Cummins Inc.

Greetings and welcome to the Cummins Second Quarter 2020 Earnings Conference Call. At this time, all participants are on listen-only mode. A question and answer session will follow the formal presentation. If you would like to ask a question, please press star zero on your telephone keypad. If anyone should require operator assistance during the conference, please press star zero on your telephone keypad. 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.

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 Leinbarger, 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 statements 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 in Media. With that out of the way, we'll begin with our chairman and CEO, Tom Weinberger.

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 to 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 organizations face some of the most significant demand fluctuations in the company's history, along with managing through 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 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 and global rollout 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 has 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 four 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. 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 component 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 system 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 benefits 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 X-12 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 X-12 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. 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. 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 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 transitioned 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 from the 13% in the second quarter of 2019 due to the strong performance of our X-12 engine with fleet customers. Fleet customers now represent 20% of the market in China. and may 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 NS6 products across the country next year. Industry interest in automated manual transmissions has also increased, and we currently expect to sell over 1,000 Endurance 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 MS6 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. Industry's 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-6 standards on April 1st, which will result in additional revenues for our components business. We've added Ashok Leyland as a new customer of our Emissions Solutions business. During the second quarter, we also finalized an agreement with Mahindra, an Indian truck and tractor company, to supply an on-highway four-cylinder BS6 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 remains stable among copper and iron ore miners, where commodity prices have risen by over 30% compared to their April lows. In contrast, coal prices remained 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. 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 will start selling electric powertrains to CalMar for use in the thermal tractor market in late 2021. We expect adoption of battery electric power chains 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, two 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, shifts, data centers, and on-highway vehicles. We have fuel cell-powered trucks running today 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 PAM hydrogen electrolysis plant in the world with Arlequia. The 20 megawatt facility in Beconcourt, Canada will be capable of producing 3000 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 16th. 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 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, while we expect declines in 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 and demand. We are prepared for a range of demand scenarios and know that these may differ by region and 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 costs 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 customer success and deliver even stronger financial performance. Now, let me turn it over to Mark.

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. 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 improved 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 for the 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 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 at $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 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 ramped down global production in April and flexed up in May and June, while executing on our cost reduction initiatives. 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 the 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 restored 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. 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. If you have additional questions, to please rejoin the queue. Operator, with that, we are now ready for our first question.

Thank you. The floor is now open for questions. If you would like to ask a question, please press star 1 on your telephone keypad at this time. A confirmation tone will indicate your line is in the question queue. You may press star 2 if you would like to remove your question from the queue. For participants using speaker equipment, it may be necessary to pick up your handset before pressing the star keys. And as just mentioned, we do ask that you please keep yourself to one question and one follow-up before rejoining the queue for any additional questions. Our first question today is coming from Andy Casey of Wells Fargo. Please go ahead.

Thank you. Good morning, everybody. 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?

I think, Andy, we are, you know, as you know, demand for capital goods in China is typically seasonally weaker in the second half of the year than 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. We have some visibility, but not perfect visibility.

Okay, thanks, Mark. And then, you know, kind of an 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, you know, how scalable is that across applications, you know, which is see a benefit from potential multiple market application versus, you know, just focusing on highway?

Hi, Eddie. It's Tom Weinberger. 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'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 the related components. And that volume will increase. 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 and a lot more sacks. So we will be delivering in those trains pretty high volumes of fuel cells that will allow us to move to more cost-effective manufacturing technology as well as other supporting components, being able to buy those at a lower cost. So there's clearly scale opportunities, and there's also some application-specific work necessary and controls in other areas to make it work in a specific application.

Okay. Thanks a lot, Tom. I'll pass it on. Thanks, Andy.

Thank you. Our next question is coming from Jerry Reavage of Goldman Sachs. Please go ahead.

Yes, hi, good morning, everyone. Hi, Jerry. Good morning.

Tom, I'm wondering if you could talk about the opportunity in electrolyzers versus fuel cell. Presumably, you know, market size could be significantly larger for electrolyzers. How big of a focus is that for you folks compared to fuel cell? And, you know, can you talk about any desire to accelerate that? the R&D investment in those areas, given growing regulatory momentum for hydrogen, you know, beyond what we spoke about at the end of the day.

Thanks for the question, Jerry. And, you know, 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 as you saw, the Europeans will enroll out their large, and they're available now. So we are expanding our investment in hydrogen. 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 did this during venture with Enflox, 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.

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?

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, You know, fuel cells, it depends on what percentage of the truck market they eventually win and that sort of thing. But, you know, definitely it's a wider field. Let's just agree that. It's a wider field. So if you participated in every part of generating hydrogen, it would be larger. No question about it because we could 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 on the market sooner.

Okay. It's terrific. I appreciate the discussion. Thanks. Yeah. Thank you.

Thank you. Our next question is from J.P. Morgan. Please go ahead.

Hi. Good morning, and thank you. I'd love to keep going on the hydrogen industry. pieces, but maybe I'll step back and ask about Q3 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 costs 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. Thank you.

Hi, Anne. 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, but the impact, 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 runway, which will be in Q3, it'll be about $90 million that comes back in the fourth quarter.

Okay, I appreciate the color. That's helpful. And then just taking a step back, you know, 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, you know, temporary COVID versus, you know, I know you said truck sales were down 70, what, 90% plus, but what are you seeing there more broadly in India?

Hey, 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, you know, weak activity and the COVID challenge, you know, if anything, increasing in India.

Okay. I appreciate the color, and I'll pass it on. Thank you. Thanks, Anne.

Thank you. Our next question is coming from Jamie Cook of Credit Suisse. Please go ahead.

Hi. Good morning. Nice quarter. I guess my first question, you know, 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 you know, your G&A control, you know, was pretty impressive in a quarter. So as you look forward, will there be incremental opportunities to reduce your structural costs beyond the $250,000 to $300,000 that you guys outlined in November? Thank you.

Hey, Mark, I'll take the first one, and you can take the second one. Jamie, you know, the real thing that happened in the second quarter was our OEM shutdowns, and the real difference between June and April and May was that Most everyone was back at work in June. And so, you know, 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 startups were pretty fast, and I want to echo Tom's comments about our supply chain team's ability to keep up with ROEMs in June. So that's been one of the interesting aspects, at least, of this, that the startup 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 ROEMs.

Okay, thank you. And then Mark on costs.

Yeah, so I think, thanks, Jeremy, and good morning. You know, 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 battening down costs. We're always looking for ways to take more costs out and what can we learn from this period so that we, you know, as revenues recover, you know, 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, you know, hopefully we're looking at a different revenue environment, but it's too early to say. But yes, we can, 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. You know, 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 aim the restructuring at the SG&A at the start of the year, and it's helped a lot.

This is Tom. Good morning to you. Good morning. 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. You know, we had a sales estimate for the year, and we aimed the cost of 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, you know, where we're going to level out on sales between the lowest level we hit and where our original estimate for 2020 was in 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, you know, we will continue to look at actions 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 our SAR or SG&A, you know, 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 and it looks like we're getting back to kind of where we thought we would be, then we'll be there thereabouts and we'll have to do relatively modest things. 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 will roll it into our planning work this fall. But, you know, we have already been looking at that and asking ourselves, you know, 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.

Okay, thank you. That's very helpful. Congrats again on a nice quarter.

Thank you. Our next question is coming from Stephen Fisher of UBS. Please go ahead.

Thanks. Good morning. Just with the better revenues that you shake in Q3 versus Q2, And 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?

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, you know, we've weathered through the toughest comps in the first half of the year. They 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 are kind of set the course now for the rest of the year, and really the revenue is going to drive the numbers from here.

So I guess on that point, Mark, I guess in terms of, or Tom, 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, 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 our least certain?

I see. We don't have a lot of backlog. The only place we really get backlog is in 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 and decreasing production, and so how they change their production week to week influences what their demand on us is. Here's what we're seeing, though. Let me just 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. 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's 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 if you took that exact movie we just talked about and played it 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 about demand trends. We are where we are in the sense that we see things stabilizing and increasing slightly month by month in tough markets in Europe and the U.S. and things like that. And our concern about China is it was just so hot for a quarter. We just don't understand how it sustained 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 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.

Yep, that's helpful to see how you're thinking about it. Thanks very much, guys. Thanks, Steve.

Thank you. Our next question is coming from David Ratso of Evercore ISI. Please go ahead.

Hi, thank you. 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 sequential EPS should grow from 2Q. Nothing you highlighted would suggest that's not the case. But then the fourth quarter, you have about 40 to 45 cents EPS cost coming back. So just to give us some baseline, I know you're not going to give, you know, guidance, but just a baseline. Do you think your second quarter EPS was the bottom EPS for the year, quarterly EPS?

Too early to say, you know, because we don't have visibility beyond the third quarter.

I would agree, David. And 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 Europe and 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 red-hot China, and that will kind of more than offset it, and that will also offset the cost coming back in the business. But 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. Here in Indiana, where we're headquartered, They just put in a new mask order just this Monday. So we just don't know where that heads. And I know, 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 open fourth quarter is where things start to kick up. That's when the temporary costs can 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.

That's fair. I mean, I'm just trying to think about we get nice EPS growth sequentially through Q. If the negative scenario plays out for 4Q, can you pull back on the 45, 40 cent EPS hit from the cost coming back? Or is that sort of written in stone for the employee comp for fourth quarter?

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 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 our feeling about restructuring is that if it comes – if we feel like the – revenues will not really come back. I mean, 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 not a sustained downtrend or are they – 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 be keeping the cost in that we think has everything to do with the growth and profitability of the future of the company. So 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. 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, you know, then Q2 will be our lowest. If it doesn't, then it won't. Right. If it starts to drop again, then it won't.

And, Tom, related to that, 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 ISX 15 liters laying around. versus maybe an off-highway, you don't want too much inventory. Can you help us a bit where the inventory lies within the company?

Hey, David, this is Tony. Yeah. Hey, David, this is Tony. Yeah. You know, we are not happy. Tom and Mark 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 as you can see from our balance sheet, AP has fallen significantly. So we have definitely reduced 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, you know, we were just managing these, you know, 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.

Thank you very much for the detail. I appreciate it.

Thank you. Our next question is from Poppenheimer. Please go ahead.

Thanks very much. One more short-term question here. You know, industrial is potentially down year over year, but potentially flat quarterly, despite, you know, a very volatile oil price environment and a big count decline. So that seems encouraging. Can you talk about the monthly trends we've seen in that business, any sequential improvement throughout the quarter as oil prices picked up? Any line of supply for support in ONG or perhaps in mining?

Yeah, 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 the copper and iron ore, whereas coal and those OEMs that cover coal 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 and gas, I would argue, is very quiet. We've seen reductions in new engine sales, but also in our aftermarket business that serves that is also looking quite weak.

Okay. Thanks for that, Tony. And then just one more. I mean, there's really solid margin performance in the distribution segment. I know you've Talk about, you know, your priorities at Investor Day in terms of transforming that business. You know, 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?

Yeah, thanks for the question. We're very pleased with how the distribution business performed and specifically how that transformation work is progressing. The downturn, 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, the way we're now running the business, which was a big change from a regional focus to a market focus transition. 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 demand. people cost and therefore they benefited more from the salary reductions and the variable comp reductions just because that business is so people heavy. But we still, I 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.

Great to hear. Thank you.

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 interesting comments, and I'll be available for any follow-ups this afternoon. Thanks very much.

James, I just want to add my thanks as well and 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.