Lear Corporation (LEA) Earnings Call Transcript & Summary

Great. So delighted to have representing Lear, Ray Scott, President and CEO; and Jason Cardew, Senior Vice President and Chief Financial Officer; Ed Lowenfeld, being here in the IR team here as well.

I want to kind of launch it right now, kind of topical good timing is saying, a nice win on the LTM platform. So tell us a bit about that, how that fits into your overall electrification strategy, and then I'll get into some other messages that you want to caught up on the...

Yes, it was a great announcement this morning and working on the press release even late last night. But the partnership with General Motors goes back a long time. And we've been working that as early as the old Volt well over 10 years ago. And recently, we partnered with General Motors for the battery disconnect unit. And so what that is, is it's really the on/off switch, very sophisticated connection system that's integrated into the battery module in the battery pack itself. And so we were able to announce -- we're currently on the Hummer pickup, the Hummer SUV and EV Silverado. Well, with the Ultium battery pack, we've designed it into the battery system. So we're obviously working with General Motors and hopeful that we'll continue that relationship as they continue to have different derivatives and different programs on that battery. And I think equally as important in the announcement, and we talked about this before, was the interconnect board. And that's a very sophisticated connection of cells. And it's really the frame between the mechanics -- mechanical and the electrical system and it connects the cells into modules and those modules make up the battery. So depending on how many modules you have, make up the size of the battery. And so we are awarded the interconnect program with General Motors. And what's important about that is we talk about the synergies between Seating and E-Systems. E-Systems makes up 25% about revenue growth. And our growth above market in the future is going to be a significant part of that is within electrification itself. And so we focused on power distribution and connection systems. And so the strategy around really playing in the area where we have the right to win is working out, and it's really doing a nice job. And the combination when I talk about the scale and synergies between the 2 groups is our precision forming and bending of metals within our structures business played a significant role in new systems with power distribution, our overmolding capabilities with our M&N acquisition that was just announced last year and our power distribution. So the combination of those skill sets allowed us to win a very sophisticated interconnect board. So could be more proud of the team and just again, more evidence that the path we're on is the right path.

Other trade-offs in terms of margins, to get on programs like that, could promise really huge scale, utilization, informational value for you. But some upfront cost development. I didn't know how you'd manage expectations or how you're thinking about some of those trade-offs of getting in the new important fast-growing business, but it may not be instantly margin accretive for you?

Well, I think it goes back to -- when we look at our product portfolio over the last 3 years, it has been very focused on where we have the right to win and winning means getting a fair return. And so yes, there's investment upfront but we look at it as getting on platforms that we believe will have much greater capabilities in scaling across multiple programs and platforms, not just with a particular OEM but across multiple OEMs. And so -- in the short-term, there is an investment that's required, but we're also looking at each part of our business with a return on invested capital that gets us a fair return even in the short-term.

Right. Jason, any update on what you're seeing so far in third quarter? Any business update? You guys were pretty diligent. We're kind of seeing things in real time providing updates or anything for this audience.

Yes. So I think we expected the third quarter to be challenging and it hasn't disappointed in that regard. So we are continuing to see disruptions in North America, Europe and China, our largest markets. But generally in line with what we had guided to on our second quarter earnings call, we expected revenue in the quarter to be $5.1 billion, operating income to be $205 million, operating margins of 4%. We're a little bit better than that as we sit here today, but there's a couple of weeks left in the quarter, and there's a lot of negotiations and process commercially, and there's still time for more production to be cut. But I would say we're sort of around $5.1 billion to $5.2 billion in revenue in the third quarter, $210 million to $215 million of operating income and slightly above 4% operating margins. And it's a nice step-up from what we saw in the second quarter, both segments are improving margins. We expected Seating to improve from 6% in the second quarter, and they're on track to do that. E-Systems, we expected a 100 basis point margin improvement from the second and the third quarter. We're a little bit ahead of that right now. And so it sets us on a nice trajectory as we look out to the fourth quarter and into next year, I think.

Anything you want to call out with respect to global macroeconomic issues, I mean you're very well diversified geographically, but any regional areas and of course, including Europe that you might want to roll out?

Yes. I think there's 3 major factors that we're looking at -- 2 are familiar to everyone, and we've been dealing with them for the last year or so. First, the semiconductor shortage. And we do see modest improvements in that area. We see more collaboration with customers, with other suppliers. We see fewer parts that we're short on. So there's a gradual improvement there. I think the second issue of the COVID-related lockdowns in China and the second round of those and tend to less impactful than what we saw in Shanghai. But nonetheless, it is impacting the business. And then [indiscernible] area, which is sort of developing -- it's the risk of natural gas shortage in Europe. And so there's certainly nothing factored into the guidance in terms of like a widespread shutdown in the region as a result of that. But you think about maybe the indirect impact of higher energy costs in Europe and a weakening economy there, I think our business is uniquely positioned to weather that storm just because of our heavy luxury presence. So we have been seeding 45% market share in luxury automakers. And if you look at European production and what's consumed domestically versus what's exported for the market overall, 20% of what's produced in Europe is exported. But on our top customers, the luxury customers, it's 35% to 70%. If you look at Porsche, Audi, BMW, Mercedes, Jaguar Land Rover. So even if there is short-term economic weakness in Europe, I think that the export potential and the demand outside of Europe for those nameplates will help support a more modest impact on our volumes in Europe.

Anything you want to add?

No, I think Jason did a really nice job. There's quite a bit, and we're working very closely with our customers on all elements relative to the different things that I think are challenges in front of us right now from the energy crisis to production to inflationary cost. But I'll tell you the relationship with our customer, I think, is something we pride ourselves on, and we do it in a very respectful way, but we work closely with our customers on offsetting these things.

Is it really unusual unprecedented time, obviously, we have some pent-up demand release. We have super low inventories. We're also [ Fed's ] desperate to destroy some demand, and I think we can agree, they'll be successful at that. They have a democracy mandate, not more than a market mandate right now. But I think when you blend it together, are you seeing -- what are you seeing on your forward production from your lens? Any areas where things are being cut back in any regions or segments you'd call out?

Yes. We're not really seeing any demand driven reductions in production. It's all been supply constrained. And you think about some of our top platforms. There's a 6-month, 1-year wait on some of the vehicles that are important for us. I think about Range Rover, Range Rover Sport in Europe, for example. So I think even with some economic weakness, there is support for growing volumes with those customers that has been a buffer for us. Now we are operating under the premise that industry volumes will be a challenge throughout the balance of this year and into next year, and we're carefully taking capacity out to better position ourselves to grow margins despite the risk of even lower industry volumes. We think we can grow margins in a flat production environment looking out to next year.

I think that's important is that regardless of the strong demand at this time, we do scenario plan for in the event demand does decrease or get lowered exactly where and what platforms will be impacted. And I think equally as important, we're taking steps to manage our own facilities where we have the ability because we have this E-Systems and manufacturing in Seating and [ seating ] components to flex our manufacturing muscle in a way that's uniquely different, where we can -- right now, we're studying Morocco. We're starting Mexico, down in South America. We did an excellent job of combining different manufacturing products into a plant to give us ultimate flexibility. So we're still, regardless of what we're seeing looking very aggressively at how we can take steps if demand does soften in respect to how we run our manufacturing plants. And I think it's something that we're doing a tremendous amount of work on and looking at how we can take things into our own control. I still think there'll be platforms that will still be at a higher level from a volume perspective, but others we have to be very sensitive to in what we do.

So you're positioning the business to like be able to grow to hold margins flat or even improve margins in a flat production environment?

Adam, as volumes are consistent and steady and flat, our margins would increase.

What's your mix assumption within that?

I think that the luxury end of the market, again, is that we're over indexed to right now, and that seems to be holding up extremely well. That's where there's a lot of pent-up demand. And -- and so I expect that to continue and maybe even an increased shift away from mainstream platforms to larger and that would be beneficial to us.

Okay. So right, let's move into Seating, okay. Can you talk about the Lear thermal comfort offering? How does the Kongsberg acquisition and pending IGB acquisition play into Lear's unique vertical integration capabilities?

It's -- we've been steadfast in our focus of really being the most vertically integrated seat company in the world. And with that, we've been focused on priceable features where we can create value for our customers. And the most recent acquisition at Kongsberg gave us that in-house capability with engineering and technical support and manufacturing competency to integrate what I consider to be a thermal comfort solution, which integrates multiple components into one modular system. Today, the way the customers source, it's 80% of it is directed to a Tier 1 seat manufacturer. And then they take those components and figure out to the best of their ability, how to stack them up in the seat. What we now have is the capability to engineer a modular component that integrates multiple different systems. So we're cutting down part number proliferation, the time to comfort or sensation is dramatically improved because right now, all those components fight through a number of different components within seat. You got plus pad, you've got foam, you got the trim. What we're doing is integrating a system that's closer to the consumer. And the value proposition, when we talk about the reduction of cost and mass in price allows the customers see what the value is and what's been astonishing in February. And I thought, listen, this is -- we were designing an integrated system well before we purchased Kongsberg. So we had designs, patents on very selective designs that we're going to push into the customers to create this value position proposition, but the overwhelming positive response. We've had several customers, significant customers within our portfolio that have already awarded us design responsibility for the components, where previously they are directed. And so now it's our responsibility because we have the engineering in-house capabilities, to supply them with a solution. And [ now ] is the benefits. Right now, the market for thermal comfort is around $2.5 billion to $3 billion. It's primarily in luxury. We believe that by offering a solution that is at a lower cost, better value, better packaging, lower weight and from an efficiency standpoint, it improves, particularly when you're talking about EVs, 20% to 30% of the draw of the battery is key and cooling the cabin. So there's an energy efficiency for a longer range on the battery, that's the benefit, too. That type of response allows for that type of component to go across multiple different features or seat systems within the vehicle. So right now, the limiting factor to go lower or in the lower platforms or into rear seats is packaging costs.

I just think from a consumer perspective, once you get used to a seat like that with integrated thermal comfort in it, it makes a normal car seat feel like pretty [indiscernible], frankly.

Well, that's the beauty of this. We're all customers. We're all sitting seats. We all know and say, Well, why doesn't it work that or one of the biggest J.D. Power scores, negative scores is the time to sensation. The ability for an occupant to be cooled. It's just -- and why? Because the fan and the bag are below all the components. Well, we're integrating those components right in the back of the trim cover or into the foam itself. We have a new foam. We have 2 development contracts with 2 different major OEs, one in Europe and one in North America where we're replacing polyurethane with polyester -- polyethylene. And that reduces CO2 emissions by 50% and weight by 20%. And those components -- the idea is to integrate those because it's more breathable, much more breathable. And so those components get integrated into the foam.

So your integration and being able to improve not just making efficiency but also a cost case, this is going to get into the mass market. So what are penetration rates to help us out with penetration rates for how you would define -- however you define the levels of thermal comfort? And when do we start seeing it in a $30,000 price point vehicles?

Yes. I mean if you look at the size of the penetration rate is very, very low. It's almost exclusively in luxury vehicles. So the market growth potential that is tremendous. Now seat [indiscernible] -- it's pretty well established, particularly in the front rows. But again, being able to lower the cost, integrated into the [ second roll ] seat system, we see that as an additional market that's not been fully penetrated. So it's second roll applications and working it down further into mainstream vehicles, both as a catalyst for growth.

And as far as when we're going to see it, we have right now a number of major contracts that we're developing it for production and will be in production. This system will be in production within the next several years.

Questions from the audience?

Yes. And I'll just add one comment to raise comments on thermal comfort. It's also been a catalyst for us to grow our jet market share, that unique value proposition that we're able to offer. We've grown the market share in Seating from 18%, 19% to 23% a few years ago. Now it's 25% as we sit here right now. And looking out 3, 4 years, we see a path to 28%, 29%. This is a key factor in driving market share and taking share from competitors. There's no one else in Seating can offer it.

On vertical integration to seats. I mean, you hear about on the edges from some new startups, but that seems to be more out of necessity rather than choice, but what does that factor in to your share assumptions longer-term? And just it could be a sign of respect. I mean, like a sign of validation of the value of the seat and the consumer experience, particularly as we're doing less driving.

Do you want to hit that one? That's...

Yes. I mean I think the level of vertical integration is a key differentiating factor for us. And if you think about it in this environment right now where you're dealing with inflationary cost increases, you're trying to work collaboratively with your customer to find ways to take cost out to offset that. We have more levers to pull just because of our capabilities across the seat.

And there's another important part there to Adam to it. What we've seen is a shift. And I think what was important when COVID hit, we focused on people, we focused on the balance sheet, we focused on strategy. We wanted to see very specifically, was there going to be shifts from our customers? What was going on with our OEs? What we've seen, and it continues to increase is the ability to allow more content to be sourced to a Tier 1 that has the competencies and capabilities. That shift has come at a much faster pace than I think we could imagine. And so having the vertical integration and capabilities around engineering and technical and manufacturing is a significant part of it. What we're seeing customers now customers right now, they always have autonomy, they have connectivity. They have electrification. They have limits on human capital. And so they're looking at how they can shift certain capabilities to suppliers that have those in-house capabilities. And so when I talk about the shift on these contracts that we've been awarded, I've never seen that. I've been in Seating 34 years. You had to and were responsible. Even if you had sourcing control, you had to work with a component that was off the shelf in some respect and then figure out how to manipulate that into a seat to make it the most efficient. That was just more for manufacturability or assembly. And what we're talking about now and what's been overwhelmingly positive from our customers is now that they see we have the technical companies are saying, you take it. you take it. And then we show them how the combination of components come together and we're getting more. And the priceable features is a key part of it, too, that we're -- we deemphasize parts. We have structures, capabilities, but we didn't want to overly influence our capabilities in-house our own structures. We want that capability, but because of the capital and some of the returns wasn't really netting us what we thought was going to be a long-term investment. What we focus is where we can have priceable features, create a value proposition and then have a technical competency to really drive it.

And your seating margins are pretty resilient, remarkably resilient over the last couple of years of production constrained environment. So what are investors missing as to how you're able to do that?

Yes, I think we get asked that question quite a bit, and I couldn't be more proud of the team and how we position ourselves in respect to margins. One is we have incredible talent. We really do have people that have been when we sit around a room and look at individuals that have been through different situations and understand how to manage through challenges, we have a tremendous amount of experience. I think equally as important Jason and I were in Seating prior to being in these positions. We're really focused on return on invested capital at every single level within our business, down to every single component. So you may hear some of our competitors talk about a jet roll-up gets a fair return. However, there might be elements within that model that don't get a fair return. We focused heavily on return on invested capital within every one of the different components and region and customer. The investments we've made over the last 15 years have been significant. We've been driving Industry 4.0 automation, manufacturing excellence. And that's resulted not into -- I mean, since 2020, we have $1.2 billion of conquest wins. They're in a very challenging time. So that reputation of managing the customer working with the customer and then also quality is significant. I mean, we ask J.D. Power scores, don't take my word for it, where we are the most awarded seat supplier out of J.D. Power. And we've had that as a history. So the quality of the reputation is important. And I think just the continuation of creating a value proposition. If you think about offering a customer something that is uniquely different and give them the ability to lower cost, lower part number and then it's much more efficient is something that is differentiating us.

Yes. First point that Ray made, I think, is worth reemphasizing the consistency of our investment in Seating over a long period of time, you look at the competitive landscape of the other large players in Seating, they haven't had that same dedication to it. They have other businesses or they have other issues that they're working towards, but our consistent investment in that business over a long period of time. And as Ray mentioned, with that continuity of management, a deep management team, that has tremendous experience in Seating over the last 30 years, I think, is another point of differentiation.

So while Seating margins has held up really well. E-Systems a bit more headwinds, a rough go of it, margins down significantly from pre-COVID levels. So what Lear-specific issues within your control, self-help or have you identified to kind of get back to that 7%, 8% and then maybe ultimately 10% plus margin level? I think you'd expect out of that business.

Well, it's very similar to what I just mentioned. Jason and I were in seating through a couple of different cycles, particularly around margin. And building that incredible team, we have -- we've built up a great team. We've talked about the need to invest on return on invested capital. But I think within E-Systems, the big one was really self-evaluating and reassessing where we're at. And we can't be everything to everybody. And our electronics represents -- our E-Systems business represents 25% of our overall business. And there's areas that we are trying to invest in that really -- it just wasn't going to work. And so we've started deemphasizing like we've talked about lighting and audio, other parts of our business, making sure we're getting a fair return or accelerating areas where we believe we have, like I said, the right to win. And we talked about power distribution in wiring, both low-voltage and high-voltage. We have an incredible space to play in, and we are doing a nice job of growing our business.

Let me talk about connection systems. In this example that just got announced today of battery disconnects and interconnect boards and plug boards. I mean, we want a very sophisticated plug board with Volkswagen that we believe will go across multiple platforms. And so investing in areas that we think we can scale properly, if not just with one OEM across multiple derivatives, but also across multiple OEMs. When you think about the battery disconnect, that's a very sophisticated, almost power electronic/connection system, and it's integrated in the battery. And we have other battery disconnect units with other customers. And so taking that patent holding capabilities. It was a PACE award winner and now developing that for other customers. There are several other customers right now in the process of quoting. We can scale that property and get a fair return. In addition to the connection systems. We talked about being $1 billion in connection systems between now and 2025. This interconnect board puts us on a trajectory straight away that we're going to get there, and we're very confident we're going to get there. And so those get above-average type returns. And that's where we're focused. And so we talk about reassessing. We've spent 3 years really assessing the market, where our customers are going to want to in-house or design themselves, where we don't have the ability to scale properly long-term and then making sure every dollar we spend in capital is invested in products, we can get a fair return.

Can you give us an example of something that you thought, let's see just go, let's invest real money in there and you realize, no, this is not for us. We're not scaling, we're cutting that. Give us a couple of examples of just [indiscernible] our debt ends for you?

Lighting and audio.

Besides lighting and audio.

Traction inverters, [ EVSE ] cord sets are 2 areas that we had previously invested in. We have small businesses in both of those product categories, and we're going to run those out. We're not reinvesting in that.

We turn the corner, you think, on this kind of concentration in areas where you can win? That I'm just trying to do...

Yes, I absolutely think that our -- our focus now is in the areas I mentioned, and it's evidenced by the business we're winning. And like I said, we're still focused on fair returns. It's not short-term trying to take a business and then make it work longer-term until we scale it. We're actually getting fair returns as we start to win these new businesses.

Other than the news today, any other opportunities that you'd like to highlight, and you do a good job on this in your regular earnings calls in terms of new wins and electrification, any other details or you'd like to...

We thought that was a pretty special amount and the I shouldn't have other one in the back pocket. Well, I think out of respect for the customers. Yes, we do have some other things we couldn't be more proud to announce. But just like this announcement, we had to work with General Motors closely. And I think even being in the battery and showing that partnership, that relationship is significant. We are going to have more announcements soon, but we do work closely with our customers on when we can announce them.

One on inflation here, any -- we've seen material costs in terms of metals and well, energy, let's put that in a separate category, but some commodities have kind of come in. Labor seems beats to a different drum. You're a [ Flint native ]. So I don't know if you're still a card-carrying member of the...

No, I had -- I don't pay my does anymore, but...

What are your thoughts on the role of humans in your cost structure and how -- what level of inflation are you seeing right now? How sticky is it? How does it change your sourcing decisions?

I think it goes back to what we talked about with this Lear forward plan. And I think it is an element that we see is going to not just be a challenge today, but it's going to be a challenge 5, 10 years from now. And we've worked aggressively. And I think one of the things we talked about with Seating, why we're so successful is the investments we've made 10, 15 years in automation, Industry 4.0 and flexibility within our manufacturing facilities. I think a continuation of that, I also think that we have to be much more geopolitical sensitive to regional concerns. And so we're flexing our muscle, like I said, where we can actually shift product quicker depending on what is happening in a regional environment. And I think having 260 manufacturing plants, and we've already started shifting product lines within our own family of manufacturing plants to give us that flexibility around labor constraints or labor issues or just the ability to flex the tech time and productivity that we're getting out of our plants. And -- and that's a lot of work that's been going on and we'll continue to focus on it because we do see the labor market changing dramatically, not just today but over a long period of time and not saying it's going to go back to an old way running, but it's a new environment and a new way of looking at labor.

You're in the ultimate just-in-time global supply chain and the types of products you provide, particularly in the Seating side and harness is just in time right there. Really in the epicenter of the global supply disruption, right? And things for 30, 40 years work so smoothly just in time and until recently. So what would you call out in terms of changes as we move from just in time, just in case. Any implications on working capital or risk mitigation that investors should find relevant?

Well, I think that what's important when I talk about modularity, that's really what we're focused on. It gives us flexibility and it allows us to flex different plants. I think even when you look at what we said with strategy, thinking about the customers and how the customers have changed post-COVID. What was -- a dedication of one plant, one platform had become much more diverse, where you can have multiple different platforms, the interchangeability between -- even ICE and electrification or electric vehicles. And so what we're looking at and what we've spent time on and why it's so important we talk about these vertical integration of how our components are coming together is a much more modular system, where we can flex different platforms or vehicle lines differently. Jet has been somewhat the way jet has run with the exception of bringing in new technology around quality and throughput and those types of things. But the model itself has to be revamped. And that's why when we talk about right now, the modularity is important for a play within the seat system, but modularity is a much greater play when we talk about manufacturing flexibility. And so that's where I could see the evolution of what we're talking about.

Turning on and off modules around a line. So sort of combine the best elements of linear production in [indiscernible].

Portfolio should be -- if it gets skewed down, modularity up, scale up, scale for SKU, up, up. I mean...

We think about a spoken hub tech.

Yes. I think you'll -- that will have structural implications to how you run the supply chain and how you -- and your margins. Well, Ray and Jason, it's about all the time we have, but thanks for sharing your thoughts with us right now and congrats on the news this morning.

Yes. Thank you, Adam.

Thank you.

Thanks being here.