And connectivity. The company has made a number of seating acquisitions while continuously working on repositioning its E-Systems segment for long-term growth. So I'm extremely excited to talk about all these trends with the A-team from here, from Lear here. We have Ray Scott, who's President and CEO, Jason Cardew, who's SVP and CFO. The format for today will be a fireside chat around some of my prepared questions, but also questions from all of you in the audience. We'll leave some time at the end. So maybe just, we'll start with mine. Thank you so much for being here.
It's great being here. Thanks for having us.
So maybe just to set the stage, how are things playing out for Lear so far in the second quarter? From an industry perspective, what do you view as the biggest risk factors and opportunity for the sector in the second half and beyond?
Well, why don't I start it? First of all, thanks for having us, and thanks for those attending here in person today. From a broader strategy perspective, we couldn't be more proud of what we've accomplished. I think in Seating, where we talked about being the most vertically integrated seat company in the world, we've done a nice job of integrating Kongsberg and IGB, really setting us up for a thermal comfort modular system, and we're moving quickly with our customers across the board in that area, along with other areas of FlexAir that really uniquely define Lear as a different way of looking at seating, you know, as we move forward. E-Systems, I couldn't be more proud of the team. We've had seven consecutive quarters of a year-over-year improvement.
The plan that we put in place, the strategy we put in place to really simplify the product portfolio is paying off, and, and we're gonna continue to make improvements in E-Systems. The last leg of the strategy plan of this vertical integration within Industry 4.0, or what we just recently rolled out, IDEA by Lear, really takes in the digitalization, the technologies around automation within our manufacturing plant, is really accelerating. So I'm really proud of what we're doing strategically within Lear Corporation, and we're seeing each one of those areas move very positively.
I'd say, from a financial perspective, the second quarter is playing out largely as we had anticipated, particularly on the things that we can control. The commercial negotiations or operating improvements, but we still have 2.5 weeks to go. We have some work, yet to close out between now and the end of the quarter. Everything on the performance side, operating income, operating margins, is on track. We are seeing revenues a little bit lower than we had anticipated in the second quarter. You know, some of it, usual things like the flood in South America impacted production in most of our out of revenue, 30-35. We see some downtime, watch how much in floor ramp up certain platforms.
We had expected that to be up about 50%, but for the second quarter, we now think more likely to be flat quarter, but performance improvement is largely offset where we had expected. Thinking about the second half of your question, if you look out the second half of the year, we had expected revenues to be flat for the second half of the year, with the benefit of the backlog going on, sort of offset by normal seasonality, particularly in Europe and North America, where there's downtime. As we look at what's happening in the first five months of the year in terms of particularly on electric vehicle platforms, we're starting to see the airports in the U.S. to connect to levels and still great inventory levels.
So we are, you know, at this point in time, I'd say probably the kind of 1%-2% lower second half year than what we've seen so far in sales, but Europe and China, large markets. In terms of our operating margins and the performance side of control, we're more optimistic about our guys here. One of the key drivers of that for first half, second half margin in the whole segment was actually what we refer to as performance, and about that $50 million-$60 million of operating that we have a good line of sight on second half. All in the three buckets. The first is the launch cost and engineering costs, and launch size at the time the program ramps up, that launch cost is a little lower in the second half.
Like engineering spending, that spending will be a little bit lower in the second half of the year. The second bucket is the restructuring savings and the benefit of automation. And so we have already started to move from Europe, North Africa, Segura, you know, one of our acquisitions that we made last year. [audio distortion] So we have ramped up the deployment of that technology, plants that are in process for the benefit of the segment. These are cycle improvement that we've already implemented, that we'll see the benefit. And then the third component of that performance with the material costs. So it's putting in place a five-day MQO process, working with our customers. All those things taken together operating side is-
... All right, that's extremely helpful. Just a quick point of clarification. So when you were talking about the second quarter so far, so you said revenues may be a bit softer than expected, some one times, et cetera, but operating income still about in line with where you thought. Does that imply a decent sequential improvement in margin?
Yeah, typically, we were where we had expected sort of flat margin for the next quarter, higher margin quarter. Now, it's supposed to be a slow down last year, but quarter by sequential margin improvement, should be higher quarter, you know, first quarter. The systems would still sort of expected by margin worldwide, despite the lower-
That upside would be driven by what?
Mostly the improvement actions that I described in the second half of structuring that done and the benefit of automation.
For the benefit of people in the back of the room, there's a few seats in the front if you want to have or put your computer down on the table, there, front table here. Thanks so much for this overview. So you were mentioning initially, you recently announced this evolution of your strategy, IDEA by Lear, as well as the acquisition of the industrial automation. What role will automation and new technology play in your plan for expanding margins in both segments?
It's going to play a big role, and I couldn't be more excited about what I'm seeing in our facilities. You know, we've had a number of acquisitions, and we've always been focused on operational excellence. And now with our acquisitions of ASI, InTouch, Thagora, and most recently, the WIP acquisition, which is centered around software and AI and algorithms that really change the dynamics of the invested capital on the floor and tying it to software that really brings to life ways to really create efficiencies. And so, you know, we talk internally about, you know, thinking differently, driving accountability, but most importantly, moving fast. And the changes that we're making in the organization are really centered around how we standardize these great technologies and capabilities that we have vertically integrated into Lear Corporation.
So we don't need external players to come in and bring those type of capabilities into Lear. And so we are becoming really quickly an advanced manufacturer integrator. And this role is very important. And we've talked about the product side of how we're moving to modularity and making sure that we're focused on really getting efficiency out of the product. But equally as important today with the technology that's coming at us with automation, AI, the software development, master control panels that are standardized across all of our facilities, we're seeing the benefits. And I think Jason alluded to how we're looking at our operations and how those are resulting in improvements, you know, quarter-over-quarter, but more importantly, year over year. I was just down in our Gratiot facility last week, and I think it's important to point that out.
It was a program that we took over from a competitor. It was the Jeep Wagoneer and the Grand Wagoneer. Walking through that facility, where traditionally we would actually outsource 80% of the capital on the floor, we sourced 75% of the capital internally to Lear. We manufactured the capital. And we did that through these acquisitions that we had in place. We saved 20% on the capital in that facility. And what was important is that we took that business over because the competitor that we took it over from couldn't get the throughput in place. They couldn't produce the parts in time for the customer. We saw a significant improvement. We could not only keep up with our customer, but we outpaced our customer.
We saw a 17% improvement in labor efficiency on the floor. And what's a great example, when we talk about how we're reducing our capital costs by writing the software and building our own master control panels that are standardized across our facilities, a camera that would typically run within our facilities at $20,000. Because of our software development programs, we got a camera at $500. We're seeing significant shifts in lower costs, and this is what we're talking about by IDEA by Lear, is integrating all these standard processes, from software development, to digital capabilities, to AI capabilities, into the capital that's on the floor. And that walking that plant and seeing what we're doing was amazing. And I think what's uniquely different is, it's the first time it was done in the industry.
I've been in the business for, since 1988. I've never seen a company come in in 10-11 months and launch a program like that, that was that much more efficient. And what's great about that, most programs take anywhere from 18-20 months to launch. Our customers want the acceleration of time in these facilities at a much faster pace. You look at some of the Chinese domestics. When we're doing a great job of winning business with the Chinese domestics, primarily because we can come in and accelerate the timeline. We can accelerate the efficiency, and we offer them a differentiated product. And so when I think about Gratiot, Gratiot was somewhat limited because the design was baked.
When we have the ability to actually change the product itself to a modular design and change the components to the efficiency that we're building on the plant floor, the savings are incredible. So I think we're just scratching the surface. I think Gratiot was an example of what we can do. If we can combine that with a product, I think we can not only outpace the labor economics, but as labor economics starts to moderate with our increased automation, and we're studying that right now, we believe we can continue to expand margins within both business segments. So the whole organization's been put in place. I had the great opportunity to move Carl Esposito into Idea by Lear.
His product, his design, his engineering experience is gonna help us accelerate that area, and then, you know, continue. We're gonna continue to improve our margins in these systems. But it's all about connecting it through wiring, trim covers, JIT facilities in our component business within seating with these modular concepts that we have. And so it's definitely a way to differentiate us. It is differentiating us, and it's actually driving our margin, and it's gonna expand our margins into 25.
One additional topic on the environment, and then we'll dive into your businesses. But the moderation of EV demand is having a large impact across the board, for OEMs, for suppliers. At the same time, we're seeing combustion engine programs having longer tail. How has this impacted your backlog, and how is Lear adjusting to the changing environment?
We started this, you know, lower than, as we look again at support levels starting to build in the U.S. in particular. You know, I still think there's some room for that number to go down in the U.S. Europe's holding up better. [audio distortion] You know, market for the sixth quarter, the European market we're on track quite well about signing some of the luxury demand moderated. And in China, very well, and I believe the benefit of the ICE platform being extended. I don't think we've seen much of that yet, but as we look out to 25, I would expect that we're going to start seeing these programs that previously were expected to build out 25. So we have a number of examples early in the year.
Just one quick follow-up. I guess what had surprised me when you updated the 2024 backlog was that obviously the electrification piece, you know, would come under pressure, but obviously, seating as well to a certain extent, even though you essentially could sell the same seats on combustion engine and on, and on EVs, like, it's essentially the same. So is there sort of like eventually a one-for-one replacement in terms of if an EV doesn't get made, then you get the business on the I side? Or is it a function of, in the end, every new vehicle that was gonna launch was likely gonna be an EV, and now these sort of, like, are being pushed out, and you don't really see that being replaced?
I think over the next three years, you will see a one-for-one trade-off. But clearly, you know, so learning different other power train, unique power train, but most of the new vehicles in the backlog were electric vehicles. So since those lines have come down, they have not been prioritized on what we're doing. Really, from a customer specific is Volvo, for example, the way to one, that program is simply kind of a program of that.
Let's dive into the seating business. What do you view as sustainable growth of a market for seating over the midterm? At your seating product day last year, you introduced midterm market share targets of 29% for JIT, 32% for total seating, including components. What are the catalysts, and how are the thermal comforts, and the opportunities for complete seat modularity helping you achieve this target?
So first, just step back and look at the last five years, we've grown that business at 4% above market, the catalyst for that, both the market and market share. We established a target of 24%-25% market share by 2027. We're now approaching 26%. We're well on our way to meeting that. Thermal comfort is a key driver of that. It's, you know, just by growth, also, you can see that growth in our component sales as well. We have a little bit more than $2 billion a year in component sales that we sell to our competitors, and we see that business growing pretty rapidly as well. So those are the key drivers for the long term.
I think in the near term, growth is gonna be a little choppy again because of, you know, what's happening in this transition from ICE to EV and some uncertainty around what our customers are going to build. It's a little harder to predict, but I think look out over five years, that four points of growth of a market is very achievable in seating.
And just to add to that point, you know, right now we're working with just about every customer on these thermal comfort modules. Currently, we're working in development programs on 22 different platforms, approximately 13 different OEMs, and we have what we consider to be phase two with three different customers, Lucid, Volvo, and a German OEM. What's important about that is this, this change to a modular design is revolutionary. So even though you talk about the cost savings, the efficiency, the way that you actually deliver the modular system and have savings within the JIT facility as far as your labor cost, is a significant change. So these development programs are very important because it goes through the validation process, and there's a time element there.
It is even though we validated internally, it's putting it in front of the customer and getting it into production, cases where you validate it. And so we're moving extremely quickly, I believe, given that the Kongsberg and IGB acquisitions just recently occurred, but that gave us a tremendous amount of credibility as we work with our customers. And we just announced, too, and it's a very important announcement, that we have a fully integrated modular design with Ford Motor Company, and so it'll launch in late 2026. But what's important about that is that as we're going through the validation process, and there's a number of elements you have to take that product through as far as the development goes, that gives us an enormous amount of credibility with other customers.
So there is this kind of wait and see in some respects, that once it gets into production, it's amazing how fast customers start to be more attracted to it. And I think FlexAir is a great example. Jason talked about we're a small player in polyurethane. It's a very, very dirty chemical that's used to really produce foam, and we have a revolutionary design around FlexAir that changes the composite, and actually, it's recyclable. It reduces CO2 emissions by 50%. And Hyundai was the first OEM that introduced it in production, and now they're looking at all kinds of different applications within the seating area to mass produce it in volume across different vehicles. Now, that went from a push. We're talking to our customers, to now it's a pull.
I was just down in a facility where we're working on the advanced manufacturing of FlexAir. It's lower capital. The cost is just about the same. We get great returns on the FlexAir, and now our customers are pulling it in all different areas to get it into production so they can use, have their use cases to take that across multiple seating applications. So those are the examples that we have, but there's a time element as we're getting those into production. So I couldn't be more proud of what we've done, where we're at. I think as we work with Ford on this, the ultimate design of integrating the components into the trim cover outside the JIT facility, and then having this spoken hub concept where you can flex and you have the ability to flex across multiple platforms, that's what we're looking for.
These programs are getting smaller in scale as far as volume. They have a number of different platforms across different types of propulsion systems, and so being able to flex the modular designs is a solution. And I think offering that to our customers is a solution that they're looking for. They are looking for ways that you can drive a modular component into seating in other areas within the vehicle. And so, we're moving fast, there's no question about it, but there's an element of the development process that takes a little bit more time.
Now, your large seating competitor recently complained about some insourcing of JIT seating by some OEMs in Europe. Have you seen this? Does it concern you? And how does thermal comfort, along with your automation initiatives, contribute to your margin in seating?
Yeah, it's, like I said, I've been in seating for a long time, and there's different customers that have different strategies. We, you know, Volkswagen has an element where they have insourced seating in the past, and BYD does a little bit of that today. Tesla's done it in the past. So we're not unfamiliar with always looking at insourcing, but I think it's when they don't have a solution. And we're not seeing any different trends or any outliers, and we talk to our customers every single day, particularly around where they're at, what they're looking at, how they're setting up their strategy for seating, moving forward. So there's been no changes. I haven't seen of anything that would, you know, raise a concern from our perspective.
But, but I always boil it down to this: I mean, you have to be the most competitive supplier in the business. You have to continue to create a value proposition for your customers. And I think when you have solutions, as you're vertically integrating these modular solutions, it's a very unique way to differentiate us. I mean, we are the only company in the world that has that capability, and offering that to our customers does create a very unique solution. I think in addition to what I just mentioned with Gratiot, that's an important element. When you're the lowest cost producer, when you look at your capital on the ground, when you're looking at how you're investing, how you're standardizing your processes, it is the solution that you can offer your customer.
And so they can have business case where they look internally, or they look at other competitors, or they look at you, and you have to be the most competitive, and I think that's the position we've put ourselves into. And so, you know, the examples that I have when I talk about us taking over conquest business from other competitors that are in mid-cycle, which is unheard of, is the example of offering a value proposition to our customers.
Let's talk about E-Systems and electrification. E-Systems had particularly strong Q1, equivalent to 10% growth over market, partly due to the, you know, Ford and GM platforms. Do you expect these strengths to continue through the rest of the year? What kind of incremental margin can we expect from this segment going forward?
Yeah, so we had an especially strong growth over market quarter in Q1 in E-Systems, and it was driven by both our backlog, and as you've mentioned in the question, certain platform volumes that were higher. We had sort of an easy comparison year-over-year on some of our really important platforms like the Ford Escape and Ford Super Duty and the GM Colorado Canyon, and so that really benefited the growth over market. So 10 points is a little bit of an anomaly as we look at the full year. Our prior guidance was five points of growth over market, so we do expect that to moderate through the balance of the year. In terms of incremental margins,
As we've talked about historically, if it's a volume increase in an existing platform, sort of 25% is what we would expect in terms of incremental margin, and the backlog between 10% and 15%, depending on the product category.
To add to that, too, we made an organizational announcement recently, and I think it's important to point that out. One, it was with the intent to accelerate IDEA by Lear, Industry 4.0, all the great acquisitions that we have in place now, and really centralize those in a way that we can standardize those great capabilities throughout our plants. But equally as important, we're in a much better position in E-Systems. And bringing Nick Roelli over from Seating, he's an expert in manufacturing processes. He's great with the customer. He's really focused on driving efficiency. So the timing was perfect for us to really shift into IDEA by Lear, setting that organization up so we can accelerate much faster across the board with standard processes that we've learned.
But equally important was a great time now to take the simplicity that we did in the product portfolio, the improvements we're seeing, and accelerate the efficiency within the E-Systems division, 'cause we're there. And so you know, our vision is to continue to see improvements within E-Systems and accelerate that business.
Can you remind us of the size of the electrification opportunity for Lear? What's in the backlog, what's being quoted, and what can revenue look down the line?
Yeah, it's been an important component of our growth story in E-Systems. That business, electrification business is about $565 million of revenue. In 2022, it grew to roughly $750 million last year. Our guidance for this year has it growing to $800 million. Growth moderated somewhat this year as that industry transition to EVs slowed down a bit. But it is an important component of growth for E-Systems. So we talked about 6 points of growth over market being the target in that business. three points of that growth over market is coming through electrification. I think in the midterm, that may moderate a little bit and more in the one-two percentage points.
But over the long term, I, I still think that's kind of the right target to think about in terms of E-Systems growth over market.
What's the opportunity from hybrids, specifically in your portfolio?
Yeah. So, in a full electric vehicle, you have about $700 of additional CPV compared to an ICE vehicle in E-Systems. And in certain cases, like a full-size truck, it could be well above that. In a plug-in hybrid, you capture about a third of that, about $250 of additional CPV. So it's still meaningful. It's not as much as the incremental content in an electric vehicle, but it's still a meaningful growth opportunity for us.
Maybe capital allocation is the next question. What are your priorities for capital allocation in the current environment between CapEx, M&A, buybacks, regular dividends? And can you walk us through your M&A strategy?
Yeah. So consistent with what we've said in the past, you know, first and foremost, we're going to invest in the business, and we've been running with CapEx just under 3% of sales. That seems to be the right level. It might, you know, go a little bit above that if we have particularly appealing opportunities in automation, and may drift back down as we find further opportunities through the acquisitions, allowing us to lower our capital spend, as Ray alluded to, for example, in the Wagoneer, Grand Wagoneer launch, where we were able to reduce our capital spending pretty dramatically. We see that as a growing opportunity for us. We're continuing to expand our supply base on the capital side, too.
Numerous opportunities, both in E-Systems and Seating, with, with new suppliers in China, that have allowed us to lower our capital costs, as well. So that's our first focus. From an M&A standpoint, we're focused on small tuck-in acquisitions, much like we've done in the last, several years, particularly on the process side. So sort of these $15 million-$25 million acquisitions. There's a number of other companies we're looking at in that space. Over the next couple of years, we'd like to do, do more there. In terms of our dividend, you know, we've, kind of held the dividend flat, until we get back to sort of pre-COVID level of earnings. We'll likely, hold that, flat and then look to grow it as, as earnings fully recover, from that time period.
So we're really focused on returning excess cash to shareholders through share repurchases. We've ramped that back up last year, about $313 million, bought back about 4% of our shares out. We expect to do the same this year. Like to do a little bit more, especially with the stock price where it's at. We bought back $30 million in the first quarter, looking at about $50 million in the second quarter. So we're gradually ramping that up as we generate free cash flow throughout the year. So that's going to continue to be an important part of the value creation story for shareholders, I think, for Lear over the next number of years.
Great. I have one more question on margins, and then we can open it up if there's any questions in the room. You're targeting 8% operating margins for both segments in the mid-term. Coming out of last earnings, you generated 6.6% in Seating, 5.1% in E-Systems. What do you need to see and do in order to get to the 8%?
Yeah, so if you look at, last year and see we're at 6.8%, our guidance this year is 6.7%-7.7%. So I think if, you know, we sort of end up right around 7% or just underneath that, this year, got 100 basis points yet to go to get to our 8% target. Thermal comfort is a component of that, bridge, that 100-point bridge. In the medium term, that's about 20 basis points, and it's 30 basis points over the next, four years or so. And we've started to see that improvement in the thermal comfort, business this year. It was, it lost-
... a little bit more than $10 million last year. That's gonna be profitable this year. It's a $20 million-plus improvement year-over-year, and we see that pace of improvement accelerating into next year as we've kind of moved our footprint from Eastern Europe to North Africa. That's had a significant impact on that business, as well as the synergies of just integrating those assets more fully into the company. In addition to that, we do expect to continue to generate margins of 10%-15% on the backlog. The backlog will be accretive, so even if industry volumes aren't growing, we see backlog as a contributor to margin expansion in seating. And then the last piece of it is net performance.
So that's our ability to offset wage inflation through customer recoveries and the automation programs that Ray described earlier. So those are the kind of the main baskets driving the improvement in seating. In E-Systems, it's a little larger step up, you know, from sort of the mid-size is what we expect for this year. So we do need a little bit of industry volume in order to get to that 8% level in E-Systems, and we've started to see some of that benefit this year. And then we also have some things that are sort of self-help measures. Our North America wire business is underperforming right now.
We've made significant improvements over the last 12 months, but we have more work to do, and we've got a great team in place, and we're well on our way to generating the improvements that we're anticipating in the outlook for the year and beyond there. So there's a kind of combination of backlog performance and then some self-help measures in E-Systems driving that margin bridge.
Thank you. I think we have time for maybe one or two questions. Jim?
Hey, good to see you guys again. I guess, Ray, my question follows up on your competitive position, low cost, leading technology, full capability, and your winning share. My question for you is, the subsector seating, the pricing dynamics versus OEMs, and what we've seen in terms of some major miscues from your competitors in the last 5 years, and more recently, mid-cycle conquest win, just unprecedented. Great for you, but in terms of the sector's pricing power versus that OEM unrelenting pressure, are you seeing or are you concerned about your competition being a little bit more aggressive on trying to win business three years out or two years out, depending on the lead time? And is that a big variable for you when you're thinking about your three-year targets that, you know, Emmanuel just asked you about?
Yeah, I don't think we're unfamiliar with irrational players thinking about their backlog, and even not that long ago, there was one of our competitors, their compensation was paid just strictly on the backlog. So we saw a lot of irrational behavior during that particular time, and that was one of the times we were growing at the fastest pace. I think, you know, it's important, one, that, like I said before, you have the most efficient low cost, and you can walk a customer through very clearly the importance of being able to produce more efficiently than your competitors. I think our customers are much more sophisticated. They understand some of the ins and outs in a much more sophisticated level, and walking them through the importance of quality, I think they have long-term memories, too.
So there's a number of examples without using names of some of our competitors that have come in under irrational pricing, taken the business, and then had to give it up or got into a major commercial battle with the customer. So our customers do have those memories on what has previously happened. So reminding them of this is what happened in the past with, you know, supplier A, B, C, is part of the process. And so it's constantly putting, you know, pressure on yourself to be the low-cost producer. Executing, I mean, executing every single day and getting the results from a quality perspective, a delivery standpoint is key, but then also working with them and explaining.
So, yeah, I, I don't see any major trends in that area because I think a lot of them have these longer-term memories when I talk about our competitors, too. But that doesn't mean that there won't be an irrational player just for the sake of backlog, trying to go off-
The takeaway for me would then be price downs, historically, 1%-3%, 2%-3%, historically. Is that kind of the framework that is still on that two- to four-year horizon in both seating and E-products?
It's a little less than that, more like 1%-1.5%, and seating a little higher than that on the E-Systems side.
That's holding pretty steady. You feel pretty good?
Yeah.
Okay.
That's pretty steady. I think what's important is the traditional OEs are really studying some of the competitors within China and trying to understand how are they delivering at a lower cost. They're working. Our customers are now working with us on solutions. Like I say, timing is everything. A modular solution or a way to integrate much more efficiently, capital on the ground is important to them. I think in the past, it was important, but not to the significance or the priority that they have in place now. So modularity is a really important component of how we're looking at growth. You know, FlexAir, these components that we have that differentiate us, customers are now much more willing to really look at those seriously around how we're gonna play longer term.
And so that has changed. You know, we talk about CTO or VAV, those type of things, but how you look at a seat assembly or harness or components within the vehicle has changed. They're much more in tune to trying to look at how that delivery model can change, and there's a lot of inefficiency. There's no question about it. We work with some of our domestics in China. They open up a lot more on specifications, how you change your product. So I think that equation around directed suppliers is gonna change over time. I do. We're seeing that right now. When we talk about thermal comfort, when I talk about working on, you know, 20 different platforms, that is a change from a directed model to working with our customers on an insource.
Because we take responsibility, but we also have the responsibility to source ourselves. That's the dynamic. That's what we're seeing our customers think through a little bit, more thoroughly, than they have in the past.
I think we're out of time. Ray and Jason, thank you so much for your time and insight.
Yeah, thanks, Emmanuel.
Thank you.
Thank you. Thanks.