Lear Corp (LEA) 2020 Q2 法說會逐字稿

Good morning, and welcome to the Lear Corporation Second Quarter Earnings Call. (Operator Instructions)

Please note, this event is being recorded. And I would now like to turn the conference over to Alicia Davis, Senior Vice President, Corporate Development and Investor Relations. Please go ahead.

Thanks, Cole. Good morning, everyone. And thanks for joining us for Lear's Second Quarter 2020 Earnings Call. Presenting today are Ray Scott, Lear's President and CEO; and Jason Cardew, Senior Vice President and CFO.

Other members of Lear's senior management team, including Frank Orsini, President of our Seating division; and Carl Esposito, President of our E-Systems division, also have joined us on the call.

Following prepared remarks, we will open the call for Q&A. You can find a copy of the presentation that accompanies these remarks at ir.lear.com.

Before we 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-K 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 describe the key factors impacting the second half of 2020. 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, Alicia, and good morning, everyone. Before I begin the formal presentation, I want to take a moment and say that we hope everyone is staying safe and healthy. Our thoughts and prayers go out to those who have been impacted by COVID-19.

Now if you could please turn to Slide 5, which provides some recent business highlights. The second quarter was among the most challenging in Lear's history. Our financial results were significantly impacted by COVID-19 pandemic, which resulted in extended production shutdowns and a 46% year-over-year decline in global vehicle production for the quarter. Despite the challenging environment, we successfully executed on the near-term priorities we set forth on our first quarter earnings call. We demonstrated both our financial strength and the resilience of our business model. We safely and efficiently restarted operations, maintained ample liquidity, effectively manage cost and continue to position the company to take advantage of growth opportunities.

We met another quarter of strong business wins, including additional conquest business in Seating. I'm very proud of what the Lear team accomplished.

During the quarter, we received a PACE Award for Xevo Market, a testament to our innovation and industry leadership. I'm also proud of the fact that Lear was named GM Supplier of the year for the 19th time in the third consecutive year. And we continued to be recognized by many of our customers for safety and quality.

As we discussed last quarter, we developed a safe work playbook, which provides a standardized approach to safely operate our facilities. And includes health and safety information related to planned operating protocols, employee education and facility assessments. On April 6, we published the playbook on our website. It has been downloaded almost 35,000 times, and the response from our customers, as well as manufacturing and nonmanufacturing firms from around the world, has been overwhelming. We are particularly proud that we have played a role in helping keep people safe around the globe.

I want to take a moment now to discuss an important new initiative at Lear. I've been deeply affected by the -- on a personal level, by the recent events that have highlighted the ongoing ratio in justice in our society, and I'm not alone. It has affected the entire Lear family. At Lear, we have a long-standing commitment to a workplace that is diverse, equitable and inclusive. But following these troubling events, we knew we had to do more. So building on our strong foundation in diversity, equity and inclusion, we launched the Drive, Educate, Fund initiative. Through this initiative, Lear will drive change by developing impactful ways to help end racial injustice in society, educate by accelerating our in-house training to be sure that we, as an organization, continue to foster diversity, equity and inclusion with our own community. And fund, by providing both financial and nonfinancial resources to nonprofits devoted to achieving racial equity. As a team, we are committed to helping drive change in this important area.

And now if you could please turn to Slide 6. During the quarter, our business was impacted by production shutdowns in our 2 major markets: North America and Europe. Almost all of Lear's operations outside of China were closed for all of April and a portion of May. After manufacturing restrictions were eased, we concentrated our efforts on safely and efficiently restarting operations. As production resumed, our plants came back online gradually, and we saw weekly improvements in capacity utilization and business performance. Then in the month of June, we reached a turning point. We started the month at similar levels to May. But by the end of the month, most of our plants in our major markets were operating at or near pre COVID levels.

Slide 7 provides an update on the Seating business. In Seating, we achieved solid growth over market of 3 percentage points. Our solid growth over market was driven in part by strong performance of the key platforms in North America, including GM's full-size trucks and Mercedes and Ford SUVs.

In addition, we enjoy a strong market position in luxury brands in China, and the premium market outperformed the overall market in China during the quarter. Decremental margins year-over-year were 20% despite significant incremental costs in the quarter. Our ability to flex our cost structure in the current volume environment and aggressively manage variable costs and overhead, lessened the financial impact of the severe production disruptions we experienced, which allowed us to continue investing in the business during the downturn.

I now want to provide an update on our innovation efforts in Seating. We have made investments in technology that enable us to grow and capture market share. We have used our unique capabilities in seating engineering and design and electronics to create a broad portfolio of innovative solutions featuring intelligent seats of the future. 2 examples of our advanced product technologies include Intu, an intelligent seating system that provides advanced solutions for wellness, comfort, sound and safety. And ConfigurE+, a PACE Award-winning, patented state-of-the-art rail system that is configurable, electrified and ideal for shared mobility applications. Even though the Intu technologies are still in the early stages of development, we have been awarded 2 advanced technology production contracts and have 10 engineering development programs underway with 7 different global OEMs. We are very encouraged by these development programs because such programs often lead to production awards in the future. ConfigurE+ is also in the early stages, but we have achieved some commercial success.

As -- The properties on platform is [slated] to launch in 2021 and 2023 with 2 global automakers. Just 2 years ago, this technology was in development. And now we expect to generate more than $100 million of annual revenue by the year 2023. We are very excited about the opportunity here because we believe there will be a number of fast followers as other customers adopt the technology as we move towards production. We believe we will be able to continue to increase our market share in Seating, not only because of our quality and operational excellence, but also because of our unique ability to innovate and offer creative, value-enhancing solutions to our customers.

In the second quarter, we again achieved significant new business wins, including Conquest wins. On our last earnings call, we announced that we had almost $500 million of Conquest awards in the first quarter. In the second quarter, we secured an additional $200 million in net Conquest awards. I'm very proud of what the team accomplished as we continue to focus on quality, execution and driving value for our customers.

Slide 8 provides an E-Systems business update. During the second quarter, E-Systems achieved growth over market of 11 percentage points. The strong growth over market was driven by a combination of launching products in our electrification portfolio, strong volume on the Ford F-Series Super Duty and our position with luxury brands in China. We're beginning to see the benefits of our growing electrification portfolio and the increased diversification of our customer base.

To better align our operations with the production environment, we accelerated restructuring actions during the quarter. We optimized global capacity and our footprint through plant consolidation and other repositioning actions, particularly in Asia. Through these actions, we were able to lower our cost structure, driving improved margins and positioning ourselves for future growth.

During the quarter, we continued to focus on electrification and connectivity with approximately 40% of our year-to-date awards coming in these 2 high-growth business areas. As we've discussed previously, increased vertical integration in our wire harness business is a key component of our E-Systems improvement plan. And our efforts have been very successful thus far as we have exceeded our internal targets in this area. Year-to-date, we have vertically integrated approximately $50 million of previously external purchases with 80% of these products launching by the year 2021. This success is helping drive margin improvement in the E-Systems segment.

Now please turn to Slide 9. On our second quarter 2019 earnings call, we laid out a detailed plan to improve E-Systems performance and position it for profitable growth. We intended to provide a comprehensive review of E-Systems business and strategy at our Investor Day, which was scheduled for June 9. We unfortunately had to postpone Investor Day because of the COVID-19. So we thought it was important to provide a brief update on the improvement plan and describe the E-System's strategic direction on today's earnings call. Over the past year, we have successfully executed on our improvement plan. We have built a strong management team. Stabilized the business, restructured operations to better align capacity with production volumes and improved visibility into profitability by customer, product and region.

We have improved margins on existing businesses through customer negotiations and cost optimization. We continue to make strategic and highly targeted investments into fast-growing industry segments where we can earn returns that exceed our cost of capital. And we are aligning our product portfolio to industry mega trends by accelerating expansions of our terminals connections business and increasing vertical integration and expanding our footprint in high-growth businesses with a focus on electric vehicles, 5G connectivity and software. We have conducted an extensive study of the markets in which we participate.

We examined the competitive dynamics, growth prospects and the future architecture of the products we supply. As Slide 9 demonstrates, we have expertise in the complete vehicle architecture. We are narrowing our electronic product portfolio to those areas where we can leverage our expertise in electrical distribution systems, body electronics and vehicle architecture, thus allowing us to make selective value-creating investments. We are focusing our product segments where we believe we can be most competitive, such as battery and charging power management with electrification, where we have demonstrated that we can be successful and in areas like software that enable us to move beyond being a component specialist to having systems and domain expertise. We believe pursuing these very targeted areas of business will allow us to leverage synergies and drive further margin improvement.

And now I'd like to invite Jason to review our second quarter financial results.

Thanks, Ray. Slide 11 shows vehicle production and key exchange rates for the second quarter. In the quarter, global vehicle production was down 9.9 million units or 46% compared to 2019 as the industry was significantly impacted by extended shutdowns related to the COVID-19 pandemic. The majority of the production declines occurred in North America and Europe, where production was down 69% and 63%, respectively.

Lear's plant operations in these regions were closed for all of April and a portion of May. And when they restarted, there was a gradual ramp-up of production over several weeks. These 2 regions normally account for over 75% of Lear sales.

Global production declines on a Lear sales weighted basis were approximately 55%. Industry production in China recovered in the second quarter, growing 7% year-over-year. From a currency standpoint, all major currencies weakened against the U.S. dollar compared to last year.

Slide 12 highlights Lear's growth over market in the second quarter. Sales grew above market in both Seating and E-Systems as well as in each of our major markets. Total company growth over market was 5%, with E-Systems at 11% and Seating at 3%. Growth over market in North America of 6% reflected the strong performance of GM full-size trucks, the Ford Explorer and Mercedes SUVs.

China's 8% growth over market reflected strong relative demand for luxury vehicles that benefited both Seating and E-Systems.

Slide 13 highlights our financial results for the second quarter, which were significantly impacted by the COVID-19 pandemic. For the quarter, sales were $2.4 billion, down $2.6 billion or 51% from last year. The decline was driven primarily by lower production in all our major markets, except for China. We did see a meaningful ramp-up in sales in the last few weeks of June, and as a result, our financial performance in the quarter was better than expected. Adjusted operating losses were $248 million compared to core operating earnings of $352 million in 2019. The decline in core operating earnings from a year ago reflects the significant decrease in sales as well as incremental costs associated with the restart of production and operating our plants in the current environment. I'll provide more detail on both these incremental costs as well as actions that we have taken to offset their impact later in the presentation.

Second quarter free cash flow was negative $611 million compared to $268 million in 2019. Negative free cash flow reflects lower earnings and higher working capital related to the restart of production, partially offset by lower capital expenditures. We expect that working capital will decline in the second half of the year and be a source of cash flow.

Slide 14 explains the second quarter year-over-year variance in sales and adjusted earnings in the Seating segment. Sales in the quarter were $1.8 billion, down 54% from the second quarter of 2019. Seating adjusted operating losses were $102 million compared to adjusted earnings of $315 million last year, reflecting lower volumes and net COVID-related costs.

Slide 15 provides the second quarter year-over-year sales and adjusted earnings walk for our E-Systems segment. Sales in the second quarter were $690 million, down 41% from the second quarter of 2019. E-Systems adjusted operating losses were $91 million. Adjusted earnings declined from last year due to lower industry volumes and net COVID-related costs.

Please turn to Slide 16, where I will describe in more detail how COVID-19 has increased our operating costs as well as the actions we took to mitigate the impact on our financial results. In the second quarter, we faced significant nonrecurring costs related to setting up our plants for safe production. The biggest cost headwind we faced in the quarter was semi-fixed labor costs. In certain locations, we were obligated to continue to pay some of our employees while they weren't working. This occurred in the first quarter in China as well. While a portion of these costs were offset by local government incentives, the net impact was significant. Inefficiencies at our plants as they restarted operations also drove higher costs during the quarter. There are other costs that impacted us in the second quarter that we expect to continue for the foreseeable future. These costs include personal protective equipment and other costs associated with lower plant efficiencies due to social distancing protocols we have put in place. Consistent with our expectations, we incurred incremental costs related to COVID-19 in the first half of the year to approximately $150 million, net of customer reimbursements for certain of these costs.

Now that production is running closer to pre-COVID levels, we expect the net cost going forward to be considerably lower in the second half of the year.

As we noted on our last earnings call, we took aggressive actions to offset these additional costs with programs that were designed to carefully balance the need to reduce costs, while also protecting our world-class operating performance and the longer-term value creation potential of both our business segments.

Our cost reduction plans, which were split into 3 distinct phases to provide flexibility were designed to operate in an environment where revenue was down 25% to 30%. As industry conditions continue to improve, we will reverse some of the nonrecurring spending reductions that we put in place. Likewise, if industry conditions worsen, we will implement additional cost reduction actions to preserve our liquidity and protect the enterprise.

Slide 17 highlights assumptions that are driving our expectations for the second half of the year. While our visibility is somewhat limited under the current circumstances, we wanted to provide some insight into how we are thinking about the rest of the year. The situation is still very fluid. The number of increasing COVID infections and the potential for additional shutdowns could have a significant impact on our financial results. Other factors that could impact the second half include the underlying mix of production, changes in foreign exchange rates and ongoing customer demand. IHS projecting global industry production to decline by 11% in the second half compared to 2019.

Given the uncertainty surrounding the COVID-19 pandemic and the possibility for government-mandated shutdowns, our internal projections are based on a range of 10% to 15% for production declines. Our production estimate also reflects uncertainty with respect to consumer demand, given the challenging economic environment.

Despite the significant drop in revenue in the second quarter, decremental margins improved somewhat on a sequential basis to 23% from 25% in the first quarter.

Looking ahead to the second half of the year, we expect decrementals to improve further to about 20%, with the fourth quarter anticipated to be better than the third quarter. Factors driving the improvement in decrementals include onetime production ramp-up costs that will not reoccur, higher production volumes and the continued benefit from cost reduction programs.

Decremental margins in the fourth quarter will also benefit from the nonreoccurrence of the GM strike. For the full year, we expect decremental margins to come in at approximately 23%, consistent with our prior public comments. Looking at our margin performance on a sequential basis, we expect incremental margins to be above 20% for the third quarter. Restructuring costs for the remainder of the year are expected to be relatively consistent with our first half run rate as we continue to realign our manufacturing capacity with industry demand. We expect free cash flow to turn positive in the third quarter and expect additional sequential improvements in the fourth quarter, reflecting lower working capital. Capital expenditures are expected to increase in the back half of the year to support new programs coming online in the second half of 2020 and throughout 2021.

Please turn to Slide 18, where I will discuss our financial position. Lear entered the pandemic with a strong balance sheet and ample liquidity. As a result, we didn't need to raise additional funding or seek covenant release when the auto industry shut down for 2 months earlier this year.

In today's uncertain economic environment, it is critical to have ample liquidity in case production is impacted again or if industry conditions worsen. At the same time, it's equally important to have the wherewithal to continue to invest in the business to further improve our competitive position and create long-term value for all stakeholders. While the second quarter was among the most challenging we have ever faced, we ended the quarter with $2.5 billion of total liquidity, a low-cost flexible debt structure and no significant near-term debt maturities.

We have investment-grade credit ratings from all 3 rating agencies. Fitch recently initiated Lear with a BBB rating in July, and Moody's affirmed Lear's investment-grade rating in June. Our allocation -- our capital allocation plans remain unchanged. Our first priority remains investing in our core businesses through capital expenditures. We'll consider bolt-on acquisitions but believe our businesses are well positioned and are not looking for any transformational M&A, and we remain fully committed to maintaining investment-grade credit metrics. We have been consistent in our commitment to returning excess cash to shareholders and look forward to continuing discussions with the Board about restarting these programs once we have greater certainty regarding the sustainability of our cash flows.

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

(inaudible) Jason. Now turning to Slide 20. In summary, the second quarter was among the most challenging in our history. Our solid performance in the quarter demonstrated resilience and our financial strength in the face of a previously unimaginable scenario and involving a global shutdown, leading to 50% decline in revenue and in the midst of a pandemic with many of our employees working remotely. And never in the history of the automotive industry, have we seen nearly simultaneously relaunch of plants around the world following in the extended shutdown with extensive new health and safety protocols in place.

I usually close earnings calls with a thank you to the Lear team after the Q&A is done. But I think it's important I take time now, while everyone is still on the line to say thank you to the team. I could not ask for a more talented, committed or loyal team. We have accomplished -- what we have accomplished is incredible, and I'm extremely proud of how we are performing during this trying time. When the crisis began, we focused on 3 near term priorities: ensuring the health and safety of our employees, preserving liquidity and aligning our operations to -- and strategic priorities with industry changes. And over the last few months, the team has worked tirelessly to implement the necessary protocols to safely and efficiently restart operations, effectively manage our costs, preserve Lear's financial flexibility and position the company to continue to take advantage of growth opportunities.

We have now transitioned into the second phase of our COVID-19 response. The economic environment remains highly uncertain, and we do not know exactly how the pandemic will continue to affect our industry. However, with today's challenge come opportunity. This crisis has brought clarity about what matters in our business as it relates to our strategy, competitive positioning, product portfolio, our cost structure, operations and our team. We are committed to executing against our strategic goals while balancing short-term challenges with long-term priorities. We will continue to make targeted strategic investments that position Lear for continued market leadership and drive long-term value for our shareholders.

And with that, we would be happy to take your questions.

(Operator Instructions) And our first question today will come from Joseph Spak with RBC Capital Markets.

First question is maybe you could talk a little bit more about the 8% margin commentary ex COVID. Is that just backing out some of the volume impact you associated with it as well as the cost in each of the segments?

Yes, that's -- Joe, that's exactly right. It's as the net COVID costs that we talked about impacting both segments as well is just adjusting for volume. And the way we measure that is we looked at what we were anticipating in terms of revenue in the quarter prior to COVID. So when we set guidance at the beginning of the year and relative to where it came out and that's the way we've measured that.

Okay. And then as we think about each of the segments headed to the back half of the year, I mean, in Seating, is that the right level, that 8% level to think about, especially since you're lapping the GM strike in the fourth quarter?

And then in the E-Systems, you talked about showing improvement going back to the back half of last year, and you mentioned some of the E-Systems initiatives today. Should we think about 8% as the new sustainable target here as volume stabilizes for that segment?

I think, ultimately, it's really a question of where volumes stabilize. So we have seen an improvement in production rates heading into the third quarter. In July, we're around 90% now, but we're -- that's still a 10% difference from our historical run rate. So the -- if you just look at the math on that, the variable margin in Seating at 20% and E-Systems at 30%, that trims about 135 basis points off the seat margins in about 200 to 250 basis points off the E-Systems' margin. So had a 10% lower volume overall. So I think that's probably sort of the right starting point as we look to the third quarter. Now if the volume environment improves, and it's down less than 10%, then I would see upside to those numbers. If volumes were flat year-over-year, then I think you've got the right idea on where we would end up. But I think we're a little ways away from that. And there's still a great deal of strain in the whole supply chain right now. And particularly, if you look at what's happening in Mexico, where you're not able to have the full complement of employees in the plant yet. And so there's still a reasonable risk of disruption that could impact volume. So even if the demand is there and the OEMs are trying to replenish inventory levels, it's uncertain as to whether they're going to be able to continue running at the rates they want to throughout the quarter. If all that worked out, then certainly, we would be back on track in terms of the operating margin for the business. But I think the volumes will be a little bit lower than what you're suggesting there, Joe.

Maybe I could just sneak one last one in. I know that your businesses are pretty just in time, but did you see any of your customers take a little bit of excess inventory to gauge against any supply disruptions? To guard against any disruptions rather?

No. I think the initial wave was just filling the pipeline and getting inventories back to a level where we could resume production. And so no, I'm not really seeing any buildup of inventory at all.

Our next question will come from Rod Lache with Wolfe Research.

2 topics. One is just electrification, obviously, is inflecting in terms of demand and also awards. Can you just give us a little bit of an updated view on what you currently expect growth over market to be for E-Systems, the impact of electrification in that? And when you say that you're focusing on a few specific products within that, what is the content per vehicle associated with that?

Yes, why don't you go ahead, Jason.

So in terms of growth over market, Rod, we're still expecting 6 points plus in these systems, and that really is underpinned by the growth potential and electrification and connectivity. We had $450 million new business awards in those categories last year, $600 million of the $900 million backlog that we had announced in January was in electrification and connectivity. And even though that the [quoting] activity slowed down a little bit in the first half of the year because of COVID, we still had $170 million of awards in that space. And so we see just a tremendous growth opportunity. The 2 biggest areas of growth within electrification for us a really high-voltage wiring and connection systems, and then onboard chargers and battery management systems. Those are sort of the -- if you had to split the portfolio, it'd be nearly 50-50 between those 2 categories. And so that's where we're winning business today, that's what we're rolling on in the backlog, and we see great potential with both those subsegments today of electrification heading out to the next several years.

Yes. I think just to add little bit to that, too, just, Rod, why I think we're so optimistic and positive about the future growth prospects within E-Systems is, we talked a lot about being customer centric with maybe 1 or 2 major customers. And the need to really differentiate our customer base and through this COVID, obviously, one benefit is we talk to our customers quite a bit. I talk to them quite frequently on everything that's going on with -- in respect to what they see as far as current volume and long-term and even their product portfolio and some of the opportunities for investment, and we've built up that customer base. I mean when we talked about the need to invest with those customers. And so for example, with Audi and Jag Land Rover and Geely and Volvo. We are investing in those customers over the last several years, and those are really starting to have some traction and some growth opportunities.

So I'm positive in respect to our growth and our ability to grow within electrification because, one, I'm hearing it from our customers as the need -- that they're looking for our products, but the actual awards that we're getting within that area.

So just to clarify, I know you've said before that you have about $500 of content or addressable content in internal combustion. When you look at the high-voltage systems, wiring, terminals and connectors and chargers, what does that come up to?

Yes. I would say on the low voltage side, it's more like $700 would be the kind of average vehicle globally with North America being a little bit higher, Asia being a little bit lower than that. And on the high-voltage side, in the areas that we're participating, we've got $1,500 to $2,000 of content opportunity per vehicle.

Okay. And just lastly, could you just clarify, I believe it's Slide 16, when you put $130 million on the right, not -- it includes both nonrecurring and ongoing. What is the ongoing component? How should we be thinking about that? Is that just more or less to offset the incremental COVID-related costs? Or are you actually coming up with additional cost savings that would allow you to get to these margin -- longer-term margin targets at lower levels of revenue.

Yes. So I would say 75% of that $130 million is in the nonrecurring category, the salary deferrals and pay cuts, the lower incentive comp, and temporary reductions in discretionary spending. The other 25% is reoccurring. And the biggest driver of that is we've increased our restructuring investment by about $50 million this year, and we expect to see about $40 million of savings from that as I look out to next year. And in particular, that investment was in 2 areas. One, lowering our SG&A costs. We've done a lot of work in that area over the years, but we did find an opportunity to lower cost of some of the administrative functions, centralizing of functions in lower cost regions, taking some headcount out in the program management and sales side on a more permanent basis to realign to the lower volume environment. And then on the manufacturing side, really 2 areas of emphasis. One is getting the footprint right in Asia in E-Systems. We're closing 3 facilities over the course of the next 6 to 9 months there to better align our footprint with the business there, both improve the cost structure and the capacity utilization. And then on the Seating side, there's a couple of facilities that we're going to close in North America to improve an already strong footprint that we have here. So you take those pieces together, that's about 1/4 of that cost reduction program. We see sort of continuing and helping offset both the ongoing cost of operating in this post COVID environment and ultimately, helping offset a little bit of the impact of the lower volumes as well.

And our next question will come from John Murphy with Bank of America.

Just a first question on this North American content number. It was $528 in the quarter, up 20% year-over-year, very good performance. Obviously, mix is helping there. But just curious if you could parse out sort of mix as well as new business wins that are supporting that. And as we get into the second half of the year, as we anniversary the GM strike in the fourth quarter, plus the launch of the SUVs at GM, I got to imagine there could be some upside to that CPV number as we go through the back half of the year. So just curious what you think about that number in the back half of the year and then maybe even beyond that, how sustainable this number is?

Yes. Well starting with the second quarter. Really, it was driven by the strong mix in the region, that was the biggest factor. But also kind of unique to Lear is, you may recall last year, Ford was going through a changeover in the Explorer and GM was finishing up their changeover on K2 to T1 on the pickup side. And so we benefited from relatively strong volumes on those platforms compared to what the market did. And so we had talked a lot about that last year, sort of weighing on our growth in Seating and that reverse course in the first half of this year. If we look out to the second half of this year, we do expect our growth over market, just generally speaking, to continue, not maybe at the sort of 6% sales weight adjusted basis that we enjoyed in the first half, but maybe a little bit less than that. And again, underpinned by the same things you described there, John, in terms of the mix in North America being particularly strong and weighted towards trucks and SUVs, where we have a lot of content and a good book of business. But also, I'll point out that we see the luxury market in China continuing to do well into the third quarter. We saw that in the first quarter. We saw it again in the second quarter where luxury is sort of outperforming the broader market there. And in both our business segments, we're overweight in luxury, maybe more so in Seating and E-Systems, but both segments do benefit from that as well.

Okay. That's incredibly helpful. And then just a second question around these Conquest wins in Seating. I think you said they were $500 million in the first quarter and $200 million in the second quarter. Just curious how fast those roll on. Are they faster than sort of your typical new business wins because they're Conquest? Or I mean, just how do those work? And how do those roll on over time?

Those are more traditional, and that it's 3, 4 years out.

Okay. Got you. And then just lastly, you sort of talked a lot about M&A opportunity on the E-Systems side. But is there anything that you're seeing on the Seating side that would either be sort of a tech acquisition or vertical integration or anything that you might do on the Seating side on M&A?

I mean we look at all kinds of different things, but there's really nothing of any significance on the Seating side. There may be some smaller type opportunities that might make sense for us to stabilize some of our business, but they're smaller.

And our next question will come from David Kelley with Jefferies.

Appreciate the breakout of segment level net COVID costs. Just curious to how you see the moderation cadence there impacting the second half? Or are you expecting more steady PPE related cost and efficiencies through the fourth quarter? Or is this more of a wind-down with a greater impact expected in the third quarter here?

Yes. So the costs were disproportionately in the second quarter. So the biggest piece of that was that semi-fixed labor costs due to contractual or statutory requirements to pay employees that weren't working plus the ramp-up of production. So it's sort of like having to go through a new program or new plant launch across all of our manufacturing plants globally. We're largely through that unless, of course, there's another wave of shutdowns. So that was the vast majority of the costs, say about 80% of the costs were nonrecurring [within] that category. The other 20%, what you're referring to is the PPE costs and some of the ongoing inefficiencies that we're going to see because social distancing in the plants and having to make some modifications to our processes, we do see those costs continuing into the second half of the year, so sort of at a $25 million a quarter rate. And just like anything else, like commodities or foreign exchange or inflation, that's going to be part of our commercial discussions with our customers. We are working collaboratively with them to try and find offsets and, where appropriate, include that in the cost models going forward. And I think it's reasonable to assume that we can offset or pass-through about half of that. But that will be a cost that we see continuing with the business, not just in the second half of the year, but likely into next year as well.

Okay. Great. That's helpful. And then maybe switching gears. You referenced expected CapEx uptick in the second half. Can you just talk about what you're seeing as it relates to planned customer launches in the back half of the year? Or are you seeing any significant delays or cancellations?

No, we're not seeing any -- there's been some small delays, but really no major cancellations. So some of those tied directly to the downtime that we had in respect to COVID, but no significant program delays or cancellations for that matter.

Most of that, we saw in advance of the first quarter earnings call, when we talked about sort of a shifting of a month or 2 and but there's been nothing new since then.

And the next question will come from James Picariello with KeyBanc Capital Markets.

Just going back to the restructuring savings and what are the permanent actions. I thought the last breakout you guys provided was maybe $60 million in incremental savings for this year with an additional $15 million for next year. Is that $60 million now $40 million for 2021?

Yes. We are -- so what we talked about in the first quarter earnings call, we sort of reprioritized our original $100 million investment in restructuring to try and yield more savings in the current year. So that's part of it. And we are expecting a greater level of savings next year than we were 3 months ago as a result of some of these plant closures that I referred to a moment ago.

Right. But would those savings be in addition to your normalized incremental margin? Or would this help offset an uptick in engineering spend and spillover from PPE costs and the like?

Yes. That's difficult to sort of bucket that. It's an incremental savings that we will enjoy next year. We haven't done our 2021 plan, and it's obviously a bit early to try and guide to next year. We're still trying to work our way through the balance of this year. But it will be a benefit to next year. And, as I've mentioned a minute ago, we do expect to see some ongoing costs related to PPE that will linger into next year as well as some inefficiencies. So you've got some pluses and minuses heading into next year that are sort of unique outside of what we've described in the past in terms of just sort of our goal to have a net performance that's positive where we're funding our customer pricing each year. And then the incremental investments that we may have for engineering to fund the backlog that's rolling on. Those would be independent of the more recent developments.

Yes. Understood. And just on the E-Systems vertical integration. So the $50 million that you've brought in, was this achieved on legacy programs since 80% is already shipping next year. And just provide some color maybe on the product mix? Is it mainly terminals and connectors? And just what's the runway potential for this initiative and over what time frame?

Yes. That one, like I said, really excited on what we've been able to achieve in such a short period of time. And to answer your question, it's a number of different engineered components, including Ts and Cs. And they're on legacy programs or programs that are in production today. And so when we described our ability to go after the vertical integration, the harness itself is probably 60% of the overall cost and 35% to 40% would make up these engineered components. And we have a right to play, and it's an opportunity for us to, like I said, increase our margin. And so when we set out, it was more on just programs that are in production. And we have a much higher number internally that we're tracking that we can go after. But I think the early indication in how successful we are -- we were so quickly was surprising. And so those are current programs.

Now I will say this, and I think I said it before, where those type of programs, we have to validate, we have to test, we have to get approval, those type of things. And that can range from any time period from 6 months to a year or longer, but boy did they really do a nice job of accelerating those things and getting those parts approved quickly and getting them vertically integrated into our harnesses. The longer duration of time takes -- will take place when we're -- we have a program that we're engineering. And we've reached out to a number of customers, and I'm going to tell you the early feedback from our customers have been overwhelmingly positive. And there are some programs we're discussing right now, they're in development that we can replace components that were either directed components from our customer or engineered components outside of Lear's engineered portfolio. And so I think 2 things going on. One, the ability to quickly get at what is the legacy program, our current program, surprisingly quick, and boy are we getting great traction right now. And two, the amazing feedback we've gotten from our customers when you have a full-service type capability where you can source yourselves and the flexibility that we're allowing our customers want to create value, but more importantly, vertically integrate our engineered designs. And so those things are going extremely well and we talked about those being a key to continue to improve our margin within our E-Systems business.

And the next question will come from Brian Johnson with Barclays.

This is Jason Store on for Brian. I appreciate all the color today. The new initiatives -- the initiatives in E-Systems. I was hoping to maybe drill in a little bit on electrification. I guess, one question, as we think about your win rate in 2019, which I think you've mentioned was around 40%, how does that compare to your win rate in the first half of this year? And I guess as we go out to the 2022 and 2023 timeframe, that business approaches near $1 billion, given your win rates, I -- how would -- what I'm kind of trying to understand is, if we think about your positioning in traditional wire harnesses, which maybe you're a #4 player or something, does do -- are the ambitions to be perhaps like a #3 or even a #2 player in high-voltage electrification? Because it seems like the win rates, if those continue, might imply that.

Yes. Well first of all, yes, we do target to be in the top 3. That's one thing that -- when we did this extensive study of our product portfolio, and we mentioned it, it's an 18-month project that we really went into detail on our ability and our right to play within a product segment. What type of market share do we believe we could capture? Can we obviously outgrow the market but also get really good returns? And so yes, we have set internal targets where we want to be in a position to be a 1 or -- the top 3 player. And so with that, we have looked at where we want to emphasize our investment and really focus on those areas of growth. And we do believe, and we've been very successful in that area, and I think what's important, too, and I mentioned it earlier is that E-Systems was primarily 2 customers of ours. And we talked about the need to diversify our customer base, and that is so important. And we have incredibly strong relationships with our customers. And now that we've extended out to Audi and Volkswagen and Jag Land Rover and Geely and Volvo, those platforms are now starting to build momentum with growth. And we talked about the need to invest, and it was the right thing to do at the time. Even though we had to sacrifice margin, we had to build up our reputation and our ability to supply them high-quality components and products. And so that's really starting to set the seeds for our growth. And so we do feel very confident. We've spent a tremendous amount of time focused on areas that we believe we absolutely have the right to play and we can win in.

Understood. Very, very helpful. And then maybe just following along a similar theme, maybe in Seating. I know there's been a lot of discussion around Conquest wins in the first half of this year, which is -- which has been very constructive for certainly shareholders of Lear. As we think about the Seating business, is there -- should we think about any incumbent business that you may have lost as well as the Conquest business that you've won? Or is it -- are we really thinking about the share -- the win rates here exceeding your current market share? And maybe there's some upside to Seating growth in the 3- to 5-year time frame?

Well yes. I mean, one, we said net new business awards. So there is business that we, obviously, will selectively, in some cases, choose to not necessarily aggressively go after or for other reasons, logistically or just competitively, it doesn't make sense for us. And so yes, we consider everything when we talk about Conquest wins. And the way we look at our backlog is net new business awards. And we have been very successful within the Conquest wins. But there are other businesses that, for financial reasons, we don't think necessarily fit with our strategy long term. But our -- we are absolutely comfortable with our growth over market in that area, and we've done a nice job of market share gains from 18% to 23% during a time when there was a lot of irrational players out there, and it position us in a very good place today. And I think about that seat business. One, we have an incredibly recognized team. We have incredible talent, and that's very important, and it's actually even more important when you go through a crisis like this. And two, on the operational excellence, we've been investing in that business for 10-plus years. And so we have made very specific targeted investments within that business that I do believe creates like a moat around our ability to execute our products, and we're recognized by our customers for that. And the last one is the product portfolio. I think what is really impressive right now as we talk about embedding technology into our seat systems and that's exactly what we're doing. We have capabilities with E-Systems and our capabilities of our manufacturing within Seating to embed technologies that create value for our customers. And so when -- why I believe we've been so successful in -- the landscape has been relatively the same -- I've been in this business for 32 years, the same forever. There's always an irrational player, somebody that's a Tier 2 that wants to be a Tier 1 and all kinds of things. But you're just focusing on the things that you can control. We have put ourselves in a position where operational excellence, it is no light switch. You have to invest over 10-plus years to put yourself in that position and create processes and operational excellence that differentiates you. And two, equally as important now is technology. We're in these development programs, why we talk about them is we're in the studio with our customers at such an early stage. And to be able to take that ConfigurE+, which was unique to itself for your power a rail system with a cassette that's patented by Lear to move a seat with reconfigurability electronic with a rail that can be powered now with the seat, the airbag. I mean it's just a totally different setup and then intuitive seating. So we're in there in a different way. It's -- I think what really creates that reputation of Lear to differentiate ourselves. And I do believe that, that's why we've been successful.

And the next question will come from Dan Levy with Crédit Suisse.

First, just housekeeping. Could you -- maybe you could provide us with a framework for when you might expect to pay down the $1 billion revolver draw? And what do you need to achieve before you think you can reinstate the dividend?

Yes. So in terms of the revolver repayment, that's something that we'll likely end up doing, at least partially in the third quarter and if not then the fourth quarter. We expect to be free cash flow positive in the third quarter and substantially positive in the fourth quarter. And so we'd like to have a cash balance of about $1.250 billion. And so we're about $500 million or so above that right now. So we're approaching a point in time where we want to return a portion of that revolver. And so provided, there aren't any surprises for the rest of the third quarter and into the fourth quarter, any new shutdowns, we should be in a position to largely pay that back.

And then in regards to the longer-term discussion around dividends and share repurchases. We're in a constant dialogue with the Board on that topic. And really, what we're looking for is a path to sustained free cash flow generation quarter in and quarter out. And we don't want to try and put it in prematurely and then have a setback. We're looking for some proof that the industry has recovered. And it doesn't have to go back to 2019 volume levels, I think we can be significantly profitable and generate significant free cash flow in a volume environment that's down 10% from 2019 levels. But ultimately, that's a decision by the Board and a dialogue that we're in with the Board constantly.

Great. Great. That's helpful. Second, I just wanted to follow-up on Seating and just touch on the $700 million of year-to-date Conquest wins, which is quite robust. Can you just give us a sense what is driving this large uptick in Conquest wins? Why are customers going [huge?] Can you give us a sense of what type of margin profile you'd expect on the new business? Is this directionally, would you say, from a margin perspective, neutral or accretive or dilutive to the existing seating margin profile that you have, ex COVID?

Yes. Just generally speaking, I would say it's in line with our existing segment margins. Ultimately, what will determine that is the level of vertical integration. And so a just-in-time seating program as a stand-alone, we can earn a return well in excess of our cost of capital at 5% or 6%. And so it depends on the level of componentry. We ultimately are awarded in conjunction with that. And in this case, there is some vertical integration with all 3 of the major Conquest awards we've had. And so I would expect that the margins should be in line with the existing segment.

Could you just -- sorry, go ahead.

No, go ahead. What was that?

No, I was going to say, if you could just talk specifically to what vertical integration it is that you have, is that on the seat structure side? Or is it more on leathers or material?

It depends on the program. So there's 3 different awards, and each of them have a different composition of vertical integration. But mostly trim or seat covers and foam. But there are -- there is some seat structures on one of the 3 programs, but not the other 2.

And our next question will come from Emmanuel Rosner with Deutsche Bank.

Wanted to just follow-up on the free cash flow outlook for the rest of the year. Could you give us an early sense of how much of the working capital drag you think you would be able to recapture in the back half?

And I guess, overall, very encouraging to -- that you expect positive cash flow in the third quarter and substantially in the fourth quarter. Any early sense on whether on a full year basis, that would enable you to be free cash flow positive?

Yes. So in regards to the third quarter, we expect to be sort of working capital neutral, maybe slightly positive. And based on our outlook for production the earnings generation will lead to the free cash flow generation in the quarter. And then in the fourth quarter, we see most, if not all, of the working capital used from the second quarter reversing itself and benefiting the fourth quarter. In terms of whether we can be free cash flow neutral or positive for the full year, ultimately, that's going to depend on the level of production in the second half of the year. And maybe equally important, the timing of that production to the extent of when it happens in the quarter, just like we saw in the second quarter, when that production ramps up in the last couple of weeks of the quarter, all of that revenue is essentially sitting in receivables and collected down the road, 30, 45 days down the road. So if that happens again in the fourth quarter, that would weigh on that working capital opportunity that I just described. But what we target is in a 20% revenue decline for the full year that we should be approaching free cash flow positive or free cash flow neutral. So sort of that -- the better end of that range of down 10% to 15% would align with revenue that's down roughly 20% year-over-year and give us a reasonable chance of getting back to that free cash flow neutral position. The other factor, though, I just want to highlight is we did take a number of temporary measures to preserve liquidity in the second quarter, particularly salary deferrals and those things. And if we're in a position where the production environment is that strong for the remainder of the year, we may look to unwind some of those as soon as the fourth quarter, particularly for lower level of salary employees, we may want to do that earlier. The sooner we can do that, the better, of course. So that's another factor we have to keep an eye on as well, Emmanuel.

Okay. That's great color. And then I guess, secondly, focusing on your -- the outlook for your second half growth above market. I understand the elements of positive mix, both in North American trucks and China luxury. Was hoping to focus maybe on the backlog outlook for the second half. Obviously, you had great growth above market this quarter despite a negative backlog. How should we think about -- what does the backlog look like in the second half?

Yes. So the backlog was pretty weak for the first half of the year and negative, as you pointed out, in the second quarter, and that's really a function of the business that rolled off and then seen some delays in programs rolling on and rolling out at lower volumes. So the second half backlog is considerably stronger. We're expecting somewhere between $500 million and $600 million of full year backlog. And so the vast majority of that's going to hit in the second half of the year. And that will be a significant factor in the growth over market, whereas the first half was more driven by mix than anything else.

That's incredibly helpful. And any breakdown by segment that you could provide?

Looking at the second half of the year, it's -- in terms of the relative breakdown of it. It's more weighted to E-Systems in terms of their size -- their relative size of the company today. In terms of absolute dollars, Seating is going to be a bigger piece of it. But we do see stronger growth from the backlog on a relative basis in E-Systems in the second half. And it's a lot of those electrification platforms that are rolling on onboard chargers and other products that are rolling on in the second half of the year that are driving that.

And the next question will come from Chris McNally with Evercore.

If we just put together the couple of different points you've made on margin over the course of the conference call, and if we look at the underlying that you're calling out for both Seating and E-Systems being 8%, obviously, there's puts and takes to next year. But is it fair to say that once we are at either pre-COVID revenue levels or maybe just global production that is pretty close to pre-COVID, that 8% is sort of a margin level that you would hope to achieve? So it may take some time, whether that's 1 or 2 years. But the underlying, even if costs come back once we hit that revenue level that, that 8% underlying would be a good starting point.

Yes. I think in Seating, that's definitely the case. In E-Systems, the other factor we have to think about is the mix of whether that revenue comes back by production volumes going up or whether it's backlog so typically, you've got this decremental margin, variable margin on the lower volumes of 30%. And then you're rolling on backlog, say, the segment margin, let's say, 8% to 12%. And so you could see a little bit of dilution as a result of that. So it depends on how the mix of revenue shakes out looking out into future years. But generally speaking, if volumes get back to 2019 levels, then what we've said is in Seating. We're very comfortable with the long-term margin range of 7.5% to 8.5%. That's what we've run this business at for the most part over the last 5 years. And in E-Systems, we still see a longer-term trajectory towards 10%. It's sort of troughed in the middle of last year at 7.6%, and we've been working our way up after this COVID setback. And we still are well on our way towards driving that incremental margin improvement over the next several years.

Okay. That's really helpful. And then just on a shorter-term basis, you gave the incremental margins from Q2 to Q3. And I think you've mentioned in a 20%-plus range. That's very helpful because, obviously, maybe we're in this COVID environment with extra cost for longer than we realized. Is that sort of low to mid-20s? All things being equalized, production gets better. Can we use that as a sort of a sequential incremental margin or at least a rule of thumb or just a checkmark to kind of keep the quarterly numbers as we think about maybe next 4 to 6 quarters?

Yes. We expect that revenue increase is driven by volume recovering. Yes, that's a good number to use. The other factor to think about in the third quarter, you had the weakening recently of the U.S. dollar. And so we may see a revenue tailwind in Q3 and Q4, but it's going to roll on at our European segment margins overall. So call it, 5% or so in today's volume environment, so that would be a little bit dilutive to that sequential incremental margin. And the other factor as well is whether that revenue comes back by volume or, again, by backlog. And so there's -- the sequential incremental margin will vary depending on the mix of volume versus backlog as well.

Great. And if I could sneak in one quick secular one on E-Systems. You've had great success with some of the big customers in Europe. Without even giving any names, can you talk about -- have you made any progress with some of these super early stage start-ups that may not even be huge volumes, but predominantly in North America? We're seeing a lot of activity in launches. Has that business been awarded on for their electrical?

We've had some -- I'll leave it at this. We've had some good conversations, but nothing of any significance that we would report as far as backlog. So -- but we are having good dialogue, good discussions. So we're obviously, remaining somewhat optimistic, but a lot more work to be done there, but good conversations.

And the next question will come from Itay Michaeli with Citi.

Just want to go back to the new business win discussion. I was hoping if you can share, on a total company basis, what Lear's net new business wins look like in the first half of this year relative to the first half of last year? Just maybe how you're thinking about the growth over market longer-term for the company? I think back in 2018, it was about 5 points over market at the Investor Day. Kind of how are you thinking about that in light of some of the Conquest wins as well?

Yes. I think it's a little bit early to provide the full backlog update at this point, Itay. But as Ray described a moment ago, when we're reporting Conquest wins, they're net of any losses. So you can use that as a proxy for backlog. And what's just a bit unusual about the last 12 months is the extent of backlog we're seeing come through Conquest wins, where historically, it's been more customers introducing a new program and winning your share of that. So I think it points to some market share opportunities in Seating maybe beyond what we anticipated. We did have an ambitious target of going from 23% to 28% market share. And I think this helps us get there. And if we do achieve that, that helps us get to the 4 to 5 points above market targeted growth opportunity that we've talked about in Seating. In E-Systems, more of the new business wins are coming in, in electrification and connectivity. So it's not so much Conquest because this is new content to the market, and that's the biggest driver of the business we're winning right now in E-Systems.

Yes. So to add to Jason's point, we're very comfortable. We're not -- we haven't changed our numbers. And I think as we continue to be successful in our growth, our trajectory will still be on track to what we committed to. And I don't think there's anything in front of us right now that would tell us otherwise.

That's very helpful. And just lastly, going back to the free cash flow discussion for the year. Jason, I was hoping you can share kind of roughly what you think CapEx might come in, in 2020? And then given the new business progress, maybe directionally, how we should think about that in absolute terms or a percentage of revenue over the next couple of years?

Yes. I think our original guidance this year was $600 million. We're targeting around $425 million of CapEx for the year at this stage with a heavy weighting to the second half of the year with Q2 being so low. And I think sort of 3% of sales on a normalized basis is still a pretty good figure to use for the combined business going forward.

And our final question today will come from Armintas Sinkevicius with Morgan Stanley.

I'm just trying to think through. How does Mexico look like? You have significant exposure. You mentioned that as something you're watching here into the back half. Maybe you could provide us with how things have gone since reopening in mid-May and how they look like today?

Yes, it's a good question. And I think to kind of quickly say we're pleasantly surprised overall with the performance and how we look at our business within our manufacturing facilities. It's gone extremely well. And we do a nice job of being able to contact trace, minimize any type of exposure, stop a spread. And the number of issues that we have had have been external to our facilities. And so we haven't gone through what I thought we'd see is a lot of start stop, start stops, and so it's been relatively smooth from that perspective. Now on the supply side, we study both, obviously, our own facilities, and we have detailed reviews of how each plant is doing internally to Lear. But on the supply side, even though it's going extremely well, better than I would have expected. It's still somewhat fragile because all suppliers are not equal. And we are seeing different locations that are having different types of hotspots or incurring significant increases in cases even outside the manufacturing plants. And so even though we monitor our facilities very closely on a daily basis, on a weekly basis from an audit standpoint, we also keep a very close eye on our suppliers.

And I would say that Mexico, and I think I said it at the last call, Mexico, unfortunately, doesn't, in some respect, even have the infrastructure that the U.S. might have and, in some respects, are probably 6 to 8 weeks behind us. And so we have some concerns around the world in different pockets based on different information and intelligence that we're gathering. And so even though we're running well, and overall, I think we're somewhat surprised at how well the overall supply chain is running, there's still pockets that we have a lot of concerns around. And we keep those very close and monitor them, making sure we can help out suppliers or infrastructure or help aid in any way that we can with PPE equipment to make sure that we can minimize any type of issues within our supply base.

But like I said, overall, somewhat surprised of how well things are going, but very cautiously concerned about certain areas in specific countries.

And then the other question I have is around incremental margins. Once we get through COVID, and you mentioned some of the detail around what the volume situation does to your margins. But once we get through this, should we be looking at the 20%, 30% variable margins for Seating and E-Systems or do the incremental margins start-up a bit slower as you're starting to put costs back in the system as volumes pick up, if you could help us think through that? I know it's a little bit early to think that far ahead, but just conceptually, when COVID does come under control.

Yes. I think if you get to a point where those incremental costs are behind you, then you can think about the incremental margins being more in line with the segment variable margins. Again, I'll just caution you on the split of weather that revenue is coming back through additional volume on existing platforms or if that revenue is coming on through backlog. Backlog is going to roll on closer to the segment margin and to the extent it's volume, it's going to roll on at variable margin. And then you also have foreign exchange, which is kind of a recent development with the recent weakening of the U.S. dollar, which was pretty significant over the last couple of weeks. And so that incremental revenue will come on at a lower margin as well.

But no reason to think it'd be any different than your variable margin today?

The volume piece of it? No.

Okay. That should be it. I think the only ones left on the line at this time are the Lear employees. And like I said earlier, thank you for everything you've done. It's been absolutely impressive. I appreciate all the great work you've done, a great job, but we have more work to do. We have to continue to focus on what we can control. We're doing a really nice job. But I appreciate everything you're going to do as we move forward and continue to separate ourselves. So thank you for everything you're doing. Bye.

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect your lines at this time.