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spk04: 2024 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 you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the question queue. You may press star 2 to remove yourself from the queue. If anyone should require operator assistance, please press star 0 on your telephone keypad. As a reminder, this conference is being recorded. It is now my pleasure to introduce Chris Clulow, Vice President of Investor Relations. Thank you. You may begin.
spk13: Thanks, Julian. Good morning, everyone, and welcome to our teleconference today to discuss Cummins results for the third quarter of 2024. Participating with me today are Jennifer Rumsey, our Chair and Chief Executive Officer, and Mark Smith, our Chief Financial Officer. We'll all be available to answer questions at the end of the teleconference. Before we start, please note that some of the information that you will hear or be given today will consist of forward-looking statements within the meaning of the Securities and Exchange Act of 1934. Such statements express our forecasts, expectations, hopes, beliefs, and intentions on strategies regarding the future. Our actual future results could differ materially from those projected in such forward-looking statements because of a number of risks and uncertainties. More information regarding such risks and uncertainties is available in the forward-looking disclosure statement in the slide deck 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. 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. I will now turn you over to our chair and CEO, Jennifer Rumsey, to kick us off.
spk07: Thank you, Chris, and good morning. I'll start with a summary of our third quarter accomplishments and financial results. Then I will discuss our sales and end market trends by region. I will finish with a discussion of our outlook for 2024. Mark will then take you through more details of both our third quarter financial performance and our forecast for the year. Before getting into the details on our financial performance, I want to take a moment to highlight a few major accomplishments from the third quarter. In September, we started full production of our X-15N natural gas engine at our Jamestown engine plant, which is the first version of our 15-liter Helm platform to launch in the U.S. The X-15N delivers performance, durability, and power required in a variety of applications and is an excellent alternative for fleets looking to significantly reduce their carbon footprint. This is an important milestone in the execution of our Destination Zero strategy, as we work to reduce the impact of our products today while investing in cleaner power solutions for the future. Some of North America's largest and most demanding heavy-duty fleets are actively engaged with Cummins. following their own tests of the natural gas engine in the field. For example, UPS has purchased 250 Kenworth X15N powered trucks in a move the company highlights as an important part of decarbonizing its ground fleet. Cummins had the opportunity to further showcase our destination zero strategy in action through our diverse portfolio of power solutions at the recent IAA transportation event in Hanover, Germany. At this event, we displayed our fully integrated powertrain concept featuring our helm engine platforms and e-components. I also personally had an opportunity to hear feedback from Cummins customers on the challenges they are experiencing with their decarbonization strategies. Cummins remains confident that our customers' needs will not be met with a single solution, and this event was a great opportunity to further demonstrate that Cummins and Accelera have the right components in our portfolio to provide the necessary solutions for our customers and their needs as they evolve over time. In addition, in October, Accelera by Cummins celebrated the opening of its electrolyzer manufacturing plant in Spain. The plant has the capacity to produce 500 megawatts of electrolyzers per year, scalable to more than 1 gigawatt per year in the future. The sustainably designed facility is expected to create 150 highly skilled jobs in the region with the potential to reach 200 jobs as production grows and will help scale up development, manufacturing, and adoption of zero-emissions technologies in Europe. Lastly, I'd like to express that our hearts are with those who were impacted and are still recovering from Hurricanes Helene and Milton here in the U.S. We are grateful that our employees in the impacted areas are all accounted for and safe. While we did see minor impacts in our third quarter financial results, I'm proud of how our Cummins employees rallied together to help impacted employees, communities, and facilities and respond to this tragedy while minimizing disruption in our industry. Now I will comment on the overall company performance for the third quarter of 2024 and cover some of our key markets starting with North America before moving on to our largest international markets. Demand for our product remains strong across many of our key markets and regions, offset by softening in the North America heavy duty truck market that was in line with our expectations. Sales for the quarter were $8.5 billion flat compared to the third quarter of 2023. primarily driven by continued high demand in our global power generation markets and improved pricing. This was offset by lower North America heavy-duty truck volumes and the reduction in sales from the separation of Atmos. EBITDA was $1.4 billion, or 16.4%, compared to $1.2 billion, or 14.6%, a year ago. Third quarter 2023 results included $26 million of costs related to the separation of Atmos. EBITDA and gross margin dollars improved compared to the third quarter of 2023 as the benefits of higher power generation volumes, pricing, and operational efficiency more than exceeded the reduction in margin from the ATMIS separation. Our third quarter revenues in North America declined 1% to $5.2 billion as a softening heavy-duty market, lower light-duty volumes, and a reduction in sales from the ATMIS separation were mostly offset by strong demand in the medium duty truck and power generation markets. Industry production of heavy duty trucks in the third quarter was 68,000 units, down 10% from 2023 levels, while our heavy duty unit sales were 25,000, down 14% from a year ago. Industry production of medium duty trucks was 41,000 units in the third quarter of 2024, an increase of 12% from 2023 levels. while our unit sales were 38,000, up 18%. We shipped 28,000 engines to Stellantis for use in their RAM pickups in the third quarter of 2024, down 31% from 2023. Revenues in North America power generation increased by 18%, driven by continued strong data center and mission-critical power demand. The impressive power generation performance in North America and across the globe helped us achieve record sales and profitability in the power system segment. Our third quarter international revenues increased by 2% compared to last year. Third quarter revenues in China, including joint ventures, were $1.5 billion, a decrease of 4% as weaker domestic truck and construction volumes were partially offset with higher data center demand. Industry demand for medium and heavy-duty trucks in China was 207,000 units, a decrease of 15% from last year. Demand in the China truck market continues to run at low levels with continued weak domestic diesel market and now softening natural gas orders as the diesel gas price differential narrowed. The light-duty market in China was down 4% from 2023 levels at 424,000 units. while our units sold, including joint ventures, were 30,000, an increase of 14%. Industry demand for excavators in China in the third quarter was 44,000 units, an increase of 10% from 2023 levels. Our units sold were 8,000 units, an increase of 14% as a result of QSM-15 penetration of both new and existing OEM partners and export growth. Sales of power generation equipment in China roughly doubled in the third quarter, primarily driven by continued growth in data center demand. Third quarter revenue in India, including joint ventures, was $641 million, a decrease of 12% from the third quarter a year ago. Industry truck production decreased by 12%, while our shipments decreased by 18%, driven by a slowdown in manufacturing and government infrastructure spending. Power generation revenues increased 49% year on year, driven by pre-buy demand for stationary power out of the CPCB4 emissions regulation changes, as well as increased data center demand. Now let me provide our outlook for 2024, including some comments on individual regions and end markets. Our revenue outlook for 2024 remains consistent with our prior guidance of down 3% to flat. We are improving our overall EBITDA guidance for the year, to be approximately 15.5%, the top end of our prior guide of 15% to 15.5%. We now expect higher revenue and stronger profitability in our power systems and distribution segments, offsetting lower revenue and profitability expected in our component segment. We are maintaining our forecast for heavy duty trucks in North America to be 255,000 to 275,000 units in 2024. In the third quarter, we saw industry demand softening in line with our expectations, and we continue to expect further softening in the fourth quarter. In the North America medium-duty truck market, we are also maintaining our forecast to be 150,000 to 160,000 units, flat to up 5% from 2023, as we continue to benefit from an elevated backlog and strength in vocational orders. Consistent with our prior guidance, our engine shipments for pickup trucks in North America are expected to be 135,000 to 145,000 units in 2024, with a planned model year changeover likely to drive sharp but temporary production decline in the fourth quarter. In China, we project total revenue, including joint ventures, to decrease 4% in 2024 as a continued weak domestic diesel truck market is partially offset by higher power generation demand. While we have not yet seen a material impact from the recent stimulus actions, we are encouraged that the emphasis on demand-side policies is a positive step forward to build economic momentum in China. In India, we project total revenue, including joint ventures, to increase 1% in 2024, primarily driven by strong power generation demand, which is offsetting lower on-highway demand. We expect industry demand for trucks to be down 5% to up 5% for the year. For global construction, we project down 10% to flat year-over-year, consistent with our prior guidance due to a weaker demand in China. We are maintaining our guidance for global power generation markets to be up 15% to 20%, driven by continued increases in the data center and mission-critical markets. Sales of mining engines are expected to be down 5% to up 5%, also consistent with our prior guidance. For aftermarket, our guidance remains at flat to up 5% for 2024, with some softening and rebuild demand expected in the fourth quarter. In summary, we are maintaining our guidance on sales of down 3% to flat and improving our EBITDA guidance to be approximately 15.5%. Our performance in the third quarter, particularly in our power systems and distribution segments, resulted in strong profitability despite a softening North America heavy-duty truck market. While we do expect continued softening in several of our key markets in the fourth quarter, we are committed to delivering strong financial performance and returning cash to our shareholders. During the quarter, we returned $250 million to shareholders in the form of dividends consistent with our long-term plan to return approximately 50% of operating cash flow to shareholders. I continue to be grateful for the commitment of our employees and leaders around the world who are delivering for our customers while also achieving strong financial performance. Our impressive third quarter results and improved full-year guidance continue to demonstrate that we remain well-positioned to invest in our future growth, bringing sustainable solutions to decarbonize our industry and improve financial performance cycle over cycle. Now let me turn it over to Mark.
spk12: Thank you, Jen, and good morning, everyone. We delivered strong revenue and profitability in the third quarter. Given this strength, we are maintaining our full year revenue guidance and have increased our expectations for EBITDA percent to be at the top end of our prior guidance range. Third quarter revenues were $8.5 billion, flat from a year ago as organic growth offset the reduction in sales driven by the separation of apps. Sales in North America decreased 1% while international revenues gained 2%. Foreign currency fluctuations negatively impacted sales by 1%. EBITDA was $1.4 billion, or 16.4% of sales for the quarter, compared to $1.2 billion, or 14.6% of sales a year ago. Those year ago numbers included $26 million of costs related to the separation of assets. The benefits of pricing, strong operational efficiency, and the absence of the ATMOS separation costs were the primary drivers behind the improved profitability. Now let's look at each line item in a bit more detail. Gross margin for the quarter was $2.2 billion or 25.7% of sales compared to $2.1 billion or 24.6% last year. The improved margins were primarily driven by favorable pricing, which varied across our different segments, and operational improvements. Selling, admin, and research expenses were $1.2 billion, or 13.8% of sales, compared to $1.2 billion, or 14.3% last year, which included costs related to the separation of apps. Joint venture income of $99 million decreased $19 million from the prior year, primarily driven by lower technology fees in our engine business. and costs incurred in the startup of the Amplify Cell Technologies, our battery cell joint venture, which is reported with an accelerator and was formed last quarter. Other income was $22 million, an increase of $29 million from a year ago, or improvement, driven by mark-to-market gains on investments related to company-owned life insurance. Interest expense was $83 million, a decrease of $14 million from prior year, primarily due to lower weighted average interest rates. The all-in effective tax rate in the third quarter was 19.2%, including $36 million, or 26 cents per diluted share, of favorable discrete items. All-in net earnings for the quarter were $809 million, or $5.86 per diluted share, compared to $656 million or $4.59 per diluted share in 2023. EPS benefited from the increased earnings and also a lower share count resulting from the tax-free share exchange associated with the separation of ATMOS that was completed in the first quarter. All-in operating cash flow was an inflow of $640 million Year-to-date operating cash flow is an inflow of $65 million, which included $1.9 billion of payments required by the previously disclosed settlement agreement with the regulatory agencies. Excluding the settlement, third quarter year-to-date operating cash flow was $2 billion compared to $2.5 billion in the first nine months of last year. The lower operating cash flow this year is primarily due to higher inventory. we do expect to see stronger operating cash flow in the fourth quarter this year. I'll now comment on segment performance and our guidance for 2024. As a reminder, guidance for 2024 includes the operations of Atmos in our consolidated results up until the full separation which occurred on March 18th. Components revenue was $2.7 billion, a decrease of 16% from the prior year, while EBITDA decreased from 13.6% of sales to 12.9%, driven primarily by the dilutive impact of the atmosphere separation and a weaker heavy-duty truck market in North America. Several facilities within our drive, train, and braking systems business in North Carolina were impacted by Hurricane Helene at the end of Q3, disrupting production and causing us to record some costs in our third quarter results. Our employees have shown incredible resilience in extremely challenging circumstances and are working very hard to raise production levels. For components, we expect 2024 full-year revenues to decrease 12% to 15%, a decrease of 2% from the prior guidance at the midpoint, and EBITDA margins in the range of 13.3% to 13.8%, lowering the range from our previous guide of 13.7%. to 14.2%. For the engine segment, third quarter revenues were $2.9 billion, a decrease of 1% from a year ago. EBITDA was 14.7%, an increase from 13.5% a year ago due to operational improvements and positive pricing, including a retroactive pricing agreement in our light duty business that was finalized within the third quarter. that benefits from pricing and lower operating costs more than offset weaker North American heavy-duty truck volumes. In 2024, we project revenues for the engine business to be down 2% to up 1%, narrowing the range of the prior guidance, and EBITDA to be in the range of 13.7% to 14.2%, consistent with our communication last quarter. In the distribution segment, revenues increased 16% from a year ago to a record $3 billion, driven by increased demand for power generation products, particularly for data center applications. EBITDA increased as a percent of sales to 12.5% compared to 12.1% a year ago, primarily due to higher volumes and pricing. We now expect 2024 distribution revenues to be up 8% to 11%, an increase of 2 percent at the midpoint from our prior guidance, primarily due to stronger power generation margins. Excuse me. EBITDA margins are now expected in the range of 11.5 to 12 percent, also up from our previous guide of 11.3 to 11.8 percent. Results for the power systems segment set another new quarterly record. Revenues were $1.7 billion an increase of 17%, and EBITDA increased from 16.2% to 19.4% of sales, driven by higher volumes, particularly in the power generation markets, improved pricing, and other operational improvements. In 2024, we expect power systems revenues to be up 8% to 11%, an increase of 4% at the midpoint from our prior guide. EBITDA expectations have also increased. to approximately 18.3 to 18.8 percent, up from 17.75 at the midpoint of the prior guide. Accelera revenues increased 7 percent to $110 million, drive by increased electrolyzer installations. Our EBITDA loss was $115 million compared to a loss of $114 million a year ago, as we continue to invest in the products and capabilities to support those parts of the business where strong growth is expected, while reducing costs in areas where we assess the prospects for growth have extended into the future. In 2024, we expect revenues to be in the range of $400 to $450 million, and net losses to be in the range of $400 to $430 million, both unchanged from last quarter. As Jen mentioned, given the strong performance in the third quarter, particularly in power systems and distribution, we're improving the full-year company guidance for profitability. We still project 2024 company revenues to be down 3% to flat. Company EBITDA margins are now projected to be approximately 15.5%, which is at the top end of our prior guidance range. Our effective tax rate is expected to be approximately 23.5% for the full year 2024, excluding the tax-free gain related to ATMOS and other discrete items, and down from our prior guidance of an expected tax rate of 24%. Capital investments will be in the range of $1.2 to $1.3 billion, consistent with our prior guidance. In summary, we still have had strong sales and record profitability in the third quarter of 2024. We will experience moderation in some markets in the fourth quarter, most notably North America heavy duty truck. We have updated our projection for EBITDA to the high end of the prior guidance range due to strong execution, particularly the projected record full year EBITDA in power systems and distribution. We took some steps to reduce costs in the fourth quarter of 2023 and the first quarter of 2024, continue to identify ways to streamline our business going forwards, leaving us well-positioned to navigate any further economic cyclicality. We are on track to continue our trend of raising performance cycle over cycle whilst continuing to invest in the future. And that's encouraging given that this is projected to be a down year for North American heavy-duty truck production. Our priorities for the remainder of this year for capital allocation remain to reinvest for profitable growth, pay out our strong cash dividends, and support our strong credit rating. Thanks for your interest today. Now let me turn it back to Chris.
spk13: Thank you, Mark. Now we'll begin our question and answer session. Out of consideration to others on the call, I'd ask that you limit yourself to one question in a related follow-up. If you have an additional question, please rejoin the queue. Operator, we're ready for our first question.
spk04: Thank you, Chris. We'll now be conducting a question and answer session. Once again, if you would like to ask a question, please press star 1 on your telephone keypad. A confirmation tone will indicate your line is in the queue. You may press star 2 to remove yourself from the queue. For participants using speaker equipment, it may be necessary to pick up a handset before pressing the star keys. One moment while we poll for questions. And our first question comes from Stephen Fisher, UBS. Thanks.
spk02: Thanks. Good morning, and congrats on the beat and raise. It's hard to find those in the machinery world these days. Nevertheless, I think there were some investors that were a little concerned that maybe the Q4 guidance looks a little conservative after the strong Q3. I don't know how much of that is related to the storm impact in components. But I guess the bigger picture question here is, even though it's maybe a little early, do you think there are enough positives to offset the rest of the downturn that we have in the heavy-duty truck market, however long that may last, to keep EBITDA growing over the next year?
spk07: Yeah, so let me just comment first. Steve, thanks, great to hear from you. Let me comment a little bit on the fourth quarter And what we expect is really three factors that I point to in the revenue guide for fourth quarter. We expect further softening in the heavy-duty market. I talked about the product changeover with Stellantis that will drive further volume reduction in that pickup truck business. And then just working days with year-end will be fewer, and we see across many of our markets. fewer working days associated with the holidays and normal maintenance and upgrades that happen during that period of time. So those are really the factors. As you can see, the team has done a great job of continuing to focus on profitability across the business, delivering strong, decremental margins where we've seen reductions in heavy duty, which takes a lot of effort. So I just want to acknowledge the great work of the team and then leveraging some of the places that we have strength with really strong performance, of course. PowerGen that impacted power systems in DBU, and we expect that to continue as we go into next year.
spk02: Okay, and maybe just building on that last part there, I mean, how would you describe the momentum in PowerGen right now? I mean, it was new record revenues in the quarter. You're sold out on the 95 liters. Where are you on the capacity utilization on 50s and 78s? What's driving the further upside from here? Is it mainly pricing or can you kind of push out more volumes?
spk07: It's really both. So over the course of this year, we've worked on strategic pricing and offsetting some of the inflationary costs that we've seen and pricing for value in that business. And we've been working on capacity and supply base and our own operational improvement and launching the new Centum product. So all of those things have given us improvements over the course of the year. 95 liter is at capacity, but we've been able to increase capacity through those improvements by about 30% on that product, and 24, the new products. And then, as we talked about previously, we are investing right now to double capacity in the 95 liter. That'll come online late next year as we go into 26. We don't see any And inside, in terms of demand in that market, we're reserving build thoughts on the 95 liter out in the 27, so really focused on how do we leverage the capacity we have now, investment we have now, while we're bringing more online late next year.
spk12: And I think, Steve, the only thing I'd add to your first question is, you know, we're building our plans with a relatively modest start on heavy-duty truck to the first half of next year with what we see right now. hear your comments and questions, and we're very focused on kind of managing through this cycle.
spk07: I will say, I mean, in terms of the impact of Helene and Milton, you know, we're back to a regular operation in that business and trying to just work through some of the backlog that built up during the period that we were most severely impacted, but it's been a really tremendous effort by the team there. We have multiple facilities in the western North Carolina region within Cummins drivetrain and braking systems that have been dealing with the impact of that hurricane.
spk04: Thank you. Our next question comes from Angel Castillo, Morgan Stanley.
spk00: Hi, good morning, and thanks for taking my question. And congrats on a strong quarter. Just wanted to dive a little bit deeper into some of the dynamics that are maybe impacting the next couple of years. I saw some headlines around maybe the California omnibus low NOx regulation in some states maybe delaying the kind of model year 25 to maybe model year 26 type enforcement. Just any comments or maybe read-throughs to what maybe that tells you about the underlying kind of enforcement of those regulations and the potential for kind of pre-buying to 25, just any broader read-throughs to maybe EPA or just industry demand for your engines? Mm-hmm.
spk07: Yeah, I mean, what we've seen, of course, this year is the CARB omnibus regulations have gone into place. As we get into 27, we see commonization again between EPA and CARB, which we believe is a positive for the industry. What happens between now and then in terms of different states following those CARB regulations? As you noted, some have pushed out. It's a little bit difficult to predict, but certainly we've seen lower volumes this year in CARB, even with some of the the flexibilities that they've put in place to sell 200 milligram NOx product and strong demand nationwide. And so we're watching that space closely, I would say. Overall, as Mark noted, we're projecting softening as we go into next year in the heavy-duty truck market and then still anticipating, depending on economic conditions, the pre-buy likely starting at some point during 2025. ahead of the 27 regulations.
spk00: That's very helpful. Thank you. And then just wanted to circle back on the prior question. Around 2025 for power generation, I think you indicated, you kind of see, you know, growth of power systems and momentum continuing there. Just curious, it seems like your power generation guide of 15 to 20 percent was unchanged despite, you know, continued strong performance there. Can you talk about 2025, just early indications based on your backlog? Should we anticipate kind of that 15% to 20% type growth to persist into next year, or how do you kind of see that based on kind of pricing and backlog indications today?
spk07: Really, that demand in that market is going to remain strong, so it's all about what we can do in terms of capacity and managing our supply base.
spk12: And that's one of the factors that gives us confidence going into the start of the year, that strong backlog. And then, of course, distribution should continue to be pretty resilient, absent a big economic shock.
spk04: Great. Thank you. Our next question comes from Kyle Menges, Citi.
spk09: Thank you, guys. I was hoping, I noticed within power systems, the industrial portion actually pretty strong growth in the quarter, despite certainly some competitors not showing great results in mining this quarter. So just would love to hear kind of what's driving that reacceleration and growth in that industrial portion and just how you're thinking about that into 4Q and into 2025.
spk07: I mean, overall, our guidance is pretty flat in the mining market. We've seen some rebuild demand that you're seeing in those results, but really not significant shifts in that market right now.
spk13: Yeah, I think overall, Kyle, I'd just add that, yeah, the mining is really the key market for us in the industrial side, as you know, and that has remained pretty resilient from our perspective, where it's moved a little bit around the world. We've maintained a pretty good – both in the first-fit side as well as in the aftermarket, which drives the rebuild. Don't over-read into one-quarters units.
spk09: Got it. And then just to follow up on power systems, it looks like with the new guidance, it's going to be doing incrementals of about 60% in 2024. So it would be helpful if you could frame just how we might think about incremental margins in that segment in 2025, and I guess why wouldn't it be close to 40% to 60% again, and what factors maybe could cause weaker incrementals next year for that?
spk12: Well, I do get accused of pushing the power systems business a bit hard, so I'll probably stay off the 40% to 60%, but here's what I'd say. Part of the improvement was really a reprioritization and a cost kind of reset at the start of this journey, which has really been going on for a couple of years now, so it's You get that benefit early on, and then there's been a lot more focus on pricing, efficient capacity improvements. So, yes, we still think there is more to come on the top line and the bottom line. Don't think we can continue to expect 40% to 60% incremental margins. We will provide specific updates here in February. But with what we know today, we would expect more improvement going into next year.
spk04: And our next question comes from Jerry Rittich, Goldman Sachs.
spk01: Yes, hi. Good morning, everyone. Hi, Jerry. Hi, Mark. I'm wondering if you folks can just expand on the margin performance and engine, you know, really outstanding results in the third quarter. The guidance implies margin expansion in the fourth quarter on lower sales. You mentioned operating efficiencies in the prepared remarks. Can you just expand on where those efficiencies are versus – be COVID levels, and it feels like there's momentum into 25, even if demand is softer, just given where the exit rate looks to be in the fourth quarter versus the cost structure in the first, but I'm wondering if you just expand around those points, if you don't mind.
spk12: Yeah, I think there's been a lot of improvement post-COVID, no doubt about that, but we're still not all the way back to those kind of 2019 operating levels, so I still think there's more room to come on operational And then we talked about kind of being at the peak part of this investment cycle. Of course, the strong medium duty demand has really helped in this environment and our positions continue to strengthen there. So that's really helped. And whilst we have flagged and it is going to happen, there is going to be short but sharp reduction in pickup truck engine production in the fourth quarter. We view that as largely temporary action. and think that with all the information we have today that that's going to resume. So I think, you know, the top line will face some first half year pressure on heavy duty relative to the first half of this year. But yes, continuing to focus on operating costs. I mentioned briefly in my remarks that we've really been making adjustments to our organization structure and costs since the fourth quarter of last year. And whilst that hasn't been dramatic in any period, I think that helps set us up well going into next year. And just so you didn't miss it, I did point out, not to make a huge deal out of it, but we did get some extra pricing, which helped in the third quarter that was retroactive back to the start of the year. So we won't get all of that again in the fourth quarter. But nevertheless, I think the cost base, the operational efficiencies helped. Maybe not in the short term, but maybe in the medium term we get some boosts from China as well because our earnings are okay, but far from what the full potential of China is in the engine business. So I think there's a lot to look forward to, but the exact timing of earnings accelerating the engine business isn't clear yet. So we've kind of got to focus on the cost and efficiency certainly through the next nine months.
spk01: Super. And can I shift gears and ask about the natural gas engine demand now that you've opened up full rate production? Can you just update us on your expectations of natural gas share in the market, you know, six to 12 months out based on the demand and the performance of the production ramp that you alluded to in the prepared remarks, please?
spk07: Yeah, I mean we we've said that we think we could get up to 8% potentially 8% share in the market with the natural gas product. We had several big fleets that were testing it during development and I noted the. Yes, is played. So how they start to ramp up volume, get, you know, get increasing confidence in the strong performance and efficiency. You know, fundamentally in most places it can provide not only a reduction in CO2, for fleets that want to lower the CO2 footprint, but also reduction in operating costs because of the fuel price differential between natural gas and diesel. And so fleets that are interested in pursuing that, I think over time will rip up. It's hard for me to exactly predict because it also depends on some of the economic conditions that are impacting fleets today of what that will be over 12 months. But we're excited to have that product out now with Kenworth and Daimler will be launching it as well in 25. So they'll be positioned with that in the market also.
spk04: And our next question comes from Jamie Cook, Truist Securities.
spk06: Hi, good morning and nice quarter. I guess my first question, you know, you guys have talked about adding capacity on the large engine side. One of your peers came out last quarter and talked about adding even additional capacity on large engines because of demand. So I'm wondering if you're making any changes to your capacity increase that you talked about historically, and then to what degree do, you know, how much incremental capacity are you adding that could potentially benefit 2025? And then my follow-up question, Mark, again, I know someone asked the questions on Q4 versus Q3 margins, and there's an implied step down, but how much was that repricing that you talked about that helped the engine business that maybe we view as one-time And then within components, how much of an impact was the hurricane? Thank you.
spk07: Thanks, Jamie. I'll take the first one up. Mark, take the second one. So over the course of this year, what you've seen is new products for power generation capacity within the constraints of the equipment and our supply chain that we have today going up about 30%. on the 95 liter. And so that, of course, is going to carry over into next year. And the mantra in power systems right now is just one more. And how do we continue to squeeze every shift, every day, one more out of what we have within our current constraints? And so we'll continue to focus on that. And then, of course, working to try to get that doubling of capacity for the 95 by next year. We're continuing to look at it. We want to be smart about where we can make reasonable investments to take capacity up further where we see strong market conditions. So nothing really specific to say right now, but just that we're continuing to look at our footprint and where there may be opportunities.
spk12: And on the second part, the first thing I say, we're going to get natural. I will answer the specific questions. I just want to share that we're going to get natural variations from quarter to quarter, but I just want to remind that we're very focused on you know, on the cost side, on the efficiency side, of course, getting value for the products which are helping our customers be successful is also important. So, yes, the kind of retroactive element of the pricing was about 50 basis points ballpark for the company in the quarter. There is a go-forward benefit, just not as much as that. And then the costs, you're talking... You're talking low tens of millions of dollars between components and the elimination segment where we incurred some costs for the impacts of Hurricane Helene. So there are puts and takes. There are some positives. There are some negatives in the results. I think the revenue guide, you can see we haven't changed because we have very clear visibility into OEM, heavy, medium, and pickup truck. production and the way that these very well-run customers like to work is to have predictability around the production level. So I think the revenue is well-pinned, and I think the key for us is maintaining this strong cost and efficiency discipline as we go into next year and continue to focus on preparing ourselves for more demand and growth in the future and raising these margins as we set out at the analyst date. and generating more cash. That's a big focus.
spk04: Thank you. Our next question comes from Tammy Zachariah, JP Morgan.
spk08: Hi, good morning. Thank you so much. So I thought of adding one more question on incremental margin because I think it's really the start of your performance in recent quarters. So when I look at your incremental margin in the third quarter, it's almost 50% X the filtration separation, which is quite impressive versus a long-term target of over 25. So do you believe your incremental margin target can move up for the long term given, you know, the power generation products success, engines are seeing some retroactive pricing as well, it seems? and you have a lot of new products coming in in the next couple of years. So would you consider revisiting your long-term incremental EBITDA margin target as you begin next year?
spk12: I think we'll give guidance just for the year, and then we'll see how we do. You know, there's a lot of moving parts to our portfolio. Of course, we're feeling like we've done a pretty good job in our core business. Since we had our analyst day, incrementally there have been more headwinds to the accelerator side of the business, but overall we're pleased with this year. Let's focus on finishing strong for this year. We'll give you our full guidance with all its technicolor when we get to February. So I appreciate the question, but today we're not going to talk about longer-term targets.
spk08: Got it. Okay. Thank you.
spk04: Thank you. Our next question comes from Rob Wartheimer, Milius Research.
spk11: Just for clarification, on the retroactive pricing, I wonder if you can describe what that is or how much continues, and more fundamentally, whether that indicates that you have any enhanced pricing power through engines, if that was something new and different. And I have a more substantial question afterwards.
spk12: I don't think we should read anything into it other than it's been a protracted discussion and it's back to January 1, Rob. So that's just sometimes things take a while to resolve.
spk13: Yeah, as a reminder, Rob, that's in our light duty space. So it was more localized there. Perfect. Okay, that helps a lot.
spk11: Just more fundamentally, obviously you and your largest competitor in large engines are seeing a lot of demand and your customers must be telling you, that you have a big role to play, you know, years and years ahead. Is it very clear that even the biggest hyperscale data centers will use ReSIP engines on backup? I wonder if you could just talk about what your customers are telling you about the changing sort of design and scope and scale of data centers and where you fit in for the next decade to come.
spk07: Yeah, I mean, I think at this point in the next decade, we think – reciprocating engines are going to be the solution for backup power. Of course, they're looking at different potential options for prime power and evaluating what that looks like. But other technologies that they might use from a lead time cost reliability, it's hard to match what a diesel gen set can do for backup power. So we really think that's going to be a solution for some time.
spk04: And our next question comes from David Rosso, Evercore.
spk05: Hi, thank you. Back to the pre-buy question. I know we're sitting here on Election Day, so I'm curious to get your thoughts if anything around the election could alter your thoughts around the pre-buy.
spk07: I'm surprised you made it this far without that question, David.
spk05: Well, to make sure if you could answer, the timing of your introduction of a 27-compliant engine Can you take us through your thoughts around that, the idea of maybe introducing that early, building some credits? Obviously, the NatGas engines already are providing some credits as well. Can you just take us through how you're thinking about the timing of your introductions? And obviously, woven within that, you know, anything you want to comment on, on whoever wins the White House and Congress, how that impacts your thoughts.
spk07: Yeah, I mean... At the end of the day, Cummins is going to do what we've always done. We're going to work across party lines and engage on issues that are important for our business and our industry. And we'll do that. We've done that with the Biden administration, with the past Trump administration. We'll do it with the next administration. And what's really important to us and our industry is having that regulatory and legislative stability. And we do not expect any change regardless of the outcome of the election on the 27 regulations for our industry. So, you know, as we have in the past, we have a history of being first into the market with products that comply with new regulations and deliver increased value to our customers. And we're always focusing on the landscape. What's the right product at the right time? How do we take, you know, consider regulations regulatory flexibility and credits as a part of that strategy. And given all that, we do intend to launch the diesel version of the 15-liter Helm platform in 26, ahead of the 27 regulation. And with that launch, not only deliver a lower NOx product into the market, but also one that has significant improvement in fuel efficiency and operating costs of 5% to 7% efficiency improvement in that product. that will deliver value to our customers. And then we're looking to how do we further strengthen our position in that market through these regulatory changes. And this is really consistent with our past strategy and what's worked well for Cummins over the years is delivering value to our customers through these regulatory changes and strengthening our position in the market. So that's our intention. We've got the 15-liter natural gas out now. We'll add the diesel version of that
spk05: in 26 and then launch our mid-range products at the start of the early intro sorry sorry the early introduction of the 27 i assume you're we're thinking first quarter 26 with the new model years can you help us though it appears in the channel there's some sense of there might be a pre-buy of your engines in 25 to get in front of that early 26 introduction Can you help us a bit? A, is that maybe helping some of the truck orders we're seeing in the industry? I mean, you are 40% of the trucks out there, so pre-buying Cummins would impact total industry numbers pretty meaningfully. And the cost of the new 27 engine coming out early in 26, can you give us some sense of the cost to the customer? And, you know, the follow-up will be how much is the warranty versus the components. I'm just trying to get a sense how much you're bring all 27 costs into 26. It's a cost improvement.
spk07: So let me try to frame it to help you think of it. Of course, the specifics on pricing, we're still discussing that with customers. The exact timing and transition between the current 15 liter and the next generation 15 liter and 26, we're still in discussions with our customers. So I'm not going to give exact answers there. What I will say is that we are at a meaningful... engine and after-treatment content and technology to both comply with the lower NOx regulation as well as deliver better fuel efficiency and operating costs and value to our customers. And that will be added as we launch this new product in 26. The requirement for a longer emissions warranty does not take effect until 27. So customers that buy this new product High efficiency market leading product in 26 will not be.
spk04: Thank you. Our next question comes from Noah K., up and higher American company.
spk03: Thanks for taking the questions. And, you know, related to this transition, I guess, is probably one of the biggest R&D investments the company's ever made. So as we start to kind of get past that, can you help us think about the direction of R&D spend? It seems like maybe an obvious place to get leverage on future growth, but you did a billion and a half of spend in 23, going to be around that range for 24. How should we think about that level of spending going forward?
spk07: Yeah, I mean, you've got it. We're investing at a record level, high level, with these new platforms that we're bringing into the market. We think those will position us well for the future. And so you'll see some normalization of that. Now, the exact shape of that is going to depend, frankly, on how regulations evolve and what I call the bridge period of technology looks like and how that transitions to zero emissions. But we'll see that coming off of our peak as we get past the 27th. product launches, and we'll continue to be investing in R&D to create differentiation and value in the market to grow business over the long term.
spk03: So if you're launching late next year, or sorry, I think you said 26, then it implies we'll start to back down from those peaks. Yeah. Okay. And then just sort of switching gears, Can you characterize the durability of strength and medium duty? You know, I think that six and seven classes have done pretty well. There's still some backlog there. But just, you know, talk about the demand you're seeing now in the market and whether that kind of continues into next year. You already kind of commented on some of your expectations for heavy duty. So medium duty color would be helpful.
spk07: Yeah. Yeah, I mean, you know, for the year, we're seeing North American medium duty up a little bit, flat top 5%. We're continuing to see pretty strong demand. I mean, you've seen a little bit of inventory and normalization of backlog, but we continue to see really strong demand. And with future regulations on that horizon, we expect that's likely to continue into next year.
spk04: And our next question comes from Timothy Raymond James.
spk10: Oh, thank you. Good morning. The first question is just on the distribution business. And I'm curious what, if any, or mixed impact there could be, you know, given the, if you look at the strength that we've seen and you're projecting to continue for some time in PowerGen, that's now running at, you know, call it 10 points higher as a percentage of distribution business. from a couple of years ago. And while, you know, some of that's coming as we've seen parts come down. So maybe in historical terms, that's a mixed negative. It's just as the whole goods grows as a percentage of revenues. But, you know, maybe just given the strength and demand and tightness and supply, that's not the case. So maybe it's your thoughts on just the mix within distribution and how to think about that going forward. Thank you.
spk07: Yeah, I mean, as you noted, typically whole goods is mixed margin negative compared to aftermarket. For us, if you just step back and look at the business in total, you've got to consider, you know, what we've done around inflationary pricing and operational efficiencies as we've tried to flex up to higher volume. And we're, you know, going to continue to focus on those operational efficiencies, but power generation, gross revenue mix compared to aftermarket will be negative on the margin line.
spk10: Got it. Okay, and then maybe one from Mark.
spk12: I think that's where, you know, Tim, that's where we continue to drive on those operational efficiencies and other areas and, of course, continue to drive as much of the parts business as we can underlying. But the most important thing is we're meeting customer expectations and growing earnings in an efficient way.
spk10: Got it. And then, Mark, just on the gross margin color that you gave earlier, was the – you highlighted pricing several times. Was there – was that – was all of that from this retroactive deal you had in the light duty, or was there maybe just – No, I mean, year over year, there's other pricing.
spk12: It just – you know, it was inappropriate for the engine – to note for the engine business that that was a particular factor. But no, there was other pricing, and the overall expectations haven't significantly changed for the rest of the business. Quite frankly, this other pricing, we'd expected to get it at the start of the year, and it's just taken time. The most important thing is it's been reset. It's more of a timing issue and a concentration. In Q3, we always anticipated something in our full year numbers. So on a full year basis, there's not much to say, but it just came in a more lumpy fashion because of the catch-up nature.
spk04: Great. Thank you for that last question. I would now like to turn the floor back to Chris Kula for closing remarks.
spk13: Great. Thanks very much. I appreciate everyone joining today. That concludes our teleconference. Appreciate your participation and continued interest. As always, the investor relations team will be available for questions after the call.
spk04: We thank you for your participation. You may disconnect your lines at this time.
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