Cummins Inc

NYSE:CMI

Earnings Call Transcript 2020-Q2

[Operator]

Greetings, and welcome to the Cummins Second Quarter 2020 Earnings Conference Call. At this time, all participants are in a listen-only mode [Operator Instructions]. As a reminder, this conference is being recorded.

It is now my pleasure to introduce your host Mr. James Hopkins, Executive Director of Investor Relations. Thank you, sir. You may begin.

[James Hopkins, Executive Director of Investor Relations]

Thank you. Good morning, everyone, and welcome to our teleconference today to discuss Cummins’ results for the second quarter of 2020. Participating with me today are our Chairman and Chief Executive Officer, Tom Linebarger; our Chief Financial Officer, Mark Smith; and our President and Chief Operating Officer, Tony Satterthwaite. We will all be available for your questions at the end of the teleconference.

Before we start, please note that some of the information that you will hear or be given today, will consist of forward-looking statements within the meaning of the Securities Exchange Act of 1934. Such statements express our forecasts, expectations, hopes, beliefs and intentions on strategies regarding the future. Our actual future results could differ materially from those projected in such forward-looking statements because of a number of risks and uncertainties. More information regarding such risks and uncertainties is available in the forward-looking disclosure statement in the slide deck, and our filings with the Securities and Exchange Commission, particularly the Risk Factor section of our most recently filed annual report on Form 10-K and any subsequent 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 Web site at www.cummins.com under the heading of Investors and Media.

With that out of the way, we’ll begin with our Chairman and CEO, Tom Linebarger.

[Tom Linebarger, Chairman and Chief Executive Officer]

Thank you, James. 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 and demand this quarter. In April, over 70% of OEM sites that we ship to experienced full shutdowns at 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 results of these shutdowns and managed reopenings was the largest decline in revenue in the company’s history.

There’s series of actions, including restructuring at the beginning of the year, temporary salary reductions and other discretionary spending cut, 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 head counts and cutting pay are the last options that we used to manage expenses given the impact on our people. While the actions we've taken this year have been necessary, I want to take this opportunity to acknowledge and thank employees for the sacrifices they're 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 faced some of the most significant demand fluctuations in the company's history, along with managing through the impacts of OEM and supplier shutdown, many of which occurred with little or no notice. If this was not enough of a challenge, we've had to rethink how we work in manufacturing and distribution facilities. Adjusting layouts, staffing patterns, instituting health checks, all to ensure employee safety and lower the risk of transmission.

Outside of our manufacturing and distribution locations, many of our engineers and office employees are still working all or part time from home. This has presented its own set of challenges from ensuring engineers can collaborate and maintain product development schedule to the rapid introduction and global roll out of new tools and network capacity up by our Archie and shared services 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 peoples 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 remain 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 filled 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 Components segment declined by 38%.

Sales in North America declined 55%, driven by lower truck build rates, while revenues in international markets declined by 9% as a result of lower truck demand in Europe and India. Revenues in China increased 63% and represented a new quarterly record for the Components group. EBITDA for the second quarter was $141 million or 12.3% compared to 16.1% in the same quarter a year ago. EBITDA percent decreased as the impact of lower volumes was partially offset by the benefits of restructuring, temporary salary reductions and reduced warranty costs.

Power Systems sales in the second quarter declined 35% year over year. Industrial sales declined 33%, driven by continued weakness in oil, and gas and mining markets. Power generation sales decreased by 37% with lower revenues in both North America and international markets. EBITDA in the second quarter was 11.7% compared to 14.4% a year ago. The impact of lower volumes, again, more than offset the benefit of cost reduction actions and lower warranty expense. In the new power business, EBITDA was a loss of $38 million in the second quarter, in line with our expectations.

Now I will comment on some of our key markets, starting with North America and then we'll cover some of our largest international markets. Our second quarter revenues in North America declined 48% to $2 billion. We experience lower demand in all end markets with OEM shutdowns impacting build rates, trucks and in construction equipment. Power generation shipments declined due to project delays. And our parts and service business was negatively impacted by end users delaying vehicle maintenance. Industry production of heavy duty trucks declined 71% in the second quarter compared to a year ago and 54% sequentially. Year-to-date, our market share is 33%, an increase from the second half of 2019 even as industry production declined. We began shipments of our X12 engine to Freightliner for use in their Cascadia Day and sleeper cab models this quarter. Our entry into their regional haul market with a low weight X12 will further support our leading share in this market.

Production of medium duty trucks decreased by 61% in the second quarter. We continue to maintain our clear market share in the medium duty truck market with over 80% of new trucks powered by Cummins powertrains in 2020. Total shipments to our North American pickup truck customers decreased 71% compared to a year ago, and we're impacted by OEM shutdowns during the second quarter.

In domestic off highway market, 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 and oil and gas markets declined by 88% due to reduction in equipment purchases of new fracking equipment. Our aftermarket sales in North America fell 25% compared to last year, and were negatively impacted by low truck utilization, especially in April May, industry destocking activity and customers’ delaying scheduled maintenance.

Now let's 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 facility’s transition from full shutdown in March to making a record number of engines, turbochargers and aftertreatment 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 NS6 trucks. Our market share was 15%, up from the 13% in the second quarter of 2019 due to the strong performance of our X12 engine with fleet customers.

Fleet customers now represent 20% of the market in China, and they continue to transition to a total cost of ownership model, focusing on fuel economy and reliability. We expect this trend to continue, providing opportunities to increase our market share as we launch our 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 Endurant AMTs in China by the end of this year.

Industry sales of light duty trucks increased by 43% in the second quarter and our market share were 8%, flat with last year. In cities where the NS6 regulations are already at 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 in 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 is 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 o BS-VI standards on April 1st, which will result in additional revenues for our components business. And we've added Ashok Leyland as new customer of our Emission Solutions business. During the second quarter, we also finalized an agreement Mahindra, an Indian truck and tractor company, to supply an on highway four cylinder BS-VI compliant engine, further cementing our leading position in the India truck market.

Outside of India and China, we saw year over year revenue declines of 29% in Europe and 59% in Latin America, primarily due to lower truck production, driven by COVID related OEM shutdowns. Global sales of mining engines declined 35% compared to a year ago. Demand 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 remain below $50 per metric ton, resulting in lower demand for equipment by coal miners.

While demand was weak across most of our markets during the second quarter, we continue to strengthen existing relationships with OEM and developing new customers for our products. We are working hard to support our customers and partnering in new ways during this challenging period, enabling us to benefit when markets recover and driving improved market share in the future.

While we continue to strengthen our position in diesel and natural gas markets, we're also focused on opportunities for our new power segment. We have 200 Cummins powered battery electric buses in service throughout North America, and we'll start selling electric powertrains to Kalmar for using the terminal tractor market in late 2021. We expect adoption of battery electric powertrains to increase in bus and terminal tractor markets over the next several years, but 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 and product uptime. And 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 applications, including trains, ships, data centers and on highway vehicles. We have fuel cell powered trucks running to date in both Europe and North America.

In addition to the opportunities we see in fuel cells, we have a leading portfolio of both alkaline and PEM electrolyzers, which will be a critical part of the infrastructure to support the hydrogen economy. Our portfolio of electrolyzers are already being utilized in a variety of applications today, including on site hydrogen production for fueling stations, industrial applications and more recently in larger scale power to gas applications. In the second half of 2020, we will complete the largest PEM hydrogen electrolysis plant in the world with Air Liquide. The 20 megawatt facility in Becancour, Canada will be capable of producing 3,000 tons of hydrogen annually.

With a leading product portfolio and a presence in Europe, North America and China, our hydrogen business is well positioned to grow as investments in hydrogen production and fuel cells increase around the world. To more fully discuss how he 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 third quarter to increase from second quarter levels in all regions except China, where we expect the clients from the record levels we experienced the second quarter. The pace of market recovery will defer though from region to region and may change based on government actions, both to control the spread of COVID-19 and/or to simulate their economies and build business and consumer confidence.

Our leadership team is very experienced in managing through period of volatility and demand. We are prepared for a range of demand scenarios and know that these may defer by region and end market as the full impact of COVID-19 becomes clear. 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 continue 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.

[Mark Smith, Chief Financial Officer]

Thank you, Tom and good morning everyone. The COVID-19 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 help to protect profitability and cash flow in the face of a very uncertain economic environment. Second quarter revenues were $3.9 billion, a decrease of 38% from a year ago. Sales in North America at 48% and international revenues declined 22%. Currency movements negatively impacted revenues by 2%. As Tom said, China was the only major market in which our revenues increased year-over-year.

Earnings before interest, and tax, depreciation and amortization or EBITDA, were $549 million or 14.3% of sales for the quarter compared to $1.1 billion or 17% of sales a year ago. EBITDA decreased by $500 million, driven primarily by the negative impact of weaker sales, partially offset by lower compensation expenses due to temporary salary reductions and lower variable compensation expenses. Results also benefited from the restructuring actions announced at the end of 2019 and record joint venture income in China.

The temporary salary -- reduction in salaries went into effect in the middle of April and reduced expenses by approximately $75 million in the second, 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 increased by $53 million in the quarter, mainly in our manufacturing facilities. There's a wave of global customer shutdowns that began at the end of March, dramatically reduced demand in our facilities was a little for a warning. Inventory did decline in the month of June as customer orders improved.

Capital expenditures was $77 million in the quarter, down from $133 million a year ago. We paid $193 million of cash dividends in the second quarter and did not repurchase any shares. Cash, cash equivalents and marketable securities, totaled $2.1 billion at the end of the quarter with total liquidity of $5.6 billion, boosted by the addition of a new $2 billion revolving credit facility in early May.

In summary, our second quarter was significantly impacted by COVID-19, industry wide production shutdowns and dramatically lower demand in most of our markets. We delivered solid profitability in the face of a record declining quarterly sales due to the incredible commitment and flexibility of our global employees. As we ramp down global production in April and flexed up in May in June, while executing on our cost reduction initiatives. The steps we've taken to protect our profitability, preserve cash and reinforce our already strong liquidity, both ensure that we can keep investing in new products that will support future profitable growth even in this extremely challenging economic environment.

While demand from OEMs has improved from historic lows in April in several markets, the pace of recovery beyond the third quarter remains uncertain. Due to this uncertainty, we will not be providing specific forward looking guidance for the remainder of the year but we hope that some brief comments on the trajectory of costs and revenues will be helpful. Our consolidated sales in the quarter are expected to improve from second quarter levels as many countries have eased the lockdowns imposed in March and April, allowing OEMs to increase build rates.

Joint venture income is expected to decline from second quarter levels as demand for trucks and construction equipment in China, moderates from this record levels in the second quarter. As I've said, we do expect an increase in engineering expenses in the third quarter as testing activities return closer to planned levels. With 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.

[James Hopkins, Executive Director of Investor Relations]

Thank you, Mark. Out of consideration to others on the call, I would ask that you limit yourselves to one question and the related follow up. And if you have additional questions to please rejoin the queue. Operator, with that, we are now ready for our first question.

[Operator]

[Operator Instructions] Our first question today is coming from Andy Casey of Wells Fargo. Please go ahead.

[Andy Casey, Wells Fargo]

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?

[Mark Smith, Chief Financial Officer]

So I think, Andy, as you know, demand for capital goods in China is typically seasonally weaker in the second half of the year and 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.

[Andy Casey, Wells Fargo]

And then a kind of unrelated follow up longer term question for the fuel cell technology. Are there any significant differences required for, let's say, trains and on highway trucks? Meaning, how scalable is that across applications, would you see a benefit from potential multiple market application versus just focusing on highway?

[Tom Linebarger, Chairman and Chief Executive Officer]

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 for fuel is volume on the stack and the related components. And that volume will provide benefits and costs, 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 are a lot more stacks. So we will be delivering in those trains pretty high volumes of fuel cells that will allow us to move to 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 in controls and other areas to make it work in specific applications.

[Operator]

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

[Jerry Revich, Goldman Sachs]

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

[Tom Linebarger, Chairman and Chief Executive Officer]

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's this significant opportunity to expand that strategic view. And of course, all the investments we're making in electrolysers 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 and 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, are the incentives are significant. And they just, as you saw the Europeans then roll out there large and they're available now. So we are expanding our investment in both R&D, but also in product launch, to make sure that we have the right sizes and range of electrolyzer technology available.

We are also partnered with Air Liquide who's involved in the market significantly, but also involving ourselves with other partnerships, like you probably saw that we had done this, we did this joint venture with NPROXX, which was a tank technology company. So that we can provide high pressure tanks, which was important for storage and transportation in the hydrogen economy. So, we are adding technologies, we're adding partners, making sure that we can participate more significantly in this market, given the growth opportunity and as you mentioned, the timing is now. So, we are expanding our presence there.

[Jerry Revich, Goldman Sachs]

Do you agree with the statement that the market size addressable opportunity for Cummins in 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?

[Tom Linebarger, Chairman and Chief Executive Officer]

I don't mind at all, Jerry, thanks for bringing it back. I really don't know, to be honest, because part of the challenge is how big a range of electrolyzers will we participate in and then also fuel cells, it depends on what percentage of the truck market they eventually win and that sort of thing. But definitely it’s a wider field. Let's just agree that. It's a wider field. So, we participate in every parts of generating hydrogen, it would be larger, no question about it, because we can serve everyone else's fuel cells as well. But our feeling is that 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 electrolyzers opportunity with more effort to get more products on the market sooner.

[Operator]

Our next question is Ann Duignan of JP Morgan. Please go ahead.

[Ann Duignan, JP Morgan]

I’d love to keep going on the hydrogen 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 years. Thank you.

[Mark Smith, Chief Financial Officer]

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 really going to be 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’ve just said that’s $75 million in Q2 on a full quarter run rate, which will be in Q3 it’ be about $90 million that comes back in the fourth quarter.

[Ann Duignan, JP Morgan]

And then just taking a step back, we talked about how weak the fundamentals were in India. Can you just talk about what you're seeing going on in the fundamentals, versus temporary COVID, versus I know you said truck sales were down 90% plus. But what are you seeing there more broadly in India?

[Tony Satterthwaite, President and Chief Operating Officer]

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. So 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 that in some other countries. And so we are quite cautious about India and not expecting any significant rebound in the second half of this year, as we see weak activity and the COVID challenge, if anything, increasing in India.

[Operator]

Your next question is coming from Jamie Cook from Credit Suisse. Please go ahead.

[Jamie Cook, Credit Suisse]

I guess my first question, you know, again, sort of on a 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 sort of more comparable to June levels or not? And then my second question, Mark, is more so to you, understanding some of these costs are going to come back in the fourth quarter. But your G&A control was pretty impressive in the quarter. So as you look forward, will there be incremental opportunities to reduce your structural costs beyond the 50 to 300 that you guys outlined in November? Thank you.

[Tom Linebarger, Chairman and Chief Executive Officer]

Hey Mark, I'll take the first one and you could take the second one. Jamie, 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, they were stabilizing production rates. Those have continued relatively steadily into July. So, we are not expecting any significant increase from June rates going into the third quarter but we see them holding relatively well and that leads us to, as Mark said, we are expecting revenue increase going into the third quarter.

Some of the start-ups were pretty fast. And I want to echo Tom's comments about our supply chain teams’ ability to keep up with our OEMs in June. So, that's been one of the interesting aspects at least of this. The start-up looks very V-shaped for at least a month. We don't expect it will keep going up but we do expect and are seeing so far in the third quarter relatively consistent build rates from most of our OEMs.

[Mark Smith, Chief Financial Officer]

We aimed our restructuring with a lot of it with SG&A, it's important work for the company but we felt we have 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 as revenues recover, we're operating in a way that doesn’t add all of those costs back.

There's no doubt compensation costs will be higher next year. Hopefully, looking at a different revenue environment but it’s too early to say. But yes, we're going to keep looking for ways to manage our SG&A as a percent of sales once our revenues start to recover on a more consistent basis. We get into our planning. We're always managing costs and then we're into our planning cycle for next year. So obviously, a keep topic of discussion. But yes, we very much aimed at restructuring at the SG&A at the start of the year and it's helped a lot.

[Tom Linebarger, Chairman and Chief Executive Officer]

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 Q4 work that we're really aiming at a downturn for the year. We had a sales estimate for the year and we aimed the cost at that structure. Then COVID hits and takes the sales down significantly lower ideally on some temporary basis. And we really just don't know at this stage how much, where we're going to level out on sales between the lowest level we hit and where our original estimate for 2020 was 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, we will continue to look at actions and all the -- because all the time we're going through it and that's fine. But if we see a sustained lower revenue in 2021 and beyond that doesn't really match where we aimed our SAR or SG&A at the end of last year, then we'll have to take another reduction. So, what we're going to try to do in Q4 is we will get the temporary ones back and if the revenue trend looks right, it looks like we're getting back to kind of where we thought we would be then we'll be there or thereabouts and we'll have to do relatively modest things.

If we think we're in a sustained lower period then we're going to have to do more than that. And we're 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 these circumstances. And as Mark said, we're not done with that work as we’re rolled into our planning work this fall. But we have already been looking at that and asking ourselves, which what would we do in every circumstance? So we will be ready for whatever revenue scenario we finally decided we're going to aim for in 2021.

[Operator]

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

[Steven Fisher, UBS]

Just with the better revenues that you shake in Q3 versus Q2, it sounds like still holding the line on your costs in Q3. Is there any reason why that the detrimentals shouldn't be even better than what we saw in the Q2 level?

[Mark Smith, Chief Financial Officer]

Well, I think we've taken the actions for now that we plan, Steve, the cost structure is going to be fairly consistent from quarter to quarter, and I think that's the best way to model it. Of course, we've weathered through the toughest comps in the first half of the year. It just really were kind of in that hands of the revenue trajectory here since there were cost actions effect for the next quarter.

So, I think you can work on your own models from there on the decremental bearing in mind some of the comments I've made about sequential increases in engineering, sequential decreases in the joint venture. And then 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, which set the course now for the rest of the year and really the revenue is going to drive the numbers from here.

[Steven Fisher, UBS]

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

[Tom Linebarger, Chairman and Chief Executive Officer]

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 sure now. And in the trucks markets, they have some backlogs but of course they're managing those backlogs by increasing production and decreasing production. And so they're, how they change their production week to week influences what their demand on us is. Here's what we're seeing though, I mean, just to give you a sense for what we're seeing.

In North America, the truck makers are definitely stabilizing their production rates. They're seeing stronger demand, 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 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 thing and 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 demand trends. We are where we are in a 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 we are concerned about China as it was just so hot for a quarter, we just don't understand how it sustains that level for the rest of the year. So, we think it probably tips down, we certainly don't have enough backlog to be able to tell you that. But we do it -- 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 kind of figure out how to be ready for all of it. And I know that's not very helpful from a model prediction point of view but that's just unfortunately the situation we live in.

[Operator]

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

[David Raso, Evercore ISI]

Trying to take a cut at 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 your largest business North America truck. I mean it feels like sequentially, EPS should grow from 2Q. Nothing you highlighted would suggests that's not the case. But then the fourth quarter, you have about $0.40 to $0.45 EPS costs come back. So just to give us some baseline, I know you're not going give guidance, but just the baseline. Do you think your second quarter EPS was the bottom EPS for the year, quarterly EPS?

[Tom Linebarger, Chairman and Chief Executive Officer]

Too early to say, Dave, because we don't have visibility beyond the third quarter. 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 in 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 down back into business.

But as we know, 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 it in a new mask order, just this Monday. So we just don't know where that hits. 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, oh, this fourth quarter is where things starts to tick up, that's when these temporary costs come off and we'll have revenues to support that and that will be fine. And now our only question is, is that true. It seems like it should be true but we just don't know.

[David Raso, Evercore ISI]

I mean, I'm just trying to think about, we get nice EPS growth sequentially 3Q. If the negative scenario plays out for 4Q, can you pull back on the $0.45, $0.40 EPS hit from the cost coming back, or is that sort of written in the stone for the employee comp for fourth quarter?

[Tom Linebarger, Chairman and Chief Executive Officer]

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 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 just not just Q4 that's going to continue for a while then we'll have to think it 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, that's really where --. So trying to predict if revenues are not coming back in Q4, does that mean there's on the sustained downtrend or are they just -- is it just a blip and they're about to come back and that's what we'll have to figure out.

And I think we will have a lot more information about that in our next earnings call and we'll be able to give you guys a much better view of what we see. But again, I think what you can expect from us is irrespective of the scenario, we will be managing costs in a appropriate and aggressive way. And we will be keeping the costs 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 continue to rebalance and restrike it depending on kind of what we see from a revenue point of view. But I think Mark's quote was the best. It's kind of a revenue deal from here through the end of this year. If revenues strengthens up then Q2 will be our lowest. If it doesn't, then it won't. If it starts to drop again, then it won't.

[David Raso, Evercore ISI]

And Tom related to the second half, the inventory 2% increase and I appreciate the suddenness, 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?

[Tony Satterthwaite, President and Chief Operating Officer]

We are not happy and 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. And as you can see from our balance sheet, AP has fallen significantly. So we have definitely reduced purchases. The vast majority of our inventory is in raw material and in our plants. It is not finished goods. It is not built up engine. And so, we were just managing these very sudden shutdowns.

And if you go back a little earlier in March, we were actually worried about continuity of supply. So we were actually bringing inventory in in March to guarantee supply and then we spent all of second quarter trying to manage reduction in demand. So overall, I'm confident in the trajectory we have with inventories but it was a tough quarter to manage inventory. And I think we did well but I think we were on top of it now. We know what we're doing. We’ve got to it under ourselves and I don't feel at all exposed in any way.

[Operator]

Thank you. Our next question from [Technical Difficulty] of Oppenheimer. Please go ahead.

[Unidentified Analyst]

Just one more short term question here, industrial [Technical Difficulty] down year-over-year but potentially flat quarterly despite very volatile oil price environments and the rig 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 [site for support] in O&G or perhaps in mining?

[Tony Satterthwaite, President and Chief Operating Officer]

I guess, the short answer is not really. 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 American in the areas where we're strong. Mining we have seen a little improvement in the hard ores in copper and iron ore, whereas closed and those OEMs and [Technical Difficulty] remain weak. I apologize, I'm getting a lot of feedback on the phone, so I don’t know 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 it serves that is also looking quite weak.

[Unidentified Analyst]

And then just one more. I mean, there's really solid margin performance in the distribution segment. I know you’ve talked about your priorities at Investor Day in terms of transforming that business. So I’m just trying to understand anything specific that you’ve done there as the downturn allows you to accelerate any of the more permanent actions that you were looking to take?

[Tony Satterthwaite, President and Chief Operating Officer]

We’re very pleased with how the distribution business performed and specifically how that transformation work is progressing. The downturn, it caught us in a awkward time and 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. And so we've kind of struggled but business has performed really well.

We have seen reductions in service and parts revenue in the second quarter, which we've talked about. But a number of the actions they took, both with cost and with efficiency have really paid off. And I'm very confident as demand starts to return and that business picks up a bit we'll see good performance. That business is more heavily impacted by people cost and therefore, they benefited more from the salary reductions and variable comp reductions just because that business is so people heavy. But I still think we will deliver on all of the improvements that we were looking to deliver and the transformation as we go through the rest of this year. So very pleased with how that business is performing.

[James Hopkins, Executive Director of Investor Relations]

Great. And with that, I think that takes us to the end of the hour for the teleconference. As always, I wanted to say thank you to everybody for your interest in Cummins and I'll be available for any follow ups this afternoon. Thanks very much..

[Tom Linebarger, Chairman and Chief Executive Officer]

James, I just want to add my thank you as well, and apologize for any technical difficulties included the unwanted guest, it was my dog, Ellie. But thanks for hanging in there with us and thanks for your support for Cummins. Bye, bye.