Lear Corporation (NYSE:LEA) Q3 2023 Earnings Call Transcript

Lear Corporation (NYSE:LEA) Q3 2023 Earnings Call Transcript October 26, 2023

Lear Corporation beats earnings expectations. Reported EPS is $2.87, expectations were $2.54.

Operator: Good morning, everyone and welcome to the Lear Corporation Third Quarter 2023 Earnings Conference Call. [Operator Instructions] Please also note today’s event is being recorded. At this time I’d like to turn the floor over to Ed Lowenfeld, Vice President Investor Relations. Please go ahead.

Ed Lowenfeld: Thanks, Jamie. Good morning, everyone and thank you for joining us for Lear’s Third Quarter 2023 Earnings Call. Presenting today are Ray Scott, Lear’s President and CEO; and Jason Cardew Senior Vice President and CFO. Other members of Lear’s senior management team have also joined us on the call. Following prepared remarks, we will open the call for Q&A. You can find a copy of the presentation that accompanies these remarks at ir.lear.com. Before we begin, I’d like to take this opportunity to remind you that as we conduct this call, we will be making forward-looking statements to assist you in understanding Lear’s expectations for the future. As detailed in our safe harbor statement on Slide 2, our actual results could differ materially from these forward-looking statements due to many factors discussed in our latest 10-Q and other periodic reports.

I also want to remind you that during today’s presentation we will refer to non-GAAP financial metrics. You are directed to the slides in the appendix of our presentation for the reconciliation of non-GAAP items to the most directly comparable GAAP measures. The agenda for today’s call is on Slide 3. First, Ray will review highlights from the quarter and provide a business update. Jason will then review our third quarter financial results and provide an update on our full year outlook. Finally, Ray will offer some concluding remarks. Following the formal presentation, we would be happy to take your questions. Now I’d like to invite Ray to begin.

Ray Scott: Thanks, Ed. Now please, turn to Slide 5, which highlights key financial metrics for the third quarter. We had another strong quarter with double-digit increases in sales and operating earnings. Total company revenue was $5.8 billion, a 10% increase compared to last year. Core operating earnings increased by 14% from last year to $267 million. Adjusted earnings per share increased 23% and operating cash flow improved significantly to $404 million for the quarter. Slide 6 summarizes key highlights from the quarter. The third quarter marked our fifth consecutive quarter of year-over-year improvements in both revenue and operating income. Our Seating team demonstrated their industry-leading operating capabilities by successfully launching the Wagoneer and Grand Wagoneer just-in-time programs.

This was an important conquest win and an unprecedented mid-cycle transition of a very complex luxury Seating program. Our thermal comfort integration and innovation continues to gain traction. During the quarter, we leveraged our strong relationship and we’re awarded our first ventilation program with General Motors. The customer response to our expanded thermal comfort capabilities has been tremendous and we will continue to work with existing and new customers to add Lear content. Key third parties continue to recognize our leadership in quality and innovation. Lear once again received more than twice as many J.D. Power Seat Quality awards as any other supplier including first place awards in both luxury categories. ReNewKnit, our fully recyclable suede alternative that will start production next year was named as an Automotive News PACE Award finalist.

In E-Systems we continue to diversify our customer base with new wiring awards with Renault and Geely. Our strong performance allowed us to increase the pace of share repurchases. In the quarter, we repurchased approximately $75 million worth of stock, more than we repurchased in the first and second quarters combined. I couldn’t be more proud of Lear team. Not only did they execute during the quarter but Lear employees always support the communities where they live and work. The team in Morocco established a special fund to help those impacted by the devastating earthquake Slide 7 provides more detail on the progress we have made in Seating. In addition to the launch of the Wagoneer and the Grand Wagoneer, we launched the seeds for the BMW 5 Series in Europe.

Both vehicle launches were key conquest awards from competitors. We continue to grow with BYD with several current and upcoming launches such as the Seat assembly for the BYD Seal, as well as component sales such as leather for the BYD Denza D9. Our leadership in quality and operational excellence once again was recognized by J.D. Power. Our four best in segment and nine total top three awards more than twice as many as any other seat supplier. We are in first place in both luxury categories. The seats for the Porsche 718 team won in the luxury car category, while the seats for the Range Rover Sports won in the luxury SUV category. In total, Lear won four of the seven awards across the two luxury categories, further evidence of our leadership in this segment.

ReNewKnit, our fully recyclable suede alternative is gaining traction with both our customers and with third parties. ReNewKnit will start production next year on three programs with three different OEMs. We are in discussions to expand ReNewKnit to additional vehicle lines, with these customers and have seen increasing interest from other customers. Momentum has increased rapidly, and we see great opportunity for additional awards in the coming months. The level of innovation for ReNewKnit led to automotive news to name — at PACE Award finalist for 2023. The winners will be named later next year. Slide 8, provides an update of the significant progress we are making in all phases of our Thermal Comfort strategy. We continue to optimize our manufacturing footprint and Thermal Comfort Systems organization.

Our new facility in North Africa, provides a low-cost alternative to our current locations. To date, we have conducted technical reviews with our thermal comfort capabilities with 14 OEMs. Positive feedback from these reviews, affirm our confidence in our strategy. The strong relationships we have built with our customers make it easier to drive growth opportunities for our thermal comfort components. During the quarter, we won a ventilation award with General Motors. This breakthrough win for Lear opens the door for additional growth opportunities for ventilation and other thermal comfort products, with our largest seat customer. Once validated, our components can be sourced across an OEM’s entire vehicle portfolio. Having sourcing control for the Thermal Comfort components allow us, for quicker proliferation particularly for programs that we are just in time supplying.

The interest level of our modular innovation has accelerated. Our timing is perfect, as our customers are looking for solutions to reduce part complexity and cost, while also offsetting the impact of elevated wage inflation. Today, we have 21 development contracts for component modularity and FlexAir solutions. And we previously, announced that we are on track to launch our first production application for FlexAir during the first quarter next year. Working with a premium European OEM, we combine pneumatic, lumbar, massage, heat and ventilation into a single modular solution. We estimate this module will reduce part complexity by 50% and in the just-in-time plant while lowering costs and improving performance for the end consumer. We are on track to have this module fully validated by our customer, by the middle of next year.

The response for our complete seat modularity has been overwhelmingly positive. As a result, we are accelerating the time line, we expect to deliver this solution from 2027 to 2026. The initial results from the seven development projects, in process for existing customers have been outstanding. Our complete seat module has significantly improved the thermal comfort performance when compared to individual components. The airflow from our ventilation systems increased by up to 55%. The heat solution increases the temperature by up to 85%, more than the current solution after only one minute improving the time to sensation. And we’ve increased the intensity of the massage system by up to 150% compared to the current component solution, allowing the module to provide a much more therapeutic experience.

Our customers are looking for these solutions. We have been meeting with the customers, at the top levels within the organizations. And the feedback has been extremely positive. The momentum has shifted from Lear pushing these concepts, to our customers really pulling us and asking us to move faster and driving their internal organizations to implement our complete seat solution. Lear’s module solutions will provide a cost savings opportunity to our customers while expanding seating margins. Turning to Slide 9. I will provide an E-Systems update. The third quarter marked our fifth consecutive quarter of year-over-year margin improvement in E-Systems. The increase in industry volume combined with our efficiency improvements and margin-accretive backlog allowed us to achieve our highest operating margins in E-Systems, in more than two years.

Based on the midpoint of our current outlook, the second half margin, this year is on track to be more than 100 basis points better than last year. The new connection systems plant in North Africa is currently producing preproduction components. This facility is key to expanding our engineering component capabilities, and will support our new vertical integration opportunities in Europe. An important driver of our margin expansion plan. We continue to win new business in both wiring and connection systems. Key awards include our conquest award with Renault, and an award with a new EV with Geely. These awards along with the opportunities we are pursuing in the fourth quarter, keep us on track to achieve our third straight year of a $1 billion three-year backlog in E-Systems.

The improvement over the last several quarters is a result of the strategy we developed in 2019, and implemented over the past three years, by streamlining our portfolio to focus on high-growth and high-return products. And deemphasizing noncore product lines, we have optimized our resources and continue to win new business in our key product areas. There’s still a lot of work to be done, but we continue to make meaningful progress towards our margin targets. Now, I’d like to turn the call over to Jason for a financial review.

Jason Cardew: Thanks, Ray. Slide 11 shows, vehicle production and key exchange rates for the third quarter. Global production increased 4% compared to the same period last year and was up 8% on a Lear’s sales weighted basis. Production volumes increased by 9% in North America and by 6% in Europe, while volumes in China were down 1%. From a currency standpoint, the US dollar weakened against the euro but strengthened against the RMB compared to 2022. Slide 12 highlights Lear’s growth compared to the market. Total company revenue growth lagged the market by one percentage point, primarily driven by unfavorable platform mix and several key programs in North America. The largest driver of the unfavorable platform mix reflected downtime in seating at General Motors full-size truck plants.

Excluding the impact of the downtime, total company sales growth would have been in line with the overall market. The UAW strike at GM’s Wentzville facility and Ford Chicago facility also had a modest negative impact on seating revenue. In E-Systems growth of the market of three percentage points was driven by our backlog in all regions, as well as favorable platform mix in Europe. Europe sales outperformed industry production by eight points with both business segments benefiting from higher volumes on the Land Rover Range Rover, Range Rover Sports and Defender. New conquest programs such as the BMW 5 and 7 Series in Seating and new business with a global OEM as well as BMW, Mercedes and Fisker and E-Systems contributed to the strong growth in the region as well.

Through the first three quarters, total company growth over market was two percentage points with Seating growing one point above market and E-Systems growing five points above market. Turning to slide 13 I will highlight our financial results for the third quarter of 2023. Sales increased 10% year-over-year to $5.8 billion. Excluding the impact of foreign exchange, commodities and acquisitions sales were up 7%, reflecting increased production on key Lear platforms and the addition of new business in both segments. Core operating earnings were $267 million compared to $235 million last year. The increase in earnings resulted from the impact of higher production at Lear platforms and the addition of new business. Adjusted earnings per share increased 23% to $2.87 as compared to $2.33 a year ago.

In addition to higher core earnings our adjusted EPS benefited from higher equity earnings and a lower share count reflecting the benefit of our share repurchase program. Operating cash flow generated in the quarter was $404 million, compared to $252 million in 2022. The increase in operating cash flow was due to an improvement in working capital and higher earnings relative to last year. Slide 14 explains the variance in sales and adjusted operating margins in the Seating segment. Sales for the third quarter were $4.3 billion, an increase of $397 million or 10% from 2022 driven primarily by an increase in volumes on Lear platforms and our strong backlog. Key backlog programs include the BMW 5 and 7 series and Batch Hornet [ph] in Europe; the Chevrolet Colorado, GMC Canyon, and Mercedes EQE SUV in North America, as well as the [indiscernible] and leather sales for the BYD Denza D9 program in China.

Excluding the impact of commodities, foreign exchange and acquisitions, sales were up 6%. Core operating earnings improved to $275 million, up $20 million or 8% from 2022 with adjusted operating margins of 6.4%. As expected, operating margins were modestly lower due to the impact of higher engineering spending and launch costs to support new business awards. This was partially offset by the benefit from higher volumes on their platforms and our margin accretive backlog. Seating margins in the third quarter were negatively impacted by production disruptions related to the UAW strike, GM full-size truck downtime and volume reductions and premium costs related to shipping delays at the Mexican border. Slide 15 explains the variance in sales and adjusted operating margins in the E-Systems segment.

Sales for the third quarter were $1.5 billion, an increase of $143 million or 11% from 2022. Excluding the impact of foreign exchange and commodities, sales were up 9% driven primarily by our strong backlog and higher volumes on key platforms. Key backlog platforms include new programs with a global EV OEM and Fisker in North America and Europe, as well as the Ford Super Duty trucks in GM Hummer EV and Silverado EV in North America. Core operating earnings improved to $79 million or 5.3% of sales compared to $53 million and 3.9% of sales in 2022. The improvement in margins reflected higher volumes on Lear platforms and our margin-accretive backlog and improvement in commodity costs and strong net operating performance. The positive net performance was driven primarily by efficiency improvements at our North American manufacturing facilities, resolution of key commercial negotiations with customers, facilitating recovery of costs due to the commodities and wage inflation and restructuring savings.

Moving to slide 16, we highlight our strong balance sheet and liquidity profile, a major competitive advantage for Lear in today’s higher interest rate environment. We do not have any near-term debt maturities. Our earliest bond maturity is in 2027 and our debt structure has a weighted average life of approximately 13.5 years. Our cost of debt is low, averaging approximately 4%. In addition, we have $3 billion of available liquidity. We are on track to meet or exceed our target of 80% free cash flow conversion for the year. We remain committed to returning excess cash to our shareholders and accelerated our share repurchases in the third quarter. During the quarter, we repurchased $75 million of stock which was more than the first and second quarters combined.

Our current share repurchase authorization has approximately $1.1 billion remaining, which allows us to repurchase shares through December 31, 2024. Now shifting to our 2023 outlook. Slide 17 provides global vehicle production volumes and currency assumptions that form the basis of our full year outlook. We base our production assumptions on several sources, including internal estimates, customer production schedules and S&P forecasts. At the midpoint of our guidance range, we assume that global industry production will be 7% higher than in 2022, an increase of 3 percentage points or two points on a Lear sales weighted basis from our prior guidance reflecting higher production in Europe and China. Our global production assumptions are generally aligned with the latest S&P forecast.

From a currency perspective, our 2023 outlook assumes an average euro exchange rate of $1.08 per euro and an average Chinese RMB exchange rate of RMB 7.02 to the dollar. Slide 18 provides more detail on our current outlook. We are increasing our 2023 outlook for net sales, core operating earnings and free cash flow from the midpoint of our prior outlook. We are increasing our outlook for restructuring costs by $25 million to fund investments that will optimize the manufacturing footprint of our new thermal comfort segment and to reduce capacity in Europe to better align with current and future customer production plans. At the same time, we are reducing our outlook for capital spending by $25 million, primarily as a result of slower customer ramp-up plans on various new electric vehicles.

In the third quarter, we lost approximately $25 million of revenue due to the UAW strike. Based on the plants that are on strike as of today, we are losing approximately $60 million of revenue per week. Based on the late news from last night the revenue impacts will drop to $35 million per week once Ford resumes production. Consistent with our prior guidance, the full year financial outlook assumes a $350 million revenue impact from industry disruptions, related to the ongoing UAW strike, including approximately $325 million in the fourth quarter. Through the end of this week, the cumulative revenue impact of the UAW strike is approximately $170 million. This leaves approximately $180 million of revenue contingency for the remainder of the fourth quarter.

Slide 19 highlights our fourth quarter outlook for sales and core operating earnings in Seating and E-systems as well as the outlook excluding the assumed impact of the ongoing UAW labor strike. In Seating, the midpoint of our fourth quarter revenue outlook includes approximately $230 million of assumed loss revenue from industry disruptions related to the UAW strike. The midpoint of our fourth quarter operating income outlook is 6.8% including negative margin impact of approximately 70 basis points due to the assumed strike impact. In E-Systems, the midpoint of our fourth quarter revenue outlook includes approximately $95 million of assumed loss revenue related to the UAW strike. The midpoint of our fourth quarter operating income outlook for E-Systems was 5.5%, including negative margin impact of approximately 90 basis points due to the assumed strike impact.

In the appendix of the presentation, we included a summary of our current full year outlook for Seating and E-Systems revenue and operating margins as well as a full year outlook that removes the assumed impact of the UAW strike. At the midpoint of our guidance, our full year Seating margins are forecasted at 6.8% our E-Systems margins at 4.6% and total company margins at 4.8%. This is an improvement of 10 basis points from the prior outlook for Seating and total company margins. Excluding the impact of the strike full year margins would be 7% in Seating 4.9% in E-Systems and 5% for the total company. Now, I’ll turn it back to Ray for some closing thoughts.

Ray Scott: Thanks, Jason. Please turn to Slide 21. Our third quarter results provided another clear example of our ability to deliver strong performance in a very volatile industry environment. In Seating, we are accelerating the pace of innovation for thermal comfort systems. The response from our customers and the demand for our modular solutions has been overwhelmingly positive. In E-Systems, our execution and focus on efficiencies continues to drive margin improvement. We are on pace to improve margins again in the fourth quarter. Our Lear Forward initiatives have yielded savings in excess of our goal for this year by streamlining processes and changing plant layouts to optimize plant capacity and accelerate automation to address labor shortages and improve efficiencies. These results put us on track to achieve our target cash conversion, allowing us to continue to return capital to shareholders. And now, we’d be happy to take your questions. Questions and Answers.

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Q&A Session

Operator: Ladies and gentlemen, we will now begin the question-and-answer session. [Operator Instructions] Our first question today comes from Rod Lache from Wolfe Research. Please go ahead with your question.

Rod Lache: Good morning everybody. I wanted to ask you about the E-Systems performance, obviously, came in better than expected. I presume that that was partly related to recoveries but it looks like as well you’ve got a pretty strong exit rate 6.4% in the fourth quarter excluding the strike. Could you maybe just speak to whether we should be looking at that level of profitability as a reasonable launching point for modeling 2024? And then just to the extent that some of that improvement look going forward is going to be driven by recoveries. Just characterize how those discussions are going just particularly in light of the pressures that some of the OEMs are seeing on labor and other areas?

Jason Cardew: There’s a lot to unpack there Rod. I’ll start maybe with the third quarter E-Systems performance when we issued kind of a mid-quarter update on what we’re expecting in E-Systems. We talked about 4.75% operating margins. So, primary improvement from that point until the end of the quarter was really a lesser impact from the strike and slightly stronger volumes. The commercial recoveries and the operating performance was directly in line with the targets we had established and was meaningful in terms of both sequential improvement in performance and year-over-year improvement in performance. As we think about what that may mean for the business as we look out to next year, I think the right way to model these systems is to look at the second half forecast for both third quarter actuals and our outlook for the fourth quarter, which right now sits at 5.4%.

Now, that does include the impact of the labor strike. It also includes some out-of-period benefit from the commercial negotiations that happened in the third quarter and that we anticipate happening in the fourth quarter. If you sort of normalize for all of that, the real run rate in the second half of the year in E-Systems is about 5.5%. So, I think that’s the right launching point as you look out into 2024 for that business. I would say overall we’re quite pleased with the progress we’ve made both operationally, particularly in North America where we were struggling with efficiencies that we talked about earlier in the year, but also in our commercial negotiations. We completed some really important negotiations in the quarter that I think established a nice precedent going forward for us give us a little more predictability.

That said we do anticipate there will be challenges with that as we look out to next year but we’re very happy with the performance thus far in E-Systems.

Ray Scott: Yes. I think Rod when we simplified this portfolio and I’ve said it before that we’re trying to be everything to everybody and started deemphasizing areas that we quite candidly couldn’t compete in longer term with the type of investment dollars that were required is really paying dividends. And so the simplification of the product portfolio clarifying it allowing us to grow profitably in those areas and we are growing. I mean what I’m really excited about is that three years of consecutive $1 billion of backlog businesses gives us a lot of confidence that we’re in the right area we have a right to grow in those areas and we can generate good returns. The diversification — the customer diversification was a key part of our strategy and we’re doing a really nice job of diversification across Geely.

We talk about Jag, Land Rover, Volkswagen, European OEs just continue to accelerate our diversification across customers and the vertical integration. I mean it’s a really — in a time right now when customers are looking for solutions it’s really opening their eyes to different possibilities of what we can do both from a Ts and Cs perspective but also engineered components. And so we just had a great review with one of our major customers to really talk about what we can do to lower their overall cost, but also help us expand our margins with the new systems. And so a lot of the aspects of what we put in with the strategy are really starting to pay off. And so we have a lot more confidence that would continue on this path. We got more work to do Rod.

I mean there’s no question we’re going to work hard on our efficiencies our improvements some of the commercial negotiations. But really confident where we’re at.

Jason Cardew: Yes, I think people highlight that E-Systems is sort of a Shelby Store. I think we’re starting to prove that the plan that Ray just laid out is working. Our operating margins for the second half of the year are 200 basis points higher than our full year margins were last year 160 basis points higher than they were in the first half of this year. So, we are — third quarter is both an inflection point and another proof point with the fifth straight quarter of year-over-year margin expansion in E-Systems. So, we’ve seen a lot of progress there.

Rod Lache: Yes. It sounds like you’ve got a lot of momentum there on the margins as well as the wins. I was just hoping to lastly you can address just one thing you can’t control is just the timing of launches in EVs which has been obviously a good part of the backlog. Can you maybe just give us some color on what you’re seeing and how we might want to just calibrate the backlog that we’ve been seeing just to the reality of pushouts here or there? How significant is that?