Lear Corp (LEA) 2005 Q3 法說會逐字稿

Good morning. My name is Judy and I will be your conference facilitator. At this time, I would like to welcome everyone to Lear Corporation's third quarter 2005 earnings conference call. [OPERATOR INSTRUCTIONS] I would now like to turn the conference over to Anne Bork , Director of Investor Relations. Ma'am, you may begin.

Good morning everyone, I would like to thank you for joining our third quarter conference call. By now you should have received our press release and financial review package. These materials have also been filed with the SEC and they are posted on the home page of the IR section Lear.com. Joining Me On the Call Today Are Bob Rossiter, Our Chairman and CEO; Jim Vandenberghe Our Vice Chairman; Dave Wajsgras, Executive Vice President and Chief Financial Officer; Doug Delgrosso, President and COO; Shari Burgess, Treasurer; Jim [Marowski], Controller; and Mel Stevens, 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 the deck and also in SEC filings. In addition we will be referring to certain non-GAAP financial measures. Additional information regarding these measures can be found in the slide labeled use of non-GAAP Financial information also at the end of this presentation. On slide 2 we see the agenda for today's review.

First although we will have Bob make a few opening remarks, then Jim Vandenberghe will provide a perspective on recent industry developments, Doug DelGrosso will provide an operational review, Dave Wajsgras will cover our financial results and outlook as well as, review of Lear's interior product segments. And then Bob Rossiter will have some closing comments before we open it up for questions. Now, please -- I'll turn it over to Bob.

Thank you very much, Anne. Morning, everybody. Today we released our third quarter results. On balance today the third quarter came in pretty much as expected, unfortunately. Production schedules were maintained as the impact of the Gulf storms had not yet impacted our supply lines. However, a lot has happened in the last 40 days that we must consider in our expectations for the fourth quarter. Raw material costs are rising again due to tight supply lines. The auto supply industry is in an even more fragile state due to the reason Delphi situation. Most recent sales of our three largest customers continues to be soft. As a result we see significant production schedule risks going forward.

There's a great deal of uncertainty for the balance of the year, but we're working hard to deal with the short-term impact, but more importantly we're working harder on the long-term answers for what to do. These are challenging times, so today on the call you will here from Jim, Doug and Dave and they will take you through specific issues that are impacting our operating environment and what we're facing. And at the end I'll provide a summary recap before we open it up for questions. I would like to turn it over now to Jim.

Thanks, Bob, and good morning. No question that automotive industry conditions continue to be very difficult for Lear. While the overall level of demand worldwide has been relatively stable the mix of vehicle production for Lear, particularly in North America, is unfavorable. Specifically, fewer pickup trucks and full size SUVs are being produced. Because these products contain significant Lear content it's had a major adverse impact on our results this year.

Overcapacity continues to put intense pressure on vehicle prices, which in turn is driving automakers to intensify their emphasis on cost reduction. In addition, high raw material prices and added costs to support the express suppliers are pressuring margins. While the automotive industry has always been very competitive these pressures are particularly severe. Turning to slide 5, the recent bankruptcies of Collins and Aikman and Delphi as well as significant automotive losses being reported by several of the worlds major auto makers and suppliers underscore the stress within the auto sector. In just the last few months we have seen several major announcements that will change the structure of this industry. These include Visteon returning $7 billion worth of troubled businesses to Ford. The announcement of a new more collaborative purchasing initiative by GM and Ford to strengthen long-term relationships and achieve greater cost efficiencies. Lear's partnership with Wilbur Ross, to take a new business model for select products, in one of the most distressed areas of the supply base, the interior trim sector.

GM's agreement with the union to address health care costs. Finally the announcement by both Ford and GM on future capacity reduction actions. Clearly there's a lot happening in the industry. While many of these industry developments I just mentioned are intended to have a lasting long-term positive impact on the industry many challenges remain and additional structural changes will be needed.

Moving to slide 6, you can see some of the significant near term risks and uncertainties that we are facing. First off the numerous supplier bankruptcies in the overall pressure on supply chain have increased the risk of labor disputes, production interruptions and potential supply interruptions. In addition, sales of big three Pickup trucks and full size SUVs as I mentioned are down reflecting higher energy prices, rising interest rates and potentially a fundamental change in consumer preferences. This could have a impact on production schedules. We're also experiencing unprecedented sustained high level of raw material prices which again add stress throughout the supply chain.

Moving to slide 7, our game plan for addressing the challenging industry conditions includes a number of near, intermediate, and long-term initiatives. Our first and most immediate priority, taking care of our customers requirements on a day to day basis. This means maintaining our quality momentum, launch execution, cost efficiency actions and working closely with our vendors and customers to insure supply. At the same time we are implementing plans to eliminate excess capacity, accelerate our move into low cost country, streamline our organization structure and improve our business practices globally. To reposition our company for improved competitiveness and profitable growth going forward we have announced a proposed joint partnership for our interiors business. And we are aggressively developing growth strategies for seating, electronic and our electrical business.

Going to slide 8, in addition to the specific initiatives I just mentioned, I think it's important to highlight Lear's strong fundamentals which will help us offset potential risks and the potential risks I mentioned earlier and provide really a solid base in the long term. We continue to be a leader in quality and customer satisfaction. This is helping us support a very busy launch schedule. We have an experienced management team. This group is leading a number of critical actions such as the joint venture of our new interior business.

We see plenty of opportunity in our by leveraging our leadership position to meet he ever increasing consumer demand. And we are not burdened by significant legacy costs. We can see our pension liability is very manageable. Lastly, we have a strong balance sheet with more than sufficient liquidity. All these factors form a solid base from which we can implement longer term operational improvements. In times of extreme change Lear has always come out stronger. Now I'll turn it over to Doug DelGrosso.

Thanks, Jim. Slide 10 shows several key factors that are impacting our near term results as well as our outlook for the business. In the third quarter we launched 26 programs that represent annual sales of about $2 billion. We are continuing to experience unfavorable platform mix in North America, but the mix is improving as several of our largest programs in the U.S. were recently changed over.

Raw material price pressure and supply base distress continue to negatively impact our results. Recent energy production disruptions in the Gulf coast will further constrain gas supply and drive resin and chemical prices even higher. Taken together we see continued challenges in the near term, the longer term we anticipate the situation improving as we implement cost efficiency actions and put our restructuring plan in place. Looking ahead we are implementing our strategy for profitably growing our Seating, Electronic and Electrical businesses and on the next few slides I'll provide additional details on each of these key operating items.

Here's a perspective of what's happening to the platform mix. This has been the key driver in our overall financial results this year. In the first half our top 15 North American platforms were down 8%, which is significantly greater than the overall industry decline. This reflects the first half inventory correction by the big three, a slow down in sales of full size SUVs and pickups as well as the change over high volume, high content models such as the Ford Explorer and the Dodge Ram.

In the third quarter North America industry production was up 3% and our top 15 platforms were down 1%. While mix improved on a sequential basis production for two of our highest content platforms, the GM full size SUV and the Ford Explorer, was down 29 and 39% respectively.

Slide 12 provides a little more color on what we're seeing for the key commodities that we utilized in our business. As well as the pressure we're experiencing in the supply chain. During the third quarter steel prices were down, but they remained significantly above historical levels. Resin and chemical prices increased and we see further upward price pressure resulting from recent storms in the Gulf coast. The sustained nature of the high commodity prices is continuing to weaken the more vulnerable tier 2 and tier 3 suppliers. We have seen a sharp increase in the number of failed and high risk suppliers. Current negotiations are in progress with respect to current and future impact.

In an effort to mitigate some of the short and long-term structural changes to our business we are implementing a global restructuring plan. Slide 13 shows a summary of this year's restructuring activities. On the left panel you can see that we expect to incur costs of about $110 million, with most of this being a direct cash impact. This has funded the closure of five manufacturing facility and the restructuring of multiple administrative offices. We also have put in place a more stream lined global organization and rationalized administrative functions.

In addition to our global restructuring plan, we are also accelerating the implementation of a more cost competitive global sourcing footprint. Our criteria for selecting products in specific locations for more cost competitive sourcing opportunities are shown on the left side of this chart. Where these conditions exist we have been able to realize cost savings of 15 to 20% compared with traditional sources. Our leading components for potential re-sourcing to more cost competitive locations are listed on the right side of this chart. We see maintaining a highly competitive global sourcing footprint as an ongoing process that will help us continue to improve our overall cost competitiveness.

We have received many questions about the impact of higher raw material prices on the profitability of our sales backlog. Slide 15 addresses this issue. First, 2005 is a transition year for Lear's North American platform mix with 50% of our major platforms undergoing change. Reduced volumes and startup costs associated with this unprecedented turnover explains a portion of this year's depressed earnings. Second, on those programs that have not launched we have completed a program by program review of our backlog business. Accordingly, we have initiatives underway which are expected to restore the profitability of our future business to historic levels.

As we indicated at the Frankfort auto show, we see plenty of profitable growth opportunities for seating electronics businesses. Based on our solid market share production in North America and Europe we see growth opportunities in new regional markets with new customers and with new products. We also see margin opportunities with selected vertical integration at the component level. Now I'll turn it over to Dave for a discussion of our financial results and interior business.

Okay. Thanks, Doug. Here's a summary of our third quarter financial results. Industry production was up 3% in North America, and down 4% in Europe. Our mix continued to be negative as several of our high content platforms in North America experienced lower production. Raw material and energy prices continued at high levels putting added pressure on our material costs. Our sales were $4 billion, up about a $100 million from a year ago.

New business globally was about offset by the impact of unfavorable platform mix in North America. The reported net loss was $11.17 per share including a goodwill impairment charge of $9.98 per share and costs for restructuring and fixed asset impairments of $1.09 per share. Excluding than the impairment charges and the restructuring costs, the net loss was $0.10 per share.

On the next slide I'll cover the major factors that explain this year's results compared with a year ago. And later in the presentation I'll cover the drivers impacting our negative free cash flow in the quarter of $444 million and also review the outlook. Move to slide 19, here we summarize the impact of our major performance items on our third quarter sales and earnings compared with a year ago. As you can see the most significant adverse factor for both a change in sales and earnings was again platform mix. Positive contributor to our net sales included global new business and favorable foreign exchange. Taken together these did not have a material offsetting impact on earnings. Results were also negatively impacted by the net amount of higher commodity costs. The goodwill and fixed asset impairments, along with the restructuring activities had an extremely negative effect on our GAAP reported net earnings.

If you'll move to slide 20 this is our traditional financial score card for the third quarter. Since I've already covered the changes in our net sales and net earnings per share here I'll cover the remaining financial metrics. SG&A as a percent of sales was 3.6%, down from 4.1% of sales a year ago reflecting the benefits of our focus on overall cost control. Interest expense was $45 million, up about $2 million from last year primarily related to the Seton litigation settlement that occurred during the second quarter. Other expense of $16.4 million was generally in line with recent experience.

Moving to slide 21, here we summarize the impact of the impairment charges and costs associated with restructuring actions during the quarter. The estimated pretax charge for Goodwill Impairment in our interiors business segment was $670 million. The Fixed Asset Impairment charge was $74 million and the restructuring costs amounted to $33 million. In total these items reduced pretax earnings by $777 million or $11 .07 per share. To help clarify how these amounts affected our financial statements we've indicated the impact by category on the right hand side of this chart.

If you will move to slide 22, free cash flow was negative $444 million during the quarter, bringing the year-to-date amount to a negative $465 million. This compares with positive free cash flow of $41 million in the third quarter of last year and positive $231 million for the first nine months. As I have indicated on past calls, the change in General Motors payment terms has had a significant one time impact on our reported free cash flow this year. The third quarter is the first reporting unit -- is the first reporting period in 2005 in which these new payment terms negatively impacted our free cash flow. This quarter ended on October 1st and we received GM's payment on October 3rd. The negative impact from working capital on our third quarter reported cash flow is largely explained by this change.

The full year net impact on free cash flow is negative by about $200 million, reflecting the fact that actions taken to realign vendor payments have been phased in throughout the year. In addition our cash flow was impacted by the up front investment required to support our near term launch schedule. We spend more on capital and tooling and engineering during the third quarter than in the prior year and built inventory to support product launches. We expect fourth quarter free cash flow to turn positive as many of our launches begin to ramp up during the fourth quarter.

If you will move to slide 23, despite this year's net use of cash our liquidity position does remain strong. During the quarter we entered into a $400 million 18 month term loan with our existing credit agreement banks to insure excess liquidity as we work through the launch phase on several key platforms and implement our restructuring plan. Our $1.7 billion revolver remains in place and is committed through early 2010. Combined with a term loan this provides us with $2.1 billion of committed liquidity. At quarter end approximately $500 million was outstanding under these facilities, and $1.6 billion was available. Even at our peak borrowing within the quarter we had had in excess of $1 billion available on these committed lines. We believe that this provides us with sufficient cushion for any unforeseen industry event.

As our launches ramp up we will return to positive cash flow, eliminating the need for the $400 million term loan. Our debt maturities through 2008 are minimal and will be refinanced at the appropriate times. We have no near term refinancing or liquidity concerns and remain confident of our ability to maintain a strong and flexible balance sheet going forward.

If you will move to slide 24, our debt has increased by $536 million during the first nine months of 2005 reflecting primarily the net $465 million use of cash just discussed and $50 million in dividends paid. This was financed partially on our combined $2.1 billion committed bank facilities and partially through the utilization of our U.S. accounts receivable ABS facility and the factoring of a portions of our European receivables. These receivable facilities provide short-term liquidity at rates that are competitive with or even better than our existing credit facilities.

If you will move to slide 25, a number of significant uncertainties are impacting the outlook for our financial results for the fourth quarter of 2005. These include instability in the raw material and commodity market, particularly given the effects of the Gulf coast hurricanes. Continuing distress throughout the supply chain exacerbated by the unprecedented raw material prices, supply disruptions and other supplier bankruptcies. An uncertain sales and production environment in North America and the timing and impact of activities surrounding Lear's interior products segment. Given this level of uncertainty, Lear does not intend to provide formal financial guidance for the fourth quarter of this year. However, on a directional basis the Company expects net income in excess of $0.75 per share excluding planned restructuring costs of approximately $0.50 in the quarter and importantly positive free cash flow.

If you will move to slide 26, this helps describe the present price pressure and future price risk for resins and other chemicals as a result of the recent Gulf coast storms. In the box on the left you can see the significant impact the hurricanes have had on disrupting energy supply in the Gulf region. Nearly 80% of demand offshore oil and gas platforms were evacuated during the storms. A significant portion of the daily oil and gas production remains shut in. This is exacerbated or further restricted already tight supplies of energy. In turn this is severely constraining the region's ability to process resins and other petroleum based chemicals. The increase price on these commodities has been severe and has intensified the pressure on and from our supply base.

If you will move to slide 27, here we provide a summary of our directional assessment for the key financial metrics for 2006. A strong backlog supports sales growth in all of our business segments. We see a marked improvement in earnings, capital spending trends notably lower following this year's peak spending levels and importantly we see an improvement in free cash flow to a meaningful positive level. We plan on providing a more detailed outlook for 2006 in January.

On slide 28, we'll turn now to what's happening with our interior products business. As you can see on this slide our financial returns have been steadily declining. Our results in this -- our result in this sector reflect the broader industry trends. These include overcapacity, a fragmented supply base with numerous competitors, insufficient pricing as competitive pressures have resulted in commodity like pricing for many of these products, and the unparalleled sustained high level of raw material costs. Last week we filed an 8K disclosing a goodwill impairment charge for the interior segment of $670 million and a fixed asset impairment charge of $83 million.

This impairments were determined following an independent valuation of this business which indicated a fair value significantly below the levels we were carrying on our books. The unacceptable results in this business combined with the structural challenges of the market have led us to seek a new business model.

On page 29 we provide a few more details for our proposed partnership with Wilbur Ross. We believe this joint venture offers the best opportunity to address the industry concerns that I just spoke to. Importantly the venture will seek acquisitions to increase scale. This should provide the opportunity to rationalize and consolidate redundant operations and achieve greater operational efficiencies than exist individually.

All or a portion of the North American [Carl and Aikman] business is the initial acquisition target for the venture. Lear Corporation is expected to hold a significant minority position in the new company and provide overall management support. With that let me turn it over to Bob for some closing comments.

Thank you, Dave. And thanks, team. If you will turn to slide 31, I think the team has provided a good overview of the tough business conditions we're facing and the outlook. I 'd like to give you my perspective on the direction we're heading for each of our major product segments.

As we have been saying the market for interior products is obviously severely depressed. As you have heard, last week we announced a joint venture with Wilbur Ross involving our interiors product business. I truly believe that this proposed joint venture gives us the greatest opportunity to achieve a better business model for this distressed segment. It also allows Lear to participate in the ongoing consolidation of the auto supply industry which really has to take place and it needs to take place now. As far as Seating and Electrical and Electronics businesses we have developed and are in the process of implementing profitable global growth plans. We reviewed these in some detail last month at Frankfurt.

e're also well underway with our restructuring actions to improve our future competitiveness and that is on going. While many challenges remain, we do see our earnings in cash flow turning positive in the fourth quarter. We also see our results improving next year. However, it is too early to provide a specific forecast. We will provide more details on the 2006 outlook in January.

Moving to slide 32, as a wrap up this slide provides you with a high level outlook for our business. This year has been the toughest in our history and I would characterize it as a transition year. We've seen tough years in the past, but this is a topper. A number of factors have converged to severely depress our operating results. The mix of North American production is unfavorable, light trucks and sport utilities are down, the impact is amplified by the fact that we're in the process of turning over a significant portion of our line up. Doug mentioned 50% of our high volume platforms are in the process of changing. Our highest volume is changing, that highest content platform is changing, so we have got a new market we're looking at in the future.

Raw material pricing continues at unprecedented levels and supply base continues to be under stress. What are we doing? Restructuring our business and looking at everything in the cost of making our products to improve them. We're taking positive steps to return our interiors to good health. Next year capital spending declines as we complete the transition of our North American line up. Earnings in cash flow will improve from this year's severely depressed levels.

The important message is I believe that longer term this company has an outstanding outlook. We have experienced management, a strong team, a resilient culture and I'm confident that the positive Lear spirit combined with the physical changes we're making to improve the structure of our business will deliver great value to our customers and our shareholders in the year ahead. So I would like to now open it up for questions.

[OPERATOR INSTRUCTIONS] We will pause for just a moment to compile the Q&A roster. Your first question comes from John Casesa at Merrill Lynch.

John Murphy for John Casesa.

Hi, John.

A question on your fourth quarter guidance, what are the real drivers of the uncertainty there in the fourth quarter and why wouldn't those pressures persist in into 2006?

Okay. Let me try to address that, it's a good opening question. There's several factors that drove our thinking and where we ended up with respect to looking at the fourth quarter. Firstly, there continues to be unanticipated costs that we are incurring to support a fairly distressed or very distressed supply base. These include excess freight, premium freight, overtime, containment costs. With respect to launches I had indicated earlier that we had expected to incur about $90 million in what we call startup costs for the year. That's grown to about $105 million and that difference is primarily going to be incurred in the fourth quarter. Importantly it's driven by a multitude of late engineering changes and customer schedule changes.

The third element here is what we spoke to, I think a number of times during the formal part of the presentation, and that's what's going on with resin pricing and other petroleum based chemicals as a result of the Gulf coast hurricanes. This has opened up a new -- a number of new commercial discussions with our customers and supply base and at this stage it's very difficult to handicap how those actually play out.

The fourth element and lastly is, although there are published production schedules out there today that we are working to for the fourth quarter, we believe that there is sufficient reason to conclude that there is some level of production uncertainty given certain inventory levels in certain product lines and especially in light of recent history, specifically what took place in the first quarter of this year. So by in large those are really the drivers for us to say okay, here is the floor give it everything we know and we feel confident that this would be the floor, but given the level of uncertainty we thought it was -- it would be more straightforward not to put book ends around formal guidance out there that could potentially change in the coming weeks.

Just one follow up on the Seating and Electronic business looking out in the future, obviously you're trying to grow that business and right now it's much more profitable, but if we look two or three years out, maybe four or five years out, what are the big differences between that business and the interior business you're pushing out in this JV and why should we think of that as a lot more defensible business going forward.

Let me firstly address the ISD business, then I think Doug will have some comments on the Seating and Electronics. The ISD business has been commoditized from a pricing standpoint with respect to the products that we deliver in that group, door panel, overhead systems, instrument panels, flooring and acoustics and other hard trim that's resin based and that's occurred over the last three to five years and you can really see it in the results this year, especially in light of what's gone on with resin pricing. So when you take what's gone on from a customer pricing standpoint in combination with resin pricing and you look at the capacity utilization within that space of the industry I would say that it's fairly unique, especially relative to Lear's other products. Given that we felt that the only reasonable path forward was some sort of combination and I think we probably addressed that at length during the formal part of the presentation as well as over the past month. So with that let me turn it over to Doug and he has some comments on the other two segments.

Yeah, the way I would comment on the other two segments is more in contrast to the interior business. If I take seating for example, we do not view seating as a commodity based business. We think it is essentially a module, there's many opportunities to work within side that module to -- even if the customer is demanding on productivity we think there is significant opportunities to find offsets to that to still support their expectations of low cost, but at the same time maintain a profitable business. In addition to that, this also applies to the electronics and electrical distribution, we're selectively vertically integrating within each one of those modules, if you will, we think that will also protect the profit margin we have as we vertically integrate into each one of those product lines. In the area of seating we're looking at trim, more investment in trim, particularly in Europe, metals and mechanisms which are becoming the core component commodity, if you will, within the seating systems. On the wire side it's terminally and connectors. We're making additional investments to the acquisition at Grote & Hartmann we made last year.

And then on the electronics side we think the electronic side of the business is really a product technology business. As you develop new product technology that's unique you can price it competitively in the market, but competitively with a significant margin attached to it. Then on top we just see both of those product segments growing. We think Asia represents the most significant opportunity for that growth. We think our reputation and our position globally allows us to quickly move into those markets faster than the competition and capitalize on that growth.

Doug, this is John Casesa, if I could just follow up then. What do you want this company to be in five years, is this going to be a seating company, an interior technology company, an electronics company, what's the big vision for what is going to come out of this whole process of transforming the business that you're going through right now?

Well, John, I think -- this is Bob. I think the business overall is going to be an automotive component supplier with a big part of our base in the seating and comfort features of the vehicle. There's plenty of opportunity there for us to grow and as Doug said to consolidate and to make a good profit in that business. I think the real growth for the business is going to be in the electronics and the electrical side of the business and what we do going forward, some of which will develop internally some will develop through other acquisitions that will help support that.

I believe the company longer term will be a huge company obviously with splitting out the interior plastics and whatever happens to that business I think we can offset that in the very near term future once we get those issues behind us. So the company will continue to be an automotive supplier that provides complete systems partially in interior, mainly seat related with the interior -- with the electronics and electrical systems supporting that.

Thanks Bob, I appreciate it.

Well, John, I thank you for the question.

Thanks.

Thanks.

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

Thanks, good morning, everyone. A few questions, when you talk about the portfolio turnover and the new programs coming on, I just want to try and get an understanding of where you think the margin benefit from that is coming from that, is that a volume assumption issue, is there some pricing that gets better when you turn it over, because I was under the impression a lot of times these new programs aren't necessarily the most profitable the first year or two years.

Well, there's two things that are happening there. There is even programs that are in production continue to go through some level of engineering changes. So that's sort of on the base business. With respect to the backlog Doug specifically addressed what we were challenged with with respect to margins and how we're addressing that as we look to 2006, 7 and 8.

Sort of apples to apples, obviously we along with most other tier one suppliers and our customers are impact by what's gone on with raw materials and we're addressing that very specifically.

I think the other element though is we talked about the amount of backlog we have coming on stream in '06, but most of that backlog is really additional volume off of products we are launching right now. So we will have the launch costs behind them, and again when you go through the typical launch phase you gain profitability as you work out the kinks and more importantly you get up to full production.

That's an excellent point, let me add one thing to what Jim just said. Two thirds of the North American backlog for next year is being launched this year, just to put a little more math around it it.

Okay. And you talked about capital spending coming down, do you have a ballpark range of what you think a normalized CapEx run rate would be for the seating and electronic business?

Yeah, if you think about it in the terms of the high 2% range, mid to high 2% range of sales you will be in the general, that's the general direction.

Okay. Finally, you talked a little bit about production uncertainty and maybe some cuts in the fourth quarter was the way I took it, when you think through the sales that are happening in October, the inventory situation, do you think we're more likely to see fourth quarter cuts or 1 Q '06 cuts

Well, again, that's very difficult to handicap. We just, -- the team thought through this a lot and given what took place in the first quarter we can't say whether it would happen in the fourth quarter or the first quarter, but we do anticipate some level of cutbacks.

Okay. Are you seeing anything in some of the forward schedules the OEM's give you or just by watching the inventory and the sales you're coming to this conclusion?

It's really the latter.

Okay. Thank you very much.

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

Good morning everybody, can you hear me?

Yes, Rod. We can hear you loud and clear.

I've got a couple questions. First one I guess for Bob, I guess we hear what you're saying about the benefit from the restructuring and the capacity and the new business ramping up into 2006 so you can have lower launch costs, but I guess it's pretty clear that GM and Ford are both going to be taking some pretty significant plant closures. There's probably going to be more distress in the tier twos, obviously raw material had wins too. So can you maybe talk a little bit about how or what gives you conviction that you can improve results for Lear into '06 and '07 despite some of those negative production head winds.

Well, I think we have covered a lot of that, but I really and truly believe this industry is changing completely. I mean that sincerely and I think a new business model is developing. I think as our customers consolidate a number of factories that doesn't necessarily mean it's bad for us. We get to eliminate some of the inefficient capacity we have in place at the same time. Those products will still be built, they may change the name plates, the badging but the facts are they're still going to build product and we're still going to supply product to them.

So I don't think consolidation or the number of factories, reduction of factories that our customers are going to have is going to be a bad thing. But I think the new business model that is going to develop for our industry and for us in particular,is what is truly exciting. I think that consolidation really and truly does afford us significant opportunity. There's definitely going to be fewer suppliers in this marketplace and we're going to be more efficient. It isn't just that I'm dreaming we're going to be more efficient, we actually believe that there's a better way to run this business.

I think it's going to be more global in nature. I think we're going to be able to buy products from around the world, components to supply in our complete systems that will make us far more efficient and make us lower cost and in the end generate, I believe as well at the same time, more profitable products. I also believe that the cost problems that are in the marketplace today, material cost problems that everybody is facing, are going to be addressed by our customers and they're going to be resolved. I'm not saying that pricing longer term is the solution to every problem. However in the short term I believe that we need to get pricing at least in material, the materials that are affected by oil, to offset those inefficiencies that we have today.

But I think longer term as we restructure this business, as we consolidate it, as we become more efficient, we can get that cost back out, develop a model that's a profitable product for us and an excellent low cost product for our customers. I also believe that we as our company is going to gain more penetration with the Asian producers, both in Asia and here in North America and in Europe. And I truly believe that that is what's really going to change the business going forward. At the same time we're going to have benefits of the restructuring that we have got in place. Now, next year you're starting to see.

Do we know what the production environment is going to be next year, no, we don't know, but we do believe it is going to be far better than it is this year. So we will have the benefits of our restructuring. I know we are going to get our material issues behind us with our customers, at some point they have no choice but to face up to it. I know that the move we've made with our interior systems group, the improvements we've planned in the potential joint venture, is really and truly going to save that business. And it's going to develop a better business for our customers going forward and a better business for all of us as they operate inside of it.

Our backlog at Lear is coming on next year, we will get primarily the full year impact of what we've got coming up right now, so that's going to get better. Launch costs are going to be behind us. And we will return to the cash flow company that we have been in the past. I think the things that we're most -- the best at is asset management and managing for cash in difficult times. This year with the expenses that we had with the new products coming on we couldn't do much about it in this quarter, but the truth is going forward this company is going to operate like a leverage buyout like it has in the past.

So I believe the positive outlook for the future is truly there. I see a changing business model. I see a customer that's more realistic. I don't think consolidation is bad at all. I think we have addressed all the tough issues at our company. And I really and truly believe we are going to continue to do that. We have an outstanding management team and great people. So this is an excellent company that is going to provide profit and I believe returns for our shareholders and real benefit for our customers. That's pretty much all I've got to say.

Okay. Well,

I didn't answer your question, but you gave me a platform.

I appreciate it.

What was your question again?

Well, look,

And I forgot safety products, too. Go ahead.

Obviously look you have got a lot going on, but am I reading into your comments that you are assuming that the production environment is somewhat more stable is one of the kind of the assumptions behind your comments about improving earnings and cash flow next year.

Well, my opinion has got to be better than it is right now, at least in the products that we supply. The overall market is not as depressed as what we have been experiencing because we have been going through these launches and changeovers. So it's affected us more than probably most. So I do see that changing next year. I do believe that we will have a more stable production environment for our company to operate in, which leads me to believe that the future is pretty bright for us.

Thank you. And Dave, if I could just follow up with a couple specific questions. I didn't understand what you said about the drag from launches, I guess conceptually I understood it, but did you quantify what the improvement would be year- over -year from '05 to '06 from most launches being this year.

It's a good follow up. No, I didn't specifically, but historically I mean for a number of years until 2005, launch or startup costs as we capture that information has been somewhere in the $50 to $60 million range. This year, you can see, it's essentially twice that. It comes down substantially next year, I'm not ready to point to a number, but I would say it would be much more in line with the launch costs that we have incurred prior to 2005.

Okay. And did you mention on the call how much of a raw material cost drag you experienced this quarter and can you walk through some broad parameters on the profitability improvement you're expecting from Q3 to Q4, typically the fourth quarter has got a lot of true UPS, is that a factor in your walk.

Well, there's a couple of things. With respect to the overall commodity impact, and we've talked to this in the past, so let me put a little color on it for you. For the year on a net basis we are -- and this is an important point. This does not -- what I'm about to address here does not include any impact of the recent spike in resins and other petroleum based chemicals that we spoke to earlier, because again it's a fairly significant number. There are commercial discussions going on and as I said before it's difficult to see how that plays out.

So excluding this recent price hike in those raw materials, again you have to roll the real back six weeks. We had anticipated somewhere in the neighborhood of about $140 million on a net basis of commodity impact for the year. In the third quarter that impact is roughly $30 million. That's one I think addresses a specific question. With respect to third quarter and fourth quarter profitability cadence the most significant driver there is a less negative mix.

And to put a little more color on that, if you just take our top platforms, let's just say our top ten platforms. In North America these improve quarter- over- quarter by about somewhere between 12 and 15% again excluding any comments that we spoke to earlier with respect to potential schedule changes. And in Europe they improve in the high single digit range, somewhere between 6 and 10%. And that's third quarter to fourth quarter. In addition, there is a significant plus from the new backlog programs. Again talking to a lot of this launch activity being behind us at that point. New business comes on at about $500 million in the quarter and notwithstanding that the margins are lower than the traditional run rate programs it's still on a relative basis a fairly significant plus from an earning standpoint.

Great, thank you.

Okay, Rod.

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

Good morning, guys.

Hi, Himanshu.

On the production comment earlier, I just wanted to clarify something. October is pretty much done, have you seen something already in the fourth quarter schedules that's causing your uncertainty or it's just a broad assessment based on where sales are going?

It's really just a broad assessment. Our schedules are firm, we have not seen any changes to our schedule to the balance of the year. I think what we're anticipating or what we're saying it's dependent upon is there are many new model launches that are hitting the fourth quarter. If those sales are strong then we are confident in our sales revenue projections. If the market continues to be depressed we're anticipating our customers may take some action.

And then on SG&A, it was quite impressive. I think typically your third quarter SG&A as a percentage of sales is usually about 40 basis points or so higher than the full year amount. Should we think of that sort of relationship holding for 2006 which would suggest maybe we're kind of in the low 3% level for SG&A as a percent of sales next year.

Yeah, I think low to mid 3% is sort of a reasonable estimate. It's probably a very good example of what Bob was speaking to earlier referencing the LBO mentality throughout the company and how we're running it today and well into the future.

Okay. Then one comment I wanted to go back to earlier. I'm just trying to understand how you guys think consolidation in the industry will specifically benefit Lear, because I mean if you look at the tier one interiors business it's already fairly consolidated, there is only a handful, maybe three to five sort of large global players like yourself in that business. It would seem that most of the consolidation is going to happen in the tier two business. And while I understand that in the near term that can help you guys because you wouldn't have to provide so much support to them, doesn't that actually make the tier two base a lot stronger and their ability to absorb sort of continuous pricing pressure from you guys. Doesn't that go away and in effect don't your bargaining powers with them effectively get a lot tougher.

Let me try that first and some other folks may want to chime in. The first thing on the tier two base, we have been talking about this I think for well over a year. There is serious distress in the tier two base and in order to survive as reasonably strong suppliers there's going to have to be consolidation there. And from a tier two standpoint I would not necessarily conclude at all that this gives the tier twos any sort of pricing leverage relative to where they are today. It's more of a survival play than anything else.

Second part of your question which was actually what you asked first, let me talk to the ISD portion specifically. We have obviously looked at how a potential new company would look financially over the next couple of years if you just simply combined Lear's ISD segment along with Collins and Aikman segment. The most simple explanation is you obviously improve scale and there are a number of very natural operational synergies that result from the combination. And it's inappropriate for me to get into the numbers specifically, but it does change the business model, results in a viable long-term and very strong company and again to Bob's earlier point we believe is a very good alternative for Lear and probably the best alternative for our customers.

I'm assuming you mean mainly higher utilization rates.

That's one great example.

I think it's important to understand when we talk about our role in the consolidation and our plastics business we're really not trying to infringe on the tier two suppliers. We're talking about large tonnage requirements, high capital investment and where we think the opportunity is. First off, we believe both ourselves and C and A operation are competitive operations for this kind of business. I think really what's hurting us now is the pressure we felt from raw materials which needs to be addressed and we believe that has to be address long term in any case. But we think there's opportunities by stream lining our operations and making sure you have full utilization. Really the key to this business is making sure your presses are running six, six and a half days a week. That's really the key to the business, getting the most out of your capital, that can best be accomplished by having greater scale. Having leverage over the raw material suppliers because you will have the greater buy. And also consolidating your business and working strategically with your customers.

And does that get those -- I mean that industry or sort of back to the '03 level of profitability or is it just no longer losing money?

Well, I think that '03 level of profitability is what the sustainable model is given the kind of capital investment you have in the business. You know you can't make the same kind of returns on the interior business if it's strictly components that you can in the seating business where you're dealing with a module and you have less investment and higher sales base.

Then one last question. You guys mentioned sort of new pricing discussions with your customers. Can you just give a little bit more color behind that, when did they start, are they happening with other suppliers as well? How advanced are they right now?

It's a combination. Yes. It's a -- let me start out, I'll talk about the ISD business, Doug may want to add something to that. There are commercial discussions going on around our ISD business really on two levels. One is the overall pricing of programs that are not sustainable over time. And that's been ongoing. And the second part is again this recent spike in resin pricing and the combination of those two have again have significantly impacted the way we view the business over time. Discussions are almost in the literal sense going on daily and it's difficult to say how this all plays out or the timing of how it all plays out.

Okay, great.

The only thing I would add to it is these are complex discussions, they're not just simple pricing discussions. I think what the crisis, if you will, has opened up is real cost discussions with our customers, allowed us to bring in ideas that perhaps in the past would have been rejected, we're driving hard on the cost side of the equation as well. So they're very open to finding offsets in addition to just passing on the raw material costs onto them.

And is there a -- any consideration given to developing sort of let's say a commodity cost pass through structure similar to some other industries where there's some sort of index cost and that doesn't necessarily affect the supplier, goes straight on to the OEM or is it strictly let's take out inefficiencies in manufacturing and talk about bottom line pricing.

No, I think that's that's exactly what we're trying to do too. We have had discussions in the past with our customer with regard to currency, for example, and defining fluctuation rates that we can work within and when you exceed those rates then that triggers a leveling off or an equalizing of the impact on the raw material side. In addition to that, I think you look at some of the new changes at Ford. They are getting more into cost modeling and those cost models have to recognize the fluctuations in raw material costs. We're encouraged by that, we think that's a more efficient way to do business in the future than just asking for productivity year after year without really recognizing the trends in the industry.

Okay, thanks a lot.

How many more calls on the line, does anybody know?

About five.

Five, okay.

Your next question comes from the line of Chris Ceraso with CSFB.

Thanks, good morning. Maybe if I can just follow up on that line of questioning. Your major U.S. competitor seems a little bit more sanguine about the whole material cost issue, so what's the risk that your customers in these discussions take a view that material costs are going to come back down and maybe they're less likely to reprice some of these contracts?

Yeah. It's -- we don't think it's appropriate to comment on what other suppliers are doing or how they're addressing these issues. We do know what we're seeing and I'll say this with absolute certainty that we are not unique with respect to what we're seeing in raw material pricing.

Thank you.

I'm sorry -- go ahead.

No fine.

So repricing these contracts though, is that a key just for the business that you're splitting off or is that a key for the remaining business as well?

It's not repricing. It's recovery of material economics, material increases is what we're after. We can't comment as Dave said on what our competitors are doing. I think our business is sufficiently different from theirs. It's really not easy to compare them that way. We're facing rising material cost, we have a high percentage of product that's in resin based products and we have to recover that and our customers have to understand we have to recover that, otherwise it will hurt this business longer term.

I think we have time for one more question, then we will be around all day, everybody will be.

Okay. We'll take our final question from the line of Ron Tadross with Banc Of America.

Good morning, guys. Good morning.

Hi, Ron.

Hi. Two questions. First, the $2 billion figure on slide 10, the new business figure, does that include your interior businesses?

Yes, it does.

So what's the number without the interior businesses?

Frankly I don't have that handy. But it would be somewhat less.

What would be like a full year number, that's obviously the third quarter number, because it doesn't seem like a lot, $2 billion of whatever it is, $12, $15 billion in sales.

Right. What we have said is about 40 to 50% of our North American business is turning over this year. Of the North American business in which Lear participates or delivers product is turning over this year. So if you just take whatever your estimate is for North American business, I think the math is fairly easy.

Then my other question is look, I guess your customers have no margin, their volumes are declining, so let's just assume for a second that they can't absorb these raw material costs. What does Lear do, do you scrutinize capital investments tougher, what do you do in that scenario?

Do a combination of everything. You take a look at whether or not you can invest in new future programs, you look at your capital, but a lot of the things that you just mentioned are things we do on a day to day basis.

We are taking a look at our new model, the way we have got our business structured. The cost carried to try to mitigate or cut the costs to our customers. But that doesn't stop the fact we have got rising material costs and they have to be offset somehow in the short term and that's just the way it's going to be. The other thing you do is you attack on the material cost side of the equation. If they're unwilling to accept the increase then we attack it from a technical solution and we think they are much more cooperative today to look at those alternatives. But it has to be one of the other.

By the way we're not trying to start a war with our customers, we're trying to get through the tough times.

Of course, but it's tough times for them too.

I understand that.

But my point is, it looks like the problems in their business are fairly significant and structural and I'm just wondering if you guys are scrutinizing your capital investments.

But Ron, it's important --

Yeah, absolutely we're looking at programs we have in launch and so forth.

But again let me re-emphasize it shouldn't be lost what Doug just said. These are real substantive discussions with our technical folks and the customer technical folks and we are going down that path as well. It's an important initiative and we think over time it absolutely does bear out some very positives for our customers and for us.

Good luck guys, thanks.

Thanks. Pray for us. Just a couple final comments. Anyway, I think there's -- I gave everybody the impression 2005 was the toughest in history, but it was toughest in the history for a couple of real reasons. Not only is the material costs went up, we have seen these things in the past, all the things that are happening to us, but it didn't impact us as badly in the past because we didn't have the volume drops on the key products and platforms that we've had in the changeovers and that's really what created the tough times for us. It's been a really tough year for us because we are getting ready to go into a new growth phase. We're paying for that growth phase at a time when our industry is kind of hurting a little bit. So that is really what created my comment. It has been tough times, but I think tough times create opportunity.

I know there's a ton of uncertainty out there, there's a ton of uncertainty with all of our people; the people that work in our factories, our family, the management team, in everybody there's fear. But please understand what we're doing for Lear. The moves we're making are going to affect Lear positively longer term. It's going to have a good impact for our shareholders and it will be good for all of our people even if the joint venture takes place. The future, I swear to God, will be better. There is a lot of doom and gloom out there, but I know one thing this company is going to be successful. So I want to thank all of the Lear guys. , I want to thank you for your understanding. I want to thank you for your attitude. And I want to thank you for your spirit. So think positive. Everything is going to get better. Thank you all.

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