2/6/2024

speaker
Operator

Good morning and welcome to the Lear Corporation fourth quarter and full year 2023 earnings conference call. All participants will be in a listen-only mode. Should you need assistance, please send your conference specialist by pressing the star key followed by zero. 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 floor over to Ed Lowenfeld, Vice President, Investor Relations. Sir, please go ahead.

speaker
Ed Lowenfeld

Thanks, Jamie. Good morning, everyone, and thank you for joining us for LEAR's fourth quarter and full year 2023 earnings call. Presenting today are Ray Scott, LEAR President and CEO, 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 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 LEER's expectations for the future. As detailed in our safe harbor statement on slide two, our actual results could differ materially from these forward-looking statements due to many factors discussed in our latest 10Q 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 three. First, Ray will review highlights from the year and provide a business update. Jason will then review our fourth quarter financial results and our full year 2024 outlook. Finally, Ray will offer some concluding remarks. Following the formal presentation, we would be happy to take your questions. Now I'd like to invite Ray to begin.

speaker
Jamie

Thanks, Ed. Please turn to slide five, which highlights key financial metrics for the fourth quarter and full year 2023. There generated record revenue in 2023 of $23.5 billion, an increase of 12% from 2022. Core operating earnings grew by 29% to $1.1 billion. Adjusted earnings per share was $12.02, an increase of 38%. Operating cash flow improved by 22% to over $1.2 billion, and we exceeded our free cash flow conversion target of 80%. Slide 6 illustrates key business and financial highlights from 2023. The acquisition of IGB increased our thermal comfort capabilities and allowed us to accelerate development of our modular seating solutions. Customer interest continues to grow. We have 15 projects in process with 11 customers to replace individual components with modular solutions. 12 of our customers have agreed to allow Lear to source the thermal comfort components for 18 different complete seat programs. This control allows us to grow the sales of our thermal comfort products and continues to differentiate our complete seat systems from competitors supporting further market share gains. We successfully launched production of the complete seats for the Wagoneer and the Grand Wagoneer, an unprecedented conquest award that we took over mid-program. In these systems, we won over $1 billion of new business awards for the third consecutive year and are making progress on diversifying our customer base. We won significant awards with General Motors and Stellantis. We won our first wiring program with BMW. And we received additional awards from a large global EV OEM, as well as Renault and Geely. Total company sales were a record, while our core operating earnings improved year over year for the fourth consecutive quarter, driven by continued improvement in each system's margins. Our strong performance in cash conversion allowed us to accelerate the pace of share repurchases. Through the second half of the year, we repurchased over $175 million worth of stock in the fourth quarter for a total of $313 million in 2023. Industry publications continue to recognize Lear for our excellence in quality and culture. Including our most recent award last week when Fortune magazine named Lear as one of the most admired companies for the eighth consecutive year. Slide seven highlights some of our upcoming key launches in seating. We have launches in all of our key regions with a wide range of customers. In 2020, the 2024 launches include a combination of next generation vehicles replacing outgoing models where we are the current supplier, as well as several brand new vehicles. In addition to assembling the complete seat, we provide a variety of vertically integrated components such as foam, trim, and thermal comfort products. The Hyundai Santa Fe is the first vehicle with a production application for our Flex Air, a fully recyclable foam alternative. FlexAir will be utilized in the Santa Fe's third row cap rest. We have a long-standing relationship with Hyundai and are their largest independent seat supplier with about 40% of their external business. We have several launches for BYD this year, including the Sea Lion, as we continue to expand with this fast-growing Chinese automaker. Turning to slide 8, I will touch on key product launches in these systems. Several programs are launching with Lear's high voltage and low voltage wiring and connection systems, as well as key electronic components across all of our key regions. We continue to grow with Volvo. We supply wiring and electronics on several nameplates across their CMA and their SPA2 platforms. Electronic sets of the high power junction box are leveraged across both hybrid and fully electric vehicles, providing a balanced exposure across these growing powertrains. Later this year, our BDU will launch on the RAM 1500 Rev, solidifying our position as a leader in high performance BDUs. 2023 was our third straight year with over $1 billion of business awards in these systems. Approximately 80% of those awards are programs that are new to Lear, which will further grow and diversify our business over the coming years. Turning to slide nine, I will illustrate key LEAR developed innovations we are bringing to market this year. Late last year, we began delivering production parts for the inter-cell connect board to support GM's launch of the Altium platform. Volumes for the ICB will grow with the launch and ramp of additional Altium-based vehicles. We're leveraging our engineering expertise along with our molding and stamping capabilities to pursue opportunities to supply ICBs to additional customers. We anticipate these programs will be awarded later this year. Proceeding, we are launching two new sustainable products in 2024, FlexAir and RenewNet. The first commercial application of our FlexAir material will be for the calf rest in the all-new Hyundai Santa Fe. The 29 development projects we have with 13 OEMs for application of FlexAir throughout the vehicle seating system is evidence of the tremendous customer demand for this very innovative new product. FlexAir is 100% recyclable, alternative to molded urethane cushion. It provides up to 20% reduction in weight and up to 50% reduction in carbon dioxide emissions. Its open-air structure has better cooling and ventilation characteristics than urethane, further improving the performance of our thermal comfort modules. FlexAir is an attractive, sustainable alternative for the roughly $4.5 billion foam market, which we believe will support continued growth of our component business. There's exclusive license for automotive applications, along with 190 patents we have filed creates a competitive moat around this very innovative technology. We're also starting production for RenewNet. which is launching with three different OEMs this year. Our suede alternative is the first to market automotive textile that is fully recyclable at the end of its life. We are seeing tremendous interest from our customers for sustainable alternative fabrics. Renew Knit is also a finalist for the Automotive News Pace Award. Once again, demonstrating our ability to develop and bring innovative products to market and add value for our customers. These innovative products combined with LEER's competitive positioning as a leader in seeding will allow us to achieve our revenue growth targets while continuing to increase operating margins and financial returns. Now please turn to slide 10, which shows our 2024 to 2026 sales backlog of approximately $2.8 billion. As a reminder, our core sales backlog includes only awarded programs. net of any lost business and programs rolling off. It excludes pursued business, net new business in our non-consolidated joint ventures, and the roll off of the discontinued product lines in these systems. Due to the slower pace of the industry transition to electrification, we now anticipate lower volumes on several of our key customers' new programs as compared to what we assumed last year. By continuing to win new business, we have maintained a three-year backlog that is a similar size to that last year, despite the significant changes in volume assumptions. The $2.8 billion backlog is roughly in line with last year's backlog and is well balanced across the three years. 2025 is impacted by the assumed roll-off of several ICE vehicles that may or may not come to fruition, depending on the pace of the EV transition. At $800 million, the third year of our backlog is higher than a typical third year. We expect that to increase further as customers continue to source new programs launching in 2026. In addition to the consolidated backlog, the 2024 through 2026 sales backlog at our non-consolidated joint ventures continues to grow. Our three-year backlog at our non-consolidated joint ventures increased approximately 70% from last year to about $650 million. The growth is largely driven by the continued business wins with BYD, which represents more than 50% of our non-consolidated backlog. We continue to win new business with a diverse set of customers, and the appendix of the presentation is a breakdown of our total sales by customer for 2023. and our expected distribution in 2027. It illustrates the continued diversification and growth we have with key customers such as BYD, a global EV OEM, and so on. Now I'd like to turn the call over to Jason for a financial review. Thanks, Ray.

speaker
Ed

Slide 12 shows vehicle production and key exchange rates for the fourth quarter. Global production increased 9% compared to the same period last year and was up 7% on a Lear sales-weighted basis. Production volumes increased by 5% in North America, 7% in Europe, and 18% in China. From a currency standpoint, the U.S. dollar weakened against the euro but strengthened against the RMB compared to 2022. Slide 13 highlights Lear's growth compared to the market for the full year as well as for the fourth quarter, and summarizes our growth relative to the market over the past four years. For the full year, total company growth over market was one percentage point, with seeding flat and eSystems growing four points above market. This was largely in line with expectations as we anticipated the strong mixed experience over the last several years to normalize, as well as the negative impact of the UAW strike. Looking at our full year growth by region in 2023, Europe growth over market was six points, with both business segments benefiting from higher volumes on the Land Rover, Range Rover, and Range Rover Sport. New Conquest programs, such as the BMW 5 Series and Seating, as well as new business with the global EVOEM, BMW, Renault, and Mercedes, and these systems contributed to the strong growth in the region. North America revenue growth underperformed the market by four percentage points, driven by unfavorable platform mix, and the impact from the UAW strike. In China, revenue growth underperformed the market by three percentage points, driven by unfavorable platform mix. The mixed shifts to domestic Chinese automakers accelerated in 2023. We continue to win new business with domestic automakers such as BYD, Geely, Chang'an, Great Wall, and others, which will further improve our customer mix in China going forward. For the fourth quarter, total company growth lagged the market by two percentage points. However, excluding the impact of the UAW strike, total company sales growth would have been in line with the overall market. Looking at our growth over market over the last several years, our average annual growth in each segment has been in line with our long-term targets, with seeding at four percentage points and e-systems at six percentage points. Turning to slide 14, I'll highlight our financial results for the fourth quarter of 2023. Sales increased 9% year-over-year to $5.8 billion, excluding the impact of foreign exchange, commodities, and acquisitions. Sales were up 5%, reflecting the addition of new business in both segments. Core operating earnings were $288 million compared to $265 million last year. The increase in earnings resulted primarily from the addition of new business. Adjusted earnings per share improved to $3.03 as compared to $2.81 a year ago, primarily reflecting higher earnings and the benefit of our share repurchase program. Operating cash flow generated in the quarter was $570 million compared to $537 million in 2022. The increase in operating cash flow was due to higher earnings and improvement in working capital, partially offset by higher cash taxes. Slide 15 explains the variance in sales and adjusted operating margins in the seeding segment. Sales for the fourth quarter were $4.3 billion, an increase of $306 million, or 8%, from 2022, driven primarily by our strong backlog. Excluding the impact of commodities for exchange and acquisition, sales were up 4%. The estimated impact of the UAW strike in the fourth quarter in seeding was $129 million, or approximately 3%. Key backlog programs include the BMW 5 Series and i5 and the Dodge Hornet in Europe, the Wagoneer and Mercedes EQE SUV in North America, as well as the Geely Zeekr 009 in China. Core operating earnings improved to $294 million or up 19 million or 7% from 2022 with adjusted operating margins of 6.8%. Operating margins were flat compared to last year as the benefit of our margin-accreted backlog was offset by the impact of acquisitions and foreign exchange. Slide 16 explains the variance in sales and adjusted operating margins in the eSystems segment. Sales for the fourth quarter were $1.5 billion, an increase of 164 million, or 12%, from 2022. Excluding the impact of foreign exchange and commodities, sales were up 11%, driven primarily by our strong backlog. The estimated impact of the UAW strike in the fourth quarter in these systems was $44 million, or approximately 3%. Key backlog programs include the Chevrolet Seeker and Buick and Vista SUVs in Asia, an electric vehicle with a global EV OEM in Europe and North America, Renault and Mitsubishi plug-in hybrid electric vehicles in Europe, as well as the Chevrolet Blazer EV and Ford Super Duty truck in North America. Core operating earnings improved to $84 million, or 5.6% of sales, compared to 64 million and 4.8% of sales in 2022. The improvement in margins reflected our margin accretive backlog and strong net operating performance, including resolution of key commercial negotiations with customers, facilitating cost recovery, and the benefit of restructuring savings. Moving to slide 17, we highlight our history of deploying capital to drive shareholder value. Over the last few years, we made strategic investments to expand our vertical integration capabilities to support growth and accelerate operational excellence. We will continue to focus on organic and modest inorganic investments that drive improvements in automation and plant efficiencies. In the fourth quarter of 2023, S&P upgraded Lear to a BBB rating with a stable outlook. We also extended the maturity of our $2 billion credit agreement by one year to 2027. These actions further solidify our already strong balance sheet. Our renewed focus on generating cash flow is driving immediate results. In 2023, we significantly exceeded our target of 80% free cash flow conversion, which enabled us to accelerate our share repurchases in the second half of the year. We remain committed to returning excess cash to our shareholders. During the year, we repurchased $313 million worth of stock, reducing our shares outstanding by 4%. Including dividends, we returned approximately half a billion dollars to shareholders in 2023. $175 million of shares were repurchased in the fourth quarter, more than the first three quarters combined. This share count reduction will help accelerate EPS growth in 2024. Our current share repurchase authorization has approximately $900 million remaining, which allows us to repurchase shares through the end of this year. Please turn to slide 18. Last year, we introduced the LEER Forward Plan. The plan is focused on driving efficiencies in our plants and across our segments. We executed several programs through the course of the year that improve efficiency and increase the long-term flexibility in our manufacturing facilities. To optimize our low-cost footprint, we continue to expand our North African operations. We recently opened a facility to expand our connection systems capabilities to support our European operations and started initial production of thermal comfort products at a second facility. Building on the progress we made in 2023, this year we will continue to focus on increasing the level of automation in our plants to drive further efficiencies to help offset global wage inflation. The acquisitions of Thagora and InTouch have resulted in increased efficiency, reduced waste, and improved quality. We have a pipeline of organic and inorganic initiatives that our teams focused on executing in 2024. The LEER Forward Plan generated cost savings of more than $50 million in 2023. We estimate the opportunities we are pursuing in 2024 can generate an incremental $50 million in annual savings, with larger savings anticipated in 2025 and beyond. These initiatives combined with commercial recoveries are critical to helping offset the impact of global wage inflation. Actions taken through the LEER Forward Plan also help maximize cash flow generation. By realigning our capacity, we can adjust to changes in production schedules and reduce capital intensity of our business. This was evident in our 2023 results as our capital expenditures were 2.7% of sales, well below our average over the last five years of roughly 3% of sales. The projects we implemented in 2023 helped us achieve free cash flow conversion of 90%, well in excess of our 80% target. Slide 20 provides detail on our outlook for 2024. Now shifting to our 2024 outlook. Slide 19 provides global vehicle production times and currency assumptions that form the basis of our full-year outlook. We base our production assumptions on several sources, including internal estimates, customer production schedules, and S&P forecasts. At the midpoint of our guidance range, we assume that global industry production will be 1% lower than in 2023, or flat on a sales-weighted basis. Our global production assumptions are generally aligned with the latest S&P forecast. From a currency perspective, our 2024 outlook assumes an average Euro exchange rate of $1.09 per Euro and an average Chinese RMB exchange rate of 7.15 RMB to the dollar. Now turning to slide 20. Slide 20 provides detail on our outlook for 2024. Despite our expectations for flat industry volumes, we're expecting our fourth consecutive year of higher sales, operating earnings, and earnings per share. Our revenue is expected to be in the range of $24 to $24.6 billion. At the midpoint, this would be an increase of $833 million, or 4% over 2023. This translates to growth over market of 4% through the total company, with eSystems growing 5% and Seeding growing 3% over market, respectively. Poor operating earnings are expected to be in the range of $1.155 to $1.305 billion. At the midpoint, this would imply an increase of 10% over 2023. Adjusted net income is expected to be in the range of $730 million to $840 million. Restructuring costs are expected to be approximately $125 million. Our outlook for operating cash flow for the year is expected to be in the range of $1.275 to $1.425 billion. And our free cash flow guidance at the midpoint is expected to increase to $675 million. At the midpoint of our outlook, free cash flow conversion would be approximately 86%, a second consecutive year in excess of our 80% target. Lear's strong focus on generating cash allows us to maintain a strong balance sheet while making organic and inorganic investments to strengthen our business, as well as to fund share repurchases to significantly reduce outstanding shares and drive growth in earnings per share. Slide 21 walks our 2023 actual results to the midpoint of our 2024 outlook. Year over year, revenues expected to grow by more than $800 million and adjusted margins are expected to improve by 30 basis points due primarily to our margin accretive backlog and strong net operating performance. Positive net operating performance reflects the benefit from earlier forward plan and other performance improvements partially offset by elevated wage inflation, and the negative impact of transactional foreign exchange. Wage inflation is expected to be approximately $90 million greater than what we experienced in 2023, and transactional FX is expected to be a headwind of approximately $70 million, primarily as a result of the strengthening of the Mexican peso. The eSystems segment is expected to continue its recent performance improvement trends with operating margins expected to increase by approximately 100 basis points in 2024. Seeding operating margins are expected to increase modestly, reflecting the continuing benefit of our margin accretive backlog, as well as the execution of our thermal comfort strategy, partially offset by the impact of lower volumes on existing platforms. We've included detailed walks to the midpoint of our guidance for seeding any systems in the appendix. And I'll turn it back to Ray for some closing thoughts.

speaker
Jamie

Thanks, Jason. Please turn to slide 23. 2023 was a key year of strategic execution. In seeding, we closed the IGB acquisition, providing additional capabilities to our thermal comfort portfolio, which further strengthens our industry-leading competitive position. We are in validation with 11 customers for our thermal comfort modular solutions. Bringing these solutions to market will accelerate the adoption of thermal comfort features more broadly to a higher volume vehicles and into second and third row seating. In these systems, our execution and focus on efficiencies drove margin improvement throughout the year. We continue to focus on our core products aligned with industry trends to further improve our margins. We expect both business segments to improve growth over market performance in 2024. And we are confident in our long-term growth of our market targets in both seeding and e-systems. We implemented Lear Forward initiatives, which yielded savings in excess of our initial targets. Our focus this year is on accelerating automation to address wage inflation and improve efficiencies in our plants. In 2024, bringing innovative products to market and executing our strategy will allow us to continue to return capital to shareholders and position Lear for long-term success. And I would be happy to take your questions.

speaker
Operator

Ladies and gentlemen, we'll now begin that question and answer session. To ask a question, you may press star and then one on your touch-tone telephones. If you are using a speakerphone, we do ask that you please pick up your handset before pressing the keys. To withdraw your questions, you may press star and two. Once again, that is star and then one to join the question queue. At this time, we'll pause momentarily to assemble the roster. Our first question today comes from Rod Lash from Wolf Research. Please go ahead with your question.

speaker
Rod

Good morning, everybody. Good morning, Rod. Two questions on the guide. First of all, versus the second half of 2023 run rate and looking out to 2024, you've got about a billion one of revenue growth at the midpoint, and your segments are expected to deliver about $120 million of additional EBIT. Is that roughly the conversion rate that we should be expecting now as more of the growth is coming from backlog, maybe 10% or 11%? And can you maybe just, Jason, in the past, you've given us a pretty helpful bridge on how you get to the targets, the 7% total company, 8% segments. Can you just refresh us as we look out beyond 2024, how that sort of looks?

speaker
Ed

Yeah, Rod, as the backlog is the primary near-term driver of growth and revenue, we would expect that to convert sort of 10% to 12%. I think we're right in line with that with our guidance for this year. We do believe that there is room for volume increases on existing platforms, and those will continue to convert at our typical variable margin in both segments, 15% to 20% in seeding and 25% roughly in any systems. As we look at this year, we're not anticipating volume increases on existing platforms. In fact, we have included volume reductions on a number of existing platforms in our guidance, largely aligned with the S&P forecast. So there's definitely room for that to improve even this year and certainly beyond this year. In terms of your question on 2025, Rod, I really want to stay focused on on 2024 at this stage. The last time we talked about 2025 was the middle of last year in seeding. We talked about 8% at our seeding investor day. And there's two or three things that have changed since then. One, wage inflation and transactional effects, a little bit more of a headwind than what we had anticipated at that point. EV volumes and the transition to EVs are a little bit slower than what we had anticipated. But we're also moving faster on automation and efficiencies in our plants and active negotiations with our customers. So it's a little bit difficult to try and call 25 with pinpoint accuracy at this stage. We're super focused on delivering or exceeding our 2024 guidance in both businesses.

speaker
Rod

Okay. Thanks for that. And just aside from production, maybe you can just give us a little bit of color as you look out to 2024. What are the the biggest potential sources of upside or downside versus the midpoint of your plan?

speaker
Ed

Yeah, as we look at our guidance for this year, I think one of the biggest challenges we have is in regards to wage inflation. So maybe just spend a minute on that. As we've talked about in the past, it's sort of 3% or 4% annual wage inflation is sort of normal. We offset that through our efficiency programs in our plants. And it's certainly running considerably beyond that at this stage, roughly 2x what we've experienced historically. And if you look at our businesses, just kind of taking a step back, the impact ranges from negligible on a business like electronics, which has almost no labor, it's very automated. JIP seeding, it's a relatively modest impact. But our more labor-intensive businesses like cut-and-sew trim, which is 35% of the seeding headcount, wire assemblies, 90% of the system's headcount, those are where we're seeing the greatest impact. Those also tend to be businesses that have model pricing with their customers with explicit assumptions around labor rates, which gives us a path to eventually recovering that either directly this year or, you know, as those programs turn over, certainly we would expect full recovery. And we really think that 24 represents the peak in terms of the impact of wage inflation because globally inflation peaked, you know, last year and now you're seeing the full effect of that in our labor costs. And so we would expect that to moderate next year. You know, we did see higher labor inflation last year as well. Just kind of look at from 22 to 23, we had a step up of roughly 60 million. We managed to offset that largely through four initiatives. In addition to our normal efficiency programs, we had an aggressive restructuring program, moving work to, you know, from Eastern Europe to North Africa, from the border of Mexico, further inland. Through automation, you have acquisitions of ASI, Intouch, and Tagora really aggressively deploying automation. the Lear Forward Plan, which is improving capacity utilization in North Africa and Mexico, and then customer recoveries, you know, passing that through to our customers. So I think there may be some upside to the assumption we've made around economics, either in terms of the absolute cost or the recovery. And in addition to that, you know, what we're doing in terms of our automation programs, and Ray can talk a little bit more about that. I mean, there's no one more focused and passionate on this topic, I think, in the industry than Ray.

speaker
Jamie

Yeah, Rob, I'll share some stories with you too next week publicly, but I couldn't, I've been in our facilities. I think the technology, the innovations, the things that we put in place, you know, when you talk about upside, I think that's a potential accelerator. What I'm seeing with the pilot lines we put in place around the areas Jason mentioned, you know, our labor focus priorities are around trim and wiring. And what I saw in our wiring facilities, we're automating and doing a great job with some of the efficiencies that we're getting our plants. And to mention, I think what's important too, the capital that we're looking at is significantly lower cost. So it's not only improving from an efficiency within our plants, the capital that's coming online is significantly lower than what we're seeing from traditional capital. So we're getting two, I think, really good benefits. You saw that last year. and our capital spend, and I think that's going to continue to accelerate. I think the negotiations with our customers, you know, we take a very balanced approach to the year starting off in January. We're in heavy discussions with our customers on all kinds of different issues relative to the pause in EVs, to what we're seeing, you know, with labor economics. You know, I think we're balanced. I think some of those we're going to be very aggressive on. Those, I think, could help significantly. quicker than maybe the second half of this year, but we do take a balanced approach in the beginning. I think volume. I think we've looked at volume very conservatively. I think right now our customers are retrenching a little bit with this pause in EV. We're hearing a lot from our inside the customers of how they're going to look at their powertrains, what that might impact as far as ICE vehicles. We've gotten some feedback that they'll formalize it here in the near future if ice continues to accelerate and some of our platforms that we've been a little bit more bearish on because that's the information we have that's a nice little tailwind for us so i think we have some opportunities here um but but we are pushing them very aggressively but we do have a very balanced approach especially coming out in january rod you know we've been absorbing a lot of these ev changes quickly and then really giving a little bit more bearish look to what the alternatives will be. And so that could be a nice boost for us.

speaker
Rod

Great. Thanks for the insights.

speaker
Operator

Yep.

speaker
Jamie

Yep.

speaker
Operator

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

speaker
Dan Levy

Hi. Good morning. Thanks for taking the question. Hello, Dan. I wanted to – hey, good morning. I wanted to go back to continue the line of questions on the guide. And maybe you could just comment a bit on two components in there. One is, I think you said 70 million of FX in there. Is that just purely transactional? You know, does that just reflect hedges unwinding? And maybe you could talk about, I think you mentioned it briefly on the commercial recoveries piece. But what are you assuming as far as pricing within each of the segments? Is this returning to the typical, call it, you know, one and a half percent price downs in seeding, two-ish percent in e-systems? So maybe just some commentary on the pricing environment as well.

speaker
Ed

Sure. Yeah, maybe start with FX, and it may be helpful just to kind of take a step back and explain our transactional FX exposures overall and our strategies. So the Mexican peso is our most significant exposure by far. We have had a little more than $1 billion. I think $1.1 billion was the exposure last year. That grows to $1.2 billion or so in 2024. And we have a very effective hedging program, which really protected us last year and also helps us again this year. And I could go through all the details of the program for competitive reasons, but I will say Generally, we lay around hedges on a multi-year basis. And at the beginning of last year and again at the beginning of this year, we had hedges in place for roughly 85% of our exposure, including the peso. And this, again, that surfaced very well last year in particular. Transactional effects on the Mexican peso negatively impacted operating margins and earnings last year by 10 basis points and $20 million, respectively. fairly insignificant in terms of the operating margin impact. There was another $10 million of exposure on balance sheet related FX expense that hit in the other line, which impacted EBIT by another $10 million. So the Mexican peso overall between operating earnings and other expense impacted EBIT by $30 million last year. And the balance sheet portion that was really back and loaded in the fourth quarter, where there's a lot of volatility with the peso, and that really weighed on earnings per share. It's about a 10 cent impact. Overall, it affects with a 10 cent impact on earnings per share in the fourth quarter. As we look out at this year overall, our guidance, as we talked about in the prepared remarks, includes $70 million impact in operating earnings, or just under 30 basis points, 31 basis points in seeding. little over 20 basis points in these systems 60 of that 70 is driven by the peso which we've assumed will average about 1725 so the exposed portion you know the 15% we've assumed a rate of 1725 that's pretty much where it's been trading over the last several months and then we've assumed a further 30 million dollars of impact on our balance sheet exposure so the guidance includes a $100 million total transactional FX impact of which 60 million or 60% of that is Peso related. Lastly, I think it's important to highlight that the Peso appreciation is also embedded in our labor inflation. As we're talking to our customers about recovery of this excess wage economics, there's an FX component to that as well. as those models are reset to reflect current exchange rates, current labor rates, we would expect the full recovery of that to take place. So some of that this year and then some of it beyond this year. And that's a little bit of what's weighing on CD margins and really margins in both segments in 2024. So you're not seeing the full benefit of all the operating improvements because it's being diluted by both wage inflation and transactional effects. In terms of our customer price downs, We're expecting a similar environment in 24 that what we experienced in 23. Your math is pretty close there in terms of 1.5%, maybe a little bit less than that. But it's important to note that there's a basket of issues that you're negotiating. And so there may be some direct reduction of that as a result of our labor inflation discussions, FX discussions, low volume discussions, EV program delay discussions. and even lingering commodities that have not been recovered from the prior year. So all of that is in play as we negotiate with our customers. But as we see this year playing out, you know, you have that contractual price down that's baked into your first quarter outlook. You have the effects of wage inflation largely heading at the beginning of the year, and that will weigh on margins at the start of the year, and then throughout the year we look to claw that back through those negotiations and through the execution of our operating improvement plans.

speaker
Dan Levy

Great. Thank you. As a follow-up, I wanted to ask about the EV strategy. And I see on your slide that talks about the strategic initiative, there's a comment here, realigning resources under eSystems, realigning resources due to changes in EV volumes. Maybe you can just talk about what specifically you are doing within eSystems to align to this new environment. You know, how much was weaker EVs a weight on the backlog? And, you know, you issued this 8% target on eSystems margins. You know, how much does lower EV environment limit your ability to get to that 8% 2025 target and margin? Thank you.

speaker
Ed

Yeah, and certainly the biggest factor that led to a lower 2024 backlog and to a certain extent the 2025 backlog is our assumptions around electric vehicle volumes, the timing of launches. So in 2024 in particular, you know, we had guided to a $1.5 billion backlog. It's now $1.2 billion. I would say within our guidance range, that could be anywhere from $1.1 to $1.3 billion, just depending on how closely the customers achieve their ramp-up schedules and their volumes, which are still in flux. And so that, yes, that is weighing on the backlog a little bit here in 2024, and it's weighing on operating margins a bit in each system, probably more so than in seeding. And similar to the question Rod asked earlier in terms of 2025, I don't want to get into a pinpoint margin discussion on 2025. You know, what we've talked about publicly of late with these systems is, you know, an 8% target. I think in a recent investor conference, I talked about 25, 26, maybe pushing that out a little bit just because of the lower EV volumes in the near term. As the year progresses, we'll provide more cholera on 25, but certainly that lower volumes will have an impact on eSystems margins there. In terms of what we're doing in response to the lower volumes, it's a combination of operating actions and commercial actions. You see what happened with capital spending at the end of last year. We had guided to $675 million. We spent $50 million less than that. We went back through every single program, not just in the systems but in seating, and reevaluated the deployment of additional capacity and found tremendous opportunity to pause a lot of that spending. So that will really help kind of near-term returns in both segments. and I think better position us for a slower ramp up. And we're doing that in collaboration with our customers. Our customers are being very open about changes to their plans, and they're working with us to try and slow down that capital deployment so that they don't have that excess capital in the supply base to worry about as well. And so then there's a commercial negotiation element to it. As volumes are lower, certainly we're having discussions with all of our customers about the impact on fixed overhead and investments that have been made previously that will result in higher prices until those volumes come back.

speaker
Jamie

I also think what was important, and we talked about this with these systems, is simplifying the product portfolio and seeing a little bit of this even before it occurred. I mean, obviously, it was a much more dramatic pullback or pause, as it's been called, with EVs. But we were ahead in some respects of really limiting what capital we would deploy. And I think equally as important where we're investing our capital, our dollars, and then also scaling certain products. When we talk about a BDU, it can be a very scalable program across multiple customers. Same thing with an ICB. And so I say it all the time, not trying to be everything to everybody, investing in all kinds of different solutions, but being very, very disciplined and selective on where we will deploy capital and being very good at it. And I think You know, that's helped us. I mean, we still have more work to do, like Jason said, on the commercial negotiation with some of these more dramatic changes within EVs. But we have that type of relationship with our customers that we are seeing as an expert. And we, you know, didn't deploy capital at the request of a particular volume to hit a run rate. It was very, very selective, intentional. And so I think that helped. But simplifying that product portfolio in these systems has really helped us as this pause has come at us over the last really three months.

speaker
Dan Levy

Great. Thank you.

speaker
Operator

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

speaker
John Murphy

Good morning, guys. I got three very quick ones. You know, first, if I said that global light vehicle production was going to be up roughly 2% this year as opposed to down 1%, and took the midpoint of your range, it would probably add about $700 million, maybe just a little bit more to the revenue outlook. If you think about that incremental $700 million and assume all else equal, what kind of contribution margin would you ascribe to that? Because when you look at the low end and the high end of the range, it's indicating a 25% contribution margin. But Jason, just trying to understand what you would think of Assuming a lot of this is coming in, you know, existing programs that do better than you're forecasting right now or the industry is expecting.

speaker
Ed

Yeah, so we would expect if volumes on existing platforms come in, you know, $700 million, we would convert it at 15% to 20% in seeding and 25% or so in any systems, depending on the underlying profitability of the platforms that come back, the level of vertical integration that we have in the platforms as well. I would say that some of that volume would be on backlog programs, though, John, so that may convert at a little bit lower rate, you know, in that first year of production, sort of 10% to 15% probably. And that's where some of that guidance range is earmarked for, so to speak, is some of the uncertainty around these new EV platforms. The other factor and the reason for a little bit higher conversion on the range is that you know, the commercial negotiations around inflation and the pace at which we can deploy our automation projects to offset wage inflation. So we've got a little wider range than we normally would have. It's fairly tight in seeding, sort of 6%, 7% to 7%. But in these systems, you know, it's a little bit wider range, you know, 6% at the top, and let's say 5% to 6% or 5.1% to 6%. any systems to sort of account for the impact of those commercial negotiations and the pace of deployment of automation.

speaker
John Murphy

That's very helpful. And then second quick one here on the backlog. It seems like you guys have dinged and hit the backlog reasonably hard for EV push down and out, but have not taken the liberty and have not seen this necessarily from your customers of backfilling that lost volume with ICE programs. Is that a fair statement in the way you've approached the recalc of the backlog and there's not a backfill or a significant backfill of these ICE vehicles actually transacting and being sold and taking the place of those?

speaker
Ed

Yeah, that's effectively what we've done because, you know, it's a fairly conservative approach, but we've taken our customers' guidance in terms of their plans to balance out some of their ICE platforms as they ramp up their EV platforms. And then we've taken a bit of a conservative view on the volumes of some of the new EV platforms. So we may have sort of double dipped a little bit there. I'll just give you a couple of examples. We have the Blazer ICE seating, but we don't have the Blazer EV seating. So GM's plan, as it sits right now, has the Blazer building out next year. So that's a backlog hit in seating that may get pushed out. And there are several programs like that, Ford with the Aviator. That is assumed to build out on the ice side and then it launches as an EV in a different plant where we don't have the production contract. I think that is sort of maybe a hidden upside to the 2025 backlog because of our sort of mechanical approach that we follow when we establish the backlog. If the customer tells us the program is building out, then we take it out of the backlog. Another example on the system side, with Ford, the focus is assumed to begin winding down in 25 and it's gone in 26. There isn't a replacement for that at this stage, so that's a negative to the backlog. So there's a handful of programs like that that could lead to some kind of underlying upside in the backlog when we post that number, you know, 12 months from now.

speaker
Jamie

Yeah, I think our customers, too, over probably the first two quarters will start clarifying the specifics around those type of situations. And, you know, We did take, like Jason said, a more balanced conservative approach given the information we have. And if there is movement, and that said, not formally but informally, we've gotten some feedback that they are internally across the board looking at how they're going to position between hybrids, electric vehicles, and the continuation, in some cases, of ICE vehicles. And what's nice about the continuation of ICE vehicles, those are usually longer in the tooth. We're usually doing a really nice job efficiently. Hey, we're with you. We hope they keep running those things. I think we'll get more clarity over the next couple quarters here as they start to kind of rebalance their own internal strategies.

speaker
Ed

John, just to add one comment to that, and with both businesses sort of being power trade agnostic, if that happens, I think it's generally positive for us. To Ray's last point, just to reinforce that, running that capital for a year, two years, three years longer than we initially planned to It's good for operating margins, good for ROIC, and on balance, good for leader overall.

speaker
John Murphy

I definitely agree with you. Then just lastly on the buyback, Jason, what was the average price you bought back the shares? I apologize, in the fourth quarter I missed that. And as I look at the operating cash flow expectation for this year and just apply that 22% cap allocation that you did last year, it looks like there would be $300 million, maybe a little bit more, in buybacks that might be earmarked. I mean, I know you're not doing it that directly, but it seems like that would be the number. So what was the average price in the fourth quarter and the buyback number you would think of for 24?

speaker
Ed

Yeah, I'll start with the second part as the guys in the room scramble to find that number for it. I think it was in the mid-130s. So, you know, we fully expect to continue to be aggressive in buying back stock and to be opportunistic as there's sort of this dislocation of value in the in the near term. And if you look at the free cash flow we're going to generate in 24, which is greater than 23, there's no near-term M&A of any significance on the horizon. We do have a term loan we could take a look at that's tied to the IGB acquisition, but we're in no rush to pay that down. So I think share repurchases sort of in that 4% of shares outstanding again range is a reasonable target. Of course, we're meeting with our board next week. That's a board decision, and we're certainly advocating for that, and the board's been very supportive of that in our recent meetings, so I'd expect that to continue.

speaker
Jamie

Our focus is driving free cash flow, and we're going to convert at our target or higher, and we're going to return it to the shareholders. What's nice is right now, we talk about this innovation technology on the plant floors, We acquired some small tokens with Agora, ASI, InTouch, and boy, they made a dramatic difference. And it's not extremely costly when we talk about this capital deployment. We're doing it at a lower cost, and we're seeing that capital come in significantly lower, and we're deploying it in a life or with new launches. So we're going to be very, very focused on our working capital, how we're converting our cash flow, and we're in a really good position. We've been doing this for several years. So when I'm going out to plant and seeing this, what's really nice is this WS launch we just went through. Unprecedented. Never done before in the history of seeding. We had our capital. We wouldn't even take the capital from our competitor because it was that bad from a throughput standpoint and how it was working within their facility. We launched that plant with our technology innovation, low capital costs. much more efficient. We produced more output than they could produce, ever produced in their three years of trying to hit their daily volumes. And what was great about it, and Frank's here, the team did a remarkable job, was our quality from our customers said it was superior to our competitor that was producing those parts for years. And so that gives me excitement because I'm looking at this technology in the plants and we're a manufacturing company, we produce parts. That acceleration of innovation technology that we've been driving for multiple years is starting to really take hold, and it's about we don't need anything. We've made some nice acquisitions. There's nothing on the horizon like Jason said. And we'll walk out of this meeting, and we're going to go to how we're going to drive more cash flow. So that's what we're going to stay focused on.

speaker
Ed

And, John, your first question there, $135.67 was the average price in the quarter.

speaker
John Murphy

Impossible. Ray, just that WS program, that's the Grand Wagoneer and the Wagoneer is what you mentioned in that takeover. That's what you were just discussing. Awesome.

speaker
Ed

Yeah.

speaker
John Murphy

Thanks, guys. I appreciate it.

speaker
Operator

Thanks, John. Our next question comes from James Piccirillo from BMP Paribas. Please go ahead with your question.

speaker
John

Hi. Good morning, everybody. Just to focus on this year's volume mix assumptions, Relative to a flat global production outlook, your seedings volume mix is going to be down almost two points, e-systems down almost four points. Can you just help unpack a little more the key drivers here for both segments that informs the underperformance first market?

speaker
Ed

Yeah, James, I can give you maybe just some highlights of some of the key platforms that are driving that. And some of it is temporary. For example, in seeding, The Audi Q5 is lower year over year. It's going through a changeover this year. We would expect that volume to eventually come back. With Stellantis, the Compass volumes are lower. You know, they're launching that Wagoneer S in the same facility, and so that's offsetting some of that volume, and that sits in our backlog. We've got Mercedes SUVs in our Tuscaloosa plant. Both the ICE and EV volumes seem to be lower. And in Europe, Audi A6, and then some of the local programs that we're on are lower. In China, there's a changeover of the Mercedes E-Class that's an important program for us, so volumes are lower this year. They seem to be lower. And some of this is, again, just kind of aligning with S&T, you know, making adjustments where necessary for customer insights. Those are the big drivers on the seating side. And these systems, it's got kind of a mixed bag. So with Ford, you have some that are up, like the Maverick, the Bronco Sport and Escape that helps. The Mach-E, however, is down pretty significantly. I think we have had it down 33%. That's a pretty good significant program in these systems. So that's weighing on the number. Focus is lower in Europe. Audi volumes are lower in Europe and China. SAIC volumes in China. Some of the Volvo Geely volumes are a little bit lower on certain platforms. Polestar 2 is down. Lincoln Coast down. Those are the big kind of big drivers as we look at our volume assumptions in each of the segments.

speaker
John

All right. That's super helpful. And then just to follow on, on that point, you know, thinking about 2025, obviously, you're not going to get 2025 guides, but just for the seeding business, you're calling for 500 million contribution, new business backlog for 2025, right, that would be just under three points, growth over market off of the 2024 guide, it sounds as you know, you just went through the seeding key platforms that are influencing 2024. My question is, can we think of four points growth over market for seeding as an achievable rate for next year or not necessarily? Just any thoughts on that. Thanks.

speaker
Ed

Yeah. Growth over market is difficult. It's choppy. It's volatile. And we saw a perfect example of that even just kind of within 2013. started out decent and got worse as the year progressed as there were some mixed shifts with certain customers. So I think it's important to kind of take a step back and look at the business over a longer time horizon. And over the last four years, we did deliver, as we highlighted in the prepared remarks, four points of growth of market exceeding six points in these systems. As I look out over the next five years, I do see this maybe uncertainty around the transition to EVs. weighing on growth over market a little bit. I do see, you know, in these systems as we wind down some of our non-core products that will temper growth in the kind of near to medium term. But if I look out five years, I think, you know, four points of growth over market in seeding, six points of growth over market in these systems in the long run is very achievable. And in seeding, the catalyst for it now In the past, it was conquest wins primarily, and we do have some benefit from that in the future, but a lot of it is from modularity, what we're doing with thermal comfort, what we're doing with new innovative products that we highlighted like FlexAir and RenewNits. So just take FlexAir, for example. Foam is a $4.5 billion market. We have a relatively small share of that today, less than 10% of that market. We see FlexAir potentially displacing polyurethane foam, you know, at least in second and third row applications and maybe in all seat back applications over a period of time. We're going to dominate that market. That could be a $500 million business for us, you know, five years out. It could be a billion dollar business for us long term. We continue to look for those kind of billion-dollar component businesses. We started back in 2015 with weather. That's a great business for us. Now we have thermal comfort. It's a $600 million business that we acquired. It will be a billion-dollar business in 2027. We're well on our way there. Flex air may be something that meets those levels of growth as well based on initial customer interest and all the environmental benefits associated with it and performance benefits associated with it. So I think that structurally the underlying drivers of growth in seeding are stronger today than they've ever been. Our path to getting more JIT market share is very clear, and we're confident in the long-term growth prospects of that business.

speaker
John

Appreciate it. Thanks.

speaker
Operator

Our next question comes from Emmanuel Rosner from Deutsche Bank. Please go ahead with your question.

speaker
spk06

Thank you very much. My first question is about the EV backlog. Just so we get a little bit of a better understanding of, I guess, to what extent this was, you know, the risk for, like, EV volume assumption, are you able to quantify for us how much of the backlog is currently tied to EV platforms in these systems as well as in ceiling? Overall, like, now that you've essentially reduced these volume assumptions, What percentage of your backlog is EV at this point?

speaker
Ed

Yeah, even after those adjustments, electric vehicles are still the most prominent new vehicles launching over the next three years. And so in seeding, it's about 57% of the backlog of the new programs going on. And in these systems, it's 75%. And that's not just electrification revenue as we define it, which would be high voltage wiring or electronics products that are unique to electric vehicles. That would include low voltage wiring on electric vehicles. So it's still, despite the fact that we have significantly reduced the volume assumptions and the timing of the launches, it's still a prominent and significant part of the backlog. And so our belief is still that the transition to electric vehicles is happening. It may happen more slowly than what was previously anticipated, but there's still a significant shift that's taking place. It may ultimately end up being a lower percentage of the market than many had expected, but it's still a significant part of the market, and it still dominates our customers' new program launches in the near term. Now, if you say you don't believe that that level of penetration is going to happen with EVs, I think the flip side to that, as a few of the questions earlier highlighted, is that some of these ICE programs that we've assumed are going to balance out are not going to balance out, or they're going to run at a higher volume than what we've assumed for a longer period of time. So, yeah, we're definitely in a transition period. It's difficult to project what's going to happen. We've tried to be balanced in our assumptions at this stage and clear in our guidance, but it's difficult to predict, Emmanuel.

speaker
spk06

Yeah, that's helpful. And then one quick follow-up or point of clarification around some of the cost headwinds, especially labor cost inflation. I guess on a full year basis, do you assume that you recover these from customers or would there be a lag or is there like a portion that you expect that you will be responsible for? I understand that it takes time and there's a process and negotiations, et cetera, but I guess net-net-net, does that remain sort of like a headwind?

speaker
Ed

Yeah, I think that going back to what we talked about earlier, historically, wage inflation was 3%, 4%. And our efficiency programs in the plant would offset that, as well as, in some cases, a little bit more than that. And that would contribute to offset our customer price reductions each year. That was kind of the old model. 3%, 4% is now twice that. And I don't think that necessarily continues as I look out 25, 26, 27, but in 24 it is. And so what we believe we should recover either this year or this year or next year is that kind of excess labor inflation beyond that historical normal level that we have seen and the economy has experienced for decades. And so that's sort of the philosophy. And so I don't want to make it as simple as this, but roughly half of it we've got to offset through our cost reduction programs, automation, restructuring, shifting the footprint, better utilization of our facilities. And then the other half has got to come through some form of recovery either this year or next year in order to preserve the margin trajectory, the margin growth that we expect to achieve this year or next year.

speaker
spk06

I guess in this year's guidance, do you assume a net headwind from labor cost inflation unrecovered, or do you assume that the piece that you need to recover from your customers is being recovered?

speaker
Ed

Yeah, I think, yes, it would be a net headwind for this year in the guidance. You know, we've talked in the past about generating 50 to 100 basis points in that performance. We've guided to less than that, and I think you could certainly attribute the shortfall to a combination of the transactional effects impact as well as unrecovered wage inflation. It's not quite that precise, but I think that's a fair perspective.

speaker
Jamie

And I think the way I categorize it and discuss it too is that even though we have past practice in some of these negotiations and historical understanding or baseline of how we get recovery, we base our guidance on that. Now, we're in for a much different number as far as getting settled within the year and that there's timing elements to that. Obviously, we're pulling on productivity, we're pulling on volume, all these other things. We're going in above what the net difference would be for negotiations based on past practice. Some of them are models or some of them are discussed in other settlements. I think in addition to that, we have a lot more control around the automation within our facilities. Like Jason mentioned earlier, 35% of our labor is in our trim. And we were just on one of our facilities, and in our own control, we've been able to automate, which has always been something that, because of the variability within the trim covers, we've done a nice job of bringing in very sophisticated innovation to automate that equipment. That's in ours. Now, accelerating that faster is another nice opportunity for us. And so we've been somewhat conservative on how we roll that out, but those are opportunities that I think would improve the overall number as we look at it today?

speaker
Ed

As we talked about earlier, that's one of the factors that could drive us into a different spot in the range. At the high end of the guidance range, if we do better than anticipated, certainly that would be a contributing factor to getting seeding to 7% and need systems to 6% this year. Very helpful. Thank you.

speaker
spk06

You're welcome.

speaker
Operator

And ladies and gentlemen, with that, we'll be concluding today's question and answer session. I'd like to turn the floor back over to management for any closing remarks.

speaker
Jamie

Yeah, thanks. I'm sure everyone on the call now is just the leader team. I just want to, again, thank everyone for their outstanding job in 2023. And like we always discuss, so what now? We've got some challenges ahead of us this year, but we know what we need to do, and I appreciate all the great work we're going to do this year to hit our targets and achieve them. So thank you, everybody, for all your hard work.

speaker
Operator

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

Disclaimer

This conference call transcript was computer generated and almost certianly contains errors. This transcript is provided for information purposes only.EarningsCall, LLC makes no representation about the accuracy of the aforementioned transcript, and you are cautioned not to place undue reliance on the information provided by the transcript.

-

-