Good morning and welcome to the Lear Corporation Third Quarter 2021 Earnings Conference Call. All participants will be in a listen only mode. [Operator Instructions]. After today's presentation, there will be an opportunity to ask questions. Please also note today's event is being recorded. At this time, I'd like to turn the conference call over to Ed Lowenfeld, Vice President of Investor Relations. Sir, please go ahead.

Thanks, Jamie. Good morning, everyone and thanks for joining us for Lear's third quarter 2021 earnings call. Presenting today are Ray Scott, Lear President and CEO; and Jason Cardew, Senior Vice President and CFO. Other members of Lear's senior management team have also joined us on the call. Following prepared remarks, we will open the call for Q&A. You can find a copy of the presentation that accompanies these remarks at ir.lear.com. Before Ray begins, I'd like to take this opportunity to remind you that as we conduct this call, we will be making forward-looking statements to assist you in understanding Lear's expectations for the future. As detailed in our Safe Harbor statement on Slide 2, our actual results could differ materially from these forward-looking statements due to many factors discussed in our latest 10-Q and other periodic reports. I also want to remind you that during today's presentation, we will refer to non-GAAP financial metrics. You are directed to the slides in the appendix of our presentation for the reconciliation of non-GAAP items to the most directly comparable GAAP measures. The agenda for today's call is on Slide 3. First, Ray will review highlights from the quarter and provide a business update. Jason will then review our third quarter financial results and our full year 2021 outlook. Finally, Ray will offer some concluding remarks. Following the formal presentation, we'll be happy to take your questions. Now I'd like to invite Ray to begin.

Thanks Ed and good morning everyone. Please turn to Slide 5 where I will provide a brief overview of our third quarter financial results. The third quarter was marked by the continuation of supply chain challenges the auto industry has been facing. Our financial results were negatively impacted not only by significant volume reductions versus last year but also by low visibility from our customers leading to short notice production shutdowns. Slide 6 highlights numerous achievements in the quarter including innovation, quality, awards, and strategic investments in both business segments. In the third quarter Lear's sales growth outpaced the market by 9 percentage points with strong growth over market involved seating and E-Systems, continued new business wins as well as products that are favorably aligned with the industry shift to electrification are expected to deliver continued growth above market over the next several years. Last week we announced the acquisition of substantially all of Kongsberg Automotive interior comfort division which will further strengthen our industry leading seating business. I will comment further on this acquisition little bit later in the presentation. On the E-Systems side, we announced agreements to form two separate joint ventures which will further enhance our capabilities on electrification. The joint venture with Hu Lane which we expect will close later this year will further enhance our growing portfolio of connectors capabilities for both high voltage and low voltage applications. This joint venture -- the joint venture with Shinry will integrate complementary portfolios of advanced onboard chargers from Lear and Shinry and increase access to a broad range of customers. We also continue to be recognized across both of our business segments for excellence and innovation in quality. We won our third consecutive Automotive News PACE award and two PACEpilot awards more than any other supplier. Lear…

Thanks Ray. Slide 14 shows vehicle production and key exchange rates for the third quarter. The impact of continuing component shortages led to a significant reduction in global industry production in the third quarter particularly in our two largest markets North America and Europe. As a result, global vehicle production in the third quarter decreased by 19% compared to 2020 and on a Lear sales weighted basis global production declined by approximately 25%. From a currency standpoint, the U.S. dollar continued to weaken against the Euro and RMB compared to 2020. Slide 15 highlights Lear’s growth over market in the third quarter. Overall company growth over market was a strong 9 percentage points with E-Systems growing nine points and seating growing eight points above market respectively. Growth over market in North America of 12 points reflected the benefit of new business in both segments and strong production on GM's full size SUVs as well as Mercedes SUVs. In Europe growth over market of five points was driven primarily by new businesses while strong performance in the luxury segment and seating. Increased business in connection systems in Europe also contributed to the growth over market performance. In China growth over market of four points resulted from strong production on BMW programs and seating and new business with GLE and Great Wall and E-Systems. Year-to-date Lear’s sales have grown faster than the market by nine points that was above market growth in both segments. Slide 16 highlights our financial results for the third quarter of 2021 compared to 2020. Our sales declined 13% year-over-year to $4.3 billion. Excluding the impact of foreign exchange, commodities, and acquisitions sales were down by 16% primarily reflecting lower production and Lear platforms partially offset by the addition of new business. Semiconductor shortages in the quarter negatively…

Thanks, Jason. Nice job. Please turn to Slide 24 where I will conclude with some thoughts on our 2022 operating environment. While it's too early to provide guidance for next year, we thought this slide might be a little bit helpful to indicate what trends we are tracking. There are many positive drivers as we head into next year and beyond, most importantly, customer demand is strong and dealer inventories are extremely low. This positions the industry for a strong recovery once we get beyond the short-term supply constraints. We have a strong product lineup, which is driving new business wins. We are laser focused on driving operational excellence and improvements that we have made in both business segments this year will support margin improvements going forward. The challenges are very similar to those we've faced over the last few quarters; limited visibility on production schedules, commodity and labor inflation, and supply chain disruptions are expected to continue to impact the auto industry into 2022. While no one in the industry is immune and it is difficult to predict when production volumes will normalize, I know that we have the right team and we have the right strategy in place to capitalize when the industry conditions do improve. The strength of our balance sheet, along with the cash generating capabilities of our business will continue to provide us with financial flexibility to support investments in our business while returning capital to our shareholders. In closing, I want the team to know how proud I am of their performance and for focusing on the things we can control. And now we'd be happy to take your questions.

[Operator Instructions]. Our first question today comes from Joseph Spock from RBC. Please go ahead with your question.

Thank you. Good morning, everyone. Jason you previously for the third quarter talked about 22% to 24% decrementals on the lowered sales guidance and third quarter came in a little bit better at 13%, so and you talked about some of the better performance. If I compare your new implied fourth quarter guide versus I guess, what you were previously expecting for the fourth quarter when you last reported. It's also that same sort of 23% decremental on the lower sales so that is sort of same range you previously indicated for the third quarter. I'm just wondering, is there something in the fourth quarter that would prevent you from coming in better than you did, like in the third quarter, I just want to try to understand the operational differences between the fourth quarter and the third quarter?

Sure, Joe. Yeah, there's a couple things going on here. So part of the performance in the third quarter was a result of commercial negotiations that we had anticipating closing in the fourth quarter. And so we had a little bit of timing benefit from that in Q3. In addition to that, because of the deteriorating outlook we had some reductions in our incentive compensation accruals. And so that benefited the third quarter and won't in the four. Those are the two primary factors. To a lesser extent, the mix of programs that were running in the fourth quarter versus the third quarter is a little less favorable for us. So the volume component of the change in guidance is a little higher downward conversion in the fourth quarter than the third quarter.

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

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

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

Yeah. To answer the first question, obviously this isn't our first acquisition where we've had vertical integration. In the supply base today, we buy components and share components with some of our competitors and there hasn't been significant shifts in revenue even post acquisition. So I think that's a very low risk, if any risk at all. The way I look at the opportunities to -- and Kongsberg has done a nice job and they're struggling with some of the same issues that we're all struggling with this year. So I think some of that's just temporarily putting pressure on the margins, but when I look at the opportunities when we can get into leveraging our purchasing strength, our operational strengths, how we look at the business, and be able to scale it, and help out with some of the scale issues, I think it's going to be a relatively quick turnaround. I mean, that's -- when I say quick, I think, 6-12 months was a good idea of what we need to do. We've -- and I want to take another step back to and we've put a team in place. Frank Orsini is here, President of our seating business. And we've been looking at this for quite some time. We've been studying the products, we've been looking at areas of opportunities where we can really dive in and get at CTO, which is vis-à-vis cost technology optimization. So we're already in the works. I mean, we're working on different solutions, different ways to make the system more efficient, and drive value longer term. And so I don't see that as a long term issue. I think it's more short term given some of the economic climate that we're facing today. But more importantly, some of the things that we already have in process before we take over day one.

So just to follow-up on Ray’s comments on the margin part of your question, so we do expect some modest margin dilution on seating next year, as a result of what you observed there. We also are going to make some investments to integrate that business. And as Ray said, we see a pretty quick turnaround in terms of that margin performance. And, we see over a two-year period that that margin becomes accretive to seating modestly as well. The structural margin of the products in the Kongsberg business are very similar and perhaps in some cases a little bit better than our underlying seat business. And so, as a result of the combination of product synergies, operational synergies, purchasing synergies that Ray described, we think that just the underlying structural margin of that business, will be at or above seat margins over time. And that's before even talking about revenue synergies that we see.

Appreciate the color guys.

Yup. Thanks, Joe.

Our next question comes from Dan Levy from Credit Suisse. Please go ahead with your question.

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

Yeah, a portion of it is market share gain. Our backlog and seating this year, that we announced at the beginning of the year was 550 million. At current volumes it's about 500 million. And so that's a key factor contributing to that growth over market. But it is also the product mix, the strong production and GMs full size pickups and SUVs relative to the market and other platforms in North America on the luxury side with Mercedes for example. And then just generally, I think the luxury market in Europe and in Asia has held up better than the general market as customers have prioritized their most profitable vehicle lines. And, with our number one position in luxury we've benefited from that. I think if you look out to next year in a constrained production environment, I wouldn't expect that to change much. And so we should see some continued benefit from that product mix that we have.

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

Yeah, Dan at this stage obviously it's difficult to call a margin for next year and as you pointed out, volumes are going to be the biggest driving assumption there. But we will and we do expect if commodity costs remain at the same level they're at during the fourth quarter, where steel is at record high, particularly in North America, leather high prices are a little bit higher, chemical price are a little bit higher. As we look at a full year impact of that next year, we would expect that that'd be about a $130 million headwind for seating. Now, on the positive side, we do expect about half of that to be offset by the lag and recovery from commodity cost increases that we saw this year. So we do see some headwind on commodities year-over-year in seating as a result of that, less so in these systems where the vast majority of time has passed through. The other factors to think about next year, we have a very strong backlog rolling on, but we announced our backlog earlier this year for 2022, we were calling for 1.175 billion in additional revenue next year from our backlog. Our latest estimates of that have it tracking closer to 1.250 billion and that backlog will roll on at normal segment margins. So from an exit rate standpoint, that will be modestly accretive to margins in both segments next year. In addition to that, if you look at the operating performance of both segments this year, they've both generated significant positive net operating performance. That means all the cost reduction activities, commercial negotiations, supplier negotiations, have significantly exceeded our customer price reductions and labor and overhead inflation. We expect that to continue next year, perhaps not at the same accelerated pace that we saw this year, where we've seen roughly a 100 basis points of net operating performance in both segments. But we do expect to see some continued benefit from that as we look out to next year. I'd say those are sort of the key drivers. And one additional point, Dan, on these systems we're continuing to grow our connection systems business. That was a business that was around 450 million in sales in 2019, it's going to be at 600 million business based on our current volume outlook for next year. And every 50 million of business we're rolling on in that space is 10 to 20 basis points accretive to E-Systems margins. So, that's an important catalyst as we look out to next year and beyond.

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

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

Great. Thank you very much.

Our next question comes from Colin Langan from Wells Fargo. Please go ahead with your question.

Oh, great. Thanks for taking my question. Can we just actually quickly go for the commodity headwinds again, is the guidance still around 135 million up slightly from that for this year, how should we think about it sequentially from Q3 to Q4 and, just to clarify, you said 130 million next year with half of that probably getting recovery?

Right. So, in terms of the impact on this year, Colin, it's 185 million, so roughly 40 million in the first half and 145 million in the second half of the year. And as you look across from the third quarter to the fourth quarter, there's about 30 million of incremental commodity cost in our seating business. E-Systems there's not much change from the third quarter to the fourth quarter. And so what you're seeing there is steel peaking in the fourth quarter, we've locked in prices for the fourth quarter. Over the last four weeks, the crew index has come down modestly. And so we are expecting that to continue somewhat as we look out to next year. But that is an increase on a net basis for us and seating sequentially. In addition to that, high prices coming off of all-time lows have an impact on the fourth quarter. And we expect that to continue into the first part of next year. We have pass through agreements on nearly a 100% of that business. So that is a temporary phenomenon that will work itself out and then the timing of that pass through is anywhere from as little as three months to as much as 12-18 months, but mostly sort of six to nine months lag. So that's the other factor once we look throughout this year and into next year.

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

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

Great, perfect. Thanks for taking my questions.

Our next question comes from John Murphy from Bank of America. Please go ahead with your question.

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

Yeah, I -- we've been discussing this for some time and actually have been working on intuitive seating as you're aware for well over six years, six to eight years. And we do believe that this trend of much better, smarter, more sophisticated seats is going to be the trend as we move forward. And, if I take a step back, this is just the next evolution within that with the acquisition of Kongsberg. We've designed systems that from a thermal comfort perspective the draw and these are my own estimates given some of the information I've gathered, for our HVAC system draws 20% of the battery life. And so if we can design and that's the intent is design a much more efficient seating system that heats and cools the occupant at the surface within in the city, you can obviously increase range and increase efficiency within the vehicle. Now we do believe that that's a very important trend for our customers and consumers. And so we've been working on that. We've obviously done a significant amount of work. We're recognized with our partnership with Gentherm and we do believe that's a trend. I think health and wellness is another step. When you talk about massage systems within the seat system and how you can help out consumers be more alert, much more aware, anticipate things particularly as you get to vehicles that are much more engaged with an autonomy. So we believe that there's good going to be a greater need and more content within the seat around autonomy and sophistication within the vehicle. And, dynamic safety is something that we've talked about significantly where the seat can actually help protect you in the event of some type of collision both rearward and frontwards. So there is a…

That's incredibly helpful. Thank you, Ray.

Yep.

Our next question comes from David Kelley from Jeffries. Please go ahead with your question.

Hi guys. This is Gavin Kennedy on for David. You guys mentioned the commodity and labor inflation would be a challenge in 2022. Can you provide some more details on how you're thinking about labor specifically, is your team seeing labor shortages today, and any thoughts you have on how the shortages might impact 2022 and the labor assuming we see a recovering in LVP?

Yeah, labor's been a challenge, there's no question about it. As far as, I think it's general, it's crossed every industry and we've done different things with incentives and different compensation packages to work with different regions around having employees in the facilities. But it has been a challenge and I think it's going to continue to be a challenge. I think, we're looking at different creative solutions not just compensation, but to make sure that we're working with our employees around the world to make sure they feel valued. I mean, that's the big thing is making sure our employees feel valued and that they understand the importance of why they're there and we're listening to some of their concerns around what they may need. And it's not like I said, all compensation, there's other things that we're trying to do with shift changes, allocating different times that workers can come in, being very flexible and listening to different employees. And it is, dependent on regions too. I mean, North America is significantly different than Mexico. We don't have a significant issue relative to year-over-year in Mexico. It's more here in North America. Europe has some issues and struggling Asia, we're not seeing significant issues. So it is more regionally focused too. In terms of the impact on the outlook for 2022, I would say it's fairly modest. So the biggest shortages, most costly shortages are more in the U.S. where we have a very relatively low employment level. And so, I wouldn't say it moves the needle in terms of operating margins in either segment, although it is a challenge as Ray described, as we look out not just the balance of this year, but into next year.

Got it. Thanks for that. And then switching gears in the connection systems business, it was good to see that Lear is still on track for around 600 million in 2022. Just was hoping you could provide some more commentary on how the recent JV with Hu Lane fits into that connection system business and then alongside the M&N plastics acquisition, would you expect further M&A in connection systems going forward, I know you touched on, you would look at it across both seating, any systems, but didn't know if you had any additional commentary here?

Yeah. The M&N acquisition has far exceeded our expectations already. It's amazing how quickly we've been able to integrate that business. It is a great business and have been able to vertically integrate revenue opportunities and grow that business. And so that's been a great acquisition. Again remember that was primarily North America. So now we're taking those great capabilities to Asia and Europe and I think those are our own directed components where we can source ourselves. So we have opportunities to grow that relatively quickly. With the joint venture, what that does is it opens up a catalog to us that we actually get to know share different resources. Some of the limited growth that we're looking at within Asia was limited to the catalogs and the approval within those catalogs. So that I believe is going to be a great opportunity for us to not only expand our breadth of different customers and remember one of our focus was diversification of customer base. We're going to be able to do that relatively quickly and also share best practices and ideas across different catalogs to grow our revenue. And as far as acquisitions yeah, I would love to do more acquisitions in the connectors business that gets us really good returns, great margin profile. I'm extremely proud in a short period of time how quickly we've been able to grow that business. I know there's a lot of concerns around can we really get into low voltage and high voltage connectors business given our scale and we have proven that we can. And so if there's opportunities that we can have a tuck in acquisition in connectors I would absolutely look at that as an opportunity for Lear. In power distribution, I think across the holes is really changing dramatically and it has been a real big growth agent for Lear. So, been excited about the partnerships we have and the acquisitions we've had to date and I guess that I think we will continue to exceed our expectations with growth within the connectors business.

Great. Thanks everyone.

Yeah, thank you.

Ladies and gentlemen our final question today will come from Douglas Dutton from Evercore ISI. Please go ahead with your question.

Hi team, Doug Dutton here on for Chris McNally. I just wanted to ask about capital allocation. So clearly the balance sheet is in a strong position right now. I was wondering if management could discuss just a little how it's thinking about capital allocation going forward. We're excited to see that $69 million buy back in Q3 but there's been a history of higher buybacks prior. So, just talking about eight times 2023 cash flow, we were just curious it makes sense to drive a stronger accelerated buyback or how you go about thinking about that? Thank you.

Yeah and we remain committed to returning excess cash to shareholders. I think if you look at the third quarter it’s a perfect synopsis of our view on capital allocation. It is modest tuck in acquisitions and returning excess cash to shareholders through growing dividend and insured purchases. And so to the extent industry conditions allow for an improvement in the free cash flow generation profile of the business we very much would like to continue buying back stock and returning excess cash to shareholders. And so as you look out through the remainder of this year and into next year, we're very committed to doing that. We're in active discussions with our Board. Ultimately it’s the Board's decision but we've had great support from our Board in that regard and I would expect that to continue.

Thank you very much.

Okay, just real quick. I am sure it’s just Lear people on the phone now but just want to say a couple words. First of all Kongsberg welcome to Lear family. I know we still got some more work to do here but it's great to have you as part of the Lear family and I know we're going to do great things together, so looking forward to continue to grow that business and continuing to move in the right direction. And to our partners Hu Lane and Shinry, looking forward to those partnerships. They're great partnerships. I know we're going to both be successful and grow our business. And to the Lear team, I can't thank you enough for staying focused on the things we can control. We're moving in the right direction. We have the right strategy, we have the right plan. These short term issues will be behind us at some point and we would position this company for long-term success. So I want to thank you for all your hard work and what you're doing. So I appreciate all your efforts. It is all I got. Thanks.

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