Good morning, welcome to the Lear Corporation Q1 2019 earnings call. My name is Kyle, and I will be facilitating the audio portion of today's interactive broadcast. All lines have been placed on mute to prevent any background noise. For those of you on the stream, please take note of the options available in your event console. At this time, I would like to turn the show over to Alicia Davis, Vice President, Investor Relations. You may begin your conference.
Thanks, Kyle. Good morning, everyone, thanks for joining us for Lear's Q1 2019 earnings call. Presenting today are Ray Scott, CEO, John Absmeier, CTO, and Jeff Vanneste, CFO. Other members of Lear's senior management team, including Frank Orsini, President of the Seating Division, and Jason Cardew, Vice President of Finance, who oversees the finance function at both Seating and E-Systems, have also joined us on the call. Following prepared remarks, we will open the call for Q&A. You can find the presentation that accompanies these remarks at ir.lear.com. Before Ray begins, 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 two, our actual results could differ materially from these forward-looking statements due to many factors discussed in our latest 10-K 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 three. First, Ray is going to share some Q1 highlights and give a business update. John will then discuss our recently completed acquisition of Xevo. Next, Jeff will review our Q1 2019 financial results and 2019 financial outlook. Finally, Ray will provide some concluding remarks. Following the formal presentation, we would be happy to take your questions.
With that, I'd like to invite Ray to begin.
Thanks, Alicia, and good morning, everyone. I'm excited to be here today and give you an update on Lear Corporation. Slide five contains a few highlights I want to share with you. Our business performed well in the Q1 despite a tough macroeconomic backdrop, significant downtime in some of our key changeover programs, and a heavy launch activity. Because of Lear's strong execution capability, industry-leading cost structure, and a relentless focus on operational excellence, we were able to deliver strong results in a very challenging environment. As I will discuss in a moment, we have seen significant increase in our backlog and quoting activity in electrification and connectivity, two key growth drivers for our company. We also have continued to show our commitment to returning excess cash to shareholders by replenishing our share repurchase authorization to $1.5 billion and increasing the quarterly dividend to $0.75 per share.
Last month, as a testament to our financial strength, Moody's upgraded Lear's credit rating. Earlier this month, Lear was recognized by Automotive News with a PACE Award for ConfigurE+, our powered adaptable seat rail system. This technology, which was jointly developed by engineers in Lear's Seating and E-Systems divisions, allows the seat to be easily reconfigured within the vehicle and customized for many different uses, making it well-suited for a future of shared mobility. This is another example of how we continue to differentiate our Seating portfolio by leveraging our E-Systems capabilities in electronics. I'm extremely proud of this prestigious award, which is viewed around the world as an industry benchmark for innovation. Finally, last week, we completed the acquisition of Xevo, an automotive software supplier that connects consumers with their favorite retail brands directly from their vehicles.
Xevo will enhance our capabilities in software, services, and data analytics, as well as our market position in connectivity. The Xevo team will bring tremendous talent and expertise to further strengthen Lear. John will say more about Xevo in a few minutes. Slide six shows our Q1 2019 financials. As anticipated, we face a tough macroeconomic backdrop and additional headwinds related to customer downtime. Throughout the current market weakness, we have continued to aggressively manage costs, and our solid financial performance is a testament to Lear's strong execution capabilities and focus on process improvement. Slide seven highlights a few of our key program changeovers, as well as new program launches that are part of our record $1.4 billion backlog for 2019.
For the second consecutive year, we have significant launch activity, including launches for several high-content products in seating and programs involving some of the most complex technologies we have ever produced in these systems. As we have stated previously, we have been and will continue to be impacted by planned customer downtime on some of our key programs, which will negatively impact first-half revenue. However, with the ramp-up of these programs, coupled with our heavily weighted second-half backlog, we expect sequential sales improvements as the year progresses. Slide eight provides details of our quoting activity in electrification and connectivity. The pace of growth in these two areas continue to accelerate as penetration rates for electrified and connected vehicles increase. OEMs are accelerating quickly towards electric and hybrid vehicles, and by 2025, IHS estimates that over 40% of the global vehicle production will be hybrid or electric.
Today, 85% of all new vehicles sold in the U.S., Europe, and China are classified as connected. By 2025, almost 450 million connected vehicles will be on the road in these regions. These trends are translating into meaningful growth opportunities for Lear's E-Systems business. We are very selective about the quoting opportunities we pursue and what we report as quoting activity. There are a number of factors we consider before deciding to quote a program, but ultimately it comes down to whether the program will allow for profitable growth and generate returns in excess of our cost of capital. In January, we reported that the level of quoting activity in electrification and connectivity was approximately $1 billion. That amount now is approximately $1.2 billion and is expected to continue to grow throughout the year.
Our historical win rate on these programs is approximately 25%-30%, and I expect that win rate to continue. As you may recall, in the $3.4 billion backlog we announced in January, there was about $400 million of electrification and connectivity business. Over the last three months alone, we have been awarded an incremental $150 million of annual revenue on electrification and connectivity programs alone. We expect revenue related to these new technologies to increase by more than half a billion dollars by 2021, driven primarily by growth in electronics. Now I'm going to turn it over to John to discuss the Xevo acquisition.
Thanks, Ray. Turning to slide 10. As Ray mentioned, last week we completed the acquisition of Xevo. Xevo is an automotive technology company and the leading developer of software that unifies the connected car user experience. The company generates two distinct recurring revenue streams. The first is from its Journeyware suite of products. Journeyware is an in-vehicle infotainment software solution that connects drivers and their vehicles to mobile applications, content, and services. The software allows auto manufacturers to deliver infotainment that is customized with insights captured through artificial intelligence. Xevo's software is agnostic to operating system or infotainment platform and can run on Android Auto, Apple CarPlay, QNX, or Linux. Through Journeyware, the company generates recurring revenue by licensing the software. Toyota is Xevo's largest Journeyware customer. Its 12-year history with Toyota has given Xevo the experience and know-how required to deliver automotive-quality software, something most startups cannot do.
Journeyware is deployed on most Toyota vehicles in the U.S. and is the delivery platform for the Toyota Entune system. The company's second revenue stream is from Xevo Market. Xevo Market is an automotive commerce platform that connects consumers with popular food, fuel, parking, hotel, and retail brands through in-vehicle touchscreens, voice assistants, and OEM-branded mobile applications. Xevo offers a white label option that allows the OEM to own the consumer interface and maintain its brand identity. Xevo Market's key differentiator is its ability to use AI and data analytics to produce tailored, highly contextual recommendations based on consumers' predictable behavior patterns. Xevo currently has no direct competitors for its market platform and has a significant first-mover advantage. Through Xevo Market, the company receives recurring revenue from retail merchants. This revenue takes many forms, including per-transaction fees, as well as loyalty bounties and payments for preferred placement.
Xevo shares a portion of this revenue with the OEMs, thus offering a compelling value proposition to automakers. General Motors is the first automaker to deploy Xevo Market technology for its GM Marketplace platform. Xevo Market is on almost all GM connected vehicles that are model year 2017 and newer. Xevo currently is in negotiations with several other OEMs regarding use of the Xevo Market product. We plan to announce new OEM relationships soon. Acquiring Xevo is the next step in Lear's evolution as a global player in the high-growth area of in-vehicle data and connectivity. The acquisition of Xevo broadens Lear's connectivity portfolio as it brings together Xevo's leading infotainment and e-commerce platforms with Lear's expertise in electronics. To position Lear for profitable growth within the connectivity megatrend, we have followed a technology roadmap from hardware to software to software as a service to data.
Over the last few years, we have enhanced our software capabilities by acquiring Autonet, Arada, and EXO Technologies. The recent addition of Xevo brings new functionality and business models to our connectivity product and service portfolio, while also offering synergy opportunities with our existing business. There are tremendous synergies with EXO's high-accuracy vehicle positioning technology, which can facilitate contextual recommendations and transactions. In addition, as gateway and connectivity modules become in-vehicle edge computing domain controllers, Lear can leverage Xevo's AI and data analytics capabilities to increase the functionality of these modules. This will allow us to deliver a better value proposition to our customers. Another example is related to our Seating business.
The seat is becoming a smart device. There are natural synergies between Xevo's data utilization capabilities and our INTU seating occupant sensing technologies. Today, Xevo's software is deployed on approximately 25 million vehicles, primarily in the U.S. Using Lear's reach and automotive industry knowledge, we can scale Xevo's innovative technology and business model globally. We have a particular focus on expansion in Europe and China. The Xevo management team includes veteran technology executives with decades of experience. The company has over 300 employees, the majority of whom are software engineers that bring unique capabilities in software, data, and artificial intelligence. Xevo's high-tech talent and innovation are terrific additions to Lear. We view this acquisition as a major win for Lear, for Xevo, and for our customers. Now I'll turn things over to Jeff, who will discuss our Q1 2019 results and review our 2019 financial outlook.
Thanks, John. Slide 12 shows vehicle production for the Q1. In the quarter, global vehicle production was down 1.6 million units or 7% from 2018. Vehicle production was down in all our major markets, with China down 14%, Europe down 5%, and North America down 2%. From a currency perspective, all major currencies weakened compared to the Q1 of 2018. Slide 13 highlights our financial results for the Q1. For the quarter, sales were $5.2 billion, down $574 million or 10% from last year, driven by production declines in all our major markets and the negative impact of foreign exchange, partially offset by growth from our backlog. Excluding the impact of foreign exchange, sales were down 5%, which reflects 2% growth above market. Core operating earnings were $378 million, down $113 million, primarily due to the decrease in sales, somewhat offset by strong overall operating performance.
Core operating margins were 7.3% in the quarter. Free cash flow for the Q1 was negative $71 million, compared to positive $74 million in 2018. The reduction in free cash flow was primarily the result of lower earnings and the timing of working capital, including tooling and engineering, somewhat offset by lower capital expenditures. Slide 14 explains the Q1 year-over-year variance in sales and adjusted operating margins in the Seating segment. Sales in the quarter were $3.9 billion, down 10% from the Q1 of 2018. Excluding the impact of foreign exchange, sales were down 5%. The decrease in sales was driven by lower production on key Lear platforms in our major markets. In North America, revenue on Lear platforms declined 7%, reflecting in part the impact of significant downtime on some of our key platforms in connection with the transition to new models.
Revenue on Lear platforms was down 8% in Europe and 15% in China. These production declines were somewhat offset by growth from the backlog. Seating margins were 7.6%. The margins were primarily impacted by lower volumes and unfavorable platform mix, somewhat offset by strong operational performance and a margin-accretive backlog. Slide 15 provides a first-quarter year-over-year sales and adjusted operating margin walk for our E-Systems segment. Sales in the Q1 were $1.25 billion, down 11% from the Q1 of 2018. Excluding the impact of foreign exchange, sales were down 6%. The decrease in sales was driven by significant volume declines on key Lear platforms in all our major markets, with revenue declines of 15% in North America, 3% in Europe, and 27% in China. These production declines were somewhat offset by growth from the backlog. E-Systems margins were 11.3%.
Consistent with the H2 of 2018, the margins were primarily impacted by lower volumes and unfavorable platform mix. Approximately 75% of the year-over-year margin decline was due to these factors. Net performance in the quarter was negatively impacted by the settlement of certain customer and supplier negotiations and costs to support the launch of new business. Slide 16 shows full-year IHS global vehicle production volumes and our currency assumptions. Since we provided our initial 2019 guidance in January, the forecast for production volumes in all major regions has declined significantly. IHS is now forecasting 2019 global industry production to be down 1% year-over-year. This represents a reduction of approximately 1.9 million units or 2% as compared to their January forecast. Slide 17 provides our financial outlook for 2019.
Our current 2019 outlook includes the estimated impact of Xevo, and despite the forecast for lower production volumes, is unchanged from our January guidance, other than with respect to an increase in interest expense associated with the financing of the Xevo acquisition. Due primarily to the weaker production environment, we now estimate 2019 sales will be at the midpoint of the guidance range. Core operating earnings, including the impact of the Xevo acquisition, which we estimate will have a dilutive impact of approximately 15 basis points on overall company margins, will now be between the low end and midpoint of our guidance range.
From a segment margin perspective, excluding the impact of the Xevo acquisition, we see margins in both Seating and E-Systems up sequentially from the H1 to the H2 of the year, driven primarily by increased volume on key platforms, the ramp-up of program changeovers, and the benefit of a H2-weighted backlog. For the Q2, excluding the impact of the Xevo acquisition, we estimate that overall company sales and adjusted margins will be slightly down compared to the Q1. We estimate that Q2 Seating margins will be higher, and Q2 E-Systems margins will be lower sequentially from the Q1. Prior to the impact of adjustments for purchase accounting, Xevo's operating earnings are expected to be breakeven for 2019. We expect purchase accounting adjustments to reduce E-Systems margins by 90 basis points per quarter. Slide 18 highlights our consistent, disciplined approach to capital allocation.
Our first priority is always to invest in the business, supporting our customers, expanding our product and process capabilities, and improving our cost competitiveness. Second, similar to our recent acquisition of Xevo, we focus on targeted, bolt-on strategic acquisitions that add product capabilities and sales diversification. We are committed to maintaining investment-grade credit metrics. Moody's recent upgrade of our senior unsecured debt rating, despite the current volatility in the macroeconomic environment, is the result of our strong financial performance, operational flexibility, and strong free cash flow generation. In the quarter, we increased our dividend for the eighth consecutive year and replenished our share repurchase authorization to $1.5 billion over three years. Since 2011, we have returned $5.1 billion to shareholders through our share repurchase and dividend programs. Now I'll turn it back to Ray for some closing thoughts.
Thanks, Jeff. I'm very optimistic about Lear's future, and slide 20 gives you a sense for why. We have never been in a better competitive position or had more financial flexibility. We have the most talented team in the industry and a long history of operational excellence. We also continue to make smart investments in innovation and technology, such as our most recent acquisition of Xevo. In Seating, we are a leader in a large, growing market and enjoy a strong competitive position and solid returns. We continue to develop new product and process capabilities and deliver first-to-market technologies, such as the PACE Award-winning ConfigurE+. In E-Systems, we continue to invest in innovation that will create long-term value. We are an industry leader, well-positioned in the fastest-growing auto tech markets, and well-aligned with industry megatrends. We continue to pursue software, services, and data opportunities across these trends.
With Xevo, generate high-value recurring revenue streams. I'd like to welcome Dan Gittleman, the CEO of Xevo, and the rest of the Xevo team to the Lear family. We look forward to continuing to build on the great business you have put in place. In closing, I'm very proud of what the Lear team has accomplished, and I look forward to our future. Now we'd be happy to take your questions.
Ladies and gentlemen, at this time, I would like to remind everyone, in order to ask a question, please press star then the number one on your telephone keypad. Again, that's going to be star then the number one on your telephone keypad. Your first question comes from the line of Brian Johnson from Barclays. Your line is now open.
Yes. Good morning.
Good.
Ray, we'd be very interested in a more detailed discussion of the margins in E-Systems both this quarter, next quarter, and just maybe even stepping back for something that used to be running about a couple of 100 basis points higher in margin. The question is what's driving this? Is it low-margin business coming on? Is it operational issues? Is it business that is low-margin but good ROIC or business perhaps you, since there has been a change of management and a new leader, namely you, maybe was quoted too low?
Good question. I've had some time and I've spent some time, obviously, in E-Systems, and I just want to be very clear, there's no operational issues. The good news is we have an incredible team over there. I've surrounded myself with a team and got a good insight to what's really driving the business today. You look at the talent we have in the business, and it's exceptional. In addition to that, now with Xevo coming on board and Dan and his team, we spent some time with Dan within the ranks within Xevo. They have incredible talent. We're excited about the opportunity to continue to strengthen the team. What's really going on in E-Systems is rebalancing or a deep reduction in volume on some of our higher-margin programs.
In addition to that, what we're doing is we're diversifying our customer base, and those customers that are coming on board, albeit, are coming in at a less margin to what was traditionally the margins within a segment, is still really good business. It is generating great returns and well in excess of our cost of capital, nonetheless, it's not accretive. When I look at that business right now, we are diversifying our customer portfolio. We were too reliant on maybe one or two key customers. Now we're introducing Audi and Geely and Volvo and a number of other key customers. With that, I like to think of it, there's a maturity that we're going through and investing with those customers. There's launching within those particular programs with those customers.
We're not going to lose sight of the long-term value proposition, not just for Lear, but our customers and our investors, but creating a longer-term play as we continue to diversify that business. No major issues. Just our issue right now is really balancing some of these customer launches and driving that margin up with those customers. I don't know, Jason, if you want to elaborate a little bit more by the sequential order of the-
In terms of what we expect to see happen throughout the year, Brian, as Jeff alluded to, we do expect the margins in the Q2 to decline. That's really driven by three factors. We have lower volumes expected in that business in the Q2. We have the changeover of the Ford Escape in North America and also some lower volumes with JLR in Europe, where we have significant content both in wire and in electronics. In addition to that, our engineering costs will be a bit higher in the Q2, which really supports the strong growth we're seeing in electrification and connectivity. The third driver is slightly higher launch costs in the Q2. As you look out to the H2 of the year, we see margins rebounding, driven by some of the reversal of some of the same factors.
Volumes will be higher in the H2 of the year. We see launch costs moderating in the H2 of the year. We also see the benefit of our normal cost reduction activities on purchased parts and in our manufacturing facilities, which will then more fully offset the impact of customer contractual price reductions that were granted early in the year.
Just to follow up, as I look at the contribution of backlog, which you helpfully, on slide 15, defined as 12%, which is below the prior segment all-in margin. That compares to the 14% roll-on of backlog and Seating, which is above segment margins, and historically, we've thought about Seating as coming in at lower margin and then value engineering and change ordering margin up. How should we think about that 12% margin on the backlog coming in? Is it low margin now because of the ramp, or are you bringing in programs that are just not going to be 14% contributors over their lifetime?
No, we've said this in the past, that typically when a program comes on board, it comes on at a level that's lower than the overall segment average at that time. Then over time, as you're able to get efficiencies and program engineering changes into that product, that's when margin tends to expand. A 12% margin business in the E-Systems backlog, that's fantastic business, and that will grow in margin as the launch gets behind us and we continue to take out costs with respect to those programs. The difference between E-Systems at roughly 12% and Seating that came in at 14%, I think with Seating, again, it's a testament to the type of business we're winning. Specifically within Seating, you may recall that we talked last year that we did not pursue a piece of BMW business.
We let our customer have that because we weren't going to chase a low-margin program. That program that rolled off for us was a low-margin program. Backlog is a combination of the roll-off and roll-on, and we rolled off a very low-margin program in Seating.
Okay, thank you.
Your next question comes from the line of James Picariello from KeyBanc Capital Markets. Your line is now open.
Hey, good morning, guys. I want to make sure that I fully understand the impact of Xevo on E-Systems' margins. I think it was mentioned that when you include PPA, is it a 90 basis point headwind per quarter? Did I hear that right?
Yeah. Here's the tale of the tape on Xevo. 2018 sales were, I think we had it in the presentation, $75 million. We closed on that acquisition in mid-April. We would estimate that 2019 sales would be in and around $100 million. The business that is in place today in Xevo is from an OI and really from an EBITDA perspective, break-even business. When you acquire something like this, accounting requires that you capitalize certain intangible assets and then ultimately have to depreciate those assets over time. Now, we've not completed our assessment of purchase accounting, but the early estimates would suggest
That given the amortization that we're going to have to have on those capitalized intangible assets, will lead to Xevo having the impact on full-year overall company margins of roughly 15 basis points, full-year E-Systems margins dilutive by roughly 70 basis points, and quarterly E-Systems margins dilutive to margin by roughly 90 basis points.
Got it. If we kind of revisit Oh, go ahead. Do you have anything?
No, I just wanted to say that it's important to know that, again, that amortization is non-cash based, so it doesn't affect the EBITDA, but it does affect the OI.
Understood. If I just think about the margin framework by segment, it seems like Seating that 8% target for the full year is still well in hand. I know for the full year, you're pointing the margin guide at the midpoint to the lower end. Just curious, including all the factors for E-Systems, what is the kind of the new updated margin target for the full year for E-Systems?
I think, let me give you a little broader explanation as to our overall guidance now versus what we anticipated when we initially gave guidance in January. I think that the main headline is it's effectively a volume story, coupled with the fact that we don't sell to the industry, we sell to specific car lines. What's happened, obviously, with IHS volumes, as I said in the presentation, was that their April estimate is now roughly 1.9 million units lower than what their estimate was in January. Effectively what that says is they're now forecasting full-year volumes global to be down 1%. Specific to Lear platforms, the impact on Lear platforms versus what we saw in January is that in each of our major regions, volumes are down more now than what we had anticipated in January.
As an example, North America, we now anticipate our key platforms will be down 6% versus 5% in January, and China is now estimated on our platforms to be down more than 15% versus more than 10% in January. Coupled with that, there has been several of our new programs or changeover programs that are forecasted to have more down weeks now and delayed launches now than what we had anticipated in January. That's the primary driver of the top line, which obviously flows down to the OI line. Sequentially, and I think it was mentioned earlier, that we expect that sales will go up pretty significantly between the H1 of the year and H2 of the year due to the volume scenario out there and the fact that we have a H2 weighted backlog versus the H1.
Getting to the margin profile, given the backdrop of lower volumes, what we see now in Seating is really a great story. That despite the fact that the volume environment is lower, we now see full-year Seating margins to be in the low 8% range, where before we thought it would be roughly 8%. That's really due to the strong operational performance that we've seen in that business. Similar to what we said in January, sequentially, the margins in the H1 of the year will be lower than that full-year average, and margins in the H2 of the year will be higher than that full-year average.
In E-Systems, which I'm finally getting to your question, is the volume scenario and ultimately the mix scenario has been more severe in E-Systems than what we've seen in Seating, and the decremental margin impact in E-Systems is greater than in Seating. What we're anticipating now in terms of full-year E-Systems margins is that the full-year margins would now be in the low 11% range, versus what we said in January to be roughly 12%. Similar to Seating, we see H1 margins to be below full-year margins and H2 margins to be greater than the full-year margins.
Got it. Thank you.
Your next question comes from the line of David Tamberrino from Goldman Sachs. Your line is now open.
Great, thank you very much for that very detailed response to the last question.
I just told everybody I need to take a nap.
It probably knocked out like four or five questions in the queue.
We aim to please.
Yeah. I'll turn it to John. A lot of acquisitions, we asked about it at the Investor Day last year. I don't think it was really fit to be discussed just yet because you just joined. Where do you see all this going? Where is it really headed? Do you want to become a much larger player in the interior software space of the vehicle? What's the timeline to really see that be accretive to the company as opposed to talking about E-Systems margins being a little bit worse now?
David, thanks. It's a good question. I think, as you know, the architecture of the car is evolving. As that architecture changes, it's changing the landscape of the electronic control units in the car. To some extent, we need to be prepared for that change and start to look at how our electronics capabilities and body computers and connectivity evolve into different domains in the vehicle. To your question about sensing in the cockpit, yes, definitely. Even in Seating, as more sensors are going in the seat, it's about the occupant sensing and about the user as part of our Seating offering, as well as how E-Systems' content changes as a result of that. With respect to when it's accretive or how it changes, I'm going to turn to Jeff for that question.
Yeah. Again, I think it's important to note the distinction here between operating income and EBITDA. EBITDA is effectively flat today and unaffected by the amortization of the intangible. Assuming a certain estimate on the amortization of that intangible asset, we would see that from an E-Systems margin perspective, it would be somewhat dilutive in 2020 and accretive thereafter to E-Systems margins.
Got it.
I think, Dave, just to kind of round some things out too. We've been very disciplined to our capital allocation, this type of acquisition fits that perfectly. We've done a nice job with Arada and Autonet and EXO and now Xevo. With Xevo, we put ourselves, they have a first-mover advantage. There's no one in that space today, really, except for Xevo. The response we've gotten back from the customer, Dan and the team at Xevo have done a great job building that business. Now with the Lear leverage of us being able to make phone calls at the highest level within our customers and get immediate responses, John and I are going to sit down with an executive within a major OEM to talk about the next steps.
I think shortly here, we're going to announce and have a really nice announcement on Xevo, with a really nice award. It's one of those type of acquisitions that was perfectly aligned with what we've been doing as far as making sure we're driving value for our customers longer term, obviously driving value for Lear long term. This was something that I just think was a home run all the way around.
I'll say one more thing of color on Xevo, that is, obviously, we anticipate some huge opportunity for growth there. The incremental margins on this business via that growth is much greater than the total company Seating or E-Systems. The incremental growth profile here is pretty significant.
Yeah, that was going to be my follow-up on this, because your break-even when you purchased it. Where do you think you need to grow revenue to in order to get that historical or tech-like licensing, 90% gross margins and significantly higher operating margins than what you currently earn for this business? Do you need to get to $400, $500? Does it need to get to $1 billion?
Well, I don't know exactly what those margins are, at 2020, assuming where we believe we're going to be in sales next year in 2020, we anticipate it being only slightly dilutive to E-Systems margins, and E-Systems margins are whatever, 11%, 12% at that point. You can see very quickly it's going to have a very accretive impact to that segment because of the growth trajectory of that business.
To get a little more insight in this, too, because the recurring revenue streams, both in the software and the merchants, this is not as somewhat familiar as a traditional quoted program. We could get awarded programs at a much quicker rate. We could pick up merchants at a much faster pace. I think we've been somewhat conservative in our analysis looking at the market, there's a number of ways to generate recurring revenue. It's something that we've been doing a lot of work and getting a lot of insight to how we can get that moving a lot faster than where we're at today.
Got it. Just one quick one. Your E-Systems, the net performance, the customer settlements negotiations, does any of that have to do with higher price downs?
Yeah. A portion of that net performance really relates to the normal cyclicality of the price reduction happening at the beginning of the year and then our offsets being implemented throughout the year. Price reductions are slightly higher this year than last year, but very much in line with what we've seen on average over the last five years. The balance of that really relates to some specific price increases on some electronic components where there's a shortage. We view that as something that will moderate over time, but that was the second driver of the net performance in the quarter.
Okay. Thanks for taking our questions.
Thanks, Dave.
Your next question comes from the line of David Kelley from Jefferies. Your line is now open.
Good morning, guys. Thanks for taking my questions. Just a quick follow-up on that Xevo conversation and looking at the slide deck, I think you mentioned an addressable market of about $5 billion by 2025. If we're thinking about the potential growth buckets for Xevo and a more integrated E-Systems platform, how much of it's tied to that software platform do you see going to further OEM penetration? How much do you see being bucketed more to reaching out to new merchants in that consumer side of the application?
Yeah. There's two elements of the revenue, as I mentioned. The Journeyware piece is a licensing revenue, and that's a piece of embedded software that goes in the car. That's tied to vehicle sales. That is a portion of the addressable market, but it's the smaller portion of the addressable market. The larger portion of the addressable market is in the market piece, which it's not tied to SAR, it's not tied to vehicle sales. It's more tied to user engagement, which is tied to the user experience and the people actually adopting and using the technology, as well as the number of merchant channels that we have. Different people have different likes and dislikes or have different things they prefer.
As we bring on more merchants and as the user experience continues to improve with more data and with more interaction, that is a much bigger piece and it grows much faster. It's disconnected from annual vehicle sales.
Okay, great. Thanks. As a follow-up, as we think about go to market with the merchant, are you going direct to someone? I know Xevo has signed a Domino's partnership in the past as an example. Are you reaching out direct to these merchants? Or maybe could you describe maybe high level the three-legged stool, the relationship between you, the merchant, and then also bringing in the OEM, since they're clearly getting a cut of this as well?
Yeah, that's a great question. Yes, Xevo does build and maintain the relationships with the consumers, which is actually a huge value for the OEMs because most of these Sorry, for most of these merchants, it's a value for the merchants as well. Most of these merchants they don't want to be tied to one brand or one platform. They want to have access to all cars. Xevo provides that channel to multiple OEMs. The scale effect is something that the merchants look for. It's also an easier integration path because the way that the Journeyware software that's embedded in the car works is that you can just add more merchants and without doing any software updates, deliver new content and new experiences because it resides in the cloud and it's basically presented through the same software that exists in the car.
Generally speaking, yes, the merchant channels are built and maintained by Xevo and we'll continue to expand that. Yeah, I think that answers your question.
All right, great. Thank you. Appreciate the color.
Yeah, thanks.
Your next question comes from the line of Adam Jonas from Morgan Stanley. Your line is now open.
Good morning. Thank you for taking the question. We think about the sort of the divergence between the first and H2, what are your biggest areas of concern when you think about the ability to hit those H2 numbers? I'm not questioning your ability to hit them, but I'm just curious, what sort of front and center, in your mind, what keeps you up at night and what gives you confidence in the ability to hit those H2 numbers then?
Yeah, I think the first one is volume. It is the production volume. We look at the launches we're having, the anticipation of how the customers are building and hitting their numbers. I think that's probably the biggest attribute to the H2 in terms of the revenue. I think as far as the work that we have to do, I mean, our teams are doing a great job. I think we're very confident in the efficiencies and the cost drivers and the things that we can control. That's something that we do a really nice job of. I'd say the biggest thing is really the production environment, the things that we've dealt with in the H1.
Okay. You've reduced the guidance as far as what you're expecting on the top platforms, North America, you mentioned from -5%- -6%, China from -10%- -15%. I guess the question is, what gives you confidence that those are the right levels? Just following up on guidance, you've cut to the midpoint of revenue guidance. You're saying that this cut to production has taken you from the high end to the midpoint effectively. Is that correct?
Yes, effectively that is correct. Notwithstanding the impact of Xevo, which takes us to the low to midpoint range. What gives us comfort? It's ever-changing, but I think we've taken the position in terms of our forecasting, for example, in China and some other regions that our internal forecasts for some of our key platforms would be down in excess of what IHS is saying. Unfortunately, in the Q1, that was proven to be true, that in fact, some of the volumes on our key platforms were down greater than IHS. Our forecast continues to suggest that. For example, only one example is if you look at Ford volumes in China and what IHS is suggesting on some of our key platforms down there, they're suggesting those platforms are down 15% year-over-year, and we've got that volume decline north of 40%.
We are taking a more conservative view as we have really in the last couple of quarters on volume. The problem has been, unfortunately, we've been more right than wrong.
Okay. I appreciate the responses. Thank you.
Okay, thanks.
Your next question comes from the line of John Murphy from Bank of America Merrill Lynch. Your line is now open.
Good morning, guys.
Hey, John.
Surprise, I've got another Xevo question. When you think about this, to put it in terms that a dumb auto analyst like me can understand, basically you're taking a great technology that is somewhat siloed with GM in North America, is what it sounds like, and taking it to all your other customers and going global with it. Is that a good, simple way to explain it?
No, actually, Toyota is the largest customer for Journeyware. GM is the largest customer for Marketplace. Two of the largest automakers in the world are already strong customers of Xevo. There's also other customers that are deploying the technology. You can find out there's some information on a Hyundai proof of concept. There's other OEMs in proof of concept now, and there's other OEMs that, as Ray alluded to, will be announced soon. Xevo on its own has been doing a fantastic job of growing its scale and expanding. Most of that, however, is in the U.S. What we think we're bringing is expanded reach globally into Europe and China. China is extremely important, and there's a need for it there because there isn't a global solution that can be deployed from U.S. to China to Europe in terms of ecosystem for connectivity services.
Xevo offers that and can do it in any region based on that.
Yeah, we think China is going to be the big market for Xevo. To your point, I think we're a little bit further along, or Xevo was further along with a number of key customers. Actually the relationship with Toyota is very strong, and that's where it originated. So obviously that puts us in a really good position with Toyota. Now taking that to Europe and taking it to China is really the next step. Like I mentioned, with our access to these OEMs, and it's been absolutely overwhelming, positively overwhelming. We put some notes out. We got some meetings already scheduled, and this is something that can move relatively quickly, too. What's nice about this is it's not like a traditional development program that takes three to four years through intense validation and those type of things.
We can easily adapt this within the vehicles, making it something that can get on programs much quicker. So that's what we're focused on.
When you think about the competitive set, if you could sort of illustrate who you might be going up against there, or if this is white space, and if we should also be thinking about sort of smartphones as potential competitors to this or potentially an opportunity for Xevo. Because it seems like a lot of this stuff is already going on on my phone and a lot of our phones at this point. I'm just trying to understand how you kind of differentiate between in-vehicle and in-device and sort of who your competitive set is.
Great question. It is a white space in the vehicle. There are no direct competitors that are doing monetization of transactions like this today. The growth into the car is coming from the mobile phone, if you will. The biggest e-commerce and digital transactions are happening through mobile phone and web today. This is taking dollars from those, but it can do that for a couple reasons. One, I had mentioned that it's sort of a three-legged stool. There's the car piece, the mobile piece, and the cloud piece. This Xevo application ties the three together.
When you look at the car, you've got a lot more relevant information about what the user is doing, where they're going, how many people are in the car, how long they've been driving, and other sensors, hundreds of sensors in the car that you can use to make better suggestions and bring a better user experience to the user. It also eliminates a driver distraction issue with mobile phones in the car. That's the way we're approaching it and looking at it. It's a better experience and a safer experience than using the phone, and it offers, again, more data and a better user experience. That's how it's taking away.
Very interesting. Just a second question on the product cadence. It sounds like the GM changeover for their SUVs or downtime they're taking there was maybe a major impact on Seating. Is that a correct assessment? As that comes back online, that may solve some of the issues that we're seeing in Seating in the short term?
Yes, that was a significant impact in the Q1. You had the downtime in Arlington as they prepare to change over to T1. That won't happen until next year, they had three and a half down weeks, and they had a bit of a slow ramp-up coming out of those down weeks as well. You had the ramp-up of the second pickup truck plant with Silao coming online starting very end of last year and into the Q1 of this year. We'll see improved volumes sequentially in both of those facilities in the Q2.
Okay. Just lastly, you mentioned the backlog is much stronger in the H2 versus H1. I think you've kind of given us the numbers in the past, if you could just remind us sort of H1 backlog roll-on and H2 backlog roll-on, if you got that split.
It's basically two-thirds, one-third. Two-thirds in the H2 of the year.
Thank you very much.
Your next question comes from the line of Rod Lache from Wolfe Research. Your line is now open.
Good morning, everybody. Thanks for fitting me in. On Xevo, just to follow up with one more thing. The $5 billion addressable market, I suspect, is the amount of commerce in total that you are primarily focusing on for 2025, and Xevo would do some share of that. Could you maybe just talk to us a little bit about what's the conceivable target for revenue per vehicle that a company like Xevo can achieve for the vehicles that it is exposed to?
Yeah, it's a great question, Rod. It's hard to answer today. Again, it's dependent upon engagement and the number of merchants that you have. We're still at an early stage. Today, the bigger part of the revenue that the company is generating is from the software licensing of the in-vehicle piece, the Journeyware piece. That scales with sales and the number of vehicles that it's in. It's a typical type of software license with a service and maintenance fee over the life of the car. On the market side, it's early days for that, it's just ramping up. As we improve the experience and bring in more data analytics and artificial intelligence that understands each user, and as people interact with it more, it gets better and better, and therefore the engagements get higher.
It's tough to say at this stage exactly what that number is, but it's significant, and it's higher than the licensing piece.
Is it sort of a low single-digit % of the commerce that a company like Xevo would be targeting? Is that a way to think about that, or could it be even higher than that?
The number we're thinking about is $10- $20.
Okay, great. Just to follow up on the Seating decremental margin, obviously, a lot of things going on in this particular quarter. I think over time, you've talked about something like a 20% decremental for that business. Is that still a reasonable number to use?
Yeah. It typically runs between 15 and 20, and depending on the underlying profitability of the programs, the level of vertical integration of the platforms that are down.
Okay, great. Lastly, just talking about your exposures in Europe, some of the key platforms. There's obviously a lot of discussion right now that OEMs are having about how they're going to comply with new regulations, CO2 regs, and in some cases, you're seeing companies that are exiting segments altogether with the German plants over time, as an example. As you think about what you guys are on in Europe, is there a significant percentage of that you would say could be on the endangered list? Or how should we be thinking about some of the changes, just given the pretty high exposure you guys have to that market?
Well, our European business is very well-diversified, perhaps better diversified than in any other region. We don't see a disproportionate risk with our book of business there in any additional exposure to particular nameplates that are going to be canceled. I think that our book of business, in general, will hold up pretty well. It is a little bit weighted to the luxury side. JLR, the German OEMs are important customers for us. FCA and their premium brands are important customers for us. There's been really no discussion about elimination of nameplates or models within that group of customers.
Okay, great. Thanks for that.
Your next question comes from the line of Itay Michaeli from Citi. Your line is now open.
Great. Thank you. Good morning, everyone. Just to go back to E-Systems, just the decline in the base business, the, I think, $159 million year-over-year. Could you just remind us in terms of your exposure, how much of E-Systems revenue is tied to passenger cars in North America and just some of the changeovers we're seeing in various customers? Just want to get a sense of how much of it is just particularly tied to those changeovers.
In the Q1, the only significant change related to passenger car for us in E-Systems was really the build-out of the Focus. That happened last year. Year-over-year, that had a pretty meaningful impact on the revenue in the quarter.
I think, Itay, what we said before as well, and really it started with the Q3 last year, was with respect to Ford and primarily Ford in China and the group of programs over there that we provide components from E-Systems on, had a very steep decline. We've seen that going into the Q1. Anytime you look at comps right now from the Q1 this year to the Q1 last year, for example, the volume comp on some of those key programs, specifically Ford in China, show very significant volume reductions.
Got it. That's helpful. When we think about the decremental margin in E-Systems, was there any product mix kind of change or issue in terms of Terminals and Connectors relative to wires or electronics that had an impact on either revenue or the margins in the quarter?
Further to Jeff's comments, we did see the sort of continuation of what we saw in the H2 of last year with the steep reduction in Ford volumes in China. Those were mature, higher margin programs. That led to a little bit higher downward conversion than our overall book of business. There has been some weakness with Europe impacting our terminals and connectors business. That carries with it very high variable margins as well. Those will probably be the two outliers and the rest of the volume reductions are sort of consistent with our overall underlying book of business in E-Systems. That business has a variable margin that's in the 25%-30% range.
It's much higher than Seating, both because the underlying operating margins are higher, also there's a little bit more capital intensity in that business and a little higher engineering and administrative infrastructure to support that business than we see in Seating.
Itay, I'd say one more thing as it relates to trying to quantify the year-over-year sales drop in E-Systems, that is FX. As a company, we're about 40% in Europe, in E-Systems, we're probably north of 50%. We're greater exposed in our E-Systems segment to top-line declines as a result of FX. Given the margin profile of that segment and the fact that we're more vertically integrated in E-Systems in Europe with respect to terminals and connectors, the margin profile is going to be impacted because of that exchange.
That's very helpful. Just maybe a question on Xevo. What's the kind of product roadmap for leveraging data in the car, location-based deals and offerings to engage the drivers and occupants? Is that already happening where that data and the location-based is being leveraged to try to encourage engagement in transactions, or is that down the road? If so, kind of what's the timetable on that?
Yeah, that's rolling out now. That's a good question because basically, I mentioned that's one of the synergy areas that we have. It's using information with GPS today that's not very accurate, but you can imagine like a fueling scenario where you're driving somewhere, the car knows where you're headed and knows that you might only have an eighth of a tank of gas. A relevant piece of information to get gas can be delivered to you in the car, and then once you arrive at the gas station, if you know which pump you're at, once you shift the car into park, the transaction can be immediately facilitated with one button click or maybe none. That's rolling out now, and there's a lot of use cases that location are being used today, but it gets smarter and better over time.
Got it. That's very helpful. Thanks so much.
Yep.
Your next question comes from the line of David Leiker from Baird. Your line is now open.
Hi, this is Joe Vruwink for David.
How you doing?
Good. Good morning. Even though, Jeff, you gave a lot of reasons for why profitability is maybe under pressure, it ultimately sounds like the move from 12% margin to low 11 is entirely Xevo. Is that correct?
No. In fact, none of it is due to that. With respect to the margin guidance that we gave, when it was January, we gave 12% full year. Now we're giving low 11s. That excludes the impact of Xevo, which is estimated to have roughly a 90 basis point dilutive impact on E-Systems margins.
Okay, got it. Then when thinking about E-Systems backlog, it was already set to be 2020 a bigger year than 2019, Xevo should add to that organically next year. Is there an additional consideration that as the backlog revenues flow on, it should be similar to the dynamics that are playing out in 2019 in terms of margin implications?
I think some of that is implied by the slide that Ray talked to, which is just in the last couple of months, we were awarded an incremental $150 million of E&C business. We fully anticipate, as we've always said, that as the third year, the backlog becomes the second, and the second becomes the first, we will see growth in those backlog years. Nothing has changed from that perspective. In fact, as you say, Xevo should add backlog.
Okay. I'll leave it there.
Just one point I just want to make that in my summary, in my slides were just electrification and connectivity. It doesn't include the traditional E-Systems business that we're quoting ongoing. What I want to do is give an update given some of the changes in some of the awards. In the time of the awards, I wanted to give an update on what we consider to be the new technology drivers, which is electrification and connectivity. The team did an excellent job of capturing some really good wins for us.
Okay, understood. Thank you.
Our final question comes from the line of Joseph Spak from RBC Capital. Your line is now open.
Thanks so much for fitting me in here. Your reward is yet one more Xevo question.
Hey, John.
John, you mentioned sort of China being a big opportunity, and I imagine that's sort of part of the rationale for the deal. I'm just curious about that market and the model there, because my understanding is the consumer is much more tied to sort of the Chinese platforms like the WeChat and sort of everything sort of runs through that. So, that sounds different than sort of how you've attacked the Marketplace maybe in the U.S., where you can sort of pull individual brands onto the platform. Is that correct? What's the go-to-market strategy to get those sort of Chinese to get those Chinese market platforms onto the-
Yeah
Xevo Market?
It's an excellent observation, and you're accurate, you're correct. The model in China has to be different than in some of the Western markets. Mainly because, as you indicated, there's technology players that often aggregate a lot of the merchant channels already. We have to work with those channels. Again, because we're bringing in relevant and contextual information about the car and the user, it affords a better user experience in the car, which the OEMs need to maintain their position and their customer satisfaction. Also keep their brand identity. Xevo offers that sort of window into the services and merchant channels that the OEMs can continue to brand as their own. That's the same in China as it is here. The only difference is now the channels are through different partners in that region.
Okay. Since so much of the power lies with those aggregators, are there additional challenges in getting them onto the platform, or does it actually make it easier? What's sort of your thinking there?
Yeah, I'd say it's early to answer that. I think that there's always gonna be challenges. Again, the OEMs own the dashboard. They want to maintain that interface, and therefore they want to have some level of control over it. We know that using the phone in the car is very dangerous, and it contributes to a lot of safety issues. Being able to control that experience and control the interaction with those merchants are something that the OEMs want to be able to design and facilitate for their users. That's the reason why it will come in through the dashboard, if you will.
Okay. Jeff, just real quick, cash flow in the quarter, I think Q1 is typically seasonally light. Is that all that sort of drove the softer free cash flow this quarter? Was there anything else from Xevo?
Yeah. Actually, versus what we thought, cash flow came in a little bit better in the quarter than we had.
Okay
previously envisioned. I think a lot of that was due to the managing of inventory, given the volume volatility. We did a great job. We're fully confident in our full-year free cash flow guidance. No story there.
Okay. Thank you very much.
Okay, thank you. Okay, with that, I think we're done with the Q&A portion. I want to thank everyone for participating today on our call and for all the good questions. Again, I want to welcome the Xevo team to the Lear family. I can't tell you how excited we are to continue to build on your success, and I think that's only going to be incredibly bright as we move forward, and the opportunities that are going to be in front of us. To the whole Lear team, I want to thank everyone for your hard work and your commitment to doing the right things every single day in driving the business. We stay focused on our people, our operational excellence. It's innovation and technology, continuing to embed it in different ways that differentiates us and ensuring that we grow this business profitably.
I want to thank you for all your work that you do every single day. With that, thanks.
This concludes today's conference call. You may now disconnect.