Lear Corporation Q4 2008 Earnings Call Transcript

| About: Lear Corporation (LEA)

Lear Corporation (NYSE:LEA)

Q4 2008 Earnings Call

January 29, 2008 8:00 am ET

Executives

Mel Stephens - Vice President, Investor Relations

Robert Rossiter - Chairman, Chief Executive Officer and President

Matthew Simoncini - Chief Financial Officer

Daniel Ninivaggi – Executive Vice President

Analysts

Chris Ceraso - Credit Suisse

Brian Johnson - Barclay's Capital

Richard Kwas - Wachovia

Himanshu Patel - JP Morgan

Brett Hoselton – Key Banc

Operator

I would like to welcome everyone to Lear Corporation’s fourth quarter and full year 2008 earnings conference call. (Operator instructions) I would now like to turn the call over to Mel Stephens, Vice President of Investor Relations.

Mel Stephens

Good morning everyone and thank you for joining our earnings call. By now you should have received our press release and our financial review slide package. These materials have also been filed with the Securities and Exchange Commission and they are also posted on our website lear.com under the Investor Relations link.

Today our presenters are Bob Rossiter, Chairman, CEO and President and Matt Simoncini, our Chief Financial Officer. Also with me here in Southfield this morning are Daniel Ninivaggi, Executive Vice President; Ray Scott, president of our Electrical Electronics Group; Terry Larkin, General Counsel; Shari Burgess, our Treasurer and other Lear financial executives.

Before we begin, I would like to remind you all that during the call we will be making forward-looking statements that are subject to risks and uncertainties. Some of the factors that could impact our future results are described in the last slide of the slide deck and also included in our SEC filings.

In addition, we will be referring to certain non-GAAP financial measures. Additional information regarding these measures can be found in the slides labeled non-GAAP financial information, also at the end of our slide presentation.

Turning now to slide two here is the agenda for today’s review. Mr. Rossiter will open with some comments on the business environment. Next, Matt Simoncini will cover our fourth quarter and full year 2008 financial results and then provide an update on our sales backlog. Finally, Bob Rossiter will have some wrap up comments. Following the formal presentation we will be happy to take any of your questions.

So now, if you’ll please turn to slide number four, I’ll hand it over to Bob.

Robert Rossiter

I’d like to begin by putting our business and our financial results in perspective. In 2007 we achieved improved financial results in our core business for the second consecutive year following the divestiture of our interiors business, successful global restructuring efforts and ongoing cost improvements.

This allowed us to enter last year with tremendous momentum. Unfortunately in 2008 the U.S. economy entered a recession and economic activity turned down globally. As a result U.S. sales and production levels fell sharply and other major markets around the world also declined. In response, we have been very proactive in restructuring our operations and reducing our costs.

In the fourth quarter we accelerated our restructuring and cost reduction efforts. However, we are also mindful that the present pace of sales is not where the longer term run rate will be. In this regard we are continuing to make progress on our operating priorities to position the company for success when economic conditions improve and industry sales and production levels recover.

Let’s move to slide five.

Our immediate attention is on managing our way through the downturn. We are focused on a lean operating structure to minimize our cash burn. This means investing our capital in the most efficient manner possible, prioritizing all of our spending on those projects with the best returns, minimizing inventories and continuing to manage the business as efficiently as possible. We are also in the process of negotiating an amendment to our current credit facility to maintain our financial flexibility during the downturn.

As I mentioned earlier we have made substantial progress on the restructuring of our business so we can operate more effectively and efficiently at lower volumes. These efforts are continuing and accelerating. We also are paying close attention to the fundamentals of our business; quality, cost, service and innovation so that we can provide our customers with superior value.

Lastly, we are working closely with our supply base, selectively insourcing certain components where it makes economic sense and we are following a disciplined pricing model.

Let’s move to slide six.

This slide provides some examples of the comprehensive actions we have taken to improve our operating efficiency and lower our operating costs. Specific actions range from facility closures to census reductions, reductions in compensation and fringe business to overall thrifting of our discretionary spending. We also have reduced non-program related spending, slowed up certain expenditures in new markets and we are implementing a number of actions to further reduce our plant and administrative costs including extended holiday shut downs, additional consolidations, reductions in overhead costs and the reduction of planned capacity expansion in emerging markets.

Let’s move to slide seven.

We also are continuing to make progress on further diversifying our sales mix. Last year 64% of our sales were outside of North America compared with 55% in 2007. We also continue to diversify our customer mix with increasing sales coming from Europe and Asian manufacturers.

As we move to slide eight, as we work our way through the downturn it is important to keep in mind that Lear is well positioned to be successful when industry volumes recover. We have strong global capabilities in critical automotive systems, seating and power distribution. We have made substantial progress on restructuring our global operations and reducing our ongoing cost structure. This includes significant low cost footprint. We continue to make progress on further diversifying our sales and we have maintained our leadership position in quality and customer service.

Lastly, we are continuing to invest in key technologies such as light weight materials in our seating business and high power and high grid electrical components and systems.

Now I will turn it over to Matt for a review of our financials.

Matthew Simoncini

Thanks Bob. I’d like to begin the review of our 2008 financials with a look at the global production environment for the fourth quarter and full year. In the fourth quarter industry production was down sharply in all of our major markets. Global industry production was down 21% from a year ago. In North America industry production was down 26% and the domestic three were down 30%.

In Europe industry production was down 29% from the fourth quarter of 2007. In South America industry production was down 27% and India and China were down 11% and 13% respectively. For the full year global industry production was down 4% led by a 16% decline in North America and a 6% decline in Europe with industry sales and production levels down sharply in the second half of the year.

Let’s turn to slide 11.

With the sharply lower industry production our financial results have been adversely impacted despite our aggressive restructuring and cost reduction efforts. In the fourth quarter our net sales were $2.6 billion and our core operating earnings were a positive $22 million.

We continue to achieve increased benefits from our restructuring initiatives as well other ongoing cost reductions. However, these favorable factors were not enough to offset the steep declines we experienced in the industry production.

Free cash flow in the quarter was a negative $38 million. For the full year we reported net sales of $13.6 billion. Our core operating earnings were $418 million. Free cash flow was negative $71 million. Our three-year sales backlog covering the 2009-2011 period now stands at $1.1 billion.

In the next few slides I will cover our fourth quarter and full year 2008 results as well as our sales backlog in more detail.

Slide 12 provides our financial scorecard for the fourth quarter. Starting with the top line we posted net sales of $2.6 billion, down $1.3 billion from last year. The decline reflects sharply lower production globally. Our reported pre-tax loss is $692 million and a loss of $688 million after taxes or $8.91 per share. These reported results included a non-cash goodwill impairment charge of $530 million and restructuring costs of $66 million.

On the next slide I will show our results excluding these special items to highlight our underlying operating performance.

SG&A as a percentage of net sales was 3.7% compared with 3.8% a year ago. Interest expense was about $51 million, up $2 million from last year primarily due to higher borrowing levels. Depreciation and amortization was $72 million and down $4 million from a year ago. Other expense was $73 million compared with income of $10 million a year ago. The increase reflects primarily an impairment charge related to our investment in IAC North America, increased losses at our IAC joint ventures and unfavorable foreign exchange.

Slide 13 summarizes the impact of the restructuring actions and other special items on our reported fourth quarter results. Our reported loss before interest, other expense and income taxes was $568 million. Excluding goodwill impairment charges of $530 million and restructuring costs of $60 million, our core operating earnings were $22 million compared with $178 million a year ago.

The decline in core operating earnings primarily reflects lower industry production globally offset in part by favorable cost performance including increased savings from restructuring initiatives. I will clarify how these special items impacted our financial statement. We have indicated the amount by income statement category on the right hand side of the chart.

Slide 14 summarizes the impact of major performance items on our fourth quarter sales and margin compared with a year ago. The major adverse factor for the change in sales was lower production in North America and Europe. Margins were adversely impacted by the lower industry production in mature markets. Favorable operating performance including restructuring savings was a partial offset.

Turning now to our performance by product line. Sales and margins for our seating business declined last year reflecting primarily sharper lower production levels in our mature markets. Our adjusted seating margins declined from 7% to 4.8%. This is below our target range reflecting the sharply lower industry production and adverse platform mix in North America and Europe, net selling price reductions as well as higher commodity costs. Longer term we expect our seating margins to improve as we realign capacity to manage demand, take a disciplined approach to pricing, implement further cost reduction actions including restructuring actions, realize the benefit from selective vertical integration, continued growth in emerging markets and an overall industry recovery.

In our electrical and electronics business full year adjusted margins declined from 3.6% to 2.7%. This reflects the impact of lower production offset in part by favorable operating performance. We have been targeting improvement in our electrical and electronic margin to the 4% range this year however, sharply lower production levels caused us to fall short of this interim target. Longer term we see our electrical electronic margins improving as we continue to implement our global improvement plan for this business and industry production levels recover.

Please turn to page 17.

Free cash flow of negative $38 million in the quarter and negative $71 million for the year. Compared with a year ago free cash flow was adversely impacted by the lower earnings and higher cash cost for restructuring.

Turning to slide 18, I would like to discuss our liquidity position. During the fourth quarter we fully borrowed $1.2 billion on our primary credit facility to protect against potential disruptions in the capital markets and uncertainty in the auto industry. We ended the year with cash and equivalents of about $1.6 billion providing us with ample resources to satisfy our ordinary course of business obligations.

As a result of this decision not to repay the amounts borrowed at year end the company is no longer in compliance with the leverage ratio contained in its primary credit facility. We have initiated discussions with our co-agent under our primary credit facility to seek a long-term amendment. These discussions have been constructive and are continuing. Because the amendment will require the support from lenders holding a majority of our outstanding commitments and borrowings under the credit facility the company intends to pursue discussions with a broader lender group before launching the full amendment process.

Slide 19 provides an update on our sales backlog. As a reminder, we define backlog as net new business awarded or new business that has been awarded less programs rolling off and lost business. We do not include pursued or high confident new business.

Since our last formal update a year ago we have been very successful in signing new business. Over the past 12 months we have been awarded approximately $1 billion in net new business. This has more than offset the adverse impact of several major loss programs primarily in North America. The present status of our base 3-year backlog covering the 2009-2011 period now is $1.1 billion.

In considering our future growth potential it is important to note that we have made significant investment in strategic joint ventures primarily in Asia and elsewhere supplying Asian manufacturers globally. If you include our non-consolidated backlog over the next three years our total backlog increases by about $300 million to $1.4 billion. I would like to point out that a number of significant sourcing decisions through the backlog period are still open so we have opportunity to add new business to our backlog shown here once these programs are awarded.

Slide 20 highlights some of the new electrical electronic wins we have achieved recently. During the fourth quarter we opened a new global center of excellence for high power and hybrid electrical components and systems on our Southfield campus. We are encouraged by the early success of this new initiative. Our most significant win is key electrical and electronic content on the new Chevy Volt.

Here we have been awarded both the high and low voltage wire harnesses, several customized terminals and connectors and other proprietary electronics. In addition, we have recently been awarded new electrical and electronic content on several other new hybrid models including high voltage wiring for the next generation of BMW hybrids, significant electrical content on the new Fisker Karma, a voltage module on the Land Rover hybrids and battery chargers on the upcoming Renault and Saturn hybrids.

Please turn to slide 21.

Given the very rapid decline in industry sales and production levels and the fact that economic conditions globally are very volatile and uncertain, there is a wide range of industry assumptions for 2009. As a result we are not providing financial guidance at this time.

While there continues to be a number of significant negatives there are also some key positive factors including low interest rates, government stimulus actions in a number of major countries, U.S. government support for domestic auto makers and their financed subsidiaries and declining energy and raw material prices globally.

In this very challenging environment we intend to keep our focus on reducing costs, proactively managing our liquidity position, maintaining financial flexibility and positioning the company for eventual industry recovery.

I would like to turn it back to Bob for some wrap up comments.

Robert Rossiter

If you will turn now to slide 23, in summary and before we take questions I would like to sincerely thank the Lear team for their dedication, hard work and perseverance in the face of unprecedented challenges. Business conditions are very tough but I am very confident in our ability to manage our way through this downturn. We have faced many challenges in the past and we have always met them head on and emerged an even stronger company. I am confident that we will prevail once again.

We have great relationships with our customers, strong global capabilities, the hardest working team, we have made exceptional progress in reducing our costs and [inaudible] our company for long-term success. We also have been having very good discussions with our customers regarding the state of the industry, productivity, pricing and all the tough issues that we face. These discussions have been constructive and our employees continue to be fully supportive of doing whatever it takes. We have endured many sacrifices in meeting the difficult business conditions before us. I truly appreciate the extraordinary effort being put forth. We are well positioned to withstand the downturn and emerge ready to take full advantage of the recovery in the industry both in sales and production.

Now I’d be happy to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) The first question comes from the line of Chris Ceraso - Credit Suisse.

Chris Ceraso - Credit Suisse

Most of the other expense you talked about has to do with IAC. I was surprised at the drop in SG&A. On a percent of sales it makes sense but I wouldn’t have thought that on a dollar basis you could change it that quickly. Can you talk about some of the expense buckets in there and how that came down so fast with sales?

Matthew Simoncini

If you go back to the third quarter call we talked about our $150 million improvement plan. Included in there, even split 1/3, 1/3, 1/3 was near-term actions which were about $50 million we thought over 12 months. It included things like eliminating non-essential spending, suspending certain compensation programs such as the 401K match, some of the things you would expect. We talked about and Bob spoke about the holiday break and vacations and a lot of things you are hearing a lot of other people do. So there is a portion of that which is not sustainable. We do believe on a go-forward basis or a year-over-year basis we can continue to bring that number down. The number you see in the fourth quarter is not the run rate but we would see going into next year a spending level that is a fair bit lower than what we saw for the full year of 2008.

Obviously when the sales come back on an absolute dollar basis the amount may be down but the percentage will probably creep up.

Chris Ceraso - Credit Suisse

To summarize that, what is kind of a normal percent of sales?

Matthew Simoncini

We spoke about in the past about 4% but that was based on a revenue number that was probably in the $14 billion range. If you extend that out you would get a number that would be higher than what we are expecting for next year but we really try to stay away from providing guidance. It is going to depend a lot on what the customers do and how they manage their programs and what they do as far as the backlog and the timing of the backlog.

Chris Ceraso - Credit Suisse

This may be up for discussion with the banks right now but as you calculate your leverage ratio do you include that other expense line so if we anticipate losses at IAC to continue is that going to impair your EBITDA from a covenant standpoint?

Matthew Simoncini

No it is excluded.

Chris Ceraso - Credit Suisse

The segment margins, if we have done the math right it looks like seating was actually better from Q3 to Q4 and electronics was a pretty meaningful loss. First, is that right? Can you just give us some color as to how that happened in both of those segments?

Matthew Simoncini

Seating was better from the third to fourth quarter and it really is because of the mix of business that they have in the fourth quarter North America to Europe. Electrical business is a little disproportionately Europe and Europe took a significant production reduction in the fourth quarter. It really came in the last 8 weeks of the quarter and so we were caught with the inability to adjust our cost structure when the production came out that quickly. So yes, leads did take a haircut and seating did step up.

Operator

The next question comes from Brian Johnson - Barclay's Capital.

Brian Johnson - Barclay's Capital

On that $75 million we had thought that with equity method accounting we wouldn’t see any bad news or negative impact from IAC flowing up. We thought you had already had that down to zero. Could you maybe flesh that out a bit?

Matthew Simoncini

We actually do have an amount, we still have investment, balances in both IAC North America and IAC Europe so on the equity method we would still take a portion of their losses. What happened in the quarter on that line item was a couple of things; one, we did actually write down the equity investment in IAC North America based on their projections and lower volumes that we are seeing in North America. They also, the IAC joint ventures, incurred a level of restructuring cost and we took our 20% share of that in North America and 33% share of whatever they did in Europe and the ventures themselves lost money in the quarter. That was probably singly the biggest driver of the increase.

Brian Johnson - Barclay's Capital

What is the remaining book value in IAC in the various geographies left for us to worry about losses?

Matthew Simoncini

It is about 130 in total and roughly 17-20 North America and the rest of it is in Europe.

Brian Johnson - Barclay's Capital

What is your thinking on if you can’t get the covenant done to your satisfaction? What are you looking for and what is the thinking visa vie a strategic filing make sense given the potential unavailability of financing?

Matthew Simoncini

First, we think it is in the bank’s best interest to work with us and we have had a constructive dialogue to date that obviously what we are looking for is financial flexibility to be able to get through what is going to be a very difficult next 18 months by any stretch of the imagination. So both from a covenant standpoint and a liquidity standpoint. We have been working with them and we have been in dialogue with them and that has been our singular focus. I will turn it over to Dan if he wants to add any comments to that.

Daniel Ninivaggi

We are reaching out to the broader bank group. We have exchanged proposals with our lead banks. As Matt said it has been very constructive. We will get a sense of the broader bank group over the next couple of weeks and then we intend to launch at that point.

Operator

The next question comes from Richard Kwas – Wachovia.

Richard Kwas - Wachovia

On the restructuring, with European volumes coming down so much and the outlook for the next year and maybe couple of years being meaningfully lower than where we were just two or three quarters ago, how do you feel about your cost structure in Europe right now and how much of a lag do you expect for the foreseeable future?

Matthew Simoncini

First and foremost I don’t think we could ever really size the business nor would we want to size the business to the production levels that we are seeing in North America. As far as Europe you are right the volumes have come down and the projections are that they recover gradually. We need to continue to reduce our costs in Europe and we started doing that well before we saw the production pull back. We have talked in the past about the low cost initiative that we have had in our component facilities, metals, trims and electrical distribution. We are continuing that. We have stepped up our efforts on our infrastructure. We need to do more in the near-term to get there. When we talk about restructuring on a go-forward basis, the last time we gave an update, we talked about 2009 in the $100 million range. In light of the production pull back that number needs to increase. We would see restructuring overall for the Lear Corporation some place between that $100 million and the $190 million we reported this year.

Richard Kwas - Wachovia

For North America how are you thinking about sizing the business if you are not going to bring it down to these levels and I completely understand that given we are at such low levels? How are you thinking about sizing the business out the next three years or so for North America?

Matthew Simoncini

A couple of things. One, a good portion of our business is just-in-time manufacturing and it really is dependent upon what the customer does with their assembly facilities. If they continue to run their assembly facilities then it is hard for us to take manufacturing capacity out of the [jig] assembly. From a component standpoint, we would have to reduce our capacity and consolidate our manufacturing. If you look at it from a broader sense, replacement values and scrap values by any stretch of the imagination are at least 10 million units if not higher, as high as 12 million units. So we continue to look for opportunities to reduce capacity and to consolidate manufacturing where it makes sense. We have been very aggressive with our administrative centers, infrastructure, salary, staff compensation programs, but there comes a point where you can’t size to 9-10 million units because quite frankly we don’t think that is sustainable.

Richard Kwas - Wachovia

So it sounds like the implication is you are sizing for something north of 12 million?

Matthew Simoncini

It is hard to really get capacity utilization. I would be a little bit hesitant to give you an exact number because quite frankly that is not how we run. That is not how the business really runs but we are looking for opportunities to bring it down but we don’t think that the 10 million unit level is sustainable.

Richard Kwas - Wachovia

When you look at the Chrysler announcement yesterday in terms of supplier price reductions how much of that have you factored into your cost savings aside from the restructuring and how much have you contemplated overall for that type of stuff occurring?

Robert Rossiter

Actually Chrysler talked about it at the last meetings what their targets were in terms of supplier and dealer price reductions and consolidations. We continue to work with them. We always work with our customers when they have pricing requests. I feel comfortable with where we are at and I don’t think it is going to be any significant down in pricing from what we have already projected.

Operator

The next question comes from Himanshu Patel - JP Morgan.

Himanshu Patel - JP Morgan

There was a lot of talk at the Detroit Auto Show about distress in the tier-2 supply base. Did you incur a lot of those costs in the fourth quarter and could you give us an outlook for what you expect on that front in the first half?

Matthew Simoncini

We did see a little bit of a pick up in activity in the fourth quarter. It wasn’t meaningful. It was higher from a run rate standpoint than what we saw. I think for the full year we saw a number between OI and some cash costs it approached $10 million and it was probably back end loaded. For 2009 we think the amount is going to increase. We factor a level of that into our thinking. We have it in pretty much pro rata over the year. To put a frame of reference on it, going back to the 2005 time frame when we had the interiors business we talked about a number of about $50 million, cut in half in 2006 and basically nil in 2007. We see the numbers starting to get back to the 2006/2005 amounts.

Himanshu Patel - JP Morgan

Back to the sort of $25-50 million range?

Matthew Simoncini

Something in that range, correct.

Himanshu Patel - JP Morgan

I know you don’t want to give earnings guidance but could you help us a little bit with 2009 CapEx and working capital thoughts?

Matthew Simoncini

I think what Bob talked about we need to have a cash focus, capital spending, running lean from a cash perspective. In the past we talked about a capital number that would be about 1.7% of sales. I think that metric needs to go out the window a little bit. CapEx is going to be driven by our focus on reducing costs, but also on our backlog and you can see in 2009 right now we have basically a nil backlog. We believe the amount for CapEx going into next year will be lower than what we have reported this year at 167.

From a working capital standpoint, Ray Scott, our President of Electrical Electronics, Lou Salvatore, the head of our seating operations globally, have aggressively attacked the inventory chain all the way through from supplier on up and are looking at ways to reduce. We believe we can continue to take inventory levels down.

Himanshu Patel - JP Morgan

The backlog number, I forgot what it was. I think $700 million for 2010. What is your industry production assumptions under that?

Matthew Simoncini

When we do our backlog we pretty much tie it in to what CSM is seeing for that year. If you use CSM you won’t be far off.

Operator

The next question comes from Brett Hoselton – Key Banc.

Brett Hoselton – Key Banc

As far as your negotiations with the bank group, do you have a sense as to the possible timing for resolution? Is this a couple of weeks or a couple of months? How long do you think this might take?

Daniel Ninivaggi

As I mentioned we have exchanged proposals with lead banks and now we are reaching out to the broader bank group. I would say over the next couple of weeks and then we will make a decision to launch at that point.

Brett Hoselton – Key Banc

From a restructuring standpoint obviously you are somewhat cash constrained at this point in time. If you were to get an agreement with the bank do you think you might get more aggressive in terms of your cash restructuring?

Matthew Simoncini

One, I like to push back a little bit on the cash constraint. Obviously we have a checkbook that we like to maintain and keep an eye on but we exited the year with a pretty healthy liquidity position. The cash restructuring comes down to a couple of things. One is the ability to action it, to actually move the product or do the types of things we need to do from an employment level and manufacturing standpoint. Two, we are probably shortening up the investment horizon meaning we would like to see quicker and faster pay back and we are putting our focus into that. From a bank standpoint we would anticipate that as part of the discussions we are having with them is the need to be able to continue to be able to restructure our business in light of industry production assumptions globally are going to be significantly lower in the near-term than what we were sized for initially.

We had a basket in the original bank facility of about 285 and we filled that basket up. We’d like to see something back into the bank agreement about that size to give us relief.

Robert Rossiter

That pretty well wraps it up. I want to thank everybody for participating in the call and I thank you Matt for an outstanding job and the team that supports him. Thank you all very much and we thank the great team Lear that continues to work hard and stay dedicated to what our goals are. We will get through this.

Operator

That does conclude today’s conference. You may now disconnect.

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