Lear Corp (LEA) 2005 Q2 法說會逐字稿

Good morning. My name is Dennis, and I will be your conference facilitator. At this time, I would like to welcome everyone to Lear Corporation's second quarter earnings 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. [OPERATOR INSTRUCTIONS] I will now turn the call over to Ms. Anne Bork, Director of Investor Relations. Ma'am, you may begin.

Thank you. Good morning, everyone. I would like to thank you for joining our call this morning.

By now you should have received our press release/financial review package. These materials have been filed with the S.E.C., and they're also posted on the home page of our website, www.lear.com.

Joining me today on the call are Bob Rossiter, Chairman and CEO; Jim Vandenberghe, our Vice Chairman; our Wajsgras, Senior Vice President and CFO; and Doug DelGrosso, President and COO. Also with us are Shari Burgess, our Treasurer; Jim Murawski, our Controller; and Mel Stephens, our Vice President of Communications.

Before we begin, I would like to remind you 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 stack and also in our S.E.C. filings. In addition, we will be referring to certain nonGAAP financial measures. Additional information regarding these measures can be found in the slide labeled "Use of NonGAAP Financial Information", also at the end of this presentation.

Slide 2 details our agenda today. First, Bob Rossiter will comment on our strategic direction. Jim Vandenberghe will discuss 2005 business conditions. Dave Wajsgras will review our financial results and guidance. Doug DelGrosso will cover our strategy and restructuring actions, and then Bob will have some closing comments.

Now I would like to hand it over to Bob Rossiter.

Thanks, Anne.

Before we get into our financial results and additional details on operating plans, I would like to comment on our overall strategic direction. As I mentioned on the last call, we've been looking at all aspects of our business for potential improvements. One element of our strategy and operating philosophy that has not changed is our unwaivering commitment to customer satisfaction. So in the near term, we are keeping our focus on the critical success factors that we can control. Most notably, quality, flawless launch execution, and just day-to-day making sure that we get cost out of our product.

We've already streamlined our organization and are pleased to announce that promoted from within Lear, one of our best and most talented people, Doug DelGrosso, to the position of President and Chief Operating Officer, and he is quickly streamlining that organization. We have also consolidated certain administrative functions and thrifted non-product related costs throughout the Company.

In the medium to longer term, we are focused on continuing to grow and diversify our sales backlog, to address our longer term competitiveness, and to improve our ongoing profitability. We outlined last month, and we will update today, our global restructuring frame work. This comprehensive initiative is intended to accelerate our low-cost country strategy, further improve our operating efficiency, and eliminate excess capacity. We are also addressing our underperforming interior components business and refocusing our investments on our core sheeting, electrical, and electronics businesses.

Lastly, our priority focus on growing our business in Asia and with Asian manufacturers globally is continuing. This emphasis is helping us to grow our sales and further diversify our sales mix.

Just to comment on acquisitions, we mentioned acquisitions at the last call, and for the time being all acquisition discussions have been put on hold, pending what we're going to do with the rest of the businesses that we have today.

Now I'll turn it over to Jim Vandenberghe and the rest of the management team to review our results, specific plans with respect to our overall strategic framework. Jim?

Thanks, Bob, and good morning.

I thought I would provide a little background before Dave and Doug give you a more detailed discussion on our business. First off, as you know, 2005 has been a very challenging environment for Lear. From a production volume perspective, while the overall industry is expected to be down only modestly on a year-over-year basis, we have seen significant declines on important Lear platforms due to lower sales and inventory corrections by our major customers.

Throughout 2005, we've been faced with numerous plant shutdowns. In the first half, many of these were on short notice, making it difficult for us to adjust costs. The unfavorable Lear product mix, combined with higher raw material prices, has affected our margins and also put stress on our supply base and the ability of the some of them to meet their commitments.

At the same time, we're also going through a record level of launch activity, bringing on a record amount of new business and launching a record level of replacement business. The high level of new and replacement platform launches has driven up capital spending, as well as tooling and engineering costs, and in some cases we've picked up some of our suppliers' obligations.

From a customer standpoint, some of our major customers are faced with adverse financial performance, which affects our ability to negotiate relief for higher material costs in our commercial discussions.

So, the bottom line is that we are experiencing near-term margin pressure due to production, pricing, and costs, coupled with making the necessary investments in our infrastructure to support our future growth opportunities.

Another subject in the news recently on slide 7 is the reversal and the trend toward -- or the possible reversal and the trend toward total interior integration. GM announced that it intends to --

Gary Fryeburg has joined.

GM has announced that it intends to increase control over sourcing on future programs. This is a step back from having a single supplier managing a total interior. But we continue to believe the basic concept of interior integration provides value. While GM's increased sourcing control does reduce the effectiveness of integration opportunities, it also means less risk and less up-front investment in tooling and engineering for suppliers such as Lear.

Lear served as the integrator for the industry's first total interior integrator vehicle program. The 2006 Cadillac DTS and Buick Lucerne. We believe that this program was successful for Lear and GM. Together, we believe we've achieved world-class interiors, which include best in class seat comfort ratings, a number of high value consumer features, and outstanding craftsmanship. We also believe we demonstrated our valued-add during the development stage and effectively integrated electronic and electrical distribution components throughout the interior.

Given our broad integration experience, we stand prepared to provide any level of interior integration to any customer, globally.

Now I'll turn it over to Dave, who will talk about our financial results and update our 2005 guidance.

Okay. Thanks, Jim.

I'm on page -- slide 9, and with that as background on the major challenges we're facing this year, here is a more detailed summary of what's gone on over the last several months.

In North America, industry production was down 1% while the Big 3 were down 6% as the inventory correction continued. T-Lear [ph] platforms were impacted even more during the quarter.

Present industry inventories are no longer expected to be an issue, following strong June sales at General Motors and the introduction of employee pricing plans at Ford and DCX in July.

In Europe, industry production was down 1%. Worldwide, the very busy launch schedule that Jim mentioned earlier is proceeding on target. High raw material prices are continuing to put stress on a number of the more vulnerable suppliers within the supply chain, and despite some moderation in steel and resin prices during the second quarter, they still remain 30 to 40% higher than 18 months ago.

As we've discussed in the past, we've had to expend additional resources to deal with a number of distressed supplier situations. Most of the our customer negotiations are complete or nearing completion, with negotiated settlements generally in line with our expectations.

If you move to slide 10, here is our financial score card for the second quarter. Starting with the top line, we posted net sales of $4.4 billion, up about 135 million from last year. Our core operating earnings were down 183 million. The decline in operational performance reflects vehicle platform mix in North America and the adverse net impact of higher raw material prices.

Our reported net loss per share was $0.66 and includes the initial charges from our earlier announced global restructuring actions, as well as litigation and impairment charges. SG&A as a percent of sales was up due to the restructuring actions and the litigation charges.

Interest expense was $48 million, up 9 million from last year. The increase reflects higher short term rates, as well as approximately $5 million associated with the litigation. Other expense of 32 million was up $17 million from a year ago. The increase was driven by the impairment of an equity investment during the second quarter that we have since sold.

Moving to slide 11, as we have already mentioned, although operating performance was in line with our expectations, we did incur costs that had not previously been considered in our prior guidance. In total, these items reduced pretax earnings by $79 million, or $0.98 per share. To help clarify how these amounts impacted our financial statements, we have indicated the impact by category on the right-hand side of this chart.

If you'd move to slide 12, here we provide some further explanation of the global restructuring and other charges we incurred during the quarter. While historically there have been recurring plant closures on an annual basis as part of normal business conditions, the costs we are referring to here are the initial costs of a formalized strategy we announced in June to accelerate the expansion of our footprint in low-cost countries, eliminate excess capacity globally, and streamline the organization with a more global customer focus. The second quarter actions will be fully implemented over the next six months and the estimated payback is approximately two years.

Also during the quarter, we incurred significant charges related to two separate supplier litigation matters that date back several years.

Lastly, as we previously discussed, we recorded an impairment charge related to a noncore equity investment, and we have since divested the holdings.

If you look at slide 13, here we summarize the impact of major performance items on our second quarter sales and earnings compared with a year ago. As you can see, the major adverse factor for both the change in sales and earnings was lower industry production, but, more specifically, adverse platform mix. Positive contributors to our net sales included global new business, favorable foreign exchange, and acquisitions. These factors did not have a material impact on earnings. Results were also negatively impacted by net commodity costs. Finally, the restructuring activities and litigation charges had a significant and negative effect on our reported earnings.

Moving to slide 14. Because the biggest single factor in our sales and earnings decline is unfavorable platform mix, we thought it would be useful to show you more specifically what we are referring to. This slide summarizes the year-over-year production changes we experienced in the second quarter on our top platforms in North America. While the Big 3 cars were down 3% and Big 3 trucks were down 8%, many of our highest content platforms were down even more.

Moving to slide 15. This slide summarizes -- this slide provides an update on what we're seeing for key commodities that we utilize in our business, as well as the pressures we're experiencing in the supply chain. During the second quarter, steel and resin prices were down about 20% versus a year ago, but they remain significantly above historical levels. The sustained nature of the high commodity prices is continuing to weaken the more vulnerable tier 2 and tier 3 suppliers. We have seen an increase in the number of distressed suppliers. As a result, in some cases we have had to dedicate additional on-site resources. In other situations we have had to directly purchase critical tooling and fund engineering.

We have had continued -- we have continued to resource some business concurrent with the compression of our production supply base. In terms of our ability to offset commodity price increases through cost mitigation actions, results have been mixed, but generally in line with our expectations.

If you move to slide 16, we'll take a look at cash flow. During the second quarter, free cash flow was negative 9.4 million. It's important to note that our reported net loss for the quarter included several noncash expense items. I would like to point out here that we now expect that the full year of General Motors' change of payment terms to reduce this year's reported free cash flow by about $200 million on a net basis. This is higher than we previously estimated and reflects our inability to implement offset actions with our supply base. I'll talk more about the outlook for capital spending and free cash flow a little later in the presentation.

On slide 17, we'll cover the -- here we cover the key assumptions underlying our revised 2005 financial guidance. Starting with production, here is what we expect now. In North America, we estimate full year industry production to be about 15.5 million units, with Big 3 production at 10.7 million units, down more than 600,000 units from last year.

In the third quarter, our industry production forecast is about 3.6 million, roughly in line with a year ago. Our third quarter Big 3 production forecast is 2.4 million units, down about 100,000 units from a year ago. In Europe, we estimate full year industry production to be about 18.6 million units. The third quarter's forecast to be about 4.1 million, down about 100,000 units from a year ago.

Moving to slide 18. Here is a perspective on what's happening to our platform mix. This has been the key driver in our overall financial results for this year. In North America, our top platforms are now estimated to be down 8%, which is significantly greater than the overall industry decline. This reflects the first half inventory correction by the Big 3, as well as the changeover of high volume, high content models, such as the Ford Explorer and Dodge Ram. In Europe, the outlook for Lear's major customers is more in line with overall industry conditions, which is down about 2% year-over-year.

Moving to slide 19, we now see Lear's worldwide net sales at $17 billion, about in line with 2004. On a global basis, the addition of new business about offset the negative platform mix for the Company during the year.

Moving to slide 20, I'll now update financial guidance. For the third quarter, our net loss is expected to be in the range of a negative $0.70 to negative $0.90 per share, including costs related to our restructuring activity estimated at about $0.55 per share. However, the actual restructuring charges will depend on various factors, including the timing of certain actions.

For the full year, our results are expected to be in the range of a loss of $0.25 per share, to a profit it of $0.15 per share. This includes restructuring costs of approximately $1.35 per share, impairment litigation charges of $0.65 per share, as well as our first quarter tax benefit of $0.25 a share. Together, these items total a net unfavorable impact of $1.75 per share.

Moving to slide 21. Here we summarize the impact of major performance items on our full-year sales and earnings, compared with the guidance we issued in April. As you can see, the major adverse factor for both the change in sales and earnings was lower production on key Lear platforms. Foreign exchange had a negative impact on sales of about 350 million, while the impact on earnings was not significant.

Global new business negatively impacted both sales and earnings as some of our backlog programs are ramping up more moderately than we had earlier expected.

The raw material environment continues to pressure some areas of our business. Restructuring costs and litigation charges adversely impacted reported earnings.

Moving to slide 22. As a result of the peek level of 2005 and 2006 launches and our focus on expanding our footprint in low-cost countries, this year's capital expenditures are higher than normal. In addition, we have invested in our flexible seating architecture, which helps improve quality, reduce costs, and increases production efficiency. We have also seen an increase in spending to support the tier 2 supply base.

As we look to 2006, our capital spending should return to more normal levels.

On slide 23. Free cash flow will be a negative $375 million this year, which includes about 120 million for restructuring. In addition, the one-time shift in customer payment terms is also affecting free cash flow in 2005 by more than we had initially estimated. As I mentioned earlier, in this environment it is increasingly difficult to offset GM's change of payment terms with supply based actions. As we look to 2006, our free cash flow should return to more normal levels.

On slide 24, I would like to sum up with a longer term view of the business. We do see our platform mix improving as key new models are changed over. Also, as a strategic priority, we do remain focussed on further diversifying our sales mix along customer, geographic, and market segment lines. From a return standpoint to favorable revenue drivers that I just mentioned will help improve margins, and as Doug will discuss in just a minute, we are concentrating our efforts on higher value-added products, manufactured at world-class cost levels to improve our overall margin profiles.

Now I'll turn it over to Doug for a further discussion of Lear's product line strategy and our plans for repositioning the Company.

Thanks, Dave.

I'm going to start on page 26 to review our strategic focus. Our strategy involve three key elements. First, retaining our core customer focus values; second, refocusing our investments; and third, operational excellence. The Lear philosophy has always been to put our customers first in everything we do.

We plan to retain our quality and customer service focus, and also adhere to our LBO operating heritage of running lean and accountable. At the same time, we need to focus on investments towards products, where we have a competitive advantage: namely, seats and electronic systems, and improve or divest where we are not competitive. We're also looking at selective vertical integration to improve our overall value proposition and margin opportunity.

And most importantly, we must maintain our operation excellence. This means discipline and pricing new program awards, lean manufacturing, stronger supply chain, flawless launches, and achieving an optimal manufacturing footprint globally. It also includes improving customer and market segment diversity and maintaining labor flexibility with strong union relationships.

Next I would like to review what this means to each of our product segments. Seating systems are the backbone of our corporation, accounting for about 2/3 of our revenue. In this segment, we are the industry sales leader, and we intend to continue to leverage our value-added proposition with investments in common architecture, additional features, and selective vertical integration.

Electronics and electrical distribution is about 18% of our revenue. Here we are investing in new products and vertical integration. We see this as a major growth opportunity for our company, as consumers are demanding more safety features and increased comfort and convenience items.

Interior systems make up 17% of our revenue, and over the last few years, we've experienced margin compression as many of these components are now priced as commodities. And given the increase in resin pricing, our financial results have now reached an unacceptable level. As a result, we're in the process of evaluation strategic options for this product group.

Our present sales backlog supports continued growth and further sales divestiture, as outlined on page 28. We have a committed three-year sales backlog of almost 4 billion, with an increasing amount of sales from Asian and European customers. Importantly, the vast majority of this is coming on-line this this year and next year, and several high-volume models are undergoing changeovers. We are continuing to work with all of our customers to offset raw material cost increases.

From a mix perspective, I would characterize 2005 as a transition year, as several of our major platforms are undergoing major changeovers, or major freshenings. This is outlined on page 29. In North America, more than half of our major platforms are turning over this year, representing more than 40% of our sales in the region.

On page 30, we outlined our international backlog. We also have a number of significant launches outside of North America this year, as you can see on this slide.

As one of our strategic imperatives, the Lear team has been focused on building relationships with the major Asian manufacturers and continuing to grow our Asian-related sales. Our revenue in Asia, with Asian automakers, globally is forecasted to reach 2.1 billion this year. This is about two and a half times the level we had just three years ago, and we see it continuing to grow rapidly.

A few examples of our Asian business wins are shown in the right panel. We've established a global relationship with Hyundai. Some new programs include seats and wiring for the Sonata, built in Alabama; several electronic awards in North America; and seats for the Tucson in Korea and China. In addition, we've been successful winning new businesses with major Japanese automakers, as well as VW.

On page 32, we outline our low-cost manufacturing capabilities and engineering centers. We also continue to pursue our low-cost country strategy to ensure that we will maintain a fully competitive global footprint. Mexico and the Philippines have been low-cost manufacturing sources for Lear Electrical distribution for some time. In just the last 12 months, we've added nearly a dozen plants in Mexico, Honduras, and eastern Europe.

We also have invested in several additional low-cost country facilities in Asia. We now have low cost manufacturing and engineering capabilities in 13 countries and plan to continue our migration of our low-cost footprint in Mexico, Honduras, eastern Europe, Africa, and Asia. Currently 20%s of our sales are manufactured in low-cost locations. Our restructuring plans will accelerate this move.

We are also leveraging our low-cost engineering capabilities, with engineering centers in China, India, and the Philippines supporting our global business.

Last month we announced restructuring actions to improve our longer term profitability and competitiveness. The restructuring actions are intended to accelerate our expansion in low-cost country production, providing us with a fully competitive global footprint, streamline our organization structure to improve our effectiveness with our customers and our operating efficiency, and eliminate excess capacity. During the second quarter, we initiated actions at six of our plants, and we're targeting to fully implement the plan over the next 12 to 24 months.

On page 34, the slide shows the current implementation status of the restructuring actions. Of the total estimated restructuring costs of 250 million, we see about 130 million being incurred this year and about 120 million next year. So far, we've identified specific actions that are worth about 190. The balance of the actions are still being evaluated, but will occur next year. The restructuring is global in nature and addresses all aspects of our business. The final plan will likely impact more than 20 of our manufacturing facilities and lower our worldwide head count by 5% to 7%.

Now I'll turn it over to Bob for some closing comments.

Thank you very much, Doug.

As we have said many times before, and we believe, the longer term outlook for Lear is very positive. I hope that today's business review has helped put the near-term challenges into perspective, provided a better understanding of our long-term strategy, and instilled confidence that our plans will return this business to healthy conditions.

Looking ahead, here is what we see: The significant launch schedule we are experiencing now will translate into stronger platform mix for Lear. Investments we're making in distressed suppliers will result in a stronger and more efficient supply base for the future. Our global restructuring plan will reduce our ongoing operating costs, improve our manufacturing efficiency, and increase our overall competitiveness.

Future margins will improve as we refocus our investments toward products where we have a competitive advantage, and those are: seating, electrical, and electronic systems. We also will address the underperforming interior components business.

To sum up, while 2005 is a challenging year for us, and in many ways, a transition year, we clearly see things improving for the business over the next couple of years. Now I'd like to turn it over for questions.

Dennis, we're ready for some questions.

[OPERATOR INSTRUCTIONS] And your first question comes from the line of John Casesa, with Merrill Lynch.

I just wanted to ask a series of questions. First of all, Dave, can you just give us a sort of a walk on the cash flow, how your outlook went from roughly break-even at the end of the first quarter to where you are today, how those pieces moved. Can you just take us through that?

Sure. Let me just put this into a few different buckets. And kind of how we get back to a break-even number, GM -- the payment term change is now hitting us on a reported base for about $200 million. We do have an additional $100 million related to near-term tooling and engineering, versus where we were a number of months ago, the result of both some softness in the supply base as well as the launch schedule that we're now in front of. There's also an additional $100 million of restructuring that we obviously hadn't had forecasted earlier. Taken together, it's about $400 million.

If you just take from an operational perspective, the mid-point of the guidance that we spoke to would be about 135 million in net earnings, and that's offset by excess capital expenditures over depreciation. So on balance, when you walk those items, you get back to about a break-even number.

John, let me just add one thing to this: the year-over-year swing is about $675 million. Let me just give you those same data points, because if you're not going to ask, someone else will. So net earnings are down, again using the mid-point that I just spoke to, are down about $300 million. The payment terms change is about $200 million negative. Restructuring in round numbers is about $100 million negative. And then if you take the difference between this year and last year of excess capital expenditures over depreciation, about another 75 million, and, again, that's the two-year walk, essentially.

And, Dave, just in terms of the payment terms, I mean, I assume it was always a $200 million number, but what you sort of suggested -- well, you tell me: it sounds like what you said on the call is it's $200 million, but your ability to offset it with other actions, so it's not so much that there's a payment terms difference here, it's that some other thinks didn't .come through for you.

Right. John, actually in the past, we had talked about a $100 million -- approximately about $100 million net impact on a recorded basis, and that's now grown to about 200 million.

So did GM change the deal, or does it relate to what --

No, it relates to our inability to offset the impact with changes in terms with our suppliers, given what's going in the tier 2 and tier 3 supply base.

Okay. Then, secondly, can I just ask you, year-to-date, through the first nine months of the year, you'll be at about break-even, excluding the charges, and your full-year guidance would imply, therefore, a pretty big fourth quarter and a much higher run rate for earnings going into next year. Is that correct? And why would that happen in the fourth quarter? What would change?

Well, John, "pretty big" in the fourth quarter is all relative, so let me kind of talk to the cadence of third quarter and fourth quarter. In the third quarter, we're still incurring a fairly significant impact from platform mix, and, importantly, it's our -- it's our largest quarter of the year with respect to launch activity. As you go into the fourth, mix is still negative, but much less so, and importantly in the fourth quarter, when you look at the timing of commodity offset actions and other commercial recoveries, we have full expectations that the guidance we put out there, the implied guidance for fourth quarter, is achievable.

Is that because you have agreements that are timed to the fourth quarter, or is it that you just think you'll get agreements by that time?

Well, there's two points. One is, like we said during the formal part of the presentation, most of the formal annual productivity discussions are completed or nearing completion. There's obviously a lot of other commercial activity that takes place between us and our customers, and historically this settles in the fourth quarter. In addition, it's simply the timing of how the cost mitigation actions are favorably impacting our income statement.

Okay. And just lastly, a strategic question, before you cut me off. You know, I wanted to first ask, related to this slide, I guess, 26, or something like that, 21 -- no, I'm sorry, 27. 17% of your sales are in interior systems. I assume that includes door panels, trim panels, floor covering, all of that stuff.

Yes.

And if that's the case, it seems to me what you're saying is you're going to disaggregate the Company somewhat, you're going to divest a lot of the stuff you acquired over many years to build this total interior capability, because the market's changing. And if that's the case, once you're done with that, what's the long-term strategy? Are you just going to be a more selective higher return company? Is there sort of a second piece of this where you build off a new leaner platform to get deeper in electronics? This seems like a retreat, and I'm just wondering if it positions you to go on the offense, and how do you do it, and what's the game plan?

Okay. It's an excellent question. Let me take the first part, and then Doug will take the second part.

It's an important point. We are -- and we thought about this a lot. When we say we are exploring various strategic options, that's exactly what it means. So we are in the process of, over the -- in the near-term working with outside advisors, and determining the best way to move forward with this business.

So with that being said, let me turn it over to Doug for the longer term outlook for the Company.

Yes, just specifically, when we look at seating we think that is the backbone of the Company, but we also believe there's a lot of unexplored opportunity, both outside of our mature markets of North America and Europe and Asia, in with that customer base, so we want to continue to focus our efforts in that product segment. We also believe electronics and electrical distribution is a huge growth market that we want to participate in, so we really want to focus on those two areas.

The issue with interiors, there have been some changes with our customer sourcing strategy that are just forcing us to relook to see if we really want to compete in that segment, possibly at the expense of the other two. So that's why we're really focused on seats and electronics, and we're reevaluating interiors systems.

Doug, would you consider -- in this range of options, would you consider over whatever time period very meaningful divestiture of revenues and very meaningful acquisition of replacement revenues? What I'm saying is, you've got $3 billion in this interior products business, almost, is it conceivable in time you could be out of a lot of that stuff and replace that with other kinds of products?

John, that would be one potential outcome to your question. The second part, I guess it's appropriate to mention here, in the near-term, we are not focused on any outside acquisitions. The focus here for the management team is to run the business and work on the type of activity that we outlined during the presentation.

Okay. So then, just to summarize, when you get through this period of refocusing the Company, would you or would you -- would you be thinking that you would have a sort of second strategic stage here where you would position yourself?

I think absolutely. We would look at options where businesses that fit within our core strategies and our core groups, as Doug mentioned, we think there's a lot of opportunity still in electronics and electrical. We think there's more opportunities within seats, either vertically, or expanding that, and so the answer is yes, John, from a longer term standpoint, but right now we're focused on our own house.

Thanks very much.

Hey, John?

Hey, Bob.

How are you doing? Thanks to your questions, we have time for one more question. (Laughter.) Sorry, John.

Thanks.

Your next question comes from the line of Himanshu Patel with J.P. Morgan.

Someone had mentioned earlier, I think it was you, Dave, about selective vertical integration. I'm just wondering, what particular areas was that in?

Actually, that was Doug. So I'll let him address this.

In the area of seating, when we talk about collective vertical integration, primarily we're talking about in the seating architecture. That is, metals and mechanisms, but also in foam and trim operations as well. On electronics and electrical distribution, we're primarily focused in terminals and connectors and in the ability to assemble wire harnesses.

And what is the rationale behind doing it? Is it just that the suppliers can no longer do it at -- cost effectively?

That's part of the rationale. The other part of the rationale is if we've got direct control over that vertical integration, we have a better opportunity to leverage across multiple customers and multiple platforms, and it really becomes the key technology that we can bring forward to the customer that we believe provides us a competitive advantage, as opposed to just sourcing out the component parts of those modules.

Okay. And then also, one of the comments that was made was, some of the new business was ramping up a bit slower than expected. Was that due to Lear's specific issues, or was that just OEM decisions on your product launch timings?

It was the latter.

Yes, OEM.

Okay. And then, going back to that slide 27, I mean, if you guys moved out of interior systems in a big way -- I'm just trying to wonder what -- the seating business, at what stage does that business start becoming more and more commoditized? Because one would imagine a lot of the outsourcing opportunities in North America are largely behind us, obviously. Even in Europe, they're probably -- we're reaching a state of maturation. So, I understand that it's a stable margin, high ROIC business now, but is there a risk that this business becomes more and more commoditized as well, over time?

No, I don't believe there is a risk, primarily because the complexity of the seating business has changed dramatically over the last few years. What customers are requiring in their vehicles -- just look at rear seat configuration. There is real technology there. Companies like Lear have to have the capability to deliver that product, and we think that creates a barrier that really prevents it becoming a commodity like the interior side.

Okay. Thank you.

Your next question comes from the line of Michael Bruynesteyn with Prudential.

Good afternoon, gentlemen -- or good morning, gentlemen. Sorry.

Hi, Michael.

Is there any reason the production schedules should be less choppy going forward than we saw in the first half?

Well, let me put a framework around this. Since our last guidance, there have been announced planned shutdowns that affect roughly 200,000 units of Lear -- important platforms to our company. And those stretch out into -- early into the fourth quarter. So that's part one.

Part two is looking at -- on the sales side, with respect to June and July, our expectation is that the choppiness will not be nearly as severe as it had been in the first half of this year.

And how wan can we think about that in terms of its impact on margins?

Well, there's two things. One is, again, the plant shutdowns that are affecting our company are with high content vehicles for Lear, so that's part one. Part two is we do have somewhat advance notice with respect to when these are going to occur, so we don't expect the margin impact to be quite as severe as it was in the first half of the year.

Okay. Great.

And then this second half of the $200 million GM cash flow hit, when does that actually hit the books? Because from what we could see, it was like 100 million in the first quarter, and we don't see anything in the second.

No, it's essentially third quarter.

So that would be when the second 100 million hit, and that's due to new product --

No, no, the 200 million is in essentially the third quarter. It did not hit us in the first half of the year.

And is that due to a new model year, basically?

No, it's due to the timing of when General Motors closes their books and makes payment to us, versus when we actually close our books. We close on a 4-4-5 quarter.

Okay, great. And then -- there's -- I guess, looking out to this low-cost production strategy, what percentage of production, Doug, would you expect would be in low-cost countries, say, in '07?

I'm not sure we're really prepared to forecast a number. We're really taking a hard line analyzing that right now, so unfortunately I'm not able to answerer in question.

Could you then talk about what kind of saving you would expect versus, producing, say, in the United States?

It -- the only difficulty in answering that question is there's quite a variety of savings when you look at the range of products and components that we're referring to, and also an expectation from our customer that we're proceeding with a low-cost country strategy that ultimately we need to work with them on that, as well. So, again, I'll stay away from pegging a number at this time

Are you saying the customer wants to grab some of that savings?

Absolutely.

All right. Thank you very much.

Your next question comes from the line of Ron Tadross with Banc of America Securities

Good morning, everyone.

Hi, Ron.

So just two quick questions. First, there seems to be a few swing factors for 2006. Obviously, the net new business seems like a big positive, but I'm wondering, if you look at things like the restructuring benefits, your top programs, the net cost performance -- I mean, could these things help you execute, I guess, a pretty strong earnings recovery then, for '06?

Yes, it's -- we're not prepared today to go through 2006 guidance, but an early look internally is that there is a -- there is a recovery in 2006. Absolutely.

And I guess, Dave, I mean your fourth quarter EPS -- and this is my second question, but tied in -- it's like almost record EPS for a fourth quarter . Is that -- should we take that as almost an indication that '06 EPS could be back to some kind of normalized run rate?

I don't think it's a record for fourth quarter, number one, and, number two is, from a run rate standpoint, we are -- again, sales, earnings, cash -- we are more in line with where we were, say, a few years back than where we will end up in 2005. I don't want to talk -- Ron, I'm purposely not talking numbers here, because we're not giving out guidance for 2006 yet, but there is a recovery in both earnings and cash as we look to next year.

Okay. So, you would characterize it as a recovery, maybe not like a strong recovery?

I don't want to characterize it right now.

All right. Thanks a lot.

Strong is a relative term. (Laughter).

He's getting better. He's getting better. Two years ago, I would have gotten it out of him.

You're right, you would have, two years ago.

Bye-bye.

Your next question comes from the line of Rich Kwas with Wachovia.

Yes, I just wanted to ask about kind of -- second half of the year, you said that production is going to be a little less choppy. Are you seeing any incremental gains here, above your expectations, kind of with what you just said about the 200,000 decrease since the last conference call. It sure doesn't sound that way. Some other suppliers have indicated, with regard to GM, that there's a little bit of a pickup here, could be a little bit of a pickup in the second half. Any thoughts on that?

I don't think we've seen any real meaningful changes in the schedules in the -- since -- probably in the last 45 days. So, if they are adding back weeks -- and I think with GM, there may be a potential for them to add back some production on pickup trucks, we have heard some of that -- but beyond that, we really haven't seen much yet. Now again, we haven't seen the result of the July sales yet, and how our customers might react to that.

And Dave, just on the tier 2, tier 3 suppliers, it really doesn't really sound like it's gotten much better, relative, to, say, the first quarter. Could you provide a little more color on that?

Yes, actually you're right. From the -- without getting into too much detail, the way we define or look at a distress supplier, in terms of absolute numbers, that has increased, and in terms of cash costs, which we expected to come down in the second half of the year, is really in line from both a direct and indirect expense standpoint, as well as tooling and capital. So it's costing us more in cash and earnings in the second half of the year than we originally thought.

And when you say in line, in line with, what, first part of the year?

Second half is in line with the first half.

Okay.

We had expected it to tail off.

All right. Thanks.

Your next question comes from the line of Jonathan Steinmetz with Morgan Stanley.

Thanks. Good morning, everybody.

Hello, Jonathan.

A few questions here. You mentioned you weren't likely to be on the acquisition path, near-term, so what would be the near-term use of proceeds from any divestitures that happen?

We would continue to look at strengthening the balance sheet.

Should I read that as debt pay-down?

Well, that would be one way to read it. Absolutely.

You mentioned about 330 million of new business in the quarter and low impact on the earnings, but was that profitable, that 330 million of business?

Yes, it was.

Okay. You mentioned some OEM decisions impacting the backlog ramping a little more slowly. Can you mention which specific programs those were?

Yes, there's a handful, obviously, that are important to the Company. The Explorer ramped up a little slower than we had originally anticipated. The GM Lucerne, and DTS, the Buick Lacrosse. There's a number of vehicles that are ramping up slower than we had anticipated a few months back.

Okay. And finally, I know you couldn't really road map savings entirely on a move to low-cost countries, but can you talk a little bit about -- what is the labor component of some of the products that would want to move to low-cost countries, and maybe what the labor rate savings in some of these areas might be, relative to the U.S.?

Yes, I think we can outline that, but when we look at a low-cost country, labor rate is only one component that we look at. We also look at, ultimately, where is our customer going from a manufacturing strategy, as they move into low-cost country production, work migrating in that direction, as well, to support ultimately delivering complete products to them. But I would say roughly, on the labor rate, we're talking a 10 to 15% reduction.

10 to 15 reduction And net-net of logistics costs? Or just on the pure labor rate only?

Just on a pure labor rate. But it really depends on the component where we relocate to, what your base line is again. So it's difficult to just plug one number.

Okay.

I think the key here is our strategy is not to -- we're not in a labor arbitrage situation. We are moving to low-cost countries where they will develop the infrastructure and have a competitive footprint so that throughout the product line, including the raw material components, we'll also enjoy those savings, as well. That's really the key to moving and locating in a low-cost country environment.

Okay, great. Thank you very much.

Your next question comes from the line of Scott Merlis with Thomas Weisel.

Good morning, everyone. Congratulations, Doug.

Thank you.

Getting back to page 23, the cash flow drivers, the -- I thought I heard you say you're spending a lot this year on your flexible seat architecture. Does that in particular go down substantially next year?

Yes, it does. This year we'll be spending about 55 or $60 million, and anticipate finalizing the program next year with between 10 and $20 million in capital.

And the capital spending outlook next year, again -- I think you might have mentioned that.

No, I didn't.

Okay. So --

We said it would be north -- the way to look at it right now, before we formalize our guidance is more in the 2.5 to 3% range, relative to sales.

Okay. That's helpful. And restructuring for year two; did I hear 120 million number? Or something else?

In total, of the 250, there's about 120 we anticipate for next year.

And a follow-up on some of the strategic questions that were asked. You are a -- if you take a step back and look at the big picture, you're a very customer-oriented company. Outside of the GM sourcing changes, in attitude, anyways, if you look at your total customer base, do they value integration less? To what extent do they still value you having most of the interior -- owning most of the interior subsystems, one. Number two, if you divest businesses, would you therefore be at a strategic disadvantage to some of your competition?

No. Not to be cute, but the overall strategic question here really is, is the customer interested in a supplier providing complete interiors, and at this point, it's clear that the direction has changed somewhat. We went down that path, built the capability, built our plants into very efficient high quality plants. We've done an excellent job, but the approach today in purchasing from a North American standpoint, and has been for a while in Europe, is that it is more -- they would rather buy components than buy a complete total interior system. Therefore, the investments we made there really from a longer term standpoint, I think that business has to go through a serious consolidation. All the interior components business has to go through a series of consolidations.

As we've mentioned in the past, Europeans -- pretty much -- we couldn't broad base sell those products in Europe. BMW had their certain supply base, and Mercedes had their certain supply base, and we really couldn't crack that as a overall general total interior supplier. So from a components standpoint, we really don't feel that in today's world, the way it's structured, that it's possible to achieve the kind of efficiencies that are there -- that we believe can be there.

So if our customers aren't interested in buying total interiors, we think it needs to go through a global restructuring of that business. Do we really want to play? That's the decision we're trying to make, as Dave said. We're looking for some outside advisors to give us a hand in making that that decision. I think we never will do anything that will affect our customers and hurt them in any way. I think more realistically, I think we should focus our efforts on what we do best. And that right now is we do the best in seating as our core product line. We're excellent at it. Globally, we're number one in the world.

In electrical and electronic systems, we really and truly believe there's a great future for this company. Now, that doesn't say that we're leaving the plastics business. What is says is we're trying to find a way to have an alternative to the way we're running the business today that gives us a chance to be successful in it again.

So that's pretty much the answer. Anybody want to add something to it?

Scott, it's always good talking to you.

And, to grow the electronics business, can a lot of it be done internally?

Yes. By the way, I forgot to tell you, there is some good news in all of this. My wife just called and she shifted our insurance over to Geico, and we saved $300. [Laughter].

My wife called and did the same thing.

Good. I'm sorry, what was the --

If you need a -- so therefore, the flip side of the question is, do we want to grow the electronics business. Is there stuff buried in there that can really be developed internally, or is that -- do you have to eventually grow that through niche acquisitions?

I think there's stuff buried in there. I think one of the advantages we have in electronics is the electrical distribution. That is, we're designing basically the architecture for the vehicles, and that provides us a lot of opportunity to introduce Lear products as we go through that development process. In addition, I think there's core technical capabilities we have in radio frequency that's allowing us to leverage that competency from key fob [ph] business into tire pressure monitoring, so we're also looking just to leverage the core technical capacity or capability, as well. So we think there's a lot of organic opportunities for us in the business.

Yes. Interesting. Well, thanks for the rundown, guys. Have a good weekend.

Thanks, Scott.

Thank you.

Your next question comes from the line of Rob Hinchliffe with UBS.

Thanks. Good morning, guys. I guess just a couple left here. How much of your backlog is in the interior systems business? Same as -- roughly 17%?

No, in the interiors business, the way the backlog sits today, it is roughly a third.

So, roughly a third, you would sort of now characterize as looking for strategic alternatives or options?

That's correct.

Okay. In talking with some of the UAW folks, they're kind of touting some creative ways -- they're helping you keep some plants open that maybe otherwise would have closed, maybe walking wages down over a period of a few years. Can you kind of give some sense of what's going on there?

Yes. Sure, Rob. Actually we did have one instance of that. We had a business that we actually -- we no longer wanted to be in, and we worked closely with the UAW, and basically found the solution to make that plant more efficient, and given an opportunity to continue production. So we did work out an arrangement that we think was a win-win, because it solved our short-term issue, but also provided them an opportunity to be competitive on a going-forward basis.

Unfortunately, many of our actions are also in taking out capacity though, and in taking out capacity, sometimes you're not faced with a situation where, you know, looking for a better arrangement on your labor contract helps.

So -- but we are actively working with them, and when there is an opportunity to come up with a solution that prevents us from closing a facility, we're certainly on board with that. In some cases, we just don't have the long-term business, or we just need to take out the capacity, or the capacity may just be in the wrong location.

Okay. Thanks, guys.

Thank you.

Your next question comes from the line of Brian Johnson with Sanford C. Bernstein.

Yes. In terms of the timing and payback on restructuring, you talk about a two to three-year payback. I guess a couple of questions. One, is that before or after the customer OEM recoveries you talked about earlier, in terms of -- that is, in your payback calculations, have you built in what you think might be OEM grabs on that savings? And, second, does the payback imply that we wait three years, and then we see 250 million, or -- what is the ramp-up of the saves?

The first part of the question is, the payback does comprehend a potential sharing of the savings with the customer.

Okay. I'm sorry. The second part was the timing?

Yes. Is it front loaded, back loaded, evenly?

Well, as we spoke to before, we've announced the actions that were triggered in the second quarter. We look to incur about $130 million of the 250 this year, and the balance next year. It's a little early to comment on the exact cadence, other than kind of on an annual basis, because there's a lot of variables that impact when these actions actually start.

Right. I guess I'm interested more in the cadence of the payback versus the charges.

Right, it's a little early to comment on that, other than in general terms.

Okay. That's it.

Okay. Thank you.

Your next question comes from the line of Rod Lache with Deutsche Bank.

Good morning, everybody.

Hello, Rod.

A couple of things left. I guess, can you just talk about the profitability of the interior components business right now? And it looks like just about everybody in the plastics business is struggling, so are there any buyers for this kind of business, in your opinion?

Okay. We are obviously not going to comment on the last part of your question, but the first part is from an overall return standpoint, it is the -- it is the segment that performs -- that performs at the lowest levels for the Company. We do see it this year, you know, essentially as a break even business. And given the heavy capital investment and at least the way we see the near-term, we've decided, and I think Bob explained that fairly comprehensively a few minutes ago, that we need to take a hard look on how we move -- how we move forward in that area.

Okay. And on the restructuring question, payback expected in two to three years. Is that -- that's sort of the time frame for when you would expect to get to normalized margins, and at this point, how are you defining normalized margins for the core businesses?

Yes, I think if you look at sort of -- take the historical margins, and obviously you have to put some bookends around those. That's what we would characterize as more normalized. This year obviously being an aberration.

When we look to a time frame at which we get back to those levels, again, a little bit early, but we're going to be going through the restructuring over the next, say, 18-month period, and I would suspect in the latter part of that 18-month period, and as we move forward, we would see a fairly healthy recovery.

Okay, great. And I was just hoping just to get a little clarification, also, on this GM shift in strategy. Is that something that is affecting your backlog? Are you actually thinking that there is sort of a shrinking business level with that customer now?

No, that's not affecting our backlog. The programs that they had in place, they're continuing to support. We just don't see incremental to the backlog, opportunity for total interiors.

Okay. One last thing, just related to the supply base. I hate to make these comparisons, but it just -- it seems like Lear has had a bit more difficulty with tier 2 suppliers recently than Johnson. Maybe they just don't talk about it as much. But is it your impression that there is a different supply base for one company versus the other, and is it something -- is that -- if this is true, that, you know, it's really some of the Lear suppliers that have been suffering disproportionately, is this something that can change in relatively short order?

Let me answer that in two parts. Number one is, we have hundreds of production suppliers worldwide, and without knowing the details, I'm sure these suppliers have multiple customers.

With respect to the second part, I don't think it's appropriate for us to compare ourselves to any other company in the space.

I think our businesses are a little bit different than Johnson's. I think -- they don't have as heavy a dependence on the plastics side of the business, interior components, and that's really where a good portion of the problems have come from. So just -- I don't think it's, as Dave said, fair to compare the two businesses.

And you also asked what is -- I mean, production problems typically flow downhill. If our customers are cutting back product, we're cutting back production, and it's affecting our supply base, as well.

I appreciate the color on that. Thank you.

Thank you.

Your next question comes from the line of Darren Kimball with Lehman Brothers.

Hi.

Hi, Darren.

So I'm still struggling with the walk to the fourth quarter. When I look back in my model, the biggest swing you ever had from the third quarter to the fourth quarter is $0.85. And that would put you at positive $0.70 at the bottom end of your range in the fourth quarter. So, I'm really still looking for some more color on how you get there, and maybe I was hoping you could start with the start-up costs. I think you said that start-up costs were peaking here in the third quarter. Can you put some numbers on that, how you think they might decline into the fourth quarter?

Yes, I think to walk through this kind of detail at this stage of the call may not be the best use of time. We did talk in terms of, you know, characterizing essentially what's going on from Q3 to Q4, and I'll be around all day, as well as Anne Bork, and we'll be glad to take any questions, more detailed questions from that perspective.

Can you give some sense of the second quarter margin performance by segment that will be in your Q?

By segment. Well, again, it will essentially -- first of all, there's a restructuring impact that will be part of the segment discussion that we have in the Q, but in general, it should be in line with the first quarter.

Okay. And you lost some money on the interior segment in the first quarter. You're saying you might break even for the year. I'm just -- I'm wondering if you can comment on the subset that relates to the plastics, which seems to be the center of your strategic action here. I mean, how much of a loss could you potentially eradicate if you're able to exit or restructure that business?

Well, again, there's a loss perspective, and then there's a cash investment perspective, because it is the area that requires intensive capital investment. So, again, from a strategic standpoint, we're evaluating it, but to quantify it today, we're not comfortable with doing.

Okay. That's all I had. Thank you.

Okay., thanks, Darren.

Take one more question.

And today's final question will come from the line of Joseph Amaturo with Calyon Securities.

Good morning, Dave.

Hi, Joe.

Could you discuss -- in one of the slides you put out some directional guidance for 2006 free cash flow. Could you discuss your assumption for, you know, the subsidy to the distressed supply base that you're dealing with right though now? As well as if if there's any CapEx assumption in there for the possible divestitures?

Yes, that's a good question. This year -- and this is a question we haven't gotten. This year we're estimating between 60 and $80 million in cash around supply-based issues that we had not anticipated earlier in the year. We do see that coming down next year, but I would say not substantially.

So it should track about $50 million next year?

That's probably a reasonable number to use at this stage.

Now, given that we have -- you know, given that we have 1.5 billion roughly in new business hitting next year, you don't see that rising at all?

No. We're fairly focused. Doug's group, Doug and his group are focused on supply based compression, and we believe we are being very proactive in this area, and we do see it coming down next year.

Okay. And then one last one. Given that you made statements that the -- the possible divestitures are at a break-even level, I'm assuming if you pay -- if you're going to put that towards debt repayment, that that would be accretive to earnings, the net of that?

The net of that -- well, on an operating -- on an operating -- perspective operating basis, that would be the case.

Okay. All right. Thank you.

Okay, we're going to wrap up the call. Obviously we said 2005 is going to be a very challenging year for us. We thank all of you for hearing what we had to say today. We'll be around all day for the -- if you have any more questions or comments.

For any Lear people on the line, or any Lear suppliers, we thank you for your performance so far this year. Again, it's a record level of activity for new business launches, and we're doing great job. So we thank you for your quality, your efficiency, and we'll talk soon. Thanks.

This concludes today's Lear corporation second quarter 2005 earnings conference call. You may now disconnect.