Dana Incorporated

Good morning and welcome to Dana Incorporated's third quarter financial webcast and conference call. My name is Holly and I'll 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, then the number one on your telephone keypad. To ensure that everyone has an opportunity to participate in today's Q&A, we do 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, Holly, and good morning to everyone on the call. Thank you for joining us today for our third quarter of 2021 earnings call. You will 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 expectations for Dana's future performance. Actual results could differ from those suggested by our comments today. Additional information about the factors that could affect future results are summarized in our Safe Harbor Statement found in our public filings, including our reports with the SEC. On the call this morning are Jim Camsiscus, 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. As we jump right in, I'd like to share a quick overview of our results for the third quarter. Dana delivered $2.2 billion in sales, representing an increase of $210 million over this time last year, as our customers continue to see strong demand despite several headwinds. Diluted adjusted EBITDA for the quarter was $210 million, a $9 million improvement over last year. Free cash flow was the use of $170 million as the semiconductor shortage drove significant and unplanned OEM demand reductions, which, of course, led to substantial downstream component inventory accumulation across the company. Diluted adjusted earnings per share was up slightly compared with last year at 41 cents for the quarter. Moving to the key highlights on the upper right-hand side of the page today. We will provide you with an update on how we're navigating through unprecedented supply chain constraints, raw material cost inflation, and labor shortages that are impacting the entire global mobility industry. We'll also outline how Dana is well-positioned to capitalize on long-term cyclical growth as near-term issues begin to subside. Finally, I'll provide a recap on a recent Capital Markets Day that we conducted last month at our world headquarters in Maumee, Ohio. This event was intentionally focused on vehicle electrification and more specifically, the tremendous progress we've achieved by executing the strategy that we initially announced in 2016 and refreshed in 2019. Very clearly, our success in e-propulsion continues to accelerate across all mobility markets as Dana's cohesive and streamlined global team is generating significant value for our customers around the globe. Please turn to page five and we'll begin our discussion with the ongoing supply chain challenges and how it is impacting our markets. Whether it's the semiconductor shortages causing OEMs to idle vehicle manufacturing or dramatic shortages of labor, sea containers, truck drivers, raw materials, or numerous other issues resulting from the global pandemic, companies across the mobility industry are having to navigate through unprecedented manufacturing constraints. As we all know too well, supply chain disruptions have significantly reduced Global auto production as OEMs are challenged to procure chips required to produce their vehicles and meet robust consumer demand. This reduced vehicle output has led to historically low finished vehicle inventories in the light vehicle segment. The commercial vehicle and off-highway segments are largely experiencing similar high demand. For example, the current Class 8 truck sales backlogs have reached pre-pandemic levels. and finished vehicle inventory levels for construction and agriculture equipment are at the lowest levels in the last three years, resulting in unfulfilled end customer demand. On the right side of the page, we are illustrating the issues constraining supply. The disruptions we are seeing continue to cause component raw material shortages and escalating prices across all of our end markets. In addition to the chip shortages I mentioned, shipping congestion at the ports around the world is translating to delays, container shortages, and increased logistic costs, resulting in overall higher input costs. Labor shortages, particularly in the United States, are also leading to production inefficiencies, plant downtime, and higher labor costs. All of this has led to customers struggling to meet the strong end market demand. We're actively navigating through the unprecedented and challenging market dynamics by working to offset and recover higher input costs for commodities such as steel through our established mechanisms. Though, due to the ongoing price inflation and inherent lag in recoveries, we continue to see a substantial margin headwind that will remain until the input costs stabilize and turn the other way. While we do expect these challenges to continue in the near term, when supply chain issues do finally lessen, We anticipate a sustained recovery period as suppressed end-market inventory levels combined with high consumer demand for our key platforms provides the opportunity for a strong volume tailwind for us. We are seeing the dynamic across all three of our end markets. The alignment of these three will provide further demand momentum across our entire mobility landscape, and Dana remains well-positioned to capitalize on these cyclical growth opportunities. Moving to slide six, I'd like to share a recap with you of our recent Capital Markets Day. Last month, many of you participated, either in person or virtually, in our 2021 Capital Markets Day, which we hosted at our Sustainable Mobility Center on the campus of our world headquarters. The goal of this event was to share our perspective on how electrified mobility will evolve in the coming years and how Dana's class-leading innovation and global presence will help to drive outsized growth and financial returns for our shareholders. As many of you may recall, we introduced eight key elements that we believe showcase how Dana has successfully built a substantial EV franchise. First is our guiding vision towards a zero-admissions future that is at the heart of everything we do and is the overarching theme of our electrification pursuits. We examined how our total addressable market is going to rise dramatically over the next decade as electrification becomes commonplace in each of the markets we serve. Third, we presented Dana's industry-leading technical competencies in e-propulsion systems. More specifically, we illustrated how we were leveraging our design, engineering, and manufacturing team members' depth and capabilities to provide the most advanced three-in-one electrified drivelines in-house across all mobility markets. Fourth, we discussed that as the use of batteries and electrodynamics accelerate in the mobility markets, the driver line will remain, and Dana will be a clear beneficiary of this megatrend. The combination of electrodynamics and mechanical systems will increase our content per vehicle potential by three times compared to our historical ICE product portfolio. Fifth, this migration of mechanical powertrains to smart electrodynamic systems requires embedded software controls. Designing and integrating these into the driveline, along with in-house production of high-value subcomponents, will create a significant margin expansion opportunity for Dana in the future. Sixth, Dana is a unique and compelling investment because we serve both the established OEMs transforming their businesses and the emerging OEMs are just getting started. Our e-propulsion systems are on a vast array of vehicles and, as a result, we are well positioned to capitalize on our broad base of new and existing customers. Seventh, we utilize our existing global footprint and asset base, established operating system, and deep industry know-how that most other competitors do not have and will require decades to build. We view this as a significant cost and strategic advantage for Dana. And finally, Dana's financial profile will remain robust throughout our electrification journey because our core ICE product will remain in demand through the transition, thus generating significant cash flow to the power EV growth. Our core business is not in a state of secular decline, but rather grows through the transition with assets that will remain largely relevant. The combination of these factors tells the story of how the ICE to EV transition is positioning us for above-market secular growth and demonstrating that Dana is a great investment within the EV growth landscape. Turning to slide seven, I'd like to share some evidence of how and where this is already happening. During our Capital Markets Day, we highlighted a significant number of electrification new business wins. As the saying goes, the scoreboard always tells the truth, and our electrification strategy is working. We're immensely thankful and proud that our customers across all mobility markets are choosing Dana as their electrification supply partner. Our EV solutions are being utilized by our off-highway customers in construction, underground mining, material handling, and even some green shoots in the agriculture applications. In commercial vehicle, it's not my accident that we've achieved a market-leading position as Dana's initial focus and commitment was to medium and heavy-duty trucks and buses. In the light vehicle market, We're extremely active, supporting full-frame electric truck OEMs with both rigid and independent e-axle concepts and potential solutions, leveraging not only our complete in-house e-propulsion capabilities, but also significant experience we have from markets that were early electrification adopters, such as buses, material handling, and last-mile delivery vehicle solutions. And while... We are on the topic of the light vehicle market. We also announced for the first time, in addition to significant battery and electrification cooling wins, a major new business win for our hydrogen fuel cell metallic bipolar plates. The combination of our past successes, present capabilities, application know-how, and clearly defined strategy for the future enables us to partner with and create value for our customers at any stage of their electrification progression, ultimately leading to us winning our share of nearly a $19 billion addressable market by the end of the decade. Thank you for your time today. Now I'd like to hand it over to Jonathan to walk you through our financials.

Thank you, Jim. Good morning, everyone. Please turn to slide nine for an overview of our third quarter results compared to the same period last year. In the third quarter of this year, sales were $2.2 billion, a $210 million increase over last year, primarily driven by improved demand in our heavy vehicle and markets and the recoveries of raw material cost inflation in the form of higher selling prices to our customers. Adjusted EBITDA was $210 million for a profit margin of 9.5%, which was 60 basis points lower than last year despite the higher sales, as margin compression from raw material cost inflation more than offset the margin expansion from organic sales growth. Diluted adjusted EPS was $0.41, a $0.04 improvement from the prior year. And finally, free cash flow this quarter was a use of $170 million, which was significantly lower than the third quarter of last year due to higher working capital requirements this year as recent customer schedule volatility and supply chain challenges have mandated higher inventory levels to ensure on-time delivery. I'll discuss this in more detail later in the presentation. Please turn with me now to slide 10 for a closer look at the drivers of the sales and profit change for the third quarter. The change in third-quarter sales in adjusted EBITDA compared to the same period last year is driven by the key factors shown here. First, the organic growth increase of over $100 million was driven by improved demand for heavy vehicles in both our commercial vehicle and off-highway equipment segments. The elevated incremental conversion of 40% was the result of targeted cost containment and cost recovery actions in the quarter, which helped offset operational inefficiencies brought on by volatile customer production schedules, supply chain disruptions, and labor shortages. Second, foreign currency translation increased sales by about 20 million as the dollar weakened against a basket of foreign currencies, principally the euro. As usual, this did not affect our profit margin. Finally, while we had expected commodity costs to level off in the second half of this year, unfortunately steel prices have continued to rise. During the quarter, gross commodity costs increased by more than $100 million compared to last year. We recovered nearly 70% of these cost increases in the form of higher selling prices to our customers. This remains lower than a steady state recovery ratio due to the timing lag caused by the continued rapid rise in commodity prices. Rising steel costs are entirely responsible for the margin compression during the quarter, despite higher production. Please turn with me to slide 11 for a closer look at how the adjusted EBITDA converted to cash flow. Free cash flow was a use in the quarter of $170 million. This use was driven by higher working capital requirements, specifically production inventory, resulting from volatile customer production schedules and instability in the global supply chain. A combination of unpredictable demand pattern for our products, longer lead times for raw materials, and the impact of slower-than-usual logistics channels have caused us to hold significantly more inventory than normal to ensure that we protect our customers across all end markets. Inventory levels increased by more than 100 million sequentially and more than 400 million versus the same time last year, as at the time, the industry was just ramping the supply chain back up coming out of the pandemic containment-related shutdowns in the second quarter of 2020. We expect our inventories will gradually retreat towards a more normalized level in the next few quarters, but the cash flow benefit won't be recognized until next year. I'll provide some additional information on this in just a few moments. Please turn with me now to slide 12 for a look at how the changing market conditions are affecting our full-year outlook in the form of our revised guidance for 2021. On our last two quarterly earnings calls, we outlined the key assumptions underpinning our full-year sales, profit, and cash flow guidance. Raw material costs were anticipated to plateau, the supply chain conditions were expected to improve modestly, and the chip famine was presumed to progressively abate. Unfortunately, none of these came to fruition, and as a result, our top and bottom line expectations for this year have declined, as you can see on the right of the page. We now anticipate full year sales to be $8.9 billion at the midpoint of our revised range, down about $100 million from the indication we provided during our Q2 earnings call, as lower than expected market demand of approximately $170 million will be partially offset by $70 million in additional commodity recoveries. Full-year adjusted EBITDA is now expected to be about $845 million at the midpoint of the revised range, which is down about $115 million from our previous indication. Lost contribution margin from lower end market demand and higher operating costs make up approximately $70 million of this profit headwind, and increased commodity costs will further lower profit by about $45 million. Profit margin is expected to be approximately 9.5%, and free cash flow margin is expected to be about 1%. Diluted adjusted EPS is expected to be $1.85 per share at the midpoint of the range. Please turn with me now to slide 13, where I will highlight the drivers of the full year expected sales and profit change from last year. First, organic growth is now expected to add nearly $1.4 billion in sales. Incremental margins are expected in the mid-20s, providing nearly 300 basis points of margin expansion. Second, as was announced yesterday, the agreement to acquire Modine's automotive liquid cooling business for $1 has been terminated as we were unable to reach agreement on revised terms that would gain the approval of the German regulator. As a result, there will be no significant impact from organic growth this year. However, this was never included in our full-year guidance. Third, we anticipate the impact of foreign currency translation to now be a benefit of approximately $150 million to sales and about $15 million to profit with no material impact to our profit margin. And finally, we now expect gross commodity cost increases to be about $350 million compared to last year as steel prices have continued to escalate. We anticipate recovering about $235 million or just below 70% of the increase from our customers in the form of higher selling prices, leaving a net profit impact of $115 million, which will compress margins by about 170 basis points. Please turn with me to slide 14 for a look at the second half profit margin implied in our revised full-year guidance and the key drivers of the trend through this year. Typically, profit margins in the first and second half of the year are relatively flat in our business, as sales and profit are higher in the middle of the year, the second and third quarters, and relatively lower in the beginning and end of the year, the first and fourth quarters, as a result of normal production seasonality. The quarterly sales and profit cadence of our revised full year guidance for 2021 is atypical, where we now expect second half margins to be about 200 basis points lower sequentially. A few anomalies are driving this year's trend, including, one, the continued volume deterioration associated with the chip shortage, and two, rapid commodity cost inflation. At a cursory view of the trend, the first anomaly is only visible by highlighting the second. Essentially, the increasing raw material cost recoveries included in our sales are masking the sequential volume deterioration, and both are having a profound adverse impact on profit and are amplified by the poor condition of the global supply chain. On the right of the page, you will note the expected sequential deterioration in fourth quarter profit on relatively flat sales. This is attributed not only to normal seasonality, but also to an episodic period cost related to the anticipated ratification of our collective bargaining agreements here in the U.S. It's important to note that as we move into next year, we continue to anticipate a plateau in commodity cost leading to an eventual decline, which will allow our recovery ratios to gravitate towards normal levels, ameliorating the commodity impact. And the period cost associated with the labor agreement ratification will not recur. Our full-year outlook for 2022, which we will provide at year-end earnings in a few months as we normally do, will take both of these sequential improvements into account. Please turn with me to slide 15 for more detail on how we expect this year's adjusted EBITDA will convert to cash flow. We now anticipate full-year free cash flow margin to be comparable with last year at about 1%, which represents a modest improvement of about $30 million as a quarter billion of higher profits are invested in working capital to navigate the current environment and higher capital spending to fuel our future growth. The downward revision compared to our prior expectation is attributed to the lower profit I just outlined on the last few pages, as well as the higher working capital requirements we experienced in the third quarter that will gravitate towards more normalized levels in the coming quarters as production schedules stabilize. It's worth noting we are pulling multiple working capital levers to mitigate the cash flow impact associated with the elevated inventory. Please turn with me now to page 16 for our perspective on the near-term challenges on the backdrop of the long-term outlook for our business. As Jim outlined at the outset of the call, the current mobility market dynamics are the most challenging they have been in over a decade, with robust demand for vehicles and equipment substantially constrained by the supply of materials, logistics, and people, which has led to dramatic cost inflation and substantial profit and cash flow margin compression. These are all represented by the icons on the left of the page. As we look to the future, we want to remind all of our stakeholders that as challenging as the current environment is, these forces position Dana for the most robust and dramatic cyclical recovery this business has seen in quite some time. This is illustrated by the chart in the upper right of the page where we affirm our conviction that our business will exceed $10 billion of sales in 2023, and this represents 45% growth over three years and will lead to substantial profit and cash flow margin expansion as we progress towards our long-term financial potential. But the cyclical recovery in our business is only a piece of our growth story. As we outlined at our Capital Markets Day last month, we're poised to substantially outpace the market growth rate as we capitalize on the secular growth trend that vehicle electrification represents for Dana. We expect the sales of our electrified products to double in the next two years, contributing to the greater than $10 billion of sales in 2023, but then quadruple by the end of the decade to deliver a $3 billion business that will expand our profit and cash flow margins and reposition the business for the future. This bright future is made possible by the highly skilled and extremely dedicated team of more than 38,000 around the globe who day in and day out embody the spirit of our company, people finding a better way. I'd like to thank all of you for listening in this morning, and I'm now going to turn the call back over to Holly so that we can take your questions.

Thank you. And as a reminder, if you would like to ask a question, please press star, then 1 on your telephone keypad. Once again, that's star 1 for questions. Our first question will come from the line of Dan Levy with Credit Suisse.

Hi. Good morning. Thank you. I wanted to just start on, I guess, a more near-term item. Could you just remind us, first of all, of what your exposure is to, you know, magnesium and how this plays out with aluminum? I think most of your aluminum exposure is in power technologies. How much of a risk is this for you? Maybe you could just frame that for us, please. Yeah, magnesium for us is negligible, Dan. So most of our commodity impact is on specialty steels like SBQ or special bar grade quality steel that's used in a lot of our driveline components. And to the extent there is an aluminum shortage, is that that doesn't impact power technologies? Yeah, I mean, we have an aluminum impact as well as nickel within power technologies, but in the overall impact for Dana, nickel is typically relatively small. Okay, great. And then second, I'd like to just revisit the dynamic with your customers, and especially on the light vehicle side. Obviously, you're facing these very sharp supply chain challenges, and we see that in the margins, but your customer is are putting up pretty solid margins. They've had the benefit of raising prices to end customers. But at the same time, they also need to invest a lot more to make the EV transition possible. So maybe you could just give us a sense of the tone and tenor of the commercial discussions with your customers. Is there any ability to recover any of these headwinds beyond what's in your contracts? Or is that a tough ask given the challenge ahead for your customers on EV? And maybe you could just also talk to within that the commodity recovery mechanism, because I know for the year it's below 70%, but I think, if I'm not mistaken, historically it's been like 75%. So maybe you could just talk about the tone and tenor of the commercial discussions with your customers. Yeah, Dan, it's Jonathan. Maybe I'll just touch on that last piece, and then Jim can highlight the market dynamic or the commercial dynamics. But as it relates to the recovery ratio, Normally, we can recover three-quarters or better on a steady-state basis, but what we're still seeing this year is we've seen rapid rises each quarter, so there's still a lag on the recovery compared to what we're paying to our suppliers. So I tried to comment on the fact that once these plateau, we would expect our recovery ratios to gravitate towards the mid-upper 70s and maybe even around 80%. once that plateaus. And then if they come down, obviously there'll be a period where we'll see a benefit in over-recovery. But the less than 70% recovery ratio on a full-year basis is just due to the lag as we've had rapid increases each quarter.

I think I also would add to that, Dan, is relative to the process and tone with customers, there's been, at least in my experience, doing way too long, but there's a lot more flexibility recognized and there's a lot of other input costs Even in the commodities, I'm not here to make a statement relative to, you know, how that's going to play out and exactly what that's going to be. But they certainly have great appreciation across dollar end markets that there's inflation in all sorts of areas besides commodity costs. So we're working through that with them.

Great. Thank you.

Thanks, Tim.

Our next question is going to come from the line of Noah Kay with Oppenheimer.

Thanks. Good morning. Can you touch on the management of your own supply chain? You know, where have all of you experienced, you know, component shortages, anything impacting your EV programs in particular around power electronics or, you know, other components? I guess, you know, are there any pain points there to be aware of that are causing some margin compression or production delays? Or is it really still just the commodities or materials?

I'll take the first part of that first. Is there any, like, one specific area of component constraint for us, if I understood your question correctly, and in particular you highlighted our, you know, our electrodynamic side of the business? I would say no. There's challenges almost in everything, but it's not like you can't work through it. So we're working through those on a case-by-case basis across the various end markets. So that's probably the best way I can say it. There's not, like, that one component. silver bullet if, you know, like maybe the OEMs are dealing with the semiconductor type issue. We don't have the same thing in our, you know, in our product lineup at this point.

Okay, great. And to follow up specifically on the EV programs, you know, I believe a number of them were reaching or had entered SOP and so would be wrapping in the back half of the year. Just curious how you're seeing the demand for those programs play out relative to expectations and whether there's been any kind of supply constraint gating factor and the volumes on that side as well.

Yeah, demand for electrified products is actually very strong. So the ramp-up of those programs, broadly speaking, is consistent with what we most recently expected. Certainly, you know, the chip shortage impacts those as well, but for us they're relatively small volumes compared to the overall, and we're broadly able to secure what we need for those programs. So, you know, generally speaking, it's in line with what we had expected.

Great. That's very helpful. Thank you.

Sure. Thanks, Noah.

Our next question will come from the line of Emmanuel Rosner with Deutsche Bank.

Thank you so much. Good morning. Good morning, Emmanuel. I was hoping to try and put a final point on the factors behind your change in outlook. And in particular, curious what – sorry, to your capital market, say, which was just a month ago and also – pretty much towards the last day of the third quarter. At that time, I think you were still thinking EBITDA margins maybe around, you know, 10.5, nice for everybody, but, you know, a full point lower, which is basically two points lower on the second half. What have you sort of seen over the past sort of like 30 days or so, which, you know, has caused this change in outlook? What are the bigger factors there?

Yeah, I would say the primary factor is the change in our customers' production schedules. So we now have a pretty decent line of sight through the end of the year, what our customers are thinking. There's been additional downtime in all of our end markets. in the fourth quarter compared to what we expected. So that's driving the almost $200 million of lost sales compared to our previous expectation. We knew commodities are going to be up a little, but now that we've seen where September landed and have better line of sight into October, commodities are going to be higher as well too. So it's really a combination of what's happened to our customers' production schedules within the last month and also the most recent outlook in commodities is really driving that additional increase sales decline, and the profit deterioration despite the higher recoveries on the commodities.

Okay, that's helpful. And then if I can just hone in on the demand piece of the equation, can you describe current condition and the visibility as you see it? I guess, which specific end market of yours are playing out maybe a bit weaker than you thought? A month ago, and if you can also comment sequentially, are you seeing sort of like light at the end of the tunnel, especially on the light vehicle side? At least sequentially, are things improving, or is it still just as volatile as it was last quarter?

Yeah, to the second point, unfortunately, the fourth quarter looks a little bit worse than the third quarter from a volume basis. That's why we included that chart on page 14 just to highlight that those additional commodity recoveries that we are getting are masking the fact that volume on a constant commodity basis or units is coming down. So unfortunately, we don't see any relief here on volume between now and the end of the year. And then to your point on which end market, unfortunately, the chip shortage is affecting all end markets now. We're seeing a greater impact in the heavy vehicle markets than we were in the first half of the year. But the volatility is a bit higher on the light vehicle side, as you noted. So I would say that our expectations across all three are lower than what we had anticipated. It's primarily due to the chip shortage, and I think that we're likely to be into next year before we start to see any improvement in the daily run rate as a result of better access to chips. At least that's our best outlook as we sit here in October.

Yeah, that's really helpful. So would you say all of your segments would likely show sequential revenue deterioration in the fourth quarter?

Yeah, heavy vehicle markets will probably be pretty close. Light vehicle will be a bit lower, but it's going to be pretty close, as you can see from the sales dollars. We're generally expecting volumes to be down just a little, probably led by the light vehicle.

Understood. Thanks for all that.

Yep, thanks, Emmanuel.

And our next question is going to come from the line of Aileen Smith with Bank of America.

Good morning, guys. You cited the year-over-year margin compression in the quarter as being entirely attributable to rising commodity costs. I'm a little bit surprised given the stop-and-go production environment in the quarter and what should be operating the leverage off the back of that, especially with some of the major automakers that were forced to take downtime on large body-on-frame trucks in the quarter. Is the implication here that you were able to completely offset those pressures, or is there an element of mix between your segments going on where operating deleverage perhaps in the light vehicle business has been offset by leverage in the heavy vehicle markets?

Yeah, it's a little bit of both. The last point you make is accurate. So if you look on a year-over-year basis, you'll remember we were still in a pretty rough spot from a volume standpoint in the heavy vehicle markets, and those have improved. So that operating leverage is helping to offset that. We also worked in a number of other ways to manage cost as much as possible, but I would say that the resurgence on a year-over-year basis of the heavy vehicle markets and the mix associated with that has been a little bit of wind in our sails to help mitigate some of the impact associated with the significant inefficiencies associated with the supply chain.

Okay. And then a question on the top-line outlook for the fourth quarter to be sequentially flat with the third quarter. Is that consistent across each of your segments, or are there certain end markets with a different trajectory? And specifically, when we look at light vehicle production schedules, I think the sequential outlook makes some sense, but just curious if this holds for the heavy vehicle markets as well.

Yeah, if you adjust for the fact that we're going to have more recoveries of commodities in the fourth quarter than we did in the third, unit volumes are going to be down from Q3 to Q4. It's going to be led by the light vehicle space. We think light vehicle is going to be softer in Q4 than in Q3. The heavy vehicle markets are going to be relatively flat, maybe down slightly in the aggregate, but a sequential deterioration is going to be led by the light vehicle segments.

Okay. And then one last higher-level question for Jim, perhaps. Obviously, you've done about as well as could be expected in managing through the production volatility recently. As we think about visibility into next year, can you talk a bit about the planning process that you're implementing, if at all? And this isn't so much a question on any formal outlook for 2022, but more an operational question of how you come up with a game plan for with your team and communicate things like if volumes were to be flat from current levels, here's where we would look to take cost out, or if the volume environment were to recover meaningfully, here's how we would manage it and plan for it if the production schedules are still being revised week to week to week.

Thank you, Eileen. That was a kind comment and a really good question. You know, I don't know how to answer it exactly other than to say this, is that at least in my career, you know, the V-shaped recovery, we call it starting last July, to the significant drop-offs in some production this year, have put more flexibility built into our operating system. Let's start at the operating system and our ability to basically look forward to the forecasts and the releases, as we call it in this business, and be able to do better and more nimble operations. labor management, more capacity management, spreading our capital in different plants around the world to be able to support. When one goes way up, it's not necessarily that we're going to just support that out of one plant because we'll have common products and common capital that has been validated around the world. So we've built in a lot of flexibility almost by default going through what we've gone through, all of us out there in manufacturing, by the way, over the last 18 months since we turned the spigot back on. So I would just say it's all built in, and I would just call you, and if it comes back to leadership, it's just a lot more dynamic of team members sitting together. and looking at indicators earlier and reacting to them quicker. So that's a lot of words to just say. I think we're not really into that. We probably have never flexed costs faster and flexed output faster than we have in the last 18 months. We're just going to continue to do that throughout the course of next year.

Great. That's a very helpful commentary. Thanks for taking the question.

Thanks, Aileen.

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

Good morning, and thanks for the update. You know, as we think of the off-highway business, especially in light of the comments about the planning process that you gave, it's a bit of a black box to model outside in compared to the production schedules we can get feel for in light vehicle and in trucking. So can you give us your sense, I was struck by the slide about construction equipment at Lowe's, of how that's going to progress and then whether those very strong incrementals we were seeing there could continue into 22.

Sure. Thanks for the question, Brian. It's Jonathan. As we look into next year, the indication from our off-highway customers on both the construction and the mining segments is that there is an intention to ramp up production. So we are preparing for that increase in their ability to secure the supply and address not only material shortages but labor shortages to get these equipment built. So what we were trying to highlight there on that chart, as you noted, is The fundamentals are there. The customers are indicated that we're going to need to fill higher demand. And as we've indicated before, obviously off-highway is our most profitable segment, but within off-highway, those two segments lead from a contribution margin standpoint. So that is something, as we think about the sales growth and margin progression that we expect over the next couple of years, that's going to be a meaningful contributor, not only to the top line, but also to the bottom line. So we're looking forward to that. And that is indeed something that we think is going to be a part of the recovery story here and the cyclical upswing that we highlighted in the slides.

Okay. And just to follow up in a different segment. So PowerTech, you highlighted the win with a new entrant on the cooling plates. Can you give us a sense of the pipeline for PowerTech and electrification and Have there been any other advancements since the capital markets day in that segment?

Good morning, Brian. This is Jim. Thanks for your participation and questions, as always. You know, just to maybe give an update for the full audience in case they weren't at our investor day. But, you know, we announced just last month ago or whatever it was that we're going to be on the Ford Lightning for the battery cooling, maybe as Brian was referring to, as well as major GM programs. And then as I announced or mentioned earlier in my prepared remarks, the hydrogen fuel cell plate is one of our more significant wins. At least it seems as though the commercial vehicle markets are going to head in that direction to some degree. So I can't give you a new update on any new awards. All I can tell you is that when you think about the marquee programs that we're referring to with General Motors or Ford, as well as what I just talked about on the hydrogen fuel cell, that we have a very strong chase list, and we expect to continue to deliver on it because our technology has been built under the foundation of two key things in power tech. For those of you that may not be familiar with it, power technologies group is a combination of ceiling technology, as well as thermal, and to have world-class battery cooling, electronics cooling, and for that matter, hydrogen fuel cell bipolar plate technology, it requires all those type of capabilities to come together, and that's what we're doing. So thank you very much for the question. Okay, thanks.

Thanks, Brian. Our next question will come from the line of Rod Lash with Wolf Research.

Good morning, everybody. We're hoping you can maybe just Give us a little bit of color on the – if commodities were to stay at spot levels, how we should be thinking about the recovery into next year, just extrapolating from the typical lag that you see.

Sure. So there would clearly be a gross commodity cost increase. If they were to stay exactly flat through next year, there would be a gross increase, the carryover impact of largely the first half of next year being higher than the first half of this year. But we would expect the commodity ratios to catch up to the mid-upper 70s, approaching 80%. So that's generally what we would anticipate. We certainly think that's a more likely scenario in the first half of the year. But as we look into next year, and I mentioned in the comments, we think it's likely that we start to see some tapering of those most third-party sources that are prognosticating there would project steel to start to fall through next year. But to your point, we would see a carryover impact if they were flat, but the recovery ratios would be close to that 80%.

And just to clarify that the – the gross impact that we're seeing in kind of the back half, that's how we should be thinking about the first half, and then just your recovery would take up closer to 80%. Is that what you're saying? You got it. Yep. Yeah, okay. And you mentioned labor shortages a couple times, and you have this new collective bargaining agreement. Can you just maybe at a high level give us some thoughts on how you're expecting that to affect – outlook for next year?

Well, thank you for the question, Rod. This is Jim. Good morning. I think you know this, but Dana's had a rich history and strong relations, particularly in North America, with our our organized labor partners. And so we feel very comfortable that we will continue that relationship moving forward. But it has to do with organized labor and labor contracts and all to do with market dynamics and that we can all see around the world and more specifically just driving down the street. You know, there's going to be some labor cost inflation across the board that we're going to deal with. But In the bigger picture of things, it's in the law of smaller numbers. It obviously doesn't come close to the impact that we're dealing with on the commodity cost and sea container cost and all that stuff. So we'll continue to navigate through that no different than we always have. Great. That makes sense. Thank you.

Thanks, Rod.

Our next question will come from the line of Colin Langan with Wells Fargo.

Oh, thanks for taking my question. Slide 14 is very helpful, but just looking at it, I guess I'm just trying to understand. Sales sequentially look fairly flat. The recovery looked pretty similar from Q3 to Q4. So is it really just only seasonality? I mean, because even if I take out the labor cost, it seems like it'd still be down. Is that really the only other driver causing the weakness from Q3 to Q4? And I guess there's an inordinate focus of the sequential right now, given all the volatility. I mean, what would also... Other than seasonality, is there any other factor and what does drive that seasonal weakness sequentially?

Yeah, those are really the biggest drivers. So what we were trying to illustrate is the fact that, and maybe it didn't come across as well as I had hoped on fourth quarter, but we do expect top-line recoveries to increase sequentially, which means that the constant commodity sales are actually going to be coming down slightly. In this environment, the contribution margin loss on decreased sales is pretty high. Our ability to flex costs in this environment is pretty challenging due to the labor shortage and other issues. We just continue to carry those. So You know, in this environment with the normal number of work days, we think of that as largely seasonality sequentially. And then, obviously, we try to call out the impact of the component of the labor agreement that's going to be a period cost, which is the other driver. But those are really the largest and most significant ones from Q3 to Q4.

Got it. And when you talk about being fairly flat sequentially, I kind of recall, I think IHS has it still up, even though they took it down. Is that Is that Dana-specific, or do you think that sequentially for the overall market is too optimistic to gauge that?

Yeah, I think our perspective right now is pretty acute to us. We're very focused on the platforms that we're supplying and the segments that we focus in on the heavy vehicle market. So I would say that's our view. We haven't really reconciled it to the latest broader market view for IHS, but I would say our perspective is we're likely to be a bit lighter on the light vehicle side and maybe just a touch softer on the heavy vehicle side from Q3 to Q4. So it may be a very specific way for us looking at it in the short term and the build patterns that we're seeing from the customers on our platforms.

Okay. All right. Thanks for the clarification.

Yep. Thanks, Collin.

Our next question will come from the line of Ryan Brinkman with JP Morgan.

Thanks for taking my questions. I wanted to start by digging a little deeper on the comment in the release about supply chain constraints impacting the entire global mobility industry, not just the light vehicle industry. So obviously we know about the semiconductor chip shortage impacting light vehicle production, but can you sort of walk us through what are the main supply chain issues by your other end markets? Are they also more impacted by the semi-shortage, or are semis the minority of the issues impacting the other end markets? And And then you were asked on magnesium, you know, maybe after another supplier reported difficulty in even finding it almost regardless of the price. So, you know, in the end, they were able to source it, but there was some concern for a while. And therefore, I thought to ask, too, if you are experiencing or seeing any emerging signs of actual commodity shortages, which could impact the top line, not just inflation, which can impact margin.

Good morning, Ryan. This is Jim. Thanks for the question. You're going to make me earn my pay today. That was a lot. So let me take them in pieces. Let's start with magnesium and other commodities. Like Jonathan, I think, answered the question a little bit earlier. It's not an impact item for us, or if it is, it's immaterial. So we're not seeing that. We are aware of it in communications with our customers, et cetera, that it's a challenge out there. We don't have anything in our line of sight that gives us a reason to believe that we have other raw material risks, but we'll keep you guys informed if anything of substance comes through. To your second question, I'm kind of working through them backwards here on purpose, is on the semiconductor impacts. I think as Jonathan implied, we still get a bit of a roller coaster on the light vehicle side that you're very close to. I don't need to tell you that. Commercial vehicle was more of a challenge in the last quarter than the first half of the year in that. I'm not going to predict exactly how that's going to work out and go forward, but that's just the case as it relates to Q3. Less, certainly, on the off-highway side of the business. There's some on that, but not as big of an issue there. specific to your first question. It was about, you know, what type of constraints are we seeing as it relates to our supply chain, I think was how you posed the question. I'll give you some examples. This is the easiest way to do it. So besides just the obvious things that we deal with on labor and what everybody else is dealing with, we can't forget, like, for example, the natural disasters that we dealt with, that we have supply chains that are coming out of Germany and the floods of kind of the middle areas of Germany, or we're aware of, obviously, we're all aware of the China power Let's shut down manufacturing scenarios that have gone over there, and you have to navigate around maybe only having three-fourths of a month to be able to get your supply built and produced for not only the domestic markets, but if you happen to use China for some of your international supply. So those are the type of things where, and again, I'm not here to look for sympathy. I mean, we're all dealing with it, but we're overcoming it in all of those examples, but there are plenty of them out there.

Okay, that's helpful. Thank you. And then just last question for me is we've been hearing from multiple suppliers that in their ordinary course commercial negotiations with customers that in addition to the usual topic of being compensated for higher raw material expense, et cetera, that these suppliers may also seek to recover costs associated with the magnitude and frequency of last-minute order cancellations. And I think this is something which automakers have historically not compensated suppliers for, particularly if it's because of reasons outside of their own control. Given that automakers are enjoying a substantial offset to the impact of lower volume on their profits in the form of higher vehicle pricing, I think that's led some suppliers to try. So how are you thinking about the potential for any volume-related recoveries?

I would answer the question this way. Whoever this is, those other suppliers are communicating that it's a real issue. They're absolutely right. They're not exaggerating. It is painful. The day is long. But it's the business, right? I mean, it's not like the OEMs are out there saying, you know, I think I'll just get up this morning and not run. They'd love to make vehicles if they had the product to do it. So it is a real issue. I can't really answer the question, and I really don't want to answer the question specifically to what the individual negotiations are. But I did, as I alluded to earlier in a question when I answered it, was that we're having different conversations with the customers now in a more holistic way. overall recovery mode than just pure commodities. You know, we're talking about the whole landscape because it's just a different world out there as it relates to all the things we've talked about, sea container delays and sea container cost and obviously labor inflation and the other things. So in just sporadic schedules, it certainly falls into the bucket of all those other things that we're talking to the customers about. Very helpful. Thank you.

And our last question for the day will come from the line of Joseph Spack with RBC Capital Markets.

Thanks. Good morning, everyone. Just going back to the CBA, was that always considered in guidance? And just to make sure, that's like the one-time ratification cost, right? So how should we think about the labor union contract going into 2022? Yeah.

The answer is yes. It's the upfront associated cost with the ratification, and we're calling it out now because it's ended up being considerably higher than what we had originally expected in this environment. So that's the primary driver.

Okay. So you considered something before, but this is higher. It ended up being higher. Okay. And can you quantify that or –

No, I would say that it's just considerably higher than what we would have normally experienced and even what we would have expected a couple of months ago.

Okay. And then just a clarification, and sorry if I missed this one. In the quarter in power technologies, negative organic sales but then positive organic EBITDA contribution, how do we square that?

Yeah, just that's the nature of a recovery that they were able to execute during the quarter that helped to drive better margins in the quarter.

Okay. And then last one for me, just on Modine. So it sounds like, you know, you couldn't come to – or both sides, I guess, couldn't come to something that was amenable, you know, given whatever the regulators were asking for. You know, I know this might have been sort of a unique situation given, you know, the purchase price and we're sort of just assuming some – some liabilities, but, you know, how should we think about, you know, clearly you saw some value, I guess, in adding the product. So is this now something you'd look to go after and build more organically? Are there other acquisitions out there?

Yeah, hey, Joe, this is Jonathan. I'm sorry, you're breaking up. I wasn't able to make out anything you said. I apologize. We may have to follow up with you afterwards. We got a bad connection.

Okay. Can you hear me now?

I'm not sure if you can still hear us. Apologies for the confusion. But, yeah, we'll follow up with you. Okay. Okay. Thanks.

Thank you. I'll turn the conference call back over to management for closing comments.

Okay. Sorry for the very last question there in terms of technical difficulties. Who knows? Given today's world, who knows what that could be. But anyway, with that, thank you very much for your participation today. The most important thing I would say is to take away from the discussion. Like I said a moment ago, there's no crying in baseball. We're not looking for sympathy. It is a challenging market out there, but if you have a cohesive team with a strong operating system, strong leadership, and committed people, you'll get through anything, I believe. And we're getting through it just like everybody else is, very proud of the team. We're not only building on our very strong internal combustion engine business, but truly building. being ahead of the disruption in electrification and sustainability, and making sure that our customers have the products and systems they need to be successful in the future. So hopefully that was your takeaway from the quarter. Thank you very much for your participation.

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