Cummins - Earnings Call - Q3 2020
October 27, 2020
Transcript
Speaker 0
Greetings, and welcome to the Cummins Third Quarter twenty twenty Earnings Conference Call. At this time, all participants are in a listen only mode. Call. Once again, this conference is being recorded. It's now my pleasure to turn the call over to James Hopkins, Executive Director of Investor Relations.
Please go ahead.
Speaker 1
Thank you. Good morning, everyone, and welcome to our teleconference today to discuss Cummins' results for the 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 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 on 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 ks and any subsequently filed quarterly reports on Form 10 Q. During the course of this call, we'll 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 ww.cummins.com under the heading of Investors and Media.
With that out of the way, we will begin with our Chairman and CEO, Tom Weinbarger.
Speaker 2
Thank you, James, and good morning. Third quarter continued a period of high demand volatility across our end markets. Three months ago, we experienced the largest sales decline in the company's history. We've now followed that with the largest sequential increase in sales in the company's history. Even with the dramatic increase, however, sales remain below last year's levels.
While we have seen increased demand in most of our end markets over the last three months, we continue to see differences in recovery rates both by market and by region and we expect these differences to continue. Our employees have done a remarkable job of supporting our customers through this period while maintaining a safe work environment. In the third quarter, our supply chain organization continued to support near record levels of truck production in China as well as ramping up production to meet significantly increased demand in the North American heavy duty truck and pickup markets. Our engineering group has continued to successfully launch new products during this period. Over the last six months, we introduced an entire range of Bharat Stage six products in India and portions of our National Standard six portfolio in China.
We also recently announced our full product lineup to meet EPA twenty twenty one regulations in North America. While the while nearly everything about the way we have worked we work has changed due to COVID nineteen, the commitment and capability of our employees has remained intact. Now I'll move to a summary of our third quarter results and a discussion of our major end markets. Mark will then take you through more details of our third quarter financial performance and update you on our balance sheet and liquidity. Revenues for the 2020 were $5,100,000,000 a decrease of 11% compared to the 2019.
EBITDA was $876,000,000 or 17.1 percent compared to $958,000,000 or 16.6% a year ago. The impact of lower volumes and higher variable compensation costs was offset by the benefits of restructuring, temporary salary reductions, reduced warranty costs and higher joint venture income. The increase in joint venture income was primarily due to continued strong levels of demand in China. Engine business revenues declined by 13% in the third quarter compared to a year ago. Lower production in North American truck markets drove most of the revenue decline.
EBITDA margin for the quarter was 18.1 compared to 14.1% 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. Third quarter results also benefited from a VAT recovery in Brazil. Sales for our Distribution segment declined by 14% year over year with lower revenues in domestic and international markets. Third quarter EBITDA was $182,000,000 or 10.6% of sales compared to 9.3% in the 2019.
EBITDA margins increased as we realized more of the benefits of our transformation work in North America. Third quarter revenues for the Components segment declined 7%. Sales in North America declined 24% driven by lower truck build rates, while revenues in international markets increased by 26 driven by higher truck demand in China. EBITDA for the third quarter was $261,000,000 or 16.9% compared to 17.3% in the same quarter a year ago. EBITDA percent decreased as the impact of lower volumes was partially offset by the benefits of restructuring and temporary salary reductions.
Power Systems sales in the third quarter declined 13% year over year. Industrial sales declined 21% driven by continued weakness in oil and gas and mining markets. Power generation sales decreased by 7% with lower revenues in both North America and international markets. EBITDA in the third quarter was 10.3% or $101,000,000 compared to 14% a year ago. The impact of lower volumes more than offset the benefits of cost reduction actions.
In the new power business, sales of $18,000,000 were double those from a year ago. EBITDA was a loss of $40,000,000 in line with our expectations. Now I will comment on some of our key regions and markets starting with North America and then I'll cover some of our largest international markets. Our third quarter revenues in North America declined 18% to $3,000,000,000 but increased by 49% sequentially. Compared to last year, we experienced lower demand in both on and off highway markets as well as within our parts and service business.
Industry production of heavy duty trucks declined 35% in the third quarter compared to a year ago, but rose 119% sequentially. Year to date, our market share is 33% driven by the continued strong performance of our products in the field. Production of medium duty trucks decreased by 33% in the third quarter compared to a year ago, but increased 76% from second quarter levels. We continue to maintain our clear market share leadership in the medium duty truck market with over 80% of new trucks powered by Cummins powertrains in 2020. Total shipments to our North American pickup truck customers increased 4% compared to a year ago and included a catch up in production by our OEM partner after an extended second quarter shutdown.
Demand in domestic bus markets remained weak in the third quarter with sales down 24 driven by lower demand from both transit and school bus customers. In domestic off highway markets, engine sales for construction equipment decreased by 47% driven by lower demand by rental fleets who went through a significant replenishment cycle in 2018 and 2019. Revenues for power generation equipment fell by 7% with lower demand in backup power markets. Demand for engines and oil and gas markets declined by 80%. Now I'll turn to our international markets.
International revenues were flat in the 2020 compared to a year ago. Third quarter revenues in China, including joint ventures, were $1,700,000,000 an increase of 46% compared to a year ago, driven by continued strong demand in both truck and construction markets. In the third quarter, industry demand for medium and heavy duty trucks in China increased by 74% compared to a year ago. While demand declined sequentially, is normal in the third quarter for China, total industry production was the highest on record for any third quarter. Demand continues to be driven by improved levels of freight activity and government policies supporting the scrapping of old NS3 trucks.
Our market share was 17% in the quarter, up from 16% in the 2019, driven by increased truck market share of our partner, Photon, along with higher utilization of our engine in Photon trucks, which now stands at over 80%. Industry sales of light duty trucks increased by 49% in the third quarter, and our market share was 9%, up from 7% last year. Our increased market share was driven by improved truck market share at Photon as well as increased use of our engines at JAC. While new NS six regulations come into effect for all markets in China next July, there are certain cities and applications where these regulations are already in place. 12 of our NS six engine models are now in production, including our entire light duty portfolio as well as our leading 6.712 liter products.
We've shipped over 50,000 NS six compliant units so far in 2020 and are seeing strong acceptance of our new engines. In addition, we are now selling our automated manual transmissions into the Chinese market and are on track to sell over 1,000 Endurance AMTs by the end of the year. Third quarter demand for excavators in China increased by 57% from a year ago. The central government is encouraging increased levels of borrowing by local municipalities to support investment in infrastructure and housing projects. So far this year, over $500,000,000,000 in local government loans have been issued, targeting infrastructure projects and resulting in increased excavator demand.
Our market share was 16% this quarter compared to 15% 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. Third quarter revenues in India, including joint ventures, were $295,000,000 a reduction of 14% from the third quarter a year ago. Industry truck sales in India decreased 47%, while power generation sales declined by 45%. While demand in India remains at very low levels, we did see industry truck sales more than triple compared to second quarter levels.
While credit availability remains tight, certain segments of the truck market, especially those tied to construction, are seeing a recovery in demand driven by government stimulus for infrastructure. Cummins is well positioned to benefit from our recovery in Indian markets, both because of our leading market position as well as the incremental content we have on engines that meet BS VI on highway emission standards, which became effective in April. Outside of India and China, we saw year over year revenue declines of 8% in Europe and 15% in Latin America, primarily due to lower truck production. Compared to
Speaker 3
the second quarter
Speaker 2
sales increased by 25% in Europe and increased by 102% in Latin America as OEMs resumed truck production in both regions. Global sales of mining engines declined 39% compared to a year ago. Demand remains stable among copper and iron ore miners, while sales related to coal mining remained low. I also wanted to discuss our aftermarket revenues during this quarter. Sales of parts declined by 12% in our engine business and 14% in our power systems business.
Parts sales remained depressed in our power systems business due to low demand in oil and gas markets as well as lower rebuild activity in mining markets. In our Engine business, part sales were down 12% year over year, but increased 20% sequentially. Compared to last year, we are seeing weaker demand in bus markets and in parts for older model trucks. Parts demand for current on highway truck engines are flat with last year. While demand increased from second quarter levels across most of our end markets, we remain cautious about future demand increases due to the continued spread of COVID-nineteen in most countries outside of Asia.
And while we are encouraged by continued strong demand in China and improving fundamentals in North American truck markets, industry backlogs remain at modest levels. We currently expect consolidated company revenues in the fourth quarter to be similar to third quarter levels with higher demand in North American truck markets and continued improvement in aftermarket sales partially offset by lower demand in China. We continue to expect that the pace of market recovery will differ from region to region and may change based on government actions both to control the spread of COVID nineteen or to stimulate their economies and build business and consumer confidence. We continue working hard to support our end users and build our build strong OEM relationships during this period. In August, we announced the extension of our medium and heavy duty truck engine partnership with Navistar.
Cummins will continue to supply engines for Navistar's medium and heavy duty trucks as well as for bus applications through the 2026, extending our eighty year relationship with Navistar. Through the development and introduction of new products, we continue to reduce the emissions levels of our products while increasing fuel economy. This includes the launch of our full product lineup for 2021 EPA regulations in North America, NS6 regulations in China and VS6 regulations in India. We are encouraged by the performance and market acceptance of these products that are already in the field. We also continue to focus on supporting our customers in their transition to carbon neutral technologies.
Our revenues doubled in our new power segment this quarter, and we are excited to share more about how we expect our hydrogen production and fuel cell business to develop at Cummins Hydrogen Day on November 16. We hope you all will be able to attend this virtual event. Now let me turn it over to Mark to discuss our financial performance this quarter, including our record operating cash flow. Mark?
Speaker 4
Thank you, Tom, and good morning, everyone. I would like you to leave this call with two key takeaways from our financial performance in the third quarter. Number one, we delivered solid decremental margins in the third quarter, which put us on track for full year performance that will extend our record of raising profitability over successive downturns. This performance is a testament to our operational flexibility, ramping down effectively in the second quarter and then converting additional volume into stronger earnings and record operating cash flow in the third quarter. Number two, as a result of the record operating cash flows and the addition of low cost long term financing in the third quarter, the company sits today with strong liquidity, which will allow us to keep investing in our future in the face of any further volatility and return any excess capital to shareholders in the future.
Now let me share some of the key details of our third quarter. Third quarter revenues were $5,100,000,000 a decrease of 11% from a year ago. Sales in North America fell 18% and international revenues were flat. Currency movements negatively impacted revenues by 1%, primarily due to a weaker Brazilian real. Earnings before interest and taxes, depreciation and amortization, or EBITDA, were $876,000,000 or 17.1 percent of sales for the quarter compared to $958,000,000 or 16.6% of sales a year ago, representing a decremental EBITDA of 13%.
EBITDA dollars decreased by $82,000,000 over the third quarter last year, driven by the negative impact of lower sales, partially offset by the benefits of prior restructuring actions, temporary salary reductions, lower warranty and material costs and increased joint venture income in China. During the quarter, we recorded a recovery of previously expensed value added taxes in Brazil, which boosted revenues and pretax earnings by 44,000,000 and primarily benefited the engine business. The variable compensation expense in the third quarter was higher than a year ago as we increased our accrual reflecting higher expectations for full year company profitability than we anticipated three months ago. For the full year 2020, variable compensation is projected to be lower than 2019. Gross margin of $1,300,000,000 or 26.4% of sales increased by 50 basis points from a year ago.
Lower base compensation expense due to the benefits of restructuring actions, temporary salary cuts, material cost reductions and the VAT recovery in Brazil more than offset the impact of lower sales and higher variable compensation expense. As a reminder, our gross margin last year was negatively impacted by $37,000,000 in pretax charges as we exited two unprofitable product lines. Selling, general and administrative expenses decreased by $67,000,000 or 11% due to the benefits of restructuring, temporary salary reductions and reduced discretionary expenses, partially offset by the increased variable compensation. Research expenses decreased by $18,000,000 or 7% from a year ago, but increased by $35,000,000 or 19% from the second quarter as expected as we ramped up work at our global technical centers and continued progress on engineering programs following some disruption to operations in the second quarter. Joint venture income increased by $30,000,000 but continued driven by continued strong demand for trucks in China.
And joint venture income in China was a record for the third quarter as we converted those higher volumes into strong earnings. Other income of $21,000,000 decreased by $40,000,000 compared to a year ago. Last year, we recognized a onetime 35,000,000 cash gain related to the company's foreign exchange hedging program, which did not repeat this year. Net earnings for the quarter were $5.00 $1,000,000 or $3.36 per diluted share compared to $622,000,000 or $3.97 a year ago. The effective tax rate in the quarter was 26.5% and income tax expense included unfavorable discrete items of $31,000,000 or $0.21 per diluted share.
After a tough second quarter, operating cash flow rebounded to a record inflow of $1,200,000,000 in the third quarter, driven by strong profitability and lower working capital levels. Our inventory decreased by $185,000,000 in the quarter, even as sales increased 33% from second quarter levels. Capital expenditures was $116,000,000 in the quarter, down from $153,000,000 a year ago. We expect full year capital expenditures to be in the range of 500,000,000 to $525,000,000 unchanged from our prior guidance and down more than 25 from 2019. We continue to return cash to shareholders in the third quarter with $194,000,000 cash dividends paid out.
In August, the company completed an aggregate $2,000,000,000 debt offering of five-, ten- and thirty year maturities, taking advantage of extremely attractive long term interest rates that reflected both favorable market conditions and our own strong credit rating. This long term financing was used in part to pay down our commercial paper borrowings and reduces our reliance on credit facilities going forward. Company's long term credit ratings remain unchanged, A plus from Standard and Poor's and A2 from Moody's with stable outlooks. As a result of our strong operating cash flow and the debt offering, we boosted our total liquidity to $6,500,000,000 at the September, which puts Cummins in a strong position to navigate any further volatility that may lie ahead. In October, we announced an increase to our quarterly cash dividend, our eleventh straight year of dividend growth.
Looking to the fourth quarter, we expect consolidated revenues to remain similar to third quarter levels. Strong industry orders are expected to lead to strong demand in North American truck markets and improved aftermarket demand. India has shown some signs of improvement from very low levels in demand as the lockdowns have eased and some economic activity is increasing. In China, where demand has been at record levels over the last six months, we expect to experience some seasonal declines in the fourth quarter, but demand to remain at relatively strong levels. The temporary salary reductions that went into effect in mid April ended at the September as planned.
The restoration of salaries will add approximately $90,000,000 of pretax expenses in the fourth quarter. In summary, we delivered a strong set of results in the third quarter, including record operating cash flow. I want to thank our employees around the globe for their dedication and commitment to excellence through these last six very challenging months. Following unprecedented decline in demand in the second quarter, we responded well in ramping back up in the third quarter, supporting our customers and maintaining financial discipline throughout. While many of our markets have improved, the effects of the pandemic can still be felt in many regions and may impact the pace of recovery.
We will continue to align our business with market conditions, deliver strong operational performance, invest in the technologies that will fuel profitable growth and return any excess to capital to shareholders. Finally, as Tom previously mentioned, we'll be holding our Hydrogen Day on November 16, where we will highlight our participation in the hydrogen economy. Additional details and registration can be found on our Investor Relations website. Thank you for joining us today and your interest in Cummins. Now let me turn it back to James.
Speaker 1
Thank you, Mark. Out of consideration to others on the call, I would ask that you limit yourselves to one question and a related follow-up. And if you have additional questions, please rejoin the queue. Operator, we're now ready for our first question.
Speaker 0
Thank you. Our first question today is coming from Steven Volkmann from Jefferies. Your line is now live.
Speaker 5
Thank you.
Speaker 4
Can you
Speaker 5
guys hear me okay?
Speaker 6
Yes, I'm good.
Speaker 5
Okay, good. Sorry. So yes, my question, maybe this is a Mark question. Don't know you you get to keep and kind of what you have to give back. Can you give us some help with that?
Speaker 4
You'll remember that we implemented the temporary salary reductions in the April, Steve. So when you do the math, it's about $165,000,000 of full year lower expenses in 2020. Obviously, that will not repeat. We restored those salaries in the fourth quarter. The restructuring, I mean, is embedded in our solid decremental margins.
And again, we don't have any further major restructuring actions in place, but we have captured the benefits of that $250,000,000 to $300,000,000 in the current year as anticipated.
Speaker 5
Okay. I guess what that's sort of where I'm trying to go, Mark, how should we think about incremental margins, assuming there's some small increment next year? Decrementals kind of maybe employ low incrementals, but maybe not if you're getting a good chunk of restructuring benefits?
Speaker 4
Yes. I think just at this point, it's a very fair I understand the question. It's just too early even to assess our market conditions next year, but you will you know, you can see from our results today that we're pushing on all the cost levers, productivity gains that we can. It's just too early beyond the obvious items to comment much on next year.
Speaker 0
Our next question today is coming from Courtney Yakavonis from Morgan Stanley. Your line is now live.
Speaker 7
Hi. Thanks, guys. If you can just comment a little bit more on, you know, the guidance that 4Q revenues would be similar to 3Q, relative to kind of some of the, you know, strength we saw in the international markets versus, you know, the increases that we're expecting in in North America. If you can just kind of help us understand that and then relative to what you're expecting, in in parts relative to, the engine side. Thanks.
Speaker 4
So the strength in international market are being flat with all down China. Right? There really wasn't any strength to speak of elsewhere in terms of year over year growth. There was steady recovery in some markets. But any part of our business that touched China, whether within the component business, even our construction business within the engine business, data center orders for the power systems business.
Anything that touched China was pretty much up year over year. And so that's really what drove flat international revenues for the quarter. It's typical, Courtney, that we see some seasonal weakening, going into the fourth quarter, every year in China. So we still expect relative to prior year, strong demand, but weaker sequentially, primarily impacting the components business, since all of pretty much all of their revenue was consolidated and then to a lesser extent, the engine business. So that's the primary market where we're expecting some seasonal declines.
And then yes, truck production build rates, I think, are largely set for the fourth quarter. And then yes, on parts, what we saw in the second quarter was particularly some weaker demand in bus in the bus market, truck, parts, particularly on newer model heavy duty truck was stable in the third quarter and we expect steadily improving parts demand in subsequent quarters. The big factor is really China easing and we're not expecting rapid further acceleration in truck demand right now.
Speaker 0
Thank you. Our next question is coming from Jamie Cook from Credit Suisse. Your line is now live.
Speaker 8
Hi, good morning. Nice quarter. I guess two questions. First, the margins in the distribution business improved again in the third quarter. So can you talk about how to think about those margins longer term, sort of what structural based on some of the internal self help you guys have been implementing?
And then my second question, Mark, understanding you guys are always conservative, but you are sitting with $3,000,000,000 or so in cash. So how do you think about cash flow for the year? What's the right number? At what point do we start to thinking about putting that cash to use? Thanks.
Speaker 4
Good. Yes. So you're right. And I'll start on distribution, Tony, if you want to chime in. We have had a very focused effort, particularly in North America, on driving margin improvement.
A lot of it's coming out of the cost side of the business this year. So we've been pleased with the progress this year, Jamie. I think then we're really looking to see as parts and service, which, you know, have been down probably more more than in in prior cycles due to the severity of the impact of COVID, how that recovers in future years. So I think, you know, we've made a lot of progress in the margin improvement over the last couple of years. We certainly expect to hang on to that, and then we'll be, you know, looking to build on revenue growth going forward.
But we'll avoid giving a specific target. Tony?
Speaker 9
Yeah. I would just add, Jamie. You know, revenue has been a little weaker in this downturn in DBU than previous downturns. And so we've been really pleased with the cost performance and the restructuring, and, you know, focusing going forward is gonna be on how do we see better revenue growth if that business comes back and how do we gain some share in the in the parts and service business in particular. So that's what we're we're looking for more about how do we get that business back to a higher revenue level than necessarily trying to get margins up.
Speaker 8
Okay. But is there any reason to believe the margins can structurally sort of be now in the double digit range on an adjusted EBITDA basis?
Speaker 9
That has been our goal. That's what we said when we launched this transformation program. So that's what we're trying to do is keep them in the double digit level going forward. That's our goal. Yep.
Speaker 8
Okay. Mark, and then on your cash Sorry. Go ahead.
Speaker 2
Yeah. It's Tom. I I I mean, just to make sure I get the you get the math right. So our view is that we are already in double digits while facing yes. We had some cost temporary cost measures that helped, but we had way more headwinds with regard to both sales and then parts and and service declined.
So our view is that that we are on our plan despite pretty heavy headwinds. So we we are not only feeling good about where we are, but we're more confident than ever that we're gonna be in double digit margins, from now forward. So, again, there you can imagine some scenarios with with COVID that would make it so you might have a quarter or two that weren't. But broadly speaking, our view is the restructuring stuff has gone better than we expected. So we as Tony said, that was our target, and we feel like we're ahead of target.
So that that's just that. On the on the cash side, I'll I'll let Mark fill in some more. But, I mean, broadly speaking, you know, we we we definitely acted conservatively from a balance sheet this year to protect ourselves against the worst potential outcomes, economic outcomes from the pandemic. So we've shored up the balance sheet with our debt offering, low cost financing. Our cash flow has improved dramatically.
So we feel we feel good about the positions the company's in and expect, you know, barring some some significant change in economic conditions to return to our cash flow plans that we've been operating under for many years. So our our plan is to go back to returning, you know, as a as a normalized level, half of our cash flow in dividends and and, share buybacks. We we still have to take all that stuff to the board. We have to finish our planning work for next year. There's a lot of work left to do.
And, of course, there's still a pandemic. So we'll keep watching and paying attention. But right now, as we see it, that's where we're headed. Mark, I don't know what you would add.
Speaker 4
Yeah. I think we've made it clear we're not trying to hoard cash a little. We've been cautious this year, but I think Tom's made it clear going forward.
Speaker 0
Our next question today is coming from Adam Uhlman from Cleveland Research. I
Speaker 6
was hoping
Speaker 3
to get your perspective on heavy truck markets. I guess we've seen a spike in spot rates, and the orders have been soaring. I guess I'm I'm just wondering how sustainable you think that is. And, you know, most of your customers are looking for pretty aggressive build growth in the next year. I guess maybe you could frame up your thoughts on on how the cycle plays out from here.
That'd be helpful.
Speaker 9
Tony? Sure, Adam. We're all waiting. Sorry. We're not together, Adam.
So this is Tony. Yeah. It's been it's been very pleasing to see the growth, particularly in the last couple months. I think the thing to remember is that the virus is still with us. And although we are very encouraged, I also think we're very cautious about how the market's gonna play out next year.
I do think that there there is a view that demand is higher, that the newer trucks and newer products are definitely working better. We get really good feedback from customers, and we've got new products coming out next year that meet the latest greenhouse gas emissions for EPA 2021. So we're excited with the products we have on offer. Our our OEM customers are are feeling pretty bullish, but at the same time, there's a lot of uncertainty out there. And so we're just we're trying to be prudent.
We're trying to keep our eye on, you know, all the things going on and and and make sure that that we we are ready if things come in stronger, and we're prepared if things all of a sudden take a downturn. So, you know, the main characteristic of this COVID environment is unpredictability and volatility. So we're just trying to be ready for that as best we can.
Speaker 4
I'll just say, Adam, the other thing we look at is really the parts consumption because in prior cycles, this one may not be the same as prior cycles. In prior cycles, we've had a pretty good run of accelerating parts consumption before orders sustainably stepped up. So that's something we're watching closely by segment and end market. And that should give you some indication from us and other participants in future quarters.
Speaker 3
Okay. Gotcha. And then, Mark, the, with with these new products coming out for '21, I guess the company has been, you know, benefiting from lower warranty expense, and there's some structural actions going on there. Should we expect a pause in in lower warranty expense next year, or do you think we have more legs lower as you execute on your, you know, strategic initiatives? Thanks.
Speaker 4
Thanks, Adam. Really good question. I think on the one hand, of course, we're always driving for more improvement, but I would say that our expenses at 1.8 or one point nine one point nine percent of sales for this year have run below expectations. And, you know, the principal drivers of the warranty performance are, you know, field performance of existing products, field campaigns, and then over a longer period of time, emissions regulations, and then the launch of new products. So launch you're right.
Launch of new products will continue. We typically start those with higher warranty rates. And this year, you know, the the number of field campaigns has been below normal. So we would expect even some tick up in the fourth quarter. And, yes, probably, we, yeah, we shouldn't be locking in 1.88% for now as a run rate.
So, yeah, we'll provide you with an update on that when we get into next year. But, you know, some tick up from here would should be expect would even expected something this quarter, but that's that's where we are right now. Thanks.
Speaker 0
Thank you. Our next question today is coming from Joel Tiss from BMO Capital Markets. Your line is now live.
Speaker 6
Hi. How's it going, guys?
Speaker 4
Hi, Joel.
Speaker 10
I wonder if Tony or or, you know, can can you talk a little bit about any product lines that have been, like, systematically challenged? And I'm thinking, you know, over a couple of years, not just because of this, and and any areas that you could, you know, like, do product lines simplification and and reduce some of that exposure to to drive the gross margins higher? Or or you're always doing that, and there's nothing that really stands out?
Speaker 4
Hey, Joel. I'll go first. I think, you know, we did some of that last year. Right? So we ended production of one of our engine platforms in the pickup market in North America, which not only, you know, we took a charge this time last year, but that's also improved our operating performance year over year and similarly in one of the transmission lines of business.
So, we're always looking at things like that, but I would say don't see any major changes like that. But there's always some opportunity to trim and prune and improve even now.
Speaker 10
And I wonder if you can talk about the m and a environment out there and what you guys are focused on. Is everything so disrupted that it's not the right time to be looking? Or maybe because things are disrupted, there are some unique opportunities? And what areas would you be thinking about?
Speaker 2
Thank you. I think thank you all. Tom, I I can step in on that. I mean, you know, sure, in the second quarter, we were on pause a little bit, making sure that our balance sheet was shored up, that with all the potential outcomes, we we took a pause. But, you know, things as I mentioned to Jamie's question, I think things have begun to normalize at least economically to a place where we feel pretty secure in our balance sheet, and we're we're looking at, restarting our cash flow return.
And we will, of course, we have continued actively looking at the strategic areas where acquisitions would be interesting to us. You probably recall from our previous calls or investor day that we kinda start with strategy first, acquisition second. So we think through what are the areas that we'd like to expand in, and we've talked about those before, but they they they're they're all the areas where we feel like our competitive advantage is the things that we bring in terms of technology, global footprint, supply chain, that sort of thing, help us move forward. And then, of course, our new technology areas, the acquisitions like we did with Hydrogenics and the batteries battery companies, those were to add new capabilities. So we're continuing to look in those same areas.
I think maybe the one question I expected maybe disruption would cause valuations to drop out a little bit. That's actually not happened so much. It doesn't mean that it won't happen, but but and it's maybe because the private equity dollars are so large. But I would say as we look around using a different different method to look at what acquisitions could mean for our company, I still see acquisition prices relatively lofty. So we'll continue to look, and we'll continue to talk to to to people and and look for the right thing.
But we will just we'll remain disciplined and look for the right things at the
Speaker 4
right price. And if we
Speaker 2
find it, we'll act. And if we don't, we'll we'll return more cash to zero just like we planned.
Speaker 10
Alright. Thank you very much.
Speaker 2
Mhmm.
Speaker 0
Our next question is coming from Jerry Revich from Goldman Sachs.
Speaker 6
Tom, now that a number of your customers have sharpened their pencils, at least publicly, on their hydrogen and alternative vehicle strategies. Are they any closer to allocating lower volume diesel engine product lines to you? Can you talk about, if you can, which regions or which product lines you see the most potential for you folks to add value for customers that have lower volumes in those areas.
Speaker 2
Jerry, here's the thing. I would say that every customer that we're talking to is doing exactly the pencil sharpening calculations that you talked about. It's it's a really different environment than it was ten or fifteen years ago, where the calculations were maybe the opposite about how to backward integrate more. Mostly what I hear is maybe backward integrate less. But that said, there's no deal till there's a deal.
Right? So so, again, I we we I can't really preannounce or or suggest anyone who's gonna go because they're tough they're difficult decisions for them and to figure out what they wanna continue and what they don't. I feel very optimistic that we'll play an increasing role with our major customers on selling them more diesel engines, providing them more components technology in the future than the past. So I I expect market share increase in in the future based on the fact that they will decide that their money is based spent best spent elsewhere. Exactly where and when, again, I just I I can't get ahead of my customers on those conversations, but we're talking with everybody about it.
We're excited about it. And, you know, they they have a lot of strategic considerations to make, as do we. So these these conversations are complicated and and and take time. But, anyway, there you are. We're we're in it for sure, and we're and I I'm I'm confident that we will win increased share.
Speaker 6
Okay. I appreciate the color. And Mark, as we look at the fourth quarter sales outlook, flattish sales, normal seasonality is closer to up 7% sequentially. You mentioned China, but obviously, North America and other regions are accelerating. So I'm just wondering, are you expecting a slowdown versus normal seasonality?
Or is it the sort of situation where, look, we're could get hit by the second wave, we don't wanna get into a situation where if it's worse, we're we're missing numbers? Is there some conservatism in there or other pieces that you're, legitimately concerned with?
Speaker 4
Yeah. The numbers will be what the numbers will be, Jerry. I mean, we've been very focused on cost and then, you know, Tony and the team on, you know, this incredible ramp back up again. But what else? So let's just use the pickup truck market as an example.
If you just stared at q three in isolation, you would see that that's in the top 10 quarters in history of pickup truck engine demand. But if you do look back at q two, you would say zero. Right? So you just can't normalize everything that happened in q three and say flat means everything's flat. So I think there's some re there'll be some rebalancing in some markets.
But again, yeah, we'll we'll see where it is. Our focus is on cost and delivery and then, you know, delivering the kind of results that go with whatever volume we're we're throwing up.
Speaker 2
And, Jerry, as as Tony says, we are encouraged by the truck market. I mean, you know, as you guys have said to us, the the the all of our customers are projecting stronger volumes, which is great for us. So we're you know, yes, we're always cautious because that's how we live. But nonetheless, we are encouraged by their comments, and they're very close to the market. They're watching their fleet customers and what they're ordering, and we're hearing good things from the fleets too.
So, yeah, we we are we're very encouraged in China while we expect seasonal demand. You know, the we don't expect a a gigantic drop off. We just expect seasonal demand normal. It's just, you know, the thing is flying so high now that that we we again, we just remain cautious. So just don't hear from us discouragement.
Speaker 4
We are
Speaker 2
the markets are going well, and we're we're we're we're surprised and pleased by how strong they are, and we're encouraged by those. We're just trying to make sure that we balance our enthusiasm with the the the cautious attitude that's appropriate for a global pandemic.
Speaker 6
Glad to hear it. Thank you.
Speaker 0
Thank you. Our next question today is coming from David Razo from Evercore ISI. Your line is now live.
Speaker 11
Hi. Thank you. Yes. My question is on engine margins for next year. Just thinking about the framework, Tom, and given your China comments just now.
I'm trying to square up. It looks like next year, you have sort of a sweet spot of strong growth but not yet at those extremely high levels where sometimes there's inefficiencies serving the domestic truck market. So on a consolidated margin basis, I'm just curious how you think about the margin structurally versus, say, 2019. Just some sense of while we might not get back to those revenues, are the domestic margins set up in a way where they could be a little closer to 2019 than otherwise, given it's a bit of a sweet spot. But then within the segment, you do have the JV income, which is a big contributor.
And thus, maybe if you could share your initial views on 'twenty one for China as that business is debatable if it's up or not So I just would appreciate your thoughts for for an early framework on 21 engine margins.
Speaker 2
Well, within China, there are a
Speaker 4
number of moving parts, David, that, you know, will will add to the complexity. You know, we're expecting a bigger step up in the penetration of NS6 products. What that will happen to demand, take up is all to be figured out there. So, we're not in a position right now to give you 2021. Yes.
Q three margins were higher than normal, for a couple of the factors that we've we've laid out, but we're we're in we're still going through our planning cycle for next year as we speak. So or not as we speak, but after we speak here, we'll be back on that again here shortly. So it's just it's just too early to say given everything that's going on. But I would just say we are very pleased with the performance of the engine business, and the fact that they were able to deliver such strong margins, in this very, very challenging environment. And I think it speaks to the strength of the global franchise and the scale we've got in multiple markets.
Obviously, America and China have been primary. But yes, we're not ready to
Speaker 2
give guidance next year.
Speaker 4
I appreciate you asking. We'll look forward to giving an update with Q4 earnings. Would you mind if I
Speaker 11
just so I clarify there, just given how high China is today, maybe while you don't want to predict the industry, I'm curious, and you've given some numbers in the past, but now we're a little bit closer. The incremental content, some of the opportunities are idiosyncratic to the company. If there is a thought that China's volumes are so high this year, they're down next year, but maybe have some self help offsets. Can you give us some framework as we've discussed in the past but now closer to it? What kind of potentially framework revenue impact you could see that is from better NS six content or increased penetration with Photon and so forth?
Can can you help us a little bit? Just frame it.
Speaker 4
Yeah. I'll I'll just make a couple of comments, and then James can maybe give you some numbers. But I think there's kind of couple of dynamics. One, so there's a potential or the expectation of higher content for the components business on a consolidated revenue basis. As the emissions regulations are rolled out, that's kind of a given, given that we source and we specify the after treatment systems that are an integral part of our engine system design.
James will give you the numbers in a moment. We hope then as we're moving through these more advanced emissions regulations that we can continue to pick up share. We feel like our NS six products have been well received and our penetration of photons already been really accelerating over the last couple of years. We're already up to 80% and it's encouraging to see photons being picking up some share as well. So, yes, we're optimistic about if we set aside the market, which, of course, markets do drive earnings as well, but our position and our ability to add self help there.
And James, you can maybe quantify the revenues.
Speaker 1
Yes. And David, from a revenue impact of that, we've talked broadly before both between the emissions content in China and in India. But that will be roughly $600,000,000 of incremental revenue, and that primarily hits our Components segment. I think in addition to that, Tom mentioned in his remarks excitement about the Endurant transmission that we're selling 1,000 units of in the second half of this year. We'll see continued growth of that product in China next year, which will provide customers with even improved fuel economy and hopefully to more market share gains.
So I think that is also some self help as we look into 2021.
Speaker 2
David, this is Tom. As you kind of think through the model, the numbers for this year are so high on the truck market that this is what Mark's saying. That right now, it's just hard for us to do the the weighing of one or the other because we know what the content is. We know who we've won the share with. We even have forecast for, you know, how we think it converts over to to to NS six and what what growth we see in in transmissions.
The challenge is just what's the overall market gonna be, and we were wrong this year. I mean, just to to say it straight out, you know, we had pretty pretty, you know, balanced assumptions about how well this year would be, and we've been wrong every single quarter on the low side. It's been better than every single quarter. So that's why we're just a little gun shy about doing the overall balance for you. We will do it, of course, when we get done with fourth quarter earnings.
But I just would say that, you know, we're hopeful that we can offset a downturn with a lot of these other content pieces, but it just depends on how big the the slope down is.
Speaker 11
Yeah. I mean, that's what's interesting, Don. I mean, historically, your order book could be accelerating. And every time on the call, wanna say, well, China's gonna slow down. And and a lot of times, you know, it doesn't.
And then in this environment, you'd almost say we're at such a high level, and you've seen Volvo and so forth, you know, already forecast China down next year. You know, a betting man would have said, like, well, knowing Tom's history with way he lives at China, just trying to be cautious with it. And we'll definitely be hearing today baseline. Oh, it's definitely down. It seems like in what you're seeing enough internally when you're on opportunities, it's still an open question, which I think it's a little more positive than than I would have thought.
Speaker 2
So Yeah.
Speaker 11
You're right. Dig into it.
Speaker 2
You're right, David. It is an open question, and I appreciate your comments. And I do acknowledge that I have been calling it down more than it has been. So I'll just take that one. It's better caution to know And accept it.
Accept it. But that that hasn't been right. And so, anyway, I I think it's a good it's a good point you raised.
Speaker 11
I appreciate it. Thank you.
Speaker 0
Thank you. Our next question today is coming from Ann Duignan from JPMorgan. Your line is now live.
Speaker 12
Yes. Hi. I'd like to go back to Q4. I mean, you've guided to revenue flattish quarter over quarter. You called out the $90,000,000 in higher compensation expenses.
You mentioned perhaps warranty costs coming back up. Could you talk about some of the positives and negatives that we ought to consider beyond those or quantify maybe the warranty impact as we head into Q4 just so we don't assume that EBITDA is flat also minus the $90,000,000 What else should we take into consideration?
Speaker 4
Yes. I mean, there's really three main things. You've got the $90,000,000 it's likely that some increase in the warranty expense in the fourth quarter. And then as I said in my prepared remarks, we trued up our variable compensation in the third quarter to catch up for our higher expectations. So I think it's unlikely now that we'll be truing up again in the fourth quarter.
JV income, despite all the comments just passed, directionally, I would expect that still to be a little bit lighter in China just based on seasonality. Still very strong, just to be clear, year over year, but just weaker into the fourth quarter. So those are really the big moving parts. And other than the volume, when we've converted that well when we've received it this year.
Speaker 2
Yes. And we hope the volume being higher in North America truck market is, you know, is is net positive towards towards incremental margins too. It's a good, you know, it's a it's a good market for us. We're operating at a reasonably efficient level, especially given all the challenges with COVID. COVID.
We're operating at a good level on North American truck market, so we're hopeful that that also helps some.
Speaker 12
Okay. And I think you mentioned also distribution. If aftermarket were to continue to accelerate, that should be a positive for mix also. Is that a fair statement?
Speaker 4
It is a fair statement, and it would it would benefit, you know, a number of businesses, but particularly distribution. Yeah.
Speaker 12
Thank you. I'll leave it there. Most of my other questions were answered. I appreciate it.
Speaker 4
Thanks, Dan.
Speaker 0
Thank you. Our next question is coming from Ross Gilardi from Bank of America. Your line is now live.
Speaker 13
Good morning, guys.
Speaker 4
Hi, Raj. How are you?
Speaker 13
Hey, good. Great. Thank you. Look. Clearly, your your overall results are are very strong and very impressive.
I I I realize that engines from mining and energy are not big parts of your company anymore. So sorry to focus there amidst the strong quarter, but but wanted to get your perspective on those two end markets. And I think you said mining engine shipments were down 39%. Was that actually worse than the second quarter? You mentioned coal.
And and are you starting to view mining or energy as more structurally challenged end markets for Cummins? Or is this just a cyclical downturn like prior downturns? And just beyond that, is there any real hope for a real pickup in either mining or energy in 2021? Or do these businesses potentially get worse or just kind of flatline at a low level before they get better?
Speaker 4
James will do the numbers for you, Ross, just to confirm, first of all.
Speaker 1
Ross. So on the mining engine sales side, as you mentioned, third quarter revenues were very similar to second quarter in Mining overall. And as you mentioned, we continue to see relatively stable demand in miners that are going to be focused more on iron ore and copper and continued weak demand more on the coal side of things. But we were flat sequentially on the mining revenues.
Speaker 4
And oil and gas was de minimis?
Speaker 1
Yes. Oil and gas, very de minimis. So sales in North America at this point on the oil and gas side for new engines, almost nothing. And we've also continued to see very weak
Speaker 2
Maybe just stepping back, I would just say that from a mining point of view, I I don't think we see it as a structurally challenged market. It it well, it's challenged in the following sense. There seems to be overshots and undershots a lot in the market. You know that well, and you know a lot of mining companies overshot by a lot in the last cycle and really got knocked back hard. And so needless to say, they're all being careful not overshooting now, which has meant that that equipment buying has been more muted even in in good markets than it was in the previous cycle.
So our expectation of of the cycle was that it wasn't gonna be as good as the last one, and sure enough, it hasn't been at all. And, of course, you know, just general, know, economic demand being dampened, confidence and future demand being dampened by the pandemic has meant that mining is indeed slow. And I I think it really won't get a lot stronger until there's confidence built in global economic growth, which means the end of the pandemic. I mean, really, I just don't see a way that it changes. Energy is a whole another conversation, and energy has a lot more structural challenge to it, but I'm not the right one to answer it.
As you say, we have a participation there, not a huge one. And so I think it's it's better for someone else to comment on that, but but it looks more structurally challenged to me than than some of the other markets.
Speaker 13
Okay. Thank you.
Speaker 1
Okay. Great. I think with that sorry.
Speaker 4
I'll turn
Speaker 0
the floor back over to you for any further or closing comments.
Speaker 1
Great. Thank you for that. So again, I just wanted to say thanks to everyone for taking the time to call in today. Appreciate that, as always, and for your continued interest in Cummins. And I'll be available for any follow-up questions here this afternoon.
Speaker 2
And let me add my thanks to James. I really appreciate your attention. I'm sorry that I did not invite my dog to this quarterly call. I'll try to include her on future calls. But it was nice to have a noise free call.
Thank you very much for your attention. Bye bye.
Speaker 0
Thank you.
Speaker 9
Thanks, everyone. Bye.
Speaker 0
That does conclude today's teleconference. You may disconnect your line at this time, and have a wonderful day. We thank you for your participation today.