Earnings Call Transcript - DAN Q2 2021

Operator, Operator

Good morning, and welcome to Dana Incorporated's Second Quarter 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 speakers' remarks and Q&A session, includes Operator Instructions. 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.

Craig Barber, Senior Director of Investor Relations and Strategic Planning

Thanks, Regina, and good morning, everyone. Thank you for joining us today for our second quarter 2021 earnings call. You'll find this morning's press release and presentation posted on our investor website. Today's call is being recorded, and supporting materials are the property of Dana Incorporated. They may not be recorded, copied, or rebroadcast without our written consent. Also, 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, as usual, are Jim Kamsickas, Chairman and Chief Executive Officer; and Jonathan Collins, Executive Vice President and Chief Financial Officer. Jim, will you start us off this morning?

James Kamsickas, Chairman and CEO

Good morning, and thank you for joining us today. A quick review of our financial results for the quarter highlights significant improvements over last year's pandemic-impacted second quarter. In contrast to last year, when we were discussing shutdowns and lower sales, this year's second quarter, we delivered a strong $2.2 billion in sales, representing a $1.1 billion improvement, as our customers continue to see strong market demand, which in many cases has outpaced production due to supply chain challenges hampering their operations. Our adjusted EBITDA for the second quarter was $233 million, a $238 million improvement over last year. The net profit margin was again tempered by high raw material costs and supply chain challenges. Adjusted free cash flow was slightly negative for the quarter, but represented an improvement of $120 million over last year, driven by higher earnings. The diluted adjusted earnings per share was $0.59 for the second quarter of 2021, an improvement of $1.28 per share compared to 2020. Moving to the key highlights, we will provide an update on how we're managing through the key challenges facing the mobility industry. Additionally, we're excited to discuss a few new business wins, including electrification programs. Lastly, I'll highlight our recent announcement to accelerate our commitment to reduce greenhouse gas emissions and our adoption of science-based targets. Continuing with slide five, we face four key challenges: higher raw material costs; semiconductor shortages impacting the production schedules of our customers; logistics constraints and higher transportation costs; and labor shortages related to COVID restrictions. These challenges affect the entire mobility industry, which is seeing high demand, but production is being constrained, resulting in lower finished vehicle inventories for our OEM customers. First, high input costs for commodities such as steel, driven by high demand and limited supply, are inflating prices across all our end markets. We're working to offset and recover these higher costs through established mechanisms, but the inherent lag in those recoveries is creating substantial margin headwinds until those input costs stabilize and reverse. Jonathan will highlight the financial impacts shortly. Second, the semiconductor shortage is leading to lower production volumes at our OEM customers or reducing model availability, particularly in light vehicles, but more recently in commercial vehicles as well. However, end customer demand remains strong, leading directly to finished vehicle inventory imbalance. Shipping delays and higher logistics costs continue to impact the industry and are driving higher input costs globally. Lastly, all three end markets are being affected by labor shortages, leading to production inefficiencies, plant downtime, and higher labor costs. We're taking necessary actions to capitalize on this unique market dynamic of low inventory and high demand, which we see as a future opportunity for a stronger and longer-lasting recovery, as the input challenges subside. Moving to slide six, I'd like to discuss how we're continuing to successfully launch our new business backlog programs despite the industry challenges. In North America, we're excited to be supplying our Spicer SmartConnect all-wheel-drive system to a new compact pick-up truck, slated to go on sale next year. Vehicles with our disconnecting all-wheel-drive systems are designed to transition to all-wheel drive automatically and seamlessly based on the vehicle system's predictions. It not only enables impressive gains in performance and safety but is also more fuel-efficient, catering to the growing market for small pickup trucks. On slide seven, I want to highlight our new partnership in electric commercial vehicles. Dana has signed a strategic agreement with Switch Mobility, an Ashok Leyland subsidiary focused on manufacturing electrified commercial vehicles. The agreement positions us as their primary supplier of electric drive train systems, including e-axles, gearboxes, motors, inverters, software, and controls for light commercial vehicles and buses in India and Europe. Light commercial vehicles continue to present significant opportunities as the commercial vehicle segment shifts to fully electrified platforms. We are very excited about the partnership that will allow us to positively impact the delivery of sustainable urban e-mobility. Continuing on the transition to electrified vehicles, slide eight highlights our collaboration with Pierce Manufacturing and Oshkosh Airport Products on their new revolutionary Volterra platform of electric vehicles. When the first vehicle rolls off the assembly line, it will feature an electric drive train with two Dana TM4 motors, coupled with a Dana-manufactured electromechanical, infinitely variable transmission. The Volterra platform of electric vehicles is engineered to maximize driving and pumping performance while reducing fuel consumption. Significant fuel savings are possible based on the usage and mission profile. The Volterra platform not only reduces emissions in EV mode but is also designed to help save lives. Every second matters in airport emergency response, and the newly Striker Volterra ARFF achieves 28% improved acceleration when fully loaded with the new EV technology. The Striker Volterra vehicle operates with zero emissions during entry and exit of the fire station in EV mode, eliminating the need for costly ventilation systems in the station. In the coming months, the Striker Volterra performance hybrid will be showcased at airports across the US, allowing firefighters to experience this revolutionary technology firsthand. Earlier this year, the first Pierce Volterra zero-emissions pumper was placed in service with the city of Madison, Wisconsin, Fire Department, marking it as the first electric fire truck in North America. This vehicle has already responded to over 500 active emergency calls. This collaboration with Pierce Manufacturing and Oshkosh Airport Products allows Dana to expand our presence in the specialty vocational vehicle market while opening doors to leverage these capabilities across other markets as well. On slide nine, I will share details on another new EV business win for us. Our Power Technologies Group is now working with several electrified lifestyle and sports trucks. This year, we highlighted our advanced battery cooling technology with a global light vehicle OEM and indicated that more announcements would follow. We are pleased to showcase our capabilities by supplying our advanced battery cooling technology. While we cannot disclose the OEM's name yet, our extensive range of long ThermaTEK battery cooling product sets the industry standard for innovation. Our award-winning custom design cooling solutions feature lightweight aluminum construction, resulting in ultra-clean products that stabilize battery temperature and allow for faster charging. As I conclude, I want to emphasize that at Dana, we believe that leading the way in sustainability closely aligns with our leadership in vehicle electrification and is critical to supporting our customers as they strive to achieve their sustainability goals. This passion is reflected in our commitment to advancing our emissions reduction targets by developing new zero-emission technologies, delivering innovative products, and driving operational efficiencies globally. Earlier this month, we announced plans to reduce our annual Scope 1 and 2 greenhouse gas emissions by at least 50% by 2030, five years ahead of our original target of 2035 announced last fall. To assist in achieving this ambitious goal, we signed a commitment letter with the Science Based Target Initiative (SBTi), which aligns resources and incorporates best practices to accelerate emissions reductions. This partnership pairs us with organizations like the Carbon Disclosure Project, United Nations Global Compact, the World Resource Institute, and the Worldwide Fund for Nature to guide emissions reduction initiatives using science-based targets.

Jonathan Collins, Executive Vice President and CFO

Thank you, Jim. Please join me on slide 12 for an overview of our second quarter results compared to the same period last year. In the second quarter this year, sales topped $2.2 billion, delivering growth of over $1.1 billion compared to the prior year. This doubling of sales is attributed entirely to the recovery across all segments from the pandemic-related shutdowns we experienced last summer, even as supply chain aftershocks continue to impact us today. Adjusted EBITDA was $233 million, with a profit margin of 10.6%, representing a dramatic improvement over last year's nearly breakeven results, even as this performance is hampered by material cost inflation and continued supply chain challenges. Adjusted net income for the second quarter was $86 million, $185 million higher than the same period in 2020. The diluted adjusted EPS was $0.59, marking a $1.28 improvement from last year. Finally, adjusted free cash flow for the quarter was a usage of $13 million, an improvement of $120 million over last year's quarter due to higher profits more than funding increases in working capital and capital expenditures to support our growth. Please turn with me to slide 13 for a closer look at the drivers of our sales and profit growth for the second quarter. The change in second quarter sales and adjusted EBITDA compared to the same period last year is driven by several key factors. First, overwhelmingly, the increase is attributed to organic growth of nearly $1 billion, as our business rebounded from the trough in sales caused by the onset of pandemic containment measures last spring and summer. The incremental conversion of 26% exceeds the decremental conversion from the same period in the previous year by about 200 basis points. Second, foreign currency translation increased sales by nearly $90 million as the dollar weakened against a basket of foreign currencies, principally the euro. As is typical, this has no impact on our profit margins. Finally, steel prices have continued to rise at a rate much higher than anticipated. Gross commodity cost increased by $70 million, and we recovered $45 million of this via higher selling prices to our customers, resulting in a recovery ratio of about 65%. This remains lower than our normal steady-state recovery ratio due to the timing lag caused by the rapid spike in commodity prices. These increases compressed our profit margin by approximately 180 basis points and represented the primary impediment to achieving 12% margins in the quarter. Please turn to slide 14 for details on how adjusted EBITDA converted to cash flow. Free cash flow was a slight use in the quarter at $13 million, although this represents a substantial improvement of $120 million compared to the same period last year, attributed entirely to higher profit, which more than funded higher capital requirements to support increased volumes. Now, please turn to slide 15 for an overview of our revised full-year guidance for 2021. Given strong market demand in the second quarter, despite the impact of the chip shortage, we now anticipate full-year top line results toward the high end of our guidance range. This represents a $250 million improvement from the previously indicated midpoint of the range. It is driven by higher commodity recoveries, stronger foreign currency exchange, and higher demand across all three of our end markets. However, we still expect profits near the midpoint of our range, implying a margin between 10.5% and 11% as the additional contribution margin from higher demand offsets higher commodity costs net of recoveries. This also implies an adjusted free cash flow margin of approximately 3% of sales. Diluted adjusted EPS is expected to move toward the higher end of our range at $2.45 per share due to lower interest and income tax expenses. On slide 16, I will highlight the drivers of our expected sales and profit changes for the full year. This chart illustrates the key factors driving the change in expected sales and profit for 2021 compared to last year. First, organic growth is expected to add nearly $1.6 billion in sales, including our new business backlog of $500 million along with a slightly higher end market volume increase mentioned earlier. Incremental margins are expected to remain strong in the mid-20s, providing about 350 basis points of margin expansion. Next, we anticipate the impact of foreign currency translation to now benefit approximately $150 million in sales and about $15 million in profit, with no impact on margins. Lastly, we now expect gross commodity cost increases approaching $250 million as steel prices continue to rise. We anticipate recovering about $180 million or 70% of the increase from our customers in the form of higher selling prices, leaving a net profit impact of $70 million, which will compress margins by more than 100 basis points. Please turn to slide 17 for more detail on how we expect this year's adjusted EBITDA will convert to cash flow. We expect full-year adjusted free cash flow of about $275 million, representing an improvement of more than $200 million compared to last year. This growth is entirely driven by the profit I outlined earlier and is partially offset by higher capital requirements to fuel sales growth. Moving to page 18 for an overview of the debt refinancing we completed in the second quarter. In April, we were the first major mobility supplier to launch a green bond here in the U.S. The proceeds were allocated to finance green projects, driving our stated sustainability and social responsibility initiatives, including reducing greenhouse gas emissions; expanding the use of energy-efficient production processes; and designing, engineering, and manufacturing products that enable the electrification of the world's mobility fleet. In May, we launched our debut bond issuance to the European capital markets with a EUR325 million placement to refinance our 2026 dollar notes that had been swapped to euros. Both of these actions lowered our borrowing costs, extended our maturities, and will serve as more permanent components of our debt stack as we deleverage in the coming years. Finally, on page 19, I'm excited to announce that we will be hosting an Electric Vehicle Technology Day for capital markets participants on Tuesday, September 28. This hands-on technology experience will be held at our world headquarters in Maumee, Ohio, and broadcast virtually. The event will feature our industry-leading EV products as well as a selection of electrified vehicles and equipment powered by these systems. Our goal for the event is to provide insights on how we see the transition to electrified mobility unfolding over the coming years and how Dana's leadership in this evolution will drive outsized growth and financial returns for our shareholders. I'd like to thank all of you for listening in this morning, and I'll now turn the call back over to Regina to take your questions.

Operator, Operator

Our first question comes from Brian Johnson with Barclays.

Brian Johnson, Analyst

Yes, good morning. I've got two questions. First, on the financials and then the competitive landscape. Just looking at the incremental margins, I was struck by the very high incrementals in Power Technologies and mid-teens in Commercial Vehicle Dynamics (CVD). Can you elaborate on that, Jonathan?

Jonathan Collins, Executive Vice President and CFO

Sure. From a Power Technologies perspective, most of the economic impact we're seeing is from steel, which has not been a significant headwind in that segment. We're seeing decent volumes across various end markets and improvements in operational performance, which are contributing to that. In the commercial vehicle segment, the primary driver of margin growth is the continued strong volumes. We expected the heavy and medium-duty markets to perform well, and aftermarkets have been performing reasonably, too. Those factors are helping deliver solid performance across the segments.

Brian Johnson, Analyst

On Power Tech, regarding the battery cooling win, could you provide insight into how we should view CVD versus typical Power Tech products? Additionally, what made your solution unique during the RFQ process?

Jonathan Collins, Executive Vice President and CFO

Maybe I'll address the content piece, and then I suspect Jim will want to highlight some of the technology embedded in the system. Our thermal management system in Power Technologies primarily cools engine oil and transmission fluid. We leveraged that competence into cooling batteries with the battery cold plate win we announced, which is similar to our earlier announcement with GM on their Ultium platform. In terms of content, that's something we plan to provide more detail on in a couple of months, but battery cold plates offer dramatically higher content per vehicle than our current engine and oil transmission coolers.

James Kamsickas, Chairman and CEO

I don’t have much to add to that, Brian, thanks for the question. One key aspect that can't be overlooked in the mobility industry is the importance of long-standing relationships, customer confidence, and our global footprint. I don't know how long we've been doing business with the customer in question, but it’s been decades. The unique offering from Dana is that battery cooling correlates well with our Power Technologies business in both thermal technology and sealing, which differentiates us from competitors.

Brian Johnson, Analyst

Thanks.

Jonathan Collins, Executive Vice President and CFO

Thanks, Brian.

Operator, Operator

Your next question comes from Colin Langan with Wells Fargo.

Colin Langan, Analyst

Thanks for taking my question. On the off-highway business, the quarter-over-quarter incremental margins seemed quite high, and there was dramatic improvement in margins. Can you comment on what's driving this? Is the margin level sustainable?

Jonathan Collins, Executive Vice President and CFO

Yes, Colin, just a couple of things. From an off-highway perspective, we noted earlier this year that agriculture has been really strong, driving much of the growth. We're starting to see better recovery across other segments in off-highway, including construction, material handling, and mining, which typically deliver better margin profiles. This is helping to overshadow the premium costs and commodity impacts in that business.

Colin Langan, Analyst

Additionally, strategically, there's a lot of discussions about in-sourcing parts of the drive train on some of these EV trucks. Can you provide insight into how you perceive in-sourcing risks for components like drivetrains and different offsets?

James Kamsickas, Chairman and CEO

Thanks for the question, Colin. Just to clarify for the broader audience, a significant number of elastic axles are currently in-sourced worldwide, but that doesn’t negate the addressable market and business potential for Dana, which we've had for over 117 years. Regarding the balance of your light vehicle question, as we've mentioned, for our electrification pull-through, which began with passenger cars and smaller SUVs, we're committed to being in the full-frame truck business, and we fully expect to capitalize as those markets evolve.

Colin Langan, Analyst

Thank you for your insights.

Jonathan Collins, Executive Vice President and CFO

Thanks, Colin.

Operator, Operator

Your next question comes from the line of Aileen Smith with Bank of America.

Aileen Smith, Analyst

Good morning. I have a question related to the semiconductor shortage. Are there any market dynamics in the commercial vehicle and off-highway segments that might allow automakers or suppliers to better manage pressures from the semiconductor shortage compared to the light vehicle and Power Technologies sectors?

James Kamsickas, Chairman and CEO

That’s a good question, Aileen. While some suppliers might want to take a stance on how OEMs are coping, I can't speak for them in specific terms. However, I can say that all industry players will face impacts to varying degrees, and each OEM will find their own solutions.

Aileen Smith, Analyst

Regarding the electrification portfolio and the battery cooling win for the North American pickup truck, historically, your core competency has been the body and frame truck market. As you look at discussions with customers for new EV products, do you still see the truck segment as the key market, or have you made progress across other segments?

James Kamsickas, Chairman and CEO

Certainly, there are notable advancements across other segments. For instance, GM's Ultium platform demonstrates our participation beyond full-frame vehicles. Our capabilities indeed extend across other end markets, including commercial vehicles and off-highway sectors.

Aileen Smith, Analyst

Thanks for your insights.

Jonathan Collins, Executive Vice President and CFO

Thanks, Aileen.

Operator, Operator

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

Joseph Spak, Analyst

Thank you. Regarding commercial vehicles, I noticed the business historically had margins around 9% to 10%. It appears we're currently trending below that. Can you discuss the margin trajectory and what needs to happen to attain previous levels?

Jonathan Collins, Executive Vice President and CFO

The main constraint on margins in the commercial vehicle space stems from the substantial investments we're making in electrification. A notable share of our activity is concentrated in this segment, and many of the investments you’re witnessing are directed at delivering products for the future.

Joseph Spak, Analyst

Could you provide more specifics about the investment in Switch? How significant was it, and when do you expect some of those products to reach the market?

Jonathan Collins, Executive Vice President and CFO

We'll share more details on the investment later, but it is consistent in quantum with previous investments—all meaningful yet modest in nature. As for the technology overview, we're partnering with Switch on a broad range of products utilizing our electrified axle alongside other technology. We’re quite excited about the potential this partnership brings and will delve deeper into it in September.

Joseph Spak, Analyst

Can you provide any insights into when revenues could start from that partnership?

Jonathan Collins, Executive Vice President and CFO

We'll provide further clarity on that timeline when we meet in September, as we aim to discuss the volume expectations of key wins. Thank you.

Operator, Operator

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

Noah Kaye, Analyst

Good morning, and thank you for taking my question. I've heard that commercial vehicle OEMs are delaying the opening of their 2020 order books to better gauge inflationary pressures for 2022 pricing. In customer discussions, how productive have conversations been regarding pricing and passing on supply chain costs long-term? Are we set for better recovery of these costs next year?

James Kamsickas, Chairman and CEO

The attributes of commodity costs are well understood across the board; however, discussions around related costs are very case-by-case and require communication with customers. This year has taught all parties the importance of a healthy supply base to sustain success in the mobility industry.

Noah Kaye, Analyst

Can we discuss any observations in construction? We've seen favorable momentum indicators recently. How might that affect off-highway demand? Also, your thoughts on the infrastructure bill?

Jonathan Collins, Executive Vice President and CFO

The leading indicators suggest demand will persist. We've observed that our customers are eager to build more vehicles than we can currently manage. Demand is outpacing supply chain capabilities, and we're hopeful for improvements that will meet that demand across all markets. The infrastructure build, particularly in the U.S. but globally, will only serve as a positive driver for us.

James Kamsickas, Chairman and CEO

I would also add that there's strong infrastructure activity globally, which is promising for our future outlook.

Noah Kaye, Analyst

Thank you for your insights.

Jonathan Collins, Executive Vice President and CFO

Thanks, Noah.

Operator, Operator

Your next question comes from Rod Lache with Wolfe Research.

Rod Lache, Analyst

Hello everyone. I wanted to focus on your electrification investments in commercial vehicles. Could you give some clarity on the magnitude of the impact on that business? Considering that the initial phases of contribution will be relatively small, will we see a similar phenomenon in light vehicles, or can you leverage the work done in CV to improve efficiencies in LV?

Jonathan Collins, Executive Vice President and CFO

The margin pressures we see in commercial vehicles arise from market demand alongside record high material costs and supply chain challenges. The resources heavily invested in electrification are primarily focused on commercial vehicles, leading to an outsized effect compared to light vehicles. However, as we ramp up applications engineering investments, those effects will extend to other segments, including light vehicles.

Rod Lache, Analyst

With everyone dealing with logistics and supply chain challenges, should we expect better incrementals next year as recovery mechanisms start to take effect?

Jonathan Collins, Executive Vice President and CFO

Given the unique environment we're in with the unprecedented prices across numerous inputs, we anticipate improvements in recoveries as conditions stabilize. Our conviction remains strong that the margins can exceed 12%, and cash flows will continue to rise, as demand improves.

Rod Lache, Analyst

Regarding recovery, do you anticipate full recovery over the program life?

Jonathan Collins, Executive Vice President and CFO

Over the life of a program, we can expect to recover costs at varying rates; however, as programs transition, we have opportunities to adjust our selling prices in line with reality regarding commodity prices.

Rod Lache, Analyst

Lastly, can you share the magnitude of bidding opportunities for EV in light vehicles currently?

Jonathan Collins, Executive Vice President and CFO

We continue to see a record pace of bidding opportunities. The second quarter demonstrated the highest activity we have ever seen, and this extends across all our end markets. We remain committed to capitalizing on this enthusiasm and will work to gain the highest win rates possible. We will discuss further details in September.

Rod Lache, Analyst

Great, looking forward to it.

Jonathan Collins, Executive Vice President and CFO

Thank you.

Operator, Operator

Your final question will come from Dan Levy with Credit Suisse.

Dan Levy, Analyst

Good morning. I want to start with light vehicle industry dynamics. Given the anticipated inventory rebuild ahead, what kind of incremental margins should we expect as that takes place?

Jonathan Collins, Executive Vice President and CFO

On a year-over-year basis, we expect margins to be consistent with those seen historically, with a potentially higher result sequentially. However, due to current labor shortages, we're flexibly adapting towards direct variable profits instead of contribution margins.

Dan Levy, Analyst

Following up on EV, with your acquisitions to enhance engineering and software capabilities, are these enhancements exclusive to EV efforts or can they be applied across multiple segments?

Jonathan Collins, Executive Vice President and CFO

These capabilities are indeed transferable across all our end markets. Our core offering includes the same technology and PDM (Product Development Management) processes applied uniformly—which means whether it's commercial vehicle, off-highway, or light vehicle—they can all leverage this expertise.

Dan Levy, Analyst

Is this capability opening doors for new opportunities that weren't there before?

James Kamsickas, Chairman and CEO

Definitely. However, our strong relationships built over a century have been crucial in securing discussions with our customers. The vital aspect during this period is understanding end market needs and ensuring we can deliver value propositions tailored towards them.

Dan Levy, Analyst

Thank you.

Jonathan Collins, Executive Vice President and CFO

Thank you.

Operator, Operator

I will now turn the conference back over to management for any concluding remarks.

James Kamsickas, Chairman and CEO

Thank you for your attendance today. The dynamics we're experiencing are unprecedented, though I believe we're making tremendous progress alongside our customers. I would like to express my gratitude to the Dana associates worldwide for their unwavering commitment to overcoming challenges. We look forward to further communication in September. Visualize the potential across end market vehicles participating in electrification—synergies that span various segments exist, and our strategic vision underpinning this has been meticulously executed over many years. We appreciate your interest and support over the years. Have a great day and a wonderful weekend.

Operator, Operator

Thank you all for participating in today’s meeting. You may now disconnect.