Lear Corp (LEA) 2021 Q3 法說會逐字稿

Good morning, and welcome to the Lear Corporation Third Quarter 2021 Earnings Conference Call. (Operator Instructions) Please also note today's event is being recorded.

At this time, I'd like to turn the conference call over to Ed Lowenfeld, Vice President, Investor Relations. Sir, please go ahead.

Thanks, Jamie. Good morning, everyone, and thanks for joining us for Lear's third quarter 2021 earnings call. Presenting today are Ray Scott, Lear President and CEO; and Jason Cardew, Senior Vice President and CFO. Other members of Lear's senior management team have also joined us on the call.

Following prepared remarks, we will open the call for Q&A. You can find a copy of the presentation accompanying these remarks at ir.lear.com. Before Ray begin, I'd like to take this opportunity to remind you that as we conduct this call, we will be making forward-looking statements to assist you in understanding Lear's expectations for the future. As detailed in our safe harbor statement on Slide 2, our actual results could differ materially from these forward-looking statements due to many factors discussed in our latest 10-Q and other periodic reports.

I also want to remind you that during today's presentation, we will refer to non-GAAP financial metrics. You are directed to the slides in the appendix of our presentation for the reconciliation of non-GAAP items to the most directly comparable GAAP measures. The agenda for today's call is on Slide 3. First, Ray will review highlights from the quarter and provide a business update. Jason will then review our third quarter financial results and our full year 2021 outlook. Finally, Ray will offer some concluding remarks. Following the formal presentation, we would be happy to take your questions.

Now I'd like to invite Ray to begin.

Thanks, Ed, and good morning, everyone. Please turn to Slide 5, where I will provide a brief overview of our third quarter financial results. The third quarter was marked by the continuation of supply chain challenges the auto industry has been facing. Our financial results were negatively impacted not only by significant volume reductions versus last year but also by low visibility from our customers, leading to short notice production shutdowns.

Slide 6 highlights numerous achievements in the quarter, including innovation, quality, awards and strategic investments in both business segments. In the third quarter, Lear's sales growth outpaced the market by 9 percentage points with strong growth over market in both Seating and E-Systems, continued new business wins as well as products that are favorably aligned with the industry shift to electrification are expected to deliver continued growth above market over the next several years.

Last week, we announced the acquisition of substantially all of Kongsberg Automotive Interior Comfort division, which will further strengthen our industry-leading Seating business. I will comment further on this acquisition a little bit later in the presentation.

On the E-Systems side, we announced agreements to form 2 separate joint ventures which will further enhance our capabilities in electrification. The joint venture with Hu Lane, which we expect will close later this year, will further enhance our growing portfolio of connectors capabilities for both high voltage and low-voltage applications.

This joint venture -- the joint venture with Shinry will integrate complementary portfolios of advanced onboard chargers from Lear and Shinry and increase access to a broad range of customers.

We also continue to be recognized across both of our business segments for excellence in innovation and quality. We won our third consecutive Automotive News PACE Award and 2 PACE pilot awards more than any other supplier. Lear has long been known as a leader in seat quality. And this year, we won more than twice as many seat quality awards from J.D. Power as any other company.

We increased cash returns to shareholders in the quarter by doubling our dividend and buying back more stock. In total, we returned $100 million to shareholders during the quarter. We also increased our credit agreement to $2 billion and extended the maturity to 2026. With respect to capital allocation, we continue to follow a balanced plan that includes organic investment, inorganic investment and returning excess cash to our shareholders.

Turning to Slide 7. Our Seating business continues to grow faster than the market, reflecting our strong position in SUVs, CUVs and luxury vehicles. In the third quarter, Seating growth over market was 8 percentage points, reflecting new business on Ford Bronco and Bronco Sport, the Hyundai Tucson and strong performance on the luxury brands in Europe, the Seating also benefited from strong demand from GM's full-size SUVs.

During the quarter, we were awarded key programs with GM, BMW, Stellantis, Nio and Great Wall. And there are additional programs we expect to be sourced prior to the year-end. We also received a new development award for our award-winning ConfigurE+ product. This award is with a European OEM and is expected to launch in 2026. Customer interest in our patent-protected ConfigurE+ product remains very high. We continue to move forward on key launches in the quarter, including a new plant in Canada to supply seats for GM's large pickup trucks at the reopened Oshawa plant.

Other key ongoing launches are highlighted on the slide. A few weeks ago, we broke ground on our new energy-efficient JIT facility in Detroit to supply seats for GM's battery electric truck programs.

I've already touched on the innovation and quality awards we received in the Seating, but I want to spend a little bit more time explaining the PACE pilot award for thermal comfort.

This new product, that was developed jointly with Gentherm, integrates intelligent climate control software into a complete seating system. The algorithms and software controls were developed by Lear, and they use a combination of occupant temperature data, seat position and cabin temperature to optimize energy usage within the vehicle and keep passengers at an optimal temperature.

Please turn to Slide 8, where I will provide more details on the Kongsberg acquisition. Kongsberg is a recognized automotive supplier specializing in luxury comfort seating solutions with strong market positions in massage, lumbar, seat heat and ventilation systems. Comfort features continue to be of increasing importance as automakers look to improve the driving experience through product differentiation, increased efficiency and improved performance, especially in luxury, SUV and electric vehicle segments.

The company has almost 50 years of experience in seating comfort solutions, technical centers and sales offices in 3 different continents, and an experienced and dedicated team with approximately $300 million of annual revenue. Kongsberg has a well-balanced customer portfolio built on long-standing relationships with leading premium automakers. Kongsberg is a global leader in seat massage and has a #3 position in lumbar and adjustable comfort.

The company is the technology leader with expertise in pneumatic comfort systems and patented technology that enables superior performance, weight reduction and packaging flexibility. In addition to performance benefits, they are also much quieter, which is even more important in electric vehicles where noise will be much more noticeable.

Kongsberg also has a strong market position as the #2 player in heat mats and the #4 player in vent systems for thermal comfort.

On Slide 9, I will highlight how Kongsberg will enhance our competitive advantage in Seating. This acquisition is consistent with other acquisitions we have made over the past decade to enhance our vertical integration capabilities. These moves have enhanced growth and margins and extend our market leadership in luxury and premium seating.

This acquisition extends our capabilities in comfort systems solutions, further solidifying our position as the most vertically integrated seating supplier while bringing additional priceable content to our offerings. It strengthens our ability to serve EV, luxury, SUV customers and to provide them with the next level of vertically integrated design solutions.

Integrating Kongsberg into Lear's operations solidifies our strategy to offer a complete suite of luxury comfort seating solutions to our OEM customers and ultimately, to the consumer. This combination will enable Lear to improve overall seat system performance by offering more efficient, lower weight and flexible packaging design solutions.

The total addressable market for massage lumbar heat ventilation products is estimated at $2.5 billion to $3 billion. IHS trend data indicates this market will grow about 2 percentage points faster than wheel production over the next 5 years.

Based on our assessments of industry mega trends, we expect the market could grow even faster in that time frame and beyond. Customers are looking for features to improve the driving experience. As cars become smarter, a higher emphasis is being placed on interior comfort. We are already seeing this with luxury and EV customers. And we anticipate this trend and focus on interior comfort to further increase when autonomous cars come to market.

We also expect increased adoption of seating comfort products beyond the luxury segments into higher-volume vehicle segments. In addition, we believe that by creating a more efficient packaging solution, we will see more proliferation of seating comfort systems in the rear seats. And perhaps the biggest opportunity, which will unfold over a longer term, will come with the acceleration in electrification, which requires more efficient heating and cooling systems in the cabin.

Our expertise in software and algorithms, combined with heating and cooling products from Kongsberg and our other partners will position us as one of the leaders in this area.

Slide 10 highlights Lear's leading performance in the latest J.D. Power U.S. Seat Quality and Satisfaction Study. For years, Lear has consistently been recognized by the industry experts and our customers as a leader in seat quality. In the latest J.D. Power Seat quality survey, Lear was the only seat supplier to win 2 first-place awards. We also won 5 additional awards and more than twice as many total awards as any other seat supplier. Our leadership in luxury and SUVs was evident by the multiple awards in both categories. The breadth of our wins was notable as well, with awards for products with 6 different OEMs and in 6 of the 7 different categories.

Okay. Please turn to Slide 11 for an update of E-Systems business. In the third quarter, E-Systems sales grew 9 percentage points faster than the market, reflecting new business on the Ford Bronco Sport in the Mustang Mach-E in North America and strong performance in connection systems in Europe and with Geely and the Great Wall in China.

We have won over $1 billion in business awards so far this year, over 80%, which are new for Lear. Based on awards to date, our 2022 to 2024 backlog is expected to be higher than our prior 3-year backlog. We will update and provide details on our backlog in our next earnings call. With the momentum of new business wins, we expect our E-Systems business to continue to grow faster than market for the next several years.

Despite the industry slowdowns, we remain busy executing launches with Mercedes, Volvo, Jaguar, among others. We also are launching our initial programs with GM and Audi on our recent award-winning battery disconnect unit and our first-to-market 5G telematics control unit. Our connection systems business is on track to grow to approximately $600 million next year.

Growing this part of our business is part of our strategy to increase the size and strength of our electrical distribution systems business and increase our margins. In addition to organic investments, we are entering into joint ventures and partnerships and making acquisitions to enhance our capabilities in connection systems. We already are seeing benefits from our M&N acquisition and are developing new high-speed connectors with IMS. And we are looking forward to closing the Hu Lane joint venture by the end of the year, which will increase our presence in connector catalogs.

We are also making progress in our plan to grow our connection systems business to $900 million -- to $1 billion by 2025. We'll continue to identify and pursue additional acquisitions and partnerships to accelerate this growth.

On the power electronics side, the joint venture announced yesterday with Shinry will expand our capabilities to improve manufacturing and design efficiencies for onboard chargers.

Now please turn to Slide 12 for a brief summary of our recent awards we have received on innovation and quality in E-Systems. They won our third consecutive automotive new PACE Award for the battery disconnect unit we designed for GM. This product controls all power switching in and out of the battery pack. Our design incorporates breakthrough thermal management innovations, which improves the efficiencies of large and high-performance electric vehicles.

We will be supplying this part on the GMC Hummer EV, the Chevrolet EV Silverado and other vehicles on GM's battery electric truck programs. We also are pursuing opportunities on strategic EV platforms with other customers. We also won a PACE pilot award for our 5G V2X telematics control unit, a single state-of-the-art installation featuring 9 antennas integrated onto one printed circuit board to support all next-generation wireless technologies.

Our design removes the shark fin external antenna required on many vehicles today, reducing complexity and improving styling capabilities and aerodynamics, which is particularly important for EVs, where every element that increases range is critical. We have received interest from numerous customers to commercialize this technology.

We also have been recognized by our customers for quality. A few weeks ago, we received the World Excellence Award from Ford for our plant in Pacheco, Argentina. And earlier this year, we received 2 plant quality awards from General Motors.

And now I'd like to invite Jason to review our third quarter financial results and full year outlook.

Thanks, Ray. Slide 14 shows vehicle production and key exchange rates for the third quarter. The impact of continuing component shortages led to a significant reduction in global industry production in the third quarter, particularly in our 2 largest markets, North America and Europe. As a result, global vehicle production in the third quarter decreased by 19% compared to 2020. And on a Lear sales weighted basis, global production declined by approximately 25%. From a currency standpoint, the U.S. dollar continued to weaken against the euro and RMB compared to 2020.

Slide 15 highlights Lear's growth over market in the third quarter. Total company growth over market was a strong 9 percentage points with E-Systems growing 9 points and Seating growing 8 points above market, respectively. Growth over market in North America of 12 points reflected the benefit of new business in both segments and strong production on GM's full-size SUVs as well as Mercedes SUVs.

In Europe, growth over market of 5 points was driven primarily by new business as well as strong performance in the luxury segment in Seating. Increased business in connection systems in Europe also contributed to the growth of our market performance.

In China, growth over market of 4 points resulted from strong production on BMW programs in Seating, and new business with Geely and Great Wall and E-Systems. Year-to-date, Lear's sales have grown faster than the market by 9 points with above-market growth in both segments.

Slide 16 highlights our financial results for the third quarter of 2021 compared to 2020. Our sales declined 13% year-over-year to $4.3 billion. Excluding the impact of foreign exchange, commodities and acquisitions, sales were down by 16%, primarily reflecting lower production on Lear platforms partially offset by the addition of new business.

Semiconductor shortages in the quarter negatively impacted our revenue by approximately 24%. Core operating earnings were $98 million compared to adjusted operating earnings of $327 million last year. The reduction in earnings resulted from the impact of lower production volumes and higher commodity costs, partially offset by positive operating performance and the addition of new business.

Adjusted earnings per share were $0.53 as compared to $3.73 a year ago. Third quarter free cash flow was negative $157 million compared to $474 million in 2020. Free cash flow was negatively impacted by lower earnings, higher capital expenditures and an increase in working capital. Working capital was higher in the quarter as volatility in customer production schedules resulted in elevated inventory levels.

Slide 17 explains the third quarter year-over-year variance in sales and adjusted operating margins in the Seating segment. Sales in the quarter were $3.2 billion, a decrease of $526 million, or 14%, from the third quarter of 2020. Excluding the impact of foreign exchange, acquisitions and commodities, sales were down 16% reflecting lower production, partially offset by the benefit of new business.

In Seating, production downtime in the third quarter related to semiconductor shortages reduced our sales by approximately $1.1 billion or 25%. Core operating earnings were $144 million, down $142 million from the third quarter of 2020. Lower volume on their platforms and higher commodity costs were partially offset by positive net operating performance and margin-accretive backlog.

Slide 18 provides detail for the third quarter year-over-year variance in sales and adjusted operating margins in our E-Systems segment. Sales in the third quarter were $1.1 billion, a decrease of 9% from the third quarter of 2020. Excluding the impact of foreign exchange, acquisitions and commodities, sales were down 15% driven primarily by lower volumes, somewhat offset by a strong backlog.

In E-Systems, production downtime in the third quarter related to semiconductor shortages reduced our sales by approximately $300 million or 21%. Core operating earnings were $23 million or 2.1% of sales compared to $93 million in 2020. The decline in earnings resulted primarily from lower volumes, higher commodity costs and semiconductor and COVID-related premium costs. The decline was partially offset by margin-accretive backlog and positive net performance.

Now please turn to Slide 19, where I'll briefly talk about our balance sheet and liquidity. Last week, our treasury team took advantage of favorable market conditions and our strong financial position to opportunistically increase and extend our revolving line of credit. The credit agreement was increased to $2 billion and the maturity was pushed out by more than 2 years to October 2026.

Our strong balance sheet supports investments in innovation and growth and positions Lear to quickly execute bolt-on acquisitions such as the pending acquisition of Kongsberg Automotive's Interior Comfort division expected to close in the first quarter of 2022. We continue to analyze additional organic and inorganic investments to strengthen both of our business segments. At the same time, we remain fully committed to returning excess cash to shareholders. In the third quarter, we returned $100 million through continued share repurchases and a doubling of our quarterly dividend of $0.50 per share.

Slide 20 provides the assumptions for global vehicle production volumes and currencies that form the basis of our 2021 full year outlook. We based our production assumption on several sources, including internal estimates, customer production schedules and IHS forecasts. Due to the ongoing supply disruptions, we expect full year 2021 global vehicle production to be roughly the same as 2020 and generally in line with the most recent IHS forecasts. From a currency perspective, our 2021 outlook assumes an average euro exchange rate of $1.19 per euro and an average Chinese RMB exchange rate of RMB 6.46 to the dollar.

Slide 21 compares our updated outlook to our prior outlook for sales and core operating earnings. We are reducing our outlook to reflect the impact of significant additional reductions in customer production schedules that have resulted from continuing component shortages. We are forecasting sales in the range of $18.8 billion to $19.2 billion and operating income in the range of $750 million to $850 million. Our 2021 outlook for core operating earnings at the midpoint was down $215 million to $800 million, primarily reflecting lower volumes and modestly higher commodity costs, partially offset by net performance improvements.

Slide 22 highlights a more detailed view of our updated financial outlook. Despite the reduction to our revenue outlook, we are projecting the company to deliver full year growth over market of approximately 8 percentage points. This reflects both the strength of our new business backlog as well as our strong customer program and product portfolio. Adjusted net income is expected to be in the range of $420 million to $500 million, down $180 million at the midpoint from our prior guidance, reflecting lower sales.

Our outlook for free cash flow for the year is expected to be approximately $175 million, which is lower than our prior outlook by $250 million, reflecting both lower earnings and higher working capital. Full year free cash flow could be further impacted by continuing production disruptions, which may lead to temporarily higher working capital. While our outlook reflects our best insight into customer production plans for the remainder of the year, the production environment remains volatile. As we've done in the past, we plan to provide an update on our financial outlook during an investor conference in early December, reflecting any new developments in industry conditions.

Now I'll turn it back to Ray for some closing thoughts.

Thanks, Jason. Nice job. Please turn to Slide 24, where I will conclude with some thoughts on our 2022 operating environment. While it's too early to provide guidance for next year, we thought this slide might be a little bit helpful to indicate what trends we are tracking. There are many positive drivers as we head into next year and beyond. Most importantly, customer demand is strong and dealer inventories are extremely low. This positions the industry for a strong recovery once we get beyond the short-term supply constraints.

We have a strong product lineup which is driving new business wins. We are laser-focused on driving operational excellence and improvements that we have made in both business segments this year will support margin improvements going forward. The challenges are very similar to those we've faced over the last few quarters. Limited visibility on production schedules, commodity and labor inflation and supply chain disruptions are expected to continue to impact the auto industry into 2022.

While no one in the industry is immune and is difficult to predict when production volumes will normalize, I know that we have the right team and we have the right strategy in place to capitalize when the industry conditions do improve. The strength of our balance sheet, along with the cash-generating capabilities of our business will continue to provide us with financial flexibility to support investments in our business while returning capital to our shareholders.

In closing, I want the team to know how proud I am of their performance and for focusing on the things we can control. And now we'd be happy to take your questions.

(Operator Instructions) Your first question today comes from Joseph Spak from RBC.

Jason, you previously, for the third quarter, talked about 22% to 24% decrementals on the lowered sales guidance and third quarter came in a little bit better at 13%. So -- and you talked about some of the better performance. If I compare your new implied fourth quarter guide versus, I guess, what you were previously expecting for the fourth quarter when you last reported, it's also that same sort of 23% decremental on the lower sales. So that sort of same range you previously indicated for the third quarter.

I'm just wondering, is there something in the fourth quarter that would prevent you from coming in better than you did like in the third quarter. I just want to try to understand the operational differences between the fourth quarter and the third quarter.

Sure, Joe. Yes, there's a couple of things going on here. So part of the performance in the third quarter was a result of commercial negotiations that we had anticipated in closing in the fourth quarter. And so we had a little bit of timing benefit from that in Q3. In addition to that, because of the deteriorating outlook, we had some reductions in our incentive compensation accruals. And so that benefited the third quarter and won't in the fourth. Those are the 2 primary factors.

To a lesser extent, the mix of programs that we're running in the fourth quarter versus the third quarter is a little less favorable for us. So the volume component of the change in guidance has a little higher downward conversion in the fourth quarter than the third quarter.

Okay. Is there any way to quantify the commercial benefits or the incentive comp to the third quarter?

It's about $20 million of favorability in the third quarter that is offset as $20 million of unfavorable performance in the fourth quarter.

And then just on -- Ray, thanks for the strategic color on Kongsberg. I guess just a couple of points here. I know they also sold to your competitors. I'm expecting that won't change as selling between seating suppliers is pretty standard. But if you could just confirm that. And then I guess, more importantly, it looks like they are running negative mid-single-digit margin. So how quick do you think you can get that business profitable with Lear's scale and some deal synergies?

Yes. To answer the first question, obviously, this isn't our first acquisition where we've had vertical integration in the supply base today, we buy components and share components with some of our competitors, and there hasn't been significant shifts in revenue even post acquisition. So I think that's a very low risk, if any risk at all.

The way I look at the opportunities to -- and Kongsberg has done a nice job and they're struggling with some of the same issues that we're all struggling with this year. So I think some of that's just temporarily putting pressure on the margins. But when I look at the opportunities when we can get into leveraging our purchasing strength, our operational strengths, how we look at the business and be able to scale it and help out with some of the scale issues, I think it's going to be a relatively quick turnaround. I mean that's -- when I say quick, I think 6 to 12 months, we'll have a good idea of what we need to do. We -- and I want to take another step back too. And we've put a team in place. Frank Orsini is here, President of our Seating business.

And we've been looking at this for quite some time. We've been studying the products. We've been looking at areas of opportunities where we can really dive in and get a CTO, which is VAV cost technology optimization. So we're already in the works. I mean we're working on different solutions, different ways to make the system more efficient and drive value longer term. And so I don't see that as a long-term issue. I think it's more short term given some of the economic climate that we're facing today, but more importantly, some of the things that we already have in process before we take over day 1.

So just to follow up on Ray's comments on the margin part of your question. So we do expect some modest margin dilution in Seating next year as a result of what you observed there. We also are going to make some investments to integrate that business. And as Ray said, we see a pretty quick turnaround in terms of that margin performance. And we see over a 2-year period that that margin becomes accretive to Seating modestly as well.

The structural margin of the products in the Kongsberg business are very similar and perhaps, in some cases, a little bit better than our underlying seat business. And so as a result of the combination of product synergies, operational synergies and purchasing synergies that Ray described, we think that just the underlying structural margin of that business will be at or above seat margins over time. And that's before even talking about revenue synergies that we see.

Our next question comes from Dan Levy from Crédit Suisse.

So I'd like to unpack first the growth over market. Maybe you could just give us a sense of what's driven this. And I'd point to, especially in Seating, it seems like you're tracking well over 10 points growth over market for the last 4 quarters. Is this all -- I know mix should be favorable, but is it all favorable mix? Or are we seeing share gains or incremental vehicle content to reflect that figures? So just maybe give us some color on the growth over market that you're getting, especially in Seating.

A portion of it is market share gain. Our backlog in Seating this year that we announced at the beginning of the year was $550 million. At current volumes, it's about $500 million. And so that's a key factor contributing to that growth over market. But it is also the product mix, the strong production and GM's full-size pickups and SUVs relative to the market and other platforms in North America on the luxury side with Mercedes, for example.

And then just generally, I think the luxury market in Europe and in Asia has held up better than the general market as customers have prioritized their most profitable vehicle lines. And with our #1 position in luxury, we've benefited from that. I think if you look out to next year in a constrained production environment, I wouldn't expect that to change much. And so we should see some continued benefits from that product mix that we had.

Great. My second question is on margins. And maybe you can just give us a sense of if you -- if we just set prices to where they are today, what's the commodity hit into next year? What's the type of -- the magnitude of cost inflation that you're seeing? I think on the last call, you said, it's $100 million of incremental commodities. And just, I guess, maybe more broadly on the margins in '22. I know margins are generally going to be a function of the volume levels and also what's happening on the cost inflation side. Should -- what's the early sense for the type of pace of margin recovery we're getting -- we'll get in 2022? Is this going to ramp on a linear basis depending on volume levels? Or are there other recoveries or efficiencies that could enable better margins sooner so that there's not a large asperity between the entrance and -- the entering and exit rates that you're going to have on margins?

Yes. Dan, it's -- at this stage, obviously, it's difficult to call a margin for next year. And as you pointed out, volumes are going to be the biggest driving assumption there. But we will -- we do expect if commodity costs remain at the same level they're at here in the fourth quarter where steel is at record highs, particularly in North America, leather hide prices are a little bit higher, chemical prices are a little bit higher.

As we look at a full year impact of that next year, we would expect that, that'd be about $130 million headwind for Seating. Now on the positive side, we do expect about half of that to be offset by the lag in recovery from commodity cost increases that we saw this year. So we do see some headwind on commodities year-over-year in seating as a result of that, less so in E-Systems where the vast majority of copper is passed through.

The other factors to think about next year is we have very strong backlog rolling on. Would we announced our backlog earlier this year for '22, we were calling for $1.175 billion in additional revenue next year from our backlog. Our latest estimates of that have a tracking closer to $1.250 billion. And that backlog will roll on at normal segment margins. So from an exit rate standpoint, that will be modestly accretive to margins in both segments next year.

In addition to that, if you look at the operating performance of both segments this year, they both generated significant positive net operating performance. That means all the cost reduction activities, commercial negotiations, supplier negotiations have significantly exceeded our customer price reductions and labor and overhead inflation.

We expect that to continue next year, perhaps not at the same accelerated pace that we saw this year where we've seen roughly 100 basis points of net operating performance in both segments, but we do expect to see some continued benefit from that as we look out to next year. I'd say those are sort of the key drivers.

Again, one additional point, Dan, on E-Systems. We're continuing to grow our connection systems business. That was a business that was around $450 million in sales in 2019. It's going to be a $600 million business based on our current volume outlook for next year. And every $50 million of business we're rolling on in that space is 10 to 20 basis points accretive to E-Systems margin. So that's an important catalyst as we look out to next year and beyond.

Just to clarify, for the quarter and year-to-date, the magnitude of headwinds from cost inflation or inefficiencies aside from just general production.

Yes. So in both segments, it's been running around $15 million to $20 million a quarter. And in Seating, that was a number that was very similar to last year, and E-Systems was about $12 million higher what we experienced in the third quarter where the trapped labor costs are more difficult to -- in a short notice volume reduction by our customers. So that's -- it has an impact on the E-Systems. It was a little greater proportionately than Seating.

Our next question comes from Colin Langan from Wells Fargo.

Can we just actually quickly go for the commodity headwinds again? It's -- is the guidance still around $135 million, up slightly from that for this year? How should we think about it sequentially in Q3 to Q4? And just to clarify, you said $130 million next year with half of that probably getting [lag] recovery.

Right. Yes. So in terms of the impact on this year, Colin, it's $185 million, so roughly $40 million in the first half and $145 million in the second half of the year. And as you look across from the third quarter to the fourth quarter, there's about $30 million of incremental commodity costs in our Seating business. E-Systems, there's not much changed from the third quarter to the fourth quarter.

And so what you're seeing there is steel peaking in the fourth quarter. We've locked in prices for the fourth quarter. Over the last 4 weeks, the crew index has come down modestly. And so we're expecting that to continue somewhat as we look out to next year, but that is an increase on a net basis for us in Seating sequentially.

In addition to that, high prices coming off of all-time lows has an impact on the fourth quarter, and we expect that to continue into the first part of next year. We have pass-through agreements on nearly 100% of that business. So that is a temporary phenomenon that will work itself out. And then the timing of that pass-through is anywhere from as little as 3 months to as much as 12 to 18 months, but mostly sort of 6 to 9 months lag. So that's the other factor as we look throughout this year and into next year.

And just as a follow-up. You think you just said commodities in Seating up $30 million quarter-over-quarter. When I look at your full year sort of the midpoint of the guidance, maybe I'm doing this wrong, it looks like sales and margins are up sequentially, which I guess would be a bit surprising if you have that. So it's up despite the increase in commodity costs sequentially and what would be driving that improvement?

Yes. Well, the main driver from the third quarter to the fourth quarter is volume. So our revenue at the midpoint in Seating would be about $300 million higher, a little less than that, than the -- fourth quarter would be about $300 million higher than the third quarter. So that's the single biggest factor sequentially driving that that's helping to offset commodities. So it's something like 150 basis points sequentially in volume offset by 90 basis points in commodities that drive the modest improvement in operating margins in Seating in the fourth quarter versus the third.

Our next question comes from John Murphy from Bank of America.

I think a lot of the walk stuff that I was going to go through has been hit here for 2022. But I guess maybe just a mid- and long-term question, as you're making the Kongsberg acquisition and making more acquisitions, it came a little bit more bolt-on than usually transformative, but then become transformative like Eagle Ottawa over time. So they're really good things. I mean as you think about the potential for content on an EV versus an ICE, it's often thought that E-Systems is where the big upside could be. But it seems like what you're indicating now is that over time you think that there's a mix opportunity here on Seating. So maybe in both segments, you can give us sort of your thoughts about where this potential content is going to go in both Seating and E-Systems as we transition to more EV vehicles over time.

Yes. We've been discussing this for some time and actually have been working on intuitive seating, as you're aware, for well over 6 years, 6 to 8 years. And we do believe that this trend of much better, smarter, more sophisticated seats is going to be the trend as we move forward. And if I take a step back, this is just the next evolution within that with the acquisition of Kongsberg. We've designed systems that, from a thermal comfort perspective, the draw -- and these are my own estimates, given some of the information I've gathered for our HVAC system draws 20% of the battery life.

And so if we can design and that's the intent is design a much more efficient seating system that heats and cools the occupant at the surface within the seat, you can, obviously, increase range and increase efficiency within the vehicle. And we do believe that, that's a very important trend for our customers and consumers. And so we've been working on that. We've, obviously, done a significant amount of work. We're recognized with our partnership with Gentherm and we do believe that's a trend. I think health and wellness is another step when you talk about massage systems within the seat system and how you can help out consumers be more alert, much more aware, anticipate things, particularly as you get to vehicles that are much more engaged with autonomy.

So we believe that there's going to be a greater need and more content within the seat around autonomy and sophistication within the vehicle. And dynamic safety is something that we've talked about significantly where the seat can actually help protect you in the event of some type of collision, both rearward and frontward.

So there's a number of different things that we've been working on and develop and have patents around within that space, and we believe that content is going to increase. And so if you think about a Kongsberg, for example, we talk about the short term, there's short-term things and Kongsberg is a great company. It's great to welcome in the Lear family, but we see a much longer horizon without those capabilities, where midterm, we believe the efficiencies that could be designed within those different contexts as far as -- today, all those systems are designed independently.

So design for manufacturability is just at the last moment with the seat designer to plug in all these different systems. There's multiple harnesses, connectors, valves, pumps, motors, it's the most, to me, inefficient system I've ever seen. And I think it makes so much sense to take those components with our architecture capabilities with software and with wiring capabilities, combine them with our seat capabilities and make a much more efficient system.

Longer term, I think, to your point is, you can see we're -- always are turning on features as a service and charging the customer if it's heat and cool or if it's pneumatic lumbars or lumbars, if there's a design, and our intent is to design a much more efficient packaging solution that then can be placed into every seating situation within the vehicle, not just fronts, but rears and then go across multiple vehicles, not just luxury.

And so I do believe that that's absolutely a trend that we're going to see continue. I think the supplier that solves that problem is going to be in a great position, and I believe it's going to be Lear and we're focused on it and have been focused on it. So I think we're just at the start of these trends within seating. And I also think we ConfigurE+, I think that's something that we've done an incredible job. I think this reconfigurability with power solutions with safety protocols is picking up incredible momentum.

As you transition to electric vehicles, our rails package perfectly into a flat low floor. And so the amount of features that now can be interchangeable within the vehicle. And now it's $100 million today, we do believe it's going to be $500 million worth of revenue here in a short period of time. And we just got a brand-new contract with a great customer in Europe that's looking at how they can take that across multiple platforms. So I think that's another content, CPV sector growth story for us. And then electrification, we've talked about. I'll tell you, we have $250 million of awarded electric -- high-power electrification right now. That's 20% higher than what we were awarded last year and we still have 2 months left in the year to win more business. That continues to grow.

Our backlog in quoting programs is higher than it was last year. So the backlogs are very strong. We've talked about power distribution. With the continuation of high-power solutions with terminals, connectors, why it's so important for us and why we -- and I believe we've been incredibly successful, like Jason said, from $450 to $500 million, $600 million next year in connector systems. These partnerships that we're establishing with battery chargers and with high-voltage connector solutions in IMS with flat wire solutions is perfectly aligned with content growth. And so we -- I believe we have a number of different secular growth stories that are key to our future, and we're perfectly aligned as this shift from ICE goes and changes over to electric vehicles.

Our next question comes from David Kelley from Jefferies.

This is Gavin Kennedy on for David. You guys mentioned that commodity and labor inflation would be a challenge in '22. Can you provide some more details on how you're thinking about labor specifically? Are you -- is your team seeing labor shortages today? And any thoughts you have on how the shortages might impact '22 and the labor assuming we see a recovery in LVP?

Yes. Labor has been a challenge. There's no question about it. As far as -- I think it's generally -- it's across every industry. And we've done different things with incentives and different compensation packages to work with different regions around having employees in the facilities. But it has been a challenge. I think it's going to continue to be a challenge. I think we're looking at different creative solutions not just compensation, but to make sure that we're working with our employees around the world to make sure they build value.

I mean that's the big thing is making sure our employees feel valued and that they understand the importance of why they're there, and we're listening to some of their concerns around what they may need. And it's not, like I said, all compensation. There's other things that we're trying to do with shift changes, allocating different times that workers could come in, being very flexible and listening to different employees.

And it is dependent on regions, too. I mean North America is significantly different than Mexico. We don't have a significant issue relative to year-over-year in Mexico. It's more here in North America. Europe has some issues and struggling. Asia, we're not seeing significant issues. So it is more regionally focused, too.

In terms of the impact on the outlook for '22, I would say it's fairly modest. So the biggest shortage is -- most costly shortages are more in the U.S., where we have a very relatively low employment level. And so I wouldn't say it moves the needle in terms of the operating margins in either segment, although it is a challenge, as Ray described, as we look out not just the balance of this year but into next year.

Got it. And then switching gears in the connection systems business, it was good to see that Lear is still on track for around $600 million in '22. Just I was hoping you can provide some more commentary on how the recent JV with Hu Lane fits into that connection system business. And then alongside the M&M Plastics (sic) [M&N Plastics] acquisition, would you expect further M&A in connection systems going forward? I know you touched on you would look at it across both Seating and E-Systems, but I didn't know if you had any additional commentary here.

Yes. The M&N acquisition has far exceeded our expectations already. It's amazing how quickly we've been able to integrate that business. It's a great business and been able to vertically integrate revenue opportunities and grow that business. And so that's been a great acquisition. And again, remember, that was primarily North America. So now we're taking those great capabilities to Asia and Europe. And I think those are our own directed components where we can source ourselves. So we have opportunities to grow that relatively quickly.

With the joint venture, what that does is it opens up a catalog to us that we actually get to now share different resources. Some of the limited growth that we are looking at within Asia was limited to the catalogs and the approval within those catalogs. So that I believe is going to be a great opportunity for us to not only expand our breadth of different customers. And remember, one of our focus was diversification of customer base. We're going to be able to do that relatively quickly. And also share best practices and ideas across different catalogs to grow our revenue.

And as far as acquisitions, yes, I would love to do more acquisitions in the connectors business. That gets us really good returns, great margin profile. I'm extremely proud in a short period of time, how quickly we've been able to grow that business. I know there's a lot of concerns around can we really get into low-voltage and high-voltage connectors business given our scale. And we've proven that we can.

And so if there's opportunities that we can have a tuck-in acquisition in connectors, I would absolutely look at that as an opportunity for Lear. And power distribution, I think, across the whole is really changing dramatically and been a real big growth agent for Lear. So we've been excited about the partnerships we have and the acquisitions we've had to date and like I said, I think we'll continue to exceed our expectations with growth within the connectors business.

Ladies and gentlemen, our final question today will come from Douglas Dutton from Evercore ISI.

Doug Dutton here on for Chris McNally. I just wanted to ask about capital allocation. So clearly, the balance sheet is in a strong position right now. I was wondering if management could discuss just a little how it's thinking about capital allocation going forward. We were excited to see that $69 million buyback in Q3, but there's been a history of higher buybacks prior. So with the stocking about 8x '23 cash flow, we were just curious if it makes sense to drive a stronger accelerated buyback or how you go about thinking about that.

Yes. And we remain committed to returning excess cash to shareholders. I think if you look at the third quarter, it's the perfect synopsis of our view on capital allocation, modest tuck-in acquisitions and returning excess cash to shareholders through a growing dividend and share repurchases. And so to the extent industry conditions allow for improvement in the free cash flow generation profile of the business, we very much would like to continue buying back stock and returning excess cash to shareholders.

And so as you look out through the remainder of this year and into next year, we're very committed to doing that. We're in active discussions with our Board. Ultimately, that's a Board decision, but we've had great support from our Board in that regard, and I would expect that to continue.

Okay. Just real quick, I'm sure it's just Lear people on phone now, but I just want to say a couple of words. First of all, Kongsberg, welcome to Lear family. I know we still have got some more work to do here, but it's great to have you part of the Lear family, and I know we're going to do great things together. So looking forward to continuing to grow that business and continue to move in the right direction.

And to our partners, Hu Lane and Shinry, looking forward to those partnerships, they're great partnerships. I know we're going to both be able to be successful and grow our business. And to the Lear team, I can't thank you enough staying focused on the things we can control. We're moving in the right direction. We have the right strategy. We have the right plan. The short-term issues will be behind us at some point. And we've positioned this company for long-term success.

So I want to thank you for all your hard work and what you're doing. So I appreciate all your efforts. That's all I got, thanks.

Ladies and gentlemen, with that, we'll conclude today's conference call. We do thank you for attending. You may now disconnect your lines.