Lear Corporation (LEA) Q3 2021 Earnings Report, Transcript and Summary

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

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

Thanks Ed and good morning everyone. Please turn to Slide 5 where I will provide a brief overview of our third quarter financial results. The third quarter was marked by the continuation of supply chain challenges the auto industry has been facing. Our financial results were negatively impacted not only by significant volume reductions versus last year but also by low visibility from our customers leading to short notice production shutdowns. Slide 6 highlights numerous achievements in the quarter including innovation, quality, awards, and strategic investments in both business segments. In the third quarter Lear's sales growth outpaced the market by 9 percentage points with strong growth over market involved seating and E-Systems, continued new business wins as well as products that are favorably aligned with the industry shift to electrification are expected to deliver continued growth above market over the next several years. Last week we announced the acquisition of substantially all of Kongsberg Automotive interior comfort division which will further strengthen our industry leading seating business. I will comment further on this acquisition little bit later in the presentation. On the E-Systems side, we announced agreements to form two separate joint ventures which will further enhance our capabilities on electrification. The joint venture with Hu Lane which we expect will close later this year will further enhance our growing portfolio of connectors capabilities for both high voltage and low voltage applications. This joint venture -- the joint venture with Shinry will integrate complementary portfolios of advanced onboard chargers from Lear and Shinry and increase access to a broad range of customers. We also continue to be recognized across both of our business segments for excellence and innovation in quality. We won our third consecutive Automotive News PACE award and two PACEpilot awards more than any other supplier. Lear has long been known as a leader in seat quality and this year we won more than twice as many seat quality awards from J.D. Power as any other company. We increased cash returns to shareholders in the quarter by doubling our dividend and buying back more stock. In total we returned $100 million to shareholders during the quarter. We also increased our credit agreement to $2 billion and extended the maturity to 2026. With respect to capital allocation, we continued to follow a balanced plan that includes organic investment, in organic investment, and returning excess cash to our shareholders. Turning to slide 7, our seating business continues to grow faster than the market reflecting our strong position in SUVs, CUVs, luxury vehicles. In the third quarter, seating growth over market was 8 percentage points reflecting new business on the Ford Bronco and Bronco Sport, the Hyundai Tucson, and strong performance on the luxury brands in Europe and seating also benefited from strong demand from GM's full sized SUVs. During the quarter we were awarded key programs with GM, BMW, Stellantis, Nio, and Great Wall. Then there are additional programs we expect to be sourced prior to the year end. We also received a new development award for our award winning ConfigurE+ product. This award is with a European OEM and is expected to launch in 2026. Customer interest in our patent protected ConfigurE+ product remains very high. We continue to move forward on key launches in the quarter including a new plant in Canada to supply seats for GM's large pickup trucks at the reopened Oshawa plant. Other key ongoing launches are highlighted on the slide. A few weeks ago we broke ground on our new energy efficient jet facility in Detroit to supply seats for GM's Battery Electric Truck programs. I've already touched on the innovation and quality awards we received in seating but I want to spend a little bit more time explaining the PACEpilot award for Thermal Comfort. This new product that was developed jointly with Gentherm integrates intelligent climate control software into a complete heating system. The algorithms and software controls were developed by Lear and use a combination of occupant temperature data, seat position, and cabin temperature to optimize energy usage within the vehicle and keep passengers at an optimal temperature. Please turn to Slide 8, where I will provide more details on the Kongsberg acquisition. Kongsberg is a recognized automotive supplier specializing in luxury comfort seating solutions with strong market positions in the size, lumbar, seat heat, and ventilation systems. Comfort features continue to be of increasing importance as automakers look to improve the driving experience through product differentiation and increased efficiency and improved performance especially in luxury SUV and electric vehicle segments. The company has almost 50 years of experience in seating comfort solutions. Tactical centers and sales offices in three different continents and an experienced and dedicated team with approximately $300 million of annual revenue. Kongsberg has a well-balanced customer portfolio built on longstanding relationships with leading premium automakers. Kongsberg is a global leader in seat massage and has the number three position in lumbar and adjustable comfort. The company is a technology leader with expertise in pneumatic comfort systems and patented technology that enables superior performance, weight reduction and packaging flexibility. In addition to performance benefits they're also much quieter which is even more important in electric vehicles where noise will be much more noticeable. Kongsberg also has a strong market positions as the number two player in heat mats and the number four player in vent systems for thermal comfort. On Slide 9 I will highlight how Kongsberg will enhance our competitive advantages in seating. This acquisition is consistent with other acquisitions we have made over the past decade to enhance our vertical integration capabilities. These moves have enhanced growth and margins and extend our market leadership in luxury and premium seating. This acquisition extends our capabilities in comfort systems, solutions, further solidifying our position as the most vertically integrated seating supplier while bringing additional priceable content to our offerings. It strengthens our ability to serve EV, luxury SUV customers and to provide them with the next level of vertically integrated design solutions. Integrating Kongsberg into Lear’s operation solidifies our strategy to offer a complete suite of luxury comfort seating solutions to our OEM customers and ultimately to the consumer. This combination will enable Lear to improve overall seat system performance by offering more efficient, lower weight, and flexible packaging design solutions. The total addressable market for massage, lumbar, heat, ventilation products is estimated at $2.5 billion to $3 billion. IHS trend data indicates this market will grow about 2 percentage points faster than the vehicle production over the next five years. Based on our assessment of industry megatrends we expect the market to grow even faster in that time frame and beyond. Customers are looking for features to improve the driving experience as cars become smarter, a higher emphasis is being placed on interior comfort. We're already seeing this with luxury in EV customers and we anticipate this trend and focus on interior comfort to further increase when [indiscernible] cars come to market. We also expect increased adoption of seating comfort products beyond the luxury segments into higher volume vehicle segments. In addition, we believe that by creating a more efficient packaging solution we will see more proliferation of seating comfort systems in the rear seats and perhaps the biggest opportunity which will unfold over a longer term will come with the acceleration in electrification which requires more efficient heating and cooling systems in the cabin. Our expertise in software and algorithms combined with heating and cooling products from Kongsberg and our other partners will position us as one of the leaders in this area. Slide 10 highlights leading performance and latest J.D. Power USC quality and satisfaction study. For years Lear has consistently been recognized by the industry experts and our customers as a leader in seat quality. In the latest J.D. Power seat quality survey, Lear was the only seat supplier to win two first place awards. We also won five additional awards and more than twice as many total awards as any other seats supplier. Our leadership in luxury and SUVs was evident by the multiple awards in both categories. The breadth of our wins was notable as well with awards for products with six different OEMs and in six of the seven different categories. Please turn to Slide 11 for an update of the E-Systems business. In the third quarter E-Systems sales grew 9 percentage points faster than the market reflecting new business on the Ford Bronco Sport and the Mustang Mach-E in North America and strong performance in connection systems in Europe and with GLE and the Great Wall in China. We have won over $1 billion in business awards so far this year, over 80% which are new for Lear. Based on awards to date our 2022 to 2024 backlog is expected to be higher than our prior three-year backlog. We'll update and provide details on our backlog in our next earnings call. With the momentum of new business wins, we expect our E-Systems business to continue to grow faster than market for the next several years. Despite the industry slowdowns we remain busy executing launches with Mercedes, Volvo, Jaguar among others. We also are launching our initial programs with GM and Audi on a recent award winning battery disconnect unit and our first to market 5G telematics control unit. Our connection systems business is on track to grow to approximately $600 million next year. Growing this part of our business is part of our strategy to increase the size and strength of our electrical distribution systems business and increase our margins. In addition to organic investments we are entering into joint ventures and partnerships and making acquisitions to enhance our capabilities in connection systems. We already are seeing benefits from our M&N acquisition earned and are developing new high speed connectors with IMS. And we are looking forward to closing the Hu Lane joint venture by the end of the year which will increase our presence in connector catalogues. We're also making progress on our plan to grow our connection systems business to $900 million to $1 billion by 2025. We will continue to identify and pursue additional acquisitions or partnerships to accelerate this growth. On the power electronic side, the joint venture announced yesterday with Shinry will expand our capabilities, improve manufacturing, and design efficiencies for onboard chargers. Now please turn to Slide 12 for a brief summary of our recent awards we have received on innovation and quality systems. Lear won our third consecutive Automotive New PACE award for the battery disconnect unit we designed for GM. This product controls all power switching in and out of the battery pack. Our design incorporates breakthrough thermal management innovations which improves the efficiencies of large and high performance electric vehicles. We'll be supplying this part on the GMC Hummer EV, the Chevrolet EV Silverado and other vehicles on GMs battery electric truck programs. We also are pursuing opportunities on strategic EV platforms with other customers. We also won our PACEpilot award for our 5G V2X Telematics Control Unit, a single state of the art installation featuring nine antennas integrated onto one printed circuit board to support all next generation wireless technologies. Our design removes the shark fin external antenna required on many vehicles today, reducing complexity and improving styling capabilities and aerodynamics which is particularly important for EV's where every element that increases range is critical. We have received interest from numerous customers to commercialize this technology. We also have been recognized by our customers for quality. A few weeks ago we received the World Excellence Award from Ford for our plant in Pacheco, Argentina and earlier this year we received two plant quality awards from General Motors. And now I would like to invite Jason to review our third quarter financial results and full year outlook.

Thanks Ray. Slide 14 shows vehicle production and key exchange rates for the third quarter. The impact of continuing component shortages led to a significant reduction in global industry production in the third quarter particularly in our two largest markets North America and Europe. As a result, global vehicle production in the third quarter decreased by 19% compared to 2020 and on a Lear sales weighted basis global production declined by approximately 25%. From a currency standpoint, the U.S. dollar continued to weaken against the Euro and RMB compared to 2020. Slide 15 highlights Lear’s growth over market in the third quarter. Overall company growth over market was a strong 9 percentage points with E-Systems growing nine points and seating growing eight points above market respectively. Growth over market in North America of 12 points reflected the benefit of new business in both segments and strong production on GM's full size SUVs as well as Mercedes SUVs. In Europe growth over market of five points was driven primarily by new businesses while strong performance in the luxury segment and seating. Increased business in connection systems in Europe also contributed to the growth over market performance. In China growth over market of four points resulted from strong production on BMW programs and seating and new business with GLE and Great Wall and E-Systems. Year-to-date Lear’s sales have grown faster than the market by nine points that was above market growth in both segments. Slide 16 highlights our financial results for the third quarter of 2021 compared to 2020. Our sales declined 13% year-over-year to $4.3 billion. Excluding the impact of foreign exchange, commodities, and acquisitions sales were down by 16% primarily reflecting lower production and Lear platforms partially offset by the addition of new business. Semiconductor shortages in the quarter negatively impacted our revenue by approximately 24%. Core operating earnings were $98 million compared to adjusted operating earnings of $327 million last year. The reduction in earnings resulted from the impact of lower production volumes and higher commodity costs partially offset by positive operating performance in addition of new business. Adjusted earnings per share were $0.53 as compared to $3.73 a year ago. Third quarter free cash flow was negative $157 million compared to $474 million in 2020. Free cash flow was negatively impacted by lower earnings, higher capital expenditures, and an increase in working capital. Working capital was higher in the quarter as volatility and customer production schedules resulted in elevated inventory levels. Slide 17 explains the third quarter year-over-year variance in sales and adjusted operating margins in the seating segment. Sales in the quarter were $3.2 billion, a decrease of 526 million or 14% from the third quarter of 2020. Excluding the impact of foreign exchange, acquisitions and commodities sales were down 16% reflecting lower production partially offset by the benefit of new business. In seating production downtime in the third quarter related to semiconductor shortages reduced our sales by approximately $1.1 billion or 25%. Core operating earnings were $144 million down $142 million from the third quarter of 2020. Lower volume on their platforms and higher commodity costs partially offset by positive net operating performance in margin accretive backlog. Slide 18 provides details for the third quarter year-over-year variance in sales and adjusted operating margins in our E-Systems segment. Sales in the third quarter were $1.1 billion, a decrease of 9% from the third quarter of 2020. Excluding the impact of foreign exchange, acquisitions and commodities, sales were down 15% driven primarily by lower volumes somewhat offset by a strong backlog. In E-Systems production downtime in the third quarter related to semiconductor shortages reduced our sales by approximately $300 million or 21%. Core operating earnings were 23 million or 2.1% of sales compared to $93 million in 2020. The decline in earnings resulted primarily from lower volumes, higher commodity costs, and semiconductor and COVID related premium cost, the decline was partially offset by margin accretive backlog and positive net performance. Now please turn to Slide 19 where I'll briefly talk about our balance sheet and liquidity. Last week our treasury team took advantage of favorable market conditions and our strong financial position to opportunistically increase and extent our revolving line of credit. The credit agreement was increased to $2 billion and the maturity was pushed out by more than 2 years to October of 2026. Our strong balance sheet supports investments in innovation and growth and positions Lear to quickly execute bolt on acquisitions such as the pending acquisition of Kongsberg Automotive’s Interior Comfort Division expected to close in the first quarter of 2022. We continue to analyze additional organic and inorganic investments to strengthen both of our business segments. At the same time, we remain fully committed to returning excess cash to shareholders. In the third quarter we returned $100 million through continued share repurchases and the doubling of our quarterly dividend of $0.50 per share. Slide 20 provides the assumptions for global vehicle production volumes and currencies that form the basis of our 2021 full year outlook. We've based our production assumption on several sources, including internal estimates, customer production schedules, and IHS forecasts. Due to the ongoing supply disruptions we expect full year 2021 global vehicle production to be roughly the same as 2020 and generally in line with the most recent IHS forecast. From a currency perspective, our 2021 outlook assumes an average Euro exchange rate of $1.19 per Euro, and an average Chinese RMB exchange rate of RMB6.46 to the dollar. Slide 21 compares our updated outlook to our prior outlook for sales and core operating earnings. We are reducing our outlook to reflect the impact of significant additional reductions in customer production schedules that have resulted from continuing component shortages. We are forecasting sales in the range of 18.8 billion to 19.2 billion and operating income in the range of 750 million to 850 million. Our 2021 outlook for core operating earnings at the midpoint was down 215 million to 800 million, primarily reflecting lower volumes and modestly higher commodity costs partially offset by net performance improvements. Slide 22 highlights a more detailed view of our updated financial outlook. Despite the reduction to our revenue outlook, we are projecting the company to deliver full year growth over market of approximately eight percentage points. This reflects both the strength of our new business backlog, as well as our strong customer program and product portfolio. Adjusted net income is expected to be in the range of $420 million to $500 million down $180 million at the midpoint from our prior guidance reflecting lower sales. Our outlook for free cash flow for the year is expected to be approximately $175 million, which is lower than our prior outlook by $250 million reflecting both lower earnings and higher working capital. Full year free cash flow could be further impacted by continuing production disruptions, which may lead to temporarily higher working capital. While our outlook reflects our best insight into customer production plans for the remainder of the year, the production environment remains volatile. As we've done in the past, we plan to provide an update on our financial outlook during an investor conference in early December, reflecting new developments and industry conditions. Now I will turn it back to Ray for some closing remarks.

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

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

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

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

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

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

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

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

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

Appreciate the color guys.

Yup. Thanks, Joe.

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

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

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

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

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

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

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

Great. Thank you very much.

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

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

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

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

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

Great, perfect. Thanks for taking my questions.

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

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

Yeah, I -- we've been discussing this for some time and actually have been working on intuitive seating as you're aware for well over six years, six to eight years. And we do believe that this trend of much better, smarter, more sophisticated seats is going to be the trend as we move forward. And, if I take a step back, this is just the next evolution within that with the acquisition of Kongsberg. We've designed systems that from a thermal comfort perspective the draw and these are my own estimates given some of the information I've gathered, for our HVAC system draws 20% of the battery life. And so if we can design and that's the intent is design a much more efficient seating system that heats and cools the occupant at the surface within in the city, you can obviously increase range and increase efficiency within the vehicle. Now we do believe that that's a very important trend for our customers and consumers. And so we've been working on that. We've obviously done a significant amount of work. We're recognized with our partnership with Gentherm and we do believe that's a trend. I think health and wellness is another step. When you talk about massage systems within the seat system and how you can help out consumers be more alert, much more aware, anticipate things particularly as you get to vehicles that are much more engaged with an autonomy. So we believe that there's good going to be a greater need and more content within the seat around autonomy and sophistication within the vehicle. And, dynamic safety is something that we've talked about significantly where the seat can actually help protect you in the event of some type of collision both rearward and frontwards. So there is a number of different things that we've been working on and develop and have patents around within that space and we believe that content's going to increase. And so if you think about a Kongsberg, for example, we talk about the short-term. It is short term things and Kongsberg is a great company. It's great to welcome in the Lear family, but we see a much longer horizon without those capabilities where, midterm we believe the efficiencies that can be designed within those different contexts, as far as today, all those systems are designed independently. So design for manufacturability is just at the last moment with the seat designer to plug in all these different systems. There's multiple harnesses, connectors, valves, pumps, motors, it's the most to me inefficient system I've ever seen. And I think it makes so much sense to take those components with our architecture capabilities with software and with wiring capabilities, combine them with our seat capabilities and make a much more efficient system. Longer term I think to your point is, the consumer always are turning on features as a service and charging the customer if it's heat and cool, or if it's pneumatic lumbar or lumbar, if there's a design and our intent is to design a much more efficient packaging solution that then can be placed into every seating situation within the vehicle, not just fronts, but rears, and then go across multiple vehicles, not just luxury. And so I do believe that that's absolutely a trend that we're going to see continue. I think the supplier that solves that problem is going to be in a great position. And I believe it's going to be Lear and we're focused on it and have been focused on it. So I think we're just at the start of these trends within seating. And I also think with ConfigurE+ I think that's something that we've done an incredible job. I think this reconfigurability with power solutions, with safety protocols is picking up incredible momentum. I know as you transition to electric vehicles, our rails package perfectly into a flat load floor. And so the amount of features now can be interchangeable within the vehicle. And now it's a 100 million today. We do believe it's going to be 500 million worth of revenue here in a short period of time. And we just got a brand new contract with a great customer in Europe that's looking at how they can take that across multiple platforms. So I think that's another content CPB sector growth story for us. And then, electrification we've talked about. I'll tell you, we have 250 million of awarded electric -- high power electrification right now. That's 20% higher than what we were awarded last year. We still have two months left in the year to win more business, that continues to grow. Our backlog in quoting programs is higher than it was last year. So the backlog is very strong. We talked about power distribution. With the continuation of high power solutions with terminals connectors, why it's so important for us and why -- and I believe we've been incredibly successful like Jason said from 450 million to 500 million, 600 million next year in connector systems. These partnerships that we're establishing with battery chargers and with high voltage connector solutions in IMS with flat wire solutions is perfectly aligned with content growth. And so, I believe we have a number of different secular growth stories that are key to our future, and we're perfectly aligned as this shift from ICE goes and changes over to electric vehicles.

That's incredibly helpful. Thank you, Ray.

Yep.

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

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

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

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

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

Great. Thanks everyone.

Yeah, thank you.

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

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

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

Thank you very much.

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

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