Lear Corporation (LEA) Earnings Call Transcript & Summary

Hi. Good morning, and good afternoon. I'm Ryan Brinkman, the U.S. automotive equity research analyst here at JPMorgan. Thanks for joining us for the JPMorgan Tech Auto Forum. Very happy to get going with our next presentation, which is Lear Corporation. And we have with us here today, Ray Scott, President and CEO -- and to the left of my screen; and Jason Cardew, Senior Vice President and Chief Financial Officer on the right. And Ray and Jason, thanks so much for being here. We appreciate it.

Yes. Thanks, Ryan. Good seeing you.

Thanks, Ryan.

Absolutely.

I bet not face-to-face, but good seeing you.

Yes. We'll get there. I think -- so I am here in Vegas and I think one of the -- GMs not there. They're virtually presenting, but certainly a lot of buzz today relative to the Chevrolet Silverado EV, right? And just given all the attention paid to the Rivian IPO and the 200,000 preorders for the Lighting and then doubling assembly capacity and then doubling it again and whatnot. A lot of excitement around this pickup truck, EV space. And I know the Silverado EV, it's just on a different architecture than the internal combustion Silverado that I know that you supply the seats for. Can you say whether you'll be supplying seats for the Silverado EV also? And any thoughts on that product?

Yes, Ryan, we're excited to be the seat supplier for the Chevrolet Silverado EV. And obviously, like you mentioned, Mary, just a few hours ago, just revealed. It's one good-looking truck, that's for sure. And not only are we the providing -- this is -- the seats for the Chevrolet Silverado EV, but we're also the seat supplier for the GMC Hummer EV, the pickup in the GMC Hummer EV SUV. So the seats for these programs will be assembled in our Lear's new energy-efficient jet facility, which we're building in Detroit, Michigan. And we broke ground on a new plant back in October, and we're expecting to open the facility in middle of 2022. And once production of the plant is fully ramped, we estimate hundreds of new jobs will be created. So not just focused on the product side, but what we can do to give back to the communities where we live and work and particularly in the city of Detroit. So we're very proud to be the seat supplier of those programs. And in addition to the Lear seats, I think, talked a little bit about being named Automotive News PACE Award winner for our battery disconnect unit. We'll be supplying that in the Chevrolet Silverado EV. And our battery disconnect unit is thermal management innovation, which helps improve efficiency to deliver the high performance that the customers are looking for with these new trucks. And the Lear content on the Chevrolet Silverado EV is a continuation of our strong relationship that we have with General Motors. And we've been named Supplier of the Year for the last 4 years, been supplier of the year with General Motors, 20x previously and have received numerous awards for innovation and technology. And I think the relationship that we have with General Motors is outstanding, continue to drive different innovation and technology with GM, and we couldn't be more proud to supply the seats. And I think also, Ryan, what we're extremely proud of is our positioning with EV. You think about the new electric vehicles with General Motors, but equally important, we've done a nice job of growing in the luxury segment with our EV customers. A couple of other products I want to mention is the Mercedes EQS. We'll be supplying the seats, the EQE, the BMW iX, the Porsche Taycan we do today. So we're doing a really nice job of positioning ourselves -- we've always been a leader in premium seating, but also positioning ourselves with premium luxury EV platforms, too. So I couldn't be more excited.

Yes. That's interesting. I didn't realize that you were doing the seats for the GMC Hummer EV. I had a chance to test drive that vehicle. The seats are part of the [ alert ]. It's a 2-tone aspect to them. And then the WTF mode, which is, I think, officially Watts To Freedom, right, that the haptics when it start -- the whole -- the seat starts to shake, right, when we've got accelerate, that's pretty cool that you had a hand in that.

Well, Ryan, we'll talk a little bit more about it, too, I'm sure, but we just -- the new technology and innovations are coming into the seat world are obviously a key part of how we're vertically integrating and how we're putting emphasis on those features because we actually believe that, that area of growth is going to continue to accelerate even beyond what is forecasted today. So yes, thanks for the feedback. It's always good to hear complements and good feedback on our seats.

That's great. And I wanted to ask about the Kongsberg acquisition. Recently, you announced that you purchased their automotive, their interior comfort systems or ICS business, right, that's focused on the seat heat and ventilation, massage, lumbar support. Previously, these features were offered in your seats, but maybe a bit more on like a Tier 2 basis and the acquisition, what brings those capabilities in-house, I think. Can you review the merits of that transaction, both in terms of the vertical integration generally, which seems to be like a continuation of the approach that you've long had with regard to Guilford Mills and Eagle Ottawa and whatnot, but also I'd be curious, if you see these particular product areas, heating, ventilation, massage, lumbar maybe particularly growthy or margin enhancing or somehow benefiting the go-to-market strategy? What made that attractive to you?

Yes. And the Kongsberg acquisition is, like you said, very consistent with other acquisitions we made in the past decade to really enhance our vertical integration capabilities and technologies and innovation. Like I said, I do believe the seat system is going to continue to grow with features and content as the customers demand it. And not just the OEMs, but I'm talking about the end consumers. With this acquisition, Lear will be the first seat manufacturer with thermal and adjustable comfort solutions in-house. This moves really to continue to enhance our margins and to extend our market leadership position in luxury and premium seating. This acquisition extends our capabilities in Comfort System Solutions, really further solidifying our position as the most vertically integrated seating supplier while also bringing additional priceable content to the offerings and to our customers from an offering perspective. It strengthens our ability to serve EV and luxury customers with high technology and innovation. It also provides comfort content to more high-volume segments. And so like I said, I do believe that over time, there's going to be much more higher emphasis in this area. I think that the thermal and adjustable comfort features are going to continue not just from a front seat perspective, are going to advance to the rear seats. I do believe it that as we start to learn how to design and incorporate much thinner profiles, much more efficient systems that's going to allow our customers to increase that option content throughout the vehicle. So I think the forecast today are light, I do believe that the growth rate is going to be much higher than what we're seeing today. I don't know, Jason?

Yes. I think we're really excited, Ryan, about this acquisition. We spent a lot of time studying the products that are produced by Kongsberg and we targeted them specifically. They weren't running a process. We went after that business very, very specifically. And it's a really attractive market. That's $2.5 billion to $3 billion market if you look at the 4 products that they produce and heat, vent, massage and lumbar. And they have a strong position in each of those, about 10% of the market overall for those 4 product categories. If you look at the growth potential, as Ray mentioned, IHS is calling for 2 percentage points of growth beyond industry volumes in these products, we think it's going to be much, much greater than that, driven by increased penetration even in the luxury segment where these are highly proliferated already, there's more room for growth there. There's more room to penetrate into other vehicle segments. And then penetrate into the rear seats where we're starting to see initial customer interest in that. Structurally, this is a business that has operating margins that are pretty similar to our seat business overall. But longer term, we see this as a key enabler to driving our seating margins beyond that historical 7.5% to 8.5% range, not just through this, but this is going to be one of the factors that will help us achieve that. It's a $300 million business today with 10% market share. I think this could be a business where we see that double or even more over the next number of years, perhaps through some additional inorganic opportunities we're looking at there. In near term, there's drivers of both growth and operating margin improvement. If you think about our reputation and our ability and operational excellence, we think we can lower the manufacturing cost in those Kongsberg plants once we finish the acquisition. We think there's a chance to also lower material costs through the purchasing leverage that we have. And then we have the best [ CTO BAV ] capabilities in seating and now being able to collaborate with Kongsberg engineers and our complete seat engineers, we think there's opportunity to take cost out that way as well. And then over the kind of the mid- to long-term, we can grow the Kongsberg sales by accessing customers that they didn't really have access to today, but leveraging the sales channels that we have in place and then offering a better value proposition to our customers if they source thermal comfort with Jet. So we think there's a chance that this also drives Jet market share growth and our goal of getting to 28% market share from 23% in complete seats today. This is going to be another factor that helps us achieve that. So you see growth kind of in the underlying products that come with the Kongsberg acquisition, but also growth opportunities in seating as well. And we're also working on a better integration of these components into a complete seat. So we think there's a chance to take components out, weighed out, cost out and that will then sort of facilitate future growth in these products as we're able to improve the performance and lower the cost we think that, that gives us a chance to bring these features to other vehicle segments longer term. So the end result here, I think, is going to be growth in this business, growth in our Jet business and expansion of margins over time as well.

Yes, that all sounds really very encouraging. Maybe just as a follow-up on it, I'd be curious how you see the vertical integration of [ seating and ] ventilation fitting within your previously outlined into thermal comfort with ClimateSense strategy. I mean, in recent years, you'd highlighted the opportunity to develop more personalized zonal approach to passenger comfort by creating sort of micro-climate zones within the vehicle, including via a more emphasis on heated and cooled seats and surfaces to help regulate the temperature of the individual passengers directly rather than the more -- less efficient approach of heating or cooling I guess, all of the ambient air in the cabin. And the gains, I think, are thought to be greatest when there's just one occupant in the vehicle and will all vehicles should see an efficiency improvement, just may have particular appeal for battery electric vehicles because of the ability to also increase range. How does the Kongsberg acquisition fit into this strategy? Will you look to offer into thermal comfort with vertically integrated products and part or in whole? Or maybe stick with your earlier development partner or potentially do both depending upon the customers' wishes. And can you leverage the Kongsberg heating technology to diversify your vertically integrated offerings into other product areas, such as, I don't know, heated steering wheels, floorboards, arm rest, door panels, cup holders, what do you think?

Yes, it's a good question. And why it was just a natural move for us with Kongsberg. There's -- in 2 family of products is an advanced intuitive platform, Ryan, that we've -- that provides many different premium luxury comfort, thermal and wellness features to the industry. I think what's key about this and why I say it's a natural extension and a natural next move for Lear Corporation, we talked about how we see the growth and priceable features accelerating across all high-volume segments, not just luxury, and it's somewhat limited even within luxury, but we see this expanding when you can solve some of the problems that exist today, but we've been working on this for over 8 years. So this isn't new to us. We've done a tremendous amount of work in-house to date. We thought, obviously, this is the time to extend our capabilities to really bring the Kongsberg family of adjustable in thermal comfort technologies in-house and really make it more a part in-house to our into technologies. But as you mentioned, it's amazing the efficiencies that are gained in thermal management of the occupancy in the electric vehicles is a tremendous opportunity to improve heating or cooling within the entire cabin. And this saves energy that can be used for the customer for longer range. I mean, you listen to every battery and they talk about we're going from [ 400 to 500 to 600 ], there's an opportunity for them to conserve energy and what is wasted in the vehicle today for using the battery or other features within the vehicle. So we believe there's a value proposition for our customers. We -- some of the suppliers provide active cooling solutions like Gentherm, others use heat, vent technologies like Kongsberg. And we're going to continue to work with either depending on the customers' needs or whether it's directed by component or specific suppliers that can bring thermal management innovation into the EV market. But we do believe that there's a better solution out there. And today, when you think about the systems, they're designed independently. Even though the components are stacked up within a jet assembler, the components are designed inefficiently as a system. We do believe that there's a much more efficient system that can create a value proposition for our customers. And we believe that individually from a component perspective, supplier perspective or individually as a just-in-time assembler, those problems can't be solved. And so the endgame for us is -- and we've been working on it is designing a solution that incorporates all the components. And everything impacts heat and cool or comfort features within the seat. It's just not a bag and a blower, it's going to be a combination of what you do with foam, how you look at proliferated trim covers, both leather and textile, what you do with the surfaces within the seat itself. And so there's going to be a system solution that solves for what is out there today. And then like we keep mentioning longer term, some of the reasons you can't offer these features in the rear seat, our packaging -- from a packaging criteria perspective, a cost perspective, a weight perspective. When you integrate these components into a system solution, you remove those constraints. And we believe that you'll have a much more efficient system. It will be designed appropriately. It'll be integrated into the packaging requirements by first row or second row or how the customers are looking to set up their specifications, but there's a tremendous opportunity. And so this is an area that we've been working on for some time. We think it's a natural progression that we now bring in these great engineers from Kongsberg, their great technology that Kongsberg has and continue with the work that we've done here at Lear Corporation. And we have unique patents already designed with the seat system that just helped incorporate these components much more efficiently.

Very interesting. And I wanted to ask you on your innovative ConfigurE+ technology, which is a solution for allowing vehicle seats to be, I guess, easily reconfigured, facing in different directions, for example, or a different changing number of seats per row while also allowing the seats to incorporate various electrical features such as powered reclining, heating and cooling or charging for smart devices, but without a mess of wiring. How does this product work exactly? What has been the interest from customers? What kind of vehicles do you expect ConfigurE+ will find its way into? And are there any competing products out there in the market that you're aware of? Do you have intellectual property protection?

Right now, we have 2 production contracts, and we have a development contract in the works right now with a major premium OE in Europe. And this ConfigurE+ is very unique. I don't know of anything in the market that's like it today. There's other features out there that you take the top of the seat, remove it and flip it and then you have what is more of a traditional setup where you move the seat along rails, but isn't powered. And so there's some traditional setups, but this is -- ConfigurE+ is a patent-protected seating system that was incredibly from a collaboration perspective, put together between our E-Systems group. And so it was both E-Systems and Seating. And you think about it, and we won another -- this was another great award, and I love all these innovation awards that we're getting, but it was another Automotive News PACE award winner in 2020 because of its uniqueness. And what it does is it has a cassette that allows -- if you think about the harnesses as you mentioned, Ryan, it's a tether, you're limited to how you can move a seat. Now you can have a seat that moves within its position within the vehicle, but you can't feed at some of the features that we're talking about with lumbars or power recliners or airbags or safety requirements with pretensioners or belts or even from an acknowledgment perspective of where that seat is located within the vehicle. The rail itself has incorporated the technology with connectors like Ts and Cs to allow it to connect within the cassette itself in any adjustable configuration within the vehicle. Very unique to the market. And I have not seen anything on the market that exists like that today. Like I said, there's cassettes that move [indiscernible] but I'll call it more of a dummy seat where you just manually can recline a seat or move a seat manually. But to give a seat the ability to move and reconfigure with everything I mentioned with airbags or safety pretensioners or understanding where that seat is locked, if it's locked appropriately from a safety perspective and give the driver the information, the appropriate information and also feed it options and features doesn't exist. And so we are seeing tremendous excitement. We've -- like I said, we have 2 development or we have 2 production contracts right now. And we have a number -- or we have one big, I'll call it, development program, but a number of other customers that are very interested in continuing with different developments contracts with them. I don't know, if you want to add a little bit.

Yes. I mean just -- this is another kind of key growth driver within Seating. The 2 contracts that Ray alluded to, it's about $100 million in revenue. We launched the first program last year, a second program launches next year. And we see this as certainly potentially a $500 million business over the next 5 or 6 years there's about $500 of content per vehicle if you don't build the structures that go on top of the rails and cassette system that Ray described and $1,000 or more on content if we do produce the structures as well. So I think this is just another great example of where we've innovated in seating. We've created something that is unique and its patent protected. It has a higher margin profile than our core Seating business does on a stand-alone basis. So it creates both revenue opportunities for us and margin opportunities longer term.

Interesting. Wanted to ask also on the announcement of a joint venture, majority owned by Lear and consolidated with Hu Lane Associate, Inc., a Taipei listed company to immediately bolster your vertical integration capabilities in the connector space. within E-Systems. Firstly, can you maybe highlight some of the differences between connectors and other E-Systems components in terms of the role that they play within electrical architecture, the relative technological sophistication, maybe margin potential? And then maybe to touch on whether there may be some margin benefits or go-to-market benefits for having that greater focus on connectors and more vertical integration. And then finally, do I recall the press release mentioning that the venture will be initially based in China, but with the ability to serve global customers? Do you foresee global operations for the venture also in terms of manufacturing or R&D? Or how are you thinking about that?

We've put significant emphasis on connectors. Connector is an integral part of the wiring harness and the design and the engineering that we do for our customers. And those connectors are only growing in technology performance. And as we shift to higher-speed connectors, higher power levels and more network to vehicle architecture, we see continued growth. And so this partnership was very important for us to really expand our capabilities. But in the consumer world, think about the technology sophistication of connectors and wearing very similar to the way we may look at what we have within our own homes with TV and audio is now connected with one specialized high-performance HDMI cable. That's the same for connectors and wiring innovation that's happening in the automotive space. And so enhancing our portfolio of connectors capabilities is a key area of focus, and we think it's an area of not just the area where we can enhance our margin but grow our business. And so the ability for Lear to supply more of these critical connectors ourselves helps improve our competitiveness, both on the wiring side of the business, but also external sales to competitors. And what was nice is we've talked a little bit about the way the customers are opening up more to their catalogs, which have been somewhat restricted, but we've identified now today over 1,800 part numbers, including high-speed connectors, that we are working on to vertically integrate at a global level. Hu Lane will increase our portfolio offering in low-voltage terminals and connectors and Hu Lane's high-voltage products will supplement Lear's connection systems portfolio, especially in relationship to Class 1 and 2 requirements with products already fully validated according to the U.S. car norms. And those are standards that you have to meet to get into the Ts and Cs business. So very positive from our perspective. And I'd tell you, the relationship has been outstanding so far. We've set up a global customer and engineering teams to identify new opportunities to really use Hu Lane's parts in our wire and harness assemblies and to make our product offerings much more competitive, like I mentioned earlier, and open up doors within the RFQ world. But right now, our operations tooling design production will remain in Asia for the moment, but we do see opportunities in the near term to expand that across multiple regions. And we're going to do that over time. And our initial response from our customers have been extremely positive. And so it's just another good partnership that we've been able to extend and really allow us to grow our business in the Ts and Cs world.

Yes. I think this is just another kind of key driver or a key component of our growth plan for connection systems. Connection systems is the highest margin subset of our E-Systems business. So growing there is really important to us. Every $50 million of growth there is 10 to 20 basis points of margin expansion in E-Systems. That's a business that historically, it's been around $450 million in revenue per year. If you look at 2019, we're estimating about $600 million in revenue in this business in 2022, depending on what happens with industry volumes could be a little bit more, a little bit less than that. And generally speaking, we're less vertically integrated in E-Systems than we are in seating. And we see an opportunity to sort of pattern what we're doing in E-Systems after seating. So we're about 1/3 vertically integrated in seating. If you look at what we do in leather and fabric cut, so trim cover structures, foam and now thermal comfort products. In E-Systems, that number on the power distribution side is more like 5% vertically integrated. So there's a tremendous opportunity, and we didn't have all these capabilities in-house. We've been investing organically, but then supplementing that with acquisitions like M&N Plastics and partnerships like Hu Lane, we see a pretty clear path to growing that business from $600 million this year to $900 million to $1 billion in 2025, mostly organically, but some perhaps inorganically as well. And so this is a really important part of not just the revenue growth plan in E-systems, but also the margin recovery plan in E-Systems as well.

That's great. And another partnership that you recently established is with Germany-based IMS Connector Systems technology company specializing in high-speed Ethernet solutions for automotive applications. What role does Ethernet cabling play in light vehicles today? How do you see that potentially evolving? And what are the benefits of Ethernet relative to traditional copper wiring, for example? How do kind of copper or aluminum Ethernet rank in terms of cost or data speed and capability or mass reduction, et cetera?

It's a good question and a good thing, we participate in all of them. And with this partnership, we'll continue to help enhance our capabilities. And power distribution in the vehicle is done with copper or aluminum wire similar to, like I said earlier, within our homes. But each of these conductors have trade-offs on price, efficiency, weight. Copper is much more expensive than aluminum, but it's twice as efficient from a transmitting power than aluminum. Aluminum while being lighter than copper has half the connectivity. So it reduces the power transmission, efficiency increases heat, but it all comes down to trade-offs with our engineers, with our customers. I mean each application might be slightly different, but you have to have the capabilities to offer different solutions for our customers. Ethernet connectors increase data content and improve the integrity of the transmission end-to-end as compared to coaxis cables. Ethernet cabling allows for faster data transfer and mass reduction. And with all these new announcements, we've never been at a time where there's been this much technology with LiDAR or ADAS, everything else is coming in. So it's that much more important to have this type of capability with a partner in-house. And so we expect this market to grow much faster than the traditional wiring business. Lear's partnership with IMS increases access to specialized high-speed data connectors, which are becoming increasingly more important as the vehicle data requirements grow, as I mentioned earlier. Right now, we're in the stage is really a prototype phase of co-development between Lear Corporation and IMS of a high-speed Ethernet with performance up to 10 gigabytes and with the potential to even increase that to 25 gigabytes. And hopefully, in this first quarter here, we'll be out quoting that with our customers and really offering a solution for our customers that creates a value proposition. And so as the vehicle continues to enhance options, features, content, so will this capability grow within the vehicle. So we've continue to position ourselves. We think you have to have capabilities in all. There are different solutions for different reasons, as I mentioned earlier, data transfer, speed, weight, cost, et cetera. But it's another extension of how we're positioning ourselves strategically for long-term success and growth within this area. But I do believe within the connectors, particularly around power distribution in the area of transferring data is obviously a key focus of Lear Corporation.

That's helpful. And just got another minute here remaining. But given we're at semiconductor as well as automotive technology conference, wanted to be sure to ask on the semiconductor chip shortage situation. Where do you think we are with regard to the shortage? Is it getting better? IHS is currently projecting 4Q global light vehicle production rose 18% sequentially versus 3Q. Is it your sense we might be rounding the corner? What do you think?

I think that certainly, the fourth quarter was better than the third quarter. And when we issued guidance in our third quarter earnings call, we talked about the sequential revenue growth that we expected and volume growth. And nothing's really changed. We participated in investor conference in December and reiterated that. So they're -- the beginning stages of the recovery seem to be in place. As we look out into 2022, I think that the pervasive shortages seem to be diminishing, and it's more part number specific. But every part is important and specific part number shortages can lead to disruptions. I think generally, we're seeing less disruption than we saw certainly in the third quarter. So we're seeing some modest improvements, but stay tuned with Omicron and other variants of COVID, we're only one government mandated shutdown away from another round of disruption. So it's hard to say. Generally speaking, I think we're in a better place than we were certainly in the third quarter. And we're super excited as you look out at the demand environment in automotive. I think we're set up for a really nice run once we get through this supply constraint, whether that's at some point this year or beyond, it's hard to call at this stage. But clearly, we're set up for a nice run in industry volume growth over the next number of years.

That's great to hear. And we are out of time. But Ray and Jason, thanks so much for all the color and insight that you shared here today. We appreciate it.

Yes. Thanks, Ryan.

Thanks, Ryan.