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Lear Corporation (NYSE:LEA)

Q2 2008 Earnings Call

July 29, 2008 9:00 am ET

Executives

Mel Stephens - Vice President, Investor Relations

Robert Rossiter - Chairman, Chief Executive Officer and President

Matthew Simoncini - Chief Financial Officer

Analysts

Brian Johnson – Lehman Brothers

Christopher Ceraso - Credit Suisse

Himanshu Patel - J.P. Morgan

John Murphy - Merrill Lynch

Rod Lache - Deutsche Bank Securities

Richard Kwas - Wachovia Capital Markets

David Leiker - Robert W. Baird & Co.

Itay Michaeli - Citigroup

Operator

Welcome everyone to Lear Corporation's second quarter 2008 earnings conference call. (Operator Instructions) I would now like to turn the call over to Mel Stephens, Vice President, Investor Relations.

Mel Stephens

By now you should have received our press release and financial review package. These materials have also been filed with the Securities and Exchange Commission and they are posted on our website at lear.com under the Investor Relations link.

Today Bob Rossiter, our Chairman, is traveling in Asia and he’s going to be joining the call from India. And also with Bob is Lou Salvatore, the President of our global Seating business. Here in Southfield are Matt Simoncini, our Chief Financial Officer; Dan Ninivaggi, Executive Vice President; Terry Larking, our General Counsel; and several of the company’s vice presidents, Shari Burgess, Treasurer, Wendy Foss, Controller, Bill McLaughlin, Tax, and John Trifall, Business Planning and Analysis.

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 and some of the factors that could impact our future results are described in the last slide of our 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 on the slides, labeled Non-GAAP Financial Information, also included at the end of this presentation.

If you will turn to Slide 2, we outline the agenda for today’s review. Bob Rossiter will open and provide a company overview, then Matt Simoncini will review our second quarter results, discuss the outlook for 2008. Lastly, Bob will come back on for a summary slide, and then we will be happy to take your questions.

So now if you will please turn to Slide 4, I will hand it over to Bob Rossiter.

Robert Rossiter

Business conditions in North America were very difficult in the second quarter, reflecting a 15% decline in industry production from 2007, dramatic mix shift away from full-size pickups and large SUVs, further restructuring by our major North American customers, and higher raw material and energy prices. In Europe industry production remains stable but sales are beginning to soften. In the emerging markets solid growth is continuing. In this challenging environment we continue to focus on the fundamentals of our business and we delivered solid overall financial results.

Please move to Slide 5. As business conditions in North America have deteriorated this year the Lear team has continued to be proactive in addressing the challenges. We have maintained a positive operating momentum as we have aggressively worked to improve our longer-term competitiveness. Specifically, we are focused on the following: Accelerating our restructuring actions, growing and further diversifying our sales, investing in our electrical and electronics businesses, and proactively managing our liquidity position.

Please move to Slide 6. This slide shows the progress we have made so far this year in winning new business. We last updated our sales backlog in January. At that time our three-year backlog stood at $640.0 million. Since then we have won about $600.0 million in net new business, $60.0 million of which in 2009, $300.0 million in 2010, and $240.0 million beyond 2010. The composition of this new business will further diversify our sales. The vast majority is coming from outside of North America. 55% is in Electrical and Electronics and 75% is with Europe and Asian automakers. In addition, we have been awarded non-consolidated new business of about $150.0 million.

Please move to Slide 7. Slide 7 provides a summary of our seat quality scores in J. D. Power’s 2008 analysis. As you can see, on the left of the chart Lear’s seat quality, as measured by the number of things gone wrong per 100 vehicles, improved 19% compared with a year ago. This performance was our best ever and ranked Lear as the highest quality among all major seat manufacturers. Lear has been top-ranking major seat manufacturer overall in J. D. Power’s study for seven of the last eight years.

Please move to Slide 8. As we enter the second half of the year it is clear that business conditions in North America have become very tough and it is likely to remain challenging into 2009. The Lear team is responding by keeping its focus on those things we can control, including maintaining excellence in our operations, concentrated efforts to further diversify our global sales, further structural cost reductions, and continuing to invest in growth opportunities.

A recent example includes our agreement to acquire a majority stake in New Trend automotive fabrics, a new center of excellence for hybrid and high-voltage technology on our Southfield campus, and our continuing investments in new business development in emerging markets. Also, proactively managing our liquidity position. As a result, I believe we are well positioned to weather the down turn and to emerge as an even stronger competitor when conditions improve.

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

Matthew Simoncini

Turning to Slide 10: Our financial results in the second quarter were adversely impacted by a difficult production environment in North America. Despite the increasing challenges in North America, we again delivered solid financial results. On sales of $4.0 billion we delivered core operating earnings of $164.0 million and positive free cash flow of $16.0 million.

We continue to achieve increased benefits from our restructuring initiative as well as other ongoing cost efficiencies, however, these favorable factors were not enough to offset the sharply lower industry production and adverse platform mix in North America. For the full year we are revising our outlook for industry production in North America downward, from 13.8 million units to 13.5 million units. Our full-year outlook for core operating earnings has been revised downward to a range of $550.0 million-$600.0 million to reflect a lower production forecast in North America. On the next few slides I will cover our second quarter results and full-year outlook in more detail.

Slide 11 of the presentation breaks down the industry environment in the second quarter. In North America, industry production was 3.34 million units, down 15% from year ago. The Domestic Three were down 21% and our top 15 platforms were down 30%. The lower production in North America includes the impact of the strike at American Axle. In Europe, industry production was 5.5 million units, up 4% from year ago. Production for our top five customers in Europe was up 3%.

Prices for key commodities increased in the second quarter. These increases did not have a significant on our second quarter financial results because of the contracts in place, price adjustment mechanisms, and the timing of price adjustments. At present levels, however, commodity costs for the full year will represent a significant increase compared with a year ago.

Slide 12 provides our financial scorecard for the second quarter in more detail. Starting with the top line, we posted net sales of $4.0 billion, down $176.0 million from last year. The decline reflects primarily the lower industry production and unfavorable platform mix in North America, offset partially by favorable foreign exchange. Our reported pre-tax income was $56.0 million and net income was $18.0 million, or $0.23 per share. These levels are down from year ago, reflecting primarily the lower volume in North America. On the next slide I will show our results excluding restructuring costs to highlight our underlying operating performance.

SG&A as a percentage of net sales was 3.9% compared with 3.4% a year ago. SG&A expenses are up primarily due to the impact of foreign exchange. And increase in production development costs related to our backlog and infrastructure costs in emerging markets were largely offset by favorable cost performance in other markets.

Interest expense was about $46.0 million, down about $6.0 million from last year, primarily due to lower net debt balances, as well as lower borrowing costs.

Depreciation and amortization at about $77.0 million was relatively flat with a year ago. Other expense was $4.0 million compared with about zero last year. Last year, other expense included foreign exchange gains. This year other expense included a small gain related to the sale of an equity position in a joint venture. We expect other expense to average about $10.0 million per quarter for the second half.

Slide 13 summarizes the impact of restructuring actions on our reported second quarter results. Reported income before interest, other expense, and income taxes, was $105.5 million. Excluding restructuring costs, core operating earnings were $164.0 million compared with $229.0 million a year ago. The decline in core operating earnings primarily reflects lower industry production and unfavorable platform mix in North America, offset in part by favorable cost performance, including increased savings from restructuring actions. To help clarify how these special items impacted our financial statements, 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 second quarter sales and margins compared with a year ago. As you can see, the major diverse factor for the change in sales was lower industry production and unfavorable platform mix in North America, including the adverse impact of the American Axle strike. Partial offsets were the favorable impact of foreign exchange and new business globally. Margins were adversely impacted by the lower industry volume and unfavorable platform mix in North America. Favorable operating performance, including restructuring savings was a partial offset.

Turning to our performance by product line, our Seating business continued to perform relatively well in the second quarter, although the adjusted margin was 5.5% compared with 7.7% a year ago. The decline in our Seating margin reflects lower industry production and unfavorable platform mix in North America, including the adverse impact of the American Axle strike.

For the full year, we are forecasting our Seating margin will be in the 5% range. This is below our target range, reflecting a sharply lower industry production and adverse platform mix in North America and higher commodity costs. Longer term, we expect our Seating margins to return to the mid-6% range. The road map for returning our Seating margins to the target range involves: realigning capacity to match demand; taking a balanced approach to customer pricing, given the commodity environment; ongoing cost improvement actions, including further restructuring; benefits from selected vertical integration; continue growth in emerging markets; and some recovery in North American production.

In our Electrical and Electronic business, second quarter adjusted margins improved from 4.7% to 4.8%. This reflects favorable operating performance, including benefits from restructuring, as well as the recovery of previously incurred product-related engineering expenditures, which more than offset the lower industry production in North America. For the full year we expect our adjusted Electrical and Electronic margin to be in the mid-4% range. This will represent an improvement of about 100 basis points from 2007 and is consistent with our prior guidance. This reflects continued favorable cost performance, restructuring savings, and the benefit from new business, offset in part by lowering industry production in North America and further investment in growth initiatives.

Free cash flow was a positive $16.0 million in the quarter. This reflects primarily our net earnings for the quarter. Higher net working capital was about offset by capital spending, net of depreciation. Compared with a year ago, free cash flow was adversely impacted by lower earnings and unfavorable net working capital reflecting the impact of the American Axle strike. For the full year we are forecasting positive free cash flow of about $150.0 million, after funding approximately $175.0 million in cash to implement our restructuring actions.

Slide 18 provides additional detail on the 2008 outlook for global automotive production. On the positive side, overall industry production is projected at 70.0 million units, which is up 2% from a year ago. The increase reflects continued strong growth in the major emerging markets, ranging from 11% increase in Russia to 27% increase in India. In Europe, production of 20.3 million units is up 1% from a year ago. In North America, however, industry production is projected to be down 10% this year to a level of 13.5 million units.

Slide 19 summarizes our 2008 financial outlook. We are forecasting net sales for 2008 of approximately $15.0 billion. This is down about $300.0 million from our prior outlook, reflecting primarily lower forecast in the industry production in North America.

Our core operating earnings are estimated to be in the range of $550.0 million-$600.0 million, down from the prior outlook of $600.0 million-$640.0 million. The decline reflects the lower production volume in North America.

Interest expense is estimated between $190.0 million-$200.0 million. Our forecast for pre-tax income, adjusted to exclude restructuring costs and other special items, is in a range of $335 million-$375 million. Our estimate for tax expense is about $125.0 million. Restructuring costs are estimated to increase to about $140.0 million, reflecting further capacity actions and census reductions.

Capital spending is expected to be in a range of $230.0 million-$250.0 million. Depreciation and amortization is estimated at about $300.0 million. Lastly, free cash flow is expected to be about $150.0 million, including about $175.0 million of cash restructuring costs.

Given the challenging business environment and volatility in the capital markets, we have been very proactive in managing our liquidity position to maintain significant financial flexibility until business conditions improve. We amended our U.S. credit facilities in July to extend a portion of the $1.7 billion of outstanding commitments for March 2010 to January 2012 and return for a one-third commitment and an increase in pricing. As a result, Lear now has a $1.3 billion of revolving credit commitments with $468.0 million maturing in 2010, $822.0 million locked in until 2012.

In addition, Lear entered into a committed factoring arrangement that provides for a maximum of EU $315.0 million aggregate capacity for the non-recourse sale of certain of our European accounts receivable through 2011.

These facilities, combined with our cash on hand, provide significant long-term liquidity and financial flexibility to continue investing in growth opportunities and to strengthen our cost structure.

Now I would like to turn it back over to Bob for the summary of the presentation.

Robert Rossiter

Go to Slide 21. We are continuing to make solid progress in improving the long-term competitiveness of our business. Major actions include restructuring of our global operations, continuing sales diversification, further evolution of our low-cost footprints, selective vertical integration in Seating and actions to strengthen and grow our Electrical and Electronic business.

Despite the challenging industry conditions, particularly in North America, we delivered solid operating and financial results in the second quarter. For the full year we remain solidly profitable with core operating earnings of $550.0 million-$600.0 million.

We do not expect industry conditions to improve in the near term and they may even worsen. We are managing the business with that in mind by restructuring our manufacturing capacity and taking aggressive cost reductions actions, while at the same time investing in opportunities that are important to our long-term success.

I will now open it up to questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Brian Johnson with Lehman Brothers.

Brian Johnson - Lehman Brothers

In terms of recovery on raw materials, what is your outlook for the remainder of 2008? In the past years we’ve seen some kind of four-quarter discussions that have come out well. What are your expectations going through the year on that?

Matthew Simoncini

Well, if you go back to what we talked about in the first quarter call, our major exposure on the commodities is in steel. And what we talked about at the time was a total steel buy, or use of steel, in our seats of about 3.0 billion pounds, of which the majority of it comes through in the purchase of components.

About 300.0 million is a direct steel buy. Of the purchased components, about half is directed from our customers and we would expect the recovery to be worked through directly with the customer that directed the buy. On the remaining portion of it there is a whole litany of contracts, from fixed prices to pass-throughs to collars and what have you.

From that portion of it, we have seen that the steel has gone from the exit rate of the first quarter of about $0.50/lb. up into the low-$0.60/lb. and that’s impacting us on the back half of the year. We are working with our customers, we do see the normal seasonality where a lot of your commercial issues do seem to get resolved in the fourth quarter. But we’re working through and what we’ve included in the back half of the year is our best knowledge of how these negotiations are going to finish, based on our current thinking.

Brian Johnson – Lehman Brothers

So where would that get you, kind of in terms of the net dollar impact? Obviously not that full $300.0 million?

Matthew Simoncini

No, it’s not. It’s not that at all. It’s a portion of it. I don’t want to put exact bookends around it, but right now what we’ve included in there is an impact on commodities in the second half and it’s based on our current commodity cost environment that we’re in and the status of our negotiations with all of our suppliers and customers.

Brian Johnson – Lehman Brothers

And a question for Bob. Is there any difference you see between this year’s commodity cost recovery discussions and what you went through in, say, 2005?

Robert Rossiter

Well, obviously the commodities are a big issue. But the approach we have always taken with things is we’ve always worked with our customers. I think as Matt explained, a good portion is directed. I think even though they are going to be difficult negotiations and discussions, that we will work through those. And I truly believe that in the face of what’s going on in the market place today that we will get resolution, equitably for the company. We’re not going to go out and threaten anybody, we’re just going to sit down and try to work through it, as we always have. And we’ve always been successful.

Matthew Simoncini

And the biggest difference is we don’t have the Interiors business so we don’t have the [inaudible] we had in 2005.

Brian Johnson - Lehman Brothers

Are you updating your backlog for the year, given the production environment?

Matthew Simoncini

We update our backlog once a year. The way we define our backlog is in a three-year window, and its net committed booked business. We will be updating all the assumptions at the end of the year or the beginning of 2009. What we have done, though, is obviously announced what our net new business wins have been through the first six months of the year.

But there’s a lot of variance that goes into calculating a backlog. Volume is one of them, and we would adjust it based on our current volume and outlook. FX is another, and we would have to adjust our backlog based on FX, as well as customer production plans. Certain car lines, sometimes the start-up production gets pulled ahead and other times that certain car lines get killed off a little bit early. So we will be providing a full backlog update towards the end of the year.

That being said, based on the status of the new business wins that we have enjoyed, or experienced, through the first six months, we would expect it to increase.

Robert Rossiter

And I will add to it and just say that I’m really impressed with the progress that the company has made in growing our backlog over the last three years, particularly this past year, in Asia and Europe and in our Electrical and Electronic and Seating business, both. We are doing, I think, extremely well.

Brian Johnson – Lehman Brothers

And is that backlog growth continuing its shift out of North American Big Three?

Robert Rossiter

It’s not shifting out. You know, we want all the business we can get, anywhere we can get it. It just so happens that there’s a significant number of programs that we’ve been working on and they’re coming to fruition.

Matthew Simoncini

There’s going to be a natural rotation, too, in the backlog for a couple of reasons. One, we’ve announced some programs that we lost, large truck. Probably the highest profile was the Ram and the F-150 back in prior periods. The new business wins are disproportionately international customers, in Europe and in Asia. Probably I would say three-quarters of it. That comes from that unit. It’s not that we’re not pursuing business in North America, we’re just fighting against the headwinds of some lost programs.

Brian Johnson – Lehman Brothers

And just in terms of the math, can we add the wins to the existing backlog?

Matthew Simoncini

It’s a little bit difficult to do it way because the announced backlog included 2008. The business wins that we have announced today really start in 2009. And if you think back to what we talked about in the beginning of the year, on the $640.0 million in backlog, roughly one-half of that was in 2008. Now, if you take that amount and go forward, that will leave a remainder of about $300.0 million in 2009 and 2010. The business wins today start in 2009 and move forward over the next 3-4 years. So if you did the math, it would work with way.

Operator

Your next question comes from Christopher Ceraso with Credit Suisse.

Christopher Ceraso - Credit Suisse

Just one clarification on that last point, Matt. Previously I think you had said that the net new business number for 2009 was $60.0 million. Is this $60.0 million on Slide 6 incremental, so now it’s $120.0 million in 2009?

Matthew Simoncini

Correct.

Christopher Ceraso - Credit Suisse

Can you give us a rough estimate of your current business in North America, how much is based on body-on-frame trucks, big pickups, SUVs, mid-size SUVs?

Matthew Simoncini

About 25%.

Christopher Ceraso - Credit Suisse

Of the North America business?

Matthew Simoncini

Of the North American business, correct.

Christopher Ceraso - Credit Suisse

There was a comment earlier about Europe, that it was okay in the quarter but it’s starting to get a little bit softer. I know you guys have a lot of Fiat and I think Italy and Spain have been particularly weak. What’s your outlook for build in the second half of the year in Europe?

Matthew Simoncini

Well, we see it relatively flat, year-over-year basis, but softer than the first half. We are seeing some weakness in the Fiat shutdowns and also some other car lines that have exposure to export into North America. So, from a production standpoint, it’s a little bit flat in the back half of the year, but down from the first half.

Christopher Ceraso - Credit Suisse

Were there any commercial settlements in the quarter that either helped or hurt your operating profit?

Matthew Simoncini

At any given time we’re in negotiations with pretty much every supplier and every customer around the world, so there’s a lot of puts and takes. The one area where we did spike out obviously, was Electrical and Electronic. Now part of the issue there is that it’s a relatively small segment in comparison to Seating, so the threshold for impact is smaller.

That being said, for that segment in particular, the adjustment or the recovery on the engineering was in our full-year outlook and thinking. We’re still up from an engineering spending standpoint in that segment because of the backlog and the investment we’re making in some of the new product. Overall, it doesn’t change our thinking whatsoever, we’re still on a full-year guidance for 100 basis point improvement.

So I would say overall, there’s probably as many puts as takes.

Christopher Ceraso - Credit Suisse

But in the Electronic side, in the quarter it’s favorable?

Matthew Simoncini

It was favorable but there’s also other things that went against it the other way. Commodities for that segment, copper specifically, while for the full year we expect it to be neutral, we believe in quarters it provides volatility because of the timing of customers. Copper is typically a 30-day lag so we had headwinds in that segment, a little bit of that against the recovery on the engineering. And overall, engineering even when the recovery was up as we continued to invest in some of the emerging markets and technologies.

Christopher Ceraso - Credit Suisse

You said that for the quarter foreign exchange helped the top line by $550.0 million. What was the impact on the operating profit line in dollars?

Matthew Simoncini

I’m sorry, can you ask that question again, please?

Christopher Ceraso - Credit Suisse

What was the benefit to operating profit from foreign exchange?

Matthew Simoncini

Typically it’s going to convert at the margins for Europe overall, which are lower than North American margins. And in the past we’ve used, you know, we’ve talked about Europe in the 4% range.

Operator

Your next question comes from Himanshu Patel with J.P. Morgan

Himanshu Patel - J.P. Morgan

I wanted to go back to Chris’ question, so was there a positive currency translation, because I thought the slide said that the impact on EBIT was neutral?

Matthew Simoncini

The impact on margin was neutral. There was a positive impact for it but obviously currency translation doesn’t convert at the same rate as sales, and the biggest driver was the Euro and so that’s going to come in pretty much at your European margins.

Himanshu Patel - J.P. Morgan

So neutral on margin but accretive to dollar amounts.

Matthew Simoncini

Correct.

Himanshu Patel - J.P. Morgan

Freight costs, was that a big issue this quarter?

Matthew Simoncini

Not yet. We’ve done a lot of things. Obviously, diesel if up quite a bit and it impacts our costs somewhat, but we’ve done a lot of good things from freight consolidation, route consolidation, both domestically and internationally, and so it has not had as much of an impact on us yet.

Himanshu Patel - J.P. Morgan

You’re not seeing diesel surcharges or anything like that imposed on you?

Matthew Simoncini

We are seeing them but we’re getting offsets through freight savings overall, through route consolidation, vendor consolidation, trying to share routes with other companies. We have been pretty aggressive in our freight studies.

Himanshu Patel - J.P. Morgan

Could you repeat the cash restructuring expense for 2008 and could you give some initial thoughts where you think cash and expense for restructuring would be in 2009?

Matthew Simoncini

Yes. What we’ve said in the past about 2009 was, first off, start in 2008, from a cash standpoint we obviously have a tailwind from the restructuring actions that we announced in the fourth quarter that we didn’t actually use the cash for in 2007. And that tailwind is now starting to come into 2008. Typically, cash use for restructuring runs at about 90% of the expense, cash restructuring.

Going into next year, what we talked about was initially about $100.0 million amount. Now we see the amount more consistent with this year, as a result of some customer-announced capacity action. So we would expect restructuring from an expense standpoint to be consistent with this year.

Himanshu Patel - J.P. Morgan

So $140.0 million of expense this year, $140.0 million [in 2009].

Matthew Simoncini

In the ballpark. It’s a little bit early to be talking about 2009, quite frankly. But right now if I had to peg a number it would be in that ballpark.

Himanshu Patel - J.P. Morgan

What is the expected cash expense for this year, just 90% of $140.0 million?

Matthew Simoncini

No, it’s a little bit different. On an overall basis that, Himanshu, but the cash use for restructuring this year is going to be about $175.0 million, so it’s in excess of our expense and the reason for that is last year, if you remember, in the fourth quarter we took a significant fourth quarter charge to close several high-cost facilities. The cash is now catching up to the expense. Last year’s expense I think was in the $180.0 million range but the case use for restructuring was only about $100.0 million. And so now what we’re starting to see is the catch-up.

Himanshu Patel - J.P. Morgan

Any sort of high-level thoughts you can give us, again, on decremental margins we should think about the business in Europe. Obviously the outlook for 2009 could be softer, in terms of industry volume.

Matthew Simoncini

Well, overall, we say for the business when there’s a short-term pullback in volumes, typically an average for the business on a consolidated basis about 20% downward conversion. Certain platforms are higher, certain platforms are lower, obviously, and what drives it is first of all, how many rows of seats and how much content is on the platform. And the other driver is the vertical integration.

In Europe, typically we have less vertical integration. And the content per vehicle, because the type of vehicles are more , typically the content per vehicle is lower in Europe so I would expect a downward conversion would be less than our average of 20%.

Operator

Your next question comes from John Murphy with Merrill Lynch.

John Murphy - Merrill Lynch

Other than the obvious pressures of incremental production cuts from your big customers, I was just wondering if you were seeing any new pressures, really specifically on changing payment terms or anything like that, on the working capital side?

Matthew Simoncini

No, we haven’t seen any of those pressures at all.

John Murphy - Merrill Lynch

And then if we think about the tier-two supply base and the stress that Barron’s intensifies, I was just wondering how you are dealing with that and what you were seeing from them as far as pass-through of raw materials and terms with them. And also, Matt, you made a very interesting comment when you talking about seating, about going to more vertical integration. I was just wondering as you deal with this stress that you might absorb some more of these tier-two guys.

Matthew Simoncini

Let me start and kind of put a framework around it, John, starting with distress in the supply base. Back in 2005 we saw a collective kind of distressed cost that we disclosed of about $50.0 million, which included price-up lifts as well as capital and tooling subsidies or funding. In 2006 we saw that number come down, probably in half. Then last year we were neutral because we had some recoveries that offset our expenses. Our business has changed significantly from the time we saw all the distress in 2005, and the biggest change, obviously, is we divested the Interiors business, which had a disproportionate amount of those distress costs.

The other thing that’s kind of happened is that there has been a consolidation of the supply base in a lot of the smaller sub-tier suppliers. Our vertical integration does take into some of the small suppliers that are in the sweet spot of the business that we want. Metals and mechanisms, for instance, we think is a core competency, and we have taken some of that into house.

So right now, there has been some distress cost that has come through but it’s been relatively minor. We are actively managing, or reviewing and evaluating, our supply base on a weekly basis. We have taken that into consideration into our guidance in the back half of the year.

John Murphy - Merrill Lynch

When we think about mix going forward, pickups and SUVs that are declining and CUVs that are growing, as we walk through next year and hopefully 2010 and this top down pressure is alleviated to some extent, just wondering if you could just talk about, at a high level, the pickup, SUV, CUV mix for your seats and electrical business and what the big delta is there. Maybe just even in the form of magnitude.

Matthew Simoncini

Well, we’ve seen, so far, I think, a come off in the sport utility/large pickup in the 30%-40% range, off of the peak, I think which was in 2005. Certain platforms are off 40% on a year-over-year basis on the large SUVs. We think that the rotation through crossovers, and we believe we have a proportionate share to the crossover market overall, which I think is running between 15%-20%. We’re slightly lower than that but pretty close to the market overall, John.

The content on the SUVs that we’ve experienced, actually averages some place in between pickups and large SUVs and are actually in excess of what we’re seeing in the pass cars. So we don’t think the rotation necessarily hurts us. The key, obviously, is to get on those platforms that are selling.

On a go forward basis, in 2009 and 2010, I would say your estimate is probably as good as mine at this point.

John Murphy - Merrill Lynch

So if we assume, roughly, just for argument’s sake, $1,000 in content on pickups and SUVs for the interiors for you guys, for seats and electrical, the CUV would be in the same ballpark?

Matthew Simoncini

I would say CUVs are going to be higher than pickups. Our content on pickups are probably $1,000-$1,100 on average, depending on is it a two-row pickup and the amount of high end, if it’s leather, if it has high electronics, what have you. We’ve used a number of about $2,000 of content on the large, fully contented SUVs. And I think CUVs, what we’ve experience on the CUVs for the most part, splits the difference.

Operator

Your next question comes from Rod Lache with Deutsche Bank Securities.

Rod Lache - Deutsche Bank Securities

[inaudible] adjusted margin was down $77.0 million on $123.0 million decline in sales, can you tell us how much the FX impact was just in that business/

Matthew Simoncini

Probably two-thirds of the FX that we reported as a company overall impacted that segment. I might be a little bit off, Rod, but that’s about the shape of it. So, what it’s doing is it’s disguising the fact that the majority of the revenue come off came from that segment. As you would expect.

Rod Lache - Deutsche Bank Securities

If you were to adjust it, it would be like a $77.0 million decline on like a $490.0 million decline in organic sales. Is that roughly correct?

Matthew Simoncini

I kind of lost you on the math there a little bit.

Rod Lache - Deutsche Bank Securities

Excluding FX. If you were just to look at the decline in margin, are you actually getting a 20%?

Matthew Simoncini

No, it’s slightly higher than, Rod, for a few reasons. One is the type of vehicles that are impacted are higher-end type vehicles. Two, it was the nature in which the volumes came out. A good chunk of the volumes in the lost revenues came out via a strike, so you’re not going to be efficient in your downward conversion. So the conversion on the revenues were actually higher than the average 20%.

Rod Lache - Deutsche Bank Securities

And can you just give us a sense of what the gross raw material cost would be for the back half of this year, and based on spot prices right now, what would you anticipate year-over-year 2009 versus 2008, for full recoveries?

Matthew Simoncini

I think if you go back to the math that we provided already, our biggest exposure is in steel. And the way we walk the number is saying basically that, you know, the majority of our steel exposure is in the purchased components. And if you look at a 3.0 billion pound use and did the math and then said roughly half of it is directed, you could probably get to the gross exposure on a go-forward basis.

Rod Lache - Deutsche Bank Securities

So the 1.5 billion pounds is the risk. And you said something about 300.0 million. Is that pounds of?

Matthew Simoncini

300.0 million of steel, Rod, is the raw buy, that we convert into components. About 1.2 [billion] to 1.3 [billion] is the steel that’s used in the components that we buy, that we direct. And the remaining balance is directed by the customers. So if you looked at the exposure, you just have to do the math on the amount of steel increases on a year-over-year basis.

Rod Lache - Deutsche Bank Securities

And can you just also elaborate a little bit on the European outlook in the back half? If you looked at it on your key platform, how would that compare to the sort of the aggregate production changes?

Matthew Simoncini

The platforms are much smaller in Europe as far as from a production volume, so you don’t have the dominant kind of top 15 platforms that you would see in North America. But in our to p five customers, on average, they’re going to be down about 2.5% on a year-over-year basis, Rod.

Rod Lache - Deutsche Bank Securities

And then could you just tell us a little bit about what your content per vehicle would be in the brick countries right now? How is that sort of evolving on a consolidated basis?

Matthew Simoncini

I’m sorry, on what?

Rod Lache - Deutsche Bank Securities

Brazil, Russia, India, China. You’re seeing, as you’re pointing out here, substantial growth in those markets. How should we be thinking about content per vehicle in those markets?

Matthew Simoncini

Content per vehicle is going to be lower than the European content per vehicle. Obviously, there’s a wide range of what the content is, depending upon what product we’re selling and what product is going in there, whether it’s kind of a kit-type vehicle coming from Europe versus a domestic vehicle made for the domestic market. But on average, it’s going to be less than Europe. On all three of those segments.

Rod Lache - Deutsche Bank Securities

Do you have a revenue you can share from those markets at this point?

Matthew Simoncini

What we’ve talked about in the past, in Asia at least, and I don’t have the other two handy right in front of me, but what we’ve talked about in Asia is roughly $1.2 billion of consolidated sales and roughly half of that comes out of China, on a consolidated basis.

Operator

Your next question comes from Richard Kwas with Wachovia Capital Markets.

Richard Kwas - Wachovia Capital Markets

Matt, on the business wins that you just announced, are you assuming production levels that are going forward? I assume you have different production estimates for the 2009, 2010, and then the revenue that you’re booking beyond 2010 versus what you had put out earlier in the year. Is that correct?

Matthew Simoncini

It is. It’s important, though, on the new business wins, we use pretty much what we expect that specific platform to do as opposed to the industry, because we’re selling to a specific platform and not the industry overall. So the business wins are really based on what we expect that specific platform to do. And there’s really no truck business in the backlog, if that’s your concern.

Richard Kwas - Wachovia Capital Markets

So when you update the backlog at the beginning of next year, there’ll be more fluidity in the original backlog versus what you just announced here?

Matthew Simoncini

Right. What I would anticipate happening, Rich, is obviously the net new business wins are a positive. We’ll see growth in the emerging markets and we’ll see pull back in the mature markets. So we’ll see changes in the volume assumptions overall and we’ll also see a change in the FX, which I think mainly the Euro, where we’ve obviously seen some strength since the last time we’ve updated the backlog. So there’s a lot of moving parts. And what we’ve given today is net new business but not necessarily a backlog update.

That being said, based on what we’ve seen to date and the success that we’ve had through the first six months of the year, we would expect to see a fairly significant increase to the $600.0 million backlog that we announced in January.

Richard Kwas - Wachovia Capital Markets

And moving over to the margins for the year, did you say 5% for the year for Seating?

Matthew Simoncini

That is correct.

Richard Kwas - Wachovia Capital Markets

And then 4% for Electrical for the year?

Matthew Simoncini

No. About 4.5%, which is a 100 basis point improvement year-over-year.

Operator

Your next question comes from David Leiker with Robert W. Baird & Co.

David Leiker - Robert W. Baird & Co.

I have this one thing I wanted to walk through a little bit. And testing my memory here a little bit, but this seat margin of 7.7%, if we go back years ago, before you starting buying the interior company, how does this compare to what the profitability of the business was at that time?

Matthew Simoncini

Help me out again. If we go back to the 7.7%, you’re talking about the adjusted margin in Q2 for the seat segment last year?

David Leiker - Robert W. Baird & Co.

How would that compare historically to go back to previous peak margin levels?

Matthew Simoncini

Last year was a record year in margins for the seat business. I don’t ever remember in my history with Lear remember a margin that was that high in that segment.

David Leiker - Robert W. Baird & Co.

Is the source of that profitability really what you’ve done on the cost side of the equation?

Matthew Simoncini

It’s two-fold. You’re right. Obviously last year wasn’t the greatest production year that we’ve seen for North America or for truck overall. So really it came off of the back of a few things. One is our restructuring efforts, largely two-thirds of which impact this segment, have been successful. We have been successful in our vertical integration. I think our metal strategy in North America has paid significant dividends for us.

And also we have seen significant growth in our international operations. So it’s not one thing. I’ll tell you, it definitely wasn’t production.

Operator

Your final question comes from Itay Michaeli with Citigroup.

Itay Michaeli - Citigroup

Matt, you talk about the covenant room you have in your EBITDA covenant at the end of the quarter. I think you can’t add back as much restructuring cost. I wanted to get an update there.

Matthew Simoncini

You’re right. We do disclose our covenant calculations in the Q and you can pretty much get there from the information we provided. We have not changed or modified our financial covenants with the recent amendment of the credit facility. If you refer back to the 10-Q in the first quarter, we had significant operating cushions to leverage covenant. We do always monitor our covenant cushion and if needed to be, we would proactively adjust our discretionary spending, whether it was restructuring R&D, what have you. But we are comfortable with our operating cushion on a go-forward basis.

Itay Michaeli – Citigroup

And then on the CAPEX now, with the backlog moving higher, do you think $230 million-$250 million can be sustained for the next couple of years or does that probably have to take a pull?

Matthew Simoncini

I think it’s probably a little bit low for a few reasons. One is we are continuing to invest in infrastructure in the emerging markets. Now, what we said on a go-forward basis is 1.7%-1.8% as a percentage of sales. Obviously there’s going to be some years it’s lower, some years it’s a little bit higher, based on the cadence of the backlog and some of the things that we’re investing in, whether it’s infrastructure in India and in rest of Asia to business growth. But if you modeled a 1.7%-1.8% of sales, you would be pretty close.

Robert Rossiter

Since there’s no more questions, this goes to the team, there’s probably no one else left on the call. Matt, you did a great job, as always.

And obviously we all know that we’re faced with some tough issues, especially in North America, but we’re tough. And we’ve had to do some things that we wouldn’t like to do normally and I know no one likes them but I know we’re doing the right things. I’m proud of all of you on the team. I appreciate your support, your understanding, and your hard work. And believe me, we have a solid company and I promise you we will be successful.

I want to thank everybody for being on the call, thank my team, and adios amigos.

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Source: Lear Corporation Q2 2008 Earnings Call Transcript
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