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Cummins Inc (Ex. Cummins Engine Inc) (NYSE:CMI)
Q3 2020 Earnings Call
Oct 27, 2020, 10:00 a.m. ET

Contents:

  • Prepared Remarks
  • Questions and Answers
  • Call Participants

Prepared Remarks:

Operator

Greetings, and welcome to the Cummins' Third Quarter 2020 Earnings Conference Call. [Operator Instructions]. It's now my pleasure to turn the call over to James Hopkins, Executive Director of Investor Relations. Please go ahead.

James Hopkins -- Executive Director, Investor Relations

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 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.

N. Thomas Linebarger -- Chairman and Chief Executive Officer

Thank you, James and good morning. Third quarter continued a period of high demand volatility across our end markets. Three months ago we experienced the largest sales decline in the company's history. We've now followed that with the largest sequential increase in sales in the company's history. Even with the dramatic increase, however, sales remain below last year's levels. While we have seen increased demand in our 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 trucks and pickup markets.

Our engineering group has continued to successfully launch new products during this period. Over the last six months, we introduced an entire range of Bharat Stage VI products in India and portions of our National Standard IV portfolio in China. We also recently announced our full product line up to meet EPA 2021 regulations in North America. While nearly everything about the way we have worked --- we work has changed due to COVID-19, the commitment and capability of our employees has remained intact.

Now I'll move to a summary of our third quarter results and a discussion of our major end markets. Mark will then take you through more details of our third quarter financial performance and update you on our balance sheet and liquidity.

Revenues for the third quarter of 2020 were $5.1 billion, a decrease of 11% compared to the third quarter of 2019. EBITDA was $876 million or 17.1%, compared to $958 million or 16.6%, a year ago. The impact of lower volumes and higher variable compensation costs was offset by the benefits of restructuring, temporary salary reductions, reduced warranty costs and higher joint venture income. The increase in joint venture income was primarily due to continued strong levels of demand in China. Engine business revenues declined by 13% in the third quarter compared to a year ago. Lower production in North American truck markets drove most of the revenue decline.

EBITDA margin for the quarter was 18.1%, compared to 14.1% for the same period in 2019. Cost savings related to restructuring activities and salary reductions as well as increased joint venture income partially offset the impact of lower volumes. Third quarter results also benefited from a VAT recovery in Brazil.

Sales for our Distribution segment declined by 14% year-over-year, with lower revenues in domestic and international markets. Third quarter EBITDA was $182 million or 10.6% of sales, compared to 9.3% in the third quarter of 2019. EBITDA margins increased as we realized more of the benefits of our transformation work in North America.

Third quarter revenues for the Components segment declined 7%. Sales in North America declined 24% driven by lower truck build rates, while revenues in international markets increased by 26% driven by higher truck demand in China. EBITDA for the third quarter was $261 million or 16.9%, compared to 17.3% in the same quarter a year ago. EBITDA percent decreased as the impact of lower volumes was partially offset by the benefits of restructuring and temporary salary reductions.

Power systems sales in the third quarter declined 13% year-over-year. Industrial sales declined 21%, driven by continued weakness in oil and gas, and mining markets. Power generation sales decreased by 7% with lower revenues in both North America and international markets. EBITDA in the third quarter was 10.3% or $101 million, compared to 14% a year ago. The impact of lower volumes more than offset the benefits of cost reduction actions. In the New Power business, sales of $18 million were double those from a year ago. EBITDA was a loss of $40 million in line with our expectations.

Now I will comment on some of our key regions and markets, starting with North America and then I'll cover some of our largest international markets. Our third quarter revenues in North America declined 18% to $3 billion but increased by 49%, sequentially. Compared to last year, we experienced lower demand, in both, on and off-highway markets as well as within our parts and service business.

Industry production of heavy-duty trucks declined 35% in the third quarter, compared to a year ago, but rose 119%, sequentially. Year-to-date, our market share is 33%, driven by the continued strong performance of our products in the field.

Production of medium-duty trucks decreased by 33% in the third quarter compared to a year ago but increased 76% from second quarter levels. We continue to maintain our clear market share leadership in the medium-duty truck market with over 80% of new trucks powered by Cummins powertrains in 2020. Total shipments to our North American pickup truck customers increased 4%, compared to a year ago and included a catch-up in production by our OEM partner after an extended second quarter shutdown.

Demand in domestic bus markets remained weak in the third quarter with sales down 24% driven by demand -- lower demand from both transit and school bus customers. In domestic off-highway markets engine sales for construction equipment decreased by 47%, driven by lower demand by rental fleets, who went through a significant replenishment cycle in 2018 and 2019. Revenues for power generation equipment fell by 7% with lower demand in backup power markets. Demand for engines in oil and gas markets declined by 80%.

Now I will turn to our International markets. International revenues were flat in the third quarter of 2020 compared to a year ago. Third quarter revenues in China, including joint ventures, were $1.7 billion, an increase of 46% compared to a year ago driven by continued strong demand in both truck and construction markets. In the third quarter, industry demand from medium and heavy-duty trucks in China increased by 74% compared to a year ago. While demand declined sequentially, which is normal in the third quarter for China, total industry production was the highest on record for any third quarter. Demand continues to be driven by improved levels of freight activity and government policies supporting the scrapping of old NSIII trucks.

Our market share was 17% into the quarter, up from 16% in the third quarter of 2019 driven by increased truck market share of our partner Foton along with higher utilization of our engine in Foton trucks, which now stands at over 80%. Industry sales of light-duty trucks increased by 49% in the third quarter and our market share was 9%, up from 7% last year. Our increased market share was driven by improved truck market share of Foton as well as increased use of our engines at JAC.

While new NSVI regulations come into effect for all markets in China next July, there are certain cities and applications where these regulations are already in place. 12 of our NSVI engine models are now in production, including our entire light-duty portfolio as well as our leading 6.7 and 12-liter products. We've shipped over 50,000 NSVI compliant units so far in 2020 and are seeing strong acceptance of our new engines. In addition, we are now selling our automated manual transmissions into the Chinese market, and are on-track to sell over 1,000 Endurant AMTs by the end of the year.

Third quarter demand for excavators in China increased by 57% from a year ago. The central government is encouraging increased levels of borrowing by local municipalities to support investment in infrastructure and housing projects. So far this year over $500 billion in local government loans have been issued, targeting infrastructure projects and resulting in increased excavator demand. Our market share was 16% this quarter compared to 15% a year ago, driven by the strong performance of our domestic OEM customers. Demand for power generation equipment in China was flat compared to a year ago with increased demand from data center customers offset by weaker demand for standby power.

Third quarter revenues in India, including joint ventures, were $295 million, a reduction of 14% from the third quarter a year ago. Industry truck sales in India decreased 47%, while power generation sales declined by 45%. While demand in India remained at very low levels, we did see industry truck sales more than triple compared to second quarter levels. While credit availability remains tight, certain segments of the truck market, especially those tied to construction, are seeing a recovery in demand driven by -- government stimulus for infrastructure. Cummins is well positioned to benefit from a recovery in Indian market, both because of our leading market position as well as the incremental content we have on engines that meet BSVI on-highway emission standards, which became effective in April.

Outside of India and China, we saw a year-over-year revenue declines of 8% in Europe and 15% in Latin America, primarily due to lower truck production. Compared to the second quarter sales increased by 25% in Europe and increased by 102% in Latin America, as OEMs resumed truck production in both regions. Global sales of mining engines declined 39% compared to a year ago. Demand remains low -- stable among copper and iron ore miners, while sales related to coal mining remain low.

I also wanted to discuss our aftermarket revenues during this quarter. Sales of parts declined by 12% in our Engine business and 14% in our Power Systems business. Part sales remain depressed in our Power systems business due to low demand in oil and gas markets as well as lower rebuild activity in mining markets. In our Engine business, part sales were down 12% year-over-year, but increased 20% sequentially. Compared to last year, we are seeing weaker demand in bus markets and in parts for older model trucks. Parts demand for current on-highway truck engines are flat with last year.

While demand increased from second quarter levels across most of our end markets, we remain cautious about future demand increases due to the continued spread of COVID-19 in most countries outside of Asia, and while we are encouraged by continued strong demand in China and improving fundamentals in North American truck markets, industry backlogs remain at modest levels. We currently expect consolidated company revenues in the fourth quarter to be similar to third quarter levels with higher demand in North American truck markets and continued improvement in aftermarket sales, partially offset by lower demand in China. We continue to expect that the pace of market recovery will differ from region to region and may change based on government actions, both to control the spread of COVID-19 or to simulate their economies and build business and consumer confidence.

We continue working hard to support our end-users and build our -- build a strong OEM relationships during this period. In August, we announced the extension of our medium and heavy-duty truck engine partnership with Navistar. Cummins will continue to supply engines for Navistar's medium and heavy-duty trucks, as well as robust applications through the end of 2026, extending our 80-year relationship with Navistar. Through the development and introduction of new products, we continue to reduce the emissions levels of our products while increasing fuel economy. This includes the launch of our full product lineup for 2021 EPA regulations in North America, NSIV regulations in China and BSVI regulations in India.

We are encouraged by the performance and market acceptance of these products that are already in the field. We also continue to focus on supporting our customers in their transition to carbon-neutral technologies.

Our revenues doubled in our New Power segment this quarter and we are excited to share more about how we expect our hydrogen production and fuel cell business to develop at Cummins Hydrogen Day on November 16. We hope you all will be able to attend this virtual event.

Now let me turn it over to Mark to discuss our financial performance this quarter, including our record operating cash flow. Mark?

Mark Smith -- Vice President and Chief Financial Officer

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 detrimental margins in the third quarter, which put us on track for full year performance that will extend our record of raising profitability over successive downturns. This performance is a testament to our operational flexibility, ramping down effectively in the second quarter and then converting additional volume into stronger earnings and record operating cash flow in the third quarter.

Number two, as a result of the record operating cash flows and the addition of low-cost, long-term financing in the third quarter, the Company sits today with strong liquidity, which will allow us to keep investing in our future in the face of any further volatility, and return any excess to capital -- 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, amortization or EBITDA were $876 million or 17.1% of the sales for the quarter, compared to $958 million or 16.6% of sales a year ago, representing a detrimental 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, 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 of 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 variable 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 continue -- 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 one-time $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 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 alliance on credit facilities going forward. Company's long-term credit ratings remain unchanged at A+ from Standard & 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 of $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.

Into the fourth quarter, we expect consolidated revenues to remain similar to third quarter levels. Strong industry orders are expected to lead to strong demand in North American truck markets and improved aftermarket demand. India has shown some signs of improvement from very low levels in demand, as the lockdowns have eased and some economic activity is increasing. In China, where demand has been at record levels over the last six months, we expect to experience some seasonal declines in the fourth quarter, but demand to remain relatively strong levels.

The temporary salary reductions 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 pre-tax expenses in the fourth quarter.

In summary, we delivered a strong set of results in the third quarter including record operating cash flow. I want to thank our employees around the globe for their dedication and commitment to excellence through these last six very challenging months. Following unprecedented decline in demand in the second quarter, responded well in ramping back up in the third quarter, supporting our customers and maintaining financial discipline throughout. While many of our markets have improved, the effects of the pandemic can still be felt in many regions and may impact the pace of recovery. We will continue to align our business with market conditions, deliver strong operational performance, invest in the technologies that will fuel profitable growth and return any excess to -- capital to shareholders.

Finally, as Tom previously mentioned, we will be holding our Hydrogen Day on November 16th, where we will highlight our participation in the hydrogen economy. Additional details and registration can be found on our Investor Relations website. Thank you for joining us today and your interest in Cummins. Now let me turn it back to James.

James Hopkins -- Executive Director, Investor Relations

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.

Questions and Answers:

Operator

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

Stephen E. Volkmann -- Jefferies & Co. -- Analyst

Thank you...

N. Thomas Linebarger -- Chairman and Chief Executive Officer

Hello? Hi, Steve...

Stephen E. Volkmann -- Jefferies & Co. -- Analyst

Can you guys hear me OK?

N. Thomas Linebarger -- Chairman and Chief Executive Officer

Yeah. Hi, Steve.

Stephen E. Volkmann -- Jefferies & Co. -- Analyst

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, sort of, 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 -- Vice President and Chief Financial Officer

Remember that we implemented the temporary salary reductions in the middle of April, Steve. So when you do the math, it's about $165 million of full year lowered expenses in 2020. Obviously, that will not repeat, we restored those salaries in the fourth quarter. The restructuring, I mean, is embedded in our solid detrimental 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 E. Volkmann -- Jefferies & Co. -- Analyst

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

Mark Smith -- Vice President and Chief Financial Officer

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

Stephen E. Volkmann -- Jefferies & Co. -- Analyst

Okay, thanks. Worth a try. Appreciate it.

Mark Smith -- Vice President and Chief Financial Officer

It was. Thank you.

N. Thomas Linebarger -- Chairman and Chief Executive Officer

Thanks, Steve.

Operator

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

Courtney Yakavonis -- Morgan Stanley -- Analyst

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

Mark Smith -- Vice President and Chief Financial Officer

The strength in international market, all being flat, is all down in the China, right, it really wasn't any strength, just fickle elsewhere in terms of year-over-year growth. There was steady recovery in some markets, but any part of our business that touched China, whether within the component business, even our construction business, within the Engine business, data center ordered or the power systems, it was anything that touched China was pretty much up year-over-year and so that's really what drove flat international revenues for the quarter.

It's typical, Courtney, that we see some seasonal weakening going into the 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 of -- pretty much all of their revenue is consolidated and then to a lesser extent, the engine business. So that's -- the primary market where we are expecting some seasonal declines and then yeah, production build rates, I think, are largely set for the fourth quarter and then yes on parts, what we saw in the second quarter was particularly some weaker demand in bus -- in the bus market, truck parts, particularly on a newer model heavy-duty truck was stable in the third quarter and we expect steadily improving parts demand in subsequent quarters. So I think the big factor is really China easing and we're not expecting rapid further acceleration in truck demand right now.

Operator

Thank you. Next question is coming from Jamie Cook from Credit Suisse. Your line is now live.

Jamie Cook -- Credit Suisse -- Analyst

Hi, good morning and 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 or -- do we start to thinking about putting that cash to use? Thanks.

Mark Smith -- Vice President and Chief Financial Officer

Good. Yes, you're right. And I'll start on distribution, Tony, if you want to chime. We have had a very focused effort, particularly in North America on driving margin improvement. A lot of it's coming out of the cost side of the business this year, so we've been pleased with the progress this year, Jamie. I think then we're really looking to see is parts and service, which have been down, probably be 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. Will avoid giving a specific target. Tony?

Tony Satterthwaite -- President and Chief Operating Officer

Yeah, I would just add Jamie, revenue has been a little weaker in this downturn in DBU than previous downturns, and so we've been really pleased with the cost performance in the restructuring and focusing going forward is going to be on how do we see better revenue growth, if 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 -- Credit Suisse -- Analyst

Okay, but is there any reason to believe the margins can structurally, sort of, be now in the double-digit range on the adjusted EBITDA basis?

Tony Satterthwaite -- President and Chief Operating Officer

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 -- Credit Suisse -- Analyst

Okay...

N. Thomas Linebarger -- Chairman and Chief Executive Officer

And Jamie...

Jamie Cook -- Credit Suisse -- Analyst

Mark and then on your cash...

N. Thomas Linebarger -- Chairman and Chief Executive Officer

Jamie, just want to...

Jamie Cook -- Credit Suisse -- Analyst

Sorry go ahead....

N. Thomas Linebarger -- Chairman and Chief Executive Officer

It's Tom. I mean, just to make sure I get the -- you get the math right. So our view is that we are already in double digits, we are all 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 we are on our plan, despite pretty heavy headwinds. So we are not only feeling good about where we are, but we are more confident than ever that we're going to be in double-digit margins from now forward. So again there -- you can imagine some scenarios with COVID that would make it, so you might have a quarter or two that weren't, but broadly speaking, our view is the restructuring stuff has gone better than we expected. So we, as Tony said, that was our target and we feel like we're ahead of target. So that's just that.

On the cash side, I'll let Mark fill in some more but I mean broadly speaking, we definitely acted conservatively from a balance sheet this year to protect ourselves against the worst potential outcomes -- economic outcomes from the pandemic. So we shored up the balance sheet with our debt offering, low cost financing, our cash flow has improved dramatically and 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 is a lot of work left to do and of course, there is 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 -- Vice President and Chief Financial Officer

Yeah, I think we've made it clear we're not trying to hoard cash. So a little, being cautious this year, but I think, Tom's made it clear going forward. Yeah.

Jamie Cook -- Credit Suisse -- Analyst

Okay. I appreciate the color. Thank you.

Operator

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

Adam Uhlman -- Cleveland Research Company -- Analyst

Yeah, hey guys, good morning. I was hoping to get your perspective on the heavy-truck markets. I guess, we've seen a spike in spot rates and the orders have been soaring. I guess I'm just wondering how sustainable you think that is? And most of your customers are still 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.

N. Thomas Linebarger -- Chairman and Chief Executive Officer

Tony?

Tony Satterthwaite -- President and Chief Operating Officer

Yeah Adam. We are all way inside, so, we're not together, Adam. So this is Tony. Yeah, 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 in newer trucks and newer products are definitely working better. We got 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 are excited with the products we have on offer, our OEM customers are feeling pretty bullish but at the same time there is 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 are 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 -- Vice President and Chief Financial Officer

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 have had a pretty good run of accelerating parts consumption before all this sustainably stepped up. So that's something we're watching closely by segment and end-market and that should give you some indication from another participants in future quarters.

Adam Uhlman -- Cleveland Research Company -- Analyst

Okay, got you and then, Mark the -- with these new products coming out for '21, I guess the company has been benefiting from lower warranty expense and there are 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 to execute on your strategic initiatives? Thanks.

Mark Smith -- Vice President and Chief Financial Officer

Thanks, Adam. Really good question. I think on the one hand, of course, we're always driving for more improvement, but I would say that our expense is at 1.8% or 1.9% of sales, but this year we have real -- 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 emissions, regulations and then the launch of new products. So launch -- you're right, launch of new products will continue, we typically start those with higher warranty rates and this year, the number of field campaigns has been below normal. So we would expect even some to tick up in the fourth quarter, and yes, probably we -- yes, we shouldn't be looking in at 1.8% for now as our run rate. So yeah, we will provide you with an update up on that when we get into next year. Some tick up from here would -- should be expect -- we even expected something this quarter but that's where we are right now.

Adam Uhlman -- Cleveland Research Company -- Analyst

Thanks.

Operator

Thank you. Our next question today is coming from Joel Tiss from BMO Capital Market. Your line is now live.

Joel Tiss -- BMO Capital Markets -- Analyst

Hi, how's it going guys?

N. Thomas Linebarger -- Chairman and Chief Executive Officer

Hi, Joel.

Joel Tiss -- BMO Capital Markets -- Analyst

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 do product lines simplification and reduce some of that exposure to drive the gross margins higher or you're always doing that and there is nothing that really stands out?

Mark Smith -- Vice President and Chief Financial Officer

Hey, Joel. 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 pick-up 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 is always some opportunity to improve and improve even better.

Joel Tiss -- BMO Capital Markets -- Analyst

And I wonder if you can talk about the M&A environment out there and what you guys are focused on, is that -- 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, what areas would you be thinking about? Thank you.

N. Thomas Linebarger -- Chairman and Chief Executive Officer

I think, -- thanks Joel, it's Tom. I can step in on that. I mean, for sure, in second quarter we were on pause a little bit, making sure that our balance sheet was short up, that 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'd probably recall 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 are all the areas where we feel like our competitive advantage is the things that we bring in terms of technology, global footprints, supply chain, that sort of thing, help us move forward and then of course, our new technology areas, the acquisitions like we did with Hydrogenics and the batteries -- battery companies, those were to add new capability. 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 expected maybe disruption would cause valuations to drop out a little bit, that's actually not happened so much. It doesn't mean that it won't happen but -- and it's maybe because the private equity dollars are so large, but I would say, as we look around, using different methods to look at what acquisitions could mean for our company, I feel the acquisition price is 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 if we find it, we'll act and if we don't, we'll return more cash this year, just like we plan.

Joel Tiss -- BMO Capital Markets -- Analyst

All right, thank you very much.

Operator

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

Jerry Revich -- Goldman Sachs -- Analyst

Yes, hi, good morning, everyone.

N. Thomas Linebarger -- Chairman and Chief Executive Officer

Hi, Jerry.

Mark Smith -- Vice President and Chief Financial Officer

Hey, Jerry.

Jerry Revich -- Goldman Sachs -- Analyst

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?

N. Thomas Linebarger -- Chairman and Chief Executive Officer

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, where the calculations were maybe the opposite about how to backward integrate more, mostly what I hear is maybe backward integrate less. But that said, there is no deal till there's a deal. Right? So again, I can't really pre-announce or suggest anyone who is going to go, because they're tough -- they're difficult decisions for them and 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 our components technology in the future than in the past. So I expect market share to increase in the future, based on the fact that they will decide that their money is based -- spent -- best spent elsewhere. Exactly where and when, again I just -- I 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 and take time, but anyways, there you are. We're in it for sure and I'm confident that we will win increased share.

Jerry Revich -- Goldman Sachs -- Analyst

I appreciate the color. End-market, as we look at the fourth quarter sales outlook of 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, we 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 -- Vice President and Chief Financial Officer

Yeah, 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 on this incredible ramp back up again. But -- well let's just use a pick-up truck market example, you just stared at Q3 in isolation, you would see that that's in the top 10 quarters in history of pick-up truck engine demand, but if you do look back at Q2, you would say zero, right? So you just can't normalize everything that happened in Q3 and say, flat means everything's flat. I think there's some -- it will be some rebalancing in some markets, but again, yeah, we'll see where it is, our focus is on cost and delivery and then delivering the calendar results that go with whatever volume we're thrown.

N. Thomas Linebarger -- Chairman and Chief Executive Officer

And Jerry, as Tony said, we are encouraged by the truck markets, I mean, as you guys have said to us the all of our customers are projecting stronger volumes which is great for us. So -- yes, we're always cautious because that's how we live, but nonetheless we are encouraged by their comments and they're very close to the market. They're watching their fleet customers and what they're ordering and we're hearing good things from the fleets too so, yeah, we 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 we -- again, we just remain cautious. So just don't hear from us discouragement. We are -- the markets are going well and we are 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.

Joel Tiss -- BMO Capital Markets -- Analyst

Glad to to hear you. Thank you.

Operator

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

David Raso -- Evercore ISI -- Analyst

Hi, thank you. Yeah, my question from 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 is 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, while we might not get back to those revenues, are the domestic margins set up in a way where they could be -- could be 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, much of the 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 want to appreciate your thoughts for an early framework on '21 engine margins.

Mark Smith -- Vice President and Chief Financial Officer

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 NSVI products, what that will happen through demand take up is all to be figured out there. So yeah, we're not in a position right now to give you 2021.

Yes, Q3 margins were higher than normal for a couple of other factors that we've laid out, but we are still going through our planning cycle for next year as we speak. So as we speak -- but after we speak there, we'll be back on that again here shortly.

It's just, it's just too early to say, given everything that's going on. Well, I would just say we are very pleased with the performance of the engine business and the fact that we have delivered 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, few primary, but yeah we're not ready to give guidance next year. I appreciate you asking. We'll look forward to give an update with Q4 earnings.

David Raso -- Evercore ISI -- Analyst

Would you mind if I just, sorry, I clarify that, it's just -- given at 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 NSVI content or increased penetration with Foton and so forth, can you help us a little bit -- just frame it?

Mark Smith -- Vice President and Chief Financial Officer

Yeah, I'll just make a couple of comments and then, James, can maybe to give you some numbers.

But I think there's kind of a couple of dynamics, one, so that the potential of the expectation of higher content for the components business on a consolidated revenue basis, as the emissions regulations are rolled out that's kind of a given, given that we source, we specify the after-treatment systems that are an integral part of our engine system design, James will give you the numbers in a moment. We hope then as we move in through these more advanced emission regulations that we can continue to pick up share. We feel like our NSVI products have been well received and our penetration at Foton's already been really accelerating over the last couple of years, we are already up to 80% and it's encouraging to see Foton's been picking up some share as well.

So yes, we're optimistic about -- if you 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 then James, you can maybe you could quantify the revenues.

James Hopkins -- Executive Director, Investor Relations

Yeah. And David, from a revenue impact of that, we've talked broadly before both between the emissions content in China and India. That will be roughly $600 million of incremental revenue and that primarily hits our Component segment. And in addition to that, Tom mentioned in his remarks, excitement about the Endurant transmission, that we're selling a 1,000 units off 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 move into 2021.

N. Thomas Linebarger -- Chairman and Chief Executive Officer

David, as you...

David Raso -- Evercore ISI -- Analyst

All right. Thanks for the color.

N. Thomas Linebarger -- Chairman and Chief Executive Officer

David, this is Tom. As you kind of think through the model, the numbers for this year are so high on the truck market that, this is what Mark's saying, that right now it's just hard for us to do that, the weighing of one or the other because we know what the content is, we know who we've won the share with, we even have forecast for how we think it converts over to NSVI and what growth we see in transmission. 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 -- Evercore ISI -- Analyst

Yeah, I mean that's what's interesting, Tom, I mean, historically, your order book could be accelerating and every time on the call, you want to say, well China's going to slow down and lot of times it doesn't.

N. Thomas Linebarger -- Chairman and Chief Executive Officer

Yeah.

David Raso -- Evercore ISI -- Analyst

And in this sort of, environment. you'd almost at say, we are at such a high level and you've seen Volvo and so forth already forecast, China down next year. Betting man would have said like, well knowing Tom's history though he will says trying -- just trying to be cautious with it.

N. Thomas Linebarger -- Chairman and Chief Executive Officer

Yeah

David Raso -- Evercore ISI -- Analyst

And we'll definitely be hearing today baseline, it's definitely down. It seems like what you're saying enough internally when your own opportunities, it's still an open question, which I've to admit is a little more positive than I would have thought. So, what I want is begin to it.

N. Thomas Linebarger -- Chairman and Chief Executive Officer

Yeah, you are right about it. It is -- 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 will just take that one...

David Raso -- Evercore ISI -- Analyst

Is there a caution to not..

N. Thomas Linebarger -- Chairman and Chief Executive Officer

And I accept. And accept it that it hasn't been right and so anyway, I think, it's a good -- it's a good point you made.

David Raso -- Evercore ISI -- Analyst

I appreciate it. Thank you.

Operator

Thank you. Our next question today is coming from Ann Duignan from JP Morgan. Your line is now live.

Ann P. Duignan -- J.P. Morgan Securities -- Analyst

Yeah, hi. I'd like to go back to Q4, I mean you've guided to revenue flattish quarter-over-quarter. You called that $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 be taken into consideration?

Mark Smith -- Vice President and Chief Financial Officer

Yeah, I mean there's really three main things. You've got the $90 million it will be -- it's likely that some increase in the warranty expense in the fourth quarter and then as I said, in my prepared remarks, we accured up our variable compensation in the third quarter to catch it for our higher expectation. So I think it's unlikely now that will be truing up again in the fourth quarter. JV income, despite all the comments just passed, yeah, directionally, I would expect that still to be a little bit lighter in China, just based on seasonality. Still very strong, just to be clear, year-over-year, but just weaker into the fourth quarter. So those are really the big moving parts. And other than the volume and we've converted that well when we've it received this year. Yeah. And we hope the volume being higher in North America truck market is net positive toward incremental margins too. It's a good -- 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 also helps us some.

Ann P. Duignan -- J.P. Morgan Securities -- Analyst

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 -- Vice President and Chief Financial Officer

It is a fair statement and it would...

Ann P. Duignan -- J.P. Morgan Securities -- Analyst

Yes, it is.

Mark Smith -- Vice President and Chief Financial Officer

It would benefit, a number of businesses, but particularly distribution. Yeah.

Ann P. Duignan -- J.P. Morgan Securities -- Analyst

Okay, thank you. I'll leave it there. As most of my other questions were answered. I appreciate it.

N. Thomas Linebarger -- Chairman and Chief Executive Officer

Thanks Ann.

Operator

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

Ross Gilardi -- Bank of America -- Analyst

Good morning, guys.

N. Thomas Linebarger -- Chairman and Chief Executive Officer

Hi Ross.

Mark Smith -- Vice President and Chief Financial Officer

Ross, how are you?

Ross Gilardi -- Bank of America -- Analyst

Hey there, 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 and it's 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 from 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 these businesses potentially get worse or just kind of flat line at a low level before they get better?

Mark Smith -- Vice President and Chief Financial Officer

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

James Hopkins -- Executive Director, Investor Relations

Yeah, Ross. So on the mining engine sales side, as you mentioned, third quarter revenues were very similar to second quarter in mining overall. And as you mentioned, we continue to see relatively stable demand in miners, that they are going to be focused more on iron ore and copper and continue to weak demand more on the coal side of things, but we were flat sequentially on the mining revenues.

Ross Gilardi -- Bank of America -- Analyst

And oil and gas was do minimis?

James Hopkins -- Executive Director, Investor Relations

Yeah. 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.

N. Thomas Linebarger -- Chairman and Chief Executive Officer

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. It -- well, it's challenged in the following sense, there seems to be overshots and undershots a lot in the market, you know that well and you know a lot of mining companies overshot by a lot in the last cycle and really got knocked back hard, and so needless to say they're all being careful not overshooting now, which has meant that 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 and I am sure now that 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 is 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 -- Bank of America -- Analyst

Okay. Thank you.

James Hopkins -- Executive Director, Investor Relations

Okay, great. Thank you. I think with the -- with that. Sorry.

Operator

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

James Hopkins -- Executive Director, Investor Relations

Great. Thank you for that. So again, I just wanted to say thanks to everyone for taking the time to call in today. I appreciate that, as always, and for your continued interest in Cummins, I'll be available for any follow-up questions here in this afternoon.

N. Thomas Linebarger -- Chairman and Chief Executive Officer

And let me add my thanks to James. I really appreciate your attention. I'm sorry that I did not invite my dog to this quarterly call. I'll try to include her on future calls. But it was nice to have a noise free call. Thank you very much for your attention. Bye bye.

Operator

Thank you.

Tony Satterthwaite -- President and Chief Operating Officer

Thanks everyone. Bye

Operator

[Operator Closing Remarks]

Duration: 60 minutes

Call participants:

James Hopkins -- Executive Director, Investor Relations

N. Thomas Linebarger -- Chairman and Chief Executive Officer

Mark Smith -- Vice President and Chief Financial Officer

Tony Satterthwaite -- President and Chief Operating Officer

Stephen E. Volkmann -- Jefferies & Co. -- Analyst

Courtney Yakavonis -- Morgan Stanley -- Analyst

Jamie Cook -- Credit Suisse -- Analyst

Adam Uhlman -- Cleveland Research Company -- Analyst

Joel Tiss -- BMO Capital Markets -- Analyst

Jerry Revich -- Goldman Sachs -- Analyst

David Raso -- Evercore ISI -- Analyst

Ann P. Duignan -- J.P. Morgan Securities -- Analyst

Ross Gilardi -- Bank of America -- Analyst

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