Lear Corp (LEA) 2003 Q2 法說會逐字稿

Good afternoon. My name is Derek, and I will be your conference facilitator today. At this time, I would like to welcome everyone to the Lear second quarter earnings release conference call. All lines have been placed on mute to prevent any background noise.

After the speakers' remarks, there will be a question and answer period. If you would like to ask a question during this time, simply press star followed by the number 1 on your telephone keypad. If you would like to withdraw your question, press the pound key. Thank you.

Mr. Stephens, you may begin your conference.

Good afternoon everybody, and thanks for joining us. By now you should have received our second quarter earnings release and financial review package. These materials also have been filed with the Securities and Exchange Commission today and they're posted on our corporate website, Lear.com, through the Investor Relations link.

Joining me on the call today are Bob Rossiter, our Chairman and CEO, Jim Vandenberghe, Vice Chairman, Dave Wajsgras, Senior Vice President and Chief Financial Officer.

Before we begin the official program, I'd like to remind you all that during the call we will be making forward-looking statements that are subject to risks and uncertainties. Some of the factors that could impact our future results are described in the last slide of this deck, and also included in our S.E.C. filings.

In addition, we will be referring to certain non-GAAP financial measures. Additional information regarding these measures can be found in the slides labeled "Use of non-GAAP financial information," also included at the end of this presentation.

If you'll turn to slide 2, this shows our agenda. First, Bob will cover a comment on our strategy, and then our second quarter highlights. Then Jim will provide a perspective on our operating results. Dave will cover our financial results in detail and update our 2003 guidance.

So, with that, please turn to slide 3. And here is Robert Rossiter.

Thanks, Mel. First off, I'd like to start off with, and I do this at every call just to make sure people know that we haven't changed focus, talk a little bit about the Lear approach. That is to serve our customers.

We believe that's the only reason we're in business is to take care of our customers. And I believe we do it better than most. The truth is if we take care of our customers and do the best job we can, we will win, our shareholders will win and we as people will win.

The Lear team seriously strives every day to be the very best automotive interior supplier. I think with the combination of the electronics business that we have today, we really have an advantage in the industry.

I think a couple of other things that are important about Lear, the culture that we established three years ago when this management team took over was to focus on quality and operational excellence. We believe that that's the way to deliver outstanding products to our customers. We think, also, that the asset management which comes out of our LBO heritage has helped us greatly.

I think the other key thing about the way we operate is to focus on teamwork. We together, all of us at Lear, union people, non-union people, salaried people, everybody, are all part of this great team, the Lear team.

We combine that with, we believe, the best supplier relationship in the industry as well as, I think, some of the best relationships with our customers worldwide. I think two good demonstrations of that really are the total interior integrated program we have today with General Motors and our support of Ford's total value management process that was instituted by David Dursfield. We're big participants in it, and we're actually seeing significant results.

I'll tell you a couple other things. Our focus on quality and operational excellence have really and truly helped the company. I think it's allowed us in a very difficult market when customers are asking for price concessions, to offset those price concessions and still maintain our margins.

The other focus I think is important that people should hear is, we did shift the company, several years back, away from a company that was in the acquisition business, and we're now totally focused on organic growth. I think the outstanding relationships that we have today with our customers are allowing our business to grow, and this business truly is growing.

I'd like now to turn over to slide 4. If you look at some of the highlights, I want to start off by complimenting the Lear team for a very good first half and a very good second quarter. They have done an outstanding job and they're working well together. If you look at the numbers themselves, you can read them. Record quarterly sales up 8%, net income up 21%.

Our focus on cash flow in this business has not and will not change. We are focused on paying down debt. I think the important thing, really, again to mention, is that the focus on quality and cost improvements and our responsibility to be true partners with our customers are what's making this the business it can be.

I believe that we will beat guidance and have beat guidance because of the favorable conditions in the market. And in the quarter industry production and platform mix came in better than our original expectations.

The benefit of our ongoing efforts to improve quality and reduce costs, improve operating efficiencies came in a little earlier than we'd expected. But our guidance for the full year last been amended to reflect the second quarter benefit and lower tax rate. Dave will provide more details.

Now, I'd like to turn it over to the Vice Chairman of Lear, Jim Vandenberghe.

Thanks, Bob. We move to slide 5. I want to talk a little bit about the company from an operating perspective. The auto industry continues to focus on the interior of the vehicle. All of the major manufacturers have initiatives to improve qualities, craftsmanship, safety and convenience for the interiors of the vehicles.

With our industry leading interior capabilities and our unique ability to integrate electronics, we believe we're in a strong position to support the automakers' efforts to improve their interiors and to grow our business. Our $4b sales backlog, which was updated last April, stands at the highest level ever, and we see opportunities for additional growth.

One area I want it highlight is the tire pressure monitoring systems, the TPMS. Those are required to be on 35% of vehicles produced in the United States beginning in 2004 model year and full implementation is required by 2007 model year.

In partnership with Beru (ph), the market leader for sensors, we have developed a range of solutions. We believe the market potential for TPMS is about $1b, and we have an opportunity to capture a significant portion. Ford is currently a TPMS customer, and we are in discussion with the other automakers, as well.

At the same time, as Bob mentioned, we are focused on operational excellence to improve our quality and drive operating efficiencies to the bottom line.

Slide 6. We'll just have an update on our total interior integrator program, or the TI program that we were awarded by General Motors. We are nearing completion for the sourcing matrix for both the Buick LeSabre and the Cadillac DeVille interiors. Existing Lear plants will supply most of the major interior components. Some of the smaller trim components will be purchased from Lear's tier two suppliers.

From a design and engineering standpoint, our team has been working closely with General Motors through the styling phase. Lear is currently designing the interior parts to support prototype builds in early 2004. The DeVille program, which was first to launch, is approximately two years away from start of production.

The 2006 LeSabre and the DeVille will be the first programs to showcase Lear's in innovative spray urethane / polyurethane cast skin technologies. This technology enables precise fits and finishes for superior craftsmanship.

In addition, Lear has developed a lightweight acoustical package which provides all the acoustical benefits found in today's vehicles with substantial reductions in masse. Also, both vehicles will utilize Lear's flexible seating architecture which provides premium performance at competitive prices.

The bottom line is Lear is on track to deliver a world-class interior for these premium vehicles. Bob mentioned quality and customer satisfaction continue to be our top operating priorities. And tools like Lear manufacturing and Six Sigma are driving improvements throughout the entire organization.

In the first half, we have achieved a 27% improvement in defective parts per million as compared to a year ago, and this is measured by our customer statistics.

We are striving to be the best automotive supplier in the world, and we believe that our customer focus strategy and continuous quality improvement approach is a competitive strength for Lear. As our quality has improved, our customers have rewarded us with recognitions, and more importantly, with the highest business backlog we've ever had.

I'd now like to turn it over to Dave Wajsgras who will walk you through the financials.

Thanks, Jim. Before I review our second quarter financial results, I'll briefly comment on the production environment.

In North America industry production was down 9% with the big 3 down 12%. Our content per vehicle increase to $597, up 8% from a year ago. The addition of new business and a favorable mix drove the improvement.

In western Europe, industry production was down 2%. The impact to Lear, however, was more significant because several of our key platforms were down more than the industry average. Our European content per vehicle was $317, up about 3% when adjusted for currency.

The euro was 24% stronger than a year ago. Compared with the assumptions considered in our second quarter financial guidance, industry production was favorable, or should I say less adverse, in both of our major markets and platform mix was better than expected in North America.

If you'd now move to the next slide. Worldwide, net sales were a record $4.1b, up $309m, or 8%. Income before interest, other expense and income taxes, which we believe represents our core operating earnings, was $212m, up $15m, and also improved by 8%.

Margins were in line with last year's second quarter, reflecting a difficult production environment offset by the positive impact of operating efficiencies. Net income per share of $1.54 was up 21% from a year ago. This reflects higher operating earnings, lower interest expense and a lower corporate tax rate.

As a percentage of net sales, SG&A was 3.5%, equal to a year ago, and in line with our guidance. For the remainder of 2003, we see SG&A as a percent of net sales in the mid to high 3% range as we continue to invest in developing new business opportunities and incur higher employee-related costs.

Absolute SG&A dollar amount will also continue to be impacted by higher foreign exchange rates versus the U.S. dollar.

Interest expense was $49m, down $4m. Lower average debt as well as efficiently managing our debt portfolio both contributed to the lower expense. Other expense of $14m, down slightly from the same quarter last year, is expected to be in the range of $15m per quarter for the back half of 2003.

If you'd now move to the next slide. This slide shows the major drivers of our improvement in core operating earnings and net sales for the quarter. The $15m improvement in operating earnings reflects the profit contribution from new business globally, net operating efficiencies and the favorable impact from foreign exchange. This was offset in large part by lower industry production globally.

Let me provide a little more detail on each of these profit drivers. The addition of new business was the major contributor, reflecting strong product and platform mix in combination with efficient launch performance. Net operating efficiencies where are comprised of ongoing quality and productivity improvements, the benefits from lean manufacturing and Six Sigma initiatives, as well as capacity rationalization. The net currency impact was primarily the result of the stronger euro.

Industry production was down 9% in North America and 2% in western Europe. Strong light truck and SUV production supported a favorable platform mix in North America. For example, production of the GMTA hundred pickups and SUVs and Ford F series were all stronger than anticipated.

The production mix in North America was a positive in both our earnings improvement and in our content per vehicle growth. I'll provide more details on CPV on the next slide.

In Europe product mix was slightly negative. The increase in net sales of $309m is the result of new business. Lower vehicle production reduced sales by $291m, which was essentially offset by favorable foreign exchange.

If you'd now move to slide 11. Our North American content per vehicle was up 8% in the quarter. In addition to our backlog of new business coming on-line, a couple of industry factors also supported the increase.

Light truck production, as a percent of total, continued its upward trend. In addition, production for SUVs was up 2% overall and full-size and luxury SUVs up more than 20%. Our sales are more heavily concentrated on these vehicles.

Also, extended versions of the Chevrolet TrailBlazer and GMC Envoy where we do not have significant content, were temporarily out of production when GM's Oklahoma City plant was damaged by a tornado.

In terms of new business, we benefited from added content and higher production on the GMP 800 platform following the mid-cycle enhancement last year. In addition, several new products, also with significant Lear content, entered the market in the last 12 months, including the Hummer H2, Lincoln Aviator, Chrysler Pacifica, Saturn Ion and Nissan Maxima. Lastly, we continued to add content to existing programs.

Looking ahead, we see our CPV essentially flat to slightly up in the third quarter. This moderation reflects major launches, such as the new F series, a less favorable product mix and a return to full production for the GM Oklahoma City plant.

In addition, the higher content for WindStar is being phased out. Their replacement program, the FreeStar, is not supplied by Lear. For the full year, we are on track for continued growth in CPV.

If you'd now move to the next slide. Our capital spending guidance was $100m for the second quarter and $300m for the full year. Actual spending in the second quarter came in at $67m, or $33m below the forecast.

This spending shortfall reflects the timing of planned expenditures between the first half and second half of the year and not a revision to our annual capital plan. Accordingly, our full year spending guidance remains unchanged at $300m.

For the first half our capital spending was $137m, up $35m from a year ago. This reflects primarily spending on new programs, including the all new Ford F series.

If you'd now move to slide 13. Free cash flow was $180m in the second quarter, reflecting strong cash conversion on our earnings. Capital spending was offset by depreciation. Working capital and other, including tooling and engineering, as well as non-cash items were $55m positive overall.

Within this, working capital performance was positive at around $44m. About half of the contribution was the result of inventory reduction efforts. I'd also like to point out that we continue to partner with our supply base and again, lower the table's outstanding metric versus last year's same quarter by two days.

On a final note, free cash flow was $105m above our guidance, again, reflecting solid conversion on the higher earnings, the timing of capital spending, earlier than expected tooling and engineering collections and an improvement in our working capital and other results.

If you'd now move to slide 14. We utilized our cash flow to continue to pay down debt. At the end of June, our net debt to cap ratio improved to 52%. We plan to use future cash flows to further pay down debt and improve our balance sheet flexibility as well as support other initiatives that will continue to drive shareholder value.

You if you'd now move to slide 15. Improving tax efficiency continues to be an area of focus for our company. As it currently stands, we see our corporate tax rate for the full year 2003 averaging about 29%. This reflects a decline of 2 percentage points in the second half of this year.

The lower tax rate reflects the following: most importantly, we have a strategic emphasis on tax planning throughout the company. We proactively manage our legal entity structure to optimize tax results. Lastly, our mix of non-U.S. earnings continues to improve.

We see a 28% effective rate that's sustainable in the foreseeable future with potential opportunity for even further reductions.

If you'd now move to slide 16. This slide summarizes our production outlook. In North America we have no change from our prior guidance for 2003 vehicle production. In the 15.7m to 15.9m unit range, down 3% to 4% from last year.

For western Europe, we also reiterate our prior forecast for 2003 vehicle production in the 15.7m to 15.9m unit range down 3% to 4% from last year. In the third quarter, we see industry production lower by 5% in North America and down 7% in western Europe.

If you'd now move to slide 17. Our earnings guidance for the third quarter and full year takes into account the lower period over period vehicle production assumptions, a 28% corporate tax rate in the second half, as well as our continuing productivity improvements and cost reduction actions.

In the third quarter we see net sales of about $3.4b, up slightly from a year ago. Net income per share is expected to be in the range of 95 cents to $1.05.

We anticipate that the addition of new business and a stronger euro will more than offset lower industry production and the outlook we expect for customer and platform mix. Interest expense is expected to be approximately $50m. Free cash flow should be about break even.

For the full year, we expect net sales to be approximately $15.2b with net income per share ranging from $5.20 to $5.50. We see interest expense around $200m and free cash flow of approximately $400m.

While our earnings guidance for both the third quarter and full year is higher than a year ago, we see margins flat to slightly down versus 2002. We're essentially able to maintain a comparable margin profile despite lower global production levels because we are continuing to drive cost improvements in our operations and achieve efficiencies throughout the entire value chain.

One final comment on our guidance. We'll continue to absorb in our core operating earnings the implementation costs of our ongoing efficiency, capacity and manufacturing productivity actions. The point here is that we don't anticipate incurring any expenses, or more specifically, any non-recurring expenses that are not already included in the third quarter and full year guidance that I just spoke to.

If you'd now move to slide 18. Our focus on improving our business fundamentals is clearly evidenced in this chart which shows the trend of our trailing 12 month return on debt to capital. This measure of capital efficiency has improved steadily since the fourth quarter of 2001.

If you'd now move to the final slide, 19. In summary, we believe our customer focus and performance-based culture is driving our success. Despite lower industry production in both North America and western Europe, we were able to maintain our margins in the second quarter. We also continued to improve our quality worldwide and our customers have been recognizing the value we're delivering with new business and performance awards.

In addition to growing our top line, we've been lowering our costs and improving our overall operating efficiency. This has translated into an improvement in our economic returns and has allowed us to meet our aggressive cost targets from the customers. We continue to drive strong cash flow, which has been used to strengthen our balance sheet.

Looking ahead, we have increased our full year earnings guidance to reflect second quarter results and a lower second half corporate tax rate. Our global strategy, to leverage our total automotive interior capabilities, to deliver value to our customers, and grow the business worldwide, remain unchanged.

With that, we'll open it up to questions.

At this time, I would like to remind everyone in order to ask a question, please press star followed by the number 1 on your telephone keypad. We'll pause for just a moment to compile the Q&A roster.

Your first question comes from John Casesa with Merrill Lynch.

Hi, Dave. Dave, I want to just ask you about the European business. I know it's been tough there for you. What can you tell us about your margin performance in Europe? Have you had any improvement? How much has it been? What's a realistic target for that business?

Okay. In the second quarter, margins did improve nicely over last year second quarter, and we see that continuing on for the balance of the year. So, on a full year basis we expect margins in Europe to be improved over last year. And that's really driven by our cost reduction actions. Over time we do have an internal objective to have margins out of Europe well in excess of 3%.

Okay. And the performance year to date has been material? I mean, it's a material change from where you've been?

The performance year to date is much improved over last year.

Okay.

John, basically the issue we have, I think we mentioned this the last call, we have two solid businesses there. We feel, in terms of seating and electronics. The interior business is a little bit more fragmented, and that's where we're focusing a lot of our cost reduction efforts.

Interiors. Okay. Thank you.

Your next question comes from Steve Girsky with Morgan Stanley.

Hi, everybody.

Hello, Steve.

Dave, investment grade still a priority for you guys, or no?

Absolutely. I think I've mentioned on the last few calls it's from a financial perspective one of our top priorities.

We continue to have dialogue with the rating agencies. We believe that from a purely financial perspective we've made tremendous progress and we've met the targets that have been placed on Lear over the last six months, and we're hopeful that in the future we'll be awarded investment grade status.

And does the strategy change at all once you become investment grade?

No.

Okay. So, how do you redeploy your excess cash once you become investment grade?

Well, that's a good problem to have, Steve, isn't it?

Yes, we've mentioned this before. We're going to do what's in the best interest of the shareholders.

I think back in January, we initially spoke about considering a dividend as we move into 2004 and we will still be considering that. We'll be looking for strategic investments, primarily in the Asia-Pacific region as well as strategic investments in Europe. We could always prefund some of our pension contributions, and we will continue to pay down debt.

Since it's such a good question, I'll pipe in here, as well. I think I said up front that we set up a strategy several years back to get out of the acquisition business and to focus on quality and operational excellence because we really believe that that's the way to provide our customers the best service and thereby grow our business.

I honestly believe, as does this team, that there's significant growth potential for us through organic growth. We do see some opportunities down the road, some small acquisitions, maybe in electronics or some in the Asia-Pacific region, which we've talked to all of you about.

So, we're not saying that that may not happen in the future, but I think for the time being this last two and a half to three years that we've focused on operational excellence and integrating our businesses together to mold them into one Lear through Six Sigma has really and truly helped this business. And I think that's the way we want to stay going for at least for the near future.

Great. Thanks, Bob. Can I just ask you about content growth in the third quarter?

You said flattish, but you do have a big back backlog of new business. So, what is it, mix is offsetting new business, kind of thing?

It's basically mix. That would be the way I would frame the most significant driver.

All right. Thank you.

Thank you.

Your next question comes from Rod Lache with Deutsche Banc.

Good afternoon. Congratulations.

Thanks, Rod.

I've got a couple questions. First of all, relative to the guidance you're raising the range by 25 to 35 cents. You just beat the second quarter by something approaching 30 cents, I guess depending on what point you use from your prior guidance range.

So, I guess the question is are you not changing your second half expectations? It seems you would given the lower tax rate?

No, that's actually well put. Let me try to address it in a couple of pieces.

First of all, production was not as down in the second quarter as we originally anticipated. It was roughly 65,000 to 70,000 more units produced in the second quarter than our guidance originally suggested.

Second part is, mix came in quite a bit more favorable than what we were seeing back in April, in particular in North America with the trucks versus the pass cars. Trucks made up about 56% of production versus 53% in last year's second quarter.

The third element is in the second quarter the cost reduction actions that we've been speaking about for the last 12 to 24 months, we started to accrue benefits in the second quarter a little bit earlier than we anticipated.

So, taking those three together, that was really why we ended up beating expectations and beating our original guidance. Looking to the back half of the year, we really don't see much change from what we were seeing in April with respect to production and mix. We'll continue to see the benefits from our cost actions, which were originally included in our guidance.

To your final point, we do see the benefit from the corporate tax rate coming down.

Was that lower tax rate incorporated into your prior guidance?

No.

Okay. So, in effect, if you look at this on a pretax basis, are you being a little bit more cautious on the second half?

We traditionally have found it prudent to be conservative looking forward. I would say we're being prudent.

Remember that we're still forecasting unit volumes in the 15-7 to the 15-9 range. And so, the fact that the second quarter came in a little higher than our expectations, naturally the second half has come out of there somewhat.

Right. On a separate issue, can you just talk a little bit more about the backlog? Are you guys actually booking significant tire pressure contracts now? Can you give us an update on the status of other wins? I believe there were some transplant opportunities out there.

Yes, I think the last time we've updated the backlog was April, and then we've typically taken a once a year approach. So, the backlog last April was about 4b.

I can't really speak to where our backlog to date - there's always plusses and minuses going on. To date, we've won about $100m worth of business on the tire pressure monitoring system, and again we see opportunities to take that - to build that up with other customers.

Okay. Have there been any changes as far as transplant awards to date?

Nothing that we can speak about.

Yes, we're going to go through the formal update on an annual basis. And as a result, we've decided not to just spike out specific program wins throughout the year, because then you have to address 25 moving parts in the backlog. For the time being, the $4b is a good number to use for forecast reasons, forecast basis.

Okay. Lastly, could you comment on how the F 150 launch affected you in the quarter in your expectations for Q3? It seems like that could be a significant factor as Ford builds inventory and then ramps up a new model.

Well, we were launching in the second quarter. The launch, from our perspective, from Lear's perspective, went even better than we anticipated from a cost standpoint. And I addressed that in the more formal comments. It will come on-line in the third quarter. Ford will launch the program during the third quarter.

I'm not sure what you mean by --

It's a stronger build of F 150s in the second quarter than we originally anticipated. And that obviously helped us in the second quarter, but we don't necessarily envision that in the third quarter.

Okay. So that's part of the sequential changes, I guess.

Right.

Okay. Thank you. Your next question comes from Gary Lapidus with Goldman Sachs.

Hey, good afternoon.

Just to clarify, when you said "flat CPV," were you referring year-over-year or sequentially in the third quarter?

Year-over-year.

Okay. Since I don't have my model open, what does that imply in terms of sequential?

Right. Well, sequentially it would be down a little bit. And again, the driver there is the mix of trucks and pass cars.

Okay. On slide 15, you mentioned the 28% tax rate.

Right.

I think you said in the foreseeable future. I'm just wondering how good your eyesight is?

Years, Gary.

So like, out through '04 for sure?

Yes.

Okay. You've probably addressed the basic drivers here, but back on slide 9, I was just kind of observing that you picked up $15m of EBIT essentially, or something close to it. Right?

On $309m of -- $309m of incremental volume.

Okay.

Which, if I do the math, is like 5%. So, you either have an extraordinarily variable cost structure, or there would just seem to be something going on that's giving it such a low conversion of revenue into EBIT . Forgive me if you haven't sort of thought of it this way before the call, but it just did strike me.

Well, there's the impact of the euro.

Okay. Right. Did you disclose how much of the revenue increase was FX?

Well, it's on the chart. It's at $300m. But that's not all euro, it's all FX. But it's principally the euro.

So, it's $300m all in?

Yes.

So then, when you pull that out, there's your cost performance.

Right. There you go.

Great. You guys are awesome. Okay. Thanks.

No, Gary, you're awesome.

Your next question comes from Chris Saresso with CSFB.

Hi. Good afternoon. If we can follow up on the margin question, if you are maintaining flat margins this year on down volume, what kind of expectation should that give us for '04 if we conservatively assume volume is flat?

If I take the cost efficiency that you've achieved this year on slide 10, the $18m, if I annualize that and apply that to your base, does that suggest something in the 50 basis point range, is that completely off the mark, or how would you look at that?

Yes, well let me tell you the way I would look at it. Production is down this year. Mix in the back half is going to be working against us. We do see more specifically margins flat to slightly down. But as we go forward into 2004 and '5, one of the objectives is to improve our margin profile on a global basis for all the reasons we've been saying. And I think it's fair to assume a 15 to 20 basis point improvement year-over-year over the next few years.

Okay. Do you have a return on capital target? I like the chart showing the historical trend there. But what is your longer term target for that metric?

Right. Well, the target is to continue to improve return on investment capital, obviously, and to improve the spread between the return on invested capital and our weighted average cost of capital.

So, we're really working on two fronts. We do see the ROIC improving over the next 18 to 24 months. Somewhere around probably 8% to 10% a year over the 10.5%.

Okay. Then lastly, I think you mentioned this, I apologize if I missed it, of the new business, how much of that $300m globally is the effect of currency?

There was about $20m was currency.

Okay. Terrific. Thank you very much.

All right.

Your next question comes from David Bradley with J. P. Morgan.

Good afternoon. Terrific results. Very, very impressive.

A short question first. We have the long bond now ticking up a bit. How exposed are you to rates if we start getting rates coming back up again?

Well, today 75% of debt portfolio is fixed.

Okay.

But we continue to manage the fixed variable structure through a fairly comprehensive swap portfolio. So, we'll continue to manage interest rates to benefit the company.

Okay. Then on these new full interior contracts, this is a fairly new thing, and I imagine that both sides, the customer and you, are struggling to figure out exactly what it means and who takes the risk.

How do you see the risk / return profile on these things in the early years and then in the later years? Is there a lot of pass through where the margin goes down and the ROIC goes up? Do you get that right away or do you get the higher return down the road or how does it play out?

I think the way to look at this is no different than being sourced the various components or modules that make up the interior. And we focus our proposal process on return on invested capital.

Frankly, the margins are really a by-product of the return on invested capital. This particular program, since much of it, as Jim mentioned earlier, will be -- much of the manufacturing process will take place within Lear's facilities, the ROIC is going to be better than the company average. I think it's fair to assume that the margins in the various mod ills will be about on average with where they are today.

Okay. And one last one. Both you and Johnston Controls have reported now some very nice revenue growth in a market where it looks like most of the other component companies and auto companies aren't going to see that. Is what we're saying here a surge on outsourcing activity of interior products by the big 3, stuff they used to do in house? Or is what we're seeing here is upgrading of the content levels and you know, companies investing more in their interiors, or is there some third explanation?

Well, we believe that as the industry continues to focus on quality and craftsmanship, it does help Lear's content with respect to the platforms that we're on.

So, it's people upgrading interiors essentially?

Sure.

Okay. Thank you.

Also, we've penetrated the Asian market. That's helped our business to grow.

Right. Thank you very much.

Your next question comes from Brett Hoselton with McDonald Investments.

Good afternoon, gentlemen. Tax rate, did you say for '04, using 28% or was it 29%?

I said 28%.

Okay. Secondly, on the dividend question, do you feel that you need to be formally rated investment grade prior to it- I know in the past we talked about the bias.

Yes. Obviously there are no rules and regulations about a dividend and investment grade. Our hope, and this is the same discussions I've had with the rating agencies, our hope is that we would be investment grade prior to issuing a dividend. And that's currently what we have planned. Again, the rating agencies have their job to do, and we can't dictate their timing.

Fair enough. Then on the total interior integrator program, specifically as we think about sourcing, and on your slide a couple of quarters ago you talked about going from OEM directed to supplier lead. Can you give me a specific example of how this total interior integrator program is different with regards to sourcing versus a prior program?

Well, in this particular program we will have 90% of the content. So, if we were to take this and put it in perspective, the amount of business we had on this vehicle platform was, I believe, about $425m, say, this past year. With the new content we have, it will be about double that.

Okay. As you think about your specific ability to control where those contracts or where those components' sourcing goes, how has this changed?

Well, I think there are a couple things. It goes beyond just where the sourcing has gone. It really goes to what type of products they are and how they interact and what you invest your money on in the interior versus how it was done in the past.

I mean, our customers are looking for more harmonized interiors. And so, it's an opportunity for us to bring some new technologies there that provide them cost efficiencies, better quality and better harmony and allow us maybe to spend more money on features that the consumer will value another day.

So, it really has to do with just using our total interior expertise and all the capabilities we have and harmonizing that interior for the best in quality and consumer value.

Thank you very much, gentlemen.

Your next question comes from Thomas Crowley with Putnam Investments.

Hello.

Hello. How are you doing?

Good. How are you?

Good.

Just two quick questions. One of them on page 10 and the slide. This, sort of, is along the same lines as Gary Lapidus question.

If I just look at the global new business of $23m earnings, if I just divide that by the 300 it comes out with an implied margin of 7.7%. Am I thinking about this incorrectly?

No. You're thinking about it absolutely correctly. And that's what I referred to again in the formal comments that our ability to manage our launches has improved over the last few years.

I guess a good data point would be if you look at start-up costs relative to backlog that's coming on-line, last year it ran about 6% in the second quarter. This year it's running about 3%. And you're seeing some of that come in through the margin improvement.

Okay. Then the second question, just referring to Brett's, the previous question. Now, the total interior, you said you have 90% of content for that program and it was $425m of content?

Mm-hmm.

And now it's double that?

Yes.

Am I thinking about this correctly? When you stated earlier that the margins are roughly the same. So, on that $800m, that second $425m, is that also at the same margins, or is that more pass-through?

No, it is at comparable margins to what we earned today.

Okay. Now, how is that done if you're actually just passing that through?

Well, we're not actually. Again, we're doing the engineering. There are some components that we'll install. But at the end of the day we're doing all the installations.

It's very similar to what we do on a seat program or any kind of a module. I mean, we buy components, and we still buy a great deal of our components. I think 63% of our sales are spent on outside material. But at the end of the day we sell a complete module or unit or in this case a complete interior and we'll do a lot of the manufacturing of the actual interior components.

Okay. Thank you very much.

Your next question comes from Darren Kimball with Lehman Brothers.

Hey, Darren.

I think most of them have been asked. Maybe I could ask for some color around the wiring business? You haven't talked much about it. How is it going in that business? How is the growth performing?

Let me try to take that. The wiring business continues to perform well. From a segment perspective, the electronics and the electrical distribution systems area is our highest margin product group. We're continuing down a strategic path of relocating manufacturing facilities to low labor cost regions.

As a matter of fact, I think we've mentioned before the biggest single plant closure as part of the restructuring was in Savara, Spain. And we reduced head count there about 1100 people and have relocated all the manufacturing to eastern European countries.

So, we continue to drive costs out of the system and actually, on the last call, we spoke to some new business wins with some of our Asian customers. We're starting to build a plant in Honduras. Another low-cost labor region where we'll be providing EDS system primarily for Hyundai.

Our wiring business is still growing. Electronics -

Does that answer your question, Darren?

Yes, that's great color. Thank you.

Your next question comes from Kirk Ludke with J. P. Morgan.

Hello.

Hello.

Getting back to the GM total interior program, I guess another way of asking this question is during this process where you picked up 90% of the program, did you take any contracts away from tier 2 suppliers or other suppliers?

Well, yes, there were other supplies that made some of those components in the past. I really wouldn't be in a position to talk about who they are.

Is that something that just happened in the last quarter? Was it a sudden move to 90%?

Well, no. You understand that we were just awarded the business last quarter. So, in working with them and working on the design, and again we have a new concept for the instrument panel and can we provide a lot of the capabilities built. I think we even mentioned back then that we had existing facilities that could make all this product. It's not really a change in direction at all.

Okay. On a different topic, you mentioned that western European production would be down 7% year-over-year in the third quarter?

Right.

Could you give us a breakdown of which of your customers are going to be down the most?

Yes. Actually, let me just go through kind of the big picture. For the second quarter, we're seeing Volkswagen down about 18%, PSA down close to 10%, we're seeing Fiat down 14% to 15% ,and BMW down about 15%.

That's for the third quarter or the second quarter?

I'm sorry. That was for the third quarter, right.

Third quarter?

That's what you're asking?

Yes, yes.

Okay.

And BMW was down 15%, you said?

BMW is expected to be down in the third quarter about 15%.

Okay. So those are all negatives. Thank you very much. Any positives?

Yes, we see the GM/Opal/SAAB group up about 10%, as well as the Ford group, made up of Ford, Volvo, Jaguar and Land Rover, up about 4%.

Great. Thank you very much.

Your next question comes from Ronald Tadross with Banc of America Securities.

Hi, guys. How are you doing?

Hey, Ron.

Excuse me if you went through this. On the European margins, did you talk at all about the year-over-year margin in Europe?

The specific margin, no, we didn't talk about it.

Maybe you can give me some color there as to what happened?

Yes, and again, I spoke about this a little earlier, but we've taken some very significant actions in Europe with respect to our cost structure and we've consolidated engineering centers, we've closed administrative offices.

The capacity reduction actions that we started to implement a couple of years ago has benefited us with respect to moving to eastern European countries; whereas before we were in high other labor cost regions. And that's really across the board.

We've also closed some facilities outside of the restructuring. We've sold facilities over the last 12 to 18 most that were not profitable or were not a strategic investment from Lear's standpoint.

With all that being said, we have improved margins year-over-year. We have not achieved our strategic target of being well in excess of 3%, we continue to move toward that and believe that over the next 12 to 18 months we've be in a range that is more -- you know, more reasonable from our perspective.

So, about 50 to 100 basis points year-over-year at least it sounds like?

I'd rather not get into that. It was significant improvement.

Okay.

And in North America production was down 9%. You said mix was better than expected. I assume that means your vehicles were down less than the market, or does that mean, like, content mix? What does that mean?

That's a great question.

Well, one is the big 3 performed better than we expected, and obviously that's the majority of our business domestically. Trucks outperformed pass cars. I said before, trucks were about 56% of production versus 53% in last year's second quarter. And the particular platforms where we have high content performed exceptionally well, in particular the GM trucks.

Okay. So, do you have a number of how much your programs were down versus the market? Is it half as much as the market?

I think what we had said earlier was overall production for the quarter was up, was it 50,000 or 60,000 vehicles than what we thought? And the other aspect of that, Oklahoma City, the good news or bad news, however you look at it, we didn't have a lot of content so we weren't impacted by Oklahoma City. And the fact that their unit build was down, really was probably a plus for us.

Okay. So, 50 or 60 more than you thought for the industry, right?

Right.

And they're probably on our higher content vehicles, trucks.

And then last question. If Ford and Chrysler's pipelines are building in terms of product over the next probably year, or 24 months. You guys have a lot of exposure to Ford and Chrysler or a good amount of exposure, how will that impact your capital spending? Should we see your capital spending starting to go up a little bit, maybe because your customers' product pipeline are building?

Yes.

The capital spending over the next two to three years is going up. Right now what we're seeing is about 7% to 10% a year. And that is in line with depreciation. So, we'll still see a reinvestment ratio of about 1 to 1.

You'll see 1 to 1 still?

Yes.

Okay. So, it's not going to go up above cap - D&A?

No.

Okay. Next two years. Okay. Thanks.

All righty.

One last question on the log.

Your next question comes from Scott Merliss with Thomas Weisel Partners.

Good afternoon, gentlemen.

Hi, Scott.

How are you?

Great.

Just to finish off the questions, if we think back in the past 24 hours we've heard GM and Ford express some surprise to the material cost reductions that they were able to get from their suppliers. From Lear's perspective, we don't obviously see that in your margins, strong margins.

But from Lear's perspective, what is happening when you look at the supply chain? The pricing to your supplier, but also the cost reductions -- the pricing to your customer and the cost reductions you're getting from your suppliers. Can there be quick reengineering? Are you?

How quickly can you reengineering what you're selling in existing programs to really get surprising cost reductions to your customer?

I think. First off, I think we are a company that's very aggressive in proposing cost reductions to our customers. Quite frankly, we do have aggressive cost down targets or price down targets. We engage our customers in that process. Some of the tools we have, we've talked about TVM, VA, VE lend themselves to our product because they're interior products and not as highly functional as maybe metal products are. And obviously we engage our supply base in that, as well.

So, we typically view any pricing, price downs and productivity gains and TVM, all those things really have to balance each other and that's how we manage our business.

Can you give a number for your material cost reductions?

I wouldn't because that would be a competitive thing and we'd rather really not go there. But I'd say about half of our stuff comes from TVM things and the other half comes from our supply base.

Good quarter. Thank you very much.

Okay. I think that was the last question.

Yes, sir. You have no further questions at this time.

I think the only ones left on the line are the Lear team. You guys had a good first half. Not a great half yet. We've got a lot of work to do, so stay focused and let's knock 'em dead out there and get 'em.

This concludes today's Lear Corporation conference call. You may now disconnect.