Lear Corp (LEA) 2021 Q2 法說會逐字稿

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

At this time, I'd like to turn the floor over to Ed Lowenfeld, Vice President of Investor Relations. Please go ahead.

Thanks, Jamie. Good morning, everyone, and thanks for joining us for Lear's Second 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 up the call for Q&A. You can find a copy of the presentation that accompanies these remarks at ir.lear.com.

Before Ray begins, 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 second quarter financial results and our full year 2021 outlook. Finally, Ray will offer some concluding comments. 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. If you could please turn to Slide 5. I'm going to provide a brief overview of our second quarter financial results.

In a very challenging environment marked by component shortages and significant production disruptions, the Lear team delivered solid results in the second quarter with sales of $4.8 billion and core operating earnings of $233 million. Our financial performance improved significantly versus last year when the global pandemic led to extended production shutdowns in North America and Europe. Adjusted operating margin in the second quarter was 4.9% and earnings per share was $2.45.

Slide 6 provides some business highlights from the quarter. I'm very proud of what the team accomplished. For the second quarter in a row, we successfully navigated supply chain shortages and related customer production shutdowns. Lear's sales growth outpaced the industry by 11 percentage points in the second quarter. We continue to focus on executing our strategic plan, which includes developing innovative products and technologies across both business segments and investing in our manufacturing operations to extend our competitive advantage and operational excellence. Our backlog is growing, driven by new business wins in both Seating and E-Systems. I will comment further on some of these product wins on the next few slides.

We are honored that Lear was named as General Motors' Supplier of the Year for the fourth consecutive year and for the 20th time overall. In addition, we received an Overdrive award from General Motors for developing innovative second-row seating functionalities in GM's full-size trucks and creating a Lear Safe Work handbook and sharing it with the industry. In May, we released our updated sustainability report, highlighting our growing portfolio of green technologies, achievements in diversity, human rights and governance and our ambitious climate change goals.

During the quarter, we began to repurchase shares for the first time since suspending share repurchase in early 2020. We spent $31 million on share repurchases in the quarter. And since the end of the quarter, we have repurchased an incremental $40 million worth of stock. Our balance sheet and financial flexibility remains strong. And over the last few months, Moody's and Fitch upgraded Lear's credit rating outlook. With respect to capital allocation, we have a balanced plan that includes organic investment, inorganic investment and returning excess cash to our shareholders.

Turning to Slide 7. Our Seating business performed extremely well despite challenging industry conditions. Our sales grew well in excess of the market, reflecting our strong position in SUVs, CUVs and luxury vehicles.

And margins remained strong despite significant downtime across the industry. In Seating alone, production downtime in the second quarter related to semiconductor shortages reduced our sales by approximately $660 million or 15%. Despite the lower volume and the unpredictable schedules, Seating posted 7.3% adjusted operating margins, demonstrating the strength and resilience of this business.

We continue to move forward on key launches in the quarter, including the Ford Bronco where Lear was awarded a full-service supply contract and is responsible for designing and engineering the complete seat system. We also are excited about the new plant we are building in Detroit to supply seats for General Motors battery electric truck programs. This plant is expected to be one of Lear's most energy-efficient plants in North America. Awarded battery electric truck programs to date include the GMC Hummer EV pickup and the GMC Hummer EV SUV.

Slide 8 highlights our E-Systems business where innovation and technology is driving new business awards and receiving industry recognition. Earlier this year, 2 new products designed by our E-Systems team were named PACE Award finalists. First, the battery disconnect controls all power switching in and out of the battery pack. Lear's new design incorporates breakthrough thermal management innovations, which improves the efficiency of large and high-performance electric vehicles. The first commercial application of this technology will be launched later this year on the GMC Hummer. In coming years, we will be bringing our BDU to market on multiple derivatives on GM's Ultium platform, including the Chevrolet EV Silverado. We also are pursuing opportunities on strategic EV platforms with other customers.

Secondly, Lear's 5G V2X telematics control units removes the need for shark fin external antennas on many vehicles today by integrating up to 10 antennas into the printed circuit board. Our design reduces complexity and improves 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 are designing and developing electric architectures for autonomous vehicles with 2 major OEMs. The amount of electrical distribution content in these vehicles far exceeds anything we have previously produced.

Our quoting pipeline across the E-Systems business is strong. In addition to the high-voltage opportunities related to growing EV market, we also are seeing significant business wins on the low-voltage side of our business. Increasing features continue to drive higher circuit counts, which we expect will more than offset any wiring content reductions related to optimized architectures. We continue to make progress winning business on electric vehicles with 55% of our year-to-date awards on EV platforms.

Our connection systems growth plan is on track. Year-to-date, we have won an incremental $45 million of commercial and vertical integration awards. Through a combination of vertical integration, new business awards and the M&N Plastics acquisition, we are expecting this business to grow in a 10% CAGR from 2019 to 2022. We continue to pursue additional acquisitions or partnerships in connection systems to accelerate our growth. The recently announced IMS Connector Systems partnership will increase our access to specialized high-speed data connectors, which will prove more important as vehicle data requirements continue to grow.

I am very confident about the long-term growth prospects in E-Systems. Our backlog is strong. Content opportunities are growing, and we remain on track for 6 percentage points of growth over market for the next several years.

Now I'd like to invite Jason to review our second quarter financial results and full year outlook.

Thanks, Ray. Slide 10 shows vehicle production and key exchange rates for the second quarter. During the second quarter of 2020, industry production in North America and Europe was negatively impacted by extended COVID pandemic-related shutdowns. While second quarter 2021 industry production volumes rebounded from 2020, total production in the quarter was negatively impacted by component shortages, particularly those related to semiconductors.

Global vehicle production in the second quarter increased by 51% compared to 2020. On a Lear sales weighted basis, global production increased by 72%. From a currency standpoint, the U.S. dollar weakened against our major currencies compared to last year.

Slide 11 highlights Lear's growth over market in the second quarter. Total company growth over market was a strong 11 percentage points, driven primarily by favorable platform mix and new business. While our Seating business benefited from customers prioritizing production of full-size truck and SUV platforms, E-Systems business mix was disproportionately impacted by supply chain disruptions, particularly with some of the segment's largest customers and in China. New business in E-Systems in the quarter partially offset the impact of the supply chain disruptions.

Growth over market in North America of 24 percentage points reflected the benefit of new business in both segments and strong production on GM's full-size pickup trucks and SUVs as well as Audi, Mercedes and Hyundai SUVs. In Europe, growth over market of 10 percentage points is driven primarily by new business as well as strong performance in the luxury segment. Our China business lagged the market by 5 percentage points due to lower volumes on our key platforms.

Slide 12 highlights our financial results for the second quarter of 2021 compared to 2020. Our sales increased 95% year-over-year to $4.8 billion. Excluding the impact of foreign exchange, commodities and acquisitions, sales increased by 83%, primarily reflecting increased production on Lear platforms and the addition of new business. Our customers experienced significant production disruptions, which reduced Lear's second quarter revenue by approximately $1 billion.

Core operating earnings were $233 million compared to an adjusted operating loss of $248 million last year. The increase in earnings resulted from strong operating performance, higher volumes, favorable platform mix and the addition of new business, partially offset by higher commodity costs and premium costs related to component shortages. Adjusted earnings per share were $2.45, up from a loss of $4.14 a year ago. We generated $120 million of free cash flow in the second quarter compared to a $611 million cash use in 2020.

Slide 13 explains the second quarter year-over-year variance in sales and adjusted operating margins in the Seating segment. Sales in the quarter were $3.6 billion, an increase of $1.9 billion or 106% from the second quarter of 2020. Excluding the impact of foreign exchange, acquisitions and commodities, sales were up 95%, reflecting higher production and the benefit of new business.

Core operating earnings were $262 million, up $364 million from the second quarter of 2020. Higher volume on Lear platforms, positive net operating performance and margin-accretive backlog more than offset the impact of higher commodity costs during the quarter. Seating margins were 7.3% in the quarter despite lost volume of approximately $660 million or 15% due to semiconductor supply shortages.

Slide 14 explains the second quarter year-over-year variance in sales and adjusted operating margins in our E-Systems segment. Sales in the second quarter were $1.2 billion, an increase of 67% from the second quarter of 2020. Excluding the impact of foreign exchange, acquisitions and commodities, sales were up 51%, driven primarily by higher volumes and a strong backlog.

Customer downtime related to the semiconductor shortages negatively impacted E-Systems sales by $360 million or 24% in the second quarter. Core operating earnings were $41 million or 3.5% of sales compared to adjusted operating losses of $91 million in 2020. The increase in earnings resulted primarily from higher volumes, net operating performance and margin accretive backlog.

Beginning on Slide 15, I will discuss some key drivers impacting our updated 2021 financial outlook. While our financial outlook in May reflected significant customer downtime due to component shortages, the extent of the disruptions worsened considerably in the last several weeks of the second quarter and has continued into August. We expect to see modest improvements in the production environment starting in September with a gradual improvement continuing throughout the remainder of the year. However, the production environment remains volatile with continuing impacts from government-mandated shutdowns due to COVID-19 in certain markets and lingering effects of very low inventory levels of various components, particularly semiconductor parts. Based on the most recent customer announcements, we are lowering the midpoint of our sales outlook by $650 million versus what we expected when we provided our earnings outlook in May.

Slide 16 highlights the recent run-up in steel costs, which is another factor negatively impacting our 2021 outlook. The chart shown here illustrates the trend in U.S. hot rolled steel prices as indicative of the broader impact rising steel prices are having on our operations, which is a combination of hot and cold rolled steel globally. Except for a few short-duration price spikes, the U.S. hot rolled steel costs have remained in the $400 to $700 per ton range for the last 4 years. Steel prices began to rise late last year and have continued to break records each month in 2021.

Historically, the typical spike above $900 has lasted 2 to 6 months. We're now 7 months into the current cycle.

We were somewhat insulated from higher steel prices in the first half of 2021 due to advanced contracts which were negotiated late last year. However, in the second half of the year, we are experiencing significant headwinds from higher steel prices. As a point of reference, steel prices are $600 to $700 per ton higher than industry experts were expecting back in May when we issued our prior financial outlook.

Slide 17 summarizes the changes to our global industry production outlook, which reflects ongoing production disruptions due primarily to semiconductor parts shortage. At the high end of our outlook range, we're projecting second half production to be lower than what IHS is projecting by about 3%, reflecting customer downtime announced in late July and into August. The midpoint and low end of our outlook reflects -- range reflect additional production downtime beyond what has been announced to date. We have included more detail about our assumptions for global vehicle production volumes and currencies that form the basis of our 2021 full year outlook on Slide 25 in the appendix section of the presentation.

Slide 18 shows our revised range of sales and operating earnings outcomes for the full year. On the sales side, the range of outcomes is dependent primarily on the extent of future unannounced production disruptions while on the operating earnings side, the range is dependent on the extent of future production disruptions, customer mix and the timing of commodity cost recoveries. Given the uncertainty in production schedules, I also want to briefly touch on what we are expecting for the third quarter. At the midpoint of our outlook range, we are expecting sales to be less than $4.7 billion, reflecting chip-related production disruptions impacting many of our higher content platforms as well as normal seasonal downtown in Europe. For core operating earnings, the midpoint of our outlook is $150 million, which reflects the impact of higher commodity costs and unfavorable platform mix. We expect the third quarter to be the low point for revenue and core operating earnings, reflecting the impact of production disruptions and higher commodity costs.

Slide 19 compares our updated outlook to our prior outlook for sales and core operating earnings. We are forecasting sales in the range of $19.7 billion to $20.5 billion and operating income in the range of $920 million to $1.11 billion. Our 2021 outlook for core operating earnings at the midpoint is down $210 million to $1.015 billion, reflecting lower volumes and higher net commodity costs.

The economic recovery as well as supply chain shortages has driven higher commodity costs across the board, including for steel, foam chemicals and resins. Transportation costs have also been impacted. The impact of higher commodity costs will be partially offset by continued strong operating performance in both business segments. The total company year-over-year impact of higher commodity costs is forecasted to be approximately $175 million. We continue to work with our customers and suppliers to mitigate the impact of the higher steel and other commodity costs through commercial negotiations, leveraging our scale, VAV and other specification changes and alternative sourcing. Our detailed 2021 financial outlook is shown on Slide 26 in the appendix.

Slide 20 summarizes the key factors that will impact Lear's longer-term financial outlook. Despite the near-term supply-driven challenges, we're very optimistic about the next few years. Global industry demand remains strong and when coupled with preferable inventory levels, we expect production rates will grow significantly over the next several years. We also anticipate that commodity costs will moderate over time as supply and demand imbalances are addressed. COVID premiums should also diminish as we enter 2022, despite the recent uptick to the Delta variant as more of the global population gets vaccinated.

The increased penetration of electric vehicles, where we are seeing the premium names at the forefront, will provide additional opportunities in Seating, where we are the luxury market leader. Our E-Systems business is also positioned to benefit from higher content related to electrification and the proliferation of other safety and comfort features.

Looking at the items Lear can control, our strong backlog and focus on vertical integration has allowed us to generate strong cash flow and margins despite the recent challenges. We have plans in place to enhance margins in both segments through increased vertical integration, development of new innovative products and continuing to separate ourselves as the leader in operational excellence through increased investment in our manufacturing facilities. In addition, we have plans to make inorganic investments in both business segments, which will provide additional opportunities to drive incremental growth and higher margins.

Now please turn to Slide 21 where I will briefly talk about our balance sheet and liquidity. Our strong balance sheet and free cash flow generation support investments in innovation and growth and positions Lear to quickly execute bolt-on acquisitions to increase our vertical integration capabilities in both businesses and execute our long-term growth strategy. At the same time, we remain fully committed to returning excess cash to shareholders via dividends and share repurchases.

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

Thanks, Jason. Nice job. Turning to Slide 23. I'm so proud of the team's performance this quarter and for executing our plan in the face of the component shortages and significant production downtime. While continuing -- continued supply chain volatility is driving uncertainty in the near term, I remain confident that Lear is well positioned to benefit from the industry recovery we expect over the next several years. Our financial position is strong, and we will continue to make investments to strengthen both business segments while returning excess cash to shareholders. We are laser-focused on executing our strategy to drive profitable growth and deliver superior returns to our shareholders.

But before -- well, I do want to pause for a moment before we move on to questions. And I do want to take the time to recognize our team in Mexico that arranged for thousands of COVID-19 vaccines to be provided to Lear employees, family members, Juarez residents and employees and other suppliers a few weeks ago. The team transformed our plant parking lots and open warehouse spaces into vaccination centers and coordinated the inoculation of over 25,000 people over the course of a week. I think this is just another example of the great work our teams are doing around the world to support the communities where we live and work, and I do want to say thank you for all your hard work and the great work that you've been doing.

And now we'd be happy to take your questions.

(Operator Instructions) And our first question today comes from Colin Langan from Wells Fargo.

Maybe we can talk about commodity costs. I think you said it's $175 million. That's the cumulative year-over-year hit in your guidance. How much is it year-to-date? I think I'm coming out with something closer to $50 million, so that means quite a bit in the second half. But maybe my numbers are wrong.

And can you just remind us what is sort of the hedging offsets that might be coming? Sort of how much of your business is hedged? And any thoughts on how this might run into 2022 from a commodity side?

Sure. Starting with the cadence of the commodity impact. So it's $135 million for the full year. About $40 million of that was in the first half and $95 million of that is in the second half, largely driven by the run-up in steel and the fact that we had locked in much of our buy in the first half of the year.

In terms of hedging, we don't do much in terms of hedging either of steel or of copper. Our best hedge really is our commercial agreements with our customers. So on the copper side, about 90% of our copper buy is on an indexing or pass-through agreement with our customers. In some cases, there's a 3- or 6-month lag, but most of it is passed through quite quickly. On the steel side, about 85% of our buys are insulated either by customer agreements or where the supplier owns that buy, and about 15% of that is our exposure.

In terms of what we see going into next year, it's a bit early to talk about guidance for next year. But certainly, we're exiting the second half of the year at a higher rate for steel than we started the year. So I would expect there to be a cost headwind for that. On the recovery side, because of the lag in some of the recovery on steel, we'll see a benefit next year that will partially offset that.

In terms of copper, we see the low point or the most significant impact in the third quarter, and that improves in the fourth quarter, again, as the pass-through mechanisms take effect. And I wouldn't expect a meaningful impact next year for copper. Copper has come down off of its all-time highs, which I think were reached in April or May of this year. And so we would expect, if anything, maybe a little bit of a tailwind on copper.

Got it. And when I look at the guidance reduction, I mean, the decrementals at the midpoint seems to be like a little over 30%, which seems a bit high. But other than -- I guess it looks like -- you said $95 million increase in commodity. That would make that decrement under 20%. Any other factors you'd be thinking about that would impact how we think first half to second half decremental?

From the first half to the second half, yes, there's 2 things going on. One is lower volumes. So if I look at our change in sales first half actuals to the second half midpoint, so reduction in sales of $130 million, there's actually an increase in sales for the commodity pass-through of about $55 million. And then volume mix and everything else is negative $185 million.

So convert that, it's about $40 million of operating income. Commodities are $95 million higher. That leaves about $10 million of favorable incremental operating performance sequentially from the first half to the second half.

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

This is Aileen Smith on for John. I'd like to ask a first question around the semiconductor shortage. Obviously, we heard from one of your major customers earlier this week, and they're really bearing the brunt of downtime in the second half, particularly on the truck side, where you have a lot of content, which is partially a function of them pulling forward some chips but then also COVID outbreaks that are forcing incremental downtime. Given there are some pretty wide indications on the production outlook in the second half of the year, how much of your outlook revision would you say is more attributable to that one major customer of yours versus what's the function of broader industry dynamics and all automakers getting hit to some extent?

Yes. So certainly, the announcement earlier in the week with one of our largest customers was a factor. But we're seeing something a little bit more pervasive, and so it's impacting all of our customers' production in the second half of the year. And really, what we see is sort of a continuation of the impact that we experienced in the second quarter.

In the second quarter, we saw an impact of about $1 billion in revenue. At the midpoint of our guidance, we're expecting a similar impact in the third quarter. So the second and third quarter sort of become the trough before it recovers in the fourth quarter. So it's not any one customer. It's really a pervasive issue across the whole supply chain.

Yes. Just to add to that. And again, I think this is an industry issue. And I think Lear has a perspective through E-Systems that's somewhat unique. Obviously, we're on calls daily with the microchip suppliers and our customers. And so we have unique intelligence and insight to kind of generally gauge what's going on across the industry and around the world.

And what started was -- as a wafer capacity constraint has quickly moved into the back-end processing of microchips. And the big issue today is the amount of downtime that's being taken with COVID-related cases and increases with shutdowns in the clean rooms in areas like Malaysia and Thailand. If you think about the microchip manufacturers, the majority of them do the back-end processing out of Asia. And so as they go down, and I believe there's a multiplier effect because there is no inventory in the pipeline in vehicles that are built up today that are requiring replacement parts, it impacts on a multiple level.

And so we're still seeing that. We're still seeing a number of key microprocessors and chip manufacturers that are having to go down for a number of different reasons. And so taking that into consideration, that really helped us understand what -- and how we look at the second half of the year, and it isn't one particular customer.

And our customers are much more sophisticated. I will say that the communication and dialogue we've had, they're much more sophisticated in respect to the chips, the chip needs. It's now become the back-end processing of the microchip. And I -- we don't see that dissipating. I mean Jason did a nice job of showing what's occurred over the last 11 weeks. Over the last 11 weeks, 10 weeks, we've received notices of continued downtime.

And so to me, it's 3 key points: one, the answer around real supply and demand with all the different releases that are in the system; two, when will the COVID-related items with shutdowns in the back end of the processors -- processing be alleviated; and then three, the time it's going to require to get back to more of a traditional inventory level. And so even though we're in a much better position than we probably were, believe it or not, several months ago, wafer production seems to be more stable. The sophistication level of how we're looking at chips, the thousands of chips that are required is much, much better.

And if we can get through some of these, like I said, COVID-related issues that are causing the back-end processing behind us, we should be in a better position. And that's why we're looking at this getting worse in the third quarter and then some improvement in the fourth quarter.

Okay. Great. That's very helpful color. And then I wanted to ask a bigger-picture question, particularly as we think about the government push on EVs with the Biden administration and Europe and China all heating up. I remember an important chart from the E-Systems Day a couple of months ago specifically referencing Lear's broad product capabilities across electrification with high-voltage wiring, connection systems, battery units, battery management systems and others and how it stacked up versus some of your competitors that only offer one or a few of these products to customers.

If the focus on EVs from automakers is ramping up in a pretty significant way, are you finding that your broad product portfolio is a key competitive advantage in the bidding process? And are you finding traction for winning multiple products at customers where you can offer a more holistic solution?

Yes. That's a great question. And I'm going to -- I have Frank Orsini here and Carl Esposito. I'm going to let them kind of, they're on the ground working every day, give some insight.

I will say this just before we get into this. We've won as much business to date in electrification than we did all last year. And so we absolutely are -- couldn't be more excited about the acceleration of electrification and our position and how we're differentiating ourselves in crossing over Seating. I think it's outstanding because there's some really cool things we have that we've patented and are very unique for electric vehicles. But I'm going to go ahead and let Frank and Carl take that one.

Sure. So from an electrification perspective, we really do see that broad portfolio as an advantage, not only in all the different types of products that we offer, but from a technology evolution, we also see a greater integration of those products. And so where a few years ago, there might be a separate onboard charger and a separate AC to DC converter, for example, 2 separate boxes, we're seeing those types of products integrate more deeply as the electronics, the power systems get more efficient and we can package those into smaller packages and more efficient products for our customers. So we definitely see that broad portfolio integrating and integrating in the ways of the products that we have for our customers.

We also get to take a whole system view of the electrification and the vehicles. Looking at the low-voltage wiring which is critically important in electric vehicle, the high-voltage wiring, the connection systems and all of the electronics that go into those vehicles and how can we package those more efficiently and more effectively. Not only from the electronics, from the packaging, the connection systems but also even, as Ray mentioned, the aerodynamics now with some of the things we're doing from integrating antennas on the vehicle and making the vehicle more efficient. All that leads to greater range, faster charging times and more performance for the vehicles, and that's what our customers are looking for.

Yes. From a Seating perspective, as Ray mentioned, we're really focused on innovation. We mentioned in the past we're laser-focused on a couple of key areas. Priceable features and content will remain a priority for us. And as you mentioned in your question, the EV platforms are great importance to our growth strategy.

So we have a technology called ConfigurE+. That's a PACE Award-winning technology, fully developed in-house at Lear. A little background on that. It's a powered reconfigurable, fully patented rail and cassette system. And the highlight of the technology is our seats do not have to be hardwired or tethered to the vehicle. The cassette itself, which is patented, allows us to connect to the power to the vehicle.

And the reason that's important is it gives us ultimate flexibility. And when you think about the EV platforms and the solutions required for EV platforms where flat load floor solutions become more important with battery packaging constraints and as customers redesign those floor strategies, our ConfigurE+ packages perfectly within those tight environment constraints.

So it really is an ideal solution for the EV market, and we've been very successful with it so far. We've been awarded over $100 million of business with 2 global OEMs. We're actually launching the platform right now with VW on the Bulli multi-van platform with VW. And over the next 5 to 6 years, we think it has the potential to grow in excess of $0.5 billion.

But we do have a number of active customer engagements going on right now. We have multiple RFIs with OEMs on a global basis. We're actually in one expert development phase on a North American EV platform with this technology. We're going to be shipping prototypes to some of our European customers early next year.

And we have one really interesting work stream that we're on right now with an OEM where they're looking at a daytime/nighttime application for a vehicle where, during the day, we could provide our ConfigurE+ system with our seats for passenger movements, ridesharing, things of that nature. And at the nighttime, we're working on a Lear cargo management solution that would adapt to the rails and cassettes, where we would serve to service them in a last-mile delivery scenario. So the vehicle could be used 24 hours.

So that's a pretty interesting technology for us. Again, those would ideally be EV platforms as well. So as Ray mentioned, it's going to provide a lot of opportunity for us, and we're very excited about what that looks like in the future.

Wish you could see the room right now because we all have smiles. We love what's going on with our technology innovation and our growth strategy. It's amazing on the E-Systems side what's coming at us, and I mentioned how excited we are around electrification. And this ConfigurE+ just has so many different applications, and it's exciting to be able to deliver that in electric vehicle in a very unique way that I believe will change the way you look at seating and cargo management. So really exciting stuff. Thanks for the question.

Our next question comes from David Kelley from Jefferies.

Just maybe to start, a follow-up on the earlier decremental second half margin discussion. I guess the schedule is clearly still touch and go. I think planning visibility seems to be low for everyone. So can you talk about the labor and plant efficiency specifically? And realizing you have your margin enhancement plans as well, but is there much opportunity to drive some efficiencies in the back half of the year given the ongoing choppy macro?

Yes. Certainly, that makes it more challenging, David. But I'll point out, and it doesn't really come through in the material we provided, but the operating performance in both segments this year is remarkable. And it's the most significant net positive operating performance, I think, we've ever achieved. And that's a testament to Frank's and Carl's teams and what they're doing day to day in the facilities.

Now in terms of managing the short-notice shutdowns, certainly, that does add labor costs to our operations. But we've taken measures to try and offset that. We're using attrition to lower our head count in our higher-labor content facilities particularly when you think about seat covers and wire harnesses that are very labor-intensive. That's the most significant step we can take, is really just lowering the head count and trying to rebalance to a lower production rate in the meantime and still being prepared for volumes to recover, which are coming back in the fourth quarter.

So there is some, call it, sticky labor, trap labor costs that we are incurring that make it more challenging. But despite that, both segments are generating significant operating improvements.

Okay. Great. And maybe one more follow-up. And I appreciate Slide 18 and kind of an initial look at the Q3 midpoint. I wanted to ask about the E-Systems margin trajectory, and clearly, we have rising input costs. But from a mix standpoint, should we start to see some improvements from the second quarter given your customer weighting specifically in North America?

Yes. We do anticipate some improvement in the mix of where the downtime is showing up in the E-Systems business. And perhaps it's going a bit in the other direction on the Seating side given the importance of General Motors to our Seating business.

Those volumes, for example, on a full-size truck and SUV are still going to be quite strong, but you heard the announcement that they made recently, is the downtime that's been taken thus far here in the third quarter. So that's going to put a little bit of pressure on the mix in Seating. But generally, on the E-Systems side, there is a modest improvement in mix as we look at North America second quarter to third quarter and in Europe, a little bit as well.

Our next question comes from Brian Johnson from Barclays.

I was struck by the strong seat margins relative to your largest competitor. Can you maybe go into some of the things -- and I know it's our job to analyze the competitor, but that led to better-than-feared, after yesterday's results from your competitor, performance in Seating. Is it just that you had platforms that were less up and down? Is it that you're less exposed to metals? Do you have better recovery mechanisms? Or what was it?

Well, I think -- I'd like to take this one. One, I think it's years of the work and the investment we've put in Seating. And we've been investing in that business well over 10 years with the improvements we've made with capital, with our layouts, with our plants, the investments that we've made in getting very granular in the details of return on invested capital by product and having those tough discussions with the customers to fix the business going forward.

And that took place over 10 years. And I do think that's really a credit to the seat business today and the hard work that they're doing. It is incredible how they're performing given all the different unexpected downtime and the downtime that they are being hit with.

And I also think a big part of it, we've talked about this, we find structures and metals to be, importantly, a core competency but we didn't grow it at all cost. We maintained a relatively good size of structures business because of these type of situations. And so I do think that helps us significantly. We do have very good customer relationships. So we're planning on going in and having some discussions with our customers. And I think the performance that we've elevated over the past years will help us there.

But I think it's a combination of everything you mentioned. And it has continued to be very resilient. And so it's a lot of different efforts. And I'm sure our competitors are listening so I don't want to get into all the details, but we've put a tremendous amount of effort in that business to put it in a position that it is. And I'll just say the outstanding hard work that the team is doing.

We talk about more work. We have more opportunities to continue to get cost out. There's a significant amount of more work we can do. But the work that they've done and how quickly they respond is absolutely amazing to me. And so part of it is just the incredible team that we have and the knowledge that we have. So a lot's gone into it, but we are very proud of the resiliency and their ability to produce during uncertainty.

Okay. And just a quick follow-on. As I walked through the Chicago auto show, which we're thankful to get in between all these COVID waves, I was struck by the touchscreen-controlled seats on some upper-end SUV models, particularly the Grand Wagoneer, not sure if it's your platform or not. But the broader question is does that kind of touchscreen control of seats kind of reinforce your position with your E-Systems? Or is it really no different than having the complicated touch knobs and dials and kind of mech levers that you see on most cars?

No, it's actually -- it's kind of -- it's in line with our intuitive seat, the work that we're doing. We believe that there's a number of features and content. If you hear where we're focused, it is on features and content into the seat. And I think we talked about embedding technology, it's exactly that.

We think there's a number of opportunities we're presenting our customers that will help the consumer in respect to comfort, features, thermal comfort, other content that we believe is right in line with what we're doing with intuitive seating. And so now we've looked at applications like that. We're looking at applications like that. But we do think there's a number of additional opportunities. I don't know if you guys want to comment a little bit.

I think it also shows the level of integration, and that drives in the vehicle higher speed connections from a wiring perspective, more technology into the data communications, data networks and computer networks in the vehicle. That's one of the reasons why we're investing in and working with things like the IMS Connection Systems for high-speed Ethernet connections, because those types of touchscreen control, more integrated features in the vehicle drives more data flow throughout the vehicle, more data routing and computer communications, and those drive both the wiring and connection systems and also the low-voltage electronics for us.

Yes. And I can highlight, Brian, to Ray's point. I highlighted ConfigurE+ a minute ago, but INTU is a great product for us. Ray mentioned thermal comfort that we're working on, but proactive comfort is exactly what you described. We have applications that work off touchscreens. We have applications that work off your cellphone.

And part of the drive is to put sensors and technology and software into our intelligent seating so that it is more intuitive and adjust automatically to our consumers for their preferences. So that's very similar to what we're doing in the market today. Yes, it works with touchscreen and, it can work with the hardwired systems that are in place today as well.

And we've discussed this, too. We think that's a unique competitive advantage for Lear Corporation. The interconnectedness between E-Systems and Seating have already proven that we can not just commercialize it but extend our ways of differentiating our seat products because they are interconnected.

We do believe that the intuitive seat is the future of seating and that the combination with E-Systems -- and we have teams that are working on the technology. We talk about embedding this innovation in the seats of the future. So we're excited, like I said, to continue to differentiate ourselves, and we have a unique position in that space to continue to do that.

Our next question comes from Joseph Spak from RBC Capital Markets.

If we could just go back and holistically listen to everything you said about the issues in the back half with commodities and mix and then we sort of look at the midpoint of your third quarter guidance at $150 million in core operating earnings, I mean, back of the envelope for us, like that seems to suggest maybe like maybe 5% or 6% margins in Seating, which would have to mean that E-Systems is breakeven. Is that correct? And if so, what's driving the breakeven in E-Systems?

Yes. It's actually a little bit better than that, Joe. It's -- we would say Seating will be between 5% and 6% and E-Systems will be between, let's say, 2.5% and 3.5% in the third quarter. The biggest factor in E-Systems in addition to the volume reduction is it's a low point on commodity. So the full effect of the higher copper price is for the first time being realized in actual material costs in our plants in the third quarter this year because we had bought ahead earlier in the year and lessened some of the impact of higher copper prices earlier in the year.

And then in the fourth quarter, you get the pass-through benefit of that. And so you have 2 things happening in the third quarter to the fourth quarter. You have volumes recovering and the benefit of the commodity pass-through agreements taking effect. And that leads to a pretty significant step back up from the third quarter to the fourth quarter. And we'd expect both segments at this guidance -- or this volume level to be right around 7% in the fourth quarter, maybe a little bit less than that but close to 7%.

Okay. Jason, that's very helpful. I appreciate that. And then just on -- I know you're not really talking about '22 on the commodities, but I think I just want to make sure I got this right. You said $175 million commodity hit for the year, $95 million of which in the back half. So I mean is it as simple as if we wanted to assume that commodities just did not move from here, which is obviously an oversimplifying assumption, that there would be an incremental $15 million commodity headwind into the first half of '22? Or can we not do that math?

I think the way we were looking at the math, if you just said that the second half commodity costs were to hold for all of next year, that would be about $100 million impact. And offsetting that, you have the benefit of some of the delayed recovery mechanisms. In some cases, some of our commercial agreements have a 3-, 6- or even 12-month lag. You'll see a benefit that will partially offset that.

And I also think that it's hard to see steel remaining at the level it's at. And so there should be some moderation from these all-time highs that we're experiencing here in the back half of the year. But if it does remain at that level, that's sort of the math there. Now we are taking steps commercially to try and improve upon that 15% exposure we have with steel. We have negotiations with several customers. Ray briefly alluded to that earlier. And we're optimistic that we're going to improve upon that exposure.

And in this business, I think more of that steel responsibility belongs with the customers. And we've been working on that for, gosh, 10, 12 years. And we have, I think, put ourselves in a pretty good position relative to the competition, but I think we can even do more there.

And then outside of your sort of indexing and pass-through agreements, at the beginning of next year, we'll be starting our annual price reduction discussions with our customers. And so if steel remains at this level, we'll have another opportunity to try and negotiate some offsets to that. Now you've got to balance the backlog and growth in other aspects of the relationship, but I think we will have a chance to deal with this if that cost remains at that elevated level.

Our next question comes from Dan Levy from Crédit Suisse.

Sorry to beat a dead horse on the commodity side. But I just want to understand the sensitivity on that $95 million comment. Is that just purely based on where prices are today? What is that embedding in terms of recovery? And just to be clear, like what's your visibility on the $95 million?

Meaning -- let's say prices happen -- and no one knows what's going to happen with prices, but let's say prices do come down, how much do you get immediate relief? Or is that relief on a lag? So what's your visibility on that $95 million hit in the back half?

Yes. So it's a bit of a mixed bag. So in Europe, for example, we've locked in the steel costs for the remainder of the year, so we have 100% line of sight on that. In North America, we've locked in the third quarter, and we have some exposure, good and bad, to the fourth quarter. So we've made an assumption on what the market is going to do there and embedded it in the outlook. So I'd say the vast majority of the $95 million, we have a clear line of sight on, Dan.

Okay. So getting to the prior comments you gave on quarterly margin of 5% to 6% for Seating and 2% to 3% for E-Systems. It sounds like, barring some large uptick in volume or a lot of performance, we're probably not going to see a lot of upside to those figures for the third quarter. Is that a fair assessment?

Yes. I think the biggest opportunity in the third quarter would be if production stabilized at the current -- what's been currently announced. So the high end of our guidance range effectively embeds everything that we were aware of. And so I think that, that may be a bit optimistic, but there's certainly a chance that conditions improve and production stabilizes. And that could be upside.

I think the prudent assumption is -- that's more in line with the midpoint is that we will see continued disruption. And July is probably the worst month we've seen of the year, and I think June and August are probably similar. So that really -- it really comes down to September and whether things stabilize or not.

And as Ray mentioned, the difficult part is on semiconductor parts where there's no buffer in the system, there's no inventory. And so any new shutdowns that take place on the back-end processing that's happening in Southeast Asia, we do an immediate disruption in production. And so that's what gives us the hesitation around being a little bit more optimistic for the third quarter at this point.

Great. And then my follow-up is on E-Systems. We know that in the past quarter, one of your large customers was highlighting at one of their Investor Day their overhauled electrical architecture. And this seems to be like an industry trend, more potential compute, much less wiring. So maybe you can just remind us because you've obviously given us a good sense on what your opportunity is with electrification. But in parallel, as we have this trend of overhauled architectures with more central compute, how is -- how does the E-Systems content change, especially as there's just less wiring content?

Yes. It's a good question. We've spent a significant amount of time understanding this and knowing where we can position ourselves for continued growth. And Carl is here. I'm going to let Carl kind of give you a little insight on how we're looking at it to continue to grow our business.

Yes. From an architecture perspective, we see that architecture changeover happening over the next kind of 15-plus years. There'll be some early adopters, and there'll be a lot of folks that will continue to use the legacy architectures or do a lot of hybrid things. And so we see that move to zonal control or central computing will improve the optimization of the electrical architecture. But at the same time, what we're seeing is a growth in circuit counts actually, where we're adding more content to the vehicle with more safety sensors, active safety sensors and even autonomy, a lot more high-speed signals in the vehicle, and that's offsetting some of the integration of the data networks.

We're well positioned, I think, on the electronic side with our body domain controller and software expertise to participate in these new architectures. And we're responding right now to a number of customer proposals for some of these new architectures. So we're definitely in the mix and talking with our customers about these changes from an architecture perspective. We also see that most of the high-volume customers will select an element of these architectures independently, not everything from one supplier. And that includes both software and hardware sourcing, very kind of federated procurement approaches they have historically done.

We're excited about the change from a technology perspective in the electronics. We're excited about that -- what that change drives from the wiring and connection system parts of the portfolio. And as Ray mentioned, some of these autonomous programs that we're working on, we really get early insight into the technologies required, into the architectures required. And even the unique manufacturing requirements and capabilities, we're developing as we're working on these programs with our customers. Some of these wire harnesses are the largest and most complex harnesses we've ever built, and we're maturing and developing both the manufacturing as well as the subcomponent technologies.

So really exciting about the change in the architectures. We're there right along with our customers in helping them define those new architectures on the electronics side, on the power side and looking at the whole system optimization.

Yes. And what's nice is like Carl mentioned and I mentioned earlier, is that we do have with 2 major OEs development contracts on autonomous vehicles. And so a lot of the new architecture, technology and capabilities are, in some respects, being applied. And we can -- you can look at what we're doing with IMS and our partnership there to get high-speed data knowledge capabilities that we can grow within the connectors part of that business, our continued acceleration of components within wiring, both high power and low voltage. And so we see this transition occurring. We do believe that we have incredible capabilities that will fit with the new architectures, and we're continuing to develop our capabilities as we move along.

And ladies and gentlemen, our last question for today comes from Emmanuel Rosner from Deutsche Bank.

I was hoping to just hone in a little bit more on, I guess, how much of your cautious second half volume view is dependent on industry-wide factors versus sort of your own customer and vehicle mix. Can you maybe frame it in terms of growth over market? You have outperformed on that metric pretty materially in the first half of the year. How do you think about it maybe in the back half of the year?

Yes. So Emmanuel, in the first half of the year, our growth over market was about 9 percentage points, total company. And as I look at the second half, it does moderate. It's right around 5%. And so the full year is about 7 percentage points of growth over market, which is, I think, consistent with what we talked about back in May. So that is part of what's going on, if you look at the second half of the year.

And in particular, if you look at our revenue in North America relative to what's happening in the market, it's down a little bit. And so that's probably a big factor. But I still believe that at the assumption we've made at 6% for total industry growth for the full year, that that's a prudent balanced view of the current circumstances that we're seeing, as Ray outlined, just because of the tremendous uncertainty around semiconductor parts and the back-end processing and unexpected shutdowns that very well might occur over the coming weeks and months.

That's great color. Would you have the second half breakdown between Seating and E-Systems for the 5 points of growth over market?

Yes. So Seating will be a little bit higher than that, and E-Systems will be a little bit lower than that. E-Systems growth over market will be better in the second half than the first half though.

Okay. That's good to hear. And then my follow-up question is on your Slide 20, which I really appreciate you including as investors are certainly very focused on what some of the current factors mean for next year and then the out-years. I was hoping you could walk through some of those, but -- on some of the factors on the slide. But I guess just overall, is -- the plus versus the plus-plus, is that -- is the sense overall that 2022, some of these headwinds will still be there but sequentially better than 2021 and then the full normalization happens in 2023? Or I guess how should I understand this slide?

Yes. That's kind of how we were looking at it, Emmanuel. Certainly, we expect 2022 to grow relative to 2021. These supply chain challenges should be alleviated somewhat. But I don't think you're going to see an industry that has the ability to fully meet consumer demand because of ongoing supply chain shortages until you get to 2023. And maybe in the back half of 2022, you get closer to that. And so that is the kind of thought process on how we laid that out.

Okay. Just to wrap things up, one, it's probably just Lear employees on the call at this time. I just -- I want to say thank you. I couldn't be more proud of the team. We continue to focus on what we can control, and we do an outstanding job. The performance in the operations are just absolutely incredible. And I know there's things outside of our control, but the things we do control, we do a remarkable job. And I want to thank the team around the world for your performance operation.

The work that purchasing is doing in both business segments, I tell you, I just can't believe what you've been doing to protect our customers, and it's being recognized. Our customers -- if there's a silver lining, we have an incredibly tight relationship with our customers because of the work that you're doing and the teams are doing. It will be recognized at some point, I believe it. I believe if you do the right things, that there will be a time when you're recognized. And I believe that will be a recognition through growth, and we'll continue to grow this business.

A special thank you to Mexico. You guys just continue to impress me, the team down there. Thank you so much for the inoculations, the vaccinations, the shots, the initiative to do the right thing. That's what we're about. It's outstanding. And I appreciate all the work around the world.

We're growing this business. We're staying focused on our strategy, and good things are bound for Lear Corporation. So thank you for all your efforts.

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