Ladies and gentlemen, thank you for standing by, and welcome to the Cummins Inc. First Quarter 2020 Earnings Release Conference Call. [Operator Instructions]

I would now like to hand the conference over to your speaker today, James Hopkins, Executive Director of Investor Relations. Please go ahead.

James Hopkins - Executive Director of Investor Relation

Thank you. Good morning, everyone, and welcome to our teleconference today to discuss Cummins results for the first 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 SEC, 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 will 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'll begin with our Chairman and CEO, Tom Linebarger.

Tom Linebarger - Chairman and Chief Executive Officer

Thank you, James. Good morning, everybody. Thank you for being with us today. Today actually marks the first for us, since Mark, Tony, James and I are all doing this call from our respective homes, and I expect many of you are listening in from your homes as well. I'm hopeful that technology will work well, but if we lose the line, the others are ready to step up. I want to start today by providing some initial comments on the environment in which we are operating and then move to our first quarter results.

Amidst the unprecedented COVID-19 pandemic, the health and safety of our employees and the communities in which we operate is our first priority. Wherever possible, our employees are now working from home. And for those frontline workers, who are keeping our plants in operation to support our customers and critical supply chains, we've introduced many additional safety measures in line with government and health authority guidelines. Across the communities where we operate, we are working through the Cummins Foundation to support families and children impacted by the COVID crisis. There were many challenges in these communities before COVID. There are many more now.

We've also partnered with DuPont and 3M to address current shortages of personal protective equipment, particularly N95 respirator masks and powered air purifying respirators using our filtration technology. We are also deeply committed to meeting our customer needs. Our teams are working hard, leveraging both our internal capabilities and the capabilities of our global network of partners and suppliers to support our customers despite major challenges in the supply chain.

During our 100-year history, we've encountered many unforeseen crisis. And I'm confident that we will successfully navigate this one and emerge stronger than ever. Cummins enters this period of uncertainty in a position of strength, with a very strong balance sheet, leading products, technology, diversity and strong relationships with the leading customers in our industry. We have also invested in sustained face-to-face leadership development with our top 200 leaders for over 10 years, providing us with a group of capable, collaborative and resilient leaders, who are ready to lead in this crisis.

We entered this period from a position of financial strength as well, with $2 billion of cash in marketable securities and $1.9 billion of committed credit facilities at the end of March. This strength is due to the successful execution of our strategy over a number of years and more recent steps we took to prepare for a downturn in 2020. During the second half of 2019, we initiated a number of actions to reduce costs, addressing underperforming parts of our business and drive performance improvement. These actions included the restructuring actions we announced in November. Taken together, these actions will save between $250 million to $300 million in 2020 and were critical in supporting our strong performance this quarter despite a 17% revenue decline.

We have continued to prioritize investments in new products and technologies that will help us emerge stronger, as we have in prior global downturns. As we entered March and the impact of COVID-19 expanded across the globe, we moved quickly to take additional actions to lower costs. In mid-April, we implemented temporary salary reductions that will save approximately $30 million per month. We have also lowered our projected capital outlays by 25% compared to 2019 and reduced discretionary spending across the company. These actions will help us maintain our strong financial position, while positioning us to deliver strong profitable growth when demand returns.

While most of our manufacturing sites around the world are currently operating, they are doing so at reduced production levels, both due to changes in facilities, line layouts and work practices to support social distancing and employee safety, and because customer demand is weaker in almost all markets. We are unable to project the full impact that the pandemic and the secondary effects will have on our demand for the remainder of the year, but we are planning for weak levels of demand for some time.

Now I'll move to a summary of our strong first quarter results and a discussion of our major end markets. Mark will then take you through more details of our first quarter financial performance and update you on the balance sheet and liquidity. Revenues for the first quarter of 2020 were $5 billion, a decrease of 17% compared to the first quarter of 2019. EBITDA was $846 million or 16.9% compared to $1 billion or 17.2% a year ago. The impact of lower volumes was partially offset by the benefits of restructuring, reduced warranty costs, material cost reductions and higher joint venture income. The increase in joint venture income was primarily due to recently passed tax legislation in India and technology fees associated with the development of new products to meet lower emission standards.

Engine business revenues declined by 19% in the first quarter compared to a year ago. Lower production in North American truck markets, along with weaker demand from global construction customers, drove most of the revenue decline. EBITDA margin for the quarter was 16.9% compared to 16.5% for the same period in 2019. Cost savings related to restructuring activities and increased joint venture income more than offset the impact of lower volumes.

Sales for our Distribution segment declined by 9% year-over-year, with lower revenues in domestic and international markets. First quarter EBITDA was $158 million or 8.7% of sales compared to 8.5% in the first quarter of 2019. EBITDA margins increased as we began to realize the benefits of our North American transformation work as well as the impact of lower variable compensation expenses and higher joint venture income.

First quarter revenues for the Components segment declined 19%. Sales in North America declined 24%, driven by lower truck build rates, while revenues in international markets declined by 12% as a result of lower truck demand in Europe and India. EBITDA for the first quarter was $279 million or 18.6% compared to 17.5% in the same quarter a year ago. EBITDA percent increased as lower warranty costs, higher joint venture income and the benefits from restructuring offset the impact of lower volumes.

Investment in research and development decreased by 9% from elevated levels a year ago, as our Global six products are now in full production in India, which transitioned to the new BS VI emissions regulations in April. And Global six products are also ramping up in China, where a phased adoption to the new regulation should be complete by next July. Power Systems sales in the first quarter declined 18% year-over-year. Industrial sales declined 30% driven by continued weakness in oil and gas and mining markets. Power generation sales decreased by 8%, with lower revenues in both North America and international markets, with particular weakness in India, where the economy has slowed in recent quarters.

EBITDA in the first quarter was 8.7% compared to 12.8% a year ago. The impact of lower volumes, combined with lower joint venture income in China, more than offset the impact of cost reduction actions. In the New Power business, EBITDA was a loss of $43 million in the first quarter, in line with our expectations. Costs associated with the development of new products and the expected slow ramp of new technology adoption are the two primary contributors to the EBITDA losses.

Now I will comment on some of our key markets, starting with North America, and then I'll cover some of our largest international markets. Our first quarter revenues in North America declined 16% to $3.1 billion. This reduction was driven by lower industry build rates of medium- and heavy-duty trucks, continued weakness in engine sales to construction and oil and gas markets and lower demand for power generation equipment. Industry production declined 32% in the first quarter compared to a year ago and 10% sequentially, with OEMs reducing build rates due to continued low order rates and shrinking industry backlog.

While OEM production was down 10% sequentially, our shipments of engines were flat. Our new X15 Efficiency Series engine, which meets 2021 greenhouse gas standards and provides improved fuel economy, is being well received by customers. We also look forward to launching the low weight X12 platform on the Freightliner Cascadia day and sleeper cab chassis, which customers can order today for delivery later this year. Production of medium-duty trucks decreased by 38% in the first quarter and was impacted by OEM shutdowns at the end of March. We continue to maintain our clear market share leadership in the medium-duty truck market and will start supplying medium-duty truck engines to Mack for the first time later this year.

Total shipments to our North American pickup truck customers decreased 1% compared to a year ago and were impacted by an unplanned OEM shutdown in the last week of March. In domestic off-highway markets, engine sales for construction equipment decreased by 39% from the near record levels experienced a year ago but were consistent with levels of demand in the second half of 2019. Revenues for power generation equipment fell by 9% with lower demand in RV and backup power markets. Demand for engines in oil and gas markets declined by 81% due to a reduction in equipment purchases of new fracking equipment.

Now I will turn to our major international markets. International revenues decreased by 17% in the first quarter of 2020 compared to a year ago. First quarter revenues in China, including joint ventures, were $1.1 billion, a decrease of 19% and were significantly impacted by COVID-19-related shutdown. The pandemic started to impact industry production of equipment in early February, and the majority of our facilities experienced shutdowns of four to six weeks in length. All of our manufacturing facilities in China were fully operational by the end of the first quarter, and we have experienced high levels of demand since reopening as OEMs prepare for a rebound in demand.

In the first quarter, industry demand for medium- and heavy-duty trucks in China decreased by 17% compared to a year ago. Our market share was 12.4%, up slightly from the first quarter of 2019. Our share was negatively impacted by lower sales of trucks by our partner Dongfeng, which is headquartered in Hubei province. Industry sales of light-duty trucks declined by 32% in the first quarter and our market share was 8%, flat with last year.First quarter demand for excavators in China decreased 8% from a year ago. Our market share was 15% compared to 14% last year, driven by the strong performance of our domestic customers. While demand was lower compared to a year ago, it remains at near-record levels.

Demand for power generation equipment in China declined by 12% in the first quarter. Sales were negatively impacted by COVID-19-related production and transportation disruptions. Demand from data center customers in China remains robust. First quarter revenues in China - excuse me, in India, first quarter revenues in India, including joint ventures, were $318 million, a reduction of 32% from the first quarter a year ago due to lower industry truck demand and weakness in power generation and construction markets. Industry truck sales in India decreased 57% compared to a very first - very strong first quarter last year, while construction and power generation sales declined by more than 30%.

Demand remains low in most end markets due to continued weak economic conditions and reduced access to credit. In addition, truck production was negatively impacted in the first quarter as a result of OEMs reducing inventory in preparation for a transition to the new BS VI emission standards. The transition to BS VI standards occurred on April 1, as scheduled. But the Indian government is allowing industry participants to sell BS IV trucks that were produced before April one for a limited period in recognition of the disruption caused by the national shutdown aimed at containing the coronavirus.

The Indian government implemented some of the most stringent lockdown procedures in the world in response to COVID-19, which resulted in the closure of all of our manufacturing facilities in late March. Starting last week, a phased approach of reopening our facilities began with strict limitations on the number of employees allowed to return to work.Outside of China and India, we saw year-over-year revenue declines of 21% in Europe and 18% in Latin America, primarily due to lower truck production.

Global sales of mining engines declined 48% compared to a year ago. Estimates for 2020 capital expenditures by miners continue to decline, with weaknesses especially pronounced in coal markets. Coal prices are now 50% below their late 2018 peak and near to trough prices reached in 2016. In China, the government-backed coal transportation and distribution association recently called for domestic coal producers to cut production to support prices.

As you know, the headlines today are filled with negative reports about economic activity and rising unemployment in many countries. Data, more specific to many of our end markets, is not encouraging, and we are prepared for weak levels of demand until global economies stabilize and start to recover. Our leadership team is spending a lot of time planning ahead, running a number of scenarios and responses, including identifying opportunities to strengthen our competitive position during this time. And of course, we will continue to invest in the new products and technologies that are key to our future success. We are able to plan ahead with confidence because of the strong position we started in. Today, we have the highest credit ratings in our industry, fully funded pension plans and robust liquidity.

Tony, Mark and I and all of our business unit leaders and many other members of my staff have been through several downturns while at Cummins and all were in senior leadership positions during the 2008 financial crisis. While this pandemic is clearly different than 2008, we have all experienced leading through challenging times and understand the importance of paying closer attention to economic conditions, preparing for the worst and taking thoughtful and decisive actions in periods of uncertainty. And to be clear, our actions will be aimed not only at reducing costs, but also continuing investment in our products and capabilities that will advance our competitive advantage. 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 for shareholders.

Now let me turn it over to Mark.

Mark Smith - Vice President and Chief Financial Officer

Thanks, Tom, and good morning, everyone. First, I want to echo some of the comments made by Tom about the resilience and determination of our colleagues in these challenging times. Across Cummins, our teams continue to relentlessly focus on safety as a top priority, while also helping to drive multiple initiatives to protect profitability, preserve cash and leave room for continued investments in the new technologies that will underpin our stronger future.

While the COVID-19 pandemic is having an unprecedented impact on the global economy, our experienced leadership team and our financial strength put Cummins in a strong position to successfully navigate the challenging period ahead. First quarter revenues were $5 billion, a decrease of 17% from a year ago. Sales in North America declined 16% and international revenues fell 17%. Currency movements, principally driven by a stronger dollar, negatively impacted revenues by 1%.

Earnings before interest and tax depreciation and amortization, or EBITDA, were $846 million or 16.9% of sales for the quarter compared to $1 billion or 17.2% of sales a year ago. EBITDA decreased by 18% year-over-year, driven by the negative impact of lower sales, partially offset by lower product quality and variable compensation expenses. We also realized the benefits of the restructuring actions that we announced in 2019, which were substantially completed in the first quarter. First quarter results included a $37 million benefit to joint venture income related to recent changes in tax law in India, which were unanticipated three months ago. As a reminder, our share of joint venture earnings is reported on an after-tax basis.

Gross margin of $1.3 billion or 25.8% of sales decreased by $238 million from a year ago but increased by 30 basis points. This improvement as a percent of sales resulted from a number of initiatives that yielded savings and quality, people and material costs. People costs declined as we saw the benefits of our restructuring actions and our variable compensation plan flexed down with weaker market conditions as it's designed to do. We reduced our selling, admin and research costs by $46 million or 6% year-over-year to $784 million. Selling, general and administrative expenses decreased by $47 million or 8%, primarily due to the benefits of restructuring and lower variable compensation expense.

In undertaking our restructuring and other cost reduction actions, we made a choice to protect engineering programs that will deliver new and improved products to drive profitable - future profitable growth and that resulted in a $1 million increase in research and engineering expenses year-over-year. Joint venture income increased by $37 million, primarily due to higher earnings in India, which benefited from the recent change in India tax law, and the receipt of a technology fee, which we flagged during our call last quarter. In China, joint venture income declined due to the impact of coronavirus on our own operations and those of our partners in Hubei province and beyond.

Other income of $39 million decreased by $44 million compared to a year ago, primarily due to strong gains last year on investments that underpin our nonqualified benefit plans. We also had gains on these investments this year but at a much lower level. Net earnings for the quarter were $511 million or $3.41 per share, diluted share, compared to $663 million or $4.20 from a year ago. First quarter results included a benefit of $35 million or $0.23 per diluted share related to the recent tax change - tax law change in India. The effective tax rate in the quarter was 19.4%.

Operating cash flow in the quarter was an inflow of $379 million, down $33 million or 8% year-over-year on a 17% decline in revenues. In fact, if we strip out the $48 million of cash payments in the first quarter of 2020 associated with restructuring actions, operating cash flow actually increased year-over-year. Capital expenditures in Q1 were $75 million, down from $109 million a year ago. In the first quarter, we repurchased $550 million of shares as we completed our trading plans placed in the fourth quarter of 2019 and early 2020, and paid $195 million out in cash dividend. The dividend remains an important part of our capital returns to shareholders, and we currently have no plans to reduce it.

As the impact of the pandemic has grown, we have responded by taking additional actions to reduce costs and preserve cash beyond the steps we had originally planned for the year. These actions include temporarily lowering salary costs across the business starting mid-April, which will result in an estimated pretax benefit of $30 million a month. We have adjusted down our cap plans for capital expenditures to be between $500 million and $525 million this year, down more than 25% from 2019.

Our industry faces a challenging second quarter, given the broad disruption caused by the coronavirus, with customers and suppliers now taking steps to restart operations after widespread closures in late March through April. We also face an uncertain outlook for the remainder of 2020 and are not providing forward-looking guidance for revenues and profitability. As Tom said, Cummins entered this period of uncertainty in a strong financial position. At the end of the first quarter, the company held cash, cash equivalents and marketable securities of $2 billion and has committed borrowing capacity of $1.9 billion under existing revolving credit facilities. We have maintained long-term credit ratings of A+ and A2 from Standard & Poor's and Moody's with stable outlooks. Our pension plans are fully funded and debt-to-capital remains below 30%. We will continue to monitor market conditions closely and may take additional steps to boost our already strong liquidity.

To summarize, the COVID-19 pandemic has presented all of us with unanticipated challenges. But Cummins is in a strong financial position to navigate this environment. We delivered strong first quarter performance and are continuing to take actions to reduce the impact of further headwinds in a challenging second quarter. But even as we aggressively cut costs and reprioritize work, we plan to continue investments in new products and technologies to put us in an even stronger competitive position when the inevitable rebound in market demand occurs.

Thanks for joining us this morning and for your support, let me turn it back to James.

James Hopkins - Executive Director of Investor Relation

Thank you, Mark. [Operator Instructions] With that, operator, we are now ready for our first question.

Question & Answers

Questions and Answers:

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Operator

Our first question comes from the line of Tim Thein with Citigroup. Your line is now open.

Tim Thein - Citigroup - Analyst

Thank you and good morning. Maybe a short and a longer-term question. First, I guess for Mark, in terms of operating cash flows for the year, Mark, should we still consider the 10% to 15% of revenues as a good way to think about targeting on cash flows? I just asked it in some - some others have flagged working capital being potentially more of a drag as we look through the remainder of the year. So maybe just your thoughts on that, and I'll start there.

Mark Smith - Vice President and Chief Financial Officer

I think there's no doubt, Tim, our inventories, in particular, were impacted in March as we started to face all of these disruptions and shutdowns. So yes, normally, we would expect a very strong inflow from working capital, and that would go some way towards offsetting the reduction in cash earnings. So I would say, yes, we're still trying to get into that range, but with an uncertain outlook, it's difficult to predict with certainty right now. What I can say is we already have very strong liquidity and we expect to maintain very strong liquidity throughout the rest of the year. So we'll keep you posted as we move through the quarters.

Tim Thein - Citigroup - Analyst

Okay. All right. Understood. And then maybe, Tom, for you. At the Analyst Day, you talked a lot about market share opportunities as customers have to prioritize investments and potentially outsource more to Cummins. I'm curious if you think what we're living through now drives more of a change in corporate behavior in terms of just more of a risk aversion. We all thought that financial crisis was kind of a 100-year flood. And now a little over a decade later, we're going through something even more significant. So it's obviously totally hypothetical at this point, but I'm just curious if, again, if this maybe drives a different thought and maybe expedite some of that potential outsourcing of capex or other projects to a company like Cummins.

Tom Linebarger - Chairman and Chief Executive Officer

Good morning, Tim, thanks for the question. So of course, we don't know yet. Today, there's - everybody is just grappling with what they see around them and trying to figure out how they can move from their heels to their toes really, given all the things that have changed and, again, trying to look ahead. But my observation so far is that this crisis has put people's attention even more on what are the critical investments I need to make for the future and which are the ones that I don't need to make anymore.

So my suspicion, again, we'll see how it plays out, is that all the decisions about trying to sort out those things that I want to outsource and those things that I want to do myself, get sharper, move faster because - just because there's not as much money as there was, you just have less resources to spread across more projects and you're trying to figure out what to do. But we'll have to watch it play out and see how it goes. From our part, Cummins is still pushing ahead with our strategy to make sure that we have the technologies that will take us into the future, the new power technologies, but also that we lead in the current power technology so that we can be partners to our customers as they decide which projects they want to do and don't want to do. We can be there to support them.

Tim Thein - Citigroup - Analyst

Okay. Thank you. Good luck.

Operator

Next question comes from the line of Rob Wertheimer with Melius Research. Your line is now open.

Rob Wertheimer - Melius Research - Analyst

Yeah. Hi. Thanks for taking the question and I hope everyone is well. Just a couple of quick ones on whether you can say anything on how order trends are going through April. I know it's very near-term and obviously very chaotic. I don't know whether there's been signed stability on orders or not. And the other one on short-term is just supply chain disruption, whether that's already peaked and you can sort of see what the shape of the year or the next couple of quarters looks like or not and how much unanticipated cost we might try to factor in from supply chain disruption.

Tony Satterthwaite - President and Chief Operating Officer

Rob, it's Tony Satterthwaite here. Let me try and cover that one. We are seeing a little bit improving trend in the context that we are seeing more OEMs reopen facilities here in April. They are essentially opening at very low production rates. And so although it is improving and it's not improving significantly, it's not bouncing hard. Our orders are - we are - we - the vast majority of our facilities outside of Mexico and India are operating. They are operating now at fairly low production levels, which is completely consistent with where our customers are. So I would say things look like they're getting a little bit better, but I think that's better from a pretty low bottom, if I look at where we've been from a customer activity perspective over the last kind of four to six weeks. So we are seeing some improvement.

We are working to restart our facilities in Mexico and India, which have had the most aggressive shutdowns. We are hopeful that we will get some level of production started there in the next couple of weeks. But the markets are very quiet. I will just say that end-user demand is down. You've seen the reports, I think, as well as I have, and we are responding with our OEM customers just to try to keep them supplied. On the supply chain side, we've been dealing with disruption in the supply chain really since China shutdown in early February. I think our global network has proved very valuable to us in that we've been able to move production around and we've been able to mitigate a large number of issues. In fact, actually even premium freight in the first quarter of this year was actually down from last year. So we are managing through this fairly well and doing our best to kind of deal with the issues that are coming up every day.

Rob Wertheimer - Melius Research - Analyst

That's very helpful. Your China JV income stuff looked quite good, actually. So thank you for your responses, and I'll stop there. Thanks.

Operator

Our next question comes from the line of Jamie Cook with Credit Suisse. Your line is now open.

Jamie Cook - Credit Suisse - Analyst

Hi, good morning. A nice quarter considering everything. I guess just building on the last question about the joint venture income, even if we back out the benefit from the India taxing, this $37 million or so, the JV income was probably more resilient than what I would have thought. So I guess, how are you thinking about that for the year given what you're seeing in China? And do you expect that part of the business to be more resilient, which would obviously help with the margins?

And then my second question, Tom, you talked about - you guys have been early to get the $250 million to $300 million. You talked about the salary cuts of 30 - that will result in $30 million of savings per year. I'm just trying to better understand the different levels - levers you could call, assuming we're in this downturn for a longer period of time and what you would sort of need to see to sort of move forward with those.

Tom Linebarger - Chairman and Chief Executive Officer

Thanks, Jamie. Appreciate your questions, and thanks for joining us. I would - let me go first. I'll answer that question, then I can give it to Mark, back to Mark on the JV income. But I would say that - as you said, it's good that we took action when we did. And it's positioned us well for a downturn, not for one of this severity, for sure. We were positioned for a downturn, but this is obviously broader and deeper than anything we were contemplating when we took those actions. That's why we added the salary reductions that we did and the time off that we did and we took the other actions just recently. We did all that to make sure that we lowered costs further from our restructuring levels while we try to assess how far and how long and how deep this economic impact from the virus is. And right now, as Mark mentioned, we really don't have a clear view. So we put these cost reductions in to say these will be in place while we try to get a better sense of where it's headed.

And then based on that, once we get a clearer sense, then we'll take longer-term actions as necessary to respond to those. And as you guess, we're running scenarios. The usual ones, you read about Ws and Vs and Us and Ls and all those other shapes to figure out what we think about what we would do in each case. And of course, what we would do in each case would be different. If we did think we were emerging pretty quickly, we might take relatively modest actions from here and carry on. That doesn't look very likely today, but you don't know until you get closer. And we are prepared with actions that we would take more dramatically if we thought we will be in a lower sales position for an extended period of time. We've done it before, and we would know what to do.

I think also, as I said in my remarks and Mark's, Mark also reinforced that we would continue to prioritize the investments in technology that we think position ourselves for our customers and look for other things to reduce, other businesses that look like in this environment they're just not going to produce the kind of profitability we want, other activities we think we could postpone or delay, we would take actions on those until we reach the cost structure that we thought would support our revenue as we emerge from the downturn. Again, how long it will last, it's just not clear today. But we are prepared for the scenario, the range of scenarios ahead.

I guess you also probably heard in my remarks a bias towards assuming it's going to be pretty bad, so that we don't get ahead of ourselves and spend in ways that we can't sustain because it's hard to catch up when you're behind. Better to start out ahead and stay ahead than go the other way. So that's kind of how we're thinking about it. Mark, let me go to you for JV income.

Mark Smith - Vice President and Chief Financial Officer

Yes. So I think the positive - the outperformance in Q1 principally came from India, Jamie. So there was the tax benefit that we talked about. I also mentioned a technology fee. I mean technology fees are an important part of our earnings stream from introducing new technologies. But I think to your go-forward question, the momentum in JV earnings is - really points to China. And beyond this initial rebound in OEM activity, how is demand for trucks and construction equipment and power generation equipment going to go from here. That's going to be the biggest driver.

In India, the economy is pretty weak. It was weak going in, and all indicators remain pretty weak. We do have some upside in the second half of the year in consolidated revenues in India as we sell more advanced after-treatment systems related to the new emissions regs. But back to JV income, kind of all eyes on China for the rest of the year.

Jamie Cook - Credit Suisse - Analyst

Okay. That's helpful. Stay well, everyone. Thanks for your insights.

Tom Linebarger - Chairman and Chief Executive Officer

Thank you, Jamie.

Operator

Our next question comes from the line of David Raso with Evercore. Your line is now open.

David Raso - Evercore - Analyst

Hi. Thank you. Kind of two related issues. The recent strength you've seen in China, can you give us some sense of how much you feel it is just a bounce back? And are your orders there already reflecting it is just a catch-up and you have a fade to it? Or just curious how you're interpreting it. And within that JV income conversations about China, Mark, you mentioned the technology fees. I assume that's showing up in the royalty and interest income line, is that correct? That's not part of the $37 million? And if so, again, how should we think about that royalty line as well? But obviously, the question first on China.

Tom Linebarger - Chairman and Chief Executive Officer

I can say a few things on China, and Tony maybe want to jump in as well. First, the way that we're seeing it is there's been a - the ramp-up has been fast in the sense that we were completely out for four to six weeks. And then as soon as the economy opened back up again, we saw a very steady ramp-up, and we're now producing at levels in many of our plants that was - is higher than when before the crisis started, which is pretty remarkable to say. What we don't understand is whether end-use demand is matching production rates today. And again, there is demand for excavators. There is demand for trucks. Whether it's at levels that they're producing now is just not clear to us.

So we are making sure we're monitoring truck lots and things like that to make sure they're sell-through. But I guess what we remain is cautious, David. I just think given the supply chains around the world and the fact that China is, like all the other economies, interlinked with other economies, we're cautious about whether or not this level of production can be supported by end-use demand in China. Part of that will depend on the stimulus that the Chinese government takes. And right now, that's unclear. But the more stimulus they provide, potentially, the longer it could go. The less they provide, the more it seems like it's probably - can't be sustained for the entire year. So we're just watching, like the other places, to see. But I guess it's safe to say we remain cautious about whether it can be sustained at this level.

David Raso - Evercore - Analyst

And to be clear, Tom, I don't think anybody is thinking we stay at the level of the peak of the catch-up. But just to be clear, are you seeing beyond this catch-up truly a sort of a lack of orders, a real notable slowdown? Or is it more just a thought process that, “Hey, we can't stay at this level, this is catch-up, so it's going to come down but we're just not sure how much”? I'm just trying to get a sense of what you're seeing versus the understandable theoretical view.

Tom Linebarger - Chairman and Chief Executive Officer

Yes - I think that's - I think that what you said was exactly where we are. We just don't think it can stay at this level, so we assume it's going to come down. To what level, though, we just don't know. And it's - again, it's tied up in what's the stimulus that the Chinese government is going to provide in China for - to drive demand in the country and then what happens with exports and imports and other things that affect the Chinese economy. Those are the two things that are still up in the air that will sort of impact the level that it settles out at.

David Raso - Evercore - Analyst

But the orders aren't rolling hard already. I'm just trying to get a sense of, of course it comes down but…

Tom Linebarger - Chairman and Chief Executive Officer

No. They're not.

David Raso - Evercore - Analyst

No, okay. I just want to make sure. Okay. And I'm sorry, there's small question about the royalties, just so we understand the JV income.

Tom Linebarger - Chairman and Chief Executive Officer

Yes.

Mark Smith - Vice President and Chief Financial Officer

So it's Mark, David. So yes, it's in the royalty and interest income. So you will see that's up to $30 million this Q1 versus $13 million last year. All of that increase is royalty, it's nothing to do with China. It's all in India related to new technologies for BS VI,etc.

David Raso - Evercore - Analyst

And that's not part of the $37 million? The $37 million is up in the all other manufacturer?

Mark Smith - Vice President and Chief Financial Officer

No. Yes, two separate issues. One is tax-related, one's a tech fee. I did call out the tech fee last quarter. Is there a reason - I think it was Courtney who asked a question how could we possibly have an increase in JV earnings, which is a reasonable question. I did call that out last quarter. Yes, that's - that is a part of our business, but it tends to come in lumps and chunks.

David Raso - Evercore - Analyst

It's lumpy, but it doesn't sound very one-off to us. I'm just trying to make sure it's 30. It's not going back to five or 10 per quarter. It's somewhat - it's lumpy, but sustainable. It wasn't a one-off completely, is what I'm trying to understand.

Mark Smith - Vice President and Chief Financial Officer

Yes. I mean it depends on the nature of it. There's a lot of - it's going to come down from the $30 million though. That is a higher level typical…

David Raso - Evercore - Analyst

Yes. No, I appreciate that.

Mark Smith - Vice President and Chief Financial Officer

But there's lots of agreements, okay?

David Raso - Evercore - Analyst

All right. Thank you.

Mark Smith - Vice President and Chief Financial Officer

Appreciate it.

Operator

Our next question comes from the line of Jerry Revich with Goldman Sachs. Your line is now open.

Jerry Revich - Goldman Sachs - Analyst

Yes, hi, good morning, everyone.

Mark Smith - Vice President and Chief Financial Officer

Good morning, Jerry.

Jerry Revich - Goldman Sachs - Analyst

Mark, I'm wondering if you could just expand on the margin discussion you had in your prepared remarks. Pretty interesting to see gross margin percentage up given the production declines. Can you just flesh out for us what was the price cost, the magnitude of that freight tailwind you spoke about and other drivers as we think about the bridge in the performance?

Mark Smith - Vice President and Chief Financial Officer

Yes. I've got an overall EBITDA bridge in front of me, Jerry, not every single line item. But let me talk to you the main points about that. We've got about 80 basis points of improvement from warranty in the cost of sales, 70 basis points of variable compensation, 60 from restructuring, 70 from the India tax. And then there are a series of pluses and minuses. Pricing cost was about 20 basis points of improvement. And then the offsets were really volume, 260 basis points. Other income, there was lower investment gains, about 60, and then the rest is maintaining the R&E, which went up as a percent of sales and lower JV earnings in China.

Jerry Revich - Goldman Sachs - Analyst

Okay. That's helpful. I mean as I would…

Mark Smith - Vice President and Chief Financial Officer

A quite a lot of drivers, principally in cost, a little bit in joint venture earnings really helped out this quarter.

Jerry Revich - Goldman Sachs - Analyst

Okay. And as we think about the possible decremental margins for the second quarter and the pieces that are going to stay with us, so variable comp, warranty, I think still faces a somewhat easier compare, so as you look at the opportunities for margin performance in the second quarter, do you feel comfortable that you can be in that 25% to 30% targeted range even with the unprecedented production cut in April? Can you talk to that a bit, please?

Mark Smith - Vice President and Chief Financial Officer

I think what you're going to think to, Jerry, is April is completely unprecedented like I think in my career in Cummins in the sense of such a high proportion of our customers, suppliers, and of course, some of our own operations shut down. So I think everyone is going to have to accept for our industry - I mean we don't publish April results, but that is going to be an anomaly, and I think we're going to have - when we get through that and see what will come on the other side, we're going to have to arm you with comments about how different will the go-forward month versus April. I think it's just going to be so unique.

Hopefully, it doesn't repeat in the remainder of the year based on some of the scenarios. But just - there's such a level of uncertainty about the pace of start-up, Jerry. The reason why we've taken these temporary cost actions is we're just not sure how long we're going to go through these difficult periods. So I'm reluctant to commit to - decrement or that we're not managing the business to what happens in a very short period of time, although we're trying to make sure we're on top of all our costs. I'm going to try and avoid giving you a very specific number, given the disruptions we're facing.

Jerry Revich - Goldman Sachs - Analyst

Okay. I appreciate the discussion and a nice quarter. Stay safe, everyone. Thanks.

Operator

Our next question comes from the line of Stephen Volkmann with Jefferies. Your line is now open.

Stephen Volkmann - Jefferies - Analyst

Hi. Good morning, everybody. Most of my questions are answered, but maybe this is a Tom question. But I think expressed some frustration around the margins in the past, you guys have worked to sort of satisfy that in various ways, and yet the margin is still fairly weak. And obviously, this is a weak point. But I'm wondering just how you're thinking about that business now and does it need additional attention or becomes a core business in a different way. Just any change you're thinking there?

Tom Linebarger - Chairman and Chief Executive Officer

Yes. Thanks, Steve, and thanks for your question today. So a couple of thoughts. First, as you said, we worked very hard over the years to try to rightsize the power generation side, the generator set business, to what has been clearly a changed environment in terms of demand across the world, with the notable exception being data centers, which has been pretty robust and continues to be in lots of parts of the world. The rest of the demand has diminished and competitiveness has increased across the market. So that's just been a reality we've been dealing with for some time. And we feel good about where we are there in terms of restructuring and getting the cost structure right for the business. Most of what we saw in terms of margin deterioration here came from the industrial side of the business. It's a terrific business, the mining business and oil and gas and other large engine business, terrific business for Cummins. It's just cyclically going down.

And of course, the crisis is going to make it doubly worse. So that was - we saw that deterioration. It was a big impact. And we are trying to figure out how to get the business rightsized for when we come out of this downturn and make sure that we're positioned from a cost structure point of view right for that. But we do believe that business will return strongly, and we think it will be a good business long run for Cummins. And at this stage, we think the generator set business is also structured right to be able to perform long run for the company. Tony has been working really closely with our - the leader of that business, Norbert Nusterer, to get that business to where we feel confident in its long-run future and its ability to return for the company. So Tony, I don't know if you want to add any comments there.

Tony Satterthwaite - President and Chief Operating Officer

Thanks, Tom. Yes, Steve, I would just add to - remember, the power generation business is linked to the industrial business in the sense that it gives a volume base that gets cost right, and then it's also linked to our Distribution business, which is the primary sales outlet for power gen. So it is an important business across Cummins and it impacts a couple of different BUs. And so you would asked if we had changed our thinking on whether it was core or not, and I would say no, we are still on the page where we think it's an important part of Cummins.

It makes the portfolio more successful overall. And we're trying to get the specific business that's part of Power Systems to the right level of performance. And I would say we've done a lot of work, I think it's starting to bear some fruit. It is a difficult time even in the power gen business though, not just in industrial, although industrial did turn down much more aggressively here in the first quarter. So we haven't changed our view. I still think we see it as a core part. It makes the portfolio more successful overall, and we're working hard to try to get it to perform the way we want within the Power Systems business unit.

Stephen Volkmann - Jefferies - Analyst

Thank you guys. Stay safe.

Tony Satterthwaite - President and Chief Operating Officer

Thanks Steve.

Operator

Our next question comes from the line of Ross Gilardi with Bank of America. Your line is now open.

Ross Gilardi - Bank of America - Analyst

Yes. Thanks. Good morning everybody. Yes. Tom, I was wondering if you could maybe just comment and somewhat related to Tim Thein's question to open up, but less on outsourcing and in sourcing, but on alternative powertrain and just how you're thinking this whole existential threat from alternative powertrains, specifically EV to the internal combustion engine for trucks in a world where we've got $20 a barrel of crude and very cheap diesel. I mean does the whole push and evolution potentially take a step back? And will the newer entrants to these markets survive? And do the customers gravitate more towards Cummins because they simply know you'll be around because you've got the financial strength to do so?

Tom Linebarger - Chairman and Chief Executive Officer

Ross, thanks so much for that question, and thanks for joining the call today. It is sort of - I've been pondering that question pretty much every day now since the crisis started. It does link to Tim's question. How are OEMs thinking about their future and what they want to spend money on? And then what happens with the technology and the environmental thrust when nations and customers are threatened with economic viability? And one obvious point is that it does feel like people are going to be more cautious about making - taking technology and capital risks associated with adopting new technologies. Just from a consumer point of view, from an OEM point of view, how much do I want to commit to a technology where the price is much higher, the capital risk of resale is much higher. I think that is definitely the case. How long that will last is unclear.

What doesn't seem to be changing that much though is government's view that over the long run, CO2 and global warming is still a gigantic threat and needs to be addressed. So what I'm hypothesizing today is that the role of regulation will increase versus the role of technology. And what I mean by that is technology still has to be driven to provide customers with good products, but the driver for substituting one technology for the other might switch from the fact that I just prefer it to regulation is driving it. This was likely anyway, but it seems like it's going to grow more likely now given the economic crisis, because the capital just won't be there to take more chances and I do think the economics of the new technologies are just not in place with such cheap oil.

So right now, we still think investing in the technologies is critical because we do believe the regulations will be there to drive people to lower CO2 products, and so we need to be ready. But we do think that the regs are going to play a bigger role than maybe even just economic trade-off. I was interested to see the announcement in Europe about Daimler and Volvo joining forces on fuel cell because it does reinforce one of the things that we've been seeing in our own technology development. It's that large-scale batteries for EVs and commercial over-the-road trucks, long-range trucks don't look like - don't look as promising as maybe they once did and fuel cells maybe look more promising.

And I think that's evidence that those large truck makers think this could be a more likely winning technology. We've made a significant investment in that technology over the last couple of years through the acquisition of Hydrogenics and are growing more confident with the long run viability of that technology. It's going to take a while, but it does look like a better solution than batteries for at least large energy and large long-range used vehicles.

Ross Gilardi - Bank of America - Analyst

And then just a quick follow-up. Just from Q1 to Q2, we can all see the industry forecast on Class eight and medium-duty truck production in North America. For that portion of your business, is there any reason to believe that Cummins' production trends don't track that delta fairly closely?

Tom Linebarger - Chairman and Chief Executive Officer

Tony, do you want to take that one?

Tony Satterthwaite - President and Chief Operating Officer

Yes. Tom, I'll take it. I think Ross, if I interpret your question, your real question is, is our share going to change? Is that what you're asking? We - I mean we do not see any major shifts in share. We're not expecting any major shifts. We expect to follow the market. Particularly, we'll see what happens, but that is what we're expecting and I wouldn't - I wouldn't be planning anything significantly different, no.

Mark Smith - Vice President and Chief Financial Officer

I would just add, we can't - Ross, we can't really track current month production with inbound orders for the month. Just where we are we've been - the industry has been working on a backlog, and then we've got disruptions. But yes, longer term, we should be moving in line, yes.

Ross Gilardi - Bank of America - Analyst

Okay, great. Thank you, guys.

Operator

Our next question comes from the line of Joe O'Dea with Vertical Research. Your line is now open.

Joe O'Dea - Vertical Research - Analyst

Hi. Good morning. Tony, just related to your comments on that last question. I mean I think we did see outperformance relative to the industry in North America on-highway in the quarter, with you more flattish and industry production that was down. Can you talk about if that's just sort of timing and sometimes you see these things versus did you see your customers trying to stock a little bit in anticipation of supply disruptions?

Tony Satterthwaite - President and Chief Operating Officer

Yes, Joe, let me answer that. We - share moves around a bit quarter-to-quarter for a bunch of different reasons. We feel good about the position we have right now. Our X15 Efficiency Series, which Tom mentioned, which meets 2021 greenhouse gas a year ahead of time and also offers customers better fuel economy is performing very well. We're getting very good feedback. We've got the X12 coming out in the Cascadia chassis that you can order now for delivery in the middle of the year. And finally, we've got the Mack launch. So we're pretty pleased about how positioned we are and how the products are doing. Performance of the X15, as I said earlier, has been very good. We've had great feedback from customers.

And so I don't think it's anything specific related to customer stocking or anything. It's hard for us to tell a bit, like what Mark said previously. But we feel good about where we are. We feel that we're - the product is doing well. And that, at the end of the day, we know is one of the biggest impacts on our share. And so we're not expecting any significant changes this year, through the course of this year. We are pleased with our new products and how they're performing. And hopefully, that will bring more customers our way.

Joe O'Dea - Vertical Research - Analyst

And then Tom, in your prepared remarks, you commented on through some of the scenario analysis that you're doing now. You're also looking at opportunities to improve your competitive position through some of these disruptions and to whatever degree you're willing to comment on where you see some of the greatest opportunities in terms of improving competitive position as we move through this.

Tom Linebarger - Chairman and Chief Executive Officer

Yes. Thank you, Joe, for that question. So not - probably won't surprise you that it's in line with the strategy that we've been following for several years. We do believe that if we continue to invest in technologies that are critical to outperforming in our core business and in the diesel and natural gas engines and the components that support that, we can offer customers better fuel economy, better cost, etc, and we can play an increasing role in that industry as some customers decide that's not where they want to put their scarce investment dollars. So that will continue to be a focus for us, both the investment and the opportunities associated with helping partner with customer those products for them.

And then the few - an area that we're looking at is how do we expand our footprint in and around the engine. You've seen us do our transmission joint venture with Eaton. We'll continue to look in those areas and up and down the engine range to say are there areas where the businesses that are - where those businesses are not successful and they'll be better, or even better if we own them. So we will continue to look for acquisitions and partnerships as we have before. I think today is not the day for an acquisition or partnership, but just recognizing that when disruptions like this happen, new opportunities get created that weren't true before the disruption. And so we'll just be having our eyes open. We know where we want to be and if we can get the right investment, we would.

And then I guess, lastly, just making sure that we have our new product portfolio tuned into where the opportunities are. What I mean by that is a little bit back to the conversation we had earlier. We have batteries, fuel cells, electrified powertrains, hybrids and making sure that we don't just launch and go, but think through where are the opportunities biggest first. So we launched our electrification businesses in buses, city buses, school buses. We've now moved over to terminal tractors and things that work at the port because there's a lot more activity there.

Making sure that we continue to examine that portfolio, spend our money where the opportunities are going to happen first, so that we can position ourselves in a lead, that's both in terms of application but also in terms of region of the world. So we're just continuing to scan those strategic opportunities and make investments on purpose in the places where we think we can gain advantage. Again, our perspective is that some of the things that we wanted to do were not affordable or not right for shareholders back during the last three or four years may become so as a result of this disruption.

James Hopkins - Executive Director of Investor Relation

Thank you, everybody, and I think that that takes us to the end of the hour today. As always, a big thank you to everybody for your interest in Cummins. Please stay safe, and then I'll be available for any follow-up questions this afternoon.

Mark Smith - Vice President and Chief Financial Officer

Thank you.

Tom Linebarger - Chairman and Chief Executive Officer

Thank you.

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CUMMINS INC

Q1 2020

Earnings Transcript

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