Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Executives

Terrence Larkin - Senior Vice President, Corporate Secretary and General Counsel

Ed Lowenfeld -

Jason Cardew -

Matthew Simoncini - Chief Financial Officer, Principal Accounting Officer and Senior Vice President

Robert Rossiter - Chief Executive Officer, President, Director and Member of Executive Committee

Analysts

Rod Lache - Deutsche Bank AG

Brian Johnson - Barclays Capital

H. Nesvold - Jefferies & Company, Inc.

Itay Michaeli - Citigroup Inc

Aditya Oberoi - Goldman Sachs Group Inc.

Christopher Ceraso - Crédit Suisse AG

Brett Hoselton - KeyBanc Capital Markets Inc.

Ravi Shanker - Morgan Stanley

Himanshu Patel - JP Morgan Chase & Co

John Murphy - BofA Merrill Lynch

Lear (LEA) Q2 2011 Earnings Call August 4, 2011 9:00 AM ET

Operator

Good morning. My name is Steve, and I will be your conference operator today. At this time, I would like to welcome everyone to the Lear Corporation Second Quarter Earnings Conference Call. [Operator Instructions] I'll now turn the call over to Ed Lowenfeld, Vice President of Investor Relations. Please go ahead.

Ed Lowenfeld

Thank you, Steve. Good morning, and thank you for joining us for our second quarter 2011 earnings call. The materials for our earnings call were filed this morning with the Securities and Exchange Commission and posted on our website, lear.com, through the Investor Relations link. Today's presenters are Bob Rossiter, CEO and President; and Matt Simoncini, Senior Vice President and Chief Financial Officer. Also participating on the call are several other members of Lear's leadership team.

Before we begin, I'd like to remind you 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 presentation materials and also 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 slide labeled Non-GAAP Financial Information, also at the end of the presentation materials. Slide #2 shows the agenda for today's review. First, Bob Rossiter will review highlights from the second quarter. Next, Matt Simoncini will review our second quarter financial results and provide an update of our 2011 outlook and sales backlog, then Bob Rossiter will have some wrap-up comments. Following the formal presentation, we will be happy to take your questions.

Now please turn to Slide #3, and I'll hand it over to Bob.

Robert Rossiter

Thank you, Ed, and good morning, everybody. Lear's positive momentum continued in the second quarter. Sales and core operating earnings were both up about 20%. We achieved our eighth consecutive quarter of year-over-year improvement of core operating earnings. Our Electrical business continues to benefit from increasing scale, and our margins improved significantly. We continue to report positive free cash flow with $121 million in the second quarter and over $200 million in the first half of 2011, and we're winning new business globally in both our business segments. The balance sheet continues to remain strong as we increase our revolving credit facility to $500 million in June. We also continue to return cash to our shareholders through share repurchase and dividends. As a result of our improved operating performance and industry outlook, we are increasing our full year guidance, and Matt will provide details later.

Now go to Slide 4. This Slide shows vehicle production in key automotive markets for the second quarter. Global vehicle production was 17.9 million units, down 1% from a year ago, reflecting a significant reduction in Japan due to the earthquake and tsunami, offset in part by growth in the emerging markets. Now I'd like to turn it over to Matt for the second quarter financial results.

Matthew Simoncini

Thanks, Bob. Please turn to Slide #6. This slide provides financial highlights for the second quarter. Lear sales were $3.7 billion up 21% from a year ago, reflecting the strong sales backlog, the positive impact of foreign exchange and increased production on Lear platforms. Core operating earnings were $228 million, up 20% from a year ago. The increase in earnings reflects the increase in sales and operating performance improvements partially offset by customer pricing and higher costs for product development, launches and commodities. This represents our eighth conservative quarter of year-over-year earnings improvement. We generated $121 million of free cash flow during the quarter and finished the quarter with $1.8 billion of cash. Our reported earnings per share was $1.65. On the next few slides, I'll cover our second quarter results in more detail and update our full year outlook.

Slide 7 provides a summary of our financial results for the second quarter of 2011. As previously mentioned, sales were up 21% to $3.7 billion. Pretax income before interest and other was $220 million, up $47 million from a year ago, and net income was $178 million up $18 million. SG&A as a percentage of sales was 3.2% compared with 3.7% a year ago. The lower SG&A rate reflects the increase in sales. Interest expense was $11 million, down $3 million primarily reflecting higher interest income. Other expense was $4 million compared with an income of $23 million a year ago, primarily reflecting a year-over-year reduction of profitability of our international automotive components joint venture and unfavorable foreign exchange. Our non-consolidated joint venture in Asia remained profitable, however. Depreciation and amortization was $64 million, up $7 million from a year ago, reflecting higher capital spending over the last several quarters.

Slide #8 shows the impact of nonoperating items on our second quarter results. As I mentioned on a previous slide, our reported pretax income before interest and other was $220 million. Excluding the impact of operational restructuring cost to special items, we have core operating earnings of $228 million, an increase of $38 million or 20% from a year ago.

Other special items in the second quarter include $19.7 million in tax benefits primarily reflecting a reversal of a valuation allowance in a foreign subsidiary. Adjusted for restructuring and other special items, net income attributable to Lear in the second quarter was $165 million and adjusted EPS was $1.54.

Please turn to Slide #9 for a summary of our results by business segment. In Seating, core operating earnings increased to $226 million, up from $209 million a year ago. The improved earnings results resulted from higher production, backlog in cost reductions which were partially offset by customer price reductions and higher product development, launch and commodity costs. Adjusted margins in the second quarter were 7.9%, down from a year ago. Year-over-year margins were negatively impacted by customer pricing, as well as higher launch development and commodity costs.

Slide #10 summarizes the operating performance in our Electrical segment. Financial results in this segment continue to improve. Adjusted margins in the second quarter improved to 6.1%, up 90 basis points from year ago. The margin improvement reflects the benefit of increased sales from higher production on Lear platforms, sales backlog as well as the benefit of cost reductions, which more than offset higher launch, development and commodity costs and a negative impact of Japanese production disruptions.

Please turn to Slide #11. We generated $121 million of free cash flow in the second quarter and $205 million in the first half of 2011. Free cash flow in the first half increased as compared to a year ago despite higher capital expenditures and working capital. The higher spending in 2011 reflects increased investment in new backlog programs and component capabilities in emerging markets.

Slide #12 provides an update regarding the share repurchase program that was announced in February. During the second quarter, we purchased 1.5 million shares of stock at an average price of $50 per share, for a total of $73 million. Year-to-date, we have purchased $100 million of stock. As of the end of the second quarter, $300 million remained under the share repurchase authorization. Going forward, we plan to continue to buy back shares consistently subject to the company's alternative uses of capital, prevailing financial and market conditions and other factors.

At June 22, we paid a cash dividend of $0.125 per share or approximately $13 million. Total cash returned to shareholders during the second quarter was $86 million.

Please turn to Slide 13 for an updated status of our share count. At the end of the second quarter, we had approximately 104 million shares of common stock outstanding. Approximately 660,000 warrants remain outstanding, which are exercisable into 1.3 million shares of common stock. The warrants expire on November 9, 2014. Assuming exercise of all the warrants investing on the management shares, Lear's total shares outstanding would be 107.6 million shares.

Please turn to Slide 15 for a review of our major assumption for our 2011 outlook. Our financial outlook assumes North American production of 12.7 million units in European production of 18 million units, an increase from our prior guidance of 2% and 3%, respectively. Production assumptions are also up modestly in our key emerging markets. Global vehicle production is forecasted to be up 2% from the prior outlook to 74.5 million units. Our full year financial outlook is based on the assumption of a 2011 average euro/$1.40, unchanged from the prior outlook. Commodity cost for steel and copper, the 2 commodities that influence our business the most are relatively flat with prior guidance, but still up meaningfully from last year. We are also seeing additional pressure on other commodities that impact our business, such as petroleum-based chemicals. Additional challenges include continued shortage for certain components used in our Electrical business.

Slide #16 details our updated 2011 financial outlook. We expect 2011 sales in the range of $13.4 billion to $13.8 billion, up $400 million from our prior outlook, reflecting primarily higher industry production. We are increasing our 2011 outlook for core operating earnings by $40 million to $740 million to $780 million. Tax expense, excluding restructuring costs and other special items, is expected to be approximately $135 million, up $10 million from our prior outlook reflecting the increase in earnings. Our outlook for cash taxes is unchanged at approximately $90 million. Pretax operational restructuring costs in 2011 are estimated to be about $100 million, down $25 million from our prior outlook.

Capital spending in 2011 is estimated to be down -- to be, I'm sorry, approximately $325 million. This is an increase of $25 million from our prior outlook, and it reflects increased investment and component capabilities in the emerging markets. Free cash flow for 2011 is expected to be approximately $425 million, up $25 million from our prior outlook. The 2011 outlook for interest expense and depreciation and amortization remain unchanged from our prior outlook. Adjusted earnings per share is forecasted at $4.95 to $5.30 per share.

Slide 17 provides an update of our 2011 to 2013 3-year backlog. As a reminder, we define backlog as new award programs over a 3-year period, net of loss, business and programs that roll off. We do not include pursued or high confidence business or nonconsolidated programs.

Since the beginning of the year, our sales backlog has increased by about $200 million. The majority of the increase reflects new programs in Asia and Europe, with most of the new business in Seating. The present status of our 3-year backlog covering a 2011 to 2013 period now stands at $2.4 billion.

Now I'd like to turn it back to Bob for some closing comments.

Robert Rossiter

Okay, on Slide 19. Thank you, Matt. In the second quarter, we sustained our positive momentum. Sales and earnings grew faster than industry production. We achieved strong financial results in both business segments, and we put in place a new credit agreement that provides additional liquidity and financial flexibility. And we've continued to win new business and increase our sales backlog. Based on our strong results in the quarter and improving production environment, we are increasing our 2011 full year outlook for sales, earnings and free cash flow. I'm extremely proud of the performance of the Lear team, and I'm proud to be a part of this team. Your hard work and dedication in serving our customers have enabled us to continue to report improving results and grow our business. I'll be happy to open it up for questions.

Question-and-Answer Session

Operator

[Operator Instructions] And your first question comes from the line of Rod Lache from Deutsche Bank.

Rod Lache - Deutsche Bank AG

Can you pass along the impact of FX raw materials and launch cost year-over-year in the quarter and what your expectations are now for the full year?

Matthew Simoncini

Yes. Launch cost in ER&D together, combined, Rod, are close to $70 million. From a foreign exchange impact, we did pick up some revenues on foreign exchange, mainly the euro was roughly $200 million in revenue, and that converts at the average kind of operating earnings in Europe of around 4% or 5%.

Rod Lache - Deutsche Bank AG

And is that -- do you happen to have a launch cost estimate increase for the full year? And is that something that comes down next year?

Matthew Simoncini

It's a little bit early to talk about next year at this point, Rod, but I would tell you that year-over-year launches are about $30 million higher than last year, and last year was about $60 million. So our launch cost -- I would put -- peg our launch cost around $90 million for the year. The cadence of the launches are slightly front-half loaded. Engineering for the full year increases about $50 million. And again from -- that would put that number at about $200 million in total. And that is a little bit different. That's a little bit more back half loaded. So net-net, between the 2 of them, we're a little bit heavier than in back half of the year as we launch the backlog. Now from a backlog cadence standpoint, I would expect that there would not be a significant change next year in launch cost, but still it's a little bit premature to get into the detail for 2012.

Rod Lache - Deutsche Bank AG

Okay. And do you happen to have the DNA forecast for the year broken down between the Seating business and Electronics? And then lastly, just a question on cash. You continue to generate cash faster than you're deploying it, even if you were to kind of run that at the current rate of repurchases. It doesn't really look like it would dent your overall cash position all that materially. Do you have any kind of updated thoughts on what your plans are for deploying that cash and getting a more efficient capital structure?

Matthew Simoncini

Let me work backwards on that question, starting with the cash deployment. One of the hallmarks of Lear is the ability to generate free cash flow, and this year is no different. From a deployment of cash standpoint, Rod, our first focus is always to make sure that we invest in the business in a manner that allow us to serve our customers and still be the supplier of choice in both segments, and we're doing that. And that's going to require mainly organic investment in some of the emerging markets as we span our footprint there and our capabilities there and lower our cost in components. Two, we're going to look to do niche acquisitions to round out the product offering, to facilitate diversity in sales and also to add scale in Electrical distribution and as we've mentioned before, we're evaluating opportunities to do that. Finally, we've announced, as you know, the share repurchase, and I think we had a nice pace this quarter on the share buyback. And we would do that because were very cognizant of our relative valuation to others in the space, and we think that's the right thing to do with the cash. From a capital structure standpoint, we had a nice step this quarter where the amended revolver will be upsized to $500 million. And I think that gives us a lot of flexibility not only to run our business on a day-to-day basis, but also to continue to invest in the business. From a depreciation and amortization standpoint by segment, it's roughly -- the breakdown is typically about 2/3 Seating, 1/3 Electrical.

Operator

Your next question comes from the line of John Murphy with Bank of America Merrill Lynch.

John Murphy - BofA Merrill Lynch

Just curious, I mean, recently you've been beating expectations and then running ahead of what your guidance has been for the past few quarters. As we look at that, is the bulk of that in your mind driven by higher volumes or is there better execution going on internally than you've been expecting, so even if volumes don't continue to recover, you can still keep posting good numbers? Just trying to understand the volume versus the internal execution side of it?

Matthew Simoncini

John, there's literally thousands of inputs that go into making a projection. First and foremost is the volume and the volume on the car lines that you're on. Each car line has its own financial DNA, so to speak, depending upon how much product we have on it and how much of the product that we make, where it's made and whatnot. So I would tell you that we did get a nice mix of product when we were presenting guidance. Earlier this year, we were at 12.5 million units in North America and 17.4 million in Europe. And the mix has benefited us in the second quarter. So it always starts on selling your product. Both businesses are performing well. Electrical made a really nice step in their margins, even with the headwinds on some of the components shortfalls that drove the premium cost. Seating continues to perform well within their target margins on higher sales. So I would tell you that it starts with sales, but both businesses are performing very well.

John Murphy - BofA Merrill Lynch

And then just a second question. I mean, if we look at the key programs that you highlighted in the second quarter and even in the first quarter, can you remind us if there are any programs that are really big standouts as a positive in that mix that you just kind of talked about? And how should we think about those key programs in the second half and how you're thinking about them?

Matthew Simoncini

I think the premier German manufacturers had a really nice quarter. I think the domestic automakers, GM, Ford both did extremely well. We've got a lot of content on the 3-series, and it still does strong in the marketplace to our expectations, as does the large trucks and SUVs from GM. The Explorer had a nice start, and that's a good platform for us as well. So those are probably the key drivers.

John Murphy - BofA Merrill Lynch

And then just lastly on the capital allocation and what you're doing to return value to shareholders, just to kind of follow up on that. Now with the new amended revolver in place, your cash balance, your forecasted free cash flow, I mean what -- it looks like you're in a good spot. What would it take to get you to release more value to shareholders through share buybacks? I mean, the stock is below where it was the entire first quarter, so I'd imagine you might want to get more aggressive on the share buybacks. Just trying to really understand if there's something that you need on a macro basis that would be a trigger or is there just this massive macro uncertainty that's keeping you from potentially getting more aggressive?

Matthew Simoncini

No, I wouldn't say there's a macro uncertainty. I think if you look at our priorities from an investment standpoint, we believe we're still a growth company in a growth industry. And our focus, first and foremost, is to continue to invest in the business in a manner that allow us to serve our customers, continue to grow profitably and provide the type of returns to our shareholders that they expect. So our first priority is always to continue to invest in the business. And we're doing that, and we'll continue to do that. I don't believe it's mutually exclusive. I think we can continue to provide cash back to our shareholders, especially when we're trading at the levels that we're trading.

John Murphy - BofA Merrill Lynch

You have net cash of $1.1 billion. It's almost 4x your annual CapEx. I mean, does that mean there's a large acquisition on the horizon that you're looking at or any of the strategic, big strategic actions?

Matthew Simoncini

No. There's not. We don't believe that we need a large acquisition. We think both businesses are well placed. We would look to do something that would provide either access to customer diversification, access to geographic diversification to facilitate our growth in the emerging markets or something that would add some scale to Electrical Power Management Systems or some component capabilities. But all in all, I don't see a major acquisition in our future. I will tell you this, Murph, that from our standpoint, we continue to run the business. We need to continue to invest in ourself. It's a growth industry. We see a nice quiet path on the industry recoveries globally over the next several years, and we're going to participate in it.

Operator

Your next question comes from the line of Itay Michaeli from Citi.

Itay Michaeli - Citigroup Inc

Matt, I think you've raised CapEx guidance for the year twice now. Just how should we think about that going forward into next year? And how does that impact the long-term margin target to both Seating and Electrical?

Matthew Simoncini

I would say that if you use -- just from an outlook standpoint directionally, if you use a rule of thumb of about 2.5% of sales from a capital investment standpoint, you won't be that far off. As we continue to invest in the business, we -- obviously, that creates a higher capital intensity. We think that we capture that in our target margins of 7.5% to 8.5% in Electrical distribution and Seating in the 7.5% to 8% range. And I think at those levels, we can provide a nice return on an investment.

Itay Michaeli - Citigroup Inc

Great. And can you just remind us what the GMT900 production assumption now is in your new guidance?

Matthew Simoncini

We've got it at 930.

Itay Michaeli - Citigroup Inc

930? Okay. And just lastly with cash restructuring, where restructuring is just coming down this year, any change to your thinking around 2012 and beyond?

Matthew Simoncini

No. At this point, I would say no. These things are somewhat fluid because we're not in complete control of when we're able to take certain key actions that comes with negotiations with our customers, production plans, discussions with our unions and labor unions and whatnot. So we're not always completely in control of the timing of it but at this point, I would tell you that it does not change our thinking in 2012.

Operator

Your next question comes from the line of Peter Nesvold from Jefferies.

H. Nesvold - Jefferies & Company, Inc.

Question on the guidance. So if I take the full year guidance and I strip out 1Q and 2Q actual results, the implied second half guide at the EPS line is about 30% below the first half. Now undoubtedly, you guys are always putting out much bigger numbers relative to your guidance. We think of it as being conservative, which seems appropriate. We've seen a number of other auto companies talk about second half being lower than first half; Ford and GM come to mind. But is there anything that might be, kind of, outsized in how you're looking at the world for the second half versus first half? I'm just trying to frame frankly how conservative is the second half guide versus what we're seeing at other companies?

Matthew Simoncini

Well, we think it's balanced. It starts with the production cadence, in the production cadence on key car lines. Right now, we think that we're going to see a more typical automotive year as far as the cadence of production in sales, which normally first half to second half is something in the 52%, thereabouts in the first half versus the second half. So it starts with that. Now from a business standpoint, we talk about a step-up in engineering and some support costs in the back half of the year as we continue to grow our business and continue to increase to the backlog. And it's going to require some additional investments in engineering and in some of the emerging markets, which will also be a headwind. We are seeing some headwinds as well on commodities. We mentioned the petroleum-based chemicals largely used in our foam fuel surcharges and whatnot with the crude oil being in the 90s. So from that standpoint, there are some headwinds but again, we expect both businesses to perform well within their target margins for the full year, again, continued improvements in Electrical Distribution year-over-year. And Seating continues to perform well.

H. Nesvold - Jefferies & Company, Inc.

Okay. And if I can ask a quick follow-up. As we hear more about technologies like electrical, power steering and vehicle stop-start, how does that impact your Electrical Power Management Systems business going forward?

Robert Rossiter

Creates more opportunity.

H. Nesvold - Jefferies & Company, Inc.

Yes. I mean, any content for vehicle that take that option package or anything else that you can help me frame the opportunity?

Matthew Simoncini

What I would tell you is this, and let me see if I can get you there. We're not going to frame the exact concept per vehicle on a power steering unit or something like that, but what I will tell you is the opportunity on a content per vehicle in that business is driven by many things. Even on traditional powertrains, you're seeing more and more features and more and more computer management of internal combustion engines to improve efficiencies. That's going to require more signals. That's going to require more circuits. That's going to require more content on electrical distribution systems. On a hybrid or full electric, the electrical content could be as much as double what you would see on a full-sized, full-power luxury vehicle; anything from $1,000 to $2,000 of content on the vehicle. What I would tell you is you'll see something in the content ranging from anywhere from 10% to 100%. I know that's a big range, but it really depends on the architecture.

Operator

Your next question comes from the line of Himanshu Patel with JPMorgan.

Himanshu Patel - JP Morgan Chase & Co

My question was really about controllable cost. I know you don't want to give an outlook exclusively for 2012, but when you look at your backlog, you have some pretty hefty years ongoing right now, but '13 seems to step down. When does that start benefiting you guys in terms of moderation on things like engineering costs? Does that start showing kind of early '12 or more towards the end of '12?

Matthew Simoncini

If that backlog number remains the same, which we don't expect it to, I think what you're seeing is really the cadence of the sourcing. There was a backlog of the backlog. There was a backlog in sourcing cadence due largely to the disruption that we saw a year ago in the industry -- a little over a year ago. And I think there was a flurry of sourcing activity, and you're seeing it in a kind of a launch. Going back to 2009, many of the programs were delayed, and what that did was push the backlog into '10, '11 and '12. I still think there's opportunity to increase that number, significant opportunity to increase that number in 2013, Himanshu, and I would expect that number to grow. Now if it stays static, yeah, you would start seeing some benefit as we're able to sunset some engineering costs on new programs in 2012. But we don't expect that number to stay at that size.

Himanshu Patel - JP Morgan Chase & Co

So there's still a scope to upgrade 2013 basically on the backlog?

Matthew Simoncini

Absolutely.

Himanshu Patel - JP Morgan Chase & Co

Okay. Is there any update you can give us on the antitrust situation? I mean, you guys put out your comments, I think, in February of 2010. And it's been a year and a half now. Has there been any movement on that you can shed some color on?

Terrence Larkin

This is Terry Larkin, the general counsel at Lear. You are correct. Just for the benefit of everybody listening in on the call, we -- our Paris offices were visited by the European Commission and the French authorities in February 2010 as part of an investigation into the anti-competitive practices allegedly occurring among automotive electrical -- electronic component suppliers. We are cooperating fully with the authorities in an investigation. We have recently received a supplemental request for information. We understand that, that request is not unusual, and so our cooperation with the authorities continues. To our knowledge, we're not involved in any of the antitrust investigations that were going on in Japan or here in the United States.

Himanshu Patel - JP Morgan Chase & Co

Okay. I guess, two questions. I mean, my understanding is the agencies, they talk to each other a lot. So -- but despite that, you still think the investigations in Japan are not related at all to the European investigation?

Terrence Larkin

We really are not in a position to speculate as to whether they are related or not. I think your premise that they talk with each other is correct, though.

Himanshu Patel - JP Morgan Chase & Co

Okay. And then just a clarification. Are you under investigation in Europe or is it a inquiry in Europe?

Terrence Larkin

The term used by the European commission is an investigation that covers the broad range of all sorts of inquiries, so there's no particular significance attached to the word investigation by the commission.

Himanshu Patel - JP Morgan Chase & Co

Okay, great. And then, Matt, just maybe a final question. We talked a little bit about this before, but we're just seeing a flurry of upper derivations on CapEx across the space. I know you guys mentioned some of it for you as related to, I think, investment on emerging market component capability. But I guess just broadly, are you seeing something on the acceleration of product development schedules from OEMs or -- that's sort of triggering this? Is there any sort of common theme you're picking up on? Or you view this as pretty kind of one-off earlier?

Matthew Simoncini

It's really, I think it's driven more than anything by the growth in the emerging markets and the need to have some selective vertical integration is an opportunity to control your qualities, serve your customers and improve your cost footprint. In our case, we balance the ability to do that organically versus niche acquisitions and the value that it can create to our investors, our shareholders. I can't speak to others. I know from our standpoint, Himanshu, really what drives it is we think there's a real opportunity to provide value to our customers and shareholders by making this investment. Returns are good. And I think more importantly, it kind of helps us improve our quality and cost footprint for our customers.

Himanshu Patel - JP Morgan Chase & Co

And when you talk about -- you've discussed better vertical integration on the Electrical business before. Is that -- just help us understand the commercial benefits of that. Does that help you win additional business, or is it more just kind of a margin play?

Matthew Simoncini

It's both. I think that whenever you can control quality and reduce your cost, it makes you more competitive and gives you advantages when you're winning new business. From our standpoint, I think we're uniquely positioned in the marketplace because of our ability to do a complete electrical distribution, design and manufacture of all of the components in every continent in the world, both high-powered and low-powered. So from that standpoint, if we could expand our capabilities to things like connector systems and expand our European business into other regions, that would be very, very good for us.

Operator

Your next question comes from Aditya Oberoi from Goldman Sachs.

Aditya Oberoi - Goldman Sachs Group Inc.

So I just want to follow up on the question about CapEx. Is it -- the increased guidance, is it more investment that you guys are doing, or you're just pulling forward some of the investments you plan for the next year -- next 2 years?

Matthew Simoncini

It's more investment. I mean, from our standpoint, we're pretty excited about some of the investments that we've made. We've expanded our capabilities in Brazil in both our mechanisms facility and new facility and mechanisms in Brazil, as well as new electrical distribution facility in Brazil and in Thailand. We're expanding our mechanisms capabilities in Asia, both in China and India. We're looking to do the same with connector systems. So it's really -- it's an increased investment.

Aditya Oberoi - Goldman Sachs Group Inc.

Okay, great. And other question I had was on pricing. You guys mentioned selling price reductions as one of the parameters that we had on margins in both the segments. Is it the standard 1% to 2% price reduction, that is what we're talking about or is there anything over and beyond that, that you saw this quarter?

Matthew Simoncini

We usually see a net price reduction of about 2%. We're able to provide much more value to our customers, though, through value engineering and being able to take costs out of the product for them in a collaborative manner. But net, it runs around 2%, plus or minus.

Operator

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

Brian Johnson - Barclays Capital

Would like to talk maybe a bit more strategically about the margin development and kind of where you are in your strategies, both in Seating and Electrical. Maybe start with Seating, because clearly you're still running above the 7.5% -- end of the 7.5% to 8% margin. Is the kind of 7.9% we're seeing about where it's going to go? And is there sort of equilibrium at work there where you can get backlog rolling in but pressure on commodities and price bounds coming to kind of keep it in that range? Conversely, are you seeing maybe better margin enhancement as you vertically integrate some of the content increases in Electrical? And what does that imply about either the 7.5%, 8% target or the pace of you getting there?

Matthew Simoncini

Let's break it down. Let's work in reverse. Electrical distribution. One of the drags on that business recently have been the fact that it was under-scaled. And the amount of investment we need to make in infrastructure cost we needed to maintain in order to be able to provide both high-powered, low-power solutions in every continent in the word fully integrated. Couple of years ago, our fixed cost was running at about 25% of sales when the business was at $2 billion. We need to scale that business up, and we need to get in the $4 billion plus range to get it into their target margin of 7.5% to 8.5%. Now again, there's no magic to that number. What makes that number work for us is at that rate, we can return in excess of our cost of capital on the asset intensity of that business. We believe that through backlog in the industry recovery that we can achieve those types of sales and margin expectations over the next several years. We're well on our path. The business has made a nice step this year, and we should expect that business to run in the 5.5% to 6% range for the remainder of the year. On Seating. Seating, we believe in the 7.5% to 8% range is kind of where it's at. In any given quarter, we could break through the upper end or the lower end, but it will average out at that rate. Sometimes it's hard to call a margin number specific in a quarter because of the mix and product and expenses are not always linear, nor are commercial remedies or commercial solutions. So sometimes we have some chop in the quarter that would put you above or below. But on average, we're comfortable with that range. That range is important as well because with the capital intensity in Seating, that again allows us to return on our investment in excess of our cost of capital. So I think Seating is pretty much running at the rate, and there's a natural commercial pothole in this business where I think it always comes back to the type of return on investment. And as long as we can return in excess of our cost of capital, then we can continue to serve our customers in a cost-efficient manner, continue to grow and still provide returns to our shareholders.

Brian Johnson - Barclays Capital

So really it's electrical where we ought to be looking for incremental profitability lifting the margins up. In Seating, it's kind of running at its, roughly, its average margin rate. And so it's not something where volume will drop to the line, in line with the average margin.

Matthew Simoncini

Let me try to answer in a Bob Rossiter manner. Seating is at target, and Electrical will continue to improve.

Brian Johnson - Barclays Capital

Okay. And the pace of Electrical isn't any faster or slower than you anticipated earlier?

Matthew Simoncini

It's pretty much as we expected. They had a nice quarter. That was a very nice performance from that segment. Ray Scott and his team did an outstanding job.

Operator

Your next question comes from the line of Chris Ceraso with Credit Suisse.

Christopher Ceraso - Crédit Suisse AG

Just a couple of items here. Can you give us the FX contribution to revenue by segment?

Matthew Simoncini

We don't have that by segment per se. Why don't I hand it over to Jason Cardew, our Vice President of Global Finance? Do you have that handy, Jason?

Jason Cardew

Foreign exchange for the quarter by segment?

Matthew Simoncini

Yes.

Jason Cardew

It was about $170 million in Seating and $60 million in Electrical.

Christopher Ceraso - Crédit Suisse AG

And any difference in the contribution on that? You said before, Matt, that it was about the -- corporate average around 4%, 5%, something like that?

Matthew Simoncini

Yes. And slightly -- I would say probably slightly higher in Seating, but pretty consistent between the 2 of them.

Christopher Ceraso - Crédit Suisse AG

Okay. And then were there any costs in the quarter associated with supply-chain disruptions, workarounds, premium freight? Can you give us a ballpark number for Q2 and if you expect that to diminish completely in Q3 and beyond?

Matthew Simoncini

There were costs associated with supply-chain disruptions. And where we're seeing it is in the -- mainly in the Electrical Distribution business, although Seating did get impacted by it in a modest way. The costs in the quarter were roughly $6 million. We would expect some level of that to continue through the remainder of the year.

Christopher Ceraso - Crédit Suisse AG

Really? Continue through the rest of the year at a lower pace than that?

Matthew Simoncini

Slightly lower.

Operator

Your next question comes from the line of Ravi Shanker with Morgan Stanley.

Ravi Shanker - Morgan Stanley

I guess on the backlog, it looked like there was a bit of a shift towards the Seating business. And if I'm doing my math right, it looks like almost all if not more of the incremental backlog came in Seating. Can you explain what's going on there?

Matthew Simoncini

I think both businesses continue to win new programs. From a backlog standpoint, if you look at it overall, we're still somewhat disproportionately Electrical that could penetrate the market. The net wins, the way the math worked in this update of $200 million, the net wins were Seating, but both businesses are winning new programs.

Ravi Shanker - Morgan Stanley

But there's been no change in how and where you're quoting business and for which segment?

Matthew Simoncini

No, not at all.

Ravi Shanker - Morgan Stanley

And can you just broadly comment on the macro environment? There's been a lot of talk of potentially going to a double-dip recession. How do you think the supply base is equipped to do something at that? And specifically, how are you guys thinking of that as well?

Matthew Simoncini

One, I can't speak to the supply base overall. I can speak to the Lear Corporation and our suppliers. From our standpoint, I think one of the benefits of Lear is, obviously, the strength of our balance sheet and our ability to take advantage of opportunities both to consolidate and invest the business. This is still a global growth industry. Whether there's a near term blip or pullback, we're still running significantly below sustainable demand or long-term demand levels in North America, and I think that provides an opportunity as in Europe and in the mature markets. From an emerging markets standpoint, I still think there's huge upside and continued growth over the foreseeable future. So while there may be a pullback, or if there was a pullback in mature markets, I think Lear is in a great position to take advantage of a market crashing like that and the ability maybe to consolidate. We don't personally see it. The releases are strong. The product is great. We're in a great shape, and we're pretty bullish on the future.

Ravi Shanker - Morgan Stanley

Got it. And finally, can you just quantify the impact of Japan disruptions in the quarter? And also you spoke about some premium cost on the Electrical side, if you can give us some more color there?

Matthew Simoncini

The impact in Japan on our direct sales into Japan really impacted Electrical Distribution mainly. And it was about $65 million in revenue and about $20 million in earnings. From that standpoint, the premium cost that we incurred, there were shortages. And one that everybody pretty much incurred across-the-board in the industry was on the circuit boards. And there was a shortage of system, majority of the world's boards come out of Japan and those facilities were offline. And what that resulted in was premium freight and inefficient operations and some bloated inventory on other components as we managed a rationed supply of the boards. It also saw an increase in some of the other electrical components like fuses and relays. From a premium standpoint, we talked about a number of $6 million, and that's really what drove it.

Operator

Your final question comes from the line of Brett Hoselton with Keybanc.

Brett Hoselton - KeyBanc Capital Markets Inc.

Matt, on the Electrical margin side, can you talk about the differences, in your view, of contribution margins on production or changes in production versus your backlog?

Matthew Simoncini

Well, backlog will typically come out a little bit lower than changes on production. And again, we're just making broad general statements as a rule of thumb. Typically, if you do just get incremental volume and you're able to run up to your facility, you obviously, get certain efficiencies on your fixed cost structures, fixed cost structure and you convert between 15% to 20% on average. Again, this is just a very broad rule of thumb. Backlog on the other hand is going to come in a little bit lower as you improve your efficiencies and designs to run it a little bit better in time, so you'll see something around 10%.

Brett Hoselton - KeyBanc Capital Markets Inc.

And then can you quantify for me -- I think you might have done this for Rod and I just missed it, but can you quantify the difference in your ER&D spending, second half versus first half?

Matthew Simoncini

Yes. It's going to be -- there's going to be a step-up in the ER&D spending. For the full year, we expect that number to be around $200 million. And we would expect the second half to be roughly 55% of that number.

Brett Hoselton - KeyBanc Capital Markets Inc.

And then, your European production forecast somewhat below what the industry is looking for. I believe part of that is because you exclude maybe Russia or something along those lines. But even on a percentage change basis, it is a little bit more conservative. I'm wondering is that merely just conservatism on your part or is it -- there's is something that you're seeing in the releases or something else along those lines or commentary from your customers that is kind of leading you towards maybe a little bit more conservative bend?

Matthew Simoncini

Well, we moved the number up from $17.4 million from our previous guidance to $18 million. It does exclude Russia, Brett. Right now, we're not hearing anything one way or the other from our customers. The releases continue to hold firm. We just believe that this is a balanced production number to use for the sake of setting guidance at this point.

Robert Rossiter

Thank you very much, everybody, for being on the call. Matt, as usual, you did an absolutely outstanding job. Finance team, couldn't do it without you. Corporation, corporate headquarters, everybody's doing an outstanding job. Ray Scott, you and your team are doing an outstanding job. And Lou Salvatore and your team are, again, continuing to be very special. You're a great team of people. Good to get out there. Let's keep this thing going. We're moving on the right direction, and I'm proud of you. Thank you.

Operator

Ladies and gentlemen, this concludes today's conference call. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Lear's CEO Discusses Q2 2011 Results - Earnings Call Transcript
This Transcript
All Transcripts