Dana Inc (DAN) 2018 Q4 法說會逐字稿

Good morning, and welcome to Dana Incorporated's Fourth Quarter and Year-End 2018 Financial Webcast and Conference Call. My name is Carmen, and I will be your operator today. Please be advised that our meeting today, both the speakers' remarks and Q&A session, will be recorded for replay purposes. (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.

Thank you, Carmen, and good morning everyone on the call. Thank you for joining us today. 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 not be recorded, copied or rebroadcast without our written consent. (Operator Instructions)

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 those factors that could affect our future results are summarized in our safe harbor statement found in our public filings, including our reports to the SEC.

Presenting this morning are Jim Kamsickas, President and Chief Executive Officer; and Jonathan Collins, Executive Vice President and Chief Financial Officer. Jim, the call is yours.

Thank you very much, Craig. Good morning, everyone. Needless to say, on behalf of the entire Dana team, I'm very proud to communicate that the 2018 was a record year for sales, profit and margin. We grew the business by nearly $1 billion, with a very substantial portion of this growth being organic, and the team executed extremely well in this high demand market. We successfully launched new business and brought on our sales backlog to the market, thus driving nearly $800 million in profitable organic growth. Our profit came in right where we expected at $957 million in adjusted EBITDA, adding $122 million in profit growth over 2017.

Strong execution drove a 20 basis point margin improvement as we overcame launch costs inherent in the business at the beginning of the year and commodity cost inflation in the back half of the year. And as we committed to, we achieved significant improvement in free cash flow, generating 51% higher returns in 2018, which is no small feat when considering that we again grew the business by double digits last year.

Translating this success, we also achieved 18% higher EPS for our shareholders. Generating shareholder value will always remain one of our highest priorities. Perhaps the best part of accomplishing this outstanding year is at the same time, we continue to increase customer satisfaction through new products, technology and overall operational performance.

As you can see on this page, we received over 30 significant customer and industry honors last year. Of course, directly or indirectly, this enables us to communicate that our backlog is $700 million in committed net new business that will layer on over the next 3 years.

In fact, finally on this page what may have us most excited is all of the opportunities that we foresee in the future coming off an incredibly successful year of acquiring the industry leading e-Propulsion companies, TM4 and the SME Group. We have added great people and technology, and this will only exacerbate once we complete the acquisition of the Oerlikon Drive Systems business at the end of this month. This acquisition will further balance our end markets and drive future growth and innovation as we evolve into the world of electrification.

Please turn to Page 5 for a quick snapshot at Dana over the past 3 years. So I've been at Dana for approximately 3.5 years now, and I've often been asked: what's changed over time? We used this slide -- sorry, the slide in our outlook presentation last month as it tells the story very well.

Over the last 3 years, sales were up 34% in -- over -- our sales were up 34% in EBITDA at nearly 50% and free cash flow is up 66% while continuing to grow the business, and that's no easy task. And finally, diluted earnings per share are up 71%.

I really do appreciate the outstanding performance of our team as they have executed our strategy and integrated 7 acquisitions. But we still have a lot more to do, and we strive towards in the future.

Thank you for your time this morning. Jonathan will now walk you through some details over the last year and our outlook for 2019.

Thank you, Jim. Slide 7 is an overview of the fourth quarter and full year of 2018 compared with the same periods in the prior year. These final results are in line with the preliminary results we provided last month.

Fourth quarter sales were $1.97 billion, an increase of $136 million compared to the same period in 2017 for a growth rate of 7%, primarily due to the conversion of our backlog and strong market demand, which helped drive over $900 million of full year sales growth as we ended 2018 with more than $8.1 billion in sales.

Adjusted EBITDA for the fourth quarter was $223 million, a $26 million increase from the prior year for a profit margin of 11.3%, which is a 60 basis point improvement over the fourth quarter of 2017.

For the full year, we generated record profit and margin with $957 million in adjusted EBITDA for an 11.8% margin. That's $122 million higher than 2017, and 20 basis points of margin expansion.

Net income for the full year was $100 million compared to a loss of $104 million in the prior year. And for the full year 2018, net income was $427 million compared to $111 million in 2017. The results for the fourth quarter of 2017 included a $186 million charge related to U.S. tax reform. Adjusting for this charge, 2018 earnings were 44% higher than the prior year.

Diluted adjusted EPS, which excludes the impact of nonrecurring items, was $0.71 in the fourth quarter, $0.09 higher than 2017. And for the full year, EPS was $2.97, $0.45 higher than the prior year.

Strong cash flow generation in the fourth quarter led to full year free cash flow of $243 million, $82 million higher than 2017. Higher adjusted EBITDA and lower capital spending more than offset the higher working capital required to support the organic sales growth.

Please turn with me now to Slide 8 for details on the fourth quarter sales and profit growth. Fourth quarter sales and adjusted EBITDA growth was driven by 4 factors.

First, organic growth added $171 million in sales as we continued to convert our backlog, and demand in our end markets remained strong. The organic growth delivered an incremental $31 million of profit for a conversion of 18%. Second, inorganic growth continued to expand margins as we realized cost synergies from the Brevini acquisition. Third, foreign currency was a headwind in the quarter, lowering sales by $52 million and adjusted EBITDA by $2 million due to the translation of international results at currency rates, primarily in Latin American countries that continued to weaken against the U.S. dollar. Finally, commodity cost increases continued to pressure margins in the fourth quarter. Raw material prices increased costs by $27 million over the same period in the prior year. However, we recovered $17 million in the form of higher selling prices for a net impact to profit of $10 million. This lowered margin by approximately 65 basis points.

Please turn with me to Slide 9 for a closer look at how free cash flow in the fourth quarter turned out. We generated virtually all of our free cash flow last year during the fourth quarter. The $241 million of free cash flow in Q4 was $190 million higher than the same period in the prior year, primarily due to the seasonality of working capital and lower capital expenditures. As we highlighted on our last call, working capital is typically a source of cash in the fourth quarter as inventory and receivable balances subside at this time of year.

Capital expenditures in the fourth quarter were significantly lower than the same period last year as spending on the Jeep Wrangler program is now behind us.

Please turn with me now to Slide 10 for details on the full year 2018 sales and profit growth. 2018 full year sales increased by $934 million and adjusted EBITDA was higher by $122 million. As with the fourth quarter comparison, this growth is attributable to 4 factors.

First, organic growth added $797 million in sales as we continued to convert our backlog, and demand in our end markets remained strong all year. The organic growth delivered an incremental $139 million of profit for a conversion of 17%. The full year conversion rate was lower than our typical 20%, a result of the significant premium cost incurred to meet the elevated demand. We've taken numerous actions to streamline our cost structure and improve our conversion rates going forward as we expect to be operating in a high-demand environment through the remainder of the year. Second, inorganic growth drove margin expansion of 30 basis points as we recognized a full year of sales for both the Brevini and USM Warren plant acquisitions and achieved significant cost synergies associated with the Brevini transaction. Third, the impact of foreign currency was negligible on a full year basis as the quarterly changes offset. Finally, the scale of the commodity cost increases were in line with the expectations we presented on the third quarter call. As we've said, we recover the majority of commodity inflation from our customers with a typical 1- to 3-month lag.

In 2018, raw material prices increased by $110 million over 2017, with increases accelerating in the back half of the year. We recovered $65 million in the form of higher selling prices. The net impact reduced full year profit by $45 million, lowering margins by approximately 70 basis points.

Please turn now to Slide 11 for a detailed look at how our profits converted to free cash flow. We generated $243 million of free cash flow in 2018 for a 3% margin compared to $161 million in 2017 for just over a 2% margin. Our profit growth and lower capital spending more than offset higher cash taxes and working capital requirements.

Elevated cash taxes were the result of timing of payments, increased income in taxpaying jurisdictions and an entity restructuring completed early last year.

Working capital was a significant use of cash last year to support the $800 million of organic sales growth. Capital expenditures were below the prior year as we had elevated spending in 2017 related to new program launches, namely the Jeep Wrangler.

Please turn with me now to Slide 12 for a look at our expectations for this year. We are affirming our full year 2019 financial guidance ranges we discussed with you last month, and we're showing it to you 2 ways. The first is the base business as it exists today before we close the Oerlikon Drive Systems acquisition in a couple of weeks. The second includes the expected impact of 10 months' worth of activity for that business.

For the base business on the left, we expect sales to be at about $8.4 billion at the midpoint of our guidance range. We expect adjusted EBITDA to be over $1 billion at $1,025,000,000, and that implies a profit margin of approximately 12.2% at the midpoint of our range.

We expect our adjusted free cash flow to expand on the base business by 100 basis points over last year as our adjusted EBITDA continues to grow and as the working capital that we invested the last couple of years to deliver this higher sales level begins to subside. We also expect to accrete another $0.20 to adjusted EPS, ending this year at $3.10.

The guidance with the Oerlikon Drive Systems business adds $750 million of sales, $100 million of adjusted EBITDA, which includes $10 million of the $40 million of expected cost synergies. We expect most of the balance of the cost synergies will be achieved next year.

Primarily due to the transaction and integration costs we will incur, we expect the acquisition to be a use of $60 million of free cash flow in 2019, lowering our implied adjusted free cash flow margin to about 3% of sales, which is in line with last year. We do expect the acquisition to accrete approximately $0.10 to EPS this year.

All in, we're expecting to deliver for the third consecutive year double-digit sales, profit and free cash flow growth.

Please turn with me now to Slide 13 for further details regarding the 2019 sales and profit growth. The same 4 factors leading to last year's sales and profit growth are also the primary drivers of our expected growth this year. First, organic growth remains a major contributor to our performance. While we expect market demand for our products to remain strong and in line with last year, our backlog is expected to generate $350 million in additional sales. We had over $100 million in nonrecurring sales in the first half of last year as a result of the old and new Jeep Wrangler programs overlapping. However, the year-over-year profit impact will be negligible as the loss contribution margin will be more than offset by the nonrecurrence of launch costs on the program. We expect the overall conversion on organic growth to be higher this year as a result of the structural cost actions we took last year as well as operating improvements we're making that will lower our conversion costs. Second, inorganic growth from the Oerlikon Drive Systems acquisition will add $750 million in sales and about $100 million profit. Third, we expect the impact of foreign currency to be a slight headwind, primarily due to the relative value of the euro to the U.S. dollar. Fourth, we expect commodity inflation to continue this year, albeit with a higher recovery rate of about $90 million and a net profit headwind of about $40 million as commodity costs level out. This continues to put pressure on our profit margin expansion, but we are beginning to see signs that commodity costs will improve as we move through the year.

Please turn with me to Slide 14 for more detail on the quarterly phasing of this year's sales and profits. The slide is intended to illustrate the progression of sales and profits through the year. Typically, our sales and margins peak in the middle of the year, and this year will be no exception. We expect the first quarter to have the lowest sales and profit margin of the year as we'll only have 1-month worth of contribution from the Oerlikon Drive Systems business. We anticipate sales and profits improving in the balance of the year as our backlog converts to sales and we recognize the accretion from the acquisition.

Please turn with me to Slide 15 for more details on how we expect profit will convert to free cash flow. As with our overall guidance, we're highlighting the drivers of adjusted free cash flow on the base business as well as providing the discreet impact of the Oerlikon Drive Systems acquisition.

The base business adjusted free cash flow margin is expected to expand by 100 basis points as our profit grows and the working capital investment we've made in the last few years subsides. The Oerlikon Drive Systems business will be a use of free cash flow of about $60 million for 2 reasons. First, we will incur transaction and integration costs associated with the deal. Second, the capital spending for the business this year is higher than normal due to the launch cycle of certain programs. We expect both of these to moderates significantly next year.

You'll note that we're using a new adjusted free cash flow measure. This measure merely excludes the discretionary pension contribution that we plan to make later this year to fund and terminate a frozen pension plan. This action supports our objectives to continue to improve the quality for balance sheet.

Slide 16 reinforces some of the highlights Jim mentioned at the start of our call. Over the past few years, we've grown the top line of the business by $2 billion and expect to add another $1 billion of sales this year, putting us on track to deliver a nearly double-digit 5-year CAGR. We have also expanded our profit margins by 100 basis points in the last few years and are poised to expand them by another 100 basis points by the end of next year.

The adjusted EBITDA growth we are delivering is substantial and is converting to cash. Just 2 years ago, the business only generated a free cash flow margin of 1%, and we're on a trajectory to generate a free cash flow margin of 5% next year. And we'll be in a position to deploy this cash in a shareholder-friendly manner.

Finally, our diluted adjusted EPS has expended by more than $1.20 over the past few years and is poised to continue to grow this year and next.

The entire Dana team remains focused on continuing this excellent trajectory of profitable growth in the coming years. I'm also pleased to announce this morning that we will be hosting an Investor Day at the New York Stock Exchange on Monday, March 11, at 9:00 am Eastern time to provide an update on our enterprise strategy, more information around our exciting new portfolio of electrified products and the future financial implication of both of these.

I'd like to thank all of you for listening in this morning, and I'll now turn the call back over to Carmen to take your questions.

(Operator Instructions) Your first question comes from the line of Aileen Smith with Bank of America.

Looking at Slide 20 in your appendix around your underlying market assumptions, which generally appear flat to stronger for 2019, it's no secret that there's been some questions around the accuracy of certain market and industry forecasts. So how much conservatism, if any, do you think you have baked into your financial outlook and these market assumptions? And more broadly, what end markets or regional markets into 2019 have you most concerned right now?

This is Jonathan. Thanks for the question. One of the things we try to be clear about is that we do our best to corroborate what the industry sources are looking at. We look at a number of different pieces of information. We do get pretty consistent releases from our customers and most of our end markets a few months out that we look at, and we also look at our customer build patterns beyond that in their operating plans. And generally, we are comfortable with the results of the independent research, and we think they're in line with what we see. So we put those in as a reference, but we do our best to corroborate and we think they're pretty comparable.

I think with regards to each of those end markets, obviously, we look closely at the North American end market. And that market remaining strong on a full-frame truck basis continues to be there for us, and we think that it's going to be a good year there. And then I think the other one that's significant this year for us is the Class 8 market in North America. We continue to see strength there through most of this year, but I would say that's a market that we continue to look at as very critical and important to us.

Great, that's very helpful. And obviously, the Wrangler was a huge launch for you guys last year, and you had costs that really hit in the front half as production was ramping up. As you think about 2019 and even into 2020 and some of the product launches that you still have coming, should we be thinking about significant launch cost headwinds associated with those new programs? And in terms of timing, have you incurred some of those costs already? Or should we be assuming that those will hit around the same time as production ramps up?

So we are continuing to grow. So the $350 million of backlog that we are bringing online this year is principally driven by the new Jeep truck that's coming on, the Ford Ranger that's coming back to North America, the rear disconnecting system that we've launched with Ford in multiple regions. So we will have some launch costs associated with those, but the magnitude of those compared to the Jeep Wrangler program is just much smaller. So we've called that out and highlighted that because the Jeep Wrangler was the second largest platform in the company and these other launches are just smaller.

From a seasonality perspective, we do have some launch activity going on now. We'll have launch activity through the balance of the year, but the financial impact, we expect to be significantly muted just as a result of the scale and size of the programs.

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

Just two questions. First, just following up on the comments you're making about the Wrangler and their transition to their pickup truck. In addition around Wrangler, there seems to be high dealer inventories. And Mike Manley called out some production downtime to both correct the inventories and get ready for a PHE version of the Wrangler. Is that fully -- not clear if that's factored into consensus IHS forecasts. I guess a couple of questions. Is that -- do you think it is in those forecasts? And then kind of when you looked at your LV guide for the year, do you have it kind of factored that in? Is that part of the cadence?

Okay. This is Jim. Thanks for the question. I'm not exactly sure if it's baked in. What I can tell you, as kind of Jon has been referring to answering a question a little bit earlier, we get pretty good -- pretty long runway on our releases -- our specific releases that come to our individual plants and so on and so forth. And everything that's in those releases right now, we have baked throughout in our overall plan that we provided to you and in our guidance that we provided to you.

Yes, when we look at IHS, Brian, we think it's pretty close as well to -- it accommodates for a little bit of downtime, and we're comfortable with the number we're putting out based on what we know.

What I will say, though, since you offered it a little bit, just to give the collective audience an update. The Gladiator, which is that truck that we launched is that we, at least from all indications and think many of you probably have -- saw it at different shows or whatever, it looks very promising as it relates to consumer pull-through and excitement. So we're pretty excited about that. We're prepping for that right now, and that'll start to come through our system. End of the Q2, we'll start coming up the curve on that.

And just a follow-on question there. Any launch cost impact to worry about there? Or is it because similar, I guess, drivelines and plants that that's de minimis?

You're very astute at this. You and I have talked in the past on this when it -- like Jonathan said a minute ago, last year was fortunately -- it was the -- double the kind of the carryover between JL and JK, and you can't build the church for Easter Sunday. So we had to share capital, that made it really difficult. This year, we don't have that circumstance, so it's more of a typical launch cadence, and we bake that into our guidance.

Okay, next question. You're expecting a 10% margin in CV, came in closer to 9%. Was that really just driven by commodity cost headwinds? And if so, can you get to that 10% margin in '19? Or are there other headwinds we should be aware of?

There are actually a little bit other headwinds. So you touched on one of them for sure, which was commodity costs. Everybody knows where those were at the second -- in the second half of last year. The other one was just the demand pull-through from our customers as well as getting extra -- getting incremental, I would call, market share and being pulled more. The demand, as I said before, the base challenge that we had wasn't for our plants, but it was getting the overall demand -- synchronized demand around the world was incredible, especially at the end of last year. So the good news is we've been installing it not ourselves but having it through our supply base, deploying a lot more capital. And that -- a lot of that supply bases came online and continues to come online. So we feel good about coming out in Q1 here and throughout the balance of the year. And as we put into our guide yes, I expect it will be back up into the double digits. It will reach double digits in our CV group this year.

Your next question comes from the line of Rod Lache with Wolfe Research.

I had a couple of questions. First, there's some debate about how big products, like the Gladiator and the Ranger, could be in terms of volume. Obviously, it's sounding very promising on both, but can you give us a sense of what your expectations are and what the content per vehicle for Dana would be?

Yes, so we are supplying the full drivelines, similar to what we do on the Jeep Wrangler program. As Jim mentioned, a lot of common equipment and comparable design included in those vehicles. From a volume perspective, while we're not giving a number discreetly, we have been conservative on the number that we've assumed for this year. It's a new vehicle. We think it's going to do very well. And if it does as well as some of the other external sources are looking at, we might do even better. But I would say that we've been a bit conservative on the new vehicle. We're also really excited about the Wrangler coming back to North America this year, the Ford product that is launching in a comparable segment. Compact pickups we think are going to continue to do well. So we're excited about the growth in that product.

So Ford had planned something like a 120,000 units originally for things like Ranger. And obviously, GM is already pushing 180,000 on Colorado Canyon, and Tacoma is like 250,000. If this thing gets to something like 200,000 units, is that something you could accommodate?

Yes, we're capacitized in line to support what our customers believe they can build. So we work with the customers on that. But I think you're going down the right path. We collectively looked at the segment and took the perspective on what we think the segment can do and calibrated our volume expectations based on that.

Okay. And I also wanted to just ask if you can elaborate on 1 point you made. Obviously, there was some inefficiency premium costs that you incurred in 2018, just given how strong production was. And you made a comment suggesting there's some changes that you've made to address that. Could you just elaborate on what that is? And what's the magnitude of the opportunity?

Yes, this is Jim. Most significant I was trying to refer to anyway was really is Tier 2 and Tier 3, even arguably Tier 4, capacity out there. The demand was just so high, particularly on the Commercial Vehicle side of the business the demand was so high. And I know you're aware of that, that there just wasn't enough out there. So -- but we didn't start the process of bringing it on. You don't bring on demand for the type of things that we were -- supply for the type of things we were looking for. You don't start just doing that in November or October. We did it certainly last year. Fortunately, that good planning that we put in at the early parts of last year, a lot of that supply capacity was coming on board at the last year, and most of it is up fully now in January and February this year. That's the most important thing or most significant thing you should take from those comments.

What does that mean financially, just the elimination of premium freight? Or what should we be expecting from that?

Exactly, that's probably the most significant because we had a spectacular year. And I'm not overcooking that word when I say it. We had a spectacular year supporting our Commercial Vehicle customers. And they rewarded us for that, but it cost us quite a bit of money in premium transportation to get parts from around the world to where we needed to, to make sure that we were protecting their lines and enable them to be able to keep their assembly lines running.

Yes, And Rod, for example, it also affects the P&L in areas like labor efficiency. So the amount of premium time when we have people standing around waiting for parts, we're not as efficient. So the addresses in the supply chain will help to make us more efficient in other areas as well.

It sounds like it's a significant number. Can you just give us a sense of what that means? What is the number that you guys incurred that you think you can address?

Yes, the conversion rate difference is reflected on the year-over-year walk schedule. So we converted at just under 20% last year. We expect to convert at about 30% this year. So that conversion difference is largely attributable to those efficiency improvements.

The other thing that we did mention at your conference a month ago is the fact that we did take some structural cost actions last year as well too that will benefit us in the tune of tens of millions of dollars. That is also encompassed there. So the combination of those 2 things are what are driving that improvement in the conversion on the organic sales growth.

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

So just a follow-up actually on this Commercial Vehicle margin and some of the actions you've put in there. So you've deployed some more capital, and the conversion rate will be considerably higher this year. I'm curious about how you would be thinking about once, sort of, like the cycle puts some pressure on volumes. So where would you see the decremental margins at that point? Can this be flexed down as a result of some of the structural cost reduction? Or at this point, would we be looking at a 30% on the way down as well?

Yes, I'll let Jonathan take the decremental question more specifically, but I will -- I do want to reinforce for the audience that the key point in our strategy, we're not -- we're also not in the business of building church for Easter Sunday. And the capacity -- largely, the capacity that we brought on was in our supply base.

So with that, Jon, and I'll let you take the second half.

Sure. So I mean, we have been heavily focused on driving our fixed costs down. The actions that we took last year are one of the examples of what we're doing to make sure that we're prepared to manage the decrementals. The other thing I would highlight is, take the Commercial Vehicle, for example. The most significant run-up that we've seen in the last couple of years of volume is in the Class 8 market. We also have a significant presence in medium-duty and in the aftermarket. And the margins in both of those businesses, the medium-duty and the aftermarket, are more attractive than the heavy vehicle over the road. So from decremental standpoint, we're comfortable that we'll see a conversion that's comparable with what we saw on the way up, and we think we have an opportunity to do even better.

Okay, that's very helpful. And then just turning to your Slide 16. I'm curious if you could give us a little bit more color on how you're thinking about the targets beyond 2019. It looks like a very nice additional step-up in margin is what you expected, obviously, revenue growth, free cash flow improvement. Can we -- can you maybe go back over some of the puts and takes as we look -- and assumptions as we look into -- beyond 2019, please?

Sure. I'll give you a couple of things here, but this is one of the things that we're going to go into more detail on in a few weeks at the Investor Day. But a couple of highlights. From an adjusted EBITDA perspective, that last 50 basis points of margin expansion that we would expect to see is going to be attributable to 2 factors. Number one, having a full year of the Oerlikon acquisition and being able to achieve those synergies is going to be a significant piece of improving that margin from 12.3% to 12.8%.

The other thing that we expect that we intoned earlier in today's materials is we are seeing signs that commodity costs are beginning to come down. So our view at this point is that they have likely peaked. And even though we will give some of that back to the customers as the cost comes down, it will be a nice margin tailwind for us.

Those are the primary drivers of the improvements in the profit margin. From a cash flow perspective, the Oerlikon business will generate attractive cash flow next year after we get past the integration expenses and the transaction costs that'll be included in our adjusted free cash flow this year. We also expect the CapEx in that business to subside to a more normal level next year, so that'll be a contributor. And then the base business, we expect to improve basically 2 reasons. Number one, profits will continue to grow, and that'll flow through to cash flow. But also due to the fact that we think the top line is going to be relatively consistent going into next year, we would not expect to see a meaningful investment in working capital, which we've had for last few years. So the combination of both of those factors will also help to drive a higher free cash flow. And then I think those are the highlights. And as I mentioned, we're going to talk more about that in a few weeks and give a little more color there.

Yes, that's very, very helpful. And then a very quick clarification. Your slide on seasonality on Page 14, is it essentially just saying, look, this is the timing of the closing of the acquisition, and therefore, you get a little more contribution post either March 1, or is there anything else in there for either in the production downtime or destocking of some of the U.S. trucks?

No, the other -- it is absolutely trying to make sure that everyone noticed the 10 months, but also just to highlight that, typically, the first and the fourth quarter for us are lower from a sales perspective and lower from a margin perspective. So just wanting to make sure that everyone recognizes, even without the Oerlikon business, the base business usually follows that curve where profits -- profit margins and sales peak in the middle of the year in the second and third quarter, largely as a result of the normal production schedule. It's not intended to intone any significant demand changes in either of those quarters.

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

I mean, we spent a bunch of time on Commercial Vehicle. But if I look at Off-Highway, it also looks like margins were maybe a little bit weaker than I thought and certainly versus the past couple of quarters. It looks like the flow-through on volume was still strong. So the issues you talked about in terms of commodities and some of the performance, is that also what sort of drove that in the Off-Highway segment?

No. Actually, it's a little more of the former, Joe. We -- our highest recovery ratios in the business are in our heavy vehicle segments from a commodities perspective. So even if we recover most of it, there is a bit of margin pressure. But I would note that some of the phenomenons that Jim was mentioning that we experienced within the Commercial Vehicle space were also present in Off-Highway. There continues to be a lot of costs that we do incur to make sure that we're delivering and meeting the customers' needs and delivering on time. So I would say, it's a combination of both of those factors and the normal seasonality that you would see from the -- from that business in the end of the year. Those are really the drivers of the performance in Off-Highway.

As we look to next year, obviously, we've said that, that market, we think, is going to continue to remain strong, and there's further opportunity for margin expansion, largely coming from the benefit of the Oerlikon acquisition.

Okay. And Jim, you've -- and I'm sure we'll hear more about this at the Analyst Day, but you've talked a lot about and made acquisitions to sort of participate in the electrification of some of the heavier machines in Off-Highway and Commercial Vehicle. There's also been a lot of increased industry talk on electrifying pickups. And I guess, just given your business, I figured it'd be a good timing to ask what you sort of see going on? What some of the discussions with the customers are like? And how do you see that evolving on the light-duty pickup side?

Yes, thank you, Joe, for the question, and thank you for the foresight but we will talk about this more in the conference coming up. But the punchline to it is, there's not one of our segments because you know very, very well we go from the smallest recreational vehicle up to the largest underground mining, there's not one of our segments -- and that would just by our definition could be directionally 12 different segments. There's not one of our segments that we're not participating in one form or another in electrification. So I kind of keep it on a kind of a broad level. But just suffice it to say that you're talking specifically in the light-duty area, yes, there too, there's plenty of activity, let's put it that way.

And is it -- I mean, how would you classify those talks? Is it sort of exploratory in terms of what your capabilities are, in terms of what an overall program could look like? Or I mean, like, just where are we in sort of the normal, I guess, kind of the cadence of...?

I would say it's -- I think exploratory is a pretty good question. I'd say it's a little bit beyond that. I mean, if you think about some of the companies, these companies like Workhorse, for example, you could argue that in that segment, there's kind of some of those maybe more of the boutique type of companies have been talking about and doing it for a bit of time. But there's all of the other OEMs that certainly are going to ensure that they're ready for the future with that as the consumer demand and pull-through is coming, and they will. So we're ready for it, as I often like to say. We positioned the company last year to be energy-source agnostic. So we're okay if they go with the internal combustion engine, if they go with full electric or they go hybrid in between. But yes, there's certainly plenty of activity. But it is like we've always said, it's further out in the cycle.

Your next question comes from the line of Colin Langan with UBS.

Any color on Power Technologies, as I think it was one of the only segments we haven't talked about so for? The margins there seem to have been drifting down. What is sort of the outlook for that expecting? And how should we think about that kind of going forward?

Sure. It was a particularly soft year from a margin perspective in Power Technologies, principally for 2 reasons. Number one, that is the segment with the lowest recovery ratio on commodities, recovering less than half as they're further down the supply chain in a number of those systems. The second factor relates to the dieselgate phenomena that we are seeing in Europe. We are predominantly supplying ceiling and thermal solutions for gasoline engines. And when dieselgate occurred and demand for diesels went down, we had to take more of our capacity to fill OE orders on a lot of those products, and at the sacrifice of the aftermarket. So sales still remain high, but our product mix deteriorated because we supplied more on a proportional basis to OE versus the aftermarket. We took some actions earlier last year to add some capacity in select places, and we feel like we're in a better position to fill that demand moving into this year. And we think margins will improve as a function of the product mix getting a bit better. But it was really a mix of the product mix issue as well as the commodity costs that caused the lower margins there. But we see an opportunity for that business to get better in time and get closer to the margins that we've recognized in the past.

Got it. And on Oerlikon, I think you originally guided to about $40 million in synergies. I mean, are all of those going to be in 2020? Are some of them baked into the kind of 3 quarters of this year?

Yes, the -- of the $40 million, $10 million is included in the $100 million number for this year. So that's what we've underwrote this year. Obviously, we will -- as we did with Brevini, get in and identify the cost opportunities as quickly as possible. But what we're calling for right now is that the balance or the majority of that next $30 million will be recognized next year in 2020, and that ends up being a meaningful contributor to the overall margin expansion next year.

Got it. And then just lastly, any color on tax? I think this year, it looks like it ended at more like a 26% rate, I'm not sure we're hitting that rate. And then I think the guidance is 28%, and that's still a fairly high tax rate. Is there any potential to bring that down over time?

Yes, I think what we saw this year may be a bit more normal moving forward. It's really a function of jurisdictional mix and where we're recognizing profits, where we're a taxpayer and where the rates are in those regions.

So 26% would be the normal rate?

Yes, I think moving forward, we'll probably be closer to that. And then we'll probably give some color on that in a few weeks when we talk about the next couple of years.

And James your line is open.

Just on Oerlikon, going back there, I mean, can you discuss their current backlog and maybe just revisit the synergy actions that get you to the $40 million by the end of next year? I mean, you clearly had success with the Brevini acquisition, raising those targets. There are some parallels with Oerlikon. So just curious what your perspective is there?

Sure. From a cost synergy perspective, when we announced the transaction, we mentioned that we see the opportunities in a few areas. First is within the supply-chain. So our purchasing leverage increases significantly when the businesses are combined. We're buying many of the same forgings and castings for our machine operations as the Oerlikon business is, so that's a big piece of the cost opportunity that we see there. The same was true with the Brevini acquisition.

The second area is clearly around our manufacturing operations. This provides us an opportunity to have some of the equipment that is fungible to be more utilized to make us more efficient across these areas and the potential opportunities to utilize our equipment more efficiently.

And then finally, obviously, there are areas that are duplicative in the business in the back office that we'll be able to address to be more efficient as well too. So those are kind of the primary drivers. We have mentioned that this is a very well-run business, and we see the $40 million as being the costs that can only be achieved by putting them together. But we'll continue to strive for more than that and certainly hope to get as much as we possibly can.

From a backlog perspective, as we get into the business and start to operate, it will likely look to adjust our backlog to reflect the Oerlikon, but we typically do that on an annual basis. I will tell you that they clearly have been growing the business in the past couple of years, and we see that growth continuing as a combination of new programs that they have won and new content that they're delivering in increment of what they have today. So we are excited to have our backlog augmented by what they've accomplished.

Okay. And then I imagine you'll address us in full next month, but just on electrification, can you talk about the key programs or prototype applications that you're working on right now? How are things progressing? And now that you have TM4 completely in-house, how are you leveraging this business? What's the progress there, yes?

Yes, I mean, there's a lot to talk about, and it's one of the big reasons that we're getting everybody -- inviting everyone to join us in a few weeks. But just as a preview, the integration of both the TM4 business as well as the SME acquisition we completed last month is going very well. We see excellent opportunities to integrate these electrodynamic components inside of e-Propulsion systems, whether those are drive units, wheel-end drives or electric axles for our customers. And in a few weeks, we're going to walk through a lot of that opportunity, help to dimension what we think the growth opportunity is in the coming years and preview some of that technology. So I don't want to get too far ahead of what we hope to do in a few weeks here.

Understood. And just a housekeeping question. What drove the higher equity income in the quarter? Was there just timing involved with your DDAC JV? Or is there some strength to point out there?

Yes, DDAC was the primary driver. The -- while the sales in that business remain relatively flat, the earnings improved and the cost structure improved, which drove higher earnings out of that venture -- joint venture in China.

And your final question comes from the line of Rajat Gupta with JPMorgan.

This is Rajat on for Ryan. On your $40 million commodity cost headwind for 2019, what's the assumption there in terms of what you're expecting for purchase price? I mean, is there -- is it assuming current spot prices? Or is there some of your -- is there some expansion expected later in the year? Or just kind of trying to understand, like, how much conservatism was baked into that.

Yes, it's a combination of both. So we certainly look at where commodities have come so far this year in the first 6 weeks of the year, but we also look at the forward. I would say that we've indicated if things continue to move in the direction that they have, there could be some opportunity for us on an overall basis. But we'll continue to monitor that closely. And at the end of the first quarter, when we recalibrate for the balance of the year, we'll provide an update on how that's progressing.

Understood. Just another question on free cash flow margin. You talked about the 5% potential in 2020. You highlighted the EBITDA margin expansion and working capital, but could you give us some more color on CapEx as to how do you see that trending going into 2020 and maybe beyond?

Yes, we've been pretty clear that we expect to operate around 4% CapEx as a percentage of sales on a go-forward basis. At that level, with all those other things I mentioned, we're able to get to that target. So you could basically assume that cash from operations would be about 9%, CapEx would be about 4%. And that's how we get to the 5% that we're expecting.

Got it. One last one for me. On Slide 20, it seems you have the APAC production outlook, fairly decent size going into '19. Is that something that you're seeing on the ground? Or because in the -- I think IHS and third parties have a little bit more of a conservative outlook. So just trying to get a sense of your visibility there.

Yes, that doesn't sound right to me. I'll have to go take a look. In general, we indicated where we expected APAC to be for the markets that are more important to us, which are the heavy-duty section. We expect that to be down next year. So medium- and heavy-duty trucks, we have got down high single digits. So the other markets, like light vehicle, being up is less relevant for us. So I would say if we're really affected, we expect to be down next year.

Okay. With that, this is Jim. I'll close. Thank you again, everybody, for taking the time to spend some time with us. From a CEO's chair, I mean, you hope that and you plan to, for sure, be in a position at the end of the year to do a recap and you're able to say things such as record sales, record profits, record margins, increased free cash flow by over 50%, scoreboard doesn't lie. So I want to thank my entire team, our entire team for everything they've done as well as our customers.

And while I'm on the customer front, you think about it for a minute, we continue to do this with new organic growth. And thinking even forward, we'll go and looks like in 2019 will be the third consecutive year of over -- or nearly $1 billion of new revenue. And while at the same time, we completely filled out our electrification e-Propulsion portfolio from high-voltage motors to lower-voltage motors and all of the inverters and everything else associated with being energy-source agnostic, as I mentioned a little bit earlier. As running a business, we can all appreciate this it's all about do what you say, and do what -- do what you say, and then go execute on it. We said that we were going to grow the business a few years ago. We said we're going to fill in the white space a few years ago through acquisitions, through bolt-on and appropriate boutique acquisitions. We continue to do that.

We look forward to a really exciting 2019. Look forward to seeing each of you, hopefully, at the Investor Conference next month, and thank you very much for your time today.

Thank you, again, for joining today's call. This concludes today's webcast. You may now disconnect.