Dana Incorporated

Good morning and welcome to Dana Incorporated's third quarter 2020 financial webcast and conference call. My name is Regina and I will be your conference facilitator. Please be advised that our meeting today, both the speaker's remarks and Q&A 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 the telephone only. If you would like to ask a question during this time, press star and the number one on your telephone keypad. To ensure that everyone has an opportunity to participate in today's Q&A, we ask that callers limit themselves to one question at a time. If you would like to ask an additional question, please return to the queue. At this time, I would like to begin the presentation by turning the call over to Dana's Senior Director of Investor Relations and Strategic Planning, Craig Barber. Please go ahead, Mr. Barber.

Thank you, Regina, and good morning, everyone, on the call. Thank you for joining us today for our 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 the supporting materials are the property of Dana Incorporated. They may not be recorded, copied, or rebroadcast without our written consent. Allow me to remind you that 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. On the call this morning as usual, Jim Kamsiscus, Chairman and Chief Executive Officer, and Jonathan Collins, Executive Vice President and Chief Financial Officer. Jim will start us off this morning. Jim?

Good morning and thank you for joining us today. When we spoke with you last quarter, we were just beginning to come out of our global lockdown in response to the COVID-19 pandemic. I cannot be more proud of how the Dana family successfully navigated the shutdown and restart of our operations around the world. driving strong sequential improvement in our quarterly results. Throughout this challenging time, we have not wavered from ensuring the safety of our people while we meet the needs of our customers. During the third quarter, our customers accelerated production to meet growing demand, particularly in the light truck market, driving sales for the quarter to nearly $2 billion. While sales this quarter were down compared with last year due to the COVID-19 related customer demand impact early in the quarter, Sales rebounded sharply to finish nearly $1 billion higher than the second quarter. Adjusted pre-cash flow for the quarter was $261 million, driven by improved working capital efficiency. Adjusted EBITDA in the third quarter was $201 million, or 10.1% margin. The Dana team did a tremendous job adjusting from a slow start to a dead sprint in production in the quarter, achieving financial results better than we had expected. These results were only possible due to the continuation of numerous cost mitigation efforts deployed during the pandemic shutdown, as well as the incredible cross-company teamwork required to restart not only our operations, but in support of our supplier partners around the world. These efforts led to diluted adjusted earnings per share of 37 cents, which was a sizable $1.06 increase from the second quarter. Moving to the key highlights in the upper right hand side of the page, we will provide our perspectives on the end markets in these dynamic times. Although the global COVID-19 pandemic continues to adversely impact our industry, we remain positive on the end market outlook as most markets continue to rebound around the world. Also, during the quarter, we are pleased to announce exciting new electric vehicle business that Dana has been awarded. Of course, winning and delivering e-propulsion programs is only possible if a company has the technical capabilities to successfully execute and deliver on customer requirements and commitments. Therefore, consistent with Dana's very decisive and methodical approach of organically and inorganically accumulating the critical skills and experienced personnel required to successfully supply e-powertrains, we are excited to share more details regarding this very important new investment our acquisition of a substantial stake in Pianola LLC, a leader in electric vehicle software development. Finally, over the past years, you have witnessed our intense commitment to sustainability by developing clean and efficient products through our efforts in electrification. Later in the presentation, I will expand upon and illustrate other key areas of Dana's sustainability plan that you may or may not be aware of. Please turn to page five, as I'd like to provide you an update on our end market conditions. As we see our markets recovering, the bright spot for us has been the light vehicle market, and in particular, full-frame truck demand has been better than expected. Inventories on some of our key vehicles remain low, indicating that most of what is being produced is being sold. We have seen the fastest recovery in North America and China. Moving to the center slide, The heavy vehicle market are also seeing pockets of strength. We began this year with softer expectations in both the medium and heavy-duty commercial truck segments. And obviously, the pandemic slowdown or shutdown has adversely impacted them as well. But as production resumed in the third quarter, we saw strengthening in Class 8 trucks, medium-duty demand in North America. Demand in Brazil and India, while showing signs of improvement, remained comparatively soft. Lastly, our off-highway markets, we have seen continued improvement in agriculture and market, while the construction markets remain stable. Specifically, markets in Asia continue to be stronger than expected, driven by China, where recovery began earlier in the year. As markets around the world continue to recover, we remain intensely focused on partnering with our customers to navigate these challenging times, all while remaining diligent about safety, quality, and cost discipline. Turn with me now to slide six, where I will provide details about an exciting new electrification program wind that is launching next year. All around the world, we are seeing global governments continue to push for cleaner emissions and improved fuel economy across all mobility sectors, including construction, agriculture, mining, and material handling industries that Dana has supported for nearly a hundred years. To date, many major port authorities have aligned with the International Maritime Organization's standards of reducing admissions by at least 50%. But it goes even further, as many of these ports are targeting aggressive initiatives to reduce admissions. Across Asia, Europe, and North America, major ports are committed to zero admissions over the next few decades. For example, the two largest ports in California are required to be zero admission by 2035. In Europe, the Port of Valencia is aiming to zero emissions by 2030. Antwerp is committed to a 50% reduction in emissions. And Oslo is committed to an 85% reduction in CO2 by 2030. Ports across Asia are also adopting similar regulations, with Singapore committed to cut greenhouse gas emissions by 50% by 2050. and China committed to peak carbon dioxide emissions before 2030 on its way towards carbon neutrality. As global logistics continue to push heavily towards zero-emission vehicles to meet the global regulations, Dana Electrified Technology is well-positioned to help our customers meet their sustainability goals. This quarter, we're excited to announce an all-new electric wheel drive system launching in 2021, that is suited for the large port container material handlers. This Dana-designed all-electric solution replaces the diesel engine and traditional driveline by leveraging our core capabilities and innovation acquired through the strategic acquisitions of Fairfield, Ravini, and TM4, combined into an all-new Spicer electrified e-pub drive. In addition, we are providing software integration by leveraging the electrification competencies we've gained through our recent acquisitions of Nedressa, Rational Motion, and as communicated in my opening remarks, Pianova. The bottom line, Dana can provide a full line of advanced technologies that deliver class-leading performance in the ever-increasing regulations across mobility markets from small interior access equipment, such as scissorless, to port container handlers, while at the same time, we will be able to increase our content per vehicle by four times in a growth segment and further expanding our portfolio of sustainable products. Turning to slide seven, I want to highlight some of the exciting things one of Dana's customers has been doing in the electric mobility space. As many of you are aware, Lion Electric is a leader in the development and manufacturing of all electric architectures from Class V through Class A trucks, full-size school buses and minibuses. In early 2019, Lion chose Dana as their preferred supplier for traditional and electric componentry on its all-electric urban Class 8 vehicle, the Lion 8. Lion Electric stated that it had chosen to partner with Dana because of our unmatched proficiency and proven e-propulsion systems, stating our capabilities will be a strong addition to the development of their all-electric truck platform. Fast forward to September of this year, and Lion Electric announced it will deliver battery electric trucks to Amazon with the first being delivered later this year. Amazon plans to use these trucks in the middle-mile trucking operations. The truck has a range of up to 250 miles and features Dana's TM4 direct drive system coupled with Spicer driveline systems. Additional Lion electric vehicles include a zero-admission waste disposal truck featuring Dana Z powertrain, vehicle controller, and onboard charger. Our relationship with Lion Electric began in 2016 when they introduced the Lion Type C school bus, North America's first all-electric, zero-admission school bus, and powered by a complete Dana drive system. With hundreds on the road, Lion electric buses have proved themselves in harsh, cold climate conditions with millions of miles driven. Our collaboration with Lion Electric and all of our electric vehicle customers further solidifies Dana's position as an industry leader in e-propulsion. Moving to slide eight, I'd like to talk about the recent addition of software engineering capabilities to our product portfolio. Earlier today, Dana announced that it had acquired a 49% stake in Pianova. a leading developer of custom embedded software solutions and electronics control units for the light vehicle, commercial vehicle, and off-highway markets. This acquisition will enable Dana to further enhance our software and controls offerings for customers, which are critically important for the management of the complete e-propulsion system. With more than 25 years of systems, control units, software, and electronics design expertise, Pianova's team of software engineers leverages experience to provide proven, flexible solutions to meet the growing demand for software in the e-mobility market and beyond. When combined with Dana's complete systems capabilities for e-propulsion, we will be able to further enhance the efficiency of the entire system while adhering to the highest functional safety requirements. As I talked about on slide six, our customers are increasingly required acquiring advanced software and control solutions that are capable of managing complete e-propulsion system as well as the telematics and ancillary control systems of today's vehicles. For example, PiAnova's electronic control units, or ECUs, and software platform will be used on an upcoming medium-duty electric vehicle program that we will be launching in the new year. This investment will further our capabilities in electric powertrain software And we're excited to be partnering with Pianova as we look for further opportunities to develop capabilities and solutions that will enable these systems. Turning to slide nine, I'd like to talk in more detail about Dana's commitment to sustainability. If you turn on the news or read the paper, it's hard to miss the increased focus on sustainability. There is a growing movement across industries and our personal lives to be even more responsible stewards of the world around us. Combine this with an ever-increasing global regulations intended to drive down emissions, it becomes very clear that clean energy sources such as electric, hydrogen fuel cell, and natural gas will continue playing an important and increasing role in our day-to-day lives. Over the last five years, our enterprise strategy has been focused on being a leader in electrification with class leading portfolio of technologies that enable all vehicles, no matter their power source. As these trends continue to quickly evolve, Dana is prepared for them. Our industry has a unique opportunity to lead by example in how we not only design, but also how we manufacture our products that will have a positive impact on the environment. That is why I publicly announced last week that Dana is committed to reducing our total annual greenhouse gas emissions by at least 50% before the end of 2035. This will result in a reduction of more than 300,000 metric tons of greenhouse gas emissions annually. While this is an aggressive target, it is a very important one. To achieve this, we have developed a roadmap focusing on three core areas. The first is reducing our energy consumption and increasing the efficiency of our processes. Over the past five years, we have completed more than 400 projects to take direct aim at reducing our emissions generation, and we have many other projects in progress. Dana is currently utilizing solar arrays at several locations globally and will be implementing the further use of renewable energy, such as wind or solar, to make use of clean energy sources that will further reduce our greenhouse gas emissions. Lastly, as we look at reaching our target, we will be exploring the use of renewable energy credits purchased on the open market. These credits represent proof that energy was generated from a renewable source and sent to the grid. Dana has a long history of developing advanced technologies that address current industry needs and potential future challenges. We not only believe it's good business, but it's the right thing to do. Thank you for your time today. Now I'd like to turn it over to Jonathan to walk you through our financial results for the quarter.

Thank you, Jim. Good morning, and thank you everyone on the call for being with us today. I'd like to begin with a review of the third quarter financial results. The comparison on page 11 shows the change from both the prior year's third quarter, as well as the sequential change from the second quarter of this year, highlighting the rapid improvement from the pandemic-related shutdowns earlier this year. If you recall, last quarter we outlined our expectations for the third quarter that called for a sequential increase in sales of over 50%, positive adjusted EBITDA, and positive adjusted free cash flow. In the third quarter, we exceeded all three of these targets. Sales were nearly $2 billion in the third quarter, a sequential increase of more than $900 million compared to the second quarter, or 85% growth. due to increased demand as customers rapidly resumed productions after the pandemic-related restrictions were lifted. Sales decreased $170 million compared to the same period last year, driven by lower demand early in the quarter resulting from COVID-19 production shutdowns and an eventual restart in June. Adjusted EBITDA for the third quarter topped $200 million, a significant sequential improvement from the near break-even level in Q2, but remained $49 million lower than the same period last year, primarily due to lost contribution margin in our heavy vehicle segments on lower sales. Net income was $45 million, up $219 million sequentially, but down $66 million from the prior year. Changes in net income were primarily driven by the changes in adjusted EBITDA. Diluted adjusted EPS, which excludes the impact of non-recurring items, was 37 cents, up $1.06 from Q2, but down 37 cents versus prior year. And finally, adjusted free cash flow was $261 million for a sequential improvement of $394 million, as well as a $136 million improvement versus last year, as improved working capital and lower capital spending more than offset lower profits. Please turn with me now to slide 12 for a closer look at the sales and profit changes in the third quarter. The change in third quarter sales in adjusted EBITDA compared to the same period last year is driven by the four key factors shown here. First, organic sales were $159 million lower than last year, primarily attributable to our heavy vehicle segments where production has yet to return to pre-pandemic levels. However, in our light vehicle businesses, volumes increased dramatically during the quarter and were largely in line with the same period last year. The rapid increase in volumes led to a number of our plants in North America running at maximum capacity when they were completely idle just a few months before. This dramatic increase in production led to premium costs, which held back the sequential incrementals and increased the year-over-year decrementals. Second is the impact of the Graziano and Fairfield acquisition, which we closed in the first quarter of last year. Since we've lapped the one-year anniversary of the acquisition, the impact illustrated here is the year-over-year improvement due to cost synergies. Third, the currency impact during the quarter was negligible as the U.S. dollar was generally unchanged from the same period last year. And finally, lower commodity costs provided a 25 basis point benefit as gross commodity costs decreased by $13 million for a net profit gain of $4 million. Please turn with me to slide 13 for a closer look at how adjusted EBITDA converted to cash flow. Adjusted free cash flow for the third quarter was $261 million, offsetting a nearly quarter billion dollar use of cash in the first half of the year, leaving us with positive free cash flow on a year-to-date basis. For the quarter, lower one-time costs related to acquisitions, lower taxes, and reduced capital spending all contributed to the improvement, but by far the largest driver was our improved working capital. As we had guided at the end of last quarter, working capital efficiency improved in the third quarter as sales volumes increased in our light vehicle segments and inventory was reduced in our heavy vehicle businesses. The strong cash flow performance in the third quarter positions us to deliver positive free cash flow in 2020, despite the challenging circumstances. Please turn with me now to slide 14 for our outlook for the remainder of the year. As a result of the dramatic improvement in our end markets during the third quarter, we are reinstating our full-year financial guidance, which does not anticipate production stoppages in the fourth quarter due to pandemic containment measures. We expect full-year sales to be approximately $6.8 billion at the midpoint of our range and adjusted EBITDA to be about $560 million, which implies a profit margin of about 8%. This guidance anticipates lower sales on a sequential basis, which is typical in our business as the fourth quarter has fewer workdays. It also implies relatively high decremental margins compared to the fourth quarter of last year when we received $17 million in proceeds related to an indirect tax expense recovery in Brazil. We expect positive adjusted free cash flow on a full year basis of up to a 1% margin. Diluted adjusted EPS is expected to be approximately $0.45 per share at the midpoint of the range. Please turn with me now to slide 15 for a closer look at the year-over-year sales and profit changes at the midpoint of our guidance ranges. Shown on slide 15 are the four factors driving our expected sales and profit changes in 2020 compared to the prior year. The difference between our current guidance and the initial guidance we issued at the beginning of the year is almost exclusively due to the impact of the global pandemic, including production shutdowns and end market disruptions. First, organic changes are expected to be about a $1.8 to $1.9 billion headwind of sales, again primarily driven by the pandemic-related shutdowns and end-market disruptions. We are expecting decrementals in the mid-20% range, as we indicated on our last earnings call, leading to nearly a half-a-billion-dollar profit decline. Second, inorganic growth from the Graziano and Fairfield businesses shown on this chart include the sales and profit for the first two months of 2020 and the full-year incremental cost synergies. This business will add nearly $115 million in sales and should expand margins by 20 basis points as a result of the subsequent contribution margin and the delivery of the remaining $15 million of cost synergies. Third, we anticipate the impact of foreign currency translation to be a headwind of about $50 million to sales and about $5 million to profit with no margin impact. Finally, we expect a commodity cost tailwind of about $10 million in profit. Our input costs have been lower this year, so the recovery from customers are lower as well, representing about a $30 million headwind to sales. The combination of lower sales and higher profit will generate about 20 basis points of margin expansion. While this year certainly has not played out as anyone had anticipated, We remain committed to managing our costs and remain on track to deliver decremental margins in the mid-20s through this unprecedented period. Please turn with me now to slide 16 for a closer look at how we expect adjusted EBITDA will convert to cash flow. As mentioned previously, we expect positive free cash flow this year, up to 1% of sales at the top end of our expectations. The chart on the page illustrates the major components that would deliver free cash flow of about $50 million and compares the major changes to last year. more than half of the year-over-year profit decline should be offset by lower one-time costs associated with last year's Graziano and Fairfield acquisitions, lower cash taxes from lower profits, a modest source of cash and working capital as sales are lower, and a meaningful reduction in capital spending. Please turn with me now to page 17, where I'll provide some color on our end market outlook as we begin to think about how 2021 is shaping up. As we look forward, we expect generally positive end market conditions. First, in the light vehicle market, we anticipate full-frame truck demand to continue its recent strength as vehicle inventories for our key platforms remain at abnormally low levels. We will also see a sales benefit from our backlog as new models such as the Bronco Sport launches later this year and from the highly anticipated Bronco launch slated for next year. Second, in the commercial vehicle market, Class 8 and medium truck demand in North America has strengthened, this year coming out of the production shutdowns. Improving demand is expected to continue into next year as third-party estimates call for production near replacement levels. We'll also begin production on key EV truck platforms for customers in mid-2021, adding modestly to our top line initially, but growing in importance from a margin contribution perspective as the programs mature. Finally, in our key segments of the off-highway equipment market, demand for agriculture equipment has strengthened over the last few quarters, and that trend is expected to continue into next year, driven by government incentives around the world aimed at stabilizing the farming sector and from normal equipment replacement activity. Construction equipment demand has stabilized and is expected to improve as we move into next year, driven by low inventory levels and infrastructure investment. The foundation of the Dana operating system is underpinned by four major pillars, safety, quality, delivery, and efficiency. As a team, we will remain laser-focused on utilizing this system to protect our employees and customers while maximizing value for shareholders as we capitalize on these improving market conditions next year. Thank you for listening in today, and I'll now turn the call back over to Regina so we can take your questions.

And at this time, we would like to begin the Q&A session. If you would like to ask a question, press the star key and the number one on your telephone keypad. Your first question is from the line of Eileen Smith with Bank of America.

Good morning, everyone. First question, using the midpoint of your revenue and EBITDA outlook for 2020 implies an EBITDA margin of let's think a little less than 9% for the fourth quarter. some of which you noted was seasonal and then also a function of the Brazilian indirect tax recovery. However, as we think about the starting point for 2021 in terms of margin performance, is 3Q or 4Q the more appropriate level to think about? Or perhaps asked another way, were there factors at work in the third quarter, like very favorable volume mix in price, that perhaps inflated margins a bit more than you would think would persist going forward, even despite you working down factors like premium freight and other cost efficiencies?

Sure. Good morning, Eileen. This is Jonathan. You know, typically our margin cadence is higher in the second and third quarter with normal seasonality. So typically we have fewer work days and a larger margin or lower margin profile in the first and fourth quarter. So, you know, seasonally Q3 is closer to a better performance, but really I think the answer is neither quarter is typical of what we would have expected to see at the beginning of the year. Sales levels are, still remain below where we would have anticipated, particularly in the heavy vehicle business. And the contribution margin from the off-highway segment is a very meaningful profit indicator to get us to that 12% range closer to where we were last year. So I think that's probably a better way to think of it as those markets continue to recover, which we expect, as we indicated, early into next year that will start to happen. We expect to see margin upside from where we are today.

Okay, great. That's helpful. And the second question, I believe your last disclosure in the fourth quarter of last year was that about 15% of your 2020 to 22 backlog was attributable to EV programs. Given what appears to be real traction more recently with EV technology and EV players across all end markets, as well as some of your partnerships like Hyliion, Do you have an updated or even high-level view around the percentage of your backlog or even programs launching next year that are attributable to EVs?

Yeah, when we provide our refreshed backlog early next year, we'll absolutely give an update on that. But you're spot on. We've had a lot of traction there. We would expect that percentage to grow. You know, we talk about the medium-duty platforms that we've won both in the U.S. and in Europe. You know, Jim touched on the REACH stacker application that's going to be coming to market next year. So we really are starting to see some traction. We would expect that to improve and more to come on the specifics early next year.

Okay. And last question, if I may, and I appreciate it may be a tough one. As we think about the upcoming U.S. election and potential implications from a new administration, internally, what are some of the things that you're thinking about, whether it's taxes or trades? or environment and you're planning around with respect to the election and perhaps some preemptive actions you might be taking to mitigate those implications, if there are any under a new administration?

Hey, Eileen, this is Jim. Thanks a lot for the question. You're right, that's a bit of a toughie. I will tell you, you know, from our standpoint, they're not really changing a lot what we at Dana have already been doing. Some would have argued, which I think would have probably been the wrong argument looking back on it, would have argued that we were ahead of the curve jumping on the electrification and sustainability trail a good five years ago doing what that is. You know, there's certainly a lot of optics on that could be a much stronger push, not just here, obviously, in the United States, but around the world. Besides that, I'd say we're very plugged in to what is going to happen in current administration, whatever the next administration may or may not be. and very representative of that was being a leader in the USMCA process as the only, you know, mobility supplier that was, you know, deep into the discussions and trying to support our customers in that. So we'll continue to be plugged in and supportive in the, you know, in what we believe is the right direction to support our customers and our stakeholders.

Great. That's very helpful. Thanks for the question.

Your next question comes from the line of Emmanuel Rosner with Deutsche Bank.

Hi, good morning, everybody.

Good morning, Emmanuel.

Just quick additional clarification on the fourth quarter implied guidance. So I think at midpoint, we're talking about maybe revenue coming down sequentially by $200 million or so, maybe 10%. So I understand the seasonality, but at the same time, a lot of production, especially on the light vehicle side, seems to be running flat out, as you pointed, with low inventory. So Any specific segments within Dana where you would expect some of that seasonal sequential decline to happen more than elsewhere?

Yeah, Manuel, we're probably just a bit more cautious on the heavy vehicle market. So I think you're right. I think we're going to continue to see quite a bit of strength in light vehicle. You know, on the margins, it may be slightly lower, but I think the space where we're probably a bit more cautious is just on the heavy vehicle side. So these are quite uncertain times. You know, we're confident enough to put guidance out because we have pretty good outlook through the end of the year. But I would say that's probably the area where we're a bit more cautious is on both of our heavy vehicle segments.

Okay. So that's what's implied in guidance, the bulk of the sequential decline in commercial and in off-highway revenue. Is that right?

Yep. That's fair.

Okay. Perfect. And then just one more clarification on the fourth quarter. So that implied sort of 8.8% EBITDA guidance. That's to understand your point on the year-over-year decremental and the absence of the tax recovery. But just in terms of absolute margins, can you just go back over some of the factors there? I think there's some currency and anything else to think about.

Yeah, biggest driver is just the sales level. So a $1.8 billion quarter is pretty low for us, particularly compared to where we would have been last year. So the lost contribution margin in the off-highway business, as an example, is a pretty meaningful impact on that. And then the second factor you noted compared to last year is the mention we made to the indirect tax recovery in Brazil. So when you take both of those into account, that's what's driving the margins that are high single digits versus into the double digits.

Okay, great. And then just following up on the electrified vehicle pipeline and your backlog, can you just remind us sort of the main segments or I guess the rough breakdown of where your current backlog is or at least as of what was last disclosed before the update and what you've announced since then? And, you know, I'm sure you're seeing a lot of increased activity in the light duty trucks as well, such as pickups. When would you expect some of those first industry awards to happen?

Sure. So as you alluded to in our indication earlier this year of our backlog having about 15% in electrification, the largest portion of that was in the commercial vehicle segment. where we had announced our first medium-duty electrification win towards the end of last year. Since then, we won another major program in Europe. We've picked up some programs in the off-highway segment, one of those that we featured today. So those would be the incremental wins that would be driving that increased proportion of our backlog that we would expect to come in electrification years. You know, as it relates to the light vehicle segment, tremendous amount of activity right there. We don't have anything that we can talk about right now within the light vehicle space on the major program side, but I would indicate that, you know, that's going to be coming in the next couple of years as we see the more effort put into that category. But a lot of effort right now on the medium duty segment with a host of customers and as well on the off-highway side. Great. Thank you.

Sure. Your next question comes from the line of Noah Kay with Oppenheimer.

Hey, thanks for taking the questions. Let me just follow up on that last one. You know, because I think it speaks to kind of an ongoing debate around degrees of insourcing around electrified powertrains. You know, and certainly with your current backlog reflecting relatively more exposure to commercial vehicle and off highway, it just strikes us that between all the acquisitions you've made, including, you know, the investment you announced today, you know, you just continue to focus more on integrated systems and getting the software capabilities, the motor integrated e-axle. And I guess just how do you think broadly about the defensibility of, you know, that sort of integrated go-to-market when you look at commercial vehicle and off-highway versus, say, the light vehicle market?

Yeah, sure. So, you know, when we think about the traction we've got in the heavy vehicle markets, you're absolutely right. Our customers are looking for full systems. But in those markets today, the customers do a lot of drive system work in-house, and many of them are working on in-house solutions for those vehicles as well, too. And we think the same is largely true on the light vehicle side. Certainly many of the early programs – customers have announced some in-house content in those. But, you know, just to continue to remind everyone in the light vehicle business today for traditional internal combustion engine, you know, propulsion systems, many of the rigid axles and drive shafts are done in-house today by customers as well, and they also outsource a number of those to us and many of our competitors. So we expect that trend to continue as we continue to develop indicate there is a lot of activity with many of our customers across all end markets demonstrating the system's capability. And we continue to believe that customers from all three of our major end markets will outsource e-propulsion systems in the future as well, too. And that's why these investments to give us Full electrodynamic capabilities in-house, the software capabilities that continue to develop and grow through the Pianovo are going to help us to deliver really strong systems when our customers look to have some of these platforms done on the outside.

If I may, just to kind of give you some color to it, I would almost argue, or not argue, but reference. It wasn't by accident of our cover page picture this time. Just reminding maybe a very good chunk of the audience in today's call about the multiple end market exposure that we have in commercial channels, which is not by accident. That's our strategy, and it's very intentional. Secondarily, you know, what does that do for us? IE gives us plenty of lessons learned, road miles or other miles, if you want to call it, that are kilometers. And as we're continuing to develop and launch medium-duty vehicles, those are obviously on the smaller side of the commercial vehicle market, all of that benefits us in terms of being prepared for our markets on light duty as they come through. But we've said since the beginning of the enterprise strategy development back when is that our markets are going to come further downstream. And we've provided the key word I would offer you to hang on is optionality. Optionality of which markets within light vehicle, optionality outside of into our other multiple markets. that it's all coming together the way we, I guess I would say, as we expected.

Yeah, I appreciate that, Jim. And I think it makes sense in terms of seeing these middle mile and last mile, you know, medium duty applications being some of the first to really, you know, show strong demand. So I understand your positioning there. And thanks. I guess just wanted to go back to, you know, the comments you made around, you know, the near term, You mentioned you're just a bit more cautious in terms of the near-term outlook on the heavy vehicle side. And I guess it would be helpful if you can provide any kind of regional color on where you think there might be some softness. Certainly, I think in North America here, we're seeing improving construction trends as we head into the fourth quarter. Obviously, the build rates for Class 8 seem pretty stable, if not on an upswing. You know, so I don't know if you're thinking about that potential sort of sequential softness coming from, you know, China or another region, but any kind of color you could provide would be helpful.

Sure. You know, just a couple of markets I'd point to that we're a little bit concerned about. South America, you know, the Brazil market is very important for us. That market continues to be quite sluggish. The second one would be India. You know, that market, particularly on the construction side, has been a bit slow. So those are a couple of areas that we'd point to. As you note, and as we even noted as we look into 2021, we think that there's promise for improvement not only in agriculture but also in construction globally. But just in the near term, I think we're a little bit cautious on the next couple of months and a couple of those spots outside of the U.S. I'd point to as areas of concern.

Okay, that's very helpful. Thank you.

No problem.

Your next question comes from the line of James Piccariello with KeyBank Capital Markets.

Hey, good morning, guys. Morning, James. Can you quantify, maybe I missed it, can you quantify the premium freight and inefficiency cost that light vehicle incurred in the quarter? Is this expected to continue in the fourth?

Yeah, it had a material impact not only on light vehicles results, but also on overall data. Had we not had premium cost in the third quarter, you would have seen decrementals closer to the mid-20s like we saw in the prior quarter. And as we mentioned, the premium freight was the biggest driver. The positive there is that has subsided significantly. So we saw the highest spike in the month of August. September improved a bit. October is on track to improve again sequentially. So we're seeing that come down. We think we'll be in a much better spot by the end of the fourth quarter. And as we mentioned, we think we're going to be in a really strong position to have strong year-over-year incrementals in the light vehicle segment next year.

So some spillover there. related to premium freight in the fourth quarter, but not to the same extent.

Yeah, just a little. I mean, it's considerably lower, but we're still incurring some in the month of October. But the important part is the trend is moving in the right direction, and we're working ourselves into a better position.

Okay.

And then just back on the guidance for revenue, the fourth quarter, the implied decline is maybe a point worse than third quarter's. And, I mean, yeah, if we look at commercial vehicle production comps for the fourth quarter, if we look at trends in off-highway, I mean, there's nothing that would directly support a worse revenue comp year over year for Dana in the fourth quarter compared to the third. Is it really just, you know, Brazil's sluggishness and India construction, or is there more to kind of round that out?

Yeah, you know, those are the best discrete examples I can point to. And then also, I think we're just, we're cautious in this environment. And, you know, we are reinstating our guidance, but we're certainly in a position to make sure that we want to have a strong finish to the year.

Okay, fair enough. And then just one last one for me. As we think about next year and, you know, Dana's normalized incremental margins, are there any one-time costs or permanent savings to kind of call out as we consider next year's earnings bridge? I mean, does the unwind of this year's temporary austerity measures temper next year's incremental margins, or are there positive offsets to sustain a normalized contribution margin, possibly something better? How should we think about maybe some of those buckets?

Yeah, you know, I think you touched on a couple. For example, you're right, we will pay all our people for a full five-day work week we would expect next year where Obviously, some of those austerity measures in the second quarter of this year were temporary. So you're right, there'll be some what were traditionally fixed costs that we flexed that'll come back. But we've also indicated that we made some very difficult decisions and made some investment and took some permanent austerity measures during the midst of the crisis. that will have a lasting benefit into next year. So we will be in a position where those cost reductions will benefit that and help us to make some of the investments we would like to bring some of these exciting new products to market. So more to come on that. We'll give some color on the permanent cost reductions when we give guidance for next year, hopefully early next year. Got it. Thanks, guys.

Sure.

Absolutely.

Your next question comes from the line of Rod Lasche with Wolf Research.

Hi, everybody. I just wanted to follow up with a few more questions on electrification. So you focused on the commercial vehicle and off-highway side, I think not only because you thought it would come first, but also because you kind of saw a more competitive, a more attractive competitive landscape. Can you just give us your high-level view on electrification? The light vehicle side, are you still kind of looking at a sector that will be significantly more competitive? Are there any specific areas that you see as more compelling for Dana specifically within light vehicle? And over time, do you believe your position in light vehicle will be sustained as that electrifies?

Hey, Rod. Good morning. This is Jim. Thanks for the question. Thanks for joining today. I think it's a good question. My view is that it's not marketing or just let me give you the positive. The reality is that we, as you know, but for everyone else, I mean, we're focused on large SUVs and trucks on up, and purely the fact that rigid axle, beam axles, and all of the torque and robustness of those products and all your knowledge and understanding the markets and all that is still going to be very critical, not to mention everything as it relates to this significant upswing in the off-road enthusiast markets and those type of products, which, you know, we're on the Wrangler, we're on the Gladiator, we're on the Bronco and all that stuff. we're going to participate in different ways. There's no doubt about that as it comes through the system. And I hope I can answer your question. What I can't do is gun jump and get any further than what I can talk about. All I can tell you is back to overuse of my word I said earlier, we have positioned ourselves in the optionality standpoint of supporting our customers with the full three-in-ones in the future in these areas, and we're going to have the benefit of of a lot of lesson learned and on-the-road products that are out there for some period of time, not to mention the full operating system software that's on these vehicles that are going to be on the road next year that will pull back as it relates to just three-in-one side of it, but it's going to be very efficient systems that are going to put our customers in that same situation they've been in for years, which is sometimes they do it in-house, sometimes they don't do it in-house, sometimes they break it up between the products of a motor, inverter, and gearbox. So all we can do is position ourselves for success, and we feel pretty strongly that we're in a good position.

Great. Thanks for addressing that. And just lastly, I know you're not updating backlog or midterm revenue expectations, but can you give us any kind of high-level thoughts on either volumes or potential content per vehicle on some of these applications and medium-duty and off-highway that you've cited?

Yeah, you know, Rod, we've given a general comment that the adding electrodynamics will at least double the content, but certainly we're seeing better than that. We indicated, for example, the medium-duty electric platform we're launching next year is at a multiple much higher than that because we were responsible for the full e-powertrain system. But we also feel that the proof point on the reach stacker is interesting as well, too, where that quadrupled our content. So, We continue to see that this is going to be at least 2x the content, and certainly there's quite a bit of upside on that depending on the application. So as we bring forward the backlog, the CPV increase is a big driver of what's helping to create this revenue potential.

Great.

Thank you. Sure.

Your next question comes from the line of Joseph Spack with IBC Capital Markets.

Thank you. Good morning, everyone. Morning, Joe. Just to go back to some of the inefficiencies and the premium costs, I understand that you say they're getting better, and it sounds like you think they should subside as they move into 21. Is that because – I just don't understand the source of, I guess, the cost this quarter. Was it really a function of the pace of the recovery and not a function of freight capacity and availability and immense price? Is that why you see it coming better?

Hey, Joe, this is Jim. This isn't your first rodeo. You hit the nail right on the head. It totally was all about pace. If you just kind of think about the programs we're on, the demand that you can imagine that was out there, and the markets that certainly our customers wanted to capitalize on, we will do what it takes to do that no matter how fast that pace is, and then all the challenges that are around the world as it relates to people getting people to go to work and all that other stuff. So it was a, I'll call it a window in time that we had to do what we had to do. But if you kind of take sequentially between the months of June to July, August, September, et cetera, et cetera, I mean, I've never in my life, I can tell you that, and I know you know this about me, I come from manufacturing. We all come from somewhere, right? And never in my life have I taken down over 150 facilities, did a dead stop, then start them all up, and then, oh, by the way, put them not at, you know, kind of a run rate, normal capacity facility, We'll put them fully at full giddy-up maximum capacity. It just is what it is, and the team did a remarkable job. Frankly, I can't even put into words what a remarkable job our operating team did to pull it off and do what they're doing today. So I hope that answers your question.

Yeah, it helps explain why if things are relatively smoother next year, you can see better margins. Just on the implied free cash flow in the fourth quarter, I think typically the fourth quarter is stronger than the third quarter from a free cash perspective. The guidance implies it's a little bit lower. Was some of that timing or working capital timing between the third and the fourth quarter, or is there any other color you can provide there?

No, you're absolutely right. More of our seasonal generation of free cash flow came in the third quarter. So that's the primary driver between that. Typically, most of that comes in the fourth quarter, but just due to the shutdowns in Q3, that's the biggest driver.

Okay. And then just to follow on some of the electrification questions as it pertains to the light vehicle side, we're seeing – In some cases, on the light vehicle side, the concept of the motor moving closer to the wheel, in some cases even in the wheel, you know, I think you actually have that type of technology for the off-highway segment. But what's your view on that approach for the light vehicle market? And, you know, can you participate if that's the way that market evolves, if it's not sort of a straight e-axle for a light vehicle like you currently have?

Let me start with that, and you set up the nail for me a little bit there, Joel, the way you put that question. I would take the audience back to the visual that we showed in the off-highway market just as a starting point. Essentially, that is a form, albeit in a reach stacker, it's a form of wheel and technology. The point here is that every vehicle is going to have – it's not going to be a one – size fits all develop depending on which type of propulsion system it's going to have it's going to depend on the vehicle i would tell you that you know there's going to be certainly a lot of them that probably i would argue more on the passenger car side that might be closer to the wheel but when you think about the the load bearing and the load carrying requirements on pickup trucks and medium duty trucks and all that stuff you still need you still need that uh support i.e beam axles and others. So I'm not going to tell you, I'm not an OEM. I never pretend to be an OEM, and I don't design cars and trucks for a living, but I would tell you at least from a propulsion system standpoint, an axle standpoint, and what we do for a living, I think you're still going to continue to see a mixed bag as it relates to the design of the vehicles and if it's either, again, a beam axle or it's at the wheel.

And you're in different, or between those two, or quite differently, I guess you could participate in either side of those approaches.

Yeah, absolutely. Again, maybe I didn't make it very clear, but I used the example without gun jumping again. That reach stacker is a form of a wheel end type of electrification execution. But if you take the vehicles that we've already communicated to you or presented to you that will be on the road in the new year, some of the media duties, those are going to be more of a beam, just more historical beam axle with the electric either either integrated design for the motor or a direct drive, as we call it.

Thank you.

Yep. Thanks, Jill.

Your next question comes from the line of Brian Johnson with Barclays.

Good morning, Jim, John, and Dana team. Everyone's circling around the same question, so I'll just ask it directly. I know you're not giving guidance, midterm guidance or backlog, but if we think of mid-decade, And I think what people are trying to get their heads around is what's the upside opportunity in commercial and off-highway from electrification versus the potential erosion of light vehicle as things like the Rivian, the Badger, if it comes to market, et cetera, kind of eat in at least at some end of the SUV pickup truck market.

Yeah, sure, Brian. The best thing I can point to, last year at our investor day, we highlighted that we believe by 2023, our electrified business would achieve half a billion dollars of sales, and that in 2018, it was only a $100 million business. So that $400 million of upside over that period was one of the big drivers to our longer-term revenue growth outlook. We don't believe there'll be any cannibalization of internal combustion product in the light vehicle side you know over the next few years so that was a pretty meaningful um you know it was largely uh all upside or you could add to and that's where we had this was pre-pandemic but we had indicated that we felt sales could go from the mid eight and a half billion dollar range to 10 billion dollars and that electrification growth story was one of the major uh drivers there so that's probably the best thing i can point to right now and we'll uh Hope to get a little more color on the progress as we prosecute against that plan early next year when we lay out a guide and a backlog refresh.

And will that go through at least mid-decade when electrification and sections likely to accelerate?

Yeah, you know, we typically do a three-year backlog, so I guess next year would take us through to 2023 on the backlog side, and that's where our target was. And we'll give some thought to what we indicate beyond 2023.

Okay, secondly, could you maybe elaborate a bit on where you see the applications for the PI software in your portfolio and kind of how quickly that relationship could ramp up and kind of accelerate your module business?

Yeah, it's probably no surprise the relationship started quite some time ago. So the investment follows working with them on some existing programs and Their open ECU platform and software architecture we're utilizing on a few programs already. This software can sit on an electronic control unit that is managing a three-in-one system. It could be a vehicle controller on a full electrified powertrain. There are a number of applications that we'll use this in, and the real key here is having a stronger relationship and an ownership stake in this business will help to improve our competitive position as the software and control logic of these systems can be a meaningful differentiator. So really excited about the further expansion there. But to your question, it's quite broad. It can be used in the three-in-one system. It can be used in the full embedded vehicle software or the vehicle control unit. There are a number of places that can be used in the electrified propulsion architecture. Okay. Thank you.

Sure. Your next question comes from the line of Ryan Brinkman with JP Morgan.

Hi, thanks for taking my question, which is how are you thinking about normalized margin now relative to before COVID-19? So sort of, you know, putting aside all of the social distancing or protective equipment costs, the sales to leverage, the premium costs and efficiencies associated with the shape of the recovery, the structural cost saves, you know, when you add it all up, What do you think that means for the normalized margin of the business relative to whatever path you were on prior to the pandemic?

Yeah, while we're not in a position, Ryan, necessarily to update our longer-term guidance right now, the indication I'd give you is that we think that these puts and takes are probably pretty balanced, maybe a little bit more leaning to upside with some of the structural cost improvements that we made. So, We still remain convicted in the long-term margin expansion potential in the business and of equal, if not greater importance, the ability to convert more of that to cash than we have in the past. You know, the growing pains that we've talked about in light vehicle in the third quarter, as Jim mentioned, are just unprecedented. Never have we idled factories for months at a time and then brought them back up to max capacity shortly thereafter. So we think those things are temporary and we'll work through and we remain convinced Pretty optimistic about the long-term profit and cash flow prospects of the business. Great. Thank you. Sure.

Our final question will come from the line of Dan Levy with Credit Suisse.

Hey, good morning. Thank you. Good morning, Dan. Hey. So first question, I just wanted to ask on power technologies, 13-plus percent margin, that's I think like the highest quarterly margin that we've seen in over two years. Just give a little color on the underlying – dynamics of that result? I mean, how much of that can we carry forward? And I think historically, the segment was doing 15% margin. I think there were some issues on commodities and reduced aftermarket mix. Is 15% margin in power technologies feasible in the future?

Sure. So, Dan, if you go back to what caused the margin compression in power tech last year that we talked about, it was a few factors. First, geographic mix hurt. We saw some reduction in highly profitable regions outside of the U.S. Second was the commodities, as you mentioned. We really saw some increases in some of the key components for aluminum, nickel and And then finally, on the front of the product launches, we had a couple of really big product launches that brought new technology into the business, and we needed some self-help to improve those. And really all three of those have improved in – 2020 compared to 2019. So lower commodity costs, getting past those initial launches that we had touched on for new technology, and then also an improvement in geographic mix have gotten us there. So as you noted, delivering 13.5% margins and still what's not a fantastic global market. you know, is a pretty good indicator that the profitability of this business has some room to improve going forward. So we'll continue to focus on that and executing to help to deliver some margin expansion out of the profit or the power tech segment as well.

Great. And then just a question on EV. And I guess, actually, let's call it maybe your powertrain 1.0 content, because I think all your customers on the light vehicle side, it's pretty clear everyone needs to focus much more heavily on the transition to EV. And so there's a lot of deallocating resources away from combustion vehicles. But we know combustion vehicles are still nearly all vehicle sales. So combustion is still very relevant. So is it possible that given combustion is very relevant, but OEMs need to shift a lot more of their focus toward EV that you could arguably gain more what's called a powertrain 1.0 content. The OEMs need to rely more heavily on the supply chain. So let's call it more of an opportunity over the next three to five years to capture that incremental business.

Yeah, you know, that's something, Dan, that we talked about when we talked about our or laid out our strategy last year. One of the real key components, the second element of our strategy is, you know, continuing to strengthen customer centricity. And the view there is that. By being close to our customer, performing well, there is greater opportunity to pick up some of the outsourced content as they focused on the other megatrends, such as shared mobility, autonomous driving, digitalization of vehicles. So we absolutely believe that their capital is precious, and we have shared some proof points over the last few years where we've picked up some incremental internal combustion engine driveline content as customers reallocate capital. So we do think that continues to be a bit of a tailwind for us, and we're focused on having the right performance to make sure we're the supplier of choice when they make those decisions.

Have those outsourcing discussions accelerated more heavily in the last, call it, six months as EV has become, you know, much, much more in focus? Is that

Yeah, last six months have been a lot of focus on EV and a lot of focus on navigating through these challenging times, but it's fair to say that we still think that that trend and opportunity exists. Okay, great. Thank you. Thanks, Dan.

Okay, this is Jim. With that, I'll do a quick close. Again, thank you for everyone for attending today with Dana. I hope it's pretty obvious, not just this quarter but any quarter, that We tend not to let the grass grow under our feet. We tend to keep moving. Like everyone, we're certainly managing through the effects of COVID-19, and that can't be minimized. And as a quick shout out to particularly all of our associates in our manufacturing facilities and technical centers or test centers, if you think about it, there's a lot more folks that are working at Dana on site than that are not. And we appreciate everything they do, not just for us, at Dana, but for everyone. It isn't by accident that ambulances get billed, and we're part of that solution and many others. So thank you to our team members. Secondarily from that, we're managing at maximum capacities and supporting our customers, and the team has done a great job with that. But at the same time, we're maintaining that optionality that I talked about earlier, which leads to scale across multiple end markets. It's not for the faint of heart, but it is for the right thing for our shareholders. And we do that at the same time, coming up now, we'll be launching new business associated with, for example, the Fiat Chrysler TRX or the Bronco Sport in the quarter. But we don't stop there. As you heard today, we've also added Pianova's outstanding partnership as it relates to gaining access to the open ECN platform, which has superior software controls that really truly provides us the ability to optimize our systems and create maximum value for our customers. So we're going to continue down with following our enterprise strategy, taking care of our customers and doing the right thing for our shareholders, all at the same time being very focused on sustainability. We thank you again for your attendance and look forward to talking to all of you very soon.

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