Cummins Inc.
Q3 2020 Earnings Call Transcript

Published: 27 Oct 2020

[Operator:]

Greetings, and welcome to the Cummins Third Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. 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.

[James Hopkins:]

Thank you. Good morning, everyone, and welcome to our teleconference today to discuss Cummins’ results for the third quarter of 2020. Participating with me today are our Chairman and Chief Executive Officer, Tom Linebarger; our Chief Financial Officer, Mark Smith; and our President and Chief Operating Officer, Tony Satterthwaite. We will all be available for your questions at the end of the teleconference. Before we start, please note that some of the information 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-K and any subsequently filed quarterly reports on Form 10-Q. During the course of this call, we will be discussing certain non-GAAP financial measures, and we refer you to our website for the reconciliation of those measures to GAAP financial measures. Our press release with a copy of the financial statements and a copy of today's webcast presentation are available on our website at www.cummins.com under the heading of Investors and media. With that out of the way, we will begin with our Chairman and CEO, Tom Linebarger.

[Tom Linebarger:]

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 have now followed that with the largest sequential increase in sales in the company's history. Even with the dramatic increase, however, sales remained below last year's levels. While we have seen increased demand around 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 continue 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 market.

[Mark Smith:]

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 is 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 $5.1 billion, 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 million or 17.1% of sales for the quarter, compared to $958 million or 16.6% of sales a year ago, representing a decremental EBITDA of 13%. EBITDA dollars decreased by $82 million 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 pre-tax earnings by $44 million 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 $1.3 billion, 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 million in pre-tax charges, as we exited two unprofitable product lines. Selling, general and administrative expenses decreased by $67 million or 11% due to the benefits of restructuring, temporary salary reductions and reduced discretionary expenses, partially offset by the increased overall compensation. Research expenses decreased by $18 million or 7% from a year ago, but increased by $35 million 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 million, but 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 million decreased by $40 million compared to a year ago. Last year, we recognized a onetime $35 million cash gain related to the company's foreign exchange hedging program, which did not repeat this year. Net earnings for the quarter were $501 million or $3.36 per diluted share compared to $622 million 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 million or $0.21 per diluted share. After a tough second quarter, operating cash flow rebounded to a record inflow of $1.2 billion in the third quarter, driven by strong profitability and lower working capital levels. Our inventory decreased by $185 million in the quarter, even as sales increased 33% from second quarter levels. Capital expenditures was $116 million in the quarter, down from $153 million a year ago. We expect full year capital expenditures to be in the range of $500 million to $525 million, 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 million of cash dividends paid out. In August, the company completed an aggregate $2 billion debt offering of 5, 10 and 30-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 at A+ 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 $6.5 billion at the end of 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 11th 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 been eased and some economic activities increasing. In China, where demand has been at record levels over the last 6 months, we expect to experience some seasonal declines in the fourth quarter, but demand remained at relatively strong levels. The temporary salary reduction that went into effect in mid-April ended at the end of September as planned. The restoration of salaries will add approximately $90 million 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 6 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 capital to shareholders. Finally, as Tom previously mentioned, we'll be holding our Hydrogen Day on November 16th, where we will highlight our participation in 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.

[James Hopkins:]

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.

[Operator:]

Thank you. Our first question today is coming from Stephen Volkmann from Jefferies. Your line is now live.

[Stephen Volkmann:]

Thank you.

[Mark Smith:]

Hello?

[Stephen Volkmann:]

Can you guys hear me okay?

[Mark Smith:]

Yeah, obviously.

[Stephen Volkmann:]

Okay, good. Sorry. So yeah, my question, maybe this is a Mark question, I don't know, but I'm trying to just see if I can disaggregate your temporary cost activities from your restructuring benefits? And obviously, I'm trying to start to think about 2021 and figure out what you get to keep and kind of what you have to give back. Can you give us some help with that?

[Mark Smith:]

You'll remember that we implemented a temporary salary reductions in the middle of April, Steve. So when you do the math, it's about $165 million of full year lower expenses in 2020. Obviously, that will not repeat. We've 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 million to $300 million in the current year as anticipated.

[Stephen Volkmann:]

Okay. I guess what -- that's sort of where I'm trying to go, Mark, is how should we think about incremental margins, assuming there's some small increment next year? Low decrementals, kind of maybe employ low incrementals, but maybe not if you're getting a good chunk of restructuring benefits.

[Mark Smith:]

Yeah. I think, just at this point, so it's a very -- I understand the question. It's just too early even to assess our market conditions next year. But you will -- you can see from our results today that we're pushing on all the levers, productivity gains that we can. It's just too early beyond the obvious items to comment much on next year.

[Stephen Volkmann:]

Okay, thanks. Worth a try. Appreciate it.

[Mark Smith:]

Thank you.

[James Hopkins:]

Thanks, Steve.

[Operator:]

Thank you. Our next question today is coming from Courtney Yakavonis from Morgan Stanley. Your line is now live.

[Courtney Yakavonis:]

Hi, thanks guys. If you can just comment a little bit more on the guidance that 4Q revenues would be similar to 3Q relative to kind of some of the strength we saw in the international markets versus the increases that we're expecting in North America, if you can just help us understand that? And then relative to what you're expecting in parts relative to the engine side? Thanks.

[Mark Smith:]

So the strength in international market, all being flat, lower down to 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 touch China, whether within the component business, even our construction business, within the engine business, data center orders for the power systems, anything that touch China was pretty much up year-over-year. And so that's really what – you're all flat international revenues for the quarter. It's typical currently that we see some seasonal weakening going into the third – 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 – 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 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.

[Operator:]

Thanks. Our next question is coming from Jamie Cook from Crédit Suisse. Your line is now live.

[Jamie Cook:]

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's 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 billion 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, you know, start to thinking about putting that cash to use? Thanks.

[Mark Smith:]

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 years we've been pleased with the progress this year Jamie. I think then, you know, then we're really looking to see, you know, as parts and service which, you know, have been down, probably more, more than in prior cycles due to the severity of the impact of COVID. How that recovers in future years. So I think, 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 looking to build on revenue growth going forward. So avoid given a specific target Tony?

[Tony Satterthwaite:]

Yes, I would just add Jamie, you know, revenue has been a little weaker in this downturn and DBU than previous downturns. And so we've been really pleased with the cost performance and the restructuring and focusing going forward is going to be on how do we see better revenue growth as that business comes back? And how do we gain some share in the parts and service business in particular? So that's what 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.

[Jamie Cook:]

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?

[Tony Satterthwaite:]

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. Yes.

[Jamie Cook:]

Okay. Mark, and then on your cash – sorry, go ahead.

[Tom Linebarger:]

Yes, it's Tom. I mean just to make sure I get them – you get the math right. So our view 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 service decline. So our view is that, that we are on our plan despite pretty heavy headwinds. So we are not only feeling good about where we are, but we're more confident than ever that we're going to be in double-digit margins from now forward. So again, you can imagine some scenarios with COVID that would make it so you might have a quarter or 2 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's just -- on the cash side, I'll let Mark fill in some more. But I mean, broadly speaking, we've 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 good about the position the company is in and expect, barring some significant change in economic conditions, to return to our cash flow plans that we've been operating under for many years. So our plan is to go back to returning as a normalized level, half of our cash flow in dividends and share buybacks. 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.

[Mark Smith:]

Yes. I think we've made it clear, we're not trying to hold cash a little -- being cautious this year but I think Tom has made it clear going forward.

[Jamie Cook:]

Okay. I appreciate the color. Thank you.

[Operator:]

Thanks. Our next question today is coming from Adam Uhlman from Cleveland Research. Your line is now live.

[Adam Uhlman:]

Hey guys. Good morning. I was hoping to get your perspective on heavy truck markets. I guess we've seen this spike in spot rates and the orders have been soaring. I guess I'm just wondering how sustainable do you think that is? And 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 how the cycle plays out from here that would be helpful.

[Tom Linebarger:]

Tony?

[Tony Satterthwaite:]

Sure, Adam. We're all waiting. Sorry. We're not together, Adam. So this is Tony. Yes. It's been very pleasing to see the growth, particularly in the last couple of 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 is going to play out next year. I do think that there is a view that demand is higher, 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 OEM customers 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 all the things going on and make sure that we are ready if things come in stronger and we're prepared if things all of a sudden take a downturn. So the main characteristic of this COVID environment is unpredictability and volatility. And so we're just trying to be ready for that as best we can.

[Mark Smith:]

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.

[Adam Uhlman:]

Okay. Got you. And then Mark, the – with these new products coming out for 2021, I guess, the company has been benefiting from lower warranty expense, and there's some structural actions going on there. Should we expect a pause in lower warranty expense next year, or do you think we have more legs lower as you execute on your strategic initiatives? Thanks.

[Mark Smith:]

Thanks, Adam. Really good question. I think on the one end, of course, we're always driving for more improvement, but I would say that our expenses at 1.8% or 1.9% of sales for this year have run below expectations. And the principal drivers of the warranty performance are field performance of existing products, field campaigns, and then over a longer period of time, changing emission regulations and then the launch of new products. So – you're right, the launch of new products will continue. We typically start those with higher warranty rates. And this year, 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 shouldn't be looking in 1.8% for now as a run rate. So yeah, we'll provide you with an update on that when we get into next year, some tick up from here should be expect – we even expected something this quarter. But that's where we are right now.

[Adam Uhlman:]

Thanks. Operator

[Joel Tiss:]

Hi. How is it going guys?

[Tom Linebarger:]

Hi, Joe.

[Joel Tiss:]

I wonder, Tony, or – can you talk a little bit about any product lines that have been, like, systematically challenged? And I'm thinking over a couple of years, not just because of this. And any areas that you could like do product line simplification and reduce some of that exposure to drive the gross margins higher, or you're always doing that, and there's nothing that really stands out?

[Tony Satterthwaite:]

Hey, Joe, I'll go first. I think 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 – 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 yeah, 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 we would never.

[Joel Tiss:]

And I wonder if you can talk about the M&A environment out there and what you guys are focused on is – 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 area would you be thinking about?

[Tom Linebarger:]

I think – it's Tom. I can step in on that. I mean, for sure, in the second quarter, we were on pause a little bit, making sure that our balance sheet was shored up. But with all the potential outcomes, we took a pause. But 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 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 wrote a call from our previous calls or Investor Day that we kind of 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're all the areas where we feel like our competitive advantages, 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 battery companies, those were to add new capabilities. So, we're continuing to look in those same areas. I think maybe the one comment I would make is that I expected, given the disruption for valuations to be lower today, so I was -- as you -- kind of like the basis of your question, I expect it, 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 -- and it's maybe because of the private equity dollars are so large. But I would say as we look around using disciplined method to look at what acquisition would mean for our company. I still see acquisition prices relatively lofty. So, we'll continue to look, and we're continuing to talk to people and look for the right thing. But we will just -- we'll remain disciplined and look for the right things at the right price, and we find it, we'll act. And if we don't, we'll return more cash to shareholders just like we planned.

[Joel Tiss:]

All right. Thank you very much.

[Operator:]

Thank you. Your next question is coming from Jerry Revich from Goldman Sachs. Your line is now live.

[Jerry Revich:]

Yes, hi. Good morning everyone.

[Tom Linebarger:]

Hi.

[Mark Smith:]

Hey Jerry.

[Jerry Revich:]

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?

[Tom Linebarger:]

Jerry, here's the thing. I would say that every customer that we're talking to is doing exactly that pencil sharpening calculations that you talked about. It's a really different environment than it was 10 or 15 years ago, or 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 until there's a deal, right? So, again, I can't really preannounce or suggest anyone who's going to go because they're -- they're difficult decisions for them to figure out what they want to 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 expect market share increase in the future based on the fact that they will decide that their money be spent elsewhere. Exactly where and when, again, I just -- 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 they have a lot of strategic considerations to make as do we. So, these conversations are complicated in -- and take time. But anyway, there you are. We're in it for sure, and we're -- and I'm confident that we will win increased share.

[Jerry Revich:]

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. And 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, where – could get hit by the second wave, and we don't want to get into a situation where if it's worse, we're missing numbers. Is there some conservatism in there or other pieces that you're legitimately concerned with?

[Mark Smith:]

Yes. The numbers will be what the numbers will be, Jerry. I mean we've been very focused on cost. And then Tony and the team are on this incredible ramp back up again. But let's just use the pickup truck market as an example. If you just said at Q3 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 Q2, you would say it's 0, right? So you just can't normalize everything that happened in Q3 and say, flat means everything is flat. So I think there will be some rebalancing in some markets. But again, we'll see where it is. Our focus is on cost and delivery and then delivering the calendar results that go with whatever volume were thrown them.

[Tom Linebarger:]

And Jerry as Tony said, we are encouraged by tough market. As these clients said to us, all of customers are projecting stronger volumes which is great for us. So yes we are always cautious, because that’s how we live. But nonetheless we are encouraged by their comments and their vehicles to the market, they are watching fleet customer and what they're ordering, and we're hearing good things from the fleets, too. So yes, we are very encouraged. In China, while we expect seasonal demand, we don't expect a gigantic drop off. We just expect seasonal demand normal. It's just the thing is flying so high now that -- again, we just remain cautious. So just don't hear from us discouragement. We are – the markets are going well, and 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 cautious attitude that's appropriate for a global pandemic.

[Jerry Revich:]

Glad to hear. Thank you.

[Operator:]

Thanks. Our next question today is coming from David Raso from Evercore ISI. Your line is now live.

[David Raso:]

Hi, thank you. 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 inefficiency 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 what we might not get back to those revenues, are the domestic margins set up in a way where they could be maybe a little closer to '19 than otherwise, given some 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 '21 for China as that business is debatable, if it's up or not next year. So I just would appreciate your thoughts for an early framework on '21 engine margins?

[Tom Linebarger:]

Well, within China, there are a number of moving parts, David that will add to the complexity. We're expecting a bigger step-up in the penetration of NS VI products. What that will happen to demand. The take up is all to be figured out there. So yeah, we're not in a position right now to give you 2021. I guess Q3 margins were higher than normal for a couple of the factors that we've laid out. But we're still going through our planning cycle for next year as we speak. So not as we speak, but after we speak here, we'll be back on that again here shortly. So it's just too early to say, given everything that's going on. Look, I would just say we are very pleased with 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, North America and China has been primary. But yeah, we're not ready to give guidance next year. I appreciate you're asking. We'll look forward to giving an update with Q4 earnings.

[David Raso:]

Would you mind just to 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 you 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 VI content or increase with photon and so forth? Can you help us a little bit, just frame it?

[Mark Smith:]

Yeah. I'll just make a couple of comments, and then James can maybe give you some numbers. But I think this, kind of, couple of dynamics. One, so there's the 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 saw -- we specify the after-treatment systems are an integral part of our engine system design. James will give you the numbers in a moment. We hope then, as we move in through these more advanced missions regulations, that we can continue to pick up share. We feel like our NS VI products have been well received. And our penetration of photon has already been really accelerating over the last couple of years. We're already up to 80%. And it's encouraging to see photons been 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.

[James Hopkins:]

Yeah. And David, from a revenue impact of that, we've talked broadly before, both between the emissions content in China and in India. That will be roughly $600 million of incremental revenue, and that primarily hits our component segment. I think in addition to that, Tom mentioned in his remarks excitement about the endurant transmission that we're selling 1,000 units out 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. And so I think that is also some self-help as we look into 2021.

[Tom Linebarger:]

David, this is Tom. As you kind of think through the model, the numbers for this year are so high in the truck market. This is what Mark's saying that right now, it's just hard for us to do that. The weighing one or the other because we know what the content is. We know we've won the share with. We even have forecast for how we think it converts over to NS VI and what growth we see in transmissions. The challenge is just what's the overall market going to be. And we were wrong this year. I mean just to say it straight out, we had pretty 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, 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 slope down is.

[David Raso:]

Yes. I mean that's what's interesting, Tom. I mean historically, your order book could be accelerating every time on the call, you want to say, well, China is going to slow down. And a lot of times, it doesn't. And in this environment, you'd almost say we're at such a high level. And you've seen Volvo and so forth already forecast China down next year. You know, betting man would have said like, well, knowing Tom's history or the way he looks 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 what you're seeing enough internally in your own opportunities, it's still an open question, which estimates a little more positive than I would have thought.

[Tom Linebarger:]

So yes, you're right about it. 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 – and accept it. That hasn't been right. And so anyway, I think it's a good point you raise.

[David Raso:]

I appreciate it. Thank you.

[Operator:]

Thanks. Our next question today is coming from Ann Duignan from JPMorgan. Your line is now live.

[Ann Duignan:]

Yes. Hi, I'd like to go back to Q4. I mean you've guided to revenue flattish quarter-over-quarter. You called out $90 million 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 million. What else should we take into consideration?

[Mark Smith:]

Yes. I mean, there's really three main things. There's – you've got the $90 million – it's likely there's 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 expectation. So I think it's unlikely now that we'll be showing 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. It's 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 – and we've converted that well when we've received it this year.

[Tom Linebarger:]

Yes. And we hope the volume being higher in the North America truck market is net positive towards incremental margins, too. It's a good market for us. And we're operating at a reasonably efficient level, especially given all the challenges as COVID. We're operating at a good level on North American truck market. So we're hopeful that, that also helps us some.

[Ann Duignan:]

Okay. And I think you mentioned also on distribution. If aftermarket were to continue to accelerate, that should be a positive for mix also. Is that a fair statement?

[Mark Smith:]

It is a first statement, and it would benefit a number of businesses, but particularly distribution, yes.

[Ann Duignan:]

Okay. Thank you. I’ll leave it there. As most of my other questions are answered. Appreciate it.

[Tom Linebarger:]

Thanks, Ann.

[Operator:]

Thanks. Our next question is coming from Ross Gilardi from Bank of America. Your line is now live.

[Ross Gilardi:]

Good morning, guys.

[Tom Linebarger:]

Hi, Ross.

[Mark Smith:]

Hi. How are you?

[Ross Gilardi:]

Okay. Great. Thank you. Look, clearly, your overall results are very strong and very impressive. I realize that engines from mining and energy are not big parts of your company anymore, so sorry to focus there. I missed the strong quarter, 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 in the second quarter? You mentioned coal, 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 flat line at a low level before they get better?

[Mark Smith:]

James will do the numbers for you, Ross, just to confirm, first of all.

[James Hopkins:]

Yes. Ross, so on the mining engine sales side, as you mentioned, third quarter revenues were very similar to second quarter in the 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 along the coal side of things. But we were flat sequentially on the mining revenues.

[Ross Gilardi:]

And oil and gas was de minimis?

[James Hopkins:]

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 demand in oil and gas markets in relation to rebuilds, really kind of highlighting the fact that there are rigs that are not currently being utilized in the market.

[Tom Linebarger:]

And, Ross, maybe just stepping back, I would just say that from a mining point of view, I don't think we see it as a structurally challenged market. Well, it's challenged in the following sense. There tends to be over shots and under shots 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 equipment buying has been more muted, even in good markets, than it was in the previous cycle. So our expectation of the cycle was that it wasn't going to be as good as the last one, I'm sure enough it hasn't been at all. And of course, just general economic demand being dampened, confidence in future demand being dampened by the pandemic has meant that mining is indeed slow. And 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 better for someone else to comment on that. But it looks more structurally challenged to me than some of the other markets.

[Ross Gilardi:]

Yes. Thank you.

[James Hopkins:]

Okay, great. I think with that, that -- sorry.

[Operator:]

I'll turn the floor back over to you for any further or closing comments.

[Tom Linebarger:]

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.

[Mark Smith:]

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 t include her on future calls, but it was nice to have a noise-free call. Thank you very much for your attention. Bye-bye.

[Tom Linebarger:]

Thanks everyone. Bye.

[Operator:]

Thank you. 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.