DANA Inc Q3 FY2022 Earnings Call

Good morning, and welcome to Dana Incorporated's Third Quarter Financial Webcast and Conference Call. My name is Lisa, and I will be your conference facilitator. Please be advised that your meeting today, both the speakers’ remarks and Q&A session will be recorded for replay purposes. There will be a question-and-answer period after the speakers’ remarks and we will take questions from the telephone only. To ensure that everyone has an opportunity to participate in today's Q&A, we ask that the 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, Lisa, and good morning everyone. Thank you for joining us today for our third quarter 2022 earnings call. You will find this morning's press release and presentation 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 is summarized in our Safe Harbor statement found in our public filings, including our reports with the SEC. On the call this morning are Jim Kamsickas, Chairman and Chief Executive Officer; and Timothy Kraus, Senior Vice President and Chief Financial Officer. It's my pleasure to turn the call over to Jim.

Good morning and thank you for joining us today. Moving to Slide 4 and our update for the third quarter, Dana had another quarter of strong sales totaling $2.5 billion, a $330 million increase over last year driven by continued robust customer demand in all of our end markets. While our strong customer requirements, Dana's new business backlog, and cost recoveries fueled sales growth in the third quarter, our input costs continue to increase due to global inflation. Additionally, volatile customer demand schedule fluctuations continue to create a challenging environment across the entire mobility industry, pressuring profit margins. Where possible, we're taking actions across the company to mitigate the impact on our profitability, positioning us for a strong rebound once the environment stabilizes. Adjusted EBITDA for the quarter was $192 million, down slightly from last year, but up $30 million sequentially. We generated a strong free cash flow of $77 million, an increase of $247 million over the prior period driven by lower working capital requirements as we manage through the choppy demand environment. Lastly, adjusted earnings per share for the quarter were $0.24. Some of the key areas we will discuss today include an update on critical market drivers for our business, exciting information regarding Dana receiving our eighth Automotive News PACE Award this year for the complete integration of e-propulsion and e-power systems in electric vehicles and an announcement that we have been sourced for the next generation of the Jeep Wrangler and Gladiator programs. Please turn to Page 5 for an update on prevailing market conditions. External market factors continue to dominate the discussion across all of our mobility markets. Many of our OEM customers are still experiencing issues in their broader supply chain, which, although somewhat improving, are impacting our ability to run operations efficiently. This is primarily an issue in our light vehicle markets but we are seeing it to a varying degree across all markets. Rapidly fluctuating demand is generating higher costs for us in the form of unplanned downtime, line changeover costs, expedited freight, trapped labor, and higher inventory. As we look forward to the remainder of this year, we see some improvement compared to the third quarter. However, operational demand volatility will likely remain a headwind into early next year. The greatest impact we have faced this year has come from external forces, notably cost inflation, currency translation, and commodity costs. In the third quarter, we saw higher prices for operating costs such as energy, labor, and fuel that are used to transport goods. Gross inflation was higher in the third quarter and we expect continued headwinds in the fourth quarter. This outlook is in line with our current financial guidance. As we bear the burden of inflation and other cost increases, we've been in constant discussions with our customers regarding cost recoveries. We have achieved some positive developments in recovering these costs and we will continue to pursue an equitable position. Additionally, we are facing macro headwinds from currency translation as the U.S. dollar has continued to strengthen against a basket of foreign currencies, notably the Euro. These currency movements are linked to global inflation and geopolitical conflicts and will not ease any time soon. The lone bright spot is that commodity costs, primarily steel, have come down somewhat from the record highs we saw in the first half of the year. We continue to have significant success in recovering commodity cost increases from prior periods. Combined with falling input prices, these recoveries are generating a slight profit benefit this year and should continue early next year before leveling out. Vehicle inventories remain at historically low levels in all of our end markets, while demand for key vehicle platforms remains strong. OEM fulfillment of the pent-up demand will likely take some time as customers continue to improve their production rates. In Dana’s case, we look forward to new vehicle launches such as the highly anticipated Ford Super Duty, which was recently unveiled at Churchill Downs in Louisville, Kentucky. The market for heavy vehicles remains resilient with OEMs reporting strong order books leading into next year. For instance, in the North American Class 8 market, demand has outpaced supply this year and orders for new trucks appear strong. The combination of low inventory and pent-up demand could provide a buffer against any short-term demand weakness next year. Turning to Slide 6, I'll walk you through why Dana was selected for one of our industry's most prestigious honors. We are pleased to share that Dana was recently honored with a PACE Award for the integration of e-Propulsion and e-Power systems. This year's award was our eighth win and is unique, showcasing capabilities that only Dana provides to the marketplace. Previously, Dana was honored as a PACE winner for specific product innovations or technologies. This time Dana was recognized for its ability to integrate our complete package of e-Propulsion and e-Power systems into electric vehicles, highlighting how we support our customers throughout the entire process of bringing an electric vehicle to market. This illustrates the shift to electrification taking place in the mobility market and is significantly different from the traditional supplier OEM business model that has evolved over the last century. Six years ago, we identified electrification as a megatrend, leading to our strategy to establish the product portfolio and capabilities to support customers across all mobility markets. We remain committed to leading in electric propulsion, developing a deep understanding of electric vehicle engineering and e-propulsion systems, delivering a foundation of in-house designed, engineered, and manufactured electrodynamic products and systems. Our goal is to create value for our customers, providing a complete portfolio of EV components that we combine and integrate into OEM platforms, enabling them to enter the electric vehicle market quickly and cost-effectively. When considering e-propulsion and e-power, one thinks of components such as gear boxes, motors, converters, software, and battery cold plates. Dana has taken a leading position in the natural evolution of EV by leveraging our vertical in-house assets and expertise to develop complete four-in-one e-propulsion and e-power systems, including thermal management products. In fact, we are the only supplier capable of delivering all elements of a complete, fully integrated electrified system across all mobility markets. The differentiator is our ability to move past just developing and manufacturing components and systems; we help our customers design vehicles and develop and integrate a complete customized e-propulsion and e-power system. With a global network of suppliers, market expertise, and EV technical centers, we leverage our capabilities across all markets, whether it’s light vehicles, delivery vehicles, mining or electric access equipment, or Class 8 long-haul trucks. We assist customers in determining how these systems are best integrated into fully electric vehicles, regardless of application. Our customers across markets count on us to help them reach their EV goals, relying on our strong institutional knowledge in the EV space to provide them with full turnkey solutions. Please turn with me to Slide 7. The proof points of our ability to serve customers across all levels and markets is making a direct and significant impact as we deliver the next generation of electric vehicles. To date, we are providing world-class and award-winning components and systems to leading manufacturers across light vehicle, commercial vehicle, and off-highway markets. Alongside our vehicle integration capabilities, Dana has multiple electric vehicle platforms in production with many more under development. We’re also in the process of securing several confidential new programs that we will disclose early next year, catering to established global OEMs as well as non-traditional manufacturers who may prefer an off-the-shelf solution from Dana's established electrodynamic products. This allows us to provide capabilities and solutions that create value for our customers for decades to come. Please turn with me to Slide 8, where I will announce exciting news about a foundational program for Dana. Although the mobility industry is rapidly moving towards electrification, internal combustion engine vehicles remain prominent depending on end market and application. Some OEMs have communicated to the media their intent not to electrify large pull-frame vehicles in the near term. While we've discussed how Dana is helping customers transition to electrification, we have also shared that our sales backlog maintains a balance of traditional ICE and EV programs. I am pleased to announce that we’ve been sourced for the next generation Jeep Wrangler and Gladiator programs beginning with the model year 2024. This program will remain one of Dana’s largest, launching next year and featuring our award-winning driveline, including axles and drive shafts, allowing Jeep enthusiasts to handle extreme off-road conditions. Dana has provided high-quality driveline and aftermarket products for the Jeep brand since its inception 81 years ago. The Jeep concept was born in response to the U.S. Army's call for a transportable 4x4 vehicle during World War II. Many historians recognize the Bantam general-purpose vehicle as the original inspiration for the Jeep. Dana's original products for the Jeep enabled owners to tackle extreme conditions, on or off-road. Thank you for your time today. Now, I’d like to hand it over to Tim for a financial update. Please go ahead, Tim.

Thank you, Jim. Please turn to Slide 10 for our third quarter results compared to last year. Sales were $2.54 billion, $331 million higher than last year’s third quarter, driven by strong demand across all of our end markets and the recovery of commodity and inflationary costs, partially offset by currency impacts. Adjusted EBITDA was $192 million, 18 million lower than the same period last year. Margin was 7.6% in the quarter, 190 basis points lower than last year. This margin compression was due to higher sales being offset by inflationary costs, including labor, energy, transportation, and raw materials, as well as operational inefficiencies from volatile demand patterns. Net income attributable to Dana was a loss of $88 million in this year’s third quarter compared to an income of $48 million last year. The loss stemmed from a non-cash goodwill impairment charge in our Commercial Vehicle segment triggered by higher discount rates and sustained cost pressures. We generated $77 million in free cash flow this third quarter, compared to the use of $170 million in the third quarter of last year. This higher free cash flow was driven by improved working capital management. Please turn with me now to Slide 11 for a closer look at sales and profit change drivers for the third quarter. Traditional organic sales growth driven by higher demand and inflationary cost recoveries contributed $263 million. Adjusted EBITDA on the increased organic sales was a loss of $19 million, primarily due to net cost inflation and operational inefficiencies caused by volatility in customer's production schedules. Sequentially, profit improved over the second quarter of 2022 due to increased cost recoveries partially offsetting higher gross inflationary costs. EV product sales increased $73 million over last year's third quarter, however, engineering investment for new technologies and cost inflation drove a $4 million loss this quarter. Foreign currency impacts reduced sales by $139 million, lowering profit by $16 million. The recovery of commodity costs added $134 million in sales and a net profit benefit of $21 million. On a gross basis, we still experience higher input costs, primarily steel, but material costs are declining from earlier peaks. Our recovery rate has ticked above 100%. Please turn to Slide 12 for details on our third quarter free cash flow. We generated $77 million in free cash flow this quarter, significantly higher than last year due to active working capital management. Net interest was $20 million higher this quarter due to timing of payments from debt refinancing actions taken last year. Taxes were also impacted by a $20 million increase due to the jurisdictional mix of earnings and payment timings. Working capital was a source of $55 million of free cash flow, amounting to a $300 million improvement over last year. We remain on track to meet our target range as our business typically generates most free cash flow in the fourth quarter. Moving on to Slide 13 for our full-year outlook, which remains unchanged. We reaffirm our full-year guidance, anticipating $10.1 billion in sales at the midpoint. Adjusted EBITDA is expected to be about $720 million, with a margin between 7% and 7.3%. Free cash flow margin is expected to range from 1.8% to 2.2% of sales, with diluted adjusted EPS projected at $0.75. Slide 14 outlines the expected sales and profit changes for the full year compared to last year. We estimate an additional $900 million in sales from traditional products through new business, market growth, and recoveries, about $20 million higher than our prior estimate. Adjusted EBITDA on traditional organic growth is now expected to be a loss of about $30 million, with higher inflationary costs totaling about $125 million net of recoveries, $20 million lower than previously estimated. As commodity prices fall, inventory levels decrease, and thereby inventory valuations will normalize. We expect $270 million in added EV product sales this year, approximately $40 million higher than our previous estimate, with a slight uptick in investment required to support this new business. Our expected EV adjusted EBITDA will reflect a loss of about $10 million. We now foresee a greater headwind from foreign currency translation, affecting sales by about $470 million, with a profit impact of roughly $55 million. Commodity outlook has stabilized, and we foresee recovering about $455 million from our customers due to higher pricing. Lastly, our full-year free cash flow outlook remains unchanged at about $200 million at the midpoint of our guidance range, improving by over $400 million compared to last year. The improvement is driven by lower working capital requirements and better alignment of customer and supplier terms with market conditions. Thank you all very much for your attention today. I will now turn the call back over to Lisa for your questions.

Thank you. We’ll take our first question from Noah Kaye with Oppenheimer.

Good morning. Thanks for taking the questions. Nice to see a slight benefit from pricing. How much of an impact to growth would pricing have as we consider 2023? There's clearly some tailwind into next year from that.

Yes, thanks, Noah, this is Tim. There will certainly be some growth into next year. We anticipate that some of the inflationary costs we've seen this year will persist. Additionally, the turnover and re-launch of some of our programs will be reflected in pricing as well.

Great, and can you comment on any slippage in expected program dates and your confidence in standing up those launches smoothly at this stage?

Good morning. It's much more challenging to launch now than it historically would have been due to difficulties in obtaining components and the constraints on equipment suppliers. However, I can tell you that we are currently poised for our major launches without any slippage that we foresee at this point in time.

That’s excellent. Lastly, what are you hearing about the rate of quoting activity and adoption trends in off-highway, and can you comment on your positioning there?

Dana took a strategy in 2016 to prepare for various pull-through markets. We're noticing a rapid adoption of electric vehicles in off-highway markets, especially in applications like area work platforms. Our team has done a remarkable job executing in this area, and we're in dialogue with various customers. Any curve you've seen in the electrification process over the last five years has likely been pulled forward.

That’s very helpful, and I appreciate the quieter lawn mower equipment. Thank you and nice quarter.

Thank you.

Thanks.

We’ll take our next question from Colin Langan with Wells Fargo.

Thanks for taking my question. To follow up on the decline in inflationary costs, broadly, what are the offsets that account for this good news? Is there much of a headwind left for Q4?

On your first question, we don't see significant decline in gross costs, but it's really about the recovery side. The offsets we're observing involve operating factors, volume mix, and a little bit of decapitalization within inventory. There’s about $30 million to $35 million of headwind remaining in Q4.

Lastly, regarding GHN and their auto division spin-off—would that be an asset you're still interested in, or have you found the scale you need without it?

We won't comment on any potential acquisition or merger activity. However, our team has strategically built out our portfolio and capabilities across electrification and electrodynamics, ensuring we are prepared for electrification. I believe Dana is ready for electrification based on our current capabilities.

Got it. Thanks for taking my questions.

Before we close, I want to commend the team for navigating these rocky times. It's crucial to operate cohesively. Today's environment presents unique challenges, but our team has positioned itself strongly for the future. The emphasis on our breadth of relationships and creating value for customers will be key to our continued success.

Thank you for your participation. You may now disconnect.