Earnings Call Transcript - CMI Q3 2024

Operator, Operator

Greetings, and welcome to the Q3 2024 Cummins Inc. Earnings Conference Call. As a reminder, this conference is being recorded. It is my pleasure to introduce Chris Clulow, Vice President of Investor Relations. Thank you. You may begin.

Chris Clulow, Vice President of Investor Relations

Thanks, Julian. Good morning, everyone, and welcome to our teleconference today to discuss Cummins results for the third quarter of 2024. Participating with me today are Jennifer Rumsey, our Chair and Chief Executive Officer; and Mark Smith, our Chief Financial Officer. We 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'll refer you to our website for the reconciliation of those measures to GAAP financial measures. Our press release with a copy of the financial statements and a copy of today's webcast presentation are available on our website within the Investor Relations section at cummins.com. I will now turn you over to our Chair and CEO, Jennifer Rumsey to kick us off.

Jennifer Rumsey, Chair and CEO

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 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 the execution of our Destination Zero strategy as we work to reduce the impact of our products today while investing in cleaner power solutions for the future. Some of North America's largest and most demanding heavy-duty fleets are actively engaged with Cummins, following their own tests of the natural gas engine in the field. For example, UPS has purchased 250 Kenworth X15N powered trucks in a move the company highlights as an important part of decarbonizing its ground fleet. Cummins had the opportunity to further showcase our Destination Zero strategy in action through our diverse portfolio of power solutions at the recent IAA transportation event in Hannover, Germany. At this event, we displayed our fully integrated powertrain concept featuring our helm engine platforms and e-components. I also personally had the 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. This event was a great opportunity to 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-emission technologies in Europe. Lastly, I'd like to express that our hearts are with those who were impacted and are still recovering from Hurricanes Helene and Milton here in the U.S. We are grateful that our employees in the impacted areas are all accounted for and safe. While we did see minor impacts on our third quarter financial results, I'm proud of how our Cummins employees rallied together to help impacted employees, communities, and facilities, and responded 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 products 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 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 Vistalantis 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-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 narrows. The light-duty market in China was down 4% from 2023 levels at 424,000 units, while our units sold, including joint ventures, were 30,000, an increase of 14%. Industry demand for excavators in China in the third quarter was 44,000 units, an increase of 10% from 2023 levels. Our units sold were 8,000 units, an increase of 14% as a result of QSM 15 penetration of both new and existing OEM partners and export growth. Sales of power generation equipment in China roughly doubled in the third quarter, primarily driven by continued growth in data center demand. Third quarter revenue in India, including joint ventures, was $641 million, a decrease of 12% from the third quarter a year ago. Industry truck production decreased by 12%, while our shipments decreased by 18%, driven by a slowdown in manufacturing and government infrastructure spending. Power generation's revenues increased 49% year-on-year, driven by pre-buy demand for stationary power out of the CPCB4 emissions regulation changes as well as increased data center demand. Now let me provide our outlook for 2024, including some comments on individual regions and end markets. Our revenue outlook for 2024 remains consistent with our prior guidance of down 3% to flat. We are improving our overall EBITDA guidance for the year to be approximately 15.5%, the top end of our prior guide of 15% to 15.5%. We now expect higher revenue and stronger profitability in our Power Systems and Distribution segments, offsetting lower revenue and profitability expected in our 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 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 of 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 the 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, CFO

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. 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, 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, costs incurred in the startup 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 the 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 $4.59 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. Year-to-date operating cash flow was 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 18. Components revenue was $2.7 billion, a decrease of 16% from the prior year, while EBITDA decreased from 13.6% of sales to 12.9%, driven primarily by the dilutive impact of the 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 Helene at the end of Q3, disrupting production and causing us to record some costs in our third quarter results. Our employees have shown incredible resilience in extremely challenging circumstances and are working very hard to raise production levels. For Components, we expect 2024 full-year revenues to decrease 12% to 15%, a decrease of 2% from the prior guidance at the midpoint, and EBITDA margins in the range of 13.3% to 13.8%, lowering the range from our previous guide of 13.7% to 14.2%. For the Engine segment, third quarter revenues were $2.9 billion, a decrease of 1% from a year ago. EBITDA was 14.7%, an increase from 13.5% a year ago due to operational improvements and positive pricing, including a retroactive pricing agreement in our light-duty business that was finalized within the third quarter. 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 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, driven 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 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 Atmus and other discrete items, and down from our prior guidance of an expected tax rate of 24. Capital investments will be in the range of $1.2 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. We will experience moderation in some markets in the fourth quarter, most notably North America heavy-duty truck. We have updated our projection for EBITDA to the high end of the prior guidance range due to strong execution, particularly the projected record full year EBITDA in Power Systems and Distribution. We took some steps to reduce costs in the fourth quarter of 2023 and the first quarter of 2024, continue to identify ways to streamline our business going 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. And that's encouraging given that this is projected to be a down year for North American heavy-duty truck production. Our priorities for the remainder of this year for capital allocation remain to reinvest for profitable growth, pay out our strong cash dividends, and support our strong credit rating. Thanks for your interest today. Now let me turn it back to Chris.

Christopher Clulow, Vice President of Investor Relations

Thank you, Mark. Now we'll begin our question-and-answer session. Operator, we're ready for our first question.

Operator, Operator

And our first question comes from Steven Fisher, UBS.

Steven Fisher, Analyst

Congrats on the beat and raise. It's hard to find those in the machinery world these days. Nevertheless, I think there were some investors that were a little concerned that maybe the Q4 guidance looks a little conservative after the strong Q3. I don't know how much of that is related to the storm impact in Components. But I guess the bigger picture question here is, even though it's maybe a little early, do you think there are enough positives to offset the rest of the downturn that we have in the heavy-duty truck market, however long that may last, to keep EBITDA growing over the next year?

Jennifer Rumsey, Chair and CEO

Yes. 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 are really three factors that I'd point to in the revenue guide for the fourth quarter. We expect further softening in the heavy-duty market. I talked about the product changeover which 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 during that period of time. So those are really the factors. As you can see, the team has done a great job of continuing to focus on profitability across the business, delivering strong decremental margins where we've seen reductions in heavy-duty, which takes a lot of effort. 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, power gen that impacted Power Systems and Distribution. And we expect that to continue as we go into next year.

Steven Fisher, Analyst

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, is that new record revenues in the quarter? You're sold out on the 95 liters. Where are you on the capacity utilization on 50 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, Chair and CEO

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. We've been working on capacity in the supply base and our own operational improvements and launching the new product. All of those things have given us improvement over the course of the year. The 95-liter is at capacity, but we've been able to increase capacity through these improvements by about 30% on that product in '24 of the new products. 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 as we go into '26. We don't see any end in sight in terms of demand in that market. We're the rebuilds up for the 95-liter out to '27. So really focused on leveraging the capacity we have now, investment we have now while we're bringing more online late next year.

Mark Smith, CFO

And I think, Steve, the only thing I'd add to your first question is, we're not 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 managing through the cycle.

Jennifer Rumsey, Chair and CEO

I will say, I mean, in terms of the impact of Helene and Milton, we're back to 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 working.

Operator, Operator

Our next question comes from Angel Castillo, Morgan Stanley.

Angel Castillo Malpica, Analyst

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, and some states maybe delaying the kind of model year '25 to maybe model year '26 type enforcement. Just any comments or maybe read-throughs to what maybe that tells you about the underlying kind of enforcement of those regulations and the potential for kind of prebuy into '25, just any broader read-through to maybe or just industry demand for your engines?

Jennifer Rumsey, Chair and CEO

Yes. I mean what we've seen, of course, this year is the new bus regulations have gone into place. As we get into '27, we see commonization again between EPA and CARB, which we believe is a positive for the industry. What happens between now and then in terms of different states following those CARB regulations, as you noted some have pushed out, it's a little bit difficult to predict. But certainly, 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 prebuy likely starting at some point during '25 ahead of the '27 regulations.

Angel Castillo Malpica, Analyst

That's very helpful. And then just wanted to circle back on the prior question around 2025 for power generation. I think you indicated you see growth in 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 pricing and backlog indications today?

Jennifer Rumsey, Chair and CEO

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, CFO

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 continue to be pretty resilient absent a big economic shock.

Operator, Operator

Our next question comes from Kyle Menges, City.

Kyle Menges, Analyst

I was hoping I noticed within Power Systems, the Industrial portion actually had pretty strong growth in the quarter despite certainly some competitors not showing great results in mining this quarter. So just would love to hear kind of what's driving that reacceleration and growth in that industrial portion and just how you're thinking about that into 4Q and into 2025?

Jennifer Rumsey, Chair and CEO

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.

Christopher Clulow, Vice President of Investor Relations

Yes. I think overall, Kyle, I'd just add, 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 down the world. We've maintained a pretty good position both in the first-fit side as well as in the aftermarket, which drives the rebuild.

Mark Smith, CFO

Don't overread into one quarter.

Kyle Menges, Analyst

Got it. And then just a follow-up on Power Systems. It looks like with the new guidance, we will be achieving incrementals of about 60% in 2024. It would be helpful if you could explain how we might think about incremental margins in that segment and in 2025. Also, why wouldn’t it be close to 40% to 60% again? What factors could potentially lead to weaker incrementals next year for that?

Mark Smith, CFO

I do get a use 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 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 and efficient capacity improvements. So yes, we still think there is more to come on the top line and the bottom line. I 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, Operator

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

Jerry Revich, Analyst

I'm wondering if you folks can just expand on the margin performance in engine, really outstanding results in the third quarter. The guidance implies margin expansion in the fourth quarter on lower sales. You mentioned operating efficiencies in the prepared remarks. Can you just expand on where those efficiencies are versus pre-COVID levels? And it feels like there's momentum into '25 even if demand is softer, just given where the exit rate looks to be in the fourth quarter versus the cost structure in the first. But I'm wondering if you could just expand around those points, if you don't mind?

Mark Smith, CFO

Yes. I think there's been a lot of improvement pre-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 happen, there is going to be short, but sharp reduction in pickup truck engine production in the fourth quarter, we view that as largely temporary. 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 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 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. 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 got to focus on the cost and efficiency certainly through the next nine months.

Jerry Revich, Analyst

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?

Jennifer Rumsey, Chair and CEO

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 example of UPS. 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 their CO2 footprint but also reductions in operating costs because of the fuel price differential between natural gas and diesel. Fleets that are interested in pursuing that, I think over time, we'll ramp up a target for me to exactly predict because it also depends on some of the economic conditions that are impacting the market 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 '25. So they'll be positioned with that in the market also.

Operator, Operator

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

Jamie Cook, Analyst

Nice quarter. My first question is about the capacity increase on the large engine side. One of your competitors mentioned last quarter their plans to enhance capacity in large engines due to demand. Are you making any adjustments to your previously discussed capacity increase? Additionally, how much incremental capacity are you adding that could benefit 2025? My follow-up question concerns the margins in Q4 compared to Q3. Although there's a noted decline, how much of that was due to the repricing you mentioned that supported the engine business, which we might consider a one-time event? Also, within Components, what impact did the hurricanes have?

Jennifer Rumsey, Chair and CEO

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 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. 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, CFO

On the second part, I will address your specific questions, Jamie. I want to emphasize that we will experience natural variations from quarter to quarter. However, we remain focused on managing costs and improving efficiency, while also ensuring our products deliver value to our customers. The retroactive pricing effect was approximately 50 basis points for the company in the quarter, and although there is a future benefit, it will be less significant. The costs mentioned are in the low tens of millions due to components and the elimination segment, including expenses related to Hurricane Helene. There are both positives and negatives in the results. Our revenue guidance remains unchanged as we are confident about production levels for heavy, medium, and pickup trucks, which our well-managed customers prefer to plan predictably. Maintaining strong cost and efficiency discipline is crucial as we approach next year, while we also prepare for increased demand and growth, aiming to raise margins as highlighted at the Analyst Day and focusing on generating more cash.

Operator, Operator

Our last question comes from Tami Zakaria, JP Morgan.

Tami Zakaria, Analyst

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% excluding 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 the next couple of years? Would you consider revisiting your long-term incremental EBITDA margin target as you begin next year?

Mark Smith, CFO

I think we'll provide guidance just for the year, and then see how we perform. There are many factors affecting our portfolio. We feel we've done a good job in our core business. Since our Analyst Day, we've faced additional challenges in the Accelera segment. Overall, we are satisfied with this year. Let's concentrate on finishing strong. We will share our complete guidance in February. I appreciate the question, but today we won't discuss long-term targets.

Operator, Operator

Our next question comes from Rob Wertheimer, Melius Research.

Robert Wertheimer, Analyst

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 then I have a more substantial question after that.

Mark Smith, CFO

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.

Christopher Clulow, Vice President of Investor Relations

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

Robert Wertheimer, Analyst

Perfect. Okay. That helps a lot. Just more fundamentally, obviously, you and the 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 for years to come. Is it very clear that even the biggest hyperscale data centers will use reciprocating engines for 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 and where you fit in for the next decade to come?

Jennifer Rumsey, Chair and CEO

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. However, other technologies that we might use for lead time cost, reliability is hard to match what a diesel generators can do for backup power. So we really think that's going to be a solution for some time.

Operator, Operator

And our next question comes from David Raso, Evercore.

David Raso, Analyst

Back to the prebuy 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 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 natural 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 on whoever wins the White House and Congress how that impacts your thoughts?

Jennifer Rumsey, Chair and CEO

Yes. I mean, at the end of the day, Cummins is going to do what we've always done. We're going to work across party lines and engage on issues that are important for our business and our industry, and we'll do that. We've done that with the Biden administration as well as past administrations and will do with the next administration. What's really important to us and our industry is having that regulatory and legislative stability. We do not expect any change regardless of the outcome of the election on the 2027 regulations for our industry. As we have in the past, we're really, we have a history of being first to market with products that comply with new regulations and deliver increased value to our customers. We're always focusing on the landscape, what's the right product at the right time, how do we consider regulatory flexibility and credits as a part of that strategy. Given all that, we do intend to launch the diesel version of the 15-liter helm platform in '26 ahead of the '27 regulation. With that launch, we aim to deliver a lower NOx product into the market that had significant improvement in fuel efficiency and operating costs to decline to 7% efficiency improvement in that product that will deliver value to our customers. We're looking to strengthen our position in that market through regulatory changes. This is really consistent with our past strategy and what has worked well for Cummins over the years is delivering value to our customers through these regulatory changes and strengthening our position in the market.

David Raso, Analyst

I assume you were considering the first quarter of 2026 for the introduction of the new model years. Can you clarify if there is a sense in the channel that there might be a prebuy of your engines in 2025 ahead of that early 2026 introduction? Is this possibly contributing to some of the truck orders we're observing in the industry? Given that you account for 40% of the trucks out there, any prebuying of Cummins engines would significantly influence overall industry figures. Additionally, could you provide some insight into the cost customers can expect for the new 2027 engine coming out early in 2026? Also, how much of that cost pertains to warranty versus the individual components? I'm trying to understand how your total costs for 2027 are being factored into 2026.

Jennifer Rumsey, Chair and CEO

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 and the next-generation 15-liter in '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 aftertreatment content and technology to both comply with the lower NOx regulation as well as deliver better fuel efficiency, operating cost, and value to our customers. That will be added as we launch this new product in '26. The requirement for a longer emissions warranty does not take effect until '27. Customers that buy this new high-efficiency market-leading product in '26 will not be affected.

Operator, Operator

Our next question comes from Noah Kaye, Oppenheimer.

Noah Kaye, Analyst

Regarding this transition, it represents one of the largest research and development investments the company has undertaken. As we move forward, could you provide some insight into the direction of R&D spending? It appears to be a promising area for future growth. In 2023, the expenditure was $1.5 billion, and it is expected to remain around that figure for 2024. How should we approach the level of spending in the future?

Jennifer Rumsey, Chair and CEO

Yes, we're making record-level investments with the new platforms we're launching. We believe these will set us up for future success. You can expect some normalization in our spending. The exact nature of that will depend on how regulations change and what the transition to zero emissions looks like. As we move beyond the product launches in 2027, we anticipate a decrease from our peak spending. However, we will maintain our investment in R&D to differentiate ourselves and create value in the market, supporting long-term business growth.

Noah Kaye, Analyst

So if you're launching late next year or in '26, that implies we'll start to reduce those peaks.

Jennifer Rumsey, Chair and CEO

As we progress through our peak and move beyond the product launches in 2027, we will keep investing in research and development to establish differentiation and create value in the market for long-term growth.

Noah Kaye, Analyst

Okay. Can you discuss the ongoing strength in the medium-duty segment? The 6 and 7 classes have performed well, and there is still some backlog. Please share your insights on the current market demand and whether it is likely to continue into next year. You've already mentioned some expectations regarding heavy duty, so any additional information on medium duty would be helpful.

Jennifer Rumsey, Chair and CEO

Yes. For the year, we're seeing medium-duty vehicles in North America increase slightly, staying flat to up by 5%. Demand remains strong, although there's been some inventory adjustments and a normalization of backlog. We anticipate that this strong demand will continue, especially with upcoming regulations on the horizon.

Operator, Operator

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

Timothy Thein, Analyst

The first question is about the Distribution business. I'm interested in any potential mix impact, especially considering the strong performance we have seen and expect to continue in power generation, which is currently about 10 percentage points higher in distribution revenues compared to a couple of years ago. Although some components are declining, which might indicate a negative mix in historical terms as whole goods increase as a revenue percentage, the strong demand and tight supply situation may change that perspective. I'd like to hear your thoughts on the mix within distribution and how to approach this moving forward.

Jennifer Rumsey, Chair and CEO

Yes. I mean, as you noted, that typically whole goods is a 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 that try to flex up to higher volume, and we're going to continue to focus on those operational efficiencies. Power generation gross revenue mix compared to aftermarket will be negative on the margin line.

Mark Smith, CFO

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

Timothy Thein, Analyst

Got it. And then, Mark, regarding the gross margin details you shared earlier, you mentioned pricing several times. Was all of that due to the retroactive deal you had in the light duty segment, or was there something else?

Mark Smith, CFO

Year-over-year, there were other pricing factors that were important for the engine business to note. However, the overall expectations for the rest of the business haven't changed significantly. We anticipated receiving this additional pricing at the start of the year, but it has taken time. The key point is that we've reset expectations, and this is more about timing, particularly in Q3. We had always expected some impact on our full-year numbers. Overall, there isn't much new information to share for the full year, but it has come in a more uneven manner due to the catch-up nature.

Operator, Operator

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

Christopher Clulow, Vice President of Investor Relations

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

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