Dana Incorporated (DAN) Q3 2019 Earnings Report, Transcript and Summary

…Third Quarter 2019 Financial Webcast and Conference Call. My name is Carmen and I will be your conference facilitator today. Please be advised that our meeting today, both the speakers' remarks and Q&A session, will be recorded for replay purposes. There will be a question-and-answer period after the speakers' remarks and we will take questions from the telephone only. [Operator Instructions] At this time, I would like to begin the presentation by turning today’s call over to Dana's Director of Investor Relations and Strategic Planning, Craig Barber. Please go ahead, Mr. Barber.

Thank you, Carmen, and good morning, everyone. Thank you for joining us today for our 2019 third quarter earnings call. You'll find this morning's press release and presentation are now posted on our investor website. Today's call is being recorded and supporting materials are the property of Dana, Incorporated. They may not be recorded, copied, or rebroadcast without our written consent. Today's presentation includes forward-looking statements about our expectations for Dana's future performance. Actual results could differ from those suggested by our comments today. Additional information about the factors that could affect future results are summarized in our Safe Harbor statement and found in our public filings, including our reports with the SEC. Presenting this morning are Jim Kamsickas, President and Chief Executive Officer; and Jonathan Collins, Executive Vice President and Chief Financial Officer. Now it's my pleasure to turn the call over to Jim.

Good morning and thank you for joining us. I'm pleased to report that Dana achieved record third quarter sales of $2.2 billion, resulting in our 12th consecutive quarter of year-over-year sales growth. This continued growth was not achieved by accident, but instead by providing exceptional customer satisfaction, which has led to very strong organic growth plus accretive inorganic growth resulting in a very disciplined and highly effective M&A strategy. Our adjusted EBITDA for the quarter was $250 million, $10 million higher than the third quarter of 2018, resulting in an 11.6% margin. Our diluted EPS was $0.74. We have several highlights this quarter, and I will briefly cover them before turning the call over to Jonathan. We saw our overall sales and profits grow yet again. This was only possible because our team continued to perform very well launching our strong, organic backlog while on the organic side successfully -- inorganic side integrating the Oerlikon Drive Systems business. In our heavy vehicle markets, we experienced high level end market demand volatility in construction and agricultural equipment end markets, as well as a significant drop in demand in India and China, which especially impacted our higher profit margin off-highway business. In addition, we were impacted by the General Motors' autoworkers labor strike, primarily in our light vehicle segment but also in our commercial vehicle and power technologies groups. We are navigating through the volatility, largely a result of our flexible manufacturing, selected vertical integration and our balanced end market exposure. We also accelerated the flexing of our cost structure thus largely offsetting the impact of market volatility and bolstering our strong free cash flow. I will share some additional color around this in just a few minutes. In addition, we announced the acquisition on Nordresa Motors, a recognized leader in the development and integration of electric commercial vehicles. The Nordresa team located in Montréal, Québec, Canada was a perfect match to fully integrate Dana's complete portfolio of electrodynamic components along with our extensive history of mechanical systems, thus providing industry-leading complete electric powertrain solutions for our customers. Lastly, Dana continues to be awarded new electric vehicle business across all of our business segments including but not limited to securing electric powertrain programs with two leading medium duty truck manufacturers. Now turning to slide 5. As you may recall, back at the end of 2016, I started to talk about quarterly year-over-year revenue growth. It only seems fitting that as we close out 12 consecutive quarters of year-over-year growth that I highlight this accomplishment and thank our customers and Dana team members for helping us to achieve such strong and sustained growth. As you can see, over the past three years, Dana has achieved a remarkable 48% growth in sales. Notably this growth has been the result of several factors. First, all four of Dana's business units have grown organically. Second, we capitalize on sustained yet challenging high volumes by delivering exceptional operating performance, which resulted in great appreciation in the form of new business awards from our customers. And third, Dana selectively acquired accretive assets that have not only contributed to the top-line but have also added new technology to our portfolio to address the vehicle electrification megatrend, increased market diversification and expand our customer base, each of which are key elements of enterprise strategy. This execution continues to set Dana apart from our peers as market volatility descends across the mobility sector. Slide 6. What you may already know in the third quarter, we experienced volatility across all of Dana's end markets. As previously communicated, the Class 8 volume decline for the quarter was in line with our expectations. However, we saw very rapid fall off in the off-highway markets, as well as the passenger car segment of the light vehicle market, which mostly impacts our power technologies business. In addition, we also experienced demand weakness in Europe, India and China that was in line with the broader economic slowdowns in the regions. Setting aside the impact of the GM strike, our core light truck market remains resilient including demand in key programs such as the Ford Super Duty and Ranger pickup trucks as well as the Jeep Wrangler and the Gladiator. The General Motors strike impacted sales across our three segments including commercial vehicle where General Motors supply systems to Navistar for the Silverado Medium-Duty truck program and our Power Technologies segment due to our exposure to multiple engine programs. Of course, the largest impact was felt in the light vehicle as strike idled the Chevy Colorado and GMC Canyon programs. As we shared with you last month and many of our customers have recently communicated most of our Off-Highway customers are experiencing weakening in end market demand, specifically in construction and agricultural equipment. For Dana, India is a key Off-Highway domestic and export market for us and the India economy has been very sluggish at best. In summary, it seems to me that the mobility market conditions right now are fairly strong indication of what we may expect for next year. From a Dana perspective, as we experienced the first signs of lower demand, we immediately transitioned to aggressive cost flexing actions across all the impacted areas of our business. We idled production and took necessary steps to adjust our converging costs to align with our customer demand. Turning to slide 7. I will outline how we managed through the cycles. Across each of our businesses, we remain focused on strong organic growth, acquisition synergies and leveraging cost management activities to help us successfully manage through the various cycles in our industry. We have talked a lot about flexible cost structure and I wanted to take a moment to provide you more detail on what that means by covering a few of these actions. Beginning in the middle of the page, you will see that as a percentage of sales cost of goods sold represents the largest cost bucket for Dana at around 80% of sales and the vast majority of cost of goods sold is variable. Breaking down cost of goods sold about two-thirds is material cost and almost completely variable due to the intentional outsourcing that limits our vertical integration to only core products such as gears, motors, controls and software. This combined with our flexibility, centrally managed global supply chain means we can respond rapidly to changes in demand and optimize our value chain. Conversion costs are the remaining one-third of our cost of goods sold for cost of sales which includes everything required to operate the business with the exception of engineering which I'll cover separately. One of our main enablers to managing conversion cost includes flexing labor to support the required demand. Having operated in volatile markets for decades, we have structured the business to have temporary labor flexibility not to mention significant experience in efficiently working with local governments to utilize subsidy programs most specifically in Europe. A major cost driver for us in periods of high demand in our heavy duty businesses is premium operating cost such as freight, overtime and so forth to meet peak customer demand. As we flex our operations for reduced demand, these associated premium costs are eliminated and they serve as a cost reduction or savings. Beginning late last year, we took actions around certain austerity measures and footprint optimization in advance of expected weaker end markets. Through early retirements and separations, we lowered our headcount by nearly 500 associates and we've continued to adjust our workforce in our heavy vehicle groups throughout 2019. We have tackled fixed costs by closing facilities and balancing our capacity. Over the last year, we've closed 10 facilities while combining our other operations improving our overall efficiency. Our manufacturing footprint optimization is ongoing and we will continue to pull these levers and more to balance our cost structure within market volatility. Engineering and SG&A expenses are 3% and 6% of sales respectively. While the majority of the cost buckets are traditionally fixed, we have several places where we can flex our spending without jeopardizing our long-term growth. In engineering spend for example, we have engaged in a more collaborative approach with our customers to share research and development cost and we continue to be diligent in prioritizing those reaches and efforts that will be most marketable. Two of the largest levers we have are the rate and depth of investments we make in electrified technology and the offsetting, de-prioritizing of legacy products. By managing these two priorities, we can reduce our investments and maintain balance through the revenue cycle. The final cost element is SG&A. Our largest opportunity remains our acquisition synergy plan we are currently executing. We are confident that we will achieve our goal of $10 million in cost synergies this year and are working on ways to accelerate the savings next year where we expect to achieve the remaining $20 million. The synergy plan is structural and not volume independent. So we expect to achieve the savings even with weaker market demand. We also have synergy opportunities beyond acquisitions. Dana's multi-market focus allows us to leverage our core attributes across the entire business. This has become a real strength as we push further into electrification as every dollar that we invest in people or processes is multiplied threefold since we can apply it across all three of our end markets. This principle leverage and consolidation holds true for our key processes in areas such as purchasing, IT and lean manufacturing to reduce our overall overhead and streamline our operations. A great example of a simple improvement we are making is further integrating our global shared services model and taking lessons learned about process automation from our manufacturing plants and applying new automation tools across administrative activities to reduce overall cost. And finally, while not part of our cost structure, there are elements of our free cash flow that are firmly in our control, including our capital expenditures. While most of our capital supports our new business growth, we are now through the heaviest period of investment and we'll be able to exercise more control over the overall timing of the CapEx spending. As a reminder, with demand falls working capital will become a source of cash as outflows slow and inventories moderate. So, hopefully, this is a helpful look at how we manage our business through the various cycles. And while we are experiencing some market headwinds next year in a few of our businesses, our core light truck business and our growing electrification business remain strong. As we evolve, our strategy to drive growth and meet the changing demands of the markets that we participate leading in electrification is a key element of the strategy. As I mentioned in my first slide, we announced during the quarter the acquisition of Nordresa Motors, a leading e-mobility company. Nordresa's proprietary e-Power solutions of battery management and charging systems as well as electric powertrain controls and integration expertise combined with Dana's complete gearbox, motor, inverter and thermal management capabilities enables Dana to assist customers in transitioning their traditional vehicles to fully electric commercial vehicles. While each of our customers are at different points of their electrification journey, our strategy remains focused on supporting them with industry-leading technology and expertise for all vehicle architectures. This acquisition enables Dana to do just that to offer our customers a complete systems solution, including fully integrated e-Axles, battery and powertrain controls and thermal management capabilities. And we're happy to report, that earlier this week, Dana announced a significant new program award with a major OEM for our medium-duty electric vehicle series that will be fully be designed, integrated and updated by Dana and feature a complete Spicer Electrified e-Powertrain including the motor, inverter and gearbox. Enabled by our acquisition of Nordresa, we can deliver the complete e-Power system, which generates stores and manages the energy including battery management system, onboard charger, power electronics cable and auxiliary systems. It's expected to be available for ordering in the second half of 2020. This three-year program will generate about $200 million in sales for Dana. Turning to Slide 9, I will talk about additional e-Powertrain business wins. Like the Nordresa transaction, we have sought strategic investments over the past few years to further expand our offerings for hybrid and electric vehicles that we can offer our customers a complete range of turnkey solutions for the rapidly evolving mobility market. I'm excited to share with you how our strategy is paying off with the new business wins across each of the markets we serve. Earlier this month, we announced a global collaboration to supply -- to develop and supply a 48-volt electric system for new mobility applications including low-speed electric and hybrid e-all-wheel-drive vehicles for the light vehicle market. The partnership with Valeo enables us to deliver a complete 48-volt vehicle e-Propulsion system, while also expanding our offerings for hybrid and electric vehicles, providing our customers with a complete range of solutions for the rapidly changing mobility market. The first system is scheduled to launch in early 2020 with a major European automaker on a series produced cars. In the lower left of the slide, you will see Dana will be supplying its Spicer Torque Hub wheel drives customized and newly developed gearboxes as well as our Ashwoods Motors for the two Terex Genie electric boom lifts. This is a new product range that Terex Genie is bringing to market next year that will set the bar for innovation emission-free operation even in the most sensitive work environments. Moving to the top right. This week we also announced new business with Lonestar Truck Group, a manufacturer of specialty commercial vehicles. Dana will be providing our Spicer Electrified full e-Powertrain system that will drive new line of fully electrified terminal trucks. These trucks will be capable of 22 hours of continuous operations with only two hours required for full battery recharge. And finally in the lower left -- lower right, Dana is very excited to announce the nomination by a major automaker to supply battery cold plates for an upcoming North America fully electric vehicle program. Our award-winning cold plate technology combine superior terminal performance -- thermal performance in a thin lightweight package and features a sophisticated channel path for optimized coolant flow, resulting in a more stabilized battery temperature and faster charge. Dana has been designing custom battery and electronics cooling solutions for more than two decades, demonstrating our leadership as a key supplier, leading the charge into the new era of mobility. I believe this slide tells the story of how our disciplined strategy to fill out our e-Powertrain portfolio is enabling us to capitalize on the quick evolving growth trends taking place across the markets we serve. Thank you for your time this morning, and I'd like to turn the call over to Jonathan.

Thank you, Jim. Good morning everyone. Slide 11 is an overview of our third quarter results compared with the same period last year. Third quarter sales were $2.16 billion, an increase of $186 million compared to the same period last year or 9% growth driven by the conversion of our backlog and the accretive acquisition in our Off-Highway segment. Adjusted EBITDA for the quarter was $250 million, a $10 million increase from the prior year or 4% growth for a profit margin of 11.6%. The primary margin headwind this quarter was unfavorable segment mix, which I'll cover in detail in a moment. Net income was $111 million, an increase of $16 million over 2018 or 17% growth, which is largely attributable to favorable income taxes due to the release of valuation allowances in Brazil as market prospects in that country have improved. Diluted adjusted EPS, which excludes the impact of nonrecurring items was $0.74, slightly lower than last year as higher adjusted EBITDA was offset by higher depreciation and interest expenses. Adjusted free cash flow was $125 million, $91 million higher than last year for a 6% margin. The growth is primarily attributable to lower cash taxes and working capital requirements. Please turn with me now to slide 12 for a closer look at the sales and profit growth in the third quarter. The growth in third quarter sales and adjusted EBITDA compared to last year is driven by four key factors. First, organic growth added $27 million in sales, primarily driven by continued conversion of our strong backlog, which was partially offset by lower market demand, principally in our heavy vehicle businesses. The unfavorable mix generated by lower off-highway sales in the high margin construction markets that Jim discussed a few months ago generated an $11 million profit headwind resulting in 65 basis points of profit margin compression. Second, inorganic growth from the Graziano and Fairfield businesses contributed $183 million in sales and $26 million in profit for the quarter. Conversion on inorganic growth has steadily improved throughout this year as we execute our cost synergy plan. In fact, we've been successful in pulling ahead these cost savings compared to our plan. Despite softer end market demand, year-to-date we've achieved approximately $15 million in cost synergy savings, which is $5 million higher than our original full year target. Third, the U.S. dollar continued to strengthen against key foreign currencies during the quarter lowering sales by $25 million and adjusted EBITDA by $4 million. However, the profit margin impact was negligible. Finally, increases in commodity costs compared to the same period in the prior year lowered margins by a mere five basis points as material costs continue to moderate. $2 million of gross cost increases were offset by $1 million incremental customer recoveries in the form of higher selling prices resulting in a net impact of $1 million reduction to profit. Please turn with me to slide 13 for a closer look of how the adjusted EBITDA converted to adjusted free cash flow. 50% of third quarter adjusted EBITDA converted to adjusted free cash flow at $125 million, which is $91 million higher than the same period last year. Growth in adjusted EBITDA was augmented by lower cash taxes and working capital requirements and these were partially offset by higher onetime costs, interest payments and capital expenditures. Lower cash taxes of $25 million were primarily due to jurisdictional mix and the timing of reforms and payments. Working capital was $50 million source of cash versus a $38 million use in the same period last year. It's important to remember that as we've experienced strong end market demand over the past few years, the resulting top line growth has required us to make significant investments in working capital. Now that we're seeing softness in our heavy vehicle markets in particular those requirements are subsiding. As Jim mentioned earlier, this is an important economic insulator as we manage the business at lower volumes. Please turn with me now to slide 14 for details on the action we undertook in the third quarter to further strengthen our capital structure. Last month, we executed two key actions to enhance our already strong balance sheet as we progressed towards our long-term leverage target. Our first key action was to amend our senior secured credit facility, which delivered three benefits. First, we extended the majority of our cash flow revolver and our Term Loan A by two years. We now have no significant maturities for four years. Second, we increased our liquidity through our cash flow revolver by increasing the capacity by $250 million to keep pace with the revenue growth our businesses achieved over the last few years. And finally, we lowered the interest rate on the Term Loan A by 25 basis points. And in doing so, we've lowered our overall effective average borrowing cost to a blended rate of just over 4.25%. Our second key action was to pay down $100 million of our Term Loan B with proceeds from a draw on our revolver, which we expect to pay down to zero in the fourth quarter. This is the first step in our stated goal of systematically reducing our leverage. Combined, these actions extended our maturities, increased our liquidity and lowered the cost to service our debt. Please turn with me now to slide 15 for a look at our updated full year guidance. Due exclusively to softer demand, primarily in our heavy vehicle segments that Jim outlined earlier in the call, we're lowering the full year guidance ranges we published early this year as well as the updated indication within that range that we provided you in July. We're now expecting sales in the range of $8.55 billion to $8.85 billion with a midpoint approximately $275 million lower than our previous indication and about $450 million lower than the midpoint of the original range. The drivers of this change are the reduced volume, foreign currency translation resulting from a stronger U.S. dollar and slightly lower commodity recoveries from an improved outlook in commodity cost. Our expectation for adjusted EBITDA is in the range of $1 billion to $1.70 billion. At the midpoint of this range, this represents a 20% conversion on the sales decline from the midpoint of our original guidance and implies a profit margin of approximately 11.9%, which is 40 basis points lower than our previous expectation, but remains 10 basis points higher than last year. Our adjusted free cash flow margin remains unchanged at approximately 3% of sales as the lower adjusted EBITDA will be largely offset by lower cash taxes and working capital requirements. Diluted adjusted EPS is now expected to remain just over $3 at the midpoint of the range. Notwithstanding, this lower outlook driven by softer end-market demand, we remain on track to deliver sales, profit and adjusted free cash flow growth for the third consecutive year. Please turn with me now to Slide 16 for a closer look at the expected sales and profit growth for the full year. The same four factors driving our third quarter sales and profit growth are also the primary drivers of our expected growth for the full year. First, organic growth is still on track to contribute a net $100 million, driven primarily by our new business backlog of $350 million. This will be partially offset by the slowdown in our heavy vehicle end markets, which is expected to be $140 million sales headwind, as well as the $110 million in nonrecurring sales in the first half of last year resulting from the old and new Jeep Wrangler programs overlapping. Even with the recent demand volatility, profit conversion on the organic growth remains strong and will generate 30 basis points of margin expansion this year. Second, inorganic growth in the Graziano and Fairfield businesses is now expected to add $650 million in sales and about $85 million in profit, contributing approximately 10 basis points to margin expansion. The sales contribution of this business is approximately $100 million lower than we expected, due entirely to lower demand in the Off-Highway markets. The loss profit contribution will be partially offset by higher cost synergies, which we expect to be 2x our original target for this year. Third, for the full year we expect the impact of foreign currency to be a headwind of $225 million of sales and $30 million to profit. Fourth, we've reduced the expected gross commodity cost increases from $60 million to $50 million. We expect to recover about $35 million this year resulting in a net profit headwind of about $15 million and 25 basis points of margin compression. Please turn with me now to Slide 17 for more detail on how we expect the adjusted EBITDA will convert to adjusted free cash flow. Our full year outlook for adjusted free cash flow remains unchanged at about 3% of sales as the revision to our profit growth will be largely offset by lower cash taxes and working capital requirements. Adjusted EBITDA growth of $75 million will be partially offset by higher onetime cost of $40 million, higher combined interest and taxes of $10 million and the net increase of $10 million between working capital and capital expenditures resulting in $15 million of adjusted free cash flow growth. Please turn with me now to page 18 for a review of the drivers of our outlook for next year. Softer market demand which has caused us to lower our expectations for this year will flow through to our outlook for next year. However, we remain convicted in our ability to deliver growth in all our key financial metrics for the fourth consecutive year for the following reasons. First, we expect organic sales will be essentially flat with this year as we anticipate our strong backlog will offset further softness in our end markets. The exciting news Jim shared earlier in our call around recent electrification wins combined with stronger volumes on key platforms in our backlog should lead to a substantial increase in the $200 million tranche for 2020 that we provided earlier this year. As is our normal practice, we'll provide our revised three-year backlog when we deliver our year-end financial results early next year. It's also worth noting that we expect more than $100 million of inorganic sales growth as a result of owning the Graziano and Fairfield businesses for a full year. Next, we expect modest profit margin expansion next year due to cost synergies on our acquisitions as well as lower commodity cost. The trends of both variables during this year provide increased confidence in the favorable impact they will have next year. Finally, we foresee a significant inflection point in our free cash flow generation next year. The modest profit increased will be bolstered by significantly lower onetime costs due to the acquisition we made this year and meaningfully lower capital requirements as market demand and program launches subside. All of these themes will be underpinned by the laser focus on cost discipline that Jim outlined earlier in the call, as we navigate modestly lower market demand. Thank you for listening in this morning and I'll now turn the call back over to Carmen to take your questions.

[Operator Instructions] Your first question comes from the line of Aileen Smith with Bank of America.

Good morning. First question to follow-up on Slide 18 of the deck. I appreciate you're not giving explicit estimates or targets at this point. But if we think about the margin target that you've had out there for a few years 12.7%, when you referenced that in the past was it based on any particular assumption for segment mix between your end markets? And has this changed substantially in any way given some of the volatility that we've seen over the past few months?

Sure. It certainly did not contemplate the level of softness that we're seeing in the Off-Highway markets in the second half of this year. So given we're going to be just under 12% this year, that target is not going to be in reach for next year. I would say it's primarily due to the overall volume decline in the heavy vehicle segments. However, as I mentioned on the slide, we do believe that there's margin expansion next year due to the cost synergies as well as the opportunity for commodity cost to continue to subside. But that's basically our perspective on the margins for next year.

Great. That's helpful. And then focusing in on Slide 22 and Off-Highway, the conversion on organic growth in the quarter was almost 100%, if I'm reading that chart correctly. Was this type of flow-through just attributable to the velocity with which end markets deteriorated in the quarter? Or is there anything notable from a cost perspective that was more one-off in nature?

Yeah. In that walk, I think it's about $10 million on $14 million. So it's a much higher contribution margin than you would typically see. It's principally two factors. The first is the one that you mentioned. Within our off-highway segments, we saw very rapid decline. And when we start to pull the levers to flex cost as Jim mentioned, there's a little bit of a period of time that it takes for those to take effect. So we do expect for the impact to be lessened significantly in the fourth quarter. The other factor is a little bit of inter-segment mix. Even within the off-highway segment, construction from a profitability perspective is very high. And some of what helped offset that decline is backlog coming online at slightly softer margins. So when you think about new backlog, at little lower margins, construction falling at higher margins, you get a little bit of a, inter-segment mix which puts a little pressure on that. But I think the principal comment is that's something, that's going to be pretty unique to the third quarter. As we move forward, we would expect the year-over-year declines to have a lower conversion than what we saw in Q3.

And your next question is from the line of Brian Johnson with Barclays.

Yes. A couple of a little bit more strategic questions, so, with the Valeo deal -- they're obviously very strong in 48-volt. But, what do you -- they haven't been as active in hybrids and B2s and B4s. So, what are they bringing to the table that you didn't have before? Will it involve their, Siemens joint venture as well? And just where do you see that going? And given your point on reviews that I see across vehicle on-highway, off-highway commercial light vehicle segments, how does that fit and given their light vehicle focus?

Good morning, Brian. This is Jim. Thanks for the questions. I appreciate it. Let me kind of dimension it for the entire audience, how we're thinking about it. Even back to the beginning of the scripting of our enterprise strategy in late 2016, refreshed again earlier this year, we are not interested in focusing on the 48-volt in passenger car business just as Dana hasn't been for decades and we're not now. What this is a relationship. And essentially let's keep it simple, in the gearbox mechanical piece only in that market. We're going to have the Valeos and the participants in those areas continue to compete. But we're going to be a partner with Valeo relative to gearboxes only. Your question specifically getting up into trucks and larger vehicles, it's not applicable. That's what we've completed. Our full suite of products, are full electrodynamic products as well as integration systems et cetera et cetera. That's where we'll continue to basically manage the business like we have for years.

Okay. So are you saying that, what you're doing with Valeo will go into 48-volt systems Valeo is offering not into their higher voltage efforts, they're pursuing with another joint venture?

That's correct. That's exactly right.

Okay. And second question is around just the free cash flow conversion. And I think a couple of things. One any changes contemplated with capital allocation in terms of returning cash to shareholders? And second, and maybe before that, any update on CapEx because it has been -- it's obviously with your guidance continues to be up year-over-year. You got Toledo coming online, should have had some and obviously had an influence on the CapEx. So, again you're not giving 2020 guidance. But just you can give fade on the cadence to CapEx and what implies for capital allocation?

Sure. I'll take those in reverse order Brian. So relative to the CapEx, we did make a few decisions to incur a little more CapEx this year in 2019. So as you know that, we green lighted a few things a little bit of that. It turned out to be somewhat of a pull ahead from next year. So we continue to believe that as we move into next year, you will see CapEx trend down closer to 4%. That's going to be part of the free cash flow improvement on a year-over-year basis. And that does contemplate the growth in electrification that, Jim announced this morning, and some other areas where we'll continue to spend the majority of our CapEx on growing the business. Relative to the use of cash flow, nothing meaningful has changed from the outlook that we laid out earlier in the year. We'll take a balanced approach towards allocating that free cash flow. We have low-cost opportunities to continue to reduce our leverage. We're starting that this year, with the pay down on our Term Loan B. We'll generate enough cash flow next year to make a meaningful delevering in 2020, as well. So I think that's our general outlook for next year.

Your next question is from the line of Dan Levy with Credit Suisse.

Hi. Good morning. Thanks.

Good morning, Dan.

Good morning. Hi. I wanted to just continue to dig in on off-highway following up on Aileen's question. So, first of all, if you could just a give us an update in terms of the lead time of how quickly you are getting visibility or updates on this and then just, in terms of the margins, if I go back to sort of the Dana's story of call it 2015, 2016. We actually saw your off-highway margins hold up pretty well despite pretty horrific end markets. So what does that tell us about the Off-Highway margins now, especially as you've added Oerlikon and Brevini? And does this slide that you put out on cost structure flexibility is that largely in line for all the segments? Or does it vary segment by segment?

Sure. So I'll take the first part touching on the Off-Highway outlook and visibility. As we've indicated before in this segment, we usually get a production calendar that's a couple of months out. What's unique about the Off-Highway space, certainly compared to the light-vehicle segment and even operates differently than commercial vehicles is the rate at which that can change. So orders can move in the order book within a narrow period of time. And that's what we saw happen in the third quarter. So it's that rapid change where production schedules in the very near term drop pretty significantly in a number of regions around the world. So it is more volatile in the short-term from that perspective. Relative to the long-term margin outlook for the Off-Highway segment, this is something that we've shown to as a proof point that that say we can manage through the cycle. Nothing has fundamentally changed in that business. What I would highlight is that there's a significant difference between the near-term flexing and what we can do once we get a few months out. So what we really saw in the third quarter of this year was just the short-term impact. Now that we've taken the actions to take labor out of our operations and flex a lot of that cost structure that Jim highlighted, we would expect to see a much better flex on the lower volumes in the fourth quarter and moving into next year? And just on your last point relative to the cost structure side that Jim walked everyone through, I just want to highlight, that is relatively comparable. As you look across our businesses, obviously that 12% profit margin is blended. But generally speaking, the engineering spend portion, the SG&A portion and the composition of cost of goods sold, those proportions are comparable as you move across all of our business segments.

Great. Thank you. That's helpful. And then just a follow-up on capital allocation. Your stock price was obviously depressed in the third quarter. And I realize the cash priority is really more to focus on the balance sheet right now to deleverage and also to fund your future growth endeavors. But I guess, wondering why you wouldn't have been somewhat opportunistic in the third quarter in terms of buying back some stocks given the depressed levels? It looks like you didn't buy back stock. So I was just wondering how you're looking at stock buybacks in the capital allocation framework amid some of the movement in the stock price?

Sure. Fair question. We have an existing authorization with plenty of capacity. It's something that we continue to evaluate. At this point, we've made the judgment that the near-term priority for us given where we are in the cycle is just to continue to bolster and strengthen the balance sheet. So we decided to initiate the delivering even though we have a lot of conviction that the stock price is lower. We think that over time as we continue to strengthen the balance sheet and differentiate ourselves there, it should help in the long run with providing an appreciation in the value of the business.

Great. Thank you.

Sure.

Your next question is from the line of Joseph Spak with RBC Capital Markets.

Thanks. Good morning, everyone.

Good morning.

I guess, first just wanted to start. I was focusing on the Off-Highway bridge. I actually want to move over to Power Technologies for a second. I know the bridge is shown year-over-year. But if you look at it more sequentially, sales were 5% lower but the EBITDA was flat. So it actually seems like there could be some evidence of improvement. And I know this is a segment that's gotten some attention in the past couple of quarters. So I just wanted to better understand what you're seeing in that business.

Sure. Good morning, Joe, it's Jonathan. As you remember at the end of the second quarter last year, Jim highlighted that this is a segment that we were not particularly concerned about and that we would continue to see improvement there. You'll remember the things that are really putting pressure on this segment were product mix. Geographically, we saw some pressure outside of the U.S., which is really important for that segment. We also had some self-help issues. We had some premium cost on launches. And then the third is commodity. While the end market outlook hasn't changed meaningfully, it's really those self-help categories that we continue to see driving the improvements from the second to the third quarter and we expect to continue to see upward movement here. Launches the big ones that we mentioned last time are behind us. Costs are contained there. And then we've also started to see some progress on commodities, alleviating a bit but also working with customers to improve recovery. And the combination of those are really driving that sequential improvement.

Okay. I'm sorry, if I missed this, but did you see any impact from the GM strike in either this segment or in LVD?

Yes. A little bit in both of those segments. As Jim mentioned in his comments, the Colorado Canyon, we produce here in North America was the largest impact that we saw in the quarter.

Okay. And then just going back to the Valeo agreement. To Brian's question, I guess, I want to better understand. Like you've taken on most other initiatives a more integrated approach with the motor. Was this -- is this just -- like on 48-volt an area you didn't invest in as much as this is sort of just an opportunity you see and that's why you sort of decided to partner there? And is there any exclusivity? And also like I don't think this was in your backlog and I believe the release said it starts in late 2020. So can you help us understand the opportunity you see here?

Yes. Thanks for the question. This is Jim. I think, you used the right word, the perfect word. It is just opportunity. We don't define this as core. In fact, we argue it is to a degree non-core. But it also comes back to exactly what Dana has built itself upon which is the gearing aspect of it. And there will be some -- they'll be sophisticated gearings certainly to support e-Propulsion in the 48-volt range and that's what we'll participate. So coming back to our enterprise strategy we always said that it's non-core, but we would capitalize on opportunities. Again, we have a good relationship with Valeo. We both obviously meet with the same customers and the customers are asking us to support. So it's kind of a win-win. But our major focus will continue to be on the SUV light truck large truck off-highway and everything as such.

Your next question is from the line of James Picariello with KeyBanc.

Hey, good morning, guys.

Good morning.

Just going back to Off-Highway, if -- for the quarter, if we exclude ODS contribution and FX your Off-Highway course sales were only down 3% call it $12 million. And so I mean you said ODS is now on track to be down $100 million for the full year versus prior expectation. I could get to an implied year-over-year decline in the low double-digits for ODS. So what's driving the more notable weakness for that business relative to your legacy Off-Highway mix?

Yes. It's just a function of where their sales are concentrated. So if you think about the past Off-Highway business larger segments construction followed by ag and then followed by mining and material handling. And within the Off-Highway segments that we support in ODS you see a heavier concentration in the construction segment and also a more meaningful presence in the India market. So Jim highlighted earlier in the call that from a geographic standpoint India saw very soft sales in the third quarter. We see it moving into the fourth quarter. And we highlighted when we made the acquisition it came with a very strong footprint in India and a meaningful portion of that supporting the local market. So those are a couple of the drivers as to why we're seeing a softer impact within the ODS business versus the rest of the Off-Highway segment.

Would you be willing to share what India represents as a total sales mix?

Yes. For overall Dana, it's still in the mid-single digits but certainly higher when you look at the Off-Highway segment and even higher -- just ODS again.

Just ODS. I'm sorry I meant for ODS.

Yes. It's a meaningful portion. I don't have the exact number at my fingertips…;

Okay.

But it is a meaningful piece of that business.

Got it. And then I think you made the comment that ODS cost-out synergies are running 2x. What your original expectation was which I think is -- was $10 million. So is -- that would imply another $20 million next year to get to the original target of $40 million. Can we assume some upside into next year regarding that number based on accelerated progress to-date? There are clear market challenges for ODS so maybe you have an additional opportunity to take out costs in the interim. So just any color there.

Yes. We'll continue to attract that $40 million on an apples-to-apples basis. So the typical cost flex we will have to do because of volumes being lower really won't be reflected in that number. But overall, I think, that number is still pretty good at about $40 million. There will be a little bit of pull ahead. But from a year-over-year impact it'll probably be pretty close to what we indicated last time keeping in mind that what we were really able to accelerate from a cost standpoint or the structural cost actions. And then a lot of the work that we'll be doing on the material cost will continue on the normal cadence as we were expecting. That stuff takes a little bit of time. But certainly the levers that we had to pull that were completely in our control, we've pulled and we're really pleased with what the team has done there.

Got it. Okay. And then if I then just can ask one more on -- I'll just keep it tied to ODS. For free cash flow can you just quantify what the onetime costs are this year so we could easily back that out when thinking about next year?

Yes. Maybe a better way to do it is I would expect onetime costs for next year to be half of what they are this year and the majority of that change is going to be driven by ODS.

Your next question is from the line of Rod Lache with Wolfe Research.

Great. Thank you for the question. So just going back to slide 22, you addressed the decrementals on Off-Highway talking about how that's due to the intersegment mix and the velocity of the decline. Can you just maybe talk a little bit about when you would expect the decrementals to normalize to the -- and maybe closer to 30% range? And what specific actions are coming into play now to normalize that? And similar question on the Power Tech segment?

Sure. So the short answer is we would expect to see a relatively normal conversion in the fourth quarter. So some of the things as Jim was walking through that cost structure side that we highlighted on the left-hand side, certainly the material cost component we're addressing. It's really on the conversion cost that takes a little bit of time. A lot of our manufacturing for this segment is in Europe. And while we have tools to flex that labor it's not something that we can do immediately. That burn-in period usually is weeks to a couple of months and we've initiated all of that activity in the third quarter. So I would expect to see a more normal conversion on the year-over-year change in the sales for the Off-Highway segment even in the fourth quarter. And that's why we think that margins for the fourth quarter can be comparable with Q3 even on lower sales. I think to your point Rod on the Power Tech segment, I think we've continued to see the team pull cost levers there and we should see some modest continued improvement in the margin profile of that business as we move into next year.

Okay. Great. Thanks. And could you maybe give us a sense of the magnitude of the production changes that you're starting to look at off-highway and maybe also for commercial vehicle just given the unique exposures that you have there?

Sure. And maybe the best way to dimension it when we gave of our guidance earlier this year, we thought that the declines in -- principally in those markets from this year to next was going to be a couple of hundred million dollars. Right now, what we see is that it's going to be higher than that. So we would expect more of a decline. However, what I indicated in my comments in our outlook for next year is that our backlog for next year is expected to be higher than what we originally thought earlier this year as well. Certainly, the new electrification win that Jim mentioned this morning is a big driver of the higher backlog. But also we took a pretty conservative perspective on a couple of a key compact truck vehicles that were coming online next year. Now that we've got a couple of those in production already and we have good line of sight into next year, the volumes on those programs are going to be stronger than what we conservatively expected. So on balance, even with a sharper decline in the heavy vehicle segments than what we expected earlier this year, we do believe organically we still see a path to the business being about flat 2019 to 2020.

Great. Thanks. And just lastly on these new awards that are coming in, it sounds like they're coming in in a relatively short time frame, which is truly impressive to see how you guys are doing there. And it obviously becomes meaningful to growth relatively soon. How should we be thinking about the incremental margins on backlog as you start to transition? Is it very different manufacturing than what you guys have done in the past? Is there some kind of a -- like a grow in period while these are still relatively mature products?

Sure. We continue to believe that there is margin expansion potential as we move from purely mechanical systems to software control mechatronic systems. We'll be conservative and thoughtful as we roll on the backlog and what we incorporate in our guidance. But certainly having more systems responsibility and having smart systems become a bigger piece of the equation, we believe drives long-term margin expansion potential. And that should give you a general sense on the financial side.

And just to add some color, good morning Rod I'd add on the manufacturing question you added there which is -- it's the beauty of being able to get the assets, while they are still in the market the companies we bought they are actually been in high volume. Motor manufacturing, inverter manufacturing so with them come a lot of folks. So I think you should recall when we first met I was with Lear I have a lot of experience on that electrification side as well albeit wiring and PCB boards and all that stuff. I think we're in pretty good shape there, but we also don't underestimate that or minimize that as we all come up the curve in a much higher volume environment and these type of electrodynamic products that we're going to -- we have to be ready for it. So that's a major focus of ours.

Your next question is from the line of Ryan Brinkman with JPMorgan.

Hi. Thanks for taking my question, which is relative to the 2020 outlook slide. I know you're looking for company-specific factors backlog and acquisition and to roughly more than offset the end market headwinds to revenue. Can you please elaborate on that second point about the potential for margin expansion? What contribution margin are you assuming from the backlog revenue? And would it will be really be the decremental to softer volume from industry headwinds will be higher than the incremental on the backlog revenue? So when you consider that, what does that imply about the magnitude of the tailwind that you're expecting from lower cost in commodities? And how would you rate your visibility into those savings?

Sure. So maybe I'll just touch on the organic mix first. The piece that's related to the market is principally made up of the heavy vehicle segments. We're going to see a meaningful decline in the Class 8 market in North America where you would expect the downward contribution margin to be less than 20%. We've highlighted before that at mid-cycle, the heavy vehicle segment represents only about one-third of the commercial vehicle segment and it is the least profitable in that area. So it helps out a little bit there. However, the other part of the organic decline that's related to market is on the off-highway segment, where we would expect it to be above 20%. So I would say on balance, on a blend, you're going to see around 20% is what I would expect for the market declines. The backlog will come online at a comparable margin, which is why we still believe similar to what we indicated at the beginning of this year when we laid out an outlook for next year is that relatively flat top line organically and the negligible impact on the bottom line there. I think what we wanted to highlight with the organic or the inorganic cost synergies in the lower commodity cost is that both of those have trended better than we expected in 2019, which just increases our confidence that those will be meaningful tailwinds moving into next year. So the impact of those is not meaningfully different than what we indicated earlier this year. I would just say our confidence in those providing a little bit of margin tailwind remains intact. I would say that's basically how things have changed since our outlook from earlier this year.

Okay. That's very helpful. Thanks. And just a follow-up on Nordresa. How should we think about the progression of the $200 million in backlog over the next several years? And understanding this is a development phase company, but what would be the rough impact on the financials near term on revenue and EBIT? Or does it replace any of what would have been internally generated R&D, anything to think about there?

Yeah. Just on the top line, the impact in next year will be pretty small. So the program launches towards the end of next year. You'll see a full -- first full year of sales in 2021. And then the program will really hit its stride from a volume perspective in 2022. So it will be -- most of the $200 million will be fully reflected in the backlog that we introduced next year. Some of that will fall outside that three-year period into 2023. But most of it, you'll see in our three-year backlog number, it's all incremental. So this is entirely new content on the program that we were awarded. And from an engineering spend perspective, we remain convicted based on what we see now that engineering spend is still going to be about 3% of sales moving into next year. I'll just highlight, as Jim mentioned in his comments, that's a lever that we will look at carefully. We discuss with all of our customers on any program, the level of engineering investment that we can make and what we'll look for subsidies on. So, I would say that's nothing meaningfully has changed in our outlook there.

And your final question will come from the line of Emmanuel Rosner with Deutsche Bank.

Good morning.

Good morning.

Good morning, Emmanuel.

Apologies, I joined the call a little bit late. On the off-highway outlook specifically, can you talk a little bit about how what you've seen in the third quarter, and then expect to the fourth quarter? How do you expect that to translate into early trends in 2020?

Yeah. Yeah fair. So, we saw a meaningful step down in production levels, particularly in the construction segment, a little less felt in agriculture and mining compared to the first half of the year. We would expect the run rate to be comparable to what we're seeing the third quarter, in the fourth quarter, although obviously we're going to see some production downtime in the November and December more so than what we would see in Q3. But, on a run rate basis pretty comparable. We think we'll move into next year a little bit softer. And then, we would probably have a full year outlook that would imply slightly higher volume outlook from a run rate standpoint towards the end of next year. So the high level gives you a sense of the cycle within off-highway.

Okay. That's helpful. And then still on 2020, just wanted to double check some numbers that I think were said in the prepared remarks. I think you spoke about $100 million of additional revenue growth from getting a full year of the recent acquisition. Could you also quantify the updated backlog for 2020?

No, I didn't. I just indicated that next year -- when we gave the original guidance for next year, we thought that markets would be down about $200 million in the backlog would cover that. What we're saying is we think the market decline will be more than $200 million now. I didn't give that number. We'll refine that over the next 60 to 90 days. But that, based on line of sight that we had into our backlog, we will be able to offset that. Some of the things I pointed to, Emmanuel were stronger volumes in the electrified area compared to what we had in our backlog. We had a limited amount of electrified sales in our backlog. And with the exciting announcements that Jim shared earlier, it's certainly going to put some wind at our backs there. And then in addition to that, we were a bit conservative on some of the volumes on the compact truck segment that are in our backlog. And now that some of those programs launched partway through this year and we have a sense of what the volumes are and we have a better sense of program volumes for next year, we think that we'll get a benefit there. So, right now we think those two will offset, but we won't be giving the revised three-year backlog until we give you our Q4 results early next year.

Great. Thank you very much.

Okay. Well, thanks every -- sorry, go ahead.

I was going to turn it back over to management for closing remarks.

Okay. Thank you, Amy. Just in closing, this is Jim again. Thank you all very much for your interest in Dana and for taking the time with us today. Just a quick recap. Hopefully, the take away from today's call, it's the 12th conservative quarter of year-over-year profitable growth very proud of our entire team for doing that. We did that, at the same time, while acquiring very strategic important e-Powertrain assets, which led us to today to be updating you relative to a significant award across the business. I would say this. From my standpoint, interesting after the enterprise strategy that we rolled out in Q1 this year is kind of an update for you. We received very, very fair feedback from many of you about potentially over-saturating the audience with our electrification plan and the things that we are working on, and we appreciate that feedback. But I'd also say at this point in time, we're very happy that we think we got it right. We think we got it right relative to if you look at the megatrends, you look at the markets and you look at the activities that we've taken to make sure we secure the assets while they were still available. It's parlaying into what we're trying to accomplish at Dana and we're going to move forward from here. So, thank you for all your support and attention, and we look forward to talking to you very soon.

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