Lear Corporation (LEA) Earnings Call Transcript & Summary

Next fireside chat, which is with management of Lear. So just to introduce this, I would say there are a lot of things that suppliers really can't control in the environment around them, things like production mix, currencies, sometimes even labor costs. But the best performing ones always seem to be 2 steps ahead of what we're seeing at the moment. They focus on the technologies that give them a competitive advantage in the future. Over the past year, it's become increasingly apparent to me that one of those companies that sets the benchmark in that regard is Lear. It really wasn't apparent when they bought InTouch and Thagora a couple of years ago that computer vision and automation is going to become so important, but certainly is now. The strategy behind the acquisitions of IGB and Kongsberg weren't obvious when we first saw them, but they're now conveying potential for some real competitive advantages in the industry in terms of market share, in terms of margin. And in fact, the company is completely rethinking how seats are actually made, which is really awesome. The culmination of all of those actions, I think now you can look back and say this is one of the reasons why Lear in this industry has had higher margins than their peers and why they've been gaining market share as that's been occurring. So there's a lot for us to be talking about today. So I'm very pleased to welcome Ray Scott, Lear CEO; and Jason Cardew, the company's CFO. Ray, I think maybe first I have a number of questions, but maybe to start us off, if you can give us a little bit of a business update, that would be great.

That was a good segue to our lead in -- Rod, we obviously work in a very demanding industry, and it's a very interesting time. And I think with some of the things that you mentioned, last year was a very important year for us. And I think the team did a remarkable job. We finalized IGB acquisition, which was a key part of our strategy moving forward in Seating. And I'll explain a little bit more about the importance of some of the other acquisitions because it is a product process, I think, development strategy going forward with Lear Corporation and how those work together within the manufacturing world. We had improvements within our E-Systems business, we simplified the product portfolio. We're doing a really nice job of continuing to improve margins. There are 6 consecutive improvements of margin, year-over-year, within the E-Systems, we continue to be very, very focused and where we get a fair return for our investment in E-Systems. And I think importantly, with our relationships with our customers and how we simplified our portfolio, we're still growing the business. We've had 3 consecutive years of $1 billion of backlog, which is really important within these systems. So that's really starting to play out. I think in the automation side of our business, you mentioned Thagora, InTouch. [ ASI ] was another tuck-in acquisition along with our own internal organic innovation. We're starting to see the improvements within our manufacturing facilities. One of the most recent, I think, unprecedented setting examples of that was the Wagoneer and Grand Wagoneer that we launched in 8 months from a competitor that couldn't have produced to the customer's output or wasn't getting a return from an efficiency standpoint. We launched that and hit on every one of their, key customers' measurables. Output was significantly higher. We have been told from our customer that our quality was significantly better, and we're getting a good return on the business. And so I think that's an example of all the hard work that we're putting in place with automation within the company. So '23 was a really good year. To continue to build on the basis of the strategy going forward. And now we're starting to see the results in 2023 from '24 and then -- and further out in the '25, '26 time frame.

I'm going to speak a little bit about [indiscernible]. But I wanted to ask you about the performance that you're delivering is actually pretty impressive. [indiscernible], more of your -- more of the performance you're delivering [indiscernible] from Lear, $90 million. We've got headwinds from FX $70 million. These are [indiscernible] two things along is like 70 basis [indiscernible] margins for a company like Lear, and yet you're still growing your market like that. I wanted to ask whether that suggests what we're seeing is underlying performance at year [indiscernible] better than what it appeared [indiscernible] that way to me. And if some of those headwinds moderate, in 2025 that acquisition [indiscernible]?

Yes, Rod, absolutely, it does. If you just look at in a normal year of wage inflation and maybe without the transactional FX headwind, which we would expect '25 to be more normal than what we're experiencing here in '24, you'll see the benefit of those performance improvements show itself in margin expansion. We think it's reasonable to target 50 basis points of margin expansion, maybe even 100 basis points of margin expansion through our performance improvements. And that starts with our normal kind of roster of cost reduction activities, purchasing negotiations, customer negotiations, plant efficiencies, but it's really bolstered by what we're doing most recently with automation. That is the catalyst for additional performance improvement. Historically, those performance improvements were designed to offset your customer price reductions and normal wage inflation. And so going forward, we see automation as a point of differentiation to allow us to not only offset those but generate 50 basis points or more of margin expansion. So I think it's only 15 basis points in 2024 because it's way down, as you pointed out, by 70 basis points of headwinds in those two areas. If that normalizes even kind of halfway back to the 2020, 2021 range, then you'll see something like 50 to 75 basis points in 2025 of margin expansion from those initiatives.

That's -- on that point on automation [indiscernible] for the past few years to focus on [indiscernible], automation, product. Timing of that of that obviously [indiscernible]. Will that expand throughout the [indiscernible]. Tell us a little bit about what that means for the company?

Yes. Well, those were, we've been talking about labor scarcity and labor disruptions and focused on this for some time now. And I think it's obviously a topic that's very important today in today's environment with a lot of the things that are going on, particularly around the lower-cost countries where a lot of that was just a labor arbitrage play. And we did a very good job at that, but really stayed focused on our operational excellence and really what we're good at. We acquired several companies that were nice tuck-in acquisitions. When you mentioned Thagora or InTouch or ASI. These are areas where you're working with cobots, you're working with laser systems, camera systems, very specific capabilities. And so I was just actually in one of our pilot facilities where we're running the different technologies. And what's nice is these companies that we've acquired have expanded and worked in a collaborative way to solve even bigger problems within the company. So one of the line examples I just recently saw, we've been able to put the different capital in place in North America is taking it from early on finesse and automating all the way to in line and all the way to the customer's point of installation. That, depending on the production environment is a 20% reduction in direct line headcount. And we're putting that in production later this year in North America and quickly expanding that throughout the world. And what we did was these companies that we acquired were servicing our competitors. And so this technology with connection system is a very sophisticated connection systems, testing systems, laser systems, camera systems, we just brought that all in-house. So we don't service our competitors anymore. We let the contracts run out, and we brought it in-house. So Lear has the capabilities in-house, and we're making our own capital around that. Now that capital is coming in significantly lower too than what was purchased on the outside. So we're not only seeing ergonomic improvements, we're seeing quality improvements. We're seeing significant improvements within our headcount within our plants. We're keeping it all internally to Lear, and we're also seeing a much more lower cost of capital. So I think one of the concerns as you shift to automation, okay, your capital number is going to go up. No, you look last year, our capital number was down. And we're putting this in every one of our facilities at some level. And so we're actually getting at our capital number much more efficiently. And I actually think that's going to only improve. What we're seeing with technology, and that's why I say I'm so excited is that we have -- in our Trim Cover business, 35% of our labor is represented with the Trim itself. We're Automating. I was just down in Mexico several weeks ago, how we're automating and taking these capabilities that we have in automating what was, I would say, turning the impossible and making it possible because as we said the variability in Trim Covers, you can't really automate. Yes, you can. I'm seeing where we're actually doing it through these vision systems, laser systems, how we're cutting the material itself through Thagora, what we learn there, we're quickly taking that across our different facilities. And same thing with E-Systems with wiring, 90% of our labor in E-Systems is tied to wiring. And I've seen great improvements in how we're reducing the -- through automation the ability to get that efficiencies within our plant. And the capital that I saw that was on deployed both in China and then we also have it in Mexico was 30% to 40% lower than what we were acquiring before with the improvements I'm talking about. I mean, you're sitting there, looking at it, I'm seeing ergonomic improvements, I'm seeing safety improvements. I'm seeing quality improvements. I'm seeing efficiencies on the plant floor, and these are things that we're getting at quickly and starting to deploy. And so it has been -- we've been somewhat quiet about it because it has been tied to some of our modularity strategies, too. We talk about Seating. Modularity Solution in Seating is something that we've been working well over 10 years. And there's a product side, but there's a process side. The product side is moving that product to the customer and the improvements that we're seeing, when you're talking about, I mean, we all sit in vehicles and you have the lumbar system that's on your back, and it's there, but it's not therapeutic. It's not something that you sit, I would say sitting in your kitchen, I want to go get my car because I got this pain in my back. We improved the system itself by moving it from what is the C surface to the B service to the A surface, 150% sensation. The customer, you sit in these seats, you're going, "That feels good on my back." The first time, I don't feel like something just moving. I feel therapeutic. I feel health and benefits from what we're seeing within the Modular System. Along with [indiscernible] sensation with heat. 85% improvement beyond the first minute in the seat, a 50% improvement in ventilation within the seat. And we'll talk about FlexAir and some of the other things that we've developed in concert or in collaboration with the Modular Seat that's really taking off. And so I think it's product, I think it's process, but we're really focused on maintaining that operational excellence and being a leader within automation and manufacturing excellence.

Can you just make this a little bit more specific for this community? So just financially, what is this automation? Do you say that 35% of your seating labor is in Trim? So what will we see if you're successful in this automation trajectory in terms of efficiency or labor cost reduction, that kind of thing?

I think it's the key driver of net performance. So performance exceeding our customer price downs each year and our wage inflation. It is the key driver. Historically, if you go back 15 years, labor arbitrage restructuring, moving from high cost to low cost was the key catalyst for differentiating yourself competitively and generating margin expansion, particularly in Seating [indiscernible] Systems. As we go forward, we see labor arbitrage are sort of in the seventh or eighth inning of that way. There's still some work we can do moving from Eastern Europe to North Africa, moving from the border towns, Mexico further inland, moving some material out of the [indiscernible] plants down to lower cost facilities. But that's the very end of the game, the last inning or so. We're in the first or second inning of the automation journey that Ray is describing. And so we see that over the next 10 years, being the key catalyst for generating margin expansion and being able to differentiate ourselves competitively, offset customer price downs and offset wage inflation. We debate this all the time internally. When is that inflection point where automation exceeds the benefit or the cost associated with wage inflation? We haven't pinpointed that to a quarter or a year yet, but that is absolutely what we're focused on delivering.

I think for an example within that, because there's a lot of different types of like harnesses, for example, you have the full body, very complex. You have high voltage, which are simpler, which can automate relatively easy. You have some of the body parts within the harness that are more simpler harnesses. What I saw with the capital that we had deployed on the ground was a 20% -- 10% to 20% reduction on -- depending on the harness of labor within that facility. So these are big numbers. And that's one area of the twisting in connection of the harness system itself. And we have projects and pilots within the whole assembly of the harness. And so each one of them are slightly different and takes a little bit different look at how we're going to automate them, but they're nonetheless seeing those type of numbers within the reduction of [indiscernible] and headcount within the plant.

It sounds really big. In the discussions we've had over the past couple of months, another thing that I found very interesting is this focus on creating a competitive advantage relative to your peers in the seating industry. And a lot of that had to do with the level of vertical integration that you're able to achieve now in Thermal Comfort Systems. And you've said that that's going to contribute to market share and ultimately to margins. So look, I know that Thermal Comfort averages around $30 per vehicle, but that's kind of misleading because it's a big denominator with low content and some vehicles have $300 of content per vehicle from that. That's relative to a seat set that could be $700 to $1,000. It's a number. Could you talk about the capabilities that the acquisition gave you? And what are you trying to accomplish with that?

Between Kongsberg and IGB, it gave us the full set of capabilities with pneumatic lumbars, lumbars, you have your sensors within the seed for occupant detection. You have heating elements, you have everything that makes up a Thermal Comfort System. And what we gained from that was having the engineering the expertise and the manufacturing competency because we're changing the way those systems are developed. And I think it's important to understand that it's been a layered approach of how seating is sourced today. And so it's inefficient at a component level when you look at it holistically. And so each component might be designed for efficiency. But when you pull it together, when you have the cables and harnesses and modules, 2 different modules with 2 different software programs can be 1. Cables that are assembled through the seat itself to the A surface doesn't make any sense. You actually -- we have a design that puts the tubes right into the modular system itself. So it was having that engineering capability where you could design these singular systems, which when you look at it, it's common sense, you say, why isn't it designed that way? But it is a breakdown in theory of how the customer sources the seat today. And what's been interesting is how overwhelmingly positive the customers have seen this because we are right now and I said this before, it's important that you get this the production validation done and we're in different levels of development with over 11 customers right now and -- 12 customers, and there's like 25 different development programs, will be done with a validation program this year. So we'll be in production with a component-level modular next year. And I think when you have that validation and it resonates with all your customers, you get more of a pull. And so we're working. I mean, finalizing that IGB was very important because it gave us an enormous amount of credibility. We already designing the integration of these components. And it's one step. So we have the 4 -- there are really 3 phases right now where the component level where we compete on any component level with anyone in the market. Phase 2, which is the integration I just mentioned. And then the last phase, which I think is very important, and we're in development with certain customers, is in the integration of the foam pad itself and Trim. So we see it moving right to back on the Trim Cover as opposed to anything on a frame. You're not feeling or getting any sensation and so waste of material, money trying to route it around the foam. And so why FlexAir has been so important. It's a ventilated foam pad that we're in production now. Hyundai put it in production, they're moving fast. There's -- we've 25 different programs right now in development with customers across 13 different customers. That is the dirtiest product within seats. It's a reduction when you go to FlexAir of carbon dioxide of 50%. It's 100% recyclable. It's very competitive when you talk about just the price of the component, and it hits what they're looking for with sustainability. That product helps the whole modular concept come together. And then the Trim cover itself. And so we see this eventually moving right to the A surface of the seat. We're cutting out 50% of the components within a thermal comfort system. I believe when you get that packaging and that efficiency, that then it's going to spread to other parts of the seat. Why it's limited to the second and third row is just packaging and the cost. We think we can actually be much more efficient within those areas and offer customers different features. And I think when you hit back on that whole value of Sensation, both from a comfort standpoint and from a time Sensation standpoint, it's what the customer is looking for. And so we're working through that right now. Our focus is completing these development programs, because once we get that validated, then we can take it across to different vehicle lines.

It's really interesting and may be hard for somebody who's not been to a seating plant to actually envision what you're saying. But basically, the way I would describe this is you've got these automakers that are saying, I want that pneumatic system so that lumbar from that company. And this company is making the cooling, heating thing, and this is the company who is supplying you with the foam and you guys, you can ship your trim from Mexico up to this [indiscernible] plant. Everything shows up in different boxes at the plant. And then you've got somebody in North America making $20 an hour, taking the spaghetti of tubes and wiring it through the seat frame and doing all that work whereas by having all these things, you just engineer it into one component kind of thing?

So you're right. It's flipping it from what is exactly taking components what the Jet World today is from an assembly standpoint is taking those and designed for assembly manufacturers. But you're stuck in some respects with these components that are not efficient. You talk about the whole seat. What we're doing, and it's amazing, like I say, it's so simple when you look at it. I mean you have multiple harnesses, multiple cables, multiple software, multiple boxes within the seat for power within the seat, and you combine them, and when you lay it on the table and you see the hundreds of parts and you're going this doesn't make sense, and you simplify it, if you take everything out and say, this is how it should be assembled. And it just -- like I said, we took 50% of the parts out. It's lower weight, I mean you're getting improvements within the comfort satisfaction within the seat, and it's hitting what the customer is looking for. So it's just changing and we're doing a good job of changing how the customer sources the components. And that was kind of the real challenge is that do you have the engineering expertise? Do you have the manufacturing expertise? Have you validated all the products? That's what we're going through. And that's what is kind of the time element right now, but that's moving extremely fast with our customers because they see the value. And then I think what's important too, Rod, is, not only are we -- the product side but it's also the automation of the modular. So these companies we bought were intentional, both on the product side, IGB and Kongsberg were very, very selective. We specifically targeted most companies because of our expertise. And the companies that we acquired with automation was intentional too because we understand what we need to do in some of our bigger plants with trim and also wiring. But more importantly, with this modular design that creates a much more flexible manufacturing process. That will be automated. So as it comes together, the automation in parallel has been worked out with the design. And so we have designed for automation engineers within the facility right now in parallel as we validating. And so I guess I was just in the facility the other day, it's exciting with what we're doing with the technology. I think the technology to Jason's point, is coming out so fast. And so having it in-house, and we're not selling to anyone. I mean we've cut the contracts off. We get to keep that benefit. And I think we saw it, like I said, real life is the Wagoneer here. I mean, how do you take a program over an 8 months and launch more efficient better quality, lower cost? It's the capabilities we have.

What does it mean for margins and capital intensity, what you're saying?

Yes. So if you look at our business historically, we've talked about low 3% capital as a percentage of sales. Last year, we were at 2.7%. Our guidance for this year is 2.8%. Historically Seatings kind of in the low 2s. The thermal comfort systems in general are a little bit more capital intensive than our overall seat business. But despite that, we see a path to continuing to lower our capital spending or hold it sort of in that low percent range in seating through the other benefits that Ray described through the acquisitions, in particular, and through just capacity utilization improvements generally through the Lear Forward Program we kicked off at the start of last year. So those two factors are allowing us to make additional investments in automation, make additional investments in capacity and Thermal Comfort Systems while still delivering sub-3% CapEx as a company. So that's a real change in the model for our business. And if you look out 5 years, we see it sort of in that similar range. So if we can earn -- if we can achieve 8% operating margins in both segments, you're going to see a return on invested capital that's higher than it has been historically just because of the reduction in capital intensity.

We are seeing the step down in like I said the piece of equipment that was $1 million, for years, we've spent the same amount of money. When we redeploy it, it was 30% lower by working with partners that are much more focused on what we need on the floor with automation. And we're doing -- there's not going to be a step up. We're doing it in parallel where it makes sense too. The introduction of what I mentioned with [indiscernible], we're going to have it 100% Automated, is done at a time when it's required to update the capital. And so it's being deployed in a very, very sensible way.

Let me ask you about one of the challenges in the industry now. Obviously, you've got a lot of growth. You're a 25% market share company now. You've been talking about getting to 29% by 2027. 4 points of market share in this industry, it's about $2.5 billion. So, the other dynamic that we're observing in the industry right now is these shifts in market share between the companies and the industry. So if we look from 2019 to today, the Western companies have lost about 9 points a share. Can you just talk a little bit about -- I don't think it's been noticeable for everybody because the industry is on the 70 million unit production to 90 million. But now in a flatter production, is that something that you spend a lot of time thinking about? And is that something that you feel like you're well positioned for, just given exposures that you've got? Do you have enough exposure to the market share gainers?

Yes. So if you look at China specifically, that's where the biggest market share shift has happened. We are under-indexed to the Chinese domestic OEMs. Historically, is about 20% of our business in China. It's now 30%, 31%, this year is our current outlook. Looking at our backlog, it's about 2/3 Chinese domestic OEMs for our China business [indiscernible] Systems combined. So over time, we see our business in China kind of more closely resembling the market over there. Clearly, that's been a challenge in the very short term, and it was reflected in the weaker growth in China, specifically towards the end of last year. As we look out into the future, we do see a lot of success with the Chinese domestic OEMs, [indiscernible] in particular. I think we're going to have 30% of their seat business in 2026, our second largest customer in Seating in China. They're clearly one of the big winners in the marketplace and were doing quite well.

Will they take you outside of China as they expand into Europe.

We won our first program with them outside of China and Southeast Asia. We're working with them, on their footprint they're putting in South America and Hungary and elsewhere. We haven't been awarded those contracts yet, but we are working around the clock to win that business.

I think having we talked about differentiation [indiscernible] advantage. Having products like FlexAir and ReNewKnit and the Modular Design that we have, particularly in China, too, because it's a really fast design concept. So they move a lot faster and particularly around some of these innovations that we're talking about. Hyundai is the first one to introduce the FlexAir. And I do believe that we're going to have a customer who's going to want to take that across all their vehicle lines. Once they validate, make sure they're okay in production. And so we're in that time right now, but that's a $4.5 billion market. I don't know why we're using some of the old chemicals and when you talk about environmental products within the seat. I think once that kind of gets released and recognized, there is a customer that says, we're going across the board, and they make a big statement that's a great opportunity. And particularly with some of these customers that Jason just mentioned. They're excited about those products. And so that's an entry point in that others don't have because we bring the innovation technology to customers that are really looking at how to explore and expand. And we can do it at a component level. And so once you get your entry point in, then you start looking at a much bigger picture with how they're expanding and where they're expanding. But that's where we've really had success. We have 40% of the Hyundai business outside of what is in-house for them [indiscernible] a big customer for us. We represent a big percentage of their business in Seating. And so those are kind of some -- you say we do think about it all the time, right? We do. And how do we deploy our capabilities innovation even at a component level to get entry? And that's been working really well for us.

Yes. Well, it's good to see that the companies are actually engaging with you on that because sometimes it's the -- the suppliers have really good ideas and there's a reluctance, there's some inertia within the OEMs that, but maybe at this point, there's enough pressure on them, they're actually looking for these kinds of things to take cost out.

I think that's where we get focused on when we get a little bit of momentum, we just go and we really ride that customer. And, but I wish I could say across the board, some of them still have that, not built here, mentality and they're a little bit more reluctant. And but I think when you get that production contract, it's a game changer. It's like the momentum we got in FlexAir when we announced Hyundai. It was amazing, it's in production.

Let me just ask one last one because we're out of time. So you have $1.2 billion of cash on your balance sheet right now. You're going to be generating $600 million, $750 million, somewhere in that zone of cash this year. what's the cash level that you want to operate within the business? And what should we be expecting as far as uses of cash now?

I think $1 billion to $1.2 billion is kind of where we're comfortable operating. We ended the year at $1.2 billion cash on hand. We're very focused on continuing to improve free cash flow generation. We got back above our target of free cash flow conversion as a percentage of adjusted net income. We had targeted 80%. We delivered 90% last year. Our guidance is mid-80s this year. We continue to generate that level of cash. It gives us all kinds of options, of course. We've looked at smaller tuck-in acquisitions, mostly around these equipment suppliers that Ray described earlier. Those continue to be appealing to us, good return, quick return acquisitions, but they're small tuck-in. The balance of our cash deployment is really going to be around share repurchases similar to what you saw last year.

Sounds good. Great. Well, thanks, guys. I really appreciate your time, management of Lear.

Yes. Thank you.