Q3 2019 Earnings Call
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Good morning, and welcome to Dana incorporated third quarter, 2019 financial webcast and conference call.
My name is common and I will be your conference facilitator today.
Please be advised that are meeting today, but the speakers remarks and session will be recorded for replay purposes.
There will be a question and answer period after the speaker's remarks, and we will take questions from telephone only.
Thank you.
A question during this time.
One on your telephone keypad.
To ensure that everyone has an opportunity to participate in today's Q and.
That callers limit themselves to one question at a time.
If you would like to ask additional questions. Please return to the Q.
At this time I would like to begin the presentation by during today's call over to Dana's director of Investor Relations and strategic planning Craig Barbara. Please go ahead Mr. Barbara.
You Karen and good morning, everyone. Thanks for joining us today for 2019 third quarter earnings call. You'll find this mornings press release and presentation are now posted on our Investor website. Today's call is being recorded supporting materials. The property have been incorporated they may not be recorded copied or rebroadcast without our written consent.
Today's presentation includes forward looking statements about our expectation 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 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 my pleasure turn call over to Jim.
Good morning, and thank you for joining us I'm pleased to report the Dana achieved record third quarter sales of 2.2 billion, resulting in our twelveth 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 third quarter 2018, resulting in an 11.6% margin.
Our diluted EPS was 74 cents.
We had several high rate 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 integrate inorganic side integrating the Oerlikon drive so.
Stems business and our heavy vehicle markets, we experienced a high level of end market demand volatility in construction and agriculture equipment end markets as well as significant drop in demand in India and China.
Hi, especially impacted or higher profit margin off highway business. In addition, we were impacted by the general Motors Auto workers 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 selective 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 on this and just a few minutes.
In addition, we announced the acquisition Omnidirectional Motors, a recognized leader in the development and integration of electric commercial vehicles than address a team located in Montreal, Quebec, Canada was a perfect match to fully integrate NAND is complete portfolio of electrodynamic components, along with our extensive history of mechanical systems.
Thus, providing in does 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 five.
As you May recall back at the end to 2016 I started to talk about quarterly year over year revenue growth and 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.
I 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 names business units have grown organically.
Second we capitalized on sustain challenging high volumes by delivering exceptional operating performance, which resulted in great appreciation in the form a new business awards from our customers.
And third Dana selectively acquired accretive assets that have not only contributed to the topline but have also added new technology to our portfolio to address the vehicle Electra electrification Mega trend.
Increased market diversification and expand our customer base each of which are key elements of our enterprise strategy.
This execution continues to set Dana apart from our peers as market volatility descends across the mobility sector.
Side Schick six.
What you may already known in the third quarter, we experienced volatility across all of Dana's end markets as previously communicated the class eight volume decline for the quarter was in line with our expectations. However, we saw very rapid falloff in the off highway markets as well as the passenger car segment of the light vehicle market, which most.
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 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 or general motors supply systems to Navistar.
For the Silverado medium duty truck program and our power technology segment due to the our exposure to multiple engine programs of course, the largest impact was felt in the light vehicle has strike idled the Chevy, Colorado in 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 and end market demand specifically in construction and agriculture equipment for Dana India is a key off highway domestic and export market for us and the India counseling 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 transition to aggressive cost flexing actions across all the impacted areas of our business.
We idled production and took necessary steps to adjust our conversion costs to align with our customer demand.
Turning to slide seven I will outline how we manage through the cycles across each of our businesses. We remained focused on strong organic growth acquisition synergies and leveraging cost manage activities to help us successfully managed 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 in the vast majority of cost of goods sold is variable.
Breaking down cost of goods sold about two thirds as 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.
Combined with our flexibility centrally managed global supply chain means we can respond rapidly to changes in demand and optimize our value chain.
Conversion cost are the remaining third of our cost of goods sold.
Cost of sales, which includes everything required to operate the business with the exception of engineering, which I will cover separately.
One of our main enablers to managing conversion cost includes.
Flexing labor to support the required demand, having operated and volatile markets for decades, we have structured the business to have temporary labor flexibility not to mention significant experience inefficiently 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 as premium operating costs, such as freight overtime and so forth to meet peak customer demand as we flex our operations for reduced demand. These associated premium cost 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 head count by nearly 500 associates and we've continued to adjust our workforce in our heavy vehicle groups throughout 2019.
We have tackle fixed costs by closing facilities in balancing our capacity.
Over the last year, we close 10 facilities, while combining our other operations improving our overall efficiency our manufacturing footprint.
Option optimization is ongoing and we will continue to pull these levers and more to balance our cost structure with end market volatility.
Engineering and SG in a expense, our three and 6% of sales respectfully.
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 in research and development cost and we continue to be diligent in price and prioritizing those researchers and efforts that will be most marketable.
Two of the largest levers we have or the rate and depth of investment we make in electrify technology and the offsetting de prioritizing of legacy products by managing these two priorities, we can reduce our investments and maintaining balance through the revenues revenue cycle.
The final cost element is achieving our largest opportunity remains our acquisitions synergy plan. We are currently executing.
We're confident we will achieve our goal of $10 million and 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, a structural and not volume dependent 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 are processes is multiple 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 IP and lean.
Manufacturing to reduce our over our overall overhead and streamline our operations.
A great example of a simple improvement we're 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're now through the heaviest period of investment and we'll be able to exercise more control over that we're all timing of the capex spending.
As a reminder, with demand falls working capital will become a source of cash as outflows slow in inventories mounted 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 lateness light truck business and our growing electrification business remains 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 we announced during the quarter the acquisition of and addressing motors, a leading E mobility company.
In addresses proprietary E power solutions, a 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 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 use that to offer our customers a complete system solution, including fully integrated excellence battery and power Gen controls and thermal management capabilities.
And we're happy to report that earlier this week, Dan outs to significant New program award with a major OEM for a medium duty electric vehicle series that will be fully be fully redesigned integrated and updated by Dana and feature a complete spicer electrified powertrain, including the motor inverter and gearbox and.
Enabled by our acquisition of an address we can deliver the complete power system, which generates stores and manages the energy, including battery management system onboard charger power electronics cable in jewelry systems, it's expected to be available for ordering in the second half of 2020. This three year partner program.
We'll generate about $200 million in sales for Dana.
Turning to slide nine I will talk about additional E powertrain business wins.
Like the and address the transaction, we have such strategic investments over the past few years to further expand our offerings for hybrid and electric vehicles that we can offer customers a complete range of turnkey solutions for the rapidly evolving mobility market.
I am excited share with you our strategy is paying off with a 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 eat all wheel drive vehicles for the light vehicle market. The partnership with Valeo enables us to deliver a complete 48 volt vehicle ie propulsion.
In system, while also expanding our offerings for hybrid and electric vehicles, providing our customers with a complete range of solutions for the rapidly rapidly changing mobility market.
The first system is scheduled to launch in early 2020 with a major European automaker on a series produced cars.
And the lower left of the slide you will see Dana will be supplying it spicer torque hub will derives customize and newly developed gearboxes as well as our Ashwin motors for the two Trx Genie electric boom lives. This is a new product range that terex Genie is bringing to market next year that will be will set the bar for.
Operation emission free operation, even in the most sensitive work environments.
Moving to the top right. This week, we also announced new business will Lonestar truck group a manufacturer of specialty commercial vehicles, Dana will be providing our spicer electrified full 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 lot lower right. Dana is very excited to announce that nomination by a major automaker to supply battery cold plates for an upcoming North America fully electric vehicle program. Our award winning coal plate technology combined superior term rental performance thermal performance in a thin.
Lightweight package and features a sophisticated channel path for optimize coolant flow, resulting in a more stabilized battery temperature and faster charge and has been that has been 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 mobile.
City.
I believe this slide tells the story of how our disciplined strategy to fill out of 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, as 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 accrue.
You have acquisition in our off highway segment.
Adjusted EBITDA for the quarter was 250 million at 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 a 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 74 cents 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 law.
Lower off highway sales in the high margin construction markets that Jim discussed a few moments ago generated an 11 million profit headwind, resulting in 65 basis points of profit margin compression.
Second inorganic growth from the Graziano in 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 cost 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 a million an 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 at 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 cash.
Matures lower cash taxes, a 25 million were primarily due to jurisdictional mix and the timing of refunds and payments.
Working capital as a 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 topline 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 requires.
Since our 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 progress 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 maturity of our cash flow revolver and our term loan a by two years, we now have.
Current 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 revenue growth. Our business has 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 lowered our overall effective at.
Average borrowing cost to a blended rate of just over four in a quarter percent.
Our second key action was to pay down 100 million of our term loan b with proceeds from Undrawn revolver, which we expect to pay down to zero in the fourth quarter. This is the first step in our stated goal is systematically reducing our leverage combined these actions extended our maturities increased our liquidity and lowered the cost to service our debt. Please.
Turning 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 to 8.85 billion with.
Midpoint, approximately 275 million lower than our previous syndication and about 450 million lower than the midpoint of the original range. The drivers of this change either reduced volume foreign currency translation recall, resulting from a stronger us dollar and slightly lower commodity recoveries from an improved outlook in commodity cost.
Our expectation for adjusted EBITDA in the range of 1 billion to $1.070 billion at the midpoint of this range. This represents a 20% conversion on the sales decline from the midpoint of our original guidance 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 reach.
Main 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 market.
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 remained strong and will generate 30 basis points of margin expansion. This year.
Second inorganic growth from the Graziano in Fairfield businesses is now expected to add 650 million in sales and about 85 million and profit contributing approximately 10 basis points of 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 lost profit contribution will be partially offset by higher cost synergies, which we expect to be two times 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 to sales and 30 million to profit.
Fourth we 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 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 and 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 will 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 in 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 that 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 increase will be bolstered by significantly lower onetime cost 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.
At this time, if you would like to ask a question press star one on your telephone keypad.
Your first question comes from the line of Aileen Smith with Bank of America.
And your line is open.
Good morning first question follow up on on Slide 18 of the data I appreciate you're not giving explicit estimate their targets at this point, but if we think about the margin target that you've had out there for a few years of 12.7, when you referenced that in the past with it based on any particular assumption for segment mix between on your end markets and has this changed.
Financially and anyway, given the some of the volatility that we've seen over the past few months.
Sure. It's 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 targets 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 Theres margin expansion next year due to the cost synergies as well as the opportunity for commodity costs to continue to subside, but thats based.
We are perspective on the on margins for next year.
Great. That's helpful and then focusing in on slide 22, and off highway conversion on organic growth in the quarter with almost 100% if I'm reading that chart correctly on with 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 and.
Yes, and that lock 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 to factor is 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.
So there is a little bit of a period of time that it takes for those to take effect. So we do expect for the the impact to be lessened significantly in the fourth quarter.
The other factors 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 as backlog coming online at slightly softer margins. 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 something that's going to be pretty unique to the third quarter as we move.
Move forward, we would expect that year over year declines to to have a lower conversion than what we saw in Q3.
Your next to questions from the line of Brian Johnson with Barclays.
Yes, a couple of a little bit more strategic question. So.
With.
The Delayo deal there, obviously very strong 48 volt, but what do you have they haven't been as activity again hybrids and btwos and before so what are they bring to the table that didn't have before with evolve their.
Zemin's joint venture as well and where do you see that going and given your point on reuse.
The across.
Goal on highway off highway commercial light vehicle segments, how does that given their light vehicle focus.
Good morning, Brian This is Jim Thanks for the questions I appreciate it let me kind of dimension and for the entire audience, how we're thinking about it even back to the beginning of the scripting of our enterprise strategy in late 16 refreshed again earlier. This year, we are not interested and focusing on the 48 volt and 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 into gearbox mechanical piece only in that market, we're going to have the values in the participants in those areas continue to compete but we're going to be a partner with value relative to gearboxes only your question specifically getting.
Up into trucks, and and larger vehicles, it's and it's not applicable that that's where we've completed our full suite of products, our full electrodynamic products as well as integration systems et cetera, et cetera, that's where we'll continue to some too.
Basically manage the business like we have for years.
Okay. So are you, saying that what you're doing with below would go into 48 volt systems will lay owns offering not into their higher voltage efforts. They are proceeding with the joined with another joint venture that's correct that's exactly right.
Okay.
Second question is around.
Just the free cash flow.
Conversion I think a couple things one any changes contemplated with capital allocation in terms of returning cash to shareholders and second maybe before that any update on capex because it had been.
It's obviously with your guidance continues to be up year over year, yet, we don't coming online.
Should have had submitted.
We had in boots on the Capex, So again youre, not giving 2020 guidance for just.
Could you update on vacated to Capex, what implies we kept location.
Sure ill 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 to as you noted we greenlighted a few things a little bit of that.
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'll 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.
We need to spend the majority of our capex on the 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.
It will 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 will generate enough cash flow next year to make a meaningful de levering.
In 2020 as well so I think thats, our general outlook for for next year.
Your next question from the line of Dan Levy with credits.
Hi, good morning. Thanks.
Good morning, Hey wanted to.
Continue to dig in on.
Off highway following upon.
Liens questions.
First of all of you could just hey give us an update in terms of the you know 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 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 in and Rivinia.
And does this slide that you put out on cost structure flexibility is that largely in line for all the segments or does it carries 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.
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 vehicle is the the rate at which that can change. So orders can move in the order book.
Within a narrow period of time and Thats, what we saw happened in the third quarter. So it's that rapid change where production schedules in the very near term dropped 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's a we can manage through the cycle nothing has fundamentally changed in that business. What I would highlight is that theres 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 a short term impact.
Act now that we've taken the actions to take labor out of our operations in a flex a lot of that cost structure that Jim highlighted we would expect to see a much better flex on the on the lower volumes in the fourth quarter and moving into next year and just on your last point relative to the cost structure slide that Jim walk 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 SGN a portion EMEA the composition of cost of goods sold those proportions are comparable as you move across all of our business segments.
Great. Thank you Thats helpful. And then just a follow a follow up on capital allocation.
Your stock price was up was obviously depressed in the third quarter and I realize the cast priority is really more to focus on the balance sheet right now.
To deleverage.
Also to fund your future growth and endeavors, but I guess I'm wondering why you wouldn't have been.
Somewhat opportunistic in the third quarter in terms of buying back some stocks given the depressed levels as looks like you Didnt buy back stock. So just wondering how you're looking at.
Stock buybacks in the capital allocation framework amid some of the movements in the stock price share a 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 de levering, even though we have a lot of conviction that the the stock prices lower we think that overtime as we continue to strengthen the balance sheet and differentiate ourselves there it should help in the long run with.
Providing a appreciation in the in the value the business.
Great. Thank you sure.
Your next question is from the line of Joseph Spak with RBC capital markets.
Thanks, Good morning, everyone.
Morning.
Okay, I guess first just wanted to start.
I know, we focus on off highway and bridge are actually want to.
Move over to power technologies for second I know the bridges showed year over year, but if we look at it more sequentially sales were 5% lower but EBITDA was flat. So it actually seems like there could be some evidence of improvement and I know. This this is a segment it's gotten some attention in the past couple of quarters. So just wanted to better understand what you're at what you're seeing in that and that bill.
Yes, sure remind us Jonathan as you'll remember at the end of the second quarter last year, Jim highlighted at this as a segment that we were not particularly concerned about in that we would continue to see improvement there.
You will remember the things that are really putting pressure on the segment where 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 in 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.
We continue to see upward movement here.
Launches the big ones that we mentioned last time are behind US cost are contained in there and then we've also started to see some progress on commodities alleviating a bit but also working with customers to improve recovery in the combination of those are really driving that sequential improvement.
Okay, and sorry, if I Miss us, but to do see any impact from from the GM striking this segment, our and Lv.
Yes, a little bit in in both of those segments as Jim mentioned in his comments the 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 video.
Agreement.
To to Brian's question, I, just I guess I want to better understand like you've you've taken on on most other initiatives have more integrated approach with that with a motor.
With this is this just.
Like on 40 of Golden Era, you Didnt investing as much. This is sort of just some opportunity you see in that and Thats why you sort of decide to partner there and why is there any exclusivity and also like I don't think this was in your your backlog and I believe the release said it starts in 2008 late 2020. So can you help us understand the opportunities here.
Yes. Thanks for the question. This is Jim I think you use the right word the perfect word. It is just opportunity. We don't define this is core effect, we argue as to a degree noncore, but it also comes back to exactly what dana's built itself upon which is the gearing aspect of it and there will be some lead to be sophisticated gearings.
Certainly to support the propulsion in the 48 volt range and that's where we'll participate so coming back to our enterprise strategy. We always said that it's noncore, but we would capitalize on opportunities. It came we have a good relationship with valeo.
We both obviously meet with the same customers and our customers are asking us to support so it's kind of a win win but where our major focus will continue to be on the sq be light truck arch truck off highway and everything is as such.
Your next question is from the line of James Pecoriello with Keybanc.
Hey, good morning, guys.
Earnings.
Just going back to off highway if if we for the quarter, if we exclude OTI EPS contribution and FX.
You off highway core sales were only down 3% call it $12 million and so I mean, you said odious is now on track to be down 100 million for the full year versus prior expectation.
It's been applied year to year over year declined in the low double digits for OTI s.. 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 largest segments.
Construction, followed by AG, and then followed by mining and material handling and within the off.
Highway segments that we support in OTI asks you see a heavier concentration in the in the construction segment and also a more meaningful presence in the India market.
So Jim highlighted earlier in the called it from a geographic standpoint, India's saw very soft sales in the third quarter, we see it moving into the fourth quarter end, we highlighted when we made the acquisition. It came with a very strong footprint in India in a meaningful portion of that supporting a local market. So those are a couple other drivers as to why were.
Seeing a a softer impact within the OTI es business versus the rest of the off highway segment.
Would you be to be willing to share with India represents has 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 an even higher idiosyncrasy Jody I am sorry, I admit I'm, sorry, I meant for Proteus, yes, it's a meaningful portion I don't have the exact number at my fingertips, but it's it's a meaningful piece of that business got it and then.
Thank you made the comment that odious cost synergies are running to exploit your.
Original expectation was which I think was $10 million so.
Is that would imply another 20 million next year to get to the original target of 40.
Is can we assume some some uptick upside into next year.
Regarding that number based on accelerated progress to date, there are mark the clear market challenges Frode, Yes, maybe you have an additional opportunities take out costs.
In the interim so just any color there.
We will continue to track that $40 million on an apples to apples basis. So the typical costs 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.
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, where the structural cost actions and then a lot of the work that will 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 completing our control we've pulled and we're really pleased with what the team has done there.
Got it Okay, and then if I could just ask one more on I'll just keep it keeps tied odious for free cash flow can you just quantify what the onetime costs are this year. So we could easily backed that out when thinking about next year.
Maybe a better way to do it is I would expect onetime cost for next year to be half of what they are this year and the majority of that changes can be driven biotest.
Your next question is from the line of Rod Lache with Wolfe Research.
Alright, Thank you for the question.
So just going back to slide 22, you address the Decrementals in off highway.
Talking about how that's due to the inner segment 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 maybe closer to 30% range and what specific actions are coming into play now to normalize that and Thats similar question on the Powertech segment.
Sure. So short answer is we would expect to see a relatively normal conversion in the fourth quarter. So at some of the things as Jim was walking through that cost structure slide that he highlighted on the left hand side certainly the material cost component. We're addressing it's really on the conversion cost it 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 than we can do immediately that burn in period, usually is weeks to a couple of months and we've initiated all 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.
The off highway segment.
And in the fourth quarter and Thats, why we think that margins for the fourth quarter can be comparable with Q3, even on lower sales I think to your point ride 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 that business as we move into next year.
Okay. Great. Thanks can you maybe give us a sense of the magnitude of the production changes that you're starting to look at.
In off highway and maybe also for commercial vehicle just given the unique exposures that you have there.
Sure maybe the best way to dimension. It when we gave 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 is going to be higher than that so.
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 when that Jim mentioned. This morning is a big driver of the higher backlog, but also we took.
Service perspective on a couple of the 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 19 to 20, great. Thanks, and just lastly.
On these new awards that are coming and it sounds like they are coming in in a relatively short timeframe, which is truly impressive to see how you guys are doing there.
And it obviously becomes meaningful the growth relatively soon.
How should we be thinking about the the incremental margins on backlog as you start to transition.
Is it very different manufacturing than what you guys have have done in the past is there's some kind of up like a growing 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 Mechel Tronics systems.
We'll be conservative and thoughtful as we roll on the backlog in 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 the beauty of.
Being able to get the assets, while they're still in the market. The companies, we bought Theyre actually been in high volume motor manufacturing inverter manufacturing so with them come a lot of folks I think as you recall when we first met those with Lear and a lot of experience on that electric application side as well, albeit wiring in 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. In these type of electrodynamic products that we're going to we have to be ready for it. So thats a major focus of ours.
Your next question is from the line of Ryan Brinkman with JP Morgan.
Hi, Thanks for taking my question, which is relative to that roughly 20 outlook slide I know you're looking for a company specific factors backlog and acquisition to roughly more than offset the end market headwinds to revenue can you. Please elaborate on that I can point about the potential for margin expansion what contribution margin are you assuming.
On the backlog revenue and presumably the decremental the softer volume from industry headwinds will be higher than that along 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 Thats related to market is principally made up of the heavy vehicle segments were going to see a meaningful decline in the class eight market in North America, where you would expect to the downward contribution margin to be less than 20% we've highlighted before.
For that at mid cycle to heavy vehicle segment represents only about a third of the commercial vehicle segment and it is the least profitable in that area. So 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 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 and outlook for next year is that relatively flat topline organically and the net.
Eligible 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.
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 said basically how things have changed since our outlook from earlier this year.
Okay. That's very helpful. Thanks, just to follow up on nor address.
How should we think about the progression of the 200 million in backlog over next several years and understanding the development based company, but what would be though the ROP impact on the financials near term on revenue and EBIT.
Or does it replace any would have been internally generated R&D anything to think about there.
Yes, just on the topline the impact 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 the that three year period ended 2023, but most of it you will 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 expense 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 and we discussed 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.
Nothing meaningful has changed in our outlook there.
Your final question will come from the line of Emmanuel Rosner with Deutsche Bank.
Good morning.
Good morning manual.
Apologies I joined the call a little bit late.
On the on the off highway outlook, specifically can can you talk a little bit about.
How whats you you've seen in the fourth quarter, and then expect to the fourth quarter. How do you expect that to to translate into early trends on in 2020.
Yes, yes fair so we saw meaningful step down in production levels, particularly in the construction segment little less.
Fell to 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 in 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 will move into next year.
A little bit softer and then we would probably have a full year outlook that would imply.
Slightly higher volume outlooks.
From a run rate standpoint towards the end of next year. So at a high level gives you a sense of the the cycle, we see within off highway.
Okay. That's helpful and then I'm still in 2020, just wondering to double check some numbers I think were set in the in the prepared remarks, I think you spoke about on $2 million of additional revenue growth from.
Getting a full year of the recent acquisition did you also quantify the.
But.
The updated backlog for 2020.
No I didn't they just indicated that next year. It when we gave the original guidance for next year, we thought that markets would be down about 200 and that backlog would cover that what we're saying as we think the market decline will be more than 200 now.
Didnt give that number will refine that over the next 60 to 90 days, but.
But that based on line of sight that we have into our backlog, we will be able to offset that some of the things I appointed to a manual 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 announcement that Jim shared earlier, it's certainly going to put some wind at our backs there and.
Mission 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 begin.
During the revised three year backlog until we give you our Q4 results early next year.
Great. Thank you very much.
Okay, well, thanks, everyone I'm sorry go ahead.
And 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 are taking the time with US today, just a quick recap hopefully the takeaway from today's call is the 12 consecutive quarter of year over year profitable growth very proud of our entire team for doing that we did that at the same time, we're acquiring very strategic importance.
Powertrain assets, which led us to today to be updating you relative to a significant awards 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 odds.
Once with our electrification plan and the things that we're 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've got it right relative to if you look at the Mega trends you look at the markets and you look at the activities that we've taken to make sure. We secured the assets why they were still available it's parlaying into what we're trying to accomplish it Dana and we're going to move forward from here. So thank you for all your support and attention.
And we'll look forward to talking to your very soon.
Thank you for joining today's conference call you may now disconnect.
Oh.