Cummins Q3 2024 Earnings Call Transcript

Presentation

[Operator]

Greetings and welcome to Cummins, Inc. Third Quarter 2024 Earnings Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. [Operator Instructions] 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.

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

Thanks very much. Good morning, everyone, and welcome to our teleconference today to discuss Cummins' results for the third quarter 2024. Participating with me today are Jennifer Rumsey, our Chair and Chief Executive Officer; and Mark Smith, our Chief Financial Officer. We will all be available to answer questions at the end of the teleconference.

Before we start, please note that some of the information that you will hear or be given today will consist of forward-looking statements within the meaning of the Securities and Exchange Act of 1934. Such statements express our forecasts, expectations, hopes, beliefs and intentions on strategies regarding the future. Our actual future results could differ materially from those projected in such forward-looking statements because of a number of risks and uncertainties.

More information regarding such risks and uncertainties is available in the forward-looking disclosure statement in the slide deck and our filings with the Securities and Exchange Commission, particularly the Risk Factors section of our most recently filed annual report on Form 10-K and any subsequently filed quarterly reports on Form 10-Q.

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

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

[Jennifer Rumsey, Chief Executive Officer at Cummins]

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 X15N natural gas engine at our Jamestown engine plant, which is the first version of our 15-liter HELM platform to launch in the US. 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 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 power 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 a 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 Hellen and Milton here in the US. 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 Atmus.

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 Atmus. 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 Atmus 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 Atmus 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 the 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 Systems 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 QSM15 penetration at 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's revenues increased 49% year-on-year, driven by pre-buy demand for stationary power out-of-the CPCB IV+ 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 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 in 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.

[Mark Smith, Chief Financial Officer at Cummins]

Thank you, Jen, and good morning, everyone. We delivered strong revenue and profitability in the third-quarter. 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. 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 Atmus. 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. But those year-ago numbers included $26 million of costs related to the separation of Atmus. The benefits of pricing, strong operational efficiency and the absence of the Atmus 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 and which included costs related to the separation of Atmus.

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 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 $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 $0.26 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 $4.4.59 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 Atmus that was completed in the first-quarter. All-in, operating cash-flow was an inflow of $640 million. The 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 Atmus 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 13 points from 13.6% of sales to 12.9%, driven primarily by the dilutive impact of the Atmus 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 Hellen 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 total 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. 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 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% 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 $1.7 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 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%, up from 17.75% at the midpoint of the prior guide. Accelera revenues increased 7% 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 million to $450 million and net losses to be in the range of $400 million 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 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 regain related to Atmus and other discrete items and down from our prior guidance of an expected tax-rate of [indecipherable]. Capital investments will be in the range of $1.2 billion to $1.3 billion, consistent with our prior guidance.

In summary, we delivered strong sales and record profitability in the third-quarter of 2024 and 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 and 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 and 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 our strong cash dividends and support our strong credit rating. Thanks for your interest today. Now let me turn it back to Chris.

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

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. Yet, if you have an additional question, please rejoin the queue. Operator, we're ready for our first question.

Questions and Answers

[Operator]

Thank you, Chris. We'll now be conducting a question-and-answer session. [Operator Instructions] And our first question comes from Steven Fisher, UBS.

[Steven Fisher, Analyst at UBS Group]

Thanks. Good morning and congrats on the beat and 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. 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.

[Jennifer Rumsey, Chief Executive Officer at Cummins]

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. There's really three factors that I'd 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 upwards that happens during that period of time. So those are really the factors. As you can see, we're -- the team has done a great job of continuing to focus on our 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, in PowerGen that impacted Power Systems and and we expect that to continue as we go into next year.

[Steven Fisher, Analyst at UBS Group]

Okay. And maybe just building on that last part there, I mean, how would you describe the momentum in Power Gen right now? I mean, it was at new record revenues in the quarter you sold-out on the 95 liters. Where are you on the capacity utilization on 50s and 78? What's driving the further upside from here? Is it mainly pricing or can you kind of push-out more volumes?

[Jennifer Rumsey, Chief Executive Officer at Cummins]

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 in the supply base and our own operational improvements and launching the new Centum products. 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 our capacity through those improvements by about 30% on that product in 2024, the new products. And then as we talked about previously, we are investing right now to double capacity in the 95 liter that will come online late next year or as we go into 2026. We don't see any end insight in terms of demand in that market. We're reserving build thoughts on the 95 liter out into 2027. 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.

[Mark Smith, Chief Financial Officer at Cummins]

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 to your comments and questions, and we're very focused on kind of managing through-the-cycle.

[Jennifer Rumsey, Chief Executive Officer at Cummins]

I will say, I mean in terms of the impact of Haleen and Milton, we're back to our 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 very 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.

[Angel Castillo, Analyst at Morgan Stanley]

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 middle -- model year 2025 to maybe model year 2026 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? Just any broader read-throughs to maybe EPA or just industry demand for your engines?

[Jennifer Rumsey, Chief Executive Officer at Cummins]

Yeah. I mean what we've seen, of course, this year is the CARB Omnibus Regulations have gone into place. As we get into 2027, 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 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 a 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 2027 regulations.

[Angel Castillo, Analyst at Morgan Stanley]

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. 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?

[Jennifer Rumsey, Chief Executive Officer at Cummins]

I mean 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.

[Mark Smith, Chief Financial Officer at Cummins]

And that's one of the factors that gives us confidence going at the start of the year that strong backlog and then of course distribution should be -- continue to be pretty resilient absent a big economic shock.

[Operator]

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

[Kyle Menges, Analyst at Smith Barney Citigroup]

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?

[Jennifer Rumsey, Chief Executive Officer at Cummins]

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.

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

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 maintain a pretty good both in the first-fit side as well as in the aftermarket, which drives the rebuild. Don't overread into one quarter's units. Yeah.

[Kyle Menges, Analyst at Smith Barney Citigroup]

Got it. And then just a follow-up on Power Systems. It looks like with the new guidance 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 and what factors maybe could cause weaker incrementals next year for that?

[Mark Smith, Chief Financial Officer at Cummins]

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 you get that benefit early-on and then there's been a lot more focus on, pricing capacity 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.

[Operator]

Our next question comes from Jerry Revich, Goldman Sachs.

[Jerry Revich, Analyst at The Goldman Sachs Group]

Yes, hi, good morning, everyone. I am wondering if you folks --

[Mark Smith, Chief Financial Officer at Cummins]

Hey, Jerry.

[Jerry Revich, Analyst at The Goldman Sachs Group]

Hi, Mark. I'm wondering if you folks can just expand on the margin performance in Engine, really outstanding results in the third-quarter of 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 pre-COVID levels 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 fourth-quarter versus the cost structure in the first. But I'm wondering if you could just expand around those points, if you don't mind?

[Mark Smith, Chief Financial Officer at Cummins]

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. So that's really helped. And whilst we have flagged, and it is going to is going to happen, there be short, but sharp reduction in pickup truck engine production in the fourth quarter, we view that as largely temporary. And I 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.

I mentioned briefly in my remarks that we've really been making adjustments to our organization structure and costs since for 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.

Just so you didn't miss it, I did point out not to make a huge deal, 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, maybe not in the short-term, but maybe in 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.

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.

[Jerry Revich, Analyst at The Goldman Sachs Group]

Super. And can I shift gears and ask about the natural gas engine demand now that you've opened up a full rate production. Can you just update us on your expectations of natural gas share in the market six to 12 months out based on the demand and the performance of production ramp that you alluded to in the prepared remarks, please?

[Jennifer Rumsey, Chief Executive Officer at Cummins]

Yes. I mean we've said that we think we could get up to a -- potentially 8% share in the market with the natural gas product. We had several big fleets that we're testing it during development. And I noted the big order that UPS 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 reductions 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 overtime, we'll ramp up a target 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 launched as well in 2025. So they'll be positioned with that in the market also.

[Operator]

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

[Jamie Cook, Analyst at Truist Securities]

Hi. Good morning. Nice quarter. I guess my first question 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 in 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?

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 onetime? And then within Components, how much of an impact was the hurricanes?

[Jennifer Rumsey, Chief Executive Officer at Cummins]

Thanks, Jamie. I'll take the first 1 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 and 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.

[Mark Smith, Chief Financial Officer at Cummins]

On the second part, the first thing I said, we're going to get natural -- I will answer the specific questions you 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 millions of dollars between components and the elimination segment where we incurred some costs for the impacts of Hurricane Helene. So there are there are puts and takes. There are some positives, 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 the 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, that's a big focus.

[Operator]

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

[Tami Zakaria, Analyst at JPMorgan Chase & Co.]

Hi. Good morning. Thank you so much. So I sort 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% 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 power generation product 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?

[Mark Smith, Chief Financial Officer at Cummins]

I don't think -- 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 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.

[Tami Zakaria, Analyst at JPMorgan Chase & Co.]

Got it. Okay. Thank you.

[Rob Wertheimer, Analyst at Melius Research]

Thank you. Our next question comes from Rob Wertheimer, Melius Research. 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 that indicates you have any enhanced pricing power through engines, if that was something new and different then I have a more substantial question after that.

[Mark Smith, Chief Financial Officer at Cummins]

I don't think we should read anything into it other than it's been a protracted discussion. It's back to January 1 Rob. So that's just sometimes things take a while to resolve.

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

Yes. As a reminder, Rob, that's in our light-duty space. So it was more localized there.

[Rob Wertheimer, Analyst at Melius Research]

Perfect. Okay. That helps a lot. Just more fundamentally, obviously, you and 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 and years ahead. Is it very clear that even the biggest hyperscale data centers will use RECIP engines on backup? I wonder if you can just talk about what your customers are telling you about the changing sort of design and scope and scale of data centers where you fit in for the next decade to come.

[Jennifer Rumsey, Chief Executive Officer at Cummins]

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 we 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.

[Operator]

And our next question comes from David Raso, Evercore.

[David Raso, Analyst at Evercore ISI]

Hi. Thank you. Back to the pre-buy question, I know we're sitting here on Election Day so curious to get your thoughts if anything around the election could alter your thoughts around --

[Jennifer Rumsey, Chief Executive Officer at Cummins]

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

[David Raso, Analyst at Evercore ISI]

Make sure, if you could answer the timing of your introduction of a 2027-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?

[Jennifer Rumsey, Chief Executive Officer at Cummins]

Yes. I mean, at the end of the day, Cummins is going to do what we've always done. We're 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 bid administration of the pass administration will do with the next administration. And what's really important to us and our industry is having that regulatory legislative stability. And we do not expect any change regardless of the outcome and the election on the 2027 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 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 -- 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 2026 ahead of the 2027 regulation.

And with that that launch, not only deliver a lower NOx product into the market, but also one had significant improvement in fuel efficiency and operating costs to decline 7% efficiency improvement in that product that will deliver value to our customers and then 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 a diesel version of that in 2026 and then launch our midrange products at the start of 2027.

[David Raso, Analyst at Evercore ISI]

Sorry -- the early introduction of the 2027 I assume you were thinking first quarter 2026 with the new model years. Can you help us though, it appears in the channel there is some sense that there might be a pre-buy of your engines in 2025 to get in front of that early 2026 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 2027 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 bring all 2027 costs into 2026. It's a case of --

[Jennifer Rumsey, Chief Executive Officer at Cummins]

Yes. So, let me try to frame it to hope you're thinking that, 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 in 2026, 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 cost and value to our customers. And that will be added as we launch this new product in 2026. The requirement for a longer emissions warranty does not take effect until 2027. So customers that buy this new high-efficiency market-leading products in 2026 will not be [Indecipherable].

[Operator]

Thank you. Our next question comes from Noah Kaye, Oppenheimer & Co.

[Noah Kaye, Analyst at Oppenheimer & Co.]

Thanks for taking the questions. And related to this transition, I guess, is probably one of the biggest R&D investments the company has ever made. So as we start to kind of get past that. Can you maybe think -- 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 $1.5 billion of spend in 2023, going to be around that range for 2024. How should we think about that level of spending going forward?

[Jennifer Rumsey, Chief Executive Officer at Cummins]

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 the -- 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 2027 product launches, and we'll continue to be investing in R&D to create differentiation value in the market to grow the business over the long-term.

[Noah Kaye, Analyst at Oppenheimer & Co.]

So if you're launching next -- late next year -- or sorry, I think you said 2026 then --

[Jennifer Rumsey, Chief Executive Officer at Cummins]

2026 and

[Noah Kaye, Analyst at Oppenheimer & Co.]

Implies we'll start to back down on those peaks.

[Jennifer Rumsey, Chief Executive Officer at Cummins]

Yes.

[Noah Kaye, Analyst at Oppenheimer & Co.]

Okay. And then just sort of switching gears, can you characterize the durability of strength in medium duty. I think the six and seven classes have done pretty well. 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.

[Jennifer Rumsey, Chief Executive Officer at Cummins]

Yes. I mean, for the year, we're seeing medium -- North America 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 Thein, Raymond James.

[Tim Thein, Analyst at Raymond James]

Thank you. Good morning. The first question is just on the Distribution business. And I'm curious what, if any, 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 at, call it, 10 points higher as a percentage of distribution revenues from a couple years ago. And while some of that's coming as we've seen parts come down. So maybe in historical terms, that's a mix negative, just as the whole goods grows as 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.

[Jennifer Rumsey, Chief Executive Officer at Cummins]

Yes. I mean, as you noted, that 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've got to consider what we've done around inflationary pricing and operational efficiencies have tried to flex up to higher volume, and we're going to continue focus on those operational efficiencies. But power generation gross revenue mix compared to aftermarket will be negative on the line.

[Tim Thein, Analyst at Raymond James]

Got it. Okay. And then maybe one --

[Mark Smith, Chief Financial Officer at Cummins]

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 underline. But the most important thing is we're meeting customer expectations and growing earnings in an efficient way.

[Tim Thein, Analyst at Raymond James]

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 may be just.

[Mark Smith, Chief Financial Officer at Cummins]

I mean year-over-year, there's other pricing, just -- it was appropriate for the engine to note for the engine business that that was a particular fact. 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 expect it to get it at the start of the year and it's just taking time. The most important thing is it's been reset. It's more of a timing issue and 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]

Thank you for our last question. I would now like to turn the floor back to Chris Clulow for closing remarks.

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

Great. Thanks very much. I appreciate everyone joining today. That concludes our teleconference. I appreciate your participation and continued interest. As always, the Investor Relations team will be available for questions after the call.

[Operator]

[Operator Closing Remarks]

Participants

Corporate Executives

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

Analysts

• Steven Fisher, UBS Group AG
• Angel Castillo, Morgan Stanley
• Kyle Menges, Smith Barney Citigroup
• Jerry Revich, The Goldman Sachs Group, Inc.
• Jamie Cook, Truist Securities
• Tami Zakaria, JPMorgan Chase & Co.
• Rob Wertheimer, Melius Research
• David Raso, Evercore ISI
• Noah Kaye, Oppenheimer & Co.
• Tim Thein, Raymond James