Hello. Thank you for joining Lear's Third Quarter Earnings Conference Call. I will now turn the call over to Alicia Davis, Senior Vice President of Corporate Development and Investor Relations. Please go ahead..

Thanks, Carmen. Good morning, everyone, and thanks for joining us for Lear's third quarter 2019 earnings call. Presenting today are Ray Scott, Lear's President and CEO; Jeff Vanneste, Senior Vice President and CFO; and Jason Cardew, Vice President of Finance.

Other members of Lear's senior management team including Frank Orsini, President of our Seating division; Carl Esposito, President of the E-Systems; and John Absmeier, our Chief Technology Officer, also have joined us on the call. Following prepared remarks, we will open the call for Q&A.

You can find 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. Then Jason will review our third quarter financial results.

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 thanks, everyone, for joining us today. Earlier this morning, we released our third quarter financial results, a summary of which appears on slide 5. Sales in the quarter were $4.8 billion, adjusted operating margin was 7%, and EPS was $3.54. Adjusted operating margins in Seating and E-Systems were 8.2% and 7.6% respectively.

For the last six weeks, our largest customer has been experiencing a labor strike. The strike has had a significant effect on North American auto supply chain, including Lear. Despite the impact of the strike and other industry headwinds, we delivered solid financial results in the quarter. Our global production was down 3% in the third quarter.

Sales in our Seating business, excluding the impact of foreign exchange, increased 3% or 6 points above market. In E-Systems, third quarter margins, although lower on a year-over-year basis, came in a bit better than what we were forecasting back in July. Slide 6 provides some recent business highlights.

Last month, Carl Esposito, a seasoned executive with expertise in electronics, software development and connectivity joined Lear as the President of E-Systems. Carl is a proven leader with the right skills to further enhance E-Systems' products and performance.

On our second quarter earnings call, we told you we were accelerating our restructuring efforts to respond to the challenging production environment. Driving efficiencies in all areas of our business is not new to us. It's in our DNA. And we are executing our plan for further improvement.

We will provide a detailed update of our progress early next year. On our second quarter call, we also laid out the framework for our comprehensive plans to improve our performance in E-Systems and position it for continued profitable growth. We have now the most experienced E-Systems leadership team in our history.

In addition to Carl, Mike Balsei, an automotive industry veteran, recently joined the E-Systems team. Mike leads our electrical distribution business, an area in which he has deep expertise and play a pivotal role in driving improvements and profitable growth in the division. Last month, we welcomed Sinn Yee [ph], as our new Head of E-Systems in Asia.

Sinn is an accomplished executive with extensive knowledge of the Asian automotive market. He is based in Shanghai and is the key role in our efforts to enhance growth and profitability in China.

Carl, Mike and Sinn as well as other recent additions, deepen the already strong management team we have in place in E-Systems and position us well for the future. In addition to having the right people, we also have the right organizational structure.

We have reorganized E-Systems to ensure greater visibility into profitability and financial returns by product segment, region, customer and program. As I said on our last earnings call, we are committed to expanding in areas with topline growth and profit potential and exit low-return and noncore product lines.

We continue to pursue opportunities in electronics, software services and data that offer incremental sales and margin expansion potential. I'm also very excited about the potential for increased vertical integration of our wire harness business.

The future of our business in terminals and connectors and other engineered components is very promising, as we increase our efforts to partner with our OEM customers to meet their sourcing needs and leverage our own manufacturing capabilities.

On the technology front, I'm happy to report that Xevo has been named a finalist in 2020 PACE Award, a prestigious award that is recognized around the world as the industry benchmark for innovation. Also, Hyundai recently agreed to launch Xevo's markets in vehicle commerce platform for Hyundai's Kia vehicles in the United States and in Europe.

And with new partnerships such as the one with Hyundai that number will only continue to grow. Finally, Lear was awarded the J.D. Power Seat Quality Award, sweeping the luxury vehicle categories for the second consecutive year and placing first in two mass market vehicle segments.

I'm extremely proud of these awards and they are a testament to our continued focus on operational excellence and quality. But before I hand it over to Jeff, I do want to express my sincere gratitude to him for his 20 years of Lear's -- Lear Corporation his outstanding leadership, his wise counsel, and most importantly his friendship.

I will miss you Jeff. We'll all miss you. We wish you the best in retirement. You absolutely deserve it. Thanks Jeff..

Thanks Ray. And thanks to the entire Lear team. It's been an honor and privilege to serve as Lear's CFO, and to have worked for such a great company for most of my professional life. I am proud and happy to transition the CFO role to Jason, a person I have known and respected his whole professional life.

I note that as I hand the retirement, I leave the job in very capable hands. Now Jason, our next CFO will guide a review of our third quarter financial results..

Thanks, Jeff. Slide 8 shows vehicle production for the third quarter. In the quarter global vehicle production was down approximately 700,000 units or 3% from 2018. Lear's top programs were down greater than the market in each of our major regions with Europe down 7%, North America down 6% and China down 14%.

From a currency standpoint, all major currencies continued to weaken against the U.S. dollars in the quarter. Turning now to slide 9. For the quarter, sales were $4.8 billion, down $67 million or 1% from last year, driven by production declines in all our major markets and the negative impact of foreign exchange partially offset by new business.

Excluding the impact of foreign exchange and the acquisition of Xevo, sales were flat reflecting three points of growth above market. Our operating earnings were $338 million, down $61 million primarily due to lower production volumes on Lear platforms. Core operating margins were 7% in the quarter.

Third quarter free cash flow was $193 million, compared to $107 million in 2018. Slide 10 explains the third quarter year-over-year variance in sales and adjusted operating margins in the Seating segment. Despite the impact of the strike in our largest customer, sales in the quarter were $3.7 billion, up 1% from the third quarter of 2018.

Excluding the impact of foreign exchange, sales increased 3%, representing six points of growth above market. The increase in sales is driven by growth from the backlog, partially offset by lower production on Lear platforms, including the strike-related impacts on North American sales.

Seating margins were 8.2% down 40 basis points from last year due to the impact of lower volumes partially offset by strong operational performance. Slide 11 provides third quarter year-over-year sales and adjusted operating margin walk for our E-Systems segment. Sales in the third quarter were $1.1 billion, down 8% from the third quarter of 2018.

The decrease in sales was driven by volume declines on Lear platforms as well as currency headwinds. These are partially offset by growth from the backlog as well as the Xevo acquisition. E-Systems margins were 7.6% in the quarter.

Consistent with the first half of the year, margins were impacted by lower volumes and unfavorable platform mix on key Lear programs.

Net performance in the quarter was negatively impacted primarily by continuing effects from commercial agreements we've reached in the second quarter as well as investments to support our backlog, elevated labor costs and other economics. Slide 12 shows our return of capital to shareholders as a percentage of free cash flow since 2015.

Over the last five years, we have returned on average almost 70% of free cash flow in the form of dividends and share buybacks to our investors. Our capital allocation philosophy has not changed. After first, investing in the business to support our customers, expand our product and process capabilities and improve our cost competitiveness.

Second, making focused strategic acquisitions that add to our product capabilities and offer sales diversification. And third, maintaining investment-grade credit metrics we are committed to returning excess cash to shareholders.

Slide 13 shows full year IHS global vehicle production volumes, our production assumptions for our Cadillac platforms and our currency assumptions. IHS is forecasting 2019 global industry production to be down 6% year-over-year. This represents a reduction of approximately 1.9 million units or 2% as compared to its July forecast.

We base our production outlook on several sources, including internal estimates, customer production schedules and IHS forecasts. At the midpoint of our updated guidance, our volume assumption for our top platforms in North America is down 12%; in Europe down 9%; and in China down more than 20%.

Slide 14 provides our updated financial outlook for 2019. Primarily as a result of the strike at our largest customer, we are lowering our full year 2019 financial outlook.

At the midpoint of our outlook, sales were estimated to be $19.25 billion, down 9% from 2018 reflecting lower production on Lear platforms, including from the impact of the strike, partially offset by the addition of new business. Excluding the impact of foreign exchange and the acquisition of Xevo, sales are expected to be down 6% year-over-year.

Core operating earnings at the midpoint of our 2019 outlook are expected to be $1.25 billion. Our updated free cash flow guidance primarily reflects our outlook for lower earnings, partially offset by lower capital expenditures. Slide 15 summarizes the changes in sales and earnings from the full year outlook we provided in July.

Since our July outlook, we have experienced significant loss volume from the strike and other further declines in global vehicle production. These factors, combined with the impact of weakening global currencies against the U.S. dollar, result in a sales decline versus our prior outlook of approximately 4%.

Our operating earnings and margins have been impacted primarily by lower production volumes, partially offset by favorable net performance, which includes lower incentive compensation expense.

On a segment basis, we now forecast full year Seating margins in the mid-7% range, down from approximately 8% in the prior outlook, primarily reflecting the impact of the strike. In E-Systems, our full year margin outlook is unchanged at the mid-8% range.

Though the strike will materially affect our 2019 financial results, we are taking aggressive steps to mitigate the impact including instituting further reductions in discretionary spending. Our updated outlook reflects the result of these efforts. I will now turn it back over to Ray for some concluding remarks..

Thanks, Jason. Now turning to slide 17. In summary, we delivered solid financial results in the third quarter, despite the challenging macro environment. I'm proud of what we've accomplished. Without question, challenges remain. But we have an experienced management team that can successfully navigate the current environment.

And now, we'll be happy to take your questions..

Thank you. [Operator Instructions] And your first question comes from the line of Rod Lache with Wolfe Research. Rod, please go ahead..

Good morning everybody. Thanks for taking my question. I was hoping, first of all, you could just clarify the change to your revenue guidance. Your prior guidance for revenue was $19.8 billion to $20.3 billion and you're now $19 million to $19.5 billion. So I could see that $800 million taken off.

And it looks like FX was probably a $75 million impact and it looks like you've adjusted some European platforms down about 1%, or $90 million. So a little over $600 million left.

Could you just give us a little bit more insight into how much of that is the GM strike or the Hyundai strike? Or how has that kind of spread between Q3 and Q4?.

Sure. Yes. Let me first start by just sort of describing the thought process we went through on providing our updated outlook. And, obviously, if the vote has been completed on the GM strike prior to issuing our guidance, this would have been a little bit different conversation.

And so, given that GM is our largest customer, particularly in North America, we have kind of a wider range than we ordinarily would at this time in the year.

And so, what we've assumed at the top-end of the range is that we would lose seven weeks of production to the GM strike and that's two weeks in the third quarter and five weeks in the fourth quarter. And so, we're now completing sixth week of the strike as we sit here today. We expect to hear the results of the vote later today.

And what we've assumed at the high end of the range is that there's one additional week of loss production as a result of the time it takes to get ramped up. Now, that's not what GM has told us. That's simply our assumption that we used to set the top-end of the range.

The bottom-end of the range, we've assumed three additional weeks of loss production due to the GM strike. So if the vote were to not pass today and the negotiations were to continue, we're protected for three additional down weeks.

So at the middle of the range, we've assumed effectively eight-and-a-half weeks of loss production and, Rod, that's about $525 million of lost revenue. The weekly impact of the strike has kind of grown as the strike as continued on as more facilities were impacted, as Mexico eventually became impacted.

And so, each week of the strike now is $70 million to $75 million of lost revenue. So that's the missing piece to your walk on the revenue guidance..

Okay. So just to clarify, if the strike is over tonight you basically lose a month in the quarter. So maybe $280 million of impact in the quarter. It looks like you're assuming quite a bit more than that, even aside from the currency and the adjustments.

Am I missing something there?.

Yes. So if the vote is passed today and GM is able to resume production next week, that would represent an opportunity even to the high-end of our range. We've assumed one additional week of loss production as they ramp production back up at the high-end of our guidance range..

Okay. Thanks for clarifying that.

And then could you just spend a little bit of time talking about the prospects for recovery in that productivity line item in your bridge and E-Systems? How are you expecting that to look here over the next couple of quarters? When would you start to expect that to turn, and presumably there is going to be some benefit over the next year from the $75 million of restructuring savings and Xevo becoming neutral to earnings? So give us a little bit of color on the prospects there?.

Yes. Rod, why don't you kind of take a step back here and think it through E-Systems, I mean, I break this down into near-term, medium-term, longer term and there's a lot going on.

I mean, one in the near-term, obviously, it was establishing a strong management team and I'll tell you that the team we've put in place is without question the best team we've ever had in E-Systems from an experience standpoint and the things that they're focused on.

The second part of the more near-term was putting in place the disciplines, which we're focusing on return on invested capital. And a lot of things that we're doing are very similar to what if you remember back in 2006-2007, I was asked to go in E-Systems and turn that business around. It was about $1.8 billion and lost money.

And then back in 2013-2014, I was asked that go turn the Seating or improve the Seating and that was down about 200 basis points. We did very similar actions. And so in the near-term we're definitely on track as far as putting a strong management team, driving discipline return on investment -- invested capital.

Looking at improving our China operations, we talked about as being an issue for us and we've hired an expert looking at that business and staying focused. Our plants are running extremely well. I mean, one thing that -- to take note that the plants are running extremely well and we're doing a really nice job at launches.

Our medium-term is what we've talked about. The transition to more -- higher margin products such as power electronics and connectivity and there's a really good opportunity. We're getting a lot of good traction right now with our customers on this --engineered products in Ts and Cs within the wire harness business.

And I'd say one major change there and we've talked about the lack of really being able to get our engineered components on harnesses in the past because of catalogs and other restrictions. Our customers have a completely different mindset now. The doors are open we're making very good progress.

That will take some time because there's design validation requirements that we have to go through testing, resourcing and that type of stuff. But nonetheless, we're getting and making some very good progress there. And the restructuring actions that you alluded to are on track and we're making some very good progress here.

Longer term in the business, we've done a nice job looking at. The overall product portfolio, we talked about we're going to stay focused and we'll be generating really good returns and then obviously exit business that's considered to be making the type of returns that we target.

And then the continuation of vertical integration, I think the last one is the software and data platforms. I mean we're really doing a nice job. One thing I want to mention is on the Xevo platform 133 million vehicles and it's up from what was just a short period of time of April 25 million.

And so those things are going to start paying dividends longer term.

But when I look at where we're at in E-Systems and thinking about the experiences I've had in the two different segments, we'll walk ahead of where we were in E-Systems prior -- back in 2007 and then seating in 2013-2014 with a strong management team in place and I think these issues that we're looking at as far as improving the overall margin takes some time and they're going to -- the traction will take -- will hit in different times too.

And Carl, you're in the room and can you kind of go through some of the ways to getting at some of the differentiation of our product?.

Absolutely. In that medium-term a lot of new product launches and particularly around the electrification side really strong portfolio of products. And I think something that differentiates Lear is that those product offerings we make everything from the outlet to the output of the electronics and the power management become broader systems.

And as we see further integration of those electronic components and power electronics then the greater power density, greater opportunity for the customers to have improved vehicles in terms of charging performance. We integrate those things.

And so on the longer term you'll see a deeper integration of the power electronics and the subsystems that we make today. In terms of new business 40% of the wins this year have been around electrification and connectivity. So playing in the right place is currently where the market is going.

As I think longer term around the software and data services as Ray mentioned, connectivity is going to really transform automotive like gas and so many other industries. And we're there. We're first with the first 4.5G-embedded connection. We'll be there with the first 5G-embedded connection.

And we'll use that connectivity position to help deliver services and software help enable things like the Xevo services. The growth in software, stand-alone services applications, in fact, we've received one of the first RFPs for stand-alone software from our customers. So we're seeing the interest there from a software perspective.

And as we work on their product road maps, the portfolio we're developing that not only for hardware, but software and the services aspect. So we're really excited about both the mid-term and the longer-term future for E-Systems. And it's good to be on the team..

Yeah. That's great, Carl. I want to go through all this, because it is important. There's a lot of different aspects that we're going after here and from my experience and before Jason, I turn it over to Jason to kind of answer your question on the financials, I don't think we've ever been in the better position.

This business I'm very confident in this business. It's amazing talking to customers and we've won significant awards recently on some of the things I'm talking about with power electronics and connectivity. And there's an absolute right for us to play in this vertical integration. And the doors are open.

It's an opportunity we haven't had I think in the past that now is a real opportunity for us to continue to drive profitable business in these systems. And with the software that we're developing, it really is impressive.

And every customer I go and talk to about Xevo, what we're doing with EXO or Arada and all and that with our capabilities is really positive and we've picked up some really nice contracts. And so there's a lot of things we're doing Rod and why I want to go through all this is an explanation. I've done this twice before.

We've never been in this type of position. And then looking at the product lineup the team that we have in place, the discipline that we're focused on, so I feel really good about the business. And I want Jason kind of give you an overview of how we see that business playing out over the next several years..

one, the benefit of the vertical integration that Ray referred to; and two, as we mature businesses with some of these new customers we see opportunities to improve margins there. And we also see opportunities on our -- some of our more mature programs that have finally finished the changeover cycle.

Once you get through the launch sector, and you're able to deploy your cost reduction programs, we see some margin benefit from that. And again, besides the fact that we've digested a massive reduction in production volumes on our core programs in that segment.

And so our restructuring program is partially designed to take some excess capacity out and improve the margin profile of that business over time. And you've highlighted the restructuring program. That certainly will help us in the near term improve margins there.

And looking out longer-term we see this mix of business allowing us to get back to that 10% plus operating margin level and that's -- it's just a bit further out..

Okay. Great. That's very helpful. I appreciate the detail. Just to clarify in the next couple of quarters though and a lot of these things are kind of longer-term and mid-term opportunities that look pretty attractive.

But in the next couple of quarters in terms of execution, should we be focusing on that 300 basis points or so year-over-year bridge starting to compress as you start to get more internal efficiency, productivity and restructuring kind of mitigating some of the headwinds you mentioned?.

Yeah. It's a bit early to provide 2020 guidance at this stage and there's lots of moving parts. And so we'll get into that in more detail in January on our fourth quarter earnings call when we provide our formal guidance..

Got you. Okay. Thank you..

Yeah. Thanks Rod..

Your next question comes from the line of Brian Johnson with Barclays..

Yes. Good morning. I have two sets of questions. One, a little bit of housekeeping follow-up on your production guidance, also recognizing you're not quite ready for 2020.

Do you just have a broad sense of how your major customer could ramp up and the potential to catch up on production this quarter versus first half? And if so in first half is it going to be first quarter inventory rebuilds or spread through the year?.

Yeah. As far as the strike and how they're going to ramp back up, obviously, we've been in limited conversations with General Motors and I'd prefer to wait till they announce what they're going to do in respect to call back in accelerating the launch. I mean, Jason mentioned how we've kind of looked at in our guidance. And it will be a slower ramp up.

It's -- obviously they come back quicker that's good news for us. And we haven't really gotten all the details of how they caught back and how they might get their volume back at this stage..

Okay. And just a related follow-up on that and then I'll ask a Seating question. The SUVs were slated to change over next year.

Any sense of how the strikes are going to affect the timing of that change over?.

Go on Jason..

Yes. Yes. We are not expecting a meaningful change in that. We've heard nothing about a change in the launch plan for the SUV. We're expecting that to happen in the second quarter of next year..

Okay. Second set of questions. Just really around the Seating business.

Some investors have been asking given the price negotiations that happened midsummer with a major customer in electronics our customers are approaching Lear and frankly your competitors pushing for price downs in the Seating segment either in just-in-time assembly which enjoys higher ROIC or in some of the components, or alternatively is major competitors still having to walk price up and that's benefiting the industry?.

Well let me start with the productivity in the requests from our customers for price downs. I haven't seen any changes both in E-Systems and Seating. I know we made some decisions last quarter in E-Systems, which have already benefited us in our relationships with our customers and longer-term growth.

So that was a good decision to make to grow our business longer term and create value for our shareholders. In respect to how our customers are behaving with price downs with some of the pressures they have and I will say that I've seen more of a willingness to look at things differently in respect to VAV and cost downs with design.

I have had some really good conversations with our customers and how we can look at the whole value chain and reduced cost, but nothing on the price downs. It's been more of a collaborative where can we help them? Are there alternatives? Are there things that we can do to really be more efficient as a system supplier and we pride ourselves on that.

Something that we're very good at and we have something we'd work on internally which is cost technology optimization, which I believe we are the benchmark. And we've been recognized by our customers for that.

And so I have seen that pick up and which I think is good for us, because they're share programs and things that we can work with our customers that help offset volume reductions those type of things that we're good at negotiating. So I think that's a positive sign for us.

And I do think that -- referring to your other point, we have picked up some nice Conquest Business. Even this week we just were awarded some Conquest Business that I talked about in Seating area that takes some time. Customers do not like resourcing during a product cycle or product life or during a time.

So we're starting to see the next generation of awards coming in and that's been very positive for us. And so I hope to continue to see that happening..

Okay. Thank you..

Thanks, Brian..

Your next question is from the line of Emmanuel Rosner with Deutsche Bank. Emmanuel, your line is open..

Hi, good morning..

Good morning..

Good morning. So a couple of questions on E-Systems. The backlog in the revenue walk was a little bit on the -- the contribution was a little bit on the low side at $21 million. And even sort of on the year-to-date basis I think we're probably only around that $150 million or $160 million.

Can you maybe talk about what sort of going on there? Is this sort of like the impact from the lower global production volume? Or is some business being pushed out or delayed into future quarters?.

Yes. So our backlog for 2019 has come down. We talked about $1.4 billion backlog in total for the company back in January and we've seen that come down by about $350 million from this year. And E-Systems has brought the brunt of those reductions.

And if you look at the composition of their backlog about 60% of this year's backlog in E-Systems was slated for Asia which is primarily going to China. And China has been hit harder than any other market in terms of lower production volumes.

And so what we've seen this year is really a combination of lower production volumes, some programs that have ramped up slower and that's impacted both segments and some programs that have been delayed and pushed out to next year.

And as we look at 2020 and our backlog, we do see that trend sort of continuing and we do expect the backlog for next year to be a bit lower than this year. As a result some of the same issues that we experienced this year. Lower volume is the main contributor to that.

And if you kind of step back and look at what IHS was calling for 2019, 2020 production volumes globally back in December when we established our backlog, they've cut their global outlook by 8% this year and 8% next year. They've cut China by 12% this year and 15% next year.

And that has had a meaningful impact on the backlog for both years and in addition to that we've had some programs that were delayed this year pushed into next year that will happen next year, unfortunately we had further program delays out of 2020 and into 2021.

Now, that will help us as we look out into that third year of the backlog, when we do formally update that in January. On the positive side as Ray mentioned, we've seen two positive developments in the third quarter.

We've seen the initial benefit of the commercial agreements that we negotiated in the second quarter starting to result in new business wins on the E-Systems side, albeit much of that is outside of our three-year backlog window, but it's a positive development nonetheless.

We've seen a really strong build on the core pipeline in electrification and connectivity and the amount of business reported there.

We have talked about $1.2 billion of core pipeline in electrification and connectivity for this year that's actually grown to $1.3 billion, of which $1 billion has been sourced and we continue to win consistent with our targeted share of sort of 25% to 35%.

So that's extremely positive and as Ray mentioned as well, we're starting to see an uptick in the Conquest awards. And we've had over $300 million of Conquest awards in Seating this year that will benefit the longer-term growth of that segment.

I think as you look at longer term in some of the data services and software aspects that will also decouple from the OEM production rates as we [Technical Difficulty] through services that are offered broadly to already field vehicles. And so that's again, another exciting aspect as we look to new areas of growth in E-Systems..

I appreciate all the detail. And then secondly, on the E-Systems margin. So, you give a lot of helpful color before I think 125 basis point was the impact from the commercial agreement in the quarter.

Can you just for that specific piece talk to us about, how do you think about on the go-forward basis? I understand that, it probably goes through at least the end of the year in terms of year-over-year walks or in the fourth quarter as well.

Does that carry through 2020? Or would that be part of different discussion?.

Yeah. So the agreements that we reached earlier in the year, those are lifetime agreements. So they've been implemented in the purchase orders this year, and so they will carry onto next year.

We talked about this before sort of 2% to 3% has been the annual price down range in E-Systems business, historically, and we're at the higher-end of the range this year too early to tell what next year looks like, but yes there is a carryover effect of that, but I also highlighted that in the third quarter we made some progress towards offsetting that with a cost reduction programs and we expect that to continue in the fourth quarter and into next year..

Great. Thank you..

Yep..

Your next question will come from the line of Dan Levy with Credit Suisse..

Hi. Good morning..

Good morning..

Thanks for taking the questions. Wanted to ask a couple of questions just on decremental or just on margins in general. First, just wanted to start on the GM strike, I noticed in your slide, slide 15 highlighting the volume – the margin impact from volume/FX that's a 22% conversion. I believe that that's probably something that's pretty typical.

I would have expected maybe larger decrementals given in this case the GM strike here the production presumably on your end literally ground to a halt that's going to be much worse than something where production is going from flat to down 2%.

So, if you could just give some color on, what the decremental margins have looked like on the GM piece of business.

And subsequently, as we potentially are looking at higher production in 2020 would you get typical incremental margins on that business? Or are there going to be any ramp inefficiencies? Do you have the capacity to handle that properly?.

Yeah. First in terms of this year and similar to what we've described previously our variable margins in Seating are 15% to 20%, 25% to 30% in E-Systems and the GM North America business is some of our most vertically integrate business. So, it's going to skew sort of to the higher end of that range as a result of that.

And in addition, as you've pointed out given the sub nature of the loss of volume that pushes the – our ability to take variable costs out, it's a little bit more difficult and pushes the number up a bit there.

Also, in that bar on the chart that we do have FX and that's sort of dilutive to the conversion and as well as volume reductions on other platforms, with varying margins. So, the way to think about the GM margin is as I mentioned sort of in a normal range and maybe a little higher on the Seating side, because of the level of vertical integration.

And in terms of how we may benefit next year from that to the extent that volume comes back and overtime on Saturday or Sunday production certainly the incremental margin would be slightly less. As a result of that, we would have some shrinking costs.

But I think generally, should be in line with the variable margin profiles of both business segments..

Great. Okay. Thank you. And then just a second follow-up on margins, or I guess trying to gauge downside risk. As we're looking into 2020, I know you're not providing 2020 guidance.

To the extent that we have maybe continued volatility in China or Europe obviously, the question is what may arise related to the CO2 emission regs and how that could flow through to the industry. Just give us a sense of sort of your typical decremental margins by -- whether it's in Europe or China.

And what options do you have to mitigate any downside pressure in either of those regions?.

Yes. I think we've talked about in the past that in general, our European margins are in line with the segment averages. Maybe in Seating a little bit lower a little bit less vertical integration in Europe than we have globally.

And in E-Systems maybe a little higher because we are a little more vertically integrated and we have a strong terminals and connectors business in Europe.

China, we've talked about the effect of lower volumes than some of our mature programs kind of skewed into the higher end of the range on E-Systems with the loss of the floor business and other mature business there.

And what we're doing in response to that is restructuring our footprint, taking capacity out, moving to lower-cost facilities to try and sort of repair the -- or offset the effects of that lost volume. And we'll continue to do that as we look into 2020.

And we took our restructuring program for this year up to $200 million increased, our savings outlook to about $75 million annually. We talked about that in the second quarter call. And 80% of that is expected to benefit us next year roughly $60 million. And so we continue to expect that would be the case next year at this stage..

And just to add a little bit more to what we can do. And we're taking a very proactive approach to this. And you did mention a few different issues that could happen next year. In some respects we're assuming they can happen. And then we're taking those steps to make sure we're countering and driving efficiency.

What's great about having the two divisions both between Seating and E-Systems for example, we're looking at in our -- consolidating in our manufacturing plants, where we can drive efficiencies between the two divisions. We're looking at all of our logistics lanes and where we can continue to consolidate in the event that volume gets reduced.

We're in negotiations right now with our customers, is a lever that we have obviously call productivity, that we start negotiating in the event that the customers aren't hitting their contractual volumes and then we negotiate through our productivity. The synergies that we have between the two divisions can't be overlooked either.

We're looking at how we can share resources globally within the region. And then down to a platform. And so this program management sales engineering, we have a great opportunity for us to continue to drive down our costs. And so in some respects having the uniqueness of the two divisions, help us in light of any type of reductions.

And so we're preparing for that right now. We have continuous meetings. We put together a team that is dedicated to this. We're looking at every line item within our costs. Jason talked about discretional spending. We're obviously getting at that aggressively.

But more mid-to longer term we have some real unique opportunities to drive between the two business divisions. And we're taking advantage of that. So, there are a lot of different levers we're pulling. Obviously we're very sensitive to any changes within volume. And we're acting and reacting quickly..

Great, thank you, that’s very helpful. I appreciate it..

Your next question comes from the line of Armintas Sinkevicius with Morgan Stanley..

Great, thank you for taking the question. Just thinking a bit ahead here, it seems like the conversation around electrification is picking up.

And I'm just wondering if that creates an opportunity for you to accelerate the product portfolio transition away from wire harnesses maybe more towards terminals and connectors as you've talked about, that would be helpful..

I think the electrification push is very complementary action between the wiring, terminals connectors. The high-voltage wiring, aspects that connect into our onboard chargers. And our charging systems, is very complementary.

So when we look at those business opportunities going forward, we look at that very holistically, at what content per vehicle can we really capture across the broader portfolio, so I think, it's very complementary..

And in terms of the time frame two. Armintas this is more in the medium to long-term. These programs are typically awarded between 2.5 and 3.5 years in advance of production. And so, we've had a lot of success this year in winning business in that side. And we would expect the margin profile of E-Systems overall to improve as that ramps up.

But it's out there a little bit. It's not -- we're not going to see a meaningful impact, it certainly next year, maybe a little less so or a little more so. In 2021, we'll begin to watch some of that..

But Carl, just walked in this morning. And just gave us a bit of news and we just won a nice bit of business on the electronics side, power electronics side that had some very nice returns. And so -- but to Jason's point it's a little bit outside the window. But nonetheless actually Carl and I have been out meeting with all the customers.

And we've had some really good conversations. And that's why when I say I'm confident, there's a nice fit for Lear. And we have been -- we are in niche in some respects supplier that we're not the mega-tier with a black box design. And they have ability to be very flexible and agile when we come in with our design capabilities.

And so that's paying off really well. And like I said we've met with the customer it's been really positive feedback. I'm very confident that we'll have a nice position within power electronics and connectivity. But to Jason's point, it does take a little bit more time and we're very selective.

One thing to point out that -- we don't quote all business around the world. We're very selective with the customers we want to position ourselves with, the vehicles we want to be on, because there's a lot of different quotes out there right now in power electronics.

And we're like I said looking at what best position for us to be with the best customers, with the best product. And so -- but it has been overwhelmingly positive from our customers' perspective..

I've had the opportunity to visit a number of customers with Ray and really impressed with the deep customer relationships that Lear has, and I think the trust in the company.

And customers currently want Lear in their future vehicles and want to understand our product portfolio and roadmap and how we align with they're going on the software side, on connectivity and deeper levels of integration into the vehicle. So it's really exciting..

Right. And then maybe near-term, you have the commercial agreement there last quarter that weighed on E-Systems margins. You mentioned that perhaps that would help the backlog in 2020 provided some nice color there on the backlog with regard to 2020. But it sounds like it will be lower than 2019.

So how do we get comfort that the commercial agreement did in fact drive further business?.

Yeah. First of all let me clarify that the agreements that we put in place this year with our customers were for potential business that are outside of our backlog window. And so it's not a 2020 effect.

It was more of a relationship if you want to think about it in this term – near-term it’s about continuing that relationship in a positive way to grow the business long-term. And that's already paid dividends for us. We've already established contracts. Unfortunately like I said they're outside the three-year window.

But there's an element here though too like Jason mentioned, we are very good at offsetting our productivity. We do that through a lot of different levers we pull internally. There was a time element of how we are getting at some of our efficiencies.

And so it also opened the door on VAV sharing program, other things that will impact this more near-term and help us improve our margin profile. And those actions are still in place and we're working those out with our customer today. But that has changed from how we worked with our customers, which will impact our margin more short term.

Longer term we are already seeing the benefits of cutting those deals and absolutely were the right thing to do. And those are paying dividends already..

Great. Appreciate it..

Your next question is from the line of Itay Michaeli with Citi..

Great, thanks. Good morning. Just had one revenue and one margin question. First, going back to the second half revenue, hoping you can quantify the GM strike effect in the third quarter. And then also what your revenue in the third quarter ex the GM strike looked like relative to your internal expectations.

Also what are some of the pressure you're seeing in your guidance ex the GM strike? Is that some in the third quarter? Or is that entirely happening in the fourth quarter?.

Yeah. So the GM strike impacts both the third and the fourth quarter, less so in the third quarter. It's about $95 million of revenue in the third quarter.

And the margin impact isn't as significant in the third quarter, because in the case of some of the component plants on the E-Systems side, for example, we continue to build some inventory and so that offsets the impact a little bit. Looking out to the fourth quarter, the impact is much more significant.

If you look at the second half impact on margins, it's about 100 basis points impact on the Seating margin, a little bit more than that and about 50 on E-Systems. So absent the GM strike, we would have been at 8% in the second half of the year in Seating and in the high sevens, mid to high sevens in E-Systems..

Got it. I guess ask a little bit differently. Out of the $725 million, I think you mentioned earlier about $500 million and change is GM.

So the other kind of $200 million, is that entirely in the fourth quarter? Or some of that pressure also impact you in the third quarter relative to your initial internal expectation?.

Yeah. That's largely in the fourth quarter. The third quarter actually came in a little bit stronger than we had anticipated. So both the foreign exchange impact and the volume impact are in the fourth quarter. And we were a bit conservative in our range just given all the uncertainty around the strike and how meaningful that impact is per week.

And so we do have built in some additional reductions in volumes that have yet to be announced to all the customers have factored into that low end of the range..

That's helpful. And just my last question going back to incremental margins. If I look at the kind of the backlog incremental contribution margin, it has been declining I think in both segments over the last few quarters.

Is that just a function of the backlog itself being somewhat smaller? And then how should we think about that backlog incremental margin perhaps into 2020 and beyond?.

Yeah. In general we've been rolling on new business in line with our segment overall margins. Sometimes in a quarter it can be skewed a bit just because of the -- you have the impact of business rolling off that we've lost and business that's rolling on. And the net number in revenue for example E-Systems is $20 million in the quarter.

It's not a real meaningful margin look. But in general, the business is rolling on in line with the segment margins that we have in both business segments today..

Got it. That’s all helpful. Thank you..

Your next question is from the line of Chris McNally with Evercore..

Hi guys. Thanks so much for the question. One real quick one. It's been answered a couple of times, I just wanted to verify. So, the backlog comments that you're roughly making for 2020, that's roughly lower than the $1 billion adjusted number for this year more or less.

I know, you're not going to give official guidance, but just I want to make sure, it's lower than the adjusted number..

That's correct..

Okay. Great. And then on E-Systems, there's been some words that the backlog adjustments have been made. Can you talk about -- when we think about the push, I mean we always have a question of are the volumes sort of lost versus moved. In Asia, is it really that basically it's disappointing performance of these platforms.

So it's not -- its quasi-lost meaning they haven't been pushed to the right and so lost backlog this year doesn't go into 2020 or 2021. It's really more around the volume of those launches are just lower..

I'd say generally speaking, it's more that than delays in the case of Asia. But there's been other factors in Asia. There's a program in E-Systems in China that was loss-making and we've decided to exit that program. That's part of what's impacting the backlog.

So that's a negative to the 2020 backlog that will be helpful to the margin profile of business going forward. There has been a couple of modest programs that have been canceled as well whether it be zero volume and that's impacted the number.

But in general, roughly call it one-third of that is probably just lower volume on a continuing basis on the business that is launching or has launched..

Okay. Great. And then just on the margin profile in E-Systems. If we think the sort of the base levels in the mid-7s and it sounds like things are going to be slow going, you talked about 10% further out that's multiyear.

But you do mention, some of the things that you're doing potentially about a cost savings program you're going to give us more detail on some of the discretionary items.

Could we expect in -- sort of in 2020 that we get a movement back to even just the low 8% range? Or is that sort of still on the list and we should kind of think about the restructuring is a year or two out until we get volume and we're going to stay in the sort of mid-7% range?.

Yes. For a lot of reasons, I think it's still, it's too early to try and guide to an operating margin for E-Systems for next year. I mean, what you can point to is that we are -- I think, we stabilized in the second half of this year.

We were encouraged by what we saw in the third quarter and what we see in our fourth quarter absent the GM strike sort of in the mid to high 7s. But you look out to next year, there's a lot of uncertainty on the production environment. And I think, we would be foolish to try and call the number right now, given all that uncertainty.

And I think we'll have a lot more clarity in January in terms of what our customers' plans are and maybe even some favorable developments on the macroeconomic side that give us more confidence in what the production environment looks like next year.

Also, as I mentioned, we do have some elevated engineering spending in that segment because of our success in growing electrification and connectivity. And I think we won more business this year than we had initially anticipated. And so, there's a little bit of a headwind as a result of that think about for next year.

And then, just in terms of overall company margins, thinking about next year, one factor that haven't come up so far in this dialogue, but I'd just point you to that guidance, the guidance block that we provided in the formal presentation.

You'll see that we had pretty significant reduction in discretionary spending and incentive compensation expense. It was about $30 million and half of that in each of those two buckets. Both of those are headwinds as we think about the 2020 margin profile of the company next year as well..

And then just the last technical, the Xevo drain on margins in E-Systems in the second half, I think it was something 50 basis points or more, but I'm -- because obviously, you get -- some of that will annualize.

But just how much was Xevo a drag on E-Systems margins in the second half?.

So the full year, it's about 40 basis points. So it's a little bit better than what we originally anticipated. In the third quarter, we came in a little bit better than anticipated and that's really just the timing of ramping up our hiring on the SG&A side.

And so, we did see that the outlook for Xevo improved slightly for this year from what we had initially anticipated..

Okay. Great. Thank you, so much..

You’re welcome..

Your next question will come from the line of Joseph Spak with RBC Capital Markets..

Hey good morning. And you may have sort of just touched on part of my question. But you mentioned on that Slide 15, the 15 basis points of improvement within the margin guidance revision from that performance. And I think that's the incentive comp and pullback in discretionary spending.

But is that all of it? Or -- because you also talked about some underlying performance improvement I think in E-Systems sort of being masked. So is that also part of the 15? I'm just wondering if you can break that down a little bit further..

Yes, I would say half of that is incentive compensation and the other half you could split into two categories. One is performance improvement in the underlying businesses and the other half is sort of temporary measures that we've taken given the extraordinary impact of the strike with GM and other volume reductions.

And that portion sort of comes back I think next year more so than the other portion of it..

Okay. The -- another quick one. I mean Mercedes just had a pretty I think visible launch issue with one of their key programs.

I mean how has that impacted your profit performance at all on the SUV?.

Yes, the Mercedes launch is -- it's a very complex -- it's great launch. But yes, it's definitely hit us on the cost side..

And is that done or--?.

It's ramped up a little bit slower than what we had originally anticipated. Longer term that's a fantastic platform for us. As Ray mentioned, it's very complicated. We had seen slight allocation of launch costs as a result of the slower ramp-up. But we're excited about the prospects for that program next year once it gets up to full volume..

Okay. And then just last one bigger picture on Xevo. And I know you have like one of the customers is the GM marketplace. And we saw this quarter they talked about putting in Android automotive into infotainment to strike a deal there.

What are the implications for Xevo there?.

Yes, John, do you want to give a little--?.

Yes. Yes sure. So, there aren't actually any implications. If you look in the press release from GM, they actually said they're going to keep their unique services and applications in the platform one of those being vehicle commerce. So, the underlying platform of that is the Xevo market.

So, we see it more as complementary services making the ecosystem richer..

Okay. Thank you very much..

Thank you..

Your next question is from the line of David Kelley with Jefferies..

Good morning guys. Thanks for squeezing me in. Just a quick question on the Seating backlog which stepped up in the quarter and accelerated throughout the year.

Was there anything customer specific or unique that's driving the ramp-up this year? I'm just trying to square that off with your comments related to the stepdown in industry volumes and impact of backlog..

Are you referring David to the impact in this year's backlog?.

Yes..

And so in Seating the impact has been a reduction of about $130 million, $140 million from what we initially expected at the beginning of the year. So, more of the reduction in 2019 is really what E-Systems.

But it's the biggest driver of that biggest single driver relates to the ramp-up in volume and some of these key programs in North America that we've talked about historically where the ramp-up start is slower than anticipated and so some of that comes back next year.

But also keep in mind that we've sort of taken a step back and looked at industry volumes overall and we're a bit more cautious on volumes globally and in each region specifically and on the programs in the backlog. And so that will kind of offset the sort of carryover benefit of some of those programs that have had a slower ramp-up this year..

Okay, great. I appreciate it. And last one and a quick one.

Anything to call out from the E-Systems portfolio review? Or is that still ongoing?.

Well, yes, that's still ongoing right now. We'll come back with a more detailed plan and the overall product portfolio that we have like I said some great areas that we have right to play in in one of those businesses was engineered components in Seating season. So, the work is ongoing and obviously we'll have more in a later date..

Okay, perfect. Thank you..

Thank you..

And our final question will come from the line of John Murphy with Bank of America Merrill Lynch. John, please go ahead..

Good morning. I just want to give a quick congrats to Jeff. And I've not seen much of you will definitely miss you. First question, you guys talked about some stress in sort of your tier supply base and sort of the disruption in the GM schedules and the pressure in global volumes.

We've been hearing more and more about that in North America and Europe as well. Just curious what you're seeing there what you're doing to mitigate risk and how we should think about that going forward..

Yes, it certainly wouldn't be a surprise to see some distress given how much industry volumes have come down. But we have seen very little impact on our supply base. It's held off very well. Even with the massive impact of GM strike we've seen very resilient suppliers in our portfolio. So, we've been pleasantly surprised I think by that.

We were preparing for the stress in the supply base, but it really hasn't been an issue for us..

I think in general the comments we've made on E-Systems we've seen some issues relative to the chip manufacturers and we work obviously very closely with our customers in getting alternative designs approved validated and give us the ability to have alternative sourcing.

And so, we do keep a very close eye on any type of distressed supplier or other related items within the supply base. And in particular cases, we'll obviously take those forward to our customers and find some optional construction or engineered components that we can move quickly to. So, that's got ended.

Like Jason said that significant issue is due to the strike, but probably more just general issues relatively and probably more significant within E-Systems on the chip manufacturers..

Okay. That's very helpful. And then just a second question. When you're looking at the 7.5% to 10% range, you're kind of talking on E-Systems margin for the next 18 months. I know you're not giving an exact guidance.

But, if we were to think about sort of the major swing factors, if we're looking 12 to 18 months out, why you would have hit 7.5% or why you would have hit 10%? I mean is it mostly macro or are there some other key factors we can focus on and stay on top of that we should think about?.

I think there are three or four factors that are going to determine the -- where we find ourselves on that range over the coming couple of years. One is the success rate, and as Ray mentioned, the vertical integration side. We're already seeing some opportunities there. It does take 12 to 18 months to ramp that up. And so it takes a little bit of time.

That's going to be a driver. We are seeing now an opportunity to improve margins with some of our new customers in the portfolio. That takes time, but the level of success we have with that is going to be a key factor. Our restructuring program is going to be a key factor, combining capacity across Seating and E-Systems.

As Ray mentioned earlier, taking some capacity out in other cases, specifically in the E-Systems to adjust to the lower production volumes will also be a factor. And then longer term, the penetration in software penetration, in electrification connectivity or power electronics and connectivity will be a significant factor.

Those are the key areas that we're focused on. And then maybe we'll further out the effects on the management of the portfolio overall. I mentioned one example where we're exiting a program that's loss making today. That's going to have a near-term benefit say, 12 months out, 12 months out. So, things like that will lead to improvement.

But it's going to take a little bit of time. Once again, we had a lot of volume production to digest. The first step in the process is really stabilizing the business. And I think we've done that here in the third quarter and feel really good about what's happened so far in the third and early into the fourth quarter with that business..

Great, thank you very much..

Okay..

Okay. Thank you.

Presenters, do you have any closing remarks?.

Yeah. Just real quick, it's probably just the Lear team on the phone now. But Jeff, thank you for your years of commitment, your dedication. I mean you're a special person. Wish you all the best in retirement. I know you'll enjoy it. I'm sure Donna will send you back to work very soon..

Thanks..

But stay with us. And to the Lear team, great job on the quarter, really outstanding job. We've got challenges ahead of us, but one thing I love about this company is we step up we'll keep driving. And I love what we're doing. I think we have absolutely the right plan in place and continue to drive this business forward.

Thank you for all your efforts and great job to the team around the table. Thank you for everything. Thanks..

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