and expand its global reach. In addition, operating cash flow for 2023 was a record of $4 billion, a significant increase from $2 billion in 2022. I'm proud of our leaders and employees' efforts in 2023 as they helped deliver on one of our primary focus areas. Strong cash generation will continue to be a top priority moving forward.

Now, let me provide our overall outlook for 2024 and then comment on individual regions and end markets. Our 2024 guidance continues to include Atmus for the full year but excludes any costs or benefits associated with the planned separation of that business. We are forecasting total company revenue for 2024 to be down 2% to 5% compared to 2023, and EBITDA to be in the range of 14.4% to 15.4% of sales as we anticipate slowing demand in some of our key regions and markets, particularly North America heavy-duty truck. Early in 2024, we expect the heavy-duty market to continue at its current rate, which is slightly off the peak of the first half of 2023, with further softening in our forecast in the second half of the year. Industry production for heavy duty trucks in North America is projected to be 245,000 to 265,000 units in 2024, a 10% to 15% decline year over year.

In medium-duty truck market, we expect market size to be 140,000 to 150,000 units, down 5% to flat compared to 2023. Our engine shipments for pickup trucks in North America are expected to be 135,000 to 145,000 units in 2024, a 5% to 10% decline year over year as we prepare to launch our model year 2025 in the fourth quarter. In China, we project total revenue, including joint ventures, to increase 3% in 2024. We're projecting a range of down 5% to up 10% in heavy-duty and medium-duty truck demand and expect a range of down 5% to up 5% in demand in light-duty truck market. We expect replacement demand to be the biggest driver, but the effect may be weakened by a sluggish economy and moderating export demand.

Despite this little pace of recovery in the China truck market, we expect to see continued strong performance for the 15-liter natural gas engine as we achieved approximately 20% share for 2023 in the heavy-duty market. In India, we project total revenue, including joint ventures, to increase 9% in 2024, primarily driven by strong power generation and on-highway demand. We expect industry demand for trucks to be flat to up 5% for the year. For global construction, we expect a 5% to 15% decline year over year, primarily driven by weak property investment and shrinking export demand in China.

We project our major global high-horsepower markets to remain strong in 2024. Revenues in the global power generation market are expected to increase 5% to 10%, driven by continued increases in the data center and mission-critical markets. Sales and mining engines are expected to be down 5% to up 5%. While a small market for us, demand for oil and gas engines is expected to decrease by 40% to 50% in 2024, primarily driven by decreased demand in North America. And for aftermarket, we expect a range of flat to an increase of 5% for 2024, as we expect to be largely through inventory management efforts and destocking that happened throughout the industry in the second half of 2023. In Accelera, we expect full year sales to be $450 million to $500 million compared to the $354 million in 2023. We have a growing pipeline of electrolyzer orders, which we expect to deliver over the course of the next 12 to 18 months, as well as expect continued growth in electrified components.

In summary, 2023 was a record year for revenues and operating cash flow. Excluding the impacts related to the agreement to resolve U.S. regulatory claims, 2023 was also a record year for EBITDA, net GAAP income, and earnings per share. While 2023 revenues were at the high end of our expectations, we anticipate moderating demand in North America truck production in the second half of 2024. We expect this moderating demand to be partially offset by a strong power generation market, resiliency in our Distribution business given the strong aftermarket presence and improved Accelera sales. In addition, we are taking steps to reduce cost, optimize our business, and position Cummins for continued success in 2024. We are in a strong position to keep investing in the future, bringing new technologies to customers and returning cash to our investors.

As I close, I would like to officially announce that our Analyst Day is now scheduled for May 16 in New York City. I look forward to further discussing our strategy and expect invitations to be sent out shortly. Now let me turn it over to Mark who will discuss our financial results in more detail. Mark?

[Mark Smith, Chief Financial Officer at Cummins]

Thank you, Jen, and good morning, everyone. I will acknowledge I have heavy cold this morning, so if I sound more dour than usual and a little rougher, please take that into consideration. We delivered solid operational results in the fourth quarter, exceeding our expectations for revenue and delivering EBITDA margins in line with our guidance. Compared to 2022, our full year sales grew 21% and our operating cash flow more than doubled to a record $4 billion, reflecting the strong focus of our employees on meeting customer demand and improving working capital.

Now let me go into more details on the fourth quarter and full year performance. Q4 revenues were $8.5 billion and EBITDA was a net loss of $878 million, or negative 10.3% of sales. For the full year, we reported revenues of a record $34.1 billion and EBITDA was $3 billion, or 8.9% of sales. As Jen mentioned, we recorded a onetime charge of $2.04 billion in Q4 to settle the previously disclosed U.S. regulatory claims. Fourth quarter results also included $42 million of costs associated with the voluntary retirement and separation programs. Costs associated with the planned separation of Atmus were $33 million in the fourth quarter and $100 million for the full year, compares to $19 million in the fourth quarter of 2022 and a total of $81 million in the previous year.

Full year 2022 results also included $111 million of costs related to the indefinite suspension of our operations in Russia. To provide clarity on the fourth quarter and 2023 full year operational performance of our business, I am now excluding the costs associated with the regulatory settlement, voluntary retirement separation programs, planned separation of Atmus, and the indefinite suspension of our operations in Russia in my following comments. Q4 revenues were $8.5 billion, an increase of 10% from a year ago. Sales in North America increased 8%, driven by improved pricing across multiple end markets and stronger demand for power generation products. International revenues increased 13%, driven by strong global power gen demand, particularly for data centers. EBITDA was $1.2 billion, or 14.4% of sales for the quarter, compared to $1.1 billion, or 14.5% of sales a year ago. Improved pricing was offset by higher compensation costs, increased investment in development and capabilities in our Accelera segment. Higher variable compensation costs were driven primarily by stronger operating cash flow, which exceeded our expectations for the quarter and the full year.

Now I'll go into each line item with a little bit more detail. Gross margin was $2 billion, or 23.7% of sales, an increase of $201 million, or 30 basis points from the prior year. The improved margins were driven by favorable pricing and higher volumes, partially offset by higher product coverage costs and compensation expenses. Selling, admin, and research expenses increased by $154 million, or 15% as we continue to invest in the development of new products that will drive future growth and also due to higher variable compensation costs. Joint venture income increased $25 million due to slowly recovering demand in China from a low base in 2022. Other income was $50 million, an increase of $17 million from a year ago, primarily due to the recovery of technology fees from customers in the fourth quarter.

Interest expense was $92 million, an increase of $5 million from the prior year, driven by higher interest rates on the floating rate portion of our debt. The all-in effective tax rate in the fourth quarter was negative 13.3%, principally due to nondeductible costs associated with the regulatory settlement. All-in net loss for the quarter was $1.4 billion, or negative $10.01 per diluted share, which includes $2.4 billion, or $13.76 per diluted share of costs associated with the regulatory settlement, $42 million, or $0.22 per diluted share, of costs associated with the voluntary retirement and separation programs, and $33 million, or $0.17 per diluted share, of costs associated with the planned separation of Atmus.

Operating cash flow was an inflow of $1.5 billion, $642 million higher than the fourth quarter last year, driven by strong earnings and a lower expansion of our working capital across the business. For the full year 2023, revenues were a record $34.1 billion, up 21%, or $6 billion from a year ago, driven by the inclusion of a full year of Meritor results and strong organic growth. Sales in North America increased 22% and international sales increased 20%. Within those numbers, organic sales growth was 12%, driven by improved pricing, strong global demand for power generation products, continued strength in the North American truck market, and slowly improving economic conditions in China. EBITDA for the year was $5.2 billion, or 15.3% of sales for 2023, an increase of $1.2 billion, or 110 basis points from the prior year. The increase in EBITDA percent was driven by higher volumes, favorable pricing, and logistics costs, and a modest and favorable mark-to-market impact from investments that underpin our company-owned life insurance plans, all of that partially offset by higher compensation expenses.

All-in net earnings were $735 million, or $5.15 per diluted share, compared to $2.2 billion, or $15.12 per diluted share, a year ago. 2023 net earnings include $2.04 billion, or $13.78 per diluted share of costs related to the regulatory settlement, $100 million, or $0.54 per diluted share of costs related to the separation of Atmus, $42 million, or $0.22 per diluted share of costs related to the voluntary separation programs that we implemented during the fourth quarter. Full year cash from operations was a record inflow of $4 billion, doubling from a year ago as a result of higher operating income and much lower expansion of working capital across the company. Capital expenditures in 2023 were $1.2 billion, in line with our forecast and an increase of $297 million from 2022 as we continued to invest in the new products and capabilities to drive growth, particularly related to the fuel-agnostic platforms within our core business.

Our long-term goal is to deliver at least 50% of operating cash flow to shareholders, and over the past five years we've returned 56% of operating cash flow in the form of share repurchases and dividends. Hang on, I've jumped one page too many. Sorry about that. I've gone the wrong way. That can happen sometimes. In 2023, we focused our capital allocation on organic investments and dividend growth, returning $921 million to shareholders via the dividend and debt reduction following the acquisition of Meritor. We currently expect that our priorities for cash deployment in 2024 will mirror those of last year.

I'll now summarize the 2023 results for the operating segments and provide guidance for 2024. If I need to say it again, I will, that the results that I'm going to discuss going forwards exclude the costs related to the separation of Atmus, the costs associated with the voluntary retirement and separation, and the costs associated with the indefinite suspension of our operations in Russia in 2022. Component segment revenues were a record $13.4 billion, 38% higher than the prior year. EBITDA was 14.4% of sales compared to 14.2%, an increase of $540 million, or 40%. For 2024, we expect total revenue for the Components business to decrease 2% to 7%, and EBITDA margins to be in the range of 13.9% to 14.9%.

For the Engine segment, 2023 revenues increased 7% to a record $11.7 billion and EBITDA was 14.1% of sales compared to 14.3% a year ago. In dollar terms, EBITDA increased $74 million, or 5%. In 2024, we project revenues for the Engine business will decrease 2% to 7% due to expected moderation in the North American heavy-duty truck market, most prominently in the second half of the year. 2024 EBITDA is projected to be in the range of 12.5% to 13.5%.

In the Distribution segment, revenues increased 15% from a year ago to a record $10.2 billion and EBITDA increased by 28% and improved as a% of sales to 11.8% compared to 10.6% a year ago. We expect Distribution revenues to be down between down 3% and up 2% and EBITDA margins to be in the range of 11.4% to 12.4% for the full year.

In the Power Systems segment, revenues were also a record of $5.7 billion, or 13% higher than last year. EBITDA was 14.7% or 250 basis points higher than 2022 driven by favorable pricing, strong volume, and certain cost reduction actions. In 2024, we expect Power Systems revenues to be down 3% to up 2% and EBITDA in the range of 15.2% to 16.2%.

Accelera revenues increased to $354 million in 2023, with a net loss at the EBITDA level of $443 million. In 2024, we anticipate that Accelera revenues will increase in the range of $450 million to $500 million and net losses to reduce to between $400 million and $430 million as we continue to make targeted investments in future technologies whilst improving the operating performance of our current products. We currently project 2024 company revenues to be down 2% to 5% and company EBITDA margins in the range of 14.4% to 15.4%. Our effective tax rate is expected to be approximately 24% in '24, excluding any discrete items. Capital investments will likely be in the range of as we continue to make critical investments to support future growth.

To summarize, we delivered record sales and strong operating profits in 2023. Cash generation has been and will continue to be a strong focus as we enter 2024, enabling us to continue investing in new products even during times of economic uncertainty, returning cash to shareholders, and maintaining a strong balance sheet. As Jen indicated, we do expect moderation in several of our key markets in 2024, especially in the U.S. truck market, as reflected in our guidance. We've already taken actions to reduce costs in the business and are in a good situation to navigate the economic cycle, improve our cycle-over-cycle performance in 2024.

Subject to our mark-to-market conditions, our intention is to split off the remaining ownership in Atmus through an exchange offer as our next step in the separation as we seek to reposition our portfolio for the future. As per part of the proposed exchange offer, Cummins shareholders will have the choice to exchange all, some, or none of their shares of common stock for shares of Atmus common stock subject to the terms of the offer. The exact timing of our decision to launch an exchange offer will, as stated earlier, depend on market conditions, but the launch of the tender could occur as early as in the coming days. Our guidance for Cummins for this year assumes the inclusion of Atmus now consolidated results for the entirety of 2024 and excludes any costs or benefits of the separation. The benefits to Cummins are expected to include a lower number of shares outstanding upon completion of the exchange. We will update our guidance as and when the separation is completed.

Thank you for your interest today. Now let me turn it back over to Chris.

[Chris Clulow, Vice President, Investor Relations at Cummins]

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.

Questions and Answers

[Operator]

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

[Jerry Revich, Analyst at Goldman Sachs & Co. Inc.]

Yes. Hi, good morning, everyone.

[Mark Smith, Chief Financial Officer at Cummins]

Morning, Jerry.

[Jennifer Rumsey, Chair and Chief Executive Officer at Cummins]

Morning, Jerry.

[Chris Clulow, Vice President, Investor Relations at Cummins]

Morning, Jerry.

[Jerry Revich, Analyst at Goldman Sachs & Co. Inc.]

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

[Jennifer Rumsey, Chair and Chief Executive Officer at Cummins]

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

[Jerry Revich, Analyst at Goldman Sachs & Co. Inc.]

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

[Chris Clulow, Vice President, Investor Relations at Cummins]

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

[Mark Smith, Chief Financial Officer at Cummins]

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

[Operator]

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

[Tim Thein, Analyst at CITI Investment Research (US)]

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

[Chris Clulow, Vice President, Investor Relations at Cummins]

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

[Jennifer Rumsey, Chair and Chief Executive Officer at Cummins]

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

[Tim Thein, Analyst at CITI Investment Research (US)]

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

[Mark Smith, Chief Financial Officer at Cummins]

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

[Operator]

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

[David Raso, Analyst at Evercore ISI International]

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

[Jennifer Rumsey, Chair and Chief Executive Officer at Cummins]

Yeah, David, thanks for the question. And first I'll say, I think you said decade-long energy transition. I would just put an s on that. Decades long, right. It's going to take time. The reality is if you look across our different markets and regions, it's going to take time for that transition to occur. We are in a period, though, of really peak investment in the Engine business as we invest in these fuel-agnostic Engine platforms. We've got a major investment in R&D and capital to do that. And we think that those engines are going to really position us well with high-efficiency diesel products as customers have and continue to decide not to invest in their own platforms and to use Cummins, and then also the fuel flexibility that will help customers as they begin to transition, whether it's natural gas or hydrogen-based engine solutions.

And so the next few years, until we launch those platforms in the '26-'27 timeframe, we're seeing higher levels of R&D in those products. And then, of course, we're also in a period where we've got somewhat lower revenue and higher investments in the Accelera business. And we are pacing that investment based on how we see the market moving. We're looking at opportunities to share investments while having a leading solution like you saw us do with the battery cell joint venture. As revenues grow, we improve parts of those businesses and electrified components. We've now delivered 1,500 buses with Blue Bird and ramping up the electrolyzer that will help improve margin performance of the business there.

And then the last thing I'd say is, as Cummins has done and we will continue to do, we're looking at how do we improve different parts of our business. And so following the acquisition of the North America Distribution business, we had a focused investment on improving margin there. And you see that playing out in the Distribution business performance. I talked about the focus last year that started in our Power Systems business. You see that playing out there, the Meritor integration, and we're continuing to look at places that we can improve operating performance of our business and then watch market demands and cost. And so the voluntary reduction actions that we took last year help us as we see some reduction in revenue this year. So all those things come together to allow us to continue to improve our returns to investors while making sure we're investing in key products and technologies for the future.

[David Raso, Analyst at Evercore ISI International]

All right, thank you. And just if you don't mind, real quick, and I'll hop off. The cadence of the declines in North America truck that you're looking to experience as the year goes on. Can you give us a little sense of the cadence maybe from an industry perspective? And would your declines, the cadence be any different? Just the idea of the lead lag between what's in inventory, how early you ship, just trying to get a sense for the cadence and how you relate to the industry cadence. Thank you.

[Jennifer Rumsey, Chair and Chief Executive Officer at Cummins]

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

[Mark Smith, Chief Financial Officer at Cummins]

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

[Jennifer Rumsey, Chair and Chief Executive Officer at Cummins]

And then the last dynamic is in pickup. We've got the product changeover that'll drive Q4 volumes over in pickup.

[Operator]

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

[Angel Castillo, Analyst at Morgan Stanley & Co., LLC]

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

[Mark Smith, Chief Financial Officer at Cummins]

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

[Angel Castillo, Analyst at Morgan Stanley & Co., LLC]

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

[Jennifer Rumsey, Chair and Chief Executive Officer at Cummins]

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

[Operator]

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

[Robert Wertheimer, Analyst at Melius Research]

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

[Jennifer Rumsey, Chair and Chief Executive Officer at Cummins]

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

[Mark Smith, Chief Financial Officer at Cummins]

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

[Jennifer Rumsey, Chair and Chief Executive Officer at Cummins]

Yeah, I think it will continue.

[Robert Wertheimer, Analyst at Melius Research]

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

[Jennifer Rumsey, Chair and Chief Executive Officer at Cummins]

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

[Robert Wertheimer, Analyst at Melius Research]

Okay, perfect. I'll stop there. If I can sneak one more in on medium-duty. There's a bit of a narrative that as COVID [Phonetic] constrained production, the OEMs prioritized large Class 8 over the medium-duty, and that's reflected somewhat in industry outlooks in year out. I'm just wondering if medium-duty has more inherent demand than that being helped by interest rates or anything else, or if that's where the market is flattish. I'll stop there.

[Jennifer Rumsey, Chair and Chief Executive Officer at Cummins]

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

[Operator]

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

[Tami Zakaria, Analyst at J.P. Morgan Securities]

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

[Jennifer Rumsey, Chair and Chief Executive Officer at Cummins]

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

[Tami Zakaria, Analyst at J.P. Morgan Securities]

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

[Jennifer Rumsey, Chair and Chief Executive Officer at Cummins]

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

[Operator]

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

[Noah Kaye, Analyst at Oppenheimer & Co. Inc.]

Thanks so much. First, a housekeeping question. I'm just trying to understand cash flow dynamics as we exit the year and the leverage profile. Obviously the settlement impacts that a bit, but you typically have a target to return 50% of cash flow to shareholders. How are we thinking about return of capital this year? And where you're aiming to end the year on leverage?

[Mark Smith, Chief Financial Officer at Cummins]

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

[Noah Kaye, Analyst at Oppenheimer & Co. Inc.]

So you do expect to delever as we get to the end of the year?

[Mark Smith, Chief Financial Officer at Cummins]

Yes.

[Noah Kaye, Analyst at Oppenheimer & Co. Inc.]

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

[Mark Smith, Chief Financial Officer at Cummins]

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

[Jennifer Rumsey, Chair and Chief Executive Officer at Cummins]

Coming out of the [Speech Overlap]

[Mark Smith, Chief Financial Officer at Cummins]

Yes. And my voice is done for the rest of the morning I think.

[Jennifer Rumsey, Chair and Chief Executive Officer at Cummins]

Chris and I will answer the rest of the questions.

[Mark Smith, Chief Financial Officer at Cummins]

[Indecipherable].

[Chris Clulow, Vice President, Investor Relations at Cummins]

Yeah. Thanks, Noah.

[Operator]

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

[Michael Feniger, Analyst at BofA Securities]

Yeah, thank you guys for squeezing me in. Just the share count's been flat to slightly up. There was a comment in the release about a focus on debt reduction, payment of dividends. Can you just flesh out the priorities in 2024? Because I know Mark mentioned with Atmus, I heard buybacks. Just maybe can you reiterate the framework of how we should think about Atmus in '24 as we move through the years, some of the puts and takes there.

[Mark Smith, Chief Financial Officer at Cummins]

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

[Michael Feniger, Analyst at BofA Securities]

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

[Mark Smith, Chief Financial Officer at Cummins]

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

[Jennifer Rumsey, Chair and Chief Executive Officer at Cummins]

Yeah. Thank you.

[Operator]

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

[Chris Clulow, Vice President, Investor Relations at Cummins]

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

[Operator]

[Operator Closing Remarks]