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Edited Transcript of CMI earnings conference call or presentation 28-Jul-20 2:00pm GMT

·47 mins read

Q2 2020 Cummins Inc Earnings Call COLUMBUS Jul 28, 2020 (Thomson StreetEvents) -- Edited Transcript of Cummins Inc earnings conference call or presentation Tuesday, July 28, 2020 at 2:00:00pm GMT TEXT version of Transcript ================================================================================ Corporate Participants ================================================================================ * James Hopkins Cummins Inc. - Executive Director of IR * Livingston L. Satterthwaite Cummins Inc. - President & COO * Mark A. Smith Cummins Inc. - CFO & VP * N. Thomas Linebarger Cummins Inc. - Chairman & CEO ================================================================================ Conference Call Participants ================================================================================ * Andrew Millard Casey Wells Fargo Securities, LLC, Research Division - Senior Machinery Analyst * Ann P. Duignan JPMorgan Chase & Co, Research Division - MD * David Michael Raso Evercore ISI Institutional Equities, Research Division - Senior MD & Head of Industrial Research Team * Jamie Lyn Cook Crédit Suisse AG, Research Division - MD, Sector Head of United States Capital Goods Research, and Analyst * Jerry David Revich Goldman Sachs Group, Inc., Research Division - VP * Steven Fisher UBS Investment Bank, Research Division - Executive Director and Senior Analyst ================================================================================ Presentation -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- Greetings, and welcome to the Cummins Second Quarter 2020 Earnings Conference Call. (Operator Instructions) As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. James Hopkins, Executive Director of Investor Relations. Thank you, sir. You may begin. -------------------------------------------------------------------------------- James Hopkins, Cummins Inc. - Executive Director of IR [2] -------------------------------------------------------------------------------- Thank you. Good morning, everyone, and welcome to our teleconference today to discuss Cummins' results for the second quarter of 2020. Participating with me today are our Chairman and Chief Executive Officer, Tom Linebarger; our Chief Financial Officer, Mark Smith; and our President and Chief Operating Officer, Tony Satterthwaite. We will all be available for your questions at the end of the teleconference. Before we start, please note that some of the information that you will hear or be given today will consist of forward-looking statements within the meaning of the Securities Exchange Act of 1934. Such statements express our forecasts, expectations, hopes, beliefs and intentions on strategies regarding the future. Our actual future results could differ materially from those projected in such forward-looking statements because of a number of risks and uncertainties. More information regarding such risks and uncertainties is available in the forward-looking disclosure statement in the slide deck 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 the call, we will be discussing certain non-GAAP financial measures, and we 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 at www.cummins.com under the heading of Investors and Media. With that out of the way, we'll begin with our Chairman and CEO, Tom Linebarger. -------------------------------------------------------------------------------- N. Thomas Linebarger, Cummins Inc. - Chairman & CEO [3] -------------------------------------------------------------------------------- Thank you, James, and good morning, everybody. I will begin by providing some initial comments on our operating environment and then move to our second quarter results. Our company faced unprecedented volatility in demand this quarter. In April, over 70% of OEM sites that we shipped to experienced full shutdowns of their facilities. Many OEMs began the process of reopening facilities in May with increases in build rates constrained by supply chain challenges. Production rates further increased in June. The result of these shutdowns and managed reopenings was the largest decline in revenue in the company's history. Through a series of actions, including restructuring at the beginning of the year, temporary salary reductions and other discretionary spending cuts, our company delivered reasonable profitability, given the magnitude of the sales decline. Many of our cost-saving actions have led the sacrifices on the part of our employees. Reducing headcount and cutting pay are the last options that we use to manage expenses, given the impact on our people. While the actions we have taken this year have been necessary, I want to take this opportunity to acknowledge and thank employees for the sacrifices they are making to support the company through this challenging time. Our employees have also worked tirelessly to navigate the unprecedented supply chain disruptions caused by the COVID-19 pandemic. Our supply chain organization has faced some of the most significant demand fluctuations in the company's history, along with managing to the impacts of OEM and supplier shutdowns, many of which occurred with little or no notice. If this was not enough of a challenge, we've had to rethink how we work in manufacturing and distribution facilities, adjusting layouts, staffing patterns, instituting health checks, all to ensure employee safety and lower the risk of transmission. Outside of our manufacturing and distribution locations, many of our engineers and office employees are still working all or part-time from home. This has presented its own set of challenges from ensuring engineers can collaborate and maintain product development schedules to the rapid introduction of global rolling out of new tools and network capacity by our RT and shared service organizations. We are continuing to manage our facilities and operations, putting the safety of our people first. These safety procedures often make it more uncomfortable for our people to work effectively, and nearly every one of our people had to innovate and find new methods for tasks that used to be straightforward. Again, I can only say thank you and express my gratitude for the commitment and agility of Cummins people everywhere. Now I'll move to a summary of our second quarter results and a discussion of our major end markets. Mark will then take you through more details of our second quarter financial performance and update you on our balance sheet and liquidity. Revenues for the second quarter of 2020 were $3.9 billion, a decrease of 38% compared to the second quarter of 2019. EBITDA was $549 million or 14.3% compared to $1.1 billion or 17% a year ago. The impact of lower volumes was partially offset by the benefits of restructuring, lower variable compensation, temporary salary reductions, reduced warranty costs and higher joint venture income. The increase in joint venture income was primarily due to record levels of demand in China. All 4 of our mature operating segments remained solidly profitable in the second quarter with only the New Power segment incurring operating losses as we continue to invest in new products and technologies ahead of broad market adoption. The Engine business revenues declined by 47% in the second quarter compared to a year ago. Lower production in North America truck markets, along with weaker demand from global construction customers, drove most of the revenue decline. The EBITDA margin for the quarter was 10.5% compared to 15.4% for the same period in 2019. Cost savings related to restructuring activities and salary reductions, as well as increased joint venture income, partially offset the impact of lower volumes. Sales for our Distribution segment declined by 21% year-over-year, with lower revenues in domestic and international markets. Second quarter EBITDA was $160 million or 10% of sales compared to 8.5% in the second quarter of 2019. EBITDA margins increased as we continue to realize the benefits of our transformation work in North America as well as the impact of lower variable compensation expenses. Second quarter revenues for the Components segment declined by 38%. Sales in North America declined 55%, driven by lower truck build rates, while revenues in international markets declined by 9% as a result of lower truck demand in Europe and India. Revenues in China increased 63% and represented a new quarterly record for the Components group. EBITDA for the second quarter was $141 million or 12.3% compared to 16.1% in the same quarter a year ago. EBITDA percent decreased as the impact of lower volumes was partially offset by the benefits of restructuring, temporary salary reductions and reduced warranty costs. Power Systems sales in the second quarter declined 35% year-over-year. Industrial sales declined 33%, driven by continued weakness in oil and gas and mining markets. Power generation sales decreased by 37% with lower revenues in both North America and international markets. EBITDA in the second quarter was 11.7% compared to 14.4% a year ago. The impact of lower volumes, again, more than offset the benefit of cost reduction actions and lower warranty expense. In the New Power business, EBITDA was a loss of $38 million in the second quarter, in line with our expectations. Now I will comment on some of our key markets, starting with North America, and then I'll cover some of our largest international markets. Our second quarter revenues in North America declined 48% to $2 billion. We experienced lower demand in all end markets, with OEM shutdowns impacting build rates of trucks and construction equipment. Power generation shipments declined due to project delays, and our parts and service business was negatively impacted by end users delaying vehicle maintenance. Industry production of heavy-duty trucks declined 71% in the second quarter compared to a year ago and 54% sequentially. Year-to-date, our market share is 33%, an increase from the second half of 2019, even as industry production declined. We began shipments of our X12 engine to freightliner for use in their Cascadia day and sleeper cab models this quarter. Our entry into the regional haul market with a low weight X12 will further support our leading share in this market. Production of medium-duty trucks decreased by 61% in the second quarter. We continue to maintain our clear market share in the medium-duty truck market with over 80% of new trucks powered by Cummins powertrains in 2020. The total shipments to our North American pickup truck customers decreased 71% compared to a year ago and were impacted by OEM shutdowns during the second quarter. In domestic off-highway markets, engine sales for construction equipment decreased by 43% from the near-record levels experienced a year ago. Revenues for power generation equipment fell by 38% with lower demand in RV and backup power markets. Demand for engines in oil and gas markets declined by 88% due to a reduction in equipment purchases of new fracking equipment. Our aftermarket sales in North America fell 25% compared to last year and were negatively impacted by low truck utilization, especially in April and May, industry destocking activity and customers delaying scheduled maintenance. Now I'll turn to our major international markets. International revenues decreased by 20 -- 22% in the second quarter of 2020 compared to a year ago. Second quarter revenues in China including joint ventures, were $1.9 billion, an increase of 30% and a record for the company. Demonstrating the flexibility of our supply chain teams, our manufacturing facilities' transition from full shutdown in March to making a record number of engines, turbochargers and after treatment systems in April and continued producing at those record levels in May and June. In the second quarter, industry demand for medium and heavy-duty trucks in China increased by 61% compared to a year ago. The record level of demand was driven by delayed purchases from the first quarter and government policy, which increased the scrapping of old NS3 trucks. Our market share was 15%, up 13% -- up from the 13%, excuse me, in the second quarter of 2019 due to the strong performance of our X12 engine with fleet customers. Fleet customers now represent 20% of the market in China, and they continue to transition to a total cost of ownership model, focusing on fuel economy and reliability. We expect this trend to continue, providing opportunities to increase our market share as we launch our NS VI products across the country next year. Industry interest in automated manual transmissions has also increased, and we currently expect to sell over 1,000 Endurant AMTs in China by the end of this year. Industry sales of light-duty trucks increased by 43% in the second quarter, and our market share was 8%, flat with last year. In cities where NS VI regulations are already in place, we are seeing strong acceptance of our new engines, with market share above our current 8% level. Second quarter demand for excavators in China increased by 63% from a year ago. The central government is encouraging increased level of borrowing by local municipalities to support investment infrastructure and housing projects, resulting in increased excavator demand. Our market share was 17% compared to 16% a year ago, driven by the strong performance of our domestic OEM customers. Demand for power generation equipment in China was flat compared to a year ago with increased demand from data center customers, offset by weaker demand for standby power. Second quarter revenues in India, including joint ventures, were $106 million, a reduction of 77% from the second quarter a year ago. Industries truck sales in India decreased 93%, while construction and power generation sales declined by more than 75%, all driven primarily by nationwide and regional shutdowns in response to COVID-19. The truck industry transitioned to BS VI standards on April 1, which will result in additional revenues for our components business. And we've added Ashok Leyland as a new customer of our Emission Solutions business. During the second quarter, we also finalized an agreement with Mahindra, an Indian truck and tractor company, to supply an on-highway 4-cylinder BS VI compliant engine, further cementing our leading position in the India truck market. Outside of India and China, we saw year-over-year revenue declines of 29% in Europe and 59% in Latin America, primarily due to lower truck production driven by COVID-related OEM shutdowns. Global sales of mining engines declined 35% compared to a year ago. Demand remained stable among copper and iron ore miners, where commodity prices have risen by over 30% compared to their April lows. In contrast, coal prices remain below $50 per metric ton, resulting in lower demand for equipment by coal miners. While demand was weak across most of our markets during the second quarter, we continue to strengthen existing relationships with OEMs and developing new customers for our products. We are working hard to support our customers and partnering in new ways during this challenging period, enabling us to benefit when markets recover and driving improved market share in the future. While we continue to strengthen our position in diesel and natural gas markets, we are also focused on opportunities for our New Power segment. We have 200 Cummins-powered battery electric buses in service throughout North America, and we'll start selling electric powertrains to Kalmar for use in the terminal tractor market in late 2021. We expect adoption of battery electric powertrains to increase in bus and terminal tractor markets over the next several years, with adoption in segments of the medium-duty truck market occurring thereafter. Our products in the field are being supported by our wholly-owned Distribution business, providing customers confidence in product uptime as this technology is used for the first time in commercial applications. During the second quarter, 2 trains powered by Cummins fuel cells completed an 18-month trial in Europe with over 180,000 kilometers traveled. By 2022, there will be 41 of these types of trains powered by Cummins fuel cells running in Europe, making Cummins the leading provider of fuel cells for trains globally. We are in active conversations with OEMs and end users about how to utilize both our PEM and solid oxide fuel cells in a variety of applications, including trains, ships, data centers and on-highway vehicles. We have fuel cell-powered trucks running to date in both Europe and North America. In addition to the opportunities we see in fuel cells, we have a leading portfolio of both alkaline and PEM electrolyzers, which will be a critical part of the infrastructure to support the hydrogen economy. Our portfolio of electrolyzers are already being utilized in a variety of applications today, including on-site hydrogen production for fueling stations, industrial applications and more recently in larger scale power to gas applications. In the second half of 2020, we will complete the largest PEM hydrogen electrolysis plant in the world with Air Liquide. The 20-megawatt facility in Becancour, Canada will be capable of producing 3,000 tons of hydrogen annually. With a leading product portfolio and a presence in Europe, North America and China, our hydrogen business is well positioned to grow as investments in hydrogen production and fuel cells increase around the world. To more fully discuss how we expect these markets to grow and how Cummins will participate in this rapidly developing industry, we will be holding Cummins Hydrogen Day for investors and analysts the morning of November 16. We hope you will all be able to attend this virtual event. While we are excited about the opportunities ahead of us in advanced diesel, natural gas and the new power markets, we will continue to face uncertain market conditions in the second half of 2020. We expect consolidated company revenues in the third quarter to increase from second quarter levels in all regions, except China, where we expect declines from the record levels we experienced in the second quarter. The pace of market recovery will differ, though, from region to region and may change based on government actions both to control the spread of COVID-19 and/or to stimulate their economies and build business and consumer confidence. Our leadership team is very experienced in managing through periods of volatility in demand. We are prepared for a range of demand scenarios and know that these may differ by region and end market as the full impact of COVID-19 becomes clearer. Due to the uncertainty that remains within our markets, we will remain focused on managing cost and cash flow in the second half of the year while continuing to invest in the products and technologies that will drive profitable growth for the company. When demand returns, which it will, Cummins will be in a strong position to deliver the products and services that will drive our customers' success and deliver even stronger financial performance. Now let me turn it over to Mark. -------------------------------------------------------------------------------- Mark A. Smith, Cummins Inc. - CFO & VP [4] -------------------------------------------------------------------------------- Thank you, Tom, and good morning, everyone. The COVID-19 pandemic had an unprecedented impact on the global economy, and we felt the effects across our markets and global operations in the second quarter. Weaker demand from end users, combined with the shutdown of OEM customers, suppliers and some of our own operations all contributed to the lowest quarterly sales for Cummins in a decade and the largest year-over-year decline in revenues in company history. We delivered solid profitability in the second quarter as the benefits of restructuring work initiated in the second half of 2019, combined with additional cost reduction measures taken this year, helped to protect profitability and cash flow in the face of a very uncertain economic environment. Second quarter revenues were $3.9 billion, a decrease of 38% from a year ago. Sales in North America at 48%, and international revenues declined 22%. Currency movements negatively impacted revenues by 2%. As Tom said, China was the only major market in which our revenues increased year-over-year. Earnings before interest and tax, depreciation and amortization, or EBITDA, were $549 million or 14.3% of sales for the quarter compared to $1.1 billion or 17% of sales a year ago. EBITDA decreased by $500 million, driven primarily by the negative impact of weaker sales, partially offset by lower compensation expenses due to temporary salary reductions and lower variable compensation expenses. Results also benefited from the restructuring actions announced at the end of 2019 and record joint venture income in China. The temporary reduction in salaries went into effect in the middle of April and reduced expenses by approximately $75 million in the second quarter and impacted the results of all of our operating segments. Salaries will be fully restored at the beginning of the fourth quarter. Gross margin of $890 million or 23.1% of sales decreased by $751 million or 3.3% of sales. The negative impact of lower sales more than offset lower warranty expenses, reduced variable compensation and the benefits of our restructuring and other cost-reduction initiatives. We reduced our selling, administrative and research costs by $221 million or 25% year-over-year to $659 million. SG&A expenses decreased by $159 million due to the benefits of restructuring, lower compensation costs and reduced discretionary expenses. Research expenses decreased by $62 million, primarily driven by lower compensation and temporary salary reductions and also reduced testing at our own and third-party facilities due to COVID-related shutdowns. We are continuing to invest in new technologies and improve products that will deliver profitable growth in the future, and we do expect our engineering expenses to increase in subsequent quarters as testing activity picks up. Joint venture income increased by $19 million year-over-year, driven primarily by record demand for trucks in China. Joint venture earnings reached a new quarterly record in China as those higher volumes were converted into strong earnings. Other income of $39 million decreased by $4 million, primarily driven by lower interest rates, yielding lower interest income on our cash and marketable securities holdings. Net earnings per quarter were $276 million or $1.86 per diluted share compared to $675 million or $4.27 a year ago. The effective tax rate in the quarter was 25.7%, up from 21.4% in the second quarter of 2019, and the expense this quarter included unfavorable discrete tax items of $14 million. Operating cash flow in the quarter was an outflow of $22 million compared to an inflow of $808 million in the second quarter last year. The decline in operating cash flow was primarily due to lower earnings and higher working capital. Inventory did increase by $53 million in the quarter, mainly in our manufacturing facilities as a wave of global customer shutdowns that began at the end of March dramatically reduced demand on our facilities with a little forewarning. Inventory did decline in the month of June as customer orders improved. Capital expenditures were $77 million in the quarter, down from $133 million a year ago. We paid $193 million of cash dividends in the second quarter and did not repurchase any shares. Cash, cash equivalents and marketable securities totaled $2.1 billion at the end of the quarter with total liquidity of $5.6 billion, boosted by the addition of a new $2 billion revolving credit facility in early May. In summary, our second quarter was significantly impacted by COVID-19 with the industry-wide production shutdowns and dramatically lower demand in most of our markets. We delivered solid profitability in the face of a record decline in quarterly sales due to the incredible commitment and flexibility of our global employees as we ramp down global production in April, flexed up in May and June, while executing on our cost reduction initiatives. The steps we have taken to protect our profitability, preserve cash and reinforce our already strong liquidity help ensure that we can keep investing in new products that will support future profitable growth even in this extremely challenging economic environment. While demand from OEMs has improved from historic lows in April in several markets, the pace of recovery beyond the third quarter remains uncertain. Due to this uncertainty, we will not be providing specific forward-looking guidance for the remainder of the year, but we hope that some brief comments on the trajectory of costs and revenues will be helpful. Our consolidated sales in the quarter are expected to improve from second quarter levels as many countries have eased the lockdowns imposed in March and April, allowing OEMs to increase build rates. Joint venture income is expected to decline from second quarter levels as demand for trucks and construction equipment in China moderates from this record levels in the second quarter. As I've said, we do expect an increase in engineering expenses in the third quarter as testing activities return closer to planned levels, and the temporary reduction in salaries, which remains in place in the third quarter, those salaries will be fully resolved by the beginning of the fourth quarter. To summarize, Cummins remains in a strong position to navigate this extremely challenging environment. We will continue to take the actions necessary to maintain the financial strength of the company, support our customers and position the company for a stronger future. Now let me turn it back over to James. -------------------------------------------------------------------------------- James Hopkins, Cummins Inc. - Executive Director of IR [5] -------------------------------------------------------------------------------- Thank you, Mark. (Operator Instructions) Operator, with that, we are now ready for our first question. ================================================================================ Questions and Answers -------------------------------------------------------------------------------- Operator [1] -------------------------------------------------------------------------------- (Operator Instructions) Our first question today is coming from Andy Casey of Wells Fargo. -------------------------------------------------------------------------------- Andrew Millard Casey, Wells Fargo Securities, LLC, Research Division - Senior Machinery Analyst [2] -------------------------------------------------------------------------------- One short-term question. Can you kind of discuss the trends in China? Are you already seeing declines that you expect in Q3 or is that more anticipatory? -------------------------------------------------------------------------------- Mark A. Smith, Cummins Inc. - CFO & VP [3] -------------------------------------------------------------------------------- Well, I think, Andy, we are -- as you know, demand for capital goods in China is typically seasonally weaker in the second half of the year. In the first half of the year, we have just come off record levels, but I think that's a reasonable expectation of some cooling going into the third quarter. You have some visibility but not perfect visibility here. -------------------------------------------------------------------------------- Andrew Millard Casey, Wells Fargo Securities, LLC, Research Division - Senior Machinery Analyst [4] -------------------------------------------------------------------------------- Okay. And then kind of unrelated follow-up, longer-term question. For the fuel cell technology, are there any significant differences required for, let's say, trains and on-highway trucks? Meaning, how scalable is that across applications, which you see a benefit from potential multiple market application versus just focusing on-highway? -------------------------------------------------------------------------------- N. Thomas Linebarger, Cummins Inc. - Chairman & CEO [5] -------------------------------------------------------------------------------- Andy, it's Tom Linebarger. Thanks for joining us today, and thanks for your question. The answer is there are scale opportunities across applications, and there are differences. So we do -- we're an investor in stack technology, and there is definitely scale opportunities. And I would say, the major driver to making fuel cells competitive besides hydrogen costs for fuel is volume on the stack and related components. And that volume will provide benefits and cost as well as just technical learning even across applications. One thing about trains is, of course, they're much lower volume than trucks, but they take a lot more fuel cells or a lot more stacks. So we will be delivering in those trains, pretty high volumes of fuel cells that will allow us to move to a more cost-effective manufacturing technology as well as other supporting components being able to buy those at a lower cost. So there are clearly scale opportunities, and there's also some application-specific work necessary in controls and other areas to make it work in a specific application. -------------------------------------------------------------------------------- Operator [6] -------------------------------------------------------------------------------- Our next question is coming from Jerry Revich of Goldman Sachs. -------------------------------------------------------------------------------- Jerry David Revich, Goldman Sachs Group, Inc., Research Division - VP [7] -------------------------------------------------------------------------------- Tom, I'm wondering if you could talk about the opportunity in electrolyzers versus fuel cell. Presumably, market size could be significantly larger for electrolyzers. How big of a focus is that for you folks compared to fuel cell? And can you talk about any desire to accelerate the R&D investments in those areas, given growing regulatory momentum for hydrogen beyond what we spoke about at the analyst day? -------------------------------------------------------------------------------- N. Thomas Linebarger, Cummins Inc. - Chairman & CEO [8] -------------------------------------------------------------------------------- Thanks for the question, Jerry. And my -- our view about electrolyzers is evolving, given our relatively recent entry into the space. I think our first thought was we needed electrolyzers in order to make sure there was fueling available for our fuel cell applications. As you mentioned, we now see that there is a significant opportunity to expand that strategic view. And of course, all the investments we're making in electrolyzers are incremental to Cummins' current business. So it does provide a significant growth platform for us. We also do have some experience, of course, in the power generation field where there is some overlap in how projects are done and the way they're engineered. So that's helping us some. And the incentives now in Europe, especially, but in China also and other parts of the world, to produce hydrogen, especially green hydrogen, which require PEM electrolyzers, of which we're one of just a few manufacturers today. The incentives are significant, and they just -- as you saw, the Europeans were in roll out, they're large and they're available now. So we are expanding our investment in both R&D but also in product launch to make sure that we have the right sizes and range of electrolyzer technology available. We are also partnered with Air Liquide, who is involved in the market significantly, but also involving ourselves with other partnerships, like you probably saw that we had done this -- we did this joint venture with NPROXX, which is a tank technology company, so that we can provide high-pressure tanks, which is important for storage and transportation in the hydrogen economy. So we are adding technologies. We're adding partners, making sure that we can participate more significantly in this market, given the growth opportunity. And as you mentioned, the timing is now. So we are expanding our presence there. -------------------------------------------------------------------------------- Jerry David Revich, Goldman Sachs Group, Inc., Research Division - VP [9] -------------------------------------------------------------------------------- And Tom, just a clarification. Do you agree with the statement that the market size and addressable opportunity for Cummins and electrolyzers is significantly larger than in fuel cell? I know it's early, but can you just comment on that part of the question, if you don't mind? -------------------------------------------------------------------------------- N. Thomas Linebarger, Cummins Inc. - Chairman & CEO [10] -------------------------------------------------------------------------------- I don't mind at all, Jerry. Thanks for bringing it back. I really don't know, to be honest, because part of the challenge is how big a range of electrolyzers will we participate in. And then also, fuel cells, it depends on what percentage of the truck market they eventually win and that sort of thing. But I do -- definitely, it's a wider field. Let's just agree to that. It's a wider field. So if we participate in every part of generating hydrogen, it would be larger. No question about it because we can serve everyone else's fuel cells as well. But our feeling is that both represent significant opportunities, but the electrolyzer opportunity is in front of the truck opportunity for fuel cells. So it's -- meaning, earlier in time. So that's why we are pursuing the electrolyzer opportunity with more effort to get more products in the market sooner. -------------------------------------------------------------------------------- Operator [11] -------------------------------------------------------------------------------- Our next question is from Ann Duignan of JPMorgan. -------------------------------------------------------------------------------- Ann P. Duignan, JPMorgan Chase & Co, Research Division - MD [12] -------------------------------------------------------------------------------- I'd love to keep going on the hydrogen pieces, but maybe I'll step back and ask about Q3, can you -- and Q4. Can you size the costs that will come back into the system in Q3 and Q4? Give us any direction in terms of the dollar cost that we should think about in terms of variable comp, salary reductions, et cetera, et cetera, just as we look at our models for the rest of the year. -------------------------------------------------------------------------------- Mark A. Smith, Cummins Inc. - CFO & VP [13] -------------------------------------------------------------------------------- Ann, it's Mark. Thanks for your question. So the combination of temporary salary cuts and variable compensation between Q2 and Q3 should be fairly similar in dollar terms that the impacts, so not significant change there. The variation is really going to be in the top line, the lower JV income and some increase in the engineering expenses. Q4 is when the salary reductions get reversed. And as I just said, that's $75 million in Q2 on a full quarter run rate, which will be in Q3, it will be about $90 million that comes back in the fourth quarter. -------------------------------------------------------------------------------- Ann P. Duignan, JPMorgan Chase & Co, Research Division - MD [14] -------------------------------------------------------------------------------- Okay. I appreciate the color. That's helpful. And then just taking a step back, we talked about how weak the fundamentals were in India. Can you just talk about what you're seeing going on in the fundamentals versus temporary COVID versus -- I know you said truck sales were down 70, what, 90% plus, but what are you seeing there more broadly in India? -------------------------------------------------------------------------------- Livingston L. Satterthwaite, Cummins Inc. - President & COO [15] -------------------------------------------------------------------------------- Ann, this is Tony. I'll cover that one. Truck sales were very weak in India. And some of this weakness started pre-COVID, as you know. Even last year was not a good market for the Indian truck market. COVID has made that worse. We are really seeing extremely low economic activity construction. All of our markets in India are significantly down. And of course, COVID has proven more difficult to manage even than in some other countries. And so we are quite cautious about India and are not expecting any significant rebound in the second half of this year as we see weak activity and the COVID challenge, if anything, increasing in India. -------------------------------------------------------------------------------- Operator [16] -------------------------------------------------------------------------------- Our next question is coming from Jamie Cook of Crédit Suisse. -------------------------------------------------------------------------------- Jamie Lyn Cook, Crédit Suisse AG, Research Division - MD, Sector Head of United States Capital Goods Research, and Analyst [17] -------------------------------------------------------------------------------- Nice quarter. I guess my first question, again, sort of on the short-term trends. Can you just talk about sort of the cadence of sales throughout the quarter, April, May versus June, and what you're seeing in July, if we're exiting sort of -- if July is sort of more comparable to June levels or not? And then my second question, Mark, is more so to you. Understanding some of these costs are going to come back in the fourth quarter, but your G&A control was pretty impressive in the quarter. So as you look forward, will there be incremental opportunities to reduce your structural cost beyond the $250 million to $300 million that you guys outlined in November? -------------------------------------------------------------------------------- Livingston L. Satterthwaite, Cummins Inc. - President & COO [18] -------------------------------------------------------------------------------- Mark, I'll take the first one and you could address the second one. Yes, Jamie, the real thing that happened in the second quarter was our OEM shutdown. And the real difference between June and April and May was that most everyone was back at work in June, and so they were stabilizing production rates. Those have continued relatively steadily into July. So we are not expecting any significant increase from June rates going into the third quarter, but we see them holding relatively well. And that leads us to, as Mark said, we are expecting revenue increase going into the third quarter. Some of the start-ups were pretty fast, and I want to echo Tom's comments about our supply chain team's ability to keep up with our OEMs in June. So that's been one of the interesting aspects, at least of this, that the start-up looked very V shaped for at least a month. We don't expect it will keep going up, but we do expect and are seeing so far in the third quarter relatively consistent build rates from most of our OEMs. -------------------------------------------------------------------------------- Jamie Lyn Cook, Crédit Suisse AG, Research Division - MD, Sector Head of United States Capital Goods Research, and Analyst [19] -------------------------------------------------------------------------------- Okay. And then Mark, on costs? -------------------------------------------------------------------------------- Mark A. Smith, Cummins Inc. - CFO & VP [20] -------------------------------------------------------------------------------- Yes. So I think -- thanks, Jamie. We aimed our restructuring work, a lot of it, at SG&A. It's important work for the company, but we thought we had some opportunities to drive efficiencies there. And quite frankly, those costs have surprised us a little bit throughout the year to the low side. That's been a help as we've gone along here, and employees have really risen to the challenge of kind of backing down costs. We're always looking for ways to take more cost out and what can we learn from this period so that we -- as revenues recover, we're operating in a way that doesn't add all of those costs back. There's no doubt, compensation costs will be higher next year. Hopefully, we're looking -- hopefully, looking at a different revenue environment, but it's too early to say. But yes, we can -- we're going to keep looking for ways to manage that SG&A as a percent of sales once our revenues start to recover on a more consistent basis. We get into our planning. We're always managing costs, and then we're into our planning cycle for next year. So that's obviously a key topic of discussion. But yes, we very much aimed at restructuring at the SG&A at the start of the year, and it's helped a lot. -------------------------------------------------------------------------------- N. Thomas Linebarger, Cummins Inc. - Chairman & CEO [21] -------------------------------------------------------------------------------- Jamie, this is Tom. I wanted to just add, like maybe just give you a sense of what our approach is, is that we took the permanent actions associated with the Q4 work that we're really aiming at a downturn for the year. We had a sales estimate for the year, and we aimed the cost at that structure. Then COVID hits and takes the sales down significantly lower, ideally on some temporary basis. And we really just don't know at this stage how much -- where we're going to level out on sales between the lowest level we hit and where our original estimate for 2020 was and 2021. But as we get a better view of that of what 2021 starts to look like, if our cost structure is appropriate for 2021, we will continue to look at actions and all the -- because all the time we're going through it, and that's fine. But if we see a sustained lower revenue in 2021 and beyond, that doesn't really match where we aimed or SAR or SG&A at the end of last year, then we'll have to take another reduction. So what we're going to try to do in Q4 is we will get the temporary ones back. And if the revenue trend looks right, it looks like we're getting back to kind of where we thought we would be, then we'll be there or thereabouts, and we'll have to do relatively modest things. If we're -- if we think we're in a sustained lower period, then we're going to have to do more than that. And we are prepared for both. In fact, we started in May, creating scenarios for all those different things and asking ourselves what would be our strategic set of actions under each circumstances. And as Mark said, we're not done with that work because we rolled into our planning work this fall. But we have already been looking at that and asking ourselves what would we do in every circumstance. So we will be ready for whatever revenue scenario we finally decide we're going to aim for in 2021. -------------------------------------------------------------------------------- Operator [22] -------------------------------------------------------------------------------- Our next question is coming from Steven Fisher of UBS. -------------------------------------------------------------------------------- Steven Fisher, UBS Investment Bank, Research Division - Executive Director and Senior Analyst [23] -------------------------------------------------------------------------------- Just with the better revenues that you checked in Q3 versus Q2, it sounds like still holding the line on your costs in Q3. Is there any reason why the decrementals shouldn't be even better than what we saw in the Q2 level? -------------------------------------------------------------------------------- Mark A. Smith, Cummins Inc. - CFO & VP [24] -------------------------------------------------------------------------------- Well, I think we've taken the actions that we -- for now that we plan, Steve, the cost structure is going to be fairly consistent from quarter-to-quarter. And I think that's the best way to model it. Of course, we've weathered through the toughest comps in the first half of the year. It just really were kind of in the hands of the revenue trajectory here since our cost actions are set for the next quarter. So I think you can work your own models from there on the decrementals, bearing in mind some of the comments I've made about sequential increases in engineering, sequential decreases in the joint venture income. We can't manage on a month-to-month basis on the decrementals. Obviously, we're pleased with the performance in the first half of the year. The actions we've taken in account has set the course now for the rest of the year. And really, the revenue is going to drive the numbers from here. -------------------------------------------------------------------------------- Steven Fisher, UBS Investment Bank, Research Division - Executive Director and Senior Analyst [25] -------------------------------------------------------------------------------- So I guess on that point, Mark, I guess, in terms of -- or Tom, and in terms of the uncertainties related to the guidance, I'm just curious how far out you have backlog visibility as I thought that you might have -- I might have thought that backlog that you have would give you enough confidence to give you some degree of a range for the rest of the year. And then related to that, I guess, I'm curious, which of your end markets and geographies do you feel like you have the most relative certainty for the rest of the year? And which ones do you think are least certain? -------------------------------------------------------------------------------- N. Thomas Linebarger, Cummins Inc. - Chairman & CEO [26] -------------------------------------------------------------------------------- Steve, it's Tom. We don't have a lot of backlog. It's not -- the only place we really get backlog is in the power generation projects. And even there, I'd say they're pretty short now. And in the truck market, they have some backlogs, but of course, they're managing those backlogs by increasing production and decreasing production. And so there, how they change their production week to week influences what their demand on us is. Here's what we're seeing, though -- I mean just to give you a sense for what we're seeing. In North America, the truck makers are definitely stabilizing their production rates. They're seeing stronger demand. Not -- it's not fabulous. It's just stronger. It's just ramped up to the June levels. And as Tony said, it looks like it's kind of leveling out there. They're feeling pretty good about that. But nobody is confused that the question of whether it holds there or decreases depends a lot on how sick everybody gets. And so if we continue to see rises in cases in the U.S., and we have to continue to revert more and more towards economic shutdowns again, you should expect demand to fall off again. If the reverse happens and things start to get better and the COVID cases start to decrease again, we expect things to gradually keep opening and getting better. So most of us are looking at that and saying, "We don't really know how to call that yet." And that -- and if you took that exact movie we just talked about and played in India and in Western Europe and in China, you'd play a slightly different movie or a very different movie, depending on which place. So I think that's why we're being cautious about demand trends. We are where we are in a sense that we see things stabilizing and increasing slightly month-by-month in truck markets in Europe and the U.S. and things like that. And we -- our concern about China is it was just so hot for a quarter. We just don't understand how it sustains that level for the rest of the year. So we think it probably tips down. We don't have -- we certainly don't have enough backlog to be able to tell you that. But we do -- that's what we expect, and we feel pretty confident about that. So that's kind of what we know. And the rest of it, frankly, we're just trying to figure out how to be ready for all of it. And I know that's not very helpful from a model prediction point of view, but that's just unfortunately the situation we live in. -------------------------------------------------------------------------------- Operator [27] -------------------------------------------------------------------------------- Our next question is coming from David Raso of Evercore ISI. -------------------------------------------------------------------------------- David Michael Raso, Evercore ISI Institutional Equities, Research Division - Senior MD & Head of Industrial Research Team [28] -------------------------------------------------------------------------------- Trying to take a cut at a similar question. When I'm thinking about sequential EPS growth, I'm just trying to balance some sequential declines in China, costs coming back later in the year. But the strengthening in your largest business, North America truck, I mean, it feels like sequentially EPS should grow from 2Q. Nothing you highlighted would suggest that's not the case. But then in the fourth quarter, you have about $0.40 to $0.45 EPS cost coming back. So just to give us some baseline -- I know you're not going to give guidance, but just the baseline. Do you think your second quarter EPS was the bottom EPS for the year, quarterly EPS? -------------------------------------------------------------------------------- Mark A. Smith, Cummins Inc. - CFO & VP [29] -------------------------------------------------------------------------------- Too early to say, David, because we don't have visibility beyond the third quarter. -------------------------------------------------------------------------------- N. Thomas Linebarger, Cummins Inc. - Chairman & CEO [30] -------------------------------------------------------------------------------- I would agree, David. And I just -- it really just goes back to this point I was making before about what happens with the disease in these different markets. I think if we expect things to get not worse than today and, in fact, start to trend better, in the U.S. and in Europe, in some of these places where we have strong markets, if those things continue to get better on a steady basis, our hope is -- what we'll see is, as you mentioned, demand increase in our major markets, even if they tip down a little bit in the red hot China. And that will kind of more than offset it. And that will also offset the costs coming back in the business. But as we note -- as we watched happen in July, everything went the wrong way from the disease point of view. It just seems like every place started to go back to almost to stage one. If you're in Indiana, where we're headquartered, they just put in a new mask order just this Monday. So it's -- we just don't know where that heads. And I know that, again, that's frustrating to us. It's frustrating to you. But that fourth quarter question, when we had done our planning back in May, we thought, "Oh, this fourth quarter is where things start to tick up. That's when these temporary costs could come off and we'll have revenues to support that, and that will be fine." And now our only question is, is that true. It seems like it should be true, but we just don't know. -------------------------------------------------------------------------------- David Michael Raso, Evercore ISI Institutional Equities, Research Division - Senior MD & Head of Industrial Research Team [31] -------------------------------------------------------------------------------- That's fair. I mean I'm just trying to think about we get nice EPS growth sequentially 3Q. If the negative scenario plays out for 4Q, can you pull back on the $0.45, $0.40 EPS hit from the cost coming back? Or is that sort of written in stone for the employee comp for fourth quarter? -------------------------------------------------------------------------------- N. Thomas Linebarger, Cummins Inc. - Chairman & CEO [32] -------------------------------------------------------------------------------- We made a commitment to our employees that we would restore the comp in the fourth quarter. We think we've probably done as much of that as we can do on paying people lower salaries for -- and also cutting their hours. So our view is that, that part, we're going to reverse. The variable comp, as you know, that just goes by how our earnings go. So if earnings are weak, then variable comp will continue to be lower than planned. So that will continue to be a cost reduction over what our plan was. So part continues and part would not come back. And then I think as we were talking earlier with Jamie, that's -- our feeling about restructuring is that if it comes -- if we feel like the revenues will not really come back, I mean, if it's not just Q4, if it's going to continue for a while, then we'll have to think through how we take more structural cost action towards the end of the year to position ourselves properly. So Q4 is interesting, but really, 2021 would really be the focus of those actions, right? That's really where -- so trying to predict, if revenues are not coming back in Q4, does that mean there's on the sustained down trend? Or are they -- are they just -- is it just a blip and they're about to come back? And that's what we'll have to figure out. And I think we will have a lot more information about that in our next earnings call, and we'll be able to give you guys a much better view of what we see. But again, I think what you can expect from us is irrespective of the scenario, we will be managing costs in an appropriate and aggressive way. And we will not be -- we will be keeping the cost in that we think have everything to do with the growth and profitability of the future of the company. So those -- that will be the balance we'll be striking, and we'll continue to rebalance and restrike it depending on kind of what we see from a revenue point of view. But I think Mark's quote was the best. It's kind of a revenue deal from here through the end of this year. If revenue strengthens up, then Q2 will be all low. And if it doesn't, then it won't, right? If it starts to drop again, then it won't. -------------------------------------------------------------------------------- David Michael Raso, Evercore ISI Institutional Equities, Research Division - Senior MD & Head of Industrial Research Team [33] -------------------------------------------------------------------------------- And Tom, related to the second half. The inventory, 2% increase. And I appreciate the suddenness of the shutdowns early in 2Q. But when we think about where the inventory is exiting June, first, how do you feel about the level of inventory and sort of where is it? Like if it's North America truck, and we've all heard PACCAR, and you would think, okay, it's not bad having a few extra ISX15 liters laying around versus maybe in off-highway, you don't want too much inventory. Can you help us a bit where the inventory lies within the company? -------------------------------------------------------------------------------- Livingston L. Satterthwaite, Cummins Inc. - President & COO [34] -------------------------------------------------------------------------------- David, this is Tony. Yes. David, this is Tony. Yes. We are not happy, Tom and Mark and I are not happy with where inventory is at the end of the second quarter. I think I will tell you, it did decrease in the month of June, so -- and as you can see from our balance sheet, AP has fallen significantly, so we have definitely reduced purchases. The vast majority of our inventory is in raw material and in our plants. It is not finished goods. It is not built-up engines. And so we were just managing these very sudden shutdowns. And if you go back a little earlier in March, we were actually worried about continuity of supply. So we were actually bringing inventory in, in March to guarantee supply, and then we spent all of second quarter trying to manage reduction in demand. So overall, I'm confident in the trajectory we have with inventory, but it was a tough quarter to manage inventory. And I think we did well, but I think we're on top of it now. We know what we're doing. We've got it under ourselves, and I don't feel at all exposed in any way. -------------------------------------------------------------------------------- Operator [35] -------------------------------------------------------------------------------- Our next question is from (inaudible) of Oppenheimer. -------------------------------------------------------------------------------- Unidentified Analyst, [36] -------------------------------------------------------------------------------- Just one more short-term question here. Industrial is [potentially] down year-over-year, but potentially flat quarterly despite a very volatile oil price environment and the rig count decline. So that seems encouraging. Can you talk about the monthly trends you've seen in that business? Any sequential improvement throughout the quarter as oil prices picked up? Any line of [supplies and site support] in O&G or perhaps in mining? -------------------------------------------------------------------------------- Livingston L. Satterthwaite, Cummins Inc. - President & COO [37] -------------------------------------------------------------------------------- Yes. This is Tony. I'll take that one. I guess the short answer is not really. We -- I think you saw our numbers. Oil and gas was down 88%. I think year-over-year, we have really not seen any pickup in North America in the areas where we're strong. Mining, we have seen a little improvement in the hard ores in copper and iron ore, whereas [cores] and those OEMs [at copper cores] remain weak. I apologize, I'm getting a lot of feedback on the phones. I don't know if it's my phone or other phones. But we have not seen anything in the quarterly trends that tell us that mining or oil and gas is looking any significantly better. In particular, oil, gas, I would argue, it was very quiet. We've seen reductions in new engine sales but also in our aftermarket business that serves that is also looking quite weak. -------------------------------------------------------------------------------- Unidentified Analyst, [38] -------------------------------------------------------------------------------- Okay. And then just one more. I mean there's really solid margin performance in the distribution segment. I know you talked about your priorities at Investor Day in terms of transforming that business, so I'm just trying to understand anything specific that you've done there. Has the downturn allowed you to accelerate any of the more permanent actions that you were looking to take? -------------------------------------------------------------------------------- Livingston L. Satterthwaite, Cummins Inc. - President & COO [39] -------------------------------------------------------------------------------- Yes, thanks for the question. We're very pleased with how the distribution business performed and specifically how that transformation work is progressing. The downturn, we -- it caught us at an awkward time in the sense that we really finished the restructuring and the broad reorganization of that business in February. And we were just really getting our new operating routines, our new structure and the way we're now running the business, which was a big change from a regional focus to a market focus. And so we've kind of struggled, but the business has performed really well. We have seen reductions in service and parts revenue in the second quarter, which we've talked about. But a number of the actions they took both with cost and with efficiency have really paid off. And I'm very confident as demand starts to return, and that business picks up a bit, we'll see good performance. That business is more heavily impacted by people cost, and therefore, they benefited more from the salary reductions and variable comp reduction just because that business is so people heavy. But we still think we will deliver on all of the improvements that we were looking to deliver in the transformation as we go through the rest of this year. So very pleased with how that business is performing. -------------------------------------------------------------------------------- James Hopkins, Cummins Inc. - Executive Director of IR [40] -------------------------------------------------------------------------------- Great. And with that, I think that takes us to the end of the hour for the teleconference. As always, I wanted to say thank you to everybody for your interest in Cummins, and I'll be available for any follow-ups this afternoon. Thank you very much. -------------------------------------------------------------------------------- N. Thomas Linebarger, Cummins Inc. - Chairman & CEO [41] -------------------------------------------------------------------------------- James, I just want to add [and I thank you] as well. And I apologize for any technical difficulties, including the unwanted guest that was my dog, [Ellie]. But thanks for hanging in there with us, and thanks for your support for Cummins. Bye-bye.