Cummins Q3 2024 Earnings Call Transcript

Quartr
Provided by Quartr
November 5, 2024

There are 14 speakers on the call.

Operator

Greetings, and welcome to the Q3 20 24 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. As a reminder, this conference is being recorded.

Operator

It is now my pleasure to introduce Chris Kulow, Vice President of Investor Relations. Thank you. You may begin.

Speaker 1

Thanks, Julian. Good morning, everyone, and welcome to our teleconference today to discuss Cummins' results for the Q3 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.

Speaker 1

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 Factors section of our most recently filed Annual Report on Form 10 ks 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.

Speaker 1

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 atcohens.com. I will now turn you over to our Chair and CEO, Jennifer Rumsey to kick us off.

Speaker 2

Thank you, Chris, and good morning. I'll start with a summary of our Q3 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 Q3 financial performance and our forecast for the year.

Speaker 2

Before getting into the details on our financial performance, I want to take a moment to highlight a few major accomplishments from the Q3. 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 X15N 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 execution of our Destination 0 strategy as we work to reduce the impact of our products today while investing in cleaner power solutions for the future.

Speaker 2

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 X-fifteen N 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.

Speaker 2

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 Exela 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 0 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.

Speaker 2

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 Q3 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 Q3 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.

Speaker 2

Sales for the quarter were $8,500,000,000 flat compared to the Q3 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 $1,400,000,000 or 16.4 percent compared to $1,200,000,000 or 14.6 percent a year ago. 3rd quarter 2023 results included $26,000,000 of costs related to the separation of Atmos. EBITDA and gross margin dollars improved compared to the Q3 of 2023 as the benefits of higher power generation volumes, pricing and operational efficiency more than exceeded the reduction in margin from the Atmos separation.

Speaker 2

Our 3rd quarter revenues in North America declined 1% to $5,200,000,000 as a softening heavy duty market, lower light duty volumes and a reduction in sales from the Atmos separation were mostly offset by strong demand in the medium duty truck and power generation markets. Industry production of heavy duty trucks in the Q3 was 68,000 units, down 10% from 2023 levels, while our duty unit sales were 25,000, down 14% from a year ago. Industry production of medium duty trucks was 41,000 units in the Q3 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 the RAM pickups in the Q3 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.

Speaker 2

The impressive power generation performance in North America and across the globe helped us achieve record sales and profitability in the Power Systems segment. Our 3rd quarter international revenues increased by 2% compared to last year. 3rd quarter revenues in China including joint ventures were $1,500,000,000 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.

Speaker 2

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 3rd 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 QSM15 penetration at both new and existing OEM partners and export growth. Sales of power generation equipment in China roughly doubled in the 3rd quarter, primarily driven by continued growth in data center demand. 3rd quarter revenue in India, including joint ventures, was $641,000,000 a decrease of 12% from the Q3 a year ago.

Speaker 2

Industry truck production decreased by 12%, while our shipments decreased by 18%, driven by a slowdown in manufacturing and government infrastructure spending. Power generations 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%.

Speaker 2

We now expect higher revenue and stronger profitability in our Power Systems and Distribution segments, offsetting lower revenue and profitability expected in our Components 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 Q3, we saw industry demand softening in line with our expectations and we continue to expect further softening in the Q4. 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 Q4.

Speaker 2

In China, we project total revenue including joint ventures to decrease 4% in 2020 4 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 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.

Speaker 2

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 Q4. 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 3rd quarter particularly in our Power Systems and Distribution segments resulted in strong profitability despite a softening North America heavy duty truck market.

Speaker 2

While we do expect continued softening in several of our key markets in the Q4, we are committed to delivering strong financial performance and returning cash to our shareholders. During the quarter, we returned $250,000,000 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 Q3 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.

Speaker 3

Thank you, Jen, and good morning, everyone. We delivered strong revenue and profitability in the Q3. Given the 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. 3rd quarter revenues were $8,500,000,000 flat from a year ago as organic growth offset the reduction in sales driven by the separation of AXE. Sales in North America decreased 1%, while international revenues gained 2%.

Speaker 3

Foreign currency fluctuations negatively impacted sales by 1%. EBITDA was $1,400,000,000 or 16.4 percent of sales for the quarter compared to $1,200,000,000 or 14.6 percent of sales a year ago. Those year ago numbers included $26,000,000 of costs related to the separation of Atmos. 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.

Speaker 3

Gross margin for the quarter was $2,200,000,000 or 25.7 percent of sales compared to $2,100,000,000 or 24.6 percent 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 $1,200,000,000 or 13.8 percent of sales compared to $1,200,000,000 or 14.3 percent last year, which included costs related to the separation of Atlas. Joint venture income of $99,000,000 decreased $19,000,000 from the prior year, primarily driven by lower technology fees in our engine business and costs incurred in the start up of the Amplify Cell Technologies, our battery cell joint venture, which is reported within Accelera and was formed last quarter. Other income was CAD22 1,000,000 an increase of CAD29 1,000,000 from a year ago or improvement, driven by mark to market gains on investments related to company owned life insurance.

Speaker 3

Interest expense was CAD83 1,000,000 a decrease of CAD14 1,000,000 from prior year, primarily due to lower weighted average interest rates. The all in effective tax rate in the 3rd quarter was 19.2%, including $36,000,000 or $0.26 per diluted share of favorable discrete items. All in, net earnings for the quarter were $809,000,000 or $5.86 per diluted share compared to $656,000,000 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 Q1. All in operating cash flow was an inflow of $640,000,000 Year to date operating cash flow was an inflow of $65,000,000 which included $1,900,000,000 of payments required by the previously disclosed settlement agreement with the regulatory agencies.

Speaker 3

Excluding the settlement, 3rd quarter year to date operating cash flow was $2,000,000,000 compared to $2,500,000,000 in the 1st 9 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 Q4 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 18.

Speaker 3

Components revenue was $2,700,000,000 a decrease of 16% from the prior year, while EBITDA decreased from 13.6% of sales to 12.9%, driven primarily by the diluted impact of the Atmos separation and a weaker heavy duty truck market in North America. Several facilities within our drivetrain 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 Q3 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, 3rd quarter revenues were $2,900,000,000 a decrease of 1% from a year ago.

Speaker 3

EBITDA was 14.7 percent, 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 Q3. The 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 $3,000,000,000 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.

Speaker 3

We now expect 2024 distribution revenues to be up 8% to 11%, an increase of 2% at the midpoint from our prior guidance, primarily due to stronger power generation markets. EBITDA margins are now expected in the range of 11.5% to 12%, also up from our previous guide of 11.3% to 11.8%. Results for the Power Systems segment set another new quarterly record. Revenues were $1,700,000,000 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 8% to 11%, an increase of 4% at the midpoint from our prior guide.

Speaker 3

EBITDA expectations have also increased to approximately 18.3% to 18.8%, up from 17.75% at the midpoint of the prior guide. Accelera revenues increased 7 percent to $110,000,000, driven by increased electrolyzer installations. Our EBITDA loss was $115,000,000 compared to a loss of $114,000,000 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 of extended into the future. In 2024, we expect revenues to be in the range of $400,000,000 to $450,000,000 and net losses to be in the range of $400,000,000 to $430,000,000 both unchanged from last quarter. As Jed mentioned, given the strong performance in the Q3, particularly in Power Systems and Distribution, we're improving the full year company guidance for profitability.

Speaker 3

We still project 2024 company revenues to be down 3% to flat. Company EBITDA margins are now expected 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 $1,200,000,000 to $1,300,000,000 consistent with our prior guidance.

Speaker 3

In summary, we still have strong sales and record profitability in the Q3 of 2024. We will experience moderation in some markets in the Q4, 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 Q4 of 2023 and the Q1 of 2024, continue to identify ways to streamline our business going forward, 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.

Speaker 3

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, payout our strong cash dividends and support our strong credit rating. Thanks for your interest today. Now let me turn it back to Chris.

Speaker 1

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 and a related follow-up. Operator, we're ready for our first question.

Operator

Thank you, Chris. We'll now be conducting a question and answer And our first question comes from Steven Fisher, UBS.

Speaker 4

Thanks. Good morning and congrats on the beaten raise. It's hard to find those in 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 impacts in components.

Speaker 4

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?

Speaker 2

So let me just comment first, Steve, thanks. Great to hear from you. Let me comment a little bit on the Q4 and what we expect. There's really three factors that I'd point to in the revenue guide for Q4. We expect further softening in the heavy duty market.

Speaker 2

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 in a half to three time period of time. So those are really the factors that 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 course in PowerGen that impacted Power Systems and DB. And we expect that to continue as we go into next year.

Speaker 4

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 that new record revenues in the quarter. You're sold out on the 95 liters. Where are you on the capacity utilization on 50s 78s?

Speaker 4

What's driving the further upside from here? Is it mainly pricing? Or can you kind of push out more volumes?

Speaker 2

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'd see 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 that 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.

Speaker 2

That will come online late next year or as we go into 'twenty six. We don't see any end in sight in terms of demand in that market. We're reserving build slots on the 95 liter out to 'twenty seven, 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.

Speaker 3

And I think, Steve, the only thing I'd add to your first question is, we're not 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. So, hear your comments and questions and we're very focused on kind of managing through the cycle.

Speaker 2

I will say, I mean, in terms of the impact of Helane and Milton, 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.

Operator

Thank you. Our next question comes from Angel Castillo, Morgan Stanley.

Speaker 5

Hi, good morning and thanks for taking my question. And congrats on the 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 and some states may be delaying the kind of middle model year 2025 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 buy into 2025?

Speaker 5

Just any broader read throughs to maybe EPA or just industry demand for your engines?

Speaker 2

Yes. I mean, what we've seen, of course, this year is the carbon and bus regulations have gone into place. As we get into 'twenty seven, 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.

Speaker 2

It's a little bit difficult to predict, but certainly you see lower volumes this year in CARB even with some of 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.

Speaker 5

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 growth power systems and momentum continuing there. Just curious, it seems like your power generation guide of 15% to 20% was unchanged despite continued strong performance there.

Speaker 5

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?

Speaker 2

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.

Speaker 3

Right. 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.

Operator

Great. Thank you. Our next question comes from Kyle Mendez, Citi.

Speaker 6

Thank you, guys. I was hoping I noticed within Power Systems Industrial 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 in growth in that industrial portion and just how you're thinking about that into 4Q and into 2025?

Speaker 2

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.

Speaker 1

Yes. I think overall, Kyle, I'd just add that, yes, 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

Speaker 3

the aftermarket, which drives the rebuild. Don't over read into 1 quarter's units.

Speaker 6

Got it. And then just a 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 kind of close to 40% to 60% again?

Speaker 6

And what factors maybe could cause weaker incrementals next year for that segment?

Speaker 3

Well, I do get accused of pushing the Power Systems business a bit hard. I'll probably stay off the 40% to 60%. But here's what I'd say, Kyle. 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 you get that benefit early on and then there's been a lot more focus on pricing, capacity efficient capacity improvements.

Speaker 3

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.

Operator

And our next question comes from Jerry Riddich, Goldman Sachs.

Speaker 7

Yes. Hi, good morning, everyone.

Speaker 3

Hi, Jerry.

Speaker 7

Hi, Mark. I'm wondering if you folks can just expand on the margin performance in Engine, really outstanding results in the Q3. The guidance implies margin expansion in the 4th quarter on lower sales. You mentioned operating efficiencies in the prepared remarks. Can you just expand on where those efficiencies are versus the COVID levels?

Speaker 7

And it feels like there is momentum into 2025 even if demand is softer just given where the exit rate looks to be in the Q4 versus the cost structure in the first. But I'm wondering if you could just expand around those points if you don't mind?

Speaker 3

Yes. 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 efficiencies. And then we've 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.

Speaker 3

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 Q4. We view that as largely temporary and think that with all the information we have today that that's going to resume. So I think 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.

Speaker 3

I mentioned briefly in my remarks that we've really been making adjustments to our organization structure and costs since for the Q4 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. Just so you didn't miss it, I did point out not to make a huge deal out, but we did get some extra pricing, which helped in the Q3 that was retroactive back to the start of the year. So we won't get all of that again in the Q4. But nevertheless, I think the cost base, the operational efficiencies may be not in the short term, but maybe in the medium term, we get some boost from China as well because our earnings are okay, but far from what the full potential of China is in the engine business.

Speaker 3

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 kind of got to focus on the cost and efficiency certainly through the next 9 months.

Speaker 7

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 6 to 12 months out based on the demand and the performance of the production ramp that you alluded to in the prepared remarks, please?

Speaker 2

Yes. I mean, 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 big quarter that EPS has played. So how they start to ramp up volume, get increasing confidence in the strong performance and efficiency. 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.

Speaker 2

And so fleets that are interested in pursuing that, I think, over time, we'll it's hard 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, we'll be launching that as well in 'twenty five. So they'll be positioned with that in the market also.

Operator

And our next question comes from Jamie Cook, Truist Securities.

Speaker 8

Hi, good morning and nice quarter. I guess my first question, you guys have talked about adding capacity on the large engine side. 1 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've talked about historically. And then to what degree do how much incremental capacity are you adding that could potentially benefit 2025?

Speaker 8

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.

Speaker 2

Thanks, Jamie. I'll take the first one and let 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.

Speaker 2

And so we'll continue to focus on that and then of course working to try to get that doubling the 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.

Speaker 3

On the second part, the first thing I'd say, we're going to get natural I will answer the specific questions, Jamie. 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 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 low tens of 1,000,000 of dollars between components and the elimination segment where we incurred some costs for the impacts of Hurricane Helane.

Speaker 3

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 business over the OEM heavy, medium and pickup truck production and the way that these very well custom 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 Day and generating more cash.

Speaker 3

That's a big focus. Thank

Operator

you. Our next question comes from Tami Zakaria, JPMorgan.

Speaker 9

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 Q3, it's almost 50% ex 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 the generation products success, engines are seeing some retroactive pricing as well it seems.

Speaker 9

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?

Speaker 3

I don't think we'll miss I think we'll give guidance just for the year and then we'll see how we do. 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 Accelera side of the business. But overall, we're pleased with this year.

Speaker 3

Let's focus on finishing strong for this year. We'll give you our full guidance with all its technical when we get to February. So I appreciate the question, but today we're not going to talk about longer term targets.

Speaker 9

Got it. Okay. Thank

Speaker 10

you.

Operator

Thank you. Our next question comes from Rob Wertheimer, Melius Research.

Speaker 11

Just a 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 after?

Speaker 3

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.

Speaker 1

Yes. And as a reminder, that's in our light duty space. So it wasn't it was more localized there.

Operator

Perfect. Okay.

Speaker 11

That helps a lot. 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 years years ahead. Is it very clear that even the biggest hyperscale data centers will use reset 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?

Speaker 2

Yes. 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 genset can do for backup power. So we really think that's going to be a solution for some time.

Operator

And our next question comes from David Raso, Evercore.

Speaker 12

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 bond.

Speaker 2

I'm surprised you made it this far without that question, David.

Operator

Well, to make sure

Speaker 5

if you could answer,

Speaker 12

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 nat gas 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, anything you want to comment on whoever wins the White House and Congress, how that impacts your thoughts?

Speaker 2

Yes. I mean, at the end of the day, Cummins is going to do what we've always done.

Speaker 3

We're going

Speaker 2

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 and 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.

Speaker 2

And we do not expect any change regardless of the outcome of the election on the 27 regulations for our industry. So as we have in the past, we're really we have a history of being first into the market with products that comply with new regulation 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 consider 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 'twenty six ahead of the 'twenty seven 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 look into 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.

Speaker 2

So that's our intention. We've got the 15 liter natural gas out now. We'll add the diesel version of that in 'twenty six and then launch our mid range products at the start of 'twenty six.

Speaker 12

The early introduction of the 'twenty seven, I assume you're we're thinking Q1 'twenty six with the new model years. Can you help us so it appears in the channel there's some sense of there might be a pre buy of your engines in 'twenty five to get in front of that early 'twenty six 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.

Speaker 12

So pre buying Cummins would impact total industry numbers pretty meaningfully. And the cost of the new 27 engine coming out early in 2026, can you give us some sense of the cost to the customer? And 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 bringing all 27 costs into 26. It's a cost improvement.

Speaker 2

Yes. So let me try to frame it to help you're thinking, but 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 adding 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 'twenty six.

Speaker 2

The requirement for a longer emissions warranty does not take effect until 'twenty seven. So customers that buy this new high efficiency market leading product in 2026 will not be.

Operator

Thank you. Our next question comes from Noah Kaye, Oppenheimer and Company.

Speaker 13

Thanks for taking the questions. And related to this transition, I guess, is probably one of the biggest R and D investments the company has ever made. So as we start to kind of get past that, can you maybe think or help us think about the direction of R and D spend? It seems like maybe an obvious place to get leverage on future growth, but you did $1,500,000,000 of spend in 2023, kind of be around that range for 24. How should we think about that level of spending going forward?

Speaker 2

Yes, 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 this what I call the bridge period of technology looks like and how that transitions to 0 emissions.

Speaker 2

But we'll see that coming off of our peak as we get past the 27 product launches and we'll continue to be investing in R and D to create differentiation and value in the market to grow business over the long term.

Speaker 13

And so if you're launching next late next year or sorry, I think you said 26, then implies we'll start

Operator

to back down from those peaks.

Speaker 13

Yes. Yes. Okay. And then just sort of switching gears, can you characterize the durability of strength in medium duty? I think that 6th and 7th classes have done pretty well.

Speaker 13

There's still some backlog there. But just 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.

Speaker 2

Yes. I mean, for the year, we're seeing medium North American medium duty up a little bit, flat to up 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.

Operator

And our next question comes from Tim Thean, Raymond James.

Speaker 10

Thank you. Good morning. The first question is just on the distribution business. And I'm curious what, if any, or mix impact there could be, given the if you look at the strength that we've seen and you're projecting to continue for some time in Power Gen, that's now running it, call it 10 points higher as a percentage of distribution revenues from a couple of years ago. And while some of that's coming as we've seen parts come down.

Speaker 10

So maybe in historical terms, that's a mix negative, just as the whole goods grows as a percentage of revenues. But maybe just given the strength in demand and tightness in supply, that's not the case. So maybe just your thoughts on just the mix within distribution and how to think about that going forward? Thank you. Yes.

Speaker 2

I mean, as you noted, typically whole goods is mix margin negative compared to aftermarket. For us, if you just step back and look at the business in total, you got to consider what we've done around inflationary pricing and operational efficiencies as we tried to flex up to higher volume and we're 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.

Speaker 10

Got it. Okay. And then maybe one for margin.

Speaker 3

I think that's where 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.

Speaker 10

Got it. And then Mark just on the gross margin color that you gave earlier was the 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,

Speaker 3

I mean year over year there's other pricing. It just it was it's 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, so the 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.

Speaker 3

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.

Operator

Great. Thank you for that last question. I would now like to turn the floor back to Chris Kullo for closing remarks.

Speaker 1

Great. Thanks very much. I appreciate everyone joining today. That concludes our teleconference. I appreciate your participation and continued interest.

Speaker 1

As always, the Investor Relations team will be available for questions after the call.

Operator

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

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Earnings Conference Call
Cummins Q3 2024
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