On time. Next session is with management of Lear. Lear, as all of you know, is a $21 billion supplier. About 75% of their sales are derived from automotive seating, where they capture about 25% of the global market. One out of every four vehicles you see anywhere in the world has Lear seats. Over time, that division expects to generate roughly 4% growth over market. 25% of this company's sales come from their E-Systems division, which produces wire harnesses, terminals, and connectors. That division is expected to achieve something like 6% growth over market over time, with a lot of that growth being propelled by vehicle electrification.
They just concluded what was obviously a very challenging year, actually challenging couple years, where they faced massive commodity inflation, which was 60 basis points of traction from margins in their seating business, 170 basis points in E-Systems. For the full year, overall EBIT grew for this company, and the margin was pretty flat despite some pretty meaningful headwinds.
More importantly, the company's performance clearly got progressively better over the course of the year, and by Q4, we saw seating EBIT margins that were up 130 basis points year-over-year. Obviously, those headwinds didn't go away. The E-Systems margins were up year-over-year by 180 basis points. For 2023, the company's guiding to another year of earnings growth.
Backlog will add at least 5% to top line growth. EBIT margins will expand again 4.5%, and it looks like growth accelerates further into 2024 and 2025 with new business backlog and margins climbing up from 4.5% right now up to 7%. Not only do we get the upside from backlog and an industry recovery, we get that turbocharged by the growth in margins. Joining me here on stage, we're very pleased to welcome Ray Scott, Lear's CEO, and Jason Cardew, CFO. I'll join you on the stage.
Okay.
Thanks for coming.
Yeah, thanks for having us, Ryan.
I wanted to start out maybe just dividing things up into the businesses and talking about the seating business first. One of the largest seating companies in the world, as I said, 25% market share. You might think that, when this industry's mature as it is with a 1/3 of the industry here and 25% there, pretty consolidated.
Every auto plant in the world has a seat plant within a couple miles from it. You wouldn't think that there'd be a lot of shifting. Also you wouldn't think that there'd be a tremendous amount of growth and content per vehicle, and maybe not that much opportunity for margins at this point. That's not what we're seeing with Lear, right? You guys are making acquisitions. You're talking about growing market share to 28%. Maybe we could just start out by talking about where you see the biggest opportunities in that business.
I've been in seating for 35 years. I think it was August 2, 1988, so a long time. It's a pretty exciting time back in the early days of just the cushion room being outsourced to the JIT assemblers. You're absolutely right, that was a time of growth. I think today's just as exciting. You're right, we've had $2 billion since 2020 of conquest wins. Even though there's legacy costs and other things in place, Lear's done a remarkable job of expanding our market share. You know, which wasn't that long ago, 18% to today's 25%. We've even shortened the range on when we think we'll be at 28%. There's a number of things going on in seating today.
When you think about the tremendous pressure our customers are under, you know, with cost, investments in electrification and autonomy and in other areas that they're really trying to change their businesses, we're under that same pressure. What Lear's been doing for, you know, well over 10 years is investing in our operational excellence. You've seen some of the smaller but important acquisitions with Thagora and InTouch and some of these things that help us really drive our business for efficiency. That's at the core of what Lear's about, is really driving our operations for Industry 4.0, you know, automation and being just very efficient and being the most vertically integrated company that we can create value for our customers on the manufacturing side of the business.
On the product side, probably equally as important, the changes we're seeing. You have to create a value proposition, focusing just on assembly of different directed components really doesn't give our customers that value proposition. You know, we really took a step back well over, you know, like I said, 10 years, 12 years ago, and looked at how you can make the seat more smart, intuitive. You know, how do you create more value for our customers? You've seen us really driving that thesis around thermal comfort management and the acquisitions that we've made that help us vertically integrate components into modular systems. The way the customer's sourcing, it's individual components. That gets shifted over to an assembler to design for manufacturability. Well, there's not a lot of creativity or innovation or really efficiency in that type of design.
Where you create value for your customer is the integration of these components. The acquisition around thermal comfort management products has really accelerated. You know, right now we're looking at those components. We've taken 50% of the components out. You know, there's pumps, valves, motors, harnesses, you know, different components that were designed for individual parts, not as a system. Well, that's an easy one.
You take out significant mass, you know, when you're talking about being able to reduce the mass for our customers. The time to sensation, one of the things. You know, the thing about selling to our customers, they say anyone can sell this product when you're doing these type of things, when you're creating value, is we're end consumers, too. When you get into an active heat and cool, the time to sensation is very long. It's loud. It's ineffective. You have a blower and a, really, a fan that takes all the different or air around different systems into the occupant. Well, we're designing those components into the trim and through the foam.
You know, when we talk about sustainability and recyclability, you know, we have a polyethylene material that we're using for foam. We have increased content into the trim cover itself through these technologies we're talking about. You know, it has been a long road, but I am more excited about the changes in seating than I ever been. I think the You know, I say the greatest compliment we get from our customers, and we get recognition, but is new business awards. Even on the heels of last year, we were contacted by one of our customers we talked about on the earnings call, and we're gonna actually take over mid-cycle. This is unheard of, right?
I mean, we've done mid-cycle changes or when a program is changing over, but we're awarded business working in a very collaborative way with our customer on taking that program over. We didn't. It wasn't a global quote. It wasn't something we had to aggressively buy. They came to us, they audited our facilities, they looked at our technology, and awarded us the business. We, you know, we talk about fair returns. We have to continuously focus on return on invested capital, or investments that we're making get fair return. Even our backlog has been accretive to our margins. You can see the success. Even though we've done nice job of growing market share, we're being very diligent and disciplined to what is the expected return. If you can create that value for your customer, we believe it's there.
It has been very exciting.
That example must have been some issue that the automaker had with the existing supplier. What was more interesting was what you said about this vertical integration and that gives you some kind of competitive advantage. The seating industry, as I've known it, is very directed, right? Like, these, the automaker will say, "We want you to use seat heat from this company and motors from here," and that kind of thing. Is that immediately changing at this point, or is that something that you think will change in time?
No, we're seeing the change. You have to have the engineering and the in-house competencies. Historically, I think on some of the components that I'm mentioning with thermal comfort management, 30% you might have control over. You know, be able to source yourself and work with another supplier. We have seven major customers that 100% direct sourced our thermal comfort management systems on business that we've recently won. That's moving from 30% to 100%. Now, they're not going to give that up unless you have the capabilities, and I think that's uniqueness, is that when we acquired Kongsberg, it immediately gave us credibility. Even though we had been working organically on designs and very specific patents and intellectual properties to design these components into other tier components that we manufacture, it was when we gained that engineering capability, when we had the manufacturing capabilities that that shifted.
Yeah.
I also think from a competitive standpoint, you know, when I say that we're reducing parts 50%, that lowers the cost. We can actually create value and expand our margins, and then create value for our customers. It really is a win-win in respect to us managing our business. That's what I think about JIT. I, listen, I was around when the cushion room, and then it came out, and then JIT took it over.
The concept around some of the difficulties we're having with labor, some of the difficulties we're having with purely the content fitting within the seat, just the size of the amount of content that's going in the seat, and solving those problems really is expanding our growth profile and allowing us to go into our customers with a really good value proposition.
What's the seat content today? Where do you see that going in, let's say five years with all this additional content that's coming in from heating, cooling, all the acquisitions that you're making?
Yeah, so it wasn't, what, 2020 it was $735. It's called CPV proceeding, and today it's around $770. A lot of that is the shift, you know, to luxury and high-end vehicles with higher content within the seat system. When you think about the thermal comfort management components, that's anywhere between $2.5 billion-$3 billion, and that's growing today at about 2% over market.
I think the issue right now, it's limited by packaging size, cost and complexity, because I do think, you know, if you look at just massage systems within seats, I think it makes up 3% of the overall market. Frankly, I think it's 'cause these don't work. I mean, they're just not therapeutic in any way. There's no wellness.
There's no health benefits to it. You don't walk out of a seat saying, "Boy, did that feel good." It's a pneumatic bag that's literally pushing against your back. Well, as we're moving those components closer to the occupant, there's more therapeutic, the more health wellness, more feeling of sensation. I see that accelerating.
I think being able to package these things right now, it's limited to, you know, we've seen this move of heater mats from front rows to second row. You know, my kids get out of the back seat, and they're like, "Where's my heat mat?" You know? It's like, once you have it in different seating positions, more customers want it, but you have to create that packaging and allow it to fit from the front row into the second rows.
That's where I see much greater growth over market than what we're anticipating right now with 2%. I do see that luxury sensation or feeling of content pushing down into lower-level vehicles, and we're seeing that today. I mean, China's a great example, particularly with the domestic OEs, where a lot lower end vehicles are now pushing up in the luxury market with luxury content. We see that continuing.
You know, we've talked about this ConfigurE+ technology that we designed that powers a cassette on a rail system within the vehicle. We launched it with Volkswagen, and we're launching the second program with Ford Motor Company. It's about $100 million in revenue to date.
You think about that, and it was actually, Stellantis debuted it in their Ram 1500, BEV truck that they had at the Consumer Electronics Show. We had the rails in the truck, and what that allows is for reconfigurability, a lot more flexibility of the seat systems within the vehicle, and there's safety elements and content that could be added to the seat. We see those type of changes within the seat system really growing content. 'Cause I think right now we're looking at $500 of content with our rail system with the cassettes. If you supply, you know, the frame structure itself, it obviously could go up to $1,000.
Let's talk about the margins in that business. It was a 7.5%, 8.5% margin business if we go back to 2017, 2018, 2019. Past two years, you had 190 basis points of pressure from commodities, doing a little bit over 6% actually isn't that bad, like, in the context of what you've had to perform.
Rod, I think that's great right now given what we're up against.
Well, there's companies that are doing 2%-
Yeah.
in your industry. It's quite good. The improvement, the rate of improvement is modest, right? It, you're gonna do about, I think, 20 basis points this year, absorbing 25 basis points of engineering, so there's a little bit of pressure there. See Jason smiling. You were gonna remind me. But it's still just 20 basis points, which is small relative to that 190 basis points. What's the bridge as we wanna get back to that 7.5%-8.5%? Can we get there in 2024 or 2025?
Rod, you know, I think we talked about on the last earnings call that there is a clear path to 8% in 2025 in seating, and it's really comprised of two drivers. First, the volume in the backlog, rolling out over the next two years, with volume rolling out at 15%, backlog at 10% or greater than that. It's about 60 basis points of margin expansion and then about 100 basis points from net performance. 50 basis points a year we would expect from net performance. Our performance this year is a little bit weighed down, as you talked about, engineering and tooling costs or engineering and launch costs being higher this year.
That's really a function of the award of the Conquest Program that we received in December that launches this year. A very short development window, very short launch window, and so the costs are compressed into 2023. We would expect those costs to come back down a little bit in 2024 and certainly not increase.
You know, as I look out at 2024 and 2025, we'd expect, you know, flat to lower launch and engineering costs. So now you can see the full effect of our performance improvements flowing through to the operating margins as we look out to next year. All the investments we've made, you know, starting with Lear Forward last year, and we've taken capacity out, kind of realigned to the lower volume environment in Europe, for example.
you know, the investments we've made in new products that are launching at, you know, higher margins than what we've been accustomed to in seating. I think structurally, the thermal comfort products have a little bit higher margin profile than just-in-time seating and other components within seating. you know, the backlog rolling out at 10%, I think you could see that working its way higher over time. Now kind of looking beyond the 25 time horizon, I think there's a path to getting back above that historical range of 7.5% and 8.5% to, you know, 8.5%-9%.
I think if you look back, you know, just as another data point, 2014, the seating business was at 5.7%, and similar kind of volume environment, but much better commodity cost environment. We're 50 basis points ahead of that right now, and we increased operating margins by, you know, more than 200 basis points from 2014 to 2017, I think on the heels of a volume recovery in the industry. I think you're gonna see a similar phenomena here over the next three or four years. It may take a little longer for the volumes to return to the historic, historical levels. You know what? We're 7.5% below where we were on industry production in 2019.
We're almost 14% below where we were in 2017 at the peak. You know, that at some point is going to normalize and come back, and I think that's kind of another tailwind on operating margins in seating, even beyond that 7.5%-8.5% historical range.
It sounds like greater than alone is 50 basis points, so greater than that in, as far as the vertical speed of margin improvement, you know, maybe closer to 100 basis points and maybe get back to the 7.5%, 8.5% in 2024, 2025 timeframe.
Yeah. I think it takes 60 basis points of volume and backlog.
Yeah
And 100 basis points of performance that gets you to 8% those two pieces.
Are you anticipating any difference in the pricing environment with your customers obviously facing deflation? Prospectively, are you pedaling softly a little bit in terms of the recoveries? Because you are gaining a lot of market share, and people are still kind of thinking about why are they gaining, is it because of some kind of pricing dynamic that's in play?
No, we treat those two issues separate. I mean, like I said, we're not gonna, on any terms buy business. We're gonna stay disciplined to what we expect as far as a fair return. When it comes to the deflationary issues that our customers are dealing with or the inflationary costs that we're dealing with, you know, we're relentless. I mean, we're going after all the costs and our customers are very sophisticated. This is a process that I think we've discussed it probably back in 2021. I think everyone thought it was gonna be more of a temporary issue. We were fixing it more with one-term-type solutions in one quarter or one timer. It's moved to a more of a fixed negotiation.
How do you fix it in the purchase order on a go-forward basis, either through indexing or solutions, to raise the price? You know, one thing that we did last year, and I think it's important, I mean, we have incredible transparency because, you know, we have the electrical side of the house, and then we have the seating side of the house. Everyone passes through us.
We get to see all the contracts for all of our competitors, both on the electrical side and the chemical side. We see the negotiations that are being done or are completed. In some cases, we're even in 'cause of a third party, 'cause of a directed situation where we're bringing them in if there's a particular situation or threat.
We know exactly what our customers are doing, so there isn't any type of, you know, advantage to any competitor that might be claiming more of a recovery than we are. What's important is the sophistication that our customers do have in their audits, and in some cases, they even do a third-party audit. You have to make sure that you've done all your work.
You have to clean up your own house. When we initiated the Lear Forward Plan last year, even though we run our business very effectively and efficiently, what we did was even search for even greater ideas. Can we combine facilities between seating and E-Systems to utilize our square footage? Can we then not spend the money on a particular plant?
Can we, some cases, lower our head count and then utilize the plant differently for a cross-population of different customers? We did that work. We went at it very aggressively last year, and we're still moving that forward this year. What we found, and most recently, we just had an audit from one of our customers that came in and reviewed one of our plants, 'cause they're gonna look at you and say, "Okay, if you're not efficient, I'm not paying you anything." If you have a 1,000 people in a plant and you should be running at 600, you gotta go do your work. We did the work.
We had an audit that came through, and they actually suggested they pay us more than what the request was at the time because we were so efficient, that they're actually claiming that we should get that based on the model. No, we're relentless. We're working every different way. You know, everyone talks about basket of goods that you can go through from productivity deals to what you're gonna do with fixing the contract or renegotiating the pricing or how you can offset with cost savings.
You know, we've worked the CTO ideas that we have with VA/VE extremely hard, and we're negotiating different settlements on a share agreement. The customer's been very accepting of looking at how they can work other areas of those basket of goods. We're gonna keep pushing.
You know, we look at these things in different paths, how they're moving across different customers, and there isn't one that we're trying to extend longer. We're just looking at how we're gonna negotiate over this year and next year no, we're gonna be relentless with that. I mean, it's the right thing to do.
Just add one point on the profitability question you had, are we trading market share for margins? If you just look at the backlog that we launched last year, we converted that at 12% in seating. If anything, it's a little bit higher than it has been historically. I think you're gonna see that, going forward.
Objectively, all you really need to do is look at the margins of Lear. Your peers, and you can see that the margins are actually a re better.
Right.
I wanna take a couple questions on E-Systems. We've known E-Systems to be a producer of harnesses and terminals and connectors, and there's a lot of growth in this area as we see more electrification and more data being transmitted within the vehicle. What is also interesting is the competencies that you're kind of bringing into this by bringing in injection molding and terminals and connectors and other things to make inroads into a variety of other parts within an EV, like Battery Disconnect Units and Intercell Connect Board. Who do you compete against here, and do you see this as a capability that others just don't have?
You know, I think when you look at the low voltage and high voltage, it's, it's some of the similar names that we've competed against in the past with, you know, Aptiv or Molex or TE or Yazaki, Sumitomo. When you get into the very selective components, and we've done a really nice job with Battery Disconnect Units and
It gets more selective, and you have KET, you have CATL, you have Panasonic, Diehl, those type of competitors within that area. I think within that you do have a very selective skill set or competency. We are very successful on the battery disconnect. That's where it gets very limited. We have multiple customers. We have, you know, a number of key customers on the battery disconnect. There's probably only three real players that have multiple customers within that area of battery disconnect. Probably Panasonic.
VA/VE and Lear, yeah.
And Lear. There's really three players that have different architectures that they're designing Battery Disconnect Units for. Within that, and you're right, we have the precision stamping and the capabilities for busbars. We have the expertise in power electronics and power distribution of power with through our wiring capabilities. We have the Connection Systems.
Right now on the Battery Disconnect Units, we have approximately about 20% of the component is vertically integrated. We have an incredible engineering center and design center that really has helped us. That's really one of the big wins that we got with General Motors. It wasn't a platform specific, it's across their Ultium battery. We supply that battery. No matter what volume's doing, it's those batteries that we're supplying the parts to.
On the Intercell Connect Board, I mean, that is some of the overmolding capabilities that really is manages the mechanical and electrical system within the cell of the battery. That's our Connection Systems, our wiring systems, we're vertically integrated to about 60%. That allows us, one, to really take advantage and gain margin, but also the competency and expertise to lower cost as we go forward.
It looks like you've got a lot of growth. Electrification alone could add something like 500 basis points per year to your growth over market prospectively. I wanna ask you about the margins in that business. Seating is kind of got line of sight on what you think they're gonna get to in the intermediate term. There's a bit of a bigger gap with E-Systems at only 4.5%.
I know you've absorbed a lot of margin pressure there, but maybe you can talk through the plan to get those margins back up. What's the plan for commodity recovery? Considering that most of the growth that you're gonna be seeing over the next couple years is actually from the backlog, which usually comes in at a lower initial margin, how do we think about the trajectory from here?
I think you can break it down into the same two pieces that we looked at for seating. Starting with the volume and the backlog, we see that as about a 250 basis point tailwind over the next two years. That's $1 billion of business rolling on at about 20%. It's a little bit higher than our traditional backlog rolls on. Some of that is because it's production volume going up on existing platforms, which converts to 25%-30%. The backlog, the mix of backlog that we have is more skewed towards Connection Systems, which is our highest margin profile sub-segment of E-Systems. The new electronic products that are rolling out in the Battery Disconnect Unit with that level of vertical integration is going to be higher margin than our existing electronics business.
you have 250 basis points from that bucket, the other 100 basis points similar to seating, 50 basis points a year of performance. That performance is a combination of some moderation or recovery in commodities and some benefit from our performance following through that was this year, you know, offset by higher wage inflation and higher engineering costs.
Okay. That would get you to?
gets us to 8% and 25%.
8% or so.
Yeah.
Any questions from the audience before I do my last one or two? Maybe just really quickly, if you could just give us a little bit of color on the cadence of earnings that we should be expecting this year, 'cause you gave a little bit of a, some color on what the beginning part of the year will be and then later on. How should we be thinking about $375 million-$525 million of free cash flow this year? Can you just remind us of what your framework is for use of cash?
At the midpoint of our guidance, you know, we have $450 million of free cash flow that we expect to generate this year. You know, we really finished strong in 2022. We generated $50 million more in free cash flow than the high end of our guidance range. It's really a combination of all the investment and effort we've put into Lear Forward, really reducing inventory levels, better capacity utilization, as Ray alluded to. We've been very focused on returning excess cash to shareholders. We don't see a need for acquisitions in the near term, that free cash flow is going to be returned in the form of dividends and share repurchases.
To the extent we generate more free cash flow this year than last year, I would look for share repurchases to get ratcheted up a little bit. In terms of your, the first part of your question on the cadence of margins throughout the year, you know, as we sit here today, we expect the first half to be up year-over-year, but down sequentially from what we saw in the fourth quarter.
I think mostly attributed to the normal seasonality of our customer price downs and how those get negotiated throughout the year. Then the second half of the year see sort of flat year-over-year with what we saw in 2022 at the production assumption that we've used.
We have kind of hedged a little bit more in the second half in terms of our production assumption, just to, you know, to be a little bit cautious given all of the difficulties in the macro environment over the last 3 years. To the extent there isn't a pullback in demand or recession globally, you know, there's probably some upside in that second half production forecast.
We've tried to capture that in the high end of our guidance range. If I look at sort of the exit rates of both businesses, at the high end of the range, we could be at 7% in seating and at or above 5% in E-Systems. That, I think, puts us on a nice trajectory towards our longer-term targets or midterm target in 25 of getting both those businesses to 8%.
Great.
I have a question.
Yeah.
Just one real quick one. You haven't seemed to complain as much about schedule volatility compared to others. I mean, your kind of recovery bridge and margin improvements, you really mentioned less schedule volatility. Like, what are you seeing there? Why has it not been as big a problem as it hasn't?
You know, I'd say that it's similar to the fourth quarter, which was an improvement over the third and, you know, sequentially throughout last year, it got better and better. It's still problematic, but no more so and probably no less so than how we ended the year. As the year progresses, we do see more capacity coming online. We do see perhaps those costs alleviating somewhat. We do see a modestly better environment year-over-year.
Yeah. We do get to see seating then obviously systems with chips and some of those supply shortages. Even though it's better, there are still very selective parts that are short. Our customers are much more sophisticated on their ordering and what they really need versus kind of overinflating to get whatever parts they could get.
That's helped, and I think the combination of this being very selective has helped. The disruptions are still there. I mean, we're still managing the disruptions. You know, I think to Jason Cardew's point, we in, you know, in some respects anticipated some of that to continue. I think by the second half, we'll see that, get better, not significantly better, but better.
A quick one?
Yeah. I had a question about Chinese OEMs and your exposure to them, specifically Chinese EV companies that are some of the fastest-growing players globally. I mean, just talk about some of your exposure to them.
Yeah, it's just on the seating side, we have a growing business with BYD. You know, historically, they had a joint venture with one of our competitors, and it was controlled by BYD, so largely in-house. They've moved away from that model. If I look at our non-consolidated backlog, half of that revenue is BYD. That may be a relatively cautious assumption that we're making there is that that relationship is just getting started. We see having, you know, something like a third of their seat business if we look three years out. NIO is another one that we have had some success with, and that does show up in the consolidated revenue.
Geely.
Geely, we've got a nice business with as well, and the derivative brands. Polestar is a very good business, both in seat and E-Systems, and Lynk & Co as well.
What's the Chinese domestics as a percentage of your China business?
It's still relatively low. We still are over-indexed to the Western-
Right.
OEMs, we do see a growing opportunity with Chinese domestics.
Yeah, regionally, we've definitely seen a pickup with the domestic EV players.
Yeah. Great. Great, Jason. Thanks again for your time.
Yeah. Thank you, guys. Thank you.
Thank you.
Great.