Lear Corporation (LEA) Earnings Call Transcript & Summary

Okay. And I think we are live as we continue the CS Global Industrials Conference. I'm Dan Levy. I lead U.S. autos research coverage at Crédit Suisse. As we continue the autos track of the conference, very pleased to have -- join us Lear Corporation, Ray Scott, CEO; Jason Cardew, CFO. In the background -- I don't think you see them but also is Alicia Davis, who leads Lear's IR efforts. And so I think we have a series of questions and that we'll try to get through and I think should be a good update. So with that, Ray and Jason, thank you so much.

Yes. Thanks for having us, Dan.

So I think most people are familiar with the Lear story. Maybe Ray, the best place to get started is if you want to just give us a general update on the state of the business, just a quick run through some opening remarks, please.

Yes. Thanks. Obviously, it was a very challenging year for everybody in the whole industry. But I can tell you I couldn't be more proud of the team in how we worked through our different levels of prioritizing what was key: one, protecting people, getting our plants back up and running from an efficiency standpoint; liquidity, making sure in a lot of cases, we talked about preparing for the worst and hoping for the best. I think we did an excellent job of really carefully managing through our cost in protecting liquidity. And obviously, we're in a much stronger position today. And then I think at the same time focusing on growth opportunities. One thing that we talked about -- and Jason and I have been through a number of different challenging situations in our tenure at Lear, but making sure we kept our eyes open on areas of growth and areas that we needed to focus on. And I think that's something that's very important. So when I reflect back -- and I've talked to the employees about this, and I believe it really galvanized one heck of a team. And I'm so proud. We lean on each other. We trust each other. I think that's important. We talk about the team and how important the team is to what we do every day. We're just a stronger team. I can't tell you the stories and what we've been able to accomplish internally in this company, and that gives me a tremendous amount of confidence as we move forward. I think equally as important, staying focused on the 2 business segments. We've done a nice job of protecting and building a moat around our seat business. And I think there are some opportunities for us to continue to strengthen that moat. And we talk about widening that moat and deepening that moat in very selective areas, and I'll talk a little bit about that. And I think equally as important in the E-Systems segment, we've seen stability in the E-Systems. We'll talk a little bit more about what the team's doing, but we have stability there. We have one heck of a team that continues to grow that business, and we've done a nice job of really defining where we have a right to win. And narrowing that scope, deemphasizing some parts of the business that we don't believe the capital was being applied appropriately given where we could grow our business, we redeployed that in areas that are already reaping benefits as far as growth. And so done a nice job overall. I kind of see it more as a silver lining. It was a very challenging year, but there are some things that were reinforced. I believe that the continuation of focus and operational excellence is key. We're looking at -- if we are going to invest, those will be areas that we invest. If we invest in E-Systems, it would be in the connectors business. And Seating continue to build and strengthen that moat that I've talked about. And most recently, we just announced -- we reinstated a dividend. And that's really to signal the confidence that we have in our business. If you think over a period of time, I think from 2014 to '19, we generated $5 billion of free cash flow. That's our focus. We want to continue to focus on free cash flow, continue to have the conversations with our Board as there's more clarity on what we can do with the dividend going forward. But more important, focused on investing back in the business as far as the operations, M&A -- no transformational M&As. We see that there's opportunities that we've done in the past where tuck-ins that have been really nice tuck-ins where we've been able to benefit and continue to grow and differentiate both business segments. And then the rest to the shareholders, and so we haven't changed our beliefs in how we're moving forward, but I'll tell you how -- what has happened is it just reinforced the need to change and make sure we're driving those things that differentiate the company. So again, tough year but very optimistic, very positive on what we've been able to reinforce as far as the strategy and very confident we're going to be able to deliver and execute on some of the things that we talked about.

Good. Let's drill down and give maybe a more near-term update, what we're seeing in the fourth quarter. Jason, maybe you can give us a sense on how things are shaping up. A question we've been asking everyone is could you give us a status update on the supply chain disruptions we've seen, be it in Mexico? Are you seeing anything incremental in Europe? And I think your last update, you noted on the fourth quarter result that if -- to the extent there are no disruptions, financial results could be near the high end of the range. Maybe just give a sense of how much the disruption or supply chain inefficiency is currently embedded in your guidance at the moment.

Yes. Dan, we're pleasantly surprised on how the fourth quarter has progressed, and we did protect for some level of disruption. And while there have been some modest disruptions, it's been more you lose a shift of production or maybe some overtime scheduled for a weekend that the customer is not able to run but nothing meaningful thus far. We do have 3 or 4 weeks left to go in the quarter. But as we sit here today, we certainly favor revenue at the high end of the guidance range, maybe even slightly above that with the weakening U.S. dollar that's helping the revenue line a bit as well. On the margin side, we talked about mid-7% in both segments at the high end of the revenue range, and we see that sort of playing out, as expected here in the fourth quarter. So the supply chain issues remain. Certainly, every day is a challenge. And it's not -- it's far from business as usual, a lot of focus by both Seating and E-Systems operating teams on supply chain management and just protecting customer production schedules. So they've done a great job of navigating those challenging times. And so we feel pretty good about how the fourth quarter is going to play out. And it's a great quarter for growth for us. We expect the company overall to grow about 7 points above the market and with E-Systems well above 10% and Seating growing at about 5 points above the market, so a really strong finish to the year for us overall.

Good. That last point, I think, is a helpful pivot to, I think, another topic that's been very relevant for investors, and that's on growth as a whole. I think if I zoom out and I look at your years of outgrowth, this, I believe, will end up being your best year of outgrowth since 2017. 2018 and 2019 were a little more sluggish relative to what you've done in the past. And I think it's also a little more consistent with the type of the longer-term outgrowth targets that you've laid out. So maybe you could just help us understand, what is it that has driven this outgrowth? Is it really that just finally the business were -- that you're on, those have launched? Is it better mix? Is it initiatives on the backlog? Help provide us with some context on that and what we can extrapolate going forward.

Yes. Dan, it's both. One, I think, in Seating, if you look at each segment differently in respect to the growth; one, in Seating, we've done a nice job. We're the largest supplier of CUV/SUV seating. So we've positioned ourselves nicely with some of the product mix in -- particularly on the CUV/SUVs. And in addition to that, we are going through some product cycle changeovers right now. So you think about the GM truck program, the Explorer, the Daimler business right now. So we are seeing some headwinds relative to just the cycle changeover. And I think heading into the fourth quarter into next year, you'll see some tailwinds in respect to Seating. And so albeit it's a little bit lower than we expect, we do see some tailwinds that will take the growth up in Seating. And I think it's a combination. One, in Seating, we've done a nice job of investing in the business. We've talked about our vertical integration that does differentiate and allow us to really win business in the luxury market, and we are the leading luxury supplier of seats and that's helped us. And so the business from a perspective of investing is now helping us grow. And like I said, when the product cycles start to mature a little bit, you can see some tailwinds in respect to Seating. In E-Systems, what's really nice and what we're seeing is this electrification connectivity growth. And we continue to win in the traditional sense on E-Systems, but we're starting to see momentum now within electrification and connectivity. And so we're launching some programs right now and have won business in electrification that are focused in those areas. And so we're going to continue to see those 2 different growth areas. But I think in E-Systems, this last quarter, it was -- 12% was their growth over market. So our targets have been 6-plus percent. We're well above that. In Seating, it's 4-plus percent, and we're doing a nice job of growing above that. And so I see that continuing as we continue to differentiate ourselves in Seating and then also the evolution of electric vehicles and how we're positioned with power electronics to continue to grow.

Good. So a combination of share and backlog. Let's drill down further on the segments themselves. I think that's a helpful segue. And you've talked about $700 million of Conquest wins year-to-date in Seating. There's opportunities going into next year. Help us understand your trends in market share because you've obviously grown the market share, but I think that the target is 27%. Your last update was 23%. So what's the trends on market share? And what's your view on expanding that?

Yes. Well, we've done a nice job over the last several years of growing from 18% to 23%. And our target's 28%. And given the history and what we've done and how we've invested, I do believe that that's going to continue without question. We've had a very good year this year in Conquest wins. And I do believe it's because of the investments we've put in place. When you talk about the capital in this operational excellence, we continue to invest in our business and continue to be very selective on how we're creating value for our customers. And in Seating, there's -- we're the most vertically integrated seat company in the world. And that, without question, helps us get into different areas like the design studios or engineering. And being sourced just doesn't come from purchasing. You have to hit the different functional areas within an OE. And having that expertise where you understand the materials and the manufacturability of leather or textiles and how you execute those different levels of components within the seat really differentiates you and allow you to gain access into a customer. And I do believe it's one of the reasons why we are the premier luxury supplier of seats, and I do believe it's why we position ourselves so well on CUV/SUVs. And going forward, I think it's going to be even more important when we talk about these customer features and how you can differentiate and create value not just for the OEs but the end consumers. You think about ConfigurE+, and we've talked about this, and I think this is a very important way to distinguish how we're focused on innovation and technology. I understand there's rail systems and there have been systems where seats move along rails, but what's unique about what we did is we built a cassette that is a modular cassette that goes into a rail system that's powered by the rail system. So you no longer have wire harnesses that hang down, creating an enormous amount of flexibility for reconfigurability within the vehicle, not just for seating but for other applications. In today's world, when you talk about moving product, moving product around with cargo bands, having that reconfigurability is essential. And so those type of innovation and technology -- and when we talk about intuitive seating and why it's so important to embed technology into a seat where you actually can create value for your customer and we always -- we talk about how we're designing seats that optimize the comfort within the seat for heat and cool. Well, right now, there's so much draw on the vehicle in the interior space for the battery that you actually create efficiencies for battery usage, battery time, those type of things that really are value for our customers. And so the way we differentiate ourselves is by allowing technology which is going to be embedded into the seat and allows us to get into areas. We're into design studios, and that's a great place to be. When you're in with a rail system that's configurable early on, 5 years before production, to talk about what you can do as far as creating value both in the intuitive seat system and the reconfigurability area, there's a halo effect. And so I believe that those type of things that we put in place and then that operational excellence that we're going to stay steadfast and invest on creates opportunities for us. And I think that's been part of the momentum that we've seen in Seating. I think that's going to continue. I think you have to stay focused on technology because the world is changing. And the quicker you embed that technology to create a value proposition for your customer across design, engineering, purchasing and manufacturing for your OE, the better position you're in. So yes, you can tell I'm a little bit excited because I think we're doing some great things and we have more announcements, hopefully have an Investor Day here where we can really show some of the things that we're doing because it is very impressive. And you're creating value for your customers that allow you to gain and grow your business.

That's helpful. And I think that maybe gives some color on what you -- what's driven these wins. So it sounds like it's a combination of both operational excellence, vertical integration. I mean if you had to pick one thing that's been more pronounced in driving these share gains, is it the tech offering or the vertical integration or just -- it's a little bit of everything and overall good package, all in?

Well, you know what, Dan, I think it's -- I think the operational excellence is your ticket in. I mean it's almost in some respects a given. You have to perform and you have to continue to perform, and that's -- we all work in a very challenging environment where you guys continue to invest in the operations. This Industry 4.0 is coming at us fast. We're making some very smart investments in Industry 4.0 that are separating us and continuing to create value, but I think that's the ticket in. Then I think when you -- if you can separate yourself, then you're not just a JIT supplier. That's a value-added assembly and you're going to quote, which is fine. We create nice cash. But the way you expand your margin and we think about in terms of multiple effect on the stock is the margin expansion is going to come through this value creation within content and the wow features for the customer. And having that gets you into -- like I said, we're in the studios with the clients, and that's where you want to be. That's where you can really drive features and content that's not just from an OE perspective a customer but end consumers. End consumers want these type of features. And like I said, ConfigurE+, to me, is a perfect example. It's $100 million in business. It makes really good returns, and I think it's something that is going to continue to expand and grow. And it's one of those very unique -- we own the patents. It's very unique to Lear. Same thing with the intuitive seat, where we have the heat and cool that we're working on how we can optimize the cabin, which takes less draw on the battery, makes more efficient battery usage longer term when we're starting to transition to an EV world, very unique technology and products. But I would say that the ticket is operational excellence. You got to perform every single day, and then having that reputation gets you into those doors.

Jason, maybe you could comment. On all of the programs that have been won, when should we expect that inflection to hit the revenue line? And what's the margin profile on that -- on all those new business wins? Is it consistent or accretive?

Yes. So the $700 million of Conquest awards that we talked about earlier in the year and we had a nice Conquest win at the end of last year in addition to that, those programs really start to launch at the very end of 2022. So most of them have your traditional 2- to 3-year engineering development cycle attached to them. And that's a net new business award for us. So there are other smaller programs that we've lost and won. So there's really 3 key programs within that, that comprise the bulk of that Conquest award. There's one with the North America OEM. It's a midsize pickup truck platform. That launch is at the end of '22. It's pretty well vertically integrated. So we have structures, JIT, and cut and sew. So that's going to favor a little bit the higher end of our operating margin range, which we've talked about 7.5% to 8.5% in Seating. The other 2 programs, one's with a European OEM with production in Europe and China. And then the last is an Asian OEM with production in North America and China. Those are a little bit less vertically integrated, but in one of those, we have leather in addition to JIT and cut and sew. And so that may be sort of in the middle of that range and then the last one maybe on the lower end of that range because it's just JIT and cut and sew. So really, ultimately, for us, it's the level of vertical integration that's going to determine the margin. The return profile, as we look at it, ROIC, is very similar in all 3 of those programs and in line with our business overall today.

Good. Let's pivot to E-Systems. And maybe you could just -- Ray and Jason, both of you, just walk through some of the initiatives that you've laid out to hit 10%. Could you maybe quantify the progress you made towards your goal of hitting 10%, your -- the 10% mix of Ts and Cs? And then what about the progress of improving business on -- and improving margins on the existing awards you have -- the existing business you have today? So can you just give us a rundown of how things have gone in the E-Systems margin recovery story?

Yes. I'll go ahead and start, Jason. One, I'm incredibly pleasantly surprised how quickly we've been able to stabilize that business. And fortunately, I guess, Jason and I have been through a number of different situations where we've had to improve margins in the business segments. Remember back in E-Systems, back in 2007, '08 when it lost money and we really turned that business around, obviously did a nice job growing that business and really driving the margin profile. And very similar, the experience that Jason I had in Seating back in 2012 and '13 when the margins dropped 250 basis points and we were able to not only stabilize the business but take it to the highest levels we've seen in Seating. And so very similar plan. When we broke down what was going on in E-Systems, it was, one, we established one heck of a team. I'd tell you we have the best team we've ever had in E-Systems. It was a combination of outside hires that were very good and skilled at some of the areas that we want to grow and really improve from an operational perspective, along with and complemented the team with inside Lear employees that were very good at building teams and really understanding what we want to do as far as return on invested capital. So really happy with the team, doing a great job, and they've really come around as far as -- in a quick period of time to establish what we're focused on. The second part of that is we talked about the vertical integration. Very similar to what we did in Seating, that is a really good opportunity for us. One thing that -- I think we did a nice job in wiring. And then obviously, the wiring business has come down in margin -- in the margin profile, but Ts and Cs is an area that we absolutely have a right to win. And it's very different today than it was 5 years ago. And that door is open and we're getting significant opportunities and higher-margin profiles within Ts and Cs. So that's moving along quickly. And I think the -- overall, we talked about really honing in and being very selective on what we're going to -- and where we're going to invest capital. And we have that in place now. And so really pleased with what's going on. I'm going to -- I know we're going to have an Investor Day here that we're going to show exactly where we're focused, what we're deemphasizing, but what we're really growing and how we're growing it and show you some of the technologies. And I'll wait to kind of share some of those thoughts. But if you want to talk a little bit about margins?

Yes. I think in addition to building the right team, it was reestablishing the processes there that -- sort of replicating what we did in Seating and having a focus on ROIC by program, by product segment, by customer and by region. And every program has to earn a return in excess of our cost of capital and really building a rigor around that process. And we've identified some of the areas where our margins were lagging, particularly with some of the new customers we brought into the mix. And while, on the one hand, we're excited about improving the customer diversification, there was a margin headwind that came with that. So we -- as Ray said, we're already making progress in addressing that. In particular, I think about our Asia wire business, and that was an area where we've added some new customers that was dilutive to margins. But we've seen over the last 12 to 18 months, the operating margins in that business improve by over 100 basis points. That's 20% of the total E-Systems revenue. So we've seen about a 20 basis point margin improvement on E-Systems overall just through the efforts by the team on that part of the business. I think that -- coupled with the restructuring that we put in place are probably the 2 most meaningful areas of progress in addition to what Ray talked about in terms of the vertical integration growth there. And I think we have a real opportunity to further build some momentum in the connection systems business through some targeted M&A. We have some smaller deals in the pipeline that we're working on and, I think, will further strengthen the portfolio over time as well.

Good. Let's -- let me ask one more follow-up. And you're talking about electrification, but maybe give us a sense -- as you're looking in the electrification space with electronics, high voltage, give us a sense of what part of that better leverages your current product, your current footprint and what's maybe more incremental, what's newer to you. Probably a good question for Ray.

Yes. Just -- I guess the way we're looking at it is, one, from our perspective too, it's important to understand what business we're focused on and, like I said, what we're not. And what we are focused on, without question, we have a right to win within power distribution. We do a nice job with traditional wires and with high-power wires. We absolutely can compete with anyone, and we're doing a nice job of growing that business. I think the unique differences, as we shift into BEV and electric vehicles, the connector systems are key. And we have great capabilities around the grounding effects of technologies within the Ts and Cs. And we're seeing our ability to grow that business. And that is something that we see as we shift to more of 65% wiring, which would include about 10% Ts and Cs, a big driver to build leverage on our margin profile within the power distribution side of the business. In high power or electrification within power management, we have a right to play within battery management systems, onboard chargers and battery disconnect systems. And we're winning business today in each one of those different areas. And that combination -- what is very unique about E-Systems that I think it gets overlooked is there's a systems architecture capability. Now even though customers may source independent components, what we're able to do is draw on our knowledge of a system because we have the high power, we have the connector systems and we have the distribution systems, that we offer solutions that are much more efficient because we understand how the whole architecture comes together. And so where we've been able to win business, even though it might be independent within those components, it's because of our ability to understand and actually create a value proposition based on efficiencies, and that's cost and efficiency to the system because of our overall capabilities. And so I think just exposing that, using that for our benefit, being able to -- and I believe that's how Lear -- and we're going head-to-head with all the major competitors and winning business. We've won the battery disconnect system on the Hummer for General Motors. We've won Volkswagen's MEB platform for the battery cell connector header. We've won business on battery management systems with Volvo, with Geely. I mean the list goes on and on, on who we're winning with. And we talked about being very selective. We're not trying to be everything to everybody. There's very selective customers that we've -- we're trying to position ourselves to be successful on, and we're spending our capital wisely in areas that we know we can be successful long term. And so I am really positive on how we're positioning ourselves, how we've looked at the products that we're playing and where we can win and how we're going to grow that business. And Jason mentioned -- we talked a little bit about M&A. We are looking at smaller tuck-ins within the connector business. I think there are some opportunities for us. There are some partners that we can actually partner with that can continue to accelerate our growth. And so there's continued opportunities not just organically but we see inorganically to accelerate our growth within the E-Systems business.

Good. Let's wrap up. I know we're getting close to time. If we can maybe ask a question around the early look at 2021 and then a question around capital allocation. Jason, obviously, we know 3Q margins were solid. Maybe give us a sense on what we can extrapolate from the third quarter into 2021. And maybe you can highlight some of the discrete items, what type of incremental margin you'd look at -- look for on volume recovery, what the full year restructuring benefit looks like, COVID costs, incremental reversal of austerity measures, maybe just some early parameters on 2021 to the extent possible.

As we were thinking about our plan for next year, we're really excited about kind of second half next year, '22. At some point in time, there's going to be a significant recovery in industry volumes. Whether that happens early next year, late next year or beyond, that is difficult to pin down. But if you use IHS sort of as a barometer, I think they have the market up 13% next year. And if you look at that on a region-by-region basis, it's 15% or 16% on a Lear sales-weighted basis. And I think we can outgrow the market next year by 4 to 5 points. Their projection may be a bit optimistic given all the uncertainty, and I think we'll have a pretty wide range. And I think volumes ultimately will be the biggest factor impacting our operating margins for next year. But that's sort of how we're thinking about the top line heading into next year. In terms of some of those discrete items that will impact operating margins, restructuring, we're expecting about $55 million of year-over-year savings. So that will be a nice tailwind for us. We think that COVID costs will continue, but that, netted against the -- some of the austerity measures, it's going to be a modest impact year-over-year, maybe slightly positive for us as we get some recovery for some of that ongoing cost as well. We do see a bit of a headwind on engineering costs in E-Systems as we continue to build that -- the backlog, particularly, as Ray mentioned, in power electronics and electrification. Generally, we're winning a lot of new business. So those are sort of the main kind of puts and takes on the operating margins as we look out to next year. And we'll obviously be giving the formal guidance on our fourth quarter earnings call at the end of January, and I think we'll learn a lot between now and then. But I think as you look out over the next 18 months, we're really confident about the trajectory of the business. I think both business segments are operating at a really high level right now. We have a nice foundation that we can build off of. And I think we're looking at an industry that's in a bit of a cyclical trough right now, maybe brought on by the pandemic, but we're down -- industry volumes are down to, what, 23% since the peak in 2017. I think that's a nice backdrop to set up a nice run in the auto space over the next 3 or 4 years.

And I think just to clarify on one of those points, the way that we should interpret your backlog, that 4 to 5 points of outgrowth, I believe, you mentioned preliminarily, that's largely a reflection of backlog launching, correct, so that we can...

It's not just backlog. Some of it is the favorable mix as well. As Ray talked about, we're just at the tail end of that changeover cycle in our Seating business, and that will help a little bit specifically in Seating with the GM full-size trucks getting up to full volume, for example, in the Explorer and some of the other big platforms that have changed over. So we're through all of that, which was a bit of a headwind for us on growth relative to the market in 2018, '19 and '20, to a lesser extent. So we're through all that, and that helps a bit next year as well.

Good. Let's wrap up with one on capital allocation. And I think this is very relevant for investors because I think if I had to zoom out, in my opinion, say how your narrative has evolved over time, I think the story of Lear in the earlier part of the decade, pre-2017, was taking advantage of operating leverage, expanding margins but then really using that incremental free cash to bolster a very nice capital -- cash return story for investors via dividends and share buybacks. I think we're now looking at a period where you're trying to pivot on technology a little more. I mean help us understand as we think about your capital allocation framework more broadly. Has the capital allocation focus shifted to be, one, more focused on fostering organic growth rather than pushing for more share buybacks or dividends if we compare today versus where we were pre-2017?

Yes. I don't think our priorities have really changed at all. And we're going to invest in the business, first and foremost, through capital expenditures and engineering to support the backlog and support our competitive position in both segments and then look at tuck-in acquisitions, as Ray alluded to as well, to round out our capabilities there and maybe accelerate growth both in margins and the top line in both business segments. And -- but we're still very focused on returning excess cash to shareholders. That's why it was important for us to restart the dividend as soon as possible, and we did that in November. And so that really hasn't changed. We're going to continue returning excess cash to shareholders. And I think we're going to generate a lot of free cash flow over the next 5 years. Again, as the industry recovers and our business continues to perform well, we would see an ample opportunity to continue returning cash to shareholders, too.

Yes. I think it's just like the way Jason mentioned it and I -- to give you an example, I mean we acquired a small company. It was [ ASI ]. It was a company that helped us with logistics and manufacturing within our facilities and this continuation of investing in the operations. Like I said, Dan, that's the ticket. That's -- you have to maintain and strengthen that. And what we talk about with making sure we deepen and widen our moat, we have a good operational excellence reputation that we do need technology and innovation to continue to drive the Industry 4.0 mentality and thinking. So they're going to be small. There's no transformational needs. Both business segments are in very good position. There's areas we can strengthen that if the opportunity presents itself that we should -- we'll consider but nothing transformational. These are tuck-in things that will just continue to grow our margins. And that's what we're focused on and, to Jason's point, continue to generate more free cash flow.

Good. Well, we're over time. So I want to thank you for being so generous with your time and for helping us to better understand the Lear narratives.

Yes. Thanks, Dan.

Thanks, Dan.

Thank you, Ray. Thank you, Jason. And thank you, Alicia and the IR team.

Yes. Thanks.

Good. Okay. OpenExchange, we can now close the call.